|HILLS BANCORPORATION
FORM 10-K
DECEMBER 31, 2004
|------------------------------------------------

|
|



|UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
    FORM 10-K
|------------------------------------------------------------------------------------
|                                                                                    

| | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| | ------------------------------------------------------------------------------------
| |                                                                                     

|For the fiscal year ended December 31, 2004. | Commission File Number 0-12668.
|-------------------------------------------- | -------------------------------
|                                             |                                

|HILLS BANCORPORATION
(Exact name of Registrant as specified in its charter)
|---------------------------------------------------------------------------
|                                                                           

|Iowa                                                               |  | 42-1208067                       
|------------------------------------------------------------------ |  | ---------------------------------
|                                                                   |  |                                  
|(State or Other Jurisdiction of
    Incorporation or Organization) |  | (IRS Employer Identification No.)
|                                                                   |  |                                  

|131 Main Street, Hills, Iowa 52235       |  | 
|---------------------------------------- |  | 
|                                         |  | 
|(Address of principal executive offices) |  | 

|                                                                                                                                                                                                           
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Registrants telephone number, including area code: (319) 679-2291
      Securities Registered pursuant to Section 12 (b) of the Act: None
    Securities Registered pursuant to Section 12 (g) of the Act:

|                         
|-------------------------
|No par value common stock
|                         
|Title of Class           
|                         

|Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes       No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Registrant S-K (229.405
of this chapter) is not contained herein, and will not be contained to the best of Registrants
knowledge, in definitive proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act)Yes       No
While it is difficult to determine the market value of shares owned by nonaffiliates (within the meaning
of such term under the applicable regulations of the Securities and Exchange Commission), the Registrant
estimates that the aggregate market value of the Registrants common stock held by nonaffiliates
on March 21, 2005 (based upon reports of beneficial ownership that approximately 81% of the shares
are so owned by nonaffiliates and upon information communicated informally to the Registrant by various
purchasers and sellers that the sale price for the common stock is generally $37 per share) was $136,894,000.
The number of shares outstanding of the Registrants common stock as of March 21, 2005 is 4,549,656
shares of no par value common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement dated March 21, 2005 for the Annual Meeting of the Shareholders of
the Registrant to be held April 18, 2005 (the Proxy Statement) are incorporated by reference
in Part III of this Form 10-K.
EXHIBIT INDEX
The exhibits index is on Page 89.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 1 of 96
|------------



|PART I
Item 1.   Business
GENERAL
Hills Bancorporation (the Company) is a holding company principally engaged, through its
subsidiary bank, in the business of banking. The Company was incorporated December 12, 1982 and all
operations are conducted within the state of Iowa. The Company became owner of 100% of the outstanding
stock of Hills Bank and Trust Company, Hills, Iowa (Hills Bank and Trust or the Bank)
as of January 23, 1984 when stockholders of Hills Bank and Trust exchanged their shares for shares
of the Company. Effective July 1, 1996, the Company formed a new subsidiary, Hills Bank, which acquired
for cash all the outstanding shares of a bank in Lisbon, Iowa. Subsequently an office of Hills Bank
was opened in Mount Vernon, Iowa, a community that is contiguous to Lisbon. Effective November 17,
2000, Hills Bank was merged into Hills Bank and Trust. On September 20, 1996, another subsidiary,
Hills Bank Kalona, acquired cash and other assets and assumed the deposits of the Kalona, Iowa office
of Boatmens Bank Iowa, N.A. Effective October 26, 2001, Hills Bank Kalona was merged into Hills
Bank and Trust.
The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental
units and institutional customers. The Bank is actively engaged in all areas of commercial banking,
including acceptance of demand, savings and time deposits; making commercial, real estate, agricultural
and consumer loans; maintaining night and safe deposit facilities; and performing collection, exchange
and other banking services tailored for individual customers. The Bank administers estates, personal
trusts, and pension plans and provides farm management and investment advisory and custodial services
for individuals, corporations and nonprofit organizations. The Bank makes commercial and agricultural
loans, real estate loans, automobile, installment and other consumer loans. In addition, the Bank
earns substantial fees from originating mortgages that are sold in the secondary residential real
estate market without mortgage servicing rights being retained.
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 that, among other things, maintenance
of minimum loan to value ratios, evidence of appropriate levels of insurance carried by borrowers
and documentation of appropriate types and amounts of collateral and sources of expected payment.
The Banks business is not seasonal, except that loan origination fees are driven by interest
rate movements and are higher in a low rate environment. The Company had no employees as of December
31, 2004 and the Bank had 310 full-time and 97 part-time employees.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 2 of 96
|------------



|Item 1.   Business (Continued)
Johnson County
The Banks primary trade area includes the Johnson County communities of Iowa City, Coralville,
Hills and North Liberty, located near Interstate 80 and Interstate 380 in Eastern Iowa. These communities
have a combined population of approximately 86,000. Johnson County, Iowa has a population of approximately
116,000. The University of Iowa in Iowa City has approximately 30,000 students and 24,500 full and
part-time employees, including 7,100 employees of The University of Iowa Hospitals and Clinics. Other
principal employers in Johnson County include the following (Data source is official statements from
various municipal bond issues):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|Employer                               |  | Type of Business                  |  | Employees
|-------------------------------------- |  | --------------------------------- |  | ---------
|                                       |  |                                   |  |          
|Iowa City Community School District    |  | Education                         |  | 1,250    
|                                       |  |                                   |  |          
|Hy-Vee Food Stores                     |  | Grocery Stores                    |  | 1,200    
|                                       |  |                                   |  |          
|Veterans Administration Medical Center |  | Health Care                       |  | 1,200    
|                                       |  |                                   |  |          
|Mercy Hospital                         |  | Health Care                       |  | 1,150    
|                                       |  |                                   |  |          
|National Computer Systems              |  | Information Service - Computers   |  | 950      
|                                       |  |                                   |  |          
|ACT                                    |  | Educational Testing Service       |  | 850      
|                                       |  |                                   |  |          
|United Technologies                    |  | Automotive Products Manufacturing |  | 850      
|                                       |  |                                   |  |          
|Rockwell International                 |  | Electronic Manufacturing          |  | 800      
|                                       |  |                                   |  |          
|Oral B Laboratories                    |  | Consumer Products                 |  | 800      
|                                       |  |                                   |  |          
|Proctor & Gamble                       |  | Consumer Products                 |  | 600      
|                                       |  |                                   |  |          
|City of Iowa City                      |  | City Government                   |  | 600      

|Page 3 of 96
|------------



|Item 1.   Business (Continued)
Linn County
The Bank also operates offices in the Linn County, Iowa communities of Lisbon, Marion, Mount Vernon
and Cedar Rapids, Iowa. Lisbon has a population of approximately 1,900 and Mount Vernon, located
two miles from Lisbon, has a population of about 3,800. Both communities are strong economically
and are within easy commuting distances to Cedar Rapids and Iowa City, Iowa. Cedar Rapids has a metropolitan
population of approximately 154,000, including approximately 27,000 from Marion and is located approximately
10 miles west of Lisbon, Iowa and approximately 25 miles north of Iowa City on Interstate 380. The
total population of Linn County is approximately 196,000.The largest employer in the Cedar Rapids
area is Rockwell Collins, manufacturer of communications instruments, with about 7,000 employees.
Other large employers in the Cedar Rapids area and their approximate number of employees are as follows
(Data source is official statements from various municipal bond issues):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|Employer                                |  | Type of Business        |  | Employees
|--------------------------------------- |  | ----------------------- |  | ---------
|                                        |  |                         |  |          
|                                        |  |                         |  |          
|Cedar Rapids, College, Linn-Mar, Marion |  |                         |  |          
|and Grant Wood School Districts         |  | Education               |  | 4,050    
|                                        |  |                         |  |          
|Mercy Medical Center                    |  | Health Care             |  | 2,900    
|                                        |  |                         |  |          
|AEGON USA, Inc.                         |  | Insurance               |  | 2,600    
|                                        |  |                         |  |          
|St. Lukes Hospital                     |  | Health Care             |  | 2,400    
|                                        |  |                         |  |          
|Maytag Appliances, Amana Iowa           |  | Appliance Manufacturing |  | 2,300    
|                                        |  |                         |  |          
|Alliant Energy Corporation              |  | Electric Utility        |  | 1,700    
|                                        |  |                         |  |          
|Hy-Vee Food Stores                      |  | Grocery Stores          |  | 1,700    
|                                        |  |                         |  |          
|City of Cedar Rapids                    |  | City Government         |  | 1,700    
|                                        |  |                         |  |          
|McLeod*USA                              |  | Telecommunications      |  | 1,600    
|                                        |  |                         |  |          
|Kirkwood Community College              |  | Education               |  | 1,300    
|                                        |  |                         |  |          
|Quaker Oats Company                     |  | Cereals and Chemicals   |  | 1,250    

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Washington County
    The Bank has an office located in Kalona, Iowa, which is in Washington County. Kalona is located approximately 20 miles south of Iowa City. Kalona has a population of approximately 2,300. The population of Washington County is approximately 21,000. Kalona is primarily an agricultural community, but it is located within easy driving distance for employment in Iowa City, Coralville and North Liberty (combined population 85,000) and Washington, Iowa (population 7,000).

|Page 4 of 96
|------------



|Item 1.   Business (Continued)
      COMPETITION
      The financial services industry is highly competitive. The Bank must compete with financial services providers, such as banks, savings and loan associations, credit unions, finance companies, mortgage banking companies, insurance companies and money market and mutual fund companies. It faces increased competition from non-banking institutions such as brokerage houses and insurance companies, as well as from financial services subsidiaries of commercial and manufacturing companies. Many of these competitors enjoy the benefits of fewer regulatory constraints and lower cost structures.
      Effective March 13, 2000, securities firms and insurance companies that elect to become financial holding companies were allowed to acquire banks and other financial institutions. This may significantly change the competitive environment in which the Company conducts business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
    The Bank is in direct competition for loans and deposits and financial services with a number of other banks and credit unions in Johnson and Linn County. A comparison of the number of office locations and deposits in the two counties as of June, 2004 (Most recent date of available data from the FDIC and national credit union websites) is as follows:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|                                            | Johnson County |  | Linn County | 
|------------------------------------------- | -------------- |  | ----------- | 
|
|
|
|                                            |                |  |             | 
|Hills Bank and Trust Company                |                |  | 6           | 
|Branches of largest competing regional bank |                |  | 5           | 
|Largest competing independent bank          |                |  | 6           | 
|Largest competing credit union              |                |  | 5           | 
|All other bank and credit union offices     |                |  | 20          | 
|
|Total Market in County                      |                |  | 42          | 
|
|

|THE ECONOMY
The Banks primary trade territory is Johnson County, Iowa. Linn County, Iowa is becoming an increasingly
important market, and the Bank now has five offices open in Linn County. The Bank also has one office
in Kalona in Washington County, Iowa. The table that follows shows employment information as of December
31, 2004, regarding the labor force and unemployment levels in the three counties in which the Bank
has office locations along with comparable data on the United States and the State of Iowa.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|                  | Labor Force |  | Unemployed  |  | Rate % |          
|----------------- | ----------- |  | ----------- |  | ------ | ---------
|
|
|United States     |             |  | 148,203,000 |  |        | 8,047,000
|State of Iowa     |             |  | 1,630,200   |  |        | 76,700   
|Johnson County    |             |  | 76,700      |  |        | 2,900    
|Linn County       |             |  | 116,200     |  |        | 5,600    
|Washington County |             |  | 11,660      |  |        | 650      

|Page 5 of 96
|------------



|Item 1.   Business (Continued)
The unemployment rate for the Banks prime market area is favorable and the rate historically
has been lower than the unemployment rates for both the United States and the State of Iowa. In December
of 2004 the unemployment rates in Linn and Washington County are slightly higher than the unemployment
rate of the State of Iowa. As discussed with the employment table of large employers in Johnson and
Linn County, the University of Iowas impact on the local economy is very important in maintaining
acceptable employment levels. The FY 2004-2005 budget for the University of Iowa is $2.1 billion
with state appropriations of approximately $300 million, or above 14% of the total. In addition,
the University of Iowa Hospitals and Clinics have a FY 2003-2004 budget of $701 million with 6% coming
from the State of Iowa appropriation. The University has reacted to the State of Iowas decreasing
tax revenues and appropriations without significant lay-offs and has continued to review and reduce
employment, when necessary, through attrition. At this time the State budget shortfalls has not had
a significant effect on the local economy. Johnson and Linn County has been one of the strongest
economic areas in Iowa and has had substantial economic growth in the past ten years. The largest
segment of the employed population is employed in manufacturing, management, professional or related occupations.
The economies in the counties continue to be enhanced by local Iowa colleges and the University of
Iowa. In addition to providing quality employment, they enroll students who provide economic benefits
to the area. The following table indicates Fall 2004 enrollment.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|The University of Iowa                 |  | 29,745 | 
|-------------------------------------- |  | ------ | 
|Iowa City                              |  |        | 
|Coe College                            |  | 1,354  | 
|Cedar Rapids                           |  |        | 
|Cornell College                        |  | 1,155  | 
|Mount Vernon                           |  |        | 
|Kirkwood Community College             |  | 15,480 | 
|Cedar Rapids, Iowa City and Washington |  |        | 
|Mount Mercy College                    |  | 1,486  | 
|Cedar Rapids                           |  |        | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Bank also serves a number of smaller communities in Johnson, Linn and Washington counties that are more dependent upon the agricultural economy, which historically has been affected by commodity prices and weather. The average price per acre of farm land continues to be an important factor to consider when reviewing the local economy. The average price per acre in Iowa in 2004 was $2,629 compared to $2,275 in 2003, a 15.6% increase. The range of average land prices in Johnson, Linn and Washington counties is between $2,915 and $3,275 per acre. The three counties average increase was 14.55% in 2004. The Banks total agricultural loans comprise about 3.9% of the Banks total loans.
      SUPERVISION AND REGULATION
    Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Iowa Superintendent of Banking (the Superintendent), the Board of Governors of the Federal Reserve System (the Federal Reserve), the Federal Deposit Insurance Corporation (the FDIC), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the SEC). The effect of applicable statues, regulations and regulatory policies can be significant and cannot be predicted with a high degree of certainty.

|Page 6 of 96
|------------



|Item 1.   Business (Continued)
The Corporation and its subsidiary Bank are subject to various regulatory capital requirements of federal
banking agencies that involve quantitative measures of assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The capital amounts and classifications
are also subject to qualitative judgments by the regulators about components, risk weightings, and
other factors. Failure to meet minimum capital requirements can result in certain mandatory and possible
additional discretionary actions by regulators that could have a material effect on financial position
and operations.
Federal and state laws and regulations generally applicable to financial institutions, such as the
Company and its subsidiary Bank, regulate, among other things, the scope of business, investments,
reserves against deposits, capital levels relative to operations, the nature and amount of collateral
for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision
and regulation applicable to the Company and its subsidiary Bank establishes a comprehensive framework
for their respective operations and is intended primarily for the protection of the FDICs deposit
insurance funds and the depositors, rather than the stockholders, of financial institutions.
The following is a summary of the material elements of the regulatory framework applicable to the Company
and its subsidiary Bank. It does not describe all of the statutes, regulations and regulatory policies
that apply, nor does it restate all of the requirements of the statutes, regulations and regulatory
policies that are described. As such, the following is qualified in its entirety by reference to
the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations
or regulatory policies may have a material effect on the business of the Company and its subsidiary Bank.
Significant Regulatory Developments
The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act (the Act),
was enacted on November 12, 1999. The Act allows eligible bank holding companies to engage in a wider
range of non-banking activities and grants them greater authority to engage in securities and insurance
activities. Under the Act, an eligible bank holding company that elects to become a financial holding
company may engage in any activity that the Federal Reserve, in consultation with the Secretary of
the Treasury, determines by regulation or order is financial in nature, incidental to any such financial
activity, or complementary to any such financial activity and does not pose a substantial risk to
the safety or soundness of depository institutions or the financial system generally. A financial
service corporation can engage in a number of financial activities including insurance and securities
underwriting and other agency activities, merchant banking and insurance company portfolio investment
activities. Activities that are ancillary to financial activities are also allowed. Additionally,
the Act amends the federal securities laws to incorporate functional regulation of bank securities
and activities and provides for the functional regulation of insurance activities by establishing
which insurance products banks and bank subsidiaries may provide as principal. National banks are
also authorized by the Act to engage, through financial subsidiaries, in certain activities
that are permissible for financial holding companies (as described above) and certain activities
that the Secretary of the Treasury, in consultation with the Federal Reserve, determines are financial
in nature or incidental to any such financial activity.
Various bank regulatory agencies have issued regulations as mandated by the Act. During June 2000,
all of the federal bank regulatory agencies jointly issued regulations implementing the privacy provisions
of the Act. In addition, the Federal Reserve issued interim regulations establishing procedures for
bank holding companies to elect to become financial holding companies and listing the financial activities
permissible for financial holding companies, as well as describing the extent to which financial
holding companies may engage in securities and merchant banking activities. The Federal Reserve has
issued an interim regulation regarding the parameters under which state member banks may establish
and maintain financial subsidiaries. As of the date of this filing, the Company has not applied for
or received approval to operate as a financial holding company. In addition, the Bank has not applied
for or received approval to establish financial subsidiaries.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 7 of 96
|------------



|Item 1.   Business (Continued)
In the area of privacy, the Act requires clear disclosure by all financial institutions of their privacy
policies regarding the sharing of nonpublic information with both affiliates and third parties. Further,
the Act requires a notice to consumers and an opportunity to opt out of sharing of nonpublic
personal information with nonaffiliated third parties, subject to certain limited exceptions. The
Act also reforms laws that regulate ATMs, Community Reinvestment Banks and Deposit Production Offices.
Specifically, the Act requires ATM operators who impose a fee for use of an ATM by a non-customer
to post a notice both on the machine and on the screen that a fee will be charged and the amount
of the fee, and further requires a notice when ATM cards are issued that surcharges may be imposed
by other parties when transactions are initiated from ATMs not operated by the card issuer. The Act
also clarifies that nothing in the act repeals any provision of the Continuity Reinvestment Act (CRA);
however, the Act requires full disclosure of all CRA agreements and reduces the frequency of CRA
exams for small banks and savings and loans (those with no more than $250 million in assets). The
Act allows community banks all the powers as a matter of right that large institutions have accumulated
on an ad hoc basis, including the ability to underwrite municipal bonds in the future. Finally, the
Act expands the prohibition of deposit production offices contained in the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the Riegle-Neal Act) to include all branches
of an out-of-state bank holding company.
Regulation of the Company
General.  The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding
company, the Company is registered with, and is subject to regulation by, the Federal Reserve under
the Bank Holding Company Act, as amended (the BHCA). Under the BHCA, the Company is subject
to periodic examination by the Federal Reserve. The Company is also required to file with the Federal
Reserve periodic reports of the Companys operations and such additional information regarding
the Company and its subsidiaries as the Federal Reserve may require.
Source of Strength Policy.According to Federal Reserve Board policy, bank/financial holding companies are expected to act as
a source of financial strength to each subsidiary bank and to commit resources to support each such
subsidiary. This support may be required at times when a bank/financial holding company may not be
able to provide support. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance
Act, in the event of a loss suffered or anticipated by the FDIC  either as a result of default
of a banking or thrift subsidiary of a bank/financial holding company such as the Company or related
to FDIC assistance provided to a subsidiary in danger of default  the other banking subsidiaries
of such bank/financial holding company may be assessed for the FDICs loss, subject to certain
exceptions.
Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring,
directly or indirectly, ownership or control of any voting shares of another bank or bank holding
company if, after the acquisition, it would own or control more than 5% of the shares of the other
bank or bank holding company (unless it already owns or controls the majority of such shares), (ii)
acquiring all or substantially all of the assets of another bank or (iii) merging or consolidating
with another bank holding company. Subject to certain conditions (including certain deposit concentration
limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire
banks located in any state of the United States without regard to whether the acquisition is prohibited
by the law of the state in which the target bank is located. On approving interstate acquisitions,
however, the Federal Reserve is required to give effect to applicable state law limitations on the
aggregate amount of deposits that may be held by the acquiring bank holding company and its insured
depository institution affiliates in the state in which the target bank is located (provided that
those limits do not discriminate against out-of-state depository institutions or their holding companies)
and state laws which require that the target bank have been in existence for a minimum period of
time (not to exceed five years) before being acquired by an out-of-state bank holding company.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 8 of 96
|------------



|Item 1.   Business (Continued)
The BHCA also generally prohibits the Company from acquiring direct or indirect ownership or control
of more than 5% of the voting shares of any company which is not a bank and from engaging in any
business other than that of banking, managing and controlling banks or furnishing services to banks
and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal
exception allows bank holding companies to engage in, and to own shares of companies engaged in,
certain businesses found by the Federal Reserve to be so closely related to banking . . . as
to be a proper incident thereto. Under current regulations of the Federal Reserve, the
Company either directly or through non-bank subsidiaries would be permitted to engage in a variety
of banking-related businesses, including the operation of a thrift, sales and consumer finance, equipment
leasing, the operation of a computer service bureau (including software development) and mortgage
banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Federal law also prohibits any person from acquiring control of a bank holding company
without prior notice to the appropriate federal bank regulator. Control is defined in
certain cases as the acquisition of 10% or more of the outstanding shares of a bank or a bank holding
company depending on the circumstances surrounding the acquisition.
Regulatory Capital Requirements
Regulatory guidelines define capital and spell out the minimum acceptable capital levels for banks.
The purpose of these guidelines is to increase depositor protection and to reduce deposit insurance
fund losses. Currently, the three federal banking agencies use a risk-based approach
to gauge bank capital. Under this approach, the agencies define what is to be included in bank capital
and establish the minimum capital a bank must have primarily to protect it from the risk inherent
in its asset holdings.
Risk-based capital guidelines divide capital into core and supplemental capital. It consists primarily
of common and certain preferred stock, surplus and retained earnings. Bank holding companies are
required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy
guidelines. If capital falls below minimum guideline levels, a bank holding company, among other
things, may be denied approval to acquire or establish additional banks or non-bank businesses. Supplemental
or Tier 2 capital consists, within certain specified limits, of such things as the allowance for
loan losses, hybrid capital instruments and subordinated debt. These supplemental items are often
forms of debt that are subordinate to claims of depositors and the FDIC. As such, they provide depositor
protection and are included in bank capital. The sum of Tier 1 and Tier 2 capital, less certain deductions,
represents a banks total capital. In the capital guidelines, Tier 1 capital must constitute
at least 50% of a banks total capital. Thus, the use of Tier 2 capital is limited by the amount
of Tier 1 capital.
As part of their capital adequacy assessment, the regulatory agencies convert a banks assets,
including off-balance sheet items, to risk-equivalent assets. The purpose of this conversion is to
quantify the relative risk, primarily credit risk, in these assets and to determine the minimum capital
necessary to compensate for this risk. Assets that pose little risk, such as cash held at the banks
offices and U. S. government securities, are weighted zero, meaning that no capital support is required
for these assets. Assets that pose greater risk are weighted at 20%, 50% or 100% of their dollar
value, indicating the level of capital support they require. Except for banks with large off-balance
sheet asset positions, risk weighting will nearly always lower total assets requiring capital
support. However, even if a bank held nothing but cash and U.S. securities, it would still be required
to maintain capital support for these assets. The reason is that banks face more than credit risk
(e.g., market risk), and these other risks require that banks maintain minimum levels of capital
to protect the banks and their depositors.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 9 of 96
|------------



|Item 1.   Business (Continued)
The Federal Reserves capital guidelines establish the following minimum regulatory capital requirements
for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted
assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement
consists of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half
of which must be Tier 1 capital. The leverage requirement consists of a minimum ratio of Tier 1 capital
to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all
others.
The risk-based and leverage standards described above are minimum requirements. Higher capital levels
will be required if warranted by the particular circumstances or risk profiles of individual banking
organizations. For example, the Federal Reserves capital guidelines contemplate that additional
capital may be required to take adequate account of, among other things, interest rate risk, or the
risks posed by concentration of credit, nontraditional activities or securities trading activities.
Further, any banking organization experiencing or anticipating significant growth would be expected
to maintain capital ratios (i.e., Tier 1 capital less all intangible assets), well above the minimum
levels. Current Federal Reserve minimum requirements for a well capitalized organization experiencing
significant growth are a leverage ratio of 5%, a Tier 1 risk-based capital ratio of 6% and total
risk-based capital ratio of 10%. As of December 31, 2004, the Company had regulatory capital in excess
of the Federal Reserves minimum and well-capitalized definition requirements, with a leverage
ratio of 9.09%, with total Tier 1 risk-based capital ratio of 12.78% and a total risk-based capital ratio of 14.03%.
Under current Federal Reserve regulations, the subsidiary Bank is limited in the amount it may loan
to the Company and the Companys nonbank subsidiaries, if any (each of the Company and the Companys
nonbank subsidiaries being an Affiliate). Loans to a single Affiliate may not exceed
10% and loans to all Affiliates may not exceed 20% of the Banks capital stock, surplus and
undivided profits, plus the allowance for loan losses. Loans from the Bank to nonbank Affiliates,
including the Company, must be collateralized.
Dividends.  The Iowa Business Corporation Act (IBCA) allows the Company to pay dividends only
out of its surplus (as defined and computed in accordance with the provision of the IBCA) or if the
Company has no such surplus, out of its net profits for the fiscal year in which the dividend is
declared and/or the preceding fiscal year. Additionally, the Federal Reserve has issued a policy
statement with regard to the payment of cash dividends by bank holding companies. The policy statement
provides that a bank holding company should not pay cash dividends which exceed its net income or
which can only be funded in ways that weaken the bank holding companys financial health, such
as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies
and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices
or violations of applicable statutes and regulations. Among these powers is the ability to proscribe
the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. The Companys common stock is registered with the SEC under the Securities Exchange Act of 1934,
as amended (the Exchange Act). Consequently, the Company is subject to the information,
proxy solicitation, insider trading and other restrictions and requirements of the SEC under the
Exchange Act.
On July 30, 2002, the United States Congress enacted the Sarbanes-Oxley Act of 2002, a law that addresses,
among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced
and timely disclosure of corporate information.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 10 of 96
|-------------



|Item 1.   Business (Continued)
As directed by Section 302(a) of the Sarbanes-Oxley Act, the Companys chief executive officer
and chief financial officer are each required to certify that the Companys Quarterly and Annual
Reports do not contain any untrue statements of material fact. Such officers must certify that: they
are responsible for establishing, maintaining, and regularly evaluating the effectiveness of the
Companys internal controls; they have made certain disclosures to the Companys auditors
[and the audit committee of the Board of Directors] about the Companys internal controls; and
they have included information in the Companys Quarterly and Annual Reports about their evaluation
and whether there have been significant changes in the Companys internal controls or in other
factors that could significantly affect internal controls subject to the evaluation.
Regulation of the Bank
General. The Bank is an Iowa-chartered bank, the deposit accounts of which are insured by the FDICs
Bank Insurance Fund (BIF). As an Iowa-chartered, FDIC insured bank, the Bank is subject
to the examination, supervision, reporting and enforcement requirements of the Superintendent of
Banking of the State of Iowa (the Superintendent), as the chartering authority for Iowa
banks, and the FDIC, as administrator of the BIF.
Deposit Insurance.   As an FDIC-insured institution, the Bank is required to pay deposit insurance premium
assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured
depository institutions are placed into one of nine categories and assessed insurance premiums based
upon their respective levels of capital and results of supervisory evaluations. Institutions classified
as well-capitalized (as defined by the FDIC) and considered healthy, pay the lowest premium while
institutions that are less than adequately capitalized (as defined by the FDIC) and considered of
substantial supervisory concern, pay the highest premium. Risk classification of all insured institutions
is made by the FDIC for each semi-annual assessment period. The Bank is currently paying the minimum
assessment under the FDICs risk assessment system.
Item 1.   Business (Continued)
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines,
after a hearing, that the institution (i) has engaged in or is engaging in unsafe or unsound practices,
(ii) is in an unsafe or unsound condition to continue operations or (iii) has violated any applicable
law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC.
The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent
termination of insurance if the institution has no tangible capital. Management of the Company is
not aware of any activity or condition that could result in termination of the deposit insurance
of the Bank.
Capital Requirements. Among the requirements and restrictions imposed upon state banks by the Superintendent are the requirements
to maintain reserves against deposits, restrictions on the nature and amount of loans, and restrictions
relating to investments, opening of bank offices and other activities of state banks. Changes in
the capital structure of state banks are also approved by the Superintendent. State banks must have
a Tier 1 risk-based leverage ratio of 6.5% plus a fully funded loan loss reserve. In certain instances,
the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement
on the Bank. In determining the Tier 1 risk-based leverage ratio, the Superintendent uses total equity
capital without unrealized securities gains and the allowance for loan losses less any intangible
assets. At December 31, 2004, the Tier 1 risk-based leverage ratio of the Bank was 8.84% and
exceeded the ratio required by the Superintendent.
Capital adequacy for banks took on an added dimension with the establishment of a formal system of
prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA). This system uses bank capital levels to trigger supervisory actions designed to quickly
correct banking problems. Capital adequacy zones are used by the federal banking agencies to trigger
these actions. The ratios and the definition of adequate capital are the same as those
used by the agencies in their capital adequacy guidelines.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 11 of 96
|-------------



|Item 1.   Business (Continued)
Federal law provides the federal banking regulators of the Bank with broad power to take prompt corrective
action to resolve the problems of undercapitalized banking institutions. The extent of the regulators
powers depends on whether the institution in question is well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized or critically
undercapitalized, in each case as defined by regulation. Under prompt corrective action, banks
that are inadequately capitalized face a variety of mandatory and discretionary supervisory actions.
For example, undercapitalized banks must restrict asset growth, obtain prior approval
for business expansion, and have an approved plan to restore capital. Critically undercapitalized
banks must be placed in receivership or conservatorship within 90 days unless some other action
would result in lower long-term costs to the deposit insurance fund.
Depending upon the capital category to which an institution is assigned, the regulators corrective
powers include: requiring the institution to submit a capital restoration plan; limiting the institutions
asset growth and restricting its activities; requiring the institution to issue additional capital
stock (including additional voting stock) or to be acquired; restricting transactions between the
institution and its affiliates; restricting the interest rate the institution may pay on deposits;
ordering a new election of directors of the institution; requiring that senior executive officers
or directors be dismissed; prohibiting the institution from accepting deposits from correspondent
banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal
or interest on subordinated debt; and ultimately, appointing a receiver for the institution. As of
December 31, 2004, the Bank was well capitalized, as defined by FDIC regulations.
Community Investment and Consumer Protection Laws.  The Community Reinvestment Act requires insured institutions to define the communities that
they serve, identify the credit needs of those communities and adopt and implement a Community
Reinvestment Act Statement pursuant to which they offer credit products and take other actions
that respond to the credit needs of the community. The responsible federal banking regulator must
conduct regular Community Reinvestment Act examinations of insured financial institutions and assign
to them a Community Reinvestment Act rating of outstanding, satisfactory,
needs improvement and unsatisfactory. From the most recent examination
in 2003, the Community Reinvestment Act rating of the Companys banking subsidiary was satisfactory.
In addition to the Community Reinvestment Act, other federal and state laws regulate various lending
and consumer aspects of the banking business. Governmental Agencies, including the Department of
Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become
concerned that in some cases prospective borrowers experience unlawful discrimination in their efforts
to obtain loans from depository and other lending institutions. These agencies have brought litigation
against some depository institutions alleging discrimination against borrowers. Many of these suits
have been settled, in some cases for material sums, short of a full trial.
Recently, these governmental agencies have clarified what they consider to be lending discrimination
and have specified various factors that they will use to determine the existence of lending discrimination
under the Equal Credit Opportunity Act and the Fair Housing Act. These factors include evidence that
a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently
based on prohibited factors in the absence of evidence that the treatment was the result of prejudice
or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral
non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect,
unless the practice could be justified as a business necessity.
Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations.
These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement
Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair
Housing Act, require compliance by depository institutions with various disclosure requirements and
requirements regulating the availability of funds after deposit or the making of certain loan, to
customers.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 12 of 96
|-------------



|Item 1.   Business (Continued)
Supervisory Assessments. All Iowa banks are required to pay supervisory assessments to the Superintendent to fund the Superintendents
examination and supervision operations. Effective July 1, 2002 the Superintendent changed the method
of computation of the supervisory assessment from billing for each state examination completed based
on an hourly rate, to billing on an annual basis based on the assets of the bank, the expected hours
needed to conduct examinations of that size bank and an additional amount if more work is required.
For fiscal 2004 the assessment total was $90,755.
Dividends.  The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater
than its undivided profits.
The payment of dividends by any financial institution or its holding company is affected by the requirement
to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations,
and a financial institution generally is prohibited from paying any dividends if, following payment
thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum
capital requirements under applicable guidelines as of December 31, 2004. Notwithstanding the availability
of funds for dividends, however, the Superintendent may prohibit the payment of any dividends by
the Bank if the Superintendent determines such payment would constitute an unsafe or unsound practice.
The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid
by the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it
may pay in dividends. To maintain acceptable capital ratios in the Bank, certain of its retained
earnings are not available for the payment of dividends. To maintain a ratio of capital to assets
of 8%, retained earnings of $13,282,000 as of December 31, 2004 are available for the payment of
dividends to the Company.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the
Company and its subsidiaries, on investments in the stock or other securities of the Company and
its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries
as collateral for loans. Certain limitations and reporting requirements are also placed on extensions
of credit by the Bank to its directors and officers, to directors and officers of the Company and
its subsidiaries, to principal stockholders of the Company, and to related interests
of such directors, officers and principal stockholders. In addition, federal law and regulations
may affect the terms upon which any person becoming a director or officer of the Company or one of
its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which
the Bank maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards
to promote the safety and soundness of federally insured depository institutions. The guidelines
set forth standards for internal controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset
quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and
each institution is responsible for establishing its own procedures to achieve those goals. If an
institution fails to comply with any of the standards set forth in the guidelines, the institutions
primary federal regulator may require the institution to submit a plan for achieving and maintaining
compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material
respect to implement a compliance plan that has been accepted by its primary federal regulator, the
regulator is required to issue an order directing the institution to cure the deficiency. Until the
deficiency cited in the regulators order is cured, the regulator may restrict the institutions
rate of growth, require the institution to increase its capital, restrict the rates the institution
pays on deposits or require the institution to take any action the regulator deems appropriate under
the circumstances. Noncompliance with the standards established by the safety and soundness guidelines
may also constitute grounds for other enforcement action by the federal banking regulators, including
cease and det orders and civil money penalty assessments.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 13 of 96
|-------------



|Item 1.   Business (Continued)
Branching Authority. Historically, Iowas intrastate branching statutes have been rather restrictive when compared
with those of other states. Iowas intrastate branching statutes were relaxed in legislation
that became effective on February 21, 2001 (the 2001 Amendment). The 2001 Amendment allows
Iowa banks to move towards statewide branching by allowing every Iowa bank, with the approval of
its primary regulator, to establish three new bank offices anywhere in Iowa during the next three
years. The three offices are in addition to those offices allowed within certain restricted geographic
areas under prior Iowa law. Effective July 1, 2004, the 2001 Amendment repeals all limitations on
bank office location and effectively allows statewide branching. After that date, banks will be allowed
to establish an unlimited number of offices in any location in Iowa subject only to regulatory approval.
Under the Riegle-Neal Act, both state and national banks are allowed to establish interstate branch
networks through acquisitions of other banks, subject to certain conditions, including certain limitations
on the aggregate amount of deposits that may be held by the surviving bank and all of its insured
depository institution affiliates. The establishment of new interstate branches or the acquisition
of individual branches of a bank in another state (rather than the acquisition of an out-of-state
bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state
law. The legislation allowed individual states to opt-out of certain provisions of the
Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997. Iowa permits interstate
bank mergers, subject to certain restrictions, including a prohibition against interstate mergers
involving an Iowa bank that has been in existence and continuous operation for fewer than five years.
Miscellaneous.The Bank is subject to certain restrictions on loans to the Company or its non-bank subsidiaries, on
investments in the stock or securities thereof, on the taking of such stock or securities as collateral
for loans to any borrower, and on the issuance of a guarantee or letter of credit on behalf of the
Company or its non-banking subsidiaries. The Bank is also subject to certain restrictions on most
types of transactions with the Company or its non-bank subsidiaries, requiring that the terms of
such transactions be substantially equivalent to terms of similar transactions with non-affiliated firms.
State Bank Activities. Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain
exceptions, from making or retaining equity investments of a type, or in an amount, that are not
permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC insured state
banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity
that is not permitted for a national bank or its subsidiary, respectively, unless the Bank meets,
and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity
would not pose a significant risk to the deposit insurance fund of which the Bank is a member. These
restrictions have not had, and are not currently expected to have, a material impact on the operations
of the Bank.
Regulatory Enforcement Authority.The enforcement powers available to federal and state banking regulators are substantial and include,
among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal
orders and to initiate injunctive actions against banking organizations and institutions-affiliated
parties, as defined. In general, these enforcement actions may be initiated for violations of laws
and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis
for enforcement action, including misleading or untimely reports filed with regulatory authorities.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 14 of 96
|-------------



|Item 1.   Business (Continued)
CONSOLIDATED STATISTICAL INFORMATION
The following consolidated statistical information reflects selected balances and operations of the
Company and the Bank for the periods indicated.
The following tables show (1) average balances of assets, liabilities and stockholders equity,
(2) interest income and expense on a tax equivalent basis, (3) interest rates and interest differential
and (4) changes in interest income and expense.
AVERAGE BALANCES
(Average Daily Basis)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                     | Year Ended December 31
|------------------------------------ | ----------------------
|
|
|
|
|ASSETS                               |                       
|Cash and due from banks              |                       
|                                     |                       
|                                     |                       
|Taxable securities                   |                       
|Nontaxable securities                |                       
|Federal funds sold                   |                       
|Loans, net                           |                       
|Property and equipment, net          |                       
|Other assets                         |                       
|
|                                     |                       
|
|                                     |                       
|LIABILITIES AND STOCKHOLDERS EQUITY |                       
|Noninterest-bearing demand deposits  |                       
|Interest-bearing demand deposits     |                       
|Savings deposits                     |                       
|Time deposits                        |                       
|Short-term borrowings                |                       
|FHLB borrowings                      |                       
|Other liabilities                    |                       
|Redeemable common stock held by      |                       
|Employee Stock Ownership Plan        |                       
|Stockholders equity                 |                       
|
|                                     |                       
|

|Page 15 of 96
|-------------



|Item 1.   Business (Continued)
INTEREST INCOME AND EXPENSE
|----------------------------------------------------------
|                                                          

|                                 | Year Ended December 31
|-------------------------------- | ----------------------
|
|
|
|
|Income:                          |                       
|Loans (1)                        | $                     
|Taxable securities               |                       
|Nontaxable securities (1)        |                       
|Federal funds sold               |                       
|
|Total interest income            |                       
|
|                                
|Expense:                         |                       
|Interest-bearing demand deposits |                       
|Savings deposits                 |                       
|Time deposits                    |                       
|Short-term borrowings            |                       
|FHLB borrowings                  |                       
|
|Total interest expense           |                       
|
|                                 |                       
|Net interest income              | $                     
|

|   
|---
|(1)

|Page 16 of 96
|-------------



|Item 1.   Business (Continued)
INTEREST RATES AND INTEREST DIFFERENTIAL
|-----------------------------------------------------------------------
|                                                                       

|                                             | Year Ended December 31
|-------------------------------------------- | ----------------------
|
|
|
|Average yields:                              |                       
|Loans (1)                                    |                       
|Loans (tax equivalent basis)                 |                       
|Taxable securities                           |                       
|Nontaxable securities                        |                       
|Nontaxable securities (tax equivalent basis) |                       
|Federal funds sold                           |                       
|Interest-bearing demand deposits             |                       
|Savings deposits                             |                       
|Time deposits                                |                       
|Short-term borrowings                        |                       
|FHLB borrowings                              |                       
|Yield on average interest-earning assets     |                       
|Rate on average interest-bearing liabilities |                       
|Net interest spread (2)                      |                       
|Net interest margin (3)                      |                       
|                                             |                       

|(1) | Non-accruing loans are not significant and have been included in the average loan balances for purposes
of this computation.                                                                                                               
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                            
|(2) | Net interest spread is the difference between the yield on average interest-earning assets and the
yield on average interest-paying liabilities stated on a tax equivalent basis using a federal rate
of 35% for the three years presented.
|    |                                                                                                                                                                                                                                            
|(3) | Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning
assets.                                                                                                                         

|Page 17 of 96
|-------------



|Item 1.   Business (Continued)
CHANGES IN INTEREST INCOME AND EXPENSE
|---------------------------------------------------------------------
|                                                                     

|                                            | Changes Due
      To Volume |       | Changes Due
      To Rates |   | Total
      Changes |  
|------------------------------------------- | --------------------------- | ----- | -------------------------- | - | ------------------- | -
|
|
|Year ended December 31, 2004:               |                             |       |                            |   |                     |  
|Change in interest income:                 
|Loans                                       | $                           | 6,632 |                            | $ | (3,372              | )
|Taxable securities                          |                             | (8    | )                          |   | (1,010              | )
|Nontaxable securities                       |                             | 408   |                            |   | (241                | )
|Federal funds sold                          |                             | (369  | )                          |   | 14                  |  
|
|
|
|Change in interest expense:                
|Interest-bearing demand deposits            |                             | 131   |                            |   | (427                | )
|Savings deposits                            |                             | 217   |                            |   | (370                | )
|Time deposits                               |                             | 6     |                            |   | (2,175              | )
|Federal funds purchased and securities sold
|under agreements to repurchase              |                             | 101   |                            |   | (25                 | )
|FHLB borrowings                             |                             | (1    | )                          |   | 23                  |  
|
|                                            |                             | 454   |                            |   | (2,974              | )
|
|Change in net interest income               | $                           | 6,209 |                            | $ | (1,635              | )
|
|                                            |                             |       |                            |   |                     |  
|Year ended December 31, 2003:               |                             |       |                            |   |                     |  
|Change in interest income:                 
|Loans                                       | $                           | 6,704 |                            | $ | (6,761              | )
|Taxable securities                          |                             | 337   |                            |   | (1,481              | )
|Nontaxable securities                       |                             | 423   |                            |   | (266                | )
|Federal funds sold                          |                             | 83    |                            |   | (221                | )
|
|                                            |                             | 7,547 |                            |   | (8,729              | )
|
|Change in interest expense:                
|Interest-bearing demand deposits            |                             | 265   |                            |   | (348                | )
|Savings deposits                            |                             | 271   |                            |   | (1,221              | )
|Time deposits                               |                             | 818   |                            |   | (5,159              | )
|Federal funds purchased and securities sold
|under agreements to repurchase              |                             | 127   |                            |   | (154                | )
|FHLB borrowings                             |                             | 773   |                            |   | (108                | )
|
|                                            |                             | 2,254 |                            |   | (6,990              | )
|
|Change in net interest income               | $                           | 5,293 |                            | $ | (1,739              | )
|

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

|Page 18 of 96
|-------------



|Item 1.   Business (Continued)
      LOANS
    The following table shows the composition of loans (before deducting the allowance for loan losses) as of December 31 for each of the last five years. The table does not include loans held for sale to the secondary market.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                             

|                          | December 31,
|------------------------- | ------------
|
|
|
|
|                          |             
|Agricultural              |             
|Commercial and financial  |             
|Real estate, construction |             
|Real estate, mortgage     |             
|Loans to individuals      |             
|
|**Total**                 |             
|
|

|There were no foreign loans outstanding for any of the years presented.
      MATURITY DISTRIBUTION OF LOANS
    The following table shows the principal payments due on loans as of December 31, 2004:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                       

|                                                                                    | Amount
      Of Loans |   | One Year
      Or Less (1) |  | One To
      Five Years |         | Over Five
      Years |  
|----------------------------------------------------------------------------------- | --------------------- | - | -------------------------- |  | ----------------------- | ------- | --------------------- | -
|
|
|                                                                                    |                       |   |                            |  |                         |         |                       |  
|Commercial                                                                          |                       | $ | 109,569                    |  | $                       | 58,102  |                       | $
|Real Estate                                                                         |                       |   | 870,346                    |  |                         | 86,120  |                       |  
|Other                                                                               |                       |   | 32,106                     |  |                         | 12,544  |                       |  
|
|Totals                                                                              |                       | $ | 1,012,021                  |  | $                       | 156,766 |                       | $
|
|                                                                                    |                       |   |                            |  |                         |         |                       |  
|The types of interest rates applicable to these principal payments are shown below: |                      
|                                                                                    |                       |   |                            |  |                         |         |                       |  
|Fixed rate                                                                          |                       | $ | 419,069                    |  | $                       | 67,295  |                       | $
|Variable rate                                                                       |                       |   | 592,952                    |  |                         | 89,471  |                       |  
|
|                                                                                    |                       | $ | 1,012,021                  |  | $                       | 156,766 |                       | $
|
|                                                                                    |                       |   |                            |  |                         |         |                       |  

|(1) | A significant portion of the commercial loans are due in one year or less. A significant percentage
of the notes are re-evaluated prior to their maturity and are likely to be extended.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 19 of 96
|-------------



|Item 1.   Business (Continued)
      NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
    The following table summarizes the Companys non-accrual, past due, restructured and impaired loans as of December 31 for each of the years presented:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                           

|                                            | 2004 |   | 2003   |  | 2002 |        | 2001 |   | 2000   | 
|------------------------------------------- | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ | 
|
|
|                                            |      |   |        |  |      |        |      |   |        | 
|Nonaccrual loans                            |      | $ | 808    |  | $    | 3,944  |      | $ | 1,538  | 
|Accruing loans past due                     |     
|90 days or more                             |      |   | 2,313  |  |      | 2,296  |      |   | 2,516  | 
|Restructured loans                          |      |   |       |  |      |       |      |   |       | 
|Impaired loans (includes non-accrual loans) |      |   | 18,977 |  |      | 18,177 |      |   | 16,261 | 
|                                            |      |   |        |  |      |        |      |   |        | 

|The Company does not have a significant amount of loans that are past due less than 90 days concerning
which there are serious doubts as to the ability of the borrowers to comply with the loan repayment
terms.
Loans are placed on non-accrual status when management believes the collection of future interest is
not reasonably assured. The decrease in non-accrual loans from December 31, 2003 to December 31,
2004 resulted from the restoration of the accrual status on a large swine production loan. At December
31, 2003, there was $2.4 million of non-accrual loans related to swine production compared to none
at December 31, 2004. The non-accrual loans are considered to be impaired loans for purposes of reviewing
the adequacy of the loan loss reserve. Interest income was not materially affected by this classification.
The Company has no individual borrower or borrowers engaged in the same or similar industry exceeding
10% of total loans. The Company has no interest-bearing assets, other than loans, that meet the non-accrual,
past due, restructured or potential problem loan criteria.
Impaired loans increased by $800,000 as of December 31, 2004 from December 31, 2003. An impaired loan
includes any loan that has been placed on nonaccrual status. They also include loans based on current
information and events that it is likely the Bank will be unable to collect all amounts due according
to the contractual terms of the original loan agreement. The reduction in impaired loans resulting
from the improved swine industry was offset by a large multi-family loan that was considered impaired
at December 31, 2004. The impaired loan balance was $2.3 million compared to no impairment at December
31, 2003. The impaired real estate loans were $11.7 million at December 31, 2004 compared to $10.5
million at December 31, 2003.
Specific allowances for losses on non-accrual and impaired loans are established if the loan balances
exceed the net present value of the relevant future cash flows or the fair value of the relevant
collateral if the loan is collateral dependent.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 20 of 96
|-------------



|Item 1.   Business (Continued)
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the Banks loan loss experience for each of the last five years:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                              

|                                         | Year Ended December 31,
|---------------------------------------- | -----------------------
|
|
|
|
|
|Allowance for loan losses                |                        
|at beginning of year                     | $                      
|
|Charge-offs:                             |                        
|Agriculture                              |                        
|Commercial and financial                 |                        
|Real estate, mortgage                    |                        
|Loans to individuals                     |                        
|
|                                         |                        
|
|Recoveries:                              |                        
|Agriculture                              |                        
|Commercial and financial                 |                        
|Real estate, mortgage                    |                        
|Loans to individuals                     |                        
|
|                                         |                        
|
|Net charge-offs (recoveries)             |                        
|
|Provision for loan losses (1)            |                        
|
|Allowance for loan losses                |                        
|at end of year                           | $                      
|
|Ratio of net charge-offs (recoveries)    |                        
|during year to average loans outstanding |                        
|
|                                        

|(1) | For financial reporting purposes, management regularly reviews the loan portfolio and determines a
  provision for loan losses based upon the impact of economic conditions on the borrowers ability
  to repay, past collection experience, the risk characteristics of the loan portfolio and such other
  factors that deserve current recognition. The growth of the loan portfolio is a significant element
  in the determination of the provision for loan losses.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 21 of 96
|-------------



|Item 1.   Business (Continued)
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
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 reviews of specific borrowers and provides allowances for areas that
management considers are of higher credit risk (agricultural loans and constructed model real estate
homes). 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 December 31, 2004, 2003, 2002, 2001 and 2000:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

|                               | 2004  |            |  | 2003 |           
|------------------------------ | ----- | ---------- |  | ---- | ----------
|
|
|
|
|Agriculture                    | **$** | **1,736**  |  |      | **12.59** 
|Commercial                     |       | **1,913**  |  |      | **13.87** 
|Real estate, 
    construction |       | **1,471**  |  |      | **10.67** 
|Real estate                    |       | **7,872**  |  |      | **57.08** 
|Consumer                       |       | **798**    |  |      | **5.79**  
|
|                               | **$** | **13,790** |  |      | **100.00**
|
|                               |       |            |  |      |           

|                               | 2002 |        |  | 2001 |       
|------------------------------ | ---- | ------ |  | ---- | ------
|                               |      |        |  |      |       
|Agriculture                    | $    | 2,219  |  |      | 18.30 
|Commercial                     |      | 1,374  |  |      | 11.33 
|Real estate, 
    construction |      | 975    |  |      | 8.04  
|Real estate                    |      | 6,638  |  |      | 54.75 
|Consumer                       |      | 919    |  |      | 7.58  
|
|                               | $    | 12,125 |  |      | 100.00
|
|                               |      |        |  |      |       

|                               | 2000 |        |  |  |       
|------------------------------ | ---- | ------ |  |  | ------
|Agriculture                    | $    | 1,576  |  |  | 15.11 
|Commercial                     |      | 1,281  |  |  | 12.28 
|Real estate, 
    construction |      | 1,544  |  |  | 14.81 
|Real estate                    |      | 5,338  |  |  | 51.19 
|Consumer                       |      | 689    |  |  | 6.61  
|
|                               | $    | 10,428 |  |  | 100.00
|
|                               |      |        |  |  |       

|The allowance for loan losses increased $1.2 million in 2004. The allocation of the allowance changes was due primarily to volume changes of loans outstanding and not material deterioration of credit quality. The allocated reserve for agriculture production was reduced as a result of the improved swine industry and a strong harvest season. The commercial loan allocation increased from $1,421,000 at December 31, 2004 to $1,913,000 at December 31, 2003 due to increased loan volume. Commercial operating loans were $70.5 million at December 31, 2004 compared to $48.0 million at December 31, 2003. The allocation increase in real estate is primarily related to volume changes. The real estate allocation will continue to be closely monitored in 2005 due to the growth and concerns with projected vacancy levels with rental properties in the Banks trade area.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 22 of 96
|-------------



|Item 1.   Business (Continued)
INVESTMENT SECURITIES
The following tables show the carrying value of the investment securities which are principally held
by the Bank as of December 31, 2004, 2003 and 2002 and the maturities and weighted average yields
of the investment securities as of December 31, 2004:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                 

|                                                | December 31,
|----------------------------------------------- | ------------
|
|
|
|
|
|Carrying value:                                 |             
|U. S. Treasury securities                       |             
|Obligations of other U. S. Government           |             
|agencies and corporations                       |             
|Obligations of state and political subdivisions |             
|
|                                                |             
|
|                                                |             

|                                                                             | December 31, 2004 |  
|---------------------------------------------------------------------------- | ----------------- | -
|
|
|
|
|
|Obligations of other U. S. Government agencies and corporations, maturities: |                   |  
|Within 1 year                                                                |                   | $
|From 1 to 5 years                                                            |                   |  
|                                                                             |                   |  
|                                                                             |                   | $
|                                                                             |                   |  
|Obligations of state and political subdivisions, maturities:                 |                   |  
|Within 1 year                                                                |                   | $
|From 1 to 5 years                                                            |                   |  
|From 5 to 10 years                                                           |                   |  
|Over 10 years                                                                |                   |  
|                                                                             |                   |  
|                                                                             |                   | $
|                                                                             |                   |  
|Total                                                                        |                   | $
|

|Page 23 of 96
|-------------



|Item 1.   Business (Continued)
INVESTMENT SECURITIES
As of December 31, 2004, there were no investment securities, exceeding 10% of stockholders equity,
other than securities of the U. S. Government agencies and corporations.
The weighted average yield is based on the amortized cost of the investment securities. The yields
are computed on a tax-equivalent basis using a federal tax rate of 35%.
DEPOSITS
The following tables show the amounts of average deposits and average rates paid on such deposits for
the years ended December 31, 2004, 2003 and 2002 and the composition of the certificates of
deposit issued in denominations in excess of $100,000 as of December 31, 2004:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|                                             | December 31,
|-------------------------------------------- | ------------
|
|
|
|Average noninterest-bearing
        deposits |             
|Average interest-bearing demand              |             
|deposits                                     |             
|Average savings deposits                     |             
|Average time deposits                        |             
|                                            
|                                             |             
|                                            
|                                            

|Time certificates issued in amounts |  | Amount |        | Rate |      | Amount |   | Rate   |  | 
|----------------------------------- |  | ------ | ------ | ---- | ---- | ------ | - | ------ |  | 
|of $100,000 or more as of           |  |        |       
|December 31, 2004 with maturity in: |  |        |        |      |      |        |   |        |  | 
|3 months or less                    |  | $      | 10,059 |      | 1.81 | %      | $ | 13,728 |  | 
|3 through 6 months                  |  |        | 9,546  |      | 2.07 |        |   | 12,649 |  | 
|6 through 12 months                 |  |        | 24,418 |      | 2.47 |        |   | 8,735  |  | 
|Over 12 months                      |  |        | 39,687 |      | 3.66 |        |   | 26,854 |  | 
|                                    |  |        |        |      |      |        |  
|                                    |  | $      | 83,710 |      |      |        | $ | 61,966 |  | 
|                                    |  |        |        |      |      |        |  

|                                                  
|--------------------------------------------------
|There were no deposits in foreign banking offices.

|Page 24 of 96
|-------------



|Item 1.   Business (Continued)
      RETURN ON STOCKHOLDERS EQUITY AND ASSETS
    The following table presents the return on average assets, return on average stockholders equity, the dividend payout ratio and average stockholders equity to average assets ratio for the years ended December 31, 2004, 2003 and 2002:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                              

|                                                     | 2004 |  | 2003  |   | 2002 |      
|---------------------------------------------------- | ---- |  | ----- | - | ---- | -----
|
|                                                     |      |  |       |   |      |      
|Return on average assets                             |      |  | 1.15  | % |      | 1.24 
|Return on average stockholders equity               |      |  | 14.34 |   |      | 15.36
|Dividend payout ratio                                |      |  | 22.44 |   |      | 19.99
|Average stockholders equity to average assets ratio |      |  | 8.04  |   |      | 8.04 
|                                                     |      |  |       |   |      |      

|SHORT-TERM BORROWINGS
    The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of federal funds purchased and securities sold under agreements to repurchase during 2004, 2003 and 2002:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                           

|                                            | 2004 |   | 2003   |   | 2002 |       
|------------------------------------------- | ---- | - | ------ | - | ---- | ------
|
|
|                                            |      |   |        |   |      |       
|Outstanding balance as of December 31       |      | $ | 37,985 |   | $    | 29,926
|Weighted average interest rate at year end  |      |   | 1.83   | % |      | 1.00  
|Maximum month-end balance                   |      |   | 65,316 |   |      | 37,205
|Average month-end balance                   |      |   | 37,441 |   |      | 29,323
|Weighted average interest rate for the year |      |   | 1.26   | % |      | 1.34  
|                                            |      |   |        |   |      |       

|FEDERAL HOME LOAN BANK BORROWINGS
    The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates during 2004, 2003 and 2002:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                         

|                                            | 2004 |   | 2003    |   | 2002 |        
|------------------------------------------- | ---- | - | ------- | - | ---- | -------
|
|
|
|Outstanding balance as of December 31       |      | $ | 167,542 |   | $    | 167,574
|Weighted average interest rate at year end  |      |   | 5.35    | % |      | 5.34   
|Maximum month-end balance                   |      |   | 167,574 |   |      | 167,606
|Average month-end balance                   |      |   | 167,563 |   |      | 167,595
|Weighted average interest rate for the year |      |   | 5.44    | % |      | 5.42   

|Page 25 of 96
|-------------



|PART I
Item 2.   Properties
The Companys office and the main bank of the Bank are located at 131 Main Street, Hills, Iowa.
This is a brick building containing approximately 45,000 square feet. A portion of the building was
built in 1977, a two-story addition was completed in 1984, and a two-story brick addition was completed
in February 2001. With the completion of the 2001 addition, the entire Banks processing and
administrative systems, including trust, were consolidated in Hills, Iowa. A majority of these operations
previously were located in the Banks Coralville office. As a result of the consolidation, sixty-five
full-time and part-time employees were relocated.
The other offices of Hills Bank and Trust are as follows:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|1. | The Iowa City office, located at 1401 South Gilbert Street, is a one-story brick building containing approximately 15,400 square feet. The branch has five drive-up teller lanes and a drive-up, 24-hour automatic teller machine. The Banks trust department customer service representatives are located here. This building was constructed in 1982 and has been expanded several times, most recently in 1998.                                                                                                                           
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|2. | The Coralville office is a two-story building built in 1972 and expanded in 2001 that contains approximately 23,000 square feet of space. This office is equipped with four drive-up teller lanes and one automatic teller machine and is used primarily for retail banking services.                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|3. | A 2,800 square foot branch bank in North Liberty, Iowa was opened for business in 1986. This office is a full-service location including three drive-up teller lanes and a drive-up automatic teller machine.                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|4. | The Bank leases an office at 132 East Washington Street in downtown Iowa City with approximately 2,500 square feet. The office has two 24-hour automatic teller machines and two private offices in addition to a tellers and customer service area. The lease expires in 2006. In March of 2005, the Bank will relocate its downtown Iowa City office to the Old Capitol Town Center. The 5,800 square feet location will be at the corner of Washington and Clinton Street and is one block west of the 132 East Washington Street location.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|5. | In December 2001, the Bank opened a new East Side office location at 2621 Muscatine Avenue, Iowa City. The office is a 5,800 square foot, one-story building, and it has three drive-up lanes and a drive-up ATM. The new office replaced a leased office that had 1,100 square feet.                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|6. | The Lisbon office is a two-story brick building in Lisbon, Iowa with approximately 3,000 square feet of banking retail space located on the first floor. The building was extensively remodeled in 1996 and has one drive-up lane and a walk-up, 24-hour automatic teller machine.                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|7. | The Mount Vernon office opened in February 1998 with the completion of a full-service, 4,200 square foot office, with four drive-up lanes and a drive-up automatic teller machine.                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|8. | In February 2000, the Bank opened a 2,900 square foot branch office in downtown Cedar Rapids that is leased. In April 2001, an additional contiguous 2,100 square feet of space was leased and then remodeled for retail banking purposes. The leases expire in 2007.                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|Page 26 of 96
|-------------



|Item 2.   Properties (Continued)
|--------------------------------
|                                

|9.  | The Kalona office is a 6,400 square foot building that contains a walk-up 24-hour automatic teller machine and one drive-up lane. This is an older building that was remodeled in late 1998.                                                                                                
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                             
|10. | In March of 2002, Hills Bank opened its eleventh office, and the second office location in the Cedar Rapids market. The new 7,200 square foot one-story building has three drive-up lanes and a drive-up ATM. The location of the office is on Williams Boulevard in Southwest Cedar Rapids.
|    |                                                                                                                                                                                                                                                                                             
|11. | A full service office opened on February 10, 2003 in Marion, Iowa, after extensive remodeling of the property located at 800 11th Street. The office is a two-story building having approximately 8,400 square feet with three drive-up lanes and a drive-up ATM.                           

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|All of the properties owned by the Bank are free and clear of any mortgages or other encumbrances of
any type.
Item 3.   Legal Proceedings
There are no materials pending legal proceedings. Neither the Company nor the Bank holds any properties
that are the subject of hazardous waste clean-up investigations.
Item 4.   Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders for the three months ended December 31, 2004.

|Page 27 of 96
|-------------



|PART II |                                                                                                                 
|------- | ----------------------------------------------------------------------------------------------------------------
|        |                                                                                                                 
|Item 5. | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|        |                                                                                                                 

|There is no established trading market for the Companys common stock. Its stock is not listed
with any exchange or quoted in an automated quotation system of a registered securities association,
nor is there any broker/dealer acting as a market maker for its stock. The Companys stock is
not actively traded. As of March 14, 2005, the Company had 1,485 stockholders.
Based on the Companys stock transfer records and information informally provided to the Company,
its stock trading transactions have been as follows:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|Year |  |  |  | Number 
      Of Shares
      Traded |  |  | Number Of 
      Transactions |  | Low 
      Selling
      Price |       | High 
      Selling
      Price |  
|---- |  |  |  | ------------------------------------ |  |  | ----------------------------- |  | ------------------------------ | ----- | ------------------------------- | -
|     |  |  |  |                                      |  |  |                               |  |                                |       |                                 |  
|2004 |  |  |  | 8,842                                |  |  | 22                            |  | $                              | 37.00 |                                 | $
|2003 |  |  |  | 22,461                               |  |  | 26                            |  |                                | 33.67 |                                 |  
|2002 |  |  |  | 50,781                               |  |  | 22                            |  |                                | 29.34 |                                 |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Company paid aggregate annual cash dividends in 2004, 2003 and 2002 of $3,185,000, $2,853,000 and $2,622,000 respectively, or $.70 per share in 2004, $.63 per share in 2003 and $.58 per share in 2002. In January 2005, the Company declared and paid a dividend of $.75 per share totaling $3,412,000. The decision to declare any such cash dividends in the future and the amount thereof rests within the discretion of the Board of Directors and will remain subject to, among other things, certain regulatory restrictions imposed on the payment of dividends by the Bank, and the future earnings, capital requirements and financial condition of the Company.
    As of December 31, 2004, stock option information is as follows:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|Number of shares that would be issued if all options were exercised |   | 63,753 
|------------------------------------------------------------------- | - | -------
|                                                                    |   |        
|Weighted average price of options outstanding                       | $ | 26.64  
|                                                                    |   |        
|Number of additional shares that could be granted                   |   | 132,426

|                                                                                
|--------------------------------------------------------------------------------
|There are no stock option plans that have not been approved by the stockholders.

|Page 28 of 96
|-------------



|Item 6.   Selected Financial Data
    CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY
|--------------------------------------------------------------------------------

|                                       | 2004 |           | 2003 |   | 2002      |   | 2001 |           | 2000 |  
|-------------------------------------- | ---- | --------- | ---- | - | --------- | - | ---- | --------- | ---- | -
|                                       |     
|YEAR-END TOTALS (Amounts in Thousands) |      |           |      |   |           |   |      |           |      |  
|Total assets                           | $    | 1,290,449 |      | $ | 1,183,521 |   | $    | 1,098,547 |      | $
|Investment securities                  |      | 218,016   |      |   | 236,157   |   |      | 214,211   |      |  
|Federal funds sold                     |      |          |      |   | 13,233    |   |      | 32,514    |      |  
|Loans held for sale                    |      | 3,908     |      |   | 1,960     |   |      | 6,884     |      |  
|Loans, net                             |      | 998,231   |      |   | 868,194   |   |      | 773,973   |      |  
|Deposits                               |      | 957,236   |      |   | 868,652   |   |      | 802,321   |      |  
|Federal Home Loan Bank borrowings      |      | 167,542   |      |   | 167,574   |   |      | 167,606   |      |  
|Redeemable common stock                |      | 16,336    |      |   | 14,864    |   |      | 12,951    |      |  
|Stockholders equity                   |      | 103,803   |      |   | 96,765    |   |      | 88,084    |      |  
|                                      
|EARNINGS (Amounts in Thousands)        |      |           |      |   |           |   |      |           |      |  
|Interest income                        | $    | 65,324    |      | $ | 63,381    |   | $    | 64,561    |      | $
|Interest expense                       |      | 23,885    |      |   | 26,405    |   |      | 31,141    |      |  
|Provision for loan losses              |      | 1,470     |      |   | 424       |   |      | 2,449     |      |  
|Other income                           |      | 12,542    |      |   | 13,852    |   |      | 10,658    |      |  
|Other expenses                         |      | 31,965    |      |   | 29,137    |   |      | 25,043    |      |  
|Income taxes                           |      | 6,351     |      |   | 6,998     |   |      | 5,122     |      |  
|Net income                             |      | 14,195    |      |   | 14,269    |   |      | 11,464    |      |  
|                                      
|PER SHARE                              |      |           |      |   |           |   |      |           |      |  
|Net income:                            |      |           |      |   |           |   |      |           |      |  
|Basic                                  | $    | 3.12      |      | $ | 3.15      |   | $    | 2.55      |      | $
|Diluted                                |      | 3.11      |      |   | 3.14      |   |      | 2.53      |      |  
|Cash dividends                         |      | 0.70      |      |   | 0.63      |   |      | 0.58      |      |  
|Book value as of December 31           |      | 22.82     |      |   | 21.27     |   |      | 19.56     |      |  
|Increase (decrease) in book value      |      |           |      |   |           |   |      |           |      |  
|due to:                               
|ESOP obligation                        |      | (3.59     | )    |   | (3.27     | ) |      | (2.88     | )    |  
|Accumulated other                      |      |           |      |   |           |   |      |           |      |  
|comprehensive income                   |      | 0.13      |      |   | 0.68      |   |      | 1.05      |      |  
|                                      
|SELECTED RATIOS                       
|Return on average assets               |      | 1.15      | %    |   | 1.24      | % |      | 1.10      | %    |  
|Return on average equity               |      | 14.34     |      |   | 15.36     |   |      | 14.05     |      |  
|Net interest margin                    |      | 3.70      |      |   | 3.53      |   |      | 3.59      |      |  
|Average stockholders equity to        |      |           |      |   |           |   |      |           |      |  
|average total assets                   |      | 8.04      |      |   | 8.04      |   |      | 7.85      |      |  
|Dividend payout ratio                  |      | 22.44     |      |   | 19.99     |   |      | 22.87     |      |  

|Page 29 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial ConditionAnd Results of

Operations
The following discussion by management is presented regarding the financial results for Hills Bancorporation
(The Company) for the dates and periods indicated. The discussion should be read in conjunction
with the Selected Consolidated Five-Year Statistical Summary and our consolidated financial
statements and the accompanying notes thereto included or incorporated by reference elsewhere in
this document.
An overview of the year 2004 is presented following the section discussing a special note regarding
forward looking statements.
Special Note Regarding Forward Looking Statements
This report contains, and future oral and written statements of the Company and its management may
contain, forward-looking statements within the meaning of such term in the Private Securities Litigation
Reform Act of 1995 with respect to the financial condition, results of operations, plans, objectives,
future performance and business of the Company. Actual results may differ materially from those included
in the forward-looking statements. Forward-looking statements, which may be based upon beliefs, expectations
and assumptions of the Companys management and on information currently available to management,
are generally identifiable by the use of words such as believe, expect, anticipate,
plan, intend, estimate, may, will, would,
could, should or other similar expressions. Additionally, all statements
in this document, including forward-looking statements, speak only as of the date they are made,
and the Company undertakes no obligation to update any statement in light of new information or future events.
The Companys ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse effect on the operations and future
prospects of the Company include, but are not limited to, the following:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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

|Page 30 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial ConditionAnd Results of

Operations
|-----------------------------------------------------------------------------------------------
|                                                                                               

| |  | The ability of the Company to retain key executives and employees and the difficulty that the Company
  may experience in replacing key executives and employees in an effective manner.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                         
| |  | Consumer spending and saving habits which may change in a manner that affects the Companys business
  adversely.                                                                       
| |   |                                                                                                                                                                                         
| |  | The economic impact of terrorist attacks and military actions.                                                                                                                          
| |   |                                                                                                                                                                                         
| |  | Business combinations and the integration of acquired businesses and assets which may be more difficult
  or expensive than expected.                                                   
| |   |                                                                                                                                                                                         
| |  | The costs, effects and outcomes of existing or future litigation.                                                                                                                       
| |   |                                                                                                                                                                                         
| |  | Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies
  and the Financial Accounting Standards Board.                                
| |   |                                                                                                                                                                                         
| |  | The ability of the Company to manage the risks associated with the foregoing as 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.
Overview
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, Cedar Rapids
and Marion, Iowa. At December 31, 2004 the Bank has twelve full service locations. In March of 2005,
the Bank will be relocating its downtown Iowa City office to the Old Capitol Town Center to provide
a 5,800 square foot office compared to the existing 2,500 square feet location.
The Companys net income for 2004 was $14,195,000 compared to $14,269,000 in 2003. Diluted earnings
per share were $3.11 and $3.14 for the years ended December 31, 2004 and 2003. As discussed in the
net income overview section the results in 2004 were very favorable given that the net gain on sale
of loans into the secondary market were $1.5 million in 2004 compared to $4.3 million in 2003. Also
in 2003 the provision for loan losses was $1.0 million less than in 2004.
The Bank depends on its net interest income as the largest component of revenue and it is a function
of the average earnings assets and the net interest margin percentage. For the period ended December
31, 2004, the Bank achieved a net interest margin of 3.70% compared to 3.53% in 2003. This favorable
increase coupled with the average earning assets growth of $74.6 million resulted in a $4.5 million
increase in net interest margin. The margin increase was the key to the Company achieving the financial
results in 2004 given the large reduction in net gain on sale of loans compared to 2003 and the smaller
provision for loan losses in 2003.

|Page 31 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of







Operations  (Continued)
Milestones reached on the balance sheet as of December 31, 2004 for the Company included the following:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                          

| | Net loans are over $1 billion at $1.002 billion.                                        
|- | ----------------------------------------------------------------------------------------
|  |                                                                                         
| | Loan growth in 2004 of $132 million and deposit growth of $88.6 million.                
|  |                                                                                         
| | Stockholders equity increased $7.0 million with dividends paid in 2004 of $3.2 million.
|  |                                                                                         
| | Three-for-one stock split effective on April 19, 2004.                                  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The return on average equity in 2004 was 14.34% and 15.36% in 2003. The returns for the three previous
years in 2002, 2001 and 2000 were 14.05%, 13.94% and 14.94% respectively. The total equity of the
Company remains strong as of December 31, 2004 with total risk-based capital at 14.03% and Tier 1
risk-based capital at 12.78%. The minimum regulatory guidelines are 8% and 4% respectively. The Company
continues to increase the dividend per share with $.70, $.63 and $.58 paid out in the years ended
December 31, 2004, 2003 and 2002 respectively.
A detailed discussion of the financial position and results of operations follows this overview.
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
credits in relation to loan structure, existing loan policies and pace of portfolio growth are other
qualitative factors that are considered in the methodology. As the Company adds new products and
increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This
discussion 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 December 31, 2004 and 2003 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.
Financial Position

|Year End Amounts (Amounts In Thousands)          |   | 2004      |  |   | 2003      |  |   | 2002      |  |   | 2001    |  |   | 2000    | 
|------------------------------------------------ | - | --------- |  | - | --------- |  | - | --------- |  | - | ------- |  | - | ------- | 
|                                                
|                                                 |   |           |  |   |           |  |   |           |  |   |         |  |   |         | 
|Total assets                                     | $ | 1,290,449 |  | $ | 1,183,521 |  | $ | 1,098,547 |  | $ | 976,105 |  | $ | 875,750 | 
|Loans, net of allowance for losses (Net Loans) |   | 1,002,139 |  |   | 870,154   |  |   | 780,857   |  |   | 682,692 |  |   | 626,873 | 
|Deposits                                         |   | 957,236   |  |   | 868,652   |  |   | 802,321   |  |   | 720,018 |  |   | 652,706 | 
|Investment securities                            |   | 218,016   |  |   | 236,157   |  |   | 214,211   |  |   | 189,960 |  |   | 161,066 | 
|Federal Home Loan Bank borrowings                |   | 167,542   |  |   | 167,574   |  |   | 167,606   |  |   | 137,637 |  |   | 120,668 | 
|Stockholders equity                             |   | 103,803   |  |   | 96,765    |  |   | 88,084    |  |   | 78,155  |  |   | 68,524  | 

|Page 32 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of







Operations  (Continued)
Total assets at December 31, 2004 increased $106.9 million, or 9.03%, from the prior year-end.
Asset growth from 2002 to 2003 was $85.0 million and represented a 7.74% increase. The largest growth
in assets occurred in Net Loans, which had an increase of $132.0 million and $89.3 million for the
years ended December 31, 2004 and 2003 respectively.
Loan demand remained strong in 2004 despite the increase in interest rates. The rise in interest rates
is also discussed in detail in the net income overview that follows the financial position review.
The movements of the federal funds target rate by the Federal Reserve Open Market Committee started
on June 30, 2004 and focused consumers on concerns with higher interest rates. By December, 2004,
the rate had increased from 1.00% to 2.25%. Interest rates on loans are generally affected since
the U.S. Treasury market rates normally move with a raise by the Federal Reserve. The Bank prices
its real estate loans based on the U.S. Treasury indexes. In 2004 the average rate indexes were approximately
50 basis points higher than those that existed in 2003. Due to this relatively small increase, loan
demand was not significantly affected by the interest rate movements. Net Loans include loans held
for sale to the secondary market of $3.9 million compared to $2.0 million at the end of 2003. Loans
secured by real estate continue to see the largest increase in terms of growth. These loans increased
$101.5 million in 2004 and had an increase of $75.2 million in 2003. The real estate loans for one
to four residential properties accounted for increases of $47.8 million in 2004 and $43.2 million
in 2003. Commercial real estate loans increased a net $34.2 million for 2004 and $17.7 million for
2003. The other large increase for loans occurred for commercial loans which in 2004 increased a
total of $22.5 million and $1.1 million in 2003. The increases in both years were driven by the continued
favorable level of interest rates which during 2003 were at fifty year lows. In addition, the overall
economy in the Companys principal place of business, Johnson and Linn Counties, remain in good
economic condition with unemployment levels that remain low. Competition for quality loans and deposits
will continue to be a challenge. In both counties, new banks and credit unions have been opened in
the last few years. Between 2001 and 2004, six new banking locations were added in Johnson County
and ten in Linn County. The sixteen new locations include an office of one of the states largest
credit unions and several large Des Moines based banks. The increased competition for both loans
and deposits could result in a lower interest rate margin that could result in lower net interest
income if the volume of loans and deposits does not increase to offset any such reduction in the interest margin.
Total deposits increased by $88.6 million in 2004. This increase in deposits included two large deposits
of public funds that totaled $37.9 million at December 31, 2004. The Company was the successful bidder
for these bond proceeds, which will be disbursed over the next two years. The deposits are priced
at similar rates as FHLB advances for the expected maturities. Short-term borrowings, which include
federal funds purchased and securities sold under agreements to repurchase, increased from $30.0
million to $38.0 million. Federal funds purchased increased by $19.2 million, and repurchase agreements
were down $11.2 million. Deposits increased by $66.3 million, or 8.27%, in 2003. Also in 2003, securities
sold under agreements to repurchase increased by $9.1 million to $30.0 million. In the last three
years, the Bank has established new offices in the Cedar Rapids and Marion areas and has relocated
its office on the East side of Iowa City. These actions have been helpful in adding new deposit customers
for the Bank. In Linn County, as of June 30, 2004, the Company had approximately $128 million in
deposits, or 3.6% of the total deposit market of $3.6 billion. The Bank has added three offices in
the Cedar Rapids-Marion area since 2000, with two of the offices added in 2003 and 2002, respectively
to capitalize on the strong Linn County market which is about twice the size of the Johnson County
market. Johnson County had fourteen banks and Linn County had twenty-eight banks at the end of 2004.
In addition, there were two credit unions in Johnson County while Linn County had eight credit unions.
In the last two years, the Company has increased its market share in Linn County and has maintained
its market share of total deposits in Johnson County of 36.2% as of June 30, 2004, according to the
latest deposits data available from the FDIC. While there is increasing competition in the Linn County
market, the Banks three newest offices in Linn County grew by a total of $42.4 million in 2003
and 2004, and management anticipates that the Banks market share in Linn County will continue to grow in the future.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 33 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of







Operations  (Continued)
Investment securities decreased by $18.1 million in 2004. In 2003, investment securities increased
by $21.9 million. The investment portfolio consists of $204.1 million of securities that are stated
at fair value, with any unrealized gain or loss, net of income taxes, reported as a separate component
of stockholders equity. The securities portfolio, which includes tax exempt securities and
stock of the FHLB that is required for borrowings, is used for liquidity and pledging purposes and
to provide a rate of return that is acceptable to management. During 2004, the major funding sources
for the growth in loans were the $88.6 million increase in deposits and decreases in both the investment
securities and federal funds sold, which totaled $31.3 million. In 2003, the major source of funding
for the growth in loans was deposit growth of $66.3 million and a reduction in federal funds sold
by $19.3 million. In 2004 and 2003, no additional funding was required from the Federal Home Loan
Bank (FHLB) and the total advances from the FHLB remained at approximately $167.5 million for both
years. It is expected that the FHLB funding source will be used in the future when loan growth exceeds
deposit increases and the interest rates are favorable compared to other funding alternatives.
Stockholders equity was $103.8 million at December 31, 2004 compared to $96.8 million at December
31, 2003. The Companys capital resources are discussed in detail in the Liquidity and Capital Resources section. Over the last five years, the Company has realized cumulative earnings of $59.4 million and
paid shareholders dividends of $14.0 million, or 23.6% of earnings, while still maintaining capital
ratios in excess of regulatory requirements.
Net Income Overview
Net income and diluted earnings per share for the last five years are as presented below:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | **Year** |  |  | Net Income         |            |  | % Increase (Decrease) |           | E.P.S.-Diluted |  |      
| | -------- |  |  | ------------------ | ---------- |  | --------------------- | --------- | -------------- |  | -----
| |          |  |  |                    |            |  |                       |           |                |  |      
| |          |  |  | **(In Thousands)** |            |  |                       |           |                |  |      
| | **2004** |  |  | **$**              | **14,195** |  |                       | **(0.05** | **)%**         |  | **$**
| | 2003     |  |  |                    | 14,269     |  |                       | 24.47     |                |  |      
| | 2002     |  |  |                    | 11,464     |  |                       | 13.01     |                |  |      
| | 2001     |  |  |                    | 10,144     |  |                       | 8.31      |                |  |      
| | 2000     |  |  |                    | 9,366      |  |                       | 10.63     |                |  |      

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Net income for 2004 was down by $74,000 from the Companys record high net income of $14,269,000 in 2003. As indicated in the table above, diluted earnings per share were down as a result of the decrease in net income. Despite a reduction on the net gain on sale of loans in 2004 compared to 2003 of $2.8 million and an increase of $1,046,000 in the provision for loan losses in 2004 compared to 2003, the Company was able to achieve net income of $14,195,000.
      Significant factors that aided in maintaining a similar level of profit in 2004 were the growth of average earning assets and the improvement in the net interest margin. These two items accounted for a $4.5 million increase in the net interest income and offset the increased provision for loan losses, the reduction in other income and increased operating expenses for the year.
    Annual fluctuations in the Companys net income continue to be driven primarily by three important factors. The first important factor is net interest margin. Net interest income of $41.4 million in 2004 was derived from the Companys $1.159 billion of average earning assets and its net interest margin of 3.70%, compared to 3.53% in 2003. The importance of net interest margin is illustrated by the fact that a decrease in the net interest margin of only 10 basis points to 3.60% would result in a $1.1 million decrease in income before taxes. Net interest margin decreased to 3.53% from 3.59% in 2003.

|Page 34 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of







Operations  (Continued)
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 $1.012 billion at the end of 2004. The increase in the provision for loan losses was
a principal factor in the increase in the Companys allowance for loan losses to $13.8 million
at December 31, 2004. (See Note 3 to the Financial Statements.) An increase in problem loans
results in a higher allocation to the provision for loan loss, which in turn reduces the Companys
net income.
The amount of mortgage loans sold on the secondary market is the third significant factor. The net
gain for 2004 was $1.5 million. The gain on the sale of loans on the secondary market previously
has ranged from $0.3 million in 1999 to $4.3 million in 2003. Sales of loans on the secondary market
are influenced by the real estate market and interest rates. Low interest rates, which also help
spur new loan growth and secondary market loans (including refinancing), had been at record lows
when compared to interest rate levels over the last fifty years in 2003. Effective June 25, 2003,
the Federal Reserve Open Market Committee lowered the federal funds target rate to 1.00%, the lowest
level since July 1958. The June 25, 2003 decrease was the thirteenth decrease since May 16, 2000,
when the federal funds rate was 6.50%. Beginning with an increase of 25 basis points on June 30,
2004, the federal funds rate has been increased five times to 2.25% with the last raise effective
December 14, 2004. The prime rate has also increased from 4.00% to 5.25%. As a result of this, coupled
with the fact that many consumers had taken advantage of lower rates, the volume of loans sold and
the related level of income from this mortgage activity did not continue at the pace which occurred
during most of 2003 and into 2004.
Net income for 2003 reached a record high of $14,269,000, or diluted earnings per share of $3.14. For
2003, diluted earnings per share increased $.61 per share. Net income for the year ended December
31, 2003, represented a $2,805,000 increase over the reported income for the same period in 2002.
Net interest income, including fees increased $3.6 million for the year ended December 31, 2003 compared
to 2002. The improvement was due to an increase in average earning assets of $116.4 million. The
mortgage refinancing growth continued in 2003 as the number of loans sold on the secondary market
and the resulting gain on sale was $4,278,000, which was $2,287,000 more than 2002.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 35 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of Operations (Continued)
      Net Interest Income
      Net interest income is the excess of the interest and fees received on interest-earning 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 volume of average earning assets has continued to grow each year, primarily due to new loans. The net interest margin increased in 2004 to 3.70% and compares favorably to 3.53% in 2003, 3.59% in 2002, 3.58% in 2001 and 3.62% in 2000. The measure is shown on a tax-equivalent basis using a rate of 35% to make the interest earned on taxable and nontaxable assets more comparable.
    Net interest income on a tax-equivalent basis changed in 2004 as follows:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 | Change In
      Average
      Balance |         | Change In
      Average
      Rate |  | Increase (Decrease) |   
|-------------------------------- | ------------------------------------- | ------- | ---------------------------------- |  | ------------------- | --
|                                 |                                       |         |                                   
|                                 |                                       |         | Volume 
      Changes              |  | Rate 
      Changes |   
|                                 |                                      
|                                 | (Amounts In Thousands)                |        
|Interest income:                 |                                       |         |                                    |  |                     |   
|Loans, net                       | $                                     | 105,549 |                                    |  | (0.39               | )%
|Taxable securities               |                                       | (201    | )                                  |  | (0.67               | ) 
|Nontaxable securities            |                                       | 7,493   |                                    |  | (0.36               | ) 
|Federal funds sold               |                                       | (38,256 | )                                  |  | (0.03               | ) 
|                                 |                                       |         |                                    |  |                    
|                                 | $                                     | 74,585  |                                    |  |                     |   
|                                 |                                       |         |                                    |  |                    
|Interest expense:                |                                       |         |                                    |  |                     |   
|Interest-bearing demand deposits | $                                     | 18,110  |                                    |  | (0.31               | )%
|Savings deposits                 |                                       | 25,909  |                                    |  | (0.16               | ) 
|Time deposits                    |                                       | 168     |                                    |  | (0.54               | ) 
|Short-term borrowings            |                                       | 8,118   |                                    |  | (0.08               | ) 
|FHLB borrowings                  |                                       | (32     | )                                  |  | 0.02                |   
|                                 |                                       |         |                                    |  |                    
|                                 | $                                     | 52,273  |                                    |  |                     |   
|                                 |                                       |         |                                    |  |                    
|Change in net interest income    |                                       |         |                                    |  |                     |   
|                                 |                                       |         |                                    |  |                    

|                                                     
|-----------------------------------------------------
|Net interest income changes for 2003 were as follows:

|                              |  |  | Change In
      Average
      Balance |         | Effect Of
      Volume 
      Changes |   | Effect Of
      Rate
      Changes |  | Net
      Changes |       
|----------------------------- |  |  | ------------------------------------- | ------- | ------------------------------------- | - | ---------------------------------- |  | ----------------- | ------
|                              |  |  |                                      
|                              |  |  | (Amounts In Thousands)                |        
|Interest-earning assets       |  |  | $                                     | 116,377 |                                       | $ | 7,547                              |  | $                 | (8,729
|Interest-bearing liabilities  |  |  |                                       | 86,631  |                                       |   | 2,254                              |  |                   | (6,990
|                              |  |  |                                       |         |                                      
|Change in net interest income |  |  |                                       |         |                                       | $ | 5,293                              |  | $                 | (1,739
|                              |  |  |                                       |         |                                      

|Page 36 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of Operations (Continued)
|----------------------------------------------------------------------------------------------------------
|                                                                                                          
|A summary of the net interest spread and margin is as follows:                                            

|(Tax Equivalent Basis)                              |  |  | 2004 |      | 2003 |  | 2002 |  
|--------------------------------------------------- |  |  | ---- | ---- | ---- |  | ---- | -
|                                                    |  |  |     
|                                                    |  |  |     
|                                                   
|                                                    |  |  |      |      |      |  |      |  
|Yield on average interest-earning assets            |  |  |      | 5.76 | %    |  | 5.96 | %
|Rate on average interest-bearing liabilities        |  |  |      | 2.42 |      |  | 2.83 |  
|                                                    | 
|Net interest spread                                 |  |  |      | 3.34 |      |  | 3.13 |  
|Effect of noninterest-bearing funds                 |  |  |      | 0.36 |      |  | 0.40 |  
|                                                    | 
|Net interest margin (tax equivalent interest income |  | 
|divided by average interest-earning assets)         |  |  |      | 3.70 | %    |  | 3.53 | %
|                                                    | 
|                                                    |  |  |     

|Provision for Loan Losses
The provision for loan losses totaled $1,470,000, $424,000 and $2,449,000 for 2004, 2003 and 2002,
respectively. Loan charge-offs net of recoveries were $265,000 in 2004 and $274,000 in 2002. Recoveries
net of charge-offs for 2003 were $36,000. The large increase in the provision in 2004 compared to
2003 is based on managements December 31, 2004 analysis of the loan portfolio. The provision
adjustment is computed on a quarterly basis and is a result of managements determination of
the quality of the loan portfolio. The provision reflects a number of factors, including the size
of the loan portfolio, loan concentrations, the level of impaired loans (which are all non-accrual)
and loans past due ninety days or more. In addition, management considers the credit quality of the
loans based on managements review of problem and watch loans, including loans with historical
higher credit risks (primarily agricultural loans).
Other factors that are considered in determining the credit quality of the Companys loan portfolio
are the vacancy rates for both residential and commercial and retail space, current equity the borrower
has in the property and overall financial strength of the customer including cash flow to continue
to fund loan payments. The Company also considers the state of the total economy including unemployment
levels, vacancy rates of rental units and demand for commercial and retail space. In most instances
the borrowers have used in their rental projections of income at least a 10% vacancy rate. As of
December 31, 2004, the unemployment levels in Johnson County and Linn County were 3.8% and 4.8%,
respectively. These levels compare favorably to the State of Iowa at 4.7% and the national unemployment
level at 5.4%. The residential rental vacancy rates in 2004 in Johnson County, the largest trade
area for the Company, were 10.0% in Iowa City and Coralville and 9.3% in the Cedar Rapids area. The
State of Iowa vacancy rate is 8.3% and the national rate is 10.0% with the Midwest rate at 12.4%.
The Company continues to consider those vacancy rates among other factors in its current evaluation
of the real estate portion of its loan portfolio.
The amount of problem or watch loans considered in the reserve computation increased approximately
$1.1 million from the end of 2003 to 2004. The increase was related to real estate mortgage loans.
Overall loan balances for such loans continue to increase significantly. Some softness in the rental
market place has been observed, although loan delinquency is about at the same level as the preceding
year. Problem or watch loans considered in the estimate for December 31, 2003 involved similar balances
to December 31, 2002. The allowance for loan losses balance is also affected by the charge-offs,
net of recoveries, for the periods presented. For the years ended December 31, 2004 and 2003, recoveries
were $1,103,000 and $1,680,000, respectively; and charge-offs were $1,368,000 in 2004 and $1,644,000
in 2003.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 37 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial ConditionAnd Results of

Operations (Continued)
The allowance for loan losses totaled $13,790,000 at December 31, 2004 compared to $12,585,000 at December
31, 2003. The percentage of the allowance to outstanding loans was 1.36% and 1.43% at December 31,
2004 and 2003, respectively. The percentage decrease was due to loan growth (fueled primarily by
an increase in demand for real estate mortgages) and a decrease in the number of problem
or watch loans as a percentage of total loans outstanding. The allowance was based on
managements consideration of a number of factors, including loan concentrations, loans with
higher credit risks (primarily agriculture loans and spec real estate construction) and overall increases
in Net Loans outstanding. The methodology used in 2004 is consistent with the methodology used in
the prior year.
Agricultural loans totaled $39,116,000 and $38,153,000 at December 31, 2004 and 2003, respectively.
The level of agriculture loans during the last five years compared to total loans has varied from
a high of 4.95% to a low of 3.87% in 2004. Management has assessed the risks for agricultural loans
to be higher than other loans due to unpredictable commodity prices, the effects of weather on crops
and uncertainties regarding government support programs. In particular, loans that are in the swine
production segment continue to be of major concern as prices for hogs are subject to severe fluctuations.
The University of Iowa, because of its 24,500 employees and because of its total budget in Johnson
County, has a tremendous impact on the economy of the Banks primary trade area. In 2004 and
2003, the University of Iowa helped Johnson Countys economy remain strong. The economy of the
state of Iowa has recovered somewhat from recent weakness, but the University continues to suffer
from budget limitations. For its fiscal year beginning July 1, 2005, the University expects continued
budget constraints. The possible effects on the local economy cannot be predicted, but such budget
limitations may weaken the economy in future years.
Other Income
The other income of the Company was $12,542,000 in 2004 compared to $13,852,000 in 2003. The net decrease
is $1,310,000. In 2003, the total other income increased $3,194,000 from 2002. The amount of the
net gain on sale of secondary market mortgage loans in each year had the greatest impact on the change
in other income for the three years presented. The gain was $1,495,000 in 2004, $4,278,000 in 2003
and $1,991,000 in 2002. The volume of activity in these types of loans is directly related to the
level of interest rates, which were low in 2002 and continuing in 2003. Many consumers took advantage
of the rates and refinanced their mortgage. In 2004, rates did not drop sufficiently to make it feasible
for a similar volume of refinancing to occur. The servicing on the loans sold into the secondary
market is not retained by the Company so there is not an ongoing stream of income.
Trust fees increased $276,000 to $2,720,000 in 2004. Trust fees were relatively flat in 2003 and 2002
at $2,444,000 and $2,352,000, respectively. As of December 31, 2004, the Banks Trust Department
had $694 million in assets under management and this compares to $623 million and $484 million at
December 31, 2003 and 2002, respectively. Trust fees are based on total assets under management.
The trust assets that are the most volatile are those that are held in common stocks, which amounts
to approximately 53% of assets under management. In 2004 the market value of such common stock continued
to increase, but at a much slower pace than in 2003 after large decreases in 2002. An example of
the changes is the Dow Jones Industrial Average which increased over 3% in 2004; over 25% in 2003
and decreased over 16% in 2002.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 38 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial ConditionAnd Results of

Operations (Continued)
Service charges and fees increased $342,000 in 2004 to $5,254,000 from $4,912,000 in 2003. Such charges
and fees include fees on deposit accounts and credit card processing fees on merchant accounts. Debit
card interchange fees increased by $156,000 and merchant credit card processing fees increased by
$193,000. Both of the increases were due to volume changes in debit card usage and credit card activity.
Other deposit fees remained at 2003 levels in total. The rental revenue on tax credit real estate
with respect to which the Company is a limited partner increased to $711,000 from $377,000 in 2003.
This income was the direct result of a new property added in January of 2004. Other noninterest income
was $2,362,000 in 2004 and $2,058,000 in 2003. The increase of $304,000 in 2004 was due to a $176,000
increase in ATM fees to consumers due to additional volume of transactions and rental of ATMs to
businesses. Total other income in 2003 was also partially offset by $177,000 in investment securities
losses. In 2004 and in 2002, no securities losses were reported.
Service charges and fees increased by $494,000 from 2002 to 2003, resulting in total fees of $4,912,000
in 2003. The increase in the number of customer deposit accounts, along with an increase in fees,
accounted for $327,000. Debit card interchange fees increased $89,000 due to volume changes, and
credit card processing fee income was up $78,000 due primarily to new accounts. Other noninterest
income increased from $1,869,000 in 2002 to $2,058,000 in 2003.
Other Expenses
Total other expenses were $31,965,000 and $29,137,000 for the years ended December 31, 2004 and 2003,
respectively. The increase includes $769,000 in salaries and benefits, a 4.84% increase which is
the direct result of salary adjustments for 2004, and a net increase in full-time equivalents of
five since December 31, 2003. Medical expenses included with salaries and benefits increased to $1.3
million from $1.1 million in 2003. This increase is due to the hiring of new employees and to 18%
increases in medical and drug costs. All other expenses other than salaries and benefits increased
a total of $2,059,000, or 15.53%. The majority of the increase of $2,059,000 is accounted for by
three items. These items are advertising and business development increases of $462,000, an increase
in outside services of $693,000 and a $431,000 increase in the rental expense on tax credit real
estate. During 2004 the Company celebrated its 100th anniversary and in connection with observing this anniversary had a number of special promotions to
celebrate with customers, employees and shareholders. The Banks employees were involved in
the construction of a Habitat for Humanity home in Iowa City, Iowa, with total costs of approximately
$75,000 not including labor. Other special items included employee events and special customer promotion
items to assist in the retail growth of primarily deposits over the prior year by $125,000. In addition,
as a result of its scorecard points awarded for credit card charges, the Bank incurred costs of $150,000
more than in 2003. This increase was due to additional volume of credit card charges and more points
redeemed by customers than expected.
Outside service expenses increased $693,000 to $4,575,000 in 2004. The outside services include professional
fees, courier services and ATM fees, processing charges for the merchant credit card program, retail
credit cards, and other data processing services. Professional fees increased by $422,000 and included
audit fee increases of $106,000 and services of $150,000 provided by outside consultants to assist
the Company in complying with the Sarbanes-Oxley Act. This requirement was new in 2004 and will be
an ongoing cost. In addition, attorney fees increased $50,000 both due to Sarbanes-Oxley matters
and regulatory compliance issues. Also, the Company effective July 1, 2004 outsourced more of its
Internal Audit work and as part of the outsourcing process incurred fees of $50,000. Data processing
and credit card processing (including debit cards) increased $329,000 due to a volume increase in
transactions. The rental expenses on the tax credit real estate increased to $927,000 in 2004 compared
to $496,000 in 2003. This increase was due to the new property added in January of 2004. This expense
for 2004 includes $457,000 of depreciation compared to $171,000 in 2003.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 39 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of







Operations  (Continued)
Total other expenses were $25,443,000 for the year ended December 31, 2002. The increase in expenses
in 2003 was $3,694,000. This included an increase of $2,212,000 in salaries and benefits, which was
the direct result of salary adjustments for 2003 and a net increase in full-time equivalents of fifteen
during 2003. The new employees added included nine in the secondary loan market department and eleven
in the Marion office, which opened in February 2003. Medical expenses included with salaries and
benefits increased to $1.1 million from $825,000 in 2002. This increase was due to the hiring of
new employees and to 20% increases in health and drug costs. All other expenses other than salaries
and benefits increased a total of $1,482,000, or 12.58%. Outside service expenses increased during
2003 by $557,000. Direct expenses for the secondary market are included in outside services for items
such as direct underwriting expense and related expenses were $285,000 higher in 2003 than in 2002.
Advertising and business development expenses increased from $1,390,000 in 2002 to $1,769,000 in
2003. The change was due to increased marketing at all offices for deposit related accounts and marketing
the new Marion location. Also included was an increase in charitable contributions of $151,000 for 2003.
Income Taxes
Income tax expense was $6,351,000, $6,998,000 and $5,122,000 for the years ended December 31, 2004,
2003 and 2002, respectively. Income taxes as a percentage of income before income taxes were 30.91%
in 2004, 32.91% in 2003 and 30.88% in 2002. The percentage in 2004 was less than 2003 due to additional
tax credits available as a result of the tax credit property placed in service in January of 2004.
The amount of tax credits was $596,000 for 2004 and $234,000 for 2003. In 2002, the tax credits were
$345,000.
Impact of Recently Issued Accounting Standards
In December, 2003, the Financial Accounting Standards Board (FASB) issued a revised Interpretation
No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 addresses consolidation by business enterprises of variable interest
entities that have certain characteristics. It requires a business enterprise that has a controlling
interest in a variable interest entity (as defined by FIN 46) to include the assets, liabilities,
and results of the activities of the variable interest entity in the consolidated financial statements
of the business enterprise. FIN 46 applies to a public entity that is not a small business issuer
no later than the end of the first reporting period that ends after March 15, 2004. The impact of
adopting FIN 46 in 2004 on the Companys financial condition and results of operations was not
material.
In March, 2004, the SEC issued Staff Accounting Bulletin No. 105, Application of Accounting Principles
to Loan Commitments (SAB 105). SAB 105 summarizes the views of the SEC staff regarding
the application of generally accepted accounting principles to loan commitments accounted for as
derivative instruments. SAB 105 pertains to recognizing and disclosing loan commitments and was effective
for commitments to originate mortgage loans to be held for sale that are entered into after March
31, 2004. The Company adopted the provisions of SAB 105 beginning April 1, 2004. Adoption of SAB
105 did not have a material impact on the Companys financial position or results of operations.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 40 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Conditionand Results of







Operations  (Continued)
At its March 2004 meeting, the Emerging Issues Task Force (EITF) revisited EITF Issue No.
03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments
(EITF No. 03-1). Effective with reporting periods beginning after June 15, 2004, companies
carrying certain types of debt and equity securities at amounts higher than the securities
fair values will have to use more detailed criteria to evaluate whether to record a loss and will
have to disclose additional information about unrealized losses. However, the FASB has since issued
a statement of financial position deferring the effective date of the revised EITF No. 03-1 until
further implementation issues are resolved. Adoption of the revised EITF No. 03-1 could have an impact
on the Companys financial position and results of operations, but the extent of any impact
will vary due to the fact that the revised EITF No. 03-1, as issued, calls for many judgments and
the gathering of additional evidence as such evidence exists at each securities valuation date.
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standard (SFAS) No. 123 (Revised 2004), Share-Based Payment. SFAS No 123R is a revision
of SFAS No. 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and its related
implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which
an entity obtains employee services through share-based payment transactions. SFAS No 123R requires
a public entity to measure the cost of employee services received in exchange for the award of equity
instruments based on the fair value of the award at the date of grant. The cost will be recognized
over the period during which an employee is required to provide services in exchange for the award.
SFAS No. 123R is effective as of the beginning of the first interim or annual reporting period that
begins after June 15, 2005. While the Company cannot precisely determine the impact on net earnings
as a result of the adoption of SFAS No 123R, estimated compensation expense related to prior periods
can be found in Note 1 in the Consolidated Financial Statements included in the Companys Form
10-K. The ultimate amount of increased compensation expense will be dependent on whether the Company
adopts SFAS 123R using the modified prospective or retrospective method, the number of option shares
granted during the year, their timing and vesting period, and the method used to calculate the fair
value of the awards, among other factors.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 41 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Condition
               and Results of Operations  (Continued)
      Interest Rate Sensitivity and Liquidity Analysis
    At December 31, 2004, the Companys interest rate sensitivity report is as follows (amounts in thousands):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                 

|                     | Repricing
      Maturities
      Immediately |          | Days |        | More than
      One Year |         | Total |        
|-------------------- | -------------------------------------------- | -------- | ---- | ------ | ------------------------ | ------- | ----- | -------
|                     |                                             
|2-30                 |                                              | 31-90    |      | 91-180 |                          | 181-365 |      
|                     |                                             
|Earning assets:      |                                              |          |      |        |                          |         |       |        
|Investment           |                                              |          |      |        |                          |         |       |        
|securities           | $                                            |         |      | $      | 3,610                    |         | $     | 6,870  
|Loans                |                                              | 6,563    |      |        | 151,062                  |         |       | 21,872 
|                     |                                             
|**Total**            |                                              | 6,563    |      |        | 154,672                  |         |       | 28,742 
|                     |                                             
|Sources of funds:   
|Interest-bearing     |                                              |          |      |        |                          |         |       |        
|checking and         |                                              |          |      |        |                          |         |       |        
|savings accounts     |                                              | 151,647  |      |        |                         |         |       |       
|Certificates of      |                                              |          |      |        |                          |         |       |        
|deposit              |                                              |         |      |        | 16,565                   |         |       | 27,227 
|Other borrowings -   |                                              |          |      |        |                          |         |       |        
|FHLB                 |                                              |         |      |        |                         |         |       |       
|Federal funds and    |                                              |          |      |        |                          |         |       |        
|repurchase           |                                              |          |      |        |                          |         |       |        
|agreements           |                                              | 37,985   |      |        |                         |         |       |       
|                     |                                             
|                     |                                              | 189,632  |      |        | 16,565                   |         |       | 27,227 
|                     |                                              |          |      |        |                          |         |       |        
|Other sources,      
|primarily            |                                              |          |      |        |                          |         |       |        
|noninterest-        
|bearing              |                                              |         |      |        |                         |         |       |       
|                     |                                             
|**Total sources**    |                                              | 189,632  |      |        | 16,565                   |         |       | 27,227 
|                     |                                             
|Interest             |                                              |          |      |        |                          |         |       |        
|Rate Gap             | $                                            | (183,069 | )    | $      | 138,107                  |         | $     | 1,515  
|                     |                                             
|                    
|Cumulative Interest  |                                              |          |      |        |                          |         |       |        
|Rate Gap             |                                              |          |      |        |                          |         |       |        
|at December 31, 2004 | $                                            | (183,069 | )    | $      | (44,962                  | )       | $     | (43,447
|                     |                                              |          |      |       

|Page 42 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Condition
               and Results of







Operations  (Continued)
The table set forth above includes the portion of the balances in interest-bearing checking, savings
and money market accounts that management has estimated to mature within one year. The classifications
are used because the Banks historical data indicates that these have been very stable deposits
without much interest rate fluctuation. Historically, these accounts would not need to be adjusted
upward as quickly in a period of rate increases so the interest risk exposure would be less than
the re-pricing schedule indicates. The FHLB borrowings are classified based on their callable dates
because they may be called if interest rates rise over current rates.
Effects of Inflation
The consolidated financial statements and the accompanying notes have been prepared in accordance with
generally accepted accounting principles. These principles require the measurement of financial position
and operating results in terms of historical dollar amounts without considering the changes in the
relative purchasing power of money over time due to inflation. The impact of inflation is reflected
in the increased cost of the Companys operations. Unlike industrial companies, nearly all of
the assets and liabilities of the Company are monetary in nature. As a result, interest rates have
a more significant impact in the Companys performance than do the effects of general levels
of inflation. Interest rates do not necessarily move in the same direction or to the same extent
as the price of goods and services. In the current economic environment, liquidity and interest rate
adjustments are features of the Companys asset/liability management, which are important to
the maintenance of acceptable performance levels. The Company attempts to maintain a balance between
monetary assets and monetary liabilities, over time, to offset the potential effects of changing interest rates.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 43 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Condition
               and Results of
Operations (Continued)
Liquidity and Capital Resources
On an unconsolidated basis, the Company had cash balances of $2,891,000 as of December 31, 2004.
In 2004, the Company received dividends of $3,186,000 from its subsidiary Bank and used those funds
to pay dividends to its stockholders of $3,185,000.
As of December 31, 2004 and 2003, stockholders equity, before deducting for the maximum cash
obligation related to the ESOP, was $120,139,000 and $111,629,000 respectively. This measure of stockholders
equity as a percent of total assets was 9.31% at December 31, 2004 and 9.43% at December 31, 2003.
As of December 31, 2004, total equity was 8.04% of assets compared to 8.18% of assets at the prior
year end. The ability of the Company to pay dividends to its shareholders is dependent upon the earnings
and capital adequacy of its subsidiary Bank, which affects the Banks dividends to the Company.
The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in
dividends. In order to maintain acceptable capital ratios in the subsidiary Bank, certain of its
retained earnings are not available for the payment of dividends. Retained earnings available for
the payment of dividends to the Company totaled approximately $13,282,000, $10,820,000 and $6,092,000
as of December 31, 2004, 2003 and 2002, respectively.
The Company and the Bank are subject to the Federal Deposit Insurance Corporation Improvement Act of
1991, and the Bank is subject to Prompt Corrective Action Rules as determined and enforced by the
Federal Reserve. These regulations establish minimum capital requirements that member banks must
maintain.
As of December 31, 2004, risk-based capital standards require 8% of risk-weighted assets. At least
half of that 8% must consist of Tier I core capital (common stockholders equity, non-cumulative
perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries),
and the remainder may be Tier II supplementary capital (perpetual debt, intermediate-term preferred
stock, cumulative perpetual, long-term and convertible preferred stock, and loan loss reserve up
to a maximum of 1.25% of risk-weighted assets). Total risk-weighted assets are determined by weighting
the assets according to their risk characteristics. Certain off-balance sheet items (such as standby
letters of credit and firm loan commitments) are multiplied by credit conversion factors
to translate them into balance sheet equivalents before assigning them risk weightings. Any bank
having a capital ratio less than the 8% minimum required level must, within 60 days, submit to the
Federal Reserve a plan describing the means and schedule by which the Bank shall achieve the applicable
minimum capital ratios.
The Bank is an insured state bank, incorporated under the laws of the state of Iowa. As such, the Bank
is subject to regulation, supervision and periodic examination by the Superintendent of Banking of
the State of Iowa (the Superintendent). Among the requirements and restrictions imposed
upon state banks by the Superintendent are the requirements to maintain reserves against deposits,
restrictions on the nature and amount of loans which may be made by state banks, and restrictions
relating to investments, opening of bank offices and other activities of state banks. Changes in
the capital structure of state banks are also approved by the Superintendent. State banks must have
a Tier 1 risk-based leverage ratio of 6.5% plus a fully funded loan loss reserve. In certain circumstances,
the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement
on the Bank. In determining the Tier 1 risk-based leverage ratio, the Superintendent uses total equity
capital without unrealized securities gains and the allowance for loan losses less any intangible
assets. At December 31, 2004, the Tier 1 risk-based leverage ratio of the Bank was 8.84% and exceeded
the ratio required by the Superintendent.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 44 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Condition
               and Results of Operations (Continued)
      The actual amounts and capital ratios as of December 31, 2004 and the minimum regulatory requirements for theCompany and the Bank are presented below (amounts in thousands):
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                              

|                          | Actual |         | For Capital
      Adequacy
      Purposes |  | To Be Well
      Capitalized Under
      Prompt Corrective
      Action Provisions |  
|------------------------- | ------ | ------- | ----------------------------------------- |  | ---------------------------------------------------------------------------------- | -
|                          |       
|                          | Amount |         | Ratio                                     |  | Amount                                                                             |  
|                          |       
|As of December 31, 2004:  |        |         |                                           |  |                                                                                    |  
|Company:                 
|Total risk based capital  | $      | 128,541 |                                           |  | 14.03                                                                              | %
|Tier 1 risk based capital |        | 117,063 |                                           |  | 12.78                                                                              |  
|Leverage ratio            |        | 117,063 |                                           |  | 9.09                                                                               |  
|Bank:                    
|Total risk based capital  |        | 125,211 |                                           |  | 13.68                                                                              |  
|Tier 1 risk based capital |        | 113,740 |                                           |  | 12.43                                                                              |  
|Leverage ratio            |        | 113,740 |                                           |  | 8.84                                                                               |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Bank is classified as well capitalized by FDIC capital guidelines.
      On a consolidated basis, 2004 cash flows from operations provided $18,562,000; proceeds of net securities provided $12,895,000 and net increases in deposits provided $88,584,000. These cash flows were invested in Net Loans of $131,507,000. Also, federal funds sold decreased by $13,233,000 to assist in the funding of the Banks increased loan demand. In addition, $2,071,000 was used to purchase property and equipment.
      At December 31, 2004, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $163,291,000 (see Note 14 to the Financial Statements). Management believes that its liquidity levels are sufficient at this time, but the Bank may increase its liquidity by limiting the growth of its assets by selling more loans in the secondary market or selling portions of loans to other banks through participation agreements.
It may also obtain additional funds from the Federal Home Loan Bank (FHLB). The Bank as of December 31, 2004 can obtain an additional $168 million from the FHLB based on the current real estate mortgage loans held. In addition, the Bank has arranged $118 million of credit lines at three banks and as of December 31, 2004 $19.2 million has been used for federal funds purchased. The borrowings under these credit lines would be secured by the Banks investment securities. As a further
source of liquidity, $54 million of additional securities are available to be pledged or liquidated.
    While the Bank has off-balance sheet commitments to fund additional borrowings of customers, it does not use other off-balance-sheet financial instruments, including interest rate swaps, as part of its asset and liability management. Contractual commitments to fund loans are met from the proceeds of federal funds sold or investment securities and additional borrowings. Many of the contractual commitments to extend credit will not be funded because they represent the credit limits on credit cards and home equity lines of credits.

|Page 45 of 96
|-------------



|Item 7.   Managements Discussion and Analysis of Financial Condition
               and Results of Operations (Continued)
      Contractual Obligations and Commitments
    As disclosed in Note 14 to the financial statements, the Company has certain obligations and commitments to make future payments under contracts. The following table summarizes significant contractual obligations and other commitments as of December 31, 2004:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                

|                                   | Payments Due By Period
|---------------------------------- | ----------------------
|                                   |                       
|                                   | (Amounts In Thousands)
|                                   | Total                 
|                                   |                       
|**Contractual obligations:**       |                       
|Long-term debt obligations         | $                     
|Operating lease obligations        |                       
|                                   |                       
|**Total contractual obligations:** | $                     
|                                   |                       
|                                   |                       
|**Other commitments:**             |                       
|Lines of credit                    | $                     
|Standby letters of credit          |                       
|                                   |                       
|**Total other commitments**        | $                     
|                                   |                       

|Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
Related Party Transactions
The Banks primary transactions with related parties are the loan and deposit relationships it
maintains with officers, directors and entities related to these individuals. The Bank makes loans
to related parties under substantially the same interest rates, terms and collateral as those prevailing
for comparable transactions with unrelated persons. In addition, these parties may maintain deposit
account relationships with the Bank that also are on the same terms as with unrelated persons. As
of December 31, 2004 and 2003, loan balances to related individuals and businesses totaled $36,247,000
and $32,454,000, respectively. Deposits from these related parties totaled $7,078,000 and $5,800,000
as of December 31, 2004 and 2003, respectively.
Commitments and Trends
The Company and the Bank have no material commitments or plans that will materially affect liquidity
or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed
if favorable terms are available.
Market Risk Exposures
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. Inversely, the Companys
yields and cost of funds will decrease when market rates decline. The Company is able to manage these
swings to some extent by attempting to control the maturity or rate adjustments of its interest-earning
assets and interest-bearing liabilities over given periods of time.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 46 of 96
|-------------



|Item 7A.   Quantitative and Qualitative Disclosures About Market Risk (Continued)
The Bank maintains an asset/liability committee, which meets at least quarterly to review the interest
rate sensitivity position and to review various strategies as to interest rate risk management. In
addition, the Bank uses a simulation model to review various assumptions relating to interest rate
movement. The model attempts to limit rate risk even if it appears the Banks asset and liability
maturities are perfectly matched and a favorable interest margin is present.
In order to minimize the potential effects of adverse material and prolonged increases or decreases
in market interest rates on the Companys operations, management has implemented an asset/liability
program designed to mitigate the Companys interest rate sensitivity. The program emphasizes
the origination of adjustable rate loans, which are held in the portfolio, the investment of excess
cash in short or intermediate term interest-earning assets, and the solicitation of passbook or transaction
deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly.
Based on the data following, net interest income should decline with instantaneous increases in interest
rates while net interest income should increase with instantaneous declines in interest rates. Generally,
during periods of increasing interest rates, the Companys interest rate sensitive liabilities
would re-price faster than its interest rate sensitive assets causing a decline in the Companys
interest rate spread and margin. This would tend to reduce net interest income because the resulting
increase in the Companys cost of funds would not be immediately offset by an increase in its
yield on earning assets. In times of decreasing interest rates, fixed rate assets could increase
in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a
positive effect on the Companys net interest income.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 47 of 96
|-------------



|Item 7A. Quantitative and Qualitative Disclosures About Market Risk (Continued)
    The following table, which presents principal cash flows and related weighted average interest rates by expected maturity dates, provides information about the Companys loans, investment securities and deposits that are sensitive to changes in interest rates.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                 | 2005                   |         | 2006 |   | 2007   |   | 2008 |        | 2009 |   | Thereafter |   | Total |         | Fair Value |  
|---------------- | ---------------------- | ------- | ---- | - | ------ | - | ---- | ------ | ---- | - | ---------- | - | ----- | ------- | ---------- | -
|                 |                       
|                 | (Amounts In Thousands) |        
|Assets:          |                        |         |      |   |        |   |      |        |      |   |            |   |       |         |            |  
|Loans, fixed:   
|Balance          | $                      | 67,295  |      | $ | 37,820 |   | $    | 67,697 |      | $ | 94,484     |   | $     | 107,215 |            | $
|Average         
|interest rate    |                        | 6.06    | %    |   | 6.47   | % |      | 6.29   | %    |   | 6.01       | % |       | 5.99    | %          |  
|                
|Loans, variable:
|Balance          | $                      | 89,471  |      | $ | 6,269  |   | $    | 9,511  |      | $ | 27,248     |   | $     | 10,939  |            | $
|Average         
|interest rate    |                        | 6.98    | %    |   | 6.20   | % |      | 5.70   | %    |   | 4.50       | % |       | 5.18    | %          |  
|                
|Investments (1):
|Balance          | $                      | 52,630  |      | $ | 39,030 |   | $    | 47,315 |      | $ | 35,548     |   | $     | 10,795  |            | $
|Average         
|interest rate    |                        | 4.32    | %    |   | 3.67   | % |      | 3.45   | %    |   | 4.21       | % |       | 5.42    | %          |  
|                
|Liabilities:    
|Liquid           |                        |         |      |   |        |   |      |        |      |   |            |   |       |         |            |  
|deposits (2):   
|Balance          | $                      | 394,034 |      | $ |       |   | $    |       |      | $ |           |   | $     |        |            | $
|Average         
|interest rate    |                        | 0.83    | %    |   | 0.00   | % |      | 0.00   | %    |   | 0.00       | % |       | 0.00    | %          |  
|                
|Deposits,       
|certificates:    |                        |         |      |   |        |   |      |        |      |   |            |   |       |         |            |  
|Balance          | $                      | 201,901 |      | $ | 98,220 |   | $    | 56,237 |      | $ | 45,355     |   | $     | 30,233  |            | $
|Average          |                        |         |      |   |        |   |      |        |      |   |            |   |       |         |            |  
|interest rate    |                        | 2.20    | %    |   | 3.23   | % |      | 4.06   | %    |   | 3.78       | % |       | 3.70    | %          |  

|(1) | Includes all available-for-sale investments, held-to-maturity investments, federal funds and Federal
Home Loan Bank stock.
|--- | --------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                           
|(2) | Includes passbook accounts, NOW accounts, Super NOW accounts and money market funds.                                      

|Page 48 of 96
|-------------



|Item 7B.  Managements Report on Internal Control Over Financial Reporting
The Companys management is responsible for establishing and maintaining a system of internal
controls over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). This
system is augmented by written policies and procedures, careful selection and training of financial
management personnel, a continuing management commitment to the integrity of the system and through
examinations by an internal audit function that coordinates its activities with the Companys
Independent Registered Public Accounting Firm.
Under the supervision and with the participation of the Companys management, including the Companys
Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness
of the Companys internal controls over financial reporting based on the framework in Internal
Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on the Companys evaluation under the framework in Internal Control 
Integrated Framework, the Companys management concluded that our internal control over financial
reporting was effective as of December 31, 2004.
The Companys managements assessment of the effectiveness of our internal control over financial
reporting as of December 31, 2004 has been audited by KPMG LLP, an independent registered public
accounting firm, as stated in their report which is included herein.
Item 8.   Financial Statements and Supplementary Data
The financial statements and supplementary data are included on Pages 50 through 83.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 49 of 96
|-------------



|KPMG LLP2500 Ruan Center666 Grand AvenueDes Moines, IA 50309
Report of Independent Registered Public Accounting Firm
The Board of Directors and StockholdersHills Bancorporation:
We have audited the accompanying consolidated balance sheets of Hills Bancorporation and subsidiaries
as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders
equity and comprehensive income, and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Companys management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of Hills Bancorporation and subsidiaries as of December 31, 2004
and 2003, and the results of their operations and their cash flows for the years then ended, in conformity
with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the effectiveness of Hills Bancorporations internal control over financial
reporting as of December 31, 2004, based on criteria established inInternal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO), and our report dated March 8, 2005 expressed an unqualified opinion on managements assessment
of, and the effective operation of, internal control over financial reporting.

Des Moines, IowaMarch 8, 2005
KPMG LLP, a U.S. limited liability partnership, is the U.S.member firm of KPMG International, a Swiss cooperative.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 50 of 96
|-------------



|KPMG LLP2500 Ruan Center666 Grand AvenueDes Moines, IA 50309
Report of Independent Registered Public Accounting Firm the Board of Directors and Stockholders
Hills Bancorporation:
We have audited managements assessment, included in the accompanying Managements Report
on Internal Control Over Financial Reporting appearing under Item 9A, that Hills Bancorporation
(the Company) maintained effective internal control over financial reporting as of December 31, 2004,
based on criteria established inInternal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Hills Bancorporations
management is responsible for maintaining effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on managements assessment and an opinion on the effectiveness of the
Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered necessary
in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting principles. A companys
internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
and dispositions of the assets of the company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject
to the risk that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Hills Bancorporation maintained effective internal
control over financial reporting as of December 31, 2004, is fairly stated, in all material respects,
based on criteria established inInternal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Also, in our opinion, Hills Bancorporation maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2004, based on criteria established inInternal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheets of Hills Bancorporation and subsidiaries as of December
31, 2004 and 2003, and the related consolidated statements of income, stockholders equity and
comprehensive income, and cash flows for the years then ended, and our report dated March 8, 2005
expressed an unqualified opinion on those consolidated financial statements.

Des Moines, IowaMarch 8, 2005
KPMG LLP, a U.S. limited liability partnership, is the U.S.member firm of KPMG International, a Swiss cooperative.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 51 of 96
|-------------



|INDEPENDENT AUDITORS REPORT
To the Board of DirectorsHills BancorporationHills, Iowa
We have audited the accompanying consolidated statements of income, comprehensive income, stockholders
equity and cash flows of Hills Bancorporation and subsidiaries for the year ended December 31, 2002.
These financial statements are the responsibility of the Companys management. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audit in accordance with auditing standards generally accepted in the United States
of America. Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audit provides
a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the results of operations and the cash flows of Hills Bancorporation and subsidiary for
the year ended December 31, 2002 in conformity with accounting principles generally accepted in the
United States of America.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Iowa City, IowaFebruary 25, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|Page 52 of 96
|-------------



|HILLS BANCORPORATION                                                                                      
|----------------------------------------------------------------------------------------------------------
|                                                                                                          
|CONSOLIDATED BALANCE SHEETS 
      December 31, 2004 and 2003 
      (Amounts In Thousands, Except Shares)
|
|
|                                                                                                          
|Cash and due from banks (Note 10)                                                                         
|Investment securities (Notes 2 and 6):                                                                    
|Available for sale (amortized cost 2004 $203,208 ; 2003 $214,530)                                         
|Held to maturity (fair value 2004 $4,986; 2003 $8,064)                                                    
|Stock of Federal Home Loan Bank                                                                           
|Federal funds sold                                                                                        
|Loans held for sale                                                                                       
|Loans, net (Notes 3, 7 and 11)                                                                            
|Property and equipment, net (Note 4)                                                                      
|Tax credit real estate                                                                                    
|Accrued interest receivable                                                                               
|Deferred income taxes (Note 9)                                                                            
|Goodwill                                                                                                  
|Other assets                                                                                              
|                                                                                                          
|                                                                                                          
|                                                                                                          
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                      
|                                                                                                          
|Liabilities                                                                                               
|Noninterest-bearing deposits                                                                              
|Interest-bearing deposits (Note 5)                                                                        
|                                                                                                          
|Total deposits                                                                                            
|Short-term borrowings (Note 6)                                                                            
|Federal Home Loan Bank borrowings (Note 7)                                                                
|Accrued interest payable                                                                                  
|Other liabilities                                                                                         
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Commitments and Contingencies (Notes 8 and 14)                                                            
|                                                                                                          
|Redeemable Common Stock Held By Employee Stock                                                            
|Ownership Plan (ESOP) (Note 8)                                                                            
|                                                                                                          
|Stockholders Equity (Note 10)                                                                            
|Capital stock, no par value; authorized 10,000,000 shares;                                                
|issued 2004 4,549,656 shares; 2003 4,550,034 shares                                                       
|Paid in capital                                                                                           
|Retained earnings                                                                                         
|Accumulated other comprehensive income                                                                    
|                                                                                                          
|                                                                                                          
|Less maximum cash obligation related to ESOP shares (Note 8)                                              
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|See Notes to Consolidated Financial Statements.                                                           

|Page 53 of 96
|-------------



|HILLS BANCORPORATION                                                                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                             
|CONSOLIDATED STATEMENTS OF INCOME 
      Years Ended December 31, 2004, 2003 and 2002 
      (Amounts In Thousands, Except Per Share Amounts)
|
|                                                                                                                                             
|Interest income:                                                                                                                             
|Loans, including fees                                                                                                                        
|Investment securities:                                                                                                                       
|Taxable                                                                                                                                      
|Nontaxable                                                                                                                                   
|Federal funds sold                                                                                                                           
|                                                                                                                                             
|Total interest income                                                                                                                        
|                                                                                                                                             
|Interest expense:                                                                                                                            
|Deposits                                                                                                                                     
|Short-term borrowings                                                                                                                        
|FHLB borrowings                                                                                                                              
|                                                                                                                                             
|Total interest expense                                                                                                                       
|                                                                                                                                             
|Net interest income                                                                                                                          
|Provision for loan losses (Note 3)                                                                                                           
|                                                                                                                                             
|Net interest income after provision for loan losses                                                                                          
|                                                                                                                                             
|Other income:                                                                                                                                
|Net gain on sale of loans                                                                                                                    
|Trust fees                                                                                                                                   
|Service charges and fees                                                                                                                     
|Rental revenue on tax credit real estate                                                                                                     
|Other noninterest income                                                                                                                     
|Net losses on sale of investment securities                                                                                                  
|                                                                                                                                             
|                                                                                                                                             
|                                                                                                                                             
|Other expenses:                                                                                                                              
|Salaries and employee benefits                                                                                                               
|Occupancy                                                                                                                                    
|Furniture and equipment                                                                                                                      
|Office supplies and postage                                                                                                                  
|Advertising and business development                                                                                                         
|Outside services                                                                                                                             
|Rental expenses on tax credit real estate                                                                                                    
|Other noninterest expenses                                                                                                                   
|                                                                                                                                             
|                                                                                                                                             
|                                                                                                                                             
|Income before income taxes                                                                                                                   
|Federal and state income taxes (Note 9)                                                                                                      
|                                                                                                                                             
|Net income                                                                                                                                   
|                                                                                                                                             
|                                                                                                                                             
|Earnings per share:                                                                                                                          
|Basic                                                                                                                                        
|Diluted                                                                                                                                      
|                                                                                                                                             
|See Notes to Consolidated Financial Statements.                                                                                              

|Page 54 of 96
|-------------



|HILLS BANCORPORATION                                                                                                             
|---------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                 
|CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 
      Years Ended December 31, 2004, 2003 and 2002 
      (Amounts In Thousands)
|
|
|                                                                                                                                 
|                                                                                                                                 
|Net income                                                                                                                       
|                                                                                                                                 
|Other comprehensive income (loss),                                                                                               
|Unrealized gains on securities:                                                                                                  
|Unrealized holding gains (losses) arising during the year,                                                                       
|                                                                                                                                 
|net of income taxes 2004 $(1,474); 2003 ($960); 2002 $998                                                                        
|                                                                                                                                 
|Less: reclassification adjustment for losses included in net income,                                                             
|                                                                                                                                 
|net of income taxes                                                                                                              
|                                                                                                                                 
|                                                                                                                                 
|                                                                                                                                 
|Other comprehensive income (loss)                                                                                                
|                                                                                                                                 
|                                                                                                                                 
|Comprehensive income                                                                                                             
|                                                                                                                                 
|                                                                                                                                 
|See Notes to Consolidated Financial Statements.                                                                                  

|Page 55 of 96
|-------------



|                                                                                                                                                       
|-------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                       
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY 
      Years Ended December 31, 2004, 2003 and 2002 
      (Amounts In Thousands, Except Share Amounts)
|
|
|                                                                                                                                                       
|                                                                                                                                                       
|                                                                                                                                                       
|Balance, December 31, 2001                                                                                                                             
|Issuance of 8,673 shares of                                                                                                                            
|                                                                                                                                                       
|common stock                                                                                                                                           
|Redemption of 1,185 shares                                                                                                                             
|                                                                                                                                                       
|of common stock                                                                                                                                        
|                                                                                                                                                       
|Change related to ESOP shares                                                                                                                          
|                                                                                                                                                       
|Net income                                                                                                                                             
|Income tax benefit related to                                                                                                                          
|                                                                                                                                                       
|stock based compensation                                                                                                                               
|                                                                                                                                                       
|Cash dividends ($.58 per share)                                                                                                                        
|                                                                                                                                                       
|Other comprehensive income                                                                                                                             
|                                                                                                                                                       
|                                                                                                                                                       
|Balance, December 31, 2002                                                                                                                             
|                                                                                                                                                       
|Issuance of 46,872 shares                                                                                                                              
|                                                                                                                                                       
|of common stock                                                                                                                                        
|                                                                                                                                                       
|Change related to ESOP shares                                                                                                                          
|                                                                                                                                                       
|Net income                                                                                                                                             
|Income tax benefit related to                                                                                                                          
|                                                                                                                                                       
|stock based compensation                                                                                                                               
|                                                                                                                                                       
|Cash dividends ($.63 per share)                                                                                                                        
|                                                                                                                                                       
|Other comprehensive income (loss)                                                                                                                      
|                                                                                                                                                       
|                                                                                                                                                       
|Balance, December 31, 2003                                                                                                                             
|                                                                                                                                                       
|Issuance of 222 shares of                                                                                                                              
|                                                                                                                                                       
|common stock                                                                                                                                           
|Redemption of 600 shares                                                                                                                               
|                                                                                                                                                       
|of common stock                                                                                                                                        
|                                                                                                                                                       
|Change related to ESOP shares                                                                                                                          
|                                                                                                                                                       
|Net income                                                                                                                                             
|Income tax benefit related to                                                                                                                          
|                                                                                                                                                       
|stock based compensation                                                                                                                               
|                                                                                                                                                       
|Cash dividends ($.70 per share)                                                                                                                        
|                                                                                                                                                       
|Other comprehensive income (loss)                                                                                                                      
|                                                                                                                                                       
|Balance, December 31, 2004                                                                                                                             
|                                                                                                                                                       
|                                                                                                                                                       
|See Notes to Consolidated Financial Statements.                                                                                                        
|                                                                                                                                                       

|Page 56 of 96
|-------------



|HILLS BANCORPORATION                                                                                                   
|-----------------------------------------------------------------------------------------------------------------------
|                                                                                                                       
|CONSOLIDATED STATEMENTS OF CASH FLOWS 
      Years Ended December 31, 2004, 2003 and 2002 
      (Amounts In Thousands)
|
|                                                                                                                       
|Cash Flows from Operating Activities                                                                                   
|                                                                                                                       
|Net income                                                                                                             
|Adjustments to reconcile net income to net cash                                                                        
|provided by operating activities:                                                                                      
|                                                                                                                       
|Depreciation                                                                                                           
|                                                                                                                       
|Provision for loan losses                                                                                              
|                                                                                                                       
|Net losses on sale of investment securities                                                                            
|                                                                                                                       
|Compensation expensed through issuance of common stock                                                                 
|                                                                                                                       
|Deferred income taxes                                                                                                  
|Increase in accrued interest receivable                                                                                
|                                                                                                                       
|Amortization of bond discount, net                                                                                     
|                                                                                                                       
|(Increase) decrease in other assets                                                                                    
|                                                                                                                       
|Increase (decrease) in accrued interest and other liabilities                                                          
|Loans originated for sale                                                                                              
|                                                                                                                       
|Proceeds on sales of loans                                                                                             
|Net gain on sales of loans                                                                                             
|                                                                                                                       
|                                                                                                                       
|Net cash provided by operating activities                                                                              
|                                                                                                                       
|Cash Flows from Investing Activities                                                                                   
|Proceeds from maturities of investment securities:                                                                     
|                                                                                                                       
|Available for sale                                                                                                     
|                                                                                                                       
|Held to maturity                                                                                                       
|                                                                                                                       
|Proceeds from sales of available for sale securities                                                                   
|Purchases of investment securities:                                                                                    
|Available for sale                                                                                                     
|                                                                                                                       
|Held to maturity                                                                                                       
|                                                                                                                       
|Federal funds sold, net                                                                                                
|Loans made to customers, net of collections                                                                            
|Purchases of property and equipment                                                                                    
|                                                                                                                       
|Investment in tax credit real estate                                                                                   
|                                                                                                                       
|                                                                                                                       
|Net cash used in investing activities                                                                                  
|                                                                                                                       
|                                                                                                                       
|(Continued)                                                                                                            

|Page 57 of 96
|-------------



|HILLS BANCORPORATION                                                                                                              
|----------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                  
|CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
      Years Ended December 31, 2004, 2003 and 2002 
      (Amounts In Thousands)
|
|
|                                                                                                                                  
|Cash Flows from Financing Activities                                                                                              
|                                                                                                                                  
|Net increase in deposits                                                                                                          
|                                                                                                                                  
|Net increase (decrease) in short-term borrowings                                                                                  
|                                                                                                                                  
|Borrowings from FHLB                                                                                                              
|                                                                                                                                  
|Payments on FHLB borrowings                                                                                                       
|                                                                                                                                  
|Stock options exercised                                                                                                           
|                                                                                                                                  
|Income tax benefits related to stock based compensation                                                                           
|                                                                                                                                  
|Redemption of common stock                                                                                                        
|                                                                                                                                  
|Dividends paid                                                                                                                    
|                                                                                                                                  
|                                                                                                                                  
|Net cash provided by financing activities                                                                                         
|                                                                                                                                  
|                                                                                                                                  
|Decrease in cash and due from banks                                                                                               
|                                                                                                                                  
|Cash and due from banks:                                                                                                          
|                                                                                                                                  
|Beginning of year                                                                                                                 
|                                                                                                                                  
|End of year                                                                                                                       
|                                                                                                                                  
|                                                                                                                                  
|Supplemental Disclosures                                                                                                          
|Cash payments for:                                                                                                                
|Interest paid to depositors                                                                                                       
|                                                                                                                                  
|Interest paid on other obligations                                                                                                
|                                                                                                                                  
|Income taxes                                                                                                                      
|                                                                                                                                  
|Noncash financing activities:                                                                                                     
|Increase in maximum cash obligation related to                                                                                    
|ESOP shares                                                                                                                       
|                                                                                                                                  
|See Notes to Consolidated Financial Statements.                                                                                   

|Page 58 of 96
|-------------



|HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1.   Nature of Activities and Significant Accounting Policies
Nature of activities: Hills Bancorporation (the Company) is a holding company engaged in the business
of commercial banking. The Companys subsidiary is Hills Bank and Trust Company, Hills, Iowa
(the Bank), which is wholly-owned. The Bank is a full-service commercial bank extending
its services to individuals, businesses, governmental units and institutional customers primarily
in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona,
Cedar Rapids and Marion, Iowa.
The Bank competes with other financial institutions and nonfinancial institutions providing similar
financial products. Although the loan activity of the Bank is diversified with commercial and agricultural
loans, real estate loans, automobile, installment and other consumer loans, the Banks credit
is concentrated in real estate loans.
Accounting estimates: The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amount of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Certain significant estimates: The allowance for loan losses, fair values of securities and other financial instruments, and
stock-based compensation expense involves certain significant estimates made by management. These
estimates are reviewed by management routinely and it is reasonably possible that circumstances that
exist at December 31, 2004 may change in the near-term future and that the effect could be material
to the consolidated financial statements.
Principles of consolidation: The consolidated financial statements include the accounts of the Company and its subsidiary.
All significant intercompany balances and transactions have been eliminated in consolidation.
Revenue recognition:  Interest income on loans and investment securities is recognized on the accrual method. Loan
origination fees are recognized when the loans are sold. Trust fees, deposit account service charges
and other fees are recognized when the services are provided or when customers use the services.
Investment securities: Held-to-maturity securities consist solely of debt securities, which the Company has the positive
intent and ability to hold to maturity and are stated at amortized cost.
Available-for-sale securities consist of debt securities not classified as trading or held to maturity.
Available-for-sale securities are stated at fair value, and unrealized holding gains and losses,
net of the related deferred tax effect, are reported as a separate component of stockholders
equity. There were no trading securities as of December 31, 2004 and 2003.
Stock of the Federal Home Loan Bank is carried at cost.
Premiums on debt securities are amortized over the earliest of the call date or the maturity date and
discounts on debt securities are accreted over the period to maturity of those securities. The method
of amortization results in a constant effective yield on those securities (the interest method).
Realized gains and losses on investment securities are included in income, determined on the basis
of the cost of the specific securities sold.
Unrealized losses judged to be other than temporary are charged to operations for both securities available
for sale and securities held to maturity.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 59 of 96
|-------------



|HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1.   Nature of Activities and Significant Accounting Policies (Continued)
Loans:  Loans are stated at the amount of unpaid principal, reduced by the allowance for loan
losses. Interest income is accrued on the unpaid balances as earned.
Loans held for sale are stated at the lower of aggregate cost or estimated fair value. Loans are sold
on a non-recourse basis with servicing released and gains and losses are recognized based on the
difference between sales proceeds and the carrying value of the loan.
The allowance for loan losses is established through a provision for loan losses charged to expense.
Loans are charged against the allowance when management believes the collectability of principal
is unlikely. The allowance for loan losses is maintained at a level considered adequate to provide
for probable losses that can be reasonably anticipated. The allowance is increased by provisions
charged to expense and is reduced by net charge-offs. The Bank makes continuous reviews of the loan
portfolio and considers current economic conditions, historical loss experience, review of specific
problem loans and other factors in determining the adequacy of the allowance.
Loans are considered impaired when, based on current information and events, it is probable the Bank
will not be able to collect all amounts due. An impaired loan includes any loan that has been placed
on nonaccrual status. They also include loans based on current information and events that it is
likely the Bank will be unable to collect all amounts due according to the contractual terms of the
original loan agreement. The portion of the allowance for loan losses applicable to impaired loans
has been computed based on the present value of the estimated future cash flows of interest and principal
discounted at the loans effective interest rate or on the fair value of the collateral for collateral
dependent loans. The entire change in present value of expected cash flows of impaired loans or of
collateral value is reported as bad debt expense in the same manner in which impairment initially
was recognized or as a reduction in the amount of bad debt expense that otherwise would be reported.
Interest income on impaired loans is recognized on the cash basis.
The accrual of interest income on loans is discontinued when, in the opinion of management, there is
reasonable doubt as to the borrowers ability to meet payments of interest or principal when
they become due.
Loan fees and origination costs are reflected in the consolidated statements of income as collected
or incurred. Compared to the net deferral method, this practice had no significant effect on income.
Transfers of financial assets: Transfers of financial assets are accounted for as sales, when control over the assets has been
surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have
been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain
it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the
Company does not maintain effective control over the transferred assets through an agreement to repurchase
them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including
commitments under credit card arrangements, commercial letters of credit and standby letters of credit.
Such financial instruments are recorded when they are funded.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 60 of 96
|-------------



|HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1.   Nature of Activities and Significant Accounting Policies (Continued)
Tax credit real estate: Represents two multi-family rental properties and an assisted living rental property, all which
are affordable housing projects as of December 31, 2004. The assisted living rental property was
added in 2004. The Bank has a 99% limited partnership interest in each limited partnership. The investment
in each was completed after the projects had been developed by the general partner. The properties
are recorded at cost less accumulated depreciation. The Company evaluates the recoverability of the
carrying value on a regular basis. If the recoverability was determined to be in doubt, a valuation
allowance would be established by way of a charge to expense. Depreciation expense is provided on
a straight-line basis over the estimated useful life of the assets. Expenditures for normal repairs
and maintenance are charged to expense as incurred.
The financial condition, results of operations and cash flows of each limited partnership is consolidated
in the Companys financial statements. The operations of the properties are not expected to
contribute significantly to the Companys net income before income taxes. However, the properties
do contribute in the form of income tax credits, which lowers the Companys effective tax rate.
Once established, the credits on each property last for ten years and are passed through from the
limited partnerships to the Bank and reduces the consolidated federal tax liability of the Company.
Property and equipment: Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed
using primarily declining-balance methods over the estimated useful lives of 7-40 years for buildings
and improvements and 3-10 years for furniture and equipment.
Deferred income taxes: Deferred income taxes are provided under the liability method whereby deferred tax assets are
recognized for deductible temporary differences and net operating loss, and tax credit carryforwards
and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences
are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely
than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Goodwill:   Goodwill represents the excess of cost over the fair value of the net assets acquired,
and FASB Statement No. 142 provides for the elimination of the amortization of goodwill and other
intangibles that are determined to have an indefinite life, and requires, at a minimum, annual impairment
tests for intangibles that are determined to have an indefinite life. Effective January 1, 2002,
the Company discontinued the amortization of goodwill, but makes an annual assessment for possible
impairment. The carrying amount of goodwill as of December 31, 2004 and 2003 totaled $2,500,000 net
of accumulated amortization of $1,396,000 and is included in other assets.
Stock awards and options: Compensation expense for stock issued through the stock award plan is accounted for using the
intrinsic value based method of accounting prescribed by APB Opinion No. 25, Accounting for
Stock Issued to Employees. Under this method, compensation is measured as the difference
between the estimated fair value of the stock at the date of award less the amount required to be
paid for the stock. The difference, if any, is amortized straight line to expense over the vesting
period of five years of service. No stock-based employee compensation cost is reflected in net income
because all options granted under the plan had an exercise price equal to the market value of the
underlying common stock on the date of grant. Therefore, the options have no intrinsic value at the
date of grant. See Note 8 to the Financial Statements for a tabular presentation of the reconciliation
between net income, basic earnings per share and diluted earnings per share as reported in the financial
statements and as the information would have been reported (pro forma) if the Company has chosen
to implement the fair value based method for all options.
Common stock held by ESOP: The Companys maximum cash obligation related to these shares is classified outside stockholders
equity because the shares are not readily traded and could be put to the Company for cash.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 61 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 1.   Nature of Activities and Significant Accounting Policies (Continued)
      Trust assets:  Trust assets, other than cash deposits, held by the Bank in fiduciary or agency capacities for its customers are not included in these financial statements since they are not assets of the Company.
      Earnings per share: Basic per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator). 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. On April 13, 2004, the Company declared a three-for-one stock split effective in a form of a dividend, for the 1,516,752 shares of common stock issued and outstanding as of April 19, 2004. The additional shares were issued as a result of the stock split. All shares and earnings per share numbers have been retroactively restated for all periods presented.
    Following is a reconciliation of the denominator:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|                                                   | Year Ended December 31, |          
|-------------------------------------------------- | ----------------------- | ---------
|
|
|                                                   |                        
|Weighted average number of shares                  |                         | 4,550,175
|Potential number of dilutive shares                |                         | 15,511   
|                                                   |                        
|Total shares to compute diluted earnings per share |                         | 4,565,686
|                                                   |                        
|                                                   |                         |          

|There are no potentially dilutive securities that have not been included in the determination of diluted
shares.
Statement of cash flows: For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts
due from banks (including cash items in process of clearing). Cash flows from loans originated by
the Bank, deposits and federal funds sold and securities sold under agreements to repurchase are
reported net.
Fair value of financial instruments: In cases where quoted market prices are not available, fair values of financial instruments
are based on estimates using present value or other valuation techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate and estimates of future cash flows.
In that regard, the derived fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain
financial instruments and all nonfinancial instruments are excluded from fair value disclosure. Accordingly,
the aggregate fair value amounts presented in Note 12 to the Financial Statements do not represent
the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating the fair value of its
financial instruments:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

| | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | Cash and due from banks and federal funds sold: The carrying amounts reported in the consolidated balance sheets for cash and short-term instruments
  approximate their fair values.                                                                                                                                                                                                                                                            

|Page 62 of 96
|-------------



|HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS
|--------------------------------------------------
|                                                  

|Note 1. | Nature of Activities and Significant Accounting Policies (Continued)                                                                                                                                                                                                                                                                                                                                                                               
|------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Investment securities: Fair values for investment securities are based on quoted market prices, where available. If
  quoted market prices are not available, fair values are based on quoted market prices of comparable
  instruments.                                                                                                                                                                                                           
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Loans receivable:  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.                                                                
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Accrued interest receivable:  The fair value of accrued interest receivable equals the amount receivable due to the current
  nature of the amounts receivable.                                                                                                                                                                                                                                                                                    
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Deposit liabilities: The fair values of demand deposits equal their carrying amounts, which represent the amount
  payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates
  of deposit are estimated using a discounted cash flow calculation that applies interest rates currently
  being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Short-term borrowings: The carrying amounts of federal funds sold and securities sold under agreements to repurchase
  approximate their fair values.                                                                                                                                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Long-term borrowings: The fair values of the Banks long-term borrowings (other than deposits) are estimated
  using discounted cash flow analyses, based on the Bank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.                                                                                                                                                                                                                                                                                                 

|                                                                                                               
|---------------------------------------------------------------------------------------------------------------
|Reclassifications:  Certain prior year amounts may be reclassified to conform to the current year presentation.

|Page 63 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 2. Investment Securities
      Investment Securities Available For Sale:
    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 December 31, 2004 or 2003. The carrying amount of available-for-sale securities and their approximate fair values were as follows December 31 (in thousands):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|                                 | Amortized
      Cost |         | Gross
      Unrealized
      Gains |   | Gross
      Unrealized
      (Losses) |  | Estimated
      Fair
      Value |     
|-------------------------------- | -------------------- | ------- | ---------------------------------- | - | ------------------------------------- |  | -------------------------------- | ----
|                                 |                     
|                                 |                      |         |                                    |   |                                       |  |                                  |     
|December 31, 2004:               |                      |         |                                    |   |                                       |  |                                  |     
|U. S. Government agencies and   
|corporations                     | $                    | 134,316 |                                    | $ | 382                                   |  | $                                | (769
|State and political subdivisions |                      | 68,892  |                                    |   | 1,484                                 |  |                                  | (182
|                                 |                     
|Total                            | $                    | 203,208 |                                    | $ | 1,866                                 |  | $                                | (951
|                                 |                     
|                                
|December 31, 2003:              
|                                 |                      |         |                                    |  
|U. S. Treasury                   | $                    | 6,020   |                                    | $ | 118                                   |  | $                                |    
|U. S. Government agencies and   
|                                 |                      |         |                                    |  
|corporations                     |                      | 150,155 |                                    |   | 2,635                                 |  |                                  | (80 
|                                 |                      |         |                                    |  
|State and political subdivisions |                      | 58,355  |                                    |   | 2,287                                 |  |                                  | (60 
|                                 |                     
|Total                            | $                    | 214,530 |                                    | $ | 5,040                                 |  | $                                | (140
|                                 |                     

|                                                                                                                                                                                              
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The amortized cost and estimated fair market value of available-for-sale securities classified according to their contractual maturities at December 31, 2004, were as follows (in thousands):
|                                                                                                                                                                                              

|                                       | Amortized
      Cost |         | Fair
      Value |  
|-------------------------------------- | -------------------- | ------- | ---------------- | -
|                                       |                     
|                                       |                      |         |                  |  
|Due in one year or less                | $                    | 48,620  |                  | $
|Due after one year through five years  |                      | 132,464 |                  |  
|Due after five years through ten years |                      | 21,027  |                  |  
|                                       |                      |        
|Due over ten years                     |                      | 1,097   |                  |  
|                                       |                     
|Total                                  | $                    | 203,208 |                  | $
|                                       |                     

|                                                                                                                                                                                                                            
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|As of December 31, 2004, investment securities with a carrying value of $100,485,000 were pledged to
collateralize public and trust deposits, short-term borrowings and for other purposes, as required
or permitted by law.

|Page 64 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 2. Investment Securities (Continued)
    Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows for the years ended December 31 (in thousands):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                

|                      | 2004 |   | 2003 |   | 2002   |  
|--------------------- | ---- | - | ---- | - | ------ | -
|                      |      |   |      |   |        |  
|Sales proceeds        | $    |  |      | $ | 11,658 |  
|Gross realized gains  |      |  |      |   |       |  
|Gross realized losses |      |  |      |   | (177   | )

|                                                                                                                                                                                                                                                                    
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The following table shows the Companys investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2004 (in thousands):
|                                                                                                                                                                                                                                                                    

|                          | Less than 12 months |    | 12 months or more |   | Total  | 
|------------------------- | ------------------- | -- | ----------------- | - | ------ | 
|
|                          |                     |    |                   |   |        | 
|                          |                     |    |                   |   |        | 
|U.S. Government           |                     |    |                   |   |        | 
|agencies and corporations |                     | 35 |                   | $ | 80,537 | 
|                          |                     |    |                   |   |        | 
|State and municipal bonds |                     | 59 |                   |   | 9,591  | 
|                          |                     |    |                   |   |        | 
|Total temporarily        
|impaired securities       |                     | 94 |                   | $ | 90,128 | 
|                          |                     |    |                   |   |        | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 nature of the investments
with gross unrealized losses as of December 31, 2004 was as follows: U.S. government agency securities;
(38 positions issued and guaranteed by FNMA, FHLB, or FHLMC); and state and municipal bonds (25 issues
are local issues, nonrated and 61 issues are A1 or better rated, general obligation bonds). Therefore,
none of the impairments 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 impairments 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.
Investment Securities Held to Maturity:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|                                 | Amortized
      Cost |       | Gross 
      Unrealized
      Gains |   | Gross 
      Unrealized 
      (Losses) |  | Fair
      Value |    
|-------------------------------- | -------------------- | ----- | ----------------------------------- | - | --------------------------------------- |  | ---------------- | ---
|
|
|December 31, 2004:               |                      |       |                                     |   |                                         |  |                  |    
|                                 |                      |       |                                     |  
|State and political subdivisions | $                    | 5,000 |                                     | $ | 28                                      |  | $                | (42
|                                 |                     
|                                
|December 31, 2003:              
|                                 |                      |       |                                     |  
|State and political subdivisions | $                    | 7,953 |                                     | $ | 127                                     |  | $                | (16
|                                 |                     

|Page 65 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 2. Investment Securities (Continued)
    The amortization cost and estimated fair market value of securities held to maturity classified according to their contractual maturities at December 31, 2004, were as follows (in thousands):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                            

|                                       | Amortized
      Cost |       | Fair
      Value |  
|-------------------------------------- | -------------------- | ----- | ---------------- | -
|Due in one year or less                | $                    | 4,685 |                  | $
|                                       |                      |      
|Due after one year through five years  |                      | 240   |                  |  
|                                       |                      |      
|Due after five years through ten years |                      | 75    |                  |  
|                                       |                      |       |                  |  
|Total                                  | $                    | 5,000 |                  | $
|                                       |                      |       |                  |  

|                                                                                                                                                                                                                                                                    
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The following table shows the Companys investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2004 (in thousands):

|                                    | Less than 12 months |   | 12 months or more |   | Total | 
|----------------------------------- | ------------------- | - | ----------------- | - | ----- | 
|
|                                    |                     |   |                   |   |       | 
|State and municipal
          bonds |                     | 1 |                   | $ | 3,945 | 
|                                    |                     |   |                   |   |       | 
|Total temporarily                   |                    
|impaired securities                 |                     | 1 |                   | $ | 3,945 | 
|                                    |                     |   |                   |   |       | 

|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 nature of the investment
with a gross unrealized loss as of December 31, 2004 was a local county capital note due June 1,
2005. The impairment in the above table was not due to the deterioration in the credit quality of
the issue that might result in the non-collection of contractual principal and interest. The cause
of the impairment is due to changes in interest rates.
Note 3. Loans
The composition of loans is as follows:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | December 31,           |          
|------------------------------ | ---------------------- | ---------
|
|
|                               |                       
|                               | (Amounts In Thousands) |          
|                               |                        |          
|Agricultural                   | $                      | 39,116   
|                               |                        |          
|Commercial and financial       |                        | 70,453   
|                               |                        |          
|Real estate:                   |                        |          
|Construction                   |                        | 72,388   
|                               |                        |          
|Mortgage                       |                        | 797,958  
|                               |                        |          
|Loans to individuals           |                        | 32,106   
|                               |                       
|                               |                        |          
|                               |                        | 1,012,021
|                               |                        |          
|Less allowance for loan losses |                        | 13,790   
|                               |                       
|                               | $                      | 998,231  
|                               |                       
|                               |                        |          

|Page 66 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 3. Loans (continued)
    Changes in the allowance for loan losses are as follows:
|-----------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                     

|                             | Year Ended December 31, |  
|---------------------------- | ----------------------- | -
|
|
|
|                             |                         |  
|Balance, beginning           |                         | $
|Provision charged to expense |                         |  
|Recoveries                   |                         |  
|Loans charged off            |                         |  
|
|Balance, ending              |                         | $
|

|Information about impaired and nonaccrual loans as of and for the years ended December 31, 2004, 2003 and 2002 are as follows:
|------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                              

|                                                                         | 2004 |   | 2003   |  | 2002 |       
|------------------------------------------------------------------------ | ---- | - | ------ |  | ---- | ------
|
|
|                                                                         |      |   |        |  |      |       
|Loans receivable for which there is a related allowance for loan losses  |      | $ | 1,567  |  | $    | 3,793 
|Loans receivable for which there is no related allowance for loan losses |      |   | 17,410 |  |      | 14,384
|
|Total                                                                    |      | $ | 18,977 |  | $    | 18,177
|
|                                                                         |      |   |        |  |      |       
|Related allowance for credit losses on impaired loans                    |      | $ | 228    |  | $    | 802   
|Average balance of impaired loans                                        |      |   | 18,087 |  |      | 17,883
|Nonaccrual loans (included as impaired loans)                            |      |   | 808    |  |      | 3,944 
|Loans past due ninety days or more and still accruing                    |      |   | 2,313  |  |      | 2,296 
|Interest income recognized on impaired loans                             |      |   | 1,168  |  |      | 1,202 

|Note 4.Property and Equipment
The major classes of property and equipment and the total accumulated depreciation are as follows:
|--------------------------------------------------------------------------------------------------------------------------------

|                              | December 31, |  
|----------------------------- | ------------ | -
|
|
|
|
|                              |              |  
|Land                          |              | $
|Buildings and improvements    |              |  
|Furniture and equipment       |              |  
|
|                              |              |  
|Less accumulated depreciation |              |  
|
|Net                           |              | $
|

|Page 67 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 5. Interest-Bearing Deposits
    A summary of these deposits are as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                

|                        | December 31, |  
|----------------------- | ------------ | -
|
|
|
|
|                        |              |  
|NOW and other demand    |              | $
|Savings                 |              |  
|Time, $100,000 and over |              |  
|Other time              |              |  
|
|                        |              | $
|

|Time deposits have a maturity as follows:
|-----------------------------------------
|                                         

|                                         | December 31, |  
|---------------------------------------- | ------------ | -
|
|
|
|Due in one year or less                  |              | $
|Due after one year through two years     |              |  
|Due after two years through three years  |              |  
|Due after three years through four years |              |  
|Due over four years                      |              |  
|                                         |              |  
|                                         |              | $
|                                         |              |  

|Note 6. Short-Term Borrowings
    The following table sets forth selected information for short-term borrowings (borrowings with a maturity of less than one year):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                   | December 31, |  
|-------------------------------------------------- | ------------ | -
|
|
|
|(1)  Federal funds purchased, secured by U.S.      |              | $
|Government agencies                                |              |  
|(1)  Repurchase agreements with customers,         |             
|renewable daily, interest payable monthly,         |             
|secured by U.S. Government agencies                |              |  
|(1) Repurchase agreements with customers, interest |             
|fixed, maturities of less than one year, secured   |             
|by U.S. Government agencies                        |              |  
|                                                   |              |  
|                                                   |              | $
|                                                   |              |  

|(1) The weighted average interest rate on short-term borrowings outstanding as of December 31, 2004 and 2003 was 1.83% and 1.00%, respectively.
|-----------------------------------------------------------------------------------------------------------------------------------------------

|Customer repurchase agreements are used by the Bank to acquire funds from customers where the customer
is required or desires to have their funds supported by collateral consisting of government, government
agency or other types of securities. The repurchase agreement is a promise to sell these securities
to a customer at a certain price and repurchase them at a future date at that same price plus interest
accrued at an agreed upon rate. The Bank uses customer repurchase agreements in its liquidity plan
as well as an accommodation to customers. At December 31, 2004, $18.7 million of securities sold
under repurchase agreements with a weighted average interest rate of 1.06%, maturing in 2005, were
collateralized by U.S. Government agencies having an estimated fair value of $19.1 million and an
amortized cost of $19.3 million.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 68 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 7.   Federal Home Loan Bank Borrowings
    As of December 31, 2004 and 2003, the borrowings were as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         | 2004 |   | 2003    | 
|------------------------ | ---- | - | ------- | 
|
|
|                         |      |   |         | 
|Due 2005, 3.80%          |      | $ | 4,350   | 
|Due 2006, 4.08%          |      |   | 22,750  | 
|Due 2007, 4.48%          |      |   | 20,000  | 
|Due 2008, 5.22% to 6.00% |      |   | 40,442  | 
|Due 2009, 5.66% to 6.22% |      |   | 40,000  | 
|Due 2010, 5.77% to 6.61% |      |   | 40,000  | 
|
|                         |      | $ | 167,542 | 
|

|$100 million of the borrowings were callable as of December 31, 2004, with $10 million callable in January of 2005.
      The borrowings are collateralized by 1-4 family mortgage loans with an aggregate face amount of $201,050,000. As of December 31, 2004, the Company held Federal Home Loan Bank stock with a cost of $8,893,000.
      Note 8.   Employee Benefit Plans
      The Company has an Employee Stock Ownership Plan (the ESOP) to which it makes discretionary cash contributions. The Companys contribution to the ESOP totaled $1,038,000, $108,000 and $93,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
    In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value. To the extent that shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders equity to liabilities. As of December 31, 2004 and 2003, the shares held by the ESOP, fair value and maximum cash obligation were as follows:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                        | 2004 |   | 2003       | 
|----------------------- | ---- | - | ---------- | 
|                        |      |   |            | 
|                        |      |   |            | 
|Shares held by the ESOP |      |   | 441,516    | 
|                        |      |   |            | 
|Fair value per share    |      | $ | 37.00      | 
|                        |      |   |            | 
|Maximum cash obligation |      | $ | 16,336,000 | 
|                        |      |   |            | 

|Page 69 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 8.    Employee Benefit Plans (Continued)
      The Company has a profit-sharing plan with a 401(k) feature, which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The profit-sharing contribution totaled $0, $862,000 and $741,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
      The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 198,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Directors may exercise options immediately and officers rights under the plan vest over a five-year period from the date of the grant. No compensation expense has been charged to expense using the intrinsic value based method as prescribed by APB No. 25.
    The following table illustrates the effect on net income and earnings per share had compensation cost for all of the stock-based compensation plans been determined based on the grant date values of awards (the method described in FASB Statement No. 123, Accounting for Stock-Based Compensation):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                  | Years Ended December 31, |  
|------------------------------------------------- | ------------------------ | -
|
|
|
|Net income:                                       |                          |  
|As reported                                       |                          | $
|                                                  |                         
|Deduct total stock-based employee compensation    |                         
|expense determined under fair value based         |                         
|method for all awards, net of related tax effects |                          |  
|
|                                                  |                          |  
|Pro forma                                         |                          | $
|
|                                                  |                         
|Basic earnings per share:                         |                         
|As reported                                       |                          | $
|Pro forma                                         |                          | $
|                                                  |                         
|Diluted earnings per share:                       |                         
|As reported                                       |                          | $
|Pro forma                                         |                          | $

|Page 70 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 8.   Employee Benefit Plans (Continued)
    A summary of the stock options are as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------

|                           | Number
      Of Shares |  | Weighted Average
      Exercise Price |  
|-------------------------- | ---------------------- |  | ------------------------------------- | -
|                           |                        | 
|                           |                        |  |                                       |  
|Balance, December 31, 2001 |                        |  | 87,537                                |  
|Granted                    |                        |  | 1,908                                 |  
|Exercised                  |                        |  | (6,000                                | )
|                           |                        | 
|Balance, December 31, 2002 |                        |  | 83,445                                |  
|Granted                    |                        |  | 18,600                                |  
|Exercised                  |                        |  | (44,172                               | )
|                           |                        | 
|Balance, December 31, 2003 |                        |  | 57,873                                |  
|Granted                    |                        |  | 5,880                                 |  
|Exercised                  |                        |  |                                      |  
|                           |                        | 
|Balance, December 31, 2004 |                        |  | 63,753                                |  
|                           |                        | 

|The weighted average fair value of options granted in 2004, 2003 and 2002 was $6.53 per share, $5.40 per share, and $6.71 per share, respectively.
    The fair value of stock options granted was determined utilizing the Black Scholes Valuation model. Significant assumptions include:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                        | 2004 |  | 2003     |   | 2002 |         
|----------------------- | ---- |  | -------- | - | ---- | --------
|
|                        |      |  |          |   |      |         
|Risk-free interest rate |      |  | 4.69     | % |      | 4.57    
|Expected option life    |      |  | 10 years |   |      | 10 years
|Expected volatility     |      |  | 4.29     | % |      | 6.69    
|Expected dividends      |      |  | 2.08     | % |      | 2.16    

|Other pertinent information related to the options outstanding at December 31, 2004 is as follows:
|--------------------------------------------------------------------------------------------------

|Exercise Price |       | Number Outstanding |        | Remaining Contractual Life |            | Number Exercisable | 
|-------------- | ----- | ------------------ | ------ | -------------------------- | ---------- | ------------------ | 
|              
|               |       |                    |        |                            |            |                    | 
|$              | 13.67 |                    | 6,165  |                            | 27 Months  |                    | 
|               | 25.67 |                    | 31,200 |                            | 77 Months  |                    | 
|               | 24.33 |                    | 1,134  |                            | 68 Months  |                    | 
|               | 25.00 |                    | 774    |                            | 72 Months  |                    | 
|               | 29.33 |                    | 15,600 |                            | 96 Months  |                    | 
|               | 33.67 |                    | 3,000  |                            | 108 Months |                    | 
|               | 34.50 |                    | 2,940  |                            | 112 Months |                    | 
|               | 36.25 |                    | 2,940  |                            | 117 Months |                    | 
|               |       |                    |        |                            |            |                    | 
|               |       |                    | 63,753 |                            |            |                    | 
|               |       |                    |        |                            |            |                    | 

|As of December 31, 2004, 132,426 shares were available for stock options and awards. The committee
is also authorized to grant awards of restricted common stock, and it authorized the issuance of
222 shares of common stock in 2004, , 2,700 in 2003 and 2,673 in 2002 to a group of employees. The
vesting period for these awards is five years and the Bank amortizes the expense on a straight line
basis during the vesting period. The expense relating to these awards for the years ended December
31, 2004, 2003 and 2002 was $57,000, $61,000 and $50,000, respectively.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 71 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 9.   Income Taxes
    Income taxes for the years ended December 31, 2004, 2003 and 2002 are summarized as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|          | 2004 |   | 2003  |   | 2002 |      
|--------- | ---- | - | ----- | - | ---- | -----
|
|
|Current:  |      |   |       |   |      |      
|Federal   |      | $ | 5,851 |   | $    | 5,465
|State     |      |   | 1,121 |   |      | 1,013
|Deferred: |     
|Federal   |      |   | (540  | ) |      | 453  
|State     |      |   | (81   | ) |      | 67   
|
|          |      | $ | 6,351 |   | $    | 6,998
|

|Temporary differences between the amounts reported in the financial statements and the tax basis of assets and liabilities result in deferred taxes. No valuation allowance was required for deferred tax assets. Based upon the Companys level of historical taxable income and anticipated future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. Deferred tax assets and liabilities at December 31, 2004 and 2003 were as follows:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                          | December 31, |  
|----------------------------------------- | ------------ | -
|
|
|
|
|Deferred income tax assets:               |              |  
|Allowance for loan losses                 |              | $
|Deferred compensation                     |              |  
|Certain accrued expenses                  |              |  
|Other                                     |              |  
|
|Gross deferred tax assets                 |              |  
|
|Deferred income tax liabilities:          |             
|Property and equipment                    |              |  
|FHLB dividends                            |              |  
|Unrealized gains on investment securities |              |  
|Other                                     |              |  
|
|Gross deferred tax liabilities            |              |  
|
|Net deferred income tax asset             |              | $
|

|Page 72 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 9.   Income Taxes (Continued)
    The net change in the deferred income taxes for the years ended December 31, 2004, 2003 and 2002 is reflected in the financial statements as follows:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                | Year Ended December 31, |  
|----------------------------------------------- | ----------------------- | -
|
|
|
|
|                                                |                         |  
|Consolidated statements of income               |                         | $
|Consolidated statements of stockholders equity |                         |  
|
|                                                |                         | $
|

|The income tax provisions for the years ended December 31, 2004, 2003 and 2002 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                    | 2004 |   | 2003  |   | 2002 |     
|------------------- | ---- | - | ----- | - | ---- | ----
|
|
|
|
|                    |      |   |       |   |      |     
|Expected provision  |      | $ | 7,191 |   |      | 35.0
|Tax-exempt interest |      |   | (951  | ) |      | (4.6
|Interest expense    |     
|limitation          |      |   | 107   |   |      | 0.5 
|State income taxes, |     
|net of federal      |     
|income tax          |     
|benefit             |      |   | 676   |   |      | 3.3 
|Income tax credits  |      |   | (596  | ) |      | (2.9
|Other               |      |   | (76   | ) |      | (0.4
|
|                    |      | $ | 6,351 |   |      | 30.9
|

|Page 73 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 10.  Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and CashRestrictions
      The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Companys financial results. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of the Company and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
      Quantitative measures established by the regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the tables that follow) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes that, as of December 31, 2004 and 2003, the Company and the Bank met all capital adequacy requirements to which they are subject.
      As of December 31, 2004, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table that follows. There are no conditions or events since that notification that management believes have changes the institutions category.
    The actual amounts and capital ratios as of December 31, 2004 and 2003, with the minimum regulatory requirements for the Company and Bank are presented below (amounts in thousands):
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                          | Actual |   | For Capital
      Adequacy
    Purposes |  | To Be Well
      Capitalized Under
      Prompt Corrective
    Action Provisions |      
|------------------------- | ------ | - | --------------------------------------- |  | -------------------------------------------------------------------------------- | -----
|
|
|
|As of December 31, 2004:  |        |   |                                         |  |                                                                                  |      
|Company:                  |       
|Total risk based capital  |        | $ | 128,541                                 |  |                                                                                  | 14.03
|Tier 1 risk based capital |        |   | 117,063                                 |  |                                                                                  | 12.78
|Leverage ratio            |        |   | 117,063                                 |  |                                                                                  | 9.09 
|Bank:                     |       
|Total risk based capital  |        |   | 125,211                                 |  |                                                                                  | 13.68
|Tier 1 risk based capital |        |   | 113,740                                 |  |                                                                                  | 12.43
|Leverage ratio            |        |   | 113,740                                 |  |                                                                                  | 8.84 

|Page 74 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 10. Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash 
                     Restrictions (continued)
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                          | Actual |   |         | For Capital
      Adequacy
    Purposes |  | To Be Well
      Capitalized Under
      Prompt Corrective
    Action Provisions |  
|------------------------- | ------ | - | ------- | --------------------------------------- |  | -------------------------------------------------------------------------------- | -
|
|
|                          |        |  
|As of December 31, 2003:  |        |   |         |                                         |  |                                                                                  |  
|Company:                  |       
|Total risk based capital  |        | $ | 116,035 |                                         |  | 14.56                                                                            | %
|Tier 1 risk based capital |        |   | 106,042 |                                         |  | 13.31                                                                            |  
|Leverage ratio            |        |   | 106,042 |                                         |  | 8.98                                                                             |  
|Bank:                     |       
|Total risk based capital  |        |   | 112,641 |                                         |  | 14.15                                                                            |  
|Tier 1 risk based capital |        |   | 102,661 |                                         |  | 12.90                                                                            |  
|Leverage ratio            |        |   | 102,661 |                                         |  | 8.71                                                                             |  

|The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by
the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it may
pay in dividends. To maintain acceptable capital ratios in the Bank, certain of its retained earnings
are not available for the payment of dividends. To maintain a ratio of capital to assets of 8%, retained
earnings of $13,282,000 as of December 31, 2004 are available for the payment of dividends to the
Company.
The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve
balances totaled $1,867,000 and $2,092,000 as of December 31, 2004 and 2003, respectively.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 75 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 11.   Related Party Transactions
      Certain directors of the Company and the Bank and companies with which the directors are affiliated and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.
    The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2004 and 2003:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                   | Year Ended December 31, |  
|------------------ | ----------------------- | -
|
|
|
|
|                   |                         |  
|Balance, beginning |                         | $
|Advances           |                         |  
|Collections        |                         |  
|
|Balance, ending    |                         | $
|

|Deposits from related parties are accepted subject to the same interest rates and terms as those from
nonrelated parties.
|-------------------------------------------------------------------------------------------------------------------------

|Page 76 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 12.   Fair Value of Financial Instruments
    The carrying value and estimated fair values of the Companys financial instruments as of December 31, 2004 and 2003 are as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                       |  |  |                        |          
|-------------------------------------- |  |  | ---------------------- | ---------
|                                       |  |  | 2004                   |          
|                                       |  |  |                       
|                                       |  |  | Carrying
      Amount  |          
|                                       |  |  |                       
|                                       |  |  | (Amounts In Thousands) |          
|                                       |  |  |                        |          
|Cash and due from banks                |  |  | $                      | 23,008   
|Federal funds sold                     |  |  |                        |         
|Investment securities                  |  |  |                        | 218,016  
|Loans                                  |  |  |                        | 1,002,139
|Accrued interest receivable            |  |  |                        | 7,349    
|Deposits                               |  |  |                        | 957,236  
|Federal funds purchased and securities |  | 
|sold under agreements to repurchase    |  |  |                        | 37,985   
|Borrowings from Federal Home Loan      |  | 
|Bank                                   |  |  |                        | 167,542  
|Accrued interest payable               |  |  |                        | 1,632    
|                                       |  |  |                        |          
|                                       |  |  | Face
      Amount      |          
|                                       |  |  |                        |          
|                                       |  |  |                        |          
|Off-balance sheet instruments:         |  |  |                        |          
|Loan commitments                       |  |  | $                      | 163,291  
|Letters of credit                      |  |  |                        | 12,693   

|Page 77 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 13.   Parent Company Only Financial Information
    Following is condensed financial information of the Company (parent company only):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|CONDENSED BALANCE SHEETS  
|--------------------------
|December 31, 2004 and 2003
|(Amounts In Thousands)    

|                                                    |  | 
|--------------------------------------------------- |  | 
|ASSETS                                              |  | 
|                                                   
|                                                    |  | 
|Cash                                                |  | 
|Investment securities available for sale            |  | 
|Investment in subsidiary bank                       |  | 
|Other assets                                        |  | 
|                                                    |  | 
|Total assets                                        |  | 
|                                                    |  | 
|LIABILITIES AND STOCKHOLDERS EQUITY                |  | 
|                                                   
|                                                    |  | 
|Liabilities                                         |  | 
|                                                    |  | 
|Redeemable common stock held by ESOP                |  | 
|                                                    |  | 
|Stockholders equity:                               |  | 
|Capital stock                                       |  | 
|Retained earnings                                   |  | 
|Accumulated other comprehensive income              |  | 
|                                                    |  | 
|                                                    |  | 
|Less maximum cash obligation related to ESOP shares |  | 
|                                                    |  | 
|Total stockholders equity                          |  | 
|                                                    |  | 
|Total liabilities and stockholders equity          |  | 
|                                                    |  | 

|Page 78 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
    Note 13.   Parent Company Only Financial Information (Continued)
|-----------------------------------------------------------------------------------------------------------------------------

|CONDENSED STATEMENTS OF INCOME              
|--------------------------------------------
|Years Ended December 31, 2004, 2003 and 2002
|(Amounts In Thousands)                      

|                                                        |  |  |     
|------------------------------------------------------- |  |  | ----
|                                                        |  |  | 2004
|                                                       
|                                                        |  |  |     
|Interest on checking accounts and investment securities |  |  | $   
|Dividends received from subsidiary                      |  |  |     
|Other expenses                                          |  |  |     
|                                                        |  |  |     
|Income before income tax benefit and                    |  | 
|equity in subsidiarys undistributed income             |  |  |     
|Income tax benefit                                      |  |  |     
|                                                        |  |  |     
|                                                        |  |  |     
|Equity in subsidiarys undistributed income             |  |  |     
|                                                        |  |  |     
|Net income                                              |  |  | $   
|                                                        |  |  |     

|Page 79 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
    Note 13.    Parent Company Only Financial Information (Continued)
|------------------------------------------------------------------------------------------------------------------------------

|CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2004, 2003 and 2002
(Amounts In Thousands)
|------------------------------------------------------------------------------------------------------

|                                                    | 2004 |         | 2003 |   | 2002    |  
|--------------------------------------------------- | ---- | ------- | ---- | - | ------- | -
|                                                   
|Cash flows from operating activities:               |      |         |      |   |         |  
|Net income                                          | $    | 14,195  |      | $ | 14,269  |  
|Noncash items included in net income:              
|Undistributed income of subsidiary                  |      | (11,079 | )    |   | (11,472 | )
|                                                    |      |         |     
|(Increase) decrease in other assets                 |      | 489     |      |   | (379    | )
|                                                    |      |         |     
|Increase (decrease) in liabilities                  |      | 117     |      |   | 110     |  
|                                                    |      |         |     
|                                                    |     
|Net cash provided by operating activities           |      | 3,722   |      |   | 2,528   |  
|                                                    |     
|Cash flows from investing activities:              
|                                                    |      |         |     
|Proceeds from maturities of investment securities   |      |        |      |   |        |  
|                                                    |      |         |     
|Purchase of investment securities                   |      |        |      |   |        |  
|                                                    |     
|Net cash provided (used in) by investing activities |     |         |     |   | 7       |  
|                                                    |     
|Cash flows from financing activities:              
|                                                    |      |         |     
|Common stock issued, net                            |      | (11     | )    |   | 465     |  
|Income tax benefits related to stock based         
|                                                    |      |         |     
|compensation                                        |      | 22      |      |   | 347     |  
|Dividends paid                                      |      | (3,185  | )    |   | (2,853  | )
|                                                    |     
|Net cash (used in) financing activities             |      | (3,174  | )    |   | (2,041  | )
|                                                    |     
|Increase in cash                                    |      | 548     |      |   | 487     |  
|Cash balance:                                      
|                                                    |      |         |     
|Beginning                                           |      | 2,343   |      |   | 1,856   |  
|                                                    |     
|Ending                                              | $    | 2,891   |      | $ | 2,343   |  
|                                                    |     

|Page 80 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
      Note 14.   Commitments and Contingencies
      Concentrations of credit risk: The Banks loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Banks market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $23,155,000. The concentrations of credit by type of loan are set forth in Note 3 to the Financial Statements. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors ability to honor their contracts is dependent upon the economic conditions in Johnson County, Iowa.
      Contingencies:  In the normal course of business, the Company and Bank are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying financial statements.
      Financial instruments with off-balance sheet risk: The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
    The Banks exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Banks commitments at December 31, 2004 and 2003 is as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                             | 2004 |   | 2003   | 
|------------------------------------------------------------ | ---- | - | ------ | 
|
|
|Firm loan commitments and unused portion of lines of credit: |      |   |        | 
|Home equity loans                                            |      | $ | 12,705 | 
|Credit card participations                                   |      |   | 17,342 | 
|Commercial, real estate and home construction                |      |   | 71,676 | 
|Commercial lines                                             |      |   | 61,568 | 
|Outstanding letters of credit                                |      |   | 12,693 | 

|Page 81 of 96
|-------------



|HILLS BANCORPORATION

      NOTES TO FINANCIAL STATEMENTS
      Note 14.    Commitments and Contingencies (Continued)
      Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customers credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on managements credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card participations are the unused portion of the holders credit limits. Such amounts represent the maximum amount of additional unsecured borrowings.
      Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year, or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment.
The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded the Bank would be
entitled to seek recovery from the customer. At December 31, 2004 and 2003 no amounts have been recorded as liabilities for the Banks potential obligations under these guarantees.
    Lease commitments:  The  Company leases  certain  facilities  under  operating  leases.  The  minimum future rental commitments as of December 31, 2004 for all noncancelable leases  relating to Bank premises were  as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Year ending December 31: |  | (Amounts In Thousands) |      
| | ------------------------ |  | ---------------------- | -----
| |                          |  |                        |      
| | 2005                     |  | $                      | 195  
| | 2006                     |  |                        | 195  
| | 2007                     |  |                        | 134  
| | 2008                     |  |                        | 129  
| | 2009                     |  |                        | 129  
| | Thereafter               |  |                        | 568  
| |                          |  |                        |      
| |                          |  | $                      | 1,350
| |                          |  |                        |      

|Page 82 of 96
|-------------



|HILLS BANCORPORATION
      NOTES TO FINANCIAL STATEMENTS
    Note 15.  Quarterly Results of Operations (unaudited, amounts in thousands, except per share amounts)
|------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                           | Quarter Ended |  
|-------------------------- | ------------- | -
|
|
|
|2004:                      |               |  
|Interest income            |               | $
|Interest expense           |               |  
|
|Net interest income        |               | $
|Provision for loan losses  |               |  
|Other income               |               |  
|Other expense              |               |  
|
|Income before income taxes |               | $
|Income taxes               |               |  
|
|Net income                 |               | $
|
|                           |               |  
|Basic earnings per share   |               | $
|Diluted earnings per share |               |  
|                           |              
|2003:                      |              
|Interest income            |               | $
|Interest expense           |               |  
|
|Net interest income        |               | $
|Provision for loan losses  |               |  
|Other income               |               |  
|Other expense              |               |  
|
|Income before income taxes |               | $
|Income taxes               |               |  
|
|Net income                 |               | $
|
|                           |               |  
|Basic earnings per share   |               | $
|Diluted earnings per share |               |  

|Page 83 of 96
|-------------



|PART II
Item 9.   Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
On May 13, 2003, upon the recommendation and approval of its Audit Committee, the Company terminated
its relationship with McGladrey & Pullen LLP (McGladrey & Pullen) as its independent
auditor and appointed the firm of KPMG LLP (KPMG) to be the Companys Auditor for
the 2003 fiscal year. There were no disagreements with KPMG on any matter of accounting principles
or practices, financial statement disclosures, or auditing scope or procedure. KPMG has not audited
any of the Companys financial statements for year-ends prior to December 31, 2002 and therefore
is unable to express an opinion on any prior years financial information.
McGladrey & Pullens audit report on the Companys consolidated financial statements
for the fiscal year ended December 31, 2002 did not contain an adverse opinion or disclaimer of opinion,
nor were they qualified or modified as to uncertainty, audit scope or accounting principles.
During the two fiscal years ended December 31, 2002 and 2001 and the subsequent interim preceding the
decision to change independent auditors, there were no disagreements with McGladrey & Pullen
on any matter of accounting principles or practices, financial statement disclosures, or auditing
scope or procedure which, if not resolved to McGladrey & Pullens satisfaction would have
caused them to make reference to the subject matter of the disagreement in connection with the audit
reports on the Companys consolidated financial statements for such year, and there were no
reportable events as defined in Item 304 (a)(1)(v) of Regulation S-K.
In the years ended December 31, 2002 and 2001 and up to May 13, 2003, the date of KPMGs
engagement, the Company did not consult KPMG with respect to the application of accounting principles
to a specified transaction, either completed or proposed, or the type of audit opinion that might
be rendered on the Companys consolidated financial statements, or any other matters or reportable
events as set forth in Items 304 (a)(2)(i) and (ii) of Regulation S-K.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
At December 31, 2004 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 pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls
and procedures are effective to ensure that information required to be disclosed in the reports that
the Company files or submits under the Exchange Act is recorded, processed, summarized and reported
as required and within the time periods specified in the SECs rules and forms. There have been
no significant changes in the Companys internal controls or in other factors that could significantly
affect these controls subsequent to the date of this evaluation.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 84 of 96
|-------------



|Item 9A. Controls and Procedures (Continued)
Managements Report on Internal Control Over Financial Reporting
The Companys management is responsible for establishing and maintaining a system of internal
controls over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). This
system is augmented by written policies and procedures, careful selection and training of financial
management personnel, a continuing management commitment to the integrity of the system and through
examinations by an internal audit function that coordinates its activities with the Companys
Independent Registered Public Accounting Firm.
Under the supervision and with the participation of the Companys management, including the Companys
Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness
of the Companys internal controls over financial reporting based on the framework in Internal
Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on the Companys evaluation under the framework in Internal Control 
Integrated Framework, the Companys management concluded that our internal control over financial
reporting was effective as of December 31, 2004.
The Companys managements assessment of the effectiveness of our internal control over financial
reporting as of December 31, 2004 has been audited by KPMG LLP, an independent registered public
accounting firm, as stated in their report which is included herein.
Item 9B. Other Information
Not Applicable.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Page 85 of 96
|-------------



|PART III
Item 10.   Directors and Executive Officers of the Registrant
The information required by Item 10 of Part III is presented under the items entitled Certain
Information Regarding Directors and Executive Officers and Section 16(a) Beneficial Ownership
Reporting Compliance in the Companys Definitive Proxy Statement dated March 21, 2005
for the Annual Meeting of Stockholders on April 18, 2005. Such information is incorporated herein
by reference.
James A. Nowak has been elected to the Companys Board of Directors and has been designated as
the financial expert of the Audit Committee. Mr. Nowak graduated from the University of Wisconsin
at Madison with a Bachelors of Business Administration degree in accounting. He is a Certified Public
Accountant and, from 1976 until his retirement in July of 2004, was an Audit and Accounting Partner
with McGladrey and Pullen, LLP (McGladrey). Most recently, he served as the location
leader of McGladreys Cedar Rapids, Iowa office.
The Company has a Code of Ethics in place for the Chief Executive Officer and Chief Financial Officer.
A copy of the Companys Code of Ethics will be provided free of charge, upon written request
to:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

| | James G. Pratt
  Treasurer
  Hills Bancorporation
  131 Main Street
  Hills, Iowa  52235
| | ----------------------------------------------------------------------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Item 11.   Executive Compensation
The information required by Item 11 of the Part III is presented under the item entitled Executive
Compensation and Benefits in the Companys Definitive Proxy Statement for the Annual Meeting
of Stockholders on April 18, 2005. Such information is incorporated herein by reference.
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Shareholders
Matters
The information required by Item 12 of Part III is presented under the item entitled Security
Ownership of Principal Stockholders and Management and Report on Executive Compensation,
in the Companys Definitive Proxy Statement for the Annual Meeting of Stockholders on April
18, 2005. Such information is incorporated herein by reference.
Item 13.   Certain Relationships and Related Transactions
The information required by Item 13 of Part III is presented under the item entitled Loans to
and Certain Other Transactions with Executive Officers and Directors in the Companys
Definitive Proxy Statement for the Annual Meeting of Stockholders on April 18, 2005. Such information
is incorporated herein by reference.
Item 14.   Principal Accountant Fees and Services
Information required by this item is contained in the Registrants Proxy Statement dated March
21, 2005, under the heading Independent Auditors  Audit and Other Fees, which section
is incorporated herein by this reference.

|Page 86 of 96
|-------------



|PART IV
    Item 15.   Exhibits, Financial Statements, Schedules and Reports on Form 8-K
|----------------------------------------------------------------------------------------

|    |      |  |                                                                                                                                                                                         | Form 10-K
|--- | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------
|(a) | 1.   |  | Financial Statements                                                                                                                                                                    | Reference
|    |      |  |                                                                                                                                                                                         |          
|    |      |  | Independent registered public accounting firms reports on the financial statements                                                                                                     | 50-52    
|    |      |  | Consolidated balance sheets as of December 31, 2004 and 2003                                                                                                                            | 53       
|    |      |  | Consolidated statements of income for the years ended December 31, 2004 , 2003, 
       and 2002                                                                                        | 54       
|    |      |  | Consolidated statements of comprehensive income for the years ended


        
   December 31, 2004 , 2003 and 2002                                                                     | 55       
|    |      |  | Consolidated statements of stockholders equity for the years ended


December 31, 2004 ,    2003 and 2002                                                                              | 56       
|    |      |  | Consolidated statements of cash flows for the years ended December 31, 2004 ,


2003 
   and 2002                                                                                       | 57-58    
|    |      |  | Notes to financial statements                                                                                                                                                           | 59-83    
|    |      |  |                                                                                                                                                                                         |          
|    | 2.   |  | Financial Statements Schedules                                                                                                                                                          |          
|    |      |  |                                                                                                                                                                                         |          
|    |      |  | All schedules are omitted because they are not applicable or not required, or because the


required information is included in the consolidated financial statements or notes thereto. |          
|    |      |  |                                                                                                                                                                                         |          
|(a) | 3.   |  | Exhibits                                                                                                                                                                                |          
|    |      |  |                                                                                                                                                                                         |          
|    | 3.1  |  | Articles of Incorporation filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993


are incorporated by reference.                                                         |          
|    |      |  |                                                                                                                                                                                         |          
|    | 3.2  |  | By-Laws filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993 are incorporated


by reference.                                                                           |          
|    |      |  |                                                                                                                                                                                         |          
|    | 10.1 |  | Material Contract (Employee Stock Ownership Plan) filed as Exhibit 10(a) in Form 10-K for the year


ended December 31, 1993 is incorporated by reference.                              |          
|    |      |  |                                                                                                                                                                                         |          
|    | 10.2 |  | Material Contract (1993 Stock Incentive Plan) filed as Exhibit 10(b) in Form 10-K for the year ended


December 31, 1993 is incorporated by reference.                                  |          
|    |      |  |                                                                                                                                                                                         |          
|    | 10.3 |  | Material Contract (1995 Deferred Compensation Plans) filed as Exhibit 10(c) in Form 10-K for the


year ended December 31, 1995 is incorporated by reference.                           |          
|    |      |  |                                                                                                                                                                                         |          
|    | 10.4 |  | Material Contract (2000 Stock Option and Incentive Plan) filed as Exhibit 10(d) in Form 10-K


for the year ended December 31, 2001 is incorporated by reference.                       |          
|    |      |  |                                                                                                                                                                                         |          
|    | 11   |  | Statement regarding Computation of Basic and Diluted Earnings Per Share on Page 90.                                                                                                     |          
|    |      |  |                                                                                                                                                                                         |          
|    | 16   |  | Letter Regarding Change in Certifying Accountant on Page 91.                                                                                                                            |          
|    |      |  |                                                                                                                                                                                         |          
|    | 21   |  | Subsidiary of the Registrant is Attached on Page 92.                                                                                                                                    |          
|    |      |  |                                                                                                                                                                                         |          
|    | 23   |  | Consent of Registered Public Accounting Firms is Attached on Pages 93.                                                                                                                  |          
|    |      |  | KPMG LLP                                                                                                                                                                                |          
|    |      |  | McGladrey & Pullen LLP                                                                                                                                                                  |          
|    |      |  |                                                                                                                                                                                         |          
|    | 31   |  | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 on Pages 94 - 95.                                                                                                    |          
|    |      |  |                                                                                                                                                                                         |          
|    | 32   |  | Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 on Page 96.                                                                                                          |          
|    |      |  |                                                                                                                                                                                         |          
|(b) |      |  | Reports on Form 8-K:                                                                                                                                                                    |          
|    |      |  |                                                                                                                                                                                         |          
|    |      |  | The Registrant filed no reports on Form 8-K for the three months ended December 31, 2004 .                                                                                              |          

|Page 87 of 96
|-------------



|SIGNATURES
    Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                    |  | HILLS BANCORPORATION                                  
|------------------- |  | ------------------------------------------------------
|                    |  |                                                       
|Date: March 8, 2005 |  | By: /s/ Dwight O. Seegmiller                          
|                   
|                    |  | Dwight O. Seegmiller, Director and President          
|                    |  |                                                       
|Date: March 8, 2005 |  | By: /s/ James G. Pratt                                
|                   
|                    |  | James G. Pratt, Treasurer and Chief Accounting Officer
|                    |  |                                                       

|Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                             

|                    |  | DIRECTORS OF THE REGISTRANT 
|------------------- |  | ----------------------------
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Willis M. Bywater   
|                   
|                    |  | Willis M. Bywater, Director 
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Thomas J. Gill      
|                   
|                    |  | Thomas J. Gill, Director    
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Donald H. Gringer   
|                   
|                    |  | Donald H. Gringer, Director 
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Michael E. Hodge    
|                   
|                    |  | Michael E. Hodge, Director  
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ James A. Nowak      
|                   
|                    |  | James A. Nowak, Director    
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Richard W. Oberman  
|                   
|                    |  | Richard W. Oberman, Director
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Theodore H. Pacha   
|                   
|                    |  | Theodore H. Pacha, Director 
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Ann M. Rhodes       
|                   
|                    |  | Ann M. Rhodes, Director     
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Ronald E. Stutsman  
|                   
|                    |  | Ronald E. Stutsman, Director
|                    |  |                             
|Date: March 8, 2005 |  | By: /s/ Sheldon E. Yoder    
|                   
|                    |  | Sheldon E. Yoder, Director  

|Page 88 of 96
|-------------



|HILLS BANCORPORATIONANNUAL REPORT OF FORM 10-K FOR THEFISCAL YEAR ENDED DECEMBER 31, 2004
|-----------------------------------------------------------------------------------------

|Exhibit


Number |  | Description                                                        | Page Number


        
      In The Sequential


Numbering System


For 2004 Form 10-K
|---------------- |  | ------------------------------------------------------------------ | --------------------------------------------------------------------------------------
|                
|                 |  |                                                                    |                                                                                       
|11               |  | Statement Re Computation of Basic and Diluted Earnings Per Share   | 90 of 96                                                                              
|                 |  |                                                                    |                                                                                       
|16               |  | Letter Regarding Change in Certifying Accountant                   | 91 of 96                                                                              
|                 |  |                                                                    |                                                                                       
|21               |  | Subsidiary of the Registrant                                       | 92 of 96                                                                              
|                 |  |                                                                    |                                                                                       
|23               |  | Consent of Independent Registered Public Accounting Firms          |                                                                                       
|                 |  |                                                                    |                                                                                       
|                 |  | KPMG LLP                                                           | 93 of 96                                                                              
|                 |  | McGladrey & Pullen LLP                                             | 93 of 96                                                                              
|                 |  |                                                                    |                                                                                       
|31               |  | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 | 94 - 95 of 96                                                                         
|                 |  |                                                                    |                                                                                       
|32               |  | Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 | 96 of 96                                                                              
|                
|                

|Page 89 of 96
|-------------