HILLS BANCORPORATION FORM 10-K DECEMBER 31, 2008   UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-Kx
ANNUAL REPORT PURSUANT TO
 SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended
 December 31, 2008.

Commission
 File Number 0-12668.HILLS BANCORPORATION(Exact
 name of Registrant as specified in its charter)Iowa

42-1208067(State or Other
 Jurisdiction of

(IRS
 Employer Identification No.)Incorporation or
 Organization)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 stockTitle of ClassIndicate
by check mark if the Registrant is well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o   No x

Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o   No x

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 x   No o

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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):

Large accelerated filer o     Accelerated filer x     Non-accelerated
filer o

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

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 January 31, 2009 (based upon reports of beneficial ownership that
approximately 81% of the shares are so owned by nonaffiliates and upon the last
independently appraised fair value of the Registrants common stock of $55.00
per share) was $196,796,930.

The
number of shares outstanding of the Registrants common stock as of February
28, 2009 is 4,437,930 shares of no par value common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions
of the Proxy Statement dated March 20, 2009 for the Annual Meeting of the
Shareholders of the Registrant to be held April 20, 2009 (the Proxy Statement)
are incorporated by reference in Part III of this Form 10-K.

Page 1 of 107

HILLS BANCORPORATIONFORM
10-K

TABLE OF CONTENTS

PagePART
IItem 1.

Business

3General

3Competition

5The
Economy

6Supervision and
Regulation

7Consolidated
Statistical Information

13Item 1A.

Risk
Factors

25Item 1B.

Unresolved Staff
Comments

31Item 2.

Properties

32Item 3.

Legal
Proceedings

33Item 4.

Submission of
Matters to a Vote of Security Holders

33Part
IIItem 5.

Market for
Registrants Common Equity, Related
 Stockholder Matters and Issuer Purchases of Equity Securities

34Item 6.

Selected
Financial Data

37Item 7.

Managements
Discussion and Analysis of Financial
 Condition and Results of Operation

38Item 7A.

Quantitative and
Qualitative Disclosures about Market
 Risk

59Item 8.

Consolidated
Financial Statements and Supplementary
 Data

61Item 9.

Changes In and
Disagreements with Accountants on
 Accounting and Financial Disclosure

97Item 9A.

Controls and
Procedures

97Item 9B.

Other
Information

98Part
IIIItem 10.

Directors,
Executive Officers and Corporate Governance

98Item 11.

Executive
Compensation

98Item 12.

Security
Ownership of Certain Beneficial Owners and
 Management and Related Stockholder Matters

98Item 13.

Certain
Relationships and Related Transactions, and
 Director Independence

98Item 14.

Principal
Accounting Fees and Services

98Part
IVItem 15.

Exhibits,
Consolidated Financial Statement Schedules

99Page 2 of 107

PART I

Item 1.
BusinessGENERAL

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.

Through
its internet website (www.hillsbank.com), the Company makes available, free of
charge, by link to the internet website of the Securities and Exchange
Commission (www.sec.gov), the Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K, all amendments to those reports, and
other filings with the Securities and Exchange Commission, as soon as
reasonably practicable after they are filed or furnished.

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, 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. As of
December 31, 2008, the Company had no employees and the Bank had 339 full-time
and 101 part-time employees.

Page 3 of 107

Item 1.
Business
 (Continued)Johnson County and Linn 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 93,700. Johnson County, Iowa has a population of approximately
124,000. The University of Iowa in Iowa City has approximately 30,600 students
and 22,700 full and part-time employees, including 7,700 employees of The
University of Iowa Hospitals and Clinics.

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 2,100 and Mount Vernon, located two miles from Lisbon, has a
population of about 4,200. Both communities are within easy commuting distances
to Cedar Rapids and Iowa City, Iowa. Cedar Rapids has a metropolitan population
of approximately 157,300, including approximately 31,400 from adjoining Marion,
Iowa 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 208,100. The largest employer in the
Cedar Rapids area is Rockwell Collins, manufacturer of communications
instruments, with about 9,400 employees.

Other
large employers in the Johnson and Linn County areas and their approximate
number of employees are as follows (Data source is Priority One):

Employer

Type of Business

EmployeesCedar Rapids and Linn-Mar
 School Districts

Education

3,800AEGON USA, Inc.

Insurance

3,500Hy-Vee Food Stores

Grocery Stores

3,000St. Lukes Hospital

Health Care

2,800Mercy Medical Center

Health Care

2,500Whirlpool Corp.

Appliances

2,300Iowa City Community School
 District

Education

1,600Kirkwood Community College

Education

1,600City of Cedar Rapids

City Government

1,500Wal-Mart Stores, Inc.

Discount Store

1,500ACT, Inc.

Educational Testing
 Service

1,400Mercy Iowa City

Health Care

1,400Pearson Educational
 Measurement

Information Services -
 Computers

1,300Veterans Administration
 Medical Center

Health Care

1,300Quaker Oats Company

Cereals and Chemicals

1,200West Liberty Foods

Food Processor

1,200Washington
County

The
Bank has offices located in Kalona and Wellman, Iowa, which are in Washington
County. Kalona is located approximately 20 miles south of Iowa City. Wellman is
located approximately 5 miles west of Kalona. Kalona has a population of
approximately 2,400 and Wellman has a population of about 1,500. The population
of Washington County is approximately 21,600. Both Kalona and Wellman are
primarily agricultural communities, but are located within easy driving
distance for employment in Iowa City, Coralville and North Liberty (combined
population 93,000) and Washington, Iowa (population 7,000).

Page 4 of 107

Item 1.
Business
 (Continued)COMPETITION

Competition
among financial institutions in attracting and retaining deposits and making
loans is intense. Traditionally, the Companys most direct competition for
deposits has come from commercial banks, savings institutions and credit unions
doing business in its areas of operation. Increasingly, the Company has
experienced additional competition for deposits from nonbanking sources, such
as securities firms, insurance companies, money market mutual funds and
financial services subsidiaries of commercial and manufacturing companies.
Competition for loans comes primarily from other commercial banks, savings
institutions, consumer finance companies, credit unions, mortgage banking
companies, insurance companies and other institutional lenders. The Company
competes primarily on the basis of products offered, customer service and
price. A number of institutions with which the Company competes enjoy the
benefits of fewer regulatory constraints and lower cost structures. Some have
greater assets and capital than the Company does and, thus, are better able to
compete on the basis of price than the Company is. Technological advances,
which may diminish the importance of depository institutions and other
financial intermediaries in the transfer of funds between parties, could make
it more difficult for the Company to compete in the future.

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 has increased the number of competitors and intensified the
competitive environment in which the Company conducts business. The
increasingly competitive environment is primarily a result of changes in
regulations and changes in technology and product delivery systems. These
competitive trends are likely to continue.

The
Bank is in direct competition for loans and deposits and financial services
with a number of other banks and credit unions in Johnson, Linn and Washington
County. A comparison of the number of office locations and deposits in the
three counties as of June, 2008 (Most recent date of available data from the
FDIC and national credit union websites) is as follows:

Johnson County

Linn County

Washington CountyOffices

Deposits (in millions)

Offices

Deposits (in millions)

Offices

Deposits (in millions)Hills Bank and Trust
Company


6

$
854


5

$
239


2

$
75Branches of largest competing
national bank


7


191


9


714


1


22Largest competing independent
bank


6


440


8


450


2


168Largest competing credit
union


6


572


7


427


1


1All other bank and credit union
offices


29


533


87


2,548


7


200Total Market in
County


54

$
2,590


116

$
4,378


13

$
466Effective
July 1, 2004, all limitations on bank office locations of Iowa law were
repealed, effectively allowing statewide branching. Since that date, banks have
been allowed to establish an unlimited number of offices in any location in
Iowa subject to regulatory approval. Since July 1, 2006, six new offices have
been added in Johnson County and fifteen in Linn County, while the population
base has increased by 5,100, or 1.56%, in the two counties in the last two
years. The number of banking offices in Washington County has increased by two
while its population has remained stable. The total deposits in the three
counties increased $699 million, or 10.38%, since July 1, 2006.

Page 5 of 107

Item 1.
Business
 (Continued)THE ECONOMY

The
Banks primary trade territory is Johnson and Linn County, Iowa. The Bank has
two offices in Washington County, Iowa. The table that follows shows employment
information as of December 31, 2008, 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


154,447,000


11,108,000


7.2
%State of Iowa


1,671,900


77,100


4.6
%Johnson County


77,400


2,500


3.3
%Linn County


118,700


5,400


4.5
%Washington County


12,900


600


4.6
%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. The unemployment rates in 2007 were 5.0% for the
United States, 4.0% for the State of Iowa and 2.8%, 4.0% and 3.9% for Johnson,
Linn and Washington Counties, respectively. As noted within 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 2008-2009 budget for the University of Iowa,
including the University of Iowa Hospital and Clinics, is $2.7 billion with
state appropriations of approximately $394 million, or about 14.7% of the
total. The University of Iowa Hospitals and Clinics have a FY 2008-2009 budget
of $855 million with 7.40% coming from State of Iowa appropriations.

Due
to national and state economic challenges, the State of Iowa took several steps
at the end of 2008 to address expected budget shortfalls including across the
board spending cuts of approximately 1.5%, or $91.4 million, for the current
fiscal year. These spending cuts are part of a total budget reduction of $178.4
million which also includes a hiring freeze, delayed capital purchases and
other measures. The spending cuts are due to reductions in estimates for state
revenues over the next two years. This reduction in the State budget will
require the University of Iowa to return $7.5 million in appropriations to the
State of Iowa and includes reductions in building repair, capital project
deferrals and general expense cutbacks. It is unclear what impact the continued
stress of the State budget will have on the University of Iowa and the
University of Iowa Hospitals and Clinics. Johnson and Linn Counties have been
one of the strongest economic areas in Iowa and have 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.

It
is difficult to predict how the national economic struggles will impact the
State of Iowa going forward. The proposed State of Iowa budget for FY 2009-2010
includes a 6.5% cut for most state agencies. The three state universities would
see a combined loss of more than $40 million. A 6.5% decrease in state
appropriations would mean an $18 million reduction for the University of Iowa.
The State budget cuts would also affect several of the large employers in the
Companys market area including county and local governments and school
districts.

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 2008 enrollment.

College

City

EnrollmentThe
 University of Iowa

Iowa City

30,561Coe
 College

Cedar Rapids

1,326Cornell
 College

Mount Vernon

1,150Kirkwood
 Community College

Cedar Rapids, Iowa City
 and Washington

15,220Mount
 Mercy College

Cedar Rapids

1,555Page 6 of 107

Item 1.
Business
 (Continued)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
2008 was $4,468 compared to $3,908 in 2007, a 14.33% increase. The range of
average land prices in Johnson, Linn and Washington counties is between $4,867
and $5,196 per acre. The three counties average increase was 12.68% in 2008.
The Banks total agricultural loans comprise about 4.29% 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 statutes, regulations
and regulatory policies can be significant and cannot be predicted with a high
degree of certainty.

Federal
and state laws and regulations generally applicable to financial institutions
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 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.

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.

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). 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. 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.

Page 7 of 107

Item 1.
Business
 (Continued)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.

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

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.

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, 2008, the Company had
regulatory capital in excess of the Federal Reserves minimum and
well-capitalized definition requirements, with a leverage ratio of 8.99%, with
total Tier 1 risk-based capital ratio of 11.38% and a total risk-based capital
ratio of 12.64%.

Page 8 of 107

Item 1.
Business
 (Continued)Dividends. The Iowa Business Corporation Act
(IBCA) allows the Company to make
distributions, including cash dividends, to its shareholders unless, after
giving effect to such distributions, either (i) the Company would not be able
to pay its debts as they become due in the ordinary course of business or (ii)
the Companys total assets would be less than the sum of its total liabilities
plus the amount that would be needed to satisfy preferential shareholder
rights, if any, that are superior to the rights of those receiving the
distribution. 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.

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. The deposits of the Bank are insured up
to applicable limits by the
Deposit Insurance Fund (the DIF) of the FDIC and are subject to deposit
insurance assessments to maintain the DIF. The FDIC utilizes a risk-based
assessment system that imposes insurance premiums based upon a risk matrix that
takes into account a banks capital level and supervisory rating. Effective
January 1, 2007, the FDIC imposed deposit assessment rates based on the risk
category of the bank. Risk Category I is the lowest risk category while Risk
Category IV is the highest risk category.

On
October 16, 2008, the FDIC published a restoration plan designed to replenish
the Deposit Insurance Fund over a period of five years and to increase the
deposit insurance reserve ratio, which decreased to 1.01% of insured deposits
on June 30, 2008, to the statutory minimum of 1.15% of insured deposits by
December 31, 2013. In order to implement the restoration plan, the FDIC
proposes to change both its risk-based assessment system and its base
assessment rates. For the first quarter of 2009 only, the FDIC increased all
FDIC deposit assessment rates by 7 basis points. These new rates range from
12-14 basis points for Risk Category I institutions to 50 basis points for Risk
Category IV institutions. Under the FDICs restoration plan, the FDIC proposes
to establish new initial base assessment rates that will be subject to
adjustment as described below. Beginning April 1, 2009, the base assessment
rates would range from 10-14 basis points for Risk Category I institutions to
45 basis points for Risk Category IV institutions. Changes to the risk-based
assessment system would include increasing premiums for institutions that rely
on excessive amounts of brokered deposits, increasing premiums for excessive
use of secured liabilities, including Federal Home Loan Bank advances, lowering
premiums for smaller institutions with very high capital levels, and adding
financial ratios and debt issuer ratings to the premium calculations for banks
with over $10 billion in assets, while providing a reduction for their
unsecured debt.

Page 9 of 107

Item 1.
Business (Continued)On February 27, 2009, the Board of Directors of the FDIC voted to
amend
its restoration plan in several respects. As a result of this amendment, (1)
the term of the restoration plan will be extended from five to seven years, (2)
the base assessment rate for Risk Category I institutions would increase from a
range of 12-14 basis points to a range of 12-16 basis points beginning on April
1, 2009, (3) the increase in assessments for institutions that rely
significantly on brokered deposits would apply to well-managed and
well-capitalized institutions only when accompanied by rapid asset growth and
(4) incentives would be provided in the form of a reduction in assessment rates
for institutions to hold long-term unsecured debt and, for smaller
institutions, high levels of Tier 1 capital. On February 27, 2009, the Board of
Directors of the FDIC also adopted an interim rule pursuant to which a 20 basis
point emergency assessment was imposed on all institutions to be collected on September
30, 2009, and an additional 10 basis point emergency assessment may be imposed
after June 30, 2009. This interim rule will not be final until after the
comment period which ends March 31, 2009. These recent actions of the Board of
Directors of the FDIC and either an increase in the risk category of the Bank
or further adjustments to the base assessment rates could have a material
adverse effect on our earnings.

In addition, all institutions with deposits insured by the FDIC are
required to pay assessments to fund interest payments on bonds issued by the
Financing Corporation (FICO), a mixed-ownership government corporation
established to recapitalize a predecessor to the Deposit Insurance Fund. The
current annualized assessment rate is 1.14 basis points, or approximately .285
basis points per quarter. These assessments will continue until the FICO bonds
mature in 2019.

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, 2008, the Tier 1 risk-based leverage ratio of the Bank was
8.98% 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.

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.

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 2008, the Banks Iowa supervisory assessment total was
$128,037.

Page 10 of 107

Item 1.
Business (Continued)Community Investment and Consumer Protection
Laws. The Community Reinvestment Act requires insured
institutions to offer credit products and take other actions that respond to
the credit needs of the community. Banks and other depository institutions also
are subject to numerous consumer-oriented laws and regulations. These laws 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.

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, 2008. 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 total risk-based capital to assets of 8%,
$31,990,000 of the Banks total retained earnings of $156,795,000 as of December
31, 2008 are available for the payment of dividends to the Bank.

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 desist orders and civil
money penalty assessments.

Branching Authority.
Historically, Iowas intrastate branching statutes have been rather restrictive
when compared with those of other states. Effective July 1, 2004, all
limitations on bank office location were repealed, which effectively allowed
statewide branching. Since that date, banks have been allowed to establish an
unlimited number of offices in any location in Iowa subject only to regulatory
approval.

Page 11 of 107

Item 1.
Business (Continued)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.

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.

Financial Privacy.
In accordance with the Gramm-Leach-Bliley Financial Modernization Act of 1999
(the GLB Act), federal banking regulators adopted rules that limit the
ability of banks and other financial institutions to disclose non-public
information about consumers to nonaffiliated third parties. These limitations
require disclosure of privacy policies to consumers and, in some circumstances,
allow consumers to prevent disclosure of certain personal information to a
nonaffiliated third party. The privacy provisions of the GLB Act affect how
consumer information is transmitted through diversified financial companies and
conveyed to outside vendors.

Anti-Money Laundering Initiatives and the USA
Patriot Act. A major focus of governmental policy on
financial institutions this decade has been aimed at combating money laundering
and terrorist financing. The USA PATRIOT Act of 2001 (the USA Patriot Act)
substantially broadened the scope of United States anti-money laundering laws
and regulations by imposing significant new compliance and due diligence
obligations, creating new crimes and penalties and expanding the
extra-territorial jurisdiction of the United States. The U. S. Treasury
Department has issued a number of regulations that apply various requirements
of the USA Patriot Act to financial institutions such as the Bank. These
regulations impose obligations on financial institutions to maintain
appropriate policies, procedures and controls to detect, prevent and report
money laundering and terrorist financing and to verify the identity of their
customers. Failure of a financial institution to maintain and implement
adequate programs to combat money laundering and terrorist financing, or to
comply with all of the relevant laws or regulations, could have serious legal
and reputational consequences for the institution.

Page 12 of 107

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)

Years Ended December 312008

2007

2006(Amounts In Thousands)ASSETSCash and cash
equivalents

$
21,308

$
22,145

$
23,840Taxable
securities


114,717


114,271


123,376Nontaxable
securities


96,771


88,727


82,031Federal funds
sold


863


6,527


878Loans,
net


1,406,447


1,305,485


1,217,009Property and
equipment, net


22,208


21,700


22,301Other
assets


37,370


31,036


27,984$
1,699,684

$
1,589,891

$
1,497,419LIABILITIES
 AND STOCKHOLDERS EQUITYNoninterest-bearing demand deposits

$
155,017

$
137,271

$
135,249Interest-bearing demand deposits


182,554


157,483


140,171Savings
deposits


255,026


261,914


264,210Time
deposits


588,691


575,738


518,313Short-term
borrowings


84,119


51,880


63,358FHLB
borrowings


261,399


248,804


231,691Other
liabilities


14,198


11,591


10,387Redeemable
common stock held by 
 Employee Stock Ownership Plan


23,010


21,573


20,787Stockholders equity


135,670


123,637


113,253$
1,699,684

$
1,589,891

$
1,497,419Page 13 of 107

Item 1.
Business (Continued)INTEREST
INCOME AND EXPENSE

Years Ended December 312008

2007

2006(Amounts In Thousands)Income:Loans
(1)

$
89,525

$
88,937

$
80,393Taxable
securities


4,734


4,706


4,438Nontaxable
securities (1)


5,204


4,852


4,462Federal funds
sold


18


325


40Total
interest income


99,481


98,820


89,333Expense:Interest-bearing demand deposits


1,571


2,246


1,372Savings
deposits


3,397


6,034


5,318Time
deposits


23,897


26,997


21,151Short-term
borrowings


1,756


2,151


2,801FHLB
borrowings


12,860


12,524


11,720Total
interest expense


43,481


49,952


42,362Net interest
income

$
56,000

$
48,868

$
46,971(1)
Presented on
 a tax equivalent basis using a rate of 35% for the three years presented.Page 14 of 107

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

Years Ended December 312008

2007

2006Average
 yields:Loans
(1)


6.35
%

6.80
%

6.59
%Loans (tax
equivalent basis)


6.37


6.81


6.61Taxable
securities


4.13


4.12


3.60Nontaxable
securities


3.50


3.55


3.54Nontaxable
securities (tax equivalent
 basis)


5.38


5.47


5.44Federal funds
sold


2.05


4.98


4.51Average
 rates paid:Interest-bearing demand deposits


0.86


1.43


0.98Savings
deposits


1.33


2.30


2.01Time
deposits


4.06


4.69


4.08Short-term
borrowings


2.09


4.15


4.42FHLB
borrowings


4.92


5.03


5.06Yield on
 average interest-earning assets


6.15


6.52


6.28Rate on
 average interest-bearing liabilities


3.15


3.85


3.47Net interest
 spread (2)


3.00


2.68


2.81Net interest
 margin (3)


3.47


3.24


3.31(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. The net interest margin
 increased 23 basis points in 2008 and declined 7 basis points in 2007. The
 net interest spread increased 32 basis points in 2008 and decreased 13 basis
 points in 2007. The net interest margin increased in 2008 due to the falling
 rate environment. The Company was able to reprice interest-bearing
 liabilities downward more quickly that the average yields on earnings assets.Page 15 of 107

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

Changes Due
 To Volume

Changes Due
 To Rates

Total
 Changes(Amounts In Thousands)Year ended
 December 31, 2008:Change in
interest income:Loans

$
7,617

$
(7,028
)
$
589Taxable
securities


24


4


28Nontaxable
securities


439


(88
)

351Federal funds
sold


(307
)




(307
)$
7,773

$
(7,112
)
$
661Change in
interest expense:Interest-bearing demand deposits


(358
)

1,032


674Savings
deposits


382


2,256


2,638Time
deposits


(607
)

3,707


3,100Federal funds
purchased and securities sold
 
 under agreements to repurchase


(1,673
)

2,068


395FHLB
borrowings


(671
)

335


(336
)(2,927
)

9,398


6,471Change in net
interest income

$
4,846

$
2,286

$
7,132Year ended
 December 31, 2007:Change in
interest income:Loans

$
5,844

$
2,700

$
8,544Taxable
securities


(321
)

589


268Nontaxable
securities


364


26


390Federal funds
sold


255


30


285$
6,142

$
3,345

$
9,487Change in
interest expense:Interest-bearing demand deposits


(169
)

(704
)

(873
)Savings
deposits


374


(1,091
)

(717
)Time
deposits


(2,343
)

(3,503
)

(5,846
)Federal funds
purchased and securities sold
 
 under agreements to repurchase


681


(31
)

650FHLB
borrowings


(866
)

62


(804
)(2,323
)

(5,267
)

(7,590
)Change in net
interest income

$
3,819

$
(1,922
)
$
1,897Rate/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 16 of 107

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 31,2008

2007

2006

2005

2004(Amounts In Thousands)Agricultural

$
64,198

$
60,004

$
49,223

$
43,730

$
39,116Commercial and
financial


162,170


132,070


118,339


91,501


70,453Real estate,
construction


140,349


123,144


114,199


83,456


72,388Real estate, mortgage


1,095,742


1,020,802


983,489


906,188


797,958Loans to individuals


35,041


36,289


31,827


32,201


32,106Total

$
1,497,500

$
1,372,309

$
1,297,077

$
1,157,076

$
1,012,021There 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, 2008:

Amount
 Of Loans

One Year
 Or Less (1)

One To
 Five Years

Over Five
 Years(Amounts In Thousands)Commercial

$
221,621

$
120,734

$
87,303

$
13,584Real
Estate


1,240,523


290,224


876,765


73,534Other


35,356


8,435


19,425


7,496Totals

$
1,497,500

$
419,393

$
983,493

$
94,614The types of
 interest rates applicable to these principal payments are shown below:Fixed
rate

$
751,802

$
172,444

$
507,346

$
72,012Variable
rate


745,698


246,949


476,147


22,602$
1,497,500

$
419,393

$
983,493

$
94,614(1)
A significant
 portion of the commercial loans are due in one year or less. A significant
 percentage of the loans are re-evaluated prior to their maturity and are
 likely to be extended.Page 17 of 107

Item 1.
Business (Continued)NONACCRUAL,
PAST DUE, RESTRUCTURED AND NON-PERFORMING LOANS

The following table summarizes the Companys non-accrual,
past due,
restructured and non-performing loans as of December 31 for each of the years
presented:

2008

2007

2006

2005

2004(Amounts
 In Thousands)Nonaccrual loans

$
2,535

$
4,948

$
879

$
175

$
808Accruing loans past due 90 days
or more


5,049


6,019


4,983


1,910


2,313Restructured loans


4,478











Non-performing (includes
non-accrual loans)


52,186


39,583


14,681


16,602


18,977Loans held for
investment


1,497,500


1,372,309


1,297,077


1,157,076


1,012,021Ratio of allowance for loan
losses to loans held for investment


1.85
%

1.44
%

1.38
%

1.33
%

1.36
%Ratio of allowance for loan
losses to non-performing loans


53.00


49.79


121.59


92.52


72.67The Company does not have a significant amount of loans that are
past
due less than 90 days where there are serious doubts as to the ability of the
borrowers to comply with the loan repayment terms.

Loans are placed on non-accrual status when management believes the
collection of future principal and interest is not reasonably assured. The
decrease in non-accrual loans from December 31, 2007 to December 31, 2008
relates to one borrower relationship that had an aggregate balance of
approximately $3.6 million as of December 31, 2007. Approximately $3.4 million
related to this borrower relationship is included in other real estate owned as
of December 31, 2008. Non-accrual loans represent 0.17% of total loans as of
December 31, 2008 compared to 0.36% of total loans as of December 31, 2007. The
non-accrual loans are considered to be impaired loans for purposes of reviewing
the adequacy of the loan loss reserve. Interest income was reduced by $163,000,
$279,000 and $34,000 for the years ended December 31, 2008, 2007 and 2006,
respectively, by the classification of the loans as non-accrual.

Accruing loans past due 90 days or more decreased $1.0 million from
2007 to $5,049,000 as of December 31, 2008. Real estate loans make up
approximately $4.5 million, or 90%, of this total. As of December 31, 2008 and
2007, loans 90 days past due and accruing were 0.34% and 0.44% of total loans,
respectively. Management believes that loans 90 days past due and accruing are
adequately collateralized.

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.

Non-performing loans increased by $12.6 million from December 31,
2007
to December 31, 2008. Non-performing loans were 3.48% of loans as of December
31, 2008 and 2.88% as of December 31, 2007. Non-performing loans, which are
considered impaired, include any loan that has been placed on nonaccrual
status. Non-performing loans also include loans that, based on managements
evaluation of current information and events, the Bank expects to be unable to
collect in full according to the contractual terms of the original loan
agreement. These loans are also considered impaired loans. This increase in
non-performing loans is due in part to $5.0 million in flood-related loans. In addition,
two large borrower relationships were added to non-performing loans. The first
borrower relationship consists mainly of commercial real estate loans with an
aggregate balance of approximately $10.4 million as of December 31, 2008. The
second borrower relationship had an aggregate balance of $3.3 million as of
December 31, 2008 and relates to residential development in the Companys
market area. These increases of $18.7 million were offset by improvements in
various borrower relationships considered non-performing as of December 31,
2007. The Company believes that the allowance for loan losses is at a level
commensurate with the overall risk exposure of the loan portfolio. However, if
economic conditions continue to deteriorate, certain borrowers may experience
additional difficulty and the level of nonperforming loans, chargeoffs and
delinquencies could continue to rise and require further increases in the
provision for loan losses.

Page 18 of 107

Item 1.
Business (Continued)The Company
restructured loans totaling $4.5 million during 2009. These loans related to
two customers. The first customer relationship consisted of six loans totaling
$1.2 million and is flood related. The Company would have recorded $63,000 in
interest income during 2008 related to these loans if the loans had been
current in accordance with their original terms. There was no interest income
related to the restructured loans included in net income for 2008 as the
accrued interest on the loans was charged off during the period and the loans
are currently on non-accrual status. The Company loaned an additional $137,000
to the borrower in 2008 after the completion of the restructuring of the loans
noted above. In addition, the Company has committed to lend an additional $270,000
to the customer. The second restructured customer relationship consisted of
four loans totaling $3.3 million. This restructure was completed as of the end
of 2008. There was no lost interest income related to this customer
relationship. The Company does not have any commitments to lend the customer
additional funds.

Specific
allowances for losses on non-accrual and non-performing 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.

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 31,2008

2007

2006

2005

2004(Amounts In Thousands)Allowance for loan losses at
beginning of
 year

$
19,710

$
17,850

$
15,360

$
13,790

$
12,585Charge-offs:Agriculture


99


343


40





78Commercial and
financial


1,359


1,422


677


802


224Real estate,
mortgage


2,427


622


529


392


431Loans to
individuals


604


531


627


981


6354,489


2,918


1,873


2,175


1,368Recoveries:Agriculture


61


44


44


47


36Commercial and
financial


335


479


863


191


151Real estate,
mortgage


237


299


223


265


104Loans to
individuals


299


427


222


1,141


812932


1,249


1,352


1,644


1,103Net charge-offs
(recoveries)


3,557


1,669


521


531


265Provision for loan losses
(1)


11,507


3,529


3,011


2,101


1,470Allowance for loan losses at end
of year

$
27,660

$
19,710

$
17,850

$
15,360

$
13,790Ratio of net charge-offs
(recoveries)
 during year to average loans outstanding


0.25
%

0.13
%

0.04
%

0.05
%

0.03
%(1)
For
 financial reporting purposes, management reviews the loan portfolio and
 determines the allowance for loan losses, which represents managements judgment
 of the probable losses inherent in the Companys loan portfolio. The loan
 loss provision is the amount necessary to adjust the allowance to the level
 considered appropriate by management. The adequacy of the allowance is
 reviewed quarterly and considers the impact of economic conditions on the
 borrowers ability to repay, loan collateral values, past collection
 experience, the risk characteristics of the loan portfolio and such other
 factors that deserve current recognition. The growth of the loan portfolio is
 a significant element in the determination of the provision for loan losses.Page 19 of 107

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 (1) reviews of specific borrowers and (2) managements assessment of
areas that management considers are of higher credit risk (e.g., agricultural
loans and constructed model real estate loans). Loans for which there are no
specific allowances are classified into one or more risk categories. Based upon
the risk category assigned, the Bank allocates a percentage, as determined by
management, for a required allowance needed. The percentage begins with
historical loss experience factors, which are then adjusted for current
economic factors.

The following table presents the allowance for loan losses on
loans by
type of loans and the percentage in each category to total loans as of December
31, 2008, 2007, 2006, 2005 and 2004:

2008


2007Amount

% of Total
 Allowance

% of Loans
 to Total Loans


Amount

% of Total
 Allowance

% of Loans
 to Total Loans(In
 Thousands)


(In Thousands)Agriculture

$
2,310


8.35
%

4.29
%

$
1,614


8.19
%

4.37
%Commercial


5,478


19.81


10.83



4,382


22.23


9.62Real estate,
construction


4,716


17.05


9.37



2,568


13.03


8.97Real estate, mortgage


14,511


52.46


73.17



10,335


52.44


74.40Consumer


645


2.33


2.34



811


4.11


2.64$
27,660


100.00
%

100.00
%

$
19,710


100.00
%

100.00
%2006


2005Agriculture

$
1,509


8.45
%

3.79
%

$
1,528


9.95
%

3.78
%Commercial


3,700


20.73


9.12



2,676


17.42


7.91Real estate,
construction


2,064


11.56


8.80



1,339


8.72


7.21Real estate, mortgage


9,782


54.80


75.82



9,061


58.99


78.32Consumer


795


4.46


2.47



756


4.92


2.78$
17,850


100.00
%

100.00
%

$
15,360


100.00
%

100.00
%2004Agriculture

$
1,736


12.59
%

3.87
%Commercial


1,913


13.87


6.96Real estate,
construction


1,471


10.67


7.15Real estate, mortgage


7,872


57.08


78.85Consumer


798


5.79


3.17$
13,790


100.00
%

100.00
%The allowance for loan losses increased $7,950,000 in 2008. Of the
$7,950,000 increase, $1,290,000 was due to the volume increase in loans
outstanding of $118.9 million in 2008. The remaining $6,660,000 increase in the
amount allocated to the allowance was due to flood-related loan credit issues
and deterioration in credit quality.

The increase in the allowance included an allocation of $375,000
related to watch loans. Watch loans increased by approximately $15.4 million
from 2007 to 2008. Approximately $7.1 million of the growth in watch loans is
flood-related. The remaining $8.3 million in growth in watch loans is related
to managements evaluation of its loan portfolio and recognition of uncertain
economic conditions. The total increase of $15.4 million is comprised of
approximately $3.7 million less in commercial real estate mortgages and $3.0
million less for construction loans which are offset by an increase in the
watch classification of $3.7 million in agricultural real estate loans, $6.1 million
in 1-to-4 family residential mortgages, $10.2 million in multi-family
residential mortgages and $2.1 million in commercial loans.

Page 20 of 107

Item 1.
Business (Continued)Substandard loan balances were $69.4 million at December 31, 2008
and $48.6
million at December 31, 2007. The increase in allowance related to substandard
loans of $6.3 million at December 31, 2008 resulted from several factors.
Flood-related loans made up $4.9 million of the increase in substandard loans.
In addition, two borrower relationships with an aggregate loan balance of $13.7
million were downgraded to substandard during 2008. The increase of $20.8
million in substandard loans at December 31, 2008 includes $7.9 million in
commercial real estate mortgages, $4.1 million in 1-to-4 family residential
mortgages, $2.8 million in agricultural real estate mortgages, $1.9 million in
agricultural operating loans, $5.5 million in construction loans, $2.8 million
in commercial loans and $0.1 million in consumer loans. Those increases were
offset by a decrease in multi-family residential mortgages of $4.3 million.

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

The subprime mortgage banking environment has been experiencing
considerable
strain from rising delinquencies and liquidity pressures and some subprime
mortgage lenders have failed. The increased scrutiny of the subprime lending
market and heightened perceptions of the risks associated with bank loan
portfolios are factors that have had a negative impact on general market
conditions. The Companys underwriting standards have been structured to limit
exposure to the types of loans that are currently experiencing high
foreclosures and loss rates. Management believes that the Companys mortgage
loan portfolio has minimal exposure to loans generally considered to be
subprime loans.

In addition, there has been a slowdown in the housing market in the
Companys trade area. This has been evidenced by reduced levels of new and existing
home sales, stagnant to declining property values, a decline in building
permits, and an increase in the time houses remain on the market. The issues
with the local housing market were mitigated by the effects of the June 2008
floods and an increased need for housing in the second half of 2008. The
Company will continue to monitor adequacy of the allowance on a quarterly basis
and will consider the impact of economic conditions on the borrowers ability
to repay, loan collateral values, past collection experience, the risk
characteristics of the loan portfolio and such other factors that deserve
current recognition.

Page 21 of 107

Item 1.
Business (Continued)INVESTMENT SECURITIES

The following tables show the carrying value of the investment
securities
held by the Bank, including stock of the Federal Home Loan Bank, as of December
31, 2008, 2007 and 2006 and the maturities and weighted average yields of the
investment securities as of December 31, 2008:

December 31,2008

2007

2006(Amounts In Thousands)Carrying value:Other
securities (FHLB, FHLMC and FNMA)

$
99,849

$
104,965

$
94,068Stock of the
Federal Home Loan Bank


14,247


14,169


12,757Obligations of
state and political subdivisions


100,463


94,634


84,159$
214,559

$
213,768

$
190,984December 31, 2008Carrying
 Value

Weighted
 Average
 Yield(Amounts In Thousands)Other securities (FHLB, FHLMC
and FNMA),
 maturities:Within 1
year

$
27,369


4.14
%From 1 to 5
years


72,480


4.18$
99,849Stock of the Federal Home Loan
Bank,
 maturities within 1 year

$
14,247


3.00
%Obligations of state and
political
 subdivisions, maturities:Within 1
year

$
12,713


5.01
%From 1 to 5
years


43,223


4.84From 5 to 10
years


43,622


5.60Over 10
years


905


6.31$
100,463Total

$
214,559Page 22 of 107

Item 1.
Business (Continued)INVESTMENT
SECURITIES

As of December 31, 2008, the Company held no investment securities
exceeding 10% of stockholders equity, other than securities of the U. S.
Government agencies and corporations. The Company does not hold any investments
in FNMA preferred stock, any pooled trust preferred stocks or other investments
except as detailed in the table above.

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, 2008, 2007 and
2006 and the composition of the certificates of deposit issued in denominations
in excess of $100,000 as of December 31, 2008, 2007 and 2006:

December 31,2008

Rate

2007

Rate

2006

Rate(Amounts In Thousands)Average noninterest-bearing
deposits

$
155,017




$
137,271




$
135,249

Average interest-bearing demand
deposits


182,554

0.86
%


157,483

1.43
%


140,171

0.98
%Average savings
deposits


255,026

1.33



261,914

2.30



264,210

2.01Average time deposits


588,691

4.06



575,738

4.69



518,313

4.08$
1,181,288




$
1,132,406




$
1,057,943Time certificates issued in
amounts 
 of $100,000 or more with maturity in:

Amount

Rate

Amount

Rate

Amount

Rate(Amounts In Thousands)3 months or less

$
19,976

3.59
%

$
33,857

4.89
%

$
27,220

4.62
%3 through 6 months


21,483

3.15



36,111

4.96



44,161

5.016 through 12 months


57,300

3.40



38,525

4.81



53,967

5.10Over 12 months


63,151

4.12



22,666

4.61



24,104

4.45$
161,910




$
131,159




$
149,452Brokered
deposits totaled $10.4 million as of December 31, 2008 with an average rate of
3.28%. There were no brokered deposits as of December 31, 2007 or 2006.
Brokered deposits are included in time deposits and are in increments less than
$100,000.

There were no
deposits in foreign banking offices.

Page 23 of 107

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,
2008, 2007 and 2006:

2008

2007

2006Return on average
assets


0.83
%

1.02
%

1.04
%Return on average
stockholders equity


10.42


13.06


13.74Dividend payout ratio


28.90


23.99


23.75Average stockholders
equity to average
 assets ratio


7.98


7.78


7.56SHORT-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 2008, 2007 and 2006:

2008

2007

2006(Amounts In Thousands)Outstanding balance as of
December 31

$
99,937

$
87,076

$
59,063Weighted average interest rate
at year end


1.20
%

3.90
%

4.40
%Maximum month-end
balance


110,492


87,076


96,039Average month-end
balance


84,119


51,880


63,358Weighted average interest rate
for the year


2.09
%

4.15
%

4.42
%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 of Federal Home Loan Bank
borrowings during 2008, 2007 and 2006:

2008

2007

2006(Amounts In Thousands)Outstanding balance as of
December 31

$
265,000

$
265,348

$
235,379Weighted average interest rate
at year end


4.79
%

4.93
%

5.00
%Maximum month-end
balance


265,348


265,348


248,161Average month-end
balance


261,399


248,804


231,691Weighted average interest rate
for the year


4.92
%

5.03
%

5.06
%Page 24 of 107

Item 1A.
Risk FactorsThe performance of our Company is subject to various risks. We
consider
the risks described below to be the most significant risks we face, but such
risks are not the only risk factors that could affect us. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially and adversely affect our business, financial
condition or results of operations. For a discussion of the impact of risks on
our financial condition and results of operations in recent years and on
forward looking statements contained in this report, reference is made to Item
7 below.

We may be adversely affected by economic
conditions in the local economies in which we conduct our operations, and in
the United States in general.

Unfavorable or uncertain economic and market conditions may
adversely
affect our business and profitability. Our business faces various material
risks, including credit risk and the risk that the demand for our products and
services will decrease. Decreases in consumer confidence, real estate values,
interest rates and investment returns, usually associated with a downturn,
could make the types of loans we originate less profitable and could increase
our credit risk and litigation expense.

Recent adverse changes in the U.S. economy have led to an increased
level of commercial and consumer delinquencies, reduced consumer confidence,
decreased market valuations and liquidity, increased market volatility and a
widespread reduction of business activity generally. The resulting economic
pressure and lack of confidence in the financial markets may adversely affect
our business, our financial condition and our results of operations, as well as
the business of our customers. Foreign or domestic terrorism or geopolitical
events could shock commodity and financial markets and prolong or worsen the
current recession. A worsening of economic conditions would likely exacerbate
the adverse effects of these difficult conditions.

We may incur losses because of ineffective
risk management processes and strategies.

We seek to monitor and control our risk exposure through a variety
of
financial, credit, operational, compliance and legal reporting systems. We
employ risk monitoring and risk mitigation techniques, but those techniques and
the judgments that accompany their application may not be adequate to deal with
unexpected economic and financial events or the specifics and timing of such
events. Thus, we may, in the course of our activities, incur losses despite our
risk management efforts.

Our profitability and liquidity may be
adversely affected by deterioration in the credit quality of, or defaults by,
third parties who owe us money or other assets.

We are exposed to the risk that third parties that owe us money or
other assets will not perform their obligations. These parties may default on
their obligations to us due to bankruptcy, lack of liquidity, operational
failure or other reasons. Our rights against third parties may not be
enforceable in all circumstances. In addition, deterioration in the credit
quality of third parties whose securities or obligations we hold could result
in losses and/or adversely affect our ability to use those securities or
obligations for liquidity purposes.

A failure in our operational systems or
infrastructure, or those of third parties, could impair our liquidity, disrupt
our business, damage our reputation and cause losses.

Shortcomings or failures in our internal processes, people or
systems
could lead to impairment of our liquidity, financial loss, disruption of our
business, liability to our customers, regulatory interventions or damage to our
reputation. Our financial, accounting, data processing or other operating
systems and facilities may fail to operate properly or become disabled as a
result of events that are wholly or partially beyond our control, adversely
affecting our ability to process transactions. We also face the risk of
operational failure or termination of any of the clearing agents, exchanges,
clearing houses or other financial intermediaries we use to facilitate
transactions. Any such failure or termination could adversely affect our
ability to effect transactions, service our customers and manage exposure to
risk.

Page 25 of 107

Item 1A.
Risk Factors (Continued)Despite the contingency plans and facilities we have in place, our
ability to conduct business may be adversely impacted by a disruption in the
infrastructure that supports our business and the communities in which we are
located. This may include a disruption involving electrical, communications,
transportation or other services used by us or by third parties with which we
conduct business. If a disruption occurs in one location and our employees in that
location are unable to occupy our offices or communicate with or travel to
other locations, our ability to service and interact with our customers may
suffer and we may be unable to successfully implement contingency plans that
depend on communication or travel.

Our operations rely on the secure processing, storage and
transmission
of confidential and other information in our computer systems and networks.
Although we take protective measures and endeavor to modify them as
circumstances warrant, our computer systems, software and networks may be
vulnerable to unauthorized access, computer viruses or other malicious code and
other events that could have a security impact. If one or more of such events
occur, this potentially could jeopardize our or our customers confidential and
other information processed and stored in, and transmitted through, our
computer systems and networks, or otherwise cause interruptions or malfunctions
in our, our customers or third parties operations, which could result in significant
losses or damage to our reputation. We may be required to expend significant
additional resources to modify our protective measures or to investigate and
remedy vulnerabilities or other exposures. In the event of such a security
breach, we may be subject to litigation and financial losses that are either
not insured against or not fully covered through any insurance maintained by
us.

A natural disaster could harm the Companys
business.

The severe flooding that occurred in 2008 affected our loan
portfolio
by damaging properties pledged as collateral and by impairing certain
borrowers abilities to repay their loans. As a result of the floods, we made a
significant provision for loan losses in 2008. The after effects of the floods
may continue to affect our loan quality into the future. The severity and
duration of the effects of the flooding will depend on a variety of factors
that are beyond our control, including the amount and timing of government
investment in the area, the pace of rebuilding and economic recovery in Johnson
and Linn Counties and the extent to which any property damage is covered by
insurance. The effects described above are difficult to accurately predict or
quantify at this time. As a result, uncertainties remain regarding the impact
the flooding will have on the financial results of the Company. Further, the
area in which the Company operates may experience flooding and other natural
disasters in the future, and some of those events may have effects similar to
those caused by the 2008 flooding.

Changing interest rates may adversely affect
our profits.

Our income and cash flows depend to a great extent on the
difference
between the interest rates earned by us on interest-earning assets such as
loans and investment securities and the interest rates paid by us on
interest-bearing liabilities such as deposits and borrowings. If interest rates
decrease, our net interest income could be negatively affected if interest
earned on interest-earning assets, such as loans, mortgage-related securities,
and other investment securities, decreases more quickly than interest paid on
interest-bearing liabilities, such as deposits and borrowings. This would cause
our net income to go down. In addition, if interest rates decline, our loans
and investments may be prepaid earlier than expected, which may also lower our
income. Rising interest rates may hurt our income because they may reduce the
demand for loans and the value of our investment securities. Higher interest
rates could adversely affect housing and other sectors of the economy that are
interest-rate sensitive. Higher interest rates could cause deterioration in the
quality of our loan portfolio. Interest rates are highly sensitive to many
factors that are beyond our control, including general economics conditions and
monetary policies established by the Federal Reserve Board. Interest rates do
and will continue to fluctuate, and we cannot predict future Federal Reserve
Board actions or other factors that will cause rates to change.

Page 26 of 107

Item 1A.
Risk Factors (Continued)We experience intense competition for loans
and deposits.

Competition among financial institutions in attracting and
retaining
deposits and making loans is intense. Traditionally, our most direct
competition for deposits has come from commercial banks, savings institutions
and credit unions doing business in our areas of operation. Increasingly, we
have experienced additional competition for deposits from nonbanking sources,
such as securities firms, insurance companies, money market mutual funds and
corporate and financial services subsidiaries of commercial and manufacturing
companies. Competition for loans comes primarily from other commercial banks,
savings institutions, consumer finance companies, credit unions, mortgage
banking companies, insurance companies and other institutional lenders. We
compete primarily on the basis of products offered, customer service and price.
A number of institutions with which we compete enjoy the benefits of fewer
regulatory constraints and lower cost structures. Some have greater assets and
capital than we do and, thus, are better able to compete on the basis of price
than we are. The increasingly competitive environment is primarily a result of
changes in regulation and changes in technology and product delivery systems.
These competitive trends are likely to continue.

We are subject to substantial regulation
which could adversely affect our business and operations.

As a financial institution, we are subject to extensive state and
federal regulation and supervision which materially affects our business. Such
regulation and supervision is primarily intended for the protection of
customers, federal deposit insurance funds and the banking system as a whole,
not our shareholders. Statutes, regulations and policies to which we are
subject may be changed at any time, and the interpretation and the application
of those laws and regulations by our regulators is also subject to change.
There can be no assurance that future changes in such statutes, regulations and
policies or in their interpretation or application will not adversely affect
us. We have established policies, procedures and systems designed to comply
with these regulatory and operational risk requirements. However, we face
complexity and costs in our compliance efforts. Adverse publicity and damage to
our reputation arising from the failure or perceived failure to comply with
legal, regulatory or contractual requirements could affect our ability to
attract and retain customers or could result in enforcement actions, fines,
penalties and lawsuits.

If we do not continue to meet or exceed
regulatory capital requirements and maintain our well-capitalized status,
there could be an adverse effect on the manner in which we do business and on
the confidence of our customers in us.

Under regulatory capital adequacy guidelines, we must meet
guidelines
that involve quantitative measures of assets, liabilities and certain
off-balance sheet items. Failure to meet minimum capital requirements could
have a material effect on our financial condition and could subject us to a
variety of enforcement actions, as well as certain restrictions on our
business. Failure to maintain the status of well capitalized under the
regulatory framework could adversely affect the confidence that our customers
have in us, which can lead to a decline in the demand for our products and
affect the prices that we are able to charge for our products and services.

If we are not able to anticipate and keep
pace with rapid changes in technology, or do not respond to rapid technological
changes in our industry, our business can be adversely affected.

Our financial performance depends, in part, on our ability to
develop
and market new and innovative services, and to adopt or develop new
technologies that differentiate our products or provide cost efficiencies. The
risks inherent in this process include rapid technological change in the
industry, our ability to access technical and other information from customers,
and the significant and ongoing investments required to bring new services to
market in a timely fashion at competitive prices. A further risk is the
introduction by competitors of services that could replace or provide
lower-cost alternatives to our products and services.

Our performance may be adversely affected if
we are unable to hire and retain qualified employees.

Our performance is largely dependent on the talents and efforts of
our
employees. Competition in the financial services industry for qualified
employees is intense. Our ability to compete effectively depends on our ability
to attract new employees and to retain and motivate our existing employees.

Page 27 of 107

Item 1A.
Risk Factors (Continued)Our allowance for loan losses may not be
adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan
losses to provide for loan defaults and non-performance. Our allowance for loan
losses is based on our historical loss experience as well as an evaluation of
the risks associated with its loan portfolio, including the size and
composition of the loan portfolio, current economic conditions and
concentrations within the portfolio. Our allowance for loan losses may not be
adequate to cover actual losses, and future provisions for loan losses could
materially and adversely affect our financial results.

Our reported financial results depend in part
on managements selection of accounting methods and certain assumptions and
estimates.

Our accounting policies and methods are fundamental to how we
record
and report our financial condition and results of operations. Our management
must exercise judgment in selecting and applying many of these accounting
policies and methods so they comply with generally accepted accounting
principles (GAAP) and reflect managements judgment of the most appropriate
manner to report our financial condition and results of operations. In some
cases, management must select the accounting method to apply from two or more
acceptable methods, any of which might be reasonable under the circumstances
yet might result in our reporting materially different results than would have
been reported under a different method.

Changes in accounting standards could
materially impact our consolidated financial statements.

From time to time, the Financial Accounting Standards Board (FASB)
and
the Securities and Exchange Commission (SEC) change the financial accounting
and reporting standards that govern the preparation of our consolidated
financial statements. These changes can be hard to predict and can materially
impact how we record and report financial condition and results of operations.
In some cases, we could be required to apply a new or revised standard
retroactively, resulting in restatement of prior period consolidated financial
statements.

We are exposed to risk of environmental
liability when we take title to properties.

In the course of our business, we may foreclose on and take title
to
real estate. As a result, we could be subject to environmental liabilities with
respect to these properties. We may be held liable to a governmental entity or
to third parties for property damage, personal injury, investigation and
clean-up costs incurred by these parties in connection with environmental contamination
or may be required to perform investigation or remediation activities that
could be substantial. In addition, if we are the owner or former owner of a
contaminated site, it may be subject to common law claims by third parties
based on damages and costs resulting from environmental contamination emanating
from the property. If we become subject to significant environmental
liabilities, our financial condition and results of operations could be
adversely affected.

Commercial loans make up a significant
portion of our loan portfolio.

Our commercial loans are primarily made based on the identified
cash
flow of the borrower and secondarily on the underlying collateral provided by
the borrower. Most often, this collateral is accounts receivable, inventory,
machinery or real estate. In the case of loans secured by accounts receivable,
the availability of funds for the repayment of these loans may be substantially
dependent on the ability of the borrower to collect amounts due from its
customers. The other types of collateral securing these loans may depreciate
over time, may be difficult to appraise and may fluctuate in value based on the
success of the business.

Page 28 of 107

Item 1A.
Risk Factors (Continued)Our loan portfolio has a large concentration
of real estate loans, which involve risks specific to real estate value.

Real estate lending is a large portion of our loan portfolio and
included home equity, commercial, construction and residential loans. The
market value of real estate can fluctuate significantly in a short period of
time as a result of market conditions in the geographic area in which the real
estate is located. Adverse developments affecting real estate values in our
market could increase the credit risk associated with our loan portfolio. Also,
real estate lending typically involves higher loan principal amounts and the
repayment of the loans generally is dependent, in large part, on sufficient
income from the properties securing the loans to cover operating expenses and debt
service. Economic events or governmental regulations outside of the control of
the borrower could negatively impact the future cash flow and market values of
the affected properties.

If the loans that are collateralized by real estate become
troubled during
a time when market conditions are declining or have declined, then we may not
be able to realize the amount of security that we anticipated at the time of
originating the loan, which could cause us to increase our provision for loan
losses and adversely affect our operating results and financial condition.

Our real estate loans also include construction loans, including
land
acquisition and development. Construction, land acquisition and development
lending involve additional risks because funds are advanced based upon
estimates of costs and the estimated value of the completed project. Because of
the uncertainties inherent in estimating construction costs, as well as the
market value of the completed project and the effects of governmental regulation
on real property, it is relatively difficult to evaluate accurately the total
funds required to complete a project and the related loan-to-value ratio. As a
result, commercial construction loans often involve the disbursement of
substantial funds with repayment dependent, in part, on the success of the
ultimate project and the ability of the borrower to sell or lease the property,
rather than the ability of the borrower or guarantor to repay principal and
interest. If our appraisal of the value of the completed project proves to be
overstated, we may have inadequate security for the repayment of the loan upon
completion of construction of the project.

Our agricultural loans may involve a greater
degree of risk than other loans, and the ability of the borrower to repay may
be affected by many factors outside of the borrowers control.

Payments on agricultural real estate loans are dependent on the
profitable operation or management of the farm property securing the loan. The
success of the farm may be affected by many factors outside the control of the
borrower, including adverse weather conditions that prevent the planting of a
crop or limit crop yields (such as hail, drought and floods), loss of livestock
due to disease or other factors, declines in market prices for agricultural
products (both domestically and internationally) and the impact of government
regulations (including changes in price supports, subsidies and environmental
regulations). In addition, many farms are dependent on a limited number of key
individuals whose injury or death may significantly affect the successful
operation of the farm. If the cash flow from a farming operation is diminished,
the borrowers ability to repay the loan may be impaired. The primary crops in
our market areas are corn and soybeans. Accordingly, adverse circumstances
affecting these crops could have an adverse effect on our agricultural real
estate loan portfolio.

We also originate agricultural operating loans. As with
agricultural
real estate loans, the repayment of operating loans is dependent on the
successful operation or management of the farm property. Likewise, agricultural
operating loans involve a greater degree of risk than lending on residential
properties, particularly in the case of loans that are unsecured or secured by
rapidly depreciating assets such as farm equipment or assets such as livestock
or crops. The primary livestock in our market areas is hogs. In these cases,
any repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation.

Page 29 of 107

Item 1A.
Risk Factors (Continued)A decline in local and national real estate
markets may impact our operations and/or financial condition.

There has been a slowdown in the national housing market as
evidenced
by reports of reduced levels of new and existing home sales, increasing
inventories of houses on the market, stagnant to declining property values, a
decline in building permits, and an increase in the time houses remain on the
market. In recent years some lenders made many adjustable-rate mortgage loans,
lowered their credit standards with respect to mortgage loans and home equity
loans, and created collateralized debt obligations which included such mortgage
loans. The slowdown in the national housing market created uncertainty and
liquidity issues relating to the value of such mortgage loans, which causes
disruption in credit markets. The extent to which local real estate mortgage
loans have been adversely affected has varied. Although management believes
that the Bank has maintained appropriate lending standards and that these
trends have yet to materially affect our local economy or our business and
profitability, no assurance can be given that these conditions will not
directly or indirectly affect our operations. If these conditions continue or
worsen, they may result in a decrease in interest income or an adverse impact
on our loan losses.

Financial market disruptions during 2008 have
increased the uncertainty and unpredictability we face in managing our
business, and continued or additional disruptions in 2009 could have an adverse
effect on our business, our results of operations and our financial condition.

During 2008, credit and other financial markets have suffered
substantial volatility, illiquidity and disruption. In the second half of 2008,
these factors resulted in the bankruptcy or acquisition of, or significant
government assistance to, a number of major domestic and international
financial institutions. These events, and the potential for increased and
continuing disruptions, have significantly diminished overall confidence in the
financial markets and in financial institutions, have exacerbated liquidity and
pricing issues within many markets, have increased the uncertainty and
unpredictability we face in managing our business. The continuation of current
disruptions or the occurrence of additional disruptions in financial markets
could have an adverse effect on our business, our results of operations and our
financial condition.

Governmental responses to recent market
disruptions may be inadequate and may have unintended consequences.

In response to recent market disruptions, legislators and financial
regulators have taken a number of steps to stabilize the financial markets.
These steps include the enactment and partial implementation of the Emergency
Economic Stabilization Act of 2008, the provision of other direct and indirect
assistance to distressed financial institutions, assistance by the banking
authorities in arranging acquisitions of weakened banks and broker-dealers, implementation
of programs by the Federal Reserve to provide liquidity to the commercial paper
markets and expansion of deposit insurance coverage. The new administration and
Congress have pursued additional initiatives in an effort to stimulate the economy
and stabilize the financial markets, including the recent enactment of the
American Recovery and Reinvestment Act of 2009, and have altered the terms of
some previously announced policies. The overall effects of these and other
legislative and regulatory efforts on the financial markets are uncertain.
Should these or other legislative or regulatory initiatives fail to stabilize
the financial markets, our business, financial condition, results of operations
and prospects could be materially and adversely affected.

If we are unable to continuously attract
deposits and other short-term funding, our financial condition, including our
capital ratios, our results of operations and our business prospects could be
harmed.

In managing our liquidity, our primary source of short-term
funding is
customer deposits. Our ability to continue to attract these deposits, and other
short-term funding sources, is subject to variability based upon a number of
factors, including the relative interest rates we are prepared to pay for these
liabilities and the perception of safety of those deposits or short-term
obligations relative to alternative short-term investments. The availability
and cost of credit in short-term markets depends upon market perceptions of our
liquidity and creditworthiness. Our efforts to monitor and manage liquidity
risk may not be successful or sufficient to deal with dramatic or unanticipated
changes in event-driven reductions in liquidity. In such events, our cost of
funds may increase, thereby reducing our net interest revenue, or we may need
to dispose of a portion of our investment portfolio, which, depending on market
conditions, could result in our realizing a loss or experiencing other adverse
consequences.

Page 30 of 107

Item 1A.
Risk Factors (Continued)Our expenses will increase as a result of
increases in FDIC insurance premiums.

The Federal Deposit Insurance Corporation (FDIC)
imposes an
assessment against institutions for deposit insurance. This assessment is based
on the risk category of the institution. Federal law requires that the
designated reserve ratio for the deposit insurance fund be established by the
FDIC at a 1.15% of estimated insured deposits. If this reserve ratio drops
below 1.15%, the FDIC must, within 90 days, establish and implement a plan to
restore the designated reserve ratio to 1.15% of estimated insured deposits
within five years (absent extraordinary circumstances). Recent bank failures
coupled with deteriorating economic conditions have significantly reduced the
deposit insurance funds reserve ratio. As a result of this reduced reserve
ratio, on October 7, 2008, the FDIC adopted a restoration plan that would
restore the reserve ratios to its required level of 1.15% over a seven-year
period.

The Emergency Economic Stabilization Act of 2008 (EESA) temporarily
increased the limit on FDIC insurance coverage for deposits to $250,000 through
December 31, 2009. In addition, the FDIC announced the Temporary Liquidity
Guarantee Program (TLGP). TLGP covers two programs: (1) Transaction Account
Guarantee Program and the (2) Debt Guarantee Program. The Company has elected
to participate in the Transaction Account Guarantee Program, which will
increase the insurance coverage for non-interest bearing deposit accounts in excess
of $250,000. The cost of the program to the Company will be 10 basis points
annualized and the expiration of the program is December 31, 2009. The Company
has also elected to participate in the Debt Guarantee Program but does not
currently have any senior unsecured debt.

Item 1B.
Unresolved Staff CommentsNone.

Page 31 of 107

Item 2.
PropertiesThe Companys office and the main office 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.

The following table sets forth
certain information concerning the other branches of the Bank as of December
31, 2008:

Location of Branch

Approximate
Square Feet

Status3905 Blairs
 Ferry Road NE
 modular temporary bank office

Cedar
 Rapids, Iowa

1,700


Leased240 3rd
 Avenue SE

Cedar
 Rapids, Iowa

7,000


Leased3610
 Williams Boulevard SW

Cedar
 Rapids, Iowa

8,200


Owned1009 2nd
 Street

Coralville,
 Iowa

23,000


Owned2771 Oakdale
 Boulevard
 Trust and Wealth Management

Coralville,
 Iowa

6,600


Leased201 South
 Clinton Street

Iowa City,
 Iowa

5,800


Leased1401 South
 Gilbert Street

Iowa City,
 Iowa

15,400


Owned2621
 Muscatine Avenue

Iowa City,
 Iowa

5,800


OwnedOaknoll
 Retirement Residence
 limited purpose office

Iowa City,
 Iowa

NA


NA120 5th
 Street

Kalona, Iowa

6,400


Owned103 West
 Main Street

Lisbon, Iowa

3,000


Owned800 11th
 Street

Marion, Iowa

8,400


Owned720 First
 Avenue SE

Mount
 Vernon, Iowa

4,200


Owned25 Highway
 965 North

North
 Liberty, Iowa

2,800


Owned229 8th
 Avenue

Wellman,
 Iowa

2,000


OwnedAll of the properties owned by the Bank are free and clear of any
mortgages or other encumbrances of any type. See Note 14 to the Consolidated
Financial Statements for minimum future rental commitments for leased
properties.

Page 32 of 107

Item 3.
Legal ProceedingsThere are no material 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 HoldersNo matters
were submitted to a vote of security holders for the three months ended
December 31, 2008.

Page 33 of 107

PART II

Item 5.
Market for the Registrants Common Equity, Related Stockholder
 Matters and Issuer Purchases of Equity SecuritiesThere 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
January 31, 2009, the Company had 1,638 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

High Selling Price

Low Selling Price2008


96,781



77



$
55.00



$
53.00
(1)2007


31,699



46




53.00




50.00
(2)2006


71,696



36




50.00




46.50
(3)(1)
2008 transactions included
 repurchases by the Company of 63,469 shares of stock under the 2005 Stock
 Repurchase Plan approved on August 8, 2005 (the Repurchase Plan). 2008 transactions
 made under the Repurchase Plan were made at prices that ranged from $53.00 to
 $55.00 per share. All transactions under the Repurchase Plan were at a price
 equal to the most recent quarterly independent appraisal of the shares of the
 Companys common stock.(2)
2007 transactions included
 repurchases by the Company of 25,492 shares of stock under the Repurchase
 Plan. 2007 transactions made under the Repurchase Plan were made at prices
 that ranged from $50.00 to $53.00 per share.(3)
2006 transactions included
 repurchases by the Company of 66,521 shares of stock under the Repurchase
 Plan. 2006 transactions made under the Repurchase Plan were made at prices
 that ranged from $46.50 to $50.00 per share.The Company paid aggregate annual cash dividends in 2008, 2007 and
2006
of $4,086,000, $3,873,000 and $3,696,000 respectively, or $.91 per share in
2008, $.86 per share in 2007 and $.81 per share in 2006. In January 2009, the
Company declared and paid a dividend of $.91 per share totaling $4,041,000. 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.

Page 34 of 107

PART II

Item 5.
Market for the Registrants Common Equity, Related Stockholder
 Matters and Issuer Purchases of Equity SecuritiesThe following
performance graph provides information regarding cumulative, five-year
shareholder returns on an indexed basis of the Companys Common Stock compared
to the NASDAQ Market Index and the Regional-Southwest Banks Index prepared by
HEMSCOTT (formerly CoreData, Inc.) of Richmond, Virginia. The latter index
reflects the performance of thirty-four bank holding companies operating
principally in the Midwest as selected by HEMSCOTT. The indexes assume the
investment of $100 on December 31, 2003 in Company Common Stock, the NASDAQ
Index and the Regional-Southwest Banks Index, with all dividends reinvested.

Hills Bancorporation 
Performance Graph (2003-2008)

(LINE GRAPPH)

2003

2004

2005

2006

2007

2008HILLS
BANCORPORATION

$
100.00

$
112.17

$
143.83

$
157.35

$
169.66

$
179.09REGIONAL-SOUTHWEST
BANKS

$
100.00

$
120.08

$
125.65

$
142.86

$
126.75

$
116.75NASDAQ MARKET
INDEX

$
100.00

$
108.41

$
110.79

$
122.16

$
134.29

$
79.25Page 35 of 107

PART II

Item 5.
Market for the Registrants Common Equity, Related Stockholder
 Matters and Issuer Purchases of Equity Securities (Continued)The following table sets forth the Companys equity
compensation plan
information as of December 31, 2008, all of which relates to stock options
issued under stock option plans approved by stockholders of the Company:

Plan Category

Number of securities
 to be issued upon exercise
 of outstanding options,
 warrants and rights
 (a)

Weighted-average exercise
 price of outstanding
 options, warrants and rights
 (b)

Number of securities remaining
 available for future issuance under
 equity compensation plans
 [excluding securities reflected in column (a)]
 (c)Equity compensation plans
approved by security holders


37,660



$
32.05



107,748Equity compensation plans not
approved by security holders











Total


37,660



$
32.05



107,748On July 26, 2005, the Companys Board of Directors authorized
a program
to repurchase up to a total of 750,000 shares of the Companys common stock
(the 2005 Stock Repurchase Program). At its January 2009 meeting, the
Companys Board of Directors extended the expiration date of the 2005 Stock
Repurchase Program to December 31, 2013. The authorization was previously set
to expire on December 31, 2009. The Company expects the purchases pursuant to
the 2005 Stock Repurchase Program to be made from time to time in private
transactions at a price equal to the most recent quarterly independent
appraisal of the shares of the Companys common stock and with the Board
reviewing the overall results of the 2005 Stock Repurchase Program on a
quarterly basis. All purchases made pursuant to the 2005 Stock Repurchase Program
since its inception have been made on that basis. The amount and timing of
stock repurchases will be based on various factors, such as the Boards
assessment of the Companys capital structure and liquidity, the amount of
interest shown by shareholders in selling shares of stock to the Company at
their appraised value, and applicable regulatory, legal and accounting factors.

The following table sets forth information about the
Companys stock
purchases pursuant to the 2005 Stock Repurchase Program for the quarter ended
December 31, 2008:

Period in 2008

Total number of shares
 purchased

Average price paid per
 share

Total number of shares
 purchased as part of
 publicly announced plans
 or programs

Maximum number of
 shares that may yet be
 purchased under the
 plans or programsOctober 1 to October
31


25,485



$
53.50



148,256



601,744November 1 to November
30


143




53.50



148,399



601,601December 1 to December
31


8,483




55.00



156,882



593,118Total


34,111



$
53.87



156,882



593,118Page 36 of 107

Item 6.
Selected Financial DataCONSOLIDATED
FIVE-YEAR STATISTICAL SUMMARY

2008

2007

2006

2005

2004YEAR-END TOTALS (Amounts in
Thousands)Total
assets

$
1,780,793

$
1,661,098

$
1,551,233

$
1,433,649

$
1,290,449Investment
securities


214,559


213,768


190,984


209,001


218,016Loans held for
sale


8,490


6,792


3,808


702


3,908Loans,
net


1,469,840


1,352,599


1,279,227


1,141,716


998,231Deposits


1,237,886


1,143,926


1,107,409


1,036,414


957,236Federal Home
Loan Bank borrowings


265,000


265,348


235,379


223,161


167,542Redeemable
common stock


23,815


22,205


20,940


20,634


16,336Stockholders equity


139,362


130,690


118,639


109,479


103,803EARNINGS (Amounts in
Thousands)Interest
income

$
97,475

$
96,928

$
87,618

$
74,403

$
65,324Interest
expense


43,481


49,952


42,362


30,363


23,885Provision for
loan losses


11,507


3,529


3,011


2,101


1,470Other
income


16,670


15,984


14,611


12,808


12,542Other
expenses


39,461


36,150


34,364


32,861


31,965Income
taxes


5,556


7,138


6,933


6,684


6,351Net
income


14,140


16,143


15,559


15,202


14,195PER SHARENet
income:Basic

$
3.16

$
3.59

$
3.42

$
3.34

$
3.12Diluted


3.15


3.57


3.39


3.32


3.11Cash
dividends


0.91


0.86


0.81


0.75


0.70Book value as
of December 31


31.38


29.11


26.34


24.00


22.82Increase
(decrease) in book value due to:ESOP
obligation


(5.36
)

(4.95
)

(4.65
)

(4.52
)

(3.59
)Accumulated
other comprehensive income (loss)


0.82


0.14


(0.28
)

(0.39
)

0.13SELECTED RATIOSReturn on
average assets


0.83
%

1.02
%

1.04
%

1.12
%

1.15
%Return on
average equity


10.42


13.06


13.74


14.47


14.34Net interest
margin


3.47


3.24


3.31


3.56


3.70Average
stockholders equity to average total assets


7.98


7.78


7.56


7.73


8.04Dividend payout
ratio


28.90


23.99


23.75


22.44


22.44Page 37 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of OperationThe 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 the consolidated
financial statements and the accompanying notes thereto included or
incorporated by reference elsewhere in this document. An overview of the year
2008 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 recent financial market disruptions and the current
 global economic recession, and monetary and other governmental actions
 designed to address such disruptions and recession.
The financial strength of the counterparties with which the Company
 or the Companys customers do business and as to which the Company has investment
 or financial exposure.
The credit quality and credit agency ratings of the securities in
the
 Companys investment securities portfolio, a deterioration or downgrade of
 which could lead to other-than-temporary impairment of the affected securities
 and the recognition of an impairment loss.
The effects of, and changes in, laws, regulations and policies
 affecting banking, securities, insurance and monetary and financial matters
 as well as any laws otherwise affecting the Company.
The effects of changes in interest rates (including the effects of
 changes in the rate of prepayments of the Companys assets) and the policies
 of the Board of Governors of the Federal Reserve System.
The ability of the Company to compete with other financial
 institutions as effectively as the Company currently intends due to increases
 in competitive pressures in the financial services sector.
The ability
 of the Company to obtain new customers and to retain existing customers.
The timely development and acceptance of products and services,
 including products and services offered through alternative 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.Page 38 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of Operation (Continued)
The ability
 of the Company to develop and maintain secure and reliable electronic
 systems.
The ability of the Company to retain key executives and employees
and
 the difficulty that the Company may experience in replacing key executives
 and employees in an effective manner.
Consumer spending and saving habits which may change in a manner
that
 affects the Companys business adversely.
The economic
 impact of natural disasters, terrorist attacks and military actions.
Business combinations and the integration of acquired businesses
and
 assets which may be more difficult or expensive than expected.
The costs,
 effects and outcomes of existing or future litigation.
Changes in accounting policies and practices that may be adopted by
 state and federal regulatory agencies and the Financial Accounting Standards
 Board.
The ability
 of the Company to manage the risks associated with the foregoing as well as
 anticipated.These risks and uncertainties should be considered in evaluating
forward-looking statements, and undue reliance should not be placed on such
statements. Additional information concerning the Company and its business,
including other factors that could materially affect the Companys financial
results, is included in the Companys filings with the Securities and Exchange
Commission.

Overview

The Company is a bank holding company engaged, through its
wholly-owned
subsidiary bank, in the business of commercial banking. The Companys subsidiary
is Hills Bank and Trust Company, Hills, Iowa (the Bank). The Bank was formed
in Hills, Iowa in 1904. The Bank is a full-service commercial bank extending
its services to individuals, businesses, governmental units and institutional
customers primarily in the communities of Hills, Iowa City, Coralville, North
Liberty, Mount Vernon, Kalona, Wellman, Cedar Rapids and Marion, Iowa.

The Companys net income for 2008 was $14,140,000 compared to
$16,143,000 in 2007. Diluted earnings per share were $3.15 and $3.57 for the
years ended December 31, 2008 and 2007, respectively.

The Banks net interest income is the largest component of
the Banks
revenue, and it is a function of the average earning assets and the net
interest margin percentage. Net interest margin is the ratio of tax equivalent
net interest income to average earning assets. For the year ended December 31,
2008, net interest income increased by $7.1 million. In 2008, the Bank achieved
a net interest margin of 3.47% compared to 3.24% in 2007, which resulted in
$2.3 million of the increase in net interest income. The remaining $4.8 million
of the increase in net interest income was attributable to growth of $103.8
million in the Banks average earning assets.

During 2008, the capital and credit markets experienced unusual
volatility and disruption. Beginning in the second half of 2008, the volatility
and disruption reached extreme levels and the markets have exerted downward
pressure on availability of liquidity and credit capacity which adversely affected
many sectors of the national economy. Recently, concerns over the availability
and cost of credit, problems in the mortgage market, a declining real estate
market, inflation, energy costs and geopolitical issues have contributed to
increased volatility and diminished expectations for the economy and the
markets going forward. These factors, combined with volatile oil prices,
declining business and consumer confidence and increased unemployment, have
precipitated a global recession. The Companys future results of operations and
financial condition could be materially adversely affected by negative effects
of the recession on the economy and continued disruptions in the capital and
credit markets.

Page 39 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Highlights
with respect to items on the Companys balance sheet as of December 31, 2008
included the following:


Net loans
 totaling $1.478 billion.
Loan growth,
 net of allowance for loan losses, in 2008 of $118.9 million.
Deposit growth of $94.0 million in 2008. Deposits increased to
$1.238
 billion and included $10.4 million of brokered deposits.
Short-term
 borrowings increased $12.8 million.
Stockholders equity increased $8.7 million to $139.4 million
in
 2008, with dividends having been paid in 2008 of $4.1 million.The return on average equity was 10.42% in 2008 compared to 13.06%
in
2007. The returns for the three previous years, 2006, 2005 and 2004, were
13.74%, 14.47% and 14.34%, respectively. The total equity of the Company
remains strong as of December 31, 2008 with total risk-based capital at 12.64%
and Tier 1 risk-based capital at 11.38%. The minimum regulatory guidelines are
8% and 4% respectively. The Company paid a dividend per share of $.91, $.86 and
$.81 in the years ended December 31, 2008, 2007 and 2006, respectively.

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

Critical Accounting Policies

The Companys consolidated financial statements are prepared
in
accordance with accounting principles generally accepted in the United States
of America. The financial information contained within these financial
statements is, to a significant extent, financial information that is based on
approximate measures of the financial effects of transactions and events that
have already occurred. Based on its consideration of accounting policies that
involve the most complex and subjective decisions and assessments, management
has identified its most critical accounting policies to be those which are
related to the allowance for loan losses. The Companys allowance for loan 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. Determinations relating to the possible level of
future loan losses are based in part on subjective judgments by management. The
difficulty of accurately estimating the future economic effects of the 2008
floods and the future impact of the global recession has introduced additional
uncertainty into such determinations. Future loan losses in excess of current
estimates, could materially adversely affect our results of operations or
financial position. Size and complexity of individual credits in relation to
loan structure, existing loan policies and pace of portfolio growth are other
qualitative factors that are considered in the methodology. As the Company adds
new products and increases the complexity of its loan portfolio, it will
enhance its methodology accordingly. This discussion of the Companys critical
accounting policies should be read in conjunction with the Companys consolidated
financial statements and the accompanying notes presented elsewhere herein, as
well as other relevant portions of Managements Discussion and Analysis of
Financial Condition and Results of Operations. Although management believes the
levels of the allowance as of December 31, 2008 and 2007 were adequate to
absorb probable losses inherent in the loan portfolio, a decline in local
economic conditions, or other factors, could result in increasing losses that
cannot be reasonably predicted at this time.

Page 40 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operations (Continued)Financial Position

Year End
 Amounts (Amounts In Thousands)

2008

2007

2006

2005

2004Total assets

$
1,780,793

$
1,661,098

$
1,551,233

$
1,433,649

$
1,290,449Investment securities


214,559


213,768


190,984


209,001


218,016Loans, net of allowance for
losses (Net Loans)


1,478,330


1,359,391


1,283,035


1,142,418


1,002,139Deposits


1,237,886


1,143,926


1,107,409


1,036,414


957,236Federal Home Loan Bank
borrowings


265,000


265,348


235,379


223,161


167,542Stockholders
equity


139,362


130,690


118,639


109,479


103,803Total assets at December 31, 2008 increased $119.7 million, or
7.21%,
from the prior year-end. Asset growth from 2006 to 2007 was $109.9 million and
represented a 7.08% increase. The largest growth in assets occurred in Net
Loans, which increased $118.9 million and $76.4 million for the years ended
December 31, 2008 and 2007, respectively. Net Loans at the end of 2008 include
loans held for sale to the secondary market of $8.5 million compared to $6.8
million at the end of 2007.

Interest rates are also discussed in the net income overview that
follows this financial position review. During 2008, the Federal Open Market
Committee decreased the target rate seven times to 0.25%. The decreases in the
target rate started on September 18, 2007 when the rate was lowered from 5.25%
to 4.75%. This was the first change in the target rate since June 29, 2006 and
the first decrease since June 25, 2003. The target rate was decreased twice
more in 2007 to a rate of 4.25% as of December 31, 2007. Prior to these
decreases, the target rate increased in June 24, 2004 when the rate was
increased from 1.00% to 1.25% and increased 17 times to 5.25% over the two-year
period to June 2006. Interest rates on loans are generally affected by these
decreases since interest rates for the U.S. Treasury market normally decrease
when the Federal Reserve Board lowers the federal funds rate. In pricing of
loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks
in determining interest rates. As of December 31, 2008, the average rate
indexes for the one, three and five year indexes were 0.40%, 1.12% and 1.50%,
respectively. The one year index decreased 88.30% from 2007, the three year
index decreased 65.33% and the five year index decreased 58.38%. During this
same period, the average federal funds rate decreased from 4.25% in 2007 to
0.25% in 2008, or 94.12%. The decrease in short-term federal funds of 400 basis
points and a 213 point decrease in the five year index caused a widening of the
investment yield curve. In the Companys trade area, demand for loans remains
adequate although there are signs of diminished activity related to national
and state economic conditions. A strong local economy that generated increased
demand for loans was a significant factor in the trend of increasing net loans
in each of the last five years. The global recession may weaken the local
economy resulting in fewer creditworthy borrowers and less robust loan demand.
Therefore, the trend of increasing net loans may not be indicative of future performance.

Loans secured by real estate represent the largest increase in loan
growth. These loans increased $74.9 million in 2008 and increased $37.3 million
in 2007. Loans secured by real estate include loans for one-to-four family
residential properties, multi-family properties, agricultural real estate and
commercial real estate. Another large increase in loans occurred for commercial
loans which in 2008 increased a total of $30.1 million and $13.7 million in
2007. Also, construction loans increased $17.2 million in 2008 compared to $8.9
million in 2007 and loans to finance agricultural production and other loans to
farmers increased $4.2 million in 2008 compared to an increase of $10.8 million
in 2007. The overall economy in the Companys principal place of business,
Johnson, Linn and Washington Counties, remains in good condition with
unemployment levels that remains below national and state levels. It is
uncertain how the overall national economic downturn will impact the Companys
principal place of business. There could be continued downward pressure on the
Iowa economy and the unemployment rates could rise in 2009. Competition for
quality loans and deposits will continue to be a challenge. In Johnson and Linn
Counties, new banks and credit unions have been opened in the last few years.
Between 2006 and 2008, six new banking locations were added in Johnson County,
fifteen in Linn County and two in Washington County. The 23 new locations
include an office of one of the states largest credit unions. 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.

Page 41 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Total deposits increased by $94.0 million in 2008 of which $10.4
million was brokered deposits. Short-term borrowings, which include federal
funds purchased and securities sold under agreements to repurchase, increased
from $87.1 million to $99.9 million. Federal funds purchased increased by $13.7
million and repurchase agreements decreased $.9 million. Deposits increased by
$36.5 million in 2007. As of June 30, 2008, Johnson County total deposits were
$2.6 billion and the Companys deposits were $854 million, which represent a
33.0% market share. The Company had 6 office locations in Johnson County as of
June 30, 2008. The total banking locations in Johnson County was 54 as of June
30, 2008. At June 30, 2007, deposits were $802 million or a 33.4% market share.
At $4.4 billion as of June 30, 2008, the Linn County deposit market is
significantly larger than the Johnson County deposit market of $2.6 billion. As
of June 30 2008, Linn County had 116 total banking locations. The five Linn
County offices of the Company had deposits of $239 million or a 5.5% share of
the market. The Companys Linn County deposits at June 30, 2007 were $253 million
and represented a 5.7% market share. In Washington County, the Companys two
offices had deposits of $75 million which was 16.1% of the Countys total
deposits of $466 million. Washington County had a total of 13 banking locations
as of June 30, 2008. In 2007, the Companys Washington County deposits were $74
million or a 16.1% market share.

Investment securities increased $.8 million in 2008. In 2007,
investment securities increased by $22.8 million. The investment portfolio
consists of $200.3 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. See Note 2 to the Companys Consolidated Financial
Statements.

During 2008, the major funding sources for the growth in loans
were the
$94.0 million increase in deposits and additional funding from federal funds
purchased. Federal funds purchased increased by $13.7 million. In 2007, the
major source of funding for the growth in loans was deposit growth of $36.5
million, increased federal funds purchased of $29.0 million and additional
advances of $30.0 million from the Federal Home Loan Bank (FHLB). The Company
did not have any brokered deposits in 2007. Total advances from the FHLB were
$265.0 million and $265.3 million at December 31, 2008 and 2007, respectively.
It is expected that the FHLB funding source will be considered in the future
when loan growth exceeds deposit increases and the interest rates on funds
borrowed from the FHLB are favorable compared to other funding alternatives.

Stockholders equity was $139.4 million at December 31, 2008
compared
to $130.7 million at December 31, 2007. 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 $75.2
million and paid shareholders dividends of $18.3 million, or 24.3% of earnings,
while still maintaining capital ratios in excess of regulatory requirements.

Page 42 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)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)2008

$
14,140

(12.41
)%

$
3.152007


16,143

3.75



3.572006


15,559

2.35



3.392005


15,202

7.09



3.322004


14,195

(0.05
)


3.11Net income for 2008 decreased by $2.0 million or 12.41% and diluted
earnings per share decreased by 11.76%. The 2008 floods (discussed below)
caused net income to decrease by $3,223,000. Without the effects of the 2008
floods, management estimates that net income would have increased $1,220,000
from 2007 to $17,363,000. A significant factor in offsetting the flood-related
losses was the growth of average earning assets. Such growth accounted for a
$4.8 million increase in the net interest income on a tax-equivalent basis. The
increased net interest margin of 23 basis points accounted for an increase of
$2.3 million in net interest income. The combined growth in earning assets and
improved net interest margin increased net interest income by $7.1 million.
Other income increased by $0.7 million. These increases were offset by the
increased provision for loan losses of $8.0 million and an increase in
operating expenses of $3.3 million for the year. The increase in operating
expenses includes $852,000 related to the 2008 floods.

Annual fluctuations in the Companys net income continue to
be driven
primarily by two important factors. The first important factor is net interest
margin. Net interest income of $54.0 million in 2008 was derived from the
Companys $1.619 billion of average earning assets and its net interest margin
of 3.47%, compared to $1.515 billion of average earning assets and a 3.24% net
interest margin in 2007. 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 3.37% would result in a $1.6 million decrease in income before taxes.
Similarly, an increase in the net interest margin of 10 basis points to 3.57%
would increase income before income taxes by $1.6 million. Net interest margin
decreased in 2007 to 3.24% from 3.31% in 2006.

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 $1.5 billion at the end of
2008. The Companys allowance for loan losses was $27.7 million at December 31,
2008. The increase in the allowance in 2008 was due to loan growth of $118.9
million, flood-related loan issues and a deterioration of credit quality. The
loan loss provision, which is the amount necessary to adjust the allowance to
the level considered appropriate by management, totaled $11,507,000, $3,529,000
and $3,011,000 for 2008, 2007 and 2006, respectively. (See Note 3 to the
Consolidated Financial Statements.) A discussion in detail is included in the
Provision for Loan Losses section below.

Net income for 2007 was $16,143,000, or diluted earnings per share
of
$3.57. For 2007, diluted earnings per share increased $.18 per share. Net
income for the year ended December 31, 2007 represented a $584,000 increase
over the reported income for the same period in 2006. Net interest income,
including fees, increased $1.7 million for the year ended December 31, 2007
compared to 2006. This increase in net interest income was due to an increase
in average earning assets of $91.7 million in 2007. Noninterest income
increased 9.40% in 2007 to $15,984,000. Noninterest expense increased from
$34,364,000 in 2006 to $36,150,000 in 2007, or 5.20%.

Page 43 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)2008 Floods

In June 2008, severe flooding occurred in large portions of East
Central and Southeast Iowa. Two of the Companys thirteen offices were damaged
by the floods. The damaged offices were the Cedar Rapids downtown office
located at 240 3rd Avenue SE and the Iowa City office located at
1401 South Gilbert Street. The Company has reopened both flood-effected
offices. The Companys operations center located in Hills, Iowa was not
affected. Access to customer accounts was unaffected by the floods. The
Companys employees were relocated to other offices. No employees were laid off
by the Company.

Financial Impact

The impact of the floods has decreased the Companys earnings
for 2008.
Net income for the year ended December 31, 2008 included $3,223,000 of
flood-related expenses, net of tax. The primary effect was from potential loan
losses related to the floods. As part of the evaluation of the allowance for
loan losses, the Company recorded an additional provision for flood-related
loan losses of $4,366,000 in 2008. Other expenses increased $852,000. A tax
benefit of $1,995,000 was recorded as a result of the $5,218,000 in additional
expenses. Both basic and diluted earnings per share were reduced $0.72 because
of the flood-related expenses. The Company did not have insurance to cover the
flood-related expenses.

Provision for Flood-Related Loan Losses

Due to wide-spread damage caused by the 2008 floods, as part of its
review of its loan portfolio, the Company attempted to determine the impact of
the 2008 floods on its customers. Management of the Company analyzed the
affected properties and businesses, flood insurance coverage, impact on sources
of repayment and underlying collateral, and customer repayment capability.

The portfolio was considered in two categories by loan type. The
first
category included all 1-to-4 family, owner-occupied mortgage loans. The second
category included construction, 1-to-4 family non-owner-occupied, multi-family
real estate, commercial real estate and commercial operating loans. The Company
evaluated the 1-to-4 family owner-occupied mortgage loans based on the address
at which the collateral is located. Collateral addresses were matched to
flooded areas. This listing was reviewed by management and it was determined
that $1,393,000 of the total additional provision for flood-related loan losses
was needed for 1-to-4 family owner-occupied mortgage loans. Loans in the second
category of construction, 1-to-4 family non-owner-occupied, multi-family,
commercial real estate and commercial operating loans were evaluated for
potential losses based on individual credit relationships. This evaluation
included a determination of whether a customer business and/or loan collateral
was located in a flooded area. Individual credit relationships for which asset
quality was downgraded based on this review resulted in $2,973,000 of the total
additional provision for flood-related loan losses.

Other Flood-Related Expenses

The Company recognized a loss of $345,000 in the second quarter of
2008
on the net book value of property and equipment at its two flood-damaged
locations in Iowa City and Cedar Rapids. This loss is included in flood
expenses on the income statement.

In addition to the loss in value of its two flood-damaged
locations,
the Company has recorded $507,000 of expenses related to the floods. These
expenses are included in flood expenses on the income statement. The expenses
include approximately $228,000 for decontaminating, drying and preparing the
two flooded offices for remodeling. This expense also includes drying of a
limited number of the Companys records. In addition, the Company incurred
$89,000 in expenses related to the evacuation of the two damaged locations. The
Company has incurred $98,000 in expenses to operate three temporary locations.
This expense includes rent, equipment and supplies. The remaining expense of
$92,000 includes various items including meals, sandbagging and other supplies
and extra mileage due to road closings and relocation of offices.

Page 44 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Office Locations

During 2008, the Company operated three temporary locations. In
Iowa
City, the Company had a 2,000 square foot location at 1210 South Gilbert
Street. Rents totaled $2,650 per month. The Iowa City temporary location is
closed. The Companys Trust Department is located at a 6,600 square foot
building at 2771 Oakdale Boulevard in Coralville, Iowa with rent of $6,600 per
month. The lease term for the Coralville location is one year. The Company also
leased an 800 square foot space in downtown Cedar Rapids for $1,025 a month.
The Cedar Rapids space was at 240 3rd Avenue SE, located on the
second floor of the Companys damaged office. The Cedar Rapids temporary
location was closed in February 2009. The rents for all of these locations
included common area charges and real estate taxes.

The Iowa City location opened on October 27, 2008. Capitalized
remodeling costs totaled $1.1 million. Additional costs of $382,000 were
incurred to replace equipment and furniture at this location.

The Cedar Rapids downtown location reopened on February 2, 2009.
Capitalized remodeling costs totaled $468,000. Additional costs of $242,000
were incurred to replace equipment and furniture at this location.

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 2008 to 3.47% and this
compares to 3.24% in 2007, 3.31% in 2006, 3.56% in 2005 and 3.70% in 2004. 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 2008 as follows:

Change In
 Average
 Balance

Change In
 Average
 Rate

Increase (Decrease)Volume
 Changes

Rate
 Changes

Net
 Change(Amounts
 In Thousands)Interest income:Loans,
net

$
100,962


(0.44
)%
$
7,617

$
(7,028
)
$
589Taxable
securities


446


0.01


24


4


28Nontaxable
securities


8,044


(0.09
)

439


(88
)

351Federal funds
sold


(5,664
)

(2.93
)

(307
)




(307
)$
103,788




$
7,773

$
(7,112
)
$
661Interest expense:Interest-bearing demand deposits

$
25,071


(0.57
)%
$
(358
)
$
1,032

$
674Savings
deposits


(6,888
)

(0.97
)

382


2,256


2,638Time
deposits


12,953


(0.63
)

(607
)

3,707


3,100Short-term
borrowings


32,239


(2.06
)

(1,673
)

2,068


395FHLB
borrowings


12,595


(0.11
)

(671
)

335


(336
)$
75,970




$
(2,927
)
$
9,398

$
6,471Change in net interest
 income







$
4,846

$
2,286

$
7,132Rate/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 45 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Net interest
income changes for 2007 were as follows:

Change In
 Average
 Balance

Effect Of
 Volume
 Changes

Effect Of
 Rate
 Changes

Net
 Change(Amounts
 In Thousands)Interest-earning assets

$
91,716

$
6,142

$
3,345

$
9,487Interest-bearing
 liabilities


78,076


(2,323
)

(5,267
)

(7,590
)Change in net interest
 income




$
3,819

$
(1,922
)
$
1,897A summary of the net interest
spread and margin is as follows:

(Tax Equivalent Basis)

2008

2007

2006Yield on average
interest-earning assets


6.15
%

6.52
%

6.28
%Rate on average interest-bearing
liabilities


3.15


3.84


3.47Net interest spread


3.00


2.68


2.81Effect of noninterest-bearing
funds


0.47


0.56


0.50Net interest margin (tax
equivalent interest income divided by
 average interest-earning assets)


3.47
%

3.24
%

3.31
%The net interest margin increased 23 basis points in 2008 and
decreased
7 basis points in 2007. The net interest spread increased 32 basis points in
2008 and decreased 13 basis points in 2007. The increase in the net interest
margin and net interest spread in 2008 are the result of declining interest
rates. The Company is able to reprice some liabilities more quickly than some
assets (particularly loans) reprice resulting in increased net interest margin
and spread.

Provision for Loan Losses

The provision for loan losses totaled $11,507,000, $3,529,000 and
$3,011,000 for 2008, 2007 and 2006, respectively. Loan charge-offs net of
recoveries were $3,557,000 in 2008 and $1,669,000 in 2007 and $521,000 in 2006.
The loan loss provision is the amount necessary to adjust the allowance to the
level considered appropriate by management. The provision is computed on a
quarterly basis and is a result of managements determination of the quality of
the loan portfolio. The provision reflects a number of factors, including the
size of the loan portfolio, the overall composition of the loan portfolio and
loan concentrations, the impact on the borrowers ability to repay, past loss
experience, loan collateral values, the level of impaired loans and loans past
due ninety days or more. In addition, management considers the credit quality
of the loans based on managements review of problem and watch loans, including
loans with historical higher credit risks (primarily agricultural and spec real
estate construction loans).

The increase in the allowance included an allocation of $375,000
related to watch loans. Watch loans increased by approximately $15.4 million
from 2007 to 2008. Approximately $7.1 million of the growth in watch loans is
flood-related. The remaining $8.3 million in growth in watch loans is related
to managements evaluation of its loan portfolio and recognition of uncertain
economic conditions. The total increase of $15.4 million is comprised of
approximately $3.7 million less in commercial real estate mortgages and $3.0
million less for construction loans which are offset by an increase in the
watch classification of $3.7 million in agricultural real estate loans, $6.1
million in 1-to-4 family residential mortgages, $10.2 million in multi-family
residential mortgages and $2.1 million in commercial loans.

Substandard loan balances were $69.4 million at December 31, 2008
and
$48.6 million at December 31, 2007. The increase in allowance related to
substandard loans of $6.3 million at December 31, 2008 resulted from several
factors. Flood-related loans made up $4.9 million of the increase in
substandard loans. In addition, two borrower relationships with an aggregate
loan balance of $13.7 million were downgraded to substandard during 2008. The
increase of $20.8 million in substandard loans at December 31, 2008 includes
$7.9 million in commercial real estate mortgages, $4.1 million in 1-to-4 family
residential mortgages, $2.8 million in agricultural real estate mortgages, $1.9
million in agricultural operating loans, $5.5 million in construction loans,
$2.8 million in commercial loans and $0.1 million in consumer loans. Those
increases were offset by a decrease in multi-family residential mortgages of
$4.3 million.

Page 46 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of Operation (Continued)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, 2008, the unemployment levels in Johnson County and Linn County were 3.3%
and 4.6%, respectively, compared to 2.8% and 4.0% in December of 2007. These
levels compare favorably to the State of Iowa at 4.5% and the national
unemployment level at 7.2%, which were 4.0% and 5.0%, respectively in December,
2007. The residential rental vacancy rates in 2008 in Johnson County, the
largest trade area for the Company, were estimated at 5.0% in Iowa City,
Coralville and North Liberty and up to 8.0% in the Cedar Rapids area. The
estimated vacancy rates for both markets were 5% one year ago. The State of
Iowa vacancy rate is 10.9% and the national rate is 9.9% with the Midwest rate
at 10.3%. These vacancy rates one year ago were 13.5%, 9.8% and 11.6%,
respectively. The Company continues to consider those vacancy rates among other
factors in its current evaluation of the real estate portion of its loan
portfolio. Due to the unstable national economic conditions, favorable vacancy
rates may not continue in 2009. Vacancy rates may rise and affect the overall
quality of the loan portfolio.

The amount of problem and watch loans considered in the allowance
for
loan losses computation increased by approximately $23,700,000 in 2007 and by
approximately $19,200,000 from the end of 2005 to 2006. The increase in problem
and watch loans for 2007 included $8,600,000 of commercial real estate loans,
$5,700,000 in commercial loans, $5,400,000 in construction loans, $3,400,000 in
residential mortgages, $1,500,000 in agricultural loans and $700,000 in
agricultural real estate loans. Those increases were offset by a reduction of
$1,600,000 in problem and watch loans for multi-family residential mortgages
contained in the loan portfolio.

The allowance for loan losses balance is also affected by the
charge-offs and recoveries for the periods presented. For the years ended
December 31, 2008, 2007 and 2006, recoveries were $932,000, $1,249,000, and
$1,352,000, respectively; charge-offs were $4,489,000, $2,918,000 and
$1,873,000 in 2008, 2007 and 2006, respectively.

Overall credit quality may continue to deteriorate in 2009. Such a
deterioration could cause increases in nonperforming loans, allowance for loan
loss provision expense and net chargeoffs. Management will monitor changing
market conditions as a part of its allowance for loan loss methodology.

The allowance for loan losses totaled $27,660,000 at December 31,
2008
compared to $19,710,000 at December 31, 2007. The percentage of the allowance
to outstanding loans was 1.85% and 1.44% at December 31, 2008 and 2007,
respectively. The percentage increase was due to loan growth and an increase in
the amount 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 composition of the loan portfolio, loans with higher
credit risks (primarily agriculture loans and spec real estate construction)
and overall increases in Net Loans outstanding. The methodology used in 2008 is
consistent with the methodology used in the prior years.

Agricultural loans totaled $64,198,000 and $60,004,000 at December
31,
2008 and 2007, respectively. The level of agriculture loans during the last
five years compared to total loans has varied from a high of 4.37% in 2007 to a
low of 3.78% in 2005. 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.

Page 47 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of Operation (Continued)Non-performing loans increased by $12.6 million from December 31,
2007
to December 31, 2008. Non-performing loans were 3.48% of loans as of December
31, 2008 and 2.88% as of December 31, 2007. Non-performing loans, which are
considered impaired, include any loan that has been placed on nonaccrual status.
Non-performing loans also include loans that, based on managements evaluation
of current information and events, the Bank expects to be unable to collect in
full according to the contractual terms of the original loan agreement. These
loans are also considered impaired loans. This increase in non-performing loans
is due in part to $5.0 million in flood-related loans. In addition, two large
borrower relationships were added to non-performing loans in 2008. The first
borrower relationship consists mainly of commercial real estate loans with an
aggregate balance of approximately $10.4 million as of December 31, 2008. The
second borrower relationship had an aggregate balance of $3.3 million as of
December 31, 2008 and relates to residential development in the Companys
market area. These increases of $18.7 million were offset by improvements in
various borrower relationships considered non-performing as of December 31,
2007. The Company believes that the allowance for loan losses is at a level
commensurate with the overall risk exposure of the loan portfolio. However, if
economic conditions continue to deteriorate, certain borrowers may experience
additional difficulty and the level of nonperforming loans, chargeoffs and
delinquencies could continue to rise and require further increases in the
provision for loan losses.

The Company restructured loans totaling $4.5 million during 2008.
These
loans related to two customers. The first customer relationship consisted of
six loans totaling $1.2 million and is flood related. The Company would have
recorded $63,000 in interest income during 2008 related to these loans if the
loans had been current in accordance with their original terms. There was no
interest income related to the restructured loans included in net income for
2008 as the accrued interest on the loans was charged off during the period and
the loans are currently on non-accrual status. The Company loaned an additional
$137,000 to the borrower in 2008 after the completion of the restructuring of
the loans noted above. In addition, the Company has committed to lend an
additional $270,000 to the customer. The second restructured customer
relationship consisted of four loans totaling $3.3 million. This restructure
was completed as of the end of 2008. There was no lost interest income related
to this customer relationship. The Company does not have any commitments to
lend the customer additional funds.

Other Income

The other income of the Company was $16,670,000 in 2008 compared to
$15,984,000 in 2007. The increase of $686,000 in 2008 was the result of a
combination of factors discussed below. In 2007, the total other income
increased $1,373,000 from 2006.

The amount of the net gain on sale of secondary market mortgage
loans
in each year can vary significantly. The gain was $1,274,000 in 2008, $934,000
in 2007 and $859,000 in 2006. The dollar volume of loans sold in 2008 was
approximately 115% of the volume in 2007 and 126% of the activity experienced
in 2006. The fee per loan in 2008 was approximately 24% higher than the fee per
loan in 2007. The volume of activity in these types of loans is directly
related to the level of interest rates. During portions of 2008, secondary
market rates were favorable resulting in the increase in the volume of loans
sold. The servicing of the loans sold into the secondary market is not retained
by the Company so these loans do not provide an ongoing stream of income.

Trust fees decreased $11,000 to $3,917,000 in 2008. Trust fees
increased $505,000 in 2007. As of December 31, 2008, the Banks Trust
Department had $784 million in assets under management compared to $963 million
and $857 million at December 31, 2007 and 2006, 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 amount to approximately 42.5%
of assets under management. In 2008, the Dow Jones Industrial Average decreased
33.8%. The market value of the Dow Jones Industrial Average increased over 6%
in 2007 and over 16% in 2006.

Service charges and fees increased $46,000 in 2008 to $7,907,000
from
$7,861,000 in 2007. Such charges and fees include fees on deposit accounts and
credit card processing fees on merchant accounts. Service fees on deposit
accounts decreased $396,000 in 2008 compared to the prior year as a result of
diminished results from fee income strategies. Debit card interchange fees
increased $226,000 and point of sale (POS) interchange income increased
$217,000. These increases were due to volume changes in debit and credit card
usage.

Page 48 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of Operation (Continued)Rental revenue on tax credit real estate increased $358,000 in
2008 due
to the additions of tax credit properties in 2007 and 2008. 2008 includes a
full year of income related to the property invested in during 2007 and a
partial year of income for the property invested in during 2008.

Other noninterest income was $2,529,000 in 2008 and $2,576,000 in
2007.
Included in other noninterest income are amounts related to Visa, Inc.
(Visa). In the first quarter of 2008, Visa completed its initial public
offering (IPO). After the redemption, the Company has 4,210 shares of Visa
Class B Common Stock which is valued at its carryover basis of $0 on the
Companys balance sheet. The sale of the stock is restricted for the longer of
3 years or until the end of the litigation noted below. The Company received
$114,000 in proceeds from the redemption of shares as a part of the IPO and
recorded a gain. In addition, during the fourth quarter of 2007, the Company
recorded a $50,000 reserve related to the Banks contingent liability, as a
member of Visa, for the Banks portion of settlement payments arising from Visas
litigation with American Express Company and Discover Financial Services. In
conjunction with the IPO, Visa created a litigation escrow which is to be used
to pay the litigation settlement payments. As a result, the Company recorded a
receivable equal to the $50,000 reserve during the first quarter of 2008. This
receivable is recorded as a contra-liability to the reserve. Both the liability
and receivable are reflected in other liabilities on the Companys consolidated
financial statements. The economic benefit of the receivable is recorded in
other noninterest income. In October 2008, Visa reached a settlement with
Discover Financial Services. The Companys share of the settlement obligation
is approximately $33,000 which has been funded through the issuance of
additional shares by Visa through the litigation escrow and a reduction in the
Class B common stock outstanding.

There was a $170,000 decrease related to official check balance
earnings. In 2007, the Company utilized a third-party service provider to issue
its official checks. The third party paid interest on the balances required to
cover outstanding official checks. In February 2008, the Company changed to an
in-house processing system for official checks. Therefore, interest is no
longer being earned on the outstanding official check balances.

Service charges and fees increased by $934,000 from 2006 to 2007,
resulting in total fees of $7,861,000 in 2007. Service fees on deposit accounts
increased $428,000 in 2007 compared to 2006 due to fee income strategies.
Service charge income on savings deposits increased $53,000 due to a change in
the related fee structure and minimum balance requirements. In addition, debit
card interchange fees increased $293,000 and point of sale (POS) interchange income
increased $116,000.

Other Expenses

Total other expenses were $39,461,000 and $36,150,000 for the years
ended December 31, 2008 and 2007, respectively. The increase is $3,311,000 or
9.16% in 2008 and $1,786,000 or 5.20% in 2007. Salaries and employee benefits,
the largest component of non-interest expense, increased $934,000 in 2008, a
4.83% change. This increase includes $906,000 in direct salaries, a 6.25%
increase which resulted from annual pay adjustments and additional employees in
2008. The Company had nine additional full time and 11 additional part-time
employees in 2008. Another component of salaries and employee benefits expense
is profit sharing plan expense which totaled $1,264,000 in 2008. This expense
increased $84,000, or 7.12% over 2007 and includes the Companys contributions
to its Profit Sharing and ESOP plans. (See Note 8 to the Consolidated Financial
Statements.) The majority of the increase is due to growth in the underlying
salary base for eligible employees.

Occupancy expense increased $19,000 with increases of $51,000 in
property taxes and $20,000 in rental paid for ATMs. Occupancy expense also
includes costs related to building maintenance and upkeep. This expense
increased $31,000 in 2008 mainly due to increased snow removal costs incurred
during the year. These increase are offset by a reduction in utilities expense
of $49,000 and building rent of $29,000. In 2007, building rents included rent
paid on a former location which has not been incurred in 2008.

Page 49 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of Operation (Continued)In 2008, furniture and equipment expense included depreciation
expense
of $1,652,000 and $1,265,000 in equipment and software maintenance contracts. These
expenses one year ago were $1,670,000 for depreciation and $1,251,000 for the
maintenance contracts. These differences in depreciation and maintenance
contracts resulted in decreased expenses of $4,000. Phone line lease expense
increased $29,000 and equipment repair expense increased $20,000 from 2007 to
2008.

Advertising and business development expense decreased $71,000 from
2007 to 2008. Factors in this decrease included reductions in costs related to
core account campaigns of $45,000, newspaper advertising of $29,000 and
community gift certificates of $35,000. These cost reductions were offset by
additional expenses in 2008 that included $28,000 for customer on-line bill
payment expense and $37,000 for credit card reward points based on customer usage
volumes.

Outside services increased $311,000 in 2008 to $5,565,000 for the
year
ended December 31, 2008 compared to the same period in 2007. Outside services
include professional fees, courier services and ATM fees, and processing
charges for the merchant credit card program, retail credit cards and other
data processing services. Professional fees increased $26,000 from 2007 to a
total of $1,658,000 for 2008. Attorneys fees increased $30,000 over 2007 due
in part to increased activity related to costs of collection efforts and
repossession activity. Credit card, debit card and merchant card processing
expenses increased $122,000 due to the volume of transactions in 2008. Data
processing expense also increased $79,000 due to a growth in the volume of transactions
from 2007 to 2008 and monthly fees for new trust system implemented in 2008 and
the teller management system implemented in the third quarter of 2007.
Appraisal and abstract fees increased $57,000 from 2007 to 2008 based on loan
volume. In addition, the loss on repossessed real estate properties and other
repossessed assets increased $85,000 from the same period in 2007. During 2007,
thirteen properties were sold at a net gain of approximately $14,000. The
twelve properties sold in 2008 were at a net loss of $71,000. Also, other
repossessed assets were sold at a loss of $25,000 in 2008.

Rental expenses on tax credit real estate increased $587,000 in
2008
due to the addition of tax credit properties in late 2007 and 2008. 2008
includes a full year of expenses related to the property invested in during
2007 and a partial year of income for the property invested in during 2008.

Flood related expenses were $852,000 in 2008. Included in the flood
expenses are a loss of $345,000 on the net book value of property and equipment
at two damaged locations. In addition, the Company recorded $507,000 of
expenses related to the floods. The expenses include approximately $228,000 for
decontaminating, drying and preparing the two flooded offices for remodeling. This
expense also includes drying of a limited number of the Companys records. In
addition, the Company incurred $89,000 in expenses related to the evacuation of
the two damaged locations. The Company has incurred $98,000 in expenses to
operate three temporary locations. This expense includes rent, equipment and
supplies. The remaining expense of $92,000 includes various items including
meals, sandbagging and other supplies and extra mileage due to road closings
and relocation of offices.

Other noninterest expense was $2,202,000 for the year ended
December
31, 2008, an increase of $644,000 over the same period in 2007. Other
noninterest expense includes fraud losses related to customer credit and debit
cards, ATM activity and customer deposit accounts. This expense increased
$116,000 in 2007 due to increased incidents of unauthorized use of customer
credit and debit cards. Other noninterest expense also includes assessments
paid by the Company to the FDIC and State of Iowa. These assessments increased
$739,000 in 2008 to a total of $993,000. In 2007, the Company received a
one-time assessment credit from the FDIC that offset the assessment expense.
There were no assessment credits available in 2008 to offset the assessment
expense.

Page 50 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition And
 Results of Operation (Continued)Total other expenses were $34,364,000 for the year ended December
31,
2006. The increase in expenses in 2007 was $1,786,000. This included an
increase of $885,000 in salaries and benefits, which was the direct result of
salary adjustments for 2007. Other expense increases in 2007 include $75,000 in
additional profit sharing plan contributions related to the growth in the
underlying salary base for eligible employees. Medical expenses included with
salaries and benefits increased from $1.5 million to $1.6 million in 2007.
Occupancy expense increased $122,000 due to property taxes, utilities and
building maintenance. Furniture and equipment expense was $39,000 higher in
2007 when compared to 2006 as a result of the costs related to equipment and
software maintenance contracts. In addition, there was an increase in outside
services of $366,000. Outside service expense increase included $35,000 in
internal audit and loan review fees to third party service providers.
Attorneys fees increased $49,000 to due in part of increased activity related
to costs of collection efforts and repossession volume. Credit card, debit card
and merchant card processing expenses, along with data processing expenses,
increased $234,000 due to the volume of transactions.

Other noninterest expense was $1,558,000 for the year ended
December
31, 2007, an increase of $313,000 over the same period in 2006. The expense
related to fraud losses on customer accounts increased $75,000 due to increased
incidents of unauthorized use of customer credit and debit cards. Other
noninterest expenses also include $243,000 related to unauthorized activities
by an employee of the Bank in a Bank internal account.

Income Taxes

Income tax expense was $5,556,000, $7,138,000 and $6,933,000 for
the
years ended December 31, 2008, 2007 and 2006, respectively. Income taxes as a
percentage of income before income taxes were 28.21% in 2008, 30.66% in 2007
and 30.82% in 2006. The amount of tax credits were $706,000, $566,000 and
$566,000 for 2008, 2007 and 2006, respectively. In 2008, the Company invested
in a fifth tax credit property. Credits related to this new property will be
approximately $2.7 million and are expected to be recognized over a fifteen
year period starting in 2009.

Page 51 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Impact of Recently Issued Accounting Standards

As of January 1, 2008, the Company adopted FASB Statement No. 157,
Fair Value Measurements (FAS 157) in its
entirety. The Statement provides a single definition of fair value, a framework
for measuring fair value and expanded disclosures concerning fair value.
Previously, different definitions of fair value were contained in various
accounting pronouncements that prescribe fair value as the relevant measure of
value. (See Footnotes 1 and 12 to the Companys consolidated financial
statements.)

In February 2007, the FASB issued FASB Statement No. 159, The
Fair Value Option for Financial Assets and
Financial Liabilities  Including an Amendment of FASB Statement No. 115
(FAS 159). FAS 159 permits companies to choose to measure many financial
instruments and certain other items at fair value that are not currently
required to be measured at fair value. The objective of FAS 159 is to provide
opportunities to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply hedge
accounting provisions. FAS 159 also establishes presentation and disclosure
requirements designed to facilitate comparisons between companies that choose
different measurement attributes for similar types of assets and liabilities.
The Statement was effective for financial statements issued for the year
beginning after November 15, 2007. As the fair value option was not elected for
any financial assets or liabilities, the adoption of this Statement did not
have a significant effect on the Companys consolidated financial statements
for 2008.

In November 2007, the SEC issued Staff Accounting Bulletin No.
109, Written Loan Commitments Recorded at Fair Value
Through Earnings (SAB 109). SAB 109 provides interpretive guidance
on the accounting for written loan commitments recorded at fair value through
earnings under generally accepted accounting principles. SAB 109 revises and
rescinds portions of Staff Accounting Bulletin No. 105, Application of
Accounting Principles to Loan Commitments. The SEC staff belief is that the
expected net future cash flows related to the associated servicing of a loan
should be included in the measurement of derivative and other written loan
commitments that are accounted for at fair value through earnings. SAB 109 was
effective for financial statements issued for the year beginning after December
15, 2007. The adoption of SAB 109 did not have a significant effect on the
Companys consolidated financial statements.

In December 2007, the FASB issued FASB Statement No. 141
(revised), Business Combinations (FAS 141R). The
standard changes the accounting for business combinations including the
measurement of acquirer shares issued in consideration for a business
combination, the recognition of contingent consideration, the accounting for
pre-acquisition gain and loss contingencies, the recognition of capitalized
in-process research and development, the accounting for acquisition-related
restructuring cost accruals, the treatment of acquisition related transaction
costs and the recognition of changes in the acquirers income tax valuation
allowance. FAS 141R is effective for financial statements issued for the year
beginning after December 15, 2008. The adoption of this Statement will not have
a significant effect on the Companys consolidated financial statements.

In December 2007, the FASB issued FASB Statement No. 160,
Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51 (FAS 160). The standard
changes the accounting for noncontrolling (minority) interests in consolidated
financial statements including the requirements to classify noncontrolling
interests as a component of consolidated stockholders equity, and the
elimination of minority interest accounting in results of operations with
earnings attributable to noncontrolling interests reported as part of
consolidated earnings. Additionally, FAS 160 revises the accounting for both
increases and decreases in a parents controlling ownership interest. FAS 160
is effective for financial statements issued for the year beginning after
December 15, 2008. The adoption of this Statement will not have a significant
effect on the Companys consolidated financial statements.

Page 52 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Impact of Recently Issued Accounting Standards (continued)

In January 2008, the SEC issued Staff Accounting Bulletin No.
110,Certain Assumptions Used in Valuation Methods
(SAB 110) which amends Staff Accounting Bulletin No. 107, Share-Based Payment (SAB 107). SAB 110
allows for the continued use, under certain circumstances, of the simplified
method in developing an estimate of expected term of so-called plain vanilla
stock options accounted for under FAS 123R. SAB 110 amends SAB 107 to permit
the use of the simplified method beyond December 31, 2007. The adoption of
SAB 110 did not have a significant effect on the Companys consolidated
financial statements.

In March 2008, the FASB issued FASB Statement No. 161,
Disclosures about Derivative Instruments and
Hedging Activities  an amendment of FASB Statement No. 133 (FAS
161). The standard requires qualitative disclosures about objectives and
strategies for using derivatives, quantitative disclosures about fair value
amounts of gains and losses on derivative instruments, and disclosures about
credit-risk related contingent features in derivative agreements. FAS 161 is
effective for financial statements issued for the year beginning after November
15, 2008. The adoption of FAS 161 will not have a significant effect on the
Companys consolidated financial statements.

In May 2008, the FASB issued FASB Statement No. 162, The
Hierarchy of Generally Accepted Accounting
Principles (FAS 162). The standard identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements that are presented in conformity
with generally accepted accounting principles in the United States of America.
FAS 162 will be effective 60 days following the SECs approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles. The adoption of FAS 162
will not have a significant effect on the Companys consolidated financial
statements.

In June 2008, the Emerging Issues Task Force (EITF)
issued EITF Issue
No. 07-5, Determining Whether an Instrument
(or Embedded Feature) is Indexed to an Entitys Own Stock (EITF No.
07-5). EITF No. 07-5 defines when adjustment features within contracts are
considered to be equity-indexed. EITF No. 07-5 is effective for financial
statements issued for the year beginning after December 15, 2008. The adoption
of EITF No. 07-5 will not have a significant effect on the Companys
consolidated financial statements.

In June 2008, the EITF issued EITF Issue No. 08-3, Accounting
by Lessees for Maintenance Deposits under
Lease Agreements (EITF No. 08-3). EITF No. 08-3 states that
lessees should account for nonrefundable maintenance deposits as deposit assets
if it is probable that maintenance activities will occur and the deposit is
therefore realizable. Amounts on deposit that are not probable of being used to
fund future maintenance activities should be charged to expense. EITF No. 08-3
is effective for financial statements issued for the year beginning after
December 15, 2008. The adoption of EITF No. 08-3 will not have a significant
effect on the Companys consolidated financial statements.

In June 2008, the FASB issued FASB Staff Position FSP EITF 03-6-1,
Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities (FSP
EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards
that contain nonforfeitable rights to dividends or dividend equivalents are
participating securities as defined in EITF 03-6, Participating Securities and the Two-Class Method under FASB Statement
No. 128, Earnings Per Share, and therefore should be included in
computing earnings per share using the two-class method. FSP EITF 03-6-1 is
effective for financial statements issued for the year beginning after December
15, 2008. The adoption of FSP EITF 03-6-1 will not have a significant effect on
the Companys consolidated financial statements.

In October 2008, the FASB issued FASB Staff Position 157-3,
Determining the Fair Value of a Financial Asset When
the Market for That Asset Is Not Active (FSP FAS 157-3). FSP FAS
157-3 clarifies that application of FAS 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active. FSP FAS 157-3 was effective upon release and applied to prior periods
for which financial statements have not been issued, including periods ending
on or before September 30, 2008. The adoption of FSP FAS 157-3 did not have a
significant effect on the Companys consolidated financial statements.

Page 53 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Impact of Recently Issued Accounting Standards (continued)

In December 2008, the FASB issued FASB Staff Position FAS 140-4
and FIN
46(R)-8, Disclosures by Public Entities
(Enterprises) about Transfers of Financial Assets and Interest in Variable
Interest Entities (FSP FAS 140-4 and FIN 46(R)-8). FSP FAS 140-4
and FIN 46(R)-8 amends FASB Statement No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities (FAS 140), and FASB Interpretation No. 46 (Revised
December 2003), Consolidation of Variable
Interest Entities (FIN 46(R)). FAS 140 is amended to require
public entities to provide additional disclosures about transferors continuing
involvement with transferred financial assets. FIN 46(R) is amended to require
public enterprises to provide additional disclosures about their involvement
with variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is effective for
financial statements issued after December 15, 2008. The adoption of FSP FAS
140-4 and FIN 46(R)-8 did not have a significant effect on the Companys
consolidated financial statements.

In January 2009, the FASB issued FASB Staff Position No. EITF
99-20-1, Amendments to the Impairment Guidance of EITF Issue
No. 99-20 (FSP EITF 99-20-1). FSP EITF 99-20-1 amends EITF Issue
No. 99-20, Recognition of Interest Income
and Impairment on Purchased Beneficial Interests and Beneficial Interests That
Continue to Be Held by a Transferor in Securitized Financial Assets,
to achieve more consistent determination of whether an other-than-temporary
impairment has occurred. Under FSP EITF 99-20-1, companies must recognize
other-than-temporary impairment of beneficial interests in securitized assets
if the current information and events indicate it is possible that there has
been an adverse change in the instruments estimated cash flows. Interest
income is also required to be based on the same cash flow estimate. FSP EITF
99-20-1 is effective for financial statements issued after December 15, 2008.
The adoption of FSP EITF 99-20-1 did not have a significant effect on the
Companys consolidated financial statements.

Page 54 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)Interest Rate Sensitivity and Liquidity Analysis

At December
31, 2008, the Companys interest rate sensitivity report is as follows (amounts
in thousands):

Repricing 
 Maturities 
 Immediately

Days

More Than 
 One Year

Total2-30

31-90

91-180

181-365Earning assets:Investment
securities

$


$
2,955

$
7,125

$
18,370

$
11,175

$
174,934

$
214,559Loans


7,780


206,376


52,509


69,971


108,634


1,060,720


1,505,990Total


7,780


209,331


59,634


88,341


119,809


1,235,654


1,720,549Sources of funds:Interest-bearing checking and savings accounts


48,474














406,297


454,771Certificates of
deposit





26,373


34,408


71,797


224,045


257,193


613,816Other
borrowings - FHLB














40,000


225,000


265,000Federal funds
and repurchase agreements


99,937

















99,937148,411


26,373


34,408


71,797


264,045


888,490


1,433,524Other sources,
primarily noninterest-bearing

















169,299


169,299Total
sources


148,411


26,373


34,408


71,797


264,045


1,057,789


1,602,823Interest Rate Gap

$
(140,631
)
$
182,958

$
25,226

$
16,544

$
(144,236
)
$
177,865

$
117,726Cumulative Interest Rate Gap at
December 31, 2008

$
(140,631
)
$
42,327

$
67,553

$
84,097

$
(60,139
)
$
117,726The 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 either their due date or if they
are callable on their most likely call date based on the interest rate.

Page 55 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)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.

Liquidity and Capital Resources

On an unconsolidated basis, the Company had cash balances of
$212,000
as of December 31, 2008. In 2008, the Company received dividends of $7,042,000
from its subsidiary Bank and used those funds to pay dividends to its
stockholders of $4,086,000 and to fund purchases of treasury stock under the
2005 Stock Repurchase Program.

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 $31,990,000, $32,641,000 and $28,138,000 as of December 31, 2008,
2007 and 2006, respectively. As of December 31, 2008 and 2007, stockholders
equity, before deducting for the maximum cash obligation related to the ESOP,
was $163,177,000 and $152,895,000, respectively. This measure of stockholders
equity as a percent of total assets was 9.16% at December 31, 2008 and 9.20% at
December 31, 2007. As of December 31, 2008, total equity was 7.83% of assets
compared to 7.87% of assets at the prior year end.

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, 2008, 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.

Page 56 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)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, 2008, the Tier 1 risk-based
leverage ratio of the Bank was 8.98% and exceeded the ratio required by the
Superintendent.

The actual amounts of risk-based capital and risk-based capital
ratios
as of December 31, 2008 and the minimum regulatory requirements for the Company
and the Bank are presented below (amounts in thousands):

Actual

For Capital
 Adequacy
 Purposes

To Be Well
 Capitalized Under
 Prompt Corrective
 Action ProvisionsAmount

Ratio

Ratio

RatioAs of
 December 31, 2008:Company:Total
risk-based capital

$
174,402


12.64
%

8.00
%

10.00
%Tier 1
risk-based capital


157,028


11.38


4.00


6.00Leverage
ratio


157,028


8.99


3.00


5.00Bank:Total
risk-based capital


174,154


12.63


8.00


10.00Tier 1
risk-based capital


156,795


11.38


4.00


6.00Leverage
ratio


156,795


8.98


3.00


5.00The Bank is
classified as well capitalized by FDIC capital guidelines.

On a consolidated basis, 2008 cash flows from operations provided
$24,211,000 and net increases in deposits provided $93,960,000. These cash
flows were invested in Net Loans of $129,869,000. In addition, $4,968,000 was
used to purchase property and equipment and leasehold improvements. Cash flows
of $3,262,000 were also used to investment in tax credit real estate
properties.

At December 31, 2008, the Bank had total outstanding loan
commitments
and unused portions of lines of credit totaling $309,305,000 (see Note 14 to
the Consolidated 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). As of December 31, 2008, the Bank can obtain an additional $189 million
from the FHLB based on the current real estate mortgage loans held. In
addition, the Bank has arranged $86.5 million of credit lines at three banks.
The borrowings under these credit lines would be secured by the Banks
investment securities.

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 57 of 107

Item 7.
Managements Discussion and Analysis of Financial Condition and
 Results of Operation (Continued)In 2008, the Bank opted to participate in both programs under the
FDICs Temporary Liquidity Guarantee Program (TLGP). The first program was
the Transaction Account Guarantee Program under which, through December 31,
2009, all non-interest bearing transaction accounts are fully guaranteed by the
FDIC for the entire amount of the account. Coverage under the Transaction
Account Guarantee Program is in addition to and separate from the coverage
available under the FDICs general deposit insurance rules. The second TLGP
program in which the Bank elected to participate was the Debt Guarantee
Program. The Debt Guarantee Program guarantees certain newly issued senior,
unsecured debt of participating financial institutions. Under the FDICs Final
Rule adopted on November 21, 2008, certain senior, unsecured debt issued before
June 30, 2009, with a maturity of greater than 30 days that matures on or prior
to June 30, 2012, is automatically included in the program. The fees associated
with this program range from 50 to 100 basis points on an annualized basis and
vary according to the maturity of the debt issuance. On February 10, 2009, it
was announced that, for an additional premium, the FDIC will extend the Debt
Guarantee Program through October 2009. The Company did not have any senior
unsecured debt as of December 31, 2008.

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

Contractual Obligations and Commitments

As disclosed in Note 14 to the Consolidated 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, 2008:

Payments Due By Period(Amounts In Thousands)Total

Less ThanOne Year

One -Three Years

Three -Five Years

More ThanFive YearsContractual
 obligations:Long-term debt
obligations

$
265,000

$
40,000

$
40,000

$


$
185,000Operating lease
obligations


2,008


340


534


521


613Total
 contractual obligations:

$
267,008

$
40,340

$
40,534

$
521

$
185,613Other
 commitments:Lines of
credit

$
309,305

$
237,271

$
63,229

$
8,082

$
723Standby letters
of credit


12,365


12,365








Total
 other commitments

$
321,670

$
249,636

$
63,229

$
8,082

$
723Page 58 of 107

Item 7A.
Quantitative and Qualitative Disclosures About Market RiskRelated Party Transactions

The Banks primary transactions with related parties are the
loan and
deposit relationships it maintains with certain principal 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, 2008 and 2007, loan balances to related individuals and businesses totaled
$41,210,000 and $38,136,000, respectively. Deposits from these related parties
totaled $7,667,000 and $11,416,000 as of December 31, 2008 and 2007,
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.

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 59 of 107

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.

2009

2010

2011

2012

2013

Thereafter

Total

Fair Value(Amounts In Thousands)Assets:Loans,
fixed:Balance

$
172,444

$
81,468

$
92,954

$
85,492

$
247,432

$
72,012

$
751,802

$
833,602Average
interest rate


6.12
%

6.45
%

6.46
%

6.86
%

5.87
%

5.69
%

6.16
%Loans,
variable:Balance

$
246,949

$
82,898

$
103,693

$
63,906

$
225,650

$
22,602

$
745,698

$
731,923Average
interest rate


4.74
%

6.36
%

6.06
%

6.49
%

5.81
%

5.81
%

5.61
%Investments (1):Balance

$
54,329

$
34,505

$
34,188

$
31,477

$
15,533

$
44,527

$
214,559

$
214,559Average
interest rate


4.19
%

4.52
%

4.66
%

4.87
%

4.83
%

5.59
%

4.76
%Liabilities:Liquid deposits
(2):Balance

$
454,771

$


$


$


$


$


$
454,771

$
454,771Average
interest rate


0.95
%

0.00
%

0.00
%

0.00
%

0.00
%

0.00
%

0.95
%Deposits, certificates:Balance

$
357,052

$
165,621

$
71,179

$
9,307

$
10,657

$


$
613,816

$
613,816Average
interest rate


3.32
%

3.96
%

3.99
%

4.05
%

3.86
%

0.00
%

3.59
%(1)
Includes all
 available-for-sale investments, federal funds and Federal Home Loan Bank
 stock.(2)
Includes
 passbook accounts, NOW accounts, Super NOW accounts and money market funds.Page 60 of 107

Item 8.
Consolidated Financial Statements and Supplementary DataThe
consolidated financial statements and supplementary data are included on Pages
62 through 96.

Page 61 of 107

(KPMG LOGO)
KPMG LLP
 2500 Ruan Center 
 666 Grand Avenue 
 Des Moines, IA 50309Report of Independent
Registered Public Accounting Firm

The Board of
Directors and Stockholders 
Hills Bancorporation:

We have audited the accompanying consolidated balance sheets of
Hills
Bancorporation and subsidiary (the Company) as of December 31, 2008 and 2007,
and the related consolidated statements of income, comprehensive income,
stockholders equity, and cash flows for each of the years in the three-year
period ended December 31, 2008. We also have audited Hills Bancorporations
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control 
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Hills Bancorporations
management is responsible for these consolidated financial statements, for
maintaining effective internal control over financial reporting, and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying managements report on internal control over
financial reporting. Our responsibility is to express an opinion on these
consolidated financial statements and an opinion on the Companys internal
control over financial reporting 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 audits to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement
and whether effective internal control over financial reporting was maintained
in all material respects. Our audits of the consolidated financial statements
included examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating
the overall consolidated financial statement presentation. Our audit of internal
control over financial reporting included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audits also
included performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our
opinions.

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, the consolidated financial statements referred to
above
present fairly, in all material respects, the financial position of Hills
Bancorporation and subsidiary as of December 31, 2008 and 2007, and the results
of its operations and its cash flows for each of the years in the three-year
period ended December 31, 2008, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, Hills
Bancorporation maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2008, based on criteria established
in Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ KPMG LLP

March 11, 2009

Page 62 of 107

HILLS BANCORPORATION

CONSOLIDATED BALANCE SHEETS 
December 31, 2008 and 2007 
(Amounts In Thousands, Except Shares)

ASSETS

2008

2007Cash and cash equivalents (Note
10)

$
22,575

$
32,383Investment securities available
for sale at fair value(amortized cost 2008 $194,402; 2007 $198,551) (Notes 2 and 6)


200,312


199,599Stock of Federal Home Loan
Bank


14,247


14,169Loans held for sale


8,490


6,792Loans, net of allowance for loan
losses(2008 $27,660; 2007 $19,710) (Notes 3, 7 and 11)


1,469,840


1,352,599Property and equipment, net
(Note 4)


23,606


21,220Tax credit real estate


12,065


8,803Accrued interest
receivable


10,437


11,391Deferred income taxes, net (Note
9)


8,959


7,731Other real estate


5,155


473Goodwill


2,500


2,500Other assets


2,607


3,438$
1,780,793

$
1,661,098LIABILITIES AND
STOCKHOLDERS EQUITYLiabilitiesNoninterest-bearing deposits

$
169,299

$
154,219Interest-bearing deposits (Note 5)


1,068,587


989,707Total
deposits


1,237,886


1,143,926Short-term
borrowings (Note 6)


99,937


87,076Federal Home
Loan Bank borrowings (Note 7)


265,000


265,348Accrued
interest payable


2,914


3,227Other
liabilities


11,879


8,6261,617,616


1,508,203Commitments and Contingencies
(Notes 8 and
 14)Redeemable Common Stock Held By
Employee Stock Ownership Plan (ESOP) (Note
8)


23,815


22,205Stockholders Equity (Note 10)Capital stock,
no par value; authorized
 10,000,000 shares; issued 2008 4,597,427 shares; 2007 4,583,520 shares





Paid in
capital


13,447


12,823Retained
earnings


154,176


144,122Accumulated
other comprehensive income


3,649


647Treasury stock
at cost (2008 156,882
 shares; 2007 93,413 shares)


(8,095
)

(4,697
)163,177


152,895Less maximum
cash obligation related to
 ESOP shares (Note 8)


23,815


22,205139,362


130,690$
1,780,793

$
1,661,098See Notes to
Consolidated Financial Statements.

Page 63 of 107

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME 
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands, Except Per Share Amounts)

2008

2007

2006Interest income:Loans,
including fees

$
89,341

$
88,743

$
80,240Investment
securities:Taxable


4,734


4,706


4,438Nontaxable


3,382


3,154


2,900Federal funds
sold


18


325


40Total
interest income


97,475


96,928


87,618Interest expense:Deposits


28,865


35,277


27,841Short-term
borrowings


1,756


2,151


2,801FHLB
borrowings


12,860


12,524


11,720Total
interest expense


43,481


49,952


42,362Net
interest income


53,994


46,976


45,256Provision for loan losses (Note
3)


11,507


3,529


3,011Net
interest income after provision for loan losses


42,487


43,447


42,245Other income:Net gain on
sale of loans


1,274


934


859Trust
fees


3,917


3,928


3,423Service charges
and fees


7,907


7,861


6,927Rental revenue
on tax credit real estate


1,043


685


781Other
noninterest income


2,529


2,576


2,62116,670


15,984


14,611Other expenses:Salaries and
employee benefits


20,287


19,353


18,468Occupancy


2,363


2,344


2,222Furniture and
equipment


3,527


3,482


3,443Office supplies
and postage


1,319


1,329


1,297Advertising and
business development


1,788


1,859


1,843Outside
services


5,565


5,254


4,888Rental expenses
on tax credit real estate


1,558


971


958Flood-related
expenses


852





Other
noninterest expenses


2,202


1,558


1,24539,461


36,150


34,364Income
before income taxes


19,696


23,281


22,492Income taxes (Note 9)


5,556


7,138


6,933Net
income

$
14,140

$
16,143

$
15,559Earnings per share:Basic

$
3.16

$
3.59

$
3.42Diluted


3.15


3.57


3.39See Notes to
Consolidated Financial Statements.

Page 64 of 107

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands)

2008

2007

2006Net income

$
14,140

$
16,143

$
15,559Other comprehensive
income,Unrealized gains on
securities:Unrealized holding gains arising
during the year, net of income taxes
 2008 $1,860; 2007 $1,185; 2006 $320


3,002


1,912


518Comprehensive
income

$
17,142

$
18,055

$
16,077See Notes to
Consolidated Financial Statements.

Page 65 of 107

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY 
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands, Except Share Amounts)

Paid In
 Capital

Retained
 Earnings

Accumulated
 Other
 Comprehensive
 Income (Loss)

Maximum
 Cash
 Obligation
 Related
 To ESOP
 Shares

Treasury
 Stock

TotalBalance, December 31,
2005

$
11,970

$
119,989

$
(1,783
)
$
(20,634
)
$
(63
)
$
109,479Issuance of
9,715 shares of common stock


346














346Forfeiture of
1,693 shares of common stock


(63
)













(63
)Share-based
compensation


44














44Income tax
benefit related to share-based
 compensation


67














67Change related
to ESOP shares











(306
)




(306
)Net
income





15,559











15,559Cash dividends
($.81 per share)





(3,696
)










(3,696
)Purchase of
66,521 shares of common stock














(3,309
)

(3,309
)Other
comprehensive income








518








518Balance, December 31,
2006

$
12,364

$
131,852

$
(1,265
)
$
(20,940
)
$
(3,372
)
$
118,639Issuance of
13,030 shares of common stock


326














326Forfeiture of
1,169 shares of common stock


(54
)













(54
)Share-based
compensation


42














42Income tax
benefit related to share-based
 compensation


145














145Change related
to ESOP shares











(1,265
)




(1,265
)Net
income





16,143











16,143Cash dividends
($.86 per share)





(3,873
)










(3,873
)Purchase of
25,492 shares of common stock














(1,325
)

(1,325
)Other
comprehensive income








1,912








1,912Balance, December 31,
2007

$
12,823

$
144,122

$
647

$
(22,205
)
$
(4,697
)
$
130,690Issuance of
15,093 shares of common stock


527














527Forfeiture of
1,186 shares of common stock


(51
)













(51
)Share-based
compensation


21














21Income tax
benefit related to share-based
 compensation


127














127Change related
to ESOP shares











(1,610
)




(1,610
)Net
income





14,140











14,140Cash dividends
($.91 per share)





(4,086
)










(4,086
)Purchase of
63,469 shares of common stock














(3,398
)

(3,398
)Other
comprehensive income








3,002








3,002Balance, December 31,
2008

$
13,447

$
154,176

$
3,649

$
(23,815
)
$
(8,095
)
$
139,362See Notes to Consolidated
Financial Statements.

Page 66 of 107

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF
CASH FLOWS 
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands)

2008


2007


2006Cash Flows from Operating
ActivitiesNet
income

$
14,140

$
16,143

$
15,559Adjustments to
reconcile net income to net
 cash and cash equivalents provided by operating activities:Depreciation


2,237


2,249


2,403Provision for
loan losses


11,507


3,529


3,011Share-based
compensation


21


42


44Compensation
expensed through issuance of
 common stock


234


133


207Excess tax
benefits related to share-based
 compensation


(127
)

(145
)

(67
)Forfeiture of
common stock


(51
)

(54
)

(63
)Provision for
deferred income taxes


(3,088
)

(1,303
)

(1,114
)Flood-related
loss on disposal of property
 and equipment


345





Net loss (gain)
on sale of other real
 estate owned and other repossessed assets


97


(14
)

42Decrease
(increase) in accrued interest
 receivable


954


(1,099
)

(1,673
)Amortization of
discount on investment
 securities, net


424


310


504(Increase)
decrease in other assets


(3,724
)

474


303Increase in
accrued interest and other
 liabilities


2,940


2,049


379Loans
originated for sale


(131,577
)

(114,169
)

(104,286
)Proceeds on
sales of loans


131,153


112,119


102,039Net gain on
sales of loans


(1,274
)

(934
)

(859
)Net cash and
cash equivalents provided by
 operating activities


24,211


19,330


16,429Cash Flows from Investing
ActivitiesProceeds from maturities of
investment
 securities:Available for
sale


47,473


36,592


40,270Held to
maturity





170


45Purchases of
investment securities
 available for sale


(43,826
)

(56,758
)

(21,964
)Loans made to
customers, net of collections


(129,869
)

(78,030
)

(141,669
)Proceeds on
sale of other real estate owned
 and other repossessed assets


1,024


1,143


1,105Purchases of
property and equipment


(4,681
)

(1,408
)

(2,199
)Purchases of
leasehold improvements


(287
)




Investment in
tax credit real estate, net


(3,262
)

(1,692
)

484Net cash used
in investing activities


(133,428
)

(99,983
)

(123,928
)Page 67 of 107

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) 
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands)

2008

2007

2006Cash Flows from Financing
ActivitiesNet increase in
deposits


93,960


36,517


70,995Net increase in
short-term borrowings


12,861


28,013


24,526Borrowings from
FHLB


20,000


60,000


45,000Payments on
FHLB borrowings


(20,348
)

(30,031
)

(32,782
)Borrowings from
FRB


1,650


9,000


Payments on FRB
borrowings


(1,650
)

(9,000
)

Stock options
exercised


293


193


139Excess tax
benefits related to share-based compensation


127


145


67Purchase of
treasury stock


(3,398
)

(1,325
)

(3,309
)Dividends
paid


(4,086
)

(3,873
)

(3,696
)Net cash
provided by financing activities


99,409


89,639


100,940(Decrease) increase in cash
and cash equivalents

$
(9,808
)
$
8,986

$
(6,559
)Cash and cash
equivalents:Beginning of
year


32,383


23,397


29,956End of
year

$
22,575

$
32,383

$
23,397Supplemental
DisclosuresCash payments
for:Interest paid
to depositors

$
29,178

$
35,550

$
26,654Interest paid
on other obligations


14,616


14,675


14,521Income taxes
paid


7,592


7,877


8,193Noncash
financing activities:Increase in
maximum cash obligation related to ESOP shares

$
1,610

$
1,265

$
306Transfers to
other real estate owned


5,756


850


912See Notes to Consolidated
 Financial Statements.Page 68 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Note 1. Nature of Activities and Significant Accounting
Policies

Nature
of activities: Hills
Bancorporation (the Company) is a holding company engaged in the business of
commercial banking. The Companys subsidiary is Hills Bank and Trust Company,
Hills, Iowa (the Bank), which is wholly-owned. The Bank is a full-service
commercial bank extending its services to individuals, businesses, governmental
units and institutional customers primarily in the communities of Hills, Iowa
City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar
Rapids and Marion, Iowa.

The
Bank competes with other financial institutions and non-financial institutions
providing similar financial products. Although the loan activity of the Bank is
diversified with commercial and agricultural loans, real estate loans,
automobile, installment and other consumer loans, the Banks credit is
concentrated in real estate loans. All of the Companys operations are
considered to be one reportable operating segment.

Accounting
estimates: The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.

Certain
significant estimates:
The allowance for loan losses, fair values of securities and other financial
instruments, and share-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, 2008 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 consisted solely of debt securities, which the
Company had the positive intent and ability to hold to maturity and were 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 or held to maturity securities as
of December 31, 2008 and 2007.

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, and a new cost
basis of the securities is established.

Page 69 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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. Management
classifies loans within the following industry standard categories: watch,
substandard and loss.

Loans
are considered non-performing when, based on current information and events, it
is probable the Bank will not be able to collect all amounts due. A
non-performing 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 non-performing 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 non-performing 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 nonaccrual 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.

Nonrefundable
loan fees and origination costs are deferred and recognized as a yield
adjustment over the life of the related loan.

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 70 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Activities and Significant Accounting
Policies (Continued)

Tax
credit real estate:
Tax credit real estate represents two multi-family rental properties, two
assisted living rental properties and a multi-tenant rental property for
persons with disabilities, all which are affordable housing projects as of
December 31, 2008. 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 consolidated financial statements.
The operations of the properties are not expected to contribute significantly
to the Companys income before income taxes. However, the properties do
contribute in the form of income tax credits, which lowers the Companys
effective tax rate. Once established, the credits on each property last for ten
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 asset and liability method whereby
deferred tax assets are recognized for deductible temporary differences and net
operating loss, and tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their
tax bases. Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some or all of the
deferred tax assets will not be realized. Deferred tax assets and liabilities
are adjusted for the effects of changes in tax laws and rates on the date of
enactment. Beginning with the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes
(FIN 48) as of January 1, 2007, the Company recognizes the effect of income tax
positions only if those positions are more likely than not of being sustained.
Recognized income tax positions are measured at the largest amount that is
greater than 50% likely of being realized. Changes in recognition or
measurement are reflected in the period in which the change in judgment occurs.
Prior to the adoption of FIN 48, the Company recognized the effect of income
tax positions only if such positions were probable of being sustained. Interest
and penalties on unrecognized tax benefits are classified as an other
noninterest expense. As of December 31, 2008, the Company had no material
unrecognized tax benefits.

Goodwill: Goodwill represents the excess of cost over
the fair value of the net assets acquired, and is not subject to amortization,
but requires, at a minimum, annual impairment tests for intangibles that are
determined to have an indefinite life.

Other
real estate: Other
real estate represents property acquired through foreclosures and settlements
of loans. Property acquired is carried at the lower of the principal amount of
the loan outstanding at the time of acquisition, plus any acquisition costs, or
the estimated fair value of the property, less disposal costs. Subsequent write
downs estimated on the basis of later valuations, gains or losses on sales and
net expenses incurred in maintaining such properties are charged to other
non-interest expense.

Page 71 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Activities and Significant
Accounting Policies (Continued)

Earning per share: Basic earnings per share is
computed using the weighted average number of actual common shares outstanding
during the period. Diluted earnings per share reflects the potential dilution
that would occur from the exercise of common stock options outstanding. The
following table presents calculations of earnings per share:

Year Ended December 31,2008

2007

2006(Amounts
 In Thousands)Computation of
weighted average number of basic and diluted shares:Common shares
outstanding at the beginning of the year


4,490,107


4,503,738


4,562,237Weighted
average number of net shares issued (redeemed)


(22,122
)

(4,158
)

(6,215
)Weighted
average shares outstanding (basic)


4,467,985


4,499,580


4,556,022Weighted
average of potential dilutive shares attributable to stock
 options granted, computed under the treasury stock method


15,202


19,495


25,581Weighted
average number of shares (diluted)


4,483,187


4,519,075


4,581,603Net income (In Thousands)

$
14,140

$
16,143

$
15,559Earnings per share:Basic

$
3.16

$
3.59

$
3.42Diluted

$
3.15

$
3.57

$
3.39Stock awards and options: Compensation expense
for stock issued through the stock award plan is accounted for using the fair
value method prescribed by Statement of Financial Accounting Standards No. 123
(revised 2004), Share-Based Payment (FAS 123R). Under this method,
compensation expense is measured and recognized for all stock-based awards made
to employees and directors based on the fair value of each option as of the
date of the grant.

Common stock held by ESOP: The Companys
maximum cash obligation related to these shares is classified outside
stockholders equity because the shares are not readily traded and could be put
to the Company for cash.

Fair value of financial instruments: The
Company adopted FASB Statement No. 157, Fair
Value Measurements (FAS 157), in its entirety on January 1, 2008.
FAS 157 provides a single definition for fair value, a framework for measuring
fair value and expanded disclosures concerning fair value. Fair value is
defined under FAS 157 as the exchange price that would be received for an asset
or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date.

The Company determines the fair market value of its financial
instruments based on the fair value hierarchy established in FAS 157. There are
three levels of inputs that may be used to measure fair value as follows:

Level 1
Valuations for assets and liabilities traded in active markets for
 identical assets or liabilities. Level 1 includes securities purchased from
 the Federal Home Loan Bank (FHLB), Federal Home Loan Mortgage Corporation
 (FHLMC) and Federal National Mortgage Association (FNMA) that are traded
 by dealers or brokers in active markets. Valuations are obtained from readily
 available pricing sources for market transactions involving identical assets
 or liabilities.Level 2
Valuations for assets and liabilities traded in less active dealer
or
 broker markets. Level 2 includes securities issued by state and political
 subdivisions. Valuations are obtained from third party pricing services for
 identical or comparable assets or liabilities.Page 72 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Activities and Significant
Accounting Policies (Continued)

Level 3
Valuations for assets and liabilities that are derived from other
 valuation methodologies, including discounted cash flow models and similar
 techniques, and not based on market exchange, dealer or broker traded
 transactions. Level 3 valuations incorporate certain assumptions and
 projections in determining the fair value assigned to such assets and
 liabilities. Level 3 assets and liabilities include financial instruments
 whose value is determined using pricing models, discounted cash flow
 methodologies, or similar techniques, as well as instruments for which the
 determination of fair value requires significant management judgment or
 estimation. The Company does not have any Level 3 assets or liabilities.It is the Companys policy to maximize the use of observable
inputs and
minimize the use of unobservable inputs when developing fair value
measurements. Recent market conditions have led to diminished, and in some
cases, non-existent trading in certain of the financial asset classes. The
Company is required to use observable inputs, to the extent available, in the
fair value estimation process unless that data results from forced liquidations
or distressed sales. Despite the Companys best efforts to maximize the use of
relevant observable inputs, the current market environment has diminished the
observability of trades and assumptions that have historically been available.

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

ASSETSCash and cash equivalents: The carrying
 amounts reported in the consolidated balance sheets for cash and short-term
 instruments approximate their fair values.Investment securities available for sale:
 Investment securities available for sale are recorded at fair value on a
 recurring basis. Fair value measurement is based upon quoted prices, if
 available. If a quoted price is not available, the fair value is obtained
 from benchmarking the security against similar securities. Level 1 securities
 include securities from the FHLB, FHLMC and FNMA. Level 2 securities include
 securities issued by state or political subdivisions.Loans held for sale: Loans held for sale are
 carried at historical cost. The carrying amount is a reasonable estimate of
 fair value because of the short time between origination of the loan and its
 sale on the secondary market.Loans: The Company does not record loans at
 fair value on a recurring basis. The Company does record nonrecurring fair
 value adjustments to loans to reflect (1) partial write-downs that are based
 on the observable market price or appraised value of the collateral or (2)
 the full charge-off of the loan carrying value.Foreclosed assets: Foreclosed assets consist
 mainly of other real estate owned but may include other types of assets
 repossessed by the Company. Foreclosed assets are adjusted to the lower of
 carrying value or fair value upon transfer of the loans to foreclosed assets.
 Fair value is generally based upon independent market prices or appraised
 values of the collateral. Foreclosed assets are classified as Level 2.Off-balance sheet instruments: Fair values
 for outstanding letters of credit are based on fees currently charged to
 enter into similar agreements, taking into account the remaining terms of the
 agreements and the counterparties credit standing. The fair value of the
 outstanding letters of credit is not significant. Unfunded loan commitments
 are not valued since the loans are generally priced at market at the time of
 funding.Accrued interest receivable: The fair value
 of accrued interest receivable equals the amount receivable due to the
 current nature of the amounts receivable.Page 73 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Activities and Significant
Accounting Policies (Continued)

Non-marketable equity investments:
 Non-marketable equity investments are recorded under the cost or equity
 method of accounting. There are generally restrictions on the sale and/or
 liquidation of these investments, including stock of the Federal Home Loan
 Bank. The carrying value of stock of the Federal Home Loan Bank approximates
 fair value.LIABILITIESDeposit liabilities: Deposit liabilities are
 carried at historical cost. The fair value of demand deposits, savings
 accounts and certain money market account deposits is the amount payable on
 demand at the reporting date. The fair value of fixed maturity certificates
 of deposit is estimated using the rates currently offered for deposits of
 similar remaining maturities. If the fair value of the fixed maturity
 certificates of deposit is calculated at less than the carrying amount, the
 carrying value of these deposits is reported as the fair value.Short-term borrowings: Short-term borrowings
 are carried at historical cost and include federal funds purchased and
 securities sold under agreements to repurchase. The carrying amount is a
 reasonable estimate of fair value because of the relatively short time
 between the origination of the liability and its expected realization.Long-term borrowings: Long-term borrowings
 are recorded at historical cost. The fair values of the Companys long-term
 borrowings are estimated using discounted cash flow analyses, based on the
 Companys current incremental borrowing rates for similar types of borrowing
 arrangements.Accrued interest payable: The fair value of
 accrued interest payable equals the amount payable due to the current nature
 of the amounts payable.Assets and Liabilities Recorded at Fair
 Value on a Recurring BasisThe table below represents the balances of assets and liabilities
 measured at fair value on a recurring basis:December 31, 2008Level 1

Level 2

Level 3

Total(Amounts in Thousands)Investment securities available for sale

$
99,849

$
100,463

$


$
200,312Total

$
99,849

$
100,463

$


$
200,312Valuation
methodologies have not changed during the year ended
December
31, 2008.

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

Page 74 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Activities and Significant
Accounting Policies (Continued)

Assets and Liabilities Recorded at Fair Value on a Nonrecurring BasisThe Company is required to measure certain assets at fair value on
a
 nonrecurring basis in accordance with GAAP. These adjustments to fair value
 usually result from application of lower-of-cost-or-market accounting or
 write-downs of individual assets. The valuation methodologies used to measure
 these fair value adjustments are described above. For assets measured at fair
 value on a nonrecurring basis in 2008 that were still held on the balance
 sheet at December 31, 2008, the following table provides the level of
 valuation assumptions used to determine the adjustment and the carrying value
 of the related individual assets at year end.December 31, 2008

Year Ended
 December 31, 2008Level 1

Level 2

Level 3

Total

Total Losses(Amounts in Thousands)Loans
(1)

$


$
4,850

$


$
4,850

$
1,417Total

$


$
4,850

$


$
4,850

$
1,417(1)
Represents carrying value and related write-downs of loans for
which
 adjustments are based on the value of the collateral. The carrying value of
 loans fully-charged off is zero.Reclassifications: Certain prior year amounts
may be reclassified to conform to the current year presentation.

Page 75 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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, 2008 or 2007. 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
 ValueDecember 31, 2008:Other
securities (FHLB, FHLMC and FNMA)

$
95,642

$
4,207

$


$
99,849State and
political subdivisions


98,760


1,774


(71
)

100,463Total

$
194,402

$
5,981

$
(71
)
$
200,312December 31, 2007:Other
securities (FHLB, FHLMC and FNMA)

$
104,041

$
1,070

$
(146
)
$
104,965State and
political subdivisions


94,510


426


(302
)

94,634Total

$
198,551

$
1,496

$
(448
)
$
199,599The amortized cost and estimated fair value of available-for-sale
securities
classified according to their contractual maturities at December 31, 2008, were
as follows (in thousands):

Amortized
 Cost

Fair
 ValueDue in one
 year or less

$
39,644

$
40,082Due after
 one year through five years


111,183


115,703Due after
 five years through ten years


42,661


43,622Due over ten
 years


914


905Total

$
194,402

$
200,312As of December 31, 2008, investment securities with a carrying
value of
$99,937,000 were pledged to collateralize public deposits, short-term
borrowings and for other purposes, as required or permitted by law.

Page 76 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2. Investment Securities (Continued)

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, 2008 and 2007 (in thousands):


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

|                                         |   |                      |            |                    |                  |       |   |     |   |  |            |   |                  |     |   |   |        |  |            |      |                   |  |      |   |  |     |  |   |        |  |   |      |   |  |      |  
|---------------------------------------- | - | -------------------- | ---------- | ------------------ | ---------------- | ----- | - | --- | - |  | ---------- | - | ---------------- | --- | - | - | ------ |  | ---------- | ---- | ----------------- |  | ---- | - |  | --- |  | - | ------ |  | - | ---- | - |  | ---- | -
|                                         |   | Less
 than 12 months |            | 12
 months or more |                  | Total |  
|2007
 Description
 of Securities         |   |                      |            |                    |                  |       |  
|                                         | # |                      | Fair Value |                    | Unrealized
 Loss |       | % |     | # |  | Fair Value |   | Unrealized
 Loss |     | % |   | #      |  | Fair Value |      | Unrealized 
 Loss |  | %    |  
|                                         |   |                      |            |                    |                  |       |  
|                                         |   |                      |            |                    |                  |       |   |     |   |  |            |   |                  |     |   |   |        |  |            |      |                   |  |      |   |  |     |  |   |        |  |   |      |   |  |      |  
|Other securities (FHLB,
 FHLMC and FNMA) |   | 3                    |            | $                  | 6,571            |       | $ | (29 | ) |  | 0.44       | % |                  | 16  |   | $ | 36,391 |  | $          | (117 | )                 |  | 0.32 | % |  | 19  |  | $ | 42,962 |  | $ | (146 | ) |  | 0.34 | %
|                                         |   |                      |            |                    |                  |       |   |     |   |  |            |   |                  |     |   |   |        |  |            |      |                   |  |      |   |  |     |  |   |        |  |   |      |   |  |      |  
|State and
 municipal bonds               |   | 41                   |            |                    | 10,892           |       |   | (41 | ) |  | 0.38       | % |                  | 159 |   |   | 32,069 |  |            | (261 | )                 |  | 0.81 | % |  | 200 |  |   | 42,961 |  |   | (302 | ) |  | 0.70 | %
|                                         |   |                      |            |                    |                  |       |   |     |   |  |            |   |                  |     |   |   |        |  |            |      |                   |  |      |   |  |     |  |   |        |  |   |      |   |  |      |  
|                                         |   |                      |            |                    |                  |       |   |     |   |  |            |   |                  |     |   |   |        |  |            |      |                   |  |      |   |  |     |  |   |        |  |   |      |   |  |      |  
|Total temporarily
 impaired securities   |   | 44                   |            | $                  | 17,463           |       | $ | (70 | ) |  | 0.40       | % |                  | 175 |   | $ | 68,460 |  | $          | (378 | )                 |  | 0.55 | % |  | 219 |  | $ | 85,923 |  | $ | (448 | ) |  | 0.52 | %
|                                         |   |                      |            |                    |                  |       |   |     |   |  |            |   |                  |     |   |   |        |  |            |      |                   |  |      |   |  |     |  |   |        |  |   |      |   |  |      |  

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, 2008 was state and municipal bonds (16
issues are non-rated local issues and 21 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. Page 77 of 107   HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Loans

The
composition of loans is as follows:

December 31,2008

2007

2006(Amounts In Thousands)Agricultural

$
64,198

$
60,004

$
49,223Commercial and
financial


162,170


132,070


118,339Real estate:Construction


140,349


123,144


114,199Mortgage


1,095,742


1,020,802


983,489Loans to individuals


35,041


36,289


31,8271,497,500


1,372,309


1,297,077Less allowance for loan
losses


27,660


19,710


17,850$
1,469,840

$
1,352,599

$
1,279,227Changes in the allowance for
loan losses are as follows:

Year Ended December 31,2008

2007

2006(Amounts In Thousands)Balance, beginning

$
19,710

$
17,850

$
15,360Provision
charged to expense


11,507


3,529


3,011Recoveries


932


1,249


1,352Loans charged
off


(4,489
)

(2,918
)

(1,873
)Balance, ending

$
27,660

$
19,710

$
17,850Page 78 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Loans (Continued)

Information about impaired and nonaccrual loans as of and for the
years
ended December 31, 2008, 2007 and 2006 are as follows:

2,008

2,007

2,006(Amounts In Thousands)Impaired loans receivable for
which there
 is a related allowance for loan losses

$
9,050

$
4,950

$
947Impaired loans receivable for
which there
 is no related allowance for loan losses


43,136


34,633


13,734Total

$
52,186

$
39,583

$
14,681Related allowance for credit
losses on
 impaired loans

$
3,551

$
355

$
292Average balance of impaired
loans


41,447


32,246


15,722Nonaccrual loans (included as
impaired
 loans)


2,535


4,948


879Loans past due ninety days or
more and
 still accruing


5,049


6,019


4,983Restructured loans


4,478





Interest income recognized on
impaired
 loans


2,582


2,554


1,212Interest income forfeited on
non-accrual
 loans


163


279


34The increase in impaired loans is due to flood-related loans
of
$5.0 million and the deterioration in credit quality of one borrower
relationships that have an aggregate balance of approximately $10.4 million as
of December 31, 2008.

The Company restructured loans totaling $4.5 million during 2008.
These
loans related to two customers. The first customer relationship consisted of
six loans totaling $1.2 million and are flood related. The Company would have
recorded $63,000 in interest income during 2008 related to these loans if the
loans had been current in accordance with their original terms. There was no
interest income related to the restructured loans included in net income for
2008 as the accrued interest on the loans was charged off during the period and
the loans are currently on non-accrual status. The Company loaned an additional
$137,000 to the borrower in 2008 after the completion of the restructuring of
the loans noted above. In addition, the Company has committed to lend an
additional $270,000 to the customer. The second restructured customer
relationship consisted of four loans totaling $3.3 million. This restructure
was completed as of the end of 2008. There was no lost interest income related
to this customer relationship in 2008. The Company does not have any
commitments to lend the customer additional funds.

Note 4. Property and Equipment

The major
classes of property and equipment and the total accumulated depreciation are as
follows:

December 31,2008

2007

2006(Amounts In Thousands)Land

$
5,598

$
4,846

$
4,648Buildings and
improvements


20,107


19,178


18,929Furniture and
equipment


18,143


15,817


14,85643,848


39,841


38,433Less accumulated
depreciation


20,242


18,621


16,372Net

$
23,606

$
21,220

$
22,061Page 79 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5. Interest-Bearing Deposits

A summary of
these deposits is as follows:

December 31,2008

2007(Amounts In Thousands)NOW and
 other demand

$
191,101

$
164,531Savings


263,670


255,345Time,
 $100,000 and over


161,910


131,159Other time


451,906


438,672$
1,068,587

$
989,707Brokered deposits totaled $10.4 million as of December 31, 2008
with an
average interest rate of 3.28%. There were no brokered deposits as of December
31, 2007. Brokered deposits are included in time deposits and are in increments
less than $100,000.

Time deposits
have a maturity as follows:

December 31,2008

2007(Amounts
 In Thousands)Due in one
 year or less

$
357,052

$
461,130Due after
 one year through two years


165,621


43,772Due after
 two years through three years


71,179


53,395Due after
 three years through four years


9,307


9,950Due over
 four years


10,657


1,584$
613,816

$
569,831Note 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 31,2008

2007(Amounts
 In Thousands)Federal funds purchased, secured
by other securities (FHLB, FHLMC and
 FNMA)

$
53,387

$
39,675Repurchase agreements with
customers, renewable daily, interest
 payable monthly, secured by other securities (FHLB, FHLMC and FNMA)


38,499


43,886Repurchase agreements with
customers, interest fixed, maturities of
 less than one year, secured by other securities (FHLB, FHLMC and
FNMA)


8,051


3,515$
99,937

$
87,076The weighted
average interest rate on short-term borrowings outstanding as of December 31,
2008 and 2007 was 1.20% and 3.90%, respectively.

Page 80 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 6. Short-Term Borrowings (Continued)

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 investment securities. The repurchase
agreement is a commitment 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,
2008, $46.6 million of securities sold under repurchase agreements with a
weighted average interest rate of 1.77%, maturing in 2009, were collateralized
by investment securities having an amortized cost of $64.6 million.

Note 7. Federal Home Loan Bank Borrowings

As of December
31, 2008 and 2007, the borrowings were as follows:

2008

2007(Effective
 interest rates as of December 31, 2008)

(Amounts In Thousands)Due 2008

$


$
20,348Due 2009,
 5.66% to 6.22%


40,000


40,000Due 2010,
 5.77% to 6.61%


40,000


40,000Due 2015,
 3.70% to 4.56%


60,000


60,000Due 2016,
 4.46% to 4.69%


45,000


45,000Due 2017,
 4.09% to 4.89%


60,000


60,000Due 2018,
 3.65%


20,000


$
265,000

$
265,348All of the borrowings are callable by the FHLB with call dates
ranging
from 2009 through 2013. $165,000,000 of the borrowings are callable in the
first quarter of 2009. The advances are unlikely to be called unless rates
would increase significantly.

To participate in the FHLB advance program, the Company is
required to
have an investment in FHLB stock. The Companys investment in FHLB stock was
$14,247,000 and $14,169,000 at December 31, 2008 and 2007, respectively. Collateral
is provided by the Companys 1-4 family mortgage loans totaling $331,250,000 at
December 31, 2008 and $318,417,000 at December 31, 2007.

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 $137,000, $140,000 and $123,000 for the years ended December 31,
2008, 2007 and 2006, 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 tradable, a sponsor must reflect the maximum
cash obligation related to those securities outside of stockholders equity. Effective
June 30, 2005, as a result of the Companys program to repurchase up to a total
of 750,000 shares of the Companys common stock, the Company began obtaining a
quarterly independent appraisal of the shares of stock. Previously, the Company
was obtaining an independent appraisal of the shares of stock on an annual
basis for the Companys ESOP. As of December 31, 2008 and 2007, the shares held
by the ESOP, fair value and maximum cash obligation were as follows:

Page 81 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 8.
Employee Benefit Plans (Continued)2008

2007Shares held by the ESOP


433,001


418,959Fair value per share

$
55.00

$
53.00Maximum cash obligation

$
23,815,000

$
22,205,000The 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 $1,124,000,
$1,049,000, and $983,000 for the years ended December 31, 2008, 2007 and 2006,
respectively. The Company made matching contributions under its 401(k) plan of
$118,000 in 2008, $111,000 in 2007 and $105,000 in 2006 and each such amount is
included in salaries and employee benefits.

The Company provides a deferred compensation program for executive
officers. This program allows executive officers to elect to defer a portion of
their salaried compensation for payment by the Company at a subsequent date.
The executive officers can defer up to 30% of their base compensation and up to
100% of any bonus into the deferral plan. Any amount so deferred is credited to
the executive officers deferred compensation account and converted to units
equivalent in value to the fair market value of a share of stock in Hills
Bancorporation. The stock units are book entry only and do not represent an
actual purchase of stock. The executive officers account is adjusted each year
for dividends paid and the change in the market value of Hills Bancorporation
stock. The deferrals and earnings grow tax deferred until withdrawn from the
plan. Earnings credited to the individuals accounts are recorded as
compensation expense when earned. The deferred compensation liability is
recorded in other liabilities and totals $3.0 million and $2.8 million at
December 31, 2008 and 2007, respectively. Expense related to the deferred
compensation plan was $177,000, $198,000 and $213,000 for 2008, 2007 and 2006,
respectively and is included in salaries and employee benefits expense.

The Company also provides a deferred compensation program for its
Board
of Directors. Under the plan, each director may elect to defer up to 50% of
such directors cash compensation from retainers and meeting fees for payment
by the Company at a subsequent date. Any amount so deferred is credited to the
directors deferred compensation account and converted to units equivalent in
value to the fair market value of a share of stock in Hills Bancorporation. The
stock units are book entry only and do not represent an actual purchase of
stock. The directors account is adjusted each year for dividends paid and the
change in the market value of Hills Bancorporation stock. The deferred
compensation liability for the directors plan is recorded in other liabilities
and totals $1.2 million and $1.1 million at December 31, 2008 and 2007,
respectively. Expense related to the directors deferred compensation plan was
$61,000, $73,000 and $74,000 for 2008, 2007 and 2006, respectively, and is
included in other noninterest expenses.

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. Director options granted on or before December 31, 2006 may
be exercised immediately. Director options granted on or after January 1, 2007,
and officers rights under the plan vest over a five-year period from the date
of the grant.

Page 82 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 8.
Employee Benefit Plans (Continued)A summary of
the stock options is as follows:

Number of Shares

Weighted-Average
 Exercise Price

Weighted-Average
 Remaining Contractual
 Term (Years)

Aggregate
 Intrinsic Value
 (In Thousands)Balance, December 31, 2005


62,619

$
26.69Granted





Exercised


(5,424
)

25.62Balance, December 31, 2006


57,195


26.79


4.88

$
1,532Granted


4,580


52.00Exercised


(10,410
)

18.55Forfeited


(3,000
)

25.67Balance, December 31, 2007


48,365


31.02


5.05


1,500Granted





Exercised


(10,705
)

27.37Balance, December 31, 2008


37,660


32.05


4.36


1,207There were no stock options granted in 2008. The weighted-average
fair
value of options granted in 2007 was $16.98 per share. The intrinsic value of
options exercised was $293,000 and $193,000 for 2008 and 2007, respectively.

The fair value of each option is estimated as of the date of grant
using a Black Scholes option pricing model. The expected lives of options
granted incorporate historical employee exercise behavior. The risk-free rate
for periods that coincide with the expected life of the options is based on the
annual 10 year interest rate swap rate as published by the Federal Reserve
Bank. Expected volatility is based on volatility levels of the Companys peers
common stock as the Companys stock has limited trading activity. Expected
dividend yield was based on historical dividend rates. Significant assumptions
include:

2007Risk-free
 interest rate


5.21%Expected
 option life


7.5 yearsExpected
 volatility


25.33%Expected
 dividends


1.69%Other
pertinent information related to the options outstanding at December 31, 2008
is as follows:

Exercise Price

Number Outstanding

Remaining Contractual Life

Number Exercisable$
25.67


10,775


29 Months


10,77529.33


14,925


48 Months


14,92533.67


3,000


60 Months


3,00034.50


2,940


64 Months


2,94036.25


1,440


69 Months


1,44052.00


4,580


101 Months


37,660





33,080Page 83 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 8.
Employee Benefit Plans (Continued)As of December 31, 2008, the outstanding options have a
weighted-average exercise price of $32.05 per share and a weighted average
remaining contractual term of 4.36 years. The intrinsic value of all options
outstanding was $1,207,000 as of December 31, 2008.

As of December 31, 2008, there was $52,000 in unrecognized
compensation
cost for stock options granted under the plan. This cost is expected to be
recognized over a weighted-average period of 3.33 years.

As of December 31, 2008, the vested options totaled 33,080 shares
with
a weighted-average exercise price of $29.29 per share and a weighted-average
remaining contractual term of 3.80 years. The intrinsic value for the vested
options was $969,000. The fair value of the 3,000 options vested during 2008
was $101,000. The fair value of the 15,100 options vested in 2007 was $123,000.

As of December 31, 2008, 107,748 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 4,388 shares of
common stock in 2008, 2,192 in 2007 and 4,291 in 2006 to certain employees. The
vesting period for these awards is five years and the Bank amortizes the
expense on a straight line basis during the vesting period. The expense
relating to these awards for the years ended December 31, 2008, 2007 and 2006
was $179,000, $166,000 and $149,000, respectively.

Note 9.
Income TaxesIncome taxes
for the years ended December 31, 2008, 2007 and 2006 are summarized as follows:

2008

2007

2006(Amounts In Thousands)Current:Federal

$
7,242

$
7,091

$
6,771State


1,402


1,350


1,276Deferred:Federal


(2,684
)

(1,133
)

(968
)State


(404
)

(170
)

(146
)$
5,556

$
7,138

$
6,933Page 84 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 9.
Income Taxes (Continued)Temporary differences between the amounts reported in the
consolidated
financial statements and the tax basis of assets and liabilities result in
deferred taxes. Deferred tax assets and liabilities at December 31, 2008 and
2007 were as follows:

December 31,2008

2007(Amounts In Thousands)Deferred
 income tax assets:Allowance for
loan losses

$
10,580

$
7,539Deferred
compensation


1,833


1,647Accrued
expenses


472


379Interest on
nonaccrual loans


62


107State net
operating loss


358


341Gross
deferred tax assets


13,305


10,013Valuation
allowance


(358
)

(341
)Deferred tax
asset, net of valuation allowance


12,947


9,672Deferred
 income tax liabilities:Property and
equipment


936


904FHLB
dividends


132


132Prepaid
expenses


180


78Unrealized
gains on investment securities


2,261


401Goodwill


447


382Other


32


44Gross
deferred tax liabilities


3,988


1,941Net
deferred income tax assets

$
8,959

$
7,731The Company has recorded a deferred tax asset for the future tax
benefits of Iowa net operating loss carry-forwards. The net operating loss
carry-forwards are generated by the parent company largely from its investment
in tax credit real estate properties. The parent company is required to file a
separate Iowa tax return and cannot be consolidated with the Bank. The net
operating loss carry-forwards will expire, if not utilized, between 2009 and
2024. The Company has recorded a valuation allowance to reduce the net
operating loss carry-forwards. At December 31, 2008 and 2007, the Company
believes it is more likely than not that the Iowa net operating loss
carry-forwards will not be realized. The increase in net operating loss
carry-forward in 2008 compared to 2007 reflects the additional Iowa income tax
net operating loss generated during 2008 less any expiring carry-forward. A
valuation allowance related to the remaining deferred tax assets has not been
provided because management believes it is more likely than not that the
results of future operations will generate sufficient taxable income to realize
the deferred tax assets.

The valuation allowance increased by $17,000 and $28,000 for each
of
the years ended December 31, 2008 and 2007, respectively.

Page 85 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 9.
Income Taxes (Continued)The net change
in the deferred income taxes for the years ended December 31, 2008, 2007 and 2006
is reflected in the consolidated financial statements as follows:

Year Ended December 31,2008

2007

2006(Amounts In Thousands)Consolidated
 statements of income

$
3,088

$
1,303

$
1,114Consolidated
 statements of stockholders equity


(1,860
)

(1,185
)

(320
)$
1,228

$
118

$
794Income tax
expense for the years ended December 31, 2008, 2007 and 2006 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:

2008

2007

2006Amount

% Of
 Pretax
 Income

Amount

% Of
 Pretax
 Income

Amount

% Of
 Pretax
 Income(Amounts In Thousands)Expected tax
 expense

$
6,893


35.0
%
$
8,148


35.0
%
$
7,872


35.0
%Tax-exempt
 interest


(1,300
)

(6.6
)

(1,230
)

(5.2
)

(1,114
)

(5.0
)Interest
 expense limitation


180


0.9


212


0.9


185


0.8State income taxes, net of
federal income
 tax benefit


649


3.3


767


3.3


735


3.3Income tax
 credits


(711
)

(3.6
)

(566
)

(2.4
)

(566
)

(2.5
)Other


(155
)

(0.8
)

(193
)

(0.9
)

(179
)

(0.8
)$
5,556


28.2
%
$
7,138


30.7
%
$
6,933


30.8
%Federal income tax expense for the years ended December 31, 2008,
2007
and 2006 was computed using the consolidated effective federal tax rate. The
Company also recognized income tax expense pertaining to state franchise taxes
payable individually by the subsidiary bank. On January 1, 2007, the Company
adopted FIN 48. The evaluation was performed for those tax years which remain
open to audit. The Company files a consolidated tax return for federal purposes
and separate tax returns for the State of Iowa purposes. The tax years ended
December 31, 2007, 2006 and 2005, remain subject to examination by the Internal
Revenue Service. For state tax purposes, the tax years ended December 31, 2007,
2006 and 2005, remain open for examination. As a result of the implementation
of FIN 48, the Company did not recognize any increase or decrease for
unrecognized tax benefits. There were no material unrecognized tax benefits on
January 1, 2008 and December 31, 2008. No interest or penalties on these
unrecognized tax benefits has been recorded. As of December 31, 2008, the
Company does not anticipate any significant increase or decrease in
unrecognized tax benefits during the next twelve months.

Page 86 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Regulatory Capital Requirements,
Restrictions on Subsidiary Dividends and Cash Restrictions

The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Companys financial results. Under capital
adequacy guidelines and the regulatory frameworks for prompt corrective action,
the Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance-sheet
items as calculated under regulatory accounting practices. Capital amounts and
classifications of the Company and the Bank are also subject to qualitative
judgments by the regulators about components, risk weightings and other
factors.

Quantitative measures established by the regulations to ensure
capital
adequacy require the Company and the Bank to maintain minimum amounts and
ratios (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, 2008 and 2007, the Company and the Bank met all capital
adequacy requirements to which they are subject.

As of December 31, 2008, 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 changed the
institutions category.

The actual amounts and capital ratios as of December 31, 2008 and
2007,
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 ProvisionsAmount

Ratio

Ratio

RatioAs of December 31,
2008:Company:Total
risk-based capital

$
174,402


12.64
%

8.00
%

10.00
%Tier 1
risk-based capital


157,028


11.38


4.00


6.00Leverage
ratio


157,028


8.99


3.00


5.00Bank:Total
risk-based capital


174,154


12.63


8.00


10.00Tier 1
risk-based capital


156,795


11.38


4.00


6.00Leverage
ratio


156,795


8.98


3.00


5.00Page 87 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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 ProvisionsAmount

Ratio

Ratio

RatioAs of December 31,
2007:Company:Total
risk-based capital

$
165,254


13.37
%

8.00
%

10.00
%Tier 1
risk-based capital


149,749


12.11


4.00


6.00Leverage
ratio


149,749


9.18


3.00


5.00Bank:Total
risk-based capital


165,024


13.36


8.00


10.00Tier 1
risk-based capital


149,532


12.11


4.00


6.00Leverage
ratio


149,532


9.17


3.00


5.00The 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 $31,990,000 as of December 31,
2008 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 $3,966,000 and $2,436,000 as of
December 31, 2008 and 2007, respectively.

In 2008, the Bank opted to participate in both programs under the
FDICs Temporary Liquidity Guarantee Program (TLGP). The first program was
the Transaction Account Guarantee Program under which, through December 31,
2009, all non-interest bearing transaction accounts are fully guaranteed by the
FDIC for the entire amount of the account. Coverage under the Transaction
Account Guarantee Program is in addition to and separate from the coverage
available under the FDICs general deposit insurance rules. The second program
was the Debt Guarantee Program which provides an FDIC guarantee for newly
issued senior unsecured debt. The Company did not have any senior unsecured
debt as of December 31, 2008.

The Bank elected not to apply for the capital available under the
U.S.
Treasurys Troubled Asset Relief Program (TARP).

Page 88 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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, 2008 and 2007:

Year Ended December 31,2008

2007(Amounts In Thousands)Balance,
beginning

$
38,136

$
32,638Advances


70,783


50,042Collections


(67,709
)

(44,544
)Balance,
ending

$
41,210

$
38,136Deposits from related parties are accepted subject to the same
interest
rates and terms as those from nonrelated parties.

Page 89 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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, 2008 and 2007 are as follows:

2008

2007Carrying
 Amount

Estimated
 Fair Value

Carrying
 Amount

Estimated
 Fair Value(Amounts In Thousands)Cash and due from
banks

$
22,575

$
22,575

$
32,383

$
32,383Investment securities


214,559


214,559


213,768


213,768Loans


1,478,330


1,565,525


1,359,391


1,316,062Accrued interest
receivable


10,437


10,437


11,391


11,391Deposits


1,237,886


1,237,886


1,143,926


1,143,926Federal funds purchased and
securities sold
 under agreements to repurchase


99,937


99,937


87,076


87,076Borrowings from Federal Home
Loan Bank


265,000


275,727


265,348


232,191Accrued interest
payable


2,914


2,914


3,227


3,227Face Amount



Face AmountOff-balance sheet
instruments:Loan
commitments

$
309,305

$


$
237,138

$
Letters of
credit


12,365





10,961


Page 90 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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, 2008 and 2007 
(Amounts In Thousands)

ASSETS

2008

2007Cash at subsidiary
bank

$
212

$
257Investment in subsidiary
bank


162,944


152,679Other assets


1,249


1,029Total
assets

$
164,405

$
153,965LIABILITIES AND
STOCKHOLDERS EQUITYLiabilities

$
1,228

$
1,070Redeemable common stock held by
ESOP


23,815


22,205Stockholders
equity:Capital
stock


13,447


12,823Retained
earnings


154,176


144,122Accumulated
other comprehensive income


3,649


647Treasury stock
at cost


(8,095
)

(4,697
)163,177


152,895Less maximum
cash obligation related to
 ESOP shares


23,815


22,205Total
stockholders equity


139,362


130,690Total
liabilities and stockholders equity

$
164,405

$
153,965Page 91 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13. Parent Company Only Financial
Information (Continued)

CONDENSED STATEMENTS OF INCOME 
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands)

2008

2007

2006Interest on checking account and
investment
 securities

$


$
18

$
160Dividends received from
subsidiary


7,042


4,376


3,696Other expenses


(255
)

(273
)

(265
)Income
before income tax benefit and equity
 in undistributed income of subsidiary


6,787


4,121


3,591Income tax benefit


89


89


376,876


4,210


3,628Equity in undistributed income of
 subsidiary


7,264


11,933


11,931Net
income

$
14,140

$
16,143

$
15,559Page 92 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13. Parent Company Only Financial
Information (Continued)

CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008, 2007 and 2006 
(Amounts In Thousands)

2008

2007

2006Cash flows from operating
activities:Net
income

$
14,140

$
16,143

$
15,559Noncash items
included in net income:Equity in
undistributed income of
 subsidiary


(7,264
)

(11,933
)

(11,931
)Share-based
compensation


21


42


44Compensation
expensed through issuance of
 common stock


234


133


207Excess tax
benefits related to share-based
 compensation


(127
)

(145
)

(67
)Forfeiture of
common stock


(51
)

(54
)

(63
)Increase in
other assets


(92
)

(216
)

(48
)Increase in
liabilities


158


164


147Net cash
provided by operating activities


7,019


4,134


3,848Cash flows from financing
activities:Stock options
exercised


293


193


139Excess tax
benefits related to share-based
 compensation


127


145


67Purchase of
treasury stock


(3,398
)

(1,325
)

(3,309
)Dividends
paid


(4,086
)

(3,873
)

(3,696
)Net cash
used in financing activities


(7,064
)

(4,860
)

(6,799
)Decrease in
cash


(45
)

(726
)

(2,951
)Cash balance:Beginning of
year


257


983


3,934Ending of
year

$
212

$
257

$
983Page 93 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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 $30,624,000. The concentrations of credit
by type of loan are set forth in Note 3 to the Consolidated Financial
Statements. Outstanding letters of credit were granted primarily to commercial
borrowers. Although the Bank has a diversified loan portfolio, a substantial
portion of its debtors ability to honor their contracts is dependent upon the economic
conditions in Johnson County and Linn 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 consolidated financial
statements.

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

The Banks exposure to credit loss in the event of
nonperformance by
the other party to the financial instrument for commitments to extend credit,
credit card participations and standby letters of credit is represented by the
contractual amount of those instruments. The Bank uses the same credit policies
in making commitments and conditional obligations as it does for on-balance
sheet instruments. A summary of the Banks commitments at December 31, 2008 and
2007 is as follows:

2008

2007(Amounts In Thousands)Firm loan
 commitments and unused portion of lines of credit:Home equity
loans

$
38,519

$
36,360Credit
cards


35,407


30,737Commercial,
real estate and home
 construction


86,073


99,580Commercial
lines and real estate purchase
 loans


149,306


123,007Outstanding
 letters of credit


12,365


10,961Commitments for commercial lines and real estate loans increased
$26.3
million since December 31, 2007. Real estate loan commitments were $23.2
million as of December 31, 2007 and $38.1 million as of December 31, 2008, an
increase of $14.9 million. This increase is due to the level of refinancing
activity in late 2008 as a result of favorable interest rates. In addition,
commercial lines increased to $74.6 million and agricultural lines increased to
$24.2 million, a change of $11.4 million in commercial and agricultural lines
since December 31, 2007. This change is due to lines of credit for new customers
and increased lines for existing customers.

Page 94 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED 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, 2008 and 2007, 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, 2008
for all non-cancelable leases relating to Bank premises were as follows:

Year ending December 31:

(Amounts In Thousands)2009



3402010



2662011



2682012



2652013



256Thereafter



613$
2,008Page 95 of 107

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15. Quarterly Results of Operations
(unaudited, amounts in thousands, except per share amounts)

Quarter EndedMarch

June

September

December

Year2008Interest
income

$
24,573

$
24,092

$
24,399

$
24,411

$
97,475Interest
expense


12,070


10,865


10,371


10,175


43,481Net interest
income

$
12,503

$
13,227

$
14,028

$
14,236

$
53,994Provision for
loan losses


587


5,172


1,026


4,722


11,507Other
income


4,310


4,248


4,072


4,040


16,670Other
expense


9,253


10,092


10,327


9,789


39,461Income before
income taxes

$
6,973

$
2,211

$
6,747

$
3,765


19,696Income
taxes


2,184


361


2,058


953


5,556Net
income

$
4,789

$
1,850

$
4,689

$
2,812

$
14,140Basic earnings
per share

$
1.07

$
0.41

$
1.05

$
0.63

$
3.16Diluted
earnings per share


1.06


0.41


1.05


0.63


3.152007Interest
income

$
23,284

$
24,008

$
24,724

$
24,912

$
96,928Interest
expense


11,966


12,396


12,698


12,892


49,952Net interest
income

$
11,318

$
11,612

$
12,026

$
12,020

$
46,976Provision for
loan losses


532


954


1,270


773


3,529Other
income


3,629


4,136


4,217


4,002


15,984Other
expense


8,612


8,921


9,070


9,547


36,150Income before
income taxes

$
5,803

$
5,873

$
5,903

$
5,702


23,281Income
taxes


1,798


1,806


1,814


1,720


7,138Net
income

$
4,005

$
4,067

$
4,089

$
3,982

$
16,143Basic earnings
per share

$
0.89

$
0.90

$
0.91

$
0.89

$
3.59Diluted
earnings per share


0.88


0.90


0.90


0.89


3.57Page 96 of 107

PART II

Item 9.
Changes In and Disagreements with Accountants on Accounting and
 Financial DisclosureNone.

Item 9A.
Controls and ProceduresDisclosure Controls and Procedures

As of the end of the period covered by this report, the Company
carried
out an evaluation under the supervision and with the participation of the
Companys management, including the Companys Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the Companys
disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule
15d-15(e) under the Securities Exchange Act of 1934). Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Companys disclosure controls and procedures are effective.

Managements Report on Internal Control Over
Financial Reporting

The Companys management is responsible for establishing and
maintaining an adequate system of internal control over financial reporting (as
defined in Rule 13a-15(f) and Rule 15d-15(f) under the Securities Exchange Act
of 1934). Internal control over financial reporting of the Company includes
those policies and procedures that: (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions 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 Companys
consolidated financial statements. Important features of the Companys system
of internal control over financial reporting include the adoption and
implementation of 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.

All internal control systems, no matter how well designed, have
inherent limitations, including the possibility of human error and the
circumvention of overriding controls. Accordingly, even effective internal
control can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of internal control may vary over time.

The Companys management conducted an evaluation of the
effectiveness
of the Companys internal controls over financial reporting as of December 31,
2008. Managements assessment is based on the criteria described in Internal
Control  Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Based on this assessment, the Companys management
concluded that the Company maintained effective internal control over financial
reporting as of December 31, 2008.

There was no change in the Companys internal control over
financial
reporting during the most recently completed fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting.

The Companys independent registered public accounting firm,
that
audited the consolidated financial statements included in this annual report,
has issued a report on the Companys internal control over financial reporting
as of December 31, 2008. Reference is made to the Report of Independent
Registered Public Accounting Firm included in this Annual Report.

Page 97 of 107

Item 9B.
Other InformationNot applicable

PART III

Item 10.
Directors, Executive Officers and Corporate GovernanceThe 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 20, 2009 for the Annual Meeting of Stockholders
on April 20, 2009. Such information is incorporated herein by reference.

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.
 PrattTreasurerHills
 Bancorporation131 Main
 StreetHills, Iowa
 52235Item 11.
Executive CompensationThe information required by Item 11 of Part III is presented under
the
item entitled Executive Compensation and Benefits in the Companys Definitive
Proxy Statement dated March 20, 2009 for the Annual Meeting of Stockholders on
April 20, 2009. Such information is incorporated herein by reference.

Item 12.
Security Ownership of Certain Beneficial Owners and Management and
 Related Stockholder MattersThe information required by Item 12 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
dated March 20, 2009 for the Annual Meeting of Stockholders on April 20, 2009.
Such information is incorporated herein by reference.

Item 13.
Certain Relationships and Related Transactions, and Director
 IndependenceThe 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 dated March 20, 2009
for the Annual Meeting of Stockholders on April 20, 2009. Such information is
incorporated herein by reference.

Item 14.
Principal Accounting Fees and ServicesInformation required by this item is contained in the
Companys
Definitive Proxy Statement dated March 20, 2009 for the Annual Meeting of
Shareholders on April 20, 2009, under the heading Independent Registered
Public Accounting Firm  Audit and Other Fees, which section is incorporated
herein by this reference.

Page 98 of 107

PART IV

Item 15.
Exhibits, Consolidated Financial Statement SchedulesForm 10-K
 Reference(a)
1.

Financial StatementsIndependent
registered public accounting firms report
 on the financial statements

62Consolidated
balance sheets as of December 31, 2008 and
 2007

63Consolidated
statements of income for the years ended
 December 31, 2008, 2007, and 2006

64Consolidated
statements of comprehensive income for the
 years ended December 31, 2008, 2007 and 2006

65Consolidated
statements of stockholders equity for the
 years ended December 31, 2008, 2007 and 2006

66Consolidated
statements of cash flows for the years
 ended December 31, 2008, 2007 and 2006

67Notes to
consolidated financial statements

692.

Financial Statements
SchedulesAll 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.

Exhibits3.1

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 A to the Hills
 Bancorporation Proxy Statement dated March 23, 2001 is incorporated by
 reference.11

Statement Regarding
 Computation of Basic and Diluted Earnings Per Share on Page 102.21

Subsidiary of the
 Registrant is Attached on Page 103.23

Consent of Independent
 Registered Public Accounting Firm is Attached on Page 104. KPMG LLP31

Certifications under
 Section 302 of the Sarbanes-Oxley Act of 2002 on Pages 105 - 106.32

Certifications under
 Section 906 of the Sarbanes-Oxley Act of 2002 on Page 107.(b)


Reports on Form 8-K:The Registrant filed no
 reports on Form 8-K for the three months ended December 31, 2008.Page 99 of 107

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
 BANCORPORATIONDate: March
 11, 2009
By: /s/
 Dwight O. SeegmillerDwight O.
 Seegmiller, Director, President and Chief Executive OfficerDate: March
 11, 2009
By: /s/
 James G. PrattJames G.
 Pratt, Secretary, Treasurer and Chief Accounting OfficerPursuant 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 REGISTRANTDate: March
 11, 2009
By: /s/
 Willis M. BywaterWillis M.
 Bywater, DirectorDate: March
 11, 2009
By: /s/
 Michael S. DonovanMichael S.
 Donovan, DirectorDate: March
 11, 2009
By: /s/
 Thomas J. GillThomas J.
 Gill, DirectorDate: March
 11, 2009
By: /s/ Michael
 E. HodgeMichael E.
 Hodge, DirectorDate: March
 11, 2009
By: /s/
 James A. NowakJames A.
 Nowak, DirectorDate: March
 11, 2009
By: /s/
 Richard W. ObermanRichard W.
 Oberman, DirectorDate: March
 11, 2009
By: /s/ Theodore
 H. PachaTheodore H.
 Pacha, DirectorDate: March
 11, 2009
By: /s/ John
 W. PhelanJohn W.
 Phelan, DirectorDate: March
 11, 2009
By: /s/ Ann
 M. RhodesAnn M.
 Rhodes, DirectorDate: March
 11, 2009
By: /s/
 Ronald E. StutsmanRonald E.
 Stutsman, DirectorDate: March
 11, 2009
By: /s/
 Sheldon E. YoderSheldon E.
 Yoder, DirectorPage 100 of 107

HILLS BANCORPORATION 
ANNUAL REPORT OF FORM 10-K FOR THE 
FISCAL YEAR ENDED DECEMBER 31, 2008

Exhibit
 Number
Description
Page Number
 In The Sequential
 Numbering System
 For 2008 Form 10-K11
Statement Re Computation of Basic and Diluted
Earnings Per Share

10221
Subsidiary of the Registrant

10323
Consent of Independent Registered Public Accounting
Firm, KPMG LLP

10431
Certifications under Section 302 of the
Sarbanes-Oxley Act of 2002

105-10632
Certifications under Section 906 of the
Sarbanes-Oxley Act of 2002

107Page 101 of 107