UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended ~~March 31,~~September 30, 2018

Transition~~Transition~~ Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ~~______________to______________~~______________ to ______________

Commission file number: 0-23636

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Missouri		43-1626350
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

~~132 East High Street, Box 688, Jefferson City, Missouri~~		~~65102~~
~~(Address of principal executive offices)~~		~~(Zip Code)~~

132 East High Street, Box 688, Jefferson City, Missouri 65102

(Address of principal executive offices)(Zip Code)

(573) 761-6100

(Registrant's telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report.)

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.xYes¨No

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate Web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit ~~and post~~ such files).xYes¨No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. ~~(Check one):~~

Large accelerated filer¨	Accelerated filerx	Non-accelerated filer¨
		~~(Do not check if a smaller reporting company)~~
Smaller reporting company¨x	Emerging growth company¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).¨YesxNo

As of ~~May 4,~~November 8, 2018, the registrant had ~~5,789,341~~6,034,843 shares of common stock, par value $1.00 per share, outstanding

~~Part I - Financial Information~~

~~Item 1. Financial Statements~~

Part I - Financial Information

Item 1. Financial Statements

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets(unaudited)

(In thousands, except per share data)

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

~~Consolidated Balance Sheets~~~~(unaudited)~~

~~(In thousands, except per share data)~~

	March 31,			December 31,			September 30,			December 31,
	2018			2017			2018			2017
ASSETS
Cash and due from banks	$	15,955		$	23,325		$	16,340		$	23,325
Federal funds sold and other interest-bearing deposits		65,449			39,553			20,478			39,553
Cash and cash equivalents		81,404			62,878			36,818			62,878
Certificates of deposit in other banks		4,812			3,460			12,243			3,460
Investment in available-for-sale securities, at fair value		215,720			226,542
Other investments and securities, at cost		9,725			11,037
Available-for-sale debt securities, at fair value								224,562			231,028
Other securities								5,018			6,551
Total investment securities		225,445			237,579			229,580			237,579
Loans		1,084,326			1,068,432			1,115,765			1,068,432
Allowances for loan losses		(10,947	)		(10,852	)		(11,358	)		(10,852	)
Net loans		1,073,379			1,057,580			1,104,407			1,057,580
Premises and equipment - net		34,777			34,811			34,746			34,811
Mortgage servicing rights		2,781			2,713			2,871			2,713
Other real estate owned and repossessed assets - net		13,239			13,182			13,373			13,182
Accrued interest receivable		5,330			5,627			5,984			5,627
Cash surrender value - life insurance		2,499			2,484			2,535			2,484
Other assets		9,242			8,902			9,107			8,902
Total assets	$	1,452,908		$	1,429,216		$	1,451,664		$	1,429,216
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Non-interest bearing demand	$	244,834		$	245,380		$	257,376		$	245,380
Savings, interest checking and money market		616,894			584,468			609,216			584,468
Time deposits $250,000 and over		84,740			63,176			110,148			63,176
Other time deposits		233,912			232,788			205,994			232,788
Total deposits		1,180,380			1,125,812			1,182,734			1,125,812
Federal funds purchased and securities sold
under agreements to repurchase		34,795			27,560
Federal funds purchased and securities sold under agreements to repurchase								32,660			27,560
Federal Home Loan Bank advances and other borrowings		84,327			121,382			78,713			121,382
Subordinated notes		49,486			49,486			49,486			49,486
Accrued interest payable		588			554			990			554
Other liabilities		12,061			13,051			12,209			13,051
Total liabilities		1,361,637			1,337,845			1,356,792			1,337,845
Stockholders’ equity:
Common stock, $1 par value, authorized 15,000,000 shares;
issued 6,046,907 shares, respectively		6,047			6,047
Common stock, $1 par value, authorized 15,000,000 shares; issued 6,278,481 and 6,046,907 shares, respectively								6,279			6,047
Surplus		45,442			45,442			50,173			45,442
Retained earnings		52,280			50,595			52,090			50,595
Accumulated other comprehensive loss, net of tax		(7,335	)		(5,662	)		(8,626	)		(5,662	)
Treasury stock; 254,366 and 248,898 shares, at cost, respectively		(5,163	)		(5,051	)
Treasury stock; 243,638 and 248,898 shares, at cost, respectively								(5,044	)		(5,051	)
Total stockholders’ equity		91,271			91,371			94,872			91,371
Total liabilities and stockholders’ equity	$	1,452,908		$	1,429,216		$	1,451,664		$	1,429,216

See accompanying notes to the consolidated financial statements(unaudited).

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

~~Consolidated Statements of Income~~~~(unaudited)~~

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income(unaudited)

	Three Months Ended				Three Months Ended				Nine Months Ended
	March 31,				September 30,				September 30,
(In thousands, except per share amounts)	2018		2017		2018		2017		2018		2017
INTEREST INCOME
Interest and fees on loans	$	12,223	$	11,050	$	13,252	$	11,856	$	38,329	$	34,577
Interest on investment securities:
Taxable		947		754		1,089		785		3,141		2,391
Nontaxable		158		157		146		169		451		494
Federal funds sold, other interest-bearing deposits, and certificates of deposit in other banks		106		48		205		84		500		144
Dividends on other securities		110		90		59		42		162		111
Total interest income		13,544		12,099		14,751		12,936		42,583		37,717
INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market		1,084		389		1,468		682		3,899		1,546
Time deposits		649		471
Time deposit accounts $250,000 and over						391		119		825		309
Other time deposits						520		463		1,566		1,252
Interest on federal funds purchased and securities sold under agreements to repurchase		171		22		166		29		526		78
Interest on Federal Home Loan Bank advances		395		322		314		440		1,042		1,182
Interest on subordinated notes		491		408		584		450		1,635		1,290
Total interest expense		2,790		1,612		3,443		2,183		9,493		5,657
Net interest income		10,754		10,487		11,308		10,753		33,090		32,060
Provision for loan losses		300		350		250		555		1,000		1,235
Net interest income after provision for loan losses		10,454		10,137		11,058		10,198		32,090		30,825
NON-INTEREST INCOME
Service charges and other fees		876		836		942		878		2,760		2,565
Bank card income and fees		656		614		699		664		2,064		1,941
Trust department income		280		274		276		288		867		828
Real estate servicing fees, net		221		453		192		70		574		557
Gain on sale of mortgage loans, net		146		155		205		225		593		599
Other		122		75		10		56		47		197
Total non-interest income		2,301		2,407		2,324		2,181		6,905		6,687
Investment securities gain, net						50		0		256		0
NON-INTEREST EXPENSE
Salaries and employee benefits		6,057		5,438		5,543		5,502		17,413		16,276
Occupancy expense, net		689		619		749		719		2,162		2,027
Furniture and equipment expense		635		598		785		764		2,104		1,996
Processing, network, and bank card expense		859		1,045		841		831		2,589		2,803
Legal, examination, and professional fees		422		280		289		331		913		928
FDIC insurance assessment		154		101		181		106		482		322
Advertising and promotion		252		239		297		342		840		845
Postage, printing, and supplies		268		223		256		215		749		690
Other		918		808		947		956		2,821		2,916
Total non-interest expense		10,254		9,351		9,888		9,766		30,073		28,803
Income before income taxes		2,501		3,193		3,544		2,613		9,178		8,709
Income tax expense		411		1,093		446		847		1,083		2,923
Net income		2,090		2,100		3,098		1,766		8,095		5,786
Basic earnings per share	$	0.36	$	0.36	$	0.51	$	0.29	$	1.34	$	0.95
Diluted earnings per share	$	0.36	$	0.36	$	0.51	$	0.29	$	1.34	$	0.95

See accompanying notes to the consolidated financial statements(unaudited).

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

~~Consolidated Statements of Comprehensive Income~~~~(unaudited)~~

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income(unaudited)

	Three Months Ended					Three Months Ended					Nine Months Ended
	March 31,					September 30,					September 30,
(In thousands)	2018			2017		2018			2017		2018			2017
Net income	$	2,090		$	2,100	$	3,098		$	1,766	$	8,095		$	5,786
Other comprehensive income, net of tax
Investment securities available-for-sale:
Unrealized (loss) gain on investment securities available-for-sale, net of tax		(1,715	)		306		(936	)		84		(3,093	)		984
Adjustment for gain on sale of investment securities, net of tax		0			0		0			0		0			0
Defined benefit pension plans:
Amortization of prior service cost included in net periodic pension cost, net of tax		42			14		44			15		129			42
Total other comprehensive (loss) income		(1,673	)		320		(892	)		99		(2,964	)		1,026
Total comprehensive income	$	417		$	2,420	$	2,206		$	1,865	$	5,131		$	6,812

See accompanying notes to the consolidated financial statements(unaudited).

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

~~Consolidated Statements of Stockholders' Equity~~~~(unaudited)~~

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity(unaudited)

								Accumulated						Total											Accumulated						Total
								Other						Stock -											Other						Stock -
	Common				Retained			Comprehensive			Treasury			holders'			Common					Retained			Comprehensive			Treasury			holders'
(In thousands)	Stock		Surplus		Earnings			Loss			Stock			Equity			Stock		Surplus			Earnings			Loss			Stock			Equity
Balance, December 31, 2016	$	5,822	$	41,498	$	51,671		$	(3,801	)	$	(4,173	)	$	91,017		$	5,822	$	41,498		$	51,671		$	(3,801	)	$	(4,173	)	$	91,017
Net income		0		0		2,100			0			0			2,100			0		0			5,786			0			0			5,786
Other comprehensive income		0		0		0			320			0			320			0		0			0			1,026			0			1,026
Stock based compensation expense		0		1		0			0			0			1			0		3			0			0			0			3
Purchase of treasury stock		0		0		0			0			(25	)		(25	)		0		0			0			0			(623	)		(623	)
Stock dividend																		225		3,940			(4,165	)		0			0			0
Cash dividends declared, common stock		0		0		(336	)		0			0			(336	)		0		0			(1,137	)		0			0			(1,137	)
Balance, March 31, 2017	$	5,822	$	41,499	$	53,435		$	(3,481	)	$	(4,198	)	$	93,077
Balance, September 30, 2017																	$	6,047	$	45,441		$	52,155		$	(2,775	)	$	(4,796	)	$	96,072

Balance, December 31, 2017	$	6,047	$	45,442	$	50,595		$	(5,662	)	$	(5,051	)	$	91,371		$	6,047	$	45,442		$	50,595		$	(5,662	)	$	(5,051	)	$	91,371
Net income		0		0		2,090			0			0			2,090			0		0			8,095			0			0			8,095
Other comprehensive loss		0		0		0			(1,673	)		0			(1,673	)		0		0			0			(2,964	)		0			(2,964	)
Issuance of stock under equity compensation plan																		0		(51	)		0			0			186			135
Purchase of treasury stock		0		0		0			0			(112	)		(112	)		0		0			0			0			(179	)		(179	)
Stock dividend																		232		4,782			(5,014	)		0			0			0
Cash dividends declared, common stock		0		0		(405	)		0			0			(405	)		0		0			(1,586	)		0			0			(1,586	)
Balance, March 31, 2018	$	6,047	$	45,442	$	52,280		$	(7,335	)	$	(5,163	)	$	91,271
Balance, September 30, 2018																	$	6,279	$	50,173		$	52,090		$	(8,626	)	$	(5,044	)	$	94,872

See accompanying notes to the consolidated financial statements(unaudited).

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

~~Consolidated Statements of Cash Flows~~~~(unaudited)~~

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows(unaudited)

	Three Months Ended March 31,						Nine Months Ended September 30,
(In thousands)	2018			2017			2018			2017
Cash flows from operating activities:
Net income	$	2,090		$	2,100		$	8,095		$	5,786
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		300			350			1,000			1,235
Depreciation expense		435			473			1,321			1,399
Net amortization of investment securities, premiums, and discounts		356			406			1,121			1,257
Stock based compensation expense		0			1			0			3
Change in fair value of mortgage servicing rights		(18	)		(244	)		40			72
Gain on sale of investment securities		(98	)		0
(Gain) loss on sales and dispositions of premises and equipment		(13	)		1
Investment securities gain, net								(256	)		0
Loss on sales and dispositions of premises and equipment								3			123
Gain on sales and dispositions of other real estate and repossessed assets		(2	)		(50	)		0			(42	)
Provision for other real estate owned		1			32			26			243
Decrease in accrued interest receivable		297			481
(Increase) decrease in accrued interest receivable								(357	)		304
Increase in cash surrender value - life insurance		(15	)		(21	)		(51	)		(55	)
Decrease in other assets		156			58
Decrease (increase) in other assets								849			(269	)
Increase (decrease) in accrued interest payable		34			(46	)		436			(12	)
Decrease in other liabilities		(989	)		(742	)		(1,038	)		(479	)
Origination of mortgage loans for sale		(7,587	)		(7,341	)		(29,197	)		(26,446	)
Proceeds from the sale of mortgage loans		7,587			6,789			30,049			26,261
Gain on sale of mortgage loans, net		(146	)		(155	)		(593	)		(599	)
Other, net		(50	)		(49	)		(198	)		(162	)
Net cash provided by operating activities		2,338			2,043			11,250			8,619
Cash flows from investing activities:
Net (increase) decrease in certificates of deposit in other banks		(1,352	)		1,000
Purchase of certificates of deposit in other banks								(8,783	)		0
Proceeds from maturities of certificates of deposit in other banks								0			1,000
Net increase in loans		(16,231	)		(35,523	)		(48,675	)		(70,572	)
Purchase of available-for-sale debt securities		(28,134	)		(15,346	)		(102,953	)		(32,330	)
Proceeds from maturities of available-for-sale debt securities		9,119			9,750			25,782			24,192
Proceeds from calls of available-for-sale debt securities		1,685			4,025			1,685			7,675
Proceeds from sales of available-for-sale debt securities		25,723			0			77,168			2,656
Purchases of FHLB stock		(1,370	)		(263	)		(2,367	)		(1,203	)
Proceeds from sales of FHLB stock		2,682			200			3,903			1,239
Purchases of premises and equipment		(401	)		(348	)		(1,374	)		(1,017	)
Proceeds from sales of premises and equipment		13			0			13			12
Proceeds from sales of other real estate and foreclosed assets		224			658			372			1,001
Net cash used in investing activities		(8,042	)		(35,847	)		(55,229	)		(67,347	)
Cash flows from financing activities:
Net (decrease) increase in demand deposits		(546	)		3,084
Net increase in demand deposits								11,996			23,482
Net increase in interest-bearing transaction accounts		32,426			50,648			24,748			70,844
Net increase (decrease) in time deposits		22,688			(21,394	)
Net increase in time deposits								20,178			2,968
Net increase in federal funds purchased and securities sold under agreements to repurchase		7,235			497			5,100			1,048
Repayment of FHLB advances and other borrowings		(131,055	)		(38,232	)		(173,619	)		(183,132	)
FHLB advances		94,000			36,740			130,950			179,640
Issuance of stock under equity compensation plan								135			0
Purchase of treasury stock		(112	)		(25	)		(179	)		(623	)
Cash dividends paid - common stock		(406	)		(336	)		(1,390	)		(1,067	)
Net cash provided by financing activities		24,230			30,982			17,919			93,160
Net increase (decrease) in cash and cash equivalents		18,526			(2,822	)
Net (decrease) increase in cash and cash equivalents								(26,060	)		34,432
Cash and cash equivalents, beginning of period		62,878			25,995			62,878			25,995
Cash and cash equivalents, end of period	$	81,404		$	23,173		$	36,818		$	60,427

See accompanying notes to the consolidated financial statements(unaudited).

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

~~Consolidated Statements of Cash Flows (continued)~~~~(unaudited)~~

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (continued)(unaudited)

	Three Months Ended March 31,				Nine Months Ended September 30,
(In thousands)	2018		2017		2018		2017
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	2,755	$	1,658	$	9,058	$	5,669
Income taxes	$	0	$	755	$	50	$	2,940
Noncash investing activities:
Noncash investing and financing activities:
Other real estate and repossessed assets acquired in settlement of loans	$	278	$	103	$	589	$	217
Stock dividends					$	5,014	$	4,165

See accompanying notes to the consolidated financial statements(unaudited).

Hawthorn Bancshares, Inc.

and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(1)

Summary of Significant Accounting Policies

Hawthorn Bancshares, Inc. (the Company) through its subsidiary, Hawthorn Bank (the Bank), provides a broad range of banking services to individual and corporate customers located within the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and the greater Kansas City metropolitan area. The Company is subject to competition from other financial and nonfinancial institutions providing financial products. Additionally, the Company and its subsidiaries are subject to the regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies.

The accompanying unaudited consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

The preparation of the consolidated financial statements includes all adjustments that, in the opinion of management, are necessary in order to make those statements not misleading. Management is required to make estimates and assumptions, including the determination of the allowance for loan losses, real estate acquired in connection with foreclosure or in satisfaction of loans, and fair values of investment securities available-for-sale that affect the reported amounts 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. The Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial ~~statements.~~statements other than mentioned below.

Stock DividendOn July 1, ~~2017,~~2018, the Company paid a special stock dividend of four percent to shareholders of record at the close of business on June 15, ~~2017.~~2018. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

Summary of Recent Transactions and EventsOn October 18, 2018, Hawthorn Bank, a wholly-owned subsidiary of the Company, announced that it has entered into an agreement to sell its branch located in Branson, Missouri with total deposits of approximately $15 million to Branson Bank in Branson, Missouri. The transaction excludes loans assigned to the branch. The transaction, which is subject to regulatory approval and certain closing conditions, is expected to close during the first quarter of 2019.

The following represents significant new accounting principles adopted in 2018:

Revenue from Contracts with Customers On January 1, 2018, the Company adopted ASU No. 2014-09,Revenue from Contracts with Customers (Topic 606)and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are ~~also~~ not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust department revenue, service charges and fees, debit card income, ATM surcharge income, and other real estate owned sales. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Noninterest revenue streams within the scope of Topic 606 are discussed in Footnote 16.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Financial InstrumentsThe FASB issued ASU 2016-01,Recognition and Measurement of Financial Assets and Financial Liabilities, in January 2016. The amendments require all equity investments to be measured at fair value with changes in the fair value recognized through net income, other than those accounted for under the equity method of accounting or those that result in the consolidation of the investee. Additionally, these amendments require presentation in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk for those liabilities measured at fair value. The amendments also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2018. The adoption of the ~~ASU's~~ASU did not have a significant effect on the Company's consolidated financial statements.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

The FASB issued ASU 2018-04,Investments - Debt Securities (Topic 320) and Regulated Operations (Topic 980): The amendment in this ASU adds, amends and supersedes various paragraphs that contain SEC guidance in ASC 320, Investments-Debt Securities and ASC 980, Regulated Operations. The amendments in this ASU are effective when a registrant adopts ASU 2016-01, which for the Company was January 1, 2018. This amendment did not have a significant effect on the Company's consolidated financial statements.

LiabilitiesThe FASB issued ASU 2016-04,Recognition of Breakage for Certain Prepaid ~~Store-Value~~Stored-Value Products, in March 2016, in order to address current and potential future diversity in practice related to the derecognition of a prepaid ~~store-value~~stored-value product liability. Such products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler's checks. The amendments require that the portion of the dollar value of prepaid stored-value products that is ultimately unredeemed (that is, the breakage) be accounted for consistent with the breakage guidance for stored-value product transactions provided in ASC Topic 606 - Revenue from Contracts with Customers. These amendments are effective for interim and annual periods beginning January 1, 2018. The adoption of the ~~ASU's~~ASU did not have a significant effect on the Company's consolidated financial statements.

PensionThe FASB issued ASU 2017-07,Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost in March 2017. Under the new guidance, employers will present the service cost component of the net periodic benefit cost in the same income statement line item (e.g., Salaries and Benefits) as other employee compensation costs arising from services rendered during the period. In addition, only the service cost component will be eligible for capitalization in assets. Employers will present the other components separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. The ASU is effective for interim and annual reporting periods beginning after December 15, 2017. ~~Early adoption is permitted, however, the Company has decided not to early adopt.~~ Employers will apply the guidance on the presentation of the components of net periodic benefit cost in the income statement retrospectively. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component will be applied prospectively. The Company ~~expects to utilize~~utilizes the ASU’s practical expedient allowing entities to estimate amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan footnote. The adoption of the ~~ASU's~~ASU did not have a significant effect on the Company's consolidated financial statements.

(2)

Loans and Allowance for Loan Losses

Loans

A summary of loans, by major class within the Company’s loan portfolio, at ~~March 31,~~September 30, 2018 and December 31, 2017 is as follows:

	March 31,		December 31,		September 30,		December 31,
(in thousands)	2018		2017		2018		2017
Commercial, financial, and agricultural	$	190,720	$	192,238	$	203,485	$	192,238
Real estate construction - residential		29,351		26,492		30,374		26,492
Real estate construction - commercial		105,345		98,340		95,806		98,340
Real estate mortgage - residential		250,131		246,754		246,334		246,754
Real estate mortgage - commercial		476,511		472,455		506,197		472,455
Installment and other consumer		32,268		32,153		33,569		32,153
Total loans	$	1,084,326	$	1,068,432	$	1,115,765	$	1,068,432

The Bank grants real estate, commercial, installment, and other consumer loans to customers located within the Missouri communities surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson and the greater Kansas City metropolitan area. As such, the Bank is susceptible to changes in the economic environment in these communities. The Bank does not have a concentration of credit in any one economic sector. Installment and other consumer loans consist primarily of the financing of automotive vehicles. At ~~March 31,~~September 30, 2018, loans of ~~$479.4~~$498.2 million were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit.

~~Allowance for Loan Losses~~

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Allowance for Loan Losses

The following is a summary of the allowance for loan losses during the periods indicated.

	Three Months Ended March 31, 2018																						Three Months Ended September 30, 2018
	Commercial,			Real Estate			Real Estate		Real Estate			Real Estate			Installment								Commercial,			Real Estate			Real Estate			Real Estate			Real Estate			Installment
	Financial, &			Construction -			Construction -		Mortgage -			Mortgage -			and Other			Un-					Financial, &			Construction -			Construction -			Mortgage -			Mortgage -			and Other			Un-
(in thousands)	Agricultural			Residential			Commercial		Residential			Commercial			Consumer			allocated		Total			Agricultural			Residential			Commercial			Residential			Commercial			Consumer			allocated		Total
Balance at beginning of period	$	3,325		$	170		$	807	$	1,689		$	4,437			345		$	79	$	10,852		$	3,943		$	201		$	905		$	2,109		$	3,630		$	413		$	11	$	11,212
Additions:
Provision for loan losses		33			106			118		369			(421	)		40			55		300			(420	)		26			(159	)		255			444			39			65		250
Deductions:
Loans charged off		110			48			30		20			14			57			0		279			75			0			0			32			5			74			0		186
Less recoveries on loans		(13	)		(12	)		0		(19	)		(6	)		(24	)		0		(74	)		(38	)		(13	)		0			(9	)		(2	)		(20	)		0		(82	)
Net loan charge-offs (recoveries)		97			36			30		1			8			33			0		205			37			(13	)		0			23			3			54			0		104
Balance at end of period	$	3,261		$	240		$	895	$	2,057		$	4,008		$	352		$	134	$	10,947		$	3,486		$	240		$	746		$	2,341		$	4,071		$	398		$	76	$	11,358

	Three Months Ended March 31, 2017																							Nine Months Ended September 30, 2018
	Commercial,			Real Estate			Real Estate		Real Estate			Real Estate			Installment									Commercial,			Real Estate			Real Estate			Real Estate			Real Estate			Installment
	Financial, &			Construction -			Construction -		Mortgage -			Mortgage -			and Other			Un-						Financial, &			Construction -			Construction -			Mortgage -			Mortgage -			and Other			Un-
(in thousands)	Agricultural			Residential			Commercial		Residential			Commercial			Consumer			allocated			Total			Agricultural			Residential			Commercial			Residential			Commercial			Consumer			allocated			Total
Balance at beginning of period	$	2,753		$	108		$	413	$	2,385		$	3,793			274		$	160		$	9,886		$	3,325		$	170		$	807		$	1,689		$	4,437			345		$	79		$	10,852
Additions:
Provision for loan losses		(384	)		(59	)		166		(276	)		945			72			(114	)		350			478			80			(31	)		672			(366	)		170			(3	)		1,000
Deductions:
Loans charged off		28			0			0		20			14			51			0			113			378			48			30			64			34			181			0			735
Less recoveries on loans		(19	)		(50	)		0		(36	)		(7	)		(27	)		0			(139	)		(61	)		(38	)		0			(44	)		(34	)		(64	)		0			(241	)
Net loan charge-offs (recoveries)		9			(50	)		0		(16	)		7			24			0			(26	)		317			10			30			20			0			117			0			494
Balance at end of period	$	2,360		$	99		$	579	$	2,125		$	4,731		$	322		$	46		$	10,262		$	3,486		$	240		$	746		$	2,341		$	4,071		$	398		$	76		$	11,358

	Three Months Ended September 30, 2017
	Commercial,			Real Estate			Real Estate		Real Estate			Real Estate			Installment
	Financial, &			Construction -			Construction -		Mortgage -			Mortgage -			and Other			Un-
(in thousands)	Agricultural			Residential			Commercial		Residential			Commercial			Consumer			allocated			Total
Balance at beginning of period	$	2,578		$	70		$	615	$	1,854		$	4,882		$	376		$	170		$	10,545
Additions:
Provision for loan losses		853			64			91		100			(426	)		32			(159	)		555
Deductions:
Loans charged off		37			0			0		68			4			56			0			165
Less recoveries on loans		(12	)		(12	)		0		(11	)		(5	)		(25	)		0			(65	)
Net loan charge-offs (recoveries)		25			(12	)		0		57			(1	)		31			0			100
Balance at end of period	$	3,406		$	146		$	706	$	1,897		$	4,457		$	377		$	11		$	11,000

	Nine Months Ended September 30, 2017
	Commercial,			Real Estate			Real Estate		Real Estate			Real Estate			Installment
	Financial, &			Construction -			Construction -		Mortgage -			Mortgage -			and Other			Un-
(in thousands)	Agricultural			Residential			Commercial		Residential			Commercial			Consumer			allocated			Total
Balance at beginning of period	$	2,753		$	108		$	413	$	2,385		$	3,793			274		$	160		$	9,886
Additions:
Provision for loan losses		695			(49	)		293		(407	)		658			194			(149	)		1,235
Deductions:
Loans charged off		97			0			0		149			20			167			0			433
Less recoveries on loans		(55	)		(87	)		0		(68	)		(26	)		(76	)		0			(312	)
Net loan charge-offs (recoveries)		42			(87	)		0		81			(6	)		91			0			121
Balance at end of period	$	3,406		$	146		$	706	$	1,897		$	4,457		$	377		$	11		$	11,000

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Loans, or portions of loans, are charged off to the extent deemed uncollectible or a loss is confirmed. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration.

Beginning in the first quarter of 2016, the Company began to lengthen its look-back period with the intent to increase such period from three to five ~~years over the next two~~ years. The Company believes that the five-year look-back period, which is consistent with the Company’s practices prior to the start of the economic recession in 2008, provides a representative historical loss period in the current economic environment. ~~As of~~Beginning with December 31, 2017, the Company has utilized a five-year look-back period.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

The following table provides the balance in the allowance for loan losses at ~~March 31,~~September 30, 2018 and December 31, 2017, and the related loan balance by impairment methodology.

	Commercial,		Real Estate		Real Estate		Real Estate		Real Estate		Installment						Commercial,		Real Estate		Real Estate		Real Estate		Real Estate		Installment
	Financial, and		Construction -		Construction -		Mortgage -		Mortgage -		and Other		Un-				Financial, and		Construction -		Construction -		Mortgage -		Mortgage -		and Other		Un-
(in thousands)	Agricultural		Residential		Commercial		Residential		Commercial		Consumer		allocated		Total		Agricultural		Residential		Commercial		Residential		Commercial		Consumer		allocated		Total
March 31, 2018
September 30, 2018
Allowance for loan losses:
Individually evaluated for impairment	$	495	$	9	$	0	$	580	$	233	$	19	$	0	$	1,336	$	381	$	0	$	0	$	657	$	166	$	21	$	0	$	1,225
Collectively evaluated for impairment		2,766		231		895		1,477		3,775		333		134		9,611		3,105		240		746		1,684		3,905		377		76		10,133
Total	$	3,261	$	240	$	895	$	2,057	$	4,008	$	352	$	134	$	10,947	$	3,486	$	240	$	746	$	2,341	$	4,071	$	398	$	76	$	11,358
Loans outstanding:
Individually evaluated for impairment	$	2,738	$	59	$	0	$	5,158	$	1,978	$	160	$	0	$	10,093	$	2,731	$	0	$	158	$	5,145	$	1,028	$	243	$	0	$	9,305
Collectively evaluated for impairment		187,982		29,292		105,345		244,973		474,533		32,108		0		1,074,233		200,754		30,374		95,648		241,189		505,169		33,326		0		1,106,460
Total	$	190,720	$	29,351	$	105,345	$	250,131	$	476,511	$	32,268	$	0	$	1,084,326	$	203,485	$	30,374	$	95,806	$	246,334	$	506,197	$	33,569	$	0	$	1,115,765

December 31, 2017
Allowance for loan losses:
Individually evaluated for impairment	$	500	$	0	$	48	$	521	$	243	$	21	$	0	$	1,333	$	500	$	0	$	48	$	521	$	243	$	21	$	0	$	1,333
Collectively evaluated for impairment		2,825		170		759		1,168		4,194		324		79		9,519		2,825		170		759		1,168		4,194		324		79		9,519
Total	$	3,325	$	170	$	807	$	1,689	$	4,437	$	345	$	79	$	10,852	$	3,325	$	170	$	807	$	1,689	$	4,437	$	345	$	79	$	10,852
Loans outstanding:
Individually evaluated for impairment	$	3,007	$	0	$	97	$	5,072	$	2,004	$	176	$	0	$	10,356	$	3,007	$	0	$	97	$	5,072	$	2,004	$	176	$	0	$	10,356
Collectively evaluated for impairment		189,231		26,492		98,243		241,682		470,451		31,977		0		1,058,076		189,231		26,492		98,243		241,682		470,451		31,977		0		1,058,076
Total	$	192,238	$	26,492	$	98,340	$	246,754	$	472,455	$	32,153	$	0	$	1,068,432	$	192,238	$	26,492	$	98,340	$	246,754	$	472,455	$	32,153	$	0	$	1,068,432

Impaired Loans

Loans evaluated under ASC 310-10-35 include loans which are individually evaluated for impairment. All other loans are collectively evaluated for impairment under ASC 450-20. Impaired loans individually evaluated for impairment totaled ~~$10.1~~$9.3 million and $10.4 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively, and are comprised of loans on non-accrual status and loans which have been classified as troubled debt restructurings (TDRs).

The net carrying value of impaired loans is based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. At ~~March 31,~~September 30, 2018 and December 31, 2017, ~~$3.8~~$4.2 million and $4.0 million, respectively, of impaired loans were evaluated based on the fair value less estimated selling costs of the loan’s collateral. Once the impairment amount is calculated, a specific reserve allocation is recorded. At ~~March 31,~~September 30, 2018, ~~$1.3~~$1.2 million of the Company’s allowance for loan losses was allocated to impaired loans totaling ~~$10.1~~$9.3 million compared to $1.3 million of the Company's allowance for loan losses allocated to impaired loans totaling approximately $10.4 million at December 31, 2017. Management determined that ~~$2.0~~$3.0 million, or ~~20%~~32%, of total impaired loans required no reserve allocation at ~~March 31,~~September 30, 2018 compared to $2.4 million, or 23%, at December 31, 2017, primarily due to adequate collateral values,acceptable payment history and adequate cash flow ability.

~~The categories of impaired loans at March 31, 2018 and December 31, 2017 are as follows:~~

March 31, December 31,
(in thousands) 2018 2017
Non-accrual loans $ 5,482 $ 5,672
Performing TDRs 4,611 4,684
Total impaired loans $ 10,093 $ 10,356

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The categories of impaired loans at September 30, 2018 and December 31, 2017 are as follows:

	September 30,		December 31,
(in thousands)	2018		2017
Non-accrual loans	$	6,045	$	5,672
Performing TDRs		3,260		4,684
Total impaired loans	$	9,305	$	10,356

The following tables provide additional information about impaired loans at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.

Unpaid
Recorded Principal Specific
(in thousands) Investment Balance Reserves
March 31, 2018
With no related allowance recorded:
Commercial, financial and agricultural $ 1,091 $ 1,151 $ 0
Real estate - residential 908 955 0
Total $ 1,999 $ 2,106 $ 0
With an allowance recorded:
Commercial, financial and agricultural $ 1,647 $ 1,960 $ 495
Real estate - construction residential 59 59 9
Real estate - residential 4,250 4,344 580
Real estate - commercial 1,978 2,123 233
Installment and other consumer 160 179 19
Total $ 8,094 $ 8,665 $ 1,336
Total impaired loans $ 10,093 $ 10,771 $ 1,336

			Unpaid
	Recorded		Principal		Specific
(in thousands)	Investment		Balance		Reserves
September 30, 2018
With no related allowance recorded:
Commercial, financial and agricultural	$	1,570	$	1,910	$	0
Real estate - construction commercial		158		183		0
Real estate - residential		1,142		1,206		0
Real estate - commercial		119		121		0
Total	$	2,989	$	3,420	$	0
With an allowance recorded:
Commercial, financial and agricultural	$	1,161	$	1,229	$	381
Real estate - residential		4,003		4,089		657
Real estate - commercial		909		994		166
Installment and other consumer		243		269		21
Total	$	6,316	$	6,581	$	1,225
Total impaired loans	$	9,305	$	10,001	$	1,225

			Unpaid
	Recorded		Principal		Specific
(in thousands)	Investment		Balance		Reserves
December 31, 2017
With no related allowance recorded:
Commercial, financial and agricultural	$	1,393	$	1,445	$	0
Real estate - residential		674		688		0
Real estate - commercial		366		395		0
Total	$	2,433	$	2,528	$	0
With an allowance recorded:
Commercial, financial and agricultural	$	1,614	$	1,834	$	500
Real estate - construction commercial		97		97		48
Real estate - residential		4,398		4,500		521
Real estate - commercial		1,638		1,743		243
Consumer		176		196		21
Total	$	7,923	$	8,370	$	1,333
Total impaired loans	$	10,356	$	10,898	$	1,333

The following table presents by class, information related to the average recorded investment and interest income recognized on impaired loans during the periods indicated.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

	Three Months Ended March 31,								Three Months Ended September 30,								Nine Months Ended September 30,
	2018				2017				2018				2017				2018				2017
			Interest				Interest				Interest				Interest				Interest				Interest
	Average		Recognized		Average		Recognized		Average		Recognized		Average		Recognized		Average		Recognized		Average		Recognized
	Recorded		For the		Recorded		For the		Recorded		For the		Recorded		For the		Recorded		For the		Recorded		For the
(in thousands)	Investment		Period Ended		Investment		Period Ended		Investment		Period Ended		Investment		Period Ended		Investment		Period Ended		Investment		Period Ended
With no related allowance recorded:
Commercial, financial and agricultural	$	906	$	0	$	555	$	1	$	1,375	$	0	$	481	$	0	$	1,334	$	1	$	478	$	0
Real estate - construction commercial		0		0		0		0		161		0		0		0		82		0		0		0
Real estate - residential		919		3		807		4		1,037		3		341		0		929		9		1,412		0
Real estate - commercial		0		0		589		2		120		3		77		3		30		22		221		9
Installment and other consumer		0		0		40		0		91		0		0		0		34		0		22		0
Total	$	1,825	$	3	$	1,991	$	7	$	2,784	$	6	$	899	$	3	$	2,409	$	32	$	2,133	$	9
With an allowance recorded:
Commercial, financial and agricultural	$	1,857	$	8	$	1,192	$	11	$	1,423	$	8	$	694	$	8	$	1,507	$	23	$	1,667	$	24
Real estate - construction residential		15		0		0		0		0		0		0		0		15		0		0		0
Real estate - construction commercial		0		0		50		0		0		0		0		0		24		0		37		0
Real estate - residential		4,379		32		4,511		43		4,076		25		1,383		33		4,211		71		4,090		121
Real estate - commercial		2,012		15		1,494		15		1,443		13		597		17		1,649		24		1,772		46
Installment and other consumer		139		0		51		0		197		0		56		0		186		1		70		0
Total	$	8,402	$	55	$	7,298	$	69	$	7,139	$	46	$	2,730	$	58	$	7,592	$	119	$	7,636	$	191
Total impaired loans	$	10,227	$	58	$	9,289	$	76	$	9,923	$	52	$	3,629	$	61	$	10,001	$	151	$	9,769	$	200

The recorded investment varies from the unpaid principal balance primarily due to partial charge-offs taken resulting from current appraisals received. The amount recognized as interest income on impaired loans continuing to accrue interest, primarily related to troubled debt restructurings, was ~~$58,000~~$52,000 and ~~$76,000,~~$151,000, for the three months and nine months ended ~~March 31,~~September 30, 2018, respectively compared to $61,000 and $200,000 for the three and nine months ended September 30, 2017, respectively. The average recorded investment in impaired loans is calculated on a monthly basis during the periods reported.

Delinquent and Non-Accrual Loans

The delinquency status of loans is determined based on the contractual terms of the notes. Borrowers are generally classified as delinquent once payments become 30 days or more past due. The Company’s policy is to discontinue the accrual of interest income on any loan when, in the opinion of management, the ultimate collectability of interest or principal is no longer probable. In general, loans are placed on non-accrual when they become 90 days or more past due. However, management considers many factors before placing a loan on non-accrual, including the delinquency status of the loan, the overall financial condition of the borrower, the progress of management’s collection efforts and the value of the underlying collateral. Non-accrual loans are returned to accrual status when, in the opinion of management, the financial condition of the borrower indicates that the timely collectability of interest and principal is probable and the borrower demonstrates the ability to pay under the terms of the note through a sustained period of repayment performance, which is generally ~~six~~nine months.

~~The following table provides aging information for the Company’s past due and non-accrual loans at March 31, 2018 and December 31, 2017.~~

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Current or 90 Days
Less Than Past Due
30 Days 30 - 89 Days And Still
(in thousands) Past Due Past Due Accruing Non-Accrual Total
March 31, 2018
Commercial, Financial, and Agricultural $ 188,436 $ 26 $ 0 $ 2,258 $ 190,720
Real Estate Construction - Residential 29,292 0 0 59 29,351
Real Estate Construction - Commercial 105,176 169 0 0 105,345
Real Estate Mortgage - Residential 246,562 1,480 0 2,089 250,131
Real Estate Mortgage - Commercial 475,349 246 0 916 476,511
Installment and Other Consumer 31,730 340 38 160 32,268
Total $ 1,076,545 $ 2,261 $ 38 $ 5,482 $ 1,084,326
December 31, 2017
Commercial, Financial, and Agricultural $ 189,537 $ 192 $ 2 $ 2,507 $ 192,238
Real Estate Construction - Residential 25,930 287 275 0 26,492
Real Estate Construction - Commercial 98,243 0 0 97 98,340
Real Estate Mortgage - Residential 242,597 2,173 28 1,956 246,754
Real Estate Mortgage - Commercial 471,476 43 0 936 472,455
Installment and Other Consumer 31,715 239 23 176 32,153
Total $ 1,059,498 $ 2,934 $ 328 $ 5,672 $ 1,068,432

The following table provides aging information for the Company’s past due and non-accrual loans at September 30, 2018 and December 31, 2017.

	Current or				90 Days
	Less Than				Past Due
	30 Days		30 - 89 Days		And Still
(in thousands)	Past Due		Past Due		Accruing		Non-Accrual		Total
September 30, 2018
Commercial, Financial, and Agricultural	$	200,893	$	288	$	8	$	2,296	$	203,485
Real Estate Construction - Residential		30,374		0		0		0		30,374
Real Estate Construction - Commercial		95,548		100		0		158		95,806
Real Estate Mortgage - Residential		242,165		1,189		212		2,768		246,334
Real Estate Mortgage - Commercial		505,087		513		0		597		506,197
Installment and Other Consumer		33,111		217		15		226		33,569
Total	$	1,107,178	$	2,307	$	235	$	6,045	$	1,115,765
December 31, 2017
Commercial, Financial, and Agricultural	$	189,537	$	192	$	2	$	2,507	$	192,238
Real Estate Construction - Residential		25,930		287		275		0		26,492
Real Estate Construction - Commercial		98,243		0		0		97		98,340
Real Estate Mortgage - Residential		242,597		2,173		28		1,956		246,754
Real Estate Mortgage - Commercial		471,476		43		0		936		472,455
Installment and Other Consumer		31,715		239		23		176		32,153
Total	$	1,059,498	$	2,934	$	328	$	5,672	$	1,068,432

Credit Quality

The Company categorizes loans into risk categories based upon an internal rating system reflecting management’s risk assessment. Loans are placed onwatchstatus when one or more weaknesses that may result in the deterioration of the repayment exits or the Company’s credit position at some future date. Loans classified assubstandardare inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified may have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. Such loans are characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not corrected. A loan is classified as atroubled debt restructuring (TDR)when a borrower is experiencing financial difficulties that lead to the restructuring of a loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. Loans classified as TDRs which are accruing interest are classified as performing TDRs. Loans classified as TDRs which are not accruing interest are classified as nonperforming TDRs and are included with all other nonaccrual loans for presentation purposes. It is the Company’s policy to discontinue the accrual of interest income on loans when management believes that the collection of interest or principal is doubtful. Loans are placed onnon-accrualstatus when (1) deterioration in the financial condition of the borrower exists for which payment of full principal and interest is not expected, or (2) payment of principal or interest has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income on a cash basis.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The following table presents the risk categories by class at ~~March 31,~~September 30, 2018 and December 31, 2017.

(in thousands)	Commercial, Financial, & Agricultural		Real Estate Construction - Residential		Real Estate Construction - Commercial		Real Estate Mortgage - Residential		Real Estate Mortgage - Commercial		Installment and Other Consumer		Total		Commercial, Financial, & Agricultural		Real Estate Construction - Residential		Real Estate Construction - Commercial		Real Estate Mortgage - Residential		Real Estate Mortgage - Commercial		Installment and Other Consumer		Total
At March 31, 2018

At September 30, 2018
Watch	$	9,460	$	1,227	$	1,291	$	8,079	$	45,938	$	147	$	66,142	$	7,116	$	593	$	3,735	$	13,114	$	35,753	$	9	$	60,320
Substandard		641		462		0		2,532		725		13		4,373		57		0		0		1,532		708		5		2,302
Performing TDRs		481		0		0		3,068		1,062		0		4,611		434		0		0		2,377		431		18		3,260
Non-accrual		2,258		59		0		2,089		916		160		5,482		2,296		0		158		2,768		597		226		6,045
Total	$	12,840	$	1,748	$	1,291	$	15,768	$	48,641	$	320	$	80,608	$	9,903	$	593	$	3,893	$	19,791	$	37,489	$	258	$	71,927

At December 31, 2017
Watch	$	9,868	$	1,459	$	1,284	$	9,978	$	49,197	$	0	$	71,786	$	9,868	$	1,459	$	1,284	$	9,978	$	49,197	$	0	$	71,786
Substandard		658		462		0		2,262		723		16		4,121		658		462		0		2,262		723		16		4,121
Performing TDRs		500		0		0		3,116		1,068		0		4,684		500		0		0		3,116		1,068		0		4,684
Non-accrual		2,507		0		97		1,956		936		176		5,672		2,507		0		97		1,956		936		176		5,672
Total	$	13,533	$	1,921	$	1,381	$	17,312	$	51,924	$	192	$	86,263	$	13,533	$	1,921	$	1,381	$	17,312	$	51,924	$	192	$	86,263

Troubled Debt Restructurings

At ~~March 31,~~September 30, 2018, loans classified as TDRs totaled ~~$6.3~~$5.4 million, of which ~~$1.7~~$2.2 million were classified as nonperforming TDRs and included in non-accrual loans and ~~$4.6~~$3.2 million were classified as performing TDRs. At December 31, 2017, loans classified as TDRs totaled $6.4 million, of which $1.7 million were classified as nonperforming TDRs and included in non-accrual loans and $4.7 million were classified as performing TDRs. Both performing and nonperforming TDRs are considered impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. Accordingly, specific reserves of ~~$662,000~~$569,000 and $577,000 related to TDRs were allocated to the allowance for loan losses at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The following table summarizes loans that were modified as TDRs during the periods indicated.

	Three Months Ended March 31,												Three Months Ended September 30,
	2018						2017						2018						2017
	Recorded Investment (1)						Recorded Investment (1)						Recorded Investment (1)						Recorded Investment (1)
(in thousands)	Number of Contracts		Pre- Modification		Post- Modification		Number of Contracts		Pre- Modification		Post- Modification		Number of Contracts		Pre- Modification		Post- Modification		Number of Contracts		Pre- Modification		Post- Modification
Troubled Debt Restructurings
Commercial, financial and agricultural		0	$	0	$	0		1	$	131	$	131		2	$	353	$	353		0	$	0	$	0
Real estate mortgage - commercial		0		0		0		1		56		56		0		0		0		1		14		14
Consumer														1		112		53		0		0		0
Total		0	$	0	$	0		2	$	187	$	187		3	$	465	$	406		1	$	14	$	14

	Nine Months Ended September 30,
	2018						2017
	Recorded Investment (1)						Recorded Investment (1)
(in thousands)	Number of Contracts		Pre- Modification		Post- Modification		Number of Contracts		Pre- Modification		Post- Modification
Troubled Debt Restructurings
Commercial, financial and agricultural		2	$	353	$	353		1	$	131	$	130
Real estate mortgage - residential		1		75		74		1		14		14
Real estate mortgage - commercial		0		0		0		1		56		52
Consumer		5		160		93		0		0		0
Total		8	$	588	$	520		3	$	201	$	196

(1) The amounts reported post-modification are inclusive of all partial pay-downs and charge-offs, and no portion of the debt was forgiven. Loans modified as a TDR that were fully paid down, charged-off or foreclosed upon during the period ended are not reported.

The Company’s portfolio of loans classified as TDRs include concessions for the borrower given financial condition such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. ~~During the~~There were three ~~months ended March 31, 2018, no~~loans and eight loans meeting the TDR criteria ~~was~~that were modified during the three and nine months ended September 30, 2018, respectively, compared to ~~two~~one loan and three loans during the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively.

The Company considers a TDR to be in default when it is 90 days or more past due under the modified terms, a charge-off occurs, or it is the process of foreclosure. There were no loans modified as a TDR that defaulted during any of the three and nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively, and within twelve months of their modification date. During 2018, one real estate mortgage loan went to foreclosure totaling ~~$48,000.~~$48,000 and one commercial real estate loan totaling $366,000 was sold at foreclosure. SeeLending and Credit Managementsection for further information.

(3)

Other Real Estate and Repossessed Assets

	September 30,			December 31,
(in thousands)	2018			2017
Commercial	$	697		$	727
Real estate construction - residential		179			0
Real estate construction - commercial		12,101			12,380
Real estate mortgage - residential		464			382
Real estate mortgage - commercial		2,934			2,909
Repossessed assets		0			5
Total	$	16,375		$	16,403
Less valuation allowance for other real estate owned		(3,002	)		(3,221	)
Total other real estate and repossessed assets	$	13,373		$	13,182

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

~~(3)~~

~~Other Real Estate and Repossessed Assets~~

March 31, December 31,
(in thousands) 2018 2017
Commercial $ 727 $ 727
Real estate construction - residential 179 0
Real estate construction - commercial 12,101 12,380
Real estate mortgage - residential 348 382
Real estate mortgage - commercial 2,909 2,909
Repossessed assets 0 5
Total $ 16,264 $ 16,403
Less valuation allowance for other real estate owned (3,025 ) (3,221 )
Total other real estate and repossessed assets $ 13,239 $ 13,182

Changes in the net carrying amount of other real estate and repossessed assets were as follows for the periods indicated:

	Three Months Ended March 31,						Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017			2018			2017
Balance at beginning of period	$	16,403		$	17,291		$	16,258		$	16,530		$	16,403		$	17,291
Additions		278			103			207			62			589			217
Proceeds from sales		(224	)		(658	)		(68	)		(217	)		(372	)		(1,001	)
Charge-offs against the valuation allowance for other real estate owned, net		(195	)		(117	)		(20	)		0			(245	)		(170	)
Net gain on sales		2			50			(2	)		4			0			42
Total other real estate and repossessed assets	$	16,264		$	16,669		$	16,375		$	16,379		$	16,375		$	16,379
Less valuation allowance for other real estate owned		(3,025	)		(3,044	)		(3,002	)		(3,202	)		(3,002	)		(3,202	)
Balance at end of period	$	13,239		$	13,625		$	13,373		$	13,177		$	13,373		$	13,177

At ~~March 31,~~September 30, 2018, ~~$27,000~~$253,000 of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to no loans at December 31, 2017.

Activity in the valuation allowance for other real estate owned was as follows for the periods indicated:

	Three Months Ended March 31,						Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands)	2018			2017			2018			2017		2018			2017
Balance, beginning of period	$	3,221		$	3,129		$	3,022		$	3,174	$	3,221		$	3,129
Provision for other real estate owned		(1	)		32			0			28		26			243
Charge-offs		(195	)		(117	)		(20	)		0		(245	)		(170	)
Balance, end of period	$	3,025		$	3,044		$	3,002		$	3,202	$	3,002		$	3,202

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(4)

Investment Securities

Available for sale securities

The amortized cost and fair value of debt securities classified as available-for-sale at ~~March 31,~~September 30, 2018 and December 31, 2017 were as follows:

	Total									Total
	Amortized		Gross Unrealized					Fair		Amortized		Gross Unrealized					Fair
(in thousands)	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
March 31, 2018
September 30, 2018
U.S. Treasury	$	1,981	$	0	$	(42	)	$	1,939	$	1,983	$	0	$	(67	)	$	1,916
U.S. government and federal agency obligations		11,798				(305	)		11,493		10,933		0		(459	)		10,474
Government sponsored enterprises		38,819		0		(642	)		38,177		45,777		0		(812	)		44,965
Obligations of states and political subdivisions		42,271		42		(709	)		41,604		41,088		21		(764	)		40,345
Mortgage-backed securities:
Residential - government agencies		126,186		11		(3,690	)		122,507		127,375		41		(4,918	)		122,498
Other debt securities (a)											3,000		0		0			3,000
Bank issued trust preferred securities (a)											1,486		0		(122	)		1,364
Total available-for-sale securities	$	221,055	$	53	$	(5,388	)	$	215,720	$	231,642	$	62	$	(7,142	)	$	224,562

December 31, 2017
U.S. Treasury	$	1,980	$	0	$	(13	)	$	1,967	$	1,980	$	0	$	(13	)	$	1,967
U.S. government and federal agency obligations		12,341				(268	)		12,073		12,341		0		(268	)		12,073
Government sponsored enterprises		37,321		0		(424	)		36,897		37,321		0		(424	)		36,897
Obligations of states and political subdivisions		47,019		114		(477	)		46,656		47,019		114		(477	)		46,656
Mortgage-backed securities:
Residential - government agencies		131,045		44		(2,140	)		128,949		131,045		44		(2,140	)		128,949
Other debt securities (a)											3,000		0		0			3,000
Bank issued trust preferred securities (a)											1,486		0		0			1,486
Total available-for-sale securities	$	229,706	$	158	$	(3,322	)	$	226,542	$	234,192	$	158	$	(3,322	)	$	231,028

~~All~~(a) As of January 1, 2018, the Company adopted ASU 2016-01, resulting in reclassification of certain hybrid instruments possessing characteristics typically associated with debt obligations from other securities carried at cost to available for sale securities carried at fair value.

The Company’s investment securities are classified as available for sale. Agency bonds and notes, small business administration guaranteed loan certificates (SBA), residential and commercial agency mortgage-backed securities, and agency collateralized mortgage obligations (CMO) include securities issued by the Government National Mortgage Association (GNMA), a U.S. government agency, and the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC), and the Federal Home Loan Bank (FHLB), which are U.S. government-sponsored enterprises.

Other Investments and securities primarily consist of Federal Home Loan Bank stock, subordinated debt equity securities, and the Company’s interest in statutory trusts. These securities are reported at cost in the amount of $9.7 million and $11.0 million as of March 31, 2018 and December 31, 2017, respectively.

Debt securities with carrying values aggregating approximately ~~$194.3~~$184.2 million and $181.7 million at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

The amortized cost and fair value of debt securities classified as available-for-sale at ~~March 31,~~September 30, 2018, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

	Amortized		Fair		Amortized		Fair
(in thousands)	Cost		Value		Cost		Value
Due in one year or less	$	9,928	$	9,883	$	16,968	$	16,846
Due after one year through five years		60,479		59,974		65,499		64,046
Due after five years through ten years		21,390		20,344		14,151		13,705
Due after ten years		3,072		3,012		7,649		7,467
Total		94,869		93,213		104,267		102,064
Mortgage-backed securities		126,186		122,507		127,375		122,498
Total available-for-sale securities	$	221,055	$	215,720	$	231,642	$	224,562

Other securities

Other securities include equity securities with readily determinable fair values and other investment securities whose accounting is not addressed in ASU 2016-01 include Federal Home Loan Bank (FHLB) stock, and Midwest Independent Bank (MIB) bankers bank stock, that do not have readily determinable fair values, which are held for debt and regulatory purposes.

(in thousands)	September 30, 2018		December 31, 2017
Other securities:
FHLB stock	$	4,854	$	6,390
MIB stock		151		151
Equity securities with readily determinable fair values		13		10
Total other investment securities	$	5,018	$	6,551

Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at ~~March 31,~~September 30, 2018 and December 31, 2017 were as follows:

	Less than 12 months					12 months or more					Total		Total			Less than 12 months					12 months or more					Total		Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(in thousands)	Value		Losses			Value		Losses			Value		Losses			Value		Losses			Value		Losses			Value		Losses
At March 31, 2018
At September 30, 2018
U.S. Treasury	$	1,939	$	(42	)	$	0	$	0		$	1,939	$	(42	)	$	1,205	$	(40	)	$	711	$	(27	)	$	1,916	$	(67	)
U.S. government and federal agency obligations		0		0			11,493		(305	)		11,493		(305	)		0		0			10,474		(459	)		10,474		(459	)
Government sponsored enterprises		14,881		(218	)		23,295		(424	)		38,176		(642	)		15,983		(220	)		28,983		(592	)		44,966		(812	)
Obligations of states and political subdivisions		22,906		(260	)		12,379		(449	)		35,285		(709	)		18,265		(182	)		17,905		(582	)		36,170		(764	)
Mortgage-backed securities:
Residential - government agencies		53,183		(1,114	)		66,854		(2,576	)		120,037		(3,690	)		31,595		(646	)		87,268		(4,272	)		118,863		(4,918	)
Bank issued trust preferred securities																	0		0			1,364		(122	)		1,364		(122	)
Total	$	92,909	$	(1,634	)	$	114,021	$	(3,754	)	$	206,930	$	(5,388	)	$	67,048	$	(1,088	)	$	146,705	$	(6,054	)	$	213,753	$	(7,142	)

(in thousands)
At December 31, 2017
U.S. Treasury	$	1,967	$	(13	)	$	0	$	0		$	1,967	$	(13	)	$	1,967	$	(13	)	$	0	$	0		$	1,967	$	(13	)
U.S. government and federal agency obligations		0		0			12,073		(268	)		12,073		(268	)		0		0			12,073		(268	)		12,073		(268	)
Government sponsored enterprises		16,471		(119	)		20,426		(305	)		36,897		(424	)		16,471		(119	)		20,426		(305	)		36,897		(424	)
Obligations of states and political subdivisions		22,013		(165	)		12,570		(312	)		34,583		(477	)		22,013		(165	)		12,570		(312	)		34,583		(477	)
Mortgage-backed securities:
Residential - government agencies		52,829		(488	)		69,580		(1,652	)		122,409		(2,140	)		52,829		(488	)		69,580		(1,652	)		122,409		(2,140	)
Total	$	93,280	$	(785	)	$	114,649	$	(2,537	)	$	207,929	$	(3,322	)	$	93,280	$	(785	)	$	114,649	$	(2,537	)	$	207,929	$	(3,322	)

The total available for sale portfolio consisted of approximately ~~341~~371 securities at ~~March 31,~~September 30, 2018. The portfolio included ~~298~~344 securities having an aggregate fair value of ~~$206.9~~$213.7 million that were in a loss position at ~~March 31,~~September 30, 2018. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled ~~$114.0~~$146.7 million at fair value. The ~~$5.4~~$7.1 million aggregate unrealized loss included in accumulated other comprehensive income at ~~March 31,~~September 30, 2018 was caused by interest rate fluctuations.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The total available for sale portfolio consisted of approximately 355 securities at December 31, 2017. The portfolio included 280 securities having an aggregate fair value of $207.9 million that were in a loss position at December 31, 2017. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer had a fair value of $114.6 million at December 31, 2017. The $3.3 million aggregate unrealized loss included in accumulated other comprehensive loss at December 31, 2017 was caused by interest rate fluctuations.

Because the decline in fair value is attributable to changes in interest rates and not credit quality, these investments were not considered other-than-temporarily impaired at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively. In the absence of changes in credit quality of these investments, the fair value is expected to recover on all debt securities as they approach their maturity date or re-pricing date, or if market yields for such investments decline. In addition, the Company does not have the intent to sell these investments over the period of recovery, and it is not more likely than not that the Company will be required to sell such investment securities.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

The table presents the components of investment securities gains and losses, which have been recognized in earnings:

	Three Months Ended March 31,				Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands)	2018		2017		2018		2017			2018		2017
Investment securities gains, net
Available for sale securities:
Gains realized on sales	$	98	$	0	$	47	$	12		$	253	$	12
Losses realized on sales		0		0		0		(12	)		0		(12	)
Other-than-temporary impairment recognized		0		0
Investment securities gains	$	98	$	0
Other securities:
Fair value adjustments, net						3		0			3		0
Investment securities gains, net					$	50	$	0		$	256	$	0

Securities gains for the three and nine months ended September 30, 2018 included gains realized from a series of short term sales of U.S. Treasury securities with repurchase agreements in order to generate capital gains to offset capital losses that were to expire during 2018 and 2019.

(5)

Intangible Assets

Mortgage Servicing Rights

At ~~March 31,~~September 30, 2018, the Company was servicing approximately ~~$283.1~~$282.9 million of loans sold to the secondary market compared to $285.8 million at December 31, 2017, and ~~$291.0~~$288.7 million at ~~March 31,~~September 30, 2017. Mortgage loan servicing fees, reported ~~as non-interest income,~~in real estate servicing fees, net, earned on loans sold were ~~$203,000~~$201,000 and $614,000 for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to $209,000 and $629,000 for the three and nine months ended ~~March 31,~~September 30, 2017, respectively.

The table below presents changes in mortgage servicing rights (MSRs) for the periods indicated.

	Three Months Ended March 31,						Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2018			2017			2018			2017			2018			2017
Balance at beginning of period	$	2,713		$	2,584		$	2,813		$	2,766		$	2,713		$	2,584
Originated mortgage servicing rights		50			49			66			61			198			176
Changes in fair value:
Due to change in model inputs and assumptions (1)		103			375			70			(30	)		203			289
Other changes in fair value (2)		(85	)		(131	)		(78	)		(109	)		(243	)		(361	)
Balance at end of period	$	2,781		$	2,877		$	2,871		$	2,688		$	2,871		$	2,688

(1)

The change in fair value resulting from changes in valuation inputs or assumptions, reported in real estate servicing fees, net, used in the valuation model reflects the change in discount rates and prepayment speed assumptions primarily due to changes in interest rates.

(2)

Other changes in fair value, reported in real estate servicing fees, net, reflect changes due to customer payments and passage of time.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The following key data and assumptions were used in estimating the fair value of the Company’s MSRs as of ~~the three months ended March 31,~~September 30, 2018 and ~~2017:~~2017, respectively:

	Three Months Ended March 31,						Nine Months Ended September 30,
	2018			2017			2018			2017
Weighted average constant prepayment rate		9.07	%		8.29	%		9.36	%		10.11	%
Weighted average note rate		3.87	%		3.85	%		3.92	%		3.86	%
Weighted average discount rate		10.39	%		9.72	%		10.36	%		9.78	%
Weighted average expected life (in years)		6.20			6.50			6.10			5.80

(6)

Federal funds purchased and securities sold under agreements to repurchase

March 31, December 31,
2018 2017
Federal funds purchased $ 0 $ 0
Repurchase agreements 34,795 27,560
Total $ 34,795 $ 27,560

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

	September 30,		December 31,
	2018		2017
Federal funds purchased	$	0	$	0
Repurchase agreements		32,660		27,560
Total	$	32,660	$	27,560

The Company offers a sweep account program whereby amounts in excess of an established limit are “swept” from the customer’s demand deposit account on a daily basis into retail repurchase agreements pursuant to individual repurchase agreements between the Company and its customers. Repurchase agreements are agreements to sell securities subject to an obligation to repurchase the same or similar securities. They are accounted for as collateralized financing transactions, not as sales and purchases of the securities portfolio. The securities collateral pledged for the repurchase agreements with customers is maintained by a designated third party custodian. The collateral amounts pledged to repurchase agreements by remaining maturity in the table below are limited to the outstanding balances of the related asset or liability; thus amounts of excess collateral are not shown.

Repurchase Agreements	Remaining Contractual Maturity of the Agreements								Remaining Contractual Maturity of the Agreements
	Overnight		Less		Greater				Overnight		Less		Greater
	and		than		than				and		than		than
(in thousands)	continuous		90 days		90 days		Total		continuous		90 days		90 days		Total
At March 31, 2018
At September 30, 2018
U.S. Treasury	$	1,948	$	0	$	0	$	1,948	$	1,442	$	0	$	0	$	1,442
U.S. government and federal agency obligations		2,987		0		0		2,987
Government sponsored enterprises		9,220		0		0		9,220		15,698		0		0		15,698
Asset-backed securities		20,640		0		0		20,640		15,520		0		0		15,520
Total	$	34,795	$	0	$	0	$	34,795	$	32,660	$	0	$	0	$	32,660

At December 31, 2017
U.S. Treasury	$	1,964	$	0	$	0	$	1,964	$	1,964	$	0	$	0	$	1,964
U.S. government and federal agency obligations		2,977		0		0		2,977		2,977		0		0		2,977
Government sponsored enterprises		8,382		0		0		8,382		8,382		0		0		8,382
Asset-backed securities		14,237		0		0		14,237		14,237		0		0		14,237
Total	$	27,560	$	0	$	0	$	27,560	$	27,560	$	0	$	0	$	27,560

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(7)

Income Taxes

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were ~~16.43%~~12.6% and 11.8% for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~34.2%~~32.4% and 33.6% for the three and nine months ended ~~March 31, 2017.~~ September 30, 2017, respectively. As further described below, the decrease in tax rate for the comparative periods is primarily due to a decrease in the federal corporate tax rate, the release of the valuation allowance related to capital losses as a result of the Company’s tax planning initiatives, a pension contribution made during the second quarter of 2018 that was attributable to the 2017 plan year, and the Company’s additional tax planning initiatives.

The federal corporate income tax rate declined from 34% to 21% effective January 1, 2018 as a result of the Tax Cuts and Jobs ~~Act.~~Act, (Tax Act). The Company’s tax rate is lower than the federal statutory rate primarily as a result of tax-exempt ~~income. The decrease in tax rate~~income, the release of the valuation allowance related to capital loss carryforwards, and a pension contribution made during the second quarter ~~over quarter is primarily due a decrease in~~of 2018 that was attributable to the ~~federal corporate tax rate~~2017 plan year, and the Company’s additional tax planning initiatives. The provisional adjustments recorded in the fourth quarter of 2017 related to the enactment of the Tax ~~Cuts and Jobs~~ Act have ~~not~~ been finalized as of ~~March 31, 2018.~~September 30, 2018 with the filing of the Company’s 2017 tax return. The ~~Company expects~~finalization of the Tax Act included a $306,000 benefit attributable to ~~finalize those~~the pension contribution discussed above and an $180,000 benefit attributable to various accounting method changes made on the Company’s 2017 tax return. Such adjustments were recorded in the second and third quarters of 2018 respectively, within the one-year measurement period provided under Staff Accounting Bulletin No. 118 in regards to the application of FASB’s ASC Topic 740,Income Taxes. The impact of the Tax Cuts and Jobs Act is expected to require further adjustments in 2018 due to anticipated additional guidance from the U.S. Department of the Treasury, changes in our assumptions, completion of 2017 U.S. tax returns and further information and interpretations that become available.

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income of the appropriate character during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning initiatives in making this assessment. ~~With the exception of certain capital losses generated during 2013 and 2014, it is~~In management’s opinion, ~~that~~ the Company will more likely than not realize the benefits of ~~these temporary differences as of March 31, 2018~~its deferred tax assets and, therefore, ~~only~~has not established a valuation ~~reserve~~allowance against ~~the Company’s capital loss carry forward.~~its deferred tax assets as of September 30, 2018. Management arrived at this conclusion based upon the level of historical taxable income and projections for future taxable income of the appropriate character over the periods in which the deferred tax assets are deductible. As indicated above, the Company ~~generated approximately $219,000~~released a $46,000 valuation allowance against certain capital loss carryforwards during the second quarter of ~~capital losses during 2013 and 2014~~2018 as a result of ~~disposing~~the execution of certain ~~limited partnership interests. The capital losses will expire between 2018 and 2019, and it is management’s opinion~~tax planning initiatives that ~~it is more likely than not that the Company will not generate the~~generated sufficient capital gain income ~~necessary~~prior to ~~utilize~~ the ~~capital loss carry forwards before~~expiration of the ~~capital losses expire. As such, the Company has established a $46,000 valuation reserve against its capital loss carry forward deferred tax asset.~~carryforwards.

The Company follows ASC Topic 740,Income Taxes,which addresses the accounting for uncertain tax positions. For each of the three and nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively, the Company did not have any uncertain tax ~~provisions.~~

~~(8)~~

~~Stockholders’ Equity~~

~~Accumulated Other Comprehensive Loss~~provisions, and did not record any related tax liabilities.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(8)

Stockholders’ Equity

Accumulated Other Comprehensive Loss

The following details the change in the components of the Company’s accumulated other comprehensive loss for the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017:

	Three months ended March 31, 2018									Nine months ended September 30, 2018
				Unrecognized Net			Accumulated						Unrecognized Net			Accumulated
	Unrealized			Pension and			Other			Unrealized			Pension and			Other
	Gain (Loss)			Postretirement			Comprehensive			Gain (Loss)			Postretirement			Comprehensive
(in thousands)	on Securities (1)			Costs (2)			(Loss) Income			on Securities (1)			Costs (2)			(Loss) Income
Balance at beginning of period	$	(2,500	)	$	(3,162	)	$	(5,662	)	$	(2,500	)	$	(3,162	)	$	(5,662	)
Other comprehensive (loss) income, before reclassifications		(2,171	)		54			(2,117	)		(3,915	)		164			(3,751	)
Amounts reclassified from accumulated other comprehensive (loss) income		0			0			0			0			0			0
Current period other comprehensive (loss) income, before tax		(2,171	)		54			(2,117	)		(3,915	)		164			(3,751	)
Income tax expense (benefit)		456			(12	)		444
Income tax benefit (expense)											822			(35	)		787
Current period other comprehensive (loss) income, net of tax		(1,715	)		42			(1,673	)		(3,093	)		129			(2,964	)
Balance at end of period	$	(4,215	)	$	(3,120	)	$	(7,335	)	$	(5,593	)	$	(3,033	)	$	(8,626	)

	Three months ended March 31, 2017									Nine months ended September 30, 2017
				Unrecognized Net			Accumulated						Unrecognized Net			Accumulated
	Unrealized			Pension and			Other			Unrealized			Pension and			Other
	Gain (Loss)			Postretirement			Comprehensive			Gain (Loss)			Postretirement			Comprehensive
(in thousands)	on Securities (1)			Costs (2)			Loss			on Securities (1)			Costs (2)			Loss
Balance at beginning of period	$	(1,936	)	$	(1,865	)	$	(3,801	)	$	(1,936	)	$	(1,865	)	$	(3,801	)
Other comprehensive income, before reclassifications		493			22			515			1,588			67			1,655
Amounts reclassified from accumulated other comprehensive income (loss)		0			0			0			0			0			0
Current period other comprehensive income, before tax		493			22			515			1,588			67			1,655
Income tax expense		(187	)		(8	)		(195	)		(604	)		(25	)		(629	)
Current period other comprehensive income, net of tax		306			14			320			984			42			1,026
Balance at end of period	$	(1,630	)	$	(1,851	)	$	(3,481	)	$	(952	)	$	(1,823	)	$	(2,775	)

(1) The pre-tax amounts reclassified from accumulated other comprehensive loss are included ingain on sale of investment securities in the consolidated statements of income.

(2) The pre-tax amounts reclassified from accumulated other comprehensive loss are included in the computation of net periodic pension cost.

(9)

Employee Benefit Plans

Employee Benefits

Employee benefits charged to operating expenses are summarized in the table below for the periods indicated.

	Three Months Ended March 31,				Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands)	2018		2017		2018		2017		2018		2017
Payroll taxes	$	351	$	356	$	261	$	267	$	913	$	911
Medical plans		548		426		490		595		1,650		1,489
401k match and profit sharing		186		250		261		218		684		694
Periodic pension cost		405		336		470		336		1,280		1,007
Other		15		16		12		17		37		42
Total employee benefits	$	1,505	$	1,384	$	1,494	$	1,433	$	4,564	$	4,143

The Company’s profit-sharing plan includes a matching 401k portion, in which the Company matches the first 3% of eligible employee contributions. The Company made annual contributions in an amount up to 6% of income before income taxes and before contributions to the profit-sharing and pension plans for all participants, limited to the maximum amount deductible for federal income tax purposes, for each of the periods shown. In addition, employees were able to make additional tax-deferred contributions.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Pension

The Company provides a noncontributory defined benefit pension plan for all full-time employees. Beginning January 1, 2018 and for all retrospective periods presented, the Company adopted the guidance under ASU 2017-07,Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Under the new guidance, only the service cost component of the net periodic benefit cost is reported in the same income statement line item as salaries and benefits, and the remaining components are reported as other non-interest expense. An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. The Company ~~expects to make~~made a pension contribution in the amount of $1.8 million in the second quarter of 2018. The 2018 minimum required contribution is ~~$1.0 million.~~$578,000. Effective July 1, 2017, the Company amended the pension plan to effectuate a “soft freeze” such that no individual hired (or rehired in the case of a former employee) by the Company after September 30, 2017, whether or not such individual is or was a vested member in the plan, will be eligible to be an active member and be entitled to accrue any benefits under the plan. Certain individuals hired by the Company before July 1, 2017 are also not eligible to participate in the plan. ~~Beginning in 2019, the Company anticipates that there may be a small reduction in the overall liability and service cost resulting from the closure of the plan to new entrants.~~

Components of Net Pension Cost and Other Amounts Recognized in Accumulated Other Comprehensive Income

The following items are components of net pension cost for the periods indicated:

	Pension Benefits						Pension Benefits
(in thousands)	2018			2017			2018			2017
Service cost - benefits earned during the year	$	1,620		$	1,343		$	1,707		$	1,343
Interest costs on projected benefit obligations (a)		1,033			1,009			1,037			1,009
Expected return on plan assets (a)		(1,267	)		(1,124	)		(1,327	)		(1,124	)
Expected administrative expenses (a)		93			88			93			88
Amortization of prior service cost (a)		79			79			79			79
Amortization of unrecognized net loss (a)		138			11			140			11
Net periodic pension cost	$	1,696		$	1,406		$	1,729		$	1,406
Net periodic pension cost for the three months ended March 31, (actual)	$	405		$	336

Net periodic pension cost for the three months ended September 30, (actual)							$	470		$	336
Net periodic pension cost for the nine months ended September 30, (actual)							$	1,280		$	1,007

~~(a) The components of net periodic pension cost other than the service cost component are included in other non-interest expense.~~

(a) The components of net periodic pension cost other than the service cost component are included in other non-interest expense.

(10)

Stock Compensation

The ~~Company’s~~Company has one equity compensation plan for its employees pursuant to which options were granted.

The following table summarizes the Company’s stock option activity:

						Weighted
				Weighted		Average		Aggregate
	Number			average		Contractual		Intrinsic
	of			Exercise		Term		Value
	Shares			Price		(in years)		($000)
Outstanding, December 31, 2017		20,909		$	14.20
Granted		0			0.00
Exercised		(20,909	)		14.20
Forfeited or expired		0			0.00
Outstanding, September 30, 2018		0		$	0.00		0.00	$	0
Exercisable, September 30, 2018		0		$	0.00		0.00	$	0

Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2018.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

~~The following table summarizes the Company’s stock option activity:~~

Weighted
Weighted Average Aggregate
Number average Contractual Intrinsic
of Exercise Term Value
Shares Price (in years) ($000)
Outstanding, beginning of period 20,103 $ 14.77
Granted 0 0.00
Exercised 0 0.00
Forfeited or expired 0 0.00
Outstanding, March 31, 2018 20,103 $ 14.77 0.48 $ 117,992
Exercisable, March 31, 2018 20,103 $ 14.77 0.48 $ 117,992

~~Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2017.~~

Total stock-based compensation expense was $0 ~~and $1,000~~ for the three and nine months ended ~~March 31,~~September 30, 2018 compared to $1,000 and $3,000 for the three and nine months ended September 30, 2017, respectively. As of December 31, 2017, there was no remaining unrecognized compensation expense related to non-vested stock awards. The Plan expired on February 28, 2010, except as to outstanding options under the Plan, and no further options may be granted pursuant to the Plan. During the third quarter of 2018, the remaining 20,909 options to purchase common shares were exercised at a weighted average price of $14.20 a share.

(11)

Earnings per Share

Stock DividendOn July 1, ~~2017,~~2018, the Company paid a special stock dividend of 4% to common shareholders of record at the close of business on June 15, ~~2017.~~2018. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

Basic earnings per share is computed by dividing income available to shareholders by the weighted average number of shares outstanding during the year. Diluted earnings per share gives effect to all dilutive potential shares that were outstanding during the year.

Presented below is a summary of the components used to calculate basic and diluted earnings per common share, which have been restated for all stock dividends:

	Three Months Ended March 31,				Three Months Ended September 30,				Nine Months Ended September 30,
(dollars in thousands, except per share data)	2018		2017		2018		2017		2018		2017
Basic earnings per share:
Net income available to shareholders	$	2,090	$	2,100	$	3,098	$	1,766	$	8,095	$	5,786
Average shares outstanding						6,023,269		6,057,399		6,024,317		6,066,253
Basic earnings per share	$	0.36	$	0.36	$	0.51	$	0.29	$	1.34	$	0.95
Diluted earnings per share:
Net income available to shareholders	$	2,090	$	2,100	$	3,098	$	1,766	$	8,095	$	5,786
Average shares outstanding		5,797,134		5,839,850		6,023,269		6,057,399		6,024,317		6,066,253
Effect of dilutive stock options		5,720		4,916		6,363		5,784		6,480		5,407
Average shares outstanding including dilutive stock options		5,802,854		5,844,766		6,029,632		6,063,183		6,030,797		6,071,660
Diluted earnings per share	$	0.36		0.36	$	0.51		0.29	$	1.34		0.95

Under the treasury stock method, outstanding stock options are dilutive when the average market price of the Company’s common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during the period, except when the Company has a loss from continuing operations available to shareholders. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

~~Options to purchase 0 and 21,621 shares during~~ There were no outstanding stock options for any of the three and nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively, that were ~~not included in~~omitted from the ~~respective computations~~computation of diluted earnings per share ~~because the exercise price~~as a result of ~~the option, when combined with the effect of the unamortized compensation expense, was greater than the average market price of the common shares and were~~being considered anti-dilutive.

~~Repurchase Program~~ ~~On August 6, 2015, the Board of Directors authorized a~~The Company’s share repurchase plan (the plan) ~~to purchase through open market transactions up to $2.0 million market value of the Company’s common stock. On August~~expired on September 8, ~~2017, the Board authorized the repurchase of an additional $1.5 million market value of the Company’s common stock.~~2018. As of ~~March 31,~~September 30, 2018, the Company had repurchased a total of ~~92,509~~95,709 shares of common stock pursuant to the plan at an average price of ~~$17.80~~$17.90 per share, including ~~5,468~~8,668 shares of common stock repurchased pursuant to the plan during the ~~three~~nine months ended ~~March 31,~~September 30, 2018 at an average price of ~~$20.51~~$20.63 per share. ~~At March 31, 2018, approximately $1.8 million remained available for the purchase of shares under the plan. The current plan expires September 8, 2018 unless renewed.~~

(12)

Fair Value Measurements

Fair value represents the amount expected to be received to sell an asset or paid to transfer a liability in its principal or most advantageous market in an orderly transaction between market participants at the measurement date.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Depending on the nature of the asset or liability, the Company uses various valuation methodologies and assumptions to estimate fair value. The measurement of fair value under US GAAP uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows. ~~As of March 31,~~During the nine months ended September 30, 2018 and the year ended December 31, 2017, respectively, there were no transfers into or out of Levels 1-3.

The fair value hierarchy is as follows:

Level 1 – Inputs are unadjusted quoted prices for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. A contractually binding sales price also provides reliable evidence of fair value.

Level 2 – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 – Inputs are unobservable inputs for the asset or liability and significant to the fair value. These may be internally developed using the Company’s best information and assumptions that a market participant would consider.

In accordance with fair value accounting guidance, the Company measures, records, and reports various types of assets and liabilities at fair value on either a recurring or non-recurring basis in the Consolidated Financial Statements. Nonfinancial assets measured at fair value on a nonrecurring basis would include foreclosed real estate, long-lived assets, and core deposit intangible assets, which are reviewed when circumstances or other events indicate that impairment may have occurred.

Valuation Methods for Assets and Labilities Measured at Fair Value on a Recurring Basis

Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

Available-for-Sale Securities

The fair value measurements of the Company’s investment securities are determined by a third party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The fair value measurements are subject to independent verification to another pricing source by management each quarter for reasonableness. ~~Securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs.~~

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Mortgage Servicing Rights

The fair value of mortgage servicing rights is based on the discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees. The valuation models estimate the present value of estimated future net servicing income. The Company classifies its servicing rights as Level 3.

Fair Value Measurements
Quoted Prices
in Active
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
(in thousands) Fair Value (Level 1) (Level 2) (Level 3)
March 31, 2018
Assets:
U.S. Treasury $ 1,939 $ 1,939 0 $ 0
U.S. government and federal agency obligations 11,493 0 11,493 0
Government sponsored enterprises 38,177 0 38,177 0
Obligations of states and political subdivisions 41,604 0 41,604 0
Mortgage-backed securities 122,507 0 122,507 0
Mortgage servicing rights 2,781 0 0 2,781
Total $ 218,501 $ 1,939 $ 213,781 $ 2,781
December 31, 2017
Assets:
U.S. Treasury $ 1,967 $ 1,967 0 $ 0
U.S. government and federal agency obligations 12,073 0 12,073 0
Government sponsored enterprises 36,897 0 36,897 0
Obligations of states and political subdivisions 46,656 0 46,656 0
Mortgage-backed securities 128,949 0 128,949 0
Mortgage servicing rights 2,713 0 0 2,713
Total $ 229,255 $ 1,967 $ 224,575 $ 2,713

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

			Fair Value Measurements
			Quoted Prices
			in Active
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2018
Assets:
U.S. Treasury	$	1,916	$	1,916		0	$	0
U.S. government and federal agency obligations		10,474		0		10,474		0
Government sponsored enterprises		44,965		0		44,965		0
Obligations of states and political subdivisions		40,345		0		40,345		0
Mortgage-backed securities		122,498		0		122,498		0
Other debt securities		4,364		0		4,364		0
Equity securities		13		0		13		0
Mortgage servicing rights		2,871		0		0		2,871
Total	$	227,446	$	1,916	$	222,659	$	2,871

December 31, 2017
Assets:
U.S. Treasury	$	1,967	$	1,967		0	$	0
U.S. government and federal agency obligations		12,073		0		12,073		0
Government sponsored enterprises		36,897		0		36,897		0
Obligations of states and political subdivisions		46,656		0		46,656		0
Mortgage-backed securities		128,949		0		128,949		0
Other debt securities		4,486		0		4,486		0
Equity securities		10		0		10		0
Mortgage servicing rights		2,713		0		0		2,713
Total	$	233,751	$	1,967	$	229,071	$	2,713

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:

	Fair Value Measurements Using				Fair Value Measurements Using						Fair Value Measurements Using
	Significant Unobservable Inputs				Significant Unobservable Inputs						Significant Unobservable Inputs
	(Level 3)				(Level 3)						(Level 3)
	Mortgage Servicing Rights				Mortgage Servicing Rights						Mortgage Servicing Rights
(in thousands)	Three Months Ended March 31,				Three Months Ended September 30,						Nine Months Ended September 30,
	2018		2017		2018			2017			2018			2017
Balance at beginning of period	$	2,713	$	2,584	$	2,813		$	2,766		$	2,713		$	2,584
Total gains or losses (realized/unrealized):
Included in earnings		18		244		(8	)		(139	)		(40	)		(72	)
Included in other comprehensive income		0		0		0			0			0			0
Purchases		0		0		0			0			0			0
Sales		0		0		0			0			0			0
Issues		50		49		66			61			198			176
Settlements		0		0		0			0			0			0
Balance at end of period	$	2,781	$	2,877	$	2,871		$	2,688		$	2,871		$	2,688

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The change in valuation of mortgage servicing rights, arising from inputs and assumptions, ~~increased $103,000~~decreased $8,000 and ~~$375,000~~$40,000 for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to a decrease of $139,000 and $72,000 for the three and nine months ended September 30, 2017, respectively.

Quantitative Information about Level 3 Fair Value Measurements
Valuation Technique Unobservable Inputs Input Value
Three Months Ended March 31,
2018 2017
Mortgage servicing rights Discounted cash flows Weighted average constant prepayment rate 9.07 % 8.29 %
Weighted average note rate 3.87 % 3.85 %
Weighted average discount rate 10.39 % 9.72 %
Weighted average expected life (in years) 6.20 6.50

Valuation methods for Assets and Liabilities measured at fair value on a nonrecurring basis

Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

Collateral dependent impaired loans

While the overall loan portfolio is not carried at fair value, the Company periodically records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral dependent loans when establishing the allowance for loan losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan. In determining the value of real estate collateral, the Company relies on external and internal appraisals of property values depending on the size and complexity of the real estate collateral. The Company maintains staff that is trained to perform in-house evaluations and also review third party appraisal reports for reasonableness. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgments based on the experience and expertise of internal specialists. Values of all loan collateral are regularly reviewed by senior loan committee. Because many of these inputs are not observable, the measurements are classified as Level 3. As of ~~March 31,~~September 30, 2018, the Company identified ~~$3.8~~$4.2 million in collateral dependent impaired loans that had specific allowances for losses aggregating ~~$952,000.~~$891,000. Related to these loans, there was ~~$57,000~~$53,000 and $303,000 in charge-offs recorded during the three and nine months ended ~~March 31, 2018.~~September 30, 2018, respectively. As of ~~March 31,~~September 30, 2017, the Company identified ~~$2.5~~$4.4 million in collateral dependent impaired loans that had specific allowances for losses aggregating ~~$677,000.~~$1.4 million. Related to these loans, there was ~~$20,000~~$64,000 and $147,000 in charge-offs recorded during the three and nine months ended ~~March 31, 2017.~~

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~September 30, 2017, respectively.

Other Real Estate and Foreclosed Assets

Other real estate owned (OREO) and foreclosed assets consisted of loan collateral that has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Subsequent to foreclosure, these assets initially are carried at fair value of the collateral less estimated selling costs. Fair value, when recorded, is generally based upon appraisals by approved, independent state certified appraisers. Like impaired loans, appraisals on OREO may be discounted based on the Company’s historical knowledge, changes in market conditions from the time of appraisal or other information available. During the holding period, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3.

Fair Value Measurements Using
Quoted Prices Three
in Active Months
Markets for Other Significant Ended
Identical Observable Unobservable March 31,
Total Assets Inputs Inputs Total Gains
(in thousands) Fair Value (Level 1) (Level 2) (Level 3) (Losses)*
March 31, 2018
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural $ 1,369 $ 0 $ 0 $ 1,369 $ 0
Real estate construction - commercial 0 0 0 0 (27 )
Real estate mortgage - residential 886 0 0 886 0
Real estate mortgage - commercial 595 0 0 595 (20 )
Consumer 0 0 0 0 (10 )
Total $ 2,850 $ 0 $ 0 $ 2,850 $ (57 )
Other real estate and foreclosed assets $ 13,239 $ 0 $ 0 $ 13,239 $ 1

March 31, 2017
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural $ 339 $ 0 $ 0 $ 339 $ (1 )
Real estate mortgage - residential 1,261 0 0 1,261 (3 )
Real estate mortgage - commercial 220 0 0 220 (4 )
Consumer 0 0 0 0 (12 )
Total $ 1,820 $ 0 $ 0 $ 1,820 $ (20 )
Other real estate and foreclosed assets $ 13,625 $ 0 $ 0 $ 13,625 $ 15

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

			Fair Value Measurements Using
			Quoted Prices						Three			Nine
			in Active						Months			Months
			Markets for		Other		Significant		Ended			Ended
			Identical		Observable		Unobservable		September 30,			September 30,
	Total		Assets		Inputs		Inputs		Total Gains			Total Gains
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)		(Losses)*			(Losses)*
September 30, 2018
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural	$	1,549	$	0	$	0	$	1,549	$	(21	)	$	(187	)
Real estate construction - commercial		158		0		0		158		0			(27	)
Real estate mortgage - residential		1,156		0		0		1,156		(32	)		(44	)
Real estate mortgage - commercial		399		0		0		399		0			(20	)
Consumer		0		0		0		0		0			(25	)
Total	$	3,262	$	0	$	0	$	3,262	$	(53	)	$	(303	)
Other real estate and foreclosed assets	$	13,373	$	0	$	0	$	13,373	$	(3	)	$	(29	)

September 30, 2017
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural	$	1,757	$	0	$	0	$	1,757	$	0		$	(1	)
Real estate mortgage - residential		1,042		0		0		1,042		(57	)		(122	)
Real estate mortgage - commercial		219		0		0		219		0			(4	)
Consumer		0		0		0		0		(7	)		(20	)
Total	$	3,018	$	0	$	0	$	3,018	$	(64	)	$	(147	)
Other real estate and foreclosed assets	$	13,177	$	0	$	0	$	13,177	$	(26	)	$	(206	)

* Total gains (losses) reported for other real estate and foreclosed assets includes charge-offs, valuation write downs, and net losses taken during the periods reported.

(13)

Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate such value:

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Loans

Fair values are estimated for portfolios with similar financial characteristics. Loans are segregated by type, such as commercial, real estate, and consumer. Each loan category is further segmented into fixed and variable interest rate categories. The fair value of loans is estimated by using the future value of discounted cash flows using comparable market rates for similar types of loan products and adjusted for market factors.The discount rates used are estimated using comparable market rates for similar types of loan products adjusted to be commensurate with the credit risk, overhead costs, and optionality of such instruments.

Investment Securities

A detailed description of the fair value measurement of the debt instruments in the available-for-sale sections of the investment security portfolio is provided in theFair Value Measurementsection above. A schedule of investment securities by category and maturity is provided in the notes onInvestment Securities.

Federal Home Loan Bank (FHLB) Stock

Ownership of equity securities of FHLB is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.

Federal Funds Sold, Cash, and Due from Banks

The carrying amounts of short-term federal funds sold, interest earning deposits with banks, and cash and due from banks approximate fair value. Federal funds sold classified as short-term generally mature in 90 days or less.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Certificates of Deposit in other banks

Certificates of deposit are other investments made by the Company with other financial institutions that are carried at ~~cost~~

~~Mortgage Servicing Rights~~

The fair value of mortgage servicing rights is based on the discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income.The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees.cost.

Cash Surrender Value - Life Insurance

The fair value of Bank owned life insurance (BOLI) approximates the carrying amount. Upon liquidation of these investments, the Company would receive the cash surrender value which equals the carrying amount.

Accrued Interest Receivable and Payable

For accrued interest receivable and payable, the carrying amount is a reasonable estimate of fair value because of the short maturity for these financial instruments.

Deposits

The fair value of deposits with no stated maturity, such as noninterest-bearing demand, NOW accounts, savings, and money market, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Securities Sold under Agreements to Repurchase

For securities sold under agreements to repurchase, the carrying amount is a reasonable estimate of fair value, as such instruments reprice in a short time period.

Subordinated Notes and Other Borrowings

The fair value of subordinated notes and other borrowings is based on the discounted value of contractual cash-flows. The discount rate is estimated using the rates currently offered for other borrowed money of similar remaining maturities.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

A summary of the carrying amounts and fair values of the Company’s financial instruments at ~~March 31,~~September 30, 2018 and December 31, 2017 is as follows:

March 31, 2018
Fair Value Measurements
Quoted Prices
in Active Net
Markets for Other Significant
March 31, 2018 Identical Observable Unobservable
Carrying Fair Assets Inputs Inputs
(in thousands) amount value (Level 1) (Level 2) (Level 3)
Assets:
Cash and due from banks $ 15,955 $ 15,955 $ 15,955 $ 0 $ 0
Federal funds sold and overnight interest-bearing deposits 65,449 65,449 65,449 0 0
Certificates of deposit in other banks 4,812 4,812 4,812 0 0
Investment in available-for-sale securities 215,720 215,720 1,939 213,781 0
Loans, net 1,073,379 1,055,059 0 0 1,055,059
Investment in FHLB stock 5,078 5,078 0 5,078 0
Mortgage servicing rights 2,781 2,781 0 0 2,781
Cash surrender value - life insurance 2,499 2,499 0 2,499 0
Accrued interest receivable 5,330 5,330 5,330 0 0
$ 1,391,003 $ 1,372,683 $ 93,485 $ 221,358 $ 1,057,840
Liabilities:
Deposits:
Non-interest bearing demand $ 244,834 $ 244,834 $ 244,834 $ 0 $ 0
Savings, interest checking and money market 616,894 616,894 616,894 0 0
Time deposits 318,652 315,994 0 0 315,994
Federal funds purchased and securities sold under agreements to repurchase 34,795 34,795 34,795 0 0
Federal Home Loan Bank advances and other borrowings 84,327 83,944 0 83,944 0
Subordinated notes 49,486 42,166 0 42,166 0
Accrued interest payable 588 588 588 0 0
$ 1,349,576 $ 1,339,215 $ 897,111 $ 126,110 $ 315,994

					September 30, 2018
					Fair Value Measurements
					Quoted Prices
					in Active				Net
					Markets for		Other		Significant
	September 30, 2018				Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	amount		value		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	16,340	$	16,340	$	16,340	$	0	$	0
Federal funds sold and overnight interest-bearing deposits		20,478		20,478		20,478		0		0
Certificates of deposit in other banks		12,243		12,243		12,243		0		0
Available for sale securities		224,562		224,562		1,916		222,646		0
Other securities		5,018		5,018		0		5,018		0
Loans, net		1,104,407		1,082,384		0		0		1,082,384
Cash surrender value - life insurance		2,535		2,535		0		2,535		0
Accrued interest receivable		5,984		5,984		5,984		0		0
	$	1,391,567	$	1,369,544	$	56,961	$	230,199	$	1,082,384
Liabilities:
Deposits:
Non-interest bearing demand	$	257,376	$	257,376	$	257,376	$	0	$	0
Savings, interest checking and money market		609,216		609,216		609,216		0		0
Time deposits		316,142		312,771		0		0		312,771

Federal funds purchased and securities sold under agreements to repurchase		32,660		32,660		32,660		0		0
Federal Home Loan Bank advances and other borrowings		78,713		78,275		0		78,275		0
Subordinated notes		49,486		45,440		0		45,440		0
Accrued interest payable		990		990		990		0		0
	$	1,344,583	$	1,336,728	$	900,242	$	123,715	$	312,771

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

December 31, 2017
Fair Value Measurements
Quoted Prices
in Active Net
Markets for Other Significant
December 31, 2017 Identical Observable Unobservable
Carrying Fair Assets Inputs Inputs
(in thousands) amount value (Level 1) (Level 2) (Level 3)
Assets:
Cash and due from banks $ 23,325 $ 23,325 $ 23,325 $ 0 $ 0
Federal funds sold and overnight interest-bearing deposits 39,553 39,553 39,553 0 0
Certificates of deposit in other banks 3,460 3,460 3,460 0 0
Investment in available-for-sale securities 226,542 226,542 1,967 224,575 0
Loans, net 1,057,580 1,058,153 0 0 1,058,153
Investment in FHLB stock 6,390 6,390 0 6,390 0
Mortgage servicing rights 2,713 2,713 0 0 2,713
Cash surrender value - life insurance 2,484 2,484 0 2,484 0
Accrued interest receivable 5,627 5,627 5,627 0 0
$ 1,367,674 $ 1,368,247 $ 73,932 $ 233,449 $ 1,060,866
Liabilities:
Deposits:
Non-interest bearing demand $ 245,380 $ 245,380 $ 245,380 $ 0 $ 0
Savings, interest checking and money market 584,468 584,468 584,468 0 0
Time deposits 295,964 294,778 0 0 294,778
Federal funds purchased and securities sold under agreements to repurchase 27,560 27,560 27,560 0 0
Federal Home Loan Bank advances and other borrowings 121,382 121,291 0 121,291 0
Subordinated notes 49,486 39,692 0 39,692 0
Accrued interest payable 554 554 554 0 0
$ 1,324,794 $ 1,313,723 $ 857,962 $ 160,983 $ 294,778

					December 31, 2017
					Fair Value Measurements
					Quoted Prices
					in Active				Net
					Markets for		Other		Significant
	December 31, 2017				Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	amount		value		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	23,325	$	23,325	$	23,325	$	0	$	0
Federal funds sold and overnight interest-bearing deposits		39,553		39,553		39,553		0		0
Certificates of deposit in other banks		3,460		3,460		3,460		0		0
Available-for-sale securities		231,028		231,028		1,967		229,061		0
Other securities		6,551		6,551		0		6,551		0
Loans, net		1,057,580		1,058,153		0		0		1,058,153
Cash surrender value - life insurance		2,484		2,484		0		2,484		0
Accrued interest receivable		5,627		5,627		5,627		0		0
	$	1,369,608	$	1,370,181	$	73,932	$	238,096	$	1,058,153
Liabilities:
Deposits:
Non-interest bearing demand	$	245,380	$	245,380	$	245,380	$	0	$	0
Savings, interest checking and money market		584,468		584,468		584,468		0		0
Time deposits		295,964		294,778		0		0		294,778
Federal funds purchased and securities sold under agreements to repurchase		27,560		27,560		27,560		0		0
Federal Home Loan Bank advances and other borrowings		121,382		121,291		0		121,291		0
Subordinated notes		49,486		39,692		0		39,692		0
Accrued interest payable		554		554		554		0		0
	$	1,324,794	$	1,313,723	$	857,962	$	160,983	$	294,778

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments, and the present creditworthiness of such counterparties. The Company believes such commitments have been made on terms that are competitive in the markets in which it operates.

Limitations

The fair value estimates provided are made at a point in time based on market information and information about the financial instruments. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the fair value estimates.

(14)

~~Repurchase Reserve Liability~~

The Company’s repurchase reserve liability for estimated losses incurred on sold loans was $160,000 at both March 31, 2018 and December 31, 2017. This liability represents management’s estimate of the potential repurchase or make-whole liability for residential mortgage loans originated for sale that may arise from representation and warranty claims that could relate to a variety of issues, including but not limited to, misrepresentation of facts, appraisal issues, or program requirements that may not meet investor guidelines. At March 31, 2018, the Company was servicing 2,743 loans sold to the secondary market with a balance of approximately $283.1 million compared to 2,773 loans sold with a balance of approximately $285.8 million at December 31, 2017.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Three Months Ended March 31,
(in thousands) 2018 2017
Balance at beginning of year $ 160 $ 160
Provision for repurchase liability 0 0
Reimbursement of expenses 0 0
Balance at end of year $ 160 $ 160

~~(15)~~

Commitments and Contingencies

The Company issues financial instruments with off-balance-sheet risk in the normal course of business of meeting the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At ~~March 31,~~September 30, 2018, no amounts have been accrued for any estimated losses for these financial instruments.

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

The contractual amount of off-balance-sheet financial instruments were as follows as of the dates indicated:

	March 31,		December 31,		September 30,		December 31,
(in thousands)	2018		2017		2018		2017
Commitments to extend credit	$	228,595	$	238,527	$	233,920	$	238,527
Commitments to originate residential first and second mortgage loans		3,490		1,471		2,217		1,471
Standby letters of credit		76,479		74,004		61,332		74,004
Total		308,564		314,002		297,469		314,002

Commitments

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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments and letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, furniture and equipment, and real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support contractual obligations of the Company’s customers. The approximate remaining term of standby letters of credit range from one month to five years at ~~March 31,~~September 30, 2018.

Pending Litigation

The Company and its subsidiaries are defendants in various legal actions incidental to the Company’s past and current business activities. Based on the Company’s analysis, and considering the inherent uncertainties associated with litigation, management does not believe that it is reasonably possible that these legal actions will materially adversely affect the Company’s consolidated financial condition or results of operations in the near term. The Company records a loss accrual for all legal matters for which it deems a loss is probable and can be reasonably estimated. Some legal matters, which are at early stages in the legal process, have not yet progressed to the point where a loss is deemed probable or an amount can be estimated.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

~~(16)~~(15)

Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2014-09,Revenue from Contracts with Customers (Topic 606)and all subsequent ASUs that modified Topic 606. As stated in Note 1Summary of Significant Accounting Policies, the implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are ~~also~~ not in the scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust department revenue, service charges and fees, debit card income, ATM surcharge income, and sales of other real estate owned. However, the recognition of these revenue streams did not change ~~significantly upon adoption~~current business practices or result in any changes to the Company’s consolidated financial statements.

Descriptions of ~~Topic 606. Noninterest revenue streams~~our revenue-generating activities within the scope of ~~Topic 606~~this guidance, which are ~~discussed below.~~

~~Trust Department Revenue~~presented in our income statement as components of noninterest income are as follows:

Trust and asset management income is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customers’ accounts. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.

~~Service Charges on Deposit Accounts~~

Service charges on deposit accounts ~~consist~~- represents fees generated from a variety of ~~account analysis fees (i.e., net fees earned on analyzed business~~deposit products and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account relatedservices provided to customers under a day-to-day contract. These fees are ~~largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue~~ recognized aton a ~~point in time. Payment for service charges on deposit accounts is primarily received immediately~~daily or ~~in the following month through a direct charge to customers’ accounts.~~

~~Fees, Exchange, and Other Service Charges~~

monthly basis.

~~Fees, exchange, and other service charges are primarily comprised of debit and credit~~

Bank card income ~~ATM~~and fees merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly– represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service ~~charges~~charge revenue earned from merchant, debit and credit cards that are ~~largely satisfied, and related revenue~~ recognized when the services are rendered or upon completion. ~~Payment is typically received immediately~~These fees are recognized on a daily or ~~in the following month.~~

monthly basis.

~~Gains/Losses~~

Gain on ~~Sales of Other Real Estate Owned (OREO)~~

~~The Company records a gain or loss from the~~ sale of ~~OREO when control of the property transfers to the buyer, which generally occurs~~other real estate - represents income recognized at the time of ~~an executed deed. When the Company finances the sale~~control of ~~OREO~~a property is transferred to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. No OREO sales for the three months ended March 31, 2018 and two sales for the three months ended March 31, 2017 were financed by the Bank, which financings were consistent with market terms.

Item 2- Management’s Discussion and Analysis of Financial Condition

And Results of Operations

Forward-Looking Statements

This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company, Hawthorn Bancshares, Inc., and its subsidiaries, including, without limitation:

statements that are not historical in nature, and

statements preceded by, followed by or that include the wordsbelieves,expects, may, will, should, could, anticipates, estimates, intends or similar expressions.

Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

competitive pressures among financial services companies may increase significantly,

changes in the interest rate environment may reduce interest margins,

general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,

increases in non-performing assets in the Company’s loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,

costs or difficulties related to the integration of the business of the Company and its acquisition targets may be greater than expected,

legislative, regulatory or tax law changes may adversely affect the business in which the Company and its subsidiaries are engaged, and

changes may occur in the securities markets.

We have described under the captionRisk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, and in other reports filed with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.

Overview

Crucial to the Company’s community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank, the Company, with $1.5 billion in assets at ~~March 31,~~September 30, 2018, provides a broad range of commercial and personal banking services. The Bank’s specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate, Small Business Administration (SBA) loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts. Other financial services that the Company provides include trust services that include estate planning, investment and asset management services and a comprehensive suite of cash management services. The geographic areas in which the Company provides products and services include the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and the greater Kansas City metropolitan area.

The Company's primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the Company's business is commercial, commercial real estate development, and residential mortgage lending. The Company's income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing activity.

The success of the Company's growth strategy depends primarily on the ability of its banking subsidiary to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. The Company's financial performance also depends, in part, on its ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of the Company's growth strategy depends on its ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control.

The Company’s subsidiary bank is a full-service bank conducting a general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, the Bank provides trust services.

The deposit accounts of the Bank are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The operations of the Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of the Bank are conducted by representatives of the FDIC and the Missouri Division of Finance. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is subject to supervision and examination by the Board of Governors of the Federal Reserve System.

CRITICAL ACCOUNTING POLICIES

The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to the critical accounting policies on the business operations are discussed throughoutManagement’s Discussion and Analysis of Financial Condition and Results of Operations, where such policies affect the reported and expected financial results.

Allowance for Loan Losses

Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of the Company's results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Further discussion of the methodology used in establishing the allowance and the impact of any associated risks related to these policies on the Company’s business operations is provided in note 1 to the Company’s unaudited consolidated financial statements and is also discussed in theLending and Credit Management section below. Many of the loans are deemed collateral dependent for purposes of the measurement of the impairment loss, thus the fair value of the underlying collateral and sensitivity of such fair values due to changing market conditions, supply and demand, condition of the collateral and other factors can be volatile over periods of time. Such volatility can have an impact on the financial performance of the Company.

SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected consolidated financial information for the Company as of and for each of the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively. The selected consolidated financial data should be read in conjunction with the unaudited consolidated financial statements of the Company, including the related notes, presented elsewhere herein.

Selected Financial Data
	Three Months Ended						Three Months Ended						Nine Months Ended
	March 31,						September 30,						September 30,
(In thousands, except per share data)	2018			2017			2018			2017			2018			2017
Per Share Data
Basic earnings per share	$	0.36		$	0.36		$	0.51		$	0.29		$	1.34		$	0.95
Diluted earnings per share		0.36			0.36			0.51			0.29			1.34			0.95
Dividends paid on common stock		406			336
Cash dividends paid on common stock								579			338			1,390			1,067
Common stock dividend								5,014			4,165			5,014			4,165
Book value per share		15.74			15.94									15.75			15.84
Market price per share		20.64			20.29									22.75			19.90
Selected Ratios
(Based on average balance sheets)
Return on total assets		0.60	%		0.65	%		0.85	%		0.51	%		0.75	%		0.58	%
Return on stockholders' equity		9.32	%		9.23	%		13.02	%		7.27	%		11.69	%		8.18	%
Stockholders' equity to total assets		6.41	%		7.01	%		6.50	%		7.04	%		6.42	%		7.06	%
Efficiency ratio (1)		78.54	%		72.52	%		72.54	%		75.51	%		75.19	%		74.34	%

(Based on end-of-period data)
Stockholders' equity to assets		6.28	%		7.05	%								6.54	%		6.93	%
Total risk-based capital ratio		12.87	%		13.60	%								13.54	%		13.42	%
Tier 1 risk-based capital ratio		10.61	%		11.25	%								11.31	%		11.17	%
Common equity Tier 1 capital		8.04	%		8.47	%								8.60	%		8.39	%
Tier 1 leverage ratio (2)		9.17	%		9.74	%								9.35	%		9.62	%

(1)

Efficiency ratio is calculated as non-interest expense as a percentage of revenue. Total revenue includes net interest income and non-interest income.

(2)

Tier I leverage ratio is calculated by dividing Tier 1 capital by average total consolidated assets.

RESULTS OF OPERATIONS ANALYSIS

The Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.

	Three Months Ended March 31,										Three Months Ended September 30,										Nine Months Ended September 30,
(In thousands)	2018		2017		$ Change			% Change			2018		2017		$ Change			% Change			2018		2017		$ Change			% Change

Net interest income	$	10,754	$	10,487	$	267			2.5	%	$	11,308	$	10,753	$	555			5.2	%	$	33,090	$	32,060	$	1,030			3.2	%
Provision for loan losses		300		350		(50	)		(14.3	)		250		555		(305	)		(55.0	)		1,000		1,235		(235	)		(19.0	)
Noninterest income		2,301		2,407		(106	)		(4.4	)		2,324		2,181		143			6.6			6,905		6,687		218			3.3
Investment securities gain, net												50		-		50			NM			256		-		256			NM
Noninterest expense		10,254		9,351		903			9.7			9,888		9,766		122			1.2			30,073		28,803		1,270			4.4
Income before
income taxes		2,501		3,193		(692	)		(21.7	)
Income before income taxes												3,544		2,613		881			33.7			9,178		8,709		213			2.4
Income tax expense		411		1,093		(682	)		(62.4	)		446		847		(401	)		(47.3	)		1,083		2,923		(1,840	)		(62.9	)
Net income	$	2,090	$	2,100	$	(10	)		(0.5	)%	$	3,098	$	1,766	$	1,332			75.4	%	$	8,095	$	5,786	$	2,309			39.9	%

Consolidated net income of ~~$2.1~~$3.1 million, or ~~$0.36~~$0.51 per diluted share, ~~was consistent~~ for ~~both~~ the three months ended ~~March 31,~~September 30, 2018 ~~and~~increased $1.3 million compared to $1.8 million, or $0.29 per diluted share, for the three months ended September 30, 2017. For the three months ended ~~March 31,~~September 30, 2018, the return on average assets was ~~0.60%~~0.85%, the return on average stockholders’ equity was ~~9.32%~~13.02%, and the efficiency ratio was ~~78.54%~~72.54%.

Consolidated net income of $8.1 million, or $1.34 per diluted share, for the nine months ended September 30, 2018 increased $2.3 million compared to $5.8 million, or $0.95 per diluted share, for the nine months ended September 30, 2017. For the nine months ended September 30, 2018, the return on average assets was 0.75%, the return on average stockholders’ equity was 11.69%, and the efficiency ratio was 75.19%.

Net interest income was ~~$10.8~~$11.3 million and $33.1 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$10.5~~$10.8 million and $32.1 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. The net interest margin (expressed on a fully taxable equivalent basis) decreased to ~~3.29%~~3.30% for the three months ended ~~March 31,~~September 30, 2018, compared to ~~3.48%~~3.35% for the three months ended ~~March 31,~~September 30, 2017, and decreased to 3.28% for the nine months ended September 30, 2018 compared to 3.44% for the nine months ended September 30, 2017. These changes are discussed in greater detail under theAverage Balance Sheets and Rate and Volume Analysis section below.

A ~~$300,000~~$250,000 and $1.0 millionprovision for loan losseswas recorded for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to a ~~$350,000~~$555,000 and $1.2 million provision for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively.

Non-performing loans totaled ~~$10.1~~$6.0 million, or ~~0.93%~~0.54% of total loans, at ~~March 31,~~September 30, 2018 compared to ~~$10.7~~$5.7 million, or ~~1.00%~~0.53% of total loans, at December 31, 2017, and ~~$9.4~~$6.2 million, or ~~0.93%~~0.59% of total loans, at ~~March 31,~~September 30, 2017. These changes are discussed in greater detail under theLending and Credit Management section below.

Non-interest income ~~decreased $106,000,~~increased $143,000, or ~~4.4%~~6.6%, for the three months ended ~~March 31,~~September 30, 2018 compared to the three months ended ~~March 31,~~September 30, 2017, and increased $218,000, or 3.3%, for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. These changes are discussed in greater detail ~~below~~ under theNon-interest ~~Income.~~Income and Expense section below.

Investment securities gains, net of $50,000 and $256,000 were recorded for the three and nine months ended September 30, 2018 compared to zero for both the prior comparative periods ending September 30, 2017. Securities gains for the three and nine months ended September 30, 2018 included gains realized from a series of short term sales of U.S. Treasury securities with repurchase agreements in order to generate capital gains to offset capital losses expiring in 2018 and 2019.

Non-interest expense increased ~~$903,000,~~$122,000, or ~~9.7%~~1.2%, for the three months ended ~~March 31,~~September 30, 2018 compared to the three months ended ~~March 31,~~September 30, 2017 and increased $1.3 million, or 4.4%, for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. These changes are discussed in greater detail ~~below~~ under theNon-interest ~~Expense.~~Income and Expense section below.

Average Balance Sheets

Net interest incomeis the largest source of revenue resulting from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the periods ended ~~March 31,~~September 30, 2018 and 2017, respectively.

Three Months Ended March 31,
(In thousands) 2018 2017
Interest Rate Interest Rate
Average Income/ Earned/ Average Income/ Earned/
Balance Expense(1) Paid(1) Balance Expense(1) Paid(1)
ASSETS
Loans: (2) (4)
Commercial $ 190,698 $ 2,257 4.80 % $ 182,548 $ 2,062 4.58 %
Real estate construction - residential 28,470 342 4.87 19,307 215 4.52
Real estate construction - commercial 101,856 1,172 4.67 66,214 720 4.41
Real estate mortgage - residential 247,579 2,859 4.68 260,551 2,922 4.55
Real estate mortgage - commercial 471,927 5,360 4.61 433,152 4,894 4.58
Consumer 32,342 293 3.67 30,234 300 4.02
Total loans $ 1,072,872 $ 12,283 4.64 % $ 992,006 $ 11,113 4.54 %
Investment securities: (3)

U.S. Treasury $ 17,502 $ 60 1.39 % $ 0 $ 0 0.00 %
U.S. government and federal agency obligations 49,399 190 1.56 45,410 156 1.39
Obligations of states and political subdivisions 44,807 270 2.44 43,733 249 2.31
Mortgage-backed securities 125,453 680 2.20 124,321 582 1.90
Total investment securities $ 237,161 $ 1,200 2.05 % $ 213,464 $ 987 1.88 %
Other investments and securities, at cost 9,910 110 4.50 9,785 90 3.73
Federal funds sold and interest bearing deposits in other financial institutions 24,573 106 1.75 21,657 48 0.90
Total interest earning assets $ 1,344,516 $ 13,699 4.13 % $ 1,236,912 $ 12,238 4.01 %
All other assets 85,116 90,264
Allowance for loan losses (10,916 ) (10,003 )
Total assets $ 1,418,716 $ 1,317,173
LIABILITIES AND
STOCKHOLDERS' EQUITY
NOW accounts $ 243,245 $ 533 0.89 % $ 216,075 $ 232 0.44 %
Savings 94,356 12 0.05 99,828 12 0.05
Commercial 1,604 4 1.01 1,655 2 0.49
Money market 265,994 535 0.82 199,698 143 0.29
Time deposits 289,970 649 0.91 296,357 471 0.64
Total interest bearing deposits $ 895,169 $ 1,733 0.79 % $ 813,613 $ 860 0.43 %
Federal funds purchased and securities sold under agreements to repurchase 43,060 171 1.61 29,078 22 0.31
Federal Home Loan advances and other 93,041 395 1.72 92,578 322 1.41
Subordinated notes 49,486 491 4.02 49,486 408 3.34
Total borrowings $ 185,587 $ 1,057 2.31 % $ 171,142 $ 752 1.78 %
Total interest bearing liabilities $ 1,080,756 $ 2,790 1.05 % $ 984,755 $ 1,612 0.66 %
Demand deposits 234,129 228,765
Other liabilities 12,892 11,322
Total liabilities 1,327,777 1,224,842
Stockholders' equity 90,939 92,331
Total liabilities and stockholders' equity $ 1,418,716 $ 1,317,173
Net interest income (FTE) 10,909 10,626
Net interest spread 3.08 % 3.35 %
Net interest margin 3.29 % 3.48 %

	Three Months Ended September 30,
(In thousands)	2018								2017
				Interest		Rate						Interest		Rate
	Average			Income/		Earned/			Average			Income/		Earned/
	Balance			Expense(1)		Paid(1)			Balance			Expense(1)		Paid(1)
ASSETS
Loans: (2) (4)
Commercial	$	199,911		$	2,556		5.07	%	$	186,001		$	2,166		4.62	%
Real estate construction - residential		29,444			404		5.44			21,532			253		4.66
Real estate construction - commercial		108,916			1,368		4.98			83,398			952		4.53
Real estate mortgage - residential		246,568			3,020		4.86			252,329			2,938		4.62
Real estate mortgage - commercial		482,800			5,662		4.65			458,684			5,289		4.57
Consumer		33,494			331		3.92			33,852			322		3.77
Total loans	$	1,101,133		$	13,341		4.81	%	$	1,035,796		$	11,920		4.57	%
Investment securities: (3)
U.S. Treasury	$	11,119		$	66		2.36	%	$	0		$	0		0.00	%
U.S. government and federal agency obligations		57,080			259		1.80			49,762			175		1.40
Obligations of states and political subdivisions		40,957			231		2.24			48,359			268		2.20
Mortgage-backed securities		125,976			683		2.15			119,160			533		1.77
Other debt securities		4,485			63		5.57			4,486			59		5.22
Total investment securities	$	239,617		$	1,302		2.16	%	$	221,767		$	1,035		1.85	%
Other securities		4,737			59		4.94			5,713			42		2.92
Federal funds sold and interest bearing deposits in other financial institutions		32,831			205		2.48			27,144			84		1.23
Total interest earning assets	$	1,378,318		$	14,907		4.29	%	$	1,290,420		$	13,081		4.02	%
All other assets		84,359								88,347
Allowance for loan losses		(11,341	)							(10,603	)
Total assets	$	1,451,336							$	1,368,164
LIABILITIES AND
STOCKHOLDERS' EQUITY
NOW accounts	$	204,370		$	513		1.00	%	$	209,704		$	302		0.57	%
Savings		96,548			13		0.05			97,285			12		0.05
Interest checking		3,051			6		0.78			1,450			3		0.82
Money market		312,597			936		1.19			239,742			365		0.60
Time deposits		319,809			911		1.13			290,767			582		0.79
Total interest bearing deposits	$	936,375		$	2,379		1.01	%	$	838,948		$	1,264		0.60	%
Federal funds purchased and securities sold under agreements to repurchase		36,743			166		1.79			29,107			29		0.40
Federal Home Loan advances and other		71,780			314		1.74			100,390			440		1.74
Subordinated notes		49,486			584		4.68			49,486			450		3.61
Total borrowings	$	158,009		$	1,064		2.67	%	$	178,983		$	919		2.04	%
Total interest bearing liabilities	$	1,094,384		$	3,443		1.25	%	$	1,017,931		$	2,183		0.85	%
Demand deposits		250,624								242,262
Other liabilities		11,944								11,627
Total liabilities		1,356,952								1,271,820
Stockholders' equity		94,384								96,344
Total liabilities and stockholders' equity	$	1,451,336							$	1,368,164
Net interest income (FTE)					11,464								10,898
Net interest spread							3.04	%							3.17	%
Net interest margin							3.30	%							3.35	%

(1)

Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21% and 34%, net of nondeductible interest expense for the three months ended ~~March 31,~~September 30, 2018 and 2017 respectively. Such adjustments totaled ~~$155,000~~$156,000 and ~~$139,000~~$145,000 for the three months ended ~~March 31,~~September 30, 2018 and 2017, respectively.

(2)

Non-accruing loans are included in the average amounts outstanding.

(3)

Average balances based on amortized cost.

(4)

Fees and costs on loans are included in interest income.

	Nine Months Ended September 30,
(In thousands)	2018								2017
				Interest		Rate						Interest		Rate
	Average			Income/		Earned/			Average			Income/		Earned/
	Balance			Expense(1)		Paid(1)			Balance			Expense(1)		Paid(1)
ASSETS
Loans: (2) (4)
Commercial	$	198,074		$	7,362		4.97	%	$	186,492		$	6,456		4.63	%
Real estate construction - residential		29,208			1,135		5.20			20,474			704		4.60
Real estate construction - commercial		104,335			3,774		4.84			73,821			2,470		4.47
Real estate mortgage - residential		247,165			8,846		4.79			257,249			8,819		4.58
Real estate mortgage - commercial		476,724			16,546		4.64			447,767			15,387		4.59
Consumer		32,838			938		3.82			31,975			931		3.89
Total loans	$	1,088,344		$	38,601		4.74	%	$	1,017,778		$	34,767		4.57	%
Investment securities: (3)
U.S. Treasury	$	16,857		$	205		1.63	%	$	0		$	0		0.00	%
U.S. government and federal agency obligations		53,600			690		1.72			48,037			507		1.41
Obligations of states and political subdivisions		42,347			735		2.32			46,621			784		2.25
Mortgage-backed securities		126,092			2,009		2.13			121,145			1,659		1.83
Other debt securities		4,485			184		5.49			4,486			174		5.19
Total investment securities	$	243,381		$	3,823		2.10	%	$	220,289		$	3,124		1.90	%
Other securities		5,042			162		4.30			5,706			111		2.60
Federal funds sold and interest bearing deposits in other financial institutions		32,416			500		2.06			17,885			144		1.08
Total interest earning assets	$	1,369,183		$	43,086		4.21	%	$	1,261,658		$	38,146		4.04	%
All other assets		84,485								88,984
Allowance for loan losses		(11,121	)							(10,332	)
Total assets	$	1,442,547							$	1,340,310
LIABILITIES AND
STOCKHOLDERS' EQUITY
NOW accounts	$	225,376		$	1,604		0.95	%	$	212,645		$	806		0.51	%
Savings		96,024			36		0.05			99,356			37		0.05
Interest checking		2,855			16		0.75			1,542			8		0.69
Money market		290,374			2,242		1.03			214,526			695		0.43
Time deposits		308,243			2,391		1.04			291,175			1,561		0.72
Total interest bearing deposits	$	922,872		$	6,289		0.91	%	$	819,244		$	3,107		0.51	%
Federal funds purchased and securities sold under agreements to repurchase		43,101			526		1.63			29,141			78		0.36
Federal Home Loan advances and other		80,745			1,042		1.73			101,059			1,290		1.71
Subordinated notes		49,486			1,636		4.42			49,486			1,182		3.19
Total borrowings	$	173,332		$	3,204		2.47	%	$	179,686		$	2,550		1.90	%
Total interest bearing liabilities	$	1,096,204		$	9,493		1.16	%	$	998,930		$	5,657		0.76	%
Demand deposits		241,618								235,469
Other liabilities		12,179								11,343
Total liabilities		1,350,001								1,245,742
Stockholders' equity		92,546								94,568
Total liabilities and stockholders' equity	$	1,442,547							$	1,340,310
Net interest income (FTE)					33,593								32,489
Net interest spread							3.05	%							3.28	%
Net interest margin							3.28	%							3.44	%

38(1)

Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21% and 34%, net of nondeductible interest expense for the nine months ended September 30, 2018 and 2017 respectively. Such adjustments totaled $503,000 and $429,000 for the nine months ended September 30, 2018 and 2017, respectively.

(2)

Non-accruing loans are included in the average amounts outstanding.

(3)

Average balances based on amortized cost.

(4)

Fees and costs on loans are included in interest income.

Rate and Volume Analysis

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates for the three and nine months ended ~~March 31,~~September 30, 2018 compared to the three and nine months ended ~~March 31,~~September 30, 2017. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each.

	Three Months Ended March 31,									Three Months Ended September 30,									Nine Months Ended September 30,
	2018 vs. 2017									2018 vs. 2017									2018 vs. 2017
				Change due to									Change due to									Change due to
	Total			Average			Average			Total			Average			Average			Total			Average			Average
(In thousands)	Change			Volume			Rate			Change			Volume			Rate			Change			Volume			Rate
Interest income on a fully taxable equivalent basis: (1)
Loans: (2) (4)
Commercial	$	195		$	94		$	101		$	390		$	169		$	221		$	906		$	415		$	491
Real estate construction - residential		127			109			18			151			104			47			431			330			101
Real estate construction - commercial		452			408			44			416			313			103			1,304			1,090			214
Real estate mortgage - residential		(63	)		(148	)		85			82			(68	)		150			27			(353	)		380
Real estate mortgage - commercial		466			440			26			373			282			91			1,159			1,004			155
Consumer		(7	)		20			(27	)		9			(3	)		12			7			25			(18	)
Investment securities: (3)
U.S. Treasury		60			55			5			66			63			3			205			200			5
U.S. government and federal agency obligations		34			15			19			84			29			55			183			63			120
Obligations of states and political subdivisions		21			6			15			(37	)		(42	)		5			(49	)		(74	)		25
Mortgage-backed securities		98			5			93			150			31			119			350			70			280
Other investments and securities, at cost		20			1			19
Other debt securities											4			0			4			10			0			10
Other securities											17			(8	)		25			51			(14	)		65
Federal funds sold and interest bearing deposits in other financial institutions		58			7			51			121			21			100			356			167			189
Total interest income		1,461			1,012			449			1,826			891			935			4,940			2,923			2,017
Interest expense:
NOW accounts		301			32			269			211			(8	)		219			798			51			747
Savings		0			(1	)		1			1			0			1			(1	)		(1	)		0
Commercial		2			0			2
Interest checking											3			0			3			8			7			1
Money market		392			60			332			571			137			434			1,547			315			1,232
Time deposits		178			(10	)		188			329			63			266			830			97			733
Federal funds purchased and securities sold under agreements to repurchase		149			16			133			137			10			127			448			53			395
Federal Home Loan Bank advances and other		73			2			71			(126	)		(125	)		(1	)		(248	)		(262	)		14
Subordinated notes		83			0			83			134			0			134			454			0			454
Total interest expense		1,178			99			1,079			1,260			77			1,183			3,836			260			3,576
Net interest income on a fully taxable equivalent basis	$	283		$	913		$	(630	)
Net interest income on a fully
taxable equivalent basis										$	566		$	814		$	(248	)	$	1,104		$	2,663		$	(1,559	)

(1)

Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 21% ~~and 34%~~, net of nondeductible interest expense for the three ~~month~~and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to 34% for the three and nine months ended September 30, 2017, respectively. Such adjustments totaled ~~$155,000~~$156,000 and ~~$139,000~~$503,000 for the three months and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to $145,000 and $429,000 for the three and nine months ended September 30, 2017, respectively.

(2)

Non-accruing loans are included in the average amounts outstanding.

(3)

Average balances based on amortized cost.

(4)

Fees and costs on loans are included in interest income.

Financial results for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to the ~~three months~~quarter ended ~~March 31,~~September 30, 2017, reflected an increase in net interest income, on a tax equivalent basis, of ~~$283,000,~~$566,000, or ~~2.66%~~5.19%, and financial results for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 reflected an increase of $1.1 million, or 3.40%. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased to ~~3.29%~~3.30% for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018, compared to ~~3.48%~~3.35% for the ~~three~~quarter ended September 30, 2017, and decreased to 3.28% for the nine months ended ~~March 31,~~September 30, 2018 compared to 3.44% for the nine months ended September 30, 2017. Although net interest income increased primarily due to an increase in average earning assets, net interest margin decreased due to the cost of interest bearing liabilities ~~repriced~~repricing faster than the rate earned on interest bearing ~~assets.~~assets in the comparative periods presented.

Average interest-earning assets increased ~~$107.6~~$87.9 million, or ~~8.70%~~6.81%, to ~~$1.34~~$1.38 billion for the three months ended ~~March 31,~~September 30, 2018 compared to ~~$1.24~~$1.29 billion for the three months ended ~~March 31,~~September 30, 2017, and average interest bearing liabilities increased ~~$96.0~~$76.5 million, or ~~9.75%~~7.51%, to ~~$1.1 million~~$1.09 billion for the three months ended ~~March 31,~~September 30, 2018 compared to ~~$984.8 million~~$1.02 billion for the three months ended ~~March 31,~~September 30, 2017.

Average interest-earning assets increased $107.5 million, or 8.52%, to $1.37 billion for the nine months ended September 30, 2018 compared to $1.26 billion for the nine months ended September 30, 2017, and average interest bearing liabilities increased $97.3 million, or 9.74%, to $1.10 billion for the nine months ended September 30, 2018 compared to $998.9 million for the nine months ended September 30, 2017.

Total interest income(expressed on a fully taxable equivalent basis) was ~~$13.7~~$14.9 million and $43.1 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$12.2~~$13.1 million and $38.1 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. The Company’s rates earned on interest earning assets were ~~4.13%~~4.29% and 4.21% for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~4.01%~~4.02% and 4.04% for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively.

Interest income on loansincreased to ~~$12.3~~$13.3 million and $38.6 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$11.1~~$11.9 million and $34.8 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively.

Average loans outstanding increased ~~$80.9~~$65.3 million, or ~~8.15%~~6.31%, to ~~$1.1~~$1.10 billion for the three months ended ~~March 31,~~September 30, 2018 compared to ~~$992.0 million~~$1.04 billion for the three months ended ~~March 31,~~September 30, 2017. The average yield on loans receivable increased to ~~4.64%~~4.81% for the three months ended ~~March 31,~~September 30, 2018 compared to ~~4.54%~~4.57% for the three months ended ~~March 31,~~September 30, 2017.

Average loans outstanding increased $70.6 million, or 6.93%, to $1.09 billion for the nine months ended September 30, 2018 compared to $1.02 billion for the nine months ended September 30, 2017. The average yield on loans receivable increased to 4.74% for the nine months ended September 30, 2018 compared to 4.57% for the nine months ended September 30, 2017. See theLending and Credit Management section for further discussion of changes in the composition of the lending portfolio.

Total interest expense increased to ~~$2.8~~$3.4 million and $9.5 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$1.6~~$2.2 million and $5.7 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. The Company’s rates paid on interest bearing liabilities was ~~1.05%~~1.25% and 1.16% for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~0.66%~~0.85% and 0.76% for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. See theLiquidity Managementsection for further discussion.

Interest expense on depositsincreased to ~~$1.7~~$2.4 million and $6.3 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$860,000~~$1.3 million and $3.1 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively.

Average interest bearing deposits increased ~~$81.6~~$97.4 million, or ~~10.02%~~11.6%, to ~~$895.2~~$936.3 million for the three months ended ~~March 31,~~September 30, 2018 compared to ~~$813.6~~$838.9 million for the three months ended ~~March 31,~~September 30, 2017. The increase was primarily due to a new money market product that brought in new deposits in addition to new public funds. The average cost of deposits increased to ~~0.79%~~1.01% for the three months ended ~~March 31,~~September 30, 2018 compared to ~~0.43%~~0.60% for the three months ended ~~March 31,~~September 30, 2017. The increase was primarily due to the rate paid on the new money market product and generally higher market interest rates quarter over quarter.

Average interest bearing deposits increased $103.6 million, or 12.6%, to $922.8 million for the nine months ended September 30, 2018 compared to $819.2 million for the nine months ended September 30, 2017. The increase was primarily due to a new money market product that brought in new deposits in addition to new public funds. The average cost of deposits increased to 0.91% for the nine months ended September 30, 2018 compared to 0.51% for the nine months ended September 30, 2017. The increase was primarily due to the rate paid on the new money market product and generally higher market interest rates during the current ~~quarter~~year versus the prior ~~year quarter ended March 31, 2017.~~year.

Interest expense on borrowingsincreased to $1.1 million and $3.2 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$752,000~~$919,000 and $2.6 million for the three and nine months ended ~~March 31, 2017.~~ September 30, 2017, respectively.

Average borrowings ~~increased~~decreased to ~~$185.6~~$158.0 million for the three months ended ~~March 31,~~September 30, 2018 compared to ~~$171.1~~$179.0 million for the three months ended ~~March 31,~~September 30, 2017. The ~~primary increase~~decrease in average borrowings resulted from the repayment of FHLB advances partially offset by an increase in average repurchase agreements due to ~~fund loan growth and~~ a tax initiative involving a short ~~sale~~sales of a U.S. Treasury security funded by a repurchase ~~agreement.~~agreements. The average cost of borrowings increased to ~~2.31%~~2.67% for the three months ended ~~March 31,~~September 30, 2018 compared to ~~1.78%~~2.04% for the three months ended ~~March 31,~~September 30, 2017. The increase in cost of funds primarily resulted from higher market interest rates and the additional interest cost of the repurchase ~~agreement~~agreements related to the short ~~sale.~~sales.

Average borrowings decreased to $173.3 million for the nine months ended September 30, 2018 compared to $179.7 million for the nine months ended September 30, 2017. The decrease in average borrowings resulted from the repayment of FHLB advances partially offset by an increase in average repurchase agreements due to a tax initiative involving short sales of a U.S. Treasury security funded by repurchase agreements. The average cost of borrowings increased to 2.47% for the nine months ended September 30, 2018 compared to 1.90% for the nine months ended September 30, 2017. The increase in cost of funds primarily resulted from higher market interest rates and the additional interest cost of the repurchase agreements related to the short sales. See theLiquidity Managementsection for further discussion.

Non-interest Income and Expense

Non-interest income for the periods indicated was as follows:

	Three Months Ended March 31,												Three Months Ended September 30,												Nine Months Ended September 30,
(In thousands)	2018			2017			$ Change			% Change			2018			2017			$ Change			% Change			2018			2017			$ Change			% Change
Non-interest Income
Service charges and other fees	$	876		$	836		$	40			4.8	%	$	942		$	878		$	64			7.3	%	$	2,760		$	2,565		$	195			7.6	%
Bank card income and fees		656			614			42			6.8			699			664			35			5.3			2,064			1,941			123			6.3
Trust department income		280			274			6			2.2			276			288			(12	)		(4.2	)		867			828			39			4.7
Real estate servicing fees, net		221			453			(232	)		(51.2	)		192			70			122			174.3			574			557			17			3.1
Gain on sales of mortgage loans, net		146			155			(9	)		(5.8	)		205			225			(20	)		(8.9	)		593			599			(6	)		(1.0	)
Other		122			75			47			62.7			10			56			(46	)		(82.1	)		47			197			(150	)		(76.1	)
Total non-interest income	$	2,301		$	2,407		$	(106	)		(4.4	)%	$	2,324		$	2,181		$	143			6.6	%	$	6,905		$	6,687		$	218			3.3	%

Non-interest income as a % of total revenue *		17.6	%		18.7	%
Non-interest income as a% of total revenue *														17.0	%		16.9	%								17.3	%		17.3	%

* Total revenue is calculated as net interest income plus non-interest income.

Total non-interest income ~~decreased $106,000,~~increased $143,000, or ~~4.4%~~6.6%, to $2.3 million for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$2.4~~$2.2 million for the ~~three~~quarter ended September 30, 2017, and increased $218,000, or 3.3%, to $6.9 million for the nine months ended ~~March 31,~~September 30, 2018 compared to $6.7 million for the nine months ended September 30, 2017.

Service charges and other fees increased $64,000, or 7.3%, to $942,000 for the quarter ended September 30, 2018 compared to $878,000 for the quarter ended September 30, 2017, and increased $195,000, or 7.6%, to $2.8 million for the nine months ended September 30, 2018 compared to $2.6 million for the nine months ended September 30, 2017. The increases period over period were primarily due to reduced waived service charges and increases in fees and ATM income resulting from deposit growth.

Real estate servicing fees, net of the change in valuation of mortgage serving rights, ~~decreased $232,000~~(MSRs) increased $122,000 to ~~$221,000~~$192,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$453,000~~$70,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2017 primarily due to ~~a $226,000 decrease~~an increase in the change in fair value quarter over quarter. ~~This~~Real estate servicing fees, net of the change in valuation of MSRs increased $17,000 to $574,000 for the nine months ended September 30, 2018 compared to $557,000 for the nine months ended September 30, 2017 primarily due to an increase in the change in fair value year over year. The change in the value of MSRs in both periods presented is primarily the result of market-driven changes in interest rates and prepayment speeds.

Mortgage loan servicing fees earned on loans sold were ~~$203,000~~$201,000 and $614,000 for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to $209,000 and $629,000 for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. The Company was servicing ~~$283.1~~$282.9 million of mortgage loans at ~~March 31,~~September 30, 2018 compared to $285.8 million and ~~$291.0~~$288.7 million at December 31, 2017 and ~~March 31,~~September 30, 2017, respectively.

Gain on sales of mortgage loans decreased ~~$9,000,~~$20,000, or ~~5.8%~~8.9%, to ~~$146,000~~$205,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$155,000~~$225,000 for the ~~three~~quarter ended September 30, 2017, and decreased $6,000, or 1.0%, to $593,000 for the nine months ended ~~March 31,~~September 30, 2018 compared to $599,000 for the nine months ended September 30, 2017. The decrease ~~quarter~~period over ~~quarter~~period was primarily due to a decrease in other loan originating income, partially offset by an increase in loan origination fees and costs. The Company sold loans of ~~$7.6~~$10.3 million and $30.0 million for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~$6.8~~$10.1 and $26.3 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively.

Other Income ~~increased $47,000,~~decreased $46,000, or ~~62.7%~~82.1%, to ~~$122,000~~$10,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$75,000~~$56,000 for the ~~three~~quarter ended September 30, 2017, and decreased $150,000, or 76.1%, to $47,000 for the nine months ended ~~March 31, 2017~~September 30, 2018 compared to $197,000 for the nine months ended September 30, 2017. The decrease period over period was primarily due to a ~~gain on the sale of investment securities~~decrease in brokerage income and partially offset by an increase in insurance claim reserve.

Investment securities gains, net for the periods indicated were as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands)	2018		2017			2018		2017
Investment securities gains, net
Available for sale securities:
Gains realized on sales	$	47	$	12		$	253	$	12
Losses realized on sales		0		(12	)		0		(12	)
Other securities:
Fair value adjustments, net		3		0			3		0
Investment securities gains, net	$	50	$	0		$	256	$	0

Securities gains for the three and nine months ended September 30, 2018 included gains realized from a ~~decrease~~series of short term sales of a U.S. Treasury security with repurchase agreements in ~~brokerage income.~~order to generate capital gains to offset capital losses that were to expire during 2018 and 2019.

Non-interest expense for the periods indicated was as follows:

	Three Months Ended March 31,												Three Months Ended September 30,												Nine Months Ended September 30,
(In thousands)	2018			2017			$ Change			% Change			2018			2017			$ Change			% Change			2018			2017			$ Change			% Change
Non-interest Expense
Salaries	$	4,552		$	4,054		$	498			12.3	%	$	4,049		$	4,069		$	(20	)		(0.5	)%	$	12,849		$	12,133		$	716			5.9	%
Employee benefits		1,505			1,384			121			8.7			1,494			1,433			61			4.3			4,564			4,143			421			10.2
Occupancy expense, net		689			619			70			11.3			749			719			30			4.2			2,162			2,027			135			6.7
Furniture and equipment expense		635			598			37			6.2			785			764			21			2.7			2,104			1,996			108			5.4
Processing expense, network and bank card expense		859			1,045			(186	)		(17.8	)		841			831			10			1.2			2,589			2,803			(214	)		(7.6	)
Legal, examination, and professional fees		422			280			142			50.7			289			331			(42	)		(12.7	)		913			928			(15	)		(1.6	)
FDIC insurance assessment		154			101			53			52.5			181			106			75			70.8			482			322			160			49.7
Advertising and promotion		252			239			13			5.4			297			342			(45	)		(13.2	)		840			845			(5	)		(0.6	)
Postage, printing, and supplies		268			223			45			20.2			256			215			41			19.1			749			690			59			8.6
Other		918			808			110			13.6			947			956			(9	)		(0.9	)		2,821			2,916			(95	)		(3.3	)
Total non-interest expense	$	10,254		$	9,351		$	903			9.7	%	$	9,888		$	9,766		$	122			1.2	%	$	30,073		$	28,803		$	1,270			4.4	%
Efficiency ratio *		78.5	%		72.5	%								72.5	%		75.5	%								75.2	%		74.3	%
Number of full-time equivalent employees		339			333									299			335

~~Efficiency ratio is calculated as non-interest expense as a percent of revenue.~~

* Efficiency ratio is calculated as non-interest expense as a percent of revenue.

Total revenue includes net interest income and non-interest income.

Total non-interest expense increased ~~$903,000,~~$122,000, or ~~9.7%~~1.2%, to ~~$10.3~~$9.9 million for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$9.4~~$9.8 million for the ~~three~~quarter ended September 30, 2017, and increased $1.3 million, or 4.4%, to $30.1 million for the nine months ended ~~March 31,~~September 30, 2018 compared to $28.8 million for the nine months ended September 30, 2017.

Salaries ~~increased $498,000,~~decreased $20,000, or ~~12.3%~~0.5%, to ~~$4.6~~$4.0 million for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to $4.1 million for the ~~three~~quarter ended September 30, 2017, and increased $716,000, or 5.9%, to $12.8 million for the nine months ended ~~March 31,~~September 30, 2018 compared to $12.1 million for the nine months ended September 30, 2017. The decrease quarter over quarter was primarily due to a reduction of thirty-six full-time equivalent employees, the majority of which occurred in the second and third quarter of 2018. The increase year over year was primarily due to a bonus that was paid in February 2018 to all eligible full-time and part-time employees as a result of the expected tax savings from the ~~new tax reform.~~Tax Act and an average 3% cost of living increase granted in January 2018.

Employee benefits increased ~~$121,000,~~$61,000, or ~~8.7%~~4.3%, to $1.5 million for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to $1.4 million for the ~~three~~quarter ended September 30, 2017, and increased $421,000, or 10.2%, to $4.6 million for the nine months ended ~~March 31,~~September 30, 2018 compared to $4.1 million for the nine months ended September 30, 2017. The increase in both periods presented was primarily due to an increase in pension expense due to lower assumed discount rates. An increase in medical plan premiums effective July 1, ~~2017.~~

2018 also contributed to the increase year over year.

~~Occupancy expense~~ increased $70,000, or 11.3%, to $689,000 for the three months ended March 31, 2018 compared to $619,000 for the three months ended March 31, 2017. The increase was primarily due to increased building repairs and maintenance, utilities, and real estate tax accruals.

Processing, network, and bank card expense ~~decreased $186,000,~~increased $10,000, or ~~17.8%~~1.2%, to ~~$859,000~~$841,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$1.0~~$831,000 for the quarter ended September 30, 2017, and decreased $214,000, or 7.6%, to $2.6 million for the ~~three~~nine months ended ~~March 31,~~September 30, 2018 compared to $2.8 million for the nine months ended September 30, 2017. The increase quarter over quarter was primarily due to an increase in ATM and debit card processing expenses partially offset by a decrease in network and data processing expenses. The decrease for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was primarily due to additional one-time costs associated with a corporate wide network upgrade and changes in processing service providers during 2017. This was partially offset by increased debit card processing expenses during 2018.

Legal, examination, and professional fees ~~increased $142,000,~~decreased $42,000, or ~~50.7%~~12.7%, to ~~$422,000~~$289,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$280,000~~$331,000 for the ~~three~~quarter ended September 30, 2017, and decreased $15,000, or 1.6%, to $913,000 for the nine months ended ~~March 31,~~September 30, 2018 compared to $928,000 for the nine months ended September 30, 2017. The ~~increase~~decrease quarter over quarter was primarily related to attorney fees incurred in 2017 related to two loan relationships. The decrease for the nine month period year over year was primarily related to a decrease in attorney fees related to settlements received on two loan relationships during 2018, partially offset by an increase in consulting fees related to tax planning initiatives and increased audit ~~fees partially offset by a decrease in legal~~ fees.

FDIC insurance assessment increased ~~$53,000,~~$75,000, or ~~52.5%~~70.8%, to ~~$154,000~~$181,000 for the ~~three months~~quarter ended ~~March 31,~~September 30, 2018 compared to ~~$101,000~~$106,000 for the ~~three~~quarter ended September 30, 2017, and increased $160,000, or 49.7%, to $482,000 for the nine months ended ~~March 31,~~September 30, 2018 compared to $322,000 for the nine months ended September 30, 2017. The increase isin both periods presented was primarily due to an increase in the Company’s total assessment ~~base quarter over quarter.~~base.

~~Postage, printing, and supplies~~ increased $45,000, or 20.2%, to $268,000 for the three months ended March 31, 2018 compared to $223,000 for the three months ended March 31, 2017. The increase was primarily due to an increase in stationary and supplies.

~~Other expense~~ increased $110,000, or 13.6%, to $918,000 for the three months ended March 31, 2018 compared to $808,000 for the three months ended March 31, 2017. The increase was primarily due to an increase in loan expense, correspondent bank and deposit fees, and miscellaneous charged off items.

Income taxes

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were ~~16.4%~~12.6% and 11.8% for the ~~quarter~~three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~34.2%~~32.4% and 33.6% for the three and nine months ended September 30, 2017, respectively. As further described below, the decrease in tax rate for the comparative periods is primarily due to a decrease in the federal corporate tax rate, the release of the valuation allowance related to capital losses as a result of the Company’s tax planning initiatives, a pension contribution made during the second quarter ~~ended March 31, 2017.~~ of 2018 that was attributable to the 2017 plan year, and the Company’s additional tax planning initiatives.

The federal corporate income tax rate declined from 34% to 21% effective January 1, 2018 as a result of the Tax Cuts and Jobs ~~Act.~~Act, (Tax Act). The Company’s tax rate is lower than the federal statutory rate primarily as a result of tax-exempt ~~income. The decrease in tax rate~~income, the release of the valuation allowance related to capital loss carryforwards, and a pension contribution made during the second quarter ~~over quarter is primarily due a decrease in~~of 2018 that was attributable to the ~~federal corporate tax rate~~2017 plan year, and the Company’s additional tax planning initiatives. The provisional adjustments recorded in the fourth quarter of 2017 related to the enactment of the Tax Cuts and Jobs Act have ~~not~~ been finalized as of ~~March 31, 2018.~~September 30, 2018 with the filing of the Company’s 2017 tax return. The ~~Company expects~~finalization of the Tax Act included a $306,000 benefit attributable to ~~finalize those~~the pension contribution discussed above and an $180,000 benefit attributable to various accounting method changes made on the Company’s 2017 tax return. Such adjustments were recorded in the second and third quarters of 2018 respectively, within the one-year measurement period provided under Staff Accounting Bulletin No. 118 in regards to the application of FASB’s ASC Topic 740,Income Taxes. The impact of the Tax Cuts and Jobs Act is expected to require further adjustments in 2018 due to anticipated additional guidance from the U.S. Department of the Treasury, changes in our assumptions, completion of 2017 U.S. tax returns and further information and interpretations that become available.

Lending and Credit Management

Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented ~~73.9%~~76.1% of total assets as of ~~March 31,~~September 30, 2018 compared to 74.0% as of December 31, 2017.

Lending activities are conducted pursuant to an established loan policy approved by the Bank’s Board of Directors. The Bank’s credit review process is overseen by regional loan committees with established loan approval limits. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and is comprised of senior managers of the Bank.

A summary of loans, by major class within the Company’s loan portfolio as of the dates indicated is as follows:

	March 31,			December 31,			September 30,			December 31,
(In thousands)	2018			2017			2018			2017
Commercial, financial, and agricultural	$	190,720		$	192,238		$	203,485		$	192,238
Real estate construction - residential		29,351			26,492			30,374			26,492
Real estate construction - commercial		105,345			98,340			95,806			98,340
Real estate mortgage - residential		250,131			246,754			246,334			246,754
Real estate mortgage - commercial		476,511			472,455			506,197			472,455
Installment loans to individuals		32,268			32,153			33,569			32,153
Total loans	$	1,084,326		$	1,068,432		$	1,115,765		$	1,068,432
Percent of categories to total loans:
Commercial, financial, and agricultural		18.1	%		18.0	%		18.2	%		18.0	%
Real estate construction - residential		2.0			2.5			2.7			2.5
Real estate construction - commercial		6.9			9.2			8.6			9.2
Real estate mortgage - residential		26.1			23.1			22.1			23.1
Real estate mortgage - commercial		43.8			44.2			45.4			44.2
Installment loans to individuals		3.1			3.0			3.0			3.0
Total		100.0	%		100.0	%		100.0	%		100.0	%

The Company extends credit to its local community market through traditional real estate mortgage products. The Company does not participate in extending credit to sub-prime residential real estate markets. The Company does not lend funds for transactions defined as “highly leveraged” by bank regulatory authorities or for foreign loans. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. The Company does not have any interest-earning assets that would have been included in nonaccrual, past due, or restructured loans if such assets were loans.

The Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers, but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price. During the three and nine months ended ~~March 31,~~September 30, 2018, the Company sold approximately ~~$7.6~~$10.3 million and $30.0 million of loans to investors, respectively, compared to ~~$6.8~~$10.1 million and $26.3 million for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. At ~~March 31,~~September 30, 2018, the Company was servicing approximately ~~$283.1~~$282.9 million of loans sold to the secondary market compared to $285.8 million at December 31, 2017, and ~~$291.0~~$288.7 million at ~~March 31,~~September 30, 2017.

Risk Elements of the Loan Portfolio

Management, the senior loan committee, and internal loan review, formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Currently, loans in excess of $2.0 million in aggregate and all adversely classified credits identified by management are reviewed. In addition, all other loans are reviewed on a sample basis. The senior loan committee reviews and reports to the board of directors, on a monthly basis, past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines which loans should be considered impaired. Management follows the guidance provided in the FASB’s ASC Topic 310-10-35 in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered necessary by management to provide for probable losses inherent in the loan portfolio.

~~Nonperforming~~Non-performing Assets

The following table summarizes ~~nonperforming~~non-performing assets at the dates indicated:

	March 31,			December 31,			September 30,			December 31,			September 30,
(In thousands)	2018			2017			2018			2017			2017
Nonaccrual loans:
Commercial, financial, and agricultural	$	2,258		$	2,507		$	2,296		$	2,507		$	3,005
Real estate construction - residential		59			0			0			0			0
Real estate construction - commercial		0			97			158			97			0
Real estate mortgage - residential		2,089			1,956			2,768			1,956			2,094
Real estate mortgage - commercial		916			936			597			936			943
Installment and other consumer		160			176			226			176			168
Total	$	5,482		$	5,672
Loans contractually past - due 90 days or more and still accruing:
Commercial, financial, and agricultural	$	0		$	2
Real estate construction - residential		0			275
Real estate mortgage - residential		0			28
Installment and other consumer		38			23
Total	$	38		$	328
Performing troubled debt restructurings		4,611			4,684
Total nonperforming loans		10,131			10,684
Total nonaccrual loans including non-performing troubled debt restructurings							$	6,045		$	5,672		$	6,210
Other real estate owned and repossessed assets		13,239			13,182			13,373			13,182			13,177
Total nonperforming assets	$	23,370		$	23,866
Total non-performing assets							$	19,418		$	18,854		$	19,387
Loans contractually past due 90 days or more and still accruing							$	235		$	328		$	178

Loans	$	1,084,326		$	1,068,432		$	1,115,765		$	1,068,432		$	1,045,047
Allowance for loan losses to loans		1.01	%		1.02	%		1.02	%		1.02	%		1.02	%
Nonperforming loans to loans		0.93	%		1.00	%
Allowance for loan losses to
nonperforming loans		108.05	%		101.57	%
Allowance for loan losses to nonperforming loans, excluding performing TDR's		198.32	%		180.87	%
Nonperforming assets to loans, other real estate owned and repossessed assets		2.13	%		2.21	%
Non-performing loans to loans								0.54	%		0.53	%		0.59	%
Loans past due 90 days or more and still accruing to loans								0.02	%		0.03	%		0.02	%
Non-performing assets to loans and other real estate owned and repossessed assets								1.72	%		1.74	%		1.77	%
Non-performing assets to total assets								1.34	%		1.32	%		1.40	%
Allowance for loan losses to non-performing loans								187.89	%		191.33	%		177.13	%

Non-performing assets consist of nonaccrual loans, TDRs on nonaccrual, and other real estate owned and repossessed assets. Total ~~nonperforming~~non-performing assets totaled $23.4 million at March 31, 2018 compared to $23.9 million at December 31, 2017. Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and TDRs totaled $10.1$19.4 million, or ~~0.93%~~1.72%, of total loans and other real estate and repossessed assets at ~~March 31,~~September 30, 2018 compared to ~~$10.7~~$18.9 million, or ~~1.00%~~1.74%, of total loans at December 31, 2017. Non-accrual loans included $2.2 million and $1.7 million of loans classified as TDRs at ~~both March 31,~~September 30, 2018 and December 31, 2017, respectively.

Total non-accrual loans at September 30, 2018 increased $373,000, or 7.0%, to $6.0 million compared to $5.7 million at December 31, 2017. This increase primarily consisted of an increase in real estate mortgage - residential loans, partially offset by a decrease in real estate mortgage – commercial loans and commercial, financial, and agricultural loans.

Loans past due 90 days and still accruing interest at September 30, 2018, were $235,000 compared to $328,000 at December 31, 2017. Other real estate and repossessed assets were $13.4 million at September 30, 2018 compared to $13.2 million at December 31, 2017. During the nine months ended September 30, 2018, $589,000 of nonaccrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to $217,000 during the nine months ended September 30, 2017.

As of ~~March 31,~~September 30, 2018 and December 31, 2017, approximately ~~$4.4~~$5.6 million and ~~$4.1~~$8.8 million, respectively, of loans classified as substandard, not included in the ~~nonperforming~~non-performing asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. Substandard loans included $3.2 million and $4.7 million of loans classified as performing TDRs at September 30, 2018 and December 31, 2017, respectively, and is further described in the table below. Management believes the general allowance was sufficient to cover the risks and probable losses related to such loans at ~~March 31,~~September 30, 2018 and December 31, 2017, respectively.

Total non-accrual loans at March 31, 2018 decreased $190,000, or 3.3%, to $5.5 million compared to $5.7 million at December 31, 2017. This decrease primarily consisted of a decrease in commercial, financial, and agricultural loans and a decrease in real estate construction – commercial loans, partially offset by an increase in real estate mortgage - residential loans, and real estate construction – residential loans.

Loans past due 90 days and still accruing interest at March 31, 2018, were $38,000 compared to $328,000 at December 31, 2017. Other real estate and repossessed assets were $13.2 million at both March 31, 2018 and December 31, 2017. During the three months ended March 31, 2018, $278,000 of nonaccrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to $103,000 during the three months ended March 31, 2017.

The following table summarizes the Company’s TDRs at the dates indicated:

	March 31, 2018						December 31, 2017						September 30, 2018						December 31, 2017
(In thousands)	Number of Contracts		Recorded Investment		Specific Reserves		Number of Contracts		Recorded Investment		Specific Reserves		Number of Contracts		Recorded Investment		Specific Reserves		Number of Contracts		Recorded Investment		Specific Reserves
Performing TDRs
Commercial, financial and agricultural		6	$	481	$	19		6	$	500	$	20		5	$	434	$	17		6	$	500	$	20
Real estate mortgage - residential		11		3,068		269		11		3,116		236		9		2,377		83		11		3,116		236
Real estate mortgage - commercial		2		1,062		72		2		1,068		109		3		431		72		2		1,068		109
Intallment - Consumer														2		18		1		-		-		-
Total performing TDRs		19	$	4,611	$	360		19	$	4,684	$	365		19	$	3,260	$	173		19	$	4,684	$	365
Nonperforming TDRs
Commercial, financial and agricultural		4	$	827	$	103		4	$	838	$	41		6	$	1,112	$	108		4	$	838	$	41
Real estate mortgage - residential		3		242		60		4		290		61		6		886		209		4		290		61
Real estate mortgage - commercial		4		581		139		4		589		110		1		112		68		4		589		110
Intallment - Consumer														3		75		11		-		-		-
Total nonperforming TDRs		11	$	1,650	$	302		12	$	1,717	$	212		16	$	2,185	$	396		12	$	1,717	$	212
Total TDRs		30	$	6,261	$	662		31	$	6,401	$	577		35	$	5,445	$	569		31	$	6,401	$	577

At ~~March 31,~~September 30, 2018, loans classified as TDRs totaled ~~$6.3~~$5.4 million, with ~~$662,000~~$569,000 of specific reserves, of which ~~$1.7~~$2.2 million were classified as nonperforming TDRs and ~~$4.6~~$3.2 million were classified as performing TDRs. This compared to $6.4 million of loans classified as TDRs, with $577,000 of specific reserves, of which $1.7 million were classified as nonperforming TDRs and $4.7 million were classified as performing TDRs at December 31, 2017. Both performing and nonperforming TDRs are considered impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. The net decrease in total TDRs from December 31, 2017 to ~~March 31,~~September 30, 2018 was primarily due to one TDR totaling $48,000 that went to foreclosure and ~~$95,000~~$1.6 million of payments received on ~~TDR’s received.~~TDRs, partially offset by nine new TDRs totaling $520,000.

Allowance for Loan Losses and Provision

Allowance for Loan Losses

The following table is a summary of the allocation of the allowance for loan losses:

	March 31,		December 31,		September 30,		December 31,
(In thousands)	2018		2017		2018		2017
Allocation of allowance for loan losses at end of period:
Commercial, financial, and agricultural	$	3,261	$	3,325	$	3,486	$	3,325
Real estate construction - residential		240		170		240		170
Real estate construction - commercial		895		807		746		807
Real estate mortgage - residential		2,057		1,689		2,341		1,689
Real estate mortgage - commercial		4,008		4,437		4,071		4,437
Installment and other consumer		352		345		398		345
Unallocated		134		79		76		79
Total	$	10,947	$	10,852	$	11,358	$	10,852

The allowance for loan losses (ALL) was ~~$10.9~~$11.4 million, or ~~1.01%~~1.02%, of loans outstanding at ~~March 31,~~September 30, 2018 compared to $10.9 million, or 1.02%, at December 31, 2017, and ~~$10.3~~$11.0 million, or ~~1.02%~~1.05%, of loans outstanding at ~~March 31,~~September 30, 2017. The ratio of the allowance for loan losses to nonperforming loans ~~excluding performing TDR’s,~~ was ~~198.32%~~187.89% at ~~March 31,~~September 30, 2018, compared to ~~180.87%~~191.33% at December 31, 2017, and 177.13% at September 30, 2017.

The following table is a summary of the general and specific allocations of the allowance for loan losses:

	March 31,		December 31,		September 30,		December 31,
(In thousands)	2018		2017		2018		2017
Allocation of allowance for loan losses:
Individually evaluated for impairment - specific reserves	$	1,336	$	1,333	$	1,225	$	1,333
Collectively evaluated for impairment - general reserves		9,611		9,519		10,133		9,519
Total	$	10,947	$	10,852	$	11,358	$	10,852

Thespecific reserve component applies to loans evaluated individually for impairment. The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals and/or internal evaluations, or by discounting the total expected future cash flows. Once the impairment amount is calculated, a specific reserve allocation is recorded. At ~~March 31,~~September 30, 2018, ~~$1.3~~$1.2 million of the Company’s ALL was allocated to impaired loans totaling approximately ~~$10.1~~$9.3 million compared to $1.3 million of the Company’s ALL allocated to impaired loans totaling approximately $10.4 million at December 31, 2017. Management determined that ~~$2.0~~$3.0 million, or ~~20%~~32%, of total impaired loans required no reserve allocation at ~~March 31,~~September 30, 2018 compared to $2.4 million, or 23%, at December 31, 2017, primarily due to adequate collateral values,acceptable payment history and adequate cash flow ability.

Theincurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying loss rates to pools of loans by asset type. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type. Beginning in the first quarter of 2016, the Company began to lengthen its look-back period with the intent to increase such period from three to five years by December 31, 2017. The Company believes that the five-year look-back period, which is consistent with the Company’s practices prior to the start of the economic recession in 2008, provides a representative historical loss period in the current economic environment. These historical loss rates for each risk group are used as the starting point to determine loss rates for measurement purposes. The historical loan loss rates are multiplied by loss emergence periods (LEP) which represent the estimated time period between a borrower first experiencing financial difficulty and the recognition of a loss.

The Company’s methodology includes qualitative risk factors that allow management to adjust its estimates of losses based on the most recent information available and to address other limitations in the quantitative component that is based on historical loss rates. Such risk factors are generally reviewed and updated quarterly, as appropriate, and are adjusted to reflect changes in national and local economic conditions and developments, the nature, volume and terms of loans in the portfolio, including changes in volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans, loan concentrations, assessment of trends in collateral values, assessment of changes in the quality of the Company’s internal loan review department, and changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices.

The specific and general reserve allocations represent management’s best estimate of probable losses inherent in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

Provision

A ~~$300,000~~$250,000 and $1.0 million provision was required for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to a ~~$350,000~~$555,000 and $1.2 million provision for the three and nine months ended ~~March 31,~~September 30, 2017. The decrease in both periods reported was primarily due to ~~loan growth slowing during~~improved credit quality and economic conditions used in assessing the ~~current quarter compared to~~risk in the ~~quarter ended March 31, 2017.~~portfolio.

The following table summarizes loan loss experience for the periods indicated:

	Three Months Ended					Three Months Ended				Nine Months Ended
	March 31,					September 30,				September 30,
(In thousands)	2018		2017			2018		2017		2018		2017
Analysis of allowance for loan losses:
Balance beginning of period	$	10,852	$	9,886		$	11,212	$	10,545	$	10,852	$	9,886
Charge-offs:
Commercial, financial, and agricultural		110		28			75		37		378		97
Real estate construction - residential		48		-			-		-		48		-
Real estate construction - commercial		30		-			-		-		30		-
Real estate mortgage - residential		20		20			32		68		64		149
Real estate mortgage - commercial		14		14			5		4		34		20
Installment and other consumer		57		51			74		56		181		167
Total charge-offs		279		113			186		165		735		433
Recoveries:
Commercial, financial, and agricultural	$	13	$	19		$	38	$	12	$	61	$	55
Real estate construction - residential		12		50			13		12		38		87
Real estate mortgage - residential		19		36			9		11		44		68
Real estate mortgage - commercial		6		7			2		5		34		26
Installment and other consumer		24		27			20		25		64		76
Total recoveries		74		139			82		65		241		312
Net charge-offs (recoveries)		205		(26	)
Net charge-offs							104		100		494		121
Provision for loan losses		300		350			250		555		1,000		1,235
Balance end of period	$	10,947	$	10,262		$	11,358	$	11,000	$	11,358	$	11,000

Net Loan Charge-offs ~~(Recoveries)~~

The Company’s net loan charge-offs were ~~$205,000,~~$104,000, or ~~0.02%~~0.01%, of average loans, and $494,000, or 0.05%, of average loans for the three and nine months ended ~~March 31,~~September 30, 2018, respectively, compared to ~~net loan recoveries~~$100,000, or 0.01%, of ~~$26,000,~~average loans, and $121,000, or ~~0.00%~~0.01%, of average loans for the three and nine months ended ~~March 31, 2017.~~September 30, 2017, respectively. The increase in charge-offs ~~quarter over quarter~~for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 primarily related to ~~one~~two commercial loan ~~relationship and two real estate construction loans.~~relationships.

Liquidity and Capital Resources

Liquidity Management

The role of liquidity management is to ensure funds are available to meet depositors' withdrawal and borrowers' credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet the demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by the Company, management prefers to focus on transaction accounts and full service relationships with customers.

The Company’s Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for the Company's liquidity position and profile. A combination of daily, weekly, and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital, and exposure to contingent draws on the Company's liquidity.

The Company has a number of sources of funds to meet liquidity needs on a daily basis. The Company’s most liquid assets are comprised of available for sale investment securities, not including other debt securities, federal funds sold, and excess reserves held at the Federal Reserve.

	March 31,		December 31,		September 30,		December 31,
(In thousands)	2018		2017		2018		2017
Federal funds sold and other overnight interest-bearing deposits	$	65,449	$	39,553	$	20,478	$	39,553
Certificates of deposit in other banks		4,812		3,460		12,243		3,460
Available-for-sale investment securities		215,720		226,542		224,562		231,028
Total	$	285,981	$	269,555	$	257,283	$	274,041

Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available-for-sale investment portfolio was ~~$215.7~~$224.6 million at ~~March 31,~~September 30, 2018 and included an unrealized net loss of ~~$5.3~~$7.1 million. The portfolio includes projected maturities and mortgage backed securities pay-downs of approximately ~~$10.1~~$17.4 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s deposit base.

The Company pledges portions of its investment securities portfolio to secure public fund deposits, federal funds purchase lines, securities sold under agreements to repurchase, borrowing capacity at the Federal Reserve Bank, and for other purposes required by law. At ~~March 31,~~September 30, 2018 and December 31, 2017, the Company’s unpledged securities in the available for sale portfolio totaled approximately ~~$21.5~~$35.9 million and $44.8 million, respectively.

Total investment securities pledged for these purposes were as follows:

	March 31,		December 31,		September 30,		December 31,
(In thousands)	2018		2017		2018		2017
Investment securities pledged for the purpose of securing:
Federal Reserve Bank borrowings	$	9,002	$	9,570	$	9,509	$	9,570
Federal funds purchased and securities sold under agreements to repurchase		47,728		40,931		45,073		40,931
Other deposits		137,538		131,197		129,670		131,197
Total pledged, at fair value	$	194,268	$	181,698	$	184,252	$	181,698

Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, money market deposit accounts, and time deposits less than $250,000, less all brokered deposits under $250,000. At ~~March 31,~~September 30, 2018, such deposits totaled $1.0 billion and represented ~~88.4%~~88.7% of the Company’s total deposits. These core deposits are normally less volatile and are often tied to other products of the Company through long lasting relationships. Time deposits and certificates of deposit of $250,000 and over totaled ~~$136.4~~$110.1 million at ~~March 31,~~September 30, 2018. These accounts are normally considered more volatile and higher costing representing ~~11.6%~~9.3% of total deposits at ~~March 31,~~September 30, 2018.

Core deposits at ~~March 31,~~September 30, 2018 and December 31, 2017 were as follows:

	March 31,		December 31,		September 30,		December 31,
(In thousands)	2018		2017		2018		2017
Core deposit base:
Non-interest bearing demand	$	244,835	$	245,380	$	257,376	$	245,380
Interest checking		246,008		229,862		197,863		229,862
Savings and money market		364,779		345,593		391,280		345,593
Other time deposits		188,361		191,563		202,529		230,309
Total	$	1,043,983	$	1,012,398	$	1,049,048	$	1,051,144

The total amount of certificates of deposit of $250,000 and greater at ~~March 31,~~September 30, 2018 and December 31, 2017 were ~~$84.7~~$110.1 million and $63.2 million, respectively. The Company had brokered deposits totaling ~~$48.9~~$29.8 million and ~~$48.5~~$9.8 million at ~~March 31,~~September 30, 2018 and December 31, 2017, ~~respectively~~respectively. Under the Economic Growth, Regulatory Relief, and Consumer Protection Act signed into law in May 2018, certain reciprocal deposits are no longer required to be classified as brokered deposits. As such, prior periods presented have been reclassified to include these reciprocal deposits in the Company’s core deposits and excluded from brokered deposit totals.

Other components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company’s outside borrowings are comprised of securities sold under agreements to repurchase, Federal Home Loan Bank advances, and subordinated notes. Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines. As of ~~March 31,~~September 30, 2018, under agreements with these unaffiliated banks, the Bank may borrow up to ~~$40.0~~$50.0 million in federal funds on an unsecured basis and ~~$16.2~~$16.4 million on a secured basis. There were no federal funds purchased outstanding at ~~March 31,~~September 30, 2018. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At ~~March 31,~~September 30, 2018, there was ~~$34.8~~$32.7 million in repurchase agreements. The Company may periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window; although no such borrowings were outstanding at ~~March 31,~~September 30, 2018.

The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB). As a member of the FHLB, the Bank has access to credit products of the FHLB. As of ~~March 31,~~September 30, 2018, the Bank had ~~$84.3~~$78.7 million in outstanding borrowings with the FHLB. In addition, the Company has $49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts.

Borrowings outstanding at ~~March 31,~~September 30, 2018 and December 31, 2017 were as follows:

	March 31,		December 31,		September 30,		December 31,
(In thousands)	2018		2017		2018		2017
Borrowings:
Federal funds purchased and securities sold under agreements to repurchase	$	34,795	$	27,560	$	32,660	$	27,560
Federal Home Loan Bank advances		84,296		121,352		78,683		121,352
Subordinated notes		49,486		49,486		49,486		49,486
Other borrowings		31		30		30		30
Total	$	168,608	$	198,428	$	160,859	$	198,428

The Company pledges certain assets, including loans and investment securities to the Federal Reserve Bank, FHLB, and other correspondent banks as security to establish lines of credit and borrow from these entities. Based on the type and value of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against this collateral. This collateral is also used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. The following table reflects collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company as follows:

	March 31,										December 31,										September 30,										December 31,
	2018										2017										2018										2017
(In thousands)	FHLB			Federal Reserve Bank		Federal Funds Purchased Lines		Total			FHLB			Federal Reserve Bank		Federal Funds Purchased Lines		Total			FHLB			Federal Reserve Bank		Federal Funds Purchased Lines		Total			FHLB			Federal Reserve Bank		Federal Funds Purchased Lines		Total
Advance equivalent	$	294,216		$	8,796	$	47,435	$	350,447		$	294,081		$	9,364	$	47,825	$	351,270		$	286,706		$	9,267	$	57,137	$	353,110		$	294,081		$	9,364	$	47,825	$	351,270
Letters of credit		(72,750	)		0		0		(72,750	)		(70,000	)		0		0		(70,000	)		(57,750	)		0		0		(57,750	)		(70,000	)		0		0		(70,000	)
Advances outstanding		(84,296	)		0		0		(84,296	)		(121,352	)		0		0		(121,352	)		(78,683	)		0		0		(78,683	)		(121,352	)		0		0		(121,352	)
Total available	$	137,170		$	8,796	$	47,435	$	193,401		$	102,729		$	9,364	$	47,825	$	159,918		$	150,273		$	9,267	$	57,137	$	216,677		$	102,729		$	9,364	$	47,825	$	159,918

At ~~March 31,~~September 30, 2018, loans of ~~$479.4~~$498.2 million were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At ~~March 31,~~September 30, 2018, investments totaling ~~$18.6~~$18.8 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.

Sources and Uses of Funds

Cash and cash equivalents were ~~$81.4~~$36.8 million at ~~March 31,~~September 30, 2018 compared to $62.9 million at December 31, 2017. The ~~$18.5~~$26.1 million ~~increase~~decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the ~~three~~nine months ended ~~March 31,~~September 30, 2018. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of ~~$2.3~~$11.3 million for the ~~three~~nine months ended ~~March 31,~~September 30, 2018.

Investing activities consisting mainly of purchases, sales and maturities of available-for-sale securities, and changes in the level of the loan portfolio used total cash of ~~$8.0~~$55.2 million. The cash outflow primarily consisted of ~~$16.2~~$48.7 million increase in loans and ~~$28.1~~$103.0 million purchases of investment securities, partially offset by ~~$36.5~~$104.6 million from maturities, calls, and sales of investment securities.

Financing activities provided cash of ~~$24.2~~$17.9 million, resulting primarily from a ~~$32.4~~$12.0 increase in demand deposits, a $24.7 million increase in interest bearing transaction accounts, ~~and $22.7~~a $20.2 million increase in time deposits, and a $5.1 million increase in federal funds purchased and securities sold under agreements to repurchase, partially offset by a net ~~$37.1~~$42.7 million repayment of FHLB advances. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during 2018.

In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company's various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company's liquidity. The Company had ~~$308.6~~$297.5 million in unused loan commitments and standby letters of credit as of ~~March 31,~~September 30, 2018. Although the Company's current liquidity resources are adequate to fund this commitment level the nature of these commitments is such that the likelihood of such a funding demand is very low.

The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company’s ongoing liquidity needs primarily include funding its operating expenses and paying cash dividends to its shareholders. The Company paid cash dividends to its shareholders totaling approximately ~~$406,000~~$1.4 million and ~~$336,000~~$1.1 million for the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid ~~$1.0~~$5.0 million and $0$2.6 million in dividends to the Company during the ~~three~~nine months ended ~~March 31,~~September 30, 2018 and 2017, respectively. At ~~March 31,~~September 30, 2018 and December 31, 2017, the Company had cash and cash equivalents totaling ~~$1.6~~$2.1 million and $1.4 million, respectively.

Capital Management

The Company and the Bank are subject to various regulatory capital requirements administered by 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 consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for the Company began on January 1, 2015. The Federal Reserve System’s (FRB) capital adequacy guidelines require that bank holding companies maintain a Common Equity Tier 1 risk-based capital ratio equal to at least 4.5% of its risk-weighted assets, a Tier 1 risk-based capital ratio equal to at least 6% of its risk-weighted assets and a total risk-based capital ratio equal to at least 8% of its risk-weighted assets. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%.

In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital conservation buffer requirement will be phased in over four years beginning in 2016. On January 1, 2016, the first phase of the requirement went into effect at 0.625% of risk-weighted assets, and the requirement will increase each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of risk weighted assets on January 1, 2019. Once fully phased in, the capital conservation buffer requirement effectively raises the minimum required risk-based capital ratios to 7% Common Equity Tier 1 Capital, 8.5% Tier 1 Capital and 10.5% Total Capital on a fully phased-in basis.

Under the Basel III requirements, at ~~March 31,~~September 30, 2018 and December 31, 2017, the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table as of periods indicated:

Well-Capitalized Under
Required for Capital Prompt Corrective Action
Actual Adequacy Purposes Provision
(in thousands) Amount Ratio Amount Ratio Amount Ratio
March 31, 2018
Total Capital (to risk-weighted assets):
Company $ 157,713 12.87 % $ 98,069 8.00 % $ N.A. N.A. %
Bank 156,390 12.79 97,794 8.00 122,243 10.00
Tier I Capital (to risk-weighted assets):
Company $ 130,070 10.61 % $ 73,551 6.00 % $ N.A. N.A. %
Bank 145,283 11.80 73,346 6.00 97,794 8.00
Common Equity Tier I Capital
(to risk-weighted assets)
Company $ 98,606 8.04 % $ 55,164 4.50 % $ N.A. N.A. %
Bank 145,283 11.88 55,009 4.50 79,458 6.50
Tier I Capital (to adjusted average assets):
Company $ 130,070 9.17 % $ 56,715 4.00 % $ N.A. N.A. %
Bank 145,283 10.37 56,028 4.00 70,035 5.00
(in thousands)
December 31, 2017
Total Capital (to risk-weighted assets):
Company $ 156,045 12.93 % $ 96,577 8.00 % $ N.A. N.A. %
Bank 154,495 12.83 96,326 8.00 120,408 10.00
Tier I Capital (to risk-weighted assets):
Company $ 129,369 10.72 % $ 72,433 6.00 % $ N.A. N.A. %
Bank 143,483 11.92 72,245 6.00 96,326 8.00
Common Equity Tier I Capital
(to risk-weighted assets)
Company $ 97,033 8.04 % $ 54,325 4.50 % $ N.A. N.A. %
Bank 143,483 11.92 54,184 4.50 78,265 6.50
Tier I leverage ratio:
Company $ 129,369 9.33 % $ 55,488 4.00 % $ N.A. N.A. %
Bank 143,483 10.38 55,315 4.00 69,144 5.00

											Well-Capitalized Under
						Required for Capital					Prompt Corrective Action
	Actual					Adequacy Purposes					Provision
(in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2018
Total Capital (to risk-weighted assets):
Company	$	162,989		13.54	%	$	96,315		8.00	%	$	N.A.		N.A	%
Bank		159,984		13.32			96,021		8.00			120,027		10.00
Tier I Capital (to risk-weighted assets):
Company	$	136,124		11.31	%	$	72,237		6.00	%	$	N.A.		N.A	%
Bank		148,403		12.36			72,016		6.00			96,021		8.00
Common Equity Tier I Capital (to risk-weighted assets)
Company	$	103,498		8.60	%	$	54,177		4.50	%	$	N.A.		N.A	%
Bank		148,403		12.36			54,012		4.50			78,017		6.50
Tier I Capital (to adjusted average assets):
Company	$	136,124		9.35	%	$	58,264		4.00	%	$	N.A.		N.A	%
Bank		148,403		10.30			57,648		4.00			72,060		5.00
(in thousands)
December 31, 2017
Total Capital (to risk-weighted assets):
Company	$	156,045		12.93	%	$	96,577		8.00	%	$	N.A.		N.A	%
Bank		154,495		12.83			96,326		8.00			120,408		10.00
Tier I Capital (to risk-weighted assets):
Company	$	129,369		10.72	%	$	72,433		6.00	%	$	N.A.		N.A	%
Bank		143,483		11.92			72,245		6.00			96,326		8.00
Common Equity Tier I Capital (to risk-weighted assets)
Company	$	97,033		8.04	%	$	54,325		4.50	%	$	N.A.		N.A	%
Bank		143,483		11.92			54,184		4.50			78,265		6.50
Tier I leverage ratio:
Company	$	129,369		9.33	%	$	55,488		4.00	%	$	N.A.		N.A	%
Bank		143,483		10.38			55,315		4.00			69,144		5.00

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Asset/Liability and Interest ~~Sensitivity~~Rate Risk

Management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit this exposure. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement of asset and liability cash flows.

~~Market~~

The principal objective of the Company's asset and liability management function is to evaluate the interest rate risk ~~arises~~within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing earnings and preserving adequate levels of liquidity and capital. The asset and liability management function is under the guidance of the Asset Liability Committee from direction of the Board of Directors. The Asset Liability Committee meets monthly to review, among other things, the sensitivity of the Company's assets and liabilities to interest rate changes, local and national market conditions and rates. The Asset Liability Committee also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company.

Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.

Management analyzes the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates ~~and other relevant market rate or price risk. The Company faces market~~on this calculation is analyzed for the risk ~~in the form of interest rate risk through transactions other than trading activities. The Company uses financial modeling techniques~~ to ~~measure interest rate risk. These techniques measure the sensitivity of~~our future earnings ~~due to changing~~and is used in conjunction with the analyses on net interest rate environments. Guidelines established by the Company's Asset/Liability Committee and approved by the board of directors are used to monitor exposure of earnings at risk. General interest rate movements are used to develop sensitivity as the Company feels it has no primary exposure to specific points on the yield curve. For the three months ended March 31, 2018, our Company utilized a 400 basis point immediate and gradual move in interest rates (both upward and downward) applied to both a parallel and proportional yield curve. However, there are no assurances that the change will not be more or less than this estimate.

The following table represents estimated interest rate sensitivity and periodic and cumulative gap positions calculated as of March 31, 2018. Significant assumptions used for this table included: loans will repay at historic repayment rates; certain interest-bearing demand accounts are interest sensitive due to immediate repricing, and fixed maturity deposits will not be withdrawn prior to maturity. A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the table.income.

Over
5 Years or
No stated
(In thousands) Year 1 Year 2 Year 3 Year 4 Year 5 Maturity Total
ASSETS
Investment securities $ 51,824 $ 41,093 $ 36,763 $ 27,061 $ 19,751 $ 39,228 $ 215,720
Federal funds sold and other over-night interest-bearing deposits 65,449 - - - - - 65,449
Certificates of deposit in other banks - 863 1,230 741 1,978 - 4,812
Other investments and securities, at cost 6,725 - 3,000 - - - 9,725
Loans 411,214 171,789 161,525 130,168 118,235 91,395 1,084,326
Total $ 535,212 $ 213,745 $ 202,518 $ 157,970 $ 139,964 $ 130,623 $ 1,380,032

LIABILITIES
Savings, interest checking, and money market deposits $ 358,209 $ - $ 258,685 $ - $ - $ - $ 616,894
Time deposits 211,852 47,850 17,813 10,808 30,319 10 318,652
Federal funds purchased and securities sold under agreements to repurchase 34,795 - - - - - 34,795
Federal Home Loan Bank advances 26,227 28,232 21,237 4,242 4,389 - 84,327
Subordinated notes 49,486 - - - - - 49,486
Total $ 680,569 $ 76,082 $ 297,735 $ 15,050 $ 34,708 $ 10 $ 1,104,154
Interest-sensitivity GAP
Periodic GAP $ (145,357 ) $ 137,663 $ (95,217 ) $ 142,920 $ 105,256 $ 130,613 $ 275,878
Cumulative GAP $ (145,357 ) $ (7,694 ) $ (102,911 ) $ 40,009 $ 145,265 $ 275,878 $ 275,878

Ratio of interest-earning assets to interest-bearing liabilities
Periodic GAP 0.79 2.81 0.68 10.50 4.03 NM 1.25
Cumulative GAP 0.79 0.99 0.90 1.04 1.13 1.25 1.25

The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 100 basis point decrease in interest rates on net interest income based on the interest rate risk model at September 30, 2018 and December 31, 2017.

	% change in projected net interest income
Hypothetical shift in interest rates (bps)	September 30, 2018			December 31, 2017
200		2.21	%		(3.14	)%
100		3.22	%		(2.05	)%
(100)		5.96	%		1.58	%

The improvement in our interest rate risk exposure from December 31, 2017 to September 30, 2018 was primarily due to higher offering rates for repricing loans at September 30, 2018 and a decrease in short-term maturity borrowings from December 31, 2017.

Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that management may undertake to manage the risks in response to anticipated changes in interest rates and actual results may also differ due to any actions taken in response to the changing rates.

Effects of Inflation

The effects of inflation on financial institutions are different from the effects on other commercial enterprises since financial institutions make few significant capital or inventory expenditures, which are directly affected by changing prices. Because bank assets and liabilities are virtually all monetary in nature, inflation does not affect a financial institution as much as do changes in interest rates. The general level of inflation does underlie the general level of most interest rates, but interest rates do not increase at the rate of inflation as do prices of goods and services. Rather, interest rates react more to changes in the expected rate of inflation and to changes in monetary and fiscal policy.

Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase capital at higher than normal rates to maintain an appropriate capital to asset ratio. In the opinion of management, inflation did not have a significant effect on the Company's operations for the ~~three~~nine months ended ~~March 31,~~September 30, 2018.

Item 4. Controls and Procedures

Our Company's management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures as defined in Rules 13a – 15(e) or 15d – 15(e) of the Securities Exchange Act of 1934 as of ~~March 31,~~September 30, 2018. Based upon and as of the date of that evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. It should be noted that any system of disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any system of disclosure controls and procedures is based in part upon assumptions about the likelihood of future events. Because of these and other inherent limitations of any such system, there can be no assurance that any design will always succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

There has been no change in our Company's internal control over financial reporting that occurred during the three months ended ~~March 31,~~September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Impact of New Accounting Standards

~~Financial Instruments~~IntangiblesIn ~~June 2016,~~August 2018, the FASB issued ASU ~~2016-13,~~2018-15,~~Financial Instruments~~Intangibles - ~~Credit Losses~~Goodwill and Other - Internal-Use Software (Topic ~~326): Measurement of Credit Losses on Financial Instruments~~~~(CECL)~~. ~~The revised accounting guidance will remove all recognition thresholds and will require~~350-40) Customer's Accounting for Implementation Costs Incurred in a ~~company~~Cloud Computing Arrangement That Is a Service Contract.This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to ~~recognize~~develop or obtain internal-use software (and hosting arrangements that include an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument's contractual life. It also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. This new accounting guidance will beinternal-use software license). ASU 2018-15 is effective for ~~interim and~~ annual reporting periods beginning after December 15, 2019. While the Company generally expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, the Company has not determined the magnitude of any such one-time adjustment or the overall impact of the new guidance on the Company’s consolidated financial statements. The Company has formed a committee and is continuing to evaluate the impact of the ASU's adoption on the Company's consolidated financial statements.

~~Leases~~~~In February 2016, the FASB issued ASU 2016-02,~~~~Leases~~, in order to increase transparency and comparability by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU primarily affects lessee accounting, which requires the lessee to recognize a right-of-use asset and a liability to make lease payments for those leases classified as operating leases under previous GAAP. For leases with a term of 12 months or less, an election by class of underlying asset not to recognize lease assets and lease liabilities is permitted. The ASU also provides additional guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The amendments in the ASU are effective for interim and annual periods beginning January 1, 2019. The Company expects to adopt this ASU in the first quarter of 2019 and ~~is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements.~~

~~In January 2018, the FASB issued ASU 2018-01~~~~, Leases: Land Easement Practical Expedient for Transition to Topic 842~~. This update provides an optional practical expedient that affects entities with land easements that existed or expired before an entity's adoption of Topic 842, provided that the entity does not account for those land easements as leases under Topic 840. The amendments in this ASU affect the amendments in ASU 2016-02, which are not yet effective but may be early adopted. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in ASU 2016-02. The Company will adopt this guidance as required, in conjunction with the adoption of ASU 2016-02 described above, however this update is not expected to ~~materially alter the implementation of ASU 2016-02, or to~~ have a ~~material~~significant impact on the Company’s consolidated financial statements.

Fair Value Measurement In August 2018, the FASB issued ASU 2018-13,Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement.ASU 2018-13 removes the requirement to disclose the amount of and reasons for transfers between Level 1 and Level 2 fair value measurement methodologies, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. It also adds a requirement to disclose changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 measurements. For certain unobservable inputs, entities may disclose other quantitative information in lieu of the weighted average if the other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently evaluating the impact of the adoption on the Company’s consolidated financial statements and disclosures.

Derivatives and Hedging The FASB issued guidance within ASU 2017-12,Targeted Improvements to Accounting for Hedging Activities (Topic 815)in August 2017. The amendments in ASU 2017-12 to Topic 815, Derivatives and Hedging, are intended to more closely align hedge accounting with companies' risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The guidance also amends the presentation and disclosure requirements and changes how companies assess effectiveness. Under the new guidance, public companies will have until the end of the first quarter in which a hedge is designated to perform an initial assessment of a hedge's effectiveness. After initial qualification, the new guidance permits a qualitative effectiveness assessment for certain hedges instead of a quantitative test if the company can reasonably support an expectation of high effectiveness throughout the term of the hedge. Additional disclosures include cumulative basis adjustments for fair value hedges and the effect of hedging on individual income statement line items. The amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted in any interim period after issuance of the Update. The ASU is not expected to have a significant effect on the Company’s Consolidated Financial Statements.

Financial InstrumentsIn June 2016, the FASB issued ASU 2016-13,Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments(CECL). The revised accounting guidance will remove all recognition thresholds and will require a company to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument's contractual life. It also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. This new accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2019. While the Company generally expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, the Company has not determined the magnitude of any such one-time adjustment or the overall impact of the new guidance on the Company’s consolidated financial statements. The Company has formed a committee and is continuing to evaluate the impact of the ASU's adoption on the Company's consolidated financial statements. Beginning in the first quarter of 2019, the Company plans to run parallel credit risk models to continue evaluating the results.

LeasesIn February 2016, the FASB issued ASU 2016-02,Leases, in order to increase transparency and comparability by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU primarily affects lessee accounting, which requires the lessee to recognize a right-of-use asset and a liability to make lease payments for those leases classified as operating leases under previous GAAP. For leases with a term of 12 months or less, an election by class of underlying asset not to recognize lease assets and lease liabilities is permitted. The ASU also provides additional guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The amendments in the ASU are effective for interim and annual periods beginning January 1, 2019. The Company’s operating leases primarily relate to office space and bank branches. The Company expects to adopt this ASU in the first quarter of 2019. Based on the Company’s current leases, the Company expects to recognize a lease liability and related right-of-use asset on the consolidated balance sheet, and is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated income statement and required disclosures.

PART II - OTHER INFORMATION

	Item 1.	Legal Proceedings

	The information required by this Item is set forth inCommitments and Contingencies, Pending Litigation,in our Company’s Notes to Consolidated Financial Statements (unaudited).

~~The information required by this Item is set forth in~~~~Commitments and Contingencies, Pending Litigation,~~~~in our Company’s Notes to Consolidated Financial Statements (~~~~unaudited)~~.

Item 1A.

Risk Factors

None


Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	None

~~The following table summarizes the purchases made by or on behalf of the Company or certain affiliated purchasers of shares of the Company's common stock during the three months ended March 31, 2018:~~

Period (a) Total Number of
Shares (or Units)
Purchased (b) Average
Price Paid per
Share (or Unit)
(c) Total Number of Shares
(or Units) Purchased as
Part of Publicly Announced
Plans or Programs

(d) Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased
Under the Plans or
Programs *

January 1-31, 2018 - $ - - $ 1,965,562
February 1-28, 2018 - $ - - $ 1,965,562
March 1-31, 2018 5,468 $ 20.51 - $ 1,853,415
Total 5,468 $ 20.51 - $ 1,853,415

* On August 6, 2015, the Company announced that its Board of Directors authorized the purchase, through open market transactions, of up to $2.0 million market value of the Company's common stock. On August 8, 2017, the Board authorized the repurchase of an additional $1.5 million market value of the Company’s common stock Management was given discretion to determine the number and pricing of the shares to be purchased, as well as, the timing of any such purchases.


Item 3.	Defaults Upon Senior Securities	None

Item 4.	Mine Safety Disclosures	None

Item 5.	Other Information	None

Item 6.	Exhibits

Exhibit No.		Description

3.1		Restated Articles of Incorporation of the Company (filed as Exhibit 3.1 to the Company's current report on Form 8-K on August 9, 2007 and incorporated herein by reference).

3.2		Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company's current report on Form 8-K on June 8, 2009 and incorporated herein by reference).

4.1		Specimen certificate representing shares of the Company's $1.00 par value Common Stock (filed as Exhibit 4.1 to the Company's current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).

31.1		Certificate of the Chief Executive Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certificate of the Chief Financial Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certificate of the Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certificate of the Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail (XBRL).

SIGNATURES

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

~~HAWTHORN BANCSHARES, INC.~~

	HAWTHORN BANCSHARES, INC.

Date

	/s/ David T. Turner

~~May 10,~~November 8, 2018	David T. Turner, Chairman of the Board and
	Chief Executive Officer (Principal Executive Officer)

	/s/ W. Bruce Phelps

~~May 10,~~November 8, 2018	W. Bruce Phelps, Chief Financial Officer (Principal Financial
	Officer and Principal Accounting Officer)

HAWTHORN BANCSHARES, INC.

INDEX TO EXHIBITS

~~March 31,~~September 30, 2018 Form 10-Q

Exhibit No.		Description

3.1		Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to the Company's current report on Form 8-K on August 9, 2007 and incorporated herein by reference).

3.2		Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company's current report on Form 8-K on June 8, 2009 and incorporated herein by reference).

4.1		Specimen certificate representing shares of the Company’s $1.00 par value Common Stock (filed as Exhibit 4.1 to the Company’s current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).

31.1		Certificate of the Chief Executive Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certificate of the Chief Financial Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certificate of the Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

32.2		Certificate of the Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

101		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail (XBRL).

* This information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934, as amended.

	Quantitative Information about Level 3 Fair Value Measurements
	Valuation Technique	Unobservable Inputs	Input Value
			Three Months Ended March 31,
			2018			2017
Mortgage servicing rights	Discounted cash flows	Weighted average constant prepayment rate		9.07	%		8.29	%
		Weighted average note rate		3.87	%		3.85	%
		Weighted average discount rate		10.39	%		9.72	%
		Weighted average expected life (in years)		6.20			6.50

														Over
														5 Years or
														No stated
(In thousands)	Year 1			Year 2			Year 3			Year 4		Year 5		Maturity		Total
ASSETS
Investment securities	$	51,824		$	41,093		$	36,763		$	27,061	$	19,751	$	39,228	$	215,720
Federal funds sold and other over-night interest-bearing deposits		65,449			-			-			-		-		-		65,449
Certificates of deposit in other banks		-			863			1,230			741		1,978		-		4,812
Other investments and securities, at cost		6,725			-			3,000			-		-		-		9,725
Loans		411,214			171,789			161,525			130,168		118,235		91,395		1,084,326
Total	$	535,212		$	213,745		$	202,518		$	157,970	$	139,964	$	130,623	$	1,380,032

LIABILITIES
Savings, interest checking, and money market deposits	$	358,209		$	-		$	258,685		$	-	$	-	$	-	$	616,894
Time deposits		211,852			47,850			17,813			10,808		30,319		10		318,652
Federal funds purchased and securities sold under agreements to repurchase		34,795			-			-			-		-		-		34,795
Federal Home Loan Bank advances		26,227			28,232			21,237			4,242		4,389		-		84,327
Subordinated notes		49,486			-			-			-		-		-		49,486
Total	$	680,569		$	76,082		$	297,735		$	15,050	$	34,708	$	10	$	1,104,154
Interest-sensitivity GAP
Periodic GAP	$	(145,357	)	$	137,663		$	(95,217	)	$	142,920	$	105,256	$	130,613	$	275,878
Cumulative GAP	$	(145,357	)	$	(7,694	)	$	(102,911	)	$	40,009	$	145,265	$	275,878	$	275,878

Ratio of interest-earning assets to interest-bearing liabilities
Periodic GAP		0.79			2.81			0.68			10.50		4.03		NM		1.25
Cumulative GAP		0.79			0.99			0.90			1.04		1.13		1.25		1.25

Period	(a) Total Number of Shares (or Units) Purchased		(b) Average Price Paid per Share (or Unit)		(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs *
January 1-31, 2018		-	$	-		-	$	1,965,562
February 1-28, 2018		-	$	-		-	$	1,965,562
March 1-31, 2018		5,468	$	20.51		-	$	1,853,415
Total		5,468	$	20.51		-	$	1,853,415