UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

~~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, ~~2018~~

2019

◻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~~

0‑23636

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Missouri		~~43-1626350~~ 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~~761‑6100

(~~Registrant's~~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.x ☒ Yes¨ ◻ 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).x ☒ Yes¨ ◻ 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~~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¨ ☒	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~~12b‑2 of the Exchange Act).¨ ◻ Yesx ☒ No

Securities registered pursuant to Section 12(g) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $1.00 par value	HWBK	The Nasdaq Stock Market LLC

As of May ~~4, 2018,~~8, 2019, the registrant had ~~5,789,341~~6,034,843 shares of common stock, par value $1.00 per share, ~~outstanding~~outstanding.

~~Part~~PART I ~~- Financial Information~~– FINANCIAL INFORMATION

Item 1. Financial Statements

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets~~(unaudited)~~

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


(In thousands, except per share data)							March 31,		December 31,
	March 31,			December 31,			2019		2018
	2018			2017			(Unaudited)
ASSETS
Cash and due from banks	$	15,955		$	23,325		$	15,679	$	23,687
Federal funds sold and other interest-bearing deposits		65,449			39,553			75,035		18,396
Cash and cash equivalents		81,404			62,878			90,714		42,083
Certificates of deposit in other banks		4,812			3,460			12,741		12,247
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								218,539		218,205
Other investments								5,735		5,675
Total investment securities		225,445			237,579			224,274		223,880
Loans		1,084,326			1,068,432			1,154,652		1,146,627
Allowances for loan losses		(10,947	)		(10,852	)		(11,845)		(11,652)
Net loans		1,073,379			1,057,580			1,142,807		1,134,975
Premises and equipment - net		34,777			34,811			35,953		34,894
Mortgage servicing rights		2,781			2,713			2,875		2,931
Other real estate owned and repossessed assets - net		13,239			13,182
Other real estate owned - net								13,537		13,691
Accrued interest receivable		5,330			5,627			6,160		6,162
Cash surrender value - life insurance		2,499			2,484			2,562		2,542
Other assets		9,242			8,902			6,688		8,277
Total assets	$	1,452,908		$	1,429,216		$	1,538,311	$	1,481,682
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Non-interest bearing demand	$	244,834		$	245,380		$	264,218	$	262,857
Savings, interest checking and money market		616,894			584,468			625,522		614,040
Time deposits $250,000 and over		84,740			63,176			140,886		104,900
Other time deposits		233,912			232,788			219,946		216,671
Total deposits		1,180,380			1,125,812			1,250,572		1,198,468
Federal funds purchased and securities sold
under agreements to repurchase		34,795			27,560
Federal funds purchased and securities sold under agreements to repurchase								22,097		24,647
Federal Home Loan Bank advances and other borrowings		84,327			121,382			95,096		95,153
Subordinated notes		49,486			49,486			49,486		49,486
Operating lease liabilities								2,347		—
Accrued interest payable		588			554			1,093		1,035
Other liabilities		12,061			13,051			12,750		13,479
Total liabilities		1,361,637			1,337,845			1,433,441		1,382,268
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 shares, respectively								6,279		6,279
Surplus		45,442			45,442			50,173		50,173
Retained earnings		52,280			50,595			58,168		54,105
Accumulated other comprehensive loss, net of tax		(7,335	)		(5,662	)		(4,706)		(6,099)
Treasury stock; 254,366 and 248,898 shares, at cost, respectively		(5,163	)		(5,051	)
Treasury stock; 243,638 shares, at cost, respectively								(5,044)		(5,044)
Total stockholders’ equity		91,271			91,371			104,870		99,414
Total liabilities and stockholders’ equity	$	1,452,908		$	1,429,216		$	1,538,311	$	1,481,682

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income(unaudited)


	Three Months Ended				Three Months Ended
	March 31,				March 31,
(In thousands, except per share amounts)	2018		2017		2019		2018
INTEREST INCOME
Interest and fees on loans	$	12,223	$	11,050	$	14,106	$	12,223
Interest on investment securities:
Taxable		947		754		1,000		947
Nontaxable		158		157		141		158
Federal funds sold, other interest-bearing deposits, and certificates of deposit in other banks		106		48		602		106
Dividends on other securities		110		90
Dividends on other investments						66		110
Total interest income		13,544		12,099		15,915		13,544
INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market		1,084		389		1,716		1,084
Time deposit accounts $250,000 and over						665		138
Time deposits		649		471		706		511
Total interest expense on deposits						3,087		1,733
Interest on federal funds purchased and securities sold under agreements to repurchase		171		22		33		171
Interest on Federal Home Loan Bank advances		395		322		542		395
Interest on subordinated notes		491		408		624		491
Total interest expense on borrowings						1,199		1,057
Total interest expense		2,790		1,612		4,286		2,790
Net interest income		10,754		10,487		11,629		10,754
Provision for loan losses		300		350		150		300
Net interest income after provision for loan losses		10,454		10,137		11,479		10,454
NON-INTEREST INCOME
Service charges and other fees		876		836		862		876
Bank card income and fees		656		614		695		656
Trust department income		280		274		293		280
Real estate servicing fees, net		221		453		84		221
Gain on sale of mortgage loans, net		146		155		105		146
Other		122		75		52		36
Total non-interest income		2,301		2,407		2,091		2,215
Investment securities gain, net						1		98
Gain on branch sale, net						2,074		—
NON-INTEREST EXPENSE
Salaries and employee benefits		6,057		5,438		5,438		6,057
Occupancy expense, net		689		619		698		689
Furniture and equipment expense		635		598		809		635
Processing, network, and bank card expense		859		1,045		1,001		859
Legal, examination, and professional fees		422		280		329		422
FDIC insurance assessment		154		101
Advertising and promotion		252		239		258		252
Postage, printing, and supplies		268		223		210		268
Other		918		808		1,145		1,084
Total non-interest expense		10,254		9,351		9,888		10,266
Income before income taxes		2,501		3,193		5,757		2,501
Income tax expense		411		1,093		1,091		411
Net income		2,090		2,100	$	4,666	$	2,090
Basic earnings per share	$	0.36	$	0.36	$	0.77	$	0.35
Diluted earnings per share	$	0.36	$	0.36	$	0.77	$	0.35

Seeaccompanying notes to the consolidated financial statements (unaudited).

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (unaudited)


	Three Months Ended
	March 31,
(In thousands)	2019		2018
Net income	$	4,666	$	2,090
Other comprehensive income, net of tax
Investment securities available-for-sale:
Unrealized gain (loss) on investment securities available-for-sale, net of tax		1,378		(1,715)
Adjustment for gain on sale of investment securities, net of tax		—		—
Defined benefit pension plans:
Amortization of prior service cost included in net periodic pension cost, net of tax		15		42
Total other comprehensive income (loss)		1,393		(1,673)
Total comprehensive income	$	6,059	$	417

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of ~~Comprehensive Income~~Stockholders’ Equity (unaudited)

Three Months Ended
March 31,
(In thousands) 2018 2017
Net income $ 2,090 $ 2,100
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
Adjustment for gain on sale of investment securities, net of tax 0 0
Defined benefit pension plans:
Amortization of prior service cost included in net periodic pension cost, net of tax 42 14
Total other comprehensive (loss) income (1,673 ) 320
Total comprehensive income $ 417 $ 2,420


							Accumulated				Total
							Other				Stock -
	Common				Retained		Comprehensive		Treasury		holders'
(In thousands)	Stock		Surplus		Earnings		Loss		Stock		Equity
Balance, December 31, 2017	$	6,047	$	45,442	$	50,595	$	(5,662)	$	(5,051)	$	91,371
Net income		—		—		2,090		—		—		2,090
Other comprehensive loss		—		—		—		(1,673)		—		(1,673)
Purchase of treasury stock		—		—		—		—		(112)		(112)
Cash dividends declared, common stock		—		—		(405)		—		—		(405)
Balance, March 31, 2018	$	6,047	$	45,442	$	52,280	$	(7,335)	$	(5,163)	$	91,271

Balance, December 31, 2018	$	6,279	$	50,173	$	54,105	$	(6,099)	$	(5,044)	$	99,414
Net income		—		—		4,666		—		—		4,666
Other comprehensive income		—		—		—		1,393		—		1,393
Cash dividends declared, common stock		—		—		(603)		—		—		(603)
Balance, March 31, 2019	$	6,279	$	50,173	$	58,168	$	(4,706)	$	(5,044)	$	104,870

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

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

Accumulated Total
Other Stock -
Common Retained Comprehensive Treasury holders'
(In thousands) Stock Surplus Earnings Loss Stock Equity
Balance, December 31, 2016 $ 5,822 $ 41,498 $ 51,671 $ (3,801 ) $ (4,173 ) $ 91,017
Net income 0 0 2,100 0 0 2,100
Other comprehensive income 0 0 0 320 0 320
Stock based compensation expense 0 1 0 0 0 1
Purchase of treasury stock 0 0 0 0 (25 ) (25 )
Cash dividends declared, common stock 0 0 (336 ) 0 0 (336 )
Balance, March 31, 2017 $ 5,822 $ 41,499 $ 53,435 $ (3,481 ) $ (4,198 ) $ 93,077

Balance, December 31, 2017 $ 6,047 $ 45,442 $ 50,595 $ (5,662 ) $ (5,051 ) $ 91,371
Net income 0 0 2,090 0 0 2,090
Other comprehensive loss 0 0 0 (1,673 ) 0 (1,673 )
Purchase of treasury stock 0 0 0 0 (112 ) (112 )
Cash dividends declared, common stock 0 0 (405 ) 0 0 (405 )
Balance, March 31, 2018 $ 6,047 $ 45,442 $ 52,280 $ (7,335 ) $ (5,163 ) $ 91,271


	Three Months Ended March 31,
(In thousands)	2019		2018
Cash flows from operating activities:
Net income	$	4,666	$	2,090
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		150		300
Depreciation expense		441		435
Net amortization of investment securities, premiums, and discounts		312		356
Change in fair value of mortgage servicing rights		94		(18)
Investment securities gain, net		(1)		(98)
Loss (gain) on sales and dispositions of premises and equipment		19		(13)
Gain on sales and dispositions of other real estate		(6)		(2)
Gain on branch sale, net		(2,074)		—
Provision for other real estate owned		28		1
Operating lease payment		1		—
Decrease in accrued interest receivable		2		297
Increase in cash surrender value - life insurance		(20)		(15)
Decrease in other assets		1,180		156
Increase in accrued interest payable		58		34
Decrease in other liabilities		(729)		(989)
Origination of mortgage loans for sale		(5,420)		(7,587)
Proceeds from the sale of mortgage loans		5,096		7,587
Gain on sale of mortgage loans, net		(105)		(146)
Other, net		(38)		(50)
Net cash provided by operating activities		3,654		2,338
Cash flows from investing activities:
Purchase of certificates of deposit in other banks		(494)		(1,352)
Net increase in loans		(7,669)		(16,231)
Purchase of available-for-sale debt securities		(12,751)		(28,134)
Proceeds from maturities of available-for-sale debt securities		10,030		9,119
Proceeds from calls of available-for-sale debt securities		3,820		1,685
Proceeds from sales of available-for-sale debt securities		—		25,723
Purchases of FHLB stock		(62)		(1,370)
Proceeds from sales of FHLB stock		3		2,682
Purchases of premises and equipment		(971)		(401)
Proceeds from sales of premises and equipment		—		13
Payment for branch sale, net		(6,700)		—
Proceeds from sales of other real estate and repossessed assets		248		224
Net cash used in investing activities		(14,546)		(8,042)
Cash flows from financing activities:
Net increase (decrease) in demand deposits		9,723		(546)
Net increase in interest-bearing transaction accounts		12,066		32,426
Net increase in time deposits		40,944		22,688
Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchase		(2,550)		7,235
Repayment of FHLB advances and other borrowings		(57)		(131,055)
FHLB advances		—		94,000
Purchase of treasury stock		—		(112)
Cash dividends paid - common stock		(603)		(406)
Net cash provided by financing activities		59,523		24,230
Net increase in cash and cash equivalents		48,631		18,526
Cash and cash equivalents, beginning of year		42,083		62,878
Cash and cash equivalents, end of year	$	90,714	$	81,404
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	15,913	$	2,755
Income taxes	$	—	$	—
Noncash investing and financing activities:
Other real estate and repossessed assets acquired in settlement of loans	$	116	$	278
Net deposits and fixed assets transferred to other assets held for sale	$	(8,885)	$	—
Right of use assets obtained in exchange for new operating lease liabilities	$	2,369	$	—

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

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

Three Months Ended March 31,
(In thousands) 2018 2017
Cash flows from operating activities:
Net income $ 2,090 $ 2,100
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 300 350
Depreciation expense 435 473
Net amortization of investment securities, premiums, and discounts 356 406
Stock based compensation expense 0 1
Change in fair value of mortgage servicing rights (18 ) (244 )
Gain on sale of investment securities (98 ) 0
(Gain) loss on sales and dispositions of premises and equipment (13 ) 1
Gain on sales and dispositions of other real estate and repossessed assets (2 ) (50 )
Provision for other real estate owned 1 32
Decrease in accrued interest receivable 297 481
Increase in cash surrender value - life insurance (15 ) (21 )
Decrease in other assets 156 58
Increase (decrease) in accrued interest payable 34 (46 )
Decrease in other liabilities (989 ) (742 )
Origination of mortgage loans for sale (7,587 ) (7,341 )
Proceeds from the sale of mortgage loans 7,587 6,789
Gain on sale of mortgage loans, net (146 ) (155 )
Other, net (50 ) (49 )
Net cash provided by operating activities 2,338 2,043
Cash flows from investing activities:
Net (increase) decrease in certificates of deposit in other banks (1,352 ) 1,000
Net increase in loans (16,231 ) (35,523 )
Purchase of available-for-sale debt securities (28,134 ) (15,346 )
Proceeds from maturities of available-for-sale debt securities 9,119 9,750
Proceeds from calls of available-for-sale debt securities 1,685 4,025
Proceeds from sales of available-for-sale debt securities 25,723 0
Purchases of FHLB stock (1,370 ) (263 )
Proceeds from sales of FHLB stock 2,682 200
Purchases of premises and equipment (401 ) (348 )
Proceeds from sales of premises and equipment 13 0
Proceeds from sales of other real estate and foreclosed assets 224 658
Net cash used in investing activities (8,042 ) (35,847 )
Cash flows from financing activities:
Net (decrease) increase in demand deposits (546 ) 3,084
Net increase in interest-bearing transaction accounts 32,426 50,648
Net increase (decrease) in time deposits 22,688 (21,394 )
Net increase in federal funds purchased and securities sold under agreements to repurchase 7,235 497
Repayment of FHLB advances and other borrowings (131,055 ) (38,232 )
FHLB advances 94,000 36,740
Purchase of treasury stock (112 ) (25 )
Cash dividends paid - common stock (406 ) (336 )
Net cash provided by financing activities 24,230 30,982
Net increase (decrease) in cash and cash equivalents 18,526 (2,822 )
Cash and cash equivalents, beginning of period 62,878 25,995
Cash and cash equivalents, end of period $ 81,404 $ 23,173

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

~~HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES~~

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

Three Months Ended March 31,
(In thousands) 2018 2017
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 2,755 $ 1,658
Income taxes $ 0 $ 755
Noncash investing activities:
Other real estate and repossessed assets acquired in settlement of loans $ 278 $ 103

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

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

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

~~(1)~~

(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,~~10‑Q, and Rule ~~10-01~~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~~10‑K for the year ended December 31, ~~2017.~~

2018.

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 Events On February 8, 2019, Hawthorn Bank, a wholly-owned subsidiary of the Company, completed the sale of its branch located in Branson, Missouri with total deposits of approximately $10.6 million to Branson Bank in Branson, Missouri. The transaction excludes loans assigned to the branch. The sale resulted in a pre-tax gain of approximately $2.1 million, or $1.6 million after tax.

The following represents significant new accounting principles adopted in ~~2018:~~2019:

~~Revenue from Contracts with Customers~~Leases On January 1, ~~2018,~~2019, the Company adopted ASU No. ~~2014-09,~~~~Revenue from Contracts~~2016-02, Leases (Topic 842) which requires that lessees and lessors recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. The ASU primarily affects lessee accounting, which requires the lessee to recognize a right-of-use asset (ROU) and a liability to make lease payments for those leases classified as operating leases. For leases with ~~Customers (Topic 606)~~a term of 12 months or less, an election by class of underlying asset not to recognize lease assets and ~~all subsequent ASUs that modified Topic 606.~~lease liabilities is permitted. The ~~implementation~~ASU also provides additional guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The Company's operating leases primarily relate to office space and bank branches.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

In January 2018, the FASB issued ASU 2018-01, which allows entities the option to apply the provisions of the new lease guidance at the effective date without adjusting the comparative periods presented. In July 2018, the FASB issued ASU 2018-10, which provides narrow-scope improvements to the lease standard and ASU 2018-11, which allows entities to choose an additional transition method, under which an entity initially applies the new lease standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Under this transitional method, the entity shall recognize and measure the leases that exist at the adoption date and the prior comparative periods are not adjusted. The Company adopted this ASU as of January 1, 2019 using the transitional method. In addition, the Company utilized the practical expedients that allowed it to retain the classifications of existing leases, not re-assess if existing leases have initial direct costs, and hindsight when determining the lease term and assessment of impairment. The adoption of ASU 2016-02 and related transition guidance resulted in the recording of right-of-use assets and lease liabilities on the consolidated balance sheets of $2.3 million and $2.3 million, respectively; however, it 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~~Company's other consolidated financial statements. See Note 7 - Leases for ~~reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted~~additional information.

Derivatives 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.

~~Financial Instruments~~HedgingThe FASB issued guidance within ASU ~~2016-01,~~~~Recognition and Measurement of Financial Assets and Financial Liabilities~~, 2017-12, Targeted Improvements to Accounting for Hedging Activities (Topic 815) in ~~January 2016.~~August 2017. The amendments ~~require all equity investments~~in ASU 2017-12 to ~~be measured at~~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 ~~with changes in~~hedges and the ~~fair value recognized through net~~effect of hedging on individual 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.statement line items. The amendments ~~also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments~~in this Update are effective for fiscal years beginning after December 15, 2018, and interim ~~and annual~~ periods ~~beginning January 1, 2018.~~within those fiscal years. 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~~Statements.

(2) Loans and Allowance for Loan Losses

~~(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.

~~Liabilities~~~~The FASB issued ASU 2016-04,~~~~Recognition of Breakage for Certain Prepaid Store-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 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 did not have a significant effect on the Company's consolidated financial statements.

~~Pension~~~~The 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 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 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, ~~2018~~2019 and December 31, ~~2017~~2018 is as follows:


	March 31,		December 31,		March 31,		December 31,
(in thousands)	2018		2017		2019		2018
Commercial, financial, and agricultural	$	190,720	$	192,238	$	204,759	$	207,720
Real estate construction - residential		29,351		26,492		26,082		28,610
Real estate construction - commercial		105,345		98,340		109,766		106,784
Real estate mortgage - residential		250,131		246,754		248,059		241,517
Real estate mortgage - commercial		476,511		472,455		534,121		529,536
Installment and other consumer		32,268		32,153		31,865		32,460
Total loans	$	1,084,326	$	1,068,432	$	1,154,652	$	1,146,627

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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, ~~2018,~~2019, loans of ~~$479.4~~$519.3 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)~~

The following ~~is a summary of~~table illustrates the changes in the allowance for loan losses ~~during the periods indicated.~~by portfolio segment:


	Three Months Ended March 31, 2019
	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	$	3,237	$	140	$	757	$	2,071	$	4,914	$	334	$	199	$	11,652
Additions:
Provision for loan losses		(60)		(66)		(119)		(196)		617		18		(44)		150
Deductions:
Loans charged off		53		—		—		84		8		52		—		197
Less recoveries on loans		(108)		—		—		(99)		—		(33)		—		(240)
Net loan charge-offs (recoveries)		(55)		—		—		(15)		8		19		—		(43)
Balance at end of period	$	3,232	$	74	$	638	$	1,890	$	5,523	$	333	$	155	$	11,845

Three Months Ended March 31, 2018
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 $ 3,325 $ 170 $ 807 $ 1,689 $ 4,437 345 $ 79 $ 10,852
Additions:
Provision for loan losses 33 106 118 369 (421 ) 40 55 300
Deductions:
Loans charged off 110 48 30 20 14 57 0 279
Less recoveries on loans (13 ) (12 ) 0 (19 ) (6 ) (24 ) 0 (74 )
Net loan charge-offs (recoveries) 97 36 30 1 8 33 0 205
Balance at end of period $ 3,261 $ 240 $ 895 $ 2,057 $ 4,008 $ 352 $ 134 $ 10,947


	Three Months Ended March 31, 2017																							Three Months Ended March 31, 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			33		106		118		369		(421)		40		55		300
Deductions:
Loans charged off		28			0			0		20			14			51			0			113			110		48		30		20		14		57		—		279
Less recoveries on loans		(19	)		(50	)		0		(36	)		(7	)		(27	)		0			(139	)		(13)		(12)		—		(19)		(6)		(24)		—		(74)
Net loan charge-offs (recoveries)		9			(50	)		0		(16	)		7			24			0			(26	)		97		36		30		1		8		33		—		205
Balance at end of period	$	2,360		$	99		$	579	$	2,125		$	4,731		$	322		$	46		$	10,262		$	3,261	$	240	$	895	$	2,057	$	4,008	$	352	$	134	$	10,947

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 with the first quarter 2019, management adjusted the look-back period to begin with loss history in the first quarter ~~of 2016, the Company began~~2012 and continue to ~~lengthen its look-back period~~include this starting point going forward. Management determined that 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 December 31, 2017,~~recovery continuing to set records for its length, the look-back period needed to be expanded to account for this extended economic cycle. This ever increasing look-back period will then be adjusted once a loss producing downturn is recognized by allowing the look-back period to shift forward by eliminating the earliest loss period and replenishing it with losses from the most recent period. Prior to 2019, the Company utilized a five-year look-back period, which was considered a representative historical loss period. The look-back period is consistently evaluated for relevance given the current facts and circumstances.

HAWTHORN BANCSHARES, INC.

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

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

The following table ~~provides the balance in~~illustrates the allowance for loan losses ~~at March 31, 2018~~ and ~~December 31, 2017, and the related loan balance~~recorded investment by ~~impairment methodology.~~portfolio segment:


	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
March 31, 2019
Allowance for loan losses:
Individually evaluated for impairment	$	495	$	9	$	0	$	580	$	233	$	19	$	0	$	1,336	$	512	$	—	$	—	$	475	$	25	$	27	$	—	$	1,039
Collectively evaluated for impairment		2,766		231		895		1,477		3,775		333		134		9,611		2,720		74		638		1,415		5,498		306		155		10,806
Total	$	3,261	$	240	$	895	$	2,057	$	4,008	$	352	$	134	$	10,947	$	3,232	$	74	$	638	$	1,890	$	5,523	$	333	$	155	$	11,845
Loans outstanding:
Individually evaluated for impairment	$	2,738	$	59	$	0	$	5,158	$	1,978	$	160	$	0	$	10,093	$	2,376	$	—	$	151	$	4,851	$	881	$	264	$	—	$	8,523
Collectively evaluated for impairment		187,982		29,292		105,345		244,973		474,533		32,108		0		1,074,233		202,383		26,082		109,615		243,208		533,240		31,601		—		1,146,129
Total	$	190,720	$	29,351	$	105,345	$	250,131	$	476,511	$	32,268	$	0	$	1,084,326	$	204,759	$	26,082	$	109,766	$	248,059	$	534,121	$	31,865	$	—	$	1,154,652

December 31, 2017
December 31, 2018
Allowance for loan losses:
Individually evaluated for impairment	$	500	$	0	$	48	$	521	$	243	$	21	$	0	$	1,333	$	551	$	—	$	—	$	579	$	37	$	27	$	—	$	1,194
Collectively evaluated for impairment		2,825		170		759		1,168		4,194		324		79		9,519		2,686		140		757		1,492		4,877		307		199		10,458
Total	$	3,325	$	170	$	807	$	1,689	$	4,437	$	345	$	79	$	10,852	$	3,237	$	140	$	757	$	2,071	$	4,914	$	334	$	199	$	11,652
Loans outstanding:
Individually evaluated for impairment	$	3,007	$	0	$	97	$	5,072	$	2,004	$	176	$	0	$	10,356	$	2,428	$	—	$	153	$	4,793	$	850	$	254	$	—	$	8,478
Collectively evaluated for impairment		189,231		26,492		98,243		241,682		470,451		31,977		0		1,058,076		205,292		28,610		106,631		236,724		528,686		32,206		—		1,138,149
Total	$	192,238	$	26,492	$	98,340	$	246,754	$	472,455	$	32,153	$	0	$	1,068,432	$	207,720	$	28,610	$	106,784	$	241,517	$	529,536	$	32,460	$	—	$	1,146,627

Impaired Loans

Loans evaluated under ASC ~~310-10-35~~310‑10‑35 include loans which are individually evaluated for impairment. All other loans are collectively evaluated for impairment under ASC ~~450-20.~~450‑20. Impaired loans individually evaluated for impairment totaled ~~$10.1 million and $10.4~~$8.5 million at both March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, 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 both March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, $3.8 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, ~~2018, $1.3~~2019, $1.0 million of the Company’s allowance for loan losses was allocated to impaired loans totaling ~~$10.1~~$8.5 million compared to ~~$1.3~~$1.2 million of the ~~Company's~~Company’s allowance for loan losses allocated to impaired loans totaling approximately ~~$10.4~~$8.5 million at December 31, ~~2017.~~2018. Management determined that ~~$2.0~~$2.3 million, or ~~20%~~27%, of total impaired loans required no reserve allocation at March 31, ~~2018~~2019 compared to ~~$2.4~~$2.1 million, or ~~23%~~25%, at December 31, ~~2017~~2018, primarily due to adequate collateral values,acceptable payment history and adequate cash flow ability.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

The categories of impaired loans at March 31, ~~2018~~2019 and December 31, ~~2017~~2018 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


	March 31,		December 31,
(in thousands)	2019		2018
Non-accrual loans	$	5,431	$	5,414
Performing TDRs		3,092		3,064
Total impaired loans	$	8,523	$	8,478

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

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

The following tables provide additional information about impaired loans at March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.


			Unpaid						Unpaid
	Recorded		Principal		Specific		Recorded		Principal		Specific
(in thousands)	Investment		Balance		Reserves		Investment		Balance		Reserves
March 31, 2018
March 31, 2019
With no related allowance recorded:
Commercial, financial and agricultural	$	1,091	$	1,151	$	0	$	1,203	$	1,516	$	—
Real estate - construction commercial								151		179		—
Real estate - residential		908		955		0		703		762		—
Real estate - commercial								233		373		—
Total	$	1,999	$	2,106	$	0	$	2,290	$	2,830	$	—
With an allowance recorded:
Commercial, financial and agricultural	$	1,647	$	1,960	$	495	$	1,173	$	1,252	$	512
Real estate - construction residential		59		59		9
Real estate - residential		4,250		4,344		580		4,148		4,421		475
Real estate - commercial		1,978		2,123		233		648		874		25
Installment and other consumer		160		179		19		264		294		27
Total	$	8,094	$	8,665	$	1,336	$	6,233	$	6,841	$	1,039
Total impaired loans	$	10,093	$	10,771	$	1,336	$	8,523	$	9,671	$	1,039


			Unpaid						Unpaid
	Recorded		Principal		Specific		Recorded		Principal		Specific
(in thousands)	Investment		Balance		Reserves		Investment		Balance		Reserves
December 31, 2017
December 31, 2018
With no related allowance recorded:
Commercial, financial and agricultural	$	1,393	$	1,445	$	0	$	1,264	$	1,550	$	—
Real estate - construction commercial								153		180		—
Real estate - residential		674		688		0		561		602		—
Real estate - commercial		366		395		0		115		119		—
Total	$	2,433	$	2,528	$	0	$	2,093	$	2,451	$	—
With an allowance recorded:
Commercial, financial and agricultural	$	1,614	$	1,834	$	500	$	1,164	$	1,236	$	551
Real estate - construction commercial		97		97		48
Real estate - residential		4,398		4,500		521		4,232		4,458		579
Real estate - commercial		1,638		1,743		243		735		1,093		37
Consumer		176		196		21
Installment and other consumer								254		280		27
Total	$	7,923	$	8,370	$	1,333	$	6,385	$	7,067	$	1,194
Total impaired loans	$	10,356	$	10,898	$	1,333	$	8,478	$	9,518	$	1,194

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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


	Three Months Ended March 31,
	2019				2018
			Interest				Interest
	Average		Recognized		Average		Recognized
	Recorded		For the		Recorded		For the
(in thousands)	Investment		Period Ended		Investment		Period Ended
With no related allowance recorded:
Commercial, financial and agricultural	$	1,330	$	—	$	906	$	—
Real estate - construction commercial		158		—		—		—
Real estate - residential		850		—		919		3
Real estate - commercial		170		—		—		—
Installment and other consumer		34		—		—		—
Total	$	2,542	$	—	$	1,825	$	3
With an allowance recorded:
Commercial, financial and agricultural	$	1,276	$	11	$	1,857	$	8
Real estate - construction residential		—		—		15		—
Real estate - residential		4,160		25		4,379		32
Real estate - commercial		946		9		2,012		15
Installment and other consumer		232		1		139		—
Total	$	6,614	$	46	$	8,402	$	55
Total impaired loans	$	9,156	$	46	$	10,227	$	58

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

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Three Months Ended March 31,
2018 2017
Interest Interest
Average Recognized Average Recognized
Recorded For the Recorded For the
(in thousands) Investment Period Ended Investment Period Ended
With no related allowance recorded:
Commercial, financial and agricultural $ 906 $ 0 $ 555 $ 1
Real estate - construction commercial 0 0 0 0
Real estate - residential 919 3 807 4
Real estate - commercial 0 0 589 2
Installment and other consumer 0 0 40 0
Total $ 1,825 $ 3 $ 1,991 $ 7
With an allowance recorded:
Commercial, financial and agricultural $ 1,857 $ 8 $ 1,192 $ 11
Real estate - construction residential 15 0 0 0
Real estate - construction commercial 0 0 50 0
Real estate - residential 4,379 32 4,511 43
Real estate - commercial 2,012 15 1,494 15
Installment and other consumer 139 0 51 0
Total $ 8,402 $ 55 $ 7,298 $ 69
Total impaired loans $ 10,227 $ 58 $ 9,289 $ 76

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 and $76,000,~~$46,000 for the three months ended March 31, ~~2018 and 2017, respectively.~~2019 compared to $58,000 for the three months ended March 31, 2018. 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. Subsequent interest payments received on non-accrual 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. 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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

ability to pay under the terms of the note through a sustained period of repayment performance, which is generally six months.

The following table provides aging information for the Company’s past due and non-accrual loans at March 31, ~~2018~~2019 and December 31, ~~2017.~~

2018.


	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, 2019
Commercial, Financial, and Agricultural	$	202,850	$	162	$	—	$	1,747	$	204,759
Real Estate Construction - Residential		26,082		—		—		—		26,082
Real Estate Construction - Commercial		109,143		472		—		151		109,766
Real Estate Mortgage - Residential		243,864		1,252		140		2,803		248,059
Real Estate Mortgage - Commercial		532,539		1,074		—		508		534,121
Installment and Other Consumer		31,391		247		5		222		31,865
Total	$	1,145,869	$	3,207	$	145	$	5,431	$	1,154,652
December 31, 2018
Commercial, Financial, and Agricultural	$	205,597	$	266	$	—	$	1,857	$	207,720
Real Estate Construction - Residential		28,404		206		—		—		28,610
Real Estate Construction - Commercial		106,531		100		—		153		106,784
Real Estate Mortgage - Residential		235,734		2,907		156		2,720		241,517
Real Estate Mortgage - Commercial		527,968		1,094		—		474		529,536
Installment and Other Consumer		32,002		242		6		210		32,460
Total	$	1,136,236	$	4,815	$	162	$	5,414	$	1,146,627

~~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

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 are identified that may result in the ~~deterioration of the~~borrower being unable to meet repayment ~~exits~~terms or the Company’s credit position could deteriorate 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~~that are accruing interest are classified as performing TDRs. Loans classified as TDRs, ~~which~~that are not accruing interest are classified as nonperforming

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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 on~~~~non-accrual~~status 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, ~~2018~~2019 and December 31, ~~2017.~~2018.


															Commercial,		Real Estate		Real Estate		Real Estate		Real Estate		Installment
															Financial, &		Construction -		Construction -		Mortgage -		Mortgage -		and other
(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		Agricultural		Residential		Commercial		Residential		Commercial		Consumer		Total
At March 31, 2018
At March 31, 2019
Watch	$	9,460	$	1,227	$	1,291	$	8,079	$	45,938	$	147	$	66,142	$	10,254	$	583	$	4,032	$	11,831	$	36,716	$	8	$	63,424
Substandard		641		462		0		2,532		725		13		4,373		173		—		—		1,391		696		3		2,263
Performing TDRs		481		0		0		3,068		1,062		0		4,611		629		—		—		2,048		373		42		3,092
Non-accrual		2,258		59		0		2,089		916		160		5,482		1,747		—		151		2,803		508		222		5,431
Total	$	12,840	$	1,748	$	1,291	$	15,768	$	48,641	$	320	$	80,608	$	12,803	$	583	$	4,183	$	18,073	$	38,293	$	275	$	74,210
At December 31, 2017
At December 31, 2018
Watch	$	9,868	$	1,459	$	1,284	$	9,978	$	49,197	$	0	$	71,786	$	8,871	$	588	$	4,063	$	12,790	$	36,408	$	8	$	62,728
Substandard		658		462		0		2,262		723		16		4,121		53		—		—		1,411		702		3		2,169
Performing TDRs		500		0		0		3,116		1,068		0		4,684		570		—		—		2,073		377		44		3,064
Non-accrual		2,507		0		97		1,956		936		176		5,672		1,857		—		153		2,720		474		210		5,414
Total	$	13,533	$	1,921	$	1,381	$	17,312	$	51,924	$	192	$	86,263	$	11,351	$	588	$	4,216	$	18,994	$	37,961	$	265	$	73,375

Troubled Debt Restructurings

At March 31, ~~2018,~~2019, loans classified as TDRs totaled ~~$6.3~~$5.0 million, of which ~~$1.7~~$1.9 million were classified as ~~nonperforming~~non-performing TDRs and included in non-accrual loans and ~~$4.6~~$3.1 million were classified as performing TDRs. At December 31, ~~2017,~~2018, loans classified as TDRs totaled ~~$6.4~~$5.0 million, of which ~~$1.7~~$2.0 million were classified as ~~nonperforming~~non-performing TDRs and included in non-accrual loans and ~~$4.7~~$3.0 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~~$512,000 and ~~$577,000~~$543,000 related to TDRs were allocated to the allowance for loan losses at March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, respectively.

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


													Three Months Ended March 31,
	Three Months Ended March 31,												2019					2018
	2018						2017						Recorded Investment (1)					Recorded Investment (1)
	Recorded Investment (1)						Recorded Investment (1)						Number of	Pre-		Post-		Number of	Pre-		Post-
(in thousands)	Number of Contracts		Pre- Modification		Post- Modification		Number of Contracts		Pre- Modification		Post- Modification		Contracts	Modification		Modification		Contracts	Modification		Modification
Troubled Debt Restructurings
Commercial, financial and agricultural		0	$	0	$	0		1	$	131	$	131	2	$	80	$	80	—	$	—	$	—
Real estate mortgage - commercial		0		0		0		1		56		56
Total		0	$	0	$	0		2	$	187	$	187	2	$	80	$	80	—	$	—	$	—

(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.

~~(1) The amounts reported post-modification are inclusive of all partial pay-downs and charge-offs, and no portion of~~HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to 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.~~Consolidated Financial Statements

(Unaudited)

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~~There were two loans meeting the TDR criteria that were modified during the three months ended March 31, ~~2018, no loans meeting the TDR criteria was modified~~2019, compared to ~~two~~no loans during the three months ended March 31, ~~2017.~~2018.

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 months ended March 31, ~~2018~~2019 and ~~2017,~~2018, respectively, and within twelve months of their modification date. During 2018, one real estate mortgage loan went to foreclosure totaling $48,000. SeeLending and Credit Managementsection for further information.

(3) Other Real Estate Acquired in Settlement of Loans


	March 31,		December 31,
(in thousands)	2019		2018
Commercial	$	1,168	$	1,168
Real estate construction - residential		—		179
Real estate construction - commercial		11,999		12,101
Real estate mortgage - residential		453		336
Real estate mortgage - commercial		2,909		2,909
Total	$	16,529	$	16,693
Less valuation allowance for other real estate owned		(2,992)		(3,002)
Total other real estate owned	$	13,537	$	13,691

~~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~~owned were as follows for the periods indicated:


	Three Months Ended March 31,						Three Months Ended March 31,
	2018			2017			2019		2018
Balance at beginning of period	$	16,403		$	17,291		$	16,693	$	16,403
Additions		278			103			116		278
Proceeds from sales		(224	)		(658	)		(248)		(224)
Charge-offs against the valuation allowance for other real estate owned, net		(195	)		(117	)		(38)		(195)
Net gain on sales		2			50			6		2
Total other real estate and repossessed assets	$	16,264		$	16,669
Total other real estate owned							$	16,529	$	16,264
Less valuation allowance for other real estate owned		(3,025	)		(3,044	)		(2,992)		(3,025)
Balance at end of period	$	13,239		$	13,625		$	13,537	$	13,239

At March 31, ~~2018, $27,000~~2019, $263,000 of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to no$200,000 of consumer mortgage loans at December 31, ~~2017.~~2018.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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

Three Months Ended March 31,
(in thousands) 2018 2017
Balance, beginning of period $ 3,221 $ 3,129
Provision for other real estate owned (1 ) 32
Charge-offs (195 ) (117 )
Balance, end of period $ 3,025 $ 3,044


	Three Months Ended March 31,
(in thousands)	2019		2018
Balance, beginning of period	$	3,002	$	3,221
Provision for other real estate owned		28		(1)
Charge-offs		(38)		(195)
Balance, end of period	$	2,992	$	3,025

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

(4) Investment Securities

~~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, ~~2018~~2019 and December 31, ~~2017~~2018 were as follows:


	Total
	Amortized		Gross Unrealized				Fair
(in thousands)	Cost		Gains		Losses		Value
March 31, 2019
U.S. Treasury	$	2,666	$	—	$	(11)	$	2,655
U.S. government and federal agency obligations		9,745		—		(230)		9,515
Government sponsored enterprises		39,790		43		(279)		39,554
Obligations of states and political subdivisions		38,408		67		(239)		38,236
Mortgage-backed securities		126,072		125		(1,954)		124,243
Other debt securities (a)		3,000		—		(1)		2,999
Bank issued trust preferred securities (a)		1,486		—		(149)		1,337
Total available-for-sale securities	$	221,167	$	235	$	(2,863)	$	218,539

December 31, 2018
U.S. Treasury	$	1,984	$	—	$	(32)	$	1,952
U.S. government and federal agency obligations		10,235		—		(269)		9,966
Government sponsored enterprises		43,784		23		(472)		43,335
Obligations of states and political subdivisions		40,859		28		(501)		40,386
Mortgage-backed securities		121,230		72		(3,110)		118,192
Other debt securities (a)		3,000		—		—		3,000
Bank issued trust preferred securities (a)		1,486		—		(112)		1,374
Total available-for-sale securities	$	222,578	$	123	$	(4,496)	$	218,205

(a) Certain hybrid instruments possessing characteristics typically associated with debt obligations.

Total
Amortized Gross Unrealized Fair
(in thousands) Cost Gains Losses Value
March 31, 2018
U.S. Treasury $ 1,981 $ 0 $ (42 ) $ 1,939
U.S. government and federal agency obligations 11,798 (305 ) 11,493
Government sponsored enterprises 38,819 0 (642 ) 38,177
Obligations of states and political subdivisions 42,271 42 (709 ) 41,604
Mortgage-backed securities:
Residential - government agencies 126,186 11 (3,690 ) 122,507
Total available-for-sale securities $ 221,055 $ 53 $ (5,388 ) $ 215,720

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

~~All of the~~The Company’s investment securities are classified as available for sale. Agency bonds and notes, ~~small business administration~~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.

HAWTHORN BANCSHARES, INC.

~~Other Investments and securities primarily consist of Federal Home Loan Bank stock, subordinated debt equity securities, and~~AND SUBSIDIARIES

Notes to 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.~~Consolidated Financial Statements

(Unaudited)

Debt securities with carrying values aggregating approximately ~~$194.3~~$176.0 million and ~~$181.7~~$153.0 million at March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, 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, ~~2018,~~2019, 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.


	Amortized		Fair
(in thousands)	Cost		Value
Due in one year or less	$	21,449	$	21,361
Due after one year through five years		53,793		53,389
Due after five years through ten years		11,409		11,285
Due after ten years		8,444		8,261
Total		95,095		94,296
Mortgage-backed securities		126,072		124,243
Total available-for-sale securities	$	221,167	$	218,539

~~Hawthorn Bancshares, Inc.~~
Other securities

Other investment securities include equity securities with readily determinable fair values and ~~subsidiaries~~other investment securities that do not have readily determinable fair values. Investments in Federal Home Loan Bank (FHLB) stock, and Midwest Independent Bank (MIB) bankers bank stock, that do not have readily determinable fair values, are required for membership in those organizations.


(in thousands)	March 31, 2019		December 31, 2018
Other securities:
FHLB stock	$	5,571	$	5,512
MIB stock		151		151
Equity securities with readily determinable fair values		13		12
Total other investment securities	$	5,735	$	5,675

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

Amortized Fair
(in thousands) Cost Value
Due in one year or less $ 9,928 $ 9,883
Due after one year through five years 60,479 59,974
Due after five years through ten years 21,390 20,344
Due after ten years 3,072 3,012
Total 94,869 93,213
Mortgage-backed securities 126,186 122,507
Total available-for-sale securities $ 221,055 $ 215,720

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, ~~2018~~2019 and December 31, ~~2017~~2018 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 March 31, 2019
U.S. Treasury	$	1,939	$	(42	)	$	0	$	0		$	1,939	$	(42	)	$	—	$	—	$	1,974	$	(11)	$	1,974	$	(11)
U.S. government and federal agency obligations		0		0			11,493		(305	)		11,493		(305	)		—		—		9,515		(230)		9,515		(230)
Government sponsored enterprises		14,881		(218	)		23,295		(424	)		38,176		(642	)		500		—		32,036		(279)		32,536		(279)
Obligations of states and political subdivisions		22,906		(260	)		12,379		(449	)		35,285		(709	)		4,042		(14)		21,790		(225)		25,832		(239)
Mortgage-backed securities:
Residential - government agencies		53,183		(1,114	)		66,854		(2,576	)		120,037		(3,690	)
Mortgage-backed securities																	11,589		(72)		93,328		(1,882)		104,917		(1,954)
Other debt securities																	2,999		(1)		—		—		2,999		(1)
Bank issued trust preferred securities																	—		—		1,337		(149)		1,337		(149)
Total	$	92,909	$	(1,634	)	$	114,021	$	(3,754	)	$	206,930	$	(5,388	)	$	19,130	$	(87)	$	159,980	$	(2,776)	$	179,110	$	(2,863)

(in thousands)
At December 31, 2017
At December 31, 2018
U.S. Treasury	$	1,967	$	(13	)	$	0	$	0		$	1,967	$	(13	)	$	—	$	—	$	1,952	$	(32)	$	1,952	$	(32)
U.S. government and federal agency obligations		0		0			12,073		(268	)		12,073		(268	)		—		—		9,966		(269)		9,966		(269)
Government sponsored enterprises		16,471		(119	)		20,426		(305	)		36,897		(424	)		1,997		(3)		33,346		(469)		35,343		(472)
Obligations of states and political subdivisions		22,013		(165	)		12,570		(312	)		34,583		(477	)		5,851		(16)		28,832		(485)		34,683		(501)
Mortgage-backed securities:
Residential - government agencies		52,829		(488	)		69,580		(1,652	)		122,409		(2,140	)
Mortgage-backed securities																	10,085		(61)		99,321		(3,049)		109,406		(3,110)
Bank issued trust preferred securities																	—		—		1,374		(112)		1,374		(112)
Total	$	93,280	$	(785	)	$	114,649	$	(2,537	)	$	207,929	$	(3,322	)	$	17,933	$	(80)	$	174,791	$	(4,416)	$	192,724	$	(4,496)

The total available for sale portfolio consisted of approximately ~~341~~353 securities at March 31, ~~2018.~~2019. The portfolio included ~~298~~258 securities having an aggregate fair value of ~~$206.9~~$179.1 million that were in a loss position at March 31, ~~2018.~~2019. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled ~~$114.0~~$160.0 million at fair value. The ~~$5.4~~$2.9 million aggregate unrealized loss included in accumulated other comprehensive income at March 31, ~~2018~~2019 was caused by interest rate ~~fluctuations~~.

fluctuations.

The total available for sale portfolio consisted of approximately ~~355~~366 securities at December 31, ~~2017.~~2018. The portfolio included ~~280~~317 securities having an aggregate fair value of ~~$207.9~~$192.7 million that were in a loss position at December 31, ~~2017.~~2018. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer had a fair value of ~~$114.6~~$174.8 million at December 31, ~~2017.~~2018. The ~~$3.3~~$4.5 million aggregate unrealized loss included in accumulated other comprehensive loss at December 31, ~~2017~~2018 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, ~~2018~~2019 and December 31, ~~2017,~~2018, 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.

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

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

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

Three Months Ended March 31,
(in thousands) 2018 2017
Gains realized on sales $ 98 $ 0
Losses realized on sales 0 0
Other-than-temporary impairment recognized 0 0
Investment securities gains $ 98 $ 0

~~(5)~~

~~Intangible Assets~~

~~Mortgage Servicing Rights~~


	Three Months Ended March 31,
(in thousands)	2019		2018
Investment securities gains, net
Available for sale securities:
Gains realized on sales	$	—	$	98
Losses realized on sales		—		—
Other-than-temporary impairment recognized		—		—
Other investment securities:
Fair value adjustments, net		1		—
Investment securities gains, net	$	1	$	98

AtDuring the three months ended March 31, 2018, the Company received $25.7 million from proceeds from a series of short-term sales of U.S. Treasury securities purchased with repurchase agreements and recognized gains of $98,000 in order to generate capital gains to offset capital losses that were to expire during 2018 and 2019. There were no security sales during the three months ended March 31, 2019.

(5) Intangible Assets

Mortgage Servicing Rights

At March 31, 2019, the Company was servicing approximately ~~$283.1~~$275.7 million of loans sold to the secondary market compared to ~~$285.8~~$279.9 million at December 31, ~~2017,~~2018, and ~~$291.0~~$283.1 million at March 31, ~~2017.~~2018. Mortgage loan servicing fees, reported ~~as non-interest income,~~in real estate servicing fees, net, earned on loans sold were ~~$203,000 for the three ended March 31, 2018 compared to $209,000~~$178,000 for the three months ended March 31, ~~2017, respectively.~~

2019, compared to $203,000 for the three months ended March 31, 2018.

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


	Three Months Ended March 31,
(in thousands)	2019		2018
Balance at beginning of period	$	2,931	$	2,713
Originated mortgage servicing rights		38		50
Changes in fair value:
Due to changes in model inputs and assumptions (1)		(32)		103
Other changes in fair value (2)		(62)		(85)
Total changes in fair value		(94)		18
Balance at end of period	$	2,875	$	2,781

(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.

Three Months Ended March 31,
(in thousands) 2018 2017
Balance at beginning of period $ 2,713 $ 2,584
Originated mortgage servicing rights 50 49
Changes in fair value:
Due to change in model inputs and assumptions (1) 103 375
Other changes in fair value (2) (85 ) (131 )
Balance at end of period $ 2,781 $ 2,877

HAWTHORN BANCSHARES, INC.

~~(1)~~

The change in fair value resulting from changes in valuation inputs or assumptions 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 reflect changes due to customer payments and passage of time.~~

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, 2019 and 2018, ~~and 2017:~~

Three Months Ended March 31,
2018 2017
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

~~(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

respectively:


	Three Months Ended March 31,
		2019		2018
Weighted average constant prepayment rate		9.47	%	9.07	%
Weighted average note rate		3.96	%	3.87	%
Weighted average discount rate		9.77	%	10.39	%
Weighted average expected life (in years)		6.00		6.20

~~Hawthorn Bancshares, Inc.~~

(6) Federal funds purchased and ~~subsidiaries~~securities sold under agreements to repurchase


	March 31,		December 31,
(in thousands)	2019		2018
Federal funds purchased	$	—	$	8,000
Repurchase agreements		22,097		16,647
Total	$	22,097	$	24,647

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

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
	Overnight		Less		Greater
	and		than		than
(in thousands)	continuous		90 days		90 days		Total
At March 31, 2019
U.S. Treasury	$	738	$	—	$	—	$	738
U.S. government and federal agency obligations		2,378		—		—		2,378
Government sponsored enterprises		9,975		—		—		9,975
Asset-backed securities		9,006		—		—		9,006
Total	$	22,097	$	—	$	—	$	22,097

At December 31, 2018
U.S. Treasury	$	1,464	$	—	$	—	$	1,464
Government sponsored enterprises		12,976		—		—		12,976
Asset-backed securities		2,207		—		—		2,207
Total	$	16,647	$	—	$	—	$	16,647

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

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

~~(7)~~

~~Income Taxes~~

(7) Leases

The Company's leases primarily consist of office space and bank branches with remaining lease terms of generally 1 to 10 years. As of March 31, 2019, operating ROU assets and liabilities were $2.3 million and $2.3 million, respectively. As of

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

March 31, 2019, the weighted-average remaining lease term on these operating leases is approximately 9.29 years and the weighted-average discount rate used to measure the lease liabilities is approximately 4.0%.

Operating leases in which the Company is the lessee are recorded as operating lease right-of-use assets and operating lease liabilities. Currently, the Company does not have any finance leases. The ROU assets are included in premises and equipment, net on the consolidated balance sheets.

Operating lease right-of-use assets represent the Company's right to use an underlying asset during the lease term and operating lease liabilities represent the Company's obligation to make lease payments arising from the lease. Right-of-use assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents the Company's incremental borrowing rate at the lease commencement date.

Operating lease cost, which is comprised of amortization of the right-of-use asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in net occupancy expense in the consolidated statements of income. The operating lease cost for the three months ended March 31, 2019 was $32,000.

At adoption of ASU 2016-02 on January 1, 2019, lease and non-lease components of new lease agreements are accounted for separately. Lease components include fixed payments including rent, real estate taxes and insurance costs and non-lease components include common-area maintenance costs. Leases with an initial term of 12 months or less are not recorded on the balance sheet; the Company recognizes lease expense for these leases on a straight-line basis over the lease term. Operating lease expense for these leases was $33,000 and $48,000 for the three months ended March 31, 2019 and 2018, respectively.

The table below summarizes the maturity of remaining operating lease liabilities:


	Operating
Lease payments due in:	Lease
(in thousands)
2019 (excluding the 1st quarter ending March 31, 2019)	$	227
2020		305
2021		308
2022		310
2023		312
Thereafter		1,345
Total lease payments		2,807
Less imputed interest		(460)
Total lease liabilities, as reported	$	2,347

As of March 31, the Company has $58,000 in additional operating leases for office space that have not yet commenced that are anticipated to commence during the second quarter of 2019.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(8) Income Taxes

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were ~~16.43%~~18.9% for the three months ended March, ~~31, 2018~~2019 compared to ~~34.2%~~16.4% for the three months ~~ended~~ March 31, ~~2017.~~ 2018. The change in the effective tax rate in the first quarter of 2019 over the first quarter of 2018 is primarily due to an increase in taxable income, which included a $2.1 million pre-taxable gain from the sale of the Branson branch.

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~~Company's tax rate is lower than the federal statutory rate ~~primarily as a result of tax-exempt income. The decrease in tax rate quarter over quarter is~~for the quarters ending March 31, 2019 and 2018, respectively, primarily due ~~a decrease in the federal corporate tax rate~~to tax-exempt income 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~~were finalized asduring the third quarter of ~~March 31, 2018. The Company expects to finalize those adjustments~~2018 with the filing of the Company's 2017 tax return, within the one-year measurement period provided under Staff Accounting Bulletin No. 118 in regards to the application of ~~FASB’s~~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 management’s~~In management's opinion, ~~that~~ the Company will more likely than not realize the benefits of ~~these temporary differences~~its deferred tax assets and, therefore, has not established a valuation allowance against its deferred tax assets as of March 31, ~~2018 and, therefore, only established a valuation reserve against the Company’s capital loss carry forward.~~2019. 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,~~of March 31, 2018, the Company ~~generated~~had a $46,000 valuation reserve against its capital loss carry forward deferred tax asset related to approximately $219,000 of capital losses during 2013 and 2014 as a result of disposing of certain limited partnership interests. The Company released this valuation allowance against certain capital ~~losses will expire between~~loss carryforwards during the second quarter of 2018 ~~and 2019, and it is management’s opinion~~as a result of the execution of certain 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 months ended March 31, 2019 and 2018, ~~and 2017,~~respectively, the Company did not have any uncertain tax ~~provisions.~~provisions, and did not record any related tax liabilities.

~~(8)~~

~~Stockholders’ Equity~~

~~Accumulated Other Comprehensive Loss~~

HAWTHORN BANCSHARES, INC.

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

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~(9) 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 months ended March 31, ~~2018~~2019 and ~~2017:~~2018:


	Three Months Ended March 31, 2019
					Accumulated
			Unrecognized Net		Other
	Unrealized		Pension and		Comprehensive
	Gain (Loss)		Postretirement		(Loss)
(in thousands)	on Securities (1)		Costs (2)		Income
Balance at beginning of period	$	(3,455)	$	(2,644)	$	(6,099)
Other comprehensive income, before reclassifications		1,745		19		1,764
Amounts reclassified from accumulated other comprehensive (loss) income		—		—		—
Current period other comprehensive income, before tax		1,745		19		1,764
Income tax expense		(367)		(4)		(371)
Current period other comprehensive income, net of tax		1,378		15		1,393
Balance at end of period	$	(2,077)	$	(2,629)	$	(4,706)

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

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


	Three Months Ended March 31, 2018

			Unrecognized Net		Accumulated
	Unrealized		Pension and		Other
	Gain (Loss)		Postretirement		Comprehensive
(in thousands)	on Securities (1)		Costs (2)		Loss
Balance at beginning of period	$	(2,500)	$	(3,162)	$	(5,662)
Other comprehensive (loss) income, before reclassifications		(2,171)		54		(2,117)
Amounts reclassified from accumulated other comprehensive (loss) income		—		—		—
Current period other comprehensive (loss) income, before tax		(2,171)		54		(2,117)
Income tax benefit (expense)		456		(12)		444
Current period other comprehensive (loss) income, net of tax		(1,715)		42		(1,673)
Balance at end of period	$	(4,215)	$	(3,120)	$	(7,335)

(1)

The pre-tax amounts reclassified from accumulated other comprehensive loss are included in gain 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.

~~(1) The pre-tax amounts reclassified from accumulated other comprehensive loss are included in~~~~gain on sale of investment securities~~ in

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the ~~consolidated statements of income.~~Consolidated Financial Statements

(Unaudited)

~~(2) The pre-tax amounts reclassified from accumulated other comprehensive loss are included in the computation of net periodic pension cost.~~(10) Employee Benefit Plans

~~(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 March 31,
(in thousands)	2018		2017		2019		2018
Payroll taxes	$	351	$	356	$	346	$	351
Medical plans		548		426		450		548
401k match and profit sharing		186		250		276		186
Periodic pension cost		405		336		379		405
Other		15		16		15		15
Total employee benefits	$	1,505	$	1,384	$	1,466	$	1,505

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.

Other Plans

~~Hawthorn Bancshares, Inc.~~
On November 7, 2018, the Board of Directors of the Company adopted a supplemental executive retirement plan (SERP) which became effective on January 1, 2018. The SERP provides select employees who satisfy certain eligibility requirements with certain benefits upon retirement, termination of employment or death.

As of March 31, 2019, the accrued liability was $400,000 and ~~subsidiaries~~expense for the three months ended March 31, 2019 was $80,000, and is recognized over the required service period. After the plan was adopted in November 2018, $320,000 was accrued and recognized over the required service period.

Pension

~~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,~~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~~$1.6 million ~~in the second quarter of 2018. The 2018 minimum required contribution is $1.0 million.~~on April 17, 2019. 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~~

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to 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.Consolidated Financial Statements

(Unaudited)

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


	Pension Benefits
(in thousands)	2019		2018
Service cost - benefits earned during the year	$	1,516	$	1,707
Interest costs on projected benefit obligations (a)		1,168		1,037
Expected return on plan assets (a)		(1,393)		(1,327)
Expected administrative expenses (a)		100		93
Amortization of prior service cost (a)		79		79
Amortization of unrecognized net loss (a)		—		140
Net periodic pension cost	$	1,470	$	1,729

Net periodic pension cost for the three months ended March 31, (actual)	$	379	$	405

(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 has one equity compensation plan for its employees pursuant to which options were granted.~~

Net periodic pension benefit costs include interest costs based on an assumed discount rate, the expected return on plan assets based on actuarially derived market-related values, and the amortization of net actuarial losses. Net periodic postretirement benefit costs include service costs, interest costs based on an assumed discount rate, and the amortization of prior service credits and net actuarial gains. Differences between expected and actual results in each year are included in the net actuarial gain or loss amount, which is recognized in other comprehensive income. The net actuarial gain or loss in excess of a 10% corridor is amortized in net periodic benefit cost over the average remaining service period of active participants in the Plans. The prior service credit is amortized over the average remaining service period to full eligibility for participating employees expected to receive benefits.

~~Hawthorn Bancshares, Inc.~~
~~and subsidiaries~~(11) Earnings per Share

~~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 months ended March 31, 2018 and 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.

~~(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.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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 March 31,
(dollars in thousands, except per share data)	2018		2017		2019		2018
Basic earnings per share:
Net income available to shareholders	$	2,090	$	2,100	$	4,666	$	2,090
Average shares outstanding						6,034,843		6,028,708
Basic earnings per share	$	0.36	$	0.36	$	0.77	$	0.35
Diluted earnings per share:
Net income available to shareholders	$	2,090	$	2,100	$	4,666	$	2,090
Average shares outstanding		5,797,134		5,839,850		6,034,843		6,028,708
Effect of dilutive stock options		5,720		4,916		—		5,949
Average shares outstanding including dilutive stock options		5,802,854		5,844,766		6,034,843		6,034,657
Diluted earnings per share	$	0.36		0.36	$	0.77		0.35

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 months ended March 31, 2019 and 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 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 8, 2017, the Board authorized the repurchase of an additional $1.5 million market value of the Company’s common stock. As of March 31, 2018, the Company had repurchased a total of 92,509 shares of common stock pursuant to the plan at an average price of $17.80 per share, including 5,468 shares of common stock repurchased pursuant to the plan during the three months ended March 31, 2018 at an average price of $20.51 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)~~

(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.

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~~During the three months ended March 31, ~~2018~~2019 and the year ended December 31, ~~2017,~~2018, respectively, there were no transfers into or out of Levels ~~1-3.~~

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.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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~~Liabilities 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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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


			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, 2019
Assets:
U.S. Treasury	$	2,655	$	2,655		—	$	—
U.S. government and federal agency obligations		9,515		—		9,515		—
Government sponsored enterprises		39,554		—		39,554		—
Obligations of states and political subdivisions		38,236		—		38,236		—
Mortgage-backed securities		124,243		—		124,243		—
Other debt securities		2,999		—		2,999		—
Bank-issued trust preferred securities		1,337		—		1,337		—
Equity securities		13		—		13		—
Mortgage servicing rights		2,875		—		—		2,875
Total	$	221,427	$	2,655	$	215,897	$	2,875

December 31, 2018
Assets:
U.S. Treasury	$	1,952	$	1,952		—	$	—
U.S. government and federal agency obligations		9,966		—		9,966		—
Government sponsored enterprises		43,335		—		43,335		—
Obligations of states and political subdivisions		40,386		—		40,386		—
Mortgage-backed securities		118,192		—		118,192		—
Other debt securities		3,000		—		3,000		—
Bank-issued trust preferred securities		1,374		—		1,374		—
Equity securities		12		—		12		—
Mortgage servicing rights		2,931		—		—		2,931
Total	$	221,148	$	1,952	$	216,265	$	2,931

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

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

Fair Value Measurements Using
Significant Unobservable Inputs
(Level 3)
Mortgage Servicing Rights
(in thousands) Three Months Ended March 31,
2018 2017
Balance at beginning of period $ 2,713 $ 2,584
Total gains or losses (realized/unrealized):
Included in earnings 18 244
Included in other comprehensive income 0 0
Purchases 0 0
Sales 0 0
Issues 50 49
Settlements 0 0
Balance at end of period $ 2,781 $ 2,877


	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)
	Mortgage Servicing Rights
	Three Months Ended March 31,
(in thousands)	2019		2018
Balance at beginning of period	$	2,931	$	2,713
Total (losses) or gains (realized/unrealized):
Included in earnings		(94)		18
Included in other comprehensive income		—		—
Purchases		—		—
Sales		—		—
Issues		38		50
Settlements		—		—
Balance at end of period	$	2,875	$	2,781

~~The change in valuation of mortgage servicing rights arising from inputs and assumptions increased $103,000 and $375,000 for the three months ended March 31, 2018 and 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, 2019, the Company identified $3.8 million in collateral dependent impaired loans that had specific allowances for losses aggregating $702,000. Related to these loans, there were no charge-offs recorded during the three months ended March 31, 2019. As of March 31, 2018, the Company identified $3.8 million in collateral dependent impaired loans that had specific allowances for losses aggregating ~~$952,000.~~$1.0 million. Related to these loans, there was $57,000 in charge-offs recorded during the three months ended March 31, 2018. As of March 31, 2017, the Company identified $2.5 million in collateral dependent impaired loans that had specific allowances for losses aggregating $677,000. Related to these loans, there was $20,000 in charge-offs recorded during the three months ended March 31, 2017.

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

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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
			in Active						Three 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, 2019
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural	$	1,263	$	—	$	—	$	1,263	$	—
Real estate construction - commercial		151		—		—		151		—
Real estate mortgage - residential		1,480		—		—		1,480		—
Real estate mortgage - commercial		233		—		—		233		—
Installment and other consumer		—		—		—		—		—
Total	$	3,127	$	—	$	—	$	3,127	$	—
Other real estate and repossessed assets	$	13,537	$	—	$	—	$	13,537	$	(106)

March 31, 2018
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural	$	1,369	$	—	$	—	$	1,369	$	—
Real estate construction - commercial		—		—		—		—		(27)
Real estate mortgage - residential		886		—		—		886		—
Real estate mortgage - commercial		595		—		—		595		(20)
Installment and other consumer		—		—		—		—		(10)
Total	$	2,850	$	—	$	—	$	2,850	$	(57)
Other real estate and repossessed assets	$	13,239	$	—	$	—	$	13,239	$	1

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

*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)~~

(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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

categories. The fair value of loans, or exit price, 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.

Other investment securities

Other investment securities include equity securities with readily determinable fair values and other investment securities that do not have readily determinable fair values. Investments in Federal Home Loan Bank (FHLB) ~~Stock~~stock, and Midwest Independent Bank (MIB) bankers bank stock, that do not have readily determinable fair values, are required for membership in those organizations.

~~Ownership of equity~~Equity securities ~~of FHLB is restricted~~with readily determinable fair values are recorded at fair value, with changes in fair value reflected in earnings. Equity securities that do not have readily determinable fair values are carried at cost and ~~there is no established market~~are periodically assessed for ~~their resale. The carrying amount is a reasonable estimate of fair value.~~

impairment.

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.

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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.~~
Federal funds purchased and ~~subsidiaries~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Securities Sold under Agreements to Repurchase

For Federal funds purchased and 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.

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

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

A summary of the carrying amounts and fair values of the Company’s financial instruments at March 31, ~~2018~~2019 and December 31, ~~2017~~2018 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


					March 31, 2019
					Fair Value Measurements
						Quoted Prices
					in Active				Net
					Markets for		Other		Significant
	March 31, 2019				Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	amount		value		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	15,679	$	15,679	$	15,679	$	—	$	—
Federal funds sold and overnight interest-bearing deposits		75,035		75,035		75,035		—		—
Certificates of deposit in other banks		12,741		12,741		12,741		—		—
Available for sale securities		218,539		218,539		2,655		215,884		—
Other investment securities		5,735		5,735		—		5,735		—
Loans, net		1,142,807		1,117,708		—		—		1,117,708
Mortgage servicing rights		2,875		2,875		—		—		2,875
Cash surrender value - life insurance		2,562		2,562		—		2,562		—
Accrued interest receivable		6,160		6,160		6,160		—		—
	$	1,482,133	$	1,457,034	$	112,270	$	224,181	$	1,120,583
Liabilities:
Deposits:
Non-interest bearing demand	$	264,218	$	264,218	$	264,218	$	—	$	—
Savings, interest checking and money market		625,522		625,522		625,522		—		—
Time deposits		360,832		359,231		—		—		359,231
Federal funds purchased and securities sold under agreements to repurchase		22,097		22,097		22,097		—		—
Federal Home Loan Bank advances and other borrowings		95,096		95,524		—		95,524		—
Subordinated notes		49,486		44,512		—		44,512		—
Accrued interest payable		1,093		1,093		1,093		—		—
	$	1,418,344	$	1,412,197	$	912,930	$	140,036	$	359,231

HAWTHORN BANCSHARES, INC.

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

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~(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, 2018
					Fair Value Measurements
					Quoted Prices
					in Active				Net
					Markets for		Other		Significant
	December 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	$	23,687	$	23,687	$	23,687	$	—	$	—
Federal funds sold and overnight interest-bearing deposits		18,396		18,396		18,396		—		—
Certificates of deposit in other banks		12,247		12,247		12,247		—		—
Available-for-sale securities		218,205		218,205		1,952		216,253		—
Other investment securities		5,675		5,675		—		5,675		—
Loans, net		1,134,975		1,115,003		—		—		1,115,003
Mortgage servicing rights		2,931		2,931		—		—		2,931
Cash surrender value - life insurance		2,542		2,542		—		2,542		—
Accrued interest receivable		6,162		6,162		6,162		—		—
	$	1,424,820	$	1,404,848	$	62,444	$	224,470	$	1,117,934
Liabilities:
Deposits:
Non-interest bearing demand	$	262,857	$	262,857	$	262,857	$	—	$	—
Savings, interest checking and money market		614,040		614,040		614,040		—		—
Time deposits		321,571		318,949		—		—		318,949
Federal funds purchased and securities sold under agreements to repurchase		24,647		24,647		24,647		—		—
Federal Home Loan Bank advances and other borrowings		95,153		94,326		—		94,326		—
Subordinated notes		49,486		45,749		—		45,749		—
Accrued interest payable		1,035		1,035		1,035		—		—
	$	1,368,789	$	1,361,603	$	902,579	$	140,075	$	318,949

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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)~~

(14) 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, ~~2018,~~2019, no amounts have been accrued for any estimated losses for these financial instruments.

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


	March 31,		December 31,
(in thousands)	2019		2018
Commitments to extend credit	$	254,735	$	267,314
Commitments to originate residential first and second mortgage loans		4,356		1,759
Standby letters of credit		112,236		82,895
Total		371,327		351,968

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

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, ~~2018.~~2019.

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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.

(15) Revenue Recognition

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

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

~~(16)~~

~~Revenue Recognition~~

On January 1, 2018, the Company adopted ASU No. ~~2014-09,~~2014‑09, Revenue from Contracts with Customers (Topic 606)and all subsequent ASUs that modified Topic 606. ~~As stated in Note 1~~~~Summary 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.~~presented in our income statement as components of noninterest income are as follows:

~~Trust Department Revenue~~

Service charges on deposit accounts - represents fees generated from a variety of deposit products and services provided to customers under a day-to-day contract. These fees are recognized on a daily or monthly basis.

Bank card income and fees – represents fees, exchange, and other service charge revenue earned from merchant, debit and credit cards that are recognized when the services are rendered or upon completion. These fees are recognized on a daily or monthly basis.

Gain on sale of other real estate - represents income recognized at the time of control of a property is transferred to the buyer.

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 of account analysis fees (i.e., net fees earned on analyzed business 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 related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

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

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM 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 are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.

~~Gains/Losses 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 at the time of an executed deed. When the Company finances the sale of OREO 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~~10‑K for the year ended December 31, ~~2017,~~2018, 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, ~~2018,~~2019, 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~~Company’s primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the ~~Company's~~Company’s business is commercial, commercial real estate development, and residential mortgage lending. The ~~Company's~~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~~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~~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~~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~~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 months ended March 31, ~~2018~~2019 and ~~2017,~~2018, 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
	March 31,
(In thousands, except per share data)		2019			2018
Per Share Data
Basic earnings per share	$	0.77		$	0.35
Diluted earnings per share		0.77			0.35
Cash dividends paid on common stock		603			406
Book value per share		17.38			15.14
Market price per share		23.24			19.84
Selected Ratios
(Based on average balance sheets)
Return on total assets		1.23	%		0.60	%
Return on stockholders' equity		18.41	%		9.32	%
Stockholders' equity to total assets		6.68	%		6.41	%
Efficiency ratio (1)		72.07	%		79.16	%
Net interest spread (Ytd)		2.95	%		3.09	%
Net interest margin (Ytd)		3.26	%		3.30	%

(Based on end-of-period data)
Stockholders' equity to assets		6.82	%		6.28	%
Total risk-based capital ratio		13.39	%		12.87	%
Tier 1 risk-based capital ratio		11.41	%		10.61	%
Common equity Tier 1 capital		8.65	%		8.04	%
Tier 1 leverage ratio (2)		9.38	%		9.17	%

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

Use of Non-GAAP Measures

Selected Financial Data
Three Months Ended
March 31,
(In thousands, except per share data) 2018 2017
Per Share Data
Basic earnings per share $ 0.36 $ 0.36
Diluted earnings per share 0.36 0.36
Dividends paid on common stock 406 336
Book value per share 15.74 15.94
Market price per share 20.64 20.29
Selected Ratios
(Based on average balance sheets)
Return on total assets 0.60 % 0.65 %
Return on stockholders' equity 9.32 % 9.23 %
Stockholders' equity to total assets 6.41 % 7.01 %
Efficiency ratio (1) 78.54 % 72.52 %

(Based on end-of-period data)
Stockholders' equity to assets 6.28 % 7.05 %
Total risk-based capital ratio 12.87 % 13.60 %
Tier 1 risk-based capital ratio 10.61 % 11.25 %
Common equity Tier 1 capital 8.04 % 8.47 %
Tier 1 leverage ratio (2) 9.17 % 9.74 %

Several financial measures in this report are non-GAAP, meaning they are not presented in accordance with generally accepted accounting principles (GAAP) in the U.S. The non-GAAP items presented in this report are non-GAAP net income, non-GAAP basic earnings per share, non-GAAP diluted earnings per share, non-GAAP return on average assets and non-GAAP return on average common equity. These measures include the adjustment to exclude the impact of the gain on the sale of our Branson branch that closed during the current quarter, which is non-recurring and not considered indicative of underlying earnings performance. The Company believes that the exclusion of this item provides a useful basis for evaluating the Company's underlying performance, but should not be considered in isolation and is not in accordance with, or a substitute for, evaluating performance utilizing GAAP financial information. The Company uses non-GAAP measures to analyze its financial performance and to make financial comparisons to prior periods presented on a similar basis. The Company believes that providing such adjusted results allows investors to better understand the Company's comparative operating performance for the periods presented. Non-GAAP measures are not formally defined by GAAP or codified in the federal banking regulations, and other entities may use calculation methods that differ from those used by the Company. The Company has reconciled each of these measures to a comparable GAAP measure below:

~~(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.~~


Income Statement Data
	Three Months Ended
	March 31,
(In thousands, except per share data)	2019			2018
Net income - GAAP	$	4,666		$	2,090
Effect of net gain on branch sale (a)		(1,638)			—
Net income - non-GAAP	$	3,028		$	2,090

Per Share Data
Basic earnings per share - GAAP	$	0.77		$	0.35
Effect of net gain on branch sale (a)		(0.27)			—
Basic earnings per share - non-GAAP	$	0.50		$	0.35
Diluted earnings per share - GAAP	$	0.77		$	0.35
Effect of net gain on branch sale (a)		(0.27)			—
Diluted earnings per share - non-GAAP	$	0.50		$	0.35

Key Ratios
Return on average total assets - GAAP		1.23	%		0.60	%
Effect of net gain on branch sale (a)		(0.43)	%		—	%
Return on average total assets - non-GAAP		0.80	%		0.60	%
Return on average stockholders' equity - GAAP		18.41	%		9.32	%
Effect of net gain on branch sale (a)		(6.46)	%		—	%
Return on average stockholders' equity - non-GAAP		11.95	%		9.32	%

(a) The pre-tax gain on the sale of the Branson Branch was $2.1 million and $1.6 million after tax.

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,
(In thousands)	2019		2018		$ Change		% Change
Net interest income	$	11,629	$	10,754	$	875		8.1	%
Provision for loan losses		150		300		(150)		(50.0)
Noninterest income		2,091		2,215		(124)		(5.6)
Investment securities gains, net		1		98		(97)		(99.0)
Gain on branch sale, net		2,074		—		2,074		NM
Noninterest expense		9,888		10,266		(378)		(3.7)
Income before income taxes		5,757		2,501		3,256		130.2
Income tax expense		1,091		411		680		165.5
Net income	$	4,666	$	2,090	$	2,576		123.3	%

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

Net interest income $ 10,754 $ 10,487 $ 267 2.5 %
Provision for loan losses 300 350 (50 ) (14.3 )
Noninterest income 2,301 2,407 (106 ) (4.4 )
Noninterest expense 10,254 9,351 903 9.7
Income before
income taxes 2,501 3,193 (692 ) (21.7 )
Income tax expense 411 1,093 (682 ) (62.4 )
Net income $ 2,090 $ 2,100 $ (10 ) (0.5 )%

Consolidated net income of ~~$2.1~~$4.7 million, or ~~$0.36~~$0.77 per diluted share, ~~was consistent~~ for ~~both~~ the three months ended March 31, ~~2018 and 2017.~~2019 increased $2.6 million compared to $2.1 million, or $0.35 per diluted share, for the three months ended March 31, 2018. For the three months ended March 31, ~~2018,~~2019, the return on average assets was ~~0.60%~~1.23%, the return on average stockholders’ equity was ~~9.32%~~18.41%, and the efficiency ratio was ~~78.54%~~72.07%.

Net interest income was $11.6 million for the three months ended March 31, 2019, compared to $10.8 million for the three months ended March 31, ~~2018 compared to $10.5 million for the three months ended March 31, 2017.~~2018. The net interest margin (expressed on a fully taxable equivalent basis) decreased to ~~3.29%~~3.26% for the three months ended March 31, ~~2018,~~2019 compared to ~~3.48%~~3.30% for the three months ended March 31, ~~2017.~~2018. These changes are discussed in greater detail under theAverage Balance Sheets and Rate and Volume Analysis section below.

A ~~$300,000~~$150,000 provision for loan losseswas recorded for the three months ended March 31, ~~2018~~2019 compared to a ~~$350,000~~$300,000 provision for the three months ended March 31, ~~2017.~~

2018.

The Company’s net ~~charge-offs~~loan recoveries were ~~$205,000,~~($43,000), or ~~0.02%~~(0.00%), of average loans for the three months ended March 31, ~~2018~~2019 compared to net ~~recoveries~~charge-offs of ~~$26,000,~~$205,000, or ~~0.00%~~0.02%, of average loans, of average loans for the three months ended March 31, ~~2017.~~ 2018.

Non-performing loans totaled ~~$10.1~~$5.6 million, or ~~0.93%~~0.48% of total loans, at March 31, ~~2018~~2019 compared to ~~$10.7~~$5.6 million, or ~~1.00%~~0.49% of total loans, at December 31, ~~2017,~~2018, and ~~$9.4~~$5.5 million, or ~~0.93%~~0.51% of total loans, at March 31, ~~2017.~~2018. These changes are discussed in greater detail under theLending and Credit Management section below.

Non-interest income decreased ~~$106,000,~~$124,000, or ~~4.4%~~5.6%, for the three months ended March 31, ~~2018~~2019 compared to the three months ended March 31, ~~2017.~~2018. These changes are discussed in greater detail ~~below~~ under the Non-interest ~~Income.~~Income and Expense section below.

Investment securities gains, net of $1,000 were recorded for the three months ended March 31, 2019 compared to $98,000 for the three months ended March 31, 2018. Securities gains for the three months ended March 31, 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.

Gain on branch sale, netOn February 8, 2019, Hawthorn Bank, a wholly-owned subsidiary of Hawthorn Bancshares, Inc., completed the sale of its branch located in Branson, Missouri to Branson Bank, Branson, Missouri. The Company sold the land and building for $3.5 million with a net book value of $1.7 million and transferred approximately $10.6 million in deposits, subject to future adjustments required in the definitive agreement for a deposit premium of 4.1%, or $0.3 million, excluding future contingent adjustments. The sale resulted in a pre-tax gain of approximately $2.1 million, or $1.6 million after tax.

Non-interest expense ~~increased $903,000,~~ decreased $378,000, or ~~9.7%~~3.7%, for the three months ended March 31, ~~2018~~2019 compared to the three months ended March 31, ~~2017.~~2018. These changes are discussed in greater detail ~~below~~ under the Non-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, 2019 and 2018, respectively.


	Three Months Ended March 31,
	2019						2018
			Interest		Rate				Interest		Rate
	Average		Income/		Earned/		Average		Income/		Earned/
(In thousands)
ASSETS
Loans: (2) (4)
Commercial	$	205,728	$	2,742	5.41	%	$	190,698	$	2,289	4.87	%
Real estate construction - residential		28,454		420	5.99			28,470		342	4.87
Real estate construction - commercial		109,769		1,403	5.18			101,856		1,172	4.67
Real estate mortgage - residential		244,343		3,047	5.06			247,579		2,859	4.68
Real estate mortgage - commercial		526,069		6,240	4.81			471,927		5,360	4.61
Installment and other consumer		32,238		336	4.23			32,342		293	3.67
Total loans	$	1,146,601	$	14,188	5.02	%	$	1,072,872	$	12,315	4.66	%
Investment securities: (3)
U.S. Treasury	$	2,491	$	13	2.12	%	$	17,502	$	60	1.39	%
U.S. government and federal agency obligations		51,963		239	1.87			49,399		190	1.56
Obligations of states and political subdivisions		38,937		222	2.31			44,807		270	2.44
Mortgage-backed securities		116,330		667	2.33			125,453		680	2.20
Other debt securities		4,409		64	5.89			4,486		60	5.42
Total investment securities	$	214,130	$	1,205	2.28	%	$	241,647	$	1,260	2.11	%
Other investment securities		5,677		66	4.71			5,424		50	3.74
Federal funds sold and interest bearing deposits in other financial institutions		99,013		602	2.47			24,573		106	1.75
Total interest earning assets	$	1,465,421	$	16,061	4.44	%	$	1,344,516	$	13,731	4.14	%
All other assets		84,740						85,116
Allowance for loan losses		(11,786)						(10,916)
Total assets	$	1,538,375					$	1,418,716
LIABILITIES AND STOCKHOLDERS' EQUITY
NOW accounts	$	238,076	$	781	1.33	%	$	243,245	$	533	0.89	%
Savings		92,426		17	0.07			94,356		12	0.05
Interest checking		10,556		49	1.88			1,604		4	1.01
Money market		295,335		869	1.19			265,994		535	0.82
Time deposits		362,660		1,371	1.53			289,970		649	0.91
Total interest bearing deposits	$	999,053	$	3,087	1.25	%	$	895,169	$	1,733	0.79	%
Federal funds purchased and securities sold under agreements to repurchase		20,836		33	0.64			43,060		171	1.61
Federal Home Loan Bank advances and other borrowings		95,133		542	2.31			93,041		395	1.72
Subordinated notes		49,486		624	5.11			49,486		491	4.02
Total borrowings	$	165,455	$	1,199	2.94	%	$	185,587	$	1,057	2.31	%
Total interest bearing liabilities	$	1,164,508	$	4,286	1.49	%	$	1,080,756	$	2,790	1.05	%
Demand deposits		256,014						234,129
Other liabilities		15,049						12,892
Total liabilities		1,435,571						1,327,777
Stockholders' equity		102,804						90,939
Total liabilities and stockholders' equity	$	1,538,375					$	1,418,716
Net interest income (FTE)			$	11,775					$	10,941
Net interest spread					2.95	%					3.09	%
Net interest margin					3.26	%					3.30	%

(1)Interest income and ~~2017,~~yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three months ended March 31, 2019 and 2018 respectively. Such adjustments totaled $146,000 and $187,000 for the three months ended March 31, 2019 and 2018, 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.

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 %

~~(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, 2018 and 2017 respectively. Such adjustments totaled $155,000 and $139,000 for the three months ended March 31, 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 months ended March 31, ~~2018~~2019 compared to the three months ended March 31, ~~2017.~~2018. 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,
	2019 vs. 2018
			Change due to
	Total		Average		Average
(In thousands)	Change		Volume		Rate
Interest income on a fully taxable equivalent basis: (1)
Loans: (2) (4)
Commercial	$	453	$	188	$	265
Real estate construction - residential		78		—		78
Real estate construction - commercial		231		95		136
Real estate mortgage - residential		188		(37)		225
Real estate mortgage - commercial		880		635		245
Installment and other consumer		43		(1)		44
Investment securities: (3)
U.S. Treasury		(47)		(68)		21
U.S. government and federal agency obligations		49		10		39
Obligations of states and political subdivisions		(48)		(34)		(14)
Mortgage-backed securities		(13)		(51)		38
Other debt securities		4		(1)		5
Other investment securities		16		2		14
Federal funds sold and interest bearing deposits in other financial institutions		496		437		59
Total interest income		2,330		1,175		1,155
Interest expense:
NOW accounts		248		(11)		259
Savings		5		—		5
Interest checking		45		39		6
Money market		334		64		270
Time deposits		722		193		529
Federal funds purchased and securities sold under agreements to repurchase		(138)		(63)		(75)
Federal Home Loan Bank advances and other borrowings		147		9		138
Subordinated notes		133		—		133
Total interest expense		1,496		231		1,265
Net interest income on a fully taxable equivalent basis	$	834	$	944	$	(110)

Three Months Ended March 31,
2018 vs. 2017
Change due to
Total Average Average
(In thousands) Change Volume Rate
Interest income on a fully taxable equivalent basis: (1)
Loans: (2) (4)
Commercial $ 195 $ 94 $ 101
Real estate construction - residential 127 109 18
Real estate construction - commercial 452 408 44
Real estate mortgage - residential (63 ) (148 ) 85
Real estate mortgage - commercial 466 440 26
Consumer (7 ) 20 (27 )
Investment securities: (3)
U.S. Treasury 60 55 5
U.S. government and federal agency obligations 34 15 19
Obligations of states and political subdivisions 21 6 15
Mortgage-backed securities 98 5 93
Other investments and securities, at cost 20 1 19
Federal funds sold and interest bearing deposits in other financial institutions 58 7 51
Total interest income 1,461 1,012 449
Interest expense:
NOW accounts 301 32 269
Savings 0 (1 ) 1
Commercial 2 0 2
Money market 392 60 332
Time deposits 178 (10 ) 188
Federal funds purchased and securities sold under agreements to repurchase 149 16 133
Federal Home Loan Bank advances and other 73 2 71
Subordinated notes 83 0 83
Total interest expense 1,178 99 1,079
Net interest income on a fully taxable equivalent basis $ 283 $ 913 $ (630 )

~~(1)~~

(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 ended March 31, 2018 and 2017, respectively. Such adjustments totaled $155,000 and $139,000 for the three months ended March 31, 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.~~

~~Financial results~~ for the three months ended March 31, 2019 and 2018, ~~compared to~~respectively. Such adjustments totaled $146,000 for the three months ended March 31, ~~2017,~~2019 compared to $187,000 for the three months ended March 31, 2018.

(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 quarter ended March 31, 2019 compared to the quarter ended March 31, 2018, reflected an increase in net interest income, on a tax equivalent basis, of ~~$283,000,~~$834,000, or ~~2.66%~~7.62%. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased to ~~3.29%~~3.26% for the ~~three months~~quarter ended March 31, ~~2018~~2019, compared to ~~3.48%~~3.30% for the ~~three months~~quarter ended March 31, ~~2017.~~2018. 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~~$120.9 million, or ~~8.70%~~8.99%, to $1.47 billion for the three months ended March 31, 2019 compared to $1.34 billion for the three months ended March 31, 2018, ~~compared~~and average interest bearing liabilities increased $83.8 million, or 7.75%, to ~~$1.24~~$1.16 billion for the three months ended March 31, ~~2017, and average~~2019 compared to $1.08 billion for the three months ended March 31, 2018.

Total interest ~~bearing liabilities increased $96.0 million, or 9.75%, to $1.1~~income (expressed on a fully taxable equivalent basis) was $16.1 million for the three months ended March 31, ~~2018~~2019 compared to ~~$984.8 million for the three months ended March 31, 2017.~~

~~Total interest income~~~~(expressed on a fully taxable equivalent basis) was~~ $13.7 million for the three months ended March 31, ~~2018 compared to $12.2 million for the three months ended March 31, 2017.~~2018. The Company’s rates earned on interest earning assets were ~~4.13%~~4.44% for the three months ended March 31, ~~2018~~2019 compared to ~~4.01%~~4.14% for the three months ended March 31, ~~2017.~~2018.

Interest income on loansincreased to $14.2 million for the three months ended March 31, 2019 compared to $12.3 million for the three months ended March 31, ~~2018 compared to $11.1 million for the three months ended March 31, 2017.~~2018.

Average loans outstanding increased ~~$80.9~~$73.7 million, or ~~8.15%~~6.87%, to ~~$1.1~~$1.15 billion for the three months ended March 31, ~~2018~~2019 compared to ~~$992.0 million~~$1.07 billion for the three months ended March 31, ~~2017.~~2018. The average yield on loans receivable increased to ~~4.64%~~5.02% for the three months ended March 31, ~~2018~~2019 compared to ~~4.54%~~4.66% for the three months ended March 31, ~~2017.~~2018. See theLending and Credit Management section for further discussion of changes in the composition of the lending portfolio.

Total interest expense increased to $4.3 million for the three months ended March 31, 2019 compared to $2.8 million for the three months ended March 31, ~~2018 compared to $1.6 million for the three months ended March 31, 2017.~~2018. The Company’s rates paid on interest bearing liabilities was 1.49% for the three months ended March 31, 2019 compared to 1.05% for the three months ended March 31, ~~2018 compared~~2018. See the Liquidity Management section for further discussion.

Interest expense on deposits increased to ~~0.66%~~$3.1 million for the three months ended March 31, ~~2017. See the~~~~Liquidity Management~~~~section for further discussion.~~

~~Interest expense on deposits~~~~increased~~2019 compared to $1.7 million for the three months ended March 31, ~~2018 compared~~2018.

Average interest bearing deposits increased $103.9 million, or 11.6%, to ~~$860,000~~$999.1 million for the three months ended March 31, ~~2017.~~

~~Average interest bearing deposits increased $81.6 million, or 10.02%,~~2019 compared to $895.2 million for the three months ended March 31, ~~2018 compared~~2018. These increases were primarily due to ~~$813.6 million~~demand deposits, public funds, Missouri Link deposits, and brokered deposits. The average cost of deposits increased to 1.25% for the three months ended March 31, ~~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~~2019 compared to 0.79% for the three months ended March 31, ~~2018 compared~~2018. The increase was primarily due to ~~0.43%~~generally higher market interest rates quarter over quarter.

Interest expense on borrowings increased to $1.2 million for the three months ended March 31, 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 versus the prior year quarter ended March 31, 2017.

~~Interest expense on borrowings~~~~increased~~2019 compared to $1.1 million for the three months ended March 31, ~~2018 compared~~2018.

Average borrowings decreased to ~~$752,000~~$165.5 million for the three months ended March 31, ~~2017. Average borrowings increased~~2019 compared to $185.6 million for the three months ended March 31, ~~2018 compared to $171.1 million for the three months ended March 31, 2017.~~2018. The ~~primary increase~~decrease in average borrowings ~~resulted from FHLB advances~~was primarily due to ~~fund loan growth and~~the $22.2 million decrease in average repurchase agreements due to a tax initiative involving a short ~~sale~~sales of a U.S. Treasury security funded by a repurchase ~~agreement.~~agreement during the first quarter ended March 31, 2018. The average cost of borrowings increased to 2.94% for the three months ended March 31, 2019 compared to 2.31% for the three months ended March 31, ~~2018 compared to 1.78% for the three months ended March 31, 2017.~~2018. The increase in cost of funds primarily resulted from higher market interest ~~rates and the additional interest cost of the repurchase agreement related to the short sale.~~rates. 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,
(In thousands)	2019			2018			$ Change		% Change
Non-interest Income
Service charges and other fees	$	862		$	876		$	(14)		(1.6)	%
Bank card income and fees		695			656			39		5.9
Trust department income		293			280			13		4.6
Real estate servicing fees, net		84			221			(137)		(62.0)
Gain on sales of mortgage loans, net		105			146			(41)		(28.1)
Other		52			36			16		44.4
Total non-interest income	$	2,091		$	2,215		$	(124)		(5.6)	%
Non-interest income as a % of total revenue *		15.2	%		17.1	%

Three Months Ended March 31,
(In thousands) 2018 2017 $ Change % Change
Non-interest Income
Service charges and other fees $ 876 $ 836 $ 40 4.8 %
Bank card income and fees 656 614 42 6.8
Trust department income 280 274 6 2.2
Real estate servicing fees, net 221 453 (232 ) (51.2 )
Gain on sales of mortgage loans, net 146 155 (9 ) (5.8 )
Other 122 75 47 62.7
Total non-interest income $ 2,301 $ 2,407 $ (106 ) (4.4 )%

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

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

Total non-interest income decreased ~~$106,000,~~$124,000, or ~~4.4%~~5.6%, to ~~$2.3~~$2.1 million for the ~~three months~~quarter ended March 31, ~~2018~~2019 compared to ~~$2.4~~$2.2 million for the ~~three months~~quarter ended March 31, ~~2017.~~2018.

Real estate servicing fees, net of the change in valuation of mortgage serving rights, (MSRs) decreased ~~$232,000~~$137,000 to $84,000 for the quarter ended March 31, 2019 compared to $221,000 for the ~~three months~~quarter ended March 31, 2018 ~~compared to $453,000 for the three months ended March 31, 2017~~ primarily due to a ~~$226,000~~ decrease in the change in fair value quarter over quarter. ~~This~~The change in the value of MSRs in the 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 $178,000 for the three months ended March 31, 2019 compared to $203,000 for the three months ended March 31, ~~2018~~2018. The Company was servicing $275.7 million of mortgage loans at March 31, 2019 compared to ~~$209,000~~$279.9 million and $283.1 million at December 31, 2018 and March 31, 2018, respectively.

Gain on sales of mortgage loans decreased $41,000, or 28.1%, to $105,000 for the quarter ended March 31, 2019 compared to $146,000 for the quarter ended March 31, 2018. The decrease period over period was primarily due to a decrease in other loan origination income, partially offset by an increase in loan origination fees and costs. The Company sold $5.1 million of loans for the three months ended March 31, ~~2017. The Company was servicing $283.1 million of mortgage loans at March 31, 2018~~2019 compared to ~~$285.8 million and $291.0 million at December 31, 2017 and March 31, 2017, respectively.~~

~~Gain on sales of mortgage loans~~ decreased $9,000, or 5.8%, to $146,000 for the three months ended March 31, 2018 compared to $155,000 for the three months ended March 31, 2017. The decrease quarter over quarter was primarily due to an increase in loan origination costs. The Company sold loans of $7.6 million for the three months ended March 31, ~~2018 compared~~2018.

Other Income increased $16,000, or 44.4%, to ~~$6.8 million~~$52,000 for the ~~three months~~quarter ended March 31, ~~2017.~~2019 compared to $36,000 for the quarter ended March 31, 2018. The increase period over period was primarily due to rental income received on a bank owned building in other real estate owned.

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


	Three Months Ended March 31,
(in thousands)	2019		2018
Investment securities gains, net
Available for sale securities:
Gains realized on sales	$	—	$	98
Losses realized on sales		—		—
Other-than-temporary impairment recognized		—		—
Other investment securities:
Fair value adjustments, net		1		—
Investment securities gains, net	$	1	$	98

~~Other Income~~ ~~increased $47,000, or 62.7%, to $122,000 for~~

During the three months ended March 31, 2018, ~~compared~~the Company received $25.7 million from proceeds from a series of short-term sales of U.S. Treasury securities purchased with repurchase agreements and recognized gains of $98,000 in order to ~~$75,000 for~~generate capital gains to offset capital losses that were to expire during 2018 and 2019. During the three months ended March 31, ~~2017 primarily due to~~2019 there were no securities sales.

Gain on branch sale, net

On February 8, 2019, Hawthorn Bank, a ~~gain on~~wholly-owned subsidiary of Hawthorn Bancshares, Inc., completed the sale of ~~investment securities partially offset by~~its branch located in Branson, Missouri to Branson Bank, Branson, Missouri. The Company sold the land and building for $3.5 million with a ~~decrease~~net book value of $1.7 million and transferred approximately $10.6 million in ~~brokerage income.~~

deposits, subject to future adjustments required in the definitive agreement for a deposit premium of 4.1%, or $0.3 million, excluding future contingent adjustments. The sale resulted in a pre-tax gain of approximately $2.1 million, or $1.6 million after tax.

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


	Three Months Ended March 31,
(In thousands)	2019			2018			$ Change		% Change
Non-interest Expense
Salaries	$	3,972		$	4,552		$	(580)	(12.7)	%
Employee benefits		1,466			1,505			(39)	(2.6)
Occupancy expense, net		698			689			9	1.3
Furniture and equipment expense		809			635			174	27.4
Processing expense, network and bank card expense		1,001			859			142	16.5
Legal, examination, and professional fees		329			422			(93)	(22.0)
Advertising and promotion		258			252			6	2.4
Postage, printing, and supplies		210			268			(58)	(21.6)
Other		1,145			1,084			61	5.6
Total non-interest expense	$	9,888		$	10,266		$	(378)	(3.7)	%
Efficiency ratio*		72.1	%		79.2	%
Number of full-time equivalent employees		286			339

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

Three Months Ended March 31,
(In thousands) 2018 2017 $ Change % Change
Non-interest Expense
Salaries $ 4,552 $ 4,054 $ 498 12.3 %
Employee benefits 1,505 1,384 121 8.7
Occupancy expense, net 689 619 70 11.3
Furniture and equipment expense 635 598 37 6.2
Processing expense, network and bank card expense 859 1,045 (186 ) (17.8 )
Legal, examination, and professional fees 422 280 142 50.7
FDIC insurance assessment 154 101 53 52.5
Advertising and promotion 252 239 13 5.4
Postage, printing, and supplies 268 223 45 20.2
Other 918 808 110 13.6
Total non-interest expense $ 10,254 $ 9,351 $ 903 9.7 %
Efficiency ratio * 78.5 % 72.5 %
Number of full-time equivalent employees 339 333

~~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,~~ decreased $378,000, or ~~9.7%~~3.7%, to $9.9 million for the quarter ended March 31, 2019 compared to $10.3 million for the ~~three months~~quarter ended March 31, ~~2018 compared~~2018.

Salaries decreased $580,000, or 12.7%, to ~~$9.4~~$4.0 million for the ~~three months~~quarter ended March 31, ~~2017.~~

~~Salaries~~ ~~increased $498,000, or 12.3%,~~2019 compared to $4.6 million for the ~~three months~~quarter ended March 31, ~~2018 compared to $4.1 million for the three months ended March 31, 2017.~~2018. The ~~increase~~decrease quarter over quarter was primarily due to a reduction of fifty-three full-time equivalent employees. In addition, a bonus ~~that~~ was paid in February 2018 to all eligible full-time and part-time employees ~~as a result of~~resulting from the expected tax savings from the ~~new tax reform.~~Tax Act.

Employee benefits ~~increased $121,000,~~ decreased $39,000, or ~~8.7%~~2.6%, to $1.5 million for the ~~three months~~quarter ended March 31, ~~2018~~2019 compared to ~~$1.4~~$1.5 million for the ~~three months~~quarter ended March 31, ~~2017.~~2018. The decrease quarter over quarter was primarily due to a decrease in medical plan premiums due to a reduction of employees as mentioned above, and was partially offset by an increase in the employer 401(k) and profit-sharing contributions.

Furniture and equipment expense increased $174,000, or 27.4%, to $809,000 for the quarter ended March 31, 2019 compared to $635,000 for the quarter ended March 31, 2018. The increase quarter over quarter was primarily due to an increase in ~~medical plan premiums effective July 1, 2017.~~the monthly cost to maintain the Company's hosted network, and the replacement of several computers below the Company's capitalization threshold during the current quarter.

~~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 $142,000, or ~~17.8%~~16.5%, ~~to $859,000 for the three months ended March 31, 2018 compared~~ to $1.0 million for the ~~three months~~quarter ended March 31, ~~2017. The decrease was primarily due~~2019 compared to ~~additional one-time costs associated with a corporate wide network upgrade and changes in processing service providers during 2017.~~

~~Legal, examination, and professional fees~~ ~~increased $142,000, or 50.7%, to $422,000~~$859,000 for the ~~three months~~quarter ended March 31, ~~2018 compared to $280,000 for the three months ended March 31, 2017.~~2018. The increase ~~was primarily related to an increase in consulting fees related to tax planning initiatives and audit fees partially offset by a decrease in legal fees.~~

~~FDIC insurance assessment~~ increased $53,000, or 52.5%, to $154,000 for the three months ended March 31, 2018 compared to $101,000 for the three months ended March 31, 2017. The increase is primarily due to an increase in the Company’s total assessment base quarter over ~~quarter.~~

~~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~~quarter was primarily due to an increase in ~~stationary~~debit card processing expenses.

Legal, examination, and ~~supplies.~~

~~Other expense~~ ~~increased $110,000,~~professional fees decreased $93,000, or ~~13.6%~~22.0%, to ~~$918,000~~$329,000 for the ~~three months~~quarter ended March 31, ~~2018~~2019 compared to ~~$808,000~~$422,000 for the ~~three months~~quarter ended March 31, ~~2017.~~2018. The ~~increase~~decrease quarter over quarter was primarily related to a decrease in attorney and consulting fees. During 2018 additional fees were incurred related to tax planning initiatives.

Postage, printing, and supplies decreased $58,000, or 21.6%, to $210,000 for the quarter ended March 31, 2019 compared to $268,000 for the quarter ended March 31, 2018. The decrease quarter over quarter was primarily due to ~~an increase in loan expense, correspondent bank~~bank-wide reduction of costs and ~~deposit fees, and miscellaneous charged off items.~~timing of supply purchases.

Income taxes

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 18.9% for the three months ended March 31, 2019 compared to 16.4% for the ~~quarter~~three months ended March 31, 2018. The change in the effective tax rate in the first quarter of 2019 over the first quarter of 2018 ~~compared~~is primarily due to ~~34.2% for~~an increase in taxable income, which included a $2.1 million pre-taxable gain from the ~~quarter ended March 31, 2017.~~ sale of the Branson branch.

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%~~74.3% of total assets as of March 31, ~~2018~~2019 compared to ~~74.0%~~76.6% as of December 31, ~~2017.~~

2018.

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,			March 31,			December 31,
(In thousands)	2018			2017			2019			2018
Commercial, financial, and agricultural	$	190,720		$	192,238		$	204,759		$	207,720
Real estate construction - residential		29,351			26,492			26,082			28,610
Real estate construction - commercial		105,345			98,340			109,766			106,784
Real estate mortgage - residential		250,131			246,754			248,059			241,517
Real estate mortgage - commercial		476,511			472,455			534,121			529,536
Installment loans to individuals		32,268			32,153
Installment and other consumer								31,865			32,460
Total loans	$	1,084,326		$	1,068,432		$	1,154,652		$	1,146,627
Percent of categories to total loans:
Commercial, financial, and agricultural		18.1	%		18.0	%		17.7	%		18.1	%
Real estate construction - residential		2.0			2.5			2.3			2.5
Real estate construction - commercial		6.9			9.2			9.5			9.3
Real estate mortgage - residential		26.1			23.1			21.4			21.1
Real estate mortgage - commercial		43.8			44.2			46.3			46.2
Installment loans to individuals		3.1			3.0
Installment and other consumer								2.8			2.8
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 months ended March 31, ~~2018,~~2019, the Company sold approximately ~~$7.6~~$5.1 million of loans to investors, compared to ~~$6.8~~$7.6 million for the three months ended March 31, ~~2017.~~2018. At March 31, ~~2018,~~2019, the Company was servicing approximately ~~$283.1~~$275.7 million of loans sold to the secondary market compared to ~~$285.8~~$279.9 million at December 31, ~~2017,~~2018, and ~~$291.0~~$283.1 million at March 31, ~~2017.~~2018.

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~~Loans in excess of $2.0 million in aggregate and all adversely classified credits identified by management are ~~reviewed.~~reviewed by the senior loan committee. In addition, all other loans are reviewed on a ~~sample basis.~~risk weighted selection process. 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~~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,			March 31,
(In thousands)	2019			2018			2018
Nonaccrual loans:
Commercial, financial, and agricultural	$	1,747		$	1,857		$	2,258
Real estate construction - residential		—			—			59
Real estate construction - commercial		151			153			—
Real estate mortgage - residential		2,803			2,720			2,089
Real estate mortgage - commercial		508			474			916
Installment and other consumer		222			210			160
Total	$	5,431		$	5,414		$	5,482
Loans contractually past - due 90 days or more and still accruing:
Commercial, financial, and agricultural	$	—		$	—		$	—
Real estate construction - residential		—			—			—
Real estate construction - commercial		—			—			—
Real estate mortgage - residential		140			156			—
Real estate mortgage - commercial		—			—			—
Installment and other consumer		5			6			38
Total	$	145		$	162		$	38
Total non-performing loans (a)		5,576			5,576			5,520
Other real estate owned and repossessed assets		13,537			13,691			10,690
Total non-performing assets	$	19,113		$	19,267		$	16,210

Loans (c)	$	1,153,640		$	1,146,044		$	1,083,797
Allowance for loan losses to loans		1.03	%		1.02	%		1.01	%
Non-performing loans to loans (a)		0.48	%		0.49	%		0.51	%
Non-performing assets to loans (b)		1.66	%		1.68	%		1.50	%
Non-performing assets to assets (b)		1.24	%		1.30	%		1.12	%
Allowance for loan losses to non-performing loans		212.43	%		208.97	%		198.32	%

March 31, December 31,
(In thousands) 2018 2017
Nonaccrual loans:
Commercial, financial, and agricultural $ 2,258 $ 2,507
Real estate construction - residential 59 0
Real estate construction - commercial 0 97
Real estate mortgage - residential 2,089 1,956
Real estate mortgage - commercial 916 936
Installment and other consumer 160 176
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
Other real estate owned and repossessed assets 13,239 13,182
Total nonperforming assets $ 23,370 $ 23,866

Loans $ 1,084,326 $ 1,068,432
Allowance for loan losses to loans 1.01 % 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 %

(a)

Non-performing loans include loans 90 days past due and accruing, nonaccrual loans, and non-performing TDRs included in nonaccrual loans.

(b)

Non-performing assets include non-performing loans and other real estate owned and repossessed assets.

(c)

Loan totals do not include loans held for sale.

Total ~~nonperforming~~non-performing assets ~~totaled $23.4~~were $19.1 million, or 1.66% of total loans, at March 31, ~~2018~~2019 compared to ~~$23.9~~$19.3 million, or 1.68% of total loans, at December 31, ~~2017. Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due~~2018, and ~~still accruing, and TDRs totaled $10.1~~$16.2 million, or ~~0.93%,~~1.50% of total loans, at March 31, 2018, ~~compared to $10.7 million, or 1.00%, of total loans at December 31, 2017.~~respectively. Non-accrual loans included ~~$1.7~~$1.9 million of loans classified as TDRs at ~~both~~March 31, 2019 compared to $2.0 million and $1.7 million at December 31, 2018 and March 31, 2018, ~~and December 31, 2017,~~ respectively.

As of March 31, 2019, approximately $5.3 million compared to $5.2 million and $9.0 million at December 31, 2018 and ~~December~~March 31, ~~2017, approximately $4.4 million and $4.1 million,~~2018, respectively, of loans classified as substandard, which include performing TDRs, and are not included in the nonperforming 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. Management believes the general allowance was sufficient to cover the risks and probable losses related to such loans at March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, respectively.

~~Total non-accrual~~Non-accrual loans were consistent at $5.4 million at March 31, ~~2018 decreased $190,000, or 3.3%, to $5.5 million compared to $5.7 million at~~2019 and 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.

2018, respectively. Loans past due 90 days and still accruing interest at March 31, ~~2018,~~2019, were ~~$38,000~~$145,000 compared to ~~$328,000~~$162,000 at December 31, ~~2017.~~2018. Other real estate and repossessed assets were ~~$13.2~~$13.5 million at ~~both~~ March 31, ~~2018 and~~2019 compared to $13.7 million at December 31, ~~2017.~~ 2018.

During the three months ended March 31, ~~2018, $278,000~~2019, $116,000 of nonaccrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to ~~$103,000~~$278,000 during the three months ended March 31, ~~2017.~~

2018.

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


													March 31, 2019					December 31, 2018
	March 31, 2018						December 31, 2017						Number of	Recorded		Specific		Number of	Recorded		Specific
(In thousands)	Number of Contracts		Recorded Investment		Specific Reserves		Number of Contracts		Recorded Investment		Specific Reserves		contracts	Investment		Reserves		contracts	Investment		Reserves
Performing TDRs
Commercial, financial and agricultural		6	$	481	$	19		6	$	500	$	20	8	$	629	$	185	6	$	570	$	174
Real estate mortgage - residential		11		3,068		269		11		3,116		236	9		2,048		77	9		2,073		72
Real estate mortgage - commercial		2		1,062		72		2		1,068		109	2		373		7	2		377		8
Installment and other consumer													3		42		4	3		44		4
Total performing TDRs		19	$	4,611	$	360		19	$	4,684	$	365	22	$	3,092	$	273	20	$	3,064	$	258
Nonperforming TDRs
Non-performing TDRs
Commercial, financial and agricultural		4	$	827	$	103		4	$	838	$	41	5	$	1,023	$	86	5	$	1,042	$	94
Real estate mortgage - residential		3		242		60		4		290		61	5		822		144	5		867		182
Real estate mortgage - commercial		4		581		139		4		589		110	—		—		—	—		—		—
Total nonperforming TDRs		11	$	1,650	$	302		12	$	1,717	$	212
Installment and other consumer													2		72		9	2		72		9
Total non-performing TDRs													12	$	1,917	$	239	12	$	1,981	$	285
Total TDRs		30	$	6,261	$	662		31	$	6,401	$	577	34	$	5,009	$	512	32	$	5,045	$	543

At March 31, ~~2018,~~2019, loans classified as TDRs totaled ~~$6.3~~$5.0 million, with ~~$662,000~~$512,000 of specific reserves, of which ~~$1.7~~$1.9 million were classified as ~~nonperforming~~non-performing TDRs and ~~$4.6~~$3.1 million were classified as performing TDRs. This compared to ~~$6.4~~$5.0 million of loans classified as TDRs, with ~~$577,000~~$543,000 of specific reserves, of which ~~$1.7~~$2.0 million were classified as ~~nonperforming~~non-performing TDRs and ~~$4.7~~$3.0 million were classified as performing TDRs at December 31, ~~2017.~~2018. 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.~~costs if the loan is collateral dependent. The net decrease in total TDRs from December 31, ~~2017~~2018 to March 31, ~~2018~~2019 was primarily due to ~~one TDR totaling $48,000 that went to foreclosure and $95,000~~$117,000 of payments received on ~~TDR’s received.~~

TDRs, partially offset by two new TDRs totaling $80,000.

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,		March 31,		December 31,
(In thousands)	2018		2017		2019		2018
Allocation of allowance for loan losses at end of period:
Commercial, financial, and agricultural	$	3,261	$	3,325	$	3,232	$	3,237
Real estate construction - residential		240		170		74		140
Real estate construction - commercial		895		807		638		757
Real estate mortgage - residential		2,057		1,689		1,890		2,071
Real estate mortgage - commercial		4,008		4,437		5,523		4,914
Installment and other consumer		352		345		333		334
Unallocated		134		79		155		199
Total	$	10,947	$	10,852	$	11,845	$	11,652

The allowance for loan losses (ALL) was $11.8 million, or 1.03%, of loans outstanding at March 31, 2019 compared to $11.7 million, or 1.02%, at December 31, 2018, and $10.9 million, or 1.01%, of loans outstanding at March 31, ~~2018 compared to $10.9 million, or 1.02%, at December 31, 2017, and $10.3 million, or 1.02%, of loans outstanding at March 31, 2017.~~2018. The

ratio of the allowance for loan losses to nonperforming loans ~~excluding performing TDR’s,~~ was 212.43% at March 31, 2019, compared to 208.97% at December 31, 2018, and 198.32% at March 31, ~~2018, compared to 180.87% at December 31, 2017.~~

2018.

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


	March 31,		December 31,		March 31,		December 31,
(In thousands)	2018		2017		2019		2018
Allocation of allowance for loan losses:
Individually evaluated for impairment - specific reserves	$	1,336	$	1,333	$	1,039	$	1,194
Collectively evaluated for impairment - general reserves		9,611		9,519		10,806		10,458
Total	$	10,947	$	10,852	$	11,845	$	11,652

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, ~~2018, $1.3~~2019, $1.0 million of the Company’s ALL was allocated to impaired loans totaling approximately ~~$10.1~~$8.5 million compared to ~~$1.3~~$1.2 million of the Company’s ALL allocated to impaired loans totaling approximately ~~$10.4~~$8.5 million at December 31, ~~2017.~~2018. Management determined that ~~$2.0~~$2.3 million, or ~~20%~~27%, of total impaired loans required no reserve allocation at March 31, ~~2018~~2019 compared to ~~$2.4~~$2.1 million, or ~~23%~~25%, at December 31, ~~2017~~2018, 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 2019, management adjusted the look-back period to begin with loss history in the first quarter ~~of 2016,~~2012 as the starting point through the current quarter and it will continue to include this starting point going forward. Management determined that with the extended current economic recovery, the look-back period should be expanded to include the current economic cycle. This increasing look-back period will then be adjusted once a loss producing downturn is recognized by allowing the look-back period to shift forward by eliminating the earliest loss period and replenishing it with losses from the most recent period. Prior to 2019, 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~~utilized a five-year look-back period, which ~~is consistent with the Company’s practices prior to the start of the economic recession in 2008, provides~~was considered a representative historical loss period. The look-back period inis consistently evaluated for relevance given the current ~~economic environment.~~ facts and circumstances.

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.

The more significant changes from December 31, 2018 to March 31, 2019 in the allocations of the allowance for loan losses to the loan portfolios listed above included the following:

~~Provision~~

Real estate mortgage – commercial increased by $609,000 primarily due to higher historical loss rates resulting from extending the look-back period back to the first quarter 2012. Real estate mortgage – residential decreased by $181,000 primarily due to a reduction in the qualitative risk factors associated with this portfolio. Real estate construction – commercial decreased by $119,000 primarily due to a reduction in the qualitative risk factors associated with this portfolio. Real estate construction – residential decreased by $66,000 primarily due to a reduction in the qualitative risk factors associated with this portfolio.

Provision

A ~~$300,000~~$150,000 provision was required for the three months ended March 31, ~~2018~~2019 compared to a ~~$350,000~~$300,000 provision for the three months ended March 31, ~~2017.~~2018. The decrease from the prior quarter 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
	March 31,
(In thousands)	2019		2018
Analysis of allowance for loan losses:
Balance beginning of period	$	11,652	$	10,852
Charge-offs:
Commercial, financial, and agricultural		53		110
Real estate construction - residential		—		48
Real estate construction - commercial		—		30
Real estate mortgage - residential		84		20
Real estate mortgage - commercial		8		14
Installment and other consumer		52		57
Total charge-offs		197		279
Recoveries:
Commercial, financial, and agricultural	$	108	$	13
Real estate construction - residential		—		12
Real estate mortgage - residential		99		19
Real estate mortgage - commercial		—		6
Installment and other consumer		33		24
Total recoveries		240		74
Net (recoveries) charge-offs		(43)		205
Provision for loan losses		150		300
Balance end of period	$	11,845	$	10,947

Three Months Ended
March 31,
(In thousands) 2018 2017
Analysis of allowance for loan losses:
Balance beginning of period $ 10,852 $ 9,886
Charge-offs:
Commercial, financial, and agricultural 110 28
Real estate construction - residential 48 -
Real estate construction - commercial 30 -
Real estate mortgage - residential 20 20
Real estate mortgage - commercial 14 14
Installment and other consumer 57 51
Total charge-offs 279 113
Recoveries:
Commercial, financial, and agricultural $ 13 $ 19
Real estate construction - residential 12 50
Real estate mortgage - residential 19 36
Real estate mortgage - commercial 6 7
Installment and other consumer 24 27
Total recoveries 74 139
Net charge-offs (recoveries) 205 (26 )
Provision for loan losses 300 350
Balance end of period $ 10,947 $ 10,262

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

The Company’s net loan recoveries were ($43,000), or (0.00%), of average loans for the three months ended March 31, 2019 compared to net charge-offs ~~were~~of $205,000, or 0.02%, of average loans for the three months ended March 31, ~~2018, compared to net loan recoveries of $26,000, or 0.00%, of average loans~~2018. The decrease in charge-offs for the three months ended March 31, ~~2017. The increase in charge-offs quarter over quarter~~2019 compared to the three months ended March 31, 2018 primarily related to one commercial loan relationship charge-off during the first quarter of 2018 partially offset by one commercial loan relationship recovery and ~~two~~one real estate ~~construction loans.~~mortgage – residential recovery during the first quarter of 2019.

Liquidity and Capital Resources

Liquidity Management

The role of liquidity management is to ensure funds are available to meet ~~depositors'~~depositors’ withdrawal and ~~borrowers'~~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~~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~~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,		March 31,		December 31,
(In thousands)	2018		2017		2019		2018
Federal funds sold and other overnight interest-bearing deposits	$	65,449	$	39,553	$	75,035	$	18,396
Certificates of deposit in other banks		4,812		3,460		12,741		12,247
Available-for-sale investment securities		215,720		226,542		218,539		218,205
Total	$	285,981	$	269,555	$	306,315	$	248,848

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~~$218.5 million at March 31, ~~2018~~2019 and included an unrealized net loss of ~~$5.3~~$2.6 million. The portfolio includes projected maturities and mortgage backed securities pay-downs of approximately ~~$10.1~~$22.1 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, ~~2018~~2019 and December 31, ~~2017,~~2018, the Company’s unpledged securities in the available for sale portfolio totaled approximately ~~$21.5~~$42.6 million and ~~$44.8~~$65.2 million, respectively.

Total investment securities pledged for these purposes were as follows:


	March 31,		December 31,		March 31,		December 31,
(In thousands)	2018		2017		2019		2018
Investment securities pledged for the purpose of securing:
Federal Reserve Bank borrowings	$	9,002	$	9,570	$	9,169	$	9,397
Federal funds purchased and securities sold under agreements to repurchase		47,728		40,931		33,651		32,529
Other deposits		137,538		131,197		133,146		111,090
Total pledged, at fair value	$	194,268	$	181,698	$	175,966	$	153,016

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, ~~2018,~~2019, such deposits totaled ~~$1.0~~$1.1 billion and represented ~~88.4%~~86.5% 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 million at March 31, 2018. These accounts are normally considered more volatile and higher costing representing 11.6% of total deposits at March 31, 2018.

Core deposits at March 31, ~~2018~~2019 and December 31, ~~2017~~2018 were as follows:


	March 31,		December 31,		March 31,		December 31,
(In thousands)	2018		2017		2019		2018
Core deposit base:
Non-interest bearing demand	$	244,835	$	245,380	$	264,218	$	262,857
Interest checking		246,008		229,862		245,211		215,432
Savings and money market		364,779		345,593		360,051		378,484
Other time deposits		188,361		191,563		211,768		211,715
Total	$	1,043,983	$	1,012,398	$	1,081,248	$	1,068,488

~~The total amount of~~Time deposits and certificates of deposit of $250,000 and greater at March 31, ~~2018~~2019 and December 31, ~~2017~~2018 were ~~$84.7~~$140.9 million and ~~$63.2~~$104.9 million, respectively. The Company had brokered deposits totaling ~~$48.9~~$40.0 million and ~~$48.5~~$39.8 million at March 31, ~~2018~~2019 and December 31, ~~2017, respectively~~

2018, respectively.

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, ~~2018,~~2019, 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~~$16.6 million on a secured basis. There were no federal funds purchased outstanding at March 31, ~~2018.~~2019. 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, ~~2018,~~2019, there ~~was $34.8~~were $22.1 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, ~~2018.~~

2019.

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, ~~2018,~~2019, the Bank had ~~$84.3~~$95.1 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, ~~2018~~2019 and December 31, ~~2017~~2018 were as follows:


	March 31,		December 31,		March 31,		December 31,
(In thousands)	2018		2017		2019		2018
Borrowings:
Federal funds purchased and securities sold under agreements to repurchase	$	34,795	$	27,560	$	22,097	$	24,647
Federal Home Loan Bank advances		84,296		121,352		95,069		95,126
Subordinated notes		49,486		49,486		49,486		49,486
Other borrowings		31		30		27		27
Total	$	168,608	$	198,428	$	166,679	$	169,286

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,
2018 2017
(In thousands) 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
Letters of credit (72,750 ) 0 0 (72,750 ) (70,000 ) 0 0 (70,000 )
Advances outstanding (84,296 ) 0 0 (84,296 ) (121,352 ) 0 0 (121,352 )
Total available $ 137,170 $ 8,796 $ 47,435 $ 193,401 $ 102,729 $ 9,364 $ 47,825 $ 159,918


	March 31,								December 31,
	2019								2018
					Federal								Federal
					Funds								Funds
			Federal		Purchased						Federal		Purchased
(In thousands)	FHLB		Reserve Bank		Lines		Total		FHLB		Reserve Bank		Lines		Total
Advance equivalent	$	293,849	$	9,451	$	57,148	$	360,448	$	301,606	$	9,160	$	57,235	$	368,001
Letters of credit		(109,000)		—		—		(109,000)		(80,000)		—		—		(80,000)
Advances outstanding		(95,069)		—		—		(95,069)		(95,126)		—		(8,000)		(103,126)
Total available	$	89,780	$	9,451	$	57,148	$	156,379	$	126,480	$	9,160	$	49,235	$	184,875

At March 31, ~~2018,~~2019, loans of ~~$479.4~~$159.3 million were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At March 31, ~~2018,~~2019, investments and certificates of deposits in other banks totaling ~~$18.6~~$19.0 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~~$90.7 million at March 31, ~~2018~~2019 compared to ~~$62.9~~$42.1 million at December 31, ~~2017.~~2018. The ~~$18.5~~$48.6 million increase 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 months ended March 31, ~~2018.~~2019. 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~~$3.7 million for the three months ended March 31, ~~2018.~~

2019.

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~~$14.5 million. The cash outflow primarily consisted of ~~$16.2~~$7.7 million increase in loans and ~~$28.1~~$12.8 million purchases of investment securities, partially offset by ~~$36.5~~$13.9 million from maturities ~~calls,~~ and ~~sales~~calls of investment securities.

Financing activities provided cash of ~~$24.2~~$59.5 million, resulting primarily from a ~~$32.4~~$9.7 increase in demand deposits, a $12.0 million increase in interest bearing transaction accounts, and ~~$22.7~~a $40.9 million increase in time ~~deposits, partially offset by a net $37.1 million repayment of FHLB advances.~~deposits. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during ~~2018.~~

2019.

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~~Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the ~~Company's~~Company’s liquidity. The Company had ~~$308.6~~$371.3 million in unused loan commitments and standby letters of credit as of March 31, ~~2018.~~2019. Although the ~~Company's~~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~~$603,000 and ~~$336,000~~$406,000 for the three months ended March 31, ~~2018~~2019 and ~~2017,~~2018, 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~~$1.5 million and $0$1.0 million in dividends to the Company during the three months ended March 31, ~~2018~~2019 and ~~2017,~~2018, respectively. At March 31, ~~2018~~2019 and December 31, ~~2017,~~2018, the Company had cash and cash equivalents totaling ~~$1.6~~$1.3 million and ~~$1.4~~$1.3 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~~The capital conservation buffer was phased in from 0.625% of risk-weighted assets ~~and the requirement will increase each subsequent year by an additional 0.625 percentage points,~~beginning January 1, 2016 to ~~reach its final level of~~ 2.5% of risk ~~weighted assets on~~weighted-assets by January 1, 2019. ~~Once fully phased in, the~~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, ~~2018~~2019 and December 31, ~~2017,~~2018, 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:



					Required for Capital				Well-Capitalized				Minimum Capital
	Actual				Adequacy Purposes				Standard				Requirement
(in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
March 31, 2019
Total Capital (to risk-weighted assets):
Company	$	169,581	13.39	%	$	101,349	8.00	%	$	N.A.	N.A	%	$	N.A.	N.A	%
Bank		167,965	13.29			101,105	8.00			126,381	10.00			132,700	10.50
Tier 1 Capital (to risk-weighted assets):
Company	$	144,533	11.41	%	$	76,012	6.00	%	$	N.A.	N.A	%	$	N.A.	N.A	%
Bank		155,960	12.34			75,829	6.00			101,105	8.00			107,424	8.50
Common Equity Tier 1 Capital (to risk-weighted assets)
Company	$	109,576	8.65	%	$	57,009	4.50	%	$	N.A.	N.A	%	$	N.A.	N.A	%
Bank		155,960	12.34			56,871	4.50			82,148	6.50			88,467	7.00
Tier 1 Capital (to adjusted average assets):
Company	$	144,533	9.38	%	$	61,667	4.00	%	$	N.A.	N.A	%	$	N.A.	N.A	%
Bank		155,960	10.16			61,394	4.00			76,742	5.00			61,394	4.00
(in thousands)
December 31, 2018
Total Capital (to risk-weighted assets):
Company	$	165,325	13.28	%	$	99,578	8.00	%	$	N.A.	N.A.	%	$	N.A.	N.A	%
Bank		163,814	13.19			99,327	8.00			124,159	10.00			130,367	10.50
Tier 1 Capital (to risk-weighted assets):
Company	$	139,532	11.21	%	$	74,683	6.00	%	$	N.A.	N.A.	%	$	N.A.	N.A	%
Bank		152,002	12.24			74,495	6.00			99,327	8.00			105,535	8.50
Common Equity Tier 1 Capital (to risk-weighted assets)
Company	$	105,513	8.48	%	$	56,013	4.50	%	$	N.A.	N.A.	%	$	N.A.	N.A	%
Bank		152,002	12.24			55,872	4.50			80,703	6.50			86,911	7.00
Tier 1 leverage ratio:
Company	$	139,532	9.55	%	$	58,467	4.00	%	$	N.A.	N.A.	%	$	N.A.	N.A	%
Bank		152,002	10.43			58,272	4.00			72,839	5.00			58,272	4.00

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Asset/Liability and Interest 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 ~~Sensitivity~~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.

The principal objective of the Company’s asset and liability management function is to evaluate the interest rate risk 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 on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.

The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 200 and 100 basis point decrease in interest rates on net interest income based on the interest rate risk model at March 31, 2019 and December 31, 2018.



	% Change in projected net interest income
Hypothetical shift in interest rates	March 31,			December 31,
(bps)	2019			2018
200		2.93	%		0.26	%
100		2.90	%		1.17	%
(100)		2.76	%		3.39	%
(200)		2.13	%		4.19	%

The change in our interest rate risk exposure from December 31, 2018 to March 31, 2019 was primarily due to the Company’s balance sheet becoming more asset sensitive leading to higher changes in net interest income in a rising rate environment. Conversely, the increased asset sensitivity also led to a lower change in net interest income in a falling rate environment. However, since the change in net interest income in all four of the rate scenarios is relatively the same it indicates that the balance sheet was well balanced between rate sensitive assets and rate sensitive liabilities at March 31, 2019.

~~Market~~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 ~~arises from exposure~~shown above do not include actions that management may undertake to manage the risks in response to anticipated changes in interest rates and other relevant market rate or price risk. The Company faces market 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 future earningsactual results may also differ due to any actions taken in response to the changing 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.

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

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~~Company’s operations for the three months ended March 31, ~~2018.~~

2019.

Item 4. Controls and Procedures

Our ~~Company's~~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, ~~2018.~~2019. 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~~Company’s internal control over financial reporting that occurred during the three months ended March 31, ~~2018~~2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Impact of New Accounting Standards

Intangibles In August 2018, the FASB issued ASU 2018‑15, Intangibles - Goodwill and Other - Internal-Use Software (Topic 350‑40) Customer’s Accounting for Implementation Costs Incurred in a 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 develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018‑15 is effective for annual reporting periods beginning after December 15, 2019 and is not expected to have a significant impact on the Company’s consolidated financial statements.

Pension In August 2018, the FASB issued ASU 2018‑14, Compensation - Retirement Benefits - Defined Benefit Plans -General (Subtopic 715-20) Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans. These amendments modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. ASU 2018‑14 is effective for annual reporting periods beginning after December 15, 2020 and is not expected to have a 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.

Financial InstrumentsIn June 2016, the FASB issued ASU 2016-13,Financial Instruments - Credit Losses ~~(Topic~~(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~~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 Beginning in the first quarter of 2019, ~~and is in~~ the ~~process of~~Company began running parallel credit risk models to continue evaluating the ~~impact of the ASU's adoption on the Company's consolidated financial statements.~~results.

~~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 impact on the Company’s consolidated financial statements.

~~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.

	Amortized		Fair
(in thousands)	Cost		Value
Due in one year or less	$	9,928	$	9,883
Due after one year through five years		60,479		59,974
Due after five years through ten years		21,390		20,344
Due after ten years		3,072		3,012
Total		94,869		93,213
Mortgage-backed securities		126,186		122,507
Total available-for-sale securities	$	221,055	$	215,720

					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

	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

	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

	Three Months Ended March 31,
	2018 vs. 2017
				Change due to
	Total			Average			Average
(In thousands)	Change			Volume			Rate
Interest income on a fully taxable equivalent basis: (1)
Loans: (2) (4)
Commercial	$	195		$	94		$	101
Real estate construction - residential		127			109			18
Real estate construction - commercial		452			408			44
Real estate mortgage - residential		(63	)		(148	)		85
Real estate mortgage - commercial		466			440			26
Consumer		(7	)		20			(27	)
Investment securities: (3)
U.S. Treasury		60			55			5
U.S. government and federal agency obligations		34			15			19
Obligations of states and political subdivisions		21			6			15
Mortgage-backed securities		98			5			93
Other investments and securities, at cost		20			1			19
Federal funds sold and interest bearing deposits in other financial institutions		58			7			51
Total interest income		1,461			1,012			449
Interest expense:
NOW accounts		301			32			269
Savings		0			(1	)		1
Commercial		2			0			2
Money market		392			60			332
Time deposits		178			(10	)		188
Federal funds purchased and securities sold under agreements to repurchase		149			16			133
Federal Home Loan Bank advances and other		73			2			71
Subordinated notes		83			0			83
Total interest expense		1,178			99			1,079
Net interest income on a fully taxable equivalent basis	$	283		$	913		$	(630	)

											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

														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