UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended ~~September 30, 2020~~March 31, 2021

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

For the transition period from ______________ to ______________

Commission file number: 0-23636

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

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

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

(Address of principal executive offices) (Zip Code)

(573) 761-6100

(Registrant’s telephone number, including area code)

N/A

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

Securities registered pursuant to Section 12(b) 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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). ☒ Yes ☐ No

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


Large accelerated filer ☐	Accelerated filer ☒☐	Non-accelerated filer☐☒

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 of the Exchange Act). ☐ Yes ☒ No

As of ~~November 5, 2020,~~May 10, 2021, the registrant had ~~6,480,108~~6,362,476 shares of common stock, par value $1.00 per share, outstanding.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets


	September 30,		December 31,		March 31,		December 31,
(In thousands, except per share data)	2020		2019		2021		2020
	(Unaudited)				(Unaudited)
ASSETS
Cash and due from banks	$	17,340	$	22,576	$	18,496	$	19,235
Federal funds sold and other interest-bearing deposits		112,050		55,545		128,207		161,128
Cash and cash equivalents		129,390		78,121		146,703		180,363
Certificates of deposit in other banks		9,874		10,862		8,897		9,376
Available-for-sale debt securities, at fair value		186,723		175,093		238,142		198,030
Other investments		6,452		5,808		6,188		6,353
Total investment securities		193,175		180,901		244,330		204,383
Loans held for investment		1,279,165		1,168,797		1,276,185		1,286,967
Allowances for loan losses		(17,764)		(12,477)
Allowance for loan losses						(18,361)		(18,113)
Net loans		1,261,401		1,156,320		1,257,824		1,268,854
Loans held for sale, at lower of cost or fair value		7,886		428		6,308		5,099
Premises and equipment - net		34,769		35,388		34,027		34,561
Mortgage servicing rights, at fair value		2,327		2,482		2,494		2,445
Other real estate owned - net		12,601		12,781		12,140		12,291
Accrued interest receivable		8,241		6,481		6,488		6,640
Cash surrender value - life insurance		2,438		2,398		2,465		2,451
Other assets		7,668		6,800		10,248		7,268
Total assets	$	1,669,770	$	1,492,962	$	1,731,924	$	1,733,731
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Non-interest bearing demand	$	372,355	$	261,166	$	431,035	$	382,492
Savings, interest checking and money market		665,351		614,331		708,615		723,808
Time deposits $250,000 and over		100,018		104,262		74,406		91,263
Other time deposits		189,028		206,762		179,926		186,043
Total deposits		1,326,752		1,186,521		1,393,982		1,383,606
Federal funds purchased and securities sold under agreements to repurchase		35,405		27,272		42,018		45,154
Federal Home Loan Bank advances and other borrowings		112,743		96,919		97,614		106,674
Subordinated notes		49,486		49,486		49,486		49,486
Operating lease liabilities		2,036		2,224		2,058		2,137
Accrued interest payable		886		1,136		439		837
Other liabilities		18,095		14,366		15,619		15,248
Total liabilities		1,545,403		1,377,924		1,601,216		1,603,142
Stockholders’ equity:
Common stock, $1 par value, authorized 15,000,000 shares; issued 6,769,322 and 6,519,874 shares, respectively		6,769		6,520
Common stock, $1 par value, authorized 15,000,000 shares; issued 6,769,322						6,769		6,769
Surplus		59,307		55,727		59,307		59,307
Retained earnings		64,594		61,590		73,947		68,935
Accumulated other comprehensive loss, net of tax		(353)		(3,755)
Treasury stock; 289,214, and 243,638 shares, at cost, respectively		(5,950)		(5,044)
Accumulated other comprehensive income (loss), net of tax						(1,217)		1,528
Treasury stock; 406,846, and 289,214 shares, at cost, respectively						(8,098)		(5,950)
Total stockholders’ equity		124,367		115,038		130,708		130,589
Total liabilities and stockholders’ equity	$	1,669,770	$	1,492,962	$	1,731,924	$	1,733,731

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income (unaudited)


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
(In thousands, except per share amounts)	2020		2019		2020		2019		2021		2020
INTEREST INCOME
Interest and fees on loans	$	14,777	$	14,806	$	43,735	$	43,662	$	14,979	$	14,422
Interest and fees on loans held for sale		41		—		96		—		25		5
Interest on investment securities:
Taxable		781		831		2,367		2,857		667		813
Nontaxable		173		119		489		408		246		142
Federal funds sold, other interest-bearing deposits, and certificates of deposit in other banks		111		103		553		897		102		326
Dividends on other investments		75		66		247		199		83		100
Total interest income		15,958		15,925		47,487		48,023		16,102		15,808
INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market		310		1,047		1,546		4,217		309		947
Time deposit accounts $250,000 and over		327		475		1,089		1,761		210		413
Time deposits		623		801		2,067		2,268		461		752
Total interest expense on deposits		1,260		2,323		4,702		8,246		980		2,112
Interest on federal funds purchased and securities sold under agreements to repurchase		25		34		121		110		26		37
Interest on Federal Home Loan Bank advances		505		619		1,749		1,699		396		632
Interest on subordinated notes		326		588		1,208		1,821		310		501
Total interest expense on borrowings		856		1,241		3,078		3,630		732		1,170
Total interest expense		2,116		3,564		7,780		11,876		1,712		3,282
Net interest income		13,842		12,361		39,707		36,147		14,390		12,526
Provision for loan losses		1,200		450		5,400		850		—		3,300
Net interest income after provision for loan losses		12,642		11,911		34,307		35,297		14,390		9,226
NON-INTEREST INCOME
Service charges and other fees		816		953		2,181		2,701		739		799
Bank card income and fees		846		794		2,351		2,282		860		693
Trust department income		263		371		920		960		294		379
Real estate servicing fees, net		54		36		(48)		38		73		(87)
Gain on sale of mortgage loans, net		3,026		215		4,369		499		2,469		419
Other		70		55		183		157		8		88
Total non-interest income		5,075		2,424		9,956		6,637		4,443		2,291
Investment securities gains (losses), net		12		(40)		18		(40)		14		(1)
Gain on branch sale, net		—		109		—		2,183
NON-INTEREST EXPENSE
Salaries and employee benefits		6,771		5,366		19,404		16,220		7,146		6,121
Occupancy expense, net		781		909		2,303		2,348		771		766
Furniture and equipment expense		725		671		2,172		2,166		744		750
Processing, network, and bank card expense		877		893		2,806		2,867		1,007		976
Legal, examination, and professional fees		381		316		1,155		948		404		367
Advertising and promotion		316		343		786		884		243		249
Postage, printing, and supplies		227		181		661		650		204		241
FDIC insurance assessment		336		133		564		462
Loan expense										174		123
Other		1,202		778		3,260		2,604		958		898
Total non-interest expense		11,616		9,590		33,111		29,149		11,651		10,491
Income before income taxes		6,113		4,814		11,170		14,928		7,196		1,025
Income tax expense		1,153		954		2,060		2,882		1,357		157
Net income	$	4,960		3,860	$	9,110	$	12,046	$	5,839	$	868
Basic earnings per share	$	0.77	$	0.59	$	1.40	$	1.85	$	0.92	$	0.13
Diluted earnings per share	$	0.77	$	0.59	$	1.40	$	1.85	$	0.92	$	0.13

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (unaudited)


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
(In thousands)	2020		2019		2020		2019		2021		2020
Net income	$	4,960	$	3,860	$	9,110	$	12,046	$	5,839	$	868
Other comprehensive income, net of tax
Investment securities available-for-sale:
Unrealized gains on investment securities available-for-sale, net of tax		218		280		3,290		3,357
Unrealized (losses) gains on investment securities available-for-sale, net of tax										(2,778)		2,180
Adjustment for (gains) losses on sale of investment securities, net of tax		(10)		32		(15)		32		(2)		—
Defined benefit pension plans:
Amortization of prior service cost included in net periodic pension cost, net of tax		43		15		127		46		35		53
Total other comprehensive income		251		327		3,402		3,435
Total other comprehensive income (loss)										(2,745)		2,233
Total comprehensive income	$	5,211	$	4,187	$	12,512	$	15,481	$	3,094	$	3,101

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity (unaudited)



	For the Three Months Ended September 30, 2020 and 2019												For the Three Months Ended March 31, 2021 and 2020
							Accumulated				Total								Accumulated				Total
							Other				Stock -								Other				Stock -
	Common				Retained		Comprehensive		Treasury		holders'		Common				Retained		Comprehensive		Treasury		holders'
(In thousands)	Stock		Surplus		Earnings		Loss		Stock		Equity		Stock		Surplus		Earnings		Income (Loss)		Stock		Equity
Balance, June 30, 2020	$	6,520	$	59,556	$	60,412	$	(604)	$	(5,853)	$	120,031
Balance, December 31, 2020													$	6,769	$	59,307	$	68,935	$	1,528	$	(5,950)	$	130,589
Net income		0		0		4,960		0		0		4,960		0		0		5,839		0		0		5,839
Other comprehensive income		0		0		0		251		0		251
Other comprehensive loss														0		0		0		(2,745)		0		(2,745)
Purchase of treasury stock		0		0		0		0		(97)		(97)		0		0		0		0		(2,148)		(2,148)
Stock dividend		249		(249)		0		0		0		0
Cash dividends declared, common stock ($0.12 per share)		0		0		(778)		0		0		(778)
Balance, September 30, 2020	$	6,769	$	59,307	$	64,594	$	(353)	$	(5,950)	$	124,367
Cash dividends declared, common stock ($0.13 per share)														0		0		(827)		0		0		(827)
Balance, March 31, 2021													$	6,769	$	59,307	$	73,947	$	(1,217)	$	(8,098)	$	130,708

Balance, June 30, 2019	$	6,279	$	55,968	$	55,168	$	(2,991)	$	(5,044)	$	109,380
Net income		0		0		3,860		0		0		3,860
Other comprehensive income		0		0		0		327		0		327
Stock dividend		241		(241)		0		0		0		0
Cash dividends declared, common stock ($0.12 per share)		0		0		(753)		0		0		(753)
Balance, September 30, 2019	$	6,520	$	55,727	$	58,275	$	(2,664)	$	(5,044)	$	112,814

	For the Nine Months Ended September 30, 2020 and 2019
							Accumulated				Total
							Other				Stock -
	Common				Retained		Comprehensive		Treasury		holders'
(In thousands)	Stock		Surplus		Earnings		Loss		Stock		Equity
Balance, December 31, 2019	$	6,520	$	55,727	$	61,590	$	(3,755)	$	(5,044)	$	115,038	$	6,520	$	55,727	$	61,590	$	(3,755)	$	(5,044)	$	115,038
Net income		0		0		9,110		0		0		9,110		0		0		868		0		0		868
Other comprehensive income		0		0		0		3,402		0		3,402		0		0		0		2,233		0		2,233
Purchase of treasury stock		0		0		0		0		(906)		(906)		0		0		0		0		(719)		(719)
Stock dividend		249		3,580		(3,829)		0		0		0
Cash dividends declared, common stock ($0.36 per share)		0		0		(2,277)		0		0		(2,277)
Balance, September 30, 2020	$	6,769	$	59,307	$	64,594	$	(353)	$	(5,950)	$	124,367
Cash dividends declared, common stock ($0.12 per share)														0		0		(750)		0		0		(750)
Balance, March 31, 2020													$	6,520	$	55,727	$	61,708	$	(1,522)	$	(5,763)	$	116,670

Balance, December 31, 2018	$	6,279	$	50,173	$	54,105	$	(6,099)	$	(5,044)	$	99,414
Net income		0		0		12,046		0		0		12,046
Other comprehensive income		0		0		0		3,435		0		3,435
Stock dividend		241		5,554		(5,795)		0		0		0
Cash dividends declared, common stock ($0.34 per share)		0		0		(2,081)		0		0		(2,081)
Balance, September 30, 2019	$	6,520	$	55,727	$	58,275	$	(2,664)	$	(5,044)	$	112,814

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

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (unaudited)


	Nine Months Ended September 30,				Three Months Ended March 31,
(In thousands)	2020		2019		2021		2020
Cash flows from operating activities:
Net income	$	9,110	$	12,046	$	5,839	$	868
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		5,400		850		0		3,300
Depreciation expense		1,687		1,505		578		562
Net amortization of investment securities, premiums, and discounts		1,089		1,023		418		312
Change in fair value of mortgage servicing rights		686		543		121		275
Investment securities (gains) losses, net		(18)		40		(14)		1
(Gains) losses on sales and dispositions of premises and equipment		(87)		53
Losses (gains) on sales and dispositions of premises and equipment						4		(55)
Gain on sales and dispositions of other real estate		(219)		(102)		(15)		0
Gain on branch sale, net		0		(2,183)
Provision for other real estate owned		(3)		49		88		12
Increase in accrued interest receivable		(1,760)		(53)
Decrease in accrued interest receivable						152		218
Increase in cash surrender value - life insurance		(40)		(65)		(14)		(13)
Decrease in other assets		475		878
Increase in other assets						(1,756)		(312)
Operating lease liabilities		(188)		(140)		(79)		(62)
Decrease in accrued interest payable		(250)		(15)		(398)		(356)
Increase (decrease) in other liabilities		1,986		(1,466)		12		(1,367)
Origination of mortgage loans held for sale		(136,249)		(29,443)		(65,012)		(16,609)
Proceeds from the sale of mortgage loans held for sale		133,160		28,275		66,272		13,170
Gain on sale of mortgage loans, net		(4,369)		(499)		(2,469)		(419)
Other, net		(531)		(187)		(170)		(67)
Net cash provided by operating activities		9,879		11,109
Net cash provided by (used in) operating activities						3,557		(542)
Cash flows from investing activities:
Purchase of certificates of deposit in other banks		(735)		(988)		(245)		(735)
Proceeds from maturities of certificates of deposit in other banks		1,723		1,634		736		491
Net increase in loans		(110,554)		(3,959)
Net decrease (increase) in loans						11,000		(11,809)
Purchase of available-for-sale debt securities		(72,050)		(20,423)		(62,297)		(43,984)
Proceeds from maturities of available-for-sale debt securities		40,096		29,460		10,491		13,860
Proceeds from calls of available-for-sale debt securities		18,685		9,620		7,745		8,935
Proceeds from sales of available-for-sale debt securities		4,715		21,503		0		681
Purchases of FHLB stock		(1,891)		(6,522)		(327)		(1,491)
Proceeds from sales of FHLB stock		1,246		5,988		505		2
Purchases of premises and equipment		(1,246)		(1,903)		(135)		(369)
Proceeds from sales of premises and equipment		162		6		12		123
Proceeds from Bank owned life insurance policy		0		222
Payment for branch sale, net		0		(6,700)
Proceeds from sales of other real estate and repossessed assets		209		1,277		108		0
Net cash (used in) provided by investing activities		(119,640)		29,215
Net cash used in investing activities						(32,407)		(34,296)
Cash flows from financing activities:
Net increase in demand deposits		111,188		27,285		48,543		11,412
Net increase (decrease) in interest-bearing transaction accounts		51,020		(60,433)
Net decrease in interest-bearing transaction accounts						(15,193)		(18,037)
Net decrease in time deposits		(21,977)		(17,284)		(22,974)		(325)
Net increase in federal funds purchased and securities sold under agreements to repurchase		8,133		2,544
Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchase						(3,136)		3,492
Repayment of FHLB advances and other borrowings		(53,176)		(166,647)		(9,060)		(58)
FHLB advances		69,000		178,474		0		37,000
Purchase of treasury stock		(906)		0		(2,148)		(719)
Cash dividends paid - common stock		(2,252)		(1,931)		(842)		(753)
Net cash provided by (used in) financing activities		161,030		(37,992)
Net increase in cash and cash equivalents		51,269		2,332
Cash and cash equivalents, beginning of year		78,121		42,083
Cash and cash equivalents, end of year	$	129,390	$	44,415
Net cash (used in) provided by financing activities						(4,810)		32,012
Net decrease in cash and cash equivalents						(33,660)		(2,826)
Cash and cash equivalents, beginning of period						180,363		78,121
Cash and cash equivalents, end of period					$	146,703	$	75,295
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Cash paid during the period for:
Interest	$	8,029	$	11,891	$	2,109	$	3,639
Income taxes	$	797	$	2,280	$	0	$	0
Noncash investing and financing activities:
Other real estate and repossessed assets acquired in settlement of loans	$	73	$	411	$	30	$	0
Net deposits and fixed assets transferred to other assets related to the Branson branch sale	$	0	$	(8,885)
Right of use assets obtained in exchange for new operating lease liabilities	$	0	$	2,424
Stock dividends	$	3,829	$	5,795

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(1) Summary of Significant Accounting Policies

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

The accompanying unaudited consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2019.~~2020.

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. These estimates and assumptions are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including the effects of the Coronavirus Disease 2019 (“COVID-19”) pandemic, including its potential effects on the economic environment, our customers and our operations, as well as any changes to federal, state and local government laws, regulations and orders in connection with the pandemic. 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.

Stock Dividend On July 1, 2020, the Company paid a special stock dividend of 4 percent to shareholders of record at the close of business on June 15, 2020. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

~~CARES Act~~ Operating, Accounting and Reporting Considerations related to COVID-19~~On March 27, 2020,~~

The COVID-19 pandemic has negatively impacted the global economy, including the United States. In response to this crisis, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act ~~("CARES Act")~~ was passed by Congress and signed into law on March 27, 2020. The CARES Act, along with subsequent relief programs, provided substantial funding to fight the COVID-19 pandemic and stimulate the economy by supporting individuals and businesses through loans, grants, tax changes, and other types of relief. Some of the provisions applicable to the Company include, but are not limited to:

●

Accounting for Loan Modifications – Section 4013 of the CARES Act provides that a financial institution may elect to suspend (1) the requirements under GAAP for certain loan modifications that would otherwise be categorized as a TDR and (2) any determination that such loan modifications would be considered a TDR, including the related impairment for accounting purposes. See Note 2 Loans and Leases and the Allowance for Credit Losses for more information.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

●

Paycheck Protection Program - The CARES Act established the Paycheck Protection Program (“PPP”), an expansion of the Small Business Administration’s (“SBA”) 7(a) loan program and the Economic Injury Disaster Loan Program (“EIDL”), administered directly by the SBA. On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”) was signed into law. The CAA provides several amendments to the PPP, including additional funding for first and second draws of PPP loans up to March 31, 2021. On March 30, 2021, the PPP Extension Act of 2021 was signed into law, which extends the program to May 31, 2021. The Company is a participant in the PPP. See Note 2 Loans and Leases and the Allowance for Credit Losses for more information.

Also in response to the COVID-19 pandemic, the Board of Governors of the Federal Reserve System (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the National Credit Union Administration (“NCUA”), the Office of the Comptroller of the Currency (“OCC”), and the Consumer Financial Protection Bureau (“CFPB”), in consultation with the state financial regulators (collectively, the “agencies”) issued a joint interagency statement (issued March 22, 2020; revised statement issued April 7, 2020). Some of the provisions applicable to the Company include, but are not limited to:

●

Accounting for Loan Modifications - Loan modifications that do not meet the conditions of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. The agencies confirmed with FASB staff that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or insignificant delays in payment. See Note 2 Loans and Leases and the Allowance for Credit Losses for more information.

●

Past Due Reporting - With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral. A loan’s payment date is governed by the due date stipulated in the legal agreement. If a financial institution agrees to a payment deferral, these loans would not be considered past due during the period of the deferral.

●

Nonaccrual Status and Charge-offs - During short-term COVID-19 modifications, these loans generally should not be reported as nonaccrual or as classified.

The Company began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic. These modifications generally involve principal and/or interest payment deferrals for up to six months. These modifications generally meet the criteria of both Section 4013 of the CARES Act and the joint interagency statement, and therefore, the Company does not account for such loan modifications as TDRs. As the COVID-19 pandemic persists in negatively impacting the economy, the Company continues to offer additional loan modifications to borrowers struggling as a result of the pandemic. Similar to the initial modifications granted, the additional round of loan modifications are granted specifically under Section 4013 of the CARES Act and generally involve principal and/or interest payment deferrals for up to an additional six months for commercial and consumer loans, and principal-only deferrals for up to an additional 12 months for selected commercial loans. On August 3, 2020, the Federal Financial Institutions Examination Council on behalf of its members (collectively “the FFIEC members”) issued a joint statement on additional loan accommodations related to the COVID-19 pandemic. The joint statement clarifies that for loan modifications in which ~~in part, established~~Section 4013 is being applied, subsequent modifications could also be eligible under Section 4013. To be eligible, each loan modification must be (1) related to the COVID-19 event; (2) executed on a loan ~~program administered~~that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020. The December 31, 2020 deadline was subsequently extended to January 1, 2022, by the CAA. Substantially all of the Company’s additional round of loan modifications granted under Section 4013 of the CARES Act are in compliance with the aforementioned FFIEC requirements. Accordingly, the Company does not account for such loan modifications as TDRs.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(2) Loans and Allowance for Loan Losses

Loans

Major classifications within the Company’s held for investment loan portfolio at March 31, 2021 and December 31, 2020 is as follows:


	March 31,		December 31,
(in thousands)	2021		2020
Commercial, financial, and agricultural (a)	$	251,943	$	272,918
Real estate construction − residential		33,962		29,692
Real estate construction − commercial		78,576		78,144
Real estate mortgage − residential		258,259		262,339
Real estate mortgage − commercial		628,178		617,133
Installment and other consumer		25,267		26,741
Total loans held for investment	$	1,276,185	$	1,286,967

(a)	Includes $56.3 million and $63.3 million SBA PPP loans, net as of March 31, 2021 and December 31, 2020, respectively.

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, St. Louis, and the greater Kansas City metropolitan area. As such, the Bank is susceptible to changes in the economic environment in these communities. The Bank does not have a concentration of credit in any one economic sector. Installment and other consumer loans consist primarily of the financing of automotive vehicles. At March 31, 2021, loans of $552.5 million were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit.

Allowance for Loan Losses

The following table illustrates the changes in the allowance for loan losses by portfolio segment:


	Three Months Ended March 31, 2021
	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	$	5,121	$	213	$	475	$	2,679	$	9,354	$	264	$	7	$	18,113
Additions:
Provision for loan losses		(567)		83		57		(253)		573		13		94		—
Deductions:
Loans charged off		27		—		—		—		23		57		—		107
Less recoveries on loans		(149)		(13)		—		(168)		—		(25)		—		(355)
Net loan charge-offs (recoveries)		(122)		(13)		—		(168)		23		32		—		(248)
Balance at end of period	$	4,676	$	309	$	532	$	2,594	$	9,904	$	245	$	101	$	18,361

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)


	Three Months Ended March 31, 2020
	Commercial,		Real Estate		Real Estate		Real Estate		Real Estate		Installment
	Financial, &		Construction -		Construction -		Mortgage -		Mortgage -		and Other		Un-
(in thousands)	Agricultural		Residential		Commercial		Residential		Commercial		Consumer		allocated		Total
Balance at beginning of period	$	2,918	$	64	$	369	$	2,118	$	6,547	$	381	$	80	$	12,477
Additions:
Provision for loan losses		721		53		253		255		2,087		8		(77)		3,300
Deductions:
Loans charged off		41		—		—		19		22		52		—		134
Less recoveries on loans		(25)		—		—		(9)		(2)		(14)		—		(50)
Net loan charge-offs		16		—		—		10		20		38		—		84
Balance at end of period	$	3,623	$	117	$	622	$	2,363	$	8,614	$	351	$	3	$	15,693

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.

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. Management's look-back period began with loss history in the first quarter 2012 as the starting point through the ~~U.S. Small Business Administration ("SBA"), referred~~current quarter and it will continue to include this starting point going forward. The look-back period will continue to be evaluated and will be adjusted once a sustained loss producing downturn is recognized and found to be representative of historical losses expected for the current portfolio.

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 ~~Paycheck Protection Program ("PPP"). Under~~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.

When the COVID-19 pandemic surfaced in the first quarter of 2020, management reassessed the calculation of the allowance for loan loss by increasing the economic qualitative factor in order to capture the impact on the credit risk present in the loan portfolio given the economic environment that existed at that time. As of the fourth quarter of 2020, management reassessed the qualitative factor and economic indicators. Enough time had passed so that data after the outbreak would be available and a better interpretation of the impact of the virus on the economy. Management determined that the local market and economy had been able to transition to a functional level while adapting to the new requirements aimed at stopping the spread of the virus and returned to calculating the qualitative adjustment according to the Company's methodology detailed above.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

Additionally, the funding of $88.4 million and $40.2 million in SBA PPP loans during 2020 and 2021, respectively, required management to assess the methodology that would be adopted in regard to the allowance for loan losses applicable to these loans. As the SBA PPP loans are expected to be mostly paid off in the next six to twelve months and carry a 100% credit guarantee from the SBA, management determined that 0 allowance for loan losses was deemed necessary for these loans. At March 31, 2021 the net balance of the PPP ~~small businesses, sole proprietorships, independent contractors, non-profit organizations and self-employed individuals could apply for~~ loans ~~from existing~~totaled $56.3 million.

All SBA ~~lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Company is participating as a lender in the~~ PPP ~~program. All~~ loans have a 1% interest rate and the Company earns a fee that is based upon a tiered schedule corresponding with the amount of the loan to the borrower, which is deferred and recognized over the life of the loan. Based upon the borrower meeting certain criteria as defined by the CARES Act, the loan may be forgiven by the SBA. The Company reports these loans at their principal amount outstanding, net of unearned income, unamortized deferred loan fee income and loan origination costs. Interest is accrued as earned and loan origination fees and direct costs are deferred and accreted or amortized into interest income, as an adjustment to the yield, over the life of the loan using the level yield method. When a PPP loan is paid off or forgiven by the SBA, the remaining unaccreted or unamortized net origination fees or costs are immediately recognized into income.

~~HAWTHORN BANCSHARES, INC.~~

~~AND SUBSIDIARIES~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

The following ~~represents significant new accounting principles adopted in 2020:~~

~~Intangibles~~ ~~In August 2018,~~table illustrates the ~~FASB issued ASU 2018-15,~~ ~~Intangibles - Goodwill~~allowance for loan losses 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. The ASU did not have a material impact on the Company's Consolidated Financial Statements.

~~Fair Value MeasurementIn 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 ASU did not have a material impact on the Company's Consolidated Financial Statements.

~~(2) Loans and Allowance for Loan Losses~~

~~Loans~~

~~A summary of loans,~~recorded investment by ~~major class within the Company’s loan~~ portfolio ~~at September 30, 2020 and December 31, 2019 is as follows:~~segment:

September 30,

December 31,
(in thousands)

2020

2019
Commercial, financial, and agricultural (a)

$
293,801

$
199,022
Real estate construction - residential

27,722

23,035
Real estate construction - commercial

86,896

84,998
Real estate mortgage - residential

258,030

252,643
Real estate mortgage - commercial

584,559

576,635
Installment and other consumer

28,157

32,464
Total loans held for investment

$
1,279,165

$
1,168,797

~~(a)~~

~~Includes $85.6 million SBA PPP loans, net~~


	Commercial,		Real Estate		Real Estate		Real Estate		Real Estate		Installment
	Financial, and		Construction -		Construction -		Mortgage -		Mortgage -		and Other		Un-
(in thousands)	Agricultural		Residential		Commercial		Residential		Commercial		Consumer		allocated		Total
March 31, 2021
Allowance for loan losses:
Individually evaluated for impairment	$	2,134	$	26	$	28	$	256	$	2,691	$	9	$	0	$	5,144
Collectively evaluated for impairment		2,542		283		504		2,338		7,213		236		101		13,217
Total	$	4,676	$	309	$	532	$	2,594	$	9,904	$	245	$	101	$	18,361
Loans outstanding:
Individually evaluated for impairment	$	7,408	$	189	$	198	$	3,134	$	25,647	$	71	$	0	$	36,647
Collectively evaluated for impairment		244,535		33,773		78,378		255,125		602,531		25,196		0		1,239,538
Total	$	251,943	$	33,962	$	78,576	$	258,259	$	628,178	$	25,267	$	0	$	1,276,185

December 31, 2020
Allowance for loan losses:
Individually evaluated for impairment	$	2,187	$	27	$	28	$	263	$	2,594	$	14	$	0	$	5,113
Collectively evaluated for impairment		2,934		186		447		2,416		6,760		250		7		13,000
Total	$	5,121	$	213	$	475	$	2,679	$	9,354	$	264	$	7	$	18,113
Loans outstanding:
Individually evaluated for impairment	$	7,552	$	192	$	200	$	3,626	$	25,657	$	108	$	0	$	37,335
Collectively evaluated for impairment		265,366		29,500		77,944		258,713		591,476		26,633		0		1,249,632
Total	$	272,918	$	29,692	$	78,144	$	262,339	$	617,133	$	26,741	$	0	$	1,286,967

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, St. Louis, and the greater Kansas City metropolitan area. As such, the Bank is susceptible to changes in the economic environment in these communities. The Bank does not have a concentration of credit in any one economic sector. Installment and other consumer loans consist primarily of the financing of automotive vehicles. At September 30, 2020, loans of $578.5 million were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit.

811

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~Allowance for Loan Losses~~

~~The following table illustrates the changes in the allowance for loan losses by portfolio segment:~~

Three Months Ended September 30, 2020

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

$
3,614

$
171

$
722

$
2,711

$
9,048

$
306

$
50

$
16,622
Additions:
















Provision for loan losses

178

49

100

577

218

58

20

1,200
Deductions:
















Loans charged off

46

0

0

—

13

42

0

101
Less recoveries on loans

(11)

(13)

0

(4)

0

(15)

0

(43)
Net loan charge-offs (recoveries)

35

(13)

0

(4)

13

27

0

58
Balance at end of period

$
3,757

$
233

$
822

$
3,292

$
9,253

$
337

$
70

$
17,764

Nine Months Ended September 30, 2020

Commercial,

Real Estate

Real Estate

Real Estate

Real Estate

Installment

Financial, &

Construction -

Construction -

Mortgage -

Mortgage -

and Other

Un-

(in thousands)

Agricultural

Residential

Commercial

Residential

Commercial

Consumer

allocated

Total
Balance at beginning of period

$
2,918

$
64

$
369

$
2,118

$
6,547

$
381

$
80

$
12,477
Additions:
















Provision for loan losses

867

125

453

1,186

2,740

39

(10)

5,400
Deductions:
















Loans charged off

130

—

—

52

37

133

—

352
Less recoveries on loans

(102)

(44)

—

(40)

(3)

(50)

—

(239)
Net loan charge-offs (recoveries)

28

(44)

—

12

34

83

—

113
Balance at end of period

$
3,757

$
233

$
822

$
3,292

$
9,253

$
337

$
70

$
17,764

Three Months Ended September 30, 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

$
2,783

$
69

$
704

$
1,772

$
6,109

$
307

$
139

$
11,883
Additions:
















Provision for loan losses

155

3

97

252

(15)

62

(104)

450
Deductions:
















Loans charged off

61

—

—

86

6

60

—

213
Less recoveries on loans

(12)

(12)

—

(8)

(7)

(19)

—

(58)
Net loan charge-offs (recoveries)

49

(12)

—

78

(1)

41

—

155
Balance at end of period

$
2,889

$
84

$
801

$
1,946

$
6,095

$
328

$
35

$
12,178

Nine Months Ended September 30, 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

(232)

(81)

44

30

1,193

60

(164)

850
Deductions:
















Loans charged off

255

—

—

266

21

151

—

693
Less recoveries on loans

(139)

(25)

—

(111)

(9)

(85)

—

(369)
Net loan charge-offs (recoveries)

116

(25)

—

155

12

66

—

324
Balance at end of period

$
2,889

$
84

$
801

$
1,946

$
6,095

$
328

$
35

$
12,178

~~HAWTHORN BANCSHARES, INC.~~

~~AND SUBSIDIARIES~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

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.

In the first quarter of 2019, management adjusted the look-back period to begin with loss history in the first quarter 2012 as the starting point through the current quarter and it will continue to include this starting point going forward. At that time, Management determined that with the extended economic recovery then existing, the look-back period should be expanded to include the current economic cycle. The look-back period will be adjusted once a sustained 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. The look-back period is consistently evaluated for relevance given the current facts and circumstances.

As a result of rapidly increasing unemployment rates resulting from the COVID-19 virus, management determined that the first quarter 2020 allowance for loan loss economic qualitative adjustment should be temporarily adapted to utilize currently published statistics rather than the lagging statistics that had been utilized historically. While these lagging indicators have been very reliable for some time, they did not accurately capture the risk that has been brought about by rapid changes in the economy due to the pandemic. Based upon the change in the national unemployment rate available as of June 30, 2020, the economic qualitative adjustment was increased according to the Company’s methodology to account for uncertainty in economic conditions compared to the lookback period. As of September 30, 2020, and based on the continuing high rates of national unemployment as compared to historic levels, management believes this temporary alteration will be a better indicator until the economy stabilizes and the true impact can be measured.

Additionally, the funding of $88.4 million in PPP loans during the second and third quarter required management to assess the methodology that would be adopted in regard to the allowance for loan loss applicable to these loans. As the SBA PPP loans are expected to be mostly paid off in the next ~~six~~ ~~to twelve months and carry a 100% credit guarantee from the SBA, management determined that 0 allowance for loan loss was deemed necessary for these loans.~~

~~HAWTHORN BANCSHARES, INC.~~

~~AND SUBSIDIARIES~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

~~The following table illustrates the allowance for loan losses and recorded investment by portfolio segment:~~

Commercial,

Real Estate

Real Estate

Real Estate

Real Estate

Installment

Financial, and

Construction -

Construction -

Mortgage -

Mortgage -

and Other

Un-

(in thousands)

Agricultural

Residential

Commercial

Residential

Commercial

Consumer

allocated

Total
September 30, 2020
















Allowance for loan losses:
















Individually evaluated for impairment

$
142

$
0

$
85

$
276

$
63

$
15

$
0

$
581
Collectively evaluated for impairment

3,615

233

737

3,016

9,190

322

70

17,183
Total

$
3,757

$
233

$
822

$
3,292

$
9,253

$
337

$
70

$
17,764
Loans outstanding:
















Individually evaluated for impairment

$
1,376

$
0

$
552

$
3,777

$
2,277

$
113

$
0

$
8,095
Collectively evaluated for impairment

292,425

27,722

86,344

254,253

582,282

28,044

0

1,271,070
Total

$
293,801

$
27,722

$
86,896

$
258,030

$
584,559

$
28,157

$
0

$
1,279,165
















December 31, 2019
















Allowance for loan losses:
















Individually evaluated for impairment

$
311

$
0

$
0

$
264

$
23

$
17

$
0

$
615
Collectively evaluated for impairment

2,607

64

369

1,854

6,524

364

80

11,862
Total

$
2,918

$
64

$
369

$
2,118

$
6,547

$
381

$
80

$
12,477
Loans outstanding:
















Individually evaluated for impairment

$
1,514

$
0

$
137

$
3,856

$
1,711

$
177

$
0

$
7,395
Collectively evaluated for impairment

197,508

23,035

84,861

248,787

574,924

32,287

0

1,161,402
Total

$
199,022

$
23,035

$
84,998

$
252,643

$
576,635

$
32,464

$
0

$
1,168,797

Impaired Loans

Loans evaluated under ASC 310-10-35 include loans which are individually evaluated for impairment. All other loans are collectively evaluated for impairment under ASC 450-20. Impaired loans individually evaluated for impairment totaled ~~$8.1~~$36.6 million and ~~$7.4~~$37.3 million at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, 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 ~~September 30, 2020, $2.9~~March 31, 2021, $31.8 million of impaired loans were evaluated based on the fair value less estimated selling costs of the loans' collateral compared to ~~$3.0~~$32.2 million at December 31, ~~2019.~~2020. Once the impairment amount is calculated, a specific reserve allocation is recorded. At ~~September 30, 2020, $581,000~~March 31, 2021, $5.1 million of the Company’s allowance for loan losses was allocated to impaired loans totaling ~~$8.1~~$36.6 million compared to ~~$615,000~~$5.1 million of the Company’s allowance for loan losses allocated to impaired loans totaling approximately ~~$7.4~~$37.3 million at December 31, ~~2019.~~2020. Management determined that ~~$2.7~~$12.6 million, or ~~33%~~34%, of total impaired loans required no reserve allocation at ~~September 30, 2020~~March 31, 2021 compared to ~~$2.6~~$11.9 million, or ~~35%~~32%, at December 31, ~~2019,~~2020, 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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 are as follows:

September 30,

December 31,
(in thousands)

2020

2019
Non-accrual loans

$
5,632

$
4,754
Non-performing TDRs - 90 days past due

—

106
Performing TDRs

2,463

2,535
Total impaired loans

$
8,095

$
7,395

The following tables provide additional information about impaired loans at September 30, 2020 and December 31, 2019, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.

Unpaid


Recorded

Principal

Specific
(in thousands)

Investment

Balance

Reserves
September 30, 2020

With no related allowance recorded:






Commercial, financial and agricultural

$
170

$
222

$
—
Real estate - residential

1,354

1,442

—
Real estate - commercial

1,148

1,213

—
Total

$
2,672

$
2,877

$
—
With an allowance recorded:






Commercial, financial and agricultural

$
1,206

$
1,545

$
142
Real estate - construction commercial

552

598

85
Real estate - residential

2,423

2,875

276
Real estate - commercial

1,129

1,261

63
Installment and other consumer

113

121

15
Total

$
5,423

$
6,400

$
581
Total impaired loans

$
8,095

$
9,277

$
581


	March 31,		December 31,
(in thousands)	2021		2020
Non-accrual loans	$	34,233	$	34,559
Performing TDRs		2,414		2,776
Total impaired loans	$	36,647	$	37,335

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

Unpaid


Recorded

Principal

Specific
(in thousands)

Investment

Balance

Reserves
December 31, 2019






With no related allowance recorded:






Commercial, financial and agricultural

$
342

$
487

$
—
Real estate - construction commercial

137

173

—
Real estate - residential

697

784

—
Real estate - commercial

1,388

1,433

—
Installment and other consumer

12

12

—
Total

$
2,576

$
2,889

$
—
With an allowance recorded:






Commercial, financial and agricultural

$
1,172

$
1,470

$
311
Real estate - residential

3,159

3,482

264
Real estate - commercial

323

425

23
Installment and other consumer

165

189

17
Total

$
4,819

$
5,566

$
615
Total impaired loans

$
7,395

$
8,455

$
615

The following tables provide additional information about impaired loans at March 31, 2021 and December 31, 2020, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.


			Unpaid
	Recorded		Principal		Specific
(in thousands)	Investment		Balance		Reserves
March 31, 2021
With no related allowance recorded:
Commercial, financial and agricultural	$	1,837	$	1,882	$	—
Real estate mortgage − residential		1,275		1,377		—
Real estate mortgage − commercial		9,457		9,467		—
Total	$	12,569	$	12,726	$	—
With an allowance recorded:
Commercial, financial and agricultural	$	5,571	$	5,645	$	2,134
Real estate construction − residential		189		189		26
Real estate construction − commercial		198		251		28
Real estate mortgage − residential		1,859		2,304		256
Real estate mortgage − commercial		16,190		16,257		2,691
Installment and other consumer		71		75		9
Total	$	24,078	$	24,721	$	5,144
Total impaired loans	$	36,647	$	37,447	$	5,144

~~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 September 30,									Nine Months Ended September 30,
	2020				2019					2020					2019
			Interest				Interest						Interest				Interest
	Average		Recognized		Average		Recognized			Average			Recognized		Average		Recognized				Unpaid
	Recorded		For the		Recorded		For the			Recorded			For the		Recorded		For the		Recorded		Principal		Specific
(in thousands)	Investment		Period Ended		Investment		Period Ended			Investment			Period Ended		Investment		Period Ended		Investment		Balance		Reserves
December 31, 2020
With no related allowance recorded:
Commercial, financial and agricultural	$	172	$	128	$	851	$	0		$	1,289		$	128	$	1,036	$	0	$	1,703	$	1,731	$	—
Real estate - construction commercial		0		0		146		0			234			0		149		0
Real estate - residential		1,414		17		1,301		0	��		1,542			17		651		0
Real estate - commercial		861		0		380		0			907			13		393		0
Installment and other consumer		0		0		4		0			8			0		3		0
Real estate mortgage − residential																				1,300		1,395		—
Real estate mortgage − commercial																				8,943		8,943		—
Total	$	2,447	$	145	$	2,682	$	0		$	3,980		$	158	$	2,232	$	0	$	11,946	$	12,069	$	—
With an allowance recorded:
Commercial, financial and agricultural	$	1,359	$	8	$	1,086	$	9		$	1,226		$	27	$	1,095	$	30	$	5,849	$	6,180	$	2,187
Real estate - construction commercial		609		0		0		0			280			0		0		0
Real estate - residential		2,412		0		2,818		21			2,772			36		3,881		68
Real estate - commercial		1,133		8		1,112		9			911			14		788		25
Real estate construction − residential																				192		192		27
Real estate construction − commercial																				200		251		28
Real estate mortgage − residential																				2,326		2,786		263
Real estate mortgage − commercial																				16,714		16,787		2,594
Installment and other consumer		113		8		188		1			127	��		7		221		2		108		112		14
Total	$	5,626	$	24	$	5,204	$	40		$	5,316		$	84	$	5,985	$	125	$	25,389	$	26,308	$	5,113
Total impaired loans	$	8,073	$	169	$	7,886	$	40		$	9,296		$	242	$	8,217	$	125	$	37,335	$	38,377	$	5,113

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

~~September 30, 2020, respectively, compared~~The following table presents by class, information related to ~~$40,000~~the average recorded investment and ~~$125,000~~interest income recognized on impaired loans during the periods indicated.


	Three Months Ended March 31,
	2021					2020
				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	$	1,742		$	8	$	1,014	$	0
Real estate construction − commercial		0			0		227		0
Real estate mortgage − residential		1,424			9		1,581		0
Real estate mortgage − commercial		9,457			0		1,163		6
Installment and other consumer		0			0		12		0
Total	$	12,623		$	17	$	3,997	$	6
With an allowance recorded:
Commercial, financial and agricultural	$	5,696		$	7	$	1,195	$	8
Real estate construction − residential		190			0		0		0
Real estate construction − commercial		199			0		0		0
Real estate mortgage − residential		1,958			6		2,550		20
Real estate mortgage − commercial		16,195			7		370		2
Installment and other consumer		85			3		117		6
Total	$	24,323		$	23	$	4,232	$	36
Total impaired loans	$	36,946		$	40	$	8,229	$	42

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 $40,000 for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2021 compared to $42,000 for the three months ended March 31, 2020. 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 ~~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 September 30, 2020 and December 31, 2019.~~

Current or



90 Days




Less Than

Past Due

30 Days

30 - 89 Days

And Still

(in thousands)

Past Due

Past Due

Accruing

Non-Accrual

Total
September 30, 2020










Commercial, Financial, and Agricultural

$
292,823

$
100

$
0

$
878

$
293,801
Real Estate Construction - Residential

27,527

195

0

0

27,722
Real Estate Construction - Commercial

86,279

65

0

552

86,896
Real Estate Mortgage - Residential

254,632

987

175

2,236

258,030
Real Estate Mortgage - Commercial

581,990

636

0

1,933

584,559
Installment and Other Consumer

28,045

71

8

33

28,157
Total

$
1,271,296

$
2,054

$
183

$
5,632

$
1,279,165
December 31, 2019










Commercial, Financial, and Agricultural

$
197,828

$
212

$
0

$
982

$
199,022
Real Estate Construction - Residential

22,468

567

0

0

23,035
Real Estate Construction - Commercial

84,861

0

0

137

84,998
Real Estate Mortgage - Residential

249,516

688

304

2,135

252,643
Real Estate Mortgage - Commercial

575,140

136

0

1,359

576,635
Installment and Other Consumer

32,179

132

12

141

32,464
Total

$
1,161,992

$
1,735

$
316

$
4,754

$
1,168,797

The Company's past due and non-accrual loans at September 30, 2020 do not include $91.1 million of loans accepting forbearance. Their delinquency status will not change through the forbearance period as they are fulfilling the agreement they have made with the bank.

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, 2021 and December 31, 2020.


	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, 2021
Commercial, Financial, and Agricultural	$	245,019	$	333	$	0	$	6,591	$	251,943
Real estate construction − residential		33,773		0		0		189		33,962
Real estate construction − commercial		78,378		0		0		198		78,576
Real estate mortgage − residential		255,172		1,170		0		1,917		258,259
Real estate mortgage − commercial		602,502		367		0		25,309		628,178
Installment and Other Consumer		25,181		57		0		29		25,267
Total	$	1,240,025	$	1,927	$	0	$	34,233	$	1,276,185
December 31, 2020
Commercial, Financial, and Agricultural	$	265,821	$	380	$	0	$	6,717	$	272,918
Real estate construction − residential		29,500		0		0		192		29,692
Real estate construction − commercial		77,944		0		0		200		78,144
Real estate mortgage − residential		259,688		546		0		2,105		262,339
Real estate mortgage − commercial		591,815		4		0		25,314		617,133
Installment and Other Consumer		26,576		117		17		31		26,741
Total	$	1,251,344	$	1,047	$	17	$	34,559	$	1,286,967

The Company's past due and non-accrual loans at March 31, 2021 and December 31, 2020 do not include $43.5 million and $57.1 million of loans accepting forbearance under the CARES Act, respectively. Their delinquency status will not change through the forbearance period as they are fulfilling the agreement they have made with the Company. Of the total remaining $72.8 million loan modifications under the CARES Act, $29.3 million, are on nonaccrual status at March 31, 2021.

Credit Quality

The Company categorizes loans into risk categories based upon an internal rating system reflecting management’s risk assessment. Loans are placed on watch status when one or more weaknesses are identified that may result in the borrower being unable to meet repayment terms or the Company’s credit position could deteriorate at some future date. Loans classified as substandard are 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 a troubled 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 that are accruing interest are classified as performing TDRs. Loans classified as TDRs, that are not accruing interest are classified as nonperforming TDRs and are included with all other nonaccrual loans for presentation purposes. It is the Company’s policy to discontinue the accrual of interest income on loans when management believes that the collection of interest or principal is doubtful.

~~The following table presents the risk categories by class at September 30, 2020 and December 31, 2019.~~

Commercial,

Real Estate

Real Estate

Real Estate

Real Estate

Installment


Financial, &

Construction -

Construction -

Mortgage -

Mortgage -

and other

(in thousands)

Agricultural

Residential

Commercial

Residential

Commercial

Consumer

Total
At September 30, 2020














Watch

$
16,308

$
551

$
17,213

$
14,415

$
73,873

$
0

$
122,360
Substandard

608

0

0

1,073

584

0

2,265
Performing TDRs

498

0

0

1,541

344

80

2,463
Non-accrual loans

878

0

552

2,236

1,933

33

5,632
Total

$
18,292

$
551

$
17,765

$
19,265

$
76,734

$
113

$
132,720
At December 31, 2019














Watch

$
16,288

$
763

$
8,484

$
15,280

$
37,271

$
0

$
78,086
Substandard

3,249

0

273

2,291

677

0

6,490
Performing TDRs

532

0

0

1,615

352

36

2,535
Non-performing TDRs - 90 days past due

—

0

0

106

—

0

106
Non-accrual loans

982

0

137

2,135

1,359

141

4,754
Total

$
21,051

$
763

$
8,894

$
21,427

$
39,659

$
177

$
91,971

~~Troubled Debt Restructurings~~

At September 30, 2020, loans classified as TDRs totaled $3.6 million, of which $1.1 million were classified as non-performing TDRs and $2.5 million were classified as performing TDRs. At December 31, 2019, loans classified as TDRs totaled $4.1 million, of which $1.6 million were classified as non-performing TDRs and $2.5 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 $211,000 and $442,000 related to TDRs were allocated to the allowance for loan losses at September 30, 2020 and December 31, 2019, respectively.

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.

The ~~CARES Act provides all banks with~~following table presents the ~~option to elect either or both~~risk categories by class at March 31, 2021 and December 31, 2020.


	Commercial,		Real Estate		Real Estate		Real Estate		Real Estate		Installment
	Financial, &		Construction -		Construction -		Mortgage -		Mortgage -		and other
(in thousands)	Agricultural		Residential		Commercial		Residential		Commercial		Consumer		Total
At March 31, 2021
Watch	$	8,675	$	540	$	7,013	$	15,694	$	71,375	$	0	$	103,297
Substandard		581		0		2,670		954		1,645		0		5,850
Performing TDRs		817		0		0		1,217		338		42		2,414
Non-accrual loans		6,591		189		198		1,917		25,309		29		34,233
Total	$	16,664	$	729	$	9,881	$	19,782	$	98,667	$	71	$	145,794
At December 31, 2020
Watch	$	9,649	$	545	$	10,806	$	15,835	$	66,936	$	0	$	103,771
Substandard		598		0		0		1,002		1,662		0		3,262
Performing TDRs		835		0		0		1,521		343		77		2,776
Non-accrual loans		6,717		192		200		2,105		25,314		31		34,559
Total	$	17,799	$	737	$	11,006	$	20,463	$	94,255	$	108	$	144,368

Troubled Debt Restructurings

At March 31, 2021, loans classified as TDRs totaled $3.3 million, of ~~the following from March 1, 2020 until the earlier of~~which $0.9 million were classified as non-performing TDRs and $2.4 million were classified as performing TDRs. At December 31, 2020, loans classified as TDRs totaled $3.7 million, of which $0.9 million were classified as non-performing TDRs and $2.8 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 ~~date that is 60 days after the termination~~fair value of the ~~national emergency:~~

~~(i)~~underlying collateral less applicable selling costs. Accordingly, specific reserves of $172,000 and $214,000 related to ~~suspend~~TDRs were allocated to the ~~requirements under GAAP~~allowance for loan ~~modifications related to the COVID–19 pandemic that would otherwise be categorized as a TDR; and/or~~

~~(ii) to suspend any determination of a loan modified as a result of the effects of the COVID–19 pandemic as being a TDR, including impairment for accounting purposes.~~

If a bank elects a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan,losses at March 31, 2021 and ~~any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of~~ December 31, ~~2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic.~~2020, respectively.

As provided for by the CARES Act, the Company offered payment modifications to borrowers. ~~Disaster relief payment modifications granted to-date include approximately 578 loans totaling $303.2~~At March 31, 2021, $72.8 million, or ~~23.7% of the total loan portfolio. At September 30, 2020, 42 loans totaling $91.1 million, or 7.1%~~5.7% of total loans, remained in some form of a modification. These loan modifications include ~~$44.6~~$28.1 million, or ~~48.9%~~38.5%, on interest only, ~~and $46.5~~$39.6 million, or ~~51.1%~~54.5%, on full ~~deferral.~~deferral and $5.1 million, or 7.0%, with extended amortization. (See table below titled – Loan Modifications under the CARES Act by NAICS Code.)

As of September 30, 2020

Loan Modifications under the CARES Act by NAICS Code

Interest
%
Full
%

Industry Category

Only
Loans
Deferral
Loans
Totals
Real Estate and Rental and Leasing

$
13,003

14.3
%
$
3,343

3.7
%
$
16,346

Accommodations and Food Services

19,859

21.8

37,918

41.7

57,777

Construction

505

0.6

-

-

505

Cinemas

-

-

4,691

5.2

4,691

Retail Trade

-

-

119

0.1

119

Arts, Entertainment, Recreation

10,166

11.2

-

-

10,166

Non-NAICS (Consumer)

77

0.1

427

0.5

504

Other

943

1.0

-

-

943

Total modifications

$
44,553

48.9
%
$
46,498

51.1
%
$
91,051

Remaining loan modifications under the CARES Act as a percent of the total loan portfolio

7.1
%
Total loan modifications under the CARES Act to date

$
303,214

Total loan modifications under the CARES Act to date as a percent of the total loan portfolio

23.7
%

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

	Total Remaining Loan Modifications under the CARES Act by NAICS Code as of March 31, 2021
			% of					% of					% of
			Total Remaining			Full		Total Remaining					Total Remaining
	Interest		Loan			Deferral		Loan			Extended		Loan
Industry Category	Only		Modifications			(1)		Modifications			Amortizations		Modifications			Totals
(in thousands)
Real Estate and Rental and Leasing	$	4,521		6.2	%	$	5,790		8.0	%	$	499		0.7	%	$	10,810
Accommodations and Food Services		10,590		14.5			29,007		39.8			4,592		6.3			44,189
Construction		144		0.2			—		—			—		—			144
Lands and lots		1,553		2.1			—		—			—		—			1,553
Cinemas		1,086		1.5			4,691		6.4			—		—			5,777
Arts, Entertainment, Recreation		10,164		14.0			—		—			—		—			10,164
Non-NAICS (Consumer)		—		0.0			161		0.3			—		—			161
Total modifications	$	28,058		38.5	%	$	39,649		54.5	%	$	5,091		7.0	%	$	72,798

Remaining loan modifications under the CARES Act as a percent of the total loan portfolio5.7%

(1)

Of the $39.6 million loan modifications on full deferral, $29.3 million, or 40.3% of the total remaining loan modifications, were determined to be on nonaccrual status as of March 31, 2021.

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


	Nine Months Ended September 30,										Three Months Ended March 31,
	2020					2019					2021					2020
	Recorded Investment (1)					Recorded Investment (1)					Recorded Investment (1)					Recorded Investment (1)
	Number of	Pre-		Post-		Number of	Pre-		Post-		Number of	Pre-		Post-		Number of	Pre-			Post-
(in thousands)	Contracts	Modification		Modification		Contracts	Modification		Modification		Contracts	Modification		Modification		Contracts	Modification			Modification
Troubled Debt Restructurings
Commercial, financial and agricultural	—	$	—	$	—	2	$	80	$	80
Real estate mortgage - residential	1		111		119	—		—		—
Installment and other consumer	1		6		5	—		—		—	—	$	—	$	—	1	$	6	$		5
Total	2	$	117	$	124	2	$	80	$	80	—	$	—	$	—	1	$	6		$	5

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

The Company’s portfolio of loans classified as TDRs include concessions for the borrower given their financial condition such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. There were 0 loans meeting the TDR criteria that were modified during the three months ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~1 loan during the three months ended March 31, 2020. 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 in the process of foreclosure. There were 0 loans ~~and 1 loan~~ modified as a TDR that defaulted during any of the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~compared 0 loans and 1 loan during the three and nine months September 30, 2019,~~ respectively, and within twelve months of their modification date. See Lending and Credit Management section for further information.

Loans Held For Sale

~~(3) Other Real Estate Acquired in Settlement of Loans~~

September 30,

December 31,
(in thousands)

2020

2019
Commercial

$
960

$
1,155
Real estate construction - commercial

11,553

11,553
Real estate mortgage - residential

242

230
Real estate mortgage - commercial

2,799

2,799
Total

$
15,554

$
15,737
Less valuation allowance for other real estate owned

(2,953)

(2,956)
Total other real estate owned

$
12,601

$
12,781

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(3) Other Real Estate Acquired in Settlement of Loans


	March 31,		December 31,
(in thousands)	2021		2020
Commercial	$	920	$	920
Real estate construction - residential		—		—
Real estate construction - commercial		10,987		10,986
Real estate mortgage - residential		137		201
Real estate mortgage - commercial		2,798		2,798
Total	$	14,842	$	14,905
Less valuation allowance for other real estate owned		(2,702)		(2,614)
Total other real estate owned	$	12,140	$	12,291

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


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
	2020		2019		2020		2019		2021		2020
Balance at beginning of period	$	15,488	$	16,066	$	15,737	$	16,693	$	14,905	$	15,737
Additions		73		68		73		411		30		—
Proceeds from sales		(15)		(352)		(209)		(1,277)		(108)		—
Charge-offs against the valuation allowance for other real estate owned, net		0		0		0		(64)		0		0
Donation		—		—		(266)		—
Net gain on sales		8		83		219		102		15		0
Total other real estate owned	$	15,554	$	15,865	$	15,554	$	15,865	$	14,842	$	15,737
Less valuation allowance for other real estate owned		(2,953)		(2,987)		(2,953)		(2,987)		(2,702)		(2,968)
Balance at end of period	$	12,601	$	12,878	$	12,601	$	12,878	$	12,140	$	12,769

At ~~September 30, 2020, $217,000~~March 31, 2021, $285,000 of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to ~~$252,000~~$287,000 of consumer mortgage loans at December 31, ~~2019.~~2020.

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


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(in thousands)	2020		2019		2020		2019		2021		2020
Balance, beginning of period	$	2,968	$	2,956	$	2,956	$	3,002	$	2,614	$	2,956
Provision for other real estate owned		(15)		31		(3)		49		88		12
Charge-offs		0		0		0		(64)		0		0
Balance, end of period	$	2,953	$	2,987	$	2,953	$	2,987	$	2,702	$	2,968

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(4) Investment Securities

Available for sale securities

The amortized cost and fair value of debt securities classified as available-for-sale at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 were as follows:


	Total								Total
	Amortized		Gross Unrealized				Fair		Amortized		Gross Unrealized				Fair
(in thousands)	Cost		Gains		Losses		Value		Cost		Gains		Losses		Value
September 30, 2020
March 31, 2021
U.S. Treasury	$	2,774	$	30	$	0	$	2,804	$	3,018	$	23	$	0	$	3,041
U.S. government and federal agency obligations		6,122		201		0		6,323		20,161		76		(408)		19,829
U.S. government-sponsored enterprises		26,994		491		0		27,485		22,497		238		(184)		22,551
Obligations of states and political subdivisions		44,408		1,340		0		45,748		70,324		961		(467)		70,818
Mortgage-backed securities		90,822		2,156		(68)		92,910		108,106		1,586		(1,048)		108,644
Other debt securities (a)		10,000		234		(3)		10,231		11,825		209		(11)		12,023
Bank issued trust preferred securities (a)		1,486		0		(264)		1,222		1,486		0		(250)		1,236
Total available-for-sale securities	$	182,606	$	4,452	$	(335)	$	186,723	$	237,417	$	3,093	$	(2,368)	$	238,142

December 31, 2019
December 31, 2020
U.S. Treasury	$	987	$	8	$	0	$	995	$	2,772	$	26	$	0	$	2,798
U.S. government and federal agency obligations		8,124		0		(77)		8,047		11,732		197		0		11,929
U.S. government-sponsored enterprises		22,300		41		(58)		22,283		22,495		379		0		22,874
Obligations of states and political subdivisions		33,704		144		(59)		33,789		56,943		1,801		0		58,744
Mortgage-backed securities		105,522		522		(428)		105,616		88,357		1,809		(54)		90,112
Other debt securities (a)		3,000		53		0		3,053		10,000		358		(14)		10,344
Bank issued trust preferred securities (a)		1,486		0		(176)		1,310		1,486		0		(257)		1,229
Total available-for-sale securities	$	175,123	$	768	$	(798)	$	175,093	$	193,785	$	4,570	$	(325)	$	198,030

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

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

Debt securities with carrying values aggregating approximately ~~$164.4~~$197.6 million and ~~$139.8~~$153.9 million at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

The amortized cost and fair value of debt securities classified as available-for-sale at ~~September 30, 2020,~~March 31, 2021, 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			Amortized		Fair
(in thousands)	Cost		Value			Cost		Value
Due in one year or less	$	5,327	$	5,360		$	4,975	$	5,011
Due after one year through five years		21,969		22,261			18,245		18,456
Due after five years through ten years		40,550		41,708			35,184		35,589
Due after ten years		23,938		24,484			70,907		70,442
Total		91,784		93,813	��		129,311		129,498
Mortgage-backed securities		90,822		92,910			108,106		108,644
Total available-for-sale securities	$	182,606	$	186,723		$	237,417	$	238,142

Other 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, and Midwest Independent Bank (MIB) bankers bank stock, that do not have readily determinable fair values, are required for membership in those organizations.


	September 30,		December 31,		March 31,		December 31,
(in thousands)	2020		2019		2021		2020
Other securities:
FHLB stock	$	6,289	$	5,644	$	5,992	$	6,170
MIB stock		151		151		151		151
Equity securities with readily determinable fair values		12		13		45		32
Total other investment securities	$	6,452	$	5,808	$	6,188	$	6,353

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 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 September 30, 2020
At March 31, 2021
U.S. Treasury	$	1,530	$	0	$	0	$	0	$	1,530	$	0	$	1,022	$	0	$	250	$	0	$	1,272	$	0
U.S. government and federal agency obligations														14,447		(408)		0		0		14,447		(408)
U.S. government-sponsored enterprises														5,816		(184)		0		0		5,816		(184)
Obligations of states and political subdivisions														22,580		(467)		0		0		22,580		(467)
Mortgage-backed securities		8,957		(68)		0		0		8,957		(68)		46,969		(1,048)		0		0		46,969		(1,048)
Other debt securities		2,997		(3)		0		0		2,997		(3)		2,989		(11)		0		0		2,989		(11)
Bank issued trust preferred securities		0		0		1,222		(264)		1,222		(264)		0		0		1,236		(250)		1,236		(250)
Total	$	13,484	$	(71)	$	1,222	$	(264)	$	14,706	$	(335)	$	93,823	$	(2,118)	$	1,486	$	(250)	$	95,309	$	(2,368)

(in thousands)
At December 31, 2019
U.S. government and federal agency obligations	$	6,238	$	(69)	$	1,809	$	(8)	$	8,047	$	(77)
U.S. government-sponsored enterprises		5,949		(47)		7,488		(11)		13,437		(58)
Obligations of states and political subdivisions		10,729		(53)		1,931		(6)		12,660		(59)
At December 31, 2020
U.S. Treasury													$	1,015	$	0	$	0	$	0	$	1,015	$	0
Mortgage-backed securities		5,444		(37)		40,120		(391)		45,564		(428)		7,494		(54)		0		0		7,494		(54)
Other debt securities														2,987		(14)		0		0		2,987		(14)
Bank issued trust preferred securities		0		0		1,310		(176)		1,310		(176)		0		0		1,229		(257)		1,229		(257)
Total	$	28,360	$	(206)	$	52,658	$	(592)	$	81,018	$	(798)	$	11,496	$	(68)	$	1,229	$	(257)	$	12,725	$	(325)

The total available for sale portfolio consisted of approximately ~~305~~342 securities at ~~September 30, 2020.~~March 31, 2021. The portfolio included 1587 securities having an aggregate fair value of ~~$14.7~~$95.3 million that were in a loss position at ~~September 30,~~March 31, 2021. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $1.5 million at fair value at March 31, 2021. The $2.4 million aggregate unrealized loss included in accumulated other comprehensive loss at March 31, 2021 was caused by interest rate fluctuations.

The total available for sale portfolio consisted of approximately 308 securities at December 31, 2020. The portfolio included 10 securities having an aggregate fair value of $12.7 million that were in a loss position at December 31, 2020. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $1.2 million at fair value at ~~September 30,~~December 31, 2020. The ~~$335,000 aggregate unrealized loss included in accumulated other comprehensive loss at September 30, 2020 was caused by interest rate fluctuations.~~

The total available for sale portfolio consisted of approximately 322 securities at December 31, 2019. The portfolio included 128 securities having an aggregate fair value of $81.0 million that were in a loss position at December 31, 2019. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer had a fair value of $52.7 million at December 31, 2019. The $798,000$325,000 aggregate unrealized loss included in accumulated other comprehensive loss at December 31, ~~2019~~2020 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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively. In the absence of changes in credit quality of these investments, the fair value is expected to recover on all debt securities as they approach their maturity date or re-pricing date, or if market yields for such investments decline. In addition, the Company does not have the intent to sell these investments over the period of recovery, and it is not more likely than not that the Company will be required to sell such investment securities.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

The following table presents the ~~components of investment securities~~gross realized gains and losses from sales and calls of available-for-sale securities, as well as gains and losses on equity securities from fair value adjustments which have been recognized in earnings:


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(in thousands)	2020		2019		2020		2019		2021		2020
Investment securities gains (losses), net
Available for sale securities:
Gains realized on sales	$	21	$	6	$	27	$	6
Losses realized on sales		(8)		(46)		(8)		(46)
Gross realized gains									$	2	$	0
Gross realized losses										0		0
Other-than-temporary impairment recognized		0		0		0		0		0		0
Other investment securities:
Fair value adjustments, net		(1)		0		(1)		0		12		(1)
Investment securities gains (losses), net	$	12	$	(40)	$	18	$	(40)	$	14	$	(1)

The Company received $3.2 million and $4.7 million proceeds from the sale of available for sale debt securities and recognized net securities gains, which include the unrealized net losses related to equity securities, of $12,000 and $18,000 for the three and nine months September 30, 2020, respectively. This is compared to $21.5 million proceeds from the sale of available for sale of debt securities and recognized net securities losses of $40,000 for both the three and nine months ended September 30, 2019.

(5) Intangible Assets

Mortgage Servicing Rights

At ~~September 30, 2020,~~March 31, 2021, the Company was servicing approximately ~~$289.3~~$288.9 million of loans sold to the secondary market compared to ~~$271.4~~$292.7 million at December 31, ~~2019,~~2020, and ~~$270.8~~$270.6 million at ~~September 30, 2019.~~March 31, 2020. Mortgage loan servicing fees, reported in real estate servicing fees, net, earned on loans sold were ~~$215,000 and $638,000~~$193,000 for the three ~~and nine~~ months ended ~~September 30, 2020,~~March 31, 2021, compared to ~~$205,000 and $581,000~~$188,000 for the three ~~and nine~~ months ended ~~September 30, 2019.~~March 31, 2020.

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


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(in thousands)	2020		2019		2020		2019		2021		2020
Balance at beginning of period	$	2,145	$	2,657	$	2,482	$	2,931	$	2,445	$	2,482
Originated mortgage servicing rights		343		88		531		187		170		67
Changes in fair value:
Due to changes in model inputs and assumptions (1)		(21)		(77)		(340)		(318)		22		(198)
Other changes in fair value (2)		(140)		(93)		(346)		(225)		(143)		(77)
Total changes in fair value		(161)		(170)		(686)		(543)		(121)		(275)
Balance at end of period	$	2,327	$	2,575	$	2,327	$	2,575	$	2,494	$	2,274

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

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

The following key data and assumptions were used in estimating the fair value of the Company’s MSRs as of ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively:


	Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019			2021		2020
Weighted average constant prepayment rate		16.89	%	13.27	%		15.04	%	15.18	%
Weighted average note rate		3.67	%	3.95	%		3.47	%	3.91	%
Weighted average discount rate		7.75	%	8.75	%		7.75	%	8.25	%
Weighted average expected life (in years)		4.7		4.8			5.0		4.4

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


	September 30,		December 31,		March 31,		December 31,
(in thousands)	2020		2019		2021		2020
Federal funds purchased	$	0	$	0	$	0	$	0
Repurchase agreements		35,405		27,272		42,018		45,154
Total	$	35,405	$	27,272	$	42,018	$	45,154

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


Repurchase Agreements	Remaining Contractual Maturity of the Agreements								Remaining Contractual Maturity of the Agreements
	Overnight		Less		Greater				Overnight		Less		Greater
	and		than		than				and		than		than
(in thousands)	continuous		90 days		90 days		Total		continuous		90 days		90 days		Total
At September 30, 2020
At March 31, 2021
U.S. government-sponsored enterprises	$	17,967	$	0	$	0	$	17,967	$	8,757	$	0	$	0	$	8,757
Mortgage-backed securities		17,438		0		0		17,438		33,261		0		0		33,261
Total	$	35,405	$	0	$	0	$	35,405	$	42,018	$	0	$	0	$	42,018

At December 31, 2019
U.S. Treasury	$	754	$	0	$	0	$	754
At December 31, 2020
U.S. government and federal agency obligations									$	2,728	$	0	$	0	$	2,728
U.S. government-sponsored enterprises		12,853		0		0		12,853		15,533		0		0		15,533
Mortgage-backed securities		13,665		0		0		13,665		26,893		0		0		26,893
Total	$	27,272	$	0	$	0	$	27,272	$	45,154	$	0	$	0	$	45,154

(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 ~~September 30, 2020,~~March 31, 2021, operating right of use (ROU) assets and liabilities were $2.0 million and ~~$2.0~~$2.1 million,

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

respectively. As of ~~September 30, 2020,~~March 31, 2021, the weighted-average remaining lease term on these operating leases is approximately ~~7.9~~7.3 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 ROU 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 ROU 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. ROU 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 ROU 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 was ~~$86,000 and $252,000~~$100,000 for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to $86,000 ~~and $202,000~~ for the three ~~and nine~~ months ended ~~September 30, 2019 respectively.~~March 31, 2020.

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 ~~$15,000 and $75,000~~$13,000 for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$20,000 and $71,000~~$35,000 for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

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


	Operating		Operating
Lease payments due in:	Lease		Lease
(in thousands)
2020 (excluding 9 months ending September 30, 2020)	$	84
2021		317
2021 (excluding 3 months ending March 31, 2021)			$	276
2022		310		367
2023		312		366
2024		258		258
2025				257
Thereafter		1,087		830
Total lease payments		2,368		2,354
Less imputed interest		(332)		(296)
Total lease liabilities, as reported	$	2,036	$	2,058

(8) 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, 2021 compared to 15.3% for the three months ended March 31, 2020, respectively. The increase in the effective tax rate for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily attributable to the increase in earnings. The effective tax rate for each of the three

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 18.9% and 18.4% for the three and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, respectively, ~~compared to 19.8% and 19.3% for~~is lower than the ~~three and nine months ended September 30, 2019, respectively. The decrease in the effective tax~~U.S. federal statutory rate ~~for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was~~of 21% primarily ~~attributable to the impact of tax-free revenues. The decrease in the effective tax rate for the nine months ended September 30, 2020 was primarily attributable~~due to tax-free ~~revenues having a greater impact on pre-tax income due to the reduced level of earnings.~~revenues.

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. In management's opinion, the Company will more likely than not realize the benefits of its deferred tax assets and, therefore, has not established a valuation allowance against its deferred tax assets as of ~~September 30, 2020.~~March 31, 2021. 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.

The Company follows ASC Topic 740, Income Taxes, which addresses the accounting for uncertain tax positions. For each of the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively, the Company did not have any uncertain tax provisions, and did not record any related tax liabilities.

(9) Stockholders’ Equity

Accumulated Other Comprehensive ~~Loss~~Income (Loss)

The following details the change in the components of the Company’s accumulated other comprehensive ~~loss~~income (loss) for the ~~nine~~three months ended ~~September 30, 2020~~March 31, 2021 and ~~2019:~~2020:


	Nine Months Ended September 30, 2020						Three Months Ended March 31, 2021
					Accumulated						Accumulated
			Unrecognized Net		Other				Unrecognized Net		Other
	Unrealized		Pension and		Comprehensive		Unrealized		Pension and		Comprehensive
	Gains (Losses)		Postretirement		(Loss)		Gains (Losses)		Postretirement		Income
(in thousands)	on Securities (1)		Costs (2)		Income		on Securities (1)		Costs (2)		(Loss)
Balance at beginning of period	$	(23)	$	(3,732)	$	(3,755)	$	3,353	$	(1,825)	$	1,528
Other comprehensive income, before reclassifications		4,165		160		4,325		(3,518)		45		(3,473)
Amounts reclassified from accumulated other comprehensive (loss) income		(19)		—		(19)		(2)		—		(2)
Current period other comprehensive income, before tax		4,146		160		4,306
Income tax expense		(871)		(33)		(904)
Current period other comprehensive income, net of tax		3,275		127		3,402
Current period other comprehensive income (loss), before tax								(3,520)		45		(3,475)
Income tax benefit (expense)								740		(10)		730
Current period other comprehensive income (loss), net of tax								(2,780)		35		(2,745)
Balance at end of period	$	3,252	$	(3,605)	$	(353)	$	573	$	(1,790)	$	(1,217)

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

Nine Months Ended September 30, 2019

Accumulated

Unrecognized Net

Other

Unrealized

Pension and

Comprehensive

Gains (Losses)

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

4,250

58

4,308
Amounts reclassified from accumulated other comprehensive (loss) income

40

0

40
Current period other comprehensive income, before tax

4,290

58

4,348
Income tax expense

(901)

(12)

(913)
Current period other comprehensive income, net of tax

3,389

46

3,435
Balance at end of period

$
(66)

$
(2,598)

$
(2,664)


	Three Months Ended March 31, 2020

					Accumulated
			Unrecognized Net		Other
	Unrealized		Pension and		Comprehensive
	Gains (Losses)		Postretirement		Income
(in thousands)	on Securities (1)		Costs (2)		(Loss)
Balance at beginning of period	$	(23)	$	(3,732)	$	(3,755)
Other comprehensive income, before reclassifications		2,760		67		2,827
Amounts reclassified from accumulated other comprehensive income (loss)		0		0		0
Current period other comprehensive income, before tax		2,760		67		2,827
Income tax expense		(580)		(14)		(594)
Current period other comprehensive income, net of tax		2,180		53		2,233
Balance at end of period	$	2,157	$	(3,679)	$	(1,522)

(1)	The pre-tax amounts reclassified from accumulated other comprehensive ~~loss~~income (loss) are included in investment securities gains (losses), net in the consolidated statements of income.

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

(10) Employee Benefit Plans

Employee Benefits

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


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(in thousands)	2020		2019		2020		2019		2021		2020
Payroll taxes	$	305	$	256	$	1,030	$	871	$	435	$	389
Medical plans		446		432		1,370		1,360		450		427
401(k) match and profit sharing		490		349		1,134		928		499		306
Periodic pension cost		404		358		1,211		1,073		416		464
Other		14		15		42		40		4		23
Total employee benefits	$	1,659	$	1,410	$	4,787	$	4,272	$	1,804	$	1,609

The Company’s profit-sharing plan includes a matching 401(k) portion, in which the Company matches the first 3% of eligible employee contributions. The Company makes 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.

Other Plans

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.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

As of ~~September 30, 2020,~~March 31, 2021, the accrued liability was ~~$880,000~~$1.1 million and the expense for ~~both~~ the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020 was $97,000 and ~~2019 was~~ $80,000, ~~and $240,000,~~ respectively, and is recognized over the required service period.

Pension

The Company provides a noncontributory defined benefit pension plan for all full-time eligible employees. Beginning January 1, 2018 and for all retrospective periods presented, the Company adopted the guidance under ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Under the new guidance, only the service cost component of the net periodic benefit cost is reported in the same income statement line item as salaries and benefits, and the remaining components are reported as other non-interest expense. An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. The Company made a pension contribution of ~~$500,000~~$1.0 million on March ~~25, 2020.~~ 22, 2021.

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.

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

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


	Pension Benefits				Pension Benefits
(in thousands)	2020		2019		2021		2020
Service cost - benefits earned during the year	$	1,614	$	1,431	$	1,663	$	1,857
Interest costs on projected benefit obligations (a)		1,127		1,168		1,023		1,159
Expected return on plan assets (a)		(1,598)		(1,467)		(1,825)		(1,572)
Expected administrative expenses (a)		110		122		104		110
Amortization of prior service cost (a)		50		79		—		50
Amortization of unrecognized net loss (a)		164		0		181		218
Net periodic pension cost	$	1,467	$	1,333	$	1,146	$	1,822

Net periodic pension cost for the three months ended September 30, (actual)	$	404	$	358
Net periodic pension cost for the nine months ended September 30, (actual)	$	1,211	$	1,073

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

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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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.

(11) Earnings per Share

Stock Dividend

On July 1, 2020, the Company paid a special stock dividend of 4% to common shareholders of record at the close of business on June 15, 2020. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

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

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


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(dollars in thousands, except per share data)	2020		2019		2020		2019		2021		2020
Basic earnings per share:
Net income available to shareholders	$	4,960	$	3,860	$	9,110	$	12,046	$	5,839	$	868
Average shares outstanding		6,483,429		6,525,684		6,493,054		6,525,684		6,362,869		6,510,189
Basic earnings per share	$	0.77	$	0.59	$	1.40	$	1.85	$	0.92	$	0.13
Diluted earnings per share:
Net income available to shareholders	$	4,960	$	3,860	$	9,110	$	12,046	$	5,839	$	868
Average shares outstanding		6,483,429		6,525,684		6,493,054		6,525,684		6,362,869		6,510,189
Effect of dilutive stock options		0		0		0		0		0		0
Average shares outstanding including dilutive stock options		6,483,429		6,525,684		6,493,054		6,525,684		6,362,869		6,510,189
Diluted earnings per share	$	0.77		0.59	$	1.40		1.85	$	0.92		0.13

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. There were 0 shares for the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 that were omitted from the computation of diluted earnings per share as a result of being considered anti-dilutive.

Repurchase Program

In ~~the third quarter of 2020,~~2019, the Company's Board of Directors authorized the purchase of up to ~~$2.5~~$5.0 million market value of the Company's common stock. Management was given discretion to determine the number and pricing of the shares to be purchased, as well as, the timing of any such purchases. During the three months ended March 31, 2021 the Company repurchased 117,632 shares at an average cost of $18.26 per share totaling $2.1 million. As of ~~September 30, 2020, $2.4~~March 31, 2021, $1.9 million remained available for the repurchase of shares pursuant to the share repurchase ~~pursuant to that~~ authorization.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(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.

The fair value hierarchy is as follows:

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

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

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

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

Valuation Methods for Assets and 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.

Equity securities with readily determinable fair values are recorded at fair value, with changes in fair value reflected in earnings. The Company uses level 1 inputs to value equity securities that are traded in active markets. Equity securities that do not have readily determinable fair values are carried at cost and are periodically assessed for impairment. Equity securities that are not actively traded are classified in level 2.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

Mortgage Servicing Rights

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


			Fair Value Measurements								Fair Value Measurements
			Quoted Prices								Quoted Prices
			in Active								in Active
			Markets for		Other		Significant				Markets for		Other		Significant
			Identical		Observable		Unobservable				Identical		Observable		Unobservable
			Assets		Inputs		Inputs				Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)		Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2020
March 31, 2021
Assets:
U.S. Treasury	$	2,804	$	2,804		0	$	0	$	3,041	$	3,041		0	$	0
U.S. government and federal agency obligations		6,323		0		6,323		0		19,829		0		19,829		0
U.S. government-sponsored enterprises		27,485		0		27,485		0		22,551		0		22,551		0
Obligations of states and political subdivisions		45,748		0		45,748		0		70,818		0		70,818		0
Mortgage-backed securities		92,910		0		92,910		0		108,644		0		108,644		0
Other debt securities		10,231		0		10,231		0		12,023		0		12,023		0
Bank-issued trust preferred securities		1,222		0		1,222		0		1,236		0		1,236		0
Equity securities		12		12		0		0		45		45		0		0
Mortgage servicing rights		2,327		0		0		2,327		2,494		0		0		2,494
Total	$	189,062	$	2,816	$	183,919	$	2,327	$	240,681	$	3,086	$	235,101	$	2,494

December 31, 2019
December 31, 2020
Assets:
U.S. Treasury	$	995	$	995		0	$	0	$	2,798	$	2,798		0	$	0
U.S. government and federal agency obligations		8,047		0		8,047		0		11,929		0		11,929		0
U.S. government-sponsored enterprises		22,283		0		22,283		0		22,874		0		22,874		0
Obligations of states and political subdivisions		33,789		0		33,789		0		58,744		0		58,744		0
Mortgage-backed securities		105,616		0		105,616		0		90,112		0		90,112		0
Other debt securities		3,053		0		3,053		0		10,344		0		10,344		0
Bank-issued trust preferred securities		1,310		0		1,310		0		1,229		0		1,229		0
Equity securities		13		13		0		0		32		32		0		0
Mortgage servicing rights		2,482		0		0		2,482		2,445		0		0		2,445
Total	$	177,588	$	1,008	$	174,098	$	2,482	$	200,507	$	2,830	$	195,232	$	2,445

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(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				Fair Value Measurements Using				Fair Value Measurements Using
	(Level 3)				(Level 3)				(Level 3)
	Mortgage Servicing Rights				Mortgage Servicing Rights				Mortgage Servicing Rights
	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(in thousands)	2020		2019		2020		2019		2021		2020
Balance at beginning of period	$	2,145	$	2,657	$	2,482	$	2,931	$	2,445	$	2,482
Total (losses) or gains (realized/unrealized):
Included in earnings		(161)		(170)		(686)		(543)		(121)		(275)
Included in other comprehensive income		0		0		0		0		0		0
Purchases		0		—		0		0		0		0
Sales		0		0		0		0		0		0
Issues		343		88		531		187		170		67
Settlements		0		0		0		0		0		0
Balance at end of period	$	2,327	$	2,575	$	2,327	$	2,575	$	2,494	$	2,274

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 ~~September 30, 2020,~~March 31, 2021, the Company identified ~~$2.9~~$31.8 million in collateral dependent impaired loans that had specific allowances for losses aggregating ~~$178,000.~~$4.7 million. Related to these loans, there were ~~$36,000 and $129,000~~$23,000 in charge-offs recorded during the three ~~and nine~~ months ended ~~September 30, 2020, respectively.~~March 31, 2021. As of ~~September 30, 2019,~~March 31, 2020 the Company identified ~~$2.9~~$5.8 million in collateral dependent impaired loans that had specific allowances for losses aggregating ~~$398,000.~~$0.2 million. Related to these loans, there were ~~$77,000 and $204,000~~$55,000 in charge-offs recorded during the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

Other Real Estate and Foreclosed Assets

Other real estate owned (OREO) and foreclosed assets consisted of loan collateral that has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Subsequent to foreclosure, these assets initially are carried at fair value of the collateral less estimated selling costs. Fair value, when recorded, is generally based

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												Fair Value Measurements Using
			Quoted Prices												Quoted Prices
			in Active						Three Months		Nine Months				in Active
			Markets for		Other		Significant		Ended		Ended				Markets for		Other		Significant
			Identical		Observable		Unobservable		September 30,		September 30,				Identical		Observable		Unobservable
	Total		Assets		Inputs		Inputs		Total Gains		Total Gains		Total		Assets		Inputs		Inputs		Total Gains
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)		(Losses)*		(Losses)*		Fair Value		(Level 1)		(Level 2)		(Level 3)		(Losses)*
September 30, 2020
March 31, 2021
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural													$	4,188	$	0	$	0	$	4,188	$	—
Real estate mortgage - residential														403		0		0		403		—
Real estate mortgage - commercial														22,484		0		0		22,484		(23)
Total													$	27,075	$	0	$	0	$	27,075	$	(23)
Other real estate and repossessed assets													$	12,140	$	0	$	0	$	12,140	$	(73)

March 31, 2020
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural	$	308	$	0	$	0	$	308	$	(20)	$	(20)	$	2,422	$	0	$	0	$	2,422	$	—
Real estate construction - commercial		360		0		0		360		0		0		408		0		0		408		0
Real estate mortgage - residential		454		0		0		454		0		(52)		1,921		0		0		1,921		(19)
Real estate mortgage - commercial		1,635		0		0		1,635		(13)		(37)		827		0		0		827		(22)
Installment and other consumer		0		0		0		0		(3)		(20)		12		0		0		12		(14)
Total	$	2,757	$	0	$	0	$	2,757	$	(36)	$	(129)	$	5,590	$	0	$	0	$	5,590	$	(55)
Other real estate and repossessed assets	$	12,601	$	0	$	0	$	12,601	$	23	$	222	$	12,769	$	0	$	0	$	12,769	$	(12)

September 30, 2019
Assets:
Collateral dependent impaired loans:
Commercial, financial, & agricultural	$	529	$	0	$	0	$	529	$	(23)	$	(132)
Real estate construction - commercial		145		0		0		145		0		0
Real estate mortgage - residential		933		0		0		933		(45)		(45)
Real estate mortgage - commercial		860		0		0		860		(5)		(15)
Installment and other consumer		13		0		0		13		(4)		(12)
Total	$	2,480	$	0	$	0	$	2,480	$	(77)	$	(204)
Other real estate and repossessed assets	$	12,878	$	0	$	0	$	12,878	$	10	$	(166)

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

~~HAWTHORN BANCSHARES, INC.~~

~~AND SUBSIDIARIES~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

(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:

Loans

Fair values are estimated for portfolios with similar financial characteristics. Loans are segregated by type, such as commercial, real estate, and consumer. Each loan category is further segmented into fixed and variable interest rate categories. The fair value of loans, 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

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

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.

Loans Held for Sale

Loans originated and intended to be sold in the secondary market, generally 1-4 family residential mortgage loans, are carried, in aggregate, at the lower of cost or estimated fair value. The estimated fair value measurements of loans held for sale are management's best estimate of market value, which is primarily based on quoted market prices for similar loans in the secondary market.

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 the Fair Value Measurement section above. A schedule of investment securities by category and maturity is provided in the notes on Investment Securities.

Other investment securities

Equity securities 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 are periodically assessed for impairment. The Company uses level 1 inputs to value equity securities that are traded in active markets.

Federal Funds Sold, Cash, and Due from Banks

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

~~HAWTHORN BANCSHARES, INC.~~

~~AND SUBSIDIARIES~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

Certificates of Deposit in other banks

Certificates of deposit are other investments made by the Company with other financial institutions that are carried at cost which is equal to fair value.

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.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

Accrued Interest Receivable and Payable

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

Deposits

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

Federal funds purchased and 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.

Operating Lease Liabilities

The fair value of 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.

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

A summary of the carrying amounts and fair values of the Company’s financial instruments at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 is as follows:


					September 30, 2020										March 31, 2021
					Fair Value Measurements										Fair Value Measurements
						Quoted Prices										Quoted Prices
					in Active				Net						in Active				Net
					Markets for		Other		Significant						Markets for		Other		Significant
	September 30, 2020				Identical		Observable		Unobservable		March 31, 2021				Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs		Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	amount		value		(Level 1)		(Level 2)		(Level 3)		amount		value		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	17,340	$	17,340	$	17,340	$	0	$	0	$	18,496	$	18,496	$	18,496	$	0	$	0
Federal funds sold and overnight interest-bearing deposits		112,050		112,050		112,050		0		0		128,207		128,207		128,207		0		0
Certificates of deposit in other banks		9,874		9,874		9,874		0		0		8,897		8,897		8,897		0		0
Available for sale securities		186,723		186,723		2,804		183,919		0		238,142		238,142		3,041		235,101		0
Other investment securities		6,452		6,452		12		6,440		0		6,188		6,188		45		6,143		0
Loans, net		1,261,401		1,388,523		0		0		1,388,523		1,257,824		1,283,560		0		0		1,283,560
Loans held for sale		7,886		8,203		0		0		8,203		6,308		6,308		0		0		6,308
Cash surrender value - life insurance		2,438		2,438		0		2,438		0		2,465		2,465		0		2,465		0
Accrued interest receivable		8,241		8,241		8,241		0		0		6,488		6,488		6,488		0		0
Total	$	1,612,405	$	1,739,844	$	150,321	$	192,797	$	1,396,726	$	1,673,015	$	1,698,751	$	165,174	$	243,709	$	1,289,868
Liabilities:
Deposits:
Non-interest bearing demand	$	372,355	$	372,355	$	372,355	$	0	$	0	$	431,035	$	431,035	$	431,035	$	0	$	0
Savings, interest checking and money market		665,351		665,351		665,351		0		0		708,615		708,615		708,615		0		0
Time deposits		289,046		291,547		0		0		291,547		254,332		256,047		0		0		256,047
Federal funds purchased and securities sold under agreements to repurchase		35,405		35,405		35,405		0		0		42,018		42,018		42,018		0		0
Federal Home Loan Bank advances and other borrowings		112,743		116,630		0		116,630		0		97,614		99,750		0		99,750		0
Subordinated notes		49,486		40,682		0		40,682		0		49,486		41,176		0		41,176		0
Operating lease liabilities		2,036		2,036				2,036				2,058		2,058		0		2,058		0
Accrued interest payable		886		886		886		0		0		439		439		439		0		0
Total	$	1,527,308	$	1,524,892	$	1,073,997	$	159,348	$	291,547	$	1,585,597	$	1,581,138	$	1,182,107	$	142,984	$	256,047

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)


					December 31, 2019										December 31, 2020
					Fair Value Measurements										Fair Value Measurements
					Quoted Prices										Quoted Prices
					in Active				Net						in Active				Net
					Markets for		Other		Significant						Markets for		Other		Significant
	December 31, 2019				Identical		Observable		Unobservable		December 31, 2020				Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs		Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	amount		value		(Level 1)		(Level 2)		(Level 3)		amount		value		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	22,576	$	22,576	$	22,576	$	0	$	0	$	19,235	$	19,235	$	19,235	$	0	$	0
Federal funds sold and overnight interest-bearing deposits		55,545		55,545		55,545		0		0		161,128		161,128		161,128		0		0
Certificates of deposit in other banks		10,862		10,862		10,862		0		0		9,376		9,376		9,376		0		0
Available-for-sale securities		175,093		175,093		995		174,098		0		198,030		198,030		2,798		195,232		0
Other investment securities		5,808		5,808		13		5,795		0		6,353		6,353		32		6,321		0
Loans, net		1,156,320		1,148,339		0		0		1,148,339		1,268,854		1,288,677		0		0		1,288,677
Loans held for sale		428		435		0		0		435		5,099		5,279		0		0		5,279
Cash surrender value - life insurance		2,398		2,398		0		2,398		0		2,451		2,451		0		2,451		0
Accrued interest receivable		6,481		6,481		6,481		0		0		6,640		6,640		6,640		0		0
	$	1,435,511	$	1,427,537	$	96,472	$	182,291	$	1,148,774	$	1,677,166	$	1,697,169	$	199,209	$	204,004	$	1,293,956
Liabilities:
Deposits:
Non-interest bearing demand	$	261,166	$	261,166	$	261,166	$	0	$	0	$	382,492	$	382,492	$	382,492	$	0	$	0
Savings, interest checking and money market		614,331		614,331		614,331		0		0		723,808		723,808		723,808		0		0
Time deposits		311,024		311,489		0		0		311,489		277,306		279,569		0		0		279,569
Federal funds purchased and securities sold under agreements to repurchase		27,272		27,272		27,272		0		0		45,154		45,154		45,154		0		0
Federal Home Loan Bank advances and other borrowings		96,919		97,833		0		97,833		0		106,674		110,121		0		110,121		0
Subordinated notes		49,486		43,640		0		43,640		0		49,486		40,929		0		40,929		0
Operating lease liabilities		2,224		2,224		0		2,224		0		2,137		2,137		0		2,137		0
Accrued interest payable		1,136		1,136		1,136		0		0		837		837		837		0		0
	$	1,363,558	$	1,359,091	$	903,905	$	143,697	$	311,489	$	1,587,894	$	1,585,047	$	1,152,291	$	153,187	$	279,569

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) 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 ~~September 30, 2020,~~March 31, 2021, 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:


	September 30,		December 31,		March 31,		December 31,
(in thousands)	2020		2019		2021		2020
Commitments to extend credit	$	295,265	$	240,758	$	350,465	$	264,528
Commitments to originate residential first and second mortgage loans		56,357		3,980		50,340		51,270
Standby letters of credit		74,635		97,348		20,810		125,800
Total		426,257		342,086		421,615		441,598

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 ~~September 30, 2020.~~March 31, 2021.

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

~~HAWTHORN BANCSHARES, INC.~~

~~AND SUBSIDIARIES~~

~~Notes to the Consolidated Financial Statements~~

~~(Unaudited)~~

for all legal matters for which it deems a loss is probable and can be reasonably estimated. Some legal matters, which are at early stages in the legal process, have not yet progressed to the point where a loss is deemed probable or an amount can be estimated.

~~(15) Revenue Recognition~~

~~On January 1, 2018, the Company adopted ASU No. 2014-09,~~ ~~Revenue from Contracts with Customers (Topic 606)~~ ~~and all subsequent ASUs that modified Topic 606.~~

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 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 current business practices or result in any changes to the Company’s consolidated financial statements.

~~Descriptions of our revenue-generating activities within the scope of this guidance, which are presented in our income statement as components of noninterest income are as follows:~~

●

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.~~

3837

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 words believes, expects, may, will, should, could, anticipates, estimates, intends, plans, hopes 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 any integration of any 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,

●

changes may occur in the securities markets and,

●

effects of the COVID-19 pandemic, or other adverse external events.

We have described under the caption Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2019,~~2020, 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 $1.7 billion in assets at ~~September 30, 2020,~~March 31, 2021, 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, St. Louis, and the greater Kansas City metropolitan area.

The Company’s primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the Company’s business is commercial, commercial real estate development, and residential mortgage

3938

lending. The Company’s income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing activity.

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

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

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

Significant Developments and Transactions

Each item listed below materially affects the comparability of our results of operations for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ and our financial condition as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, and may affect the comparability of financial information we report in future fiscal periods.

Impact of COVID-19. The ~~progression of the~~ COVID-19 pandemic and related restrictive measures taken by governments, businesses and individuals caused unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States ~~has had an adverse impact on our financial condition~~ and ~~results of operations as of and for~~globally, including the ~~three months ended September 30,~~markets that we serve. As the restrictive measures have been eased during 2020 and ~~is expected~~into 2021, the U.S. economy has begun to ~~have~~recover and with the availability and distribution of a ~~complex~~COVID-19 vaccine, we anticipate continued improvements in commercial and ~~significant adverse impact on~~consumer activity and the ~~economy,~~U.S. economy. As of June 16, 2020, the ~~banking industry~~governor of Missouri rescinded all COVID-19 related statewide public health orders. He announced it would be the responsibility of local officials to put further measures and ~~our Company~~regulations in ~~future fiscal periods, all subject to a high degree of uncertainty.~~place.

Effects on Our Market Areas. Our commercial and consumer banking products and services are delivered primarily in Missouri, where individual and governmental responses to the COVID-19 pandemic have led to a broad curtailment of economic activity ~~beginning March 2020. In Missouri,~~While positive headwinds exist, we recognize that our business and consumer customers are experiencing varying degrees of financial distress, which is expected to continue into the ~~Director~~second quarter of 2021, especially if new COVID-19 variant infections increase and new economic restrictions are mandated. Commercial activity has improved, but has not returned to the levels existing prior to the outbreak of the ~~Missouri Department~~pandemic, which may result in our customers’ inability to meet their loan obligations to us. In addition, the economic pressures and uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors, which may negatively impact the demand for loans and other services we offer. Our borrowing base includes customers in industries hotel/lodging, restaurants, entertainment, retail and commercial real estate, all of ~~Health and Senior Services issued an order~~which have been significantly impacted by the COVID-19 pandemic. We recognize that ~~individuals stay at home and that businesses abide by certain limitations~~these industries may take longer to recover as consumers may be hesitant to return to full social interaction or may change their spending habits on ~~gathering sizes. This order was effective from April 6, 2020 and extended through May 3, 2020. Effective May 4, 2020,~~a more permanent basis as a result of the ~~governor of Missouri announced a partial relaxation of~~pandemic. We continue to monitor these limitations by lifting the stay at home order for individuals and allowing businesses to reopen subject to social distancing guidelines. The Bank and its branches remained open during these orders because banking is deemed an essential business, although it suspended lobby access at its branches from March 18, 2020 until May 4, 2020. Effective June16, 2020 the governor of Missouri rescinded all COVID-19 related statewide public health orders. He announced it would be the responsibility of local officials to put further measures and regulations in place.

customers closely.

4039

~~Policy and Regulatory Developments~~~~. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:~~

●

~~The Federal Reserve decreased the range for the federal funds target rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a range of 0.0% – 0.25%.~~

●

On March 27, 2020 the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. The CARES Act contains provisions to assist individuals and businesses, including the SBA’s Paycheck Protection program (“PPP”). The PPP provided $349 billion in guaranteed loans that are forgivable if certain requirements are met. On April 24, 2020, an additional $310 billion was added to the PPP.

●

On April 7, 2020, the U.S. banking agencies issued Interagency Statement on Loan modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised). The statement describes accounting for COVID-19-related loan modifications, including clarifying the interaction between current accounting rules and the temporary relief provided by the CARES Act. The statement also encourages institutions to work constructively with borrowers affected by COVID-19 and states the agencies will not criticize supervised institutions for prudent loan modifications. Both the CARES Act and the interagency statement provide relief from the accounting and reporting implications of troubled debt restructurings.

Effects on Our Business. The COVID-19 pandemic and the specific developments referred to above will continue to have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the hotel, restaurant, gaming, long-term healthcare and retail industries will continue to endure significant economic distress, which has caused, and will continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing ~~indebtedness, and is expected to adversely impact the value of collateral.~~indebtedness. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans.

The Company continues to lend to qualified consumer and commercial customers. We continue to participate in the SBA’s Small Business Paycheck Protection Program. As of March 31, 2021 the net balance of the PPP loans totaled $56.3 million.

As provided for by the CARES Act, the Company offered payment modifications to borrowers. At March 31, 2021, $72.8 million, or 5.7% of total loans, remained in some form of a ~~result, we anticipate that our financial condition, capital levels~~modification. These loan modifications include $28.1 million, or 38.5%, on interest only, $39.6 million, or 54.5%, on full deferral and ~~results of operations will be adversely affected, as described in further detail below.~~$5.1 million, or 7.0%, with extended amortization.

~~Our Response~~~~. We have taken numerous steps in response to the COVID-19 pandemic, including the following:~~

●

To protect the health and safety of our employees and customers, from March 18, 2020 until May 4, 2020, we suspended lobby access at each of our locatons but continued to serve clients by appointment or through our drive-up lanes.

●

~~To meet the financial needs of our customers, we have instituted the following measures:~~

The Bank participated, as a lender, in the Small Business Administration ("SBA") Payroll Protection Program ("PPP") and began taking applications on the first day of the program. Through September 30, 2020, the Bank had processed $88.4 million in PPP loans that had been approved by the SBA.

To account for the probable increased losses inherent in the loan portfolio, Management recorded an additional $0.8 million and $4.4 million provision for loan losses for the three and nine months ended September 30, 2020, respectively.

Disaster relief payment modifications granted to-date include approximately 578 loans totaling $303.2 million. At September 30, 2020, 42 loans totaling $91.1 million, or 7.1% of total loans, remained in some form of a modification. These loan modifications include $44.6 million, or 48.9%, on interest only, and $46.5 million, or 51.1%, on full deferral.

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 throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations, where such policies affect the reported and expected financial results.

Allowance for Loan Losses

Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of the Company’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Further discussion of the methodology used in establishing the allowance and the impact of any associated risks related to these policies on the Company’s business operations is provided in note 1 to the Company’s unaudited consolidated financial statements and is also discussed in the Lending 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.

4240

SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected consolidated financial information for the Company as of and for each of the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ 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						Nine Months Ended						Three Months Ended
	September 30,						September 30,						March 31,
(In thousands, except per share data)		2020			2019			2020			2019			2021			2020
Per Share Data
Basic earnings per share	$	0.77		$	0.59		$	1.40		$	1.85		$	0.92		$	0.13
Diluted earnings per share		0.77			0.59			1.40			1.85			0.92			0.13
Cash dividends paid on common stock		750			604			2,252			1,931			842			753
Book value per share								19.15			17.29			20.54			17.92
Market price per share								18.94			22.91			21.29			17.64
Selected Ratios
(Based on average balance sheets)
Return on total assets		1.18	%		1.07	%		0.76	%		1.09	%		1.38	%		0.23	%
Return on stockholders' equity		15.99	%		13.72	%		10.15	%		15.03	%		18.03	%		2.97	%
Stockholders' equity to total assets		7.40	%		7.79	%		7.47	%		7.22	%		7.64	%		7.80	%
Efficiency ratio (1)		61.41	%		64.86	%		66.67	%		68.13	%		61.86	%		70.80	%
Net interest spread		3.30	%		3.32	%		3.27	%		3.15	%		3.44	%		3.28	%
Net interest margin		3.50	%		3.64	%		3.50	%		3.47	%		3.62	%		3.55	%

(Based on end-of-period data)
Stockholders' equity to assets								7.45	%		7.78	%		7.55	%		7.64	%
Total risk-based capital ratio								15.05	%		14.47	%		14.80	%		14.80	%
Tier 1 risk-based capital ratio								13.28	%		12.60	%		13.21	%		12.81	%
Common equity Tier 1 capital								9.97	%		9.50	%		9.93	%		9.64	%
Tier 1 leverage ratio (2)								9.99	%		10.69	%		10.22	%		10.43	%

(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~~

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 adjustments to exclude the additional loan loss provision recorded in the three and nine months ended September 30, 2020 caused by the impact on current economic conditions due to the COVID-19 pandemic and the impact of the gain on the sale of our Branson branch that closed during the quarter ended March 31, 2019. The Company believes that the exclusion of these items 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:

Income Statement Data







Three Months Ended

Nine Months Ended


September 30,

September 30,

(In thousands, except per share data)

2020

2019

2020

2019

Net income - GAAP

$
4,960

$
3,860

$
9,110

$
12,046

Effect of ALL provision COVID-19 (a)

632

—

3,476

—

Effect of net gain on branch sale (b)

—

(86)

—

(1,725)

Net income - non-GAAP

$
5,592

$
3,774

$
12,586

$
10,321

Per Share Data









Basic earnings per share - GAAP

$
0.77

$
0.59

$
1.40

$
1.85

Effect of ALL provision COVID-19 (a)

0.10

—

0.54

—

Effect of net gain on branch sale (b)

—

(0.01)

—

(0.26)

Basic earnings per share - non-GAAP

$
0.87

$
0.58

$
1.94

$
1.59

Diluted earnings per share - GAAP

$
0.77

$
0.59

$
1.40

$
1.85

Effect of ALL provision COVID-19 (a)

0.10

—

0.54

—

Effect of net gain on branch sale (b)

—

(0.01)

—

(0.26)

Diluted earnings per share - non-GAAP

$
0.87

$
0.58

$
1.94

$
1.59

Key Ratios









Return on average total assets - GAAP

1.18
%

1.07
%

0.76
%

1.09
%
Effect of ALL provision COVID-19 (a)

0.15

—

0.29

—

Effect of net gain on branch sale (b)

—

(0.02)

—

(0.16)

Return on average total assets - non-GAAP

1.33
%

1.05
%

1.05
%

0.93
%
Return on average stockholders' equity - GAAP

15.99
%

13.72
%

10.15
%

15.03
%
Effect of ALL provision COVID-19 (a)

2.04

—

3.87

—

Effect of net gain on branch sale (b)

—

(0.31)

—

(2.15)

Return on average stockholders' equity - non-GAAP

18.03
%

13.41
%

14.02
%

12.88
%

~~(a)~~

An additional $0.8 million and $4.4 million pre-tax ALL provision and $0.6 million and $3.5 million after tax was recorded during the three and nine months ended September 30, 2020, respectively, due to current economic conditions resulting from the COVID-19 pandemic.

~~(b)~~

The gain on the sale of the Branson Branch was $0.1 million pre-tax and $86,000 after tax for the three months ended September 30, 2019, and $2.2 million pre-tax and $1.7 million after tax for the three months ended September 30, 2019.

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

4441

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 September 30,									Nine Months Ended September 30,									Three Months Ended March 31,
(In thousands)	2020		2019		$ Change		% Change			2020		2019		$ Change		% Change			2021		2020		$ Change		% Change
Net interest income	$	13,842	$	12,361	$	1,481		12.0	%	$	39,707	$	36,147	$	3,560		9.8	%	$	14,390	$	12,526	$	1,864		14.9	%
Provision for loan losses		1,200		450		750		166.7			5,400		850		4,550		535.3			—		3,300		(3,300)		(100.0)
Non-interest income		5,075		2,424		2,651		109.4			9,956		6,637		3,319		50.0			4,443		2,291		2,152		93.9
Investment securities gains, net		12		(40)		52		(130.0)			18		(40)		58		(145.0)
Gain on branch sale, net		—		109		(109)		(100.0)			—		2,183		(2,183)		(100.0)
Investment securities gains (losses), net																				14		(1)		15		100.0
Non-interest expense		11,616		9,590		2,026		21.1			33,111		29,149		3,962		13.6			11,651		10,491		1,160		11.1
Income before income taxes		6,113		4,814		1,299		27.0			11,170		14,928		(3,758)		(25.2)			7,196		1,025		6,171		602.0
Income tax expense		1,153		954		199		20.9			2,060		2,882		(822)		(28.5)			1,357		157		1,200		764.3
Net income	$	4,960	$	3,860	$	1,100		28.5	%	$	9,110	$	12,046	$	(2,936)		(24.4)	%	$	5,839	$	868	$	4,971		572.7	%

NM = not meaningful

Consolidated net income of ~~$5.0~~$5.8 million, or ~~$0.77~~$0.92 per diluted share, for the three months ended ~~September 30, 2020~~March 31, 2021 increased ~~$1.1~~$5.0 million compared to ~~$3.9~~$.9 million, or ~~$0.59~~$0.13 per diluted share, for the three months ended ~~September 30, 2019.~~March 31, 2020. For the three months ended ~~September 30, 2020,~~March 31, 2021, the return on average assets was ~~1.18%~~1.38%, the return on average stockholders’ equity was ~~15.99%~~18.03%, and the efficiency ratio was ~~61.4%.~~

Consolidated net income of $9.1 million, or $1.40 per diluted share, for the nine months ended September 30, 2020 decreased $2.9 million compared to $12.0 million, or $1.85 per diluted share, for the nine months ended September 30, 2019. For the nine months ended September 30, 2020, the return on average assets was 0.76%, the return on average stockholders’ equity was 10.15%, and the efficiency ratio was 66.7%61.9%.

Net interest income was ~~$13.8 million and $39.7~~$14.4 million for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$12.4 million and $36.1~~$12.5 million for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. The net interest margin (expressed on a fully taxable equivalent basis) ~~decreased~~increased to ~~3.50%~~3.62% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~3.64%~~3.55% for the three months ended ~~September 30, 2019, and increased to 3.50% for the nine months ended September 30, 2020 compared to 3.47% for the nine months ended September 30, 2019.~~March 31, 2020. These changes are discussed in greater detail under the Average Balance Sheets and Rate and Volume Analysis section below.

~~A $1.2 million and $5.4 million~~No provision for loan losses was required for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to a ~~$450,000 and $850,000~~$3.3 million provision for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. The ~~increase~~decreased provision in the first quarter of 2021 compared to the first quarter of 2020 resulted primarily from the impact of net recoveries and improvement in the economic outlook as the economy begins to recover from the impacts of the COVID-19 pandemic. The provision in the first quarter of 2020 was primarily due to ~~an additional $800,000 and $4.4 million recorded during the three and nine months ended September 30, 2020, respectively, due to the~~ current ~~and continued~~ economic conditions resulting from the COVID-19 ~~pandemic and the resulting financial stress being felt by the Company's borrowers.~~pandemic.

The Company’s net loan ~~charge-offs~~recoveries were ~~$58,000 and $113,000~~$248,000 for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to net loan charge-offs of ~~$155,000 and $324,000~~$84,000 for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

Non-performing loans totaled ~~$5.8~~$34.2 million, or ~~0.45%~~2.68% of total loans, at ~~September 30, 2020~~March 31, 2021 compared to ~~$5.1~~$34.6 million, or ~~0.43%~~2.69% of total loans, at December 31, ~~2019,~~2020, and ~~$4.8~~$8.1 million, or ~~0.41%~~0.68% of total loans, at ~~September 30, 2019.~~March 31, 2020. These changes are discussed in greater detail under the Lending and Credit Management section below.

Non-interest income increased ~~$2.7~~$2.2 million, or ~~109.4%~~93.9%, for the three months ended ~~September 30, 2020~~March 31, 2021 compared to the three months ended ~~September 30, 2019, and increased $3.3 million, or 50.0% for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.~~March 31, 2020. These changes are discussed in greater detail under the Non-interest Income and Expense section below.

Investment securities gains, net The Company recognized net securities gains, which include the unrealized net gains related to equity securities, of ~~$12,000 and $18,000~~$14,000 for the three ~~and nine~~ months ~~September 30, 2020, respectively,~~March 31, 2021 compared to net securities losses of ~~$40,000~~$1,000 for ~~both~~ the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. These changes are discussed in greater detail under Investment securities gains, net section below.

~~Gain on branch sale, net~~On 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 $2.2 million, or $1.7 million after tax, for the nine months ended September 30, 2019. Included in the current quarter's net income is the final pretax gain on the sale of our Branson branch of $0.1 million, or $86,000 after tax, was recognized resulting from contingent deposit accounts.

Non-interest expense increased ~~$2.0~~$1.2 million, or ~~21.1%~~11.1%, for the three months ended ~~September 30, 2020~~March 31, 2021 compared to the three months ended ~~September 30, 2019, and increased $4.0 million, or 13.6% for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.~~March 31, 2020. These changes are discussed in greater detail under the Non-interest Income and Expense section below.

Average Balance Sheets

Net interest income is 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 ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively.


	Three Months Ended September 30,												Three Months Ended March 31,
	2020						2019						2021						2020
			Interest		Rate				Interest		Rate				Interest		Rate				Interest		Rate
	Average		Income/		Earned/		Average		Income/		Earned/		Average		Income/		Earned/		Average		Income/		Earned/
(In thousands)	Balance		Expense(1)		Paid(1)		Balance		Expense(1)		Paid(1)		Balance		Expense(1)		Paid(1)		Balance		Expense(1)		Paid(1)
ASSETS
Loans: (2) (3)
Commercial	$	291,657	$	3,364	4.59	%	$	198,444	$	2,777	5.55	%	$	257,623	$	4,159	6.55	%	$	199,082	$	2,570	5.19	%
Real estate construction - residential		26,263		345	5.23			24,895		369	5.88			33,492		394	4.77			23,467		323	5.54
Real estate construction - commercial		86,056		989	4.57			122,179		1,614	5.24			78,578		878	4.53			85,573		1,108	5.21
Real estate mortgage - residential		253,451		2,967	4.66			246,833		3,229	5.19			260,040		2,841	4.43			250,757		3,132	5.02
Real estate mortgage - commercial		588,464		6,959	4.70			527,324		6,538	4.92			621,877		6,600	4.30			573,133		7,005	4.92
Installment and other consumer		28,691		297	4.12			31,689		354	4.43			25,992		265	4.13			31,441		357	4.57
Total loans	$	1,274,582	$	14,921	4.66	%	$	1,151,364	$	14,881	5.13	%	$	1,277,602	$	15,137	4.81	%	$	1,163,453	$	14,495	5.01	%
Loans held for sale	$	11,573	$	41	1.41	%	$	1,337	$	—	—	%	$	5,500	$	25	1.84	%	$	1,892	$	5	1.06	%
Investment securities:
U.S. Treasury	$	2,808	$	8	1.13	%	$	1,340	$	7	2.07	%	$	3,006	$	8	1.08	%	$	758	$	4	2.12	%
U.S. government and federal agency obligations		39,927		179	1.78			33,249		150	1.79			38,605		146	1.53			37,167		195	2.11
Obligations of states and political subdivisions		45,609		305	2.66			30,129		219	2.88			61,456		452	2.98			36,785		270	2.95
Mortgage-backed securities		96,017		411	1.70			119,911		595	1.97			101,101		338	1.36			104,029		525	2.03
Other debt securities		11,133		152	5.43			4,415		63	5.66			11,539		143	5.03			4,402		60	5.48
Total investment securities	$	195,494	$	1,055	2.15	%	$	189,044	$	1,034	2.17	%	$	215,707	$	1,087	2.04	%	$	183,141	$	1,054	2.31	%
Other investment securities		6,623		75	4.51			5,968		66	4.39			5,982		83	5.63			6,253		100	6.43
Federal funds sold and interest bearing deposits in other financial institutions		112,710		111	0.39			16,375		103	2.50			149,325		102	0.28			82,215		325	1.59
Total interest earning assets	$	1,600,982	$	16,203	4.03	%	$	1,364,088	$	16,084	4.68	%	$	1,654,116	$	16,434	4.03	%	$	1,436,954	$	15,979	4.47	%
All other assets		84,068						80,345						84,733						83,136
Allowance for loan losses		(16,727)						(11,933)						(18,466)						(12,584)
Total assets	$	1,668,323					$	1,432,500					$	1,720,383					$	1,507,506
LIABILITIES AND STOCKHOLDERS' EQUITY
NOW accounts	$	198,913	$	124	0.25	%	$	165,275	$	272	0.65	%	$	231,312	$	138	0.24	%	$	185,642	$	290	0.63	%
Savings		123,405		11	0.04			98,008		26	0.11			142,735		12	0.03			100,862		22	0.09
Interest checking		53,734		75	0.56			11,807		62	2.08			61,521		76	0.50			47,295		173	1.47
Money market		281,454		100	0.14			271,068		687	1.01			279,234		83	0.12			270,520		462	0.69
Time deposits		297,359		950	1.27			324,081		1,276	1.56			267,047		671	1.02			323,103		1,165	1.45
Total interest bearing deposits	$	954,865	$	1,260	0.53	%	$	870,239	$	2,323	1.06	%	$	981,849	$	980	0.40	%	$	927,422	$	2,112	0.92	%
Federal funds purchased and securities sold under agreements to repurchase		36,412		25	0.27			21,947		34	0.61			41,507		26	0.25			26,290		37	0.57
Federal Home Loan Bank advances and other borrowings		116,977		505	1.72			100,990		619	2.43			98,152		396	1.64			108,031		632	2.35
Subordinated notes		49,486		326	2.62			49,486		588	4.71			49,486		310	2.54			49,486		501	4.07
Total borrowings	$	202,875	$	856	1.68	%	$	172,423	$	1,241	2.86	%	$	189,145	$	732	1.57	%	$	183,807	$	1,170	2.56	%
Total interest bearing liabilities	$	1,157,740	$	2,116	0.73	%	$	1,042,662	$	3,564	1.36	%	$	1,170,994	$	1,712	0.59	%	$	1,111,229	$	3,282	1.19	%
Demand deposits		368,709						263,336						399,429						261,244
Other liabilities		18,486						14,879						18,601						17,433
Total liabilities		1,544,935						1,320,877						1,589,024						1,389,906
Stockholders' equity		123,388						111,623						131,359						117,600
Total liabilities and stockholders' equity	$	1,668,323					$	1,432,500					$	1,720,383					$	1,507,506
Net interest income (FTE)			$	14,087					$	12,520					$	14,722					$	12,697
Net interest spread					3.30	%					3.32	%					3.44	%					3.28	%
Net interest margin					3.50	%					3.64	%					3.62	%					3.55	%

(1)

Interest income and 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 ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020. Such adjustments totaled ~~$245,000~~$332,000 and ~~$159,000~~$171,000 for the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively.

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

(3)	Fees and costs on loans are included in interest income. ($~~445,000~~1.5 million of PPP fees were included in commercial loan income for the three months ended ~~September 30, 2020)~~

Nine Months Ended September 30,

2020

2019

Interest

Rate

Interest

Rate

Average

Income/

Earned/

Average

Income/

Earned/

(In thousands)

Balance

Expense(1)

Paid(1)

Balance

Expense(1)

Paid(1)

ASSETS

Loans: (2) (4)













Commercial

$
257,328

$
9,055

4.70
%
$
202,708

$
8,408

5.55
%
Real estate construction - residential

25,245

999

5.29

26,623

1,195

6.00

Real estate construction - commercial

85,486

3,059

4.78

115,923

4,536

5.23

Real estate mortgage - residential

251,029

9,031

4.81

246,053

9,456

5.14

Real estate mortgage - commercial

582,568

20,955

4.80

528,152

19,263

4.88

Installment and other consumer

30,063

950

4.22

31,965

1,035

4.33

Total loans

$
1,231,719

$
44,049

4.78
%
$
1,151,424

$
43,893

5.10
%
Loans held for sale

$
8,338

$
96

1.54
%
$
873

$
—

—
%
Investment securities: (3)











U.S. Treasury

$
1,453

$
16

1.47
%
$
2,160

$
35

2.17
%
U.S. government and federal agency obligations

41,353

619

2.00

43,982

621

1.89

Obligations of states and political subdivisions

42,088

895

2.84

35,876

743

2.77

Mortgage-backed securities

100,186

1,348

1.80

120,698

1,961

2.17

Other debt securities

7,229

294

5.43

4,389

190

5.79

Total investment securities

$
192,309

$
3,172

2.20
%
$
207,105

$
3,550

2.29
%
Other investment securities

6,765

247

4.88

5,709

199

4.66

Federal funds sold and interest bearing deposits in other financial institutions

98,238

553

0.75

47,724

897

2.51

Total interest earning assets

$
1,537,369

$
48,117

4.18
%
$
1,412,835

$
48,539

4.59
%
All other assets

83,104

82,791





Allowance for loan losses

(15,061)

(11,874)





Total assets

$
1,605,412

$
1,483,752





LIABILITIES AND STOCKHOLDERS' EQUITY













NOW accounts

$
190,734

$
533

0.37
%
$
208,639

$
1,708

1.09
%
Savings

112,917

43

0.05

95,792

65

0.09

Interest checking

49,026

323

0.88

11,572

170

1.96

Money market

278,244

647

0.31

280,643

2,274

1.08

Time deposits

308,442

3,156

1.37

341,466

4,029

1.58

Total interest bearing deposits

$
939,363

$
4,702

0.67
%
$
938,112

$
8,246

1.18
%
Federal funds purchased and securities sold under agreements to repurchase

34,028

121

0.48

21,716

110

0.68

Federal Home Loan Bank advances and other borrowings

120,650

1,749

1.94

94,969

1,699

2.39

Subordinated notes

49,486

1,208

3.26

49,486

1,821

4.92

Total borrowings

$
204,164

$
3,078

2.01
%
$
166,171

$
3,630

2.92
%
Total interest bearing liabilities

$
1,143,527

$
7,780

0.91
%
$
1,104,283

$
11,876

1.44
%
Demand deposits

324,479

257,157





Other liabilities

17,498

15,143





Total liabilities

1,485,504

1,376,583





Stockholders' equity

119,908

107,169





Total liabilities and stockholders' equity

$
1,605,412

$
1,483,752





Net interest income (FTE)

$
40,337

$
36,663



Net interest spread

3.27
%



3.15
%
Net interest margin

3.50
%



3.47
%

~~(1)~~

Interest income and 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 nine months ended September 30, 2020 and 2019. Such adjustments totaled $630,000 and $516,000 for the nine months ended September 30, 2020 and 2019, respectively.

~~(2)~~

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

~~(3)~~

~~Fees and costs on loans are included in interest income. ($800,000 of PPP fees were included in commercial loan income for the nine months ended September 30, 2020)~~March 31, 2021)

Rate and Volume Analysis

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates for the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 compared to the three ~~and nine~~ months ended ~~September 30, 2019.~~March 31, 2020. 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 September 30,						Nine Months Ended September 30,						Three Months Ended March 31,
	2020 vs. 2019						2020 vs. 2019						2021 vs. 2020
			Change due to						Change due to						Change due to
	Total		Average		Average		Total		Average		Average		Total		Average		Average
(In thousands)	Change		Volume		Rate		Change		Volume		Rate		Change		Volume		Rate
Interest income on a fully taxable equivalent basis: (1)
Loans: (2) (3)
Commercial	$	587	$	1,139	$	(552)	$	647	$	2,050	$	(1,403)	$	1,589	$	858	$	731
Real estate construction - residential		(24)		19		(43)		(196)		(60)		(136)		71		123		(52)
Real estate construction - commercial		(625)		(435)		(190)		(1,477)		(1,116)		(361)		(230)		(86)		(144)
Real estate mortgage - residential		(262)		85		(347)		(425)		188		(613)		(291)		113		(404)
Real estate mortgage - commercial		421		734		(313)		1,692		1,966		(274)		(405)		565		(970)
Installment and other consumer		(57)		(32)		(25)		(85)		(61)		(24)		(92)		(58)		(34)
Loans held for sale		41		—		41		96		—		96		20		15		5
Investment securities:
U.S. Treasury		1		6		(5)		(19)		(9)		(10)		4		7		(3)
U.S. government and federal agency obligations		29		30		(1)		(2)		(38)		36		(49)		8		(57)
Obligations of states and political subdivisions		86		105		(19)		152		132		20		182		181		1
Mortgage-backed securities		(184)		(110)		(74)		(613)		(305)		(308)		(187)		(15)		(172)
Other debt securities		89		92		(3)		104		116		(12)		83		89		(6)
Other investment securities		9		7		2		48		38		10		(17)		(4)		(13)
Federal funds sold and interest bearing deposits in other financial institutions		8		159		(151)		(344)		549		(893)		(223)		156		(379)
Total interest income		119		1,799		(1,680)		(422)		3,450		(3,872)		455		1,952		(1,497)
Interest expense:
NOW accounts		(148)		47		(195)		(1,175)		(136)		(1,039)		(152)		58		(210)
Savings		(15)		6		(21)		(22)		11		(33)		(10)		7		(17)
Interest checking		13		86		(73)		153		291		(138)		(97)		41		(138)
Money market		(587)		25		(612)		(1,627)		(19)		(1,608)		(379)		15		(394)
Time deposits		(326)		(99)		(227)		(873)		(369)		(504)		(494)		(180)		(314)
Federal funds purchased and securities sold under agreements to repurchase		(9)		15		(24)		11		50		(39)		(11)		15		(26)
Federal Home Loan Bank advances and other borrowings		(114)		88		(202)		50		408		(358)		(236)		(54)		(182)
Subordinated notes		(262)		—		(262)		(613)		—		(613)		(191)		—		(191)
Total interest expense		(1,448)		168		(1,616)		(4,096)		236		(4,332)		(1,570)		(98)		(1,472)
Net interest income on a fully taxable equivalent basis	$	1,567	$	1,631	$	(64)	$	3,674	$	3,214	$	460	$	2,025	$	2,050	$	(25)

(1)

Interest income and 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 ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020. Such adjustments totaled ~~$245,000 and $630,000~~$332,000 for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$159,000 and $516,000~~$171,000 for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

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

(3)	Fees and costs on loans are included in interest income. ($~~445,000 and $800,000~~1.5 million of PPP fees were included in commercial loan income for the three ~~and nine~~ months ended ~~September 30, 2020)~~March 31, 2021)

Financial results for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to the ~~quarter~~three months ended ~~September 30, 2019,~~March 31, 2020, reflected an increase in net interest income, on a tax equivalent basis, of ~~$1.6~~$2.0 million, or ~~12.5%, and financial results for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 reflected an increase of $3.7 million, or 10.0%~~15.6%. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) ~~decreased~~increased to ~~3.50%~~3.62% for the ~~quarter~~three months ended ~~September 30, 2020,~~March 31, 2021 compared to ~~3.64%~~3.55% for the ~~quarter ended September 30, 2019, respectively, and increased to 3.50% for the nine~~three months ended ~~September 30, 2020 compared to 3.47% for the nine months ended September 30, 2019, respectively.~~March 31, 2020. Net interest income and

4944

~~Net~~net interest ~~income~~margin increased primarily due to an increase in average earning assets and a decrease in rates paid on average interest bearing liabilities in the three ~~and nine~~ month comparative periods. Although average earning assets increased for both the three and nine month comparative periods, net interest margin decreased quarter over quarter primarily due to a decrease in rates earned, while net interest margin increased for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 primarily due to the decrease in rates paid on interest bearing liabilities partially offset by the decrease in rates earned on average interest earning assets.

Average interest-earning assets increased ~~$236.9~~$217.2 million, or ~~17.4%~~15.1%, to ~~$1.60~~$1.65 billion for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$1.36~~$1.44 billion for the three months ended September 30, 2019, and average interest bearing liabilities increased $115.1 million, or 11.0%, to $1.16 billion for the three months ended September 30, 2020 compared to $1.04 billion for the three months ended September 30, 2019.

Average interest-earning assets increased $124.5 million, or 8.8%, to $1.54 billion for the nine months ended September 30, 2020 compared to $1.41 billion for the nine months ended September 30, 2019, and average interest bearing liabilities increased $39.2 million, or 3.6%, to $1.14 billion for the nine months ended September 30, 2020 compared to $1.10 billion for the nine months ended September 30, 2019.March 31, 2020.

Total interest income (expressed on a fully taxable equivalent basis) was ~~$16.2 million and $48.1~~$16.4 million for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$16.1 million and $48.5~~$16.0 million for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. The Company’s rates earned on interest earning assets were 4.03% ~~and 4.18%~~ for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~4.68% and 4.59%~~4.47% for the three ~~and nine months ended September 30, 2019, respectively.~~March 31, 2020.

Interest income on loans held for investment was ~~$14.9 million and $44.0~~$15.1 million for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$14.9 million and $43.9~~$14.5 million for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

Average loans outstanding increased ~~$123.2~~$114.1 million, or ~~10.7%~~9.8%, to $1.27 billion for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$1.15~~$1.16 billion for the three months ended ~~September 30, 2019.~~March 31, 2020. The average yield on loans decreased to ~~4.66%~~4.81% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~5.13%~~5.01% for the three months ended ~~September 30, 2019.~~

Average loans outstanding increased $80.3 million, or 7.0%, to $1.23 billion for the nine months ended September 30, 2020 compared to $1.15 billion for the nine months ended September 30, 2019. The average yield on loans decreased to 4.78% for the nine months ended September 30, 2020 compared to 5.10% for the nine months ended September 30, 2019.March 31, 2020. See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio.

Interest income on available-for-sale securities was $1.1 million ~~and $3.2 million~~ for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$1.0 million and $3.6 million for the three and nine months ended September 30, 2019, respectively.~~

~~Average securities increased $6.5 million, or 3.4%, to $195.5~~$1.1 million for the three months ended ~~September 30, 2020 compared~~March 31, 2020.

Average securities increased $32.6 million, or 17.8%, to ~~$189.0~~$215.7 million for the three months ended ~~September 30, 2019.~~March 31, 2021 compared to $183.1 million for the three months ended March 31, 2020. The average yield on securities decreased to ~~2.15%~~2.04% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~2.17%~~2.31% for the three months ended ~~September 30, 2019.~~

~~Average securities decreased $14.8~~March 31, 2020. Management plans to grow the investment portfolio to $300.0 million ~~or 7.1%, to $192.3 million for~~by the nine months ended September 30, 2020 compared to $207.1 million for the nine months ended September 30, 2019. The average yield on securities decreased to 2.20% for the nine months ended September 30, 2020 compared to 2.29% for the nine months ended September 30, 2019.end of 2021. See the Liquidity Management section for further discussion.

Total interest expense decreased to ~~$2.1 million and $7.8~~$1.7 million for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$3.6 million and $11.9~~$3.3 million for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. The Company’s rates paid on interest bearing liabilities were ~~0.73% and 0.91%~~0.59% for the three ~~and nine~~ months

ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~1.36% and 1.44%~~1.19% for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. See the Liquidity Management section for further discussion.

Interest expense on deposits decreased to ~~$1.3 million and $4.7~~$1.0 million for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$2.3 million and $8.2~~$2.1 million for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

Average interest bearing deposits increased ~~$84.6~~$54.4 million, or ~~9.7%~~5.9%, to ~~$954.9~~$981.8 million for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$870.2~~$927.4 million for the three months ended ~~September 30, 2019.~~March 31, 2020. The average cost of deposits decreased to ~~0.53%~~0.40% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~1.06%~~0.92% for the three months ended ~~September 30, 2019. During the three months ended September 30, 2019, public funds decreased significantly resulting from the loss of a public fund account at renewal.~~

Average interest bearing deposits increased $1.3 million, or 0.13%, to $939.4 million for the nine months ended September 30, 2020 compared to $938.1 million for the nine months ended September 30, 2019. The average cost of deposits decreased to 0.67% for the nine months ended September 30, 2020 compared to 1.18% for the nine months ended September 30, 2019.March 31, 2020. Although offering rates remain low in response to lower market interest rates, growth in deposits was positively impacted in part by customers who deposited both economic stimulus payments and PPP loan proceeds.

Interest expense on borrowings was $0.9 million and $3.1 million for the three and nine months ended September 30, 2020, respectively, compared to $1.2 million and $3.6 million for the three and nine months ended September 30, 2019, respectively.

~~Average borrowings increased to $202.9~~$0.7 million for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$172.4~~$1.2 million for the three months ended ~~September 30, 2019.~~March 31, 2020.

Average borrowings increased to $189.1 million for the three months ended March 31, 2021 compared to $183.8 million for the three months ended March 31, 2020. The average cost of borrowings decreased to ~~1.68%~~1.57% for the three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~2.86%~~2.56% for the three months ended ~~September 30, 2019. The decrease in cost of funds primarily resulted from lower market interest rates.~~

Average borrowings increased to $204.2 million for the nine months ended September 30, 2020 compared to $166.2 million for the nine months ended September 30, 2019. The average cost of borrowings decreased to 2.01% for the nine months ended September 30, 2020 compared to 2.92% for the nine months ended September 30, 2019.March 31, 2020. The decrease in cost of funds primarily resulted from lower market interest rates.

The increase in average borrowings during 2020 was primarily due to an increase in FHLB advances to fund liquidity needs as refinancing activity increased when rates dropped during the first quarter of 2020. This in turn was offset beginning in April of 2020 when the Company had an increase in liquidity due to participation in the CARES Act economic stimulus programs. The Company experienced significant deposit growth primarily due to stimulus checks, proceeds from

PPP loan funding, deferral of income tax payments, and customers holding on to savings due to uncertain ~~times.~~times and has been repaying these advances as they come due since May of 2020. See the Liquidity Management section for further discussion.

Non-interest income and expense

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


	Three Months Ended September 30,											Nine Months Ended September 30,											Three Months Ended March 31,
(In thousands)	2020			2019			$ Change		% Change			2020			2019			$ Change		% Change			2021			2020			$ Change		% Change
Non-interest income
Service charges and other fees	$	816		$	953		$	(137)		(14.4)	%	$	2,181		$	2,701		$	(520)		(19.3)	%	$	739		$	799		$	(60)		(7.5)	%
Bank card income and fees		846			794			52		6.5			2,351			2,282			69		3.0			860			693			167		24.1
Trust department income		263			371			(108)		(29.1)			920			960			(40)		(4.2)			294			379			(85)		(22.4)
Real estate servicing fees, net		54			36			18		50.0			(48)			38			(86)		(226.3)			73			(87)			160		(183.9)
Gain on sales of mortgage loans, net		3,026			215			2,811		1,307.4			4,369			499			3,870		775.6			2,469			419			2,050		489.3
Other		70			55			15		27.3			183			157			26		16.6			8			88			(80)		(90.9)
Total non-interest income	$	5,075		$	2,424		$	2,651		109.4	%	$	9,956		$	6,637		$	3,319		50.0	%	$	4,443		$	2,291		$	2,152		93.9	%
Non-interest income as a % of total revenue *		26.8	%		16.4	%							20.0	%		15.5	%							23.6	%		15.5	%

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

Total non-interest income increased ~~$2.7~~$2.2 million, or ~~109.4%~~93.9%, to ~~$5.1~~$4.4 million for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$2.4~~$2.3 million for the ~~quarter ended September 30, 2019, and increased $3.3 million, or 50.0%, to $10.0 million for the nine~~three months ended ~~September 30, 2020 compared to $6.6 million for the nine months ended September 30, 2019.~~March 31, 2020.

Service charges and fees decreased ~~$137,000,~~$60,000, or ~~14.4%~~7.5%, to ~~$816,000~~$739,000 for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$953,000~~$799,000 for the ~~quarter ended September 30, 2019, and decreased $520,000, or 19.3%, to $2.2 million for the nine~~three months ended ~~September 30, 2020 compared to $2.7 million for nine months ended September 30, 2019.~~March 31, 2020. The decrease in fees was primarily due to a ~~decrease in nonsufficient fund~~refund of service ~~charges (NSF) resulting from both a decrease in volume, in addition to temporary fee waivers for customers related to~~fees issued during the ~~COVID-19 pandemic.~~first quarter of 2021.

Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) increased ~~$18,000~~$160,000 to ~~$54,000~~$73,000 for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$36,000~~$(87,000) for the ~~quarter ended September 30, 2019, and decreased $86,000 to $(48,000) for the nine~~three months ended ~~September 30, 2020 compared to $38,000 for the nine months ended September 30, 2019.~~March 31, 2020.

Mortgage loan servicing fees earned on loans sold were ~~$215,000 and $638,000~~$193,000 for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$205,000 and $581,000~~$188,000 for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020. The current quarter's MSR valuation ~~decreased $21,000~~increased $22,000 from the prior linked quarter ~~and decreased $340,000 for the nine months ended September 30, 2020~~ primarily due to ~~increased~~decreased prepayment assumptions. The dramatic drop in market interest rates ~~from December 31, 2019 to September 30, 2020,~~ created an economic incentive for borrowers to refinance their existing home mortgage ~~loans.~~loans during 2020 that has slowed down in 2021.

The Company was servicing ~~$289.3~~$288.9 million of mortgage loans at ~~September 30, 2020~~March 31, 2021 compared to ~~$271.4~~$292.7 million and ~~$270.8~~$270.6 million at December 31, ~~2019~~2020 and ~~September 30, 2019,~~March 31, 2020, respectively.

Gain on sales of mortgage loans increased ~~$2.8~~$2.1 million to ~~$3.0~~$2.5 million for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$215,000 for the quarter ended September 30, 2019, and increased $3.9 million to $4.4~~$0.4 million for the ~~nine~~three months ended ~~September 30, 2020 compared to $499,000 for the nine months ended September 30, 2019.~~March 31, 2020. During the fourth quarter of 2019, the Company focused on creation and development of a new mortgage loan department and began offering new mortgage loan products in addition to Freddie and Fannie loans that are sold to the secondary market. The Company sold ~~$73.5 million and $133.2~~$66.3 million of loans for the three ~~and nine~~ months ended ~~September 30, 2020, respectively,~~March 31, 2021 compared to ~~$13.3 million and $28.3~~$13.2 million for the three ~~and nine~~ months ended ~~September 30, 2019, respectively.~~March 31, 2020.

Other Income decreased $80,000, or 90.9%, to $8,000 for the three months ended March 31, 2021 compared to $88,000 for the three months ended March 31, 2020. The decrease resulted from an increase in net losses on sales of other real estate owned and net losses on disposal of fixed assets, and a reduction in rent received on foreclosed properties. These decreases were partially offset by an increase in brokerage income.

5246

~~Other Income~~ ~~increased $15,000, or 27.3%, to $70,000 for~~The following table presents the ~~quarter ended September 30, 2020 compared to $55,000 for the quarter ended September 30, 2019,~~gross realized gains and increased $26,000, or 16.6%, to $183,000 for the nine months ended compared to $157,000 for the nine months ended September 30, 2019. The increase in the periods presented was primarily due to increased brokerage income partially offset by a decrease in insurance commissions, rental incomelosses from ~~other real estate owned,~~sales and ~~income earned~~calls of available-for-sale securities, as well as gains and losses on ~~bank owned life insurance policies due to one of the Company's polices being redeemed in the third quarter of 2019.~~

~~Investment securities gains (losses), net for the periods indicated were as follows:~~

Three Months Ended September 30,

Nine Months Ended September 30,

(in thousands)

2020

2019

2020

2019

Investment securities gains (losses), net









Available for sale securities:









Gains realized on sales

$
21

$
6

$
27

$
6

Losses realized on sales

(8)

(46)

(8)

(46)

Other-than-temporary impairment recognized

—

—

—

—

Other investment securities:









Fair value adjustments, net

(1)

—

(1)

—

Investment securities gains (losses), net

$
12

$
(40)

$
18

$
(40)

~~The Company received $3.2 million and $4.7 million proceeds from the sale of available for sale debt securities and recognized net securities gains, which include the unrealized net losses related to~~ equity securities ~~of $12,000 and $18,000 for the three and nine months September 30, 2020, respectively. This is compared to $21.5 million proceeds~~ from ~~the sale of available for sale of debt securities and~~fair value adjustments which have been recognized ~~net securities losses of $40,000 for both the three and nine months ended September 30, 2019.~~in earnings:


	Three Months Ended March 31,
(in thousands)	2021		2020
Investment securities gains (losses), net
Available for sale securities:
Gross realized gains	$	2	$	—
Gross realized losses		—		—
Other-than-temporary impairment recognized		—		—
Other investment securities:
Fair value adjustments, net		12		(1)
Investment securities gains (losses), net	$	14	$	(1)

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


	Three Months Ended September 30,										Nine Months Ended September 30,										Three Months Ended March 31,
(In thousands)	2020			2019			$ Change		% Change		2020			2019			$ Change		% Change		2021			2020			$ Change		% Change
Non-interest expense
Salaries	$	5,112		$	3,956		$	1,156	29.2	%	$	14,617		$	11,948		$	2,669	22.3	%	$	5,342		$	4,512		$	830	18.4	%
Employee benefits		1,659			1,410			249	17.7			4,787			4,272			515	12.1			1,804			1,609			195	12.1
Occupancy expense, net		781			909			(128)	(14.1)			2,303			2,348			(45)	(1.9)			771			766			5	0.7
Furniture and equipment expense		725			671			54	8.0			2,172			2,166			6	0.3			744			750			(6)	(0.8)
Processing, network and bank card expense		877			893			(16)	(1.8)			2,806			2,867			(61)	(2.1)			1,007			976			31	3.2
Legal, examination, and professional fees		381			316			65	20.6			1,155			948			207	21.8			404			367			37	10.1
Advertising and promotion		316			343			(27)	(7.9)			786			884			(98)	(11.1)			243			249			(6)	(2.4)
Postage, printing, and supplies		227			181			46	25.4			661			650			11	1.7			204			241			(37)	(15.4)
Loan expense		336			133			203	152.6			564			462			102	22.1			174			123			51	41.5
Other		1,202			778			424	54.5			3,260			2,604			656	25.2			958			898			60	6.7
Total non-interest expense	$	11,616		$	9,590		$	2,026	21.1	%	$	33,111		$	29,149		$	3,962	13.6	%	$	11,651		$	10,491		$	1,160	11.1	%
Efficiency ratio*		61.4	%		64.9	%						66.7	%		68.1	%						61.9	%		70.8	%
Number of full-time equivalent employees		301			277							301			277							304			303

*	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 ~~$2.0~~$1.2 million, or ~~21.1%~~11.1%, to ~~$11.6~~$11.7 million for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$9.6~~$10.5 million for the ~~quarter~~three months ended ~~September 30, 2019, and~~March 31, 2020.

Salaries increased ~~$4.0~~$0.8 million, or ~~13.6%~~18.4%, to ~~$33.1~~$5.3 million for the ~~nine~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$29.1~~$4.5 million for the ~~nine~~three months ended ~~September 30, 2019.~~

~~Salaries~~ increased $1.2 million, or 29.2%, to $5.1 million for the quarter ended September 30, 2020 compared to $4.0 million for the quarter ended September 30, 2019, and increased $2.7 million, or 22.3%, to $14.6 million for the nine months ended September 30, 2020 compared to $11.9 million for the nine months ended September 30, 2019.March 31, 2020. The increases were primarily due to adding ~~25 full-time equivalent (FTE) employees~~additional personnel to ~~expand~~ the ~~Company's~~ new mortgage loan ~~department that was formed in late 2019.~~department. In addition, annual merit increases average approximately 4.0% each year and are awarded in the first quarter of each year.

Employee benefits increased ~~$249,000,~~$0.2 million, or ~~17.7%~~12.1%, to ~~$1.7~~$1.8 million for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$1.4~~$1.6 million for the ~~quarter ended September 30, 2019 and increased $515,000, or 12.1%, to $4.8 million for the nine~~three months ended ~~September 30, 2020 compared to $4.3 million for the nine months ended September 30, 2019.~~March 31, 2020. The increases were primarily due to ~~higher~~an increase in 401(k) plan contributions and payroll taxes, partially offset by a decrease in pension cost due to ~~lower~~higher annual discount rate assumptions compared to the prior year's annual ~~assumptions, an increase in payroll taxes due to the increase in FTE mentioned above, and an increase in 401(k) plan contributions.~~

~~Occupancy expense~~ decreased $128,000, or 14.1%, to $781,000 for the quarter ended September 30, 2020 compared to $909,000 for the quarter ended September 30, 2019 and was consistent at $2.3 million for both the nine months ended September 30, 2020 and 2019, respectively. The net decrease for the quarter ended September 30, 2020 over the quarter ended September 30, 2019 primarily consisted of decreases in building repairs and maintenance, and utilities, partially offset by increases in building depreciation and building lease expense. During 2019 there were increases in building and parking lot repairs and maintenance. The increase in building lease expense was primarily related to the Company's new Columbia branch location that began in March of 2019.

The net decrease for the nine months ended September 30, 2020 over the nine months ended September 30, 2019 primarily consisted of a $67,000 net gain primarily related to the sale of land adjacent to one of the Company's branches compared to a net loss of $43,000 in the prior year recognized on the sale of equipment. This decrease was partially offset by increases in core maintenance agreements and depreciation.assumptions.

Legal, examination, and professional fees increased ~~$65,000,~~$37,000, or ~~20.6%~~10.1%, to ~~$381,000~~$404,000 for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$316,000~~$367,000 for the ~~quarter ended September 30, 2019, and increased $207,000, or 21.8%, to $1.2 million for the nine~~three months ended ~~September 30, 2020 compared to $948,000 for the nine months ended September 30, 2019.~~March 31, 2020. These increases are primarily related to an increase in ~~legal~~audit expenses related to subsidiaries and professional fees related to ~~one pending lawsuit that is~~a new investment adviser, partially offset by a decrease in ~~its early stages,~~legal fees.

Postage, printing, and ~~consulting expenses.~~ supplies decreased $37,000, or 15.4%, to $204,000 for the three months ended March 31, 2021 compared to $241,000 for the three months ended March 31, 2020. These decreases are primarily related to savings in stationary and supplies purchases and check printing expenses related to switching vendors.

Loan expense increased ~~$203,000,~~$51,000, or ~~152.6%~~41.5%, to ~~$336,000~~$174,000 for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$133,000~~$123,000 for the ~~quarter ended September 30, 2019, and increased $102,000, or 22.1, to $564,000 compared to $462,000 for the nine~~three months ended ~~September 30, 2019.~~March 31, 2020. The increases were primarily related to increases in real estate loan expenses ~~related~~due to the growth in loan volume ~~partially offset by real estate foreclosure (gain) expense. In~~sold to the second quarter of 2020, the Company sold an out-of-service branch building being held as other real estate owned (OREO) to a non-profit organization. This transaction consisted of a $266,000 donation expense and the company realized a net gain of $210,000secondary market.

Other non-interest expense increased ~~$424,000,~~$60,000, or ~~54.5%~~6.7%, to ~~$1.2 million~~$958,000 for the ~~quarter~~three months ended ~~September 30, 2020~~March 31, 2021 compared to ~~$778,000~~$898,000 for the ~~quarter ended September 30, 2019, and increased $656,000, or 25.2, to $3.3 million compared to $2.6 million for the nine~~three months ended ~~September 30, 2019.~~March 31, 2020. The increases were primarily related to ~~increases~~an increase in ~~donations,~~the FDIC assessment expense and software expense due to new mortgage loan software, partially offset by a decrease in the pension net interest cost. The increase in the FDIC assessment was due to the Company had received the remaining FDIC assessment credit ~~card fraud charge-offs. In~~during the ~~second~~first quarter of 2020 that reduced the Company sold an out-of-service branch building being held as other real estate owned (OREO) to a non-profit organization. This transaction consisted of a $266,000 donation expense and the company realized a net gain of $210,000. During the third quarter of 2020 the Company recognized approximately $150,000 of disputed credit card fraud losses from prior years.overall assessment due.

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 ~~September 30, 2020~~March 31, 2021 compared to ~~19.8%~~15.3% for the three months ended ~~September 30, 2019,~~

~~and 18.4% for the nine months ended September 30,~~March 31, 2020, ~~compared to 19.3% for the nine months ended September 30, 2019.~~respectively. The ~~decrease~~increase in the effective tax rate for the three months ended ~~September 30, 2020~~March 31, 2021 compared to the three months ended ~~September 30, 2019~~March 31, 2020 was primarily attributable to the ~~impact of tax-free revenues.~~increase in earnings. The ~~decrease in the~~ effective tax rate for each of the ~~nine~~three months ended ~~September 30,~~March 31, 2021 and 2020, ~~was~~respectively, is lower than the U.S. federal statutory rate of 21% primarily ~~attributable~~due to tax-free ~~revenues having a greater impact on pre-tax income due to the reduced level of earnings.~~revenues.

Lending and Credit Management

Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented ~~75.5%~~72.6% of total assets as of ~~September 30, 2020~~March 31, 2021 compared to ~~77.5%~~73.2% as of December 31, ~~2019.~~2020.

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~~Major classifications within the Company’s held for investment loan portfolio as of the dates indicated is as follows:

September 30,

December 31,

(In thousands)

2020

2019

Commercial, financial, and agricultural (a)

$
293,801

$
199,022

Real estate construction - residential

27,722

23,035

Real estate construction - commercial

86,896

84,998

Real estate mortgage - residential

258,030

252,643

Real estate mortgage - commercial

584,559

576,635

Installment and other consumer

28,157

32,464

Total loans

$
1,279,165

$
1,168,797

Percent of categories to total loans:





Commercial, financial, and agricultural

23.0
%

17.0
%
Real estate construction - residential

2.2

2.0

Real estate construction - commercial

6.8

7.3

Real estate mortgage - residential

20.2

21.6

Real estate mortgage - commercial

45.7

49.3

Installment and other consumer

2.2

2.8

Total

100.0
%

100.0
%


	March 31, 2021				December 31, 2020
(In thousands)	Amount		% of Loans		2020		% of Loans
Commercial, financial, and agricultural (a)	$	251,943	19.7	%	$	272,918	21.2	%
Real estate construction − residential		33,962	2.7			29,692	2.3
Real estate construction − commercial		78,576	6.2			78,144	6.1
Real estate mortgage − residential		258,259	20.2			262,339	20.4
Real estate mortgage − commercial		628,178	49.2			617,133	48.0
Installment and other consumer		25,267	2.0			26,741	2.1
Total loans held for investment	$	1,276,185	100.0	%	$	1,286,967	100.0	%

(a)	Includes ~~$85.6~~$56.3 million and $63.3 million SBA PPP loans, net as of March 31, 2021 and December 31, 2020, respectively.

The Company extends credit to its local community markets 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 ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, the Company sold approximately ~~$133.2~~$66.3 million of loans to investors compared to ~~$28.3~~$13.2 million for the ~~nine~~three months ended ~~September 30, 2019.~~March 31, 2020. At ~~September 30, 2020,~~March 31, 2021, the Company was servicing approximately ~~$289.3~~$288.9 million of loans sold to the secondary market compared to ~~$271.4~~$292.7 million at December 31, ~~2019,~~2020, and ~~$270.8~~$270.6 million at ~~September 30, 2019.~~March 31, 2020.

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. Loans in excess of $2.0 million in aggregate and all adversely classified credits identified by management are reviewed by the senior loan committee. In addition, all other loans are reviewed on a 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 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 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.

Non-performing Assets

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


	September 30,			December 31,			September 30,			March 31,			December 31,			March 31,
(In thousands)	2020			2019			2019			2021			2020			2020
Nonaccrual loans:
Commercial, financial, and agricultural	$	878		$	982		$	1,027		$	6,591		$	6,717		$	3,111
Real estate construction - commercial		552			137			145
Real estate mortgage - residential		2,236			2,135			2,158
Real estate mortgage - commercial		1,933			1,359			1,111
Real estate construction − residential											189			192			—
Real estate construction − commercial											198			200			408
Real estate mortgage − residential											1,917			2,105			3,211
Real estate mortgage − commercial											25,309			25,314			1,068
Installment and other consumer		33			141			123			29			31			46
Total	$	5,632		$	4,754		$	4,564		$	34,233		$	34,559		$	7,844
Loans contractually past - due 90 days or more and still accruing:
Real estate mortgage - residential	$	175		$	304		$	193		$	—		$	—		$	190
Installment and other consumer		8			12			4			—			17			27
Total	$	183		$	316		$	197		$	—		$	17		$	217
Total non-performing loans (a)		5,815			5,070			4,761			34,233			34,576			8,061
Other real estate owned and repossessed assets		12,601			12,781			12,878			12,140			12,291			12,769
Total non-performing assets	$	18,416		$	17,851		$	17,639		$	46,373		$	46,867		$	20,830

Loans held for investment	$	1,279,165		$	1,168,797		$	1,149,268		$	1,276,185		$	1,286,967		$	1,180,522
Allowance for loan losses to loans		1.39	%		1.07	%		1.06	%		1.44	%		1.41	%		1.33	%
Non-performing loans to loans (a)		0.45	%		0.43	%		0.41	%		2.68	%		2.69	%		0.68	%
Non-performing assets to loans (b)		1.44	%		1.53	%		1.53	%		3.63	%		3.64	%		1.76	%
Non-performing assets to assets (b)		1.10	%		1.20	%		1.22	%		2.68	%		2.70	%		1.36	%
Allowance for loan losses to non-performing loans		305.49	%		246.09	%		255.79	%		53.64	%		52.39	%		194.68	%

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

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

Total non-performing assets were ~~$18.4~~$46.4 million, or ~~1.44%~~3.63% of total loans, at ~~September 30, 2020~~March 31, 2021 compared to ~~$17.9~~$46.9 million, or ~~1.53%~~3.64% of total loans, at December 31, ~~2019,~~2020, and ~~$17.6~~$20.8 million, or ~~1.53%~~1.76% of total loans, at ~~September 30, 2019,~~March 31, 2020, respectively.

Total non-accrual loans at ~~September 30, 2020 increased $878,000~~March 31, 2021 decreased $326,000 million, ~~18.5%~~or 0.9%, to ~~$5.6~~$34.2 million compared to ~~$4.8~~$34.6 million at December 31, ~~2019. The increase in non-accrual~~2020. There were no loans primarily consisted of increases in real estate mortgage commercial loans and real estate construction commercial loans. The increase in real estate mortgage commercial loans primarily related to two loan relationships and the increase in real estate construction commercial loans primarily related to one loan relationships.

~~Loans~~ past due 90 days and still accruing interest at ~~September 30, 2020, were $183,000~~March 31, 2021 compared to ~~$316,000~~$17,000 at December 31, ~~2019.~~2020. Other real estate and repossessed assets were ~~$12.6~~$12.1 million and ~~$12.8~~$12.3 million at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively. During the ~~nine~~three months ended ~~September 30, 2020, $73,000~~March 31, 2021, $30,000 of non-accrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to ~~$411,000~~no loans during the ~~nine~~three months ended ~~September 30, 2019.~~March 31, 2020.

As of ~~September 30, 2020,~~March 31, 2021, approximately ~~$4.7~~$8.3 million compared to ~~$9.0~~$6.0 million and ~~$5.9~~$5.8 million at December 31, ~~2019~~2020 and ~~September 30, 2019,~~March 31, 2020, respectively, of loans classified as substandard, which include performing TDRs, and are not included in the non-performing asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. Management believes the allowance for loan losses was sufficient to cover the risks and probable losses related to such loans at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, respectively.

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


	September 30, 2020					December 31, 2019					March 31, 2021					December 31, 2020
	Number of	Recorded		Specific		Number of	Recorded		Specific		Number of	Recorded		Specific		Number of	Recorded		Specific
(In thousands)	contracts	Investment		Reserves		contracts	Investment		Reserves		contracts	Investment		Reserves		contracts	Investment		Reserves
Performing TDRs
Commercial, financial and agricultural	5	$	498	$	39	5	$	532	$	177	7	$	817	$	37	7	$	835	$	90
Real estate mortgage - residential	5		1,541		28	6		1,615		33
Real estate mortgage - commercial	2		344		7	2		352		7
Real estate mortgage − residential											5		1,217		46	5		1,521		28
Real estate mortgage − commercial											2		338		7	2		343		7
Installment and other consumer	5		80		10	2		36		2	4		42		5	5		77		10
Total performing TDRs	17	$	2,463	$	84	15	$	2,535	$	219	18	$	2,414	$	95	19	$	2,776	$	135
Non-performing TDRs
Commercial, financial and agricultural	4	$	304	$	61	6	$	496	$	99	1	$	3	$	—	1	$	4	$	1
Real estate mortgage - residential	7		814		66	6		782		117
Real estate mortgage - commercial	—		—		—	2		266		—
Installment and other consumer	—		—		—	2		72		7
Real estate mortgage − residential											8		876		77	8		895		78
Total non-performing TDRs	11	$	1,118	$	127	16	$	1,616	$	223	9	$	879	$	77	9	$	899	$	79
Total TDRs	28	$	3,581	$	211	31	$	4,151	$	442	27	$	3,293	$	172	28	$	3,675	$	214

At ~~September 30, 2020,~~March 31, 2021, loans classified as TDRs totaled ~~$3.6~~$3.3 million, with ~~$211,000~~$172,000 of specific reserves compared to ~~$4.1~~$3.7 million of loans classified as TDRs, with ~~$442,000~~$214,000 of specific reserves at December 31, ~~2019.~~2020. Non-performing loans, included ~~$1.1~~$0.9 million of loans classified as TDRs at ~~September 30, 2020~~March 31, 2021 compared to ~~$1.6~~$0.9 million at December 31, ~~2019.~~2020. 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 if the loan is collateral dependent. The net decrease in total TDRs from December 31, ~~2019~~2020 to ~~September 30, 2020~~March 31, 2021 was primarily due to ~~$687,000~~$382,000 of payments received on ~~TDRs, partially offset by two new TDR totaling $125,000.~~TDRs.

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:


	September 30,		December 31,		March 31,		December 31,
(In thousands)	2020		2019		2021		2020
Allocation of allowance for loan losses at end of period:
Commercial, financial, and agricultural	$	3,757	$	2,918	$	4,676	$	5,121
Real estate construction - residential		233		64
Real estate construction - commercial		822		369
Real estate mortgage - residential		3,292		2,118
Real estate mortgage - commercial		9,253		6,547
Real estate construction − residential						309		213
Real estate construction − commercial						532		475
Real estate mortgage − residential						2,594		2,679
Real estate mortgage − commercial						9,904		9,354
Installment and other consumer		337		381		245		264
Unallocated		70		80		101		7
Total	$	17,764	$	12,477	$	18,361	$	18,113

The allowance for loan losses (ALL) was ~~$17.8~~$18.4 million, or ~~1.39%~~1.44% of loans outstanding, at ~~September 30, 2020~~March 31, 2021 compared to ~~$12.5~~$18.1 million, or ~~1.07%~~1.41%, at December 31, ~~2019,~~2020, and ~~$12.2~~$15.7 million, or ~~1.06%~~1.33% at ~~September 30, 2019.~~March 31, 2020. The ratio of the allowance for loan losses to nonperforming loans was ~~305.49%~~53.64% at ~~September 30, 2020,~~March 31, 2021, compared to ~~246.09%~~52.39% at December 31, ~~2019,~~2020, and ~~255.79%~~194.68% at ~~September 30, 2019.~~March 31, 2020.

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


	September 30,		December 31,		March 31,		December 31,
(In thousands)	2020		2019		2021		2020
Allocation of allowance for loan losses:
Individually evaluated for impairment - specific reserves	$	581	$	615
Collectively evaluated for impairment - general reserves		17,183		11,862
Individually evaluated for impairment − specific reserves					$	5,144	$	5,113
Collectively evaluated for impairment − general reserves						13,217		13,000
Total	$	17,764	$	12,477	$	18,361	$	18,113

The specific 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 ~~September 30, 2020, $581,000~~March 31, 2021, $5.1 million of the Company’s ALL was allocated to impaired loans totaling approximately ~~$8.1~~$36.6 million compared to ~~$615,000~~$5.1 million of the Company’s ALL allocated to impaired loans totaling approximately ~~$7.4~~$37.3 million at December 31, ~~2019.~~2020. Management determined that ~~$2.7~~$12.6 million, or ~~33%~~34%, of total impaired loans required no reserve allocation at ~~September 30, 2020~~March 31, 2021 compared to ~~$2.6~~$11.9 million, or ~~35%~~32%, at December 31, ~~2019,~~2020, primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability.

The incurred 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. ~~In the first quarter of 2019, management adjusted the~~The look-back period ~~to begin~~begins with loss history in the first quarter 2012 as the starting point through the current quarter and it will continue to include this starting point going forward. ~~At that time,~~ Management determined that ~~with the extended economic recovery then existing,~~ the look-back period should be expanded ~~to include the current economic cycle. The look-back period will then be adjusted once~~until a ~~sustained~~ loss producing downturn is ~~recognized~~recognized. This would be accomplished 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. The look-back period is consistently evaluated for relevance given the current facts and circumstances.

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.

~~As a result of rapidly increasing unemployment rates resulting from the COVID-19 virus, management determined that the first quarter 2020~~The allowance for loan loss economic qualitative adjustment should be temporarily adapted to utilize currently published statistics rather than the lagging statistics that had been utilized historically. While these lagging indicators have been very reliable for some time, they did not accurately capture the risk that has been brought about by rapid changes in the economy due to the pandemic. Based upon the change in the national unemployment rate available as of March 31, 2020, the economic qualitative adjustment was increased according to the Company’s methodology to account for uncertainty in economic conditions compared to the lookback period. As of September 30, 2020, and based on the continuing high rates of national unemployment as compared to historic levels, management believes this temporary alteration will be a better indicator until the economy stabilizes and the true impact can be measured. In addition, as of September 30, 2020, management increased the lending staff and management qualitative adjustment to reflect changes which have occurred, both organizational and operational.

~~The more significant~~losses changes from December 31, ~~2019~~2020 to ~~September 30, 2020 in~~March 31, 2021 primarily resulted from net recovery activity, as there was no provision recorded during the ~~allocations of the allowance for loan losses to~~quarter given the loan ~~portfolios listed above was primarily attributed~~portfolio remained stable from December 31, 2020. The Company continues to monitor the ~~additional economic qualitative factor adjustment resulting from~~risks associated with its nonperforming loans and the ~~COVID-19 pandemic.~~

~~Additionally,~~remaining loans modified under the funding of $88.4 million in PPP loans during the second and third quarter required management to assess the methodology that would be adopted in regard to the allowance for loan loss applicable to these loans. As the SBA PPP loans are expected to begin paying off in the next six to twelve months and carry a 100% credit guarantee from the SBA, management determined that no allowance for loan loss was deemed necessary for these loans.CARES Act.

Provision

5952

quarter of 2020 resulted primarily from the impact of net recoveries and improvement in the economic outlook as the economy begins to recover from the impacts of the COVID-19 pandemic. Criticized loan levels remain elevated when compared to pre-pandemic levels due to the downgrade of loans to borrowers that have been impacted by the COVID-19 pandemic.

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


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
(In thousands)	2020		2019		2020		2019		2021		2020
Analysis of allowance for loan losses:
Balance beginning of period	$	16,622	$	11,883	$	12,477	$	11,652	$	18,113	$	12,477
Charge-offs:
Commercial, financial, and agricultural		46		61		130		255		27		41
Real estate construction - residential		—		—		—		—
Real estate construction - commercial		—		—		—		—
Real estate mortgage - residential		—		86		52		266
Real estate mortgage - commercial		13		6		37		21
Real estate construction − residential										—		—
Real estate construction − commercial										—		—
Real estate mortgage − residential										—		19
Real estate mortgage − commercial										23		22
Installment and other consumer		42		60		133		151		57		52
Total charge-offs	$	101	$	213	$	352	$	693	$	107	$	134
Recoveries:
Commercial, financial, and agricultural	$	11	$	12	$	102	$	139	$	149	$	25
Real estate construction - residential		13		12		44		25
Real estate construction - commercial		—		—		—		—
Real estate mortgage - residential		4		8		40		111
Real estate mortgage - commercial		—		7		3		9
Real estate construction − residential										13		—
Real estate construction − commercial										—		—
Real estate mortgage − residential										168		9
Real estate mortgage − commercial										—		2
Installment and other consumer		15		19		50		85		25		14
Total recoveries	$	43	$	58	$	239	$	369	$	355	$	50
Net charge-offs		58		155		113		324
Net charge-offs (recoveries)										(248)		84
Provision for loan losses		1,200		450		5,400		850		—		3,300
Balance end of period	$	17,764	$	12,178	$	17,764	$	12,178	$	18,361	$	15,693

Net Loan Charge-offs (recoveries)

The Company’s net ~~charge-offs~~recoveries were ~~$58,000~~$248,000 for the three months ended ~~September 30, 2020~~March 31, 2021 compared to net charge-offs of ~~$155,000~~$84,000 for the three months ended ~~September 30, 2019, and net charge-offs were $113,000, for the nine months ended September 30, 2020 compared to $324,000 for the nine months ended September 30, 2019.~~

The decrease in net charge-offs for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily related to a decrease in commercial, financial, and agricultural, real estate mortgage – residential charge-offs, and installment loans to individuals. The net decrease in the Company's net charge-offs for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 was primarily due to a decrease in commercial, financial, and agricultural, and real estate mortgage – residential loan charge-offs. The Company recovered commercial deposit fraud charge-offs through the Company's insurance captive during the second quarter of 2020, two real estate construction – residential recoveries, and one real estate mortgage – residential recovery obtained in a settlement. This is compared to one large commercial loan relationship recovery and one real estate mortgage – residential recovery received duringMarch 31, 2020. During the first quarter of ~~2019.~~2021 the Company received commercial and a real estate mortgage recoveries primarily related two loan relationships.

Loans Held For Sale

The Company designates certain long-term fixed rate personal real estate loans as held for sale, and the Company carries them at the lower of cost or fair value. The loans are primarily sold to Freddie Mac, Fannie Mae, and PennyMac and other various secondary market investors. At ~~September 30, 2020,~~March 31, 2021, the carrying amount of these loans was ~~$7.9~~$6.3 million compared to ~~$428,000~~$5.1 million at December 31, 2019. A contributing factor for the increase in balance of loans held for sale at September 30, 2020 was due to the significant increase in real estate mortgage originations, as compared to the capability of the relatively recently formed mortgage lending department to sell the mortgages to investors (as more fully described in the following paragraph.)2020.

In the fourth quarter of 2019 the Company expanded its current home loan program to better serve our customers. This expansion began with hiring new mortgage lending personnel and expanding the bank’s available loan products and upgrading the Company's operating systems. New home loan programs for its customers include VA loans, designed for military families and veterans; USDA loans for those buying homes in rural communities; and FHA loans, which offer low down payments and flexible underwriting guidelines. In addition, we have added several secondary market investors, allowing us to sell loans on the secondary market versus servicing them at the Company. This provides us with the ability to offer clients more aggressive pricing and at the same time improve the Company's financial return.

Liquidity and Capital Resources

Liquidity Management

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

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

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

September 30,

December 31,

(In thousands)

2020

2019

Federal funds sold and other overnight interest-bearing deposits

$
112,050

$
55,545

Certificates of deposit in other banks

9,874

10,862

Available-for-sale investment securities

186,723

175,093

Total

$
308,647

$
241,500


	March 31,		December 31,
(In thousands)	2021		2020
Federal funds sold and other interest-bearing deposits	$	128,207	$	161,128
Certificates of deposit in other banks		8,897		9,376
Available-for-sale investment securities		238,142		198,030
Total	$	375,246	$	368,534

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 ~~$186.7~~$238.1 million at ~~September 30, 2020~~March 31, 2021 and included an unrealized net gain of ~~$4.1~~$0.7 million. The portfolio includes projected maturities and mortgage backed securities pay-downs of approximately ~~$10.4~~$5.0 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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the Company’s unpledged securities in the available for sale portfolio totaled approximately ~~$22.3~~$40.6 million and ~~$35.3~~$44.1 million, respectively.

Total investment securities pledged for these purposes were as follows:


	September 30,		December 31,		March 31,		December 31,
(In thousands)	2020		2019		2021		2020
Investment securities pledged for the purpose of securing:
Federal Reserve Bank borrowings	$	9,327	$	9,385	$	10,824	$	9,115
Federal funds purchased and securities sold under agreements to repurchase		52,704		38,238		51,625		59,695
Other deposits		102,351		92,189		135,122		85,130
Total pledged, at fair value	$	164,382	$	139,812	$	197,571	$	153,940

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 ~~September 30, 2020,~~March 31, 2021, such deposits totaled ~~$1.2~~$1.3 billion and represented ~~89.2%~~92.4% 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.

Core deposits at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 were as follows:


	September 30,		December 31,		March 31,		December 31,
(In thousands)	2020		2019		2021		2020
Core deposit base:
Non-interest bearing demand	$	372,355	$	261,166	$	431,035	$	382,492
Interest checking		237,669		227,662		264,210		292,375
Savings and money market		387,508		346,593		414,215		391,248
Other time deposits		185,559		197,089		177,943		183,072
Total	$	1,183,091	$	1,032,510	$	1,287,403	$	1,249,187

Time deposits and certificates of deposit of $250,000 and greater at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 were ~~$100.0~~$74.4 million and ~~$104.3~~$91.3 million, respectively. The Company had brokered deposits totaling $30.2 million and $40.2 million ~~and $45.2 million~~ at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, 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 ~~September 30, 2020,~~March 31, 2021, under agreements with these unaffiliated banks, the Bank may borrow up to ~~$50.0~~$60.0 million in federal funds on an unsecured basis and ~~$16.0~~$10.4 million on a secured basis. There were no federal funds purchased outstanding at ~~September 30, 2020.~~March 31, 2021. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At ~~September 30, 2020,~~March 31, 2021 there were ~~$35.4~~$42.0 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 ~~September 30, 2020.~~March 31, 2021.

The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB) and has access to credit products of the FHLB. As of ~~September 30, 2020,~~March 31, 2021, the Bank had ~~$112.7~~$97.6 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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 were as follows:


	September 30,		December 31,		March 31,		December 31,
(In thousands)	2020		2019		2021		2020
Borrowings:
Federal funds purchased and securities sold under agreements to repurchase	$	35,405	$	27,272	$	42,018	$	45,154
Federal Home Loan Bank advances		112,719		96,895		97,600		106,660
Subordinated notes		49,486		49,486		49,486		49,486
Other borrowings		24		24		14		14
Total	$	197,634	$	173,677	$	189,118	$	201,314

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:

September 30,

December 31,

2020

2019






Federal







Federal


Funds

Funds

Federal

Purchased

Federal

Purchased

(In thousands)

FHLB

Reserve Bank

Lines

Total

FHLB

Reserve Bank

Lines

Total
Advance equivalent

$
295,616

$
9,100

$
56,869

$
361,585

$
284,813

$
9,190

$
56,839

$
350,842
Letters of credit

(71,500)

—

—

(71,500)

(115,000)

—

—

(115,000)
Advances outstanding

(112,719)

—

—

(112,719)

(96,895)

—

—

(96,895)
Total available

$
111,397

$
9,100

$
56,869

$
177,366

$
72,918

$
9,190

$
56,839

$
138,947


	March 31,								December 31,
	2021								2020
					Federal								Federal
					Funds								Funds
			Federal		Purchased						Federal		Purchased
(In thousands)	FHLB		Reserve Bank		Lines		Total		FHLB		Reserve Bank		Lines		Total
Advance equivalent	$	281,044	$	10,388	$	60,000	$	351,432	$	300,633	$	8,898	$	56,835	$	366,366
Letters of credit		(18,000)		—		—		(18,000)		(123,000)		—		—		(123,000)
Advances outstanding		(97,599)		—		—		(97,599)		(106,660)		—		—		(106,660)
Total available	$	165,445	$	10,388	$	60,000	$	235,833	$	70,973	$	8,898	$	56,835	$	136,706

At ~~September 30, 2020,~~March 31, 2021, loans of ~~$578.5~~$552.5 million were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At ~~September 30, 2020,~~March 31, 2021, investments totaling ~~$18.3~~$10.8 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.

Based upon the above, management believes the Company has more than adequate liquidity, both on balance sheet and through the additional funding capacity with the FHLB, the Federal Reserve Bank and Federal funds purchased lines to meet future anticipated needs; this includes the impact of the COVID-19 pandemic that is difficult to currently measure. Management believes the most significant impact to the Company’s liquidity position in the short-term may be related to the PPP as loans are expected to be forgiven and depositors may choose to redirect their funds. The longer-term impact on the Company's liquidity from the pandemic will be closely monitored and addressed as needs arise.

The Company also has available additional liquidity having pledged the PPP loans to the FHLB as collateral for available advances.

Sources and Uses of Funds

Cash and cash equivalents were ~~$129.4~~$146.7 million at ~~September 30, 2020~~March 31, 2021 compared to ~~$78.1~~$180.4 million at December 31, ~~2019.~~2020. The ~~$51.3~~$33.6 million ~~increase~~decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the ~~nine~~three months ended ~~September 30, 2020.~~March 31, 2021. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of ~~$9.9~~$3.6 million for the ~~nine~~three months ended ~~September 30, 2020.~~March 31, 2021.

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 ~~$119.6~~$32.4 million. The cash outflow primarily consisted of ~~$110.6 million increase~~

~~in loans and $72.1~~$62.3 million purchase of investment securities partially offset by ~~$63.5~~an $11.0 million decrease in loans and $18.2 million from maturities, calls, and sales of investment securities. ~~The increase in loans was primarily a result~~Management hopes to grow the investment portfolio to $300.0 million by the end of ~~$85.6 million (net of PPP deferred fees) increase in commercial loans due to customers who participated in the PPP.~~2021.

Financing activities ~~provided~~used total cash of ~~$161.0~~$4.8 million, resulting primarily from a ~~$111.2~~$38.2 million ~~increase in demand deposits, a $51.0 million increase~~decrease in interest-bearing transaction accounts and time deposits and a ~~$15.8~~$9.1 million repayment of FHLB advances, partially offset by a $48.5 million increase in ~~net FHLB advances.~~demand deposits. The growth in demand deposits was positively impacted by customers who deposited both economic stimulus payments and PPP loan proceeds into demand accounts. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during ~~2020.~~2021.

In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Company had ~~$426.3~~$421.6 million in unused loan commitments and standby letters of credit

as of ~~September 30, 2020.~~March 31, 2021. Although the Company’s current liquidity resources are adequate to fund this commitment level the nature of these commitments is such that the likelihood of such a funding demand is very low.

The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company’s ongoing liquidity needs primarily include funding its operating expenses and paying cash dividends to its shareholders. The Company paid cash dividends to its shareholders totaling approximately ~~$2.3 million~~$842,000 and ~~$1.9 million~~$753,000 for the ~~nine~~three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid ~~$2.5~~$4.5 million and ~~$5.5 million in~~no dividends to the Company during the ~~nine~~three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively. At ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the Company had cash and cash equivalents totaling ~~$1.5~~$3.0 million and ~~$2.6~~$2.0 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~~The Basel III regulatory capital ~~reforms~~framework (the "Basel III Capital Rules") adopted by U.S. federal regulatory authorities, among other things, (i) establishes the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specifies that Tier 1 capital consist of CET1 and ~~changes required by~~"Additional Tier 1 Capital" instruments meeting stated requirements, (iii) requires that most deductions/adjustments to regulatory capital measures be made to CET1 and not to other components of capital and (iv) defines the ~~Dodd-Frank Act. The phase-in period for~~scope of the deductions/adjustments to the capital measures.

Additionally, the Basel III Capital Rules require that the Company ~~began on January~~maintain a 2.5% capital conservation buffer with respect to each of CET1, Tier 1 ~~2015. The Federal Reserve System’s (FRB)~~and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy ~~guidelines~~requirements. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as of March 31, 2021, that ~~bank holding companies maintain a Common Equity~~the Company and the Bank meet all capital adequacy requirements to which they are subject.

Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, ~~capital ratio equal to at least 4.5% of its risk-weighted assets, a~~CET1 and Tier 1 ~~risk-based~~leverage ratios. As shown in the table below, the Company’s capital ~~ratio equal~~ratios exceeded the regulatory definition of adequately capitalized as of March 31, 2021 and December 31, 2020. Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to ~~at least 6%~~be well capitalized. The regulatory authorities can apply changes in classification of ~~its risk-weighted~~ assets and such changes may retroactively subject the Company to changes in capital ratios. Any such change could reduce one or more capital ratios below well-capitalized status. In addition, a ~~total risk-based capital ratio equal to at least 8%~~change may result in imposition of ~~its risk-weighted assets.~~additional assessments by the FDIC or could result in regulatory actions that could have a material effect on our condition and results of operations. 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~~Because our Bank had less than $15.0 billion in total consolidated assets as 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 began being phased in over four years beginning in 2016. On January 1, 2016, the first phase of the requirement went into effect at 0.625% of risk-weighted assets, and increased each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of risk weighted assets on January 1, 2019. At December 31, ~~2019,~~2009, the ~~capital conservation buffer~~Company is allowed to continue to classify our trust preferred securities, all of ~~2.5%, effectively raised the minimum required risk-based capital ratios~~which were issued prior to ~~7% Common Equity~~May 19, 2010, as Tier 1 ~~Capital, 8.5% Tier 1 Capital and 10.5% Total Capital on a fully phased-in basis.~~capital.

6457

Under the Basel III requirements, at ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, 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:


					Minimum Capital				Required to be								Minimum Capital				Required to be
					Required - Basel III				Considered Well-								Required - Basel III				Considered Well-
	Actual				Fully Phased-In				Capitalized				Actual				Fully Phased-In				Capitalized
(in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2020
March 31, 2021
Total Capital (to risk-weighted assets):
Company	$	188,390	15.05	%	$	131,393	10.50	%	$	—	N.A	%	$	196,553	14.80	%	$	139,475	10.50	%	$	—	N.A	%
Bank		186,837	14.97			131,006	10.50			124,768	10.00			193,745	14.62			139,119	10.50			132,495	10.00
Tier 1 Capital (to risk-weighted assets):
Company	$	166,176	13.28	%	$	106,365	8.50	%	$	—	N.A	%	$	172,591	13.21	%	$	112,909	8.50	%	$	—	N.A	%
Bank		171,213	13.72			106,052	8.50			99,814	8.00			177,159	13.37			112,620	8.50			105,996	8.00
Common Equity Tier 1 Capital (to risk-weighted assets):
Company	$	124,720	9.97	%	$	87,595	7.00	%	$	—	N.A	%	$	131,925	9.93	%	$	92,984	7.00	%	$	—	N.A	%
Bank		171,213	13.72			87,337	7.00			81,099	6.50			177,159	13.37			92,746	7.00			86,121	6.50
Tier 1 leverage ratio (to adjusted average assets):
Company	$	166,176	9.99	%	$	66,525	4.00	%	$	—	N.A	%	$	175,494	10.22	%	$	68,654	4.00	%	$	—	N.A	%
Bank		171,213	10.34			66,231	4.00			82,788	5.00			177,159	10.37			68,315	4.00			85,394	5.00

December 31, 2019
December 31, 2020
Total Capital (to risk-weighted assets):
Company	$	179,430	14.89	%	$	126,511	10.50	%	$	—	N.A	%	$	193,220	14.97	%	$	135,518	10.50	%	$	—	N.A	%
Bank		175,459	14.60			126,165	10.50			120,158	10.00			191,504	14.87			135,186	10.50			128,748	10.00
Tier 1 Capital (to risk-weighted assets):
Company	$	157,139	13.04	%	$	102,414	8.50	%	$	—	N.A	%	$	172,591	13.37	%	$	109,705	8.50	%	$	—	N.A	%
Bank		162,822	13.55			102,134	8.50			96,126	8.00			175,384	13.62			109,436	8.50			102,999	8.00
Common Equity Tier 1 Capital (to risk-weighted assets)
Company	$	118,793	9.86	%	$	84,341	7.00	%	$	—	N.A	%	$	129,061	10.00	%	$	90,345	7.00	%	$	—	N.A	%
Bank		162,822	13.55			84,110	7.00			78,102	6.50			175,384	13.62			90,124	7.00			83,686	6.50
Tier 1 leverage ratio:
Company	$	157,139	10.73	%	$	58,562	4.00	%	$	—	N.A	%	$	172,591	10.19	%	$	67,724	4.00	%	$	—	N.A	%
Bank		162,822	11.18			58,280	4.00			72,850	5.00			175,384	10.41			67,394	4.00			84,243	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 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

6558

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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019.~~2020.


	% Change in projected net interest income						% Change in projected net interest income
Hypothetical shift in interest rates	September 30,				December 31,		March 31,			December 31,
(bps)	2020			2019			2021			2020
200		1.16	%		1.07	%		(1.06)	%		0.73	%
100		0.78	%		1.61	%		(1.50)	%		0.10	%
(100)		0.71	%		0.78	%		(2.73)	%		(1.28)	%
(200)		0.55	%		(0.51)	%		(3.34)	%		(1.81)	%

The change in our interest rate risk exposure from December 31, ~~2019~~2020 to ~~September 30, 2020~~March 31, 2021 was primarily due to the ~~significant~~ decrease in market rates over this ~~time~~ period that has caused ~~offering rates~~the yields for both interest-bearing liabilities and earning assets to ~~decrease more~~be lower. While the percent change of net interest income is lower than ~~offering rates for earning assets. In addition,~~the current position, the increase in fed funds sold and PPP loan program have caused an overall shortening of the balance sheet, ~~creating a larger asset sensitive position in a rising rate environment.~~where assets would be repricing faster than liabilities. These factors have caused the Company’s balance sheet to become more asset sensitive in the next 12 months, where interest rate increases translate into higher net interest income. Management believes the change in projected net interest income from interest rate shifts of up 200 bps and down 200 bps is an acceptable level of interest rate risk.

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

Effects of Inflation

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

Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase capital at higher than normal rates to maintain an appropriate capital to asset ratio. In the opinion of management, inflation did not have a significant effect on the Company’s operations for the three months ended ~~September 30, 2020.~~March 31, 2021.

6659

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Company’s management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures ~~(as~~as defined in Rules ~~13a-15(e)~~13a – 15(e) or ~~15d-15(e) under~~15d – 15(e) of the Securities Exchange Act of 1934 as ~~amended) are designed~~of March 31, 2021. 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 ~~that~~ we file orand submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported ~~within the time periods specified in the rules~~as and ~~forms~~when required. It should be noted that any system of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures, ashowever well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of ~~November 5, 2020 and, based on their evaluation, have concluded~~ the system are met. In addition, the design of any system of disclosure controls and procedures ~~were not effective as~~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 ~~date due to a material weakness~~any design will always succeed in ~~internal control over financial reporting that was disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.~~achieving its stated goals under all circumstances.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the three months ~~ending September 30, 2020~~ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

~~Remediation~~

As previously described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, we began implementing a remediation plan to address the material weakness mentioned above. The material weakness will not be considered remediated, until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2020.

Impact of New Accounting Standards

~~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.

Financial Instruments In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (CECL). The revised accounting guidance will remove all recognition thresholds and will require a company to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument's contractual life. It also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. This new accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2022. While the Company generally expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, the Company has not determined the magnitude of any such one-time adjustment or the overall impact of the new guidance on the Company's consolidated financial statements. The Company has formed a committee and is continuing to evaluate the impact of the ASU's adoption on the Company's consolidated financial statements by assessing different credit risk models. ~~As a result of~~In 2019 and 2020, the ~~FASB issuing a delay~~Company modeled the various methods prescribed in the ~~implementation~~ASU against the identified loan segments. The Company will continue to run parallel computations as it continues to evaluate the impact of adoption of this ASU ~~the Company will extend its evaluation process over the new implementation deadline of~~on January 1, 2023.

Rate Reform In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying generally accepted accounting

principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The amendments in this update are effective for all entities as of March 12, 2020 through December 31, 2022. The Company is currently evaluating the impact of the reference rate reform on the Company’s consolidated financial statements.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

~~In addition to the~~There has been no material change in risk factors ~~set forth~~previously disclosed under Part I, Item 1A ~~“Risk Factors” in~~of the ~~Company’s~~Company's Annual Report on Form 10-K for the ~~fiscal~~ year ended December 31, ~~2019, the following risk factor applies to the Company.~~

The outbreak of Coronavirus Disease 2019 (“COVID-19”) has adversely impacted, or an outbreak of other highly infectious or contagious diseases could adversely impact certain industries in which the Company’s customers operate and impair their ability to fulfill their obligations to the Company. Further, the spread of the outbreak could lead to an economic recession or other severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which the Company operates and could potentially create widespread business continuity issues for the Company.

The spread of highly infectious or contagious diseases could cause, and the spread of COVID-19 has caused, severe disruptions in the U.S. economy at large, and for small businesses in particular, which could disrupt the Company’s operations. We are starting to see the impact from COVID-19 on our business, and we believe that it will be significant, adverse and potentially material. Currently, COVID-19 is spreading through the United States and the world. The resulting concerns on the part of the U.S. and global population have created the threat of a recession, reduced economic activity and a significant correction in the global stock markets. We expect that we will experience significant disruption across our business due to these effects, leading to decreased earnings, significant slowdowns in our loan collections and loan defaults.

COVID-19 may impact businesses’ and consumers’ desire and willingness to borrow money, which would negatively impact loan volumes. In addition, certain of our borrowers are in or have exposure to the hospitality, restaurant, gaming, and long-term health care industries and/or are located in areas that are quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on our commercial real estate, and consumer loan portfolios. A prolonged quarantine or stay-at-home order would have an adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations and could result in loan defaults.

The outbreak of COVID-19 or an outbreak of other highly infectious or contagious diseases may result in a decrease in our customers’ businesses, a decrease in consumer confidence and business generally, an increase in unemployment or a disruption in the services provided by the Company’s vendors. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.

The Company relies upon its third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide the Company with these services, it could negatively impact the Company’s ability to serve its customers. Furthermore, the outbreak could negatively impact the ability of the Company’s employees and customers to engage in banking and other financial transactions in the geographic areas in which the Company operates and could create widespread business continuity issues for the Company. The Company also could be

adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas. Although the Company has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

Management believes that the economic impact from COVID-19 will be severe and could have a material and adverse impact on our business and that it could result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital.

2020.

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

The following table summarizes the purchases made by or on behalf of the Company or certain affiliated purchasers of shares of the Company's common stock during the three months ended ~~September 30, 2020:~~March 31, 2021:


					(d) Maximum Number (or						(d) Maximum Number (or
				(c) Total Number of	Approximate Dollar					(c) Total Number of	Approximate Dollar
				Shares (or Units)	Value) of Shares (or					Shares (or Units)	Value) of Shares (or
	(a) Total Number of	(b) Average Price		Purchased as Part of	Units) that May Yet Be		(a) Total Number of	(b) Average Price		Purchased as Part of	Units) that May Yet Be
	Shares (or Units)	Paid per Share (or		Publicly Announced Plans	Purchased Under the		Shares (or Units)	Paid per Share (or		Publicly Announced Plans	Purchased Under the
Period	Purchased	Unit)		or Programs	Plans or Programs *		Purchased	Unit)		or Programs	Plans or Programs *
					$	2,500,000
July 1-31, 2020	—	$	—	—	$	2,500,000
August 1-31, 2020	1,223	$	18.23	1,223	$	2,477,706
September 1-30, 2020	4,317	$	17.38	4,317	$	2,402,688
January 1-31, 2021							116,490	$	18.25	116,490	$	1,966,362
February 1-28, 2021							1,142	$	18.76	1,142	$	1,944,942
March 1-31, 2021							—	$	—	—	$	1,944,942
Total	5,540	$	17.57	5,540	$	2,402,688	117,632	$	18.26	117,632	$	1,944,942

* In 2019, the ~~third quarter of 2020, the Company’s~~Company's Board of Directors authorized the purchase of up to ~~$2.5~~$5.0 million market value of the ~~Company’s~~Company's common stock. Management was given discretion to determine the number and pricing of the shares to be purchased, as well as, the timing of any such purchases. As of ~~September 30, 2020, $2.4~~March 31, 2021, $1.9 million remained available for the repurchase of shares pursuant to the share repurchase ~~pursuant to that~~ authorization.


Item 3.	Defaults Upon Senior Securities	None

Item 4.	Mine Safety Disclosures	None

Item 5.	Other Information	None

Item 6.	Exhibits

6961


Exhibit No.		Description
3.1		Restated Articles of Incorporation of the Company (filed as Exhibit 3.1 to the Company’s current report on Form 8-K on August 9, 2007 and incorporated herein by reference).
3.2		Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company’s current report on Form 8-K on ~~June 8, 2009~~January 27, 2021 and incorporated herein by reference).
4.1		Specimen certificate representing shares of the Company’s $1.00 par value Common Stock (filed as Exhibit 4.1 to the Company’s current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).
31.1		Certificate of the Chief Executive Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certificate of the Chief Financial Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certificate of the Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certificate of the Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS		Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document).
101.SCH		Inline XBRL Taxonomy Extension Schema Document.
101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB		Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104		Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101).

~~HAWTHORN BANCSHARES, INC.~~

~~INDEX TO EXHIBITS~~

~~September 30, 2020 Form 10-Q~~


~~Exhibit~~ ~~No.~~		~~Description~~
~~3.1~~		~~Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to the Company’s current report on Form 8-K on August 9, 2007 and incorporated herein by reference).~~
~~3.2~~		~~Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company’s current report on Form 8-K on June 8, 2009 and incorporated herein by reference).~~
~~4.1~~		Specimen certificate representing shares of the Company’s $1.00 par value Common Stock (filed as Exhibit 4.1 to the Company’s current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).
~~31.1~~		Certificate of the Chief Executive Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
~~31.2~~		Certificate of the Chief Financial Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
~~32.1~~		Certificate of the Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
~~32.2~~		Certificate of the Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
~~101.INS~~		~~Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document).~~
~~101.SCH~~		~~Inline XBRL Taxonomy Extension Schema Document.~~
~~101.CAL~~		~~Inline XBRL Taxonomy Extension Calculation Linkbase Document.~~
~~101.DEF~~		~~Inline XBRL Taxonomy Extension Definition Linkbase Document.~~
~~101.LAB~~		~~Inline XBRL Taxonomy Extension Label Linkbase Document.~~
~~101.PRE~~		~~Inline XBRL Taxonomy Extension Presentation Linkbase Document.~~
~~104~~		~~Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101).~~

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

7162

SIGNATURES

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


	HAWTHORN BANCSHARES, INC.

Date

	/s/ David T. Turner

~~November 5, 2020~~May 10, 2021	David T. Turner, Chairman of the Board, President and
	Chief Executive Officer (Principal Executive Officer)

	/s/ Stephen E. Guthrie

~~November 5, 2020~~May 10, 2021	Stephen E. Guthrie, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

7263



	As of September 30, 2020
	Loan Modifications under the CARES Act by NAICS Code
	Interest		%			Full		%
Industry Category	Only		Loans			Deferral		Loans			Totals
Real Estate and Rental and Leasing	$	13,003		14.3	%	$	3,343		3.7	%	$	16,346
Accommodations and Food Services		19,859		21.8			37,918		41.7			57,777
Construction		505		0.6			-		-			505
Cinemas		-		-			4,691		5.2			4,691
Retail Trade		-		-			119		0.1			119
Arts, Entertainment, Recreation		10,166		11.2			-		-			10,166
Non-NAICS (Consumer)		77		0.1			427		0.5			504
Other		943		1.0			-		-			943
Total modifications	$	44,553		48.9	%	$	46,498		51.1	%	$	91,051

Remaining loan modifications under the CARES Act as a percent of the total loan portfolio												7.1	%
Total loan modifications under the CARES Act to date											$	303,214
Total loan modifications under the CARES Act to date as a percent of the total loan portfolio												23.7	%


Income Statement Data
	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In thousands, except per share data)	2020			2019			2020			2019
Net income - GAAP	$	4,960		$	3,860		$	9,110		$	12,046
Effect of ALL provision COVID-19 (a)		632			—			3,476			—
Effect of net gain on branch sale (b)		—			(86)			—			(1,725)
Net income - non-GAAP	$	5,592		$	3,774		$	12,586		$	10,321

Per Share Data
Basic earnings per share - GAAP	$	0.77		$	0.59		$	1.40		$	1.85
Effect of ALL provision COVID-19 (a)		0.10			—			0.54			—
Effect of net gain on branch sale (b)		—			(0.01)			—			(0.26)
Basic earnings per share - non-GAAP	$	0.87		$	0.58		$	1.94		$	1.59
Diluted earnings per share - GAAP	$	0.77		$	0.59		$	1.40		$	1.85
Effect of ALL provision COVID-19 (a)		0.10			—			0.54			—
Effect of net gain on branch sale (b)		—			(0.01)			—			(0.26)
Diluted earnings per share - non-GAAP	$	0.87		$	0.58		$	1.94		$	1.59

Key Ratios
Return on average total assets - GAAP		1.18	%		1.07	%		0.76	%		1.09	%
Effect of ALL provision COVID-19 (a)		0.15			—			0.29			—
Effect of net gain on branch sale (b)		—			(0.02)			—			(0.16)
Return on average total assets - non-GAAP		1.33	%		1.05	%		1.05	%		0.93	%
Return on average stockholders' equity - GAAP		15.99	%		13.72	%		10.15	%		15.03	%
Effect of ALL provision COVID-19 (a)		2.04			—			3.87			—
Effect of net gain on branch sale (b)		—			(0.31)			—			(2.15)
Return on average stockholders' equity - non-GAAP		18.03	%		13.41	%		14.02	%		12.88	%