HAWTHORN BANCSHARES, INC. 10-Q

Item 1. Financial Statements HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except per share data) September 30, 2022 December 31, 2021 (Unaudited) ASSETS Cash and due from banks $ 15,081 $ 17,287 Federal funds sold 46 7,122 Other interest-bearing deposits 26,259 135,500 Cash and cash equivalents 41,386 159,909 Certificates of deposit in other banks 4,195 5,193 Available-for-sale debt securities, at fair value 245,155 310,870 Other investments 5,361 5,408 Total investment securities 250,516 316,278 Loans held for investment 1,491,997 1,302,133 Allowance for loan losses ( 15,505 ) ( 16,903 ) Net loans 1,476,492 1,285,230 Loans held for sale, at lower of cost or fair value 913 2,249 Premises and equipment - net 33,334 32,719 Mortgage servicing rights, at fair value 2,906 2,659 Other real estate owned - net 9,210 10,525 Accrued interest receivable 7,048 6,621 Cash surrender value - life insurance 2,553 2,509 Other assets 19,045 7,658 Total assets $ 1,847,598 $ 1,831,550 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing demand $ 498,653 $ 453,066 Savings, interest checking and money market 825,593 818,358 Time deposits $250,000 and over 110,859 69,075 Other time deposits 157,693 176,321 Total deposits 1,592,798 1,516,820 Federal funds purchased and securities sold under agreements to repurchase 5,890 23,829 Federal Home Loan Bank advances and other borrowings 73,000 77,418 Subordinated notes 49,486 49,486 Operating lease liabilities 1,610 1,837 Accrued interest payable 565 282 Other liabilities 8,844 12,922 Total liabilities 1,732,193 1,682,594 Stockholders’ equity: Common stock, $ 1.00 par value, authorized 15,000,000 shares; issued 7,284,151 and 7,023,821 shares, respectively 7,284 7,024 Surplus 71,042 64,437 Retained earnings 88,214 82,300 Accumulated other comprehensive (loss) income, net of tax ( 40,145 ) 3,293 Treasury stock; 515,570 , and 406,846 shares, at cost, respectively ( 10,990 ) ( 8,098 ) Total stockholders’ equity 115,405 148,956 Total liabilities and stockholders’ equity $ 1,847,598 $ 1,831,550 See accompanying notes to the consolidated financial statements (unaudited) . 2 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Income (unaudited) Three Months Ended September 30, Nine Months Ended September 30, (In thousands, except per share data) 2022 2021 2022 2021 INTEREST INCOME Interest and fees on loans $ 16,328 $ 15,448 $ 44,831 $ 44,311 Interest and fees on loans held for sale 23 24 69 79 Interest on investment securities: Taxable 781 679 2,361 2,057 Nontaxable 621 493 1,822 1,114 Federal funds sold — 1 5 6 Other interest-bearing deposits and certificates of deposit in other banks 76 78 179 263 Dividends on other investments 64 81 204 246 Total interest income 17,893 16,804 49,471 48,076 INTEREST EXPENSE Interest on deposits: Savings, interest checking and money market 1,382 280 2,275 865 Time deposit accounts $250,000 and over 345 117 588 473 Time deposits 239 320 709 1,139 Total interest expense on deposits 1,966 717 3,572 2,477 Interest on federal funds purchased and securities sold under agreements to repurchase 13 19 32 72 Interest on Federal Home Loan Bank advances 277 383 778 1,164 Interest on subordinated notes 570 305 1,316 921 Total interest expense on borrowings 860 707 2,126 2,157 Total interest expense 2,826 1,424 5,698 4,634 Net interest income 15,067 15,380 43,773 43,442 Provision for (release of) loan losses 300 300 ( 1,000 ) 700 Net interest income after provision for (release of) loan losses 14,767 15,080 44,773 42,742 NON-INTEREST INCOME Service charges and other fees 693 782 2,322 2,285 Bank card income and fees 1,030 1,043 3,054 2,925 Trust department income 287 308 924 910 Real estate servicing fees, net 383 71 861 495 Gain on sale of mortgage loans, net 628 1,369 2,322 5,881 Other 464 203 1,376 514 Total non-interest income 3,485 3,776 10,859 13,010 Investment securities gains (losses), net 1 126 ( 12 ) 140 NON-INTEREST EXPENSE Salaries and employee benefits 6,750 6,665 20,251 20,766 Occupancy expense, net 789 808 2,339 2,298 Furniture and equipment expense 774 787 2,301 2,284 Processing, network, and bank card expense 1,261 1,288 3,545 3,520 Legal, examination, and professional fees 395 357 1,210 1,146 Advertising and promotion 430 310 1,027 862 Postage, printing, and supplies 237 218 653 608 Loan expense 123 209 426 612 Other 1,436 1,127 4,210 3,295 Total non-interest expense 12,195 11,769 35,962 35,391 Income before income taxes 6,058 7,213 19,658 20,501 Income tax expense 1,131 1,417 3,633 3,974 Net income $ 4,927 $ 5,796 $ 16,025 $ 16,527 Basic earnings per share $ 0.73 $ 0.84 $ 2.36 $ 2.40 Diluted earnings per share $ 0.73 $ 0.84 $ 2.36 $ 2.40 See accompanying notes to the consolidated financial statements (unaudited) . 3 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive (Loss) Income (unaudited) Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2022 2021 2022 2021 Net income $ 4,927 $ 5,796 $ 16,025 $ 16,527 Other comprehensive (loss) income, net of tax Investment securities available-for-sale: Change in unrealized losses on investment securities available-for-sale, net of tax ( 12,430 ) ( 2,192 ) ( 43,438 ) ( 3,222 ) Adjustment for gains on sale of investment securities, net of tax — ( 93 ) — ( 95 ) Defined benefit pension plans: Amortization of prior service cost included in net periodic pension cost, net of tax — 72 — 217 Total other comprehensive loss ( 12,430 ) ( 2,213 ) ( 43,438 ) ( 3,100 ) Total comprehensive (loss) income $ ( 7,503 ) $ 3,583 $ ( 27,413 ) $ 13,427 See accompanying notes to the consolidated financial statements (unaudited) . 4 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity (unaudited) Three Months Ended September 30, 2022 and 2021 (In thousands, except per share data) Common Stock Surplus Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Total Stockholders' Equity Balance, June 30, 2022 $ 7,024 $ 71,302 $ 84,437 $ ( 27,715 ) $ ( 10,990 ) $ 124,058 Net income — — 4,927 — — 4,927 Other comprehensive loss — — — ( 12,430 ) — ( 12,430 ) Purchase of treasury stock — — — — — — Stock dividend 260 ( 260 ) — — — — Cash dividends declared, common stock ($ 0.17 per share) — — ( 1,150 ) — — ( 1,150 ) Balance, September 30, 2022 $ 7,284 $ 71,042 $ 88,214 $ ( 40,145 ) $ ( 10,990 ) $ 115,405 Balance, June 30, 2021 $ 6,769 $ 64,692 $ 72,499 $ 641 $ ( 8,098 ) $ 136,503 Net income — — 5,796 — — 5,796 Other comprehensive loss — — — ( 2,213 ) — ( 2,213 ) Stock dividend 255 ( 255 ) — — Cash dividends declared, common stock ($ 0.15 per share) ( 992 ) ( 992 ) Balance, September 30, 2021 $ 7,024 $ 64,437 $ 77,303 $ ( 1,572 ) $ ( 8,098 ) $ 139,094 Nine Months Ended September 30, 2022 and 2021 (In thousands, except per share data) Common Stock Surplus Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Total Stockholders' Equity Balance, December 31, 2021 $ 7,024 $ 64,437 $ 82,300 $ 3,293 $ ( 8,098 ) $ 148,956 Net income — — 16,025 — — 16,025 Other comprehensive loss — — — ( 43,438 ) — ( 43,438 ) Purchase of treasury stock — — — — ( 2,892 ) ( 2,892 ) Stock dividend 260 6,605 ( 6,865 ) — — — Cash dividends declared, common stock ($ 0.49 per share) — — ( 3,246 ) — — ( 3,246 ) Balance, September 30, 2022 $ 7,284 $ 71,042 $ 88,214 $ ( 40,145 ) $ ( 10,990 ) $ 115,405 Balance, December 31, 2020 $ 6,769 $ 59,307 $ 68,935 $ 1,528 $ ( 5,950 ) $ 130,589 Net income — — 16,527 — — 16,527 Other comprehensive loss — — — ( 3,100 ) — ( 3,100 ) Purchase of treasury stock ( 2,148 ) ( 2,148 ) Stock dividend 255 5,130 ( 5,385 ) — Cash dividends declared, common stock ($ 0.43 per share) ( 2,774 ) ( 2,774 ) Balance, September 30, 2021 $ 7,024 $ 64,437 $ 77,303 $ ( 1,572 ) $ ( 8,098 ) $ 139,094 See accompanying notes to the consolidated financial statements (unaudited) . 5 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) Nine Months Ended September 30, (In thousands) 2022 2021 Cash flows from operating activities: Net income $ 16,025 $ 16,527 Adjustments to reconcile net income to net cash provided by operating activities: (Release of) provision for loan losses ( 1,000 ) 700 Depreciation expense 1,615 1,727 Net amortization of investment securities, premiums, and discounts 1,086 1,337 Change in fair value of mortgage servicing rights ( 186 ) 86 Investment securities (gains) losses, net 12 ( 140 ) (Gain) losses on sales and dispositions of premises and equipment ( 147 ) 8 Gain on sales and dispositions of other real estate ( 2 ) ( 25 ) (Release of) provision for other real estate owned ( 28 ) 97 Increase in accrued interest receivable ( 427 ) ( 928 ) Increase in cash surrender value - life insurance ( 44 ) ( 44 ) Decrease in other assets 155 694 Decrease in operating lease liabilities ( 227 ) ( 227 ) Increase (decrease) in accrued interest payable 283 ( 529 ) (Decrease) increase in other liabilities ( 4,185 ) 64 Origination of mortgage loans held for sale ( 72,563 ) ( 161,244 ) Proceeds from the sale of mortgage loans held for sale 76,110 167,289 Gain on sale of mortgage loans, net ( 2,322 ) ( 5,881 ) Net cash provided by operating activities 14,155 19,511 Cash flows from investing activities: Purchase of certificates of deposit in other banks ( 245 ) ( 245 ) Proceeds from maturities of certificates of deposit in other banks 1,237 2,957 Net (increase) decrease in loans ( 190,215 ) 4,121 Purchase of available-for-sale debt securities ( 17,318 ) ( 136,686 ) Proceeds from maturities of available-for-sale debt securities 24,673 30,658 Proceeds from calls of available-for-sale debt securities 2,295 14,685 Proceeds from sales of available-for-sale debt securities — 5,420 Purchases of FHLB stock ( 8,103 ) ( 330 ) Proceeds from sales of FHLB stock 8,138 688 Purchases of premises and equipment ( 2,433 ) ( 425 ) Proceeds from sales of premises and equipment 304 13 Proceeds from sales of other real estate and repossessed assets 1,348 747 Net cash used in investing activities ( 180,319 ) ( 78,397 ) Cash flows from financing activities: Net increase in demand deposits 45,587 79,134 Net increase (decrease) in interest-bearing transaction accounts 7,235 ( 30,743 ) Net increase (decrease) in time deposits 23,156 ( 20,938 ) Net decrease in federal funds purchased and securities sold under agreements to repurchase ( 17,939 ) ( 17,711 ) Repayment of FHLB advances and other borrowings ( 195,962 ) ( 13,181 ) FHLB advances 191,544 — Purchase of treasury stock ( 2,892 ) ( 2,148 ) Cash dividends paid - common stock ( 3,088 ) ( 2,624 ) Net cash provided by (used in) financing activities 47,641 ( 8,211 ) Net decrease in cash and cash equivalents ( 118,523 ) ( 67,097 ) Cash and cash equivalents, beginning of period 159,909 180,363 Cash and cash equivalents, end of period $ 41,386 $ 113,266 See accompanying notes to the consolidated financial statements (unaudited). 6 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) continued Nine Months Ended September 30, (In thousands) 2022 2021 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 5,415 $ 5,163 Income taxes $ 4,307 $ 4,729 Noncash investing and financing activities: Other real estate and repossessed assets acquired in settlement of loans net of (charge-offs) $ 3 $ 142 See accompanying notes to the consolidated financial statements (unaudited). 7 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, 2021. 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 novel coronavirus (COVID-19) pandemic or any resurgence thereof, including its potential effects on the economic environment, the Company's customers and 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, 2022, the Company paid a special stock dividend of four percent to shareholders of record at the close of business on June 15, 2022. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change. (2) Loans and Allowance for Loan Losses Loans Major classifications within the Company’s held for investment loan portfolio at September 30, 2022 and December 31, 2021 is as follows: (in thousands) September 30, 2022 December 31, 2021 Commercial, financial, and agricultural (a) $ 248,913 $ 217,214 Real estate construction − residential 25,243 27,920 Real estate construction − commercial 133,186 91,369 Real estate mortgage − residential 343,661 279,346 Real estate mortgage − commercial 717,192 663,256 Installment and other consumer 23,802 23,028 Total loans held for investment $ 1,491,997 $ 1,302,133 (a) Includes $ 0.6 million and $ 8.4 million of Small Business Administration Paycheck Protection (PPP) loans, net as of September 30, 2022 and December 31, 2021, 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 8 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) primarily of the financing of automotive vehicles. At September 30, 2022, loans of $ 636.5 million were pledged to the Federal Home Loan Bank (FHLB) 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 September 30, 2022 (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total Balance at beginning of period $ 3,005 $ 66 $ 762 $ 2,747 $ 8,410 $ 312 $ 51 $ 15,353 Additions: Provision for (release of ) loan losses ( 124 ) 5 87 481 ( 414 ) 129 136 300 Deductions: Loans charged off 46 — — — ( 1 ) 146 — 191 Less recoveries on loans ( 13 ) — — ( 4 ) ( 5 ) ( 21 ) ( 43 ) Net loan charge-offs (recoveries) 33 — — ( 4 ) ( 6 ) 125 — 148 Balance at end of period $ 2,848 $ 71 $ 849 $ 3,232 $ 8,002 $ 316 $ 187 $ 15,505 Three Months Ended September 30, 2021 (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total Balance at beginning of period $ 5,336 $ 251 $ 495 $ 2,467 $ 9,915 $ 252 $ 19 $ 18,735 Additions: Provision for (release of ) loan losses ( 609 ) ( 16 ) ( 70 ) 216 780 59 ( 60 ) 300 Deductions: Loans charged off 45 — — 18 15 78 156 Less recoveries on loans ( 19 ) — — ( 8 ) ( 1 ) ( 22 ) ( 50 ) Net loan charge-offs (recoveries) 26 — — 10 14 56 — 106 Balance at end of period $ 4,701 $ 235 $ 425 $ 2,673 $ 10,681 $ 255 $ ( 41 ) $ 18,929 Nine Months Ended September 30, 2022 (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total Balance at beginning of period $ 2,717 $ 137 $ 588 $ 2,482 $ 10,662 $ 256 $ 61 $ 16,903 Additions: Provision for (release of ) loan losses 188 ( 66 ) 261 723 ( 2,491 ) 259 126 ( 1,000 ) Deductions: Loans charged off 106 — — — 178 262 — 546 Less recoveries on loans ( 49 ) — — ( 27 ) ( 9 ) ( 63 ) — ( 148 ) Net loan charge-offs (recoveries) 57 — — ( 27 ) 169 199 — 398 Balance at end of period $ 2,848 $ 71 $ 849 $ 3,232 $ 8,002 $ 316 $ 187 $ 15,505 Nine Months Ended September 30, 2021 (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total Balance at beginning of period $ 5,121 $ 213 $ 475 $ 2,679 $ 9,354 $ 264 $ 7 $ 18,113 Additions: Provision for (release of ) loan losses ( 522 ) 9 ( 50 ) ( 167 ) 1,368 110 ( 48 ) 700 Deductions: Loans charged off 100 — — 22 42 181 345 Less recoveries on loans ( 202 ) ( 13 ) — ( 183 ) ( 1 ) ( 62 ) ( 461 ) Net loan charge-offs (recoveries) ( 102 ) ( 13 ) — ( 161 ) 41 119 — ( 116 ) Balance at end of period $ 4,701 $ 235 $ 425 $ 2,673 $ 10,681 $ 255 $ ( 41 ) $ 18,929 9 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Loans, or portions of loans, are charged off to the extent deemed uncollectible or a loss is confirmed. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration. 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 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 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 non-accrual 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 funding of $ 88.4 million and $ 47.5 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. Because the SBA PPP loans are expected to be mostly paid off within a year and carry a 100 % credit guarantee from the SBA, management determined that no allowance for loan losses was deemed necessary for these loans. At September 30, 2022, the net balance of the PPP loans totaled $ 0.6 million. All SBA PPP loans have a 1 % interest rate and the Company earns a fee 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. The PPP loan may be forgiven by the SBA if the borrower meets certain criteria as defined by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. 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. 10 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: (in thousands) Commercial, Financial, and Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total September 30, 2022 Allowance for loan losses: Individually evaluated for impairment $ 43 $ — $ 11 $ 190 $ 57 $ 1 $ — $ 302 Collectively evaluated for impairment 2,805 71 838 3,042 7,945 315 187 15,203 Total $ 2,848 $ 71 $ 849 $ 3,232 $ 8,002 $ 316 $ 187 $ 15,505 Loans outstanding: Individually evaluated for impairment $ 350 $ — $ 91 $ 2,181 $ 16,308 $ 6 $ — $ 18,936 Collectively evaluated for impairment 248,563 25,243 133,095 341,480 700,884 23,796 — 1,473,061 Total $ 248,913 $ 25,243 $ 133,186 $ 343,661 $ 717,192 $ 23,802 $ — $ 1,491,997 December 31, 2021 Allowance for loan losses: Individually evaluated for impairment $ 42 $ — $ 13 $ 166 $ 2,815 $ 8 $ — $ 3,044 Collectively evaluated for impairment 2,675 137 575 2,316 7,847 248 61 13,859 Total $ 2,717 $ 137 $ 588 $ 2,482 $ 10,662 $ 256 $ 61 $ 16,903 Loans outstanding: Individually evaluated for impairment $ 341 $ — $ 105 $ 2,391 $ 24,357 $ 60 $ — $ 27,254 Collectively evaluated for impairment 216,873 27,920 91,264 276,955 638,899 22,968 — 1,274,879 Total $ 217,214 $ 27,920 $ 91,369 $ 279,346 $ 663,256 $ 23,028 $ — $ 1,302,133 Impaired Loans Loans evaluated under Accounting Standards Codification (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 $ 18.9 million and $ 27.3 million at September 30, 2022 and December 31, 2021, 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, 2022, $ 15.9 million of impaired loans were evaluated based on the fair value less estimated selling costs of the loans' collateral compared to $ 24.2 million at December 31, 2021. Once the impairment amount is calculated, a specific reserve allocation is recorded. At September 30, 2022, $ 0.3 million of the Company’s allowance for loan losses was allocated to impaired loans totaling $ 18.9 million compared to $ 3.0 million of the Company’s allowance for loan losses allocated to impaired loans totaling $ 27.3 million at December 31, 2021. Management determined that $ 15.9 million, or 84 %, of total impaired loans required no reserve allocation at September 30, 2022 compared to $ 16.6 million, or 61 %, at December 31, 2021, primarily due to adequate collateral values , acceptable payment history and adequate cash flow ability. 11 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The categories of impaired loans at September 30, 2022 and December 31, 2021 are as follows: (in thousands) September 30, 2022 December 31, 2021 Non-accrual loans $ 17,348 $ 25,459 Performing TDRs 1,588 1,795 Total impaired loans $ 18,936 $ 27,254 The following tables provide additional information about impaired loans at September 30, 2022 and December 31, 2021, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided. (in thousands) Recorded Investment Unpaid Principal Balance Specific Reserves September 30, 2022 With no related allowance recorded: Real estate mortgage − commercial $ 15,898 $ 16,949 $ — Total $ 15,898 $ 16,949 $ — With an allowance recorded: Commercial, financial and agricultural $ 350 $ 384 $ 43 Real estate construction − commercial 91 130 11 Real estate mortgage − residential 2,181 2,686 190 Real estate mortgage − commercial 410 496 57 Installment and other consumer 6 6 1 Total $ 3,038 $ 3,702 $ 302 Total impaired loans $ 18,936 $ 20,651 $ 302 (in thousands) Recorded Investment Unpaid Principal Balance Specific Reserves December 31, 2021 With no related allowance recorded: Real estate mortgage − residential $ 1,034 $ 1,152 $ — Real estate mortgage − commercial 15,593 16,057 — Total $ 16,627 $ 17,209 $ — With an allowance recorded: Commercial, financial and agricultural $ 341 $ 374 $ 42 Real estate construction − commercial 105 138 13 Real estate mortgage − residential 1,357 1,730 166 Real estate mortgage − commercial 8,764 9,142 2,815 Installment and other consumer 60 61 8 Total $ 10,627 $ 11,445 $ 3,044 Total impaired loans $ 27,254 $ 28,654 $ 3,044 12 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents by class, information related to the average recorded investment and interest income recognized on impaired loans during the periods indicated. Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 (in thousands) Average Recorded Investment Interest Recognized For the Period Ended Average Recorded Investment Interest Recognized For the Period Ended Average Recorded Investment Interest Recognized For the Period Ended Average Recorded Investment Interest Recognized For the Period Ended With no related allowance recorded: Commercial, financial and agricultural $ — $ — $ 1,517 $ 18 $ — $ — $ 1,703 $ 31 Real estate mortgage − residential — — 1,131 — 4 1 1,238 21 Real estate mortgage − commercial 15,937 — 9,376 — 15,752 — 9,411 — Total $ 15,937 $ — $ 12,024 $ 18 $ 15,756 $ 1 $ 12,352 $ 52 With an allowance recorded: Commercial, financial and agricultural $ 322 $ 3 $ 5,295 $ 5 $ 328 $ 8 $ 5,409 $ 19 Real estate construction − residential — — — — — — 63 — Real estate construction − commercial 93 15 109 — 95 45 139 — Real estate mortgage − residential 2,177 6 1,713 16 2,297 22 1,691 26 Real estate mortgage − commercial 414 — 16,102 7 422 1 16,111 21 Installment and other consumer 99 — 55 — 118 — 63 3 Total $ 3,105 $ 24 $ 23,274 $ 28 $ 3,260 $ 76 $ 23,476 $ 69 Total impaired loans $ 19,042 $ 24 $ 35,298 $ 46 $ 19,016 $ 77 $ 35,828 $ 121 The recorded investment varies from the unpaid principal balance primarily due to partial charge-offs taken as a result of from current appraisals received. The amount recognized as interest income on impaired loans continuing to accrue interest, primarily related to TDRs, was $ 24 ,000 and $ 77 ,000 for the three and nine months ended September 30, 2022, respectively, compared to $ 46 ,000 and $ 121 ,000 for the three and nine months ended September 30, 2021, respectively. The average recorded investment in impaired loans is calculated on a monthly basis during the periods reported. Delinquent and Non-Accrual Loans The delinquency status of loans is determined based on the contractual terms of the notes. Loans 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 status, 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. 13 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table provides aging information for the Company’s past due and non-accrual loans at September 30, 2022 and December 31, 2021. (in thousands) Current or Less Than 30 Days Past Due 30 - 89 Days Past Due 90 Days Past Due And Still Accruing Non-Accrual Total September 30, 2022 Commercial, Financial, and Agricultural $ 248,707 $ 33 $ — $ 173 $ 248,913 Real estate construction − residential 25,243 — — — 25,243 Real estate construction − commercial 133,095 — — 91 133,186 Real estate mortgage − residential 342,357 221 — 1,083 343,661 Real estate mortgage − commercial 700,960 237 — 15,995 717,192 Installment and Other Consumer 23,720 76 — 6 23,802 Total $ 1,474,082 $ 567 $ — $ 17,348 $ 1,491,997 December 31, 2021 Commercial, Financial, and Agricultural $ 217,058 $ 3 $ — $ 153 $ 217,214 Real estate construction − residential 27,920 — — — 27,920 Real estate construction − commercial 91,264 — — 105 91,369 Real estate mortgage − residential 277,532 671 14 1,129 279,346 Real estate mortgage − commercial 638,982 245 — 24,029 663,256 Installment and Other Consumer 22,848 137 — 43 23,028 Total $ 1,275,604 $ 1,056 $ 14 $ 25,459 $ 1,302,133 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 when 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 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 non-performing TDRs and are included with all other non-accrual 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. 14 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents the risk categories by class at September 30, 2022 and December 31, 2021. (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and other Consumer Total At September 30, 2022 Watch $ 8,035 $ — $ 2,269 $ 6,447 $ 47,953 $ — $ 64,704 Substandard 7,064 — 3,358 513 2,130 — 13,065 Performing TDRs 177 — — 1,098 313 — 1,588 Non-accrual loans 173 — 91 1,083 15,995 6 17,348 Total $ 15,449 $ — $ 5,718 $ 9,141 $ 66,391 $ 6 $ 96,705 At December 31, 2021 Watch $ 9,219 $ — $ 4,304 $ 12,185 $ 43,348 $ — $ 69,056 Substandard 6,284 — 2,673 750 2,305 — 12,012 Performing TDRs 188 — — 1,262 328 17 1,795 Non-accrual loans 153 — 105 1,129 24,029 43 25,459 Total $ 15,844 $ — $ 7,082 $ 15,326 $ 70,010 $ 60 $ 108,322 Troubled Debt Restructurings At September 30, 2022, loans classified as TDRs totaled $ 1.9 million, of which $ 0.3 million were classified as non-performing TDRs and $ 1.6 million were classified as performing TDRs. At December 31, 2021, loans classified as TDRs totaled $ 2.4 million, of which $ 0.6 million were classified as non-performing TDRs and $ 1.8 million were classified as performing TDRs. Both performing and non-performing 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 $ 171 ,000 and $ 159 ,000 related to TDRs were allocated to the allowance for loan losses at September 30, 2022 and December 31, 2021, respectively. The Company’s portfolio of loans classified as TDRs include concessions for the borrower given their financial condition such as applying interest rates below the current market rate, deferring principal payments, and extending maturity dates. There was one loan meeting the TDR criteria that was modified during the three and nine months ended September 30, 2022, respectively, compared to no loans during the three and nine months ended September 30, 2021, respectively. The Company considers a TDR to be in default when it is 90 days or more past due under the modified terms, a charge-off occurs, or it is in the process of foreclosure. There were no loans modified as a TDR that defaulted during the three and nine months ended September 30, 2022 and 2021, respectively, and within twelve months of their modification date. Loans Held For Sale The Company designates certain long-term fixed rate personal real estate loans as held for sale. In the fourth quarter of 2021, the Company elected the fair value option for all newly originated long-term personal real estate loans held for sale. As of December 31, 2021, all loans held for sale were carried at fair value. The loans are primarily sold to Freddie Mac, Fannie Mae, PennyMac, and various other secondary market investors. At September 30, 2022, the carrying amount of these loans was $ 0.9 million compared to $ 2.2 million at December 31, 2021. 15 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (3) Other Real Estate and Other Assets Acquired in Settlement of Loans September 30, December 31, (in thousands) 2022 2021 Commercial $ — $ 643 Real estate construction - commercial 10,094 10,166 Real estate mortgage - residential 86 117 Real estate mortgage - commercial 1,639 2,510 Repossessed assets 55 — Total $ 11,874 $ 13,436 Less valuation allowance for other real estate owned ( 2,664 ) ( 2,911 ) Total other real estate owned and repossessed assets $ 9,210 $ 10,525 Changes in the net carrying amount of other real estate owned and repossessed assets were as follows for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Balance at beginning of period $ 11,819 $ 14,552 $ 13,436 $ 14,905 Additions net of (charge-offs) 55 112 3 142 Proceeds from sales — ( 423 ) ( 1,348 ) ( 747 ) Charge-offs against the valuation allowance for other real estate owned, net — ( 470 ) ( 219 ) ( 554 ) Net gain on sales — — 2 25 Total other real estate owned 11,874 13,771 11,874 13,771 Less valuation allowance for other real estate owned ( 2,664 ) ( 2,157 ) ( 2,664 ) ( 2,157 ) Balance at end of period $ 9,210 $ 11,614 $ 9,210 $ 11,614 At September 30, 2022, $ 0.2 million of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to $ 0.2 million of consumer mortgage loans at December 31, 2021. 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, (in thousands) 2022 2021 2022 2021 Balance at beginning of period $ 2,664 $ 2,614 $ 2,911 $ 2,614 Provision for other real estate owned — 13 ( 28 ) 97 Charge-offs — ( 470 ) ( 219 ) ( 554 ) Balance at end of period $ 2,664 $ 2,157 $ 2,664 $ 2,157 16 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (4) Investment Securities The amortized cost and fair value of debt securities classified as available-for-sale at September 30, 2022 and December 31, 2021 were as follows: Gross Unrealized (in thousands) Total Amortized Cost Gains Losses Fair Value September 30, 2022 U.S. Treasury $ 3,555 $ — $ ( 49 ) $ 3,506 U.S. government and federal agency obligations 592 — ( 34 ) 558 U.S. government-sponsored enterprises 26,499 — ( 2,896 ) 23,603 Obligations of states and political subdivisions 134,747 — ( 32,591 ) 102,156 Mortgage-backed securities 120,977 7 ( 18,038 ) 102,946 Other debt securities (a) 11,825 — ( 646 ) 11,179 Bank issued trust preferred securities (a) 1,486 — ( 279 ) 1,207 Total available-for-sale securities $ 299,681 $ 7 $ ( 54,533 ) $ 245,155 December 31, 2021 U.S. Treasury $ 3,909 $ 11 $ ( 3 ) $ 3,917 U.S. government and federal agency obligations 1,314 5 — 1,319 U.S. government-sponsored enterprises 26,498 70 ( 196 ) 26,372 Obligations of states and political subdivisions 128,093 1,605 ( 474 ) 129,224 Mortgage-backed securities 137,286 791 ( 1,611 ) 136,466 Other debt securities (a) 11,825 482 ( 23 ) 12,284 Bank issued trust preferred securities (a) 1,486 — ( 198 ) 1,288 Total available-for-sale securities $ 310,411 $ 2,964 $ ( 2,505 ) $ 310,870 (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, SBA guaranteed loan certificates, 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 $ 169.0 million and $ 275.4 million at September 30, 2022 and December 31, 2021, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law. 17 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, 2022, 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. (in thousands) Amortized Cost Fair Value Due in one year or less $ 5,732 $ 5,675 Due after one year through five years 22,437 20,913 Due after five years through ten years 28,976 25,920 Due after ten years 121,559 89,701 Total 178,704 142,209 Mortgage-backed securities 120,977 102,946 Total available-for-sale securities $ 299,681 $ 245,155 Other Investment Securities Other investment securities include equity securities with readily determinable fair values and other investment securities that do not have readily determinable fair values. Investments in FHLB stock, and Midwest Independent Bank (MIB) bankers bank stock, that do not have readily determinable fair values, are required for membership in those organizations. (in thousands) September 30, 2022 December 31, 2021 Other securities: FHLB stock $ 5,162 $ 5,197 MIB stock 151 151 Equity securities with readily determinable fair values 48 60 Total other investment securities $ 5,361 $ 5,408 18 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, 2022 and December 31, 2021 were as follows: Less than 12 months 12 months or more (in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Total Fair Value Total Unrealized Losses September 30, 2022 U.S. Treasury $ 2,758 $ ( 46 ) $ 748 $ ( 3 ) $ 3,506 $ ( 49 ) U.S. government and federal agency obligations 558 ( 34 ) — — 558 ( 34 ) U.S. government-sponsored enterprises 19,487 ( 2,012 ) 4,116 ( 884 ) 23,603 ( 2,896 ) Obligations of states and political subdivisions 75,649 ( 20,664 ) 26,507 ( 11,927 ) 102,156 ( 32,591 ) Mortgage-backed securities 60,397 ( 7,945 ) 41,998 ( 10,093 ) 102,395 ( 18,038 ) Other debt securities 11,179 ( 646 ) — — 11,179 ( 646 ) Bank issued trust preferred securities — — 1,207 ( 279 ) 1,207 ( 279 ) Total $ 170,028 $ ( 31,347 ) $ 74,576 $ ( 23,186 ) $ 244,604 $ ( 54,533 ) (in thousands) December 31, 2021 U.S. Treasury $ 1,758 $ ( 3 ) $ — $ — $ 1,758 $ ( 3 ) U.S. government-sponsored enterprises 18,304 ( 196 ) — — 18,304 ( 196 ) Obligations of states and political subdivisions 39,221 ( 474 ) — — 39,221 ( 474 ) Mortgage-backed securities 89,520 ( 1,579 ) 1,864 ( 32 ) 91,384 ( 1,611 ) Other debt securities 3,802 ( 23 ) — — 3,802 ( 23 ) Bank issued trust preferred securities — — 1,288 ( 198 ) 1,288 ( 198 ) Total $ 152,605 $ ( 2,275 ) $ 3,152 $ ( 230 ) $ 155,757 $ ( 2,505 ) The total available-for-sale portfolio consisted of approximately 444 securities at September 30, 2022. The portfolio included 438 securities having an aggregate fair value of $ 244.6 million that were in a loss position at September 30, 2022. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $ 74.6 million at fair value at September 30, 2022. The $ 54.5 million aggregate unrealized loss included in accumulated other comprehensive loss at September 30, 2022 was caused by interest rate fluctuations. The total available-for-sale portfolio consisted of approximately 435 securities at December 31, 2021. The portfolio included 134 securities having an aggregate fair value of $ 155.8 million that were in a loss position at December 31, 2021. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $ 3.2 million at fair value at December 31, 2021. The $ 2.5 million aggregate unrealized loss included in accumulated other comprehensive loss at December 31, 2021 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, 2022 and December 31, 2021, 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. 19 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents the 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 for the periods indicated: Three Months Ended June 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Investment securities gains (losses), net Available-for-sale securities: Gross realized gains $ — $ 119 $ — $ 121 Gross realized losses — — — — Other-than-temporary impairment recognized — — — — Other investment securities: Fair value adjustments, net 1 7 ( 12 ) 19 Investment securities gains (losses), net $ 1 $ 126 $ ( 12 ) $ 140 (5) Intangible Assets Mortgage Servicing Rights At September 30, 2022, the Company was servicing approximately $ 247.6 million of loans sold to the secondary market compared to $ 270.0 million at December 31, 2021, and $ 277.1 million at September 30, 2021. Mortgage loan servicing fees, reported in real estate servicing fees, net, earned on loans sold were $ 0.2 million and $ 0.7 million for the three and nine months ended September 30, 2022, respectively, compared to $ 0.2 million and $ 0.6 million for the three and nine months ended September 30, 2021, respectively. The table below presents changes in mortgage servicing rights (MSRs) for the periods indicated. Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Balance at beginning of period $ 2,730 $ 2,775 $ 2,659 $ 2,445 Originated mortgage servicing rights 21 66 61 359 Changes in fair value: Due to changes in model inputs and assumptions (1) 228 ( 13 ) 418 269 Other changes in fair value (2) ( 73 ) ( 110 ) ( 232 ) ( 355 ) Total changes in fair value 155 ( 123 ) 186 ( 86 ) Balance at end of period $ 2,906 $ 2,718 $ 2,906 $ 2,718 (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. The following key data and assumptions were used in estimating the fair value of the Company’s MSRs as of September 30, 2022 and 2021, respectively: Nine Months Ended September 30, 2022 2021 Weighted average constant prepayment rate 7.30 % 11.41 % Weighted average note rate 3.42 % 3.38 % Weighted average discount rate 10.00 % 8.00 % Weighted average expected life (in years) 6.98 6.03 20 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (6) Deposits The table below represents the aggregate amount of time deposits with balances that met or exceeded the Federal Deposit Insurance Corporation (FDIC) insurance limit of $250,000 and brokered deposits for the periods indicated. (aggregate amounts in thousands) September 30, 2022 December 31, 2021 Time deposits with balances > $250,000 $ 110,859 $ 69,075 Brokered deposits $ 36,086 $ 20,202 (7) Federal Funds Purchased and Securities Sold under Agreements to Repurchase (in thousands) September 30, 2022 December 31, 2021 Federal funds purchased $ — $ — Repurchase agreements 5,890 23,829 Total $ 5,890 $ 23,829 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 (in thousands) Overnight and continuous Less than 90 days Greater than 90 days Total September 30, 2022 U.S. government-sponsored enterprises $ 5,890 $ — $ — $ 5,890 Total $ 5,890 $ — $ — $ 5,890 December 31, 2021 U.S. government-sponsored enterprises $ 9,113 $ — $ — $ 9,113 Mortgage-backed securities 14,716 — — 14,716 Total $ 23,829 $ — $ — $ 23,829 (8) 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, 2022, operating right of use (ROU) assets and liabilities were $ 1.6 million and $ 1.6 million, respectively. As of September 30, 2022, the weighted-average remaining lease term on these operating leases is approximately 5.9 years and the weighted-average discount rate used to measure the lease liabilities was 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 21 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 $ 93,000 and $ 280,000 for the three and nine months ended September 30, 2022, respectively, compared to $ 93,000 and $ 289,000 for the three and nine months ended September 30, 2021, respectively. At adoption of Accounting Standards Update (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 $ 21,000 and $ 65,000 for the three and nine months ended September 30, 2022, respectively, compared to $ 24,000 and $ 56,000 for the three and nine months ended September 30, 2021, respectively. The table below summarizes the maturity of remaining operating lease liabilities: Lease payments due in: Operating Lease (in thousands) 2022 (excluding 9 months ended September 30, 2022) $ 92 2023 367 2024 258 2025 257 2026 259 Thereafter 571 Total lease payments 1,804 Less imputed interest ( 194 ) Total lease liabilities, as reported $ 1,610 (9) Income Taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 18.7 % and 18.5 % for the three and nine months ended September 30, 2022, respectively, compared to 19.6 % and 19.4 % for the three and nine months ended September 30, 2021, respectively. The decrease in the effective tax rate for the three months ended September 30, 2022 compared to the three months ended September 30, 2021 was primarily attributable to the decrease in earnings and the benefit recorded pertaining to the historical tax credit. The decrease in the effective tax rate for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 was primarily attributable to the decrease in earnings and the benefit recorded pertaining to the historical tax credit. The effective tax rate for each of the three and nine months ended September 30, 2022 and 2021, respectively, is lower than the U.S. federal statutory rate of 21% primarily due to tax-free revenues. Included in the effective tax rate is a $ 13,000 and $ 40,000 benefit associated with a historic tax credit investment for the three and nine months ended September 30, 2022, respectively. The investment is expected to generate a $ 331,000 tax benefit over the life of the project and is being recognized under the deferral method of accounting. 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, 2022. 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. 22 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The Company follows ASC Topic 740, Income Taxes, which addresses the accounting for uncertain tax positions . For each of the nine months ended September 30, 2022 and 2021, respectively, the Company did not have any uncertain tax provisions, and did not record any related tax liabilities. (10) Stockholders’ Equity Accumulated Other Comprehensive Income (Loss) The following table summarizes the change in the components of the Company’s accumulated other comprehensive income (loss) for the nine months ended September 30, 2022 and 2021: Nine Months Ended September 30, 2022 (in thousands) Unrealized Gains (Losses) on Securities (1) Unrecognized Net Pension and Postretirement Costs (2) Accumulated Other Comprehensive Income (Loss) Balance at beginning of period $ 362 $ 2,931 $ 3,293 Other comprehensive loss, before reclassifications ( 54,985 ) — ( 54,985 ) Amounts reclassified from accumulated other comprehensive income (loss) — — — Current period other comprehensive loss, before tax ( 54,985 ) — ( 54,985 ) Income tax benefit 11,547 — 11,547 Current period other comprehensive loss, net of tax ( 43,438 ) — ( 43,438 ) Balance at end of period $ ( 43,076 ) $ 2,931 $ ( 40,145 ) Nine Months Ended September 30, 2021 (in thousands) Unrealized Gains (Losses) on Securities (1) Unrecognized Net Pension and Postretirement Costs (2) Accumulated Other Comprehensive Income (Loss) Balance at beginning of period $ 3,353 $ ( 1,825 ) $ 1,528 Other comprehensive (loss) income, before reclassifications ( 4,105 ) 275 ( 3,830 ) Amounts reclassified from accumulated other comprehensive (loss) income ( 95 ) — ( 95 ) Current period other comprehensive (loss) income, before tax ( 4,200 ) 275 ( 3,925 ) Income tax benefit (expense) 883 ( 58 ) 825 Current period other comprehensive (loss) income, net of tax ( 3,317 ) 217 ( 3,100 ) Balance at end of period $ 36 $ ( 1,608 ) $ ( 1,572 ) (1) The pre-tax amounts reclassified from accumulated other comprehensive 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 income (loss) are included in the computation of net periodic pension cost. (11) 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, (in thousands) 2022 2021 2022 2021 Payroll taxes $ 338 $ 310 $ 1,123 $ 1,102 Medical plans 426 436 1,368 1,405 401(k) match and profit sharing 411 513 1,206 1,456 Periodic pension cost 402 449 1,206 1,347 Other 20 3 32 10 Total employee benefits $ 1,597 $ 1,711 $ 4,936 $ 5,320 23 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 made annual contributions for the discretionary portion in an amount up to 6 % of income before income taxes and before contributions to the profit-sharing and pension plans for all participants, limited to the maximum amount deductible for federal income tax purposes, for each of the periods shown. In addition, employees were able to make additional tax-deferred contributions. Other Plans On November 7, 2018, the Board of Directors of the Company adopted a supplemental executive retirement plan (SERP), effective as of January 1, 2018. The SERP provides select employees who satisfy certain eligibility requirements with certain benefits upon retirement, termination of employment or death. The accrued liability relating to the SERP was $ 1.6 million as of September 30, 2022, and the expense for the three and nine months ended September 30, 2022 was $ 93,000 and $ 279,000 , respectively, compared to $ 97,000 and 290,000 , for the three and nine months ended September 30, 2021, respectively, and is recognized over the required service period. Pension The Company provides a noncontributory defined benefit pension plan for all full-time and 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 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 $ 1.0 million on April 1, 2022. 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 (Loss) The following items are components of net pension cost for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Service cost - benefits earned during the year $ 373 $ 423 $ 1,118 $ 1,269 Interest costs on projected benefit obligations (a) 294 268 881 804 Expected return on plan assets (a) ( 570 ) ( 461 ) ( 1,711 ) ( 1,382 ) Expected administrative expenses 29 26 89 78 Amortization of prior service cost (a) — — — — Amortization of unrecognized net loss (a) — 92 — 275 Net periodic pension cost $ 125 $ 348 $ 376 $ 1,044 (a) The components of net periodic pension cost other than the service cost and expected administrative expenses 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 24 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) excess of a 10% corridor is amortized in net periodic benefit cost over the average remaining service period of active participants in the pension plan. The prior service credit is amortized over the average remaining service period to full eligibility for participating employees expected to receive benefits. Currently, there is no prior service cost or net transition (asset)/obligation to be amortized. (12) Earnings per Share Stock Dividend On July 1, 2022, the Company paid a special stock dividend of 4.0 % to common shareholders of record at the close of business on June 15, 2022. 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 period. Diluted earnings per share gives effect to all dilutive potential shares that were outstanding during the period. Presented below is a summary of the components used to calculate basic and diluted earnings per common share for the periods indicated, which have been restated to reflect all stock dividends: Three Months Ended September 30, Nine Months Ended September 30, (dollars in thousands, except per share data) 2022 2021 2022 2021 Basic earnings per share: Net income available to shareholders $ 4,927 $ 5,796 $ 16,025 $ 16,527 Average shares outstanding 6,768,581 6,877,305 6,800,309 6,877,435 Basic earnings per share $ 0.73 $ 0.84 $ 2.36 $ 2.40 Diluted earnings per share: Net income available to shareholders $ 4,927 $ 5,796 $ 16,025 $ 16,527 Average shares outstanding 6,768,581 6,877,305 6,800,309 6,877,435 Diluted earnings per share $ 0.73 0.84 $ 2.36 $ 2.40 Repurchase Program The Company's 2019 Repurchase Plan was amended during the second quarter of 2021 to authorize the purchase of up to an additional $ 5.0 million in 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. The Company repurchased 108,724 common shares under the plan during the nine months ended September 30, 2022, at an average cost of $ 26.60 per share totaling $ 2.9 million. As of September 30, 2022, $ 2.1 million remained available for share repurchases pursuant to the plan. (13) 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 U.S. 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: 25 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 non-recurring 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. Other Investment Securities Other investment securities include equity securities with readily determinable fair values and other investment securities that do not have readily determinable fair values. Investments in Federal Home Loan Bank (FHLB) stock, and Midwest Independent Bank (MIB) bankers bank stock, that do not have readily determinable fair values, are required for membership in those organizations. Equity securities that are not actively traded are classified in level 2. 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. Loans Held for Sale The fair value of the committed in forward sale agreements loans is the price at which they could be sold in the principal market at the measurement date, therefore the Company classifies as level 2. Derivative Assets and Liabilities Derivative assets and liabilities include interest rate lock commitments (IRLCs) and forward sale commitments. The fair values of IRLCs and forward sale commitments are determined using readily observable market data such as interest rates, prices, volatility factors, and customer credit-related adjustments. For IRLCs, the fair value is subject to the anticipated loan funding probability (pull-through rate), which is considered an unobservable factor. Factors that affect pull-through rates include origination channel, current mortgage interest rates in the market versus the interest rate incorporated in the IRLC, the purpose of the mortgage, stage of completion of the underlying application and underwriting process, and the time remaining until the IRLC expires. The Company classifies IRLCs as level 3 due to the unobservable input of pull-through rates. 26 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. 27 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Fair Value Measurements (in thousands) Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) September 30, 2022 Assets: U.S. Treasury $ 3,506 $ 3,506 $ — $ — U.S. government and federal agency obligations 558 — 558 — U.S. government-sponsored enterprises 23,603 — 23,603 — Obligations of states and political subdivisions 102,156 — 102,156 — Mortgage-backed securities 102,946 — 102,946 — Other debt securities 11,179 — 11,179 — Bank-issued trust preferred securities 1,207 — 1,207 — Equity securities 48 48 — — Interest rate lock commitments 10 — — 10 Forward sale commitments 35 — 35 — Loans held for sale 913 — 913 — Mortgage servicing rights 2,906 — — 2,906 Total $ 249,067 $ 3,554 $ 242,597 $ 2,916 Liabilities: Interest rate lock commitments $ 76 $ — $ — $ 76 Total $ 76 $ — $ — $ 76 December 31, 2021 Assets: U.S. Treasury $ 3,917 $ 3,917 $ — $ — U.S. government and federal agency obligations 1,319 — 1,319 — U.S. government-sponsored enterprises 26,372 — 26,372 — Obligations of states and political subdivisions 129,224 — 129,224 — Mortgage-backed securities 136,466 — 136,466 — Other debt securities 12,284 — 12,284 — Bank-issued trust preferred securities 1,288 — 1,288 — Equity securities 60 60 — — Interest rate lock commitments 312 — — 312 Forward sale commitments 12 — 12 — Loans held for sale 2,249 — 2,249 — Mortgage servicing rights 2,659 — — 2,659 Total $ 316,162 $ 3,977 $ 309,214 $ 2,971 Liabilities: Interest rate lock commitments $ 26 $ — $ — $ 26 Total $ 26 $ — $ — $ 26 28 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 for the periods indicated: Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Mortgage Servicing Rights Interest Rate Lock Commitments Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Balance at beginning of period $ 2,659 $ 2,445 $ 286 $ — Total gains or (losses) (realized/unrealized): Included in earnings 186 ( 86 ) ( 22 ) — Included in other comprehensive income — — — — Purchases — — — — Sales — — ( 474 ) — Issues 61 359 144 — Settlements — — — — Balance at end of period $ 2,906 $ 2,718 $ ( 66 ) $ — Valuation Methods for Assets and Liabilities Measured at Fair Value on a Non-recurring Basis Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a non-recurring basis: Collateral Dependent Impaired Loans While the overall loan portfolio is not carried at fair value, the Company periodically records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring 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 trained to perform in-house evaluations and also to 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 a senior loan committee. Because many of these inputs are not observable, the measurements are classified as Level 3. As of September 30, 2022, the Company identified $ 15.9 million in collateral-dependent impaired loans that required no specific allowance for loan losses. Related to these loans, there were $ 61,000 and $ 86,000 in charge-offs recorded during the three and nine months ended September 30, 2022, respectively. As of September 30, 2021, the Company identified $ 31.2 million in collateral-dependent impaired loans that had specific allowances for losses aggregating $ 4.7 million. Related to these loans, there were $ 33,000 and $ 69,000 in charge-offs recorded during the three and nine months ended September 30, 2021, respectively. Other Real Estate and Foreclosed Assets Other real estate owned (OREO) and foreclosed assets consisted of loan collateral repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Subsequent to foreclosure, these assets initially are carried at fair value of the collateral less estimated selling costs. Fair value, when recorded, is generally based upon appraisals by approved, independent state-certified appraisers. Like impaired loans, appraisals on OREO may be discounted based on the Company’s historical knowledge, changes in market conditions from the time of appraisal or other information available. During the holding period, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3. 29 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Fair Value Measurements Using (in thousands) Total Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Three Months Ended September 30, Total Gains (Losses)* Nine Months Ended September 30, Total Gains (Losses)* September 30, 2022 Assets: Collateral dependent impaired loans: Real estate mortgage - commercial $ 15,898 $ — $ — $ 15,898 $ ( 23 ) $ ( 48 ) Installment and other consumer — — — — ( 38 ) ( 38 ) Total $ 15,898 $ — $ — $ 15,898 $ ( 61 ) $ ( 86 ) Other real estate and repossessed assets $ 9,210 $ — $ — $ 9,210 $ — $ ( 22 ) September 30, 2021 Assets: Collateral dependent impaired loans: Commercial, financial, & agricultural $ 3,960 $ — $ — $ 3,960 $ — $ — Real estate mortgage - residential 324 — — 324 ( 18 ) ( 22 ) Real estate mortgage - commercial 22,266 — — 22,266 ( 15 ) ( 41 ) Installment and other consumer — — — — — ( 6 ) Total $ 26,550 $ — $ — $ 26,550 $ ( 33 ) $ ( 69 ) Other real estate and repossessed assets $ 11,614 $ — $ — $ 11,614 $ ( 12 ) $ ( 71 ) * Total losses reported for other real estate and foreclosed assets includes charge-offs, valuation write downs, and net losses taken during the periods reported. (14) 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 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. Federal Funds Sold, Cash, and Due from Banks The carrying amounts of short-term federal funds sold, interest-earning deposits with banks, and cash and due from banks approximate fair value. Federal funds sold classified as short-term generally mature in 90 days or less. Certificates of Deposit in Other Banks Certificates of deposit are other investments made by the Company with other financial institutions that are carried at cost 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. 30 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 non-interest-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. 31 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, 2022 and December 31, 2021 is as follows: September 30, 2022 Fair Value Measurements September 30, 2022 Quoted Prices in Active Markets for Identical Assets Other Observable Inputs Net Significant Unobservable Inputs (in thousands) Carrying amount Fair value (Level 1) (Level 2) (Level 3) Assets: Cash and due from banks $ 15,081 $ 15,081 $ 15,081 $ — $ — Federal funds sold and overnight interest-bearing deposits 26,305 26,305 26,305 — — Certificates of deposit in other banks 4,195 4,195 4,195 — — Available-for-sale securities 245,155 245,155 3,506 241,649 — Other investment securities 5,361 5,361 48 5,313 — Loans, net 1,476,492 1,424,475 — — 1,424,475 Loans held for sale 913 913 — 913 — Cash surrender value - life insurance 2,553 2,553 — 2,553 — Interest rate lock commitments 10 10 — — 10 Forward sale commitments 35 35 — 35 — Accrued interest receivable 7,048 7,048 7,048 — — Total $ 1,783,148 $ 1,731,131 $ 56,183 $ 250,463 $ 1,424,485 Liabilities: Deposits: Non-interest bearing demand $ 498,653 $ 498,653 $ 498,653 $ — $ — Savings, interest checking and money market 825,593 825,593 825,593 — — Time deposits 268,552 264,472 — — 264,472 Federal funds purchased and securities sold under agreements to repurchase 5,890 5,890 5,890 — — Federal Home Loan Bank advances and other borrowings 73,000 73,000 — 73,000 — Subordinated notes 49,486 40,187 — 40,187 — Interest rate lock commitments 76 76 — — 76 Accrued interest payable 565 565 565 — — Total $ 1,721,815 $ 1,708,436 $ 1,330,701 $ 113,187 $ 264,548 32 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) December 31, 2021 Fair Value Measurements December 31, 2021 Quoted Prices in Active Markets for Identical Assets Other Observable Inputs Net Significant Unobservable Inputs (in thousands) Carrying amount Fair value (Level 1) (Level 2) (Level 3) Assets: Cash and due from banks $ 17,287 $ 17,287 $ 17,287 $ — $ — Federal funds sold and overnight interest-bearing deposits 142,622 142,622 142,622 — — Certificates of deposit in other banks 5,193 5,193 5,193 — — Available-for-sale securities 310,870 310,870 3,917 306,953 — Other investment securities 5,408 5,408 60 5,348 — Loans, net 1,285,230 1,308,539 — — 1,308,539 Loans held for sale 2,249 2,249 — 2,249 — Cash surrender value - life insurance 2,509 2,509 — 2,509 — Interest rate lock commitments 312 312 — — 312 Forward sale commitments 12 12 — 12 — Accrued interest receivable 6,621 6,621 6,621 — — Total $ 1,778,313 $ 1,801,622 $ 175,700 $ 317,071 $ 1,308,851 Liabilities: Deposits: Non-interest bearing demand $ 453,066 $ 453,066 $ 453,066 $ — $ — Savings, interest checking and money market 818,358 818,358 818,358 — — Time deposits 245,396 246,025 — — 246,025 Federal funds purchased and securities sold under agreements to repurchase 23,829 23,829 23,829 — — Federal Home Loan Bank advances and other borrowings 77,418 78,152 — 78,152 — Subordinated notes 49,486 42,908 — 42,908 — Interest rate lock commitments 26 26 — — 26 Accrued interest payable 282 282 282 — — Total $ 1,667,861 $ 1,662,646 $ 1,295,535 $ 121,060 $ 246,051 Off-Balance Sheet Financial Instruments The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments, and the present creditworthiness of such counterparties. The Company believes such commitments have been made on terms that are competitive in the markets in which it operates. Limitations The fair value estimates provided are made at a point in time based on market information and information about the financial instruments. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the fair value estimates. 33 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (15) Commitments and Contingencies The Company issues financial instruments with off-balance-sheet risk in the normal course of business of meeting the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Company’s extent of involvement and maximum potential exposure to credit loss in the event of non-performance 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, 2022, 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: (in thousands) September 30, 2022 December 31, 2021 Commitments to extend credit $ 362,569 $ 396,958 Interest rate lock commitments 6,520 16,161 Forward sale commitments 923 2,199 Standby letters of credit 56,240 35,514 Total $ 426,252 $ 450,832 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. The Company has two types of commitments related to mortgage loans held for sale: interest rate lock commitments and forward loan sale commitments. Interest rate lock commitments are commitments to extend credit to a customer that has an interest rate lock and are considered derivative instruments. 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, 2022. Pending Litigation The Company and its subsidiaries are defendants in various legal actions incidental to the Company’s past and current business activities. Based on the Company’s analysis, and considering the inherent uncertainties associated with litigation, management does not believe that it is reasonably possible that these legal actions will materially adversely affect the Company’s consolidated financial condition or results of operations in the near term. The Company records a loss accrual for all legal matters for which it deems a loss is probable and can be reasonably estimated. Some legal matters, which are at early stages in the legal process, have not yet progressed to the point where a loss is deemed probable or an amount can be estimated. 34