HAWTHORN BANCSHARES, INC. 10-Q

Item 1. Financial Statements 2 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except per share data) March 31, 2023 December 31, 2022 (Unaudited) ASSETS Cash and due from banks $ 18,301 $ 18,661 Federal funds sold 47 46 Other interest-bearing deposits 15,425 65,013 Cash and cash equivalents 33,773 83,720 Certificates of deposit in other banks 2,215 2,955 Available-for-sale debt securities, at fair value 259,653 250,747 Other investments 6,240 6,353 Total investment securities 265,893 257,100 Loans held for investment 1,542,074 1,521,252 Allowance for credit losses (1) ( 21,979 ) ( 15,588 ) Net loans 1,520,095 1,505,664 Loans held for sale, at lower of cost or fair value 1,753 591 Premises and equipment - net 32,454 32,856 Mortgage servicing rights, at fair value 2,934 2,899 Other real estate owned - net 8,247 8,795 Accrued interest receivable 7,288 7,953 Cash surrender value - life insurance 2,582 2,567 Other assets (1) 18,587 18,440 Total assets $ 1,895,821 $ 1,923,540 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing demand $ 444,437 $ 453,443 Savings, interest checking and money market 817,183 923,602 Time deposits $250,000 and over 175,251 94,859 Other time deposits 171,141 160,175 Total deposits 1,608,012 1,632,079 Federal funds purchased and securities sold under agreements to repurchase 5,115 5,187 Federal Home Loan Bank advances and other borrowings 93,000 98,000 Subordinated notes 49,486 49,486 Operating lease liabilities 1,454 1,533 Accrued interest payable 1,602 902 Liability for unfunded commitments (1) 1,302 — Other liabilities 7,498 8,942 Total liabilities 1,767,469 1,796,129 Stockholders’ equity: Common stock, $ 1.00 par value, authorized 15,000,000 shares; issued 7,284,151 shares, respectively 7,284 7,284 Surplus 71,042 71,042 Retained earnings 88,329 91,789 Accumulated other comprehensive loss, net of tax ( 27,313 ) ( 31,714 ) Treasury stock; 515,570 shares, at cost, respectively ( 10,990 ) ( 10,990 ) Total stockholders’ equity 128,352 127,411 Total liabilities and stockholders’ equity $ 1,895,821 $ 1,923,540 (1) March 31, 2023 amounts include the impacts of the January 1, 2023 adoption of ASU 2013-13. See Note 2 for details. See accompanying notes to the consolidated financial statements (unaudited) . 1 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Income (unaudited) Three Months Ended March 31, (In thousands, except per share data) 2023 2022 INTEREST INCOME Interest and fees on loans $ 18,803 $ 13,915 Interest and fees on loans held for sale 27 20 Interest on investment securities: Taxable 847 788 Nontaxable 626 577 Federal funds sold — 1 Other interest-bearing deposits and certificates of deposit in other banks 537 60 Dividends on other investments 93 75 Total interest income 20,933 15,436 INTEREST EXPENSE Interest on deposits: Savings, interest checking and money market 3,854 316 Time deposit accounts $250,000 and over 1,150 113 Time deposits 548 276 Total interest expense on deposits 5,552 705 Interest on federal funds purchased and securities sold under agreements to repurchase 21 10 Interest on Federal Home Loan Bank advances 540 252 Interest on subordinated notes 872 324 Total interest expense on borrowings 1,433 586 Total interest expense 6,985 1,291 Net interest income 13,948 14,145 Provision for (release of) credit losses on loans and unfunded commitments (1) 680 ( 2,500 ) Net interest income after provision for (release of) credit losses on loans and unfunded commitments 13,268 16,645 NON-INTEREST INCOME Service charges and other fees 684 793 Bank card income and fees 960 961 Trust department income 271 340 Real estate servicing fees, net 193 231 Gain on sale of mortgage loans, net 496 888 Other 578 513 Total non-interest income 3,182 3,726 Investment securities gains (losses), net 8 ( 4 ) NON-INTEREST EXPENSE Salaries and employee benefits 7,003 6,886 Occupancy expense, net 795 786 Furniture and equipment expense 752 755 Processing, network, and bank card expense 1,157 1,142 Legal, examination, and professional fees 505 440 Advertising and promotion 357 293 Postage, printing, and supplies 193 190 Loan expense 385 145 Other 1,331 1,590 Total non-interest expense 12,478 12,227 Income before income taxes 3,980 8,140 Income tax expense 709 1,531 Net income $ 3,271 $ 6,609 Basic earnings per share $ 0.48 $ 0.97 Diluted earnings per share $ 0.48 $ 0.97 (1) Prior to adoption of ASU No 2016-13 on January 1, 2023, credit losses were estimated using the incurred loss approach. See accompanying notes to the consolidated financial statements (unaudited) . 3 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Loss) (unaudited) Three Months Ended March 31, (In thousands) 2023 2022 Net income $ 3,271 $ 6,609 Other comprehensive income (loss), net of tax Investment securities available-for-sale: Change in unrealized gains (losses) on investment securities available-for-sale, net of tax 4,513 ( 19,582 ) Defined benefit pension plans: Amortization of net gains included in net periodic pension cost, net of tax ( 112 ) — Total other comprehensive income (loss) 4,401 ( 19,582 ) Total comprehensive income (loss) $ 7,672 $ ( 12,973 ) See accompanying notes to the consolidated financial statements (unaudited) . 4 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity (unaudited) Three Months Ended March 31, 2023 and 2022 (In thousands, except per share data) Common Stock Surplus Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Total Stockholders' Equity Balance, December 31, 2022 $ 7,284 $ 71,042 $ 91,789 $ ( 31,714 ) $ ( 10,990 ) $ 127,411 Adoption of ASU 2016-13 — — ( 5,581 ) — — ( 5,581 ) Balance, January 01, 2023 7,284 71,042 86,208 ( 31,714 ) ( 10,990 ) 121,830 Net income — — 3,271 — — 3,271 Other comprehensive income — — — 4,401 — 4,401 Cash dividends declared, common stock ($ 0.17 per share) — — ( 1,150 ) — — ( 1,150 ) Balance, March 31, 2023 $ 7,284 $ 71,042 $ 88,329 $ ( 27,313 ) $ ( 10,990 ) $ 128,352 Balance, December 31, 2021 $ 7,024 $ 64,437 $ 82,300 $ 3,293 $ ( 8,098 ) $ 148,956 Net income — — 6,609 — — 6,609 Other comprehensive loss — — — ( 19,582 ) — ( 19,582 ) Purchase of treasury stock — — — — ( 606 ) ( 606 ) Cash dividends declared, common stock ($ 0.15 per share) — — ( 990 ) — — ( 990 ) Balance, March 31, 2022 $ 7,024 $ 64,437 $ 87,919 $ ( 16,289 ) $ ( 8,704 ) $ 134,387 See accompanying notes to the consolidated financial statements (unaudited) . 5 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) Three Months Ended March 31, (In thousands) 2023 2022 Cash flows from operating activities: Net income $ 3,271 $ 6,609 Adjustments to reconcile net income to net cash provided by operating activities: Provision for (release of) credit losses on loans and unfunded commitments 680 ( 2,500 ) Depreciation expense 540 545 Net amortization of investment securities, premiums, and discounts 276 378 Change in fair value of mortgage servicing rights ( 29 ) 48 Investment securities (gains) losses, net ( 8 ) 4 Gain on sales and dispositions of premises and equipment ( 132 ) — Gain on sales and dispositions of other real estate ( 9 ) ( 8 ) Decrease in accrued interest receivable 665 380 Increase in cash surrender value - life insurance ( 15 ) ( 15 ) Decrease in other assets 102 329 Decrease in operating lease liabilities ( 79 ) ( 74 ) Increase in accrued interest payable 700 16 Decrease in other liabilities ( 1,398 ) ( 2,567 ) Origination of mortgage loans held for sale ( 20,910 ) ( 26,935 ) Proceeds from the sale of mortgage loans held for sale 20,238 29,085 Gain on sale of mortgage loans, net ( 496 ) ( 888 ) Net cash provided by operating activities 3,396 4,407 Cash flows from investing activities: Proceeds from maturities of certificates of deposit in other banks 739 490 Net increase in loans ( 20,903 ) ( 31,812 ) Purchase of available-for-sale debt securities ( 8,505 ) ( 14,581 ) Proceeds from maturities of available-for-sale debt securities 4,427 11,284 Proceeds from calls of available-for-sale debt securities 610 2,250 Purchases of FHLB stock ( 137 ) ( 178 ) Proceeds from sales of FHLB stock 258 92 Purchases of premises and equipment ( 226 ) ( 1,417 ) Proceeds from sales of premises and equipment 126 — Proceeds from sales of other real estate and repossessed assets 557 723 Net cash used in investing activities ( 23,054 ) ( 33,149 ) Cash flows from financing activities: Net decrease in demand deposits ( 9,006 ) ( 2,841 ) Net decrease in interest-bearing transaction accounts ( 106,419 ) ( 66,194 ) Net increase in time deposits 91,358 8,358 Net decrease in federal funds purchased and securities sold under agreements to repurchase ( 72 ) ( 18,315 ) Repayment of FHLB advances and other borrowings ( 5,500 ) ( 61 ) FHLB advances 500 — Purchase of treasury stock — ( 606 ) Cash dividends paid - common stock ( 1,150 ) ( 993 ) Net cash used in financing activities ( 30,289 ) ( 80,652 ) Net decrease in cash and cash equivalents ( 49,947 ) ( 109,394 ) Cash and cash equivalents, beginning of period 83,720 159,909 Cash and cash equivalents, end of period $ 33,773 $ 50,515 See accompanying notes to the consolidated financial statements (unaudited). 6 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) continued Three Months Ended March 31, (In thousands) 2023 2022 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 6,285 $ 1,275 Income taxes $ — $ — Noncash investing and financing activities: Other real estate and repossessed assets acquired in settlement of loans net of (charge-offs) $ — $ ( 52 ) 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 that provide 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 United States (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, 2022. 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 credit losses, real estate acquired in connection with foreclosure or in satisfaction of loans, and fair values of investment securities available-for-sale that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial statements other than mentioned below. Stock Dividend. On July 1, 2022, the Company paid a special stock dividend of four percent (4%) 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. Recently Adopted Accounting Pronouncements Trouble Debt Restructurings. On January 1, 2023, the effective date of the guidance, the Company adopted Accounting Standards Update (ASU) 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures”, on a prospective basis. ASU 2022-02 eliminated the accounting guidance for troubled debt restructurings (TDRs), while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying the recognition and measurement guidance for TDRs, an entity must apply the loan refinancing and restructuring guidance to determine whether a modification results in a new loan or a continuation of an existing loan. For entities that have already adopted ASU 2016-13, the amendments in ASU 2022-02 are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Effective January 1, 2023, the Company adopted the amendments within ASU 2022-02, using the prospective transition method. ASU 2022-02 did not have a material impact on the Company's consolidated financial statements. ASU 2016-13. On January 1, 2023, the Company adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which replaces the incurred loss methodology with an expected loss methodology commonly referred to as the current expected credit losses (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, this standard made changes to the accounting for available-for-sale debt securities, including the requirement for credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities. The Company adopted this standard using the modified retrospective method for all financial assets measured at amortized cost, and off-balance-sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under the new standard while prior period amounts continue to be reported in accordance with previously applicable U.S. 8 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) GAAP. The Company recorded an after-tax decrease to retained earnings of $ 5.6 million as of January 1, 2023 for the cumulative effect of adopting this standard. The following table illustrates the impact of adoption of ASU 2016-13: (in thousands) December 31, 2022 Impact of Adoption January 1, 2023 Assets: Allowance for credit losses on loans $ 15,588 $ 5,793 $ 21,381 Deferred tax asset 3,267 1,483 4,750 Liabilities: Liability for unfunded commitments — 1,272 1,272 Shareholders' Equity Retained Earnings 91,789 ( 5,581 ) 86,208 (2) Loans and Allowance for Credit Losses Loans Major classifications within the Company’s held for investment loan portfolio at March 31, 2023 and December 31, 2022 were as follows: (in thousands) March 31, 2023 December 31, 2022 Commercial, financial, and agricultural $ 227,992 $ 244,549 Real estate construction − residential 44,467 32,095 Real estate construction − commercial 157,860 137,235 Real estate mortgage − residential 363,634 361,025 Real estate mortgage − commercial 725,573 722,729 Installment and other consumer 22,548 23,619 Total loans held for investment $ 1,542,074 $ 1,521,252 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. Accrued interest on loans totaled $ 5.9 million and $ 6.4 million at March 31, 2023 and December 31, 2022, respectively, and is included in the accrued interest receivable on the Company's Consolidated Balance Sheets. The total amount of accrued interest is excluded from the amortized cost basis of loans presented above. Further, the Company has elected not to measure an allowance for credit losses for accrued interest receivable. At March 31, 2023, loans of $ 598.1 million were pledged to the Federal Home Loan Bank (FHLB) as collateral for borrowings and letters of credit. Allowance for Credit Losses The allowance for credit losses is measured using an average historical loss model which incorporates relevant information about past events, including historical credit loss experience on loans with similar risk characteristics, current conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the loans. The allowance for credit losses is measured on a collective (pool) basis. Loans are aggregated into pools based on similar risk characteristics including borrower type, collateral type and expected credit loss patterns. Loans that do not share similar risk characteristics, primarily large loans on non-accrual status, are evaluated on an individual basis. The allowance for credit losses is a valuation account that is deducted from loans amortized cost basis to present the net amount expected to be collected on the instrument. Expected recoveries are included in the allowance and do not exceed the 9 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) aggregate of amounts previously charged-off and expected to be charged-off. Loans are charged off against the allowance for credit losses when management believes the balance has become uncollectible. For loans evaluated for credit losses on a collective basis, average historical loss rates are calculated for each pool using relevant peer historical net charge-offs (combined charge-offs and recoveries by observable historical reporting period) and the Company's outstanding loan balances during a lookback period. The Company chose to use relevant peer loan loss data due to statistical relevance concerns, low observation counts, historical data limitations, and the inability to secure loans through the cycle loan-level data. Lookback periods can be different based on the individual pool and represent management’s credit expectations for the pool of loans over the remaining contractual life. The calculated average net charge-off rate is then adjusted for current conditions and reasonable and supportable forecasts. These adjustments increase or decrease the average historical loss rate to reflect expectations of future losses given a single path economic forecast of a single macroeconomic variable, which is the civilian unemployment rate. The adjustments are based on results from various regression models projecting the impact of the selected macroeconomic variable to loss rates. The forecast is used for a reasonable and supportable period before reverting back to historical averages using a straight-line method. The forecast adjusted loss rate is applied to the loans over the remaining contractual lives, adjusted for expected prepayments. The contractual term excludes expected extensions, renewals and modifications. Credit cards and certain similar consumer lines of credit do not have stated maturities and therefore, for these loan classes, remaining contractual lives are determined by estimating future cash flows expected to be received from customers until payments have been fully allocated to outstanding balances. Agriculture loans also use the remaining life methodology for estimating life of loan losses. Additionally, the allowance for credit losses considers other qualitative factors not included in historical loss rates or macroeconomic forecast such as changes in portfolio composition, underwriting practices, or significant unique events or conditions. Allowance for Credit Losses on Off-Balance-Sheet Credit Exposures The Company maintains a separate allowance for credit losses for off-balance-sheet credit exposures, including unfunded loan commitments, unless the associated obligation is unconditionally cancellable by the Company. This allowance is included in other liabilities on the consolidated balance sheets with associated expense recognized as a component of the provision for credit losses on the consolidated statements of income. The liability for unfunded lending commitments utilizes the same model as the allowance for credit losses on loans, however, the liability for unfunded lending commitments incorporates an assumption for the portion of unfunded commitments that are expected to be funded. Sensitivity in the Allowance for Credit Loss Model The allowance for credit losses is an estimate that requires significant judgment, including projections of the macroeconomic environment. The forecasted macroeconomic environment continuously changes, which can cause fluctuations in estimated expected losses. 10 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table illustrates the changes in the allowance for credit losses by portfolio segment: Three Months Ended March 31, 2023 (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 $ 2,735 $ 157 $ 875 $ 3,329 $ 8,000 $ 326 $ 166 $ 15,588 Adoption of ASU 2016-13 ( 649 ) 291 2,894 1,890 1,613 ( 80 ) ( 166 ) 5,793 Balance at January 1, 2023 2,086 448 3,769 5,219 9,613 246 — 21,381 Provision for (release of ) credit losses (1) ( 144 ) 183 695 41 ( 123 ) 6 ( 8 ) 650 Loans charged off 30 — — — 5 58 — 93 Less recoveries on loans ( 9 ) — — ( 2 ) ( 2 ) ( 28 ) — ( 41 ) Net loan charge-offs (recoveries) 21 — — ( 2 ) 3 30 — 52 Balance at end of period $ 1,921 $ 631 $ 4,464 $ 5,262 $ 9,487 $ 222 $ ( 8 ) $ 21,979 Liability for Unfunded Commitments Balance at beginning of period $ — $ — $ — $ — $ — $ — $ — $ — Adoption of ASU 2016-13 104 341 569 107 150 1 — 1,272 Balance at January 1, 2023 104 341 569 107 150 1 — 1,272 Provision for credit losses on unfunded commitments 20 48 ( 7 ) 3 ( 8 ) — ( 26 ) 30 Balance at end of period $ 124 $ 389 $ 562 $ 110 $ 142 $ 1 $ ( 26 ) $ 1,302 Allowance for credit losses on loans and liability for unfunded commitments $ 2,045 $ 1,020 $ 5,026 $ 5,372 $ 9,629 $ 223 $ ( 34 ) $ 23,281 Three Months Ended March 31, 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 Provision for (release of ) loan losses (1) 128 ( 77 ) 76 93 ( 2,897 ) 56 121 ( 2,500 ) Loans charged off 35 — — — 75 56 — 166 Less recoveries on loans ( 20 ) — — ( 3 ) ( 2 ) ( 17 ) — ( 42 ) Net loan charge-offs (recoveries) 15 — — ( 3 ) 73 39 — 124 Balance at end of period $ 2,830 $ 60 $ 664 $ 2,578 $ 7,692 $ 273 $ 182 $ 14,279 (1) Beginning January 1, 2023, calculation is based on CECL methodology. Prior to January 1, 2023, calculation was based on probable incurred loss methodology. On January 1, 2023, the Company's adoption of the CECL methodology resulted in an increase to the allowance for credit losses of $ 5.8 million and a liability for unfunded commitments totaling $ 1.3 million. Under the CECL methodology, the Company recorded a $ 0.7 million provision for credit losses in the first quarter of 2023 compared to a $ 2.5 million release of provision for loan losses in the first quarter of 2022 under the incurred-loss method. Collateral-Dependent loans Collateral-dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. Under the CECL methodology, for collateral-dependent loans, the Company has adopted the practical expedient to measure the allowance on the fair value of collateral. The allowance is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and the loan’s amortized cost. If the fair value of the collateral exceeds the loan’s amortized cost, no allowance is necessary. The Company’s policy is to obtain appraisals on any significant pieces of collateral. Higher discounts are applied in determining fair value for real estate collateral in industries that are undergoing significant stress, or for properties that are specialized use or have limited marketability. 11 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) There have been no significant changes to the types of collateral securing the Company's collateral-dependent loans since December 31, 2022. The amortized cost of collateral-dependent loans by class as of March 31, 2023 was as follows: Collateral Type (in thousands) Real Estate Other Allowance Allocated March 31, 2023 Commercial, financial, and agricultural $ — $ 50 $ — Real estate mortgage − residential 149 — 63 Real estate mortgage − commercial 18,228 — — Total $ 18,377 $ 50 $ 63 Impaired Loans The following impaired loans disclosures were superseded by ASU 2016-13. The following table illustrates the allowance for loan losses and recorded investment by portfolio segment based on the impairment method: (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 December 31, 2022 Allowance for loan losses: Individually evaluated for impairment $ 36 $ — $ 11 $ 148 $ 62 $ 1 $ — $ 258 Collectively evaluated for impairment 2,699 157 864 3,181 7,938 325 166 15,330 Total $ 2,735 $ 157 $ 875 $ 3,329 $ 8,000 $ 326 $ 166 $ 15,588 Loans outstanding: Individually evaluated for impairment $ 295 $ — $ 87 $ 1,863 $ 18,110 $ 6 $ — $ 20,361 Collectively evaluated for impairment 244,254 32,095 137,148 359,162 704,619 23,613 — 1,500,891 Total $ 244,549 $ 32,095 $ 137,235 $ 361,025 $ 722,729 $ 23,619 $ — $ 1,521,252 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 $ 20.4 million at December 31, 2022, and were comprised of loans on non-accrual status and loans classified as TDRs. The net carrying value of impaired loans is based on the fair values of collateral obtained through independent appraisals, internal evaluations, or by discounting the total expected future cash flows. At December 31, 2022, $ 17.7 million of impaired loans were evaluated based on the fair value less estimated selling costs of the loans' collateral. The categories of impaired loans at December 31, 2022 were as follows: (in thousands) December 31, 2022 Non-accrual loans $ 18,700 Performing TDRs 1,661 Total impaired loans $ 20,361 12 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following tables presents loans individually evaluated for impairment at December 31, 2022, segregated between loans for which an allowance was provided and loans for which no allowance was provided. (in thousands) Recorded Investment Unpaid Principal Balance Specific Reserves Average Recorded Investment December 31, 2022 With no related allowance recorded: Real estate mortgage − residential $ — $ — $ — $ 1 Real estate mortgage − commercial 17,664 18,975 — 16,230 Total $ 17,664 $ 18,975 $ — $ 16,231 With an allowance recorded: Commercial, financial and agricultural $ 295 $ 330 $ 36 $ 319 Real estate construction − commercial 87 127 11 93 Real estate mortgage − residential 1,863 2,080 148 2,189 Real estate mortgage − commercial 446 535 62 428 Installment and other consumer 6 6 1 90 Total $ 2,697 $ 3,078 $ 258 $ 3,119 Total impaired loans $ 20,361 $ 22,053 $ 258 $ 19,350 Credit Quality The Company categorizes loans into risk categories based upon an internal rating system reflecting management’s risk assessment. • Pass - loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell in a timely manner, of any underlying collateral. • Watch - loans which have one or more weaknesses 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. • Substandard - loans that 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. • Doubtful - loans which have all the weaknesses inherent in loans classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable on the basis of currently known facts, conditions, and values. In the following tables, consumer loans are generally assigned a risk grade similar to the classifications described above; however, upon reaching 90 days and 120 days past due, they are generally downgraded to non-accrual status, in accordance with the Federal Financial Institutions Examination Counsel's Retail Credit Classification Policy. 13 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents the recorded investment by risk categories at March 31, 2023: Term Loans Amortized Cost Basis by Origination Year and Risk Grades (in thousands) 2023 2022 2021 2020 2019 Prior Revolving Loans Amortized Cost Basis Revolving Loans Converted to Term Loans Amortized Cost Basis Total March 31, 2023 Commercial, Financial, & Agricultural Pass $ 19,920 $ 58,909 $ 38,221 $ 34,975 $ 5,761 $ 6,911 $ 49,034 $ 220 $ 213,951 Watch — 2,744 82 724 123 348 3,567 — 7,588 Substandard 386 3,957 58 22 — — 1,864 — 6,287 Non-accrual (1) — 50 — — 21 95 — — 166 Total $ 20,306 $ 65,660 $ 38,361 $ 35,721 $ 5,905 $ 7,354 $ 54,465 $ 220 $ 227,992 Real Estate Construction - Residential Pass $ 12,681 $ 28,902 $ 965 $ 760 $ 444 $ — $ 340 $ — $ 44,092 Watch 375 — — — — — — — 375 Substandard — — — — — — — — — Non-accrual (1) — — — — — — — — — Total $ 13,056 $ 28,902 $ 965 $ 760 $ 444 $ — $ 340 $ — $ 44,467 Real Estate Construction - Commercial Pass $ 12,835 $ 64,556 $ 72,260 $ 1,922 $ 73 $ 1,185 $ 1,498 $ — $ 154,329 Watch 744 1,660 241 — — 14 103 — 2,762 Substandard 686 — — — — — — — 686 Non-accrual (1) — — — — — 83 — — 83 Total $ 14,265 $ 66,216 $ 72,501 $ 1,922 $ 73 $ 1,282 $ 1,601 $ — $ 157,860 Real Estate Mortgage - Residential Pass $ 15,427 $ 141,707 $ 66,939 $ 52,760 $ 7,517 $ 30,034 $ 43,232 $ — $ 357,616 Watch — 212 425 1,294 137 2,292 224 — 4,584 Substandard — — — — — 520 — — 520 Non-accrual (1) — 56 — 241 — 357 260 — 914 Total $ 15,427 $ 141,975 $ 67,364 $ 54,295 $ 7,654 $ 33,203 $ 43,716 $ — $ 363,634 Real Estate Mortgage - Commercial Pass $ 36,871 $ 234,139 $ 194,254 $ 96,532 $ 29,834 $ 53,122 $ 12,725 $ 501 $ 657,978 Watch 85 13,298 12,854 16,706 1,113 1,650 287 — 45,993 Substandard — 225 2,674 — 46 302 — — 3,247 Non-accrual (1) 1,789 2,775 13,522 233 — 36 — — 18,355 Total $ 38,745 $ 250,437 $ 223,304 $ 113,471 $ 30,993 $ 55,110 $ 13,012 $ 501 $ 725,573 Installment and other Consumer Pass $ 2,116 $ 9,284 $ 4,512 $ 2,439 $ 1,709 $ 592 $ 1,816 $ — $ 22,468 Watch — — — — — — — — — Substandard — — — — — — — — — Non-accrual (1) — 76 4 — — — — — 80 Total $ 2,116 $ 9,360 $ 4,516 $ 2,439 $ 1,709 $ 592 $ 1,816 $ — $ 22,548 Total Portfolio Pass $ 99,850 $ 537,497 $ 377,151 $ 189,388 $ 45,338 $ 91,844 $ 108,645 $ 721 $ 1,450,434 Watch 1,204 17,914 13,602 18,724 1,373 4,304 4,181 — 61,302 Substandard 1,072 4,182 2,732 22 46 822 1,864 — 10,740 Non-accrual (1) 1,789 2,957 13,526 474 21 571 260 — 19,598 Total $ 103,915 $ 562,550 $ 407,011 $ 208,608 $ 46,778 $ 97,541 $ 114,950 $ 721 $ 1,542,074 (1) The majority of non-accrual loans have a substandard risk grade 14 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents the risk categories by class at December 31, 2022 ( superseded by ASU 2016-13) (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 December 31, 2022 Pass $ 229,949 $ 32,095 $ 133,785 $ 353,121 $ 653,552 $ 23,613 $ 1,426,115 Watch 7,411 — 2,677 5,541 48,041 — 63,670 Substandard 6,894 — 686 500 3,026 — 11,106 Performing TDRs (1) 174 — — 1,178 309 — 1,661 Non-accrual loans (1) 121 — 87 685 17,801 6 18,700 Total $ 244,549 $ 32,095 $ 137,235 $ 361,025 $ 722,729 $ 23,619 $ 1,521,252 (1) The majority of non-accrual and performing TDRs loans have a substandard risk grade 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 status 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. The following tables present the recorded investment in non-accrual loans and loans past due over 90 days still on accrual by class of loans as of March 31, 2023 and December 31, 2022: (in thousands) Non-accrual with no Allowance Non-accrual with Allowance Total Non-accrual (1) 90 Days Past Due And Still Accruing Total Non-performing Loans March 31, 2023 Commercial, Financial, and Agricultural $ 50 $ 116 $ 166 $ — $ 166 Real estate construction − commercial — 83 83 — 83 Real estate mortgage − residential — 914 914 — 914 Real estate mortgage − commercial 18,226 129 18,355 — 18,355 Installment and Other Consumer — 80 80 1 81 Total $ 18,276 $ 1,322 $ 19,598 $ 1 $ 19,599 December 31, 2022 Commercial, Financial, and Agricultural $ — $ 121 $ 121 $ — $ 121 Real estate construction − commercial — 87 87 — 87 Real estate mortgage − residential — 685 685 — 685 Real estate mortgage − commercial 17,664 137 17,801 — 17,801 Installment and Other Consumer — 6 6 1 7 Total $ 17,664 $ 1,036 $ 18,700 $ 1 $ 18,701 (1) Includes $ 0.3 million of restructured loans as of both March 31, 2023 and December 31, 2022. 15 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) No material amount of interest income was recognized on non-accrual loans during the three months ended March 31, 2023. The following table provides aging information for the Company’s past due and non-accrual loans at March 31, 2023 and December 31, 2022: (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 March 31, 2023 Commercial, Financial, and Agricultural $ 227,824 $ 2 $ — $ 166 $ 227,992 Real estate construction − residential 44,467 — — — 44,467 Real estate construction − commercial 157,777 — — 83 157,860 Real estate mortgage − residential 361,087 1,633 — 914 363,634 Real estate mortgage − commercial 707,032 186 — 18,355 725,573 Installment and Other Consumer 22,375 92 1 80 22,548 Total $ 1,520,562 $ 1,913 $ 1 $ 19,598 $ 1,542,074 December 31, 2022 Commercial, Financial, and Agricultural $ 244,392 $ 36 $ — $ 121 $ 244,549 Real estate construction − residential 32,095 — — — 32,095 Real estate construction − commercial 137,148 — — 87 137,235 Real estate mortgage − residential 359,672 668 — 685 361,025 Real estate mortgage − commercial 704,925 3 — 17,801 722,729 Installment and Other Consumer 23,506 106 1 6 23,619 Total $ 1,501,738 $ 813 $ 1 $ 18,700 $ 1,521,252 Loan Modifications for Borrowers Experiencing Financial Difficulty Subsequent to the Adoption of ASU 2022-02 In the normal course of business, the Company may execute loan modifications with borrowers. These modifications are analyzed to determine whether the modification is considered concessionary, long-term and made to a borrower experiencing financial difficulty. The Company’s modifications generally include interest rate adjustments, principal reductions, and amortization and maturity date extensions. If a loan modification is determined to be made to a borrower experiencing financial difficulty, the loan is considered collateral-dependent and evaluated as part of the allowance for credit losses as described above in the Allowance for Credit Losses section of this note. For the three months ended March 31, 2023, the Company did not modify any loans made to borrowers experiencing financial difficulty. The Company monitors loan payments on an on-going basis to determine if a loan is considered to have a payment default. Determination of payment default involves analyzing the economic conditions that exist for each customer and their ability to generate positive cash flows during the loan term. For the three-month period ended March 31, 2023, the Company did not modify any loans made to borrowers experiencing financial difficulty. 16 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents information regarding modifications to borrowers experiencing financial difficulty as of March 31, 2023: March 31, 2023 (Dollars in thousands) Number of contracts Recorded Investment % to Total Loans Commercial, financial and agricultural 2 $ 171 0.01 % Real estate mortgage − residential 9 1,336 0.09 % Real estate mortgage − commercial 3 327 0.02 % Total 14 $ 1,834 0.12 % Troubled Debt Restructurings (TDRs) Prior to Adoption of ASU 2022-02 Prior to the adoption of ASU 2022-02, the Company accounted for a modification to the contractual terms of a loan that resulted in granting a concession to a borrower experiencing financial difficulties as a TDR. See “Note 1 Summary of Significant Accounting Policies” in the Company's Annual Report on Form 10-K for the year ended December 31, 2022 for more information on our TDR policy, and “Note 1, Summary of Significant Accounting Policies” in this report for more information on the adoption of ASU 2022-02. At March 31, 2022, loans classified as TDRs totaled $ 2.2 million, of which $ 0.5 million were classified as non-performing TDRs and $ 1.7 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 $ 179,000 related to TDRs were allocated to the allowance for loan losses at March 31, 2022. For the three months ended March 31, 2022, the Company had no new TDRs. For the three months ended March 31, 2022, the Company had no TDRs for which there was a payment default within the 12 months following the restructure date. Loans Held for Sale The Company designates certain long-term fixed rate personal real estate loans as held for sale. These loans are initially measured at fair value under the fair value option election with subsequent changes in fair value recognized in mortgage banking income. The loans are primarily sold to Freddie Mac, Fannie Mae, PennyMac, and various other secondary market investors. At March 31, 2023, the carrying amount of these loans was $ 1.8 million compared to $ 0.6 million at December 31, 2022. (3) Other Real Estate and Other Assets Acquired in Settlement of Loans March 31, December 31, (in thousands) 2023 2022 Real estate construction - commercial $ 10,094 $ 10,094 Real estate mortgage - residential 110 179 Real estate mortgage - commercial 707 1,186 Total $ 10,911 $ 11,459 Less valuation allowance for other real estate owned ( 2,664 ) ( 2,664 ) Total other real estate owned and repossessed assets $ 8,247 $ 8,795 Changes in the net carrying amount of other real estate owned and repossessed assets were as follows for the periods indicated: 17 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Three Months Ended March 31, (in thousands) 2023 2022 Balance at beginning of period $ 11,459 $ 13,436 Additions net of (charge-offs) — ( 52 ) Proceeds from sales ( 557 ) ( 723 ) Net gain on sales 9 8 Total other real estate owned $ 10,911 $ 12,669 Less valuation allowance for other real estate owned ( 2,664 ) ( 2,911 ) Balance at end of period $ 8,247 $ 9,758 At March 31, 2023, $ 0.1 million of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to no such consumer mortgage loans at December 31, 2022. Activity in the valuation allowance for other real estate owned was as follows for the periods indicated: Three Months Ended March 31, (in thousands) 2023 2022 Balance at beginning of period $ 2,664 $ 2,911 Provision for other real estate owned — — Charge-offs — — Balance at end of period $ 2,664 $ 2,911 18 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 March 31, 2023 and December 31, 2022 were as follows: Gross Unrealized (in thousands) Total Amortized Cost Gains Losses Fair Value March 31, 2023 U.S. Treasury $ 5,125 $ 13 $ ( 34 ) $ 5,104 U.S. government and federal agency obligations 515 — ( 25 ) 490 U.S. government-sponsored enterprises 27,499 — ( 2,282 ) 25,217 Obligations of states and political subdivisions 134,531 28 ( 21,970 ) 112,589 Mortgage-backed securities 119,360 65 ( 15,045 ) 104,380 Other debt securities (a) 11,825 — ( 1,099 ) 10,726 Bank issued trust preferred securities (a) 1,486 — ( 339 ) 1,147 Total available-for-sale securities $ 300,341 $ 106 $ ( 40,794 ) $ 259,653 December 31, 2022 U.S. Treasury $ 2,198 $ — $ ( 46 ) $ 2,152 U.S. government and federal agency obligations 591 — ( 32 ) 559 U.S. government-sponsored enterprises 26,499 — ( 2,722 ) 23,777 Obligations of states and political subdivisions 134,994 — ( 25,554 ) 109,440 Mortgage-backed securities 119,556 7 ( 16,864 ) 102,699 Other debt securities (a) 11,825 — ( 882 ) 10,943 Bank issued trust preferred securities (a) 1,486 — ( 309 ) 1,177 Total available-for-sale securities $ 297,149 $ 7 $ ( 46,409 ) $ 250,747 (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, loan certificates guaranteed by the Small Business Administration, residential and commercial agency mortgage-backed securities, and agency collateralized mortgage obligations include securities issued by the Government National Mortgage Association, a U.S. government agency, and the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the FHLB, which are U.S. government-sponsored enterprises. Debt securities with carrying values aggregating approximately $ 205.3 million and $ 111.6 million at March 31, 2023 and December 31, 2022, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law. 19 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 March 31, 2023, by contractual maturity, are shown below. Accrued interest on investments totaled $ 1.4 million and $ 1.5 million at March 31, 2023 and December 31, 2022, respectively, and is included in the accrued interest receivable on the Company's Consolidated Balance Sheets. The total amount of accrued interest is excluded from the amortized cost basis of investments presented below. Further, the Company has elected not to measure an allowance for credit losses for accrued interest receivable. 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 $ 10,317 $ 10,157 Due after one year through five years 19,015 18,085 Due after five years through ten years 30,663 27,539 Due after ten years 120,986 99,492 Total $ 180,981 $ 155,273 Mortgage-backed securities 119,360 104,380 Total available-for-sale securities $ 300,341 $ 259,653 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 BankersBank (MIB) stock, that do not have readily determinable fair values, are required for membership in those organizations. (in thousands) March 31, 2023 December 31, 2022 Other securities: FHLB stock $ 6,035 $ 6,156 MIB stock 151 151 Equity securities with readily determinable fair values 54 46 Total other investment securities $ 6,240 $ 6,353 20 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 March 31, 2023 and December 31, 2022 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 March 31, 2023 U.S. Treasury $ 468 $ ( 3 ) $ 1,391 $ ( 31 ) $ 1,859 $ ( 34 ) U.S. government and federal agency obligations — — 490 ( 25 ) 490 ( 25 ) U.S. government-sponsored enterprises 996 ( 4 ) 24,221 ( 2,278 ) 25,217 ( 2,282 ) Obligations of states and political subdivisions 3,968 ( 180 ) 106,281 ( 21,790 ) 110,249 ( 21,970 ) Mortgage-backed securities 4,271 ( 119 ) 93,925 ( 14,926 ) 98,196 ( 15,045 ) Other debt securities 6,652 ( 348 ) 4,074 ( 751 ) 10,726 ( 1,099 ) Bank issued trust preferred securities — — 1,147 ( 339 ) 1,147 ( 339 ) Total $ 16,355 $ ( 654 ) $ 231,529 $ ( 40,140 ) $ 247,884 $ ( 40,794 ) (in thousands) December 31, 2022 U.S. Treasury $ 1,908 $ ( 41 ) $ 244 $ ( 5 ) $ 2,152 $ ( 46 ) U.S. government and federal agency obligations 559 ( 32 ) — — 559 ( 32 ) U.S. government-sponsored enterprises 7,066 ( 933 ) 16,711 ( 1,789 ) 23,777 ( 2,722 ) Obligations of states and political subdivisions 79,396 ( 15,421 ) 29,370 ( 10,133 ) 108,766 ( 25,554 ) Mortgage-backed securities 33,334 ( 3,124 ) 68,911 ( 13,740 ) 102,245 ( 16,864 ) Other debt securities 7,557 ( 443 ) 3,386 ( 439 ) 10,943 ( 882 ) Bank issued trust preferred securities — — 1,177 ( 309 ) 1,177 ( 309 ) Total $ 129,820 $ ( 19,994 ) $ 119,799 $ ( 26,415 ) $ 249,619 $ ( 46,409 ) The total available-for-sale portfolio consisted of approximately 444 securities at March 31, 2023. The portfolio included 426 securities having an aggregate fair value of $ 247.9 million that were in a loss position at March 31, 2023. Securities identified as which had been in a loss position for 12 months or longer totaled $ 231.5 million at fair value at March 31, 2023. The $ 40.8 million aggregate unrealized loss included in accumulated other comprehensive loss at March 31, 2023 was caused by interest rate fluctuations. As of March 31, 2023, there was no allowance for credit loss related to the Company's available-for-sale securities as the decline in fair value did not result from credit issues. The total available-for-sale portfolio consisted of approximately 439 securities at December 31, 2022. The portfolio included 436 securities having an aggregate fair value of $ 249.6 million that were in a loss position at December 31, 2022. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $ 119.8 million at fair value at December 31, 2022. The $ 46.4 million aggregate unrealized loss included in accumulated other comprehensive loss at December 31, 2022 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 and December 31, 2022. 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. 21 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: Three Months Ended March 31, (in thousands) 2023 2022 Investment securities gains (losses), net Available-for-sale securities: Gross realized gains $ — $ — Gross realized losses — — Other-than-temporary impairment recognized — — Other investment securities: Fair value adjustments, net 8 ( 4 ) Investment securities gains (losses), net $ 8 $ ( 4 ) (5) Intangible Assets Mortgage Servicing Rights At March 31, 2023, the Company was servicing approximately $ 235.2 million of loans sold to the secondary market compared to $ 240.5 million at December 31, 2022, and $ 261.5 million at March 31, 2022. Mortgage loan servicing fees, reported in real estate servicing fees, net, earned on loans sold were $ 0.2 million for the three months ended March 31, 2023 compared to $ 0.3 million for the three months ended March 31, 2022. The table below presents changes in mortgage servicing rights (MSRs) for the periods indicated. Three Months Ended March 31, (in thousands) 2023 2022 Balance at beginning of period $ 2,899 $ 2,659 Originated mortgage servicing rights 6 28 Changes in fair value: Due to changes in model inputs and assumptions (1) 93 30 Other changes in fair value (2) ( 64 ) ( 78 ) Total changes in fair value 29 ( 48 ) Balance at end of period $ 2,934 $ 2,639 (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 March 31, 2023 and 2022, respectively: Three Months Ended March 31, 2023 2022 Weighted average constant prepayment rate 6.51 % 9.40 % Weighted average note rate 3.44 % 3.36 % Weighted average discount rate 11.00 % 8.00 % Weighted average expected life (in years) 7.18 6.23 22 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) March 31, 2023 December 31, 2022 Time deposits with balances > $250,000 $ 175,251 $ 94,859 Brokered deposits $ 40,122 $ 40,135 (7) Federal Funds Purchased and Securities Sold under Agreements to Repurchase (in thousands) March 31, 2023 December 31, 2022 Federal funds purchased $ — $ — Repurchase agreements 5,115 5,187 Total $ 5,115 $ 5,187 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 March 31, 2023 U.S. government-sponsored enterprises $ 5,115 $ — $ — $ 5,115 Total $ 5,115 $ — $ — $ 5,115 December 31, 2022 U.S. government-sponsored enterprises $ 5,187 $ — $ — $ 5,187 Total $ 5,187 $ — $ — $ 5,187 (8) Leases The Company's leases primarily consist of office space and bank branches with remaining lease terms of generally one to ten years . As of March 31, 2023, operating right of use (ROU) assets and liabilities were $ 1.4 million and $ 1.5 million, respectively. As of March 31, 2023, the weighted-average remaining lease term on these operating leases was approximately 5.6 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 23 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 for the three months ended March 31, 2023 compared to $ 94,000 for the three months ended March 31, 2022. 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, such as 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 $ 28,000 for the three months ended March 31, 2023 compared to $ 24,000 for the three months ended March 31, 2022. The table below summarizes the maturity of remaining operating lease liabilities: Lease payments due in: Operating Lease (in thousands) 2023 (excluding 3 months ended March 31, 2023) $ 274 2024 258 2025 257 2026 259 2027 262 Thereafter 309 Total lease payments $ 1,619 Less imputed interest ( 165 ) Total lease liabilities, as reported $ 1,454 (9) Income Taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 17.8 % for the three months ended March 31, 2023 compared to 18.8 % for the three months ended March 31, 2022. The effective tax rate for each of the three months ended March 31, 2023 and 2022, 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 benefit associated with a historic tax credit investment for the three months ended March 31, 2023. The investment is expected to generate a $ 0.3 million 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 March 31, 2023. 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 months ended March 31, 2023 and 2022, respectively, the Company did not have any uncertain tax provisions, and did not record any related tax liabilities. 24 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (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 three months ended March 31, 2023 and 2022: Three Months Ended March 31, 2023 (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 $ ( 36,657 ) $ 4,943 $ ( 31,714 ) Other comprehensive income (loss), before reclassifications 5,713 ( 142 ) 5,571 Amounts reclassified from accumulated other comprehensive income (loss) — — — Current period other comprehensive income (loss), before tax 5,713 ( 142 ) 5,571 Income tax (expense) benefit ( 1,200 ) 30 ( 1,170 ) Current period other comprehensive income (loss), net of tax 4,513 ( 112 ) 4,401 Balance at end of period $ ( 32,144 ) $ 4,831 $ ( 27,313 ) Three Months Ended March 31, 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 ( 24,787 ) — ( 24,787 ) Amounts reclassified from accumulated other comprehensive loss — — — Current period other comprehensive loss, before tax ( 24,787 ) — ( 24,787 ) Income tax benefit 5,205 — 5,205 Current period other comprehensive loss, net of tax ( 19,582 ) — ( 19,582 ) Balance at end of period $ ( 19,220 ) $ 2,931 $ ( 16,289 ) (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 March 31, (in thousands) 2023 2022 Payroll taxes $ 467 $ 441 Medical plans 468 475 401(k) match and profit sharing 290 369 Periodic pension cost 283 437 Other 11 8 Total employee benefits $ 1,519 $ 1,730 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, 25 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 $ 1.7 million as of March 31, 2023, and the expense was $ 93,000 for both the three months ended March 31, 2023 and 2022 and was 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. 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 March 31, (in thousands) 2023 2022 Service cost - benefits earned during the year $ 254 $ 408 Interest costs on projected benefit obligations (a) 365 296 Expected return on plan assets (a) ( 545 ) ( 558 ) Expected administrative expenses 29 29 Amortization of prior service cost (a) — — Amortization of unrecognized net gain (a) ( 142 ) — Net periodic pension cost $ ( 39 ) $ 175 (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 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. 26 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (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, which have been restated for all stock dividends: Three Months Ended March 31, (dollars in thousands, except per share data) 2023 2022 Basic earnings per share: Net income available to shareholders $ 3,271 $ 6,609 Average shares outstanding 6,768,581 6,864,823 Basic earnings per share $ 0.48 $ 0.97 Diluted earnings per share $ 0.48 $ 0.97 Repurchase Program Pursuant to the Company's 2019 Repurchase Plan, management is 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 did not repurchase any shares during the current quarter. As of March 31, 2023, $ 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: 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, 27 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 management's independent verification to another pricing source for reasonableness each quarter. 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 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. Mortgage Servicing Rights (MSRs) The fair value of MSRs 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 MSRs as Level 3. 28 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) March 31, 2023 Assets: U.S. Treasury $ 5,104 $ 5,104 $ — $ — U.S. government and federal agency obligations 490 — 490 — U.S. government-sponsored enterprises 25,217 — 25,217 — Obligations of states and political subdivisions 112,589 — 112,589 — Mortgage-backed securities 104,380 — 104,380 — Other debt securities 10,726 — 10,726 — Bank-issued trust preferred securities 1,147 — 1,147 — Equity securities 54 54 — — Interest rate lock commitments 108 — — 108 Forward sale commitments 6 — 6 — Loans held for sale 1,753 — 1,753 — Mortgage servicing rights 2,934 — — 2,934 Total $ 264,508 $ 5,158 $ 256,308 $ 3,042 Liabilities: Interest rate lock commitments $ 1 $ — $ — $ 1 Forward sale commitments 10 — 10 — Total $ 11 $ — $ 10 $ 1 December 31, 2022 Assets: U.S. Treasury $ 2,152 $ 2,152 $ — $ — U.S. government and federal agency obligations 559 — 559 — U.S. government-sponsored enterprises 23,777 — 23,777 — Obligations of states and political subdivisions 109,440 — 109,440 — Mortgage-backed securities 102,699 — 102,699 — Other debt securities 10,943 — 10,943 — Bank-issued trust preferred securities 1,177 — 1,177 — Equity securities 46 46 — — Interest rate lock commitments 20 — — 20 Forward sale commitments 3 — 3 — Loans held for sale 591 — 591 — Mortgage servicing rights 2,899 — — 2,899 Total $ 254,306 $ 2,198 $ 249,189 $ 2,919 Liabilities: Interest rate lock commitments $ 18 $ — $ — $ 18 Forward sale commitments 3 — 3 — Total $ 21 $ — $ 3 $ 18 29 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 Significant Unobservable Inputs (Level 3) Mortgage Servicing Rights Interest Rate Lock Commitments Three Months Ended March 31, (in thousands) 2023 2022 2023 2022 Balance at beginning of period $ 2,899 $ 2,659 $ 2 $ 286 Total gains or (losses) (realized/unrealized): Included in earnings 29 ( 48 ) 106 ( 8 ) Included in other comprehensive income — — — — Purchases — — — — Sales — — ( 128 ) ( 286 ) Issues 6 28 127 25 Settlements — — — — Balance at end of period $ 2,934 $ 2,639 $ 107 $ 17 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 credit 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 March 31, 2023, the Company identified $ 18.4 million in collateral-dependent loans that required $ 0.1 million allowance for credit losses. Related to these loans, there were $ 5,000 in charge-offs recorded during the three months ended March 31, 2023. As of March 31, 2022, the Company identified $ 15.4 million in collateral-dependent impaired loans that required no specific allowances for losses aggregating. Related to these loans, there were $ 23,000 in charge-offs recorded during the three months ended March 31, 2022. 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 are initially 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. 30 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 March 31, Total Gains (Losses)* March 31, 2023 Assets: Collateral dependent impaired loans: Commercial, financial, & agricultural $ 50 — — $ 50 $ — Real estate mortgage - residential 86 — — 86 — Real estate mortgage - commercial 18,228 — — 18,228 ( 5 ) Total $ 18,364 $ — $ — $ 18,364 $ ( 5 ) Other real estate and repossessed assets $ 8,247 $ — $ — $ 8,247 $ 9 March 31, 2022 Assets: Collateral dependent impaired loans: Real estate mortgage - commercial $ 15,365 $ — $ — $ 15,365 $ ( 23 ) Total $ 15,365 $ — $ — $ 15,365 $ ( 23 ) Other real estate and repossessed assets $ 9,758 $ — $ — $ 9,758 $ ( 45 ) * 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 approximates the carrying amount. Upon liquidation of these investments, the Company would receive the cash surrender value which equals the carrying amount. 31 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. 32 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) A summary of the carrying amounts and fair values of the Company’s financial instruments at March 31, 2023 and December 31, 2022 is as follows: March 31, 2023 Fair Value Measurements March 31, 2023 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 $ 18,301 $ 18,301 $ 18,301 $ — $ — Federal funds sold and overnight interest-bearing deposits 15,472 15,472 15,472 — — Certificates of deposit in other banks 2,215 2,215 2,215 — — Available-for-sale securities 259,653 259,653 5,104 254,549 — Other investment securities 6,240 6,240 54 6,186 — Loans, net 1,520,095 1,434,610 — — 1,434,610 Loans held for sale 1,753 1,753 — 1,753 — Cash surrender value - life insurance 2,582 2,582 — 2,582 — Interest rate lock commitments 108 108 — — 108 Forward sale commitments 6 6 — 6 — Accrued interest receivable 7,288 7,288 7,288 — — Total $ 1,833,713 $ 1,748,228 $ 48,434 $ 265,076 $ 1,434,718 Liabilities: Deposits: Non-interest bearing demand $ 444,437 $ 444,437 $ 444,437 $ — $ — Savings, interest checking and money market 817,183 817,183 817,183 — — Time deposits 346,392 342,896 — — 342,896 Federal funds purchased and securities sold under agreements to repurchase 5,115 5,115 5,115 — — Federal Home Loan Bank advances and other borrowings 93,000 93,316 — 93,316 — Subordinated notes 49,486 38,197 — 38,197 — Interest rate lock commitments 1 1 — — 1 Forward sale commitments 10 10 10 Accrued interest payable 1,602 1,602 1,602 — — Total $ 1,757,226 $ 1,742,757 $ 1,268,337 $ 131,523 $ 342,897 33 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) December 31, 2022 Fair Value Measurements December 31, 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 $ 18,661 $ 18,661 $ 18,661 $ — $ — Federal funds sold and overnight interest-bearing deposits 65,059 65,059 65,059 — — Certificates of deposit in other banks 2,955 2,955 2,955 — — Available-for-sale securities 250,747 250,747 2,152 248,595 — Other investment securities 6,353 6,353 46 6,307 — Loans, net 1,505,664 1,389,018 — — 1,389,018 Loans held for sale 591 591 — 591 — Cash surrender value - life insurance 2,567 2,567 — 2,567 — Interest rate lock commitments 20 20 — — 20 Forward sale commitments 3 3 — 3 — Accrued interest receivable 7,953 7,953 7,953 — — Total $ 1,860,573 $ 1,743,927 $ 96,826 $ 258,063 $ 1,389,038 Liabilities: Deposits: Non-interest bearing demand $ 453,443 $ 453,443 $ 453,443 $ — $ — Savings, interest checking and money market 923,602 923,602 923,602 — — Time deposits 255,034 250,433 — — 250,433 Federal funds purchased and securities sold under agreements to repurchase 5,187 5,187 5,187 — — Federal Home Loan Bank advances and other borrowings 98,000 98,000 — 98,000 — Subordinated notes 49,486 39,197 — 39,197 — Interest rate lock commitments 18 18 — — 18 Forward sale commitments 3 3 — 3 — Accrued interest payable 902 902 902 — — Total $ 1,785,675 $ 1,770,785 $ 1,383,134 $ 137,200 $ 250,451 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. 34 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 March 31, 2023, 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) March 31, 2023 December 31, 2022 Commitments to extend credit $ 383,722 $ 388,264 Interest rate lock commitments 10,111 6,331 Forward sale commitments 1,723 576 Standby letters of credit 22,042 49,740 Total $ 417,598 $ 444,911 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 ranged from one month to five years at March 31, 2023. 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. 35