HAWTHORN BANCSHARES, INC. 10-Q

Item 1. Financial Statements 2 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except per share data) September 30, 2023 December 31, 2022 (Unaudited) ASSETS Cash and due from banks $ 17,793 $ 18,661 Federal funds sold — 46 Other interest-bearing deposits 10,061 65,013 Cash and cash equivalents 27,854 83,720 Certificates of deposit in other banks 735 2,955 Available-for-sale debt securities, at fair value 233,516 250,747 Other investments 7,005 6,353 Total investment securities 240,521 257,100 Loans held for investment 1,556,969 1,521,252 Allowance for credit losses (1) ( 22,462 ) ( 15,588 ) Net loans 1,534,507 1,505,664 Loans held for sale, at lower of cost or fair value 3,006 591 Premises and equipment - net 32,508 32,856 Mortgage servicing rights, at fair value 2,885 2,899 Other real estate owned - net 3,564 8,795 Accrued interest receivable 8,533 7,953 Cash surrender value - life insurance 2,610 2,567 Other assets (1) 22,282 18,440 Total assets $ 1,879,005 $ 1,923,540 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing demand $ 425,105 $ 453,443 Savings, interest checking and money market 802,591 923,602 Time deposits $250,000 and over 115,197 94,859 Other time deposits 237,472 160,175 Total deposits 1,580,365 1,632,079 Federal funds purchased and securities sold under agreements to repurchase 6,196 5,187 Federal Home Loan Bank advances and other borrowings 112,000 98,000 Subordinated notes 49,486 49,486 Operating lease liabilities 1,295 1,533 Accrued interest payable 1,851 902 Liability for unfunded commitments (1) 947 — Other liabilities 8,461 8,942 Total liabilities 1,760,601 1,796,129 Stockholders’ equity: Common stock, $ 1.00 par value, authorized 15,000,000 shares; issued 7,554,893 and 7,284,151 shares, respectively 7,555 7,284 Surplus 76,776 71,042 Retained earnings 85,104 91,789 Accumulated other comprehensive loss, net of tax ( 40,041 ) ( 31,714 ) Treasury stock; 515,570 shares, at cost, respectively ( 10,990 ) ( 10,990 ) Total stockholders’ equity 118,404 127,411 Total liabilities and stockholders’ equity $ 1,879,005 $ 1,923,540 (1) September 30, 2023 amounts include the impacts of the January 1, 2023 adoption of ASU 2016-13. 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 September 30, Nine Months Ended September 30, (In thousands, except per share data) 2023 2022 2023 2022 INTEREST INCOME Interest and fees on loans $ 22,134 $ 16,328 $ 61,105 $ 44,831 Interest and fees on loans held for sale 59 23 119 69 Interest on investment securities: Taxable 871 781 2,601 2,361 Nontaxable 618 621 1,876 1,822 Federal funds sold — — 2 5 Other interest-bearing deposits and certificates of deposit in other banks 85 76 724 179 Dividends on other investments 121 64 321 204 Total interest income 23,888 17,893 66,748 49,471 INTEREST EXPENSE Interest on deposits: Savings, interest checking and money market 4,466 1,382 11,961 2,275 Time deposit accounts $250,000 and over 816 345 3,493 588 Time deposits 1,357 239 2,715 709 Total interest expense on deposits 6,639 1,966 18,169 3,572 Interest on federal funds purchased and securities sold under agreements to repurchase 38 13 83 32 Interest on Federal Home Loan Bank advances 1,075 277 2,430 778 Interest on subordinated notes 989 570 2,769 1,316 Total interest expense on borrowings 2,102 860 5,282 2,126 Total interest expense 8,741 2,826 23,451 5,698 Net interest income 15,147 15,067 43,297 43,773 Provision for (release of) credit losses on loans and unfunded commitments (1) 110 300 790 ( 1,000 ) Net interest income after provision for (release of) credit losses on loans and unfunded commitments 15,037 14,767 42,507 44,773 NON-INTEREST INCOME Service charges and other fees 760 693 2,180 2,322 Bank card income and fees 1,029 1,030 3,044 3,054 Trust department income 283 287 820 924 Real estate servicing fees, net 125 383 417 861 Gain on sale of mortgage loans, net 851 628 2,014 2,322 Losses (gains) on other real estate owned, net ( 2,809 ) — ( 4,592 ) 30 Other 367 464 1,501 1,346 Total non-interest income 606 3,485 5,384 10,859 Investment securities gains (losses), net 3 1 18 ( 12 ) NON-INTEREST EXPENSE Salaries and employee benefits 7,124 6,750 20,978 20,251 Occupancy expense, net 842 789 2,437 2,339 Furniture and equipment expense 768 774 2,236 2,301 Processing, network, and bank card expense 1,320 1,261 3,797 3,545 Legal, examination, and professional fees 499 395 1,447 1,210 Advertising and promotion 375 430 1,084 1,027 Postage, printing, and supplies 248 237 621 653 Loan expense 147 123 771 426 Other 1,246 1,436 4,401 4,210 Total non-interest expense 12,569 12,195 37,772 35,962 Income before income taxes 3,077 6,058 10,137 19,658 Income tax expense 498 1,131 1,738 3,633 Net income $ 2,579 $ 4,927 $ 8,399 $ 16,025 Basic earnings per share $ 0.36 $ 0.70 $ 1.19 $ 2.27 Diluted earnings per share $ 0.36 $ 0.70 $ 1.19 $ 2.27 (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 (Loss) Income (unaudited) Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2023 2022 2023 2022 Net income $ 2,579 $ 4,927 $ 8,399 $ 16,025 Other comprehensive loss, net of tax Investment securities available-for-sale: Change in unrealized (losses) gains on investment securities available-for-sale, net of tax ( 9,325 ) ( 12,430 ) ( 7,948 ) ( 43,438 ) Defined benefit pension plans: Amortization of net gains included in net periodic pension cost, net of tax ( 126 ) — ( 379 ) — Total other comprehensive loss ( 9,451 ) ( 12,430 ) ( 8,327 ) ( 43,438 ) Total comprehensive (loss) income $ ( 6,872 ) $ ( 7,503 ) $ 72 $ ( 27,413 ) See accompanying notes to the consolidated financial statements (unaudited) . 4 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity (unaudited) Three Months Ended September 30, 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, June 30, 2023 $ 7,284 $ 77,047 $ 83,722 $ ( 30,590 ) $ ( 10,990 ) $ 126,473 Net income — — 2,579 — — 2,579 Other comprehensive loss — — — ( 9,451 ) — ( 9,451 ) Stock dividend 271 ( 271 ) — — — — Cash dividends declared, common stock ($ 0.17 per share) — — ( 1,197 ) — — ( 1,197 ) Balance, September 30, 2023 $ 7,555 $ 76,776 $ 85,104 $ ( 40,041 ) $ ( 10,990 ) $ 118,404 Balance, June 30, 2022 $ 7,024 $ 71,302 $ 84,437 $ ( 27,715 ) $ ( 10,990 ) $ 124,058 Net income — — 4,927 — — 4,927 Other comprehensive loss — — — ( 12,430 ) — ( 12,430 ) Stock dividend 260 ( 260 ) — — — — Cash dividends declared, common stock ($ 0.17 per share) — — ( 1,150 ) — — ( 1,150 ) Balance, September 30, 2022 $ 7,284 $ 71,042 $ 88,214 $ ( 40,145 ) $ ( 10,990 ) $ 115,405 Nine Months Ended September 30, 2023 and 2022 (In thousands, except per share data) Common Stock Surplus Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Total Stock - holders' 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 — — 8,399 — — 8,399 Other comprehensive loss — — — ( 8,327 ) — ( 8,327 ) Stock dividend 271 5,734 ( 6,005 ) — — — Cash dividends declared, common stock ($ 0.51 per share) — — ( 3,498 ) — — ( 3,498 ) Balance, September 30, 2023 $ 7,555 $ 76,776 $ 85,104 $ ( 40,041 ) $ ( 10,990 ) $ 118,404 Balance, December 31, 2021 $ 7,024 $ 64,437 $ 82,300 $ 3,293 $ ( 8,098 ) $ 148,956 Net income — — 16,025 — — 16,025 Other comprehensive loss — — — ( 43,438 ) — ( 43,438 ) Purchase of treasury stock — — — — ( 2,892 ) ( 2,892 ) Stock dividend 260 6,605 ( 6,865 ) — — — Cash dividends declared, common stock ($ 0.49 per share) — — ( 3,246 ) — — ( 3,246 ) Balance, September 30, 2022 $ 7,284 $ 71,042 $ 88,214 $ ( 40,145 ) $ ( 10,990 ) $ 115,405 See accompanying notes to the consolidated financial statements (unaudited) . 5 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) Nine Months Ended September 30, (In thousands) 2023 2022 Cash flows from operating activities: Net income $ 8,399 $ 16,025 Adjustments to reconcile net income to net cash provided by operating activities: Provision for (release of) credit losses on loans and unfunded commitments 790 ( 1,000 ) Depreciation expense 1,608 1,615 Net amortization of investment securities, premiums, and discounts 772 1,086 Change in fair value of mortgage servicing rights 52 ( 186 ) Investment securities (gains) losses, net ( 18 ) 12 Gain on sales and dispositions of premises and equipment ( 154 ) ( 147 ) Gain on sales and dispositions of other real estate ( 49 ) ( 2 ) Provision for (release of) valuation allowance for other real estate owned 4,643 ( 28 ) Increase in accrued interest receivable ( 580 ) ( 427 ) Increase in cash surrender value - life insurance ( 43 ) ( 44 ) (Increase) decrease in other assets ( 554 ) 155 Decrease in operating lease liabilities ( 238 ) ( 227 ) Increase in accrued interest payable 949 283 Decrease in other liabilities ( 803 ) ( 4,185 ) Origination of mortgage loans held for sale ( 84,821 ) ( 72,563 ) Proceeds from the sale of mortgage loans held for sale 84,382 76,110 Gain on sale of mortgage loans, net ( 2,014 ) ( 2,322 ) Net cash provided by operating activities 12,321 14,155 Cash flows from investing activities: Purchase of certificates of deposit in other banks — ( 245 ) Proceeds from maturities of certificates of deposit in other banks 2,219 1,237 Net increase in loans ( 35,469 ) ( 190,215 ) Purchase of available-for-sale debt securities ( 9,468 ) ( 17,318 ) Proceeds from maturities of available-for-sale debt securities 15,252 24,673 Proceeds from calls of available-for-sale debt securities 615 2,295 Purchases of FHLB stock ( 13,838 ) ( 8,103 ) Proceeds from sales of FHLB stock 13,204 8,138 Purchases of premises and equipment ( 1,384 ) ( 2,433 ) Proceeds from sales of premises and equipment 158 304 Proceeds from sales of other real estate and repossessed assets 681 1,348 Net cash used in investing activities ( 28,030 ) ( 180,319 ) Cash flows from financing activities: Net (decrease) increase in demand deposits ( 28,338 ) 45,587 Net (decrease) increase in interest-bearing transaction accounts ( 121,011 ) 7,235 Net increase in time deposits 97,635 23,156 Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase 1,009 ( 17,939 ) Repayment of FHLB advances and other borrowings ( 328,890 ) ( 195,962 ) FHLB advances 342,890 191,544 Purchase of treasury stock — ( 2,892 ) Cash dividends paid - common stock ( 3,452 ) ( 3,088 ) Net cash (used in) provided for financing activities ( 40,157 ) 47,641 Net decrease in cash and cash equivalents ( 55,866 ) ( 118,523 ) Cash and cash equivalents, beginning of period 83,720 159,909 Cash and cash equivalents, end of period $ 27,854 $ 41,386 See accompanying notes to the consolidated financial statements (unaudited). 6 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) continued Nine Months Ended September 30, (In thousands) 2023 2022 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 22,501 $ 5,415 Income taxes $ 1,925 $ 4,307 Noncash investing and financing activities: Other real estate and repossessed assets acquired in settlement of loans $ 44 $ 3 Stock dividends $ 6,005 $ 6,865 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. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. 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, 2023, the Company paid a special stock dividend of four percent ( 4 %) to shareholders of record at the close of business on June 15, 2023. 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. 8 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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. 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 September 30, 2023 and December 31, 2022 were as follows: (in thousands) September 30, 2023 December 31, 2022 Commercial, financial, and agricultural $ 227,372 $ 244,549 Real estate construction − residential 58,774 32,095 Real estate construction − commercial 130,572 137,235 Real estate mortgage − residential 379,514 361,025 Real estate mortgage − commercial 739,413 722,729 Installment and other consumer 21,324 23,619 Total loans held for investment $ 1,556,969 $ 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 $ 7.1 million and $ 6.4 million at September 30, 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 September 30, 2023, loans of $ 719.9 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 a lifetime expected loss model that 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 9 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) expected to be collected on the instrument. Expected recoveries are included in the allowance and do not exceed the 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 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. 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. 10 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following tables illustrate the changes in the allowance for credit losses by portfolio segment: Three Months Ended September 30, 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 $ 1,844 $ 748 $ 3,422 $ 5,465 $ 10,295 $ 217 $ 245 $ 22,236 Additions: Provision for (release of ) credit losses (1) 99 125 ( 157 ) ( 153 ) 440 94 ( 148 ) 300 Deductions: Loans charged off 16 — — — 3 76 — 95 Less recoveries on loans ( 9 ) — — ( 2 ) ( 1 ) ( 9 ) — ( 21 ) Net loan charge-offs (recoveries) 7 — — ( 2 ) 2 67 — 74 Balance at end of period $ 1,936 $ 873 $ 3,265 $ 5,314 $ 10,733 $ 244 $ 97 $ 22,462 Liability for Unfunded Commitments Balance at beginning of period $ 112 $ 355 $ 414 $ 108 $ 126 $ 1 $ 21 $ 1,137 Provision for credit losses on unfunded commitments 9 ( 68 ) ( 110 ) ( 4 ) ( 1 ) — ( 16 ) ( 190 ) Balance at end of period $ 121 $ 287 $ 304 $ 104 $ 125 $ 1 $ 5 $ 947 Allowance for credit losses on loans and liability for unfunded commitments $ 2,057 $ 1,160 $ 3,569 $ 5,418 $ 10,858 $ 245 $ 102 $ 23,409 Three Months Ended September 30, 2022 (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total Balance at beginning of period $ 3,005 $ 66 $ 762 $ 2,747 $ 8,410 $ 312 $ 51 $ 15,353 Additions: Provision for (release of ) loan losses (1) ( 124 ) 5 87 481 ( 414 ) 129 136 300 Deductions: Loans charged off 46 — — — ( 1 ) 146 191 Less recoveries on loans ( 13 ) — — ( 4 ) ( 5 ) ( 21 ) ( 43 ) Net loan charge-offs (recoveries) 33 — — ( 4 ) ( 6 ) 125 — 148 Balance at end of period $ 2,848 $ 71 $ 849 $ 3,232 $ 8,002 $ 316 $ 187 $ 15,505 11 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following tables illustrate the changes in the allowance for loan losses by portfolio segment: Nine Months Ended September 30, 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 Additions: Provision for (release of ) credit losses (1) ( 274 ) 425 ( 504 ) 89 1,145 137 97 1,115 Deductions: Loans charged off 59 — — — 28 204 — 291 Less recoveries on loans ( 183 ) — — ( 6 ) ( 3 ) ( 65 ) — ( 257 ) Net loan charge-offs (recoveries) ( 124 ) — — ( 6 ) 25 139 — 34 Balance at end of period $ 1,936 $ 873 $ 3,265 $ 5,314 $ 10,733 $ 244 $ 97 $ 22,462 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 17 ( 54 ) ( 265 ) ( 3 ) ( 25 ) — 5 ( 325 ) Balance at end of period $ 121 $ 287 $ 304 $ 104 $ 125 $ 1 $ 5 $ 947 Allowance for credit losses on loans and liability for unfunded commitments $ 2,057 $ 1,160 $ 3,569 $ 5,418 $ 10,858 $ 245 $ 102 $ 23,409 Nine Months Ended September 30, 2022 (in thousands) Commercial, Financial, & Agricultural Real Estate Construction - Residential Real Estate Construction - Commercial Real Estate Mortgage - Residential Real Estate Mortgage - Commercial Installment and Other Consumer Un- allocated Total Balance at beginning of period $ 2,717 $ 137 $ 588 $ 2,482 $ 10,662 $ 256 $ 61 $ 16,903 Additions: Provision for (release of ) loan losses (1) 188 ( 66 ) 261 723 ( 2,491 ) 259 126 ( 1,000 ) Deductions: Loans charged off 106 — — — 178 262 — 546 Less recoveries on loans ( 49 ) — — ( 27 ) ( 9 ) ( 63 ) — ( 148 ) Net loan charge-offs (recoveries) 57 — — ( 27 ) 169 199 — 398 Balance at end of period $ 2,848 $ 71 $ 849 $ 3,232 $ 8,002 $ 316 $ 187 $ 15,505 (1) Beginning January 1, 2023, calculation is based on CECL methodology. Prior to January 1, 2023, calculation was based on probable incurred loss methodology. 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. There have been no significant changes to the types of collateral securing the Company's collateral dependent loans since December 31, 2022. 12 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The amortized cost of collateral-dependent loans by class as of September 30, 2023 was as follows: Collateral Type (in thousands) Real Estate Other Allowance Allocated September 30, 2023 Real estate mortgage − residential $ 142 $ — $ 22 Real estate mortgage − commercial 2,432 — — Total $ 2,574 $ — $ 22 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 that 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 13 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table 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 that 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 that 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. • Non-accrual - loans that are delinquent for 90 days or more and the ultimate collectability of interest or principal is no longer probable. (The majority of the Company's non-accrual loans have a substandard risk grade) • Doubtful - loans that 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. 14 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents the recorded investment by risk categories at September 30, 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 September 30, 2023 Commercial, Financial, & Agricultural Pass $ 38,345 $ 46,113 $ 34,333 $ 32,286 $ 5,094 $ 4,851 $ 51,245 $ 603 $ 212,870 Watch 181 2,630 381 610 3 331 4,159 — 8,295 Substandard 382 3,841 58 18 — — 1,820 — 6,119 Non-accrual loans — 2 — — 11 75 — — 88 Total $ 38,908 $ 52,586 $ 34,772 $ 32,914 $ 5,108 $ 5,257 $ 57,224 $ 603 $ 227,372 Gross YTD charge-offs — — — — — 59 — — 59 Real Estate Construction - Residential Pass $ 35,074 $ 22,884 $ 638 $ 177 $ — $ — $ 1 $ — $ 58,774 Watch — — — — — — — — — Substandard — — — — — — — — — Non-accrual loans — — — — — — — — — Total $ 35,074 $ 22,884 $ 638 $ 177 $ — $ — $ 1 $ — $ 58,774 Gross YTD charge-offs — — — — — — — — — Real Estate Construction - Commercial Pass $ 40,936 $ 56,321 $ 29,056 $ 1,193 $ 63 $ 739 $ 311 $ — $ 128,619 Watch 839 18 196 — — 13 103 — 1,169 Substandard 710 — — — — — — — 710 Non-accrual loans — — — — — 74 — — 74 Total $ 42,485 $ 56,339 $ 29,252 $ 1,193 $ 63 $ 826 $ 414 $ — $ 130,572 Gross YTD charge-offs — — — — — — — — — Real Estate Mortgage - Residential Pass $ 59,185 $ 126,650 $ 64,789 $ 49,317 $ 7,345 $ 22,551 $ 44,237 $ 202 $ 374,276 Watch 180 208 416 989 127 2,265 — — 4,185 Substandard 16 — — 130 — 134 — — 280 Non-accrual loans — 49 — 232 — 273 219 — 773 Total $ 59,381 $ 126,907 $ 65,205 $ 50,668 $ 7,472 $ 25,223 $ 44,456 $ 202 $ 379,514 Gross YTD charge-offs — — — — — — — — — Real Estate Mortgage - Commercial Pass $ 89,802 $ 214,581 $ 205,323 $ 86,113 $ 27,954 $ 42,089 $ 15,563 $ 662 $ 682,087 Watch 16,073 11,881 4,405 1,417 390 1,352 75 — 35,593 Substandard 2,541 219 15,519 — 128 294 100 58 18,859 Non-accrual loans 1,815 111 730 218 — — — — 2,874 Total $ 110,231 $ 226,792 $ 225,977 $ 87,748 $ 28,472 $ 43,735 $ 15,738 $ 720 $ 739,413 Gross YTD charge-offs — — — — — 28 — — 28 Installment and other Consumer Pass $ 6,434 $ 7,243 $ 3,217 $ 1,543 $ 1,202 $ 1,602 $ 80 $ — $ 21,321 Watch — — — 2 — — — — 2 Substandard — — — — — — — — — Non-accrual loans — — 1 — — — — — 1 Total $ 6,434 $ 7,243 $ 3,218 $ 1,545 $ 1,202 $ 1,602 $ 80 $ — $ 21,324 Gross YTD charge-offs — 21 13 — — 169 1 — 204 Total Portfolio Pass $ 269,776 $ 473,792 $ 337,356 $ 170,629 $ 41,658 $ 71,832 $ 111,437 $ 1,467 $ 1,477,947 Watch 17,273 14,737 5,398 3,018 520 3,961 4,337 — 49,244 Substandard 3,649 4,060 15,577 148 128 428 1,920 58 25,968 Non-accrual loans 1,815 162 731 450 11 422 219 — 3,810 Total $ 292,513 $ 492,751 $ 359,062 $ 174,245 $ 42,317 $ 76,643 $ 117,913 $ 1,525 $ 1,556,969 Total Gross YTD charge-offs $ — $ 21 $ 13 $ — $ — $ 256 $ 1 $ — $ 291 15 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table presents the recorded investment by risk categories at December 31, 2022: Term Loans Amortized Cost Basis by Origination Year and Risk Grades (in thousands) 2022 2021 2020 2019 2018 Prior Revolving Loans Amortized Cost Basis Revolving Loans Converted to Term Loans Amortized Cost Basis Total December 31, 2022 Commercial, Financial, & Agricultural Pass $ 73,654 $ 40,681 $ 37,994 $ 6,479 $ 4,050 $ 2,718 $ 63,869 $ 504 $ 229,949 Watch 1,228 296 756 150 48 251 3,155 1,527 7,411 Substandard 5,014 58 24 — 152 — 1,820 — 7,068 Non-accrual loans — — — 26 95 — — — 121 Total $ 79,896 $ 41,035 $ 38,774 $ 6,655 $ 4,345 $ 2,969 $ 68,844 $ 2,031 $ 244,549 Gross YTD charge-offs 135 — — — — — — — 135 Real Estate Construction - Residential Pass $ 29,289 $ 1,248 $ 769 $ 449 $ — $ — $ 340 $ — $ 32,095 Watch — — — — — — — — — Substandard — — — — — — — — — Non-accrual loans — — — — — — — — — Total $ 29,289 $ 1,248 $ 769 $ 449 $ — $ — $ 340 $ — $ 32,095 Gross YTD charge-offs — — — — — — — — — Real Estate Construction - Commercial Pass $ 60,318 $ 67,977 $ 2,249 $ 78 $ 676 $ 656 $ 1,831 $ — $ 133,785 Watch 2,239 321 — — — 14 103 — 2,677 Substandard 686 — — — — — — — 686 Non-accrual loans — — — — — 87 — — 87 Total $ 63,243 $ 68,298 $ 2,249 $ 78 $ 676 $ 757 $ 1,934 $ — $ 137,235 Gross YTD charge-offs — — — — — — — — — Real Estate Mortgage - Residential Pass $ 147,130 $ 68,380 $ 53,322 $ 8,013 $ 4,981 $ 25,590 $ 45,182 $ 523 $ 353,121 Watch 1,226 429 1,511 145 215 2,015 — — 5,541 Substandard — 136 820 — 10 712 — — 1,678 Non-accrual loans 59 — 144 — — 386 96 — 685 Total $ 148,415 $ 68,945 $ 55,797 $ 8,158 $ 5,206 $ 28,703 $ 45,278 $ 523 $ 361,025 Gross YTD charge-offs — — — — — — — — — Real Estate Mortgage - Commercial Pass $ 248,529 $ 203,033 $ 99,989 $ 31,341 $ 21,354 $ 38,317 $ 10,868 $ 121 $ 653,552 Watch 14,049 14,029 16,863 842 897 811 149 401 48,041 Substandard 260 2,673 — 48 — 306 — 48 3,335 Non-accrual loans 4,621 13,180 — — — — — — 17,801 Total $ 267,459 $ 232,915 $ 116,852 $ 32,231 $ 22,251 $ 39,434 $ 11,017 $ 570 $ 722,729 Gross YTD charge-offs 101 — — — — 80 — — 181 Installment and other Consumer Pass $ 11,170 $ 5,183 $ 2,891 $ 2,016 $ 459 $ 88 $ 1,806 $ — $ 23,613 Watch — — — — — — — — — Substandard — — — — — — — — — Non-accrual loans 2 3 — 1 — — — — 6 Total $ 11,172 $ 5,186 $ 2,891 $ 2,017 $ 459 $ 88 $ 1,806 $ — $ 23,619 Gross YTD charge-offs 268 10 5 21 1 — 16 — 321 Total Portfolio Pass $ 570,090 $ 386,502 $ 197,214 $ 48,376 $ 31,520 $ 67,369 $ 123,896 $ 1,148 $ 1,426,115 Watch 18,742 15,075 19,130 1,137 1,160 3,091 3,407 1,928 63,670 Substandard 5,960 2,867 844 48 162 1,018 1,820 48 12,767 Non-accrual loans 4,682 13,183 144 27 95 473 96 — 18,700 Total $ 599,474 $ 417,627 $ 217,332 $ 49,588 $ 32,937 $ 71,951 $ 129,219 $ 3,124 $ 1,521,252 Total Gross YTD charge-offs $ 504 $ 10 $ 5 $ 21 $ 1 $ 80 $ 16 $ — $ 637 16 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 September 30, 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 September 30, 2023 Commercial, Financial, and Agricultural $ — $ 88 $ 88 $ — $ 88 Real estate construction − commercial — 74 74 — 74 Real estate mortgage − residential 95 678 773 31 804 Real estate mortgage − commercial 2,431 443 2,874 — 2,874 Installment and Other Consumer — 1 1 6 7 Total $ 2,526 $ 1,284 $ 3,810 $ 37 $ 3,847 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 September 30, 2023 and December 31, 2022. No material amount of interest income was recognized on non-accrual loans during the three and nine months ended September 30, 2023. 17 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The following table provides aging information for the Company’s past due and non-accrual loans at September 30, 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 September 30, 2023 Commercial, Financial, and Agricultural $ 227,106 $ 178 $ — $ 88 $ 227,372 Real estate construction − residential 58,540 234 — — 58,774 Real estate construction − commercial 130,498 — — 74 130,572 Real estate mortgage − residential 378,362 348 31 773 379,514 Real estate mortgage − commercial 736,318 221 — 2,874 739,413 Installment and Other Consumer 21,156 161 6 1 21,324 Total $ 1,551,980 $ 1,142 $ 37 $ 3,810 $ 1,556,969 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 both the three and nine months ended September 30, 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. 18 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 September 30, 2023: September 30, 2023 (Dollars in thousands) Number of contracts Recorded Investment % to Total Loans Commercial, financial and agricultural 2 $ 164 0.01 % Real estate mortgage − residential 6 998 0.06 % Real estate mortgage − commercial 2 273 0.02 % Total 10 $ 1,435 0.09 % 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 September 30, 2022, loans classified as TDRs totaled $ 1.9 million, of which $ 0.3 million were classified as non-performing TDRs and $ 1.6 million were classified as performing TDRs. Both performing and non-performing TDRs are considered impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. Accordingly, specific reserves of $ 171,000 related to TDRs were allocated to the allowance for loan losses at September 30, 2022. For both the three and nine months ended September 30, 2022, the Company had one new loan meeting the TDR criteria. For both the three and nine months ended September 30, 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 September 30, 2023, the carrying amount of these loans was $ 3.0 million compared to $ 0.6 million at December 31, 2022. (3) Other Real Estate and Other Assets Acquired in Settlement of Loans September 30, December 31, (in thousands) 2023 2022 Real estate construction - commercial $ 10,054 $ 10,094 Real estate mortgage - residential 71 179 Real estate mortgage - commercial 706 1,186 Total $ 10,831 $ 11,459 Less valuation allowance for other real estate owned ( 7,267 ) ( 2,664 ) Total other real estate owned and repossessed assets $ 3,564 $ 8,795 19 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Changes in the net carrying amount of other real estate owned and repossessed assets were as follows for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Balance at beginning of period $ 10,924 $ 11,819 $ 11,459 $ 13,436 Additions net of (charge-offs) — 55 44 3 Proceeds from sales ( 54 ) — ( 681 ) ( 1,348 ) Charge-offs against the valuation allowance for other real estate owned, net ( 40 ) — ( 40 ) ( 219 ) Net gain on sales 1 — 49 2 Total other real estate owned 10,831 11,874 $ 10,831 $ 11,874 Less valuation allowance for other real estate owned ( 7,267 ) ( 2,664 ) ( 7,267 ) ( 2,664 ) Balance at end of period $ 3,564 $ 9,210 $ 3,564 $ 9,210 At September 30, 2023, there were $ 72,000 in consumer mortgage loans secured by residential real estate properties 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 September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Balance at beginning of period $ 4,495 $ 2,664 $ 2,664 $ 2,911 Provision for (release of) valuation allowance for other real estate owned 2,812 — 4,643 ( 28 ) Charge-offs ( 40 ) — ( 40 ) ( 219 ) Balance at end of period $ 7,267 $ 2,664 $ 7,267 $ 2,664 20 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (4) Investment Securities The amortized cost and fair value of debt securities classified as available-for-sale at September 30, 2023 and December 31, 2022 were as follows: Gross Unrealized (in thousands) Total Amortized Cost Gains Losses Fair Value September 30, 2023 U.S. Treasury $ 4,908 $ — $ ( 40 ) $ 4,868 U.S. government and federal agency obligations 446 — ( 26 ) 420 U.S. government-sponsored enterprises 27,499 — ( 2,637 ) 24,862 Obligations of states and political subdivisions 131,697 — ( 32,762 ) 98,935 Mortgage-backed securities 112,116 2 ( 19,375 ) 92,743 Other debt securities (a) 11,825 — ( 1,291 ) 10,534 Bank issued trust preferred securities (a) 1,486 — ( 332 ) 1,154 Total available-for-sale securities $ 289,977 $ 2 $ ( 56,463 ) $ 233,516 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 $ 117.4 million and $ 111.6 million at September 30, 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. 21 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) The amortized cost and fair value of debt securities classified as available-for-sale at September 30, 2023, by contractual maturity are shown below. Accrued interest on investments totaled $ 1.3 million and $ 1.5 million at September 30, 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 $ 9,120 $ 9,064 Due after one year through five years 23,853 21,728 Due after five years through ten years 28,982 24,924 Due after ten years 115,906 85,057 Total $ 177,861 $ 140,773 Mortgage-backed securities 112,116 92,743 Total available-for-sale securities $ 289,977 $ 233,516 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) September 30, 2023 December 31, 2022 Other securities: FHLB stock $ 6,790 $ 6,156 MIB stock 151 151 Equity securities with readily determinable fair values 64 46 Total other investment securities $ 7,005 $ 6,353 22 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 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 September 30, 2023 U.S. Treasury $ 3,568 $ ( 10 ) $ 1,300 $ ( 30 ) $ 4,868 $ ( 40 ) U.S. government and federal agency obligations — — 420 ( 26 ) 420 ( 26 ) U.S. government-sponsored enterprises 985 ( 15 ) 23,877 ( 2,622 ) 24,862 ( 2,637 ) Obligations of states and political subdivisions 3,326 ( 380 ) 95,609 ( 32,382 ) 98,935 ( 32,762 ) Mortgage-backed securities 5,760 ( 296 ) 86,648 ( 19,079 ) 92,408 ( 19,375 ) Other debt securities — — 10,534 ( 1,291 ) 10,534 ( 1,291 ) Bank issued trust preferred securities — — 1,154 ( 332 ) 1,154 ( 332 ) Total $ 13,639 $ ( 701 ) $ 219,542 $ ( 55,762 ) $ 233,181 $ ( 56,463 ) (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 435 securities at September 30, 2023. The portfolio included 434 securities having an aggregate fair value of $ 233.2 million that were in a loss position at September 30, 2023. Securities identified as temporarily impaired that had been in a loss position for 12 months or longer totaled $ 219.5 million at fair value at September 30, 2023. The $ 56.5 million aggregate unrealized loss included in accumulated other comprehensive loss at September 30, 2023 was caused by interest rate fluctuations. 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 that 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 September 30, 2023 and December 31, 2022, respectively. In the absence of changes in credit quality of these investments, the fair value is expected to recover on all debt securities as they approach their maturity date or re-pricing date, or if market yields for such investments decline. In addition, the Company does not have the intent to sell these investments over the period of recovery, and it is not more likely than not that the Company will be required to sell such investment securities. 23 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 were recognized in earnings: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Gross realized gains $ — $ — $ — $ — Gross realized losses — — — — Other-than-temporary impairment recognized — — — — Other investment securities: Fair value adjustments, net 3 1 18 ( 12 ) Investment securities gains (losses), net $ 3 $ 1 $ 18 $ ( 12 ) (5) Intangible Assets Mortgage Servicing Rights At September 30, 2023, the Company was servicing approximately $ 226.3 million of loans sold to the secondary market compared to $ 240.5 million at December 31, 2022, and $ 247.6 million at September 30, 2022. Mortgage loan servicing fees, reported in real estate servicing fees, net, earned on loans sold were $ 0.2 million and $ 0.5 million for the three and nine months ended September 30, 2023, respectively, compared to $ 0.2 million and $ 0.7 million for the three and nine months ended September 30, 2022, respectively. The table below presents changes in mortgage servicing rights (MSRs) for the periods indicated. Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Balance at beginning of period $ 2,902 $ 2,730 $ 2,899 $ 2,659 Originated mortgage servicing rights 8 21 38 61 Changes in fair value: Due to changes in model inputs and assumptions (1) 45 228 145 418 Other changes in fair value (2) ( 70 ) ( 73 ) ( 197 ) ( 232 ) Total changes in fair value ( 25 ) 155 ( 52 ) 186 Balance at end of period $ 2,885 $ 2,906 $ 2,885 $ 2,906 (1) The change in fair value resulting from changes in valuation inputs or assumptions, reported in real estate servicing fees, net, used in the valuation model reflects the change in discount rates and prepayment speed assumptions primarily due to changes in interest rates. (2) Other changes in fair value, reported in real estate servicing fees, net, reflect changes due to customer payments and passage of time. The following key data and assumptions were used in estimating the fair value of the Company’s MSRs as of September 30, 2023 and 2022, respectively: Nine Months Ended September 30, 2023 2022 Weighted average constant prepayment rate 6.51 % 7.30 % Weighted average note rate 3.49 % 3.42 % Weighted average discount rate 11.00 % 10.00 % Weighted average expected life (in years) 7.14 6.98 24 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (6) Deposits The table below represents the aggregate amount of time deposits with balances that met or exceeded the Federal Deposit Insurance Corporation (FDIC) insurance limit of $250,000 and brokered deposits for the periods indicated. (aggregate amounts in thousands) September 30, 2023 December 31, 2022 Time deposits with balances > $250,000 $ 115,197 $ 94,859 Brokered deposits $ 42,543 $ 40,135 (7) Federal Funds Purchased and Securities Sold under Agreements to Repurchase (in thousands) September 30, 2023 December 31, 2022 Federal funds purchased $ — $ — Repurchase agreements 6,196 5,187 Total $ 6,196 $ 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 September 30, 2023 U.S. government-sponsored enterprises $ 6,196 $ — $ — $ 6,196 Total $ 6,196 $ — $ — $ 6,196 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 1 to 10 years. As of September 30, 2023, operating right of use (ROU) assets and liabilities were $ 1.3 million and $ 1.3 million, respectively. As of September 30, 2023, the weighted-average remaining lease term on these operating leases is approximately 5.3 years and the weighted-average discount rate used to measure the lease liabilities is approximately 4.0 %. Operating leases in which the Company is the lessee are recorded as operating lease ROU assets and operating lease liabilities. Currently, the Company does not have any finance leases. The ROU assets are included in premises and equipment, net on the consolidated balance sheets. Operating lease ROU assets represent the Company's right to use an underlying asset during the lease term and operating lease liabilities represent the Company's obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents the Company's incremental borrowing rate at the lease commencement date. 25 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Operating lease cost, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in net occupancy expense in the consolidated statements of income. The operating lease cost was $ 93,000 and $ 279,000 for the three and nine months ended September 30, 2023, respectively, compared to $ 93,000 and $ 280,000 for the three and nine months ended September 30, 2022, respectively. 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 $ 33,000 and $ 95,000 for the three and nine months ended September 30, 2023, respectively, compared to $ 21,000 and $ 65,000 for the three and nine months ended September 30, 2022, respectively. The table below summarizes the maturity of remaining operating lease liabilities: Lease payments due in: Operating Lease (in thousands) 2023 (excluding 9 months ended September 30, 2023) $ 88 2024 258 2025 257 2026 259 2027 262 Thereafter 309 Total lease payments $ 1,433 Less imputed interest ( 138 ) Total lease liabilities, as reported $ 1,295 (9) Income Taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 16.2 % and 17.1 % for the three and nine months ended September 30, 2023, respectively, compared to 18.7 % and 18.5 % for the three and nine months ended September 30, 2022, respectively. The effective tax rate for each of the three and nine months ended September 30, 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 and $ 40,000 benefit associated with a historic tax credit investment for the three and nine months ended September 30, 2023, respectively. 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 September 30, 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 nine months ended September 30, 2023 and 2022, respectively, the Company did not have any uncertain tax provisions, and did not record any related tax liabilities. 26 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (10) Stockholders’ Equity and Accumulated Other Comprehensive (Loss) Income Equity-Based Compensation Plan The following table summarizes the status of the Company's restricted share units (RSUs) for the nine months ended September 30, 2023: RSUs (in thousands, except per share amounts) Quantity Weighted-Average Grant Date Fair Value Per share Non-vested at January 1, 2023 — $ — Granted 12,277 18.33 Vested — — Forfeited — — Non-vested at September 30, 2023 12,277 $ 18.33 Accumulated Other Comprehensive (Loss) Income The following table summarizes the change in the components of the Company’s accumulated other comprehensive loss for the nine months ended September 30, 2023 and 2022: Nine Months Ended September 30, 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 loss, before reclassifications ( 10,061 ) ( 480 ) ( 10,541 ) Amounts reclassified from accumulated other comprehensive loss — — — Current period other comprehensive loss, before tax ( 10,061 ) ( 480 ) ( 10,541 ) Income tax benefit 2,113 101 2,214 Current period other comprehensive loss, net of tax ( 7,948 ) ( 379 ) ( 8,327 ) Balance at end of period $ ( 44,605 ) $ 4,564 $ ( 40,041 ) Nine Months Ended September 30, 2022 (in thousands) Unrealized Gains (Losses) on Securities (1) Unrecognized Net Pension and Postretirement Costs (2) Accumulated Other Comprehensive Income (Loss) Balance at beginning of period $ 362 $ 2,931 $ 3,293 Other comprehensive loss, before reclassifications ( 54,985 ) — ( 54,985 ) Amounts reclassified from accumulated other comprehensive loss — — — Current period other comprehensive loss, before tax ( 54,985 ) — ( 54,985 ) Income tax benefit 11,547 — 11,547 Current period other comprehensive loss, net of tax ( 43,438 ) — ( 43,438 ) Balance at end of period $ ( 43,076 ) $ 2,931 $ ( 40,145 ) (1) The pre-tax amounts reclassified from accumulated other comprehensive (loss) income are included in investment securities gains (losses), net in the consolidated statements of income. (2) The pre-tax amounts reclassified from accumulated other comprehensive (loss) income are included in the computation of net periodic pension cost. 27 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) (11) Employee Benefit Plans Employee Benefits Employee benefits charged to operating expenses are summarized in the table below for the periods indicated. Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Payroll taxes $ 374 $ 338 $ 1,228 $ 1,123 Medical plans 505 426 1,400 1,368 401(k) match and profit sharing 250 411 761 1,207 Periodic pension cost 265 402 796 1,206 Other 11 20 30 32 Total employee benefits $ 1,405 $ 1,597 $ 4,215 $ 4,936 The Company's profit-sharing plan includes a matching 401(k) portion, in which the Company matches the first 3 % of eligible employee contributions. The Company made annual contributions for the discretionary portion in an amount up to 6 % of income before income taxes and before contributions to the profit-sharing and pension plans for all participants, limited to the maximum amount deductible for federal income tax purposes, for each of the periods shown. In addition, employees were able to make additional tax-deferred contributions. Other Plans On November 7, 2018, the Board of Directors of the Company adopted a supplemental executive retirement plan (SERP), effective as of January 1, 2018. The SERP provides select employees who satisfy certain eligibility requirements with certain benefits upon retirement, termination of employment or death. The accrued liability relating to the SERP was $ 1.7 million as of September 30, 2023, and the expense for the three and nine months ended September 30, 2023 was $ 9,600 and $ 29,000 , respectively, compared to $ 93,000 and $ 279,000 for the three and nine months ended September 30, 2022, respectively, and is recognized over the required service period. Pension The Company provides a noncontributory defined benefit pension plan for all full-time and eligible employees. Beginning January 1, 2018 and for all retrospective periods presented, the Company adopted the guidance under ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . Under the guidance, only the service cost component of the net periodic benefit cost is reported in the same income statement line item as salaries and benefits, and the remaining components are reported as other non-interest expense. An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. 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. 28 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Components of Net Pension Cost and Other Amounts Recognized in Accumulated Other Comprehensive (Loss) Income The following items are components of net pension cost for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Service cost - benefits earned during the year $ 237 $ 373 $ 710 $ 1,118 Interest costs on projected benefit obligations (a) 357 293 1,071 881 Expected return on plan assets (a) ( 544 ) ( 570 ) ( 1,634 ) ( 1,711 ) Expected administrative expenses 28 29 86 88 Amortization of unrecognized net loss (a) ( 160 ) — ( 480 ) — Net periodic pension cost $ ( 82 ) $ 125 $ ( 247 ) $ 376 (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 (loss) 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. (12) Earnings per Share Stock Dividend On July 1, 2023, the Company paid a special stock dividend of 4.0 % to common shareholders of record at the close of business on June 15, 2023. 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 September 30, Nine Months Ended September 30, (dollars in thousands, except per share data) 2023 2022 2023 2022 Basic and Diluted Earnings Per Share: Net income available to shareholders $ 2,579 $ 4,927 $ 8,399 $ 16,025 Basic weighted-average shares outstanding 7,039,323 7,039,323 7,039,323 7,071,051 Effect of dilutive equity-based awards — — — — Diluted weighted-average shares outstanding 7,039,323 7,039,323 7,039,323 7,071,051 Basic earnings per share $ 0.36 $ 0.70 $ 1.19 $ 2.27 Diluted earnings per share $ 0.36 $ 0.70 $ 1.19 $ 2.27 The dilutive effect of restricted share units is reflected in diluted earnings per share unless the impact is anti-dilutive, by application of the treasury stock method. 29 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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 September 30, 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, 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 that 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. 30 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) 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. 31 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Fair Value Measurements (in thousands) Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) September 30, 2023 Assets: U.S. Treasury $ 4,868 $ 4,868 $ — $ — U.S. government and federal agency obligations 420 — 420 — U.S. government-sponsored enterprises 24,862 — 24,862 — Obligations of states and political subdivisions 98,935 — 98,935 — Mortgage-backed securities 92,743 — 92,743 — Other debt securities 10,534 — 10,534 — Bank-issued trust preferred securities 1,154 — 1,154 — Equity securities 64 64 — — Interest rate lock commitments 45 — — 45 Forward sale commitments 18 — 18 — Loans held for sale 3,006 — 3,006 — Mortgage servicing rights 2,885 — — 2,885 Total $ 239,534 $ 4,932 $ 231,672 $ 2,930 Liabilities: Interest rate lock commitments $ 2 $ — $ — $ 2 Total $ 2 $ — $ — $ 2 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 32 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 Nine Months Ended September 30, (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 ( 52 ) 186 ( 31 ) ( 22 ) Included in other comprehensive income — — — — Purchases — — — — Sales — — ( 125 ) ( 474 ) Issues 38 61 197 144 Settlements — — — — Balance at end of period $ 2,885 $ 2,906 $ 43 $ ( 66 ) Valuation Methods for Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a non-recurring basis: Collateral Dependent Impaired Loans While the overall loan portfolio is not carried at fair value, the Company periodically records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments also include certain impairment amounts for collateral dependent loans when establishing the allowance for 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 September 30, 2023, the Company identified $ 2.6 million in collateral-dependent loans that required $ 22,000 of specific allowances for credit losses. Related to these loans, there were $ 13,800 and $ 54,800 in charge-offs recorded during the three and nine months ended September 30, 2023, respectively. As of September 30, 2022, the Company identified $ 15.9 million in collateral-dependent impaired loans that required no specific allowances for losses aggregating. Related to these loans, there were $ 61,000 and $ 86,000 in charge-offs recorded during the three and nine months ended September 30, 2022, respectively. 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. 33 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) Fair Value Measurements Using (in thousands) Total Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Three Months Ended September 30, Total Gains (Losses)* Nine Months Ended September 30, Total Gains (Losses)* September 30, 2023 Assets: Collateral dependent impaired loans: Real estate mortgage - residential $ 120 $ — $ — $ 120 $ — $ — Real estate mortgage - commercial 2,432 — — 2,432 ( 2 ) ( 26 ) Installment and other consumer — — — — ( 12 ) ( 29 ) Total $ 2,552 $ — $ — $ 2,552 $ ( 14 ) $ ( 55 ) Other real estate and repossessed assets $ 3,564 $ — $ — $ 3,564 $ ( 2,811 ) $ ( 4,594 ) September 30, 2022 Assets: Collateral dependent impaired loans: Real estate mortgage - commercial $ 15,898 $ — $ — $ 15,898 $ ( 23 ) $ ( 48 ) Installment and other consumer — — — — ( 38 ) ( 38 ) Total $ 15,898 $ — $ — $ 15,898 $ ( 61 ) $ ( 86 ) Other real estate and repossessed assets $ 9,210 $ — $ — $ 9,210 $ — $ ( 22 ) * 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. 34 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. 35 HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited) A summary of the carrying amounts and fair values of the Company’s financial instruments at September 30, 2023 and December 31, 2022 is as follows: September 30, 2023 Fair Value Measurements September 30, 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 $ 17,793 $ 17,793 $ 17,793 $ — $ — Federal funds sold and overnight interest-bearing deposits 10,061 10,061 10,061 — — Certificates of deposit in other banks 735 735 735 — — Available-for-sale securities 233,516 233,516 4,868 228,648 — Other investment securities 7,005 7,005 64 6,941 — Loans, net 1,534,507 1,369,455 — — 1,369,455 Loans held for sale 3,006 3,006 — 3,006 — Cash surrender value - life insurance 2,610 2,610 — 2,610 — Interest rate lock commitments 45 45 — — 45 Forward sale commitments 18 18 — 18 — Accrued interest receivable 8,533 8,533 8,533 — — Total $ 1,817,829 $ 1,652,777 $ 42,054 $ 241,223 $ 1,369,500 Liabilities: Deposits: Non-interest bearing demand $ 425,105 $ 425,105 $ 425,105 $ — $ — Savings, interest checking and money market 802,591 802,591 802,591 — — Time deposits 352,669 349,641 — — 349,641 Federal funds purchased and securities sold under agreements to repurchase 6,196 6,196 6,196 — — Federal Home Loan Bank advances and other borrowings 112,000 112,000 — 112,000 — Subordinated notes 49,486 38,444 — 38,444 — Interest rate lock commitments 2 2 — — 2 Accrued interest payable 1,851 1,851 1,851 — — Total $ 1,749,900 $ 1,735,830 $ 1,235,743 $ 150,444 $ 349,643 36 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. 37 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. 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. The allowance for credit losses associated with unfunded commitments and letters of credit is recorded within other liabilities on the consolidated balance sheets. At September 30, 2023, the allowance for credit losses for unfunded commitments was $ 0.9 million. The contractual amount of off-balance-sheet financial instruments were as follows as of the dates indicated: (in thousands) September 30, 2023 December 31, 2022 Commitments to extend credit $ 309,847 $ 388,264 Interest rate lock commitments 8,956 6,331 Forward sale commitments 2,977 576 Standby letters of credit 17,991 49,740 Total $ 339,771 $ 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. 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. 38