HAWTHORN BANCSHARES, INC. 10-Q

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, strategy, future performance and business of Hawthorn Bancshares, Inc., and its subsidiaries (collectively, the "Company", "we", "our", or "us"), including, without limitation statements that are not historical in nature, and statements preceded by, followed by or that include the words believes , expects, may, will, should, could, anticipates, estimates, intends, plans, hopes or similar expressions. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, such possible events or factors such as: changes in economic conditions generally or in the Company's market area, changes in policies by regulatory agencies, governmental legislation and regulation, tariffs and trade disruptions, fluctuations in interest rates, changes in liquidity requirements, demand for loans in the Company's market area, changes in accounting and tax principles, estimates made on income taxes, competition with other entities that offer financial services, and cybersecurity threats and such other factors as described in described in the forward-looking statements under the caption Risk Factors in Item 1A. of the Company’s Annual Report on Form 10-K for the year ended December 31, 2024 (the "2024 Form 10-K"), and in other reports filed by us with the Securities and Exchange Commission ("SEC") from time to time. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made. Except as required by law, the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, or changes in its business, results of operations or financial condition over time. During the quarter ended March 31, 2025, there were no material changes to the Risk Factors disclosed in the Company's 2024 Annual Report on Form 10-K. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Certain accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies and estimates require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The Company has identified certain accounting policies as "critical accounting policies and estimates," consisting of those related to the allowance for credit losses, as described in the section captioned "Critical Accounting Policies and Estimates" incorporated by reference in Item 7, Management's Discussion and Analysis of Financial Condition and results of Operations included in the 2024 Form 10-K. There have been no changes in the Company's application of critical accounting policies and estimates since December 31, 2024. 35 Overview Crucial to the Company’s community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank, Hawthorn Bank (the "Bank"), the Company, with $1.9 billion in assets at March 31, 2025, provides a broad range of commercial and personal banking services. The Bank's specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate, Small Business Administration ("SBA") loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts. The Company also provides other financial services through its Wealth Management business, including trust services, estate planning, investment and asset management services and a comprehensive suite of cash management services. Beginning with the first quarter of 2025, the Company's Wealth Management business is now reported as a separate reporting segment, and the Company now operates two reporting segments, consisting of the Bank and the Wealth Management business. The geographic areas in which the Company provides products and services include the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, and the greater Kansas City metropolitan area. The Company's primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the Company's business is commercial, commercial real estate development, and residential mortgage lending. The Company's income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing activity. The success of the Company's growth strategy depends primarily on the ability of its banking subsidiary to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. The Company's financial performance also depends, in part, on its ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of the Company's growth strategy depends on its ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control. The Company's subsidiary bank is a full-service bank that conducts general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, the Bank provides trust and brokerage services. The deposit accounts of the Bank are insured by the Federal Deposit Insurance Corporation ("FDIC") to the extent provided by law. The operations of the Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of the Bank are conducted by representatives of the FDIC and the Missouri Division of Finance. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is subject to supervision and examination by the Board of Governors of the Federal Reserve System. 36 Executive Summary The Company has prepared all of the consolidated financial information in this report in accordance with United States (U.S.) generally accepted accounting principles ("U.S. GAAP") and the rules of the SEC. In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates. Three Months Ended March 31, (dollars in thousands, except per share data) 2025 2024 Net interest income $ 15,294 $ 14,748 Release of provision for credit losses (340) (230) Non-interest income 3,463 3,019 Investment securities losses, net (2) — Non-interest expense 12,499 12,575 Income before income taxes 6,596 5,422 Income tax expense 1,213 966 Net income $ 5,383 $ 4,456 Basic earnings per share $ 0.77 $ 0.63 Diluted earnings per share $ 0.77 $ 0.63 As of and for the Three Months Ended March 31, (dollars in thousands, except per share data) 2025 2024 Market and per share data Book value per share (1) $ 21.97 $ 19.43 Market price per share $ 28.23 $ 20.43 Cash dividends paid on common stock $ 1,328 $ 1,197 Performance Ratios Return on total assets 1.20% 0.97% Return on stockholders' equity 14.29% 12.49% Efficiency ratio (2) 66.64% 70.78% Net interest margin 3.67% 3.39% Average stockholders' equity to total assets 8.42% 7.41% (1) Book value per share is calculated using weighted average shares (2) Efficiency ratio is calculated as non-interest expense as a percentage of revenue. Total revenue is calculated as net interest income plus non-interest income. 37 As of and for the Three Months Ended March 31, (dollars in thousands, except per share data) 2025 2024 Capital Ratios Stockholders' equity to assets 8.15% 7.45% Total risk-based capital ratio 14.94% 13.92% Tier 1 risk-based capital ratio 13.69% 12.51% Common equity Tier 1 capital 10.64% 9.68% Tier 1 leverage ratio (3) 11.64% 10.71% Asset Quality Non-performing loans $ 2,461 $ 8,549 Non-performing assets $ 3,129 $ 10,486 Net loan (recoveries) charge-offs $ (18) $ 69 Net (recoveries) charge-offs to average loans (4) 0.00% 0.02% Allowance for credit losses to total loans 1.48% 1.56% Non-performing loans to total loans 0.17% 0.56% Non-performing assets to total loans 0.21% 0.69% Non-performing assets to total assets 0.17% 0.57% (3) Tier 1 leverage ratio is calculated by dividing Tier 1 capital by average total consolidated assets (4) Annualized Results of Operations Highlights: Consolidated net income of $5.4 million, or $0.77 per diluted share, for the first quarter ended March 31, 2025 increased $0.9 million, or 20.8%, compared to $4.5 million, or $0.63 per diluted share, for the first quarter ended March 31, 2024. For the first quarter 2025, the return on average assets was 1.20%, the return on average stockholders’ equity was 14.29%, and the efficiency ratio was 66.6%. Net interest income of $15.3 million for the first quarter ended March 31, 2025 increased $0.5 million compared to $14.7 million for the first quarter ended March 31, 2024. Net interest margin, on a fully taxable equivalent ("FTE") basis, was 3.67% for the first quarter 2025, an increase from 3.39% for the first quarter 2024. The change to net interest margin on a fully taxable equivalent basis is discussed in greater detail under the Average Balance Sheet Data and Rate and Volume Analysis sections. Non-interest income was $3.5 million for the three months ended March 31, 2025 compared to $3.0 million for the three months ended March 31, 2024. These changes are discussed in greater detail under the Non-interest Income and Expense section. Non-interest expense was $12.5 million for the three months ended March 31, 2025 compared to $12.6 million for the three months ended March 31, 2024. These changes are discussed in greater detail under the Non-interest Income and Expense section. Balance Sheet Highlights: Cash and cash equivalents – Cash and cash equivalents increased $51.3 million to $102.3 million as of March 31, 2025 compared to $51.0 million as of December 31, 2024 and increased $58.8 million compared to $43.5 million as of March 31, 2024. See the Liquidity Management section for further discussion. Loans – Loans held for investment increased $4.2 million to $1.47 billion as of March 31, 2025 compared to $1.47 billion as of December 31, 2024 and decreased $48.5 million compared to $1.52 billion as of March 31, 2024. 38 Asset quality – Non-performing assets totaled $3.1 million, or 0.21% of total loans, at March 31, 2025 compared to $4.2 million, or 0.29% of total loans, at December 31, 2024 and $10.5 million, or 0.69% of total loans, at March 31, 2024. In the first quarter 2025, the Company had net loan recoveries of $0.02 million, or 0%, of average loans, compared to net loan charge-offs $0.07 million, or 0.02% of average loans, in the prior year quarter. The allowance for credit losses was $21.8 million, or 1.48%, of loans outstanding at March 31, 2025 compared to $22.0 million, or 1.50%, of loans outstanding at December 31, 2024, and $23.7 million, or 1.56% of loans outstanding at March 31, 2024. These changes are discussed in greater detail under the Lending and Credit Management section. Deposit s – Total deposits increased $10.7 million to $1.54 billion as of March 31, 2025 compared to $1.53 billion as of December 31, 2024, and increased $16.0 million compared to $1.53 billion as of March 31, 2024. Federal Home Loan Bank ("FHLB") advances and other borrowings – Total FHLB advances and other borrowings increased $42.6 million to $124.1 million as of March 31, 2025, compared to $81.5 million as of December 31, 2024, and increased $15.1 million compared to $109.0 million as of March 31, 2024. Capital – The Company maintains its “well capitalized” regulatory capital position. At March 31, 2025, capital ratios were as follows: total risk-based capital to risk-weighted assets 14.94%; tier 1 capital to risk-weighted assets 13.69%; tier 1 leverage 11.64%; and common equity to assets 8.15%. Average Balance Sheet Data Net interest income is the largest source of revenue resulting from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected both by changes in the level of interest rates and changes in the amounts and mix of interest-earning assets and interest-bearing liabilities. The following table presents average balance sheet data, net interest income, average yields of earning assets, average costs of interest-bearing liabilities, net interest spread and net interest margin on a FTE basis for each of the three month periods ended March 31, 2025 and 2024, respectively. The average balances used in this table and other statistical data were calculated using average daily balances. 39 Three Months Ended March 31, 2025 2024 (dollars in thousands) Average Balance Interest Income/ Expense (1) Rate Earned/ Paid (1) Average Balance Interest Income/ Expense (1) Rate Earned/ Paid (1) ASSETS Loans: (2) Commercial $ 200,696 $ 3,171 6.41% $ 220,122 $ 3,604 6.59% Real estate construction - residential 33,504 620 7.50 57,945 1,124 7.80 Real estate construction - commercial 82,176 1,570 7.75 96,485 1,468 6.12 Real estate mortgage - residential 363,327 5,175 5.78 372,081 5,244 5.67 Real estate mortgage - commercial 772,402 10,520 5.52 758,104 10,065 5.34 Installment and other consumer 13,204 208 6.39 19,907 289 5.84 Total loans $ 1,465,309 $ 21,264 5.89% $ 1,524,644 $ 21,794 5.75% Loans held for sale 82 2 9.89 2,141 31 5.82 Investment securities: U.S. Treasury 4,944 53 4.35 1,479 19 5.17 U.S. government and federal agency obligations 13,211 140 4.30 18,711 220 4.73 Obligations of states and political subdivisions 101,882 784 3.12 105,623 753 2.87 Mortgage-backed securities 80,069 782 3.96 46,755 309 2.66 Other debt securities 22,203 303 5.53 11,948 176 5.92 Total investment securities $ 222,309 $ 2,062 3.76% $ 184,516 $ 1,477 3.22% Other investment securities 4,820 120 10.10 6,430 137 8.57 Interest bearing deposits in other financial institutions 23,198 249 4.35 56,588 812 5.77 Total interest earning assets $ 1,715,718 $ 23,697 5.60% $ 1,774,319 $ 24,251 5.50% All other assets 121,339 93,227 Allowance for credit losses (22,224) (23,851) Total assets $ 1,814,833 $ 1,843,695 LIABILITIES AND STOCKHOLDERS' EQUITY Savings $ 271,983 $ 1,278 1.91% $ 228,711 $ 1,025 1.80% NOW accounts 203,921 757 1.51 207,030 756 1.47 Interest checking 146,283 1,378 3.82 144,370 1,625 4.53 Money market 208,135 936 1.82 234,188 1,224 2.10 Time deposits 300,383 2,464 3.33 336,033 2,835 3.39 Total interest bearing deposits $ 1,130,705 $ 6,813 2.44% $ 1,150,332 $ 7,465 2.61% Federal funds purchased and securities sold under agreements to repurchase 29 — — — — — Federal Home Loan Bank advances and other borrowings 75,521 499 2.68 111,088 849 3.07 Subordinated notes 49,486 852 6.98 49,486 990 8.05 Total borrowings $ 125,036 $ 1,351 4.38% $ 160,574 $ 1,839 4.61% Total interest bearing liabilities $ 1,255,741 $ 8,164 2.64% $ 1,310,906 $ 9,304 2.85% Demand deposits 393,469 384,572 Other liabilities 12,895 11,582 Total liabilities $ 1,662,105 $ 1,707,060 Stockholders' equity 152,728 136,635 Total liabilities and stockholders' equity $ 1,814,833 $ 1,843,695 Net interest income (FTE) $ 15,533 $ 14,947 Net interest spread (FTE) 2.96% 2.64% Net interest margin (FTE) 3.67% 3.39% (1) Interest income and yields are presented on a FTE basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for both the three months ended March 31, 2025 and 2024. Such adjustments totaled $0.24 million and $0.20 million for the three months ended March 31, 2025 and 2024, respectively. (2) Non-accruing loans are included in the average amounts outstanding. 40 Rate and Volume Analysis The following table summarizes the changes in net interest income on a FTE basis, by major category of interest earning assets and interest-bearing liabilities, identifying changes related to volumes and rates for the three months ended March 31, 2025 compared to the three months ending ended March 31, 2024, respectively. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each. Three Months Ended March 31, 2025 vs. 2024 Change due to (dollars in thousands) Total Change Average Volume Average Rate Interest income on a fully taxable equivalent basis: (1) Loans: (2) Commercial $ (433) $ (311) $ (122) Real estate construction - residential (504) (455) (49) Real estate construction - commercial 102 (239) 341 Real estate mortgage - residential (69) (125) 56 Real estate mortgage - commercial 455 192 263 Installment and other consumer (81) (104) 23 Loans held for sale (29) (42) 13 Investment securities: U.S. Treasury 34 38 (4) U.S. government and federal agency obligations (80) (61) (19) Obligations of states and political subdivisions 31 (28) 59 Mortgage-backed securities 473 284 189 Other debt securities 127 141 (14) Other investment securities (17) (38) 21 Interest bearing deposits in other financial institutions (563) (395) (168) Total interest income $ (554) $ (1,143) $ 589 Interest expense: Savings $ 253 $ 201 $ 52 NOW accounts 1 (11) 12 Interest checking (247) 22 (269) Money market (288) (129) (159) Time deposits (371) (296) (75) FHLB advances and other borrowings (350) (247) (103) Subordinated notes (138) — (138) Total interest expense $ (1,140) $ (460) $ (680) Net interest income on a FTE basis $ 586 $ (683) $ 1,269 (1) Interest income and yields are presented on a FTE basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three months ended March 31, 2025 and 2024, respectively. Such adjustments totaled $0.24 million for the three months ended March 31, 2025 compared to $0.20 million for the three months ended March 31, 2024. (2) Non-accruing loans are included in the average amounts outstanding. 41 Financial results for the three months ended March 31, 2025 compared to the three months ended March 31, 2024 reflected an increase in net interest income on a FTE basis, of $0.6 million, or 3.9%. Measured as a percentage of average earning assets, the net interest margin (expressed on a FTE basis) increased to 3.67% for the three months ended March 31, 2025 compared to 3.39% for the three months ended March 31, 2024. Average interest-earning assets decreased $58.6 million, or 3.3%, to $1.72 billion for the quarter ended March 31, 2025 compared to $1.77 billion for the quarter ended March 31, 2024, and average interest-bearing liabilities decreased $55.2 million, or 4.2%, to $1.26 billion for the quarter ended March 31, 2025 compared to $1.31 billion for the quarter ended March 31, 2024. Total interest income (expressed on a FTE basis) was $23.7 million for the three months ended March 31, 2025 compared to $24.3 million for the three months ended March 31, 2024. The Company’s rates earned on interest earning assets were 5.60% for the three months ended March 31, 2025 compared to 5.50% for the three months ended March 31, 2024. Interest income on loans held for investment was $21.3 million for the three months ended March 31, 2025 compared to $21.8 million for the three months ended March 31, 2024. Average loans outstanding decreased $59.3 million, or 3.9%, to $1.47 billion for the quarter ended March 31, 2025 compared to $1.52 billion for the quarter ended March 31, 2024. The average yield on loans increased to 5.89% for the quarter ended March 31, 2025 compared to 5.75% for the quarter ended March 31, 2024. See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio. Interest income on available-for-sale securities was $2.1 million for the three months ended March 31, 2025 compared to $1.5 million for the three months ended March 31, 2024. Average securities increased $37.8 million, or 20.5%, to $222.3 million for the quarter ended March 31, 2025 compared to $184.5 million for the quarter ended March 31, 2024. The average yield on securities increased to 3.76% for the quarter ended March 31, 2025 compared to 3.22% for the quarter ended March 31, 2024. See the Liquidity Management section for further discussion. Total interest expense was $8.2 million for the three months ended March 31, 2025 compared to $9.3 million for the three months ended March 31, 2024. The Company’s rates paid on interest bearing liabilities were 2.64% for the three months ended March 31, 2025 compared to 2.85% for the three months ended March 31, 2024. See the Liquidity Management section for further discussion. Interest expense on deposits was $6.8 million for the three months ended March 31, 2025 compared to $7.5 million for the three months ended March 31, 2024. Average interest-bearing deposits decreased $19.6 million, or 1.7%, to $1.13 billion for the quarter ended March 31, 2025 compared to $1.15 billion for the quarter ended March 31, 2024. The average cost of deposits decreased to 2.44% for the quarter ended March 31, 2025 compared to 2.61% for the quarter ended March 31, 2024. Interest expense on borrowings was $1.4 million for the three months ended March 31, 2025 compared to $1.8 million for the three months ended March 31, 2024. Average borrowings decreased $35.5 million, or 22.1%, to $125.0 million for the quarter ended March 31, 2025 compared to $160.6 million for the quarter ended March 31, 2024. The average cost of borrowings decreased to 4.38% for the quarter ended March 31, 2025 compared to 4.61% for the quarter ended March 31, 2024. 42 Non-interest Income The following table shows the principal components of non-interest income. Three Months Ended March 31, (dollars in thousands) 2025 2024 $ Change % Change Service charges and other fees $ 914 $ 817 $ 97 11.9 % Bank card income and fees 925 973 (48) (4.9) % Earnings on bank-owned life insurance 509 136 373 274.3% Wealth management revenue 473 380 93 24.5 % Gain on sales of mortgage loans, net 126 277 (151) (54.5) % Gains on other real estate owned, net 21 34 (13) (38.2) % Other 495 402 93 23.1 % Total non-interest income $ 3,463 $ 3,019 $ 444 14.7 % Non-interest income as a % of total revenue * 18.5 % 17.0 % * Total revenue is calculated as net interest income plus non-interest income. Total non-interest income increased $0.4 million, or 14.7%, to $3.5 million for the three months ended March 31, 2025 compared to $3.0 million for the three months ended March 31, 2024. The increase was primarily due to earnings on bank-owned life insurance, offset by a decrease on gains on sales of mortgage loans during the current quarter. Earnings on bank-owned life insurance increased to $0.5 million for the three months ended March 31, 2025 compared to $0.1 million for the three months ended March 31, 2024. The Company purchased $35.0 million in bank-owned life insurance policies in the first quarter of 2024. The earnings generated from these polices are primarily derived from the investment returns on the cash value component. Gain on sales of mortgage loans decreased to $0.1 million for the three months ended March 31, 2025 compared to $0.3 million for the three months ended March 31, 2024. The Company sold mortgage loans totaling $1.2 million for the three months ended March 31, 2025 compared to $15.1 million for the three months ended March 31, 2024. Non-interest Expense The following table shows the principal components of non-interest expense. Three Months Ended March 31, (dollars in thousands) 2025 2024 $ Change % Change Salaries $ 5,366 $ 5,249 $ 117 2.2% Employee benefits 1,546 1,481 65 4.4 Occupancy expense, net 935 813 122 15.0 Furniture and equipment expense 793 756 37 4.9 Processing, network and bank card expense 1,401 1,370 31 2.3 Legal, examination, and professional fees 493 823 (330) (40.1) Advertising and promotion 160 263 (103) (39.2) Postage, printing, and supplies 294 167 127 76.0 Other 1,511 1,653 (142) (8.6) Total non-interest expense $ 12,499 $ 12,575 $ (76) (0.6)% Efficiency ratio* 66.6 % 70.8 % Number of full-time equivalent employees 264 276 * Efficiency ratio is calculated as non-interest expense as a percent of revenue. Total revenue is calculated as net interest income plus non-interest income. 43 Total non-interest expense decreased $0.1 million, or 0.6%, to $12.5 million for the three months ended March 31, 2025 compared to $12.6 million for the three months ended March 31, 2024. Occupancy expense increased $0.1 million, or 15.0%, to $0.9 million for the three months ended March 31, 2025 compared to $0.8 million for the three months ended March 31, 2024. The increase primarily resulted from the opening of two new branch locations and one new operations facility. Legal, examination and professional fees decreased $0.3 million, or 40.1%, to $0.5 million for the three months ended March 31, 2025 compared to $0.8 million for the three months ended March 31, 2024. The decrease was primarily due to the costs from a settlement agreement from terminating a contract related to a digital account opening project in the prior year quarter. Advertising and promotion decreased $0.1 million, or 39.2%, to $0.2 million for the three months ended March 31, 2025 compared to $0.3 million for the three months ended March 31, 2024. The Company is utilizing internal marketing resources whereas, in the prior year quarter, external resources were used. Postage, printing and supplies increased $0.1 million, or 76.0%, to $0.3 million for the three months ended March 31, 2025 compared to $0.2 million for the three months ended March 31, 2024. The increase was primarily a result of customer mailings related to an account consolidation project. Income Taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements was 18.4% for the three months ended March 31, 2025 compared to 17.8% for the three months ended March 31, 2024. The effective tax rate for each of the three months ended March 31, 2025 and 2024 was lower than the U.S. federal statutory rate of 21% primarily due to tax-free revenues. Lending and Credit Management Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 76.9% of total assets as of March 31, 2025 compared to 79.1% as of December 31, 2024. Lending activities are conducted pursuant to an established loan policy approved by the Bank's Board of Directors. The Bank's credit review process is overseen by regional loan committees with established loan approval limits. In addition, the executive loan committee reviews all credit relationships in aggregate over an established dollar amount. The executive loan committee meets weekly and is comprised of senior managers of the Bank. Major classifications within the Company’s held-for-investment loan portfolio as of the dates indicated is as follows: March 31, 2025 December 31, 2024 (dollars in thousands) Amount % of Loans Amount % of Loans Commercial, financial, and agricultural $ 202,405 13.7 % $ 202,329 13.8 % Real estate construction − residential 30,670 2.1 32,046 2.2 Real estate construction − commercial 75,053 5.1 80,435 4.5 Real estate mortgage − residential 376,026 25.5 361,735 25.2 Real estate mortgage − commercial 773,622 52.6 775,594 53.3 Installment and other consumer 12,547 1.0 14,021 1.0 Total loans held for investment $ 1,470,323 100.0 % $ 1,466,160 100.0 % Commercial Real Estate Loans Commercial real estate loans ("CRE") consist primarily of income-producing investment property loans. Additionally, CRE loans include 1-4 family property loans as well as land and development loans. 44 The following table shows the categories of the Company's non-owner occupied CRE loan portfolio at March 31, 2025 and December 31, 2024: March 31, 2025 December 31, 2024 (Dollars in thousands) Amount % of Loans Amount % of Loans Retail $ 183,030 28.9 % $ 190,915 30.0 % Multi Family 170,429 27.0 168,629 26.5 Hotel & Food Service 70,217 11.1 70,816 11.2 Office Buildings 54,263 8.6 47,042 7.4 Other Construction 46,057 7.3 39,696 6.3 1-4 Family Construction 30,670 4.8 32,045 5.0 Other Real Estate 26,581 4.2 27,053 4.3 Industrial 22,043 3.5 18,446 2.9 Land Subdivision 10,068 1.6 10,844 1.7 Commercial and Institutional Building Construction 9,538 1.5 9,481 1.5 Residential Building Construction 9,390 1.5 20,413 3.2 Total Commercial Real Estate - Non Owner Occupied $ 632,286 98.5 % $ 635,380 96.8 % The Company extends credit to its local community markets through traditional real estate mortgage products. The Company does not participate in credit extension to sub-prime residential real estate markets. The Company does not lend funds for transactions defined as “highly leveraged” by bank regulatory authorities or for foreign loans. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. Risk Elements of the Loan Portfolio Management, internal loan review and the executive loan committee formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Loans in excess of $2.0 million in the aggregate and all adversely classified credits identified by management are reviewed by the executive loan committee. In addition, all other loans are reviewed on a risk weighted selection process. The executive loan committee reviews and reports to the Board of Directors, at scheduled meetings: past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, special mention, substandard, doubtful, or loss. During this review, management will evaluate individual loans for expected credit losses when those loans do not share similar risk characteristics with loans evaluated using a collective (pooled) basis. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is individually analyzed and in conjunction with current economic conditions and loss experience, reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and collectively analyzed. Management determined that segmenting loans not individually analyzed by the federal call report codes represents the most prudent way to consolidate loans by their associated risk qualities. General reserves are recorded for collectively analyzed loans using a consistent methodology. Two different models are used for calculating the general reserve. The Discounted Cash Flow model considers quantitative peer group historic loss experience, forecasts over the estimated life of the loan pools, industry data, and qualitative or environmental factors, such as: lending policies and procedures; economic conditions; the nature, volume and terms of the portfolio; lending staff and management; past due loans; the loan review system; collateral values; concentrations of credit; and external factors. The Remaining Life model applies a long-term average loss rate calculated using peer data that is adjusted for qualitative or environmental factors such as those previously noted. The model used depends on the loan portfolio segment. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. At March 31, 2025 and December 31, 2024, the ACL on loans included a qualitative adjustment of approximately $10.9 million and $11.2 million, respectively. 45 Non-Performing Assets The following table summarizes non-performing assets at the dates indicated: March 31, December 31, (dollars in thousands) 2025 2024 Non-accrual loans: Commercial, financial, and agricultural $ 923 $ 923 Real estate construction − residential 454 454 Real estate construction − commercial 44 49 Real estate mortgage − residential 859 963 Real estate mortgage − commercial 136 138 Installment and other consumer 28 10 Total $ 2,444 $ 2,537 Loans contractually past - due 90 days or more and still accruing: Real estate mortgage − residential $ — $ 207 Installment and other consumer 17 3 Total $ 17 $ 210 Total non-performing loans (a) 2,461 2,747 Other real estate owned and repossessed assets 668 1,446 Total non-performing assets (b) $ 3,129 $ 4,193 Loans held for investment $ 1,470,323 $ 1,466,160 Allowance for credit losses on loans $ 21,780 $ 22,044 Allowance for credit losses to loans 1.48 % 1.50 % Non-accrual loans to total loans 0.17 % 0.17 % Non-performing loans to loans (a) 0.17 % 0.19 % Non-performing assets to loans (b) 0.21 % 0.29 % Non-performing assets to assets (b) 0.17 % 0.23 % Allowance for credit losses to non-accrual loans 891.16 % 868.90 % Allowance for credit losses to non-performing loans 885.01 % 802.48 % (a) Non-performing loans include loans 90 days past due and accruing and non-accrual loans. (b) Non-performing assets include non-performing loans and other real estate owned and repossessed assets. Total non-performing assets were $3.1 million, or 0.21% of total loans, at March 31, 2025 compared to $4.2 million, or 0.29% of total loans, at December 31, 2024. Total non-accrual loans at March 31, 2025 decreased $0.1 million, or 3.7%, to $2.4 million compared to $2.5 million at December 31, 2024. There were $0.02 million in loans past due 90 days and still accruing interest at March 31, 2025 compared to $0.21 million at December 31, 2024. Other real estate and repossessed assets were $0.7 million and $1.4 million at March 31, 2025 and December 31, 2024, respectively. There were no non-accrual loans added to other real estate owned and repossessed assets during the three months ended March 31, 2025 and 2024. 46 Provision and Allowance for Credit Losses on Loans and Liability for Unfunded Commitments Allowance for Credit Losses The following table is a summary of the allocation of the allowance for credit losses: March 31, 2025 December 31, 2024 (dollars in thousands) Amount % of loans in each category to total loans Amount % of loans in each category to total loans Allocation of allowance for credit losses at end of period: Commercial, financial, and agricultural $ 1,447 13.7 % $ 1,560 13.8 % Real estate construction − residential 583 2.1 578 2.2 Real estate construction − commercial 1,667 5.1 2,221 4.5 Real estate mortgage − residential 5,134 25.5 5,310 25.2 Real estate mortgage − commercial 12,608 52.6 12,305 53.3 Installment and other consumer 117 1.0 138 1.0 Unallocated 224 — (68) — Total $ 21,780 100.0 % $ 22,044 100.0 % The allowance for credit losses was $21.8 million, or 1.48%, of loans outstanding at March 31, 2025 compared to $22.0 million, or 1.50%, of loans outstanding at December 31, 2024. The ratio of the allowance for credit losses to non-performing loans was 885.01% at March 31, 2025, compared to 802.48% at December 31, 2024. Release of Provision for Credit Losses Three Months Ended March 31, (dollars in thousands) 2025 2024 Release of provision for credit losses on loans $ (282) $ — Release of provision credit losses for off-balance sheet commitments (58) (230) Total release of provision for credit losses $ (340) $ (230) The Company recognized a release of provision for credit losses of $0.3 million for the three months ended March 31, 2025 compared to a $0.2 million release of provision for credit losses for the three months ended March 31, 2024. 47 The following table summarizes credit loss experience for the periods indicated: Three Months Ended March 31, 2025 2024 (dollars in thousands) (Net Charge-offs) Recoveries Average Loans Net (Charge-offs) Recoveries / Average Loans (Net Charge-offs) Recoveries Average Loans Net (Charge-offs) Recoveries / Average Loans Commercial, financial, and agricultural $ 54 $ 200,696 0.03 % $ (20) $ 220,122 (0.01) % Real estate construction − residential — 33,504 — — 57,945 — Real estate construction − commercial — 82,176 — — 96,485 — Real estate mortgage − residential 2 363,327 — — 372,081 — Real estate mortgage − commercial 25 772,402 — (23) 758,104 — Installment and other consumer (63) 13,204 (0.48) (26) 19,907 (0.13) Total $ 18 $ 1,465,309 — % $ (69) $ 1,524,644 — % Net Loan Recoveries (Charge-Offs) The Company’s net recoveries were $0.02 million for the three months ended March 31, 2025 compared to $0.07 million net charge-offs for the three months ended March 31, 2024. Loans Held for Sale The Company designates certain long-term fixed rate personal real estate loans as held for sale. Loans held for sale are being carried at the lower of cost or estimated fair value. The loans are primarily sold to Freddie Mac, Fannie Mae, and PennyMac and various other secondary market investors. At March 31, 2025, the carrying amount of these loans was $0.2 million compared to no loans at December 31, 2024. The Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price. During the three months ended March 31, 2025, the Company sold approximately $1.2 million of loans to investors compared to $15.1 million for the three months ended March 31, 2024. Liquidity and Capital Resources Liquidity Management The role of liquidity management is to ensure that funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet these demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by the Company, management prefers to focus on transaction accounts and full-service relationships with customers as the primary sources of funding. The Company’s Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for the Company’s liquidity position and profile. A combination of daily, weekly, and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital, and exposure to contingent draws on the Company’s liquidity. 48 The Company has a number of sources of funds to meet liquidity needs on a daily basis. The Company’s most liquid assets are comprised of available-for-sale investment securities, not including other debt securities, federal funds sold, and excess reserves held at the Federal Reserve. (dollars in thousands) March 31, 2025 December 31, 2024 Other interest-bearing deposits $ 80,700 $ 27,326 Certificates of deposit in other banks 1,000 1,000 Available-for-sale investment securities 219,647 218,652 Total $ 301,347 $ 246,978 Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available-for-sale investment portfolio was $219.6 million at March 31, 2025 and included an unrealized net loss of $30.4 million. The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately $3.3 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s borrowings. The Company pledges portions of its investment securities portfolio to secure public fund deposits, federal funds purchase lines, securities sold under agreements to repurchase, borrowing capacity at the Federal Reserve Bank, and for other purposes as required or permitted by law. At March 31, 2025 and December 31, 2024, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $130.8 million and $136.3 million, respectively. Total investment securities pledged for these purposes were as follows: (dollars in thousands) March 31, 2025 December 31, 2024 Federal Reserve Bank borrowings $ 7,694 $ 7,915 Other deposits 81,143 74,470 Total pledged, at fair value $ 88,837 $ 82,385 Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, money market deposit accounts, and time deposits less than $250,000, less all brokered deposits under $250,000. At March 31, 2025, such deposits totaled $1.4 billion and represented 93.7% of the Company’s total deposits. These core deposits are normally less volatile and are often tied to other products of the Company through long lasting relationships. Core deposits at March 31, 2025 and December 31, 2024 were as follows: (dollars in thousands) March 31, 2025 December 31, 2024 Non-interest bearing demand $ 427,107 $ 385,022 Interest checking 331,652 381,877 Savings and money market 487,232 464,449 Other time deposits 200,377 201,438 Total $ 1,446,368 $ 1,432,786 Estimated uninsured deposits totaled $349.4 million, including $97.5 million of certificates of deposit, at March 31, 2025, compared to $352.0 million, including $100.4 million of certificates of deposit, at December 31, 2024. The Company's brokered deposits were consistent at $0.01 million at March 31, 2025 and December 31, 2024. Other components of liquidity are the level of borrowings from third-party sources and the availability of future credit. The Company’s outside borrowings are comprised of federal funds purchased, advances from the Federal Home Loan Bank (FHLB) and subordinated notes. Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines. As of March 31, 2025, under agreements with these unaffiliated banks, the Bank may borrow up to $35.0 million in federal funds on an unsecured basis and $7.2 million on a secured basis. There were no federal funds purchased outstanding at March 31, 2025. The Company may 49 periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window, although no such borrowings were outstanding at March 31, 2025. The Bank is a member of the FHLB and has access to credit products of the FHLB. As of March 31, 2025, the Bank had $124.0 million in outstanding borrowings with the FHLB. In addition, the Company has $49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts. Borrowings outstanding at March 31, 2025 and December 31, 2024 were as follows: (dollars in thousands) March 31, 2025 December 31, 2024 Federal Home Loan Bank advances $ 124,000 $ 81,425 Other borrowings 100 100 Subordinated notes 49,486 49,486 Total $ 173,586 $ 131,011 The Company pledges certain assets, including loans and investment securities to the Federal Reserve Bank, FHLB, and other correspondent banks as security to establish lines of credit and to borrow from these entities. Based on the type and value of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against this collateral. This collateral is also used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. The following table reflects collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company: March 31, 2025 December 31, 2024 (dollars in thousands) FHLB Federal Reserve Bank Federal Funds Purchased Lines Total FHLB Federal Reserve Bank Federal Funds Purchased Lines Total Advance equivalent $ 404,441 $ 7,186 $ 35,000 $ 446,627 $ 407,678 $ 7,468 $ 35,000 $ 450,146 Letters of credit (44,000) — — (44,000) (139,000) — — (139,000) Advances outstanding (124,000) — — (124,000) (81,425) — — (81,425) Total available $ 236,441 $ 7,186 $ 35,000 $ 278,627 $ 187,253 $ 7,468 $ 35,000 $ 229,721 At March 31, 2025, loans of $733.7 million were pledged to the FHLB as collateral for borrowings and letters of credit. At March 31, 2025, investments with a market value of $7.7 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank. Based upon the above, management believes the Company has more than adequate liquidity, both on balance sheet and through the additional funding capacity with the FHLB, the Federal Reserve Bank and Federal funds purchased lines to meet future anticipated liquidity needs in both the short and long-term. Sources and Uses of Funds Cash and cash equivalents were $102.3 million at March 31, 2025 compared to $51.0 million at December 31, 2024. The $51.3 million increase resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the three months ended March 31, 2025. Cash flow provided by operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided total cash of $5.7 million for the three months ended March 31, 2025. Investing activities, consisting mainly of purchases, sales and maturities of available-for-sale securities, and changes in the level of the loan portfolio, used total cash of $6.0 million during the three months ended March 31, 2025. The cash outflow primarily consisted of a $4.1 million net increase in loans held for investment and $6.7 million in purchases of securities, partially offset by $6.0 million proceeds from maturities and calls of available-for-sale securities. 50 Financing activities provided total cash of $51.5 million during the three months ended March 31, 2025, resulting primarily from a $42.1 million increase in demand deposits and a $42.6 million net increase in FHLB advances, partially offset by a $27.4 million decrease in interest-bearing transaction accounts and $3.9 million decrease in time deposits. In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Company had $368.7 million in unused loan commitments and standby letters of credit as of March 31, 2025. Although the Company’s current liquidity resources are adequate to fund this commitment level, the nature of these commitments is such that the likelihood of such a funding demand is very low. The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company’s ongoing liquidity needs primarily include funding its operating expenses, paying cash dividends to its shareholders and, to a lesser extent, repurchasing its shares of common stock. The Company paid cash dividends to its shareholders totaling approximately $1.3 million and $1.2 million during the three months ended March 31, 2025 and 2024, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank did not declare a dividend to the Company during the three months ended March 31, 2025 and declared a $5.0 million dividend to the Company during the three months ended March 31, 2024. At March 31, 2025 and December 31, 2024, the Company had cash and cash equivalents totaling $14.4 million and $15.3 million, respectively. Subject to declaration by the Company's Board of Directors, the Company expects to continue paying quarterly cash dividends as a part of its current capital allocation strategy. Future dividends will be subject to the determination, declaration and discretion of the Company's Board of Directors and compliance with applicable regulatory capital requirements. Capital Management The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. The Basel III regulatory capital reforms adopted by U.S. federal regulatory authorities (the "Basel III Capital Rules"), among other things, (i) establish the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specify that Tier 1 capital consists of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) require that most deductions/adjustments to regulatory capital measures be made to CET1 and not to other components of capital and (iv) define the scope of the deductions/adjustments to the capital measures. Additionally, the Basel III Capital Rules require that the Company maintain a 2.50% capital conservation buffer with respect to each of CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as of March 31, 2025, that the Company and the Bank meet all capital adequacy requirements to which they are subject. Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios. As shown in the table below, the Company’s capital ratios exceeded the regulatory definition of adequately capitalized as of March 31, 2025 and December 31, 2024. Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well-capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such change could reduce one or more capital ratios below well-capitalized status. In 51 addition, a change may result in imposition of additional assessments by the FDIC or could result in regulatory actions that could have a material effect on our condition and results of operations. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%. Because the Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, the Company is allowed to continue its trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital. Under the Basel III Capital Rules, at March 31, 2025 and December 31, 2024, the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table as the dates indicated: Actual Minimum Capital Required - Basel III Fully Phased-In Required to be Considered Well- Capitalized (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio March 31, 2025 Total Capital (to risk-weighted assets): Company $ 234,734 14.94 % $ 164,945 10.50 % $ — N.A% Bank 224,321 14.41 % 163,455 10.50 % 155,672 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 215,081 13.69 % $ 133,527 8.50 % $ — N.A% Bank 204,843 13.16 % 132,321 8.50 % 124,537 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 167,081 10.64 % $ 109,963 7.00 % $ — N.A% Bank 204,843 13.16 % 108,970 7.00 % 101,187 6.50 % Tier 1 leverage ratio (to adjusted average assets): Company $ 215,081 11.64 % $ 73,931 4.00 % $ — N.A% Bank 204,843 11.18 % 73,291 4.00 % 91,614 5.00 % December 31, 2024 Total Capital (to risk-weighted assets): Company $ 232,400 14.79 % $ 164,953 10.50 % $ — N.A% Bank 219,410 14.10 % 163,365 10.50 % 155,586 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 212,780 13.54 % $ 133,533 8.50 % $ — N.A% Bank 199,960 12.85 % 132,248 8.50 % 124,469 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 164,780 10.49 % $ 109,968 7.00 % $ — N.A% Bank 199,960 12.85 % 108,910 7.00 % 101,131 6.50 % Tier 1 leverage ratio: Company $ 212,780 11.46 % $ 74,261 4.00 % $ — N.A% Bank 199,960 10.83 % 73,847 4.00 % 92,309 5.00 % 52