HAWTHORN BANCSHARES, INC. - Quarter Report: 2010 March (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

Commission File Number: 0-23636

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

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

(Address of principal executive offices)                (Zip Code)

(816) 347-8100
(Registrant’s telephone number, including area code)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes      o No

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

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes      þ No

As of May 17, 2010 the registrant had 4,301,955 shares of common stock, par value $1.00 per share, outstanding.

Index to Exhibits located on page 39

 

 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets

		March 31,				December 31,
		2010				2009
ASSETS
Loans		$	974,187,039			$	991,614,007
Allowances for loan losses			(14,657,622	)			(14,796,549	)
Net loans			959,529,417				976,817,458
Investment in available - for - sale securities, at fair value			159,048,121				152,926,685
Federal funds sold and securities purchased under agreements to resell			225,016				89,752
Cash and due from banks			58,649,312				24,575,943
Premises and equipment - net			38,251,680				38,623,293
Other real estate owned and repossessed assets			11,368,113				8,490,914
Accrued interest receivable			6,015,006				6,625,557
Mortgage servicing rights			2,000,456				2,020,964
Intangible assets - net			1,353,467				1,503,986
Cash surrender value - life insurance			1,948,654				1,929,910
Other assets			22,021,603				22,866,092
Total assets		$	1,260,410,845			$	1,236,470,554
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Non - interest bearing demand		$	130,856,351			$	135,017,639
Savings, interest checking and money market			402,042,287				354,284,004
Time deposits $100,000 and over			133,904,306				137,860,435
Other time deposits			322,992,318				329,160,719
Total deposits			989,795,262				956,322,797
Federal funds purchased and securities sold under agreements to repurchase			32,107,860				36,645,434
Subordinated notes			49,486,000				49,486,000
Other borrowed money			74,128,083				79,317,302
Accrued interest payable			2,336,292				2,438,121
Other liabilities			5,006,326				4,489,617
Total liabilities			1,152,859,823				1,128,699,271
Stockholders’ equity:
Preferred stock, $1,000 par value Authorized and issued 30,255 shares			28,483,887				28,364,768
Common stock, $1 par value Authorized 15,000,000 shares; issued 4,463,813 shares			4,463,813				4,463,813
Surplus			26,999,926				26,970,745
Retained earnings			50,099,798				50,576,551
Accumulated other comprehensive income, net of tax			1,020,416				912,224
Treasury stock; 161,858 shares, at cost			(3,516,818	)			(3,516,818	)
Total stockholders’ equity			107,551,022				107,771,283
Total liabilities and stockholders’ equity		$	1,260,410,845			$	1,236,470,554

See accompanying notes to consolidated financial statements.

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)

		For the Three Months Ended
		March 31,
		2010				2009
INTEREST INCOME
Interest and fees on loans		$	13,418,476			$	14,444,026
Interest on debt securities:
Taxable			1,063,979				1,162,507
Nontaxable			326,202				393,616
Interest on federal funds sold and securities purchased under agreements to resell			36				150
Interest on interest - bearing deposits			13,631				14,392
Dividends on other securities			50,697				19,559
Total interest income			14,873,021				16,034,250
INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market			630,753				949,950
Time deposit accounts $100,000 and over			711,382				1,080,246
Other time deposit accounts			1,998,651				2,939,881
Interest on federal funds purchased and securities sold under agreements to repurchase			20,540				22,487
Interest on subordinated notes			524,300				662,046
Interest on other borrowed money			676,361				849,183
Total interest expense			4,561,987				6,503,793
Net interest income			10,311,034				9,530,457
Provision for loan losses			2,505,000				1,750,000
Net interest income after provision for loan losses			7,806,034				7,780,457
NON - INTEREST INCOME
Service charges on deposit accounts			1,296,088				1,377,799
Trust department income			178,862				201,647
Gain on sale of mortgage loans, net			224,573				1,020,971
Other			305,933				164,351
Total non - interest income			2,005,456				2,764,768
NON - INTEREST EXPENSE
Salaries and employee benefits			4,657,121				4,362,282
Occupancy expense, net			621,672				608,277
Furniture and equipment expense			492,039				563,658
FDIC insurance assessment			410,178				680,781
Legal, examination, and professional fees			247,290				360,870
Advertising and promotion			278,189				281,271
Postage, printing, and supplies			288,166				284,470
Processing expense			850,365				854,748
Other real estate expense			506,455				164,317
Other			779,271				834,058
Total non - interest expense			9,130,746				8,994,732
Income before income taxes			680,744				1,550,493
Less income taxes			186,976				493,862
Net income			493,768				1,056,631
Preferred stock dividends			369,783				373,985
Accretion of discount on preferred stock			119,119				119,119
Net income available to common shareholders		$	4,866			$	563,527
Basic earnings per share		$	0.00			$	0.13
Diluted earnings per share		$	0.00			$	0.13

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)

		Three months Ended March 31,
		2010				2009
Cash flows from operating activities:
Net income		$	493,768			$	1,056,631
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			2,505,000				1,750,000
Depreciation expense			506,615				525,900
Net amortization of debt securities, premiums, and discounts			160,499				84,597
Amortization of intangible assets			150,519				168,543
Stock based compensation expense			29,181				37,803
(Gain) loss on sales and dispositions of premises and equipment			(104	)			3,513
Other real estate owned impairment charges			62,690				815,574
Decrease (increase) in deferred tax asset, net			7,667				(55,965	)
Decrease in accrued interest receivable			610,551				480,220
Increase in cash surrender value - life insurance			(18,744	)			(8,156	)
Decrease in other assets			629,603				460,862
(Decrease) increase in accrued interest payable			(101,829	)			137,492
Increase in other liabilities			516,709				94,405
Origination of mortgage loans held for sale			(10,355,738	)			(51,495,000	)
Proceeds from the sale of mortgage loans held for sale			10,580,311				52,515,971
Gain on sale of mortgage loans, net			(224,573	)			(1,020,971	)
Other, net			11,991				158,846
Net cash provided by operating activities			5,564,116				5,710,265
Cash flows from investing activities:
Net decrease in loans			10,683,563				2,631,238
Purchase of available - for - sale debt securities			(108,812,450	)			(36,673,418	)
Proceeds from maturities of available - for - sale debt securities			81,462,422				31,174,201
Proceeds from calls of available - for - sale debt securities			21,225,800				8,190,000
Proceeds from sales of FHLB stock			230,900				—
Purchases of premises and equipment			(135,298	)			(166,876	)
Proceeds from sales of premises and equipment			400				36,990
Proceeds from sales of other real estate owned and repossessions			1,094,910				224,411
Net cash provided by investing activities			5,750,247				5,416,546
Cash flows from financing activities:
Net decrease in non - interest - bearing demand deposits			(4,161,288	)			(1,565,998	)
Net increase in savings, interest checking, and money market accounts			47,758,283				18,131,440
Net (decrease) increase in time deposits			(10,124,530	)			19,159,374
Net decrease in federal funds purchased and securities sold under agreements to repurchase			(4,537,574	)			(2,816,502	)
Repayment of other borrowed money			(5,189,219	)			(45,199,639	)
Cash dividends paid - preferred stock			(378,187	)			(235,317	)
Cash dividends paid - common stock			(473,215	)			(868,663	)
Net cash provided (used) by financing activities			22,894,270				(13,395,305	)
Net increase (decrease) in cash and cash equivalents			34,208,633				(2,268,494	)
Cash and cash equivalents, beginning of year			24,665,695				53,827,468
Cash and cash equivalents, end of period		$	58,874,328			$	51,558,974
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest		$	4,663,816			$	6,366,301
Income taxes		$	200,000			$	—
Supplemental schedule of noncash investing and financing activities:
Other real estate and repossessions acquired in settlement of loans		$	4,099,478			$	685,000

See accompanying notes to consolidated financial statements.

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements include all adjustments that, in the opinion of management, are necessary in order to make those statements not misleading. Management is required to make estimates and assumptions, including the determination of the allowance for loan losses, real estate acquired in connection with foreclosure or in satisfaction of loans, and fair values of investments 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. Operating results for the three-month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. Our Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial statements.

     These unaudited condensed consolidated interim financial statements should be read in conjunction with our Company’s audited consolidated financial statements included in its 2009 Annual Report to Shareholders under the caption Consolidated Financial Statements and incorporated by reference into its Annual Report on Form 10-K for the year ended December 31, 2009 as Exhibit 13.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed and omitted. These financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our Company’s consolidated financial position as of March 31, 2010 and the consolidated statements of operations and cash flows for the three-month periods ended March 31, 2010 and 2009.

     On July 1, 2009, our Company paid a special stock dividend of four percent to common shareholders of record at the close of business on June 15, 2009. For all periods presented, share information, including basic and diluted earnings per share, have been adjusted retroactively to reflect this change.

Loans and Allowance for Loan Losses

Major classifications in our Company’s loan portfolio at March 31, 2010 and December 31, 2009 are as follows:

		March 31,				December 31,
		2010				2009
Commercial, financial, and agricultural		$	145,576,990			$	151,399,300
Real estate construction — residential			39,142,763				38,840,664
Real estate construction — commercial			77,449,610				77,936,569
Real estate mortgage — residential			226,233,066				232,332,124
Real estate mortgage — commercial			450,070,277				453,975,271
Installment loans to individuals			35,547,090				36,966,018
Unamortized loan origination fees and costs, net			167,243				164,061
Total loans		$	974,187,039			$	991,614,007

     The Bank grants real estate, commercial, and installment loans to customers located within the communities surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri. 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 loans consist primarily of the financing of vehicles.

A summary of impaired loans as of March 31, 2010 and December 31, 2009 is as follows:

		March 31, 2010				December 31, 2009
Loans classified as impaired:
Non-accrual loans		$	54,420,542			$	34,153,731
Impaired loans continuing to accrue interest			15,810,178				39,713,014
Total impaired loans		$	70,230,720			$	73,866,745
Balance of impaired loans with reserves		$	27,537,263			$	26,294,560
Balance of impaired loans without reserves			42,693,457				47,572,185
Total impaired loans		$	70,230,720			$	73,866,745
Reserves for impaired loans		$	6,207,043			$	6,414,729
Average balance of impaired loans during the period			66,413,767				39,048,298
Balance of trouble debt restructured loans included in impaired loans			13,605,033				11,233,326

     The table above shows our Company’s investment in impaired loans at March 31, 2010 and December 31, 2009. These loans consist of loans on non-accrual status and other restructured loans whose terms have been modified and classified as troubled debt restructurings. Although our non-accrual loans significantly increased from $34,153,731 at December 31, 2009 to $54,420,542 at March 31, 2010, total impaired loans decreased $3,636,025. The increase in nonaccrual loans did not impact total impaired loans or reserves for impaired loans as these loans were previously classified as impaired loans continuing to accrue interest, and adequately reserved for at December of 2009. The balance of impaired loans without reserves is 61% of total impaired loans at March 31, 2010 and 64% at December 31, 2009. Management believes the excess value in the collateral was sufficient at March 31, and December 31, and these loans did not require additional reserves.

The following is a summary of the allowance for loan losses for the three months ended March 31, 2010:

		Three Months Ended March 31,
		2010				2009
Balance at beginning of period		$	14,796,549			$	12,666,546
Additions:
Provision for loan losses			2,505,000				1,750,000
Total additions			2,505,000				1,750,000
Deductions:
Loans charged off			2,806,275				1,381,358
Less recoveries on loans			(162,348	)			(124,237	)
Net loans charged off			2,643,927				1,257,121
Balance at end of period		$	14,657,622			$	13,159,425

Investment Securities

A summary of investment securities by major category, at fair value, consisted of the following at March 31, 2010 and December 31, 2009.

		March 31,				December 31,
		2010				2009
U.S. treasury		$	1,000,156			$	—
Government sponsored enterprises			40,254,563				44,380,798
Asset-backed securities			85,335,896				69,434,650
Obligations of states and political subdivisions			32,457,506				39,111,237
Total available for sale securities		$	159,048,121			$	152,926,685

     The asset backed securities include agency mortgage-backed securities, which are guaranteed by government sponsored agencies such as the FHLMC, FNMA and GNMA. Our Company does not have exposure to subprime originated mortgage-backed or collateralized debt obligation instruments.

     The amortized cost and fair value of securities classified as available-for-sale at March 31, 2010 and December 31, 2009 are as follows:

						Gross				Gross
		Amortized				unrealized				unrealized
		cost				gains				losses				Fair value
March 31, 2010
U.S. treasury		$	999,768			$	388			$	—			$	1,000,156
Government sponsored enterprises			40,085,881				243,519				74,837				40,254,563
Asset-backed securities			83,635,365				1,938,086				237,555				85,335,896
Obligations of states and political subdivisions			31,851,353				633,226				27,073				32,457,506
Total available for sale securities		$	156,572,367			$	2,815,219			$	339,465			$	159,048,121
December 31, 2009
Government sponsored enterprises		$	44,059,540			$	371,258			$	50,000			$	44,380,798
Asset-backed securities			68,092,852				1,585,774				243,976				69,434,650
Obligations of states and political subdivisions			38,456,246				708,196				53,205				39,111,237
Total available for sale securities		$	150,608,638			$	2,665,228			$	347,181			$	152,926,685

Restricted investments in equity securities, reported in other assets, in the amount of $6,522,650 and $6,753,550 as of March 31, 2010 and December 31, 2009, respectively, are recorded at cost, and consist primarily of Federal Home Loan Bank Stock and our Company’s interest in the statutory trusts.

     The amortized cost and fair value of debt securities classified as available-for-sale at March 31, 2010 and December 31, 2009, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.

		Amortized				Fair
		cost				value
Due in one year or less		$	9,564,388			$	9,657,095
Due after one year through five years			48,132,196				48,579,197
Due after five years through ten years			12,111,354				12,320,776
Due after ten years			3,129,064				3,155,157
			72,937,002				73,712,225
Asset-backed securities			83,635,365				85,335,896
Total available for sale investment securities		$	156,572,367			$	159,048,121

     Debt securities with carrying values aggregating approximately $149,464,414 and $132,322,000 at March 31, 2010 and December 31, 2009, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

     Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2010 and December 31, 2009, were as follows:

		Less than 12 months								12 months or more												Total
																		Number of
		Fair				Unrealized				Fair				Unrealized				Investment				Fair				Unrealized
		Value				Losses				Value				Losses				Positions				Value				Losses
At March 31, 2010
Government sponsored enterprises		$	17,465,754			$	(74,837	)		$	—			$	—				18			$	17,465,754			$	(74,837	)
Asset-backed securities			28,016,205				(237,555	)			—				—				28				28,016,205				(237,555	)
Obligations of states and political subdivisions			2,204,733				(18,932	)			231,859				(8,141	)			10				2,436,592				(27,073	)
		$	47,686,692			$	(331,324	)		$	231,859			$	(8,141	)			56			$	47,918,551			$	(339,465	)
		Less than 12 months								12 months or more												Total
																		Number of
		Fair				Unrealized				Fair				Unrealized				Investment				Fair				Unrealized
		Value				Losses				Value				Losses				Positions				Value				Losses
At December 31, 2009
Government sponsored enterprises		$	5,943,819			$	(50,000	)		$	—			$	—				6			$	5,943,819				(50,000	)
Asset-backed securities			14,600,160				(243,904	)			20,551				(72	)			15				14,620,711			$	(243,976	)
Obligations of states and political subdivisions			3,576,780				(53,205	)			—				—				14				3,576,780				(53,205	)
		$	24,120,759			$	(347,109	)		$	20,551			$	(72	)			35			$	24,141,310			$	(347,181	)

     Our Company’s available for sale portfolio consists of approximately 290 securities at March 31, 2010, of which 56 securities were temporarily impaired. Two of these securities have been in the loss position for 12 months or longer. Our Company believes the $339,000 in unrealized losses included in other comprehensive income at March 31, 2010 is attributable to changes in market interest rates and not the credit quality of the issuer and are not considered other-than-temporarily impaired. Our Company does not intend to sell these investments and it is not more likely than not that our Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity.

     The $72 unrealized losses included in other comprehensive income at December 31, 2009 on asset-backed securities were caused by interest rate increases. The contractual cash flows of these securities are guaranteed by various government or government sponsored enterprises. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality these investments are not considered other-than-temporarily impaired.

     During the three months ended March 31, 2010 and March 31, 2009, there were no proceeds from sales of securities and no components of investment securities gains and losses which have been recognized in earnings.

Intangible Assets

A summary of other intangible assets at March 31, 2010 and December 31, 2009 is as follows:

		March 31, 2010												December 31, 2009
		Gross												Gross
		Carrying				Accumulated				Net				Carrying				Accumulated				Net
		Amount				Amortization				Amount				Amount				Amortization				Amount
Amortizable intangible assets:
Core deposit intangible		$	7,060,224			$	(5,706,757	)		$	1,353,467			$	7,060,224			$	(5,556,238	)		$	1,503,986
Mortgage servicing rights			2,887,111				(886,655	)			2,000,456				2,945,019				(924,055	)			2,020,964
Total amortizable intangible assets		$	9,947,335			$	(6,593,412	)		$	3,353,923			$	10,005,243			$	(6,480,293	)		$	3,524,950

     Changes in the net carrying amount of other intangible assets for the three months ended March 31, 2010 are as follows:

		Core Deposit				Mortgage Servicing
		Intangible Asset				Rights
Balance at December 31, 2009		$	1,503,986			$	2,020,964
Additions			—				114,366
Amortization			(150,519	)			(134,874	)
Balance at March 31, 2010		$	1,353,467			$	2,000,456

     Mortgage servicing rights (MSRs) are amortized over the shorter of 7 years or the life of the loan. They are periodically reviewed for impairment and if impairment is indicated, recorded at fair value. At March 31, 2010 and December 31, 2009, no temporary impairment was recognized. The fair value of MSRs is based on the present value of expected cash flows, as further discussed in Fair Value of Financial Instruments. Mortgage loans serviced for others totaled approximately $271,284,000 and $269,475,000 at March 31, 2010 and December 31, 2009, respectively. Included in other noninterest income were real estate servicing fees for the three month ended March 31, 2010 and 2009 of $191,661 and $225,040, respectively.

     Our Company’s amortization expense on intangible assets in any given period may be different from the estimated amounts depending upon the acquisition of intangible assets, changes in mortgage interest rates, prepayment rates and other market conditions. The following table shows the estimated future amortization expense based on existing asset balances and the interest rate environment as of March 31, 2010 and for the next five years:

		Core Deposit				Mortgage
		Intangible Asset				Servicing Rights
2010		$	375,958			$	443,126
2011			434,763				439,000
2012			408,062				335,000
2013			134,684				256,000
2014			—				196,000
2015			—				151,000

     The aggregate amortization expense of intangible assets subject to amortization for the three month period ended March 31, 2010 is as follows:

		Three Months Ended
		March 31,
Aggregate amortization expense		2010				2009
Core deposit intangible asset		$	150,519			$	168,543
Mortgage servicing rights			134,874				318,626

Income Taxes

     At March 31, 2010 and December 31, 2009, our Company had $562,000 of gross unrecognized tax benefits that if recognized would affect the effective tax rate. Our Company believes that during 2010 it is reasonably possible that there would be a reduction of $222,000 in gross unrecognized tax benefits as a result of the lapse of statute of limitations for the 2006 tax year. At March 31, 2010, total interest accrued on unrecognized tax benefits was approximately $103,000. As of March 31, 2010, there were no federal or state income tax examinations in process.

     Our Company recognizes deferred tax assets only to the extent that they are expected to be used to reduce amounts that have been paid or will be paid to tax authorities. Management believes, based on all positive and negative evidence, that the deferred tax asset at March 31, 2010 is more likely-than-not-to be realized, and accordingly, no valuation allowance has been recorded. Future facts and circumstances may require a valuation allowance. Charges to establish a valuation allowance could have a material adverse effect on our results of operations and financial position.

Employee Benefit Plans

     Employee benefits charged to operating expenses are summarized for the three months ended March 31, 2010 in the table below.

		For the Three Months Ended
		March 31,
		2010				2009
Payroll taxes		$	321,967			$	329,300
Medical plans			404,852				370,545
401k match			80,012				77,730
Pension plan			216,299				228,999
Profit-sharing			72,470				67,175
Other			41,328				21,140
Total employee benefits		$	1,136,928			$	1,094,889

     Our Company provides a noncontributory defined benefit pension plan for all full-time employees. Pension expense for the periods indicated is as follows:

		Estimated				Actual
		2010				2009
Service cost — benefits earned during the year		$	844,178			$	850,940
Interest cost on projected benefit obligations			556,047				509,482
Expected return on plan assets			(613,659	)			(539,283	)
Amortization of prior service cost			78,628				78,628
Amortization of net gains			—				(9,075	)
Net periodic pension expense — Annual		$	865,194			$	890,692
Pension expense — three months ended March 31, (actual)		$	216,299			$	228,999

     Our Company made a $1,000,000 contribution to the defined benefit plan in 2009, and the minimum required contribution for 2010 is estimated to be $864,000. Our Company contributed $183,000 in April 2010.

Stock-Based Compensation

     Our Company’s stock option plan provides for the grant of options to purchase up to 468,000 shares of our Company’s common stock to officers and other key employees of our Company and its subsidiaries. All options have been granted at exercise prices equal to fair value and vest over periods ranging from four to five years, except 4,821 options issued in 2002, and 9,519 options issued in 2008 that vested immediately.

The following table summarizes our Company’s stock option activity:

														Weighted
						Weighted				Aggregate				Average
						Average				Intrinsic				Contractual
						Exercise				Value				Term
		Options				Price				(000)				(in years)
Outstanding at January 1, 2010			275,966			$	25.07
Granted			—				—
Exercised			—				—
Forfeited			—				—
Canceled			—				—
Outstanding at March 31, 2010			275,966			$	25.07			$	—				4.7
Exercisable at March 31, 2010			221,109			$	24.80			$	—				4.0

     Total stock-based compensation expense for the three months ended March 31, 2010 and 2009 was $29,000 and $38,000, respectively. As of March 31, 2010, the total unrecognized compensation expense related to non-vested stock awards was $214,000 and the related weighted average period over which it is expected to be recognized is approximately two years.

Comprehensive Income

Comprehensive income for the three months ended March 31, 2010 and 2009 is summarized as follows:

		Three Months Ended March 31,
		2010				2009
Net income		$	493,768			$	1,056,631
Other comprehensive income:
Unrealized gain (loss) on securities:
Unrealized gain (loss) on debt and equity securities available-for-sale, net of tax			96,201				(99,585	)
Defined benefit pension plan:
Amortization of prior service cost included in net periodic pension cost, net of tax			11,991				12,045
Total other comprehensive income (loss)			108,192				(87,540	)
Comprehensive income		$	601,960			$	969,091

Preferred Stock

     On December 19, 2008, our Company announced its participation in the U.S. Treasury Department’s Capital Purchase Program (CPP) a voluntary program that provides capital to financially healthy banks. This program was designed to attract broad participation by banking institutions to help stabilize the financial system by encouraging lending. Our Company has used the funds received, as discussed below, to continue to provide loans to its customers and to look for ways to deploy additional funds to benefit the communities in our Company’s market area.

     Participation in this program included our Company’s issuance of 30,255 shares of senior preferred stock (with a par value of $1,000 per share) and a ten year warrant to purchase approximately 255,260 shares of common stock (see below for additional information) to the U.S. Department of Treasury in exchange for $30,255,000. The proceeds received were allocated between the preferred stock and the common stock warrant based upon their

relative fair values. This resulted in the recording of a discount on the preferred stock upon issuance that reflects the value allocated to the warrant. The discount on the preferred stock will be accreted over five years, consistent with management’s estimate of the life of the preferred stock. Such accretion will be treated as additional dividends on the preferred stock. The allocated carrying values of the senior preferred stock and common stock warrants at March 31, 2010 were $28,484,000 and $2,382,000, respectively.

          The preferred shares carry a 5% cumulative dividend for the first five years and 9% thereafter if not redeemed. The preferred shares are redeemable after three years at par plus accrued dividends, or before three years if our Company raises Tier 1 capital in an amount equal to the preferred stock issued. The preferred stock generally does not have any voting rights, subject to an exception in the event our Company fails to pay dividends on the preferred stock for six or more quarterly periods, whether or not consecutive. Under such circumstances, the Treasury will be entitled to vote to elect two directors to the board until all unpaid dividends have been paid or declared and set apart for payment. Our Company is prohibited from paying any dividends with respect to shares of common stock unless all accrued and unpaid dividends are paid in full on the senior preferred stock for all past dividend periods. The Treasury Department may also transfer the senior preferred stock to a third party at any time.

          The common stock warrant is exercisable immediately with a ten year term, in whole or in part, at an exercise price of $17.78 per share. The preferred stock and warrant are classified as stockholders’ equity in the consolidated balance sheets and qualify, for regulatory capital purposes, as Tier I capital. Through the three months ended March 31, 2010, our Company had declared and paid dividends in the amount of $378,000 on the preferred stock.

Earnings per Share

     Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the three month period ending March 31, 2010. Diluted earnings per share gives effect to all dilutive potential common shares that were outstanding during the three month period ending March 31, 2010.

          The weighted average common and diluted shares outstanding and earnings per share amounts have been adjusted to give effect to the 4% stock dividend on July 1, 2009. The calculations of basic and diluted earnings per share are as follows:

		For the Three Months Ended
		March 31,
		2010				2009
Net income, basic and diluted		$	493,768			$	1,056,631
Less:
Preferred stock dividends			369,783				373,985
Accretion of discount on preferred stock			119,119				119,119
Net income available to common shareholders			4,866				563,527
Average shares outstanding			4,301,955				4,301,955
Average shares outstanding including dilutive stock options		$	4,301,955			$	4,301,955
Net income per share, basic		$	0.00			$	0.13
Net income per share, diluted			0.00				0.13

          Under the treasury stock method, outstanding stock options are dilutive when the average market price of our Company’s common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during the period, except when our Company has a loss from continuing operations available to common shareholders. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period.

          The following options and warrant to purchase shares during the three month-periods ended 2010 and 2009 were not included in the respective computations of diluted earnings per share because the exercise price, when combined with the effect of the unamortized compensation expense, was greater than the average market price of the common shares and were considered anti-dilutive.

		Three months ended March 31,
		2010				2009
Anti-dilutive shares — option shares			275,966				275,966
Anti-dilutive shares — warrant shares			255,260				255,260

Fair Value Measurements

          Our Company uses fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities. The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. The standard applies whenever other standards require (permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, FASB clarified the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. As of March 31, 2010 there were no transfers into or out of Level 2.

The fair value hierarchy is as follows:

Level 1 – Inputs are unadjusted quoted prices for identical assets or liabilities in active markets.

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 our Company’s best information and assumptions that a market participant would consider.

ASC Topic 820 also provides guidance on determining fair value when the volume and level of activity for the asset or liability has significantly decreased and on identifying circumstances when a transaction may not be considered orderly.

Our Company is required to disclose assets and liabilities measured at fair value on a recurring basis separate from those measured at fair value on a nonrecurring basis. Nonfinancial assets measured at fair value on a nonrecurring basis would include foreclosed real estate, long-lived assets, and core deposit intangible assets, which are reviewed when circumstances or other events indicate that impairment may have occurred.

          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:

Valuation methods for instruments measured at fair value on a recurring basis

          Following is a description of our Company’s valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

Available-for-sale securities

     Available-for-sale securities are recorded at fair value on a recurring basis. Available-for-sale securities is the only balance sheet category our Company is required, in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), to carry at fair value on a recurring basis. Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, our Company obtains fair value measurements from an independent pricing service. The fair value measurements consider 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.

						Fair Value Measurements
						At March 31, 2010 Using
						Quoted Prices
						in Active
						Markets for				Other				Significant
						Identical				Observable				Unobservable
		Fair Value				Assets				Inputs				Inputs
Description		March 31, 2010				(Level 1)				(Level 2)				(Level 3)
U.S. treasury		$	1,000,156			$	—			$	1,000,156			$	—
Government sponsored enterprises			40,254,563				—				40,254,563				—
Asset-backed securities			85,335,896				—				85,335,896				—
Obligations of states and political subdivisions			32,457,506				—				32,457,506				—
Total		$	159,048,121			$	—			$	159,048,121			$	—

Valuation methods for instruments measured at fair value on a nonrecurring basis

          Following is a description of our Company’s valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

Impaired Loans

     Our Company does not record loans at fair value on a recurring basis other than loans that are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the FASB ASC Topic 310, Accounting by Creditors for Impairment of a Loan. Impaired loans for which an allowance is established are generally based on market prices for similar assets determined through independent appraisals, the fair value of the collateral for a collateral-dependent loan, or in the case of trouble debt restructured loans, impairment is measured by discounting the total expected future cash flows. Because many of these inputs are not observable, the measurements are classified as Level 3. As of March 31, 2010, our Company identified $27.5 million in impaired loans that had specific allowances for losses aggregating $6.2 million. Related to these loans, there was $2.6 million in charge-offs recorded during 2010.

Other Real Estate Owned and Repossessed Assets

          Other real estate owned and repossessed assets consist of loan collateral which has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Other real estate owned assets are recorded as held for sale initially at the lower of the cost basis or fair value of the collateral less estimated selling costs. Our Company relies on external appraisals and assessment of property values by our internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgment based on experience and expertise of internal specialists. Subsequent to foreclosure, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3.

						Fair Value Measurements
						At March 31, 2010 Using
						Quoted Prices
						in Active												Three Months
						Markets for				Other				Significant				Ended
						Identical				Observable				Unobservable				March 31, 2010
		Fair Value				Assets				Inputs				Inputs				Total Gains
Description		March 31, 2010				(Level 1)				(Level 2)				(Level 3)				(Losses)
Impaired loans:
Commercial		$	1,147,532			$	—			$	—			$	1,147,532			$	(487,937	)
Construction — residential			1,013,480				—				—				1,013,480				(321,170	)
Construction — commercial			3,888,327				—				—				3,888,327				(64,000	)
Real estate — residential			5,628,926				—				—				5,628,926				(1,740,827	)
Real estate — commercial			9,651,955				—				—				9,651,955				(17,083	)
Total		$	21,330,220			$	—			$	—				21,330,220			$	(2,631,017	)
Other real estate owned and repossessed assets		$	11,368,113			$	—			$	—			$	11,368,113			$	(468,942	)

For both recurring and nonrecurring fair value measurements, there were no transfers between the various levels for the three months ending March 31, 2010.

Fair Value of Financial Instruments

          The carrying amounts and estimated fair values of financial instruments help by our Company, in addition to a discussion of the methods used and assumptions made in computing those estimates, are set forth below.

Loans

          The fair value of loans is estimated based on present values using applicable risk-adjusted spreads to the U. S. Treasury curve to approximate current interest rates applicable to each category of such financial instruments. The fair values of impaired loans are generally based on market prices for similar assets determined through independent appraisals or discounted values of independent appraisals and brokers’ opinions of value. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.

Investment Securities

          A detailed description of the fair value measurement of the debt instruments in the available for sale sections of the investment security portfolio is proved in the Fair Value Measurement section above. A schedule of investment securities by category and maturity is provided in the notes on Investment Securities.

Federal Funds Sold, Cash, and Due from Banks

          For federal funds sold, cash, and due from banks, the carrying amount is a reasonable estimate of fair value, as such instruments reprice in a short time period.

Mortgage Servicing Rights

          The fair value of mortgage servicing rights is calculated by pooling loans into buckets of homogeneous characteristics and performing a present value analysis of future cash flows utilizing the current market rate. The buckets are created based on individual loans characteristics such as loan age, note rate, product type, and the investor remittance schedule. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.

Accrued Interest Receivable and Payable

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

Deposits

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

Securities Sold under Agreements to Repurchase and Interest-bearing Demand Notes to U.S. Treasury

          For securities sold under agreements to repurchase and interest-bearing demand notes to U.S. Treasury, the carrying amount is a reasonable estimate of fair value, as such instruments reprice in a short time period.

Other Borrowings

          The fair value of other borrowings, which include subordinated notes and Federal Home Loan 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.

          A summary of the carrying amounts and fair values of our Company’s financial instruments at March 31, 2010 and December 31, 2009 is as follows:

		March 31,								December 31,
		2010								2009
		Carrying				Fair				Carrying				Fair
		amount				value				amount				value
Assets:
Loans		$	959,529,417			$	967,188,000			$	976,817,458			$	984,305,000
Investment in debt securities			159,048,121				159,048,121				152,926,685				152,926,685
Federal fund sold and securities purchased under agreements to resell			225,016				225,016				89,752				89,752
Cash and due from banks			58,649,312				58,649,312				24,575,943				24,575,943
Mortgage servicing rights			2,000,456				2,883,000				2,020,964				2,904,000
Accrued interest receivable			6,015,006				6,015,006				6,625,557				6,625,557
		$	1,185,467,328			$	1,194,008,455			$	1,163,056,359			$	1,171,426,937
Liabilities:
Deposits:
Demand		$	130,856,351			$	130,856,351			$	135,017,639			$	135,017,639
NOW			180,512,089				180,512,089				139,623,577				139,623,577
Savings			51,904,576				51,904,576				47,637,148				47,637,148
Money market			169,625,622				169,625,622				167,023,279				167,023,279
Time			456,896,624				466,603,000				467,021,154				478,011,000
Federal funds purchased and securities sold under agreements to repurchase			32,107,860				32,107,860				36,645,434				36,645,434
Subordinated notes			49,486,000				20,930,000				49,486,000				18,329,000
Other borrowings			74,128,083				74,974,000				79,317,302				80,557,000
Accrued interest payable			2,336,292				2,336,292				2,438,121				2,438,121
		$	1,147,853,497			$	1,129,849,790			$	1,124,209,654			$	1,105,282,198

Item 2 - Management’s Discussion and Analysis of Financial Condition
And Results of Operations

Forward-Looking Statements

     This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of our Company and its subsidiaries, including, without limitation:

•

statements that are not historical in nature, and

•

statements preceded by, followed by or that include the words believes, expects, may, will, should, could, anticipates, estimates, intends or similar expressions.

          Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

•

competitive pressures among financial services companies may increase significantly,

•

changes in the interest rate environment may reduce interest margins,

•

general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,

•

increases in non-performing assets in our loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,

•

costs or difficulties related to the integration of the business of our Company and its acquisition targets may be greater than expected,

•

legislative or regulatory changes may adversely affect the business in which our Company and its subsidiaries are engaged, and

•

changes may occur in the securities markets.

          We have described under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, and in other reports that we file with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that we have not identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.

Overview

          Our Company, Hawthorn Bancshares, Inc., is a community-based, financial institution bank holding company headquartered in Lee’s Summit, Missouri. Our Company was incorporated under the laws of the State of Missouri on October 23, 1992 as Exchange National Bancshares, Inc. and changed its name to Hawthorn Bancshares, Inc. in August 2007. Our Company owns all of the issued and outstanding capital stock of Union State Bancshares, Inc., which in turn owns all of the issued and outstanding capital stock of Hawthorn Bank. Our Company conducts operations primarily through our Bank. Our Bank, a state charted bank, had $1.26 billion in assets at March 31, 2010, and 24 full-service banking offices, including its principal office in Jefferson City, Missouri. Our Bank is committed to providing the most up-to-date financial products and services and delivering these products and services to our market area with superior customer service.

          Through our branch network, our Bank provides a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts, and money market accounts. We also provide a wide range of lending services, including real estate, commercial, installment, and other consumer loans. Other financial services that we provide include automatic teller machines, trust services, credit related insurance, and safe deposit boxes. The geographic areas in which we provide our products and services include the communities in and surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri. The products and services are offered to customers primarily within these geographical areas.

          Our Company’s primary source of revenue is net interest income derived primarily from lending and deposit taking activities. A secondary source of revenue is investment income. Our Company also derives income from trust, brokerage, credit card and mortgage banking activities and service charge income.

Critical Accounting Policies

          The following accounting policies are considered most critical to the understanding of our Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such polices affect our reported and expected financial results.

Allowance for Loan Losses

          We have identified the accounting policy related to the allowance for loan losses as critical to the understanding of our Company’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. The impact and any associated risks related to these policies on our business operations are discussed in the “Lending and Credit Management” section below.

Income Taxes

          Income taxes are accounted for under the asset / liability method by recognizing the amount of taxes payable or refundable for the current period and deferred tax assets and liabilities for future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in addressing our Company’s future tax consequences of events that have been recognized in the consolidated financial statements or tax returns such as realization of the effects of temporary differences, net operating loss carry forward, and changes in tax laws or interpretations thereof. A valuation allowance is established when in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. In this case, our Company would adjust the recorded value of our deferred tax asset, which would result in a direct charge to income tax expense in the period that the determination was made. Likewise, our Company would reverse the valuation allowance when the realization of the deferred tax asset is expected. In addition, our Company is subject to the continuous examination of our tax returns by the Internal Revenue Service and other taxing authorities. Our Company accrues for interest related to income taxes in income tax expense. Total interest expense recognized for the three months ended March 31, 2010 and 2009 was $9,000 and $16,000, respectively. As of March 31, 2010 and December 31, 2009, total accrued interest was $103,000 and $94,000, respectively

SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected consolidated financial information for our Company as of and for each of the three month period ended March 31, 2010. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements of our Company, including the accompanying notes, presented elsewhere herein.

Selected Financial Data

		Three Months
		Ended
		March 31,
(In thousands, except per share data)		2010				2009
Per Share Data
Basic earnings per common share		$	—			$	0.13
Diluted earnings per common share			—				0.13
Dividends paid on preferred stock			378				235
Amortization of discount on preferred stock			119				119
Dividends paid on common stock			473				869
Book value per common share			18.38				18.93
Market price common stock			11.69				11.75
Selected Ratios
(Based on average balance sheets)
Return on average total assets			0.16	%			0.34	%
Return on average common stockholders’ equity			0.02	%			2.88	%
Average common stockholders’ equity to average total assets			6.37	%			6.28	%
(Based on end-of-period data)
Efficiency ratio (1)			74.13	%			73.16	%
Period-end stockholders’ equity to period-end assets			6.27	%			6.18	%
Period-end common stockholders’ equity to period-end assets			8.53	%			8.39	%
Total risk-based capital ratio			16.68				16.22
Tier 1 risk-based capital ratio			14.19				13.70
Leverage ratio			11.20				11.02

Results of Operations

Summary

						Three Months
		Ended March, 31
(Dollars in thousands)		2010				2009				$ Change				% Change
Net interest income		$	10,311			$	9,530			$	781				8.2	%
Provision for loan losses			2,505				1,750				755				43.1
Noninterest income			2,006				2,765				(759	)			(27.5	)
Noninterest expense			9,131				8,995				136				1.5
Income before income taxes			681				1,550				(869	)			(56.1	)
Income taxes			187				493				(306	)			(62.1	)
Net income		$	494			$	1,057			$	(563	)			(53.3)	%
Less:
Preferred dividends			370				374				(4	)			—
Accretion of discount on
Preferred stock			119				119				—				—
Net income available to common shareholders		$	5			$	564			$	(559	)			(99.1)	%

     Our Company’s consolidated net income of $494,000 for the first three months ended March 31, 2010 decreased $563,000, or 53.3%, compared to the first three months ended March 31, 2009. Our Bank, which is the main operating subsidiary of our Company, reported $1,394,000 for the first three months ended March 31, 2010, compared to $2,027,000 for first three months ended March 31, 2009. Our Company recorded preferred stock dividends and accretion on preferred stock of $489,000 in the first three months of 2010, resulting in $5,000 of net income available to common shareholders, compared to $493,000 for the first three months of 2009. Diluted earnings per share decreased from $0.13 per common share to $0.00 per common share. Results for the first three months ended March 31, 2010 were negatively impacted by the $2,505,000 provision for loan losses compared to $1,750,000 for the same period in 2009. The decrease in noninterest income was primarily due to substantial real estate refinancing activity our Company experienced during the first three months of 2009 which resulted in a lower gain on sales of mortgage loans. For the first three months of 2010, the annualized return on average assets was 0.16%, the annualized return on average common shareholders’ equity was 0.02%, and the efficiency ratio was 74.1%. Net interest margin increased from 3.32% to 3.61%. Net interest income, on a tax equivalent basis, increased $770,000 or 7.9% from 2009 to 2010. Total assets at March 31, 2010 were $1,260,411,000, compared to $1,236,471,000 at December 31, 2009, an increase of $23,940,000, or 1.9%.

Net Interest Income

     Net interest income is the largest source of revenue resulting from our Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities.

Average Balance Sheets

     The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the three month periods ended March 31, 2010 and 2009, respectively.

		Three Months Ended March 31,
		2010												2009
						Interest				Rate								Interest				Rate
		Average				Income/				Earned/				Average				Income/				Earned/
(dollars in thousands)		Balance				Expense(1)				Paid(1)				Balance				Expense(1)				Paid(1)
ASSETS
Loans (2)(4)
Commercial		$	148,251			$	1,994				5.45	%		$	150,519			$	2,002				5.39	%
Real estate construction — residential			38,744				508				5.32				45,806				603				5.34
Real estate construction — commercial			77,268				657				3.45				66,015				1,006				6.18
Real estate mortgage — residential			231,757				3,250				5.69				205,989				3,654				7.19
Real estate mortgage — commercial			448,632				6,344				5.73				508,694				6,581				5.25
Consumer			36,397				696				7.76				33,144				621				7.60
Investment in securities: (3)
U.S. Treasury			77				—				—				—				—				—
Government sponsored enterprises			46,137				333				2.93				68,592				515				3.05
Asset backed securities			77,423				718				3.76				40,203				628				6.34
State and municipal			36,733				493				5.44				41,828				586				5.68
Restricted investments			6,728				51				3.07				8,875				20				0.91
Federal funds sold			194				—				—				451				—				—
Interest bearing deposits in other financial institutions			30,941				14				0.18				17,604				14				0.32
Total interest earning assets			1,179,282				15,058				5.18				1,187,720				16,230				5.54
All other assets			93,855												88,750
Allowance for loan losses			(14,925	)											(12,729	)
Total assets		$	1,258,212											$	1,263,741
LIABILITIES AND STOCKHOLDERS’ EQUITY
NOW accounts		$	176,736			$	276				0.63	%		$	143,674			$	336				0.95	%
Savings			49,286				32				0.26				44,391				36				0.33
Money market			169,496				323				0.77				177,300				578				1.32
Time deposits of $100,000 and over			136,170				711				2.12				138,539				1,080				3.16
Other time deposits			326,958				1,999				2.48				356,812				2,940				3.34
Total time deposits			858,646				3,341				1.58				860,716				4,970				2.34
Federal funds purchased and securities sold under agreements to repurchase			33,734				21				0.25				29,344				23				0.32
Subordinated notes			49,486				524				4.29				49,486				662				5.43
Other borrowed money			77,638				676				3.53				89,037				849				3.87
Total interest bearing liabilities			1,019,504				4,562				1.81				1,028,583				6,504				2.56
Demand deposits			123,096												118,620
Other liabilities			7,071												9,267
Total liabilities			1,149,671												1,156,470
Stockholders’ equity			108,541												107,271
Total liabilities and stockholders’ equity		$	1,258,212											$	1,263,741
Net interest income (FTE)						$	10,496											$	9,726
Net interest spread											3.37	%											2.98	%
Net interest margin											3.61	%											3.32	%

Comparison of the three periods ended March 31, 2010 and 2009

     Financial results for the first quarter of 2010 compared to 2009 included an increase in net interest income, on a tax equivalent basis of $770,000, or 7.9%. Average interest-earning assets decreased $8,438,000, or 0.7%, to $1,179,282,000 at March 31, 2010 compared to $1,187,720,000 at March 31, 2009, while average interest bearing liabilities decreased $9,079,000, or 0.88%, to $1,019,504,000 at March 31, 2010 compared to $1,028,583,000 at March 31, 2009.

The following is a summary of the changes in average loan balance by major category:

		Three Months Ended March 31,
(Dollars in thousands)		2010				2009				$ Change				% Change
Average loans:
Commercial		$	148,251			$	150,519			$	(2,268	)			(1.5)	%
Real estate construction - residential			38,744				45,806				(7,062	)			(15.4	)
Real estate construction - residential			77,268				66,015				11,253				17.0
Real estate mortgage - residential			231,757				205,989				25,768				12.5
Real estate mortgage - commercial			448,632				508,694				(60,062	)			(11.8	)
Consumer			36,397				33,144				3,253				9.8
Total		$	981,049			$	1,010,167			$	(29,118	)			(2.9)	%