Exhibit 13

2011

ANNUAL REPORT

TO

SHAREHOLDERS

HAWTHORN BANCSHARES, INC.

Lee’s Summit, Missouri

March 30, 2012

Dear Investors:

Given the significantly harsh market conditions we faced, 2011 was a difficult year for your company; but it was nevertheless a successful one. The banking industry is recovering. For 2011, our company reported a net profit of $2.9 million compared to a net loss of $3.6 million for 2010. Income available to common shareholders for 2011 was $0.9 million compared to a net loss available to common shareholders of $5.5 million for 2010. On a per share basis, this equates to a net profit of $0.19 per common share for 2011 compared to a net loss of $1.19 for 2010. Although we have made significant progress, persistent challenges remain and our operating results are clearly below the level for which we are striving. We are working through our credit issues in a methodical process and have seen incremental improvements.

The $6.4 million improvement in earnings results largely from reductions in other real estate expenses (which included impairment valuation write-downs in 2010) and lower loan loss provisions. Credit quality remains unacceptable with non-performing assets equaling 8.11% of loans and foreclosed assets. Nonperforming loans declined from $56.3 million in 2010 to $53.7 million in 2011 while other real estate owned increased $2.3 million reflecting the migration of nonperforming loans to assets closer to cash. Provision expense was reduced from $15.3 million in 2010 to $11.5 million in 2011.

As we evaluate our loan portfolio today, we are not seeing the same level of continual deterioration in our portfolio that we have seen in the recent past. A significant portion of our reserves is allocated to loans of customers who are trying to work through their problems but have seen serious deterioration in the value of their collateral — which requires a reserve. Our philosophy is to try and work with our customers who are willing to work with us. It may be a longer path, but we believe it will lead to less long-term loss for both the customer and the bank.

Hawthorn’s core earnings remain strong due to further net interest margin strengthening despite a lower volume of earning assets. For 2011, a 9% decline in average loan volume resulted in a $54.1 million decline in earning assets; however, Hawthorn’s net interest margin increased from 3.78% at 2010 to 3.92% for 2011 mostly offsetting the decline in earning assets. Maintaining a strong core earnings base has enabled Hawthorn to absorb the negative financial impact of the recession to a large extent.

Capital was built slightly through earnings and proportionately through balance sheet discipline. Hawthorn’s total risk-based capital ratio was 18.03% at year end 2011 and our leverage capital ratio was 11.52% for the same period. As such, Hawthorn continues to be well-capitalized by regulatory definitions. We are disappointed that 2011 earnings were not higher; however, we are working to improve asset quality which will equate to greater shareholder value in the long-term. In 2008, we participated in the U.S. Treasury’s Capital Purchase Program (commonly called TARP) which added $30.3 million in additional capital to the company. It is our intent to fully repay TARP by the end of 2013. Hawthorn has both the capacity and ability to repay the TARP debt without having to raise additional capital. As of December 31, 2011, inclusion of the TARP funds in Hawthorn’s capital structure increased total risk-based capital from 14.71% to 18.03%. As such, Hawthorn would continue to exceed regulatory “well-capitalized” levels after repaying the TARP funds.

I am pleased, though not entirely satisfied, to report the results which reflect an improved, profitable 2011 at Hawthorn Bank. Despite facing significant economic headwinds, we reported positive net income for 2011, continued to pay our regular quarterly dividends to shareholders, and increased our regulatory and tangible common capital ratios. Hawthorn Bank has a solid future.

Sincerely,

David T. Turner

Chairman, Chief Executive Officer,

and President

A WORD CONCERNING 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 Hawthorn and its acquisition targets may be greater than expected,

• legislative or regulatory changes may adversely affect the business in which Hawthorn 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, 2011, 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.

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HAWTHORN BANCSHARES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Through the branch network of its subsidiary bank, our Company, Hawthorn Bancshares, Inc., 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.

Much of our Company’s business is commercial, commercial real estate development, and mortgage lending. Our Company has experienced soft loan demand in the communities within which we operate during the current economic slowdown. Our Company’s income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancings.

The successes of our Company’s growth strategy depends primarily on the ability of our 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. Our Company’s financial performance also depends, in part, on our 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 our Company’s growth strategy depends on our ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond our control.

Our subsidiary Bank is a full service bank conducting a 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, our Bank provides trust services.

The deposit accounts of our Bank are insured by the Federal Deposit Insurance Corporation or “FDIC” to the extent provided by law. The operations of our Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of our 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. Hawthorn Bancshares is subject to supervision and examination by the Federal Reserve Board.

Except as otherwise provided herein, references herein to “Hawthorn” or our “Company” include Hawthorn and its consolidated subsidiaries, and references herein to our “Bank” refers to Hawthorn Bank and its constituent predecessors.

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SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected consolidated financial information for our Company as of and for each of the years in the five-year period ended December 31, 2011. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements of our Company, including the related notes, presented elsewhere herein.

Income Statement Data
(In thousands, except per share data)	2011			2010			2009			2008			2007
Interest income	$	53,468		$	58,739		$	63,562		$	69,715		$	74,207
Interest expense		10,853			15,753			22,974			31,599			37,175
Net interest income		42,615			42,986			40,588			38,116			37,032
Provision for loan losses		11,523			15,255			8,354			8,211			1,154
Net interest income after provision for loan losses		31,092			27,731			32,234			29,905			35,878
Non-interest income		9,200			10,481			10,702			9,294			10,223
Security gains, net		—			—			606			3			(2	)
Total non-interest income		9,200			10,481			11,308			9,297			10,221
Non-interest expense		36,844			44,851			36,730			75,975			35,054
Income (loss) before income taxes		3,448			(6,639	)		6,812			(36,773	)		11,045
Income tax expense (benefit)		591			(3,087	)		1,856			(6,146	)		3,245
Net income (loss)		2,857			(3,552	)		4,956			(30,627	)		7,800
Less: preferred stock dividends		1,513			1,513			1,517			50			—
and accretion of discount on
preferred stock		476			476			477			16			—
Net income (loss) available to common shareholders	$	868		$	(5,541	)	$	2,962		$	(30,693	)	$	7,800
Dividends on Common Stock
Declared	$	913		$	1,136		$	2,270		$	3,486		$	3,504
Paid		904			1,385			2,666			3,486			3,504
Ratio of total dividends declared to net income		105.18	%		N.M.			76.64	%		N.M.			44.92	%
Per Share Data
Basic earnings (loss) per common share	$	0.19		$	(1.19	)	$	0.64		$	(6.47	)	$	1.67
Diluted earnings (loss) per common share		0.19			(1.19	)		0.64			(6.47	)		1.65
Basic weighted average shares of common stock outstanding		4,652,994			4,652,994			4,652,994			4,674,645			4,674,645
Diluted weighted average shares of common stock outstanding		4,652,994			4,652,994			4,652,994			4,674,645			4,715,509

N.M. - not meaningful

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(In thousands, except per share data)	2011			2010			2009			2008			2007
Balance Sheet Data (at period end)
Total assets	$	1,171,161		$	1,200,172		$	1,236,471		$	1,279,699		$	1,195,804
Loans		842,931			898,472			991,614			1,009,104			911,278
Investment securities		213,806			178,978			152,927			149,401			151,742
Total deposits		958,224			946,663			956,323			955,296			921,257
Subordinated notes		49,486			49,486			49,486			49,486			49,486
Other borrowed money		28,410			66,986			79,317			129,057			77,915
Common stockholders’ equity		73,258			72,647			79,406			78,530			111,199
Total stockholders’ equity		102,576			101,488			107,771			106,418			111,199
Balance Sheet Data (average balances)
Total assets	$	1,187,410		$	1,236,841		$	1,258,381		$	1,251,496		$	1,156,500
Loans		865,214			949,457			1,002,830			963,252			848,771
Investment securities		209,077			165,213			151,907			156,870			171,179
Total deposits		957,965			967,970			977,826			914,218			921,257
Subordinated notes		49,486			49,486			49,486			49,486			49,486
Other borrowed money		42,230			70,456			78,626			124,025			53,626
Common stockholders’ equity		75,390			80,735			79,828			112,307			108,052
Total stockholders’ equity		104,455			109,323			107,938			113,375			108,052
Key Ratios
Earnings Ratios
Return (loss) on average total assets		0.24	%		(0.29	)%		0.39	%		(2.45	)%		0.67	%
Return (loss) on average common stockholders’ equity		1.15			(6.86	)		3.71			(27.33	)		7.22
Efficiency ratio (3)		71.11			83.89			71.61			160.25			74.18
Asset Quality Ratios
Allowance for loan losses to loans		1.64			1.62			1.49			1.26			1.02
Nonperforming loans to loans (1)		6.37			6.27			4.27			2.46			0.67
Allowance for loan losses to nonperforming loans (1)		25.73			25.87			34.94			50.94			152.54
Nonperforming assets to loans and foreclosed assets (2)		8.11			7.71			5.08			3.21			0.92
Net loan charge-offs to average loans		1.42			1.63			0.62			0.50			0.10
Capital Ratios
Average stockholders’ equity to average total assets		8.80	%		8.84	%		8.58	%		9.06	%		9.34	%
Period-end common stockholders’ equity to period-end assets		6.26			6.05			6.42			6.14			9.30
Period-end stockholders’ equity to period-end assets		8.76			8.46			8.72			8.32			9.30
Total risk-based capital ratio		18.03			17.05			16.49			16.01			13.24
Tier 1 risk-based capital ratio		15.16			14.25			14.01			13.55			11.08
Leverage ratio		11.52			11.00			11.35			10.80			9.12

(1) Nonperforming loans consist of nonaccrual loans, troubled debt restructurings, and loans contractually past due 90 days or more and still accruing interest.

(2) Nonperforming assets consist of nonperforming loans and foreclosed assets.

(3) Efficiency ratio is calculated as non-interest expense as a percent of revenue. Total revenue includes net interest income and non-interest income.

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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 policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to our Company’s consolidated financial statements.

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. Further discussion of the methodology used in establishing the allowance and the impact of any associated risks related to these policies on our business operations is provided in Note 1 to our Company’s consolidated financial statements and is also discussed in the Lending and Credit Management section below. Many of the loans are deemed collateral dependent for purposes of the measurement of the impairment loss, thus the fair value of the underlying collateral and sensitivity of such fair values due to changing market conditions, supply and demand, condition of the collateral and other factors can be volatile over periods of time. Such volatility can have an impact on the financial performance of our Company.

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 forwards 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 penalties and interest related to income taxes in income tax expense. At December 31, 2010, total accrued interest was $31,000 and total interest expense recognized for the year ended 2010 was $24,000. As of December 31, 2011, our Company released $28,000 of interest accrued related to the release of $221,000 of uncertain tax provisions.

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 initially recorded as held for sale at the lower of the loan balance or fair value of the collateral less estimated selling costs. Any adjustment is recorded as a charge-off against the allowance for loan losses. Our Company relies on external appraisals and assessment of property values by 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. The write-downs are recorded as other real estate expense. Our Company establishes a valuation allowance related to other real estate owned on an asset-by-asset basis. The valuation allowance is created during the holding period when the fair value less cost to sell is lower than the “cost” of a parcel of other real estate.

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RESULTS OF OPERATIONS ANALYSIS

Our Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, our 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.

								$ Change						% Change
(Dollars in thousands)	2011		2010			2009		‘11-‘10			‘10-‘09			‘11-‘10			‘10-‘09
Net interest income	$	42,615	$	42,986		$	40,588	$	(371	)	$	2,398			(0.9	)%		5.9	%
Provision for loan losses		11,523		15,255			8,354		(3,732	)		6,901			(24.5	)		82.6
Noninterest income		9,200		10,481			10,702		(1,281	)		(221	)		(12.2	)		(2.1	)
Investment securities gains, net		—		—			606		—			(606	)		NM			(100.0	)
Noninterest expense		36,844		44,851			36,730		(8,007	)		8,121			(17.9	)		22.1
Income (loss) before income taxes		3,448		(6,639	)		6,812		10,087			(13,451	)		151.9			(197.5	)
Income tax (benefit) expense		591		(3,087	)		1,856		3,678			(4,943	)		119.1			(266.3	)
Net income (loss)	$	2,857	$	(3,552	)	$	4,956	$	6,409		$	(8,508	)		(180.4	)%		(171.7	)%
Less: preferred dividends		1,513		1,513			1,517		—			(4	)		—			—
and accretion of discount		476		476			477		—			(1	)		—			—
Net income (loss) available to common shareholders	$	868	$	(5,541	)	$	2,962	$	6,409		$	(8,503	)		(115.7	)%		287.1	%

Our Company’s consolidated net income of $2,857,000 for the year ended December 31, 2011 increased $6,409,000 compared to a net loss of ($3,552,000) for the year ended December 31, 2010. Our Company recorded preferred stock dividends and accretion on preferred stock of $1,989,000 for the year ended December 31, 2011, resulting in $868,000 of net income available for common shareholders compared to a net loss of ($5,541,000) for the year ended December 31, 2010. Diluted earnings per share increased from ($1.19) per common share to $0.19 per common share. The provision for loan losses decreased $3,732,000, or 24.5%, from December 31, 2010 to December 31, 2011. Other real estate expenses and impairment losses incurred on foreclosed properties decreased from $9,804,000 for the year ended December 31, 2010 to $2,736,000 for the year ended December 31, 2011. Our Company had recorded a $6,158,000 valuation allowance for other real estate owned during the fourth quarter of 2010 that had significantly increased noninterest expense. Our Company’s net interest income, on a tax equivalent basis, decreased $432,000, or 1.0%, to $43,225,000 for the year ended December 31, 2011 compared to $43,657,000 for the year ended December 31, 2010 primarily due to a $54,149,000 decrease in average earning assets. For the year ended December 31, 2011, the return on average assets was 0.24%, the return on average common stockholders’ equity was 1.15%, and the efficiency ratio was 71.1%. Net interest margin increased from 3.78% to 3.92% from December 31, 2010 to 2011, respectively.

Our Company’s consolidated net loss of ($3,552,000) for the year ended December 31, 2010 decreased $8,508,000 compared to net income of $4,956,000 for the year ended December 31, 2009. Our Company recorded preferred stock dividends and accretion on preferred stock of $1,989,000 for the year ended December 31, 2010, resulting in a ($5,541,000) net loss available for common shareholders compared to net income of $2,962,000 for the year ended December 31, 2009. Diluted earnings per share decreased from $0.64 per common share to ($1.19) per common share. Results for the year ended December 31, 2010 were negatively impacted by the $15,255,000 provision for loan losses compared to $8,354,000 for the same time period in 2009. Our Company had recorded a $6,158,000 valuation allowance for other real estate owned during the fourth quarter of 2010 that significantly increased noninterest expense. For the year ended December 31, 2010, the return on average assets was (0.29)%, the return on average stockholders’ equity was (6.86)%, and the efficiency ratio was 83.9%. Net interest margin increased from 3.50% to 3.78% from December 31, 2009 to 2010, respectively and net interest income, on a tax equivalent basis, increased $2,317,000, or 5.6%, from 2009 to 2010.

Total assets at December 31, 2011 were $1,171,161,000, compared to $1,200,172,000 at December 31, 2010, a decrease of $29,011,000, or 2.4%. On July 1, 2011, our Company distributed a four percent stock dividend for the third consecutive year to common shareholders of record at the close of business May 12, 2011. For all periods presented, share information, including basic and diluted earnings (loss) per share, have been adjusted retroactively to reflect the stock dividend.

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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 years in the three year period ended December 31, 2011.

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(Dollars In thousands)	2011								2010								2009
	Average Balance			Interest Income/ Expense(1)		Rate Earned/ Paid(1)			Average Balance			Interest Income/ Expense(1)		Rate Earned/ Paid(1)			Average Balance			Interest Income/ Expense(1)		Rate Earned/ Paid(1)
ASSETS
Loans: (2) (4)
Commercial	$	127,572		$	6,952		5.45	%	$	139,679		$	7,739		5.54	%	$	149,695		$	8,151		5.45	%
Real estate construction - residential		30,171			1,704		5.65			37,954			1,959		5.16			36,630			2,137		5.83
Real estate construction - commercial		50,374			2,255		4.48			75,207			2,904		3.86			64,548			3,610		5.59
Real estate mortgage - residential		203,587			11,619		5.71			221,545			12,672		5.72			222,798			14,197		6.37
Real estate mortgage - commercial		423,682			22,884		5.40			440,285			25,309		5.75			494,703			26,813		5.42
Consumer		29,828			2,057		6.90			34,787			2,626		7.55			34,456			2,606		7.56
Total Loans	$	865,214		$	47,471		5.49	%	$	949,457		$	53,209		5.60	%	$	1,002,830		$	57,514		5.74	%
Investment in securities: (3)
U.S. treasury	$	1,754		$	29		1.65	%	$	790		$	15		1.90	%	$	—		$	—		—	%
Government sponsored enterprises		63,089			1,240		1.97			47,914			1,242		2.59			47,958			1,800		3.75
Asset backed securities		111,859			3,551		3.17			83,237			2,918		3.51			64,133			2,617		4.08
State and municipal		32,375			1,573		4.86			33,272			1,764		5.30			39,816			2,166		5.44
Total Investment securities	$	209,077		$	6,393		3.06	%	$	165,213		$	5,939		3.59	%	$	151,907		$	6,583		4.33	%
Restricted Investments		5,091			156		3.06			6,356			176		2.77			8,817			164		1.86
Federal funds sold		117			—		—			187			—		—			309			—		—
Interest bearing deposits in other financial institutions		22,245			58		0.26			34,680			86		0.25			18,807			53		0.28
Total interest earning assets	$	1,101,744		$	54,078		4.91	%	$	1,155,893		$	59,410		5.14	%	$	1,182,670		$	64,314		5.44	%
All other assets		99,216								94,802								89,108
Allowance for loan losses		(13,550	)							(13,854	)							(13,397	)
Total assets	$	1,187,410							$	1,236,841							$	1,258,381
LIABILITIES AND STOCKHOLDERS’ EQUITY
NOW accounts	$	175,347		$	911		0.52	%	$	167,303		$	960		0.57	%	$	138,456		$	1,131		0.82	%
Savings		60,582			125		0.21			52,605			131		0.25			46,464			139		0.30
Money market		153,672			608		0.40			167,240			1,080		0.65			175,894			1,747		0.99
Time deposits of $100,000 and over		131,175			1,663		1.27			130,493			2,485		1.90			140,502			3,862		2.75
Other time deposits		291,842			5,124		1.76			318,891			7,211		2.26			351,597			10,543		3.00
Total time deposits	$	812,618		$	8,431		1.04	%	$	836,532		$	11,867		1.42	%	$	852,913		$	17,422		2.04	%
Federal funds purchased and securities sold under agreements to repurchase		27,636			47		0.17			32,723			75		0.23			33,923			88		0.26
Subordinated notes		49,486			1,301		2.63			49,486			1,526		3.08			49,486			2,447		4.94
Federal Home Loan Advances		42,230			1,074		2.54			70,456			2,285		3.24			78,626			3,017		3.84
Total borrowings	$	119,352		$	2,422		2.03	%	$	152,665		$	3,886		2.55	%	$	162,035		$	5,552		3.43	%
Total interest bearing liabilities	$	931,970		$	10,853		1.16	%	$	989,197		$	15,753		1.59	%	$	1,014,948		$	22,974		2.26	%
Demand deposits		145,347								131,438								124,913
Other liabilities		5,638								6,883								10,582
Total liabilities		1,082,955								1,127,518								1,150,443
Stockholders’ equity		104,455								109,323								107,938
Total liabilities and stockholders’ equity	$	1,187,410							$	1,236,841							$	1,258,381
Net interest income (FTE)				$	43,225							$	43,657							$	41,340
Net interest spread							3.75	%							3.55	%							3.18	%
Net interest margin							3.92	%							3.78	%							3.50	%

(1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $610,000, $671,000 and $751,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

(2) Non-accruing loans are included in the average amounts outstanding.

(3) Average balances based on amortized cost.

(4) Fees and costs on loans are included in interest income.

10

Comparison of Years ended December 31, 2011 and 2010

Financial results for 2011 compared to 2010 included a decrease in net interest income, on a tax equivalent basis, of $432,000, or 1.0%. Average interest-earning assets decreased $54,149,000, or 4.7% to $1,101,744,000 at December 31, 2011 compared to $1,155,893,000 at December 31, 2010 and average interest bearing liabilities decreased $57,227,000, or 5.8%, to $931,970,000 at December 31, 2011 compared to $989,197,000 at December 31, 2010.

Average loans outstanding decreased $84,243,000 or 8.9% to $865,214,000 at December 31, 2011 compared to $949,457,000 at December 31, 2010. See the Lending and Credit Management section for further discussion of changes in the composition of our lending portfolio. Average investment securities and federal funds sold increased $43,794,000 or 26.5% to $209,194,000 at December 31, 2011 compared to $165,400,000 at December 31, 2010. Average interest bearing deposits in other financial institutions decreased $12,435,000 to $22,245,000 at December 31, 2011 compared to $34,680,000 at December 31, 2010. See the Liquidity Management section for further discussion.

Average time deposits decreased $23,914,000 to $812,618,000 at December 31, 2011 compared to $836,532,000 at December 31, 2010. Average borrowings decreased $33,313,000 to $119,352,000 at December 31, 2011 compared to $152,665,000 at December 31, 2010. The decrease in average borrowings primarily reflects a net decrease in Federal Home Loan Bank advances. See the Liquidity Management section for further discussion.

Comparison of Years ended December 31, 2010 and 2009

Financial results for 2010 compared to 2009 included an increase in net interest income, on a tax equivalent basis, of $2,317,000, or 5.6%. Average interest-earning assets decreased $26,777,000, or 2.3% to $1,155,893,000 at December 31, 2010 compared to $1,182,670,000 at December 31, 2009 and average interest bearing liabilities decreased $25,751,000, or 2.5%, to $989,197,000 at December 31, 2010 compared to $1,014,948,000 at December 31, 2009.

Average loans outstanding decreased $53,372,000 or 5.3% to $949,457,000 at December 31, 2010 compared to $1,002,830,000 at December 31, 2009. See the Lending and Credit Management section of this discussion for further discussion of changes in the composition of our lending portfolio. Average investment securities and federal funds sold decreased $13,184,000 or 8.7% to $165,400,000 at December 31, 2010 compared to $152,216,000 at December 31, 2009. Average interest bearing deposits in other financial institutions increased $15,873,000 to $34,680,000 at December 31, 2010 compared to $18,807,000 at December 31, 2009. See the Liquidity Management section below for further discussion.

The overall decrease in average interest bearing liabilities was due to a decrease in time deposits and other borrowed money. Average time deposits decreased $16,381,000, or 1.9%, to $836,532,000 at December 31, 2010 compared to $852,913,000 at December 31, 2009. Average borrowings decreased $9,370,000 or 5.8% to $152,665,000 for 2010 compared to $162,035,000 for 2009. The decrease in 2010 reflects a net decrease in Federal Home Loan Bank advances.

Rate and volume analysis

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, indentifying changes related to volumes and rates for the years ended December 31, 2011, compared to December 31, 2010 and for the years ended December 31, 2010 compared to December 31, 2009. 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.

11

	2011									2010
				Change due to									Change due to
(Dollars In thousands)	Total Change			Average Volume			Average Rate			Total Change			Average Volume			Average Rate
Interest income on a fully taxable equivalent basis:
Loans: (1) (3)
Commercial	$	(787	)	$	(662	)	$	(125	)	$	(412	)	$	(546	)	$	134
Real estate construction - residential		(255	)		(428	)		173			(178	)		75			(253	)
Real estate construction - commercial		(649	)		(1,062	)		413			(706	)		532			(1,238	)
Real estate mortgage - residential		(1,053	)		(1,025	)		(28	)		(1,525	)		(80	)		(1,445	)
Real estate mortgage - commercial		(2,425	)		(932	)		(1,493	)		(1,504	)		(3,064	)		1,560
Consumer		(569	)		(354	)		(215	)		20			25			(5	)
Investment securities:
U.S. treasury		14			15			(1	)		15			—			15
Government sponsored entities		(2	)		339			(341	)		(558	)		(2	)		(556	)
Asset backed securities		633			929			(296	)		301			705			(404	)
State and municipal(2)		(191	)		(47	)		(144	)		(402	)		(348	)		(54	)
Restricted Investments		(20	)		(37	)		17			12			(54	)		66
Federal funds sold		—			—			—			—			—			—
Interest bearing deposits in other financial institutions		(28	)		(32	)		4			33			40			(7	)
Total interest income		(5,332	)		(3,296	)		(2,036	)		(4,904	)		(2,717	)		(2,187	)
Interest expense:
NOW accounts		(49	)		45			(94	)		(171	)		207			(378	)
Savings		(6	)		18			(24	)		(8	)		17			(25	)
Money market		(472	)		(82	)		(390	)		(667	)		(82	)		(585	)
Time deposits of 100,000 and over		(822	)		13			(835	)		(1,377	)		(259	)		(1,118	)
Other time deposits		(2,087	)		(574	)		(1,513	)		(3,332	)		(915	)		(2,417	)
Federal funds purchased and securities sold under agreements to repurchase		(28	)		(11	)		(17	)		(13	)		(3	)		(10	)
Subordinated notes		(225	)		—			(225	)		(921	)		—			(921	)
Other borrowed money		(1,211	)		(787	)		(424	)		(732	)		(294	)		(438	)
Total interest expense		(4,900	)		(1,378	)		(3,522	)		(7,221	)		(1,329	)		(5,892	)
Net interest income on a fully taxable equivalent basis	$	(432	)	$	(1,918	)	$	1,486		$	2,317		$	(1,388	)	$	3,705

(1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $610,000, $671,000 and $751,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

(2) Non-accruing loans are included in the average amounts outstanding.

(3) Fees and costs on loans are included in interest income.

Net interest income on a fully taxable equivalent basis decreased $432,000, or 1.0%, to $43,225,000 for 2011 compared to $43,657,000 for 2010 and followed a $2,317,000, or 5.6%, increase for 2010 compared to 2009. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) increased to 3.92% for the year ended December 31, 2011 from 3.78% for 2010 and 3.50% for 2009. Our Company’s net interest spread increased to 3.75% in 2011 from 3.55% in 2010 and 3.18% in 2009.

While our Company was able to decrease the rate paid on interest bearing liabilities to 1.16% for the year ended December 31, 2011 from 1.59% for the year ended 2010, and 2.26% for the year ended 2009, this decrease was partially offset by the decrease in the rates earned on interest bearing assets to 4.91% December 31, 2011 from 5.14% in 2010, and 5.44% in 2009.

12

Non-interest Income and Expense

Non-interest income for the years ended December 31, 2011, 2010, and 2009 were as follows:

										$ Change						% Change
(Dollars in thousands)	2011			2010			2009			‘11-‘10			‘10-‘09			‘11-‘10			‘10-‘09
Non-interest Income
Service charges on deposit accounts	$	5,566		$	5,554		$	5,864		$	12		$	(310	)		0.2	%		(5.3	)%
Trust department income		898			803			815			95			(12	)		11.8			(1.5	)
Gain on sales of mortgage loans		1,649			2,493			2,974			(844	)		(481	)		(33.9	)		(16.2	)
Other		1,087			1,631			1,049			(544	)		582			(33.4	)		55.5
Total non-interest income	$	9,200		$	10,481		$	10,702		$	(1,281	)	$	(221	)		(12.2	)%		(2.1	)%
Investment securities gains (losses), net	$	—		$	—		$	606		$	—		$	(606	)		—	%		NM	%
Non-interest income as a % of total revenue *		17.8	%		19.6	%		20.9	%
Total revenue per full time equivalent employee	$	153.8		$	157.3		$	147.4

* Total revenue is calculated as net interest income plus non-interest income.

Years Ended December 31, 2011 and 2010

Noninterest income decreased $1,281,000 or 12.2% to $9,200,000 for 2011 compared to $10,481,000 for 2010. The decrease was primarily the result of a $844,000 decrease in the gains on sales of mortgage loans and a $544,000 decrease in other income. Our Company’s loans sold decreased from $106,547,000 for 2010 to $74,983,000 for 2011. A decrease in refinancing activity impacted both the volume of loans sold and gains recognized. Our Company was servicing $307,016,000 of mortgage loans at December 31, 2011 compared to $298,325,000 at December 31, 2010. The decrease in other noninterest income was primarily due to a $268,000 refund of prior year’s processing fees received in 2010 and a $139,000 decrease in credit card income. Our Company had no sales of debt securities during 2011 or 2010.

Years Ended December 31, 2010 and 2009

Noninterest income decreased $221,000 or 2.1% to $10,481,000 for 2010 compared to $10,702,000 for 2009. The decrease was primarily the result of a $481,000 decrease in the gains on sales of mortgage loans and a $310,000 decrease in service charges on deposit accounts. Although refinancing activity substantially increased during the last half of 2010, our Company experienced more refinancing activity throughout 2009, impacting both volumes of loans sold and gains recognized. Our Company was servicing $298,325,000 of mortgage loans at December 31, 2010 compared to $269,475,000 at December 31, 2009. The decrease in noninterest income was partially offset by an increase in other income that included a $268,000 refund of prior year’s processing fees and a $227,000 increase in credit card income, of which $167,000 was due to a nonmaterial correction. Our Company recognized $606,000 in gain on sales and calls of debt securities during 2009. Our Company had no sales of debt securities during 2010.

13

Non-interest expense for the years ended December 31, 2011, 2010, and 2009 were as follows:

										$ Change						% Change
(Dollars in thousands)	2011			2010			2009			‘11-‘10			‘10-‘09			‘11-‘10			‘10-‘09
Non-interest Expense
Salaries	$	13,760		$	13,904		$	13,253		$	(144	)	$	651			(1.0	)%		4.9	%
Employee benefits		4,222			3,995			4,204			227			(209	)		5.7			(5.0	)
Occupancy expense, net		2,701			2,532			2,335			169			197			6.7			8.4
Furniture and equipment expense		2,019			1,997			2,286			22			(289	)		1.1			(12.6	)
FDIC insurance assessment		1,107			1,651			2,519			(544	)		(868	)		(32.9	)		(34.5	)
Legal, examination, and professional fees		1,332			1,441			1,222			(109	)		219			(7.6	)		17.9
Advertising and promotion		1,103			1,256			1,272			(153	)		(16	)		(12.2	)		(1.3	)
Postage, printing, and supplies		1,158			1,201			1,168			(43	)		33			(3.6	)		2.8
Processing expense		3,193			3,353			3,420			(160	)		(67	)		(4.8	)		(2.0	)
Other real estate expense		2,736			9,804			1,189			(7,068	)		8,615			(72.1	)		724.6
Other		3,513			3,717			3,862			(204	)		(145	)		(5.5	)		(3.8	)
Total non-interest expense	$	36,844		$	44,851		$	36,730		$	(8,007	)	$	8,121			(17.9	)%		22.1	%
Efficiency ratio		71.1	%		83.9	%		71.6	%
Salaries and benefits as a % of total non-interest expense		48.8	%		39.9	%		47.5	%
Number of full-time equivalent employees		337			340			348

Years Ended December 31, 2011 and 2010

Noninterest expense decreased $8,007,000, or 17.9%, to $36,844,000 for 2011 compared to $44,851,000 for 2010. The decrease primarily resulted from a $7,068,000, or 72.1%, decease in other real estate expense, a $544,000, or 32.9%, decrease in Federal Deposit Insurance Corporation (FDIC) insurance assessment, and an $144,000, or 1.0% decrease in salary expense. These decreases were partially offset by a $227,000, or 5.7%, increase in employee benefits expense. Our Company recorded a $1,252,000 provision for other real estate owned, included in other real estate expense on foreclosed property for the year ended December 31, 2011 compared to $6,158,000 for the year ended December 31, 2010. Our Company recognized $18,000 in losses on sales on foreclosed properties for the year ended December 31, 2011 compared to $2,071,000 in losses for the year ended December 31, 2010. The decrease in FDIC insurance assessments was due to amendments made by the FDIC effective for the third quarter of 2011 to implement revisions to the Federal Deposit Insurance Act made by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The last six months of 2011 reflect a new assessment base using assets and tier one capital in the assessment calculation. A slight decrease in the number of employees for 2011 compared to 2010 primarily resulted in the decrease in salary expense that was offset by an increase in employee benefits primarily due to an increase in medical insurance premiums.

Years Ended December 31, 2010 and 2009

Noninterest expense increased $8,121,000, or 22.1%, to $44,851,000 for 2010 compared to $36,730,000 for 2009. Other real estate expense increased $8,615,000, or 724.6%, legal, examination, and professional fees increased $219,000, or 17.9%, partially offset by a decrease in Federal Deposit Insurance Corporation (FDIC) insurance assessment of $868,000, or 34.5%. The increase in other real estate expense reflects expenses incurred related to the increase in our Company’s foreclosed property for 2010. $6,158,000 of this expense was incurred for the fourth quarter when our Company recorded a provision to the valuation allowance for other real estate owned based on current appraisals received on two commercial real estate properties. The increase in legal, examination, and professional fees primarily resulted in an increase in accrued expenses representing our Company’s estimated obligation in a suit filed against Hawthorn Bank found in favor of the customer. See Note 17 Commitments and Contingencies for further explanation in the consolidated financial statements. The decrease in the FDIC insurance assessment is a result of a decrease in the estimated expense accrued for 2010 in comparison to 2009 and an increase in special assessments for 2009.

14

Fourth Quarter Results for 2011

Comparing fourth quarter 2011 to third quarter 2011:

Our Company’s net loss of ($1,522,000) for the fourth quarter ended December 31, 2011 decreased $2,540,000, compared to net income of $1,018,000 for the third quarter ended September 30, 2011. Net interest income decreased to $10,548,000 from $10,804,000 over the same period. This decrease was primarily the result of a decrease in average interest earning assets from $1,092,000 for the third quarter ended September 30, 2011 to $1,082,000 for the fourth quarter ended December 31, 2011.

The fourth quarter 2011 provision for loan losses of $5,880,000 was $3,870,000 higher than third quarter 2011’s provision of $2,010,000 and was based upon management’s determination of the loan loss reserve required to cover probable losses in the loan portfolio at year-end.

Noninterest income of $2,612,000 for fourth quarter 2011 increased $254,000 from third quarter 2011’s noninterest income of $2,358,000. This increase was primarily a result of gains on sales of mortgages increased $325,000 to $756,000 for the fourth quarter of 2011 from $431,000 in the third quarter of 2011. Our Company’s loans sold were $31,491,000 for three months ended December 31, 2011 compared to $22,543,000 for the three months ended September 30, 2011.

Noninterest expense of $9,533,000 for fourth quarter 2011 increased by $608,000 from third quarter 2011’s noninterest expense of $8,925,000. This increase primarily resulted from a $647,000 increase in other real estate expenses from $524,000 for the three months ended September 30, 2011 to $1,171,000 for the three months ended December 31, 2011. Included in this increase was a $370,000 increase to the provision for the valuation allowance for other real estate owned. Partially offsetting this increase was a $277,000 decrease in the FDIC insurance assessment calculated for the fourth quarter of 2011 using the results from the third quarter call report.

Comparing fourth quarter 2011 to fourth quarter 2010:

Our Company’s net loss of ($1,522,000) for the fourth quarter ended December 31, 2011 decreased $5,230,000, compared to a net loss of ($6,752,000) for the fourth quarter ended December 31, 2010. Net interest income of $10,548,000 decreased $154,000 in the fourth quarter of 2011 compared to the fourth quarter of 2010. This decrease was primarily the result of a decrease in average interest earning assets from $1,132,000 for the fourth quarter ended December 31, 2010 to $1,082,000 for the fourth quarter ended December 31, 2011.

The fourth quarter 2011 provision for loan losses of $5,880,000 was $2,270,000 less than the fourth quarter 2010 provision of $8,150,000 and was based upon management’s determination of the loan loss reserve required to cover probable losses in the loan portfolio at year-end.

Noninterest income of $2,612,000 for the fourth quarter 2011 decreased by $503,000 from noninterest income of $3,115,000 for the fourth quarter 2010. This decrease was a result of $756,000 in gains on sales of mortgages for the three months ended December 31, 2011 compared to $960,000 for the three months ended December 31, 2010. Our Company’s loans sold were $38,001,000 for the three months ended December 31, 2010 compared to $31,491,000 for three months ended December 31, 2011. The decrease in noninterest income was also a result of our Company receiving a $268,000 refund of prior year’s processing fees during the fourth quarter of 2010.

Noninterest expense of $9,533,000 for the fourth quarter 2011 decreased $6,501,000 from the fourth quarter 2010 noninterest expense of $16,035,000. This decrease primarily resulted from a $6,158,000 provision to the valuation allowance for other real estate owned based on current appraisals received on two commercial real estate properties for the three months ended December 31, 2010.

Income taxes (benefit)

Income taxes as a percentage of earnings (loss) before income taxes as reported in the consolidated financial statements were 17.2% for 2011, compared to 46.5% for 2010, and 27.3% for 2009. The decrease in the effective tax rate for 2011 in comparison to 2010 was due to the recognition of tax benefits during the fourth quarter of 2011 as a result of the expiration of the statute of limitation on our Company’s 2007 state tax return. The increase in the effective tax rate for 2010 in comparison to 2009 is primarily the result of tax exempt income and other tax benefits increasing the overall income tax benefit related to the pre-tax loss. As a result, these calculated tax benefits increase the statutory tax rate in a year where our Company has a pre-tax loss versus a decrease in the statutory tax rate in years with positive pre-tax income. In addition, 2009 tax expense reflects the recognition of tax benefits as a result of the expiration of the statute of limitations on our Company’s 2005 state tax return during the fourth quarter of 2009.

15

Lending and Credit Management

Interest earned on the loan portfolio is a primary source of interest income for our Company. Net loans represented 70.8% of total assets as of December 31, 2011 compared to 73.7% as of December 31, 2010.

Lending activities are conducted pursuant to an established loan policy approved by our Bank’s Board of Directors. The Bank’s credit review process is comprised of a regional loan committee with an established approval limit. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and is comprised of senior managers of the Bank.

A summary of loans, by major class within our Company’s loan portfolio as of the dates indicated are as follows:

	Balance at December 31,
(In thousands)	2011		2010		2009		2008		2007
	Amount		Amount		Amount		Amount		Amount
Commercial, financial, and agricultural	$	128,555	$	131,382	$	151,399	$	153,386	$	151,488
Real estate construction - residential		30,201		31,834		38,841		49,623		—
Real estate construction - commercial		47,697		56,053		77,937		80,016		147,432
Real estate mortgage - residential		203,454		207,835		232,332		235,834		210,458
Real estate mortgage - commercial		402,960		439,069		453,975		456,696		365,094
Installment loans to individuals		29,884		32,132		36,966		33,404		36,738
Deferred fees and costs, net		179		167		164		144		68
Total loans	$	842,930	$	898,472	$	991,614	$	1,009,103	$	911,278

Our Company’s loan portfolio decreased $55,542,000, or 6.2%, from 2010 to 2011, primarily due to repayments, charge-offs and transfers to other real estate owned. Due to reduced loan demand during the year 2011, loan repayments exceeded new originations. This reduction in demand was seen throughout our Company’s loan portfolio. Contributing to the decline of our loan portfolio were gross loans charged-off in the amount of $13,206,000 and $10,904,000 of assets transferred from loans to other real estate owned and repossessed assets.

Our Company’s loan portfolio decreased $93,142,000, or 9.4% from 2009 to 2010. This decrease was primarily a result of a decrease in commercial loans of $20,017,000, or 13.2%, a decrease in real estate mortgage — residential loans of $24,498,000, or 10.5%, a decrease in real estate mortgage — commercial loans of $14,907,000, or 3.3%, and a decrease in real estate construction — commercial loans of $21,884,000, or 28.1%. The decrease in commercial loans and real estate mortgage loans primarily reflects the payoff of four large commercial credits and three large real estate mortgage loans. The decrease in individual consumer loans reflects the payoff of one large consumer loan which was secured by a Bank certificate of deposit. Also contributing to the decrease in total loans were gross charge-offs of $16,190,000 and $23,677,000 of assets transferred from loans to other real estate owned and repossessed assets.

During the current down-turn in the economy, management continues to focus on the improvement of asset quality. Management has tightened underwriting standards and is focused on lending to credit worthy borrowers with the capacity to service their debts. Where appropriate, management actively works with existing borrowers to modify loan terms and conditions in order to assist the borrowers in servicing their debt obligations to our Company. The decrease in lending activities in the real estate construction market also reflects the slowdown in the housing industry and residential construction industry as well as foreclosures on various residential construction properties. Construction lending will continue to be closely monitored.

Our Company extends credit to its local community market through traditional real estate mortgage products. Our Company does not participate in extending credit to sub-prime residential real estate markets. Our Company does not lend funds for the type of transactions defined as “highly leveraged” by bank regulatory authorities or for foreign loans. Additionally, our Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. Our Company does not have any interest-earning assets which would have been included in nonaccrual, past due, or restructured loans if such assets were loans.

16

The contractual maturities of loan categories at December 31, 2011, and the break down of those loans between fixed rate and floating rate loans are as follows:

	Principal Payments Due
	One Year Or Less		Over One Year Through Five Years		Over Five Years		Total
Commercial, financial, and agricultural	$	88,437	$	37,383	$	2,735	$	128,555
Real estate construction - residential		20,281		9,920		—		30,201
Real estate construction - commercial		30,284		16,188		1,225		47,697
Real estate mortgage - residential		45,603		97,594		60,257		203,454
Real estate mortgage - commercial		154,448		247,091		1,421		402,960
Installment loans to individuals		13,638		15,864		561		30,063
Total loans net of unearned income	$	352,691	$	424,040	$	66,199	$	842,930
Loans with fixed rates		291,734		393,268		21,461		706,463
Loans with floating rates		60,957		30,772		44,738		136,467
Total loans net of unearned income	$	352,691	$	424,040	$	66,199	$	842,930

Our 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 our Company has a non-recourse purchase commitment from the secondary market at a predetermined price. For the year ended December 31, 2011 our Company sold $74,983,000 loans to investors. At December 31, 2011 our Company was servicing approximately $307,016,000 of loans sold to the secondary market.

Real estate mortgage loans retained in our Company’s portfolio generally include provisions for rate adjustments at one to three year intervals. Commercial loans and real estate construction loans generally have maturities of less than one year. Installment loans to individuals are primarily fixed rate loans with maturities from one to five years.

Management along with the senior loan committee, and internal loan review, formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Currently, loans in excess of $2,000,000 in aggregate and all adversely classified credits identified by management as containing more than usual risk are reviewed. In addition, loans below the above scope are reviewed on a sample basis. On a monthly basis, the senior loan committee reviews and reports to the Board of Directors past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines which loans should be considered impaired. Management follows the guidance provided in the FASB’s ASC Topic 310, Accounting by Creditors for Impairment of a Loan, in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered necessary by management to provide for probable losses inherent in the loan portfolio.

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Nonperforming Assets

The following table summarizes our Company’s nonperforming assets at the dates indicated:

	Years Ended December 31,
(Dollars in thousands)	2011			2010			2009			2008			2007
Nonaccrual loans:
Commercial, financial, and agricultural	$	2,068		$	3,532		$	2,067		$	2,071		$	2,332
Real estate construction - residential		1,147			3,586			2,678			2,775			—
Real estate construction - commercial		7,867			10,067			9,277			7,572			866
Real estate mortgage - residential		4,153			5,672			6,692			4,345			658
Real estate mortgage - commercial		31,000			27,604			13,161			3,505			651
Installment loans to individuals		168			126			279			119			32
Total nonaccrual loans		46,403			50,587			34,154			20,387			4,539
Loans contractually past - due 90 days or more and still accruing:
Commercial, financial, and agricultural		—			—			2			140			265
Real estate construction - residential		—			—			—			—			—
Real estate construction - commercial		8			—			—			52			158
Real estate mortgage - residential		9			—			—						864
Real estate mortgage - commercial		36			—			—			547			189
Installment loans to individuals		1			33			—			4			70
Total loans contractually past - due 90 days or more and still accruing		54			33			2			743			1,546
Troubled debt restructurings - accruing		7,217			5,683			8,191			3,736			—
Total nonperforming loans		53,674			56,303			42,347			24,866			6,085
Other real estate		15,741			13,393			8,452			7,828			2,337
Repossessions		279			616			39			—			—
Total nonperforming assets	$	69,694		$	70,312		$	50,838		$	32,694		$	8,422
Loans	$	842,930		$	898,472		$	991,614		$	1,009,103		$	911,278
Allowance for loan losses to loans		1.64	%		1.62	%		1.49	%		1.26	%		1.02	%
Nonperforming loans to loans		6.37	%		6.27	%		4.27	%		2.46	%		0.67	%
Allowance for loan losses to nonperforming loans		25.73	%		25.87	%		34.94	%		50.94	%		152.54	%
Nonperforming assets to loans and foreclosed assets		8.11	%		7.71	%		5.08	%		3.21	%		0.92	%

Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and restructured loans totaled $53,674,000 or 6.37% of total loans at December 31, 2011 compared to $56,303,000 or 6.27% of total loans at December 31, 2010.

It is our Company’s policy to discontinue the accrual of interest income on loans when management believes that the borrower’s financial condition, after consideration of business conditions and collection efforts, is such that the collection of interest is doubtful, or upon which principal or interest has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectibles of such principal; otherwise, such receipts are recorded as interest income on a cash basis. Interest on nonaccrual loans, which would have been recorded under the original terms of the loans, was approximately $1,963,000, $2,552,000 and $1,726,000 for the years ended December 31, 2011, 2010 and 2009, respectively. Approximately $11,000, $22,000 and $158,000 was actually recorded as interest income on such loans for the year ended December 31, 2011, 2010 and 2009, respectively.

Total non-accrual loans at December 31, 2011 decreased $4,184,000 from December 31, 2010. The decrease from December 31, 2010 consisted of a $1,464,000 decrease in commercial, financial, and agricultural non-accrual loans, a $2,439,000 decrease in real estate construction — residential non-accrual loans, a $2,200,000 decrease in real estate construction — commercial non-accrual loans, and a $1,519,000 decrease in real estate mortgage — residential non-accrual loans. This decrease was partially offset by a $3,396,000 increase in real estate mortgage — commercial non-accrual loans. The decreases primarily resulted from the foreclosure of several loans with balances totaling $10,904,000 that had been in

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nonaccrual status as of December 31, 2010. Loan charge-offs resulted in an additional decline of approximately $9,203,000. The increase in real estate mortgage — commercial non-accrual loans resulted primarily from four significant loan relationships with balances totaling $7,700,000 at December 31, 2011 that were put on non-accrual status during 2011. At December 31, 2011, real estate mortgage — commercial non-accrual loans made up 67% of total non-accrual loans compared to 55% at December 31, 2010.

Loans past due 90 days and still accruing interest increased $21,000 from $33,000 at December 31, 2010 to $54,000 at December 31, 2011. Foreclosed real estate and other repossessions increased $2,011,000 from $14,009,000 at December 31, 2010 to $16,020,000 at December 31, 2011 primarily due to construction and land real estate foreclosures and real estate mortgage — commercial foreclosures.

At December 31, 2011, loans classified as troubled debt restructurings (TDR) totaled $32,165,000, of which $24,948,000 was on non-accrual status and $7,217,000 was on accrual status. At December 31, 2010, loans classified as TDR totaled $22,080,000, of which $16,397,000 was on non-accrual status and $5,683,000 was on accrual status. Current economic conditions negatively impact our borrowers’ ability to keep their debt payments current.

The following table summarizes our Company’s TDR’s at the dates indicated:

(Dollars in thousands)	December 31, 2011						December 31, 2010
Accruing TDRs	Number of contracts		Recorded Investment		Specific Reserves		Number of contracts		Recorded Investment		Specific Reserves
Commercial, financial and agricultural		9	$	2,360	$	120		3	$	128	$	20
Real estate construction - commercial		—		—		—		1		1,716		95
Real estate mortgage - residential		20		2,416		61		20		2,364		82
Real estate mortgage - commercial		3		2,441		—		4		1,475		14
Total		32	$	7,217	$	181		28	$	5,683	$	211
	2011						2010
TDRs - Non-accruals	Number of contracts		Recorded Investment		Specific Reserves		Number of contracts		Recorded Investment		Specific Reserves
Commercial, financial and agricultural		2	$	84	$	52		5	$	871	$	76
Real estate construction - commercial		8		6,227		321		2		1,210		—
Real estate mortgage - residential		9		1,278		108		6		1,092		67
Real estate mortgage - commercial		15		17,359		860		5		13,224		1,005
Total		34	$	24,948	$	1,341		18	$	16,397	$	1,148
Total TDRs		66	$	32,165	$	1,522		46	$	22,080	$	1,359

As of December 31, 2011 and December 31, 2010 approximately $11,673,000 and $19,658,000, respectively, of loans not included in the nonperforming asset table were identified by management as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. The $7,566,000 decrease in such substandard loans primarily resulted from four significant loan relationships totaling $7,700,000 that are now included in the impaired totals. Several borrowers are continuing to experience cash flow problems and as well as some deterioration in collateral value. Management believes the general allowance was sufficient to cover the risks and probable losses related to such loans at December 31, 2011 and 2010.

Provision and Allowance for Loan Losses

The provision for loan losses decreased $3,732,000 or 24.5% to $11,523,000 for 2011 compared to $15,255,000 for 2010 and followed a $6,901,000 or 82.6% increase for 2010 compared to 2009.

The current economy has contributed to the deterioration of collateral values. The economic downturn and elevated unemployment rates in our market area have impaired the ability for certain of our customers to make payments on our loans in accordance with contractual terms.

Our Company has taken an active approach to obtain current appraisals and has adjusted the provision to reflect the amounts management determined necessary to maintain the allowance for loan losses at a level necessary to cover

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probable losses in the loan portfolio. The allowance for loan losses decreased to $13,809,000 or 1.6% of loans outstanding at December 31, 2011 compared to $14,565,000 or 1.6% of loans outstanding at December 31, 2010. Charge-offs taken during 2011 and 2010 contributed to the decrease in the allowance for loan losses without being fully offset by new provisions as our Company works through its problem loans.

The following table summarizes loan loss experience for the years indicated:

	Years Ended December 31,
(Dollars in thousands)	2011			2010			2009			2008			2007
Analysis of allowance for loan losses:
Balance beginning of year	$	14,565		$	14,797		$	12,667		$	9,282		$	9,015
Charge-offs:
Commercial, financial, and agricultural		2,157			1,903			1,404			3,571			524
Real estate construction - residential		1,858			933			1,012			492			—
Real estate construction - commercial		512			4,556			450			189			56
Real estate mortgage - residential		1,883			4,534			2,673			417			413
Real estate mortgage - commercial		6,420			3,841			728			115			—
Installment loans to individuals		376			423			534			656			314
Total charge-offs		13,206			16,190			6,801			5,440			1,307
Recoveries:
Commercial, financial, and agricultural		193			153			213			153			141
Real estate construction - residential		65			30			5			34			—
Real estate construction - commercial		250			22			—			1			11
Real estate mortgage - residential		108			228			61			1			96
Real estate mortgage - commercial		103			29			4			80			14
Installment loans to individuals		208			241			294			345			158
Total recoveries		927			703			577			614			420
Net charge-offs		12,279			15,487			6,224			4,826			887
Provision for loan losses		11,523			15,255			8,354			8,211			1,154
Balance at end of year	$	13,809		$	14,565		$	14,797		$	12,667		$	9,282
Loans outstanding:
Average	$	865,214		$	949,457		$	1,002,829		$	963,252		$	848,772
End of period		842,930			898,472			991,614			1,009,104			911,278
Allowance for loan losses to loans outstanding:
Average		1.60	%		1.53	%		1.48	%		1.32	%		1.09	%
End of period		1.64			1.62			1.49			1.26			1.02
Net charge-offs to average loans outstanding		1.42			1.63			0.62			0.50			0.10

As shown in the table above, our Company’s net loan charge-offs were $12,279,000, or 1.42% of average loans, for 2011. In comparison net loan charge-offs were $15,487,000, or 1.63% of average loans, for 2010, and $6,224,000, or 0.62% of average loans, for 2009. Net charge-offs for 2011 continued to include significant write-downs on foreclosed properties to reflect current collateral values. Real estate construction — commercial net charge-offs decreased $4,272,000 to $262,000 for 2011 from $4,534,000 for 2010. Real estate mortgage — residential net charge-offs decreased $2,531,000 to $1,775,000 for 2011 from $4,306,000 for 2010. Net charge-offs for the year ended December 31, 2010 included $2,020,000, or 13% of total charge-offs for 2010, related to two significant loan relationships collateralized by section eight properties. Partially offsetting these decreases, real estate mortgage — commercial loan net charge-offs increased $2,505,000 to $6,317,000 at December 31, 2011, or 51% of total net charges-offs for 2011. One significant commercial loan relationship in the process of foreclosure for 2012 represented $3,800,000, or 31% of total net charge-offs for 2011. Additionally, real estate construction — residential net charge offs increased $890,000 to $1,793,000 for 2011 from $903,000 for 2010. The increase in real estate construction — residential net charge–offs was primarily due to charge-offs taken on two credits management had specifically reserved $2,000,000 as of December 31, 2010. Since these credits were fully reserved at December 31, 2010, no additional provision for these credits was required for 2011, and as a result, total net charge-offs exceeded the provision for 2011. Net loan charge-offs for 2010 primarily reflected write-downs taken on various loans and foreclosed properties to reflect current collateral values.

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The allowance for loan losses is available to absorb probable loan losses regardless of the category of loans to be charged off. The allowance for loan losses consists of asset-specific reserves, and general reserves based on expected loss estimates and unallocated reserves.

The asset-specific reserve component applies to loans evaluated individually for impairment and is primarily based on management’s best estimate of proceeds from liquidating collateral. The majority of our nonperforming loans are secured by real estate collateral. The actual timing and amount of repayments and the ultimate realizable value of the collateral may differ from management’s estimate.

The general reserve component is determined by applying percentages to pools of loans by asset type. These percentages are determined by using historical loss percentages. These expected loss estimates are sensitive to changes in delinquency status, realizable value of collateral, and other risk factors.

The unallocated portion of the allowance is based on management’s evaluation of conditions that are not directly reflected in the determination of the asset-specific component and the expected loss component discussed above. The evaluation of inherent loss with respect to these qualitative conditions is subject to a higher degree of uncertainty because they may not be identified with specific problem credits or portfolio segments. Conditions evaluated in connection with the unallocated portion of the allowance include general economic and business conditions affecting our key lending areas, credit quality trends (including trends in substandard loans expected to result from existing conditions), collateral values, specific industry conditions within portfolio segments, bank regulatory examination results, and findings of our internal loan review department. Management believes that based on detailed analysis of each credit risk inherent to our loan portfolio and the value of any associated collateral, that the allowance for loan losses at December 31, 2011 is a reasonable estimate of probable losses incurred at that date.

The underlying assumptions, estimates and assessments used by management to determine these components are continually evaluated and updated to reflect management’s current view of overall economic conditions and relevant factors impacting credit quality and inherent losses. Changes in such estimates could significantly impact the allowance and provision for credit losses. Our Company could experience credit losses that are different from the current estimates made by management.

The following table is a summary of the allocation of the allowance for loan losses as of the dates indicated:

	Years Ended December 31,
(Dollars in thousands)	2011			2010			2009			2008			2007
Allocation of allowance for loan losses at end of period:
Commercial, financial, and agricultural	$	1,804		$	2,931		$	2,773		$	1,712		$	3,762
Real estate construction - residential		1,188			2,067			348			—			—
Real estate construction - commercial		1,562			1,339			1,740			2,490			590
Real estate mortgage - residential		3,251			3,922			3,488			557			381
Real estate mortgage - commercial		5,734			3,458			4,693			6,014			3,492
Installment loans to individuals		267			231			380			391			419
Unallocated		3			617			1,375			1,503			638
Total	$	13,809		$	14,565		$	14,797		$	12,667		$	9,282
Percent of categories to total loans:
Commercial, financial, and agricultural		15.3	%		14.6	%		15.3	%		15.2	%		16.6	%
Real estate construction - residential		3.6			3.5			3.9			4.9			—
Real estate construction - commercial		5.7			6.2			7.9			7.9			16.2
Real estate mortgage - residential		24.1			23.2			23.4			23.4			23.1
Real estate mortgage - commercial		47.8			48.9			45.8			45.3			40.1
Installment loans to individuals		3.5			3.6			3.7			3.3			4.0
Total		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%

Our Company’s allowance for loan losses decreased $756,000 from December 31, 2010 to December 31, 2011. The overall decline of the allowance for loan losses primarily consisted of a $1,127,000 decrease in the allocation for commercial, financial, and agricultural loans, a $879,000 decrease in the allocation of real estate construction — residential loans, a $671,000 decrease in the allocation for real estate mortgage — residential loans, and was partially offset by a $2,276,000 increase in the allocation for real estate mortgage — commercial loans. The ratio of allowance for loan losses to nonperforming was 25.73% at December 31, 2011 compared to 25.87% at December 31, 2010. The percentage of allowance for loan losses to loans outstanding increased to 1.64% at December 31, 2011 compared to 1.62% at December 31, 2010 as a result of the decrease in period end loan balances of 6.2%.

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At December 31, 2011, management determined that $13,806,000 of the $13,809,000 total allowance for loan losses comprised of the asset-specific and expected loss components and $3,000 was unallocated. This is compared to $13,948,000 of the $14,565,000 total allowance for loan losses allocated to asset-specific and expected loss components and $617,000 that was unallocated at December 31,2010. The increase in the portion of the allowance for loan losses related to non asset-specific reserves is the result of management analyzing and assessing this portion of the allowance for loan losses on a detailed level by homogeneous loan categories for loans not considered impaired. Such analysis measured reserve requirements based on historical loss experiences of loans in those individual categories. Such reserve methodology considers the loss experience for certain types of loans and loan grades for the past twelve quarters.

The following table is a summary of the general and specific allocations within the allowance for loan losses:

	December 31,
(Dollars in thousands)	2011		2010
Allocation of allowance for loan losses:
Specific reserve allocation for impaired loans	$	3,747	$	6,376
General reserve allocation for all other non-impaired loans		10,062		8,189
Total	$	13,809	$	14,565

The asset-specific reserve component of our allowance for loan losses at December 31, 2011 was determined by using fair values of the underlying collateral through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. The general reserve component of our allowance for loan losses at December 31, 2011 was determined by calculating historical loss percentages for various loan categories over the previous twelve quarters. Management determined that the previous twelve quarters were reflective of the loss characteristics of our Company’s loan portfolio during the recent economic downturn. Management realizes there are inherent weaknesses in relying solely on historical loss percentages and also considers qualitative factors in determining the allowance for loan losses. Prior to the third quarter of 2011, qualitative factors, internally and externally not directly related to the asset-specific component and the expected loss component, were considered within the unallocated portion of the reserve. Internal factors management considers consist of underwriting standards, nature and volume of loans, lending staff experience, volume and severity of delinquencies and classified loans, loan review quality, value of underlying collateral, and concentrations of credit. Management also considers external factors such as economic conditions, market segments, regulatory and legal considerations, and competition. Beginning with the third quarter of 2011 analysis, management elected to further refine the methodology by distributing the previous quarter’s unallocated reserve throughout the call report classes of loans by adding qualitative adjustments in addition to the historical loss rate applied to determine the expected probable loss requirement for the current portfolio. The specific and general allocations represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

At December 31, 2011, the asset-specific reserve component decreased $2,629,000 due to a comparable decrease in the volume of impaired loans as well as the charge-off of two credits during the first quarter of 2011 for which management had specifically reserved approximately $2,000,000 as of December 31, 2010. During the same period, the general reserve component increased from $8,189,000 at December 31, 2010 to $10,062,000 at December 31, 2011 due to usage of a historical loss experience and qualitative measures reflective of our Company’s loss characteristics.

The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. Once the impairment amount is calculated, a specific reserve allocation is recorded. At December 31, 2011, $3,747,000 of our Company’s allowance for loan losses was allocated to impaired loans totaling approximately $53,619,000 compared to $6,376,000 of our Company’s allowance for loan losses allocated to impaired loans totaling approximately $56,271,000 at December 31, 2010. Based upon detailed analysis of all impaired loans, management has determined that $23,223,000, or 43%, of impaired loans required no reserve allocation at December 31, 2011 compared to $26,038,000, or 46%, at December 31, 2010.

Investment Portfolio

Our Company classifies its debt and equity securities into one of the following two categories:

Held-to-Maturity — includes investments in debt securities which our Company has the positive intent and ability to hold until maturity. Available-for-Sale — includes investments in debt and equity securities not classified as held to maturity or trading (i.e., investments which our Company has no present plans to sell in the near-term but may be sold in the future under different circumstances). Our Company’s investment portfolio consists of available-for-sale securities.

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Debt securities classified as held-to-maturity are carried at amortized cost, while debt and equity securities classified as available-for-sale are carried at estimated market value. Unrealized holding gains and losses from available-for-sale securities are excluded from earnings and reported, net of applicable taxes, as a separate component of stockholders’ equity until realized.

Our Company does not engage in trading activities and accordingly does not have any debt or equity securities classified as trading securities. Historically our Company’s practice had been to purchase and hold debt instruments until maturity unless special circumstances exist. However, since the investment portfolio’s major function is to provide liquidity and to balance our Company’s interest rate sensitivity position, all debt securities are classified as available-for-sale.

At December 31, 2011, our investment portfolio classified as available-for-sale represented 18.3% of total consolidated assets. Future levels of held-to-maturity and available-for-sale investment securities can be expected to vary depending upon liquidity and interest sensitivity needs as well as other factors.

The following table presents the composition of the investment portfolio by major category for the periods presented:

	December 31,
(In thousands)	2011		2010
U.S. treasury	$	2,054	$	1,028
Government sponsored enterprises		70,314		53,342
Asset-backed securities		107,329		90,176
Obligations of states and political subdivisions		34,109		34,432
Total available for sale debt securities	$	213,806	$	178,978

As of December 31, 2011 the maturity of debt securities in the investment portfolio was as follows:

(In thousands)	One Year Or Less			Over One Through Five Years			Over Five Through Ten Years			Over Ten Years			Total			Weighted Average Yield (1)
U.S. treasury	$	—		$	2,054		$	—		$	—		$	2,054			1.64	%
Government sponsored enterprises		—			70,314			—			—			70,314			1.67
Asset-backed (2)		7,069			86,686			13,574			—			107,329			3.22
States and political subdivisions (3)		2,452			10,181			19,682			1,794			34,109			4.59
Total available-for-sale debt securities	$	9,521		$	169,235		$	33,256		$	1,794		$	213,806			2.89	%
Weighted average yield (1)		3.58	%		2.68	%		3.81	%		4.65	%		2.89	%

(1) Weighted average yield is based on amortized cost.

(2) Asset-backed securities have been included using historic repayment speeds. Repayment speeds were determined from actual portfolio experience during the twelve months ended December 31, 2011 calculated separately for each mortgage-backed security. These repayment speeds are not necessarily indicative of future repayment speeds and are subject to change based on changing mortgage interest rates.

(3) Rates on obligations of states and political subdivisions have been adjusted to fully taxable equivalent rates using the statutory Federal income tax rate of 34%.

At December 31, 2011 $131,000 of debt securities classified as available-for-sale in the table above had variable rate provisions with adjustment periods ranging from one week to twelve months.

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The following non-marketable securities are restricted securities which, lacking a market, are carried at cost. These securities are reported in other assets. At December 31, 2011, $2,738,000 of the total included Federal Home Loan Bank (Des Moines) stock held by the Bank in accordance with debt and regulatory requirements. Other non-marketable securities include an $1,486,000 equity investment in our Company’s unconsolidated Exchange Statutory Trusts. (See Note 8 to our Company’s consolidated financials for further explanation on the Exchange Statutory Trusts.)

	December 31,
(In thousands)	2011		2010
Federal Home Loan Bank of Des Moines Stock	$	2,738	$	4,495
Midwest Independent Bank Stock		151		151
Federal Agricultural Mortgage Corporation		10		10
Investment in unconsolidated trusts		1,486		1,486
Total non-marketable investment securities	$	4,385	$	6,142

Liquidity and Capital Resources

Liquidity Management

The role of liquidity management is to ensure 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 the 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 our Company, management prefers to focus on transaction accounts and full service relationships with customers. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than the market rate.

Our Company’s Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for our 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 our Company’s liquidity.

Our Company has a number of sources of funds to meet liquidity needs on a daily basis. Our Company’s most liquid assets are comprised of available for sale investment securities, federal funds sold, and securities purchased under agreements to resell, and excess reserves held at the Federal Reserve as follows:

	December 31,
(dollars in thousands)	2011		2010
Federal funds sold	$	75	$	126
Federal Reserve - excess reserves		19,997		29,286
Available for sale investments securities		213,806		178,978
Total	$	233,878	$	208,390

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 $213,806,000 at December 31, 2011 and included an unrealized net gain of $5,582,000. The portfolio includes maturities of approximately $9,521,000 over the next twelve months, which offer resources to meet either new loan demand or reductions in our Company’s deposit base.

Our 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 required by law.

At December 31, 2011, total investment securities pledged for these purposes were as follows:

	December 31,
(dollars in thousands)	2011		2010
Investment securities pledged for the purpose of securing:
Federal Reserve Bank borrowings	$	1,819	$	3,262
Repurchase agreements		29,656		45,929
Other Deposits		140,972		98,908
Total pledged, at fair value	$	172,447	$	148,099

At December 31, 2011 and 2010, our Company’s unpledged securities in the available for sale portfolio totaled approximately $41,359,000 and $30,879,000, respectively.

24

Liquidity is available from our Company’s base of core customer deposits, defined as demand, interest, checking, savings, and money market deposit accounts. At December 31, 2011, such deposits totaled $543,786,000 and represented 56.7% of our Company’s total deposits. These core deposits are normally less volatile and are often tied to other products of our Company through long lasting relationships. Time deposits and certificates of deposit of $100,000 and over totaled $414,438,000 at December 31, 2011. These accounts are normally considered more volatile and higher costing representing 43.3% of total deposits at December 31, 2011.

	December 31,
(dollars in thousands)	2011		2010
Core deposit base:
Non-interest bearing demand	$	159,187	$	137,750
Interest checking		169,452		160,225
Savings and money market		215,147		218,912
Total	$	543,786	$	516,887

Other components of liquidity are the level of borrowings from third party sources and the availability of future credit. Our Company’s outside borrowings are comprised of securities sold under agreements to repurchase, FHLB advances, and subordinated notes as follows:

	December 31,
(dollars in thousands)	2011		2010
Borrowings:
Securities sold under agreements to repurchase	$	24,516	$	30,068
FHLB advances		28,410		66,986
Subordinated notes		49,486		49,486
Total	$	102,412	$	146,540

Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which our Company maintains approved credit lines. As of December 31, 2011, under agreements with these unaffiliated banks, the Bank may borrow up to $15,000,000 in federal funds on an unsecured basis and $19,918,000 on a secured basis. There were no federal funds purchased outstanding at December 31, 2011. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of our Company’s investment portfolio. At December 31, 2011 there was $24,516,000 in repurchase agreements. Our Company may periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window; although no such borrowings were outstanding at the year end. The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB). As a member of the FHLB, the Bank has access to credit products of the FHLB. As of December 31, 2011, the Bank had $28,410,000 in outstanding borrowings with the FHLB. In addition, our Company has $49,486,000 in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts.

Our 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 borrow from these entities. Based on the type and value of collateral pledged, our Company may draw advances against this collateral. The following table reflects the advance equivalent of the assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to our Company at December 31, 2011:

	December 31, 2011
(dollars in thousands)	FHLB			Federal Reserve Bank		Federal Funds Purchased Lines
Advance equivalent	$	259,081		$	1,783	$	33,135
Advances outstanding		(28,410	)		—		—
Letters of credit issued		(206	)		—		—
Total	$	230,465		$	1,783	$	33,135

At December 31, 2011, loans with a market value of $426,274,000 were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At December 31, 2011, investments with a market value of $24,687,000 were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.

25

Sources and Uses of Funds

As loan demand has declined and overnight borrowing rates remain at historic lows, management has expanded our investment portfolio to keep excess cash minimized. A deposit reclassification program was implemented in January of 2011 that lowered the Federal Reserve account requirement, improving liquidity, and enabling our Company to lower cash balances maintained at the Federal Reserve and invest in higher yielding investment securities.

Cash and cash equivalents were $43,210,000 at December 31, 2011 compared to $50,980,000 at December 31, 2010. The $7,770,000 decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of our Company, as shown in the accompanying consolidated statement of cash flows for the year ended December 31, 2011. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $20,832,000 for the year ended 2011.

Investing activities consisting mainly of purchases, sales and maturities of available for sale securities, and changes in the level of the loan portfolio, provided cash flow of $6,381,000. The cash inflow primarily consisted of a $32,298,000 decrease in the loan portfolio, $91,108,000 in proceeds from maturities, calls, and pay-downs of investment securities, and $7,435,000 in proceeds from sales of other real estate owned and repossessions, partially offset by $122,871,000 purchases of investment securities and $3,393,00 purchases of premises and equipment.

Financing activities used total cash of $34,983,000, resulting primarily from a $38,576,000 net repayment of FHLB advances, a decrease of $5,552,000 of federal funds purchased and securities sold under agreements to repurchase, a net $9,876,00 decrease in time deposits and interest-bearing transaction accounts, partially offset by a $21,437,000 increase in demand deposits. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during 2012.

In the normal course of business, our Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through our Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of our Company’s liquidity. In the section entitled, Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements, below we disclose that our Company had $120,163,000 in unused loan commitments and standby letters of credit as of December 31, 2011. While this commitment level would be difficult to fund given our Company’s current liquidity resources, we know that the nature of these commitments are such that the likelihood of such a funding demand is very low.

Our Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. On December 19, 2008, as part of our Company’s participation in the U.S. Treasury Department’s Capital Purchase Program (CPP), our Company issued 30,255 shares of senior preferred stock and a ten year warrant to purchase approximately 265,471 shares of common stock to the U.S. Department of Treasury in exchange for $30,255,000. See Note 12 to our Company’s consolidated financial statements. Our Company’s ongoing liquidity needs primarily include funding its operating expenses and paying cash dividends to its common and preferred shareholders. For the years ended December 31, 2011 and 2010, respectively, our Company paid cash dividends to its common and preferred shareholders totaling $2,417,000 and $2,898,000. A large portion of our Company’s liquidity is obtained from the Bank in the form of dividends. For the year ended December 31, 2011 the Bank declared and paid $5,000,000 of dividends to our Company. At December 31, 2011 and 2010, our Company had cash and cash equivalents totaling $13,282,000 and $12,449,000 respectively.

Capital Management

Risk-based capital guidelines for financial institutions were adopted by regulatory authorities effective January 1, 1991. These guidelines are designed to relate regulatory capital requirements to the risk profiles of the specific institutions and to provide more uniform requirements among the various regulators. Our Company is required to maintain a minimum risk-based capital to risk-weighted assets ratio of 8.00%, with at least 4.00% being “Tier 1” capital. In addition, a minimum leverage ratio, Tier 1 capital to adjusted total assets, of 3.00% must be maintained. However, for all but the most highly rated financial institutions, a leverage ratio of 3.00% plus an additional cushion of 100 to 200 basis points is expected.

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	2011			2010			2009			Well-Capitalized Regulatory Guidelines
Risk-based capital ratios:
Total capital		18.03	%		17.05	%		16.49	%		10.00	%
Tier I capital		15.16			14.25			14.01			6.00
Leverage ratio		11.52			11.00			11.35			5.00

Commitments, Contractual Obligations, and Off-Balance Sheet Arrangements

The required payments of time deposits and other borrowed money, not including interest, at December 31, 2011 are as follows:

	Payments due by Period
(Dollars in thousands)	Total		Less than 1 Year		1-3 Years		3-5 Years		Over 5 Years
Time deposits	$	414,439	$	266,517	$	127,939	$	19,983	$	—
Other borrowed money		28,410		8,284		10,126		—		10,000

In the normal course of business, our Company is party to activities that contain credit, market and operational risk that are not reflected in whole or in part in our Company’s consolidated financial statements. Such activities include traditional off-balance sheet credit related financial instruments.

Our Company provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Summarized credit-related financial instruments, including both commitments to extend credit and letters of credit at December 31, 2011 are as follows:

	Amount of Commitment Expiration per Period
(Dollars in thousands)	Total		Less than 1 Year		1-3 Years		3-5 Years		Over 5 Years
Unused loan commitments	$	117,171	$	94,255	$	13,932	$	2,083	$	6,901
Standby letters of credit		2,992		2,693		60		217		22

Since many of the unused commitments are expected to expire or be only partially used, the total amount of commitments in the preceding table does not necessarily represent future cash requirements.

Quantitative and Qualitative Disclosures About Market Risk

Interest Sensitivity

Our Company’s exposure to market risk is reviewed on a monthly basis by our Company’s Asset/Liability Committee and Board of Directors. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent and that the goal is to identify and minimize those risks. Tools used by our Bank’s management include the standard gap report subject to different rate shock scenarios. At December 31, 2011, the rate shock scenario models indicated that annual net interest income could change by as much as (25.4)% to 36.0% should interest rates rise or fall, respectively, within 400 basis points from their current level over a one year period. However there are no assurances that the change will not be more or less than this estimate. Management further believes this is an acceptable level of risk.

The following table represents the estimated interest rate sensitivity and periodic and cumulative gap positions calculated as of December 31, 2011. Significant assumptions used for this table included: loans will repay at historic repayment rates; certain interest-bearing demand accounts are interest sensitive due to immediate repricing, and fixed maturity deposits will not be withdrawn prior to maturity. A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the table.

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(Dollars in thousands)	Year 1			Year 2		Year 3		Year 4		Year 5		Over 5 years or no stated Maturity		Total
ASSETS
Investment securities	$	50,639		$	20,593	$	60,213	$	38,883	$	16,778	$	26,700	$	213,806
Interest-bearing deposits		20,267			—		—		—		—		—		20,267
Other restricted investments		4,385			—		—		—		—		—		4,385
Federal funds sold and securities purchased under agreements to resell		75			—		—		—		—		—		75
Loans		439,572			172,399		147,966		22,885		33,362		26,746		842,930
Total	$	514,938		$	192,992	$	208,179	$	61,768	$	50,140	$	53,446	$	1,081,463
LIABILITIES
Savings, Now deposits	$	—		$	—	$	154,807	$	—	$	—	$	—	$	154,807
Rewards checking, Super Now, money market deposits		229,792											—		229,792
Time deposits		266,517			93,209		34,730		8,811		11,172		—		414,439
Federal funds purchased and securities sold under agreements to repurchase		24,516			—		—		—		—		—		24,516
Subordinated notes		49,486			—		—		—		—		—		49,486
Other borrowed money		18,305			10,105		—		—		—		—		28,410
Total	$	588,616		$	103,314	$	189,537	$	8,811	$	11,172	$	—	$	901,450
Interest-sensitivity GAP
Periodic GAP	$	(73,678	)	$	89,678	$	18,642	$	52,957	$	38,968	$	53,446	$	180,013
Cumulative GAP	$	(73,678	)	$	16,000	$	34,642	$	87,599	$	126,567	$	180,013	$	180,013
Ratio of interest-earnings assets to interest-bearing liabilities
Periodic GAP		0.87			1.87		1.10		7.01		4.49		NM		1.20
Cumulative GAP		0.87			1.02		1.04		1.10		1.14		1.20		1.20

Impact of New Accounting Standards

Other Comprehensive Income In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. The new guidance removes the presentation options in ASC 220 and requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. ASU 2011-05 does not change the items that must be reported in other comprehensive income. ASU 2011-05 is effective for periods beginning January 1, 2012 and requires retrospective application. The ASU does not change the components of other comprehensive income, the timing of items reclassified to net income, or the net income basis for income per share calculations.

In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting in Accounting Standards Update No. 2011-05 (Topic 220), which defers the requirement within ASU No. 2011-05 to present the reclassification amounts from other comprehensive income to net income as a separate component on the income statement. Until the FASB has reached a resolution, entities are required to report reclassification out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05.

Fair Value Measurements In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to substantially converge the guidance in U.S. GAAP and IFRS on fair value measurements and disclosures. The amended guidance changes several aspects of the

28

fair value measurement guidance ASC 820, Fair Value Measurement, and includes several new fair value disclosure requirements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a material impact on our Company’s consolidated financial statements.

Repurchase Agreements In April 2011, the FASB issued ASU 2011-03, Consideration of Effective Control on Repurchase Agreements, which deals with the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 changes the rules for determining when these transactions should be accounted for as financings, as opposed to sales. The guidance in ASU 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The adoption of ASU 2011-03 is not expected to have a material impact on our Company’s consolidated financial statements.

Troubled Debt Restructurings In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. The provisions of ASU No. 2011-02 provide a creditor additional guidance in determining whether a restructuring constitutes a troubled debt restructuring by concluding that both the following conditions exist (1) a creditor has granted a concession, and (2) the borrower is experiencing financial difficulties. A provision in ASU No. 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by ASU No. 2010-20. The provisions of ASU No. 2011-02 were adopted for our Company’s reporting period ending September 30, 2011 and required retrospective application to all restructurings occurring during 2011 along with additional required disclosures. Under the guidance for identifying TDR’s provided in the ASU, our Company identified 10 additional loans as a result of the adoption. See Note 2 for further discussion.

Credit Quality of Financing Receivables and the Allowance for Credit Losses In July 2010, the FASB issued ASU No. 2010-20 — Receivables (ASC Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU requires expanded credit risk disclosures intended to provide investors with greater transparency regarding the allowance for credit losses and the credit quality of financing receivables. Under this ASU, companies are required to provide more information about the credit quality of their financing receivables in the disclosures to financial statements, such as aging information, credit quality indicators, changes in the allowance for credit losses, and the nature and extent of troubled debt restructurings and their effect on the allowance for credit losses. Both new and existing disclosures must be disaggregated by portfolio segment or class based on the level of disaggregation that management uses when assessing its allowance for credit losses and managing its credit exposure. The disclosures as of the end of a reporting period are effective for annual periods ending on or after December 15, 2010. The disclosures about activities that occur during a reporting period are effective for annual reporting periods beginning on or after December 15, 2010. The disclosures required by this update are reported in the notes to our Company’s consolidated financial statements.

Effects of Inflation

The effects of inflation on financial institutions are different from the effects on other commercial enterprises since financial institutions make few significant capital or inventory expenditures which are directly affected by changing prices. Because bank assets and liabilities are virtually all monetary in nature, inflation does not affect a financial institution as much as do changes in interest rates. The general level of inflation does underlie the general level of most interest rates, but interest rates do not increase at the rate of inflation as do prices of goods and services. Rather, interest rates react more to changes in the expected rate of inflation and to changes in monetary and fiscal policy.

Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase capital at higher than normal rates to maintain an appropriate capital to asset ratio. In the opinion of management, inflation did not have a significant effect on our Company’s operations for the three years ended December 31, 2011.

29

CONSOLIDATED FINANCIAL STATEMENTS

The following consolidated financial statements of our Company and report of our Company’s independent auditors appear on the pages indicated.

	Page
Report of Independent Registered Public Accounting Firm.		31
Consolidated Balance Sheets as of December 31, 2011 and 2010.		32
Consolidated Statements of Operations for each of the years ended December 31, 2011, 2010 and 2009.		33
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for each of the years ended December 31, 2011, 2010 and 2009.		34
Consolidated Statements of Cash Flows for each of the years ended December 31, 2011, 2010 and 2009.		35-36
Notes to the Consolidated Financial Statements.		37

30

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Hawthorn Bancshares, Inc.:

We have audited the accompanying consolidated balance sheets of Hawthorn Bancshares, Inc. and subsidiaries (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hawthorn Bancshares, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Hawthorn Bancshares, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 30, 2012 expressed an unqualified opinion on the effectiveness of Hawthorn Bancshares Inc.’s internal control over financial reporting.

/s/ KPMG LLP

St. Louis, Missouri

March 30, 2012

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	December 31,
	2011			2010
ASSETS
Loans	$	842,930,548		$	898,472,463
Allowances for loan losses		(13,809,224	)		(14,564,867	)
Net loans		829,121,324			883,907,596
Investment in available-for-sale securities, at fair value		213,806,001			178,977,550
Federal funds sold and securities purchased under agreements to resell		75,000			125,815
Cash and due from banks		43,134,530			50,853,985
Premises and equipment - net		37,953,372			36,980,503
Other real estate owned and repossessed assets - net		16,020,023			14,009,017
Accrued interest receivable		5,340,610			5,733,684
Mortgage servicing rights		2,308,377			2,355,990
Intangible assets - net		542,746			977,509
Cash surrender value - life insurance		2,064,452			2,001,965
Other assets		20,794,988			24,248,590
Total assets	$	1,171,161,423		$	1,200,172,204
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Non-interest bearing demand	$	159,186,859		$	137,749,571
Savings, interest checking and money market		384,598,688			379,137,539
Time deposits $100,000 and over		139,504,648			124,566,760
Other time deposits		274,933,958			305,208,786
Total deposits		958,224,153			946,662,656
Federal funds purchased and securities sold under agreements to repurchase		24,516,277			30,068,453
Subordinated notes		49,486,000			49,486,000
Federal Home Loan Bank advances		28,409,989			66,985,978
Accrued interest payable		1,054,202			1,491,503
Other liabilities		6,895,029			3,989,303
Total liabilities		1,068,585,650			1,098,683,893
Stockholders’ equity:
Preferred stock, $0.01 par value per share, 1,000,000 shares authorized; Issued 30,255 shares, $1,000 per share liquidation value, net of discount		29,317,716			28,841,242
Common stock, $1 par value Authorized 15,000,000 shares; issued 4,814,852 and 4,635,891 shares respectively		4,814,852			4,635,891
Surplus		30,265,992			28,928,545
Retained earnings		40,354,112			41,857,302
Accumulated other comprehensive income, net of tax		1,339,919			742,149
Treasury stock; 161,858 shares, at cost		(3,516,818	)		(3,516,818	)
Total stockholders’ equity		102,575,773			101,488,311
Total liabilities and stockholders’ equity	$	1,171,161,423		$	1,200,172,204

See accompanying notes to the consolidated financial statements.

32

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

	Years ended December 31,
	2011		2010			2009
INTEREST INCOME
Interest and fees on loans	$	47,360,717	$	53,088,943		$	57,409,274
Interest on debt securities:
Taxable		4,864,256		4,214,192			4,495,259
Nontaxable		1,029,473		1,173,805			1,441,418
Interest on federal funds sold and securities purchased under agreements to resell		87		193			373
Interest on interest-bearing deposits		57,877		85,913			52,761
Dividends on other securities		155,937		175,634			163,533
Total interest income		53,468,347		58,738,680			63,562,618
INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market		1,644,328		2,170,718			3,017,488
Time deposit accounts $100,000 and over		1,663,147		2,484,929			3,862,075
Other time deposit accounts		5,122,927		7,211,251			10,542,476
Interest on federal funds purchased and securities sold under agreements to repurchase		47,033		75,402			88,573
Interest on subordinated notes		1,301,178		1,525,553			2,446,742
Interest on Federal Home Loan Bank advances		1,074,232		2,284,649			3,016,872
Total interest expense		10,852,845		15,752,502			22,974,226
Net interest income		42,615,502		42,986,178			40,588,392
Provision for loan losses		11,523,338		15,255,000			8,354,000
Net interest income after provision for loan losses		31,092,164		27,731,178			32,234,392
NON-INTEREST INCOME
Service charges on deposit accounts		5,565,772		5,553,532			5,864,090
Trust department income		897,854		803,132			814,988
Gain on sale of mortgage loans, net		1,649,309		2,493,465			2,973,630
Other		1,087,524		1,630,589			1,049,441
Total non-interest income		9,200,459		10,480,718			10,702,149
INVESTMENT SECURITIES GAINS, NET		—		—			605,716
NON-INTEREST EXPENSE
Salaries and employee benefits		17,982,147		17,898,448			17,457,123
Occupancy expense, net		2,700,780		2,531,847			2,335,496
Furniture and equipment expense		2,019,469		1,996,837			2,286,014
FDIC insurance assessment		1,106,771		1,651,052			2,518,743
Legal, examination, and professional fees		1,331,708		1,441,063			1,221,861
Advertising and promotion		1,102,918		1,256,302			1,272,046
Postage, printing, and supplies		1,157,865		1,201,072			1,168,290
Processing expense		3,193,101		3,353,354			3,419,939
Other real estate expense		2,735,714		9,803,809			1,188,972
Other		3,513,736		3,716,665			3,861,896
Total non-interest expense		36,844,209		44,850,449			36,730,380
Income (loss) before income taxes		3,448,414		(6,638,553	)		6,811,877
Income tax (benefit) expense		591,144		(3,086,813	)		1,856,120
Net income (loss)		2,857,270		(3,551,740	)		4,955,757
Preferred stock dividends		1,512,750		1,512,750			1,516,952
Accretion of discount on preferred stock		476,474		476,474			476,474
Net income (loss) available to common shareholders	$	868,046	$	(5,540,964	)	$	2,962,331
Basic earnings (loss) per share	$	0.19	$	(1.19	)	$	0.64
Diluted earnings (loss) per share	$	0.19	$	(1.19	)	$	0.64

See accompanying notes to the consolidated financial statements.

33

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

	Preferred Stock		Common Stock		Surplus		Retained Earnings			Accumulated other Comprehensive Income (Loss)			Treasury Stock			Total Stock - holders’ Equity
Balance, December 31, 2008	$	27,888,294	$	4,298,353	$	25,144,323	$	51,598,678		$	1,005,553		$	(3,516,818	)	$	106,418,383
Net income		—		—		—		4,955,757			—			—			4,955,757
Change in unrealized gain (loss) on securities:
Unrealized loss on debt securities available-for-sale, net of tax		—		—		—		—			(277,903	)		—			(277,903	)
Adjustment on sales and calls of debt securities, net of tax		—		—		—		—			(369,487	)		—			(369,487	)
Defined benefit pension plans:
Net gain arising during the year, net of tax		—		—		—		—			511,634			—			511,634
Amortization of prior service cost included in net periodic pension cost, net of tax		—		—		—		—			42,427			—			42,427
Total other comprehensive loss																	(93,329	)
Total comprehensive income																	4,862,428
Stock based compensation expense		—		—		130,459		—			—			—			130,459
Accretion of preferred stock discount		476,474		—		—		(476,474	)		—			—			—
Stock dividend		—		165,460		1,695,963		(1,861,423	)		—			—			—
Cash dividends declared, preferred stock								(1,369,879	)								(1,369,879	)
Cash dividends declared, common stock		—		—		—		(2,270,108	)		—			—			(2,270,108	)
Balance, December 31, 2009	$	28,364,768	$	4,463,813	$	26,970,745	$	50,576,551		$	912,224		$	(3,516,818	)	$	107,771,283
Net loss		—		—		—		(3,551,740	)		—			—			(3,551,740	)
Change in unrealized gain (loss) on securities:
Unrealized loss on debt securities available-for-sale, net of tax		—		—		—		—			(389,428	)		—			(389,428	)
Defined benefit pension plans:
Net gain arising during the year, net of tax		—		—		—		—			171,388			—			171,388
Amortization of prior service cost included in net periodic pension cost, net of tax		—		—		—		—			47,965			—			47,965
Total other comprehensive loss																	(170,075	)
Total comprehensive loss																	(3,721,815	)
Stock based compensation expense		—		—		87,310		—			—			—			87,310
Accretion of preferred stock discount		476,474		—		—		(476,474	)		—			—			—
Stock dividend		—		172,078		1,870,490		(2,042,568	)		—			—			—
Cash dividends declared, preferred stock								(1,512,750	)								(1,512,750	)
Cash dividends declared, common stock		—		—		—		(1,135,717	)		—			—			(1,135,717	)
Balance, December 31, 2010	$	28,841,242	$	4,635,891	$	28,928,545	$	41,857,302		$	742,149		$	(3,516,818	)	$	101,488,311
Net income		—		—		—		2,857,270			—			—			2,857,270
Change in unrealized gain on securities:
Unrealized gain on debt securities available-for-sale, net of tax		—		—		—		—			2,380,142			—			2,380,142
Defined benefit pension plans:
Net loss arising during the year, net of tax		—		—		—		—			(1,830,335	)		—			(1,830,335	)
Amortization of prior service cost included in net periodic pension cost, net of tax		—		—		—		—			47,963			—			47,963
Total other comprehensive income																	597,770
Total comprehensive income																	3,455,040
Stock based compensation expense		—		—		57,874		—			—			—			57,874
Accretion of preferred stock discount		476,474		—		—		(476,474	)		—			—			—
Stock dividend		—		178,961		1,279,573		(1,458,534	)		—			—			—
Cash dividends declared, preferred stock		—		—		—		(1,512,750	)		—			—			(1,512,750	)
Cash dividends declared, common stock		—		—		—		(912,702	)		—			—			(912,702	)
Balance, December 31, 2011	$	29,317,716	$	4,814,852	$	30,265,992	$	40,354,112		$	1,339,919		$	(3,516,818	)	$	102,575,773

See accompanying notes to the consolidated financial statements

34

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

	Years ended December 31,
	2011			2010			2009
Cash flows from operating activities:
Net income (loss)	$	2,857,270		$	(3,551,740	)	$	4,955,757
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		11,523,338			15,255,000			8,354,000
Depreciation expense		1,940,319			1,963,842			2,044,257
Net amortization (accretion) of debt securities, premiums, and discounts		836,955			698,420			524,639
Amortization of intangible assets		434,763			526,477			626,111
Stock based compensation expense		57,874			87,310			130,459
(Gain) loss on sales and dispositions of premises and equipment		(12,633	)		59,716			137,209
Loss (gain) on sales and dispositions of other real estate owned and repossessions		206,337			2,310,734			(27,158	)
Provision for other real estate owned		1,251,466			6,158,433			—
Decrease in accrued interest receivable		393,074			891,873			850,536
Increase in cash surrender value - life insurance		(62,487	)		(72,055	)		(77,008	)
Decrease (increase) in other assets		1,042,111			(124,729	)		(4,419,959	)
Decrease in accrued interest payable		(437,301	)		(946,618	)		(1,409,294	)
Increase (decrease) in other liabilities		161,386			30,164			(730,764	)
Gain on sales of debt securities		—			—			(605,716	)
Origination of mortgage loans for sale		(73,271,617	)		(104,001,793	)		(150,628,000	)
Proceeds from the sale of mortgage loans		74,982,503			106,547,681			153,601,630
Gain on sale of mortgage loans, net		(1,649,309	)		(2,493,465	)		(2,973,630	)
Decrease (increase) in net deferred tax asset		461,624			(2,298,860	)		(1,016,107	)
Other, net		116,205			415,823			414,193
Net cash provided by operating activities		20,831,878			21,456,213			9,751,155
Cash flows from investing activities:
Net decrease in loans		32,297,544			53,925,733			4,283,403
Purchase of available-for-sale debt securities		(122,871,083	)		(189,081,925	)		(156,459,542	)
Proceeds from maturities of available-for-sale debt securities		36,922,899			114,899,133			115,169,758
Proceeds from calls of available-for-sale debt securities		54,184,650			46,795,100			24,237,200
Proceeds from sales of available-for-sale debt securities		—			—			12,546,609
Purchase of FHLB stock		—			(392,300	)		—
Proceeds from sales of FHLB stock		1,757,100			1,003,900			2,121,700
Purchases of premises and equipment		(3,392,639	)		(549,285	)		(2,369,890	)
Proceeds from sales of premises and equipment		47,549			34,528			632,165
Proceeds from sales of other real estate owned and repossessions		7,435,005			9,689,435			6,168,067
Net cash provided by investing activities		6,381,025			36,324,319			6,329,470
Cash flows from financing activities:
Net increase in demand deposits		21,437,288			2,731,931			9,772,439
Net increase in interest-bearing transaction accounts		5,461,149			24,853,535			11,657,302
Net decrease in time deposits		(15,336,940	)		(37,245,608	)		(20,403,333	)
Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchase		(5,552,176	)		(6,576,981	)		7,506,811
Proceeds from Federal Home Loan Bank advances		—			10,000,000			20,145,000
Repayment of Federal Home Loan Bank advances		(38,575,989	)		(22,331,324	)		(69,885,181	)
Cash dividends paid - preferred stock		(1,512,750	)		(1,512,750	)		(1,369,879	)
Cash dividends paid - common stock		(903,755	)		(1,385,230	)		(2,665,557	)
Net cash used by financing activities		(34,983,173	)		(31,466,427	)		(45,242,398	)
Net (decrease) increase in cash and cash equivalents		(7,770,270	)		26,314,105			(29,161,773	)
Cash and cash equivalents, beginning of year		50,979,800			24,665,695			53,827,468
Cash and cash equivalents, end of year	$	43,209,530		$	50,979,800		$	24,665,695

See accompanying notes to the consolidated financial statements.

35

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (continued)

	Years ended December 31,
	2011		2010		2009
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	11,290,146	$	16,699,120	$	24,383,520
Income taxes	$	665,000	$	800,000	$	1,487,000
Supplemental schedule of noncash investing and financing activities:
Other real estate and repossessions acquired in settlement of loans	$	10,903,813	$	23,676,706	$	6,982,125

See accompanying notes to consolidated financial statements.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(1) Summary of Significant Accounting Policies

Hawthorn Bancshares, Inc. (the Company) provides a broad range of banking services to individual and corporate customers located within the communities in and surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri. The Company is subject to competition from other financial and nonfinancial institutions providing financial products. Additionally, the Company and its subsidiaries are subject to the regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies.

The consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting (U.S. GAAP) principles and conform to predominant practices within the banking industry. The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions, including the determination of the allowance for loan losses, values of real estate acquired in connection with foreclosure or in satisfaction of loans, and fair values of investment securities available-for-sale that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial statements.

On July 1, 2011, the Company paid a special stock dividend of four percent to common shareholders of record at the close of business on May 12, 2011. For all periods presented, share information, including basic and diluted earnings (loss) per share, have been adjusted retroactively to reflect this change.

The significant accounting policies used by the Company in the preparation of the consolidated financial statements are summarized below:

Principles of Consolidation

In December of 2008 and March of 2010, the Company formed Hawthorn Real Estate, LLC, and Real Estate Holdings of Missouri, LLC, respectively, (the Real Estate Companies); both are wholly owned subsidiaries of the Company. The consolidated financial statements include the accounts of the Company, Hawthorn Bank (the Bank), and the Real Estate Companies. All significant intercompany accounts and transactions have been eliminated in consolidation.

Loans

Loans which the Company has the intent and ability to hold for the foreseeable future or maturity are held for investment at their stated unpaid principal balance amount less unearned income and the allowance for loan losses. Income on loans is accrued on a simple-interest basis. Loan origination fees and certain direct costs are deferred and recognized over the life of the loan as an adjustment to yield.

Non-Accrual Loans

Loans are placed on nonaccrual status when management believes that the borrower’s financial condition, after consideration of business conditions and collection efforts, is such that collection of interest is doubtful. Loans that are contractually 90 day days past due as to principal and/or interest payments are generally placed on non-accrual, unless they are both well-secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and/or the borrower demonstrates the ability to pay and remain current.

Restructured Loans

A modified or restructured loan is accounted for as a troubled debt restructuring (TDR) for any loans in which concessions are made to the borrower for economic or legal reasons that the Company would not otherwise consider and the borrower is experiencing financial difficulty. Once a loan has been classified as a TDR it remains a TDR for the life of the loan. The Company includes all accruing and non-accruing TDR’s in the impaired and non-performing asset totals. TDR’s are measured for impairment loss by using fair values of the underlying collateral obtained through independent appraisals and internal evaluations, or by discounting the total expected future cash flows.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Impaired Loans

A loan is considered impaired when it is probable the Company will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. Included in impaired loans are all non-accrual loans and loans whose terms have been modified in a troubled debt restructuring. Impaired loans are individually evaluated for impairment based on fair values of the underlying collateral, obtained through independent appraisals or internal valuations for a collateral dependent loan, or by discounting the total expected future cash flows.

Loans Held for Sale

The Bank originates certain loans which are sold in the secondary mortgage market. These long-term, fixed-rate loans are typically classified as held for sale upon origination based upon management’s intent to sell. For loans with servicing rights retained, immediately upon locking in an interest rate, the Company enters into an agreement to sell the mortgage loan without recourse. At December 31, 2011 there were no mortgage loans that were held for sale in comparison to $62,000 at December 31, 2010.

Mortgage loan servicing fees earned on loans sold are reported as income when the related loan payments are collected net of amortization from mortgage servicing rights. Operational costs to service such loans are charged to expense as incurred.

Allowance/ Provision for Loan Losses

The allowance for loan losses is available to absorb probable loan losses regardless of the category of loan to be charged off. The allowance for loan losses consists of asset-specific reserves, and reserves based on expected loss estimates.

Management follows the guidance provided in FASB’s ASC Topic 310, Accounting by Creditors for Impairment of a Loan, in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, to determine specific reserves as further discussed below. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration.

The asset-specific reserve component of the Company’s allowance for loan losses at December 31, 2011 was measured by fair values of the underlying collateral through independent appraisals, internal evaluations, or by discounting the total expected future cash flows. The general reserve component of the Company’s allowance for loan losses at December 31, 2011 was determined by calculating historical loss percentages for various loan categories over the previous twelve quarters. Management determined that the previous twelve quarters were reflective of the loss characteristics of the Company’s loan portfolio during the recent three year economic downturn. These historical loss percentages were then applied to the various categories of loans to determine an expected loss requirement for the current portfolio. Prior to 2010, the historical loss percentage for non-impaired loans was based on a blend between industry standards and the Company’s five year loss experience.

The unallocated portion of the allowance is based on management’s evaluation of conditions that are not directly reflected in the determination of the asset-specific component and the expected loss component discussed above. The evaluation of incurred loss with respect to these qualitative conditions is subject to a higher degree of uncertainty because they may not be identified with specific problem credits or portfolio segments. Conditions evaluated in connection with the unallocated portion of the allowance include general economic and business conditions affecting the Company’s key lending areas, credit quality trends (including trends in substandard loans expected to result from existing conditions), collateral values, specific industry conditions within portfolio segments, bank regulatory examination results, and findings of the internal loan review department.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The underlying assumptions, estimates and assessments used by management to determine these components are continually evaluated and updated to reflect management’s current view of overall economic conditions and relevant factors impacting credit quality and inherent losses. Changes in such estimates could significantly impact the allowance and provision for credit losses. The Company could experience credit losses that are different from the current estimates made by management.

Loans, or portions of loans, are charged off to the extent deemed uncollectible. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. Once the fair value for a collateral dependent loan has been determined, any impaired amount is typically charged off unless the loan has other income streams to support repayment. For impaired loans which have other income streams to support repayment, a specific reserve is established for the amount determined to be impaired.

Investment in Debt and Equity Securities

At the time of purchase, debt securities are classified into one of two categories: available-for-sale or held-to-maturity. Held-to-maturity securities are those securities which the Company has the positive intent and ability to hold until maturity. All debt securities not classified as held-to-maturity are classified as available-for-sale. The Company’s securities are classified as available-for-sale and are carried at fair value. Changes in fair value, excluding certain losses associated with other-than-temporary impairment, are reported in other comprehensive income, net of taxes, a component of stockholders’ equity. Securities are periodically evaluated for other-than-temporary impairment in accordance with guidance provided in the FASB ASC Topic 320, Investments — Debt and Equity Securities. For those securities with other-than-temporary impairment, the entire loss in fair value is required to be recognized in current earnings if the Company intends to sell the securities or believes it more likely than not that it will be required to sell the security before the anticipated recovery. If neither condition is met, but the Company does not expect to recover the amortized cost basis, the Company determines whether a credit loss has occurred, which is then recognized in current earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Premiums and discounts are amortized using the interest method over the lives of the respective securities, with consideration of historical and estimated prepayment rates for mortgage-backed securities, as an adjustment to yield. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale are included in earnings based on the specific identification method for determining the cost of securities sold.

Capital Stock of the Federal Home Loan Bank

The Bank, as a member of the Federal Home Loan Bank System administered by the Federal Housing Finance Board, is required to maintain an investment in the capital stock of the Federal Home Loan Bank of Des Moines (FHLB) in an amount equal to 12 basis points of the Bank’s year-end total assets plus 4.45% of advances from the FHLB to the Bank. These investments are recorded at cost, which represents redemption value.

Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation. Depreciation applicable to buildings and improvements and furniture and equipment is charged to expense using straight-line and accelerated methods over the estimated useful lives of the assets. Such lives are estimated to be 5 to 40 years for buildings and improvements and 3 to 15 years for furniture and equipment. Maintenance and repairs are charged to expense as incurred.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Intangible Assets

Intangible assets that have indefinite useful lives are not amortized, but tested annually for impairment. Intangible assets that have finite useful lives, such as core deposit intangibles and mortgage servicing rights, are amortized over their estimated useful lives. Core deposit intangibles are amortized over periods of 7 to 8 years representing their estimated lives using straight line and accelerated methods. Mortgage servicing rights are amortized using straight line over the shorter of 7 years or the life of the loan.

When facts and circumstances indicate potential impairment of amortizable intangible assets, the Company evaluates the recoverability of the carrying value based upon future cash flows expected to result from the use of the underlying asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying value of the underlying asset, the Company recognizes an impairment loss. The impairment loss recognized represents the amount by which the carrying value of the underlying asset exceeds the fair value of the underlying asset.

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 initially recorded as held for sale at the lower of the loan balance or fair value of the collateral less estimated selling costs. Any adjustment is recorded as a charge-off against the allowance for loan losses. The Company relies on external appraisals and assessment of property values by 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. The write-downs are recorded as other real estate expense. The Company establishes a valuation allowance related to other real estate owned on an asset-by-asset basis. The valuation allowance is created during the holding period when the fair value less cost to sell is lower than the “cost” of a parcel of other real estate.

Pension Plan

The Company provides a noncontributory defined benefit pension plan for all full-time employees. The benefits are based on age, years of service and the level of compensation during the employees highest ten years of compensation before retirement. Net periodic costs are recognized as employees render the services necessary to earn the retirement benefits. The Company records annual amounts relating to its pension plan based on calculations that incorporate various actuarial and other assumptions including discount rates, mortality, assumed rates of return, compensation increases and turnover rates. The Company reviews its assumptions on an annual basis and may make modifications to the assumptions based on current rates and trends when it is appropriate to do so. The Company believes that the assumptions utilized in recording its obligations under its plan are reasonable based on its experience and market conditions.

The Company follows authoritative guidance included in the FASB ASC Topic 715, Compensation — Retirement Plans under the subtopic Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. ASC Topic 715 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its consolidated balance sheet and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. This guidance also requires an employer to measure the funded status of a plan as of the date of its fiscal year-end, with limited exceptions. Additional disclosures are required to provide users with an understanding of how investment allocation decisions are made, major categories of plan assets, and fair value measurement of plan assets as defined in ASC Topic 820, Fair Value Measurements and Disclosures.

40

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

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 the 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 forwards 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, the 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, the Company would reverse the valuation allowance when the realization of the deferred tax asset is more likely than not. In addition, the Company is subject to the continuous examination of its tax returns by the Internal Revenue Service and other taxing authorities. The Company accrues for penalties and interest related to income taxes in income tax expense. At December 31, 2010, total accrued interest was $31,000 and total interest expense recognized for the year ended 2010 was $24,000. As of December 31, 2011, the Company released $28,000 of interest accrued related to the release of $221,000 of uncertain tax provisions.

Trust Department

Property held by the Bank in a fiduciary or agency capacity for customers is not included in the accompanying consolidated balance sheets, since such items are not assets of the Company. Trust department income is recognized on the accrual basis.

Consolidated Statements of Cash Flows

For the purpose of the consolidated statements of cash flows, cash and cash equivalents consist of short-term federal funds sold and securities sold or purchased under agreements to resell, interest earning deposits with banks, cash, and due from banks.

Stock-Based Compensation

The Company’s stock-based employee compensation plan is described in Note 11, Stock Compensation. In accordance with FASB ASC Topic 718, Compensation — Stock Compensation, the Company measures the cost of the stock-based compensation based on the grant-date fair value of the award, recognizing the cost over the requisite service period. The fair value of an award is estimated using the Black-Scholes option-pricing model. The expense recognized is based on an estimation of the number of awards for which the requisite service is expected to be rendered, and is included in salaries and employee benefits in the accompanying consolidated statements of operations. The standard also requires that excess tax benefits related to stock option exercises be reflected as financing cash inflows instead of operating cash inflows.

Treasury Stock

The purchase of the Company’s common stock is recorded at cost. Purchases of the stock are made both in the open market and through negotiated private purchases based on market prices. At the date of subsequent reissue, the treasury stock account is reduced by the cost associated with such stock on a first-in-first-out basis.

Comprehensive Income

The Company reports comprehensive income (loss) in the consolidated statements of stockholders’ equity and comprehensive income (loss).

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Reclassifications

Certain prior year information has been reclassified to conform to the current year presentation.

Impact of New Accounting Standards

Other Comprehensive Income In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. The new guidance removes the presentation options in ASC 220 and requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. ASU 2011-05 does not change the items that must be reported in other comprehensive income. ASU 2011-05 is effective for periods beginning January 1, 2012 and requires retrospective application. The ASU does not change the components of other comprehensive income, the timing of items reclassified to net income, or the net income basis for income per share calculations.

In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting in Accounting Standards Update No. 2011-05 (Topic 220), which defers the requirement within ASU No. 2011-05 to present the reclassification amounts from other comprehensive income to net income as a separate component on the income statement. Until the FASB has reached a resolution, entities are required to report reclassification out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05.

Fair Value Measurements In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to substantially converge the guidance in U.S. GAAP and IFRS on fair value measurements and disclosures. The amended guidance changes several aspects of the fair value measurement guidance ASC 820, Fair Value Measurement, and includes several new fair value disclosure requirements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a material impact on the Company’s consolidated financial statements.

Repurchase Agreements In April 2011, the FASB issued ASU 2011-03, Consideration of Effective Control on Repurchase Agreements, which deals with the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 changes the rules for determining when these transactions should be accounted for as financings, as opposed to sales. The guidance in ASU 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The adoption of ASU 2011-03 is not expected to have a material impact on the Company’s consolidated financial statements.

Troubled Debt Restructurings In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. The provisions of ASU No. 2011-02 provide a creditor additional guidance in determining whether a restructuring constitutes a troubled debt restructuring by concluding that both the following conditions exist (1) a creditor has granted a concession, and (2) the borrower is experiencing financial difficulties. A provision in ASU No. 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by ASU No. 2010-20. The provisions of ASU No. 2011-02 were adopted for the Company’s reporting period ending September 30, 2011 and required retrospective application to all restructurings occurring during 2011 along with additional required disclosures. Under the guidance for identifying TDR’s provided in the ASU, the Company identified 10 additional loans as a result of the adoption. See Note 2 for further discussion.

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AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Credit Quality of Financing Receivables and the Allowance for Credit Losses In July 2010, the FASB issued ASU No. 2010-20 — Receivables (ASC Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU requires expanded credit risk disclosures intended to provide investors with greater transparency regarding the allowance for credit losses and the credit quality of financing receivables. Under this ASU, companies are required to provide more information about the credit quality of their financing receivables in the disclosures to financial statements, such as aging information, credit quality indicators, changes in the allowance for credit losses, and the nature and extent of troubled debt restructurings and their effect on the allowance for credit losses. Both new and existing disclosures must be disaggregated by portfolio segment or class based on the level of disaggregation that management uses when assessing its allowance for credit losses and managing its credit exposure. The disclosures as of the end of a reporting period are effective for annual periods ending on or after December 15, 2010. The disclosures about activity that occur during a reporting period are effective for annual reporting periods beginning on or after December 15, 2010. The disclosures required by this update are reported in the notes to the Company’s consolidated financial statements.

(2) Loans and Allowance for Loan Losses

A summary of loans, by major class within the Company’s loan portfolio, at December 31, 2011 and 2010 are as follows:

	2011		2010
Commercial, financial, and agricultural	$	128,555,173	$	131,382,467
Real estate construction - residential		30,201,198		31,834,174
Real estate construction - commercial		47,696,759		56,052,910
Real estate mortgage - residential		203,454,204		207,834,488
Real estate mortgage - commercial		402,960,327		439,068,622
Installment and other consumer		29,883,986		32,132,336
Unamortized loan origination fees and costs, net		178,901		167,466
Total loans	$	842,930,548	$	898,472,463

The Bank grants real estate, commercial, installment, and other consumer 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 and other consumer loans consist primarily of the financing of vehicles. At December 31, 2011, loans with a carrying value of $432,478,000 were pledged at Federal Home Loan Bank as collateral for borrowings and letters of credit.

The following is a summary of activity in 2011 of loans made by the Bank to executive officers and directors or to entities in which such individuals had a beneficial interest. Such loans were made in the normal course of business on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the same time for comparable transactions with other persons, and did not involve more than the normal risk of collectability or present unfavorable features.

Balance at December 31, 2010	$	2,263,065
New loans		1,585,721
Amounts collected		(658,749	)
Balance at December 31, 2011	$	3,190,037

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Allowance for loan losses

The following is a summary of the allowance for loan losses for the years ended December 31, 2011, 2010 and 2009 is as follows:

(in thousands)	Commercial, Financial, and Agricultural			Real Estate Construction - Residential			Real Estate Construction - Commercial			Real Estate Mortgage - Residential			Real Estate Mortgage - Commercial			Installment Loans to Individuals			Unallocated			Total
Allowance for loan losses:
Balance, 12-31-08	$	1,712		$	1,355		$	1,135		$	2,931		$	3,640		$	391		$	1,503		$	12,667
Additions:
Provision for loan losses		2,252			—			1,055			3,169			1,777			229			(128	)		8,354
Deductions:
Loans charged off		1,404			1,012			450			2,673			728			534			—			6,801
Less recoveries on loans		(213	)		(5	)		—			(61	)		(4	)		(294	)		—			(577	)
Net loans charged off		1,191			1,007			450			2,612			724			240			—			6,224
Balance, 12-31-09	$	2,773		$	348		$	1,740		$	3,488		$	4,693		$	380		$	1,375		$	14,797
Additions:
Provision for loan losses		1,908			2,622			4,133			4,740			2,577			32			(758	)		15,254
Deductions:
Loans charged off		1,903			933			4,556			4,534			3,841			422			—			16,189
Less recoveries on loans		(153	)		(30	)		(22	)		(228	)		(29	)		(241	)		—			(703	)
Net loans charged off		1,750			903			4,534			4,306			3,812			181			—			15,486
Balance, 12-31-10	$	2,931		$	2,067		$	1,339		$	3,922		$	3,458		$	231		$	617		$	14,565
Additions:
Provision for loan losses		837			914			485			1,104			8,593			204			(614	)		11,523
Deductions:
Loans charged off		2,157			1,858			512			1,883			6,420			376			—			13,206
Less recoveries on loans		(193	)		(65	)		(250	)		(108	)		(103	)		(208	)		—			(927	)
Net loans charged off		1,964			1,793			262			1,775			6,317			168			—			12,279
Balance, 12/31/11	$	1,804		$	1,188		$	1,562		$	3,251		$	5,734		$	267		$	3		$	13,809

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The following table provides the balance in the allowance for loan losses at December 31, 2011 and 2010, and the related loan balance by impairment methodology. Loans evaluated under ASC 310-10-35 include loans on non-accrual status, which are individually evaluated for impairment, troubled debt restructurings, and other impaired loans deemed to have similar risk characteristics. All other loans are collectively evaluated for impairment under ASC 450-20. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb credit losses.

For the Year Ended December 31, 2011
(in thousands)	Commercial, Financial, and Agricultural		Real Estate Construction - Residential		Real Estate Construction - Commercial		Real Estate Mortgage - Residential		Real Estate Mortgage - Commercial		Installment Loans to Individuals		Unallocated		Total
Allowance for loan losses:
Individually evaluated for impairment	$	239	$	166	$	380	$	653	$	2,309	$	—	$	—	$	3,747
Collectively evaluated for impairment		1,565		1,022		1,182		2,598		3,425		267		3		10,062
Total	$	1,804	$	1,188	$	1,562	$	3,251	$	5,734	$	267	$	3	$	13,809
Loans outstanding:
Individually evaluated for impairment	$	4,428	$	1,147	$	7,867	$	6,569	$	33,440	$	—	$	—	$	53,451
Collectively evaluated for impairment		124,127		29,054		39,830		196,885		369,520		30,063		—		789,479
Total	$	128,555	$	30,201	$	47,697	$	203,454	$	402,960	$	30,063	$	—	$	842,930
For the Year Ended December 31, 2010
(in thousands)	Commercial, Financial, and Agricultural		Real Estate Construction - Residential		Real Estate Construction - Commercial		Real Estate Mortgage - Residential		Real Estate Mortgage - Commercial		Installment Loans to Individuals		Unallocated		Total
Allowance for loan losses:
Individually evaluated for impairment	$	1,737	$	1,553	$	201	$	1,117	$	1,768	$	—	$	—	$	6,376
Collectively evaluated for impairment		1,194		514		1,138		2,805		1,690		231		617		8,189
Total	$	2,931	$	2,067	$	1,339	$	3,922	$	3,458	$	231	$	617	$	14,565
Loans outstanding:
Individually evaluated for impairment	$	3,660	$	3,586	$	11,783	$	8,040	$	29,076	$	—	$	—	$	56,145
Collectively evaluated for impairment		127,722		28,248		44,270		199,795		409,993		32,299		—		842,327
Total	$	131,382	$	31,834	$	56,053	$	207,835	$	439,069	$	32,299	$	—	$	898,472

Loans, or portions of loans, are charged off to the extent deemed uncollectible. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. Once the fair value for a collateral dependent loan has been determined, any impaired amount is typically charged off unless the loan has other income streams to support repayment. For impaired loans which have other income streams to support repayment, a specific reserve is established for the amount determined to be impaired.

Impaired loans

Impaired loans totaled $53,619,534 and $56,270,543 at December 31, 2011 and 2010 respectively, and are comprised of loans on non-accrual status and loans which have been classified as troubled debt restructurings.

The categories of impaired loans at December 31, 2011 and 2010 are as follows:

	2011		2010
Non-accrual loans	$	46,402,747	$	50,586,887
Troubled debt restructurings continuing to accrue interest		7,216,787		5,683,656
Total impaired loans	$	53,619,534	$	56,270,543

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The following table provides additional information about impaired loans at December 31, 2011 and 2010, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided:

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Recognized For the Year Ended 12/31/2011
At December 31, 2011
With no related allowance recorded:
Commercial, financial and Agricultural	$	3,546,088	$	3,625,113	$	—	$	3,510,156	$	51,893
Real estate - construction residential		584,034		788,152		—		1,272,564		—
Real estate - construction commercial		1,458,346		1,755,248		—		3,567,873		—
Real estate - residential		2,315,344		2,653,979		—		3,596,694		25,774
Real estate - commercial		15,150,920		21,189,966		—		18,269,985		73,601
Consumer		168,257		177,332		—		189,722		3,622
Total	$	23,222,989	$	30,189,790	$	—	$	30,406,994	$	154,890
With an allowance recorded:
Commercial, financial and Agricultural	$	881,585	$	904,168	$	238,840	$	654,874	$	17,285
Real estate - construction residential		562,760		562,760		166,300		46,897		—
Real estate - construction commercial		6,408,713		6,448,100		379,921		5,805,604		—
Real estate - residential		4,254,023		4,265,660		653,279		3,202,511		112,932
Real estate - commercial		18,289,464		18,779,725		2,309,226		12,723,918		—
Total	$	30,396,545	$	30,960,413	$	3,747,566	$	22,433,804	$	130,217
Total impaired loans	$	53,619,534	$	61,150,203	$	3,747,566	$	52,840,798	$	285,107
At December 31, 2010
With no related allowance recorded:
Commercial, financial and Agricultural	$	441,861	$	629,296	$	—	$	1,250,446	$	1,293
Real estate - construction residential		1,769,622		2,355,936		—		2,533,863		2,003
Real estate - construction commercial		8,297,388		9,393,368		—		15,889,842		475
Real estate - residential		2,463,735		2,950,560		—		5,269,211		13,480
Real estate - commercial		12,939,973		14,869,833		—		24,373,677		476,932
Consumer		125,858		132,688		—		149,971		4,219
Total	$	26,038,437	$	30,331,681	$	—	$	49,467,010	$	498,402
With an allowance recorded:
Commercial, financial and Agricultural	$	3,217,995	$	3,260,009	$	1,737,159	$	1,243,084	$	19,544
Real estate - construction residential		1,816,276		1,848,593		1,552,406		460,869		—
Real estate - construction commercial		3,485,517		4,740,517		201,147		4,363,077		42,824
Real estate - residential		5,576,292		5,669,041		1,117,141		3,662,862		115,609
Real estate - commercial		16,136,025		16,215,862		1,767,893		4,554,688		8,325
Total	$	30,232,106	$	31,734,022	$	6,375,746	$	14,284,580	$	186,302
Total impaired loans	$	56,270,543	$	62,065,703	$	6,375,746	$	63,751,590	$	684,704

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AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Interest income recognized on loans in non-accrual status and contractual interest that would have been recorded had the loans performed in accordance with their original contractual terms is as follows:

	2011		2010		2009
Contractual interest due on non-accrual loans	$	1,962,972	$	2,551,645	$	1,726,395
Interest income recognized on loans in non-accrual status		10,588		22,356		158,124
Net reduction in interest income	$	1,952,384	$	2,529,289	$	1,568,271

The specific reserve component of the Company’s allowance for loan losses at December 31, 2011 and 2010 was determined by using fair values of the underlying collateral obtained through independent appraisals and internal evaluations, or by discounting the total expected future cash flows. The recorded investment varies from the unpaid principal balance primarily due to partial charge-offs taken resulting from current appraisals received. The amount recognized as interest income on impaired loans continuing to accrue interest, primarily related to troubled debt restructurings, was $274,519, $662,348, and $436,787, for the years ended December 31, 2011, 2010, and 2009, respectively. The average recorded investment in impaired loans is calculated on a monthly basis during the years reported.

Delinquent and Non-Accrual Loans

The delinquency status of loans is determined based on the contractual terms of the notes. Borrowers are generally classified as delinquent once payments become 30 days or more past due. The following table provides aging information for the Company’s past due and non-accrual loans at December 31, 2011 and 2010.

	Current or Less Than 30 Days Past Due		30 - 89 Days Past Due		90 Days Past Due And Still Accruing		Non-Accrual		Total
December 31, 2011
Commercial, Financial, and Agricultural	$	126,244,521	$	242,672	$	—	$	2,067,980	$	128,555,173
Real Estate Construction - Residential		29,054,404		—		—		1,146,794		30,201,198
Real Estate Construction - Commercial		39,821,946		—		7,754		7,867,059		47,696,759
Real Estate Mortgage - Residential		195,779,337		3,513,373		8,566		4,152,928		203,454,204
Real Estate Mortgage - Commercial		371,000,415		923,704		36,479		30,999,729		402,960,327
Installment and Other Consumer		29,281,191		612,461		978		168,257		30,062,887
Total	$	791,181,814	$	5,292,210	$	53,777	$	46,402,747	$	842,930,548
December 31, 2010
Commercial, Financial, and Agricultural	$	127,315,586	$	534,865	$	—	$	3,532,016	$	131,382,467
Real Estate Construction - Residential		28,200,876		47,400		—		3,585,898		31,834,174
Real Estate Construction - Commercial		45,511,088		474,934		—		10,066,888		56,052,910
Real Estate Mortgage - Residential		199,386,784		2,775,654		—		5,672,050		207,834,488
Real Estate Mortgage - Commercial		409,906,845		1,557,599		—		27,604,178		439,068,622
Installment and Other Consumer		31,784,217		356,812		32,916		125,857		32,299,802
Total	$	842,105,396	$	5,747,264	$	32,916	$	50,586,887	$	898,472,463

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AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Credit Quality

The following table provides information about the credit quality of the loan portfolio using the Company’s internal rating system reflecting management’s risk assessment. Recent reviews by the Company’s credit officer identified areas of concern that resulted in heightened attention being given to reducing concentrations of credit and, in particular, to strengthening credit quality and administration. Loans are placed on watch status when (1) one or more weaknesses which could jeopardize timely liquidation exits; or (2) the margin or liquidity of an asset is sufficiently tenuous that adverse trends could result in a collection problem. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified may have a well defined weakness or weaknesses that jeopardize the repayment of the debt. Such loans are characterized by the distinct possibility that the company may sustain some loss if the deficiencies are not corrected. It is the Company’s policy to discontinue the accrual of interest income on loans when management believes such that the collection of interest or principal is doubtful. Loans are placed on non-accrual status when (1) deterioration in the financial condition of the borrower exists for which payment of full principal and interest is not expected, or (2) upon which principal or interest has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income on a cash basis.

	Commercial		Real Estate Construction - Residential		Real Estate Construction - Commercial		Real Estate Mortgage - Residential		Real Estate Mortgage - Commercial		Installment and other Consumer		Total
At December 31, 2011
Watch	$	22,206,456	$	9,644,326	$	9,337,768	$	13,231,006	$	24,392,448	$	557,278	$	79,369,282
Substandard		4,141,582		842,063		1,189,122		4,268,914		8,003,868		444,003		18,889,552
Non-accrual		2,067,980		1,146,794		7,867,059		4,152,928		30,999,729		168,257		46,402,747
Total	$	28,416,018	$	11,633,183	$	18,393,949	$	21,652,848	$	63,396,045	$	1,169,538	$	144,661,581
At December 31, 2010
Watch	$	21,981,367	$	7,519,394	$	9,400,584	$	9,184,659	$	35,050,206	$	564,489	$	83,700,699
Substandard		2,840,703		757,637		4,242,934		4,423,219		12,635,163		441,514		25,341,170
Non-accrual		3,532,016		3,585,898		10,066,888		5,672,050		27,604,178		125,857		50,586,887
Total	$	28,354,086	$	11,862,929	$	23,710,406	$	19,279,928	$	75,289,547	$	1,131,860	$	159,628,756

Troubled Debt Restructurings

At December 31, 2011, loans classified as troubled debt restructurings (TDRs) totaled $32,165,238, of which $24,948,451 was on non-accrual status and $7,216,787 was on accrual status. At December 31, 2010, loans classified as TDRs totaled $22,080,431, of which $16,397,775 was on non-accrual status and $5,683,656 was on accrual status. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. Accordingly, specific reserves of $1,522,422 and $1,359,079 were allocated to the allowance for loan losses at December 31, 2011 and December 31, 2010, respectively. As a result of adopting the amendments in Accounting Standards Update (ASU) No. 2011-02 — Receivables (ASC Topic 310) — A Creditor’s Determination of Whether a restructuring Is a Troubled Debt Restructuring, the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as TDRs. Based upon the provisions of this standard, the Company determined that 10 loans totaling $10,377,700 not previously classified as troubled debt restructurings met the definition of a troubled debt restructuring set forth under the ASU 2011-02. In all cases, these loans had previously been, and continue to be, classified as impaired. As each loan had been previously identified as impaired, an impairment review had been performed with respect to each loan and appropriate provisions for loan loss had been provided in prior periods.

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AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The following table summarizes loans that were modified as TDRs during the year ended December 31, 2011:

	The Year Ended December 31, 2011
	Recorded Investment (1)
	Number of Contracts		Pre- Modification		Post- Modification
Troubled Debt Restructurings
Commercial, financial and agricultural		9	$	3,500,192	$	3,485,661
Real estate construction - commercial		8		6,616,223		6,227,302
Real estate mortgage - residential		7		1,157,063		1,009,716
Real estate mortgage - commercial		9		9,552,474		9,215,406
Total		33	$	20,825,952	$	19,938,085

(1) The amounts reported post-modification are inclusive of all partial pay-downs and charge-offs, and no portion of the debt was forgiven. Loans modified as a TDR that were fully paid down, charged-off or foreclosed upon during the period ended are not reported.

According to guidance provided in ASC subtopic 310-40, Troubled Debt Restructurings by Creditors, a loan restructuring or modification of terms is a TDR if the creditor for economic or legal reasons related to the borrowers financial difficulties grants a concession to the borrower that it would not otherwise consider. The Company’s portfolio of loans classified as TDRs include concessions such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is ultimately repaid in full, charged-off, or foreclosed and sold. The Company considers a loan in TDR status in default when the borrowers payment according to the modified terms is at least 90 days past due or has defaulted due to expiration of the loans maturity date. During the year ended December 31, 2011, thirty-three loans were modified meeting the criteria for troubled debt restructurings. During this time period none of these 2011 TDRs have subsequently defaulted based on their restructured terms.

(3) Real Estate Acquired in Settlement of Loans

	December 31, 2011			December 31, 2010
Commercial	$	17,150		$	67,421
Real estate construction - residential		306,863			294,960
Real estate construction - commercial		13,649,784			12,934,239
Real estate mortgage - residential		2,120,721			2,777,614
Real estate mortgage - commercial		6,623,580			3,476,607
Total	$	22,718,098		$	19,550,841
Less valuation allowance for other real estate owned		(6,976,985	)		(6,158,433	)
Total	$	15,741,113		$	13,392,408
Balance at December 31, 2010				$	19,550,841
Additions, net of charge-offs					10,447,979
Proceeds from sales					(6,841,293	)
Net loss on sales					(439,429	)
Total other real estate owned				$	22,718,098
Less valuation allowance for other real estate owned					(6,976,985	)
Balance at December 31, 2011				$	15,741,113

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AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Activity in the valuation allowance for other real estate owned in settlement of loans for the years ended December 31, 2011, 2010, and 2009, respectively, is summarized as follows:

	The Year Ended December 31,
	2011			2010		2009
Balance, beginning of period	$	6,158,433		$	—	$	—
Provision for other real estate owned		1,251,466			6,158,433		—
Charge-offs		(432,914	)		—		—
Balance, end of period	$	6,976,985		$	6,158,433	$	—

(4) Investment Securities

A summary of investment securities by major category, at fair value, consisted of the following at December 31, 2011 and 2010.

	2011		2010
U.S. treasury	$	2,054,102	$	1,027,891
Government sponsored enterprises		70,313,978		53,341,551
Asset-backed securities		107,328,618		90,176,241
Obligations of states and political subdivisions		34,109,303		34,431,867
Total available for sale securities	$	213,806,001	$	178,977,550

All of the Company’s investment securities are classified as available for sale, as discussed in more detail below. Asset backed securities include agency mortgage-backed securities, which are guaranteed by government sponsored agencies such as the FHLMC, FNMA and GNMA. The Company does not invest in subprime originated mortgage-backed or collateralized debt obligation instruments.

Investment securities which are classified as restricted equity securities primarily consist of Federal Home Loan Bank Stock and the Company’s interest in statutory trusts. These securities are reported at cost in other assets in the amount of $4,384,850 and $6,141,950, as of December 31, 2011 and 2010 respectively.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The amortized cost and fair value of debt securities classified as available-for-sale at December 31, 2011 and 2010 are as follows:

	Amortized cost			Gross unrealized gains		Gross unrealized losses		Fair value
December 31, 2011
U.S. Treasury	$	1,999,643		$	54,459	$	—	$	2,054,102
Government sponsored enterprises		69,703,105			628,888		18,015		70,313,978
Asset-backed securities		103,805,717			3,546,712		23,811		107,328,618
Obligations of states and political subdivisions		32,716,023			1,393,874		594		34,109,303
Total available for sale securities	$	208,224,488		$	5,623,933	$	42,420	$	213,806,001
Weighted average yield at end of period		2.89	%
	Amortized cost			Gross unrealized gains		Gross unrealized losses		Fair value
December 31, 2010
U.S Treasury	$	999,823		$	28,068	$	—	$	1,027,891
Government sponsored enterprises		53,516,545			327,051		502,045		53,341,551
Asset-backed securities		88,634,760			1,905,377		363,896		90,176,241
Obligations of states and political subdivisions		34,146,782			555,240		270,155		34,431,867
Total available for sale securities	$	177,297,910		$	2,815,736	$	1,136,096	$	178,977,550
Weighted average yield at end of period		3.37	%

The amortized cost and fair value of debt securities classified as available-for-sale at December 31, 2011, 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 cost		Fair value
Due in one year or less	$	2,441,553	$	2,452,493
Due after one year through five years		81,561,345		82,549,044
Due after five years through ten years		18,713,149		19,682,253
Due after ten years		1,702,724		1,793,593
		104,418,771		106,477,383
Asset-backed securities		103,805,717		107,328,618
Total	$	208,224,488	$	213,806,001

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Debt securities with carrying values aggregating approximately $172,447,000 and $148,099,000 at December 31, 2011 and 2010, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

	2011		2010		2009
Proceeds from sales	$	—	$	—	$	12,546,609
Gains		—		—		605,716
Losses		—		—		—
Net gains	$	—	$	—	$	605,716

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 December 31, 2011 and 2010, were as follows:

	Less than 12 months					12 months or more							Total
At December 31, 2011	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Number of Investment Positions		Fair Value		Unrealized Losses
Government sponsored enterprises	$	13,250,239	$	(18,015	)	$	—	$	—			13	$	13,250,239		(18,015	)
Asset-backed securities		4,591,075		(23,811	)		—		—			5		4,591,075	$	(23,811	)
Obligations of states and political subdivisions		229,089		(300	)		150,279		(294	)		2		379,368		(594	)
	$	18,070,403	$	(42,126	)	$	150,279	$	(294	)		20	$	18,220,682	$	(42,420	)
	Less than 12 months					12 months or more							Total
At December 31, 2010	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Number of Investment Positions		Fair Value		Unrealized Losses
Government sponsored enterprises	$	20,504,526	$	(502,045	)	$	—	$	—			19	$	20,504,526		(502,045	)
Asset-backed securities		21,177,793		(363,896	)		—		—			20		21,177,793	$	(363,896	)
Obligations of states and political subdivisions		8,038,946		(270,155	)		—		—			29		8,038,946		(270,155	)
	$	49,721,265	$	(1,136,096	)	$	—	$	—			68	$	49,721,265	$	(1,136,096	)

The Company’s available for sale portfolio consisted of approximately 365 securities at December 31, 2011. One of these securities with an unrealized loss of $294 had been in the loss position for 12 months or longer. The $42,000 unrealized loss included in other comprehensive income at December 31, 2011 was caused by interest rate fluctuations. The Company’s available for sale portfolio consisted of approximately 333 securities at December 31, 2010. None of these securities had been in the loss position for 12 months or longer. The $1,136,000 unrealized loss included in other comprehensive income at December 31, 2010 was caused by interest rate fluctuations. Because the decline in fair value is attributable to changes in interest rates and not credit quality these investments were not considered other-than-temporarily impaired at December 31, 2011 and 2010.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(5) Premises and Equipment

A summary of premises and equipment at December 31, 2011 and 2010 is as follows:

	2011		2010
Land and land improvements	$	10,120,668	$	10,324,154
Buildings and improvements		33,652,171		32,209,975
Furniture and equipment		12,013,172		10,992,544
Construction in progress		277,031		207,880
Total		56,063,042		53,734,553
Less accumulated depreciation		18,109,670		16,754,050
Net premises and equipment	$	37,953,372	$	36,980,503

Depreciation expense for the past three years is as follows:

	For the Years Ended December 31,
	2011		2010		2009
Depreciation expense	$	1,940,319	$	1,963,842	$	2,044,257

(6) Other Intangible Assets

A summary of other intangible assets at and for the years ended December 31, 2011 and 2010 is as follows:

	For the Years Ended December 31,
	2011							2010
	Gross Carrying Amount		Accumulated Amortization			Net Amount		Gross Carrying Amount		Accumulated Amortization			Net Amount
Amortizable intangible assets:
Core deposit intangible	$	4,795,224	$	(4,252,478	)	$	542,746	$	7,060,224	$	(6,082,715	)	$	977,509
Mortgage servicing rights		3,170,639		(862,262	)		2,308,377		3,067,368		(711,378	)		2,355,990
Total intangible assets	$	7,965,863	$	(5,114,740	)	$	2,851,123	$	10,127,592	$	(6,794,093	)	$	3,333,499

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Changes in the net carrying amount of other intangible assets for the years ended December 31, 2011 and 2010 are shown in the following table:

	Core Deposit Intangible Asset			Mortgage Servicing Rights
Balance at December 31, 2009	$	1,503,986		$	2,020,964
Additions		—			1,168,701
Amortization		(526,477	)		(833,675	)
Balance at December 31, 2010		977,509			2,355,990
Additions		—			760,322
Amortization		(434,763	)		(807,935	)
Balance at December 31, 2011	$	542,746		$	2,308,377

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 December 31, 2011 and 2010, 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 $307,016,000 and $298,325,000 at December 31, 2011 and 2010, respectively. Included in other noninterest income were real estate servicing fees for the years ended December 31, 2011, 2010 and 2009 of $863,000, $927,000, and $888,000, respectively.

The 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 December 31, 2011 for the next five years:

	Core Deposit Intangible Asset		Mortgage Servicing Rights
2012	$	408,062	$	487,000
2013		134,684		412,000
2014		—		349,000
2015		—		295,000
2016		—		249,000

The aggregate amortization expense of intangible assets subject to amortization for the past three years is as follows:

	For the Years Ended December 31,
Aggregate amortization expense	2011		2010		2009
Core deposit intangible asset	$	434,763	$	526,477	$	626,111
Mortgage servicing rights		807,935		833,675		916,093

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(7) Deposits

The scheduled maturities of total time deposits are as follows:

	2011		2010
Due within:
One year	$	266,516,536	$	304,221,827
Two years		93,209,127		58,226,647
Three years		34,729,677		54,968,145
Four years		8,811,088		5,196,284
Five years		11,172,178		7,162,643
Thereafter		—		—
	$	414,438,606	$	429,775,546

At December 31, 2011 and 2010, the Company had certificates and other time deposits in denominations of $100,000 or more which mature as follows:

	2011		2010
Due within:
Three months or less	$	52,273,804	$	19,997,962
Over three months through six months		16,016,986		35,685,505
Over six months through twelve months		32,291,758		37,901,059
Over twelve months		38,922,100		30,982,234
	$	139,504,648	$	124,566,760

The Federal Reserve Bank required the Bank to maintain cash or balances of $1,335,000 and $23,564,000 at December 31, 2011 and 2010, respectively, to satisfy reserve requirements.

Average compensating balances held at correspondent banks were $489,000 and $667,000 at December 31, 2011 and 2010, respectively. The Bank maintains such compensating balances with correspondent banks to offset charges for services rendered by those banks.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(8) Borrowings

Federal Funds Purchased and Securities Sold Under Agreements to Repurchase (repurchase agreements)

Information relating to federal funds purchased and repurchase agreements is as follows:

	Year End Weighted Rate			Average Weighted Rate			Average Balance Outstanding		Maximum Outstanding at any Month End		Balance at December 31,
2011
Federal funds purchased		—	%		0.3	%	$	2,225	$	—	$	—
Short-term repurchase agreements		0.1			0.2			27,634,019		30,227,375		24,516,277
Total												24,516,277
2010
Federal funds purchased		—	%		1.0	%	$	425,805	$	—	$	—
Short-term repurchase agreements		0.2			0.2			32,297,375		35,168,836		30,068,453
Total												30,068,453
2009
Federal funds purchased		0.9	%		0.9	%	$	1,507,904	$	7,175,000	$	4,980,000
Short-term repurchase agreements		0.2			0.2			32,414,635		32,489,362		31,665,434
Total												36,645,434

The securities underlying the agreements to repurchase are under the control of the Bank. All securities sold under agreements to repurchase are secured by a portion of the Company’s investment portfolio.

Under agreements with unaffiliated banks, the Bank may borrow federal funds up to $15,000,000 on an unsecured basis and $19,918,000 on a secured basis at December 31, 2011.

Subordinated Notes and Other Borrowings

Other borrowings of the Company consisted of the following:

				2011					2010
	Borrower	Maturity Date		Year End Balance		Year End Weighted Rate			Year End Balance		Year End Weighted Rate
FHLB advances	Subsidiary bank		2012	$	8,283,528		1.6	%	$	38,575,989		3.6	%
			2013		10,126,461		1.5	%		8,283,528		1.6	%
			2014		—		na			10,126,461		1.6	%
			2015		—		na			—		na
			2016		—		na			—		na
			2017-18		10,000,000		2.5	%		10,000,000		2.5	%
Total					28,409,989					66,985,978
Subordinated notes	The Company		2034		25,774,000		3.3	%		25,774,000		3.0	%
			2035		23,712,000		2.4	%		23,712,000		2.1	%
Total				$	49,486,000				$	49,486,000

The Bank subsidiary of the Company is a member of the Federal Home Loan Bank of Des Moines (FHLB) and has access to term financing from the FHLB. These borrowings are secured under a blanket agreement which assigns all investment in Federal Home Loan Bank of Des Moines stock, as well as mortgage loans equal to 125% to 175% (based

56

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

on collateral type) of the outstanding advance balance, to secure amounts borrowed by the Bank. The outstanding balance of $28,410,000 includes $10,000,000 which the FHLB may call for early payment within the next year. The FHLB has also issued letters of credit totaling $206,000 at December 31, 2011. Based upon the collateral pledged to the Federal Home Loan Bank of Des Moines at December 31, 2010, the Bank could borrow up to an additional $230,465,000 under the agreement.

On March 17, 2005, Exchange Statutory Trust II, a business trust issued $23,000,000 of 30-year floating rate Trust Preferred Securities (TPS) to a TPS Pool. The floating rate is equal to a three-month LIBOR rate plus 1.83% and reprices quarterly (2.39% at December 31, 2011). The TPS can be prepaid without penalty at any time after five years from the issuance date.

The TPS represent preferred interests in the trust. The Company invested approximately $712,000 in common interests in the trust and the purchaser in the private placement purchased $23,000,000 in preferred interests. The proceeds were used by the trust to purchase from the Company its 30-year deeply subordinated debentures whose terms mirror those stated above for the TPS. The debentures are guaranteed by the Company pursuant to a subordinated guarantee. Distributions on the TPS are payable quarterly on March 17, June 17, September 17, and December 17 of each year that the TPS are outstanding. The trustee for the TPS holders is U.S. Bank, N.A.. The trustee does not have the power to take enforcement action in the event of a default under the TPS for five years from the date of default. In the event of default, however, the Company would be precluded from paying dividends until the default is cured.

On March 17, 2004, Exchange Statutory Trust I, a Delaware business trust and subsidiary of the Company issued $25,000,000 of floating TPS to a TPS Pool. The floating rate is equal to the three-month LIBOR rate plus 2.70% and reprices quarterly (3.26% at December 31, 2011). The TPS are fully, irrevocably, and unconditionally guaranteed on a subordinated basis by the Company. The proceeds of the TPS were invested in junior subordinated debentures of the Company. Distributions on the TPS are payable quarterly on March 17, June 17, September 17, and December 17 of each year that the TPS are outstanding. The TPS mature on March 17, 2034. That maturity date may be shortened if certain conditions are met.

The Exchange Statutory Trusts are not consolidated in the Company’s financial statements. Accordingly, the Company does not report the securities issued by the Exchange Statutory Trusts as liabilities, and instead reports the subordinated notes issued by the Company and held by the Exchange Statutory Trusts as liabilities. The amount of the subordinated notes as of December 31, 2010 and 2009 was $49,486,000. The Company has recorded the investments in the common securities issued by the Exchange Statutory Trusts aggregating $1,486,000, and the corresponding obligations under the subordinated notes, as well as the interest income and interest expense on such investments and obligations in its consolidated financial statements.

(9) Income Taxes

The composition of income tax (benefit) expense for 2011, 2010, and 2009 is as follows:

	2011			2010			2009
Current:
Federal	$	374,369		$	(836,846	)	$	2,131,373
State		(214,183	)		79,556			354,072
Total current		160,186			(757,290	)		2,485,445
Deferred:
Federal		385,594			(2,090,598	)		(564,779	)
State		45,364			(238,925	)		(64,546	)
Total deferred		430,958			(2,329,523	)		(629,325	)
Total income tax (benefit) expense	$	591,144		$	(3,086,813	)	$	1,856,120

57

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Applicable income tax (benefit) expense for financial reporting purposes differ from the amount computed by applying the statutory Federal income tax rate for the reasons noted in the table below:

	2011						2010						2009
	Amount			%			Amount			%			Amount			%
Income (loss) before provision for income tax (benefit) expense	$	3,448,414					$	(6,638,553	)				$	6,811,877
Tax at statutory Federal income tax rate	$	1,172,461			34.00	%	$	(2,257,108	)		34.00	%	$	2,316,038			34.00	%
Tax-exempt income		(404,001	)		(11.72	)		(445,020	)		6.70			(508,002	)		(7.46	)
State income tax, net of Federal tax benefit		(111,421	)		(3.23	)		(105,184	)		1.58			191,087			2.81
Other, net		(65,895	)		(1.91	)		(279,501	)		4.22			(143,003	)		(2.10	)
Provision for income tax (benefit) expense	$	591,144			17.14	%	$	(3,086,813	)		46.50	%	$	1,856,120			27.25	%

The components of deferred tax assets and deferred tax liabilities at December 31, 2011 and 2010 are as follows:

	2011		2010
Deferred tax assets:
Allowance for loan losses	$	5,247,505	$	5,680,298
Nonaccrual loan interest		1,033,195		1,208,665
Core deposit intangible		882,583		873,017
Goodwill		2,831,425		3,263,670
Impairment of other real estate owned		2,734,539		2,547,425
Deferred compensation		26,879		46,878
Deferred taxes on pension		1,379,898		240,349
Pension		276,331		—
Other		548,980		447,485
Total deferred tax assets		14,961,335		14,307,787
Deferred tax liabilities:
Premises and equipment		960,245		999,943
Mortgage servicing rights		791,037		789,759
FHLB stock dividend		100,282		102,921
Assets held for sale		108,735		—
Available-for-sale securities		2,176,790		655,060
Pension		—		118,265
Other		1,892		6,345
Total deferred tax liabilities		4,138,981		2,672,293
Net deferred tax asset	$	10,822,354	$	11,635,494

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these temporary differences at December 31, 2011 and, therefore, has not established a valuation reserve.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

At December 31, 2011, the accumulation of prior years’ earnings representing tax bad debt deductions of the Bank was $2,931,503. If these tax bad debt reserves were charged for losses other than bad debt losses, the Bank would be required to recognize taxable income in the amount of the charge. It is not contemplated that such tax-restricted retained earnings will be used in a manner that would create federal income tax liabilities.

The Company follows ASC Topic 740, Income Taxes, which addresses the accounting for uncertain tax positions. As a result of the lapse of the statue of limitations for the 2007 tax year, the Company recognized $340,351 of gross unrecognized tax benefits and $30,969 of accrued interest. This resulted in a decrease of the effective tax rate for the year-ended December 31, 2011 compared to December 31, 2010. As of December 31, 2011, the Company did not have any uncertain tax provisions.

A reconciliation of the beginning and ending amount of the unrecognized tax benefits is as follows:

	2011			2010			2009
Unrecognized tax benefits as of January 1,	$	340,351		$	562,076		$	748,942
Gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during prior years		—			—			—
Gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during year		—			—			—
The amount of decreases in unrecognized tax benefits relating to settlements with taxing authorities		—			—			—
Reductions to unrecognized benefits as a result of a lapse of the applicable statute of limitations		(340,351	)		(221,725	)		(186,866	)
Unrecognized tax benefits as of December 31,	$	—		$	340,351		$	562,076

(10) Employee Benefit Plans

Employee benefits charged to operating expenses are summarized in the table below.

	2011		2010		2009
Payroll taxes	$	1,098,110	$	1,105,599	$	1,096,793
Medical plans		1,676,494		1,544,670		1,494,166
401k match		290,665		318,518		306,042
Pension plan		907,455		864,871		890,692
Profit-sharing		—		2		282,904
Other		249,671		161,210		133,803
Total employee benefits	$	4,222,395	$	3,994,870	$	4,204,400

The Company’s profit-sharing plan includes a matching 401k portion, in which the Company matches the first 3% of eligible employee contributions. The Company made annual contributions in an amount up to 6% of income before income taxes and before contributions to the profit-sharing and pension plans for all participants, limited to the maximum amount deductible for Federal income tax purposes, for each of the years shown. In addition, employees were able to make additional tax-deferred contributions.

Pension

The Company also provides a noncontributory defined benefit pension plan for all full-time employees.

59

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. The Company made a $1,243,000 contribution to the defined benefit plan through March 30, 2012, of which $310,000 relates to the 2010 plan year and $933,000 relates to the 2011 plan year. The minimum required contribution for the 2012 plan year is estimated to be $1,048,000. The Company has not determined whether it will make any contributions other than the minimum required funding contribution for 2012.

Obligations and Funded Status at December 31

	2011			2010
Change in projected benefit obligation:
Balance, January 1	$	10,655,180		$	9,400,952
Service cost		930,691			844,178
Interest cost		603,903			556,047
Actuarial loss		2,240,500			59,386
Benefits paid		(213,069	)		(205,383	)
Balance, December 31		14,217,205			10,655,180
Change in plan assets:
Fair value, January 1		9,296,645			7,993,695
Actual gain (loss) return on plan assets		(54,282	)		954,332
Employer contribution		1,005,000			554,000
Benefits paid		(213,069	)		(205,382	)
Fair value, December 31		10,034,294			9,296,645
Funded status at end of year	$	(4,182,911	)	$	(1,358,535	)
Accumulated benefit obligation	$	10,762,152		$	8,172,291

Components of Net Pension Cost and Other Amounts Recognized in Accumulated Other Comprehensive Income

The following items are components of net pension cost for the years ended December 31, 2011, 2010 and 2009:

	2011			2010			2009
Service cost - benefits earned during the year	$	930,691		$	844,178		$	850,940
Interest costs on projected benefit obligations		603,903			556,047			509,482
Expected return on plan assets		(705,767	)		(613,982	)		(539,283	)
Amortization of prior service cost		78,628			78,628			78,628
Amortization of net gains		—			—			(9,075	)
Net periodic pension expense	$	907,455		$	864,871		$	890,692

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive income (loss) at December 31, 2011 and 2010 are shown below, including amounts recognized in other comprehensive income during the periods. All amounts are shown on a pre-tax basis.

	2011			2010
Prior service costs	$	(678,812	)	$	(757,440	)
Net accumulated actuarial net (loss) gain		(2,776,911	)		223,639
Accumulated other comprehensive loss		(3,455,723	)		(533,801	)
Net periodic benefit cost in excess of cumulative employer contributions		(727,188	)		(824,734	)
Net amount recognized at December 31, balance sheet	$	(4,182,911	)	$	(1,358,535	)
Net loss (gain) arising during period	$	3,000,549		$	(280,964	)
Prior service cost amortization		(78,628	)		(78,628	)
Amortization of net actuarial gain / (loss)		—			—
Total recognized in other comprehensive income	$	2,921,921		$	(359,592	)
Total recognized in net periodic pension cost and other comprehensive income	$	3,829,376		$	505,279

The estimated prior service cost for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic cost in 2012 is $78,628. During 2012, $92,378 is the estimated amount of actuarial loss subject to amortization into net periodic pension cost.

Assumptions utilized to determine benefit obligations as of December 31, 2011, 2010 and 2009 and to determine pension expense for the year then ended are as follows:

	2011			2010			2009
Determination of Benefit obligation at year end:
Discount rate		4.75	%		5.75	%		6.00	%
Annual rate of compensation increase		4.50	%		4.50	%		4.50	%
Determination of Pension expense for year ended:
Discount rate for the service cost		5.75	%		5.75	%		6.00	%
Annual rate of compensation increase		4.50	%		4.50	%		4.50	%
Expected long-term rate of return on plan assets		7.00	%		7.00	%		7.00	%

The assumed overall expected long-term rate of return on pension plan assets used in calculating 2011 pension expense was 7%. Determination of the plan’s rate of return is based upon historical returns for equities and fixed income indexes. During the past five years the Company’s plan assets have experienced the following annual returns: 0.1% in 2011, 12.4% in 2010, 22.0% in 2009, (32.6)% in 2008, and 7.4% in 2007. The rate used in plan calculations may be adjusted by management for current trends in the economic environment. With a traditional investment mix of over half of the plan’s investments in equities, the actual return for any one plan year may fluctuate significantly with changes in the stock market. Due to a decline in the economy and a decrease in discount rates used in the actuarial calculation of plan income, the Company expects to incur $1,320,000 expense in 2012 compared to $907,000 in 2011.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Plan Assets

The investment policy of the pension plan is designed for growth in value while minimizing risk to the overall portfolio. The Company diversifies the assets through investments in domestic and international fixed income securities and domestic and international equity securities. The assets are readily marketable and can be sold to fund benefit payment obligations as they become payable. The Company’s long-term investment target mix for the plan is 70% equity securities and 30% fixed income. The Company regularly reviews its policies on the investment mix and may make changes depending on economic conditions and perceived investment mix.

The fair value of the Company’s pension plan assets at December 31, 2011 and 2010 by asset category are as follows:

			Fair Value Measurements At December 31, 2011 Using
Description	Fair Value December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	1,790,943	$	1,790,943	$	—	$	—
Equity securities:
U.S. large-cap (a)		3,820,667		3,820,667		—		—
U.S. mid-cap (b)		502,246		502,246		—		—
U.S. small-cap (c)		595,027		595,027		—		—
International (d)		1,277,798		1,277,798		—		—
Real Estate (e)		203,000		203,000		—		—
Commodities (f)		198,253		198,253		—		—
Fixed income securities:
U.S. Gov’t Agency Obligations (g)		841,083		—		841,083		—
Corporate investment grade (g)		653,144		—		653,144		—
Corporate non-investment grade (g)		152,133		—		152,133		—
Total	$	10,034,294	$	8,387,934	$	1,646,360	$	—

(a) This category is comprised of low-cost equity index funds not actively managed that track the S&P 500.

(b) This category is comprised of low-cost equity index funds not actively managed that track the MSCI U.S. mid-cap 450.

(c) This is comprised of actively managed mutual funds.

(d) 37% of this category is comprised of low-cost equity index funds not actively managed that track the MSCI EAFE.

(e) This category comprised low-cost real estate index exchange traded funds.

(f) This category is comprised of exchange traded funds investing agricultural and energy commodities.

(g) This category is comprised of individual bonds.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

			Fair Value Measurements At December 31, 2010 Using
Description	Fair Value December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	1,123,265	$	1,123,265	$	—	$	—
Equity securities:
U.S. large-cap (a)		3,364,627		3,364,627		—		—
U.S. mid-cap (b)		1,138,036		1,138,036		—		—
U.S. small-cap (c)		445,318		445,318		—		—
International (d)		1,276,752		1,276,752		—		—
Fixed income securities:
U.S. Govt Agency Obligations (e)		993,464		—		993,464		—
Corporate investment grade (e)		682,715		—		682,715		—
Corporate non-investment grade (e)		272,468		—		272,468		—
Total	$	9,296,645	$	7,347,998	$	1,948,647	$	—

(a) This category is comprised of low-cost equity index funds not actively managed that track the S&P 500.

(b) This category is comprised of low-cost equity index funds not actively managed that track the MSCI U.S. mid-cap 450.

(c) This is comprised of actively managed mutual funds.

(d) 44% of this category is comprised of low-cost equity index funds not actively managed that track the MSCI EAFE.

(e) This category is comprised of individual bonds.

The following future benefit payments are expected to be paid:

Year	Pension benefits
2012	$	326,953
2013		335,437
2014		413,817
2015		429,802
2016		432,330
2017 to 2021		2,793,297

(11) Stock Compensation

The Company’s stock option plan provides for the grant of options to purchase up to 506,188 shares of the Company’s common stock to officers and other key employees of the 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 10,705 options issued in 2008 to acquire shares that vested immediately.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

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

	Number of shares December 31									Weighted average exercise price December 31
	2011			2010			2009			2011		2010		2009
Outstanding, beginning of year		260,466			298,382			299,988		$	24.44	$	23.18	$	23.21
Granted		—			—			—			—		—		—
Exercised		—			—			—			—		—		—
Forfeited		—			—			(1,606	)		—		—		27.94
Expired		(192	)		(37,916	)		—			18.68		14.52		—
Outstanding, end of year		260,274			260,466			298,382		$	24.45	$	24.44	$	23.18
Exercisable, end of year		233,706			217,503			233,256		$	24.53	$	24.52	$	22.84

Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2011.

Options outstanding at December 31, 2011 had a weighted average remaining contractual life of approximately 3.5 years and no intrinsic value. Options outstanding at December 31, 2010 had a remaining contractual life of approximately 4.5 years and no intrinsic value. No stock options were granted during in the years presented above.

Options exercisable at December 31, 2011 had a weighted average remaining contractual life of approximately 3.3 years and no intrinsic value. Options exercisable at December 31, 2010 had a weighted average remaining contractual life of approximately 4.1 years and no intrinsic value. No stock options were exercised during the years presented above.

Total stock-based compensation expense for the years ended December 31, 2011, 2010, and 2009 was $58,000, $87,000, and $130,000, respectively. As of December 31, 2011, the total unrecognized compensation expense related to non-vested stock awards was $99,000 and the related weighted average period over which it is expected to be recognized is approximately 3 years.

(12) Preferred Stock

On December 19, 2008, the 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 is designed to attract broad participation by banking institutions to help stabilize the financial system by encouraging lending. The 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 the Company’s market area.

Participating in this program included the 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 276,090 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 managements’ 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 warrant at December 31, 2011 were $29,318,000 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 the 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 the Company fails to pay dividends on the preferred stock for six or

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

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. The 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 $16.44 per share. The preferred stock and warrant are classified as stockholders’ equity in the consolidated balance sheet and qualify, for regulatory capital purposes, as Tier I capital. For the year ended December 31, 2011, the Company had declared and paid $1,513,000 of dividends and amortized $476,000 of accretion of the discount on preferred stock.

(13) Earnings (loss) per Share

Basic earnings (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding during the year. Diluted earnings (loss) per share gives effect to all dilutive potential common shares that were outstanding during the year. The calculations of basic and diluted earnings (loss) per share are as follows:

	2011		2010			2009
Basic earnings (loss) per common share:
Net income (loss)	$	2,857,270	$	(3,551,740	)	$	4,955,757
Less:
Preferred stock dividends		1,512,750		1,512,750			1,516,952
Accretion of discount on preferred stock		476,474		476,474			476,474
Net income (loss) available to common shareholders	$	868,046	$	(5,540,964	)	$	2,962,331
Basic (loss) earnings per share	$	0.19	$	(1.19	)	$	0.64
Diluted earnings (loss) per common share:
Net income (loss)	$	2,857,270	$	(3,551,740	)	$	4,955,757
Less:
Preferred stock dividends		1,512,750		1,512,750			1,516,952
Accretion of discount on preferred stock		476,474		476,474			476,474
Net income (loss) available to common shareholders	$	868,046	$	(5,540,964	)	$	2,962,331
Average shares outstanding		4,652,994		4,652,994			4,652,994
Effect of dilutive stock options		—		—			—
Average shares outstanding including dilutive stock options		4,652,994		4,652,994			4,652,994
Diluted earnings (loss) per share	$	0.19	$	(1.19	)	$	0.64

Under the treasury stock method, outstanding stock options are dilutive when the average market price of the Company’s common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during the period, except when the 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.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The following options to purchase shares during the fiscal years ended 2011, 2010, and 2009 were not included in the respective computations of diluted earnings (loss) per share because the exercise price of the option, 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.

	Years Ended December 31,
	2011		2010		2009
Anti-dilutive shares - option shares		260,274		260,466		298,382
Anti-dilutive shares - warrant shares		276,090		276,090		276,090

(14) Capital Requirements

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.

Quantitative measures established by regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets, and of Tier I capital to adjusted-average assets. Management believes, as of December 31, 2011 and 2010, the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2011, the most recent notification from the regulatory authorities categorized the bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since the notifications that management believes have changed the Bank’s categories.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

The actual and required capital amounts and ratios for the Company and the Bank as of December 31, 2011 and 2010 are as follows (dollars in thousands):

	Actual					Minimum Capital  requirements					Well-Capitalized Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2011
Total capital (to risk-weighted assets):
Company	$	159,768		18.03	%	$	70,905		8.00	%		—		—
Hawthorn Bank		130,398		15.00			69,567		8.00		$	86,959		10.00	%
Tier I capital (to risk-weighted assets):
Company	$	134,391		15.16	%	$	35,453		4.00	%		—		—
Hawthorn Bank		119,498		13.74			34,784		4.00		$	52,175		6.00	%
Tier I capital (to adjusted average assets):
Company	$	134,391		11.52	%	$	34,993		3.00	%		—		—
Hawthorn Bank		119,498		10.45			34,309		3.00		$	57,181		5.00	%
	Actual					Minimum Capital  requirements					Well-Capitalized Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2010
Total capital (to risk-weighted assets):
Company	$	159,510		17.05	%	$	74,863		8.00	%		—		—
Hawthorn Bank		130,361		14.18			73,548		8.00		$	91,834		10.00	%
Tier I capital (to risk-weighted assets):
Company	$	133,349		14.25	%	$	37,431		4.00	%		—		—
Hawthorn Bank		118,837		12.93			36,774		4.00		$	55,161		6.00	%
Tier I capital (to adjusted average assets):
Company	$	133,349		11.00	%	$	36,360		3.00	%		—		—
Hawthorn Bank		118,837		9.99			35,685		3.00		$	59,475		5.00	%

(15) Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities. The FASB 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 December 31, 2011 and 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.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Level 3 — Inputs are unobservable inputs for the asset or liability and significant to the fair value. These may be internally developed using the Company’s best information and assumptions that a market participant would consider.

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.

The 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.

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

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

Available-for-sale securities

Available-for-sale securities are recorded at fair value on a recurring basis. Available-for-sale securities is the only balance sheet category the Company is required to prepare in conformity with 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, the 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.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

			Fair Value Measurements At December 31, 2011 Using
Description	Fair Value December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. treasury	$	2,054,102	$	—	$	2,054,102	$	—
Government sponsored enterprises		70,313,978		—		70,313,978		—
Asset-backed securities		107,328,618		—		107,328,618		—
Obligations of states and political subdivisions		34,109,303		—		34,109,303		—
Total	$	213,806,001			$	213,806,001	$	—
			Fair Value Measurements At December 31, 2010 Using
Description	Fair Value December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. treasury	$	1,027,891	$	—	$	1,027,891	$	—
Government sponsored enterprises		53,341,551		—		53,341,551		—
Asset-backed securities		90,176,241		—		90,176,241		—
Obligations of states and political subdivisions		34,431,867		—		34,431,867		—
Total	$	178,977,550			$	178,977,550	$	—

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

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

Impaired Loans

The Company does not record loans at fair value on a recurring basis other than loans that are considered impaired. The net carrying value of impaired loans is generally based on fair values of the underlying collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. Once the fair value of the collateral has been determined and any impairment amount calculated, a specific reserve allocation is made. Because many of these inputs are not observable, the measurements are classified as Level 3. As of December 31, 2011, the Company identified $30.4 million in impaired loans that had specific allowances for losses aggregating $3.7 million. Related to these loans, there was $11.3 million in charge-offs recorded during 2011.

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 loan balance or fair value of the collateral less estimated selling costs. The Company relies on external appraisals and assessment of property values by our internal staff. In the case of non-real

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

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 Using
Description	Fair Value December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)*
Impaired loans:
Commercial, financial, & agricultural	$	642,745	$	—	$	—	$	642,745	$	(2,135,996	)
Real estate construction - residential		396,460		—		—		396,460		(1,556,738	)
Real estate construction - commercial		6,028,792		—		—		6,028,792		(279,088	)
Real estate mortgage - residential		3,600,744		—		—		3,600,744		(1,509,328	)
Real estate mortgage - commercial		15,980,238		—		—		15,980,238		(5,841,988	)
Total	$	26,648,979	$	—	$	—	$	26,648,979	$	(11,323,138	)
Other real estate owned and repossessed assets	$	16,020,023	$	—	$	—	$	16,020,023	$	(2,111,929	)
			Fair Value Measurements Using
Description	Fair Value December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)*
Impaired loans:
Commercial, financial, & agricultural	$	1,480,836	$	—	$	—	$	1,480,836	$	(1,634,544	)
Real estate construction - residential		263,870		—		—		263,870		(863,399	)
Real estate construction - commercial		3,284,371		—		—		3,284,371		(4,496,156	)
Real estate mortgage - residential		4,459,151		—		—		4,459,151		(3,971,927	)
Real estate mortgage - commercial		14,368,132		—		—		14,368,132		(3,626,892	)
Total	$	23,856,360	$	—	$	—	$	23,856,360	$	(14,592,918	)
Other real estate owned and repossessed assets	$	14,009,017	$	—	$	—	$	14,009,017	$	(3,528,011	)

* Total gains (losses) reported for other real estate owned and repossessed assets includes charge offs, valuation write downs, and net losses taken during the periods reported.

(16) Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate such value:

Loans

The fair values of loans are estimated by discounting the expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The net carrying amount of impaired loans is generally based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.

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Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

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 provided 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

The carrying amounts of short-term federal funds sold and securities purchased under agreements to resell, interest earning deposits with banks, and cash and due from banks approximate fair value. Federal funds sold and securities purchased under agreements to resell classified as short-term generally mature in 90 days or less.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is based on the discounted value of contractual cash flows utilizing servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model which calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees.

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.

Subordinated Notes and Other Borrowings

The fair value of subordinated notes and other borrowings is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for other borrowed money of similar remaining maturities.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

A summary of the carrying amounts and fair values of the Company’s financial instruments at December 31, 2011 and 2010 is as follows:

	2011				2010
	Carrying amount		Fair value		Carrying amount		Fair value
Assets:
Loans	$	829,121,324	$	830,077,000	$	883,907,596	$	889,291,000
Investment in debt securities		213,806,001		213,806,001		178,977,550		178,977,550
Federal fund sold and securities purchased under agreements to resell		75,000		75,000		125,815		125,815
Cash and due from banks		43,134,530		43,134,530		50,853,985		50,853,985
Mortgage servicing rights		2,308,377		2,512,000		2,355,990		3,027,000
Accrued interest receivable		5,340,610		5,340,610		5,733,684		5,733,684
	$	1,093,785,842	$	1,094,945,141	$	1,121,954,620	$	1,128,009,034
Liabilities:
Deposits:
Demand	$	159,186,859	$	159,186,859	$	137,749,571	$	137,749,571
NOW		169,451,594		169,451,594		160,225,356		160,225,356
Savings		62,075,470		62,075,470		54,722,129		54,722,129
Money market		153,071,624		153,071,624		164,190,054		164,190,054
Time		414,438,606		421,687,000		429,775,546		437,996,000
Federal funds purchased and securities sold under agreements to repurchase		24,516,277		24,516,277		30,068,453		30,068,453
Subordinated notes		49,486,000		22,082,000		49,486,000		21,105,000
Other borrowings		28,409,989		29,525,000		66,985,978		69,329,000
Accrued interest payable		1,054,202		1,054,202		1,491,503		1,491,503
	$	1,061,690,621	$	1,042,650,026	$	1,094,694,590	$	1,076,877,066

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments, and the present creditworthiness of such counterparties. The Company believes such commitments have been made on terms, which are competitive in the markets in which it operates. See Note 17 for further discussion.

Limitations

The fair value estimates provided are made at a point in time based on market information and information about the financial instruments. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the fair value estimates.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(17) Commitments and Contingencies

The Company issues financial instruments with off-balance-sheet risk in the normal course of business of meeting the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At December 31, 2011 no amounts have been accrued for any estimated losses for these financial instruments.

The contractual amount of off-balance-sheet financial instruments as of December 31, 2011 and 2010 as follows:

	2011		2010
Commitments to extend credit	$	117,170,561		94,114,449
Standby letters of credit		2,992,497		3,446,527

Commitments

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments and letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, furniture and equipment, and real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support contractual obligations of the Company’s customers. The approximate remaining term of standby letters of credit range from one month to five years at December 31, 2011.

Pending Litigation

The Company and its subsidiaries, are defendants in various legal actions incidental to the Company’s past and current business activities. At December 31, 2011 and 2010, the Company’s consolidated balance sheets included liabilities for these legal actions of $161,000 and $275,000, respectively. Based on the Company’s analysis, and considering the inherent uncertainties associated with litigation, management does not believe that it is reasonably possible that these legal actions will materially adversely affect the Company’s consolidated financial statements or results of operations in the near term.

On November 18, 2010, a suit was filed against the Company and its subsidiary, Hawthorn Bank (the Bank) in the Circuit Court of Jackson County for the Eastern Division of Missouri state court by a customer alleging that the fees associated with the Bank’s automated overdraft program in connection with its debit card and ATM cards constitute unlawful interest in violation of Missouri’s usury laws. The suit seeks class-action status for Bank customers who have paid overdraft fees on their checking accounts. The suit seeks forefeiture and refund of twice the amount of improper overdraft fees assessed and collected. The court has denied the Bank’s motion to dismiss the suit. At this early stage of the litigation, it is not possible for management of the Bank to determine the probability of a material adverse outcome or reasonably estimate the amount of any potential loss.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

On December 17, 2009, a suit was filed against Hawthorn Bank (the Bank) in Circuit Court of Jackson County for the Eastern Division of Missouri state court by a customer alleging that the Bank had not followed through on its commitment to fund a loan request. A jury found in favor of the customer and awarded $630,000 in damages to the plaintiffs, including $200,000 in punitive damages. After hearing post-judgment motions, the trial court struck the punitive damage award and entered an amended judgment for a total of $510,000 against the Bank. As of December 31, 2011, the Company carried a liability of $161,000 with respect to this matter. The Company is in the early stages of the appeals process and the probable outcome is presently not determinable.

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(18) Condensed Financial Information of the Parent Company Only

Following are the condensed financial statements of Hawthorn Bancshares, Inc. (Parent only) as of and for the years indicated:

Condensed Balance Sheets

	December 31,
	2011		2010
Assets
Cash and due from bank subsidiaries	$	13,281,671	$	12,448,772
Investment in equity securities		1,486,000		1,486,000
Investment in subsidiaries		140,361,330		138,677,199
Premises and equipment		1,611		3,662
Deferred tax asset		1,610,808		166,349
Other assets		9,921		21,430
Total assets	$	156,751,341	$	152,803,412
Liabilities and Stockholders’ Equity
Subordinated notes	$	49,486,000	$	49,486,000
Other liabilities		4,689,568		1,829,101
Stockholders’ equity		102,575,773		101,488,311
Total liabilities and stockholders’ equity	$	156,751,341	$	152,803,412

Condensed Statements of Operations

	For the Years Ended December 31,
	2011		2010			2009
Income
Interest and dividends received from subsidiaries		$5,191,614	$	4,405,349		$	247,842
Total income		5,191,614		4,405,349			247,842
Expenses
Interest on subordinated notes		1,301,178		1,525,553			2,446,742
Other		2,605,082		2,904,355			3,057,108
Total expenses		3,906,260		4,429,908			5,503,850
Income (loss) before income tax benefit and equity in undistributed income of subsidiaries		1,285,354		(24,559	)		(5,256,008	)
Income tax benefit		1,367,927		1,449,929			1,918,880
Equity in undistributed income (loss) of subsidiaries		203,989		(4,977,110	)		8,292,885
Net income (loss)	$	2,857,270	$	(3,551,740	)	$	4,955,757

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

Condensed Statements of Cash Flows

	2011			2010			2009
Cash flows from operating activities:
Net income (loss)	$	2,857,270		$	(3,551,740	)	$	4,955,757
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		2,051			2,441			3,404
Equity in undistributed (income) losses of subsidiaries		(203,989	)		4,977,110			(8,292,885	)
Stock based compensation expense		57,874			87,310			130,459
(Increase) decrease in deferred tax asset		(274,245	)		(37,876	)		120,281
Other, net		(89,557	)		381,702			(109,419	)
Net cash provided by (used in) operating activities		2,349,404			1,858,947			(3,192,403	)
Cash flows from investing activities:
Purchase of premise and equipment		—			—			(3,052	)
Proceeds from sale premise and equipment		—			—			500
Investment in subsidiary		900,000			(1,250,000	)		(8,000,000	)
Net cash provided by (used in) investing activities		900,000			(1,250,000	)		(8,002,552	)
Cash flows from financing activities:
Proceeds from issuance of preferred stock and warrant		—			—			—
Purchase of treasury stock		—			—			—
Cash dividends paid - preferred stock		(1,512,750	)		(1,512,750	)		(1,369,879	)
Cash dividends paid - common stock		(903,755	)		(1,385,230	)		(2,665,557	)
Net cash used in financing activities		(2,416,505	)		(2,897,980	)		(4,035,436	)
Net increase (decrease) in cash and due from banks		832,899			(2,289,033	)		(15,230,391	)
Cash and due from banks at beginning of year		12,448,772			14,737,805			29,968,196
Cash and due from banks at end of year	$	13,281,671		$	12,448,772		$	14,737,805

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

December 31, 2011, 2010, and 2009

(19) Quarterly Financial Information (Unaudited)

Year Ended December 31, 2011
(In thousands except per share data)	First quarter		Second quarter		Third quarter		Fourth quarter			Year to Date
Interest income	$	13,583	$	13,640	$	13,384	$	12,861		$	53,468
Interest expense		3,102		2,858		2,580		2,313			10,853
Net interest income		10,481		10,782		10,804		10,548			42,615
Provision for loan losses		1,750		1,883		2,010		5,880			11,523
Noninterest income		2,052		2,178		2,358		2,612			9,200
Noninterest expense		9,378		9,008		8,925		9,533			36,844
Income tax (benefit) expense		451		661		711		(1,232	)		591
Net income (loss)	$	954	$	1,408	$	1,516	$	(1,021	)	$	2,857
Preferred stock dividends		370		382		379		382			1,513
Accretion of discount on preferred stock		119		119		119		119			476
Net income (loss) available to common stockholders	$	465	$	907	$	1,018	$	(1,522	)	$	868
Net income (loss) per share:
Basic earnings (loss) per share	$	0.10	$	0.19	$	0.22	$	(0.33	)	$	0.19
Diluted earnings (loss) per share		0.10		0.19		0.22		(0.33	)		0.19
Year Ended December 31, 2010
(In thousands except per share data)	First quarter		Second quarter		Third quarter		Fourth quarter			Year to Date
Interest income	$	14,873	$	15,103	$	14,625	$	14,138		$	58,739
Interest expense		4,562		3,989		3,766		3,436			15,753
Net interest income		10,311		11,114		10,859		10,702			42,986
Provision for loan losses		2,505		2,150		2,450		8,150			15,255
Noninterest income		2,006		2,450		2,910		3,115			10,481
Noninterest expense		9,131		10,320		9,365		16,035			44,851
Income tax (benefit) expense		187		312		531		(4,117	)		(3,087	)
Net income (loss)	$	494	$	782	$	1,423	$	(6,251	)	$	(3,552	)
Preferred stock dividends		370		382		379		382			1,513
Accretion of discount on preferred stock		119		119		119		119			476
Net income (loss) available to common stockholders	$	5	$	281	$	925	$	(6,752	)	$	(5,541	)
Net income (loss) per share:
Basic earnings (loss) per share	$	—	$	0.06	$	0.20	$	(1.45	)	$	(1.19	)
Diluted earnings (loss) per share		—		0.06		0.20		(1.45	)		(1.19	)

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MARKET PRICE OF AND DIVIDENDS ON EQUITY SECURITIES AND RELATED MATTERS

Market Price. Our Company’s common stock trades on Nasdaq’s global select market under the stock symbol of “HWBK.” The following table sets forth the range of high and low bid prices of our Company’s common stock by quarter for each quarter in 2011 and 2010 in which the stock was traded.

2011	High		Low
First Quarter	$	9.33	$	8.06
Second Quarter	$	8.89	$	7.29
Third Quarter	$	8.50	$	5.80
Fourth Quarter	$	8.10	$	5.50
2010	High		Low
First Quarter	$	12.50	$	9.08
Second Quarter	$	13.20	$	11.06
Third Quarter	$	13.37	$	8.69
Fourth Quarter	$	10.21	$	8.26

Shares Outstanding. As of March 5, 2012, our Company had issued 4,814,852 shares of common stock, of which 4,652,944 shares were outstanding. The outstanding shares were held of record by approximately 1,749 shareholders. Our Company has a warrant outstanding for the purchase of 276,090 shares of common stock. In addition, our Company has 30,255 shares of cumulative, perpetual preferred stock outstanding. The warrant and preferred shares were issued pursuant to the U.S. Treasury’s Capital Purchase Program (or CPP).

Dividends. The following table sets forth information on dividends paid by our Company in 2011 and 2010.

Month Paid	Dividends Per Share
January, 2011	$	0.05
April, 2011		0.05
July, 2011		0.05
October, 2011		0.05
Total for 2011	$	0.20
January, 2010	$	0.11
April, 2010		0.11
July, 2010		0.05
October, 2010		0.05
Total for 2010	$	0.32

Our Board of Directors intends that our Company will continue to pay quarterly dividends. The actual amount of quarterly dividends and the payment, as well as the amount, of any special dividend ultimately will depend on the payment of sufficient dividends by our subsidiary Bank to our Company. The payment by our Bank of dividends to our Company will depend upon such factors as our Bank’s financial condition, results of operations and current and anticipated cash needs, including capital requirements. In addition to the above limitations, our ability to pay dividends on our common stock is limited by our participation in the Treasury’s Capital Purchase Program (or CPP). If we are not current in the payment of quarterly dividends on the Series A preferred stock issued to the U.S. Treasury in CPP, we cannot pay dividends on our common stock.

Stock Performance Graph. The following performance graph shows a comparison of cumulative total returns for our Company, the Nasdaq Stock Market (U.S. Companies), and a peer index of financial institutions having total assets of between $1 billion and $5 billion for the period from December 31, 2006, through December 31, 2011. The cumulative total return on investment for each of the periods for our Company, the Nasdaq Stock Market (U.S. Companies) and the peer index is based on the stock price or index at December 31, 2006. The performance graph

78

assumes that the value of an investment in our common stock and each index was $100 at December 31, 2006 and that all dividends were reinvested. The information presented in the performance graph is historical in nature and is not intended to represent or guarantee future returns.

The comparison of cumulative total returns presented in the above graph was plotted using the following index values and common stock price values:

	12/31/06		12/31/07		12/31/08		12/31/09		12/31/10		12/31/11
Hawthorn Bancshares, Inc.	$	100.00	$	81.56	$	58.41	$	35.36	$	33.94	$	25.52
Nasdaq Composite (U.S. Companies)	$	100.00	$	110.66	$	66.42	$	96.54	$	114.06	$	113.16
Index of financial institutions ($1 billion to $5 billion)	$	100.00	$	72.84	$	60.42	$	43.31	$	49.09	$	44.77

79

DIRECTORS AND EXECUTIVE OFFICERS OF OUR COMPANY

Name	Position with Our Company	Position with Subsidiary Bank	Principal Occupation
David T. Turner	Chairman, Chief Executive Officer, President and Director -Class III	Chairman, Chief Executive Officer, President and Director	Position with Hawthorn Bancshares and Hawthorn Bank
Charles G. Dudenhoeffer, Jr.	Director-Class II	Director	Retired
Philip D. Freeman	Director-Class I	Director	Owner/Manager, Freeman Mortuary, Jefferson City, Missouri
Kevin L. Riley	Director-Class III	Director	Co-owner, Riley Chevrolet, Buick, GMC Cadilac, and Riley Toyota Scion, Jefferson City, Missouri
James E. Smith	Director-Class I	Director	Retired
Gus S. Wetzel, II	Director-Class II	Director	Physician, Wetzel Clinic, Clinton, Missouri
W. Bruce Phelps	Chief Financial Officer	Senior Vice President and Chief Financial Officer	Position with Hawthorn Bancshares and Hawthorn Bank
Kathleen L. Bruegenhemke	Senior Vice President, Chief Risk Officer and Corporate Secretary	Senior Vice President and Chief Risk Officer	Position with Hawthorn Bancshares and Hawthorn Bank
Richard G. Rose	Former Chief Financial Officer - Retired 1-30-12	Senior Vice President	Position with Hawthorn Bank

ANNUAL REPORT ON FORM 10-K

A copy of our Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission, excluding exhibits, will be furnished without charge to shareholders entitled to vote at the 2012 annual meeting of shareholders upon written request to Kathleen L. Bruegenhemke, Secretary, Hawthorn Bancshares, Inc., 132 East High Street, Jefferson City, Missouri 65101. Our Company will provide a copy of any exhibit to the Form 10-K to any such person upon written request and the payment of our Company’s reasonable expenses in furnishing such exhibits.

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