UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

Commission File Number: 0-23636

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

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

300 Southwest Longview Boulevard, Lee’s Summit, Missouri 64081
(Address of principal executive offices)       (Zip Code)

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

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

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

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

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

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

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

As of November 9, 2009 the registrant had 4,301,955 shares of common stock, par value $1.00 per share, outstanding.

 

 

Index to Exhibits located on page 43

PART I — FINANCIAL INFORMATION

Item 1.		Financial Statements

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)

		September 30,				December 31,
		2009				2008
ASSETS
Loans		$	993,452,421			$	1,009,103,532
Allowances for loan losses			(13,927,534	)			(12,666,546	)
Net loans			979,524,887				996,436,986
Investment in available-for-sale securities, at fair value			159,013,809				149,400,929
Investment in equity securities, at cost			8,875,250				8,875,250
Total investment securities			167,889,059				158,276,179
Federal funds sold and securities purchased under agreements to resell			106,226				104,393
Cash and due from banks			21,834,033				53,723,075
Premises and equipment — net			37,222,310				39,260,220
Other real estate owned and repossessed assets			11,578,503				7,828,278
Accrued interest receivable			6,878,022				7,476,093
Mortgage servicing rights			1,881,355				1,171,225
Intangible assets — net			1,654,505				2,130,097
Cash surrender value — life insurance			1,910,652				1,852,902
Other assets			9,748,122				11,439,419
Total assets		$	1,240,227,674			$	1,279,698,867
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Non-interest bearing demand		$	126,116,754			$	125,245,200
Savings, interest checking and money market			357,905,369				342,626,702
Time deposits $100,000 and over			144,097,466				142,972,489
Other time deposits			340,015,283				344,451,998
Total deposits			968,134,872				955,296,389
Federal funds purchased and securities sold under agreements to repurchase			32,374,577				29,138,623
Subordinated notes			49,486,000				49,486,000
Other borrowed money			71,481,166				129,057,483
Accrued interest payable			2,391,949				3,847,415
Other liabilities			7,867,557				6,454,574
Total liabilities			1,131,736,121				1,173,280,484
Stockholders’ equity:
Preferred stock, $1,000 par value
Authorized and issued 30,255 shares			28,245,649				27,888,294
Common stock, $1 par value
Authorized 15,000,000 shares; issued 4,463,813 and 4,298,353 shares respectively			4,463,813				4,298,353
Surplus			26,939,983				25,144,323
Retained earnings			50,759,013				51,598,678
Accumulated other comprehensive income, net of tax			1,599,913				1,005,553
Treasury stock; 161,858 shares, at cost			(3,516,818	)			(3,516,818	)
Total stockholders’ equity			108,491,553				106,418,383
Total liabilities and stockholders’ equity		$	1,240,227,674			$	1,279,698,867

See accompanying notes to consolidated financial statements.

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

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
INTEREST INCOME
Interest and fees on loans		$	14,340,996			$	15,757,925			$	43,332,581			$	47,531,888
Interest on debt securities:
Taxable			1,152,935				1,140,427				3,430,153				3,864,716
Nontaxable			350,839				406,598				1,088,561				1,288,395
Interest on federal funds sold and securities purchased under agreements to resell			60				14,238				253				58,464
Interest on interest-bearing deposits			11,556				12				43,565				301
Dividends on equity securities			53,742				110,627				110,010				233,035
Total interest income			15,910,128				17,429,827				48,005,123				52,976,799
INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market			693,242				1,100,575				2,390,089				3,673,278
Time deposit accounts $100,000 and over			949,273				1,333,732				3,056,793				4,419,749
Other time deposit accounts			2,532,085				2,975,430				8,311,234				9,721,086
Interest on federal funds purchased and securities sold under agreements to repurchase			23,458				170,386				64,028				823,425
Interest on subordinated notes			588,554				736,663				1,878,657				2,319,585
Interest on other borrowed money			687,535				1,258,578				2,320,481				3,104,659
Total interest expense			5,474,147				7,575,364				18,021,282				24,061,782
Net interest income			10,435,981				9,854,463				29,983,841				28,915,017
Provision for loan losses			1,250,000				1,000,000				4,404,000				3,950,000
Net interest income after provision for loan losses			9,185,981				8,854,463				25,579,841				24,965,017
NON-INTEREST INCOME
Service charges on deposit accounts			1,547,038				1,636,165				4,380,248				4,636,065
Trust department income			237,939				198,743				623,258				604,617
Gain on sale of mortgage loans, net			489,069				132,988				2,437,169				685,782
Other			326,560				353,429				732,189				1,082,040
Total non-interest income			2,600,606				2,321,325				8,172,864				7,008,504
INVESTMENT SECURITIES GAINS (LOSSES), NET			—				—				—				2,773
NON-INTEREST EXPENSE
Salaries and employee benefits			4,454,183				4,483,943				13,403,853				13,662,257
Occupancy expense, net			599,555				601,435				1,762,990				1,802,215
Furniture and equipment expense			506,469				536,786				1,794,400				1,805,304
FDIC insurance assessment			421,690				39,264				2,085,472				165,284
Legal, examination, and professional fees			311,780				312,485				985,274				838,482
Advertising and promotion			301,348				328,696				901,066				839,831
Postage, printing, and supplies			271,434				259,538				833,846				894,188
Processing expense			845,288				774,314				2,538,067				2,327,224
Other real estate expense			239,747				85,686				575,008				430,303
Other			1,088,245				959,696				2,815,972				2,887,285
Total non-interest expense			9,039,739				8,381,843				27,695,948				25,652,373
Income before income taxes			2,746,848				2,793,945				6,056,757				6,323,921
Less income taxes			840,070				779,745				1,889,060				1,905,386
Net income			1,906,778				2,014,200				4,167,697				4,418,535
Preferred stock dividends			497,306				—				1,491,918				—
Net income available to common shareholders		$	1,409,472			$	2,014,200			$	2,675,779			$	4,418,535
Basic earnings per share		$	0.33			$	0.47			$	0.62			$	1.02
Diluted earnings per share		$	0.33			$	0.47			$	0.62			$	1.02

See accompanying notes to consolidated financial statements.

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

		Nine months ended September 30,
		2009				2008
Cash flows from operating activities:
Net income		$	4,167,697			$	4,418,535
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			4,404,000				3,950,000
Depreciation expense			1,540,942				1,619,146
Net amortization (accretion) of debt securities, premiums, and discounts			366,383				(49,056	)
Amortization of intangible assets			475,592				532,901
Stock based compensation expense			99,697				190,107
Decrease in accrued interest receivable			598,071				1,113,112
Increase in cash surrender value -life insurance			(57,750	)			(34,000	)
Decrease (increase) in other assets			93,894				(153,536	)
Decrease in accrued interest payable			(1,455,466	)			(619,265	)
Increase (decrease) in other liabilities			1,808,432				(426,773	)
Gain on sales of debt securities			—				(2,773	)
Origination of mortgage loans for sale			(125,186,177	)			(39,900,081	)
Proceeds from the sale of mortgage loans			127,623,346				40,585,863
Gain on sale of mortgage loans, net			(2,437,169	)			(685,782	)
Loss on sales and dispositions of premises and equipment			147,166				74,932
Other real estate owned impairment charges			62,535				153,500
(Decrease) increase in deferred tax asset			380,001				(258,438	)
Other, net			371,107				11,780
Net cash provided by operating activities			13,002,301				10,520,172
Cash flows from investing activities:
Net (decrease) increase in loans			6,768,359				(93,628,211	)
Purchase of available-for-sale debt securities			(110,865,517	)			(258,120,019	)
Proceeds from maturities of available-for-sale debt securities			83,996,365				186,799,283
Proceeds from calls of available-for-sale debt securities			17,805,000				39,132,640
Proceeds from sales of available-for-sale debt securities			—				30,920,778
Purchase of equity securities			—				(5,040,800	)
Proceeds from sales of equity securities			—				494,800
Purchases of premises and equipment			(420,575	)			(884,886	)
Proceeds from sales of premises and equipment			582,816				29,900
Proceeds from sales of other real estate owned and repossessions			1,929,955				1,486,453
Net cash used in investing activities			(203,597	)			(98,810,062	)
Cash flows from financing activities:
Net increase (decrease) in demand deposits			871,554				(13,395,525	)
Net increase in interest-bearing transaction accounts			15,278,667				2,069,084
Net (decrease) increase in time deposits			(3,311,738	)			18,722,934
Net increase in federal funds purchased and securities sold under agreements to repurchase			3,235,954				1,043,214
Proceeds from Federal Home Loan Bank advances			—				257,300,000
Repayment of Federal Home Loan Bank advances			(57,576,317	)			(175,954,819	)
Cash dividends paid — preferred stock			(991,691	)			—
Cash dividends paid — common stock			(2,192,342	)			(2,625,731	)
Purchase of treasury stock			—				(802,445	)
Net cash (used) in provided by financing activities			(44,685,913	)			86,356,712
Net decrease in cash and cash equivalents			(31,887,209	)			(1,933,178	)
Cash and cash equivalents, beginning of year			53,827,468				35,873,385
Cash and cash equivalents, end of period		$	21,940,259			$	33,940,207
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest		$	19,476,748			$	24,681,047
Income taxes		$	390,000			$	2,240,000
Supplemental schedule of noncash investing and financing activities:
Other real estate and repossessions acquired in settlement of loans		$	6,807,763			$	6,471,593

See accompanying notes to consolidated financial statements.

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Basis of Presentation

          The accompanying unaudited condensed consolidated financial statements include all adjustments that, in the opinion of management, are necessary in order to make those statements not misleading. Certain amounts in the 2008 condensed consolidated financial statements have been reclassified to conform to the 2009 condensed consolidated presentation. Such reclassifications have no effect on previously reported net income or stockholders’ equity. Operating results for the three and nine month periods ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. Our Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial statements through November 9, 2009, the dated the financial statements herein were issued.

          These unaudited condensed consolidated interim financial statements should be read in conjunction with our Company’s audited consolidated financial statements included in its 2008 Annual Report to Shareholders under the caption “Consolidated Financial Statements” and incorporated by reference into its Annual Report on Form 10-K for the year ended December 31, 2008 as Exhibit 13.

          The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed and omitted. These financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our Company’s consolidated financial position as of September 30, 2009 and the consolidated statements of operations and cash flows for the three and nine-month periods ended September 30, 2009 and 2008.

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

Loans and Allowance for Loan Losses

Major classifications in the Company’s loan portfolio at September 30, 2009 and December 31, 2008 are as follows:

		September 30,				December 31,
		2009				2008
		Amount				Amount
Commercial, financial, and agricultural		$	145,553,629			$	153,386,062
Real estate Construction			114,438,639				129,638,759
Real estate Mortgage			697,187,716				692,530,252
Installment loans to individuals			36,272,437				33,548,459
Total loans		$	993,452,421			$	1,009,103,532

          Included in the table above are impaired loans in the amount of $37,859,612 at September 30, 2009 and $29,933,773 at December 31, 2008. A loan is considered impaired when, based on current information and events, it is probable that all amounts due under the contractual terms of the agreement will not be collected. Such loans increased $7,925,839 during the first nine months of 2009 primarily due to higher levels of impaired construction and commercial real estate loans.

The following table shows outstanding amounts of impaired loans as of September 30, 2009 and December 31, 2008:

		September 30,				December 31,
		2009				2008
Loans classified as impaired:
Impaired loans with reserves		$	27,372,066			$	18,482,148
Impaired loans without reserves			10,487,546				11,451,625
Total impaired loans		$	37,859,612			$	29,933,773
Reserves for impaired loans		$	5,250,757			$	3,837,419
Average balance of impaired loans during the period		$	33,344,450			$	20,645,519

The following is a summary of the allowance for loan losses for the three and nine months ended September 30, 2009 and 2008 as follows:

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2009				2008				2009				2008
		Amount				Amount				Amount				Amount
Balance at beginning of period		$	13,704,736			$	11,131,032			$	12,666,546			$	9,281,848
Additions:
Provision for loan losses			1,250,000				1,000,000				4,404,000				3,950,000
Total additions			1,250,000				1,000,000				4,404,000				3,950,000
Deductions:
Loans charged off			1,198,165				2,937,682				3,549,572				4,331,793
Less recoveries on loans			(170,963	)			(162,867	)			(406,560	)			(456,162	)
Net loans charged off			1,027,202				2,774,815				3,143,012				3,875,631
Balance at end of period		$	13,927,534			$	9,356,217			$	13,927,534			$	9,356,217

Investment Securities

The amortized cost and fair value of securities classified as available-for-sale at September 30, 2009 and December 31, 2008 are as follows:

						Gross				Gross
		Amortized				unrealized				unrealized
		cost				gains				losses				Fair value
September 30, 2009
Government sponsored enterprises		$	46,670,668			$	695,110			$	—			$	47,365,778
Asset-backed securities			68,076,303				2,591,350				36,590				70,631,063
Obligations of states and political subdivisions			39,972,384				1,051,630				7,046				41,016,968
Total debt securities			154,719,355				4,338,090				43,636				159,013,809
Equity securities			8,875,250				—				—				8,875,250
Total investment securities		$	163,594,605			$	4,338,090			$	43,636			$	167,889,059
December 31, 2008
Government sponsored enterprises		$	54,018,436			$	1,526,240			$	—			$	55,544,676
Asset-backed securities			48,801,151				1,292,982				3,148				50,090,985
Obligations of states and political subdivisions			43,201,999				755,091				191,822				43,765,268
Total debt securities			146,021,586				3,574,313				194,970				149,400,929
Equity securities			8,875,250				—				—				8,875,250
Total investment securities		$	154,896,836			$	3,574,313			$	194,970			$	158,276,179

          Equity securities in the amount of $8,875,250 as of September 30, 2009 and December 31, 2008 are recorded at cost, and consist primarily of Federal Home Loan Bank Stock and the Company’s interest in the statutory trusts.

The amortized cost and fair value of debt securities classified as available-for-sale at September 30, 2009 December 31, 2008, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.

		Amortized				Fair
		cost				value
Due in one year or less		$	14,576,193			$	14,770,578
Due after one year through five years			45,887,667				46,702,223
Due after five years through ten years			21,916,619				22,487,280
Due after ten years			4,262,573				4,422,665
			86,643,052				88,382,746
Asset-backed securities			68,076,303				70,631,063
Total debt securities			154,719,355				159,013,809
Equity securities			8,875,250				8,875,250
Total available for sale investment securities		$	163,594,605			$	167,889,059

          Our Company conducts periodic reviews to identify and evaluate each investment that has an unrealized loss, in accordance with Financial Accounting Standards Board’s (FASB) Accounting Standard Codification (ASC) The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. In June 2009, FASB issued authoritative guidance on recognition and presentation of other-than-temporary impairments, which changed the accounting requirements for other than temporary impairment for debt securities, and, in certain prescribed circumstances, separated the amount of total impairment into credit and noncredit-related amounts.

          The following table presents proceeds from sales of securities and the components of investment securities gains and losses which have been recognized in earnings:

		For the three months								For the nine months
		ended September 30,								ended September 30,
		2009				2008				2009				2008
Proceeds from sales of available for sale securities		$	—			$	—			$	—			$	30,920,778
Available for sale:
Gains realized on sales			—				—				—				2,773
Losses realized on sales			—				—				—				—
Other-than-temporary impairment recognized			—				—				—				—
Investment securities gains (losses), net		$	—			$	—			$	—			$	2,773

          At September 30, 2009, our Company’s investment portfolio had unrealized gains of $4,338,090 and unrealized losses of $43,636. Of the $43,636 in unrealized losses, $1 of the unrealized loss has been in the loss position for greater than twelve months. The carrying value of the investments in this loss position at September 30, 2009 was $43,310 and consisted of one asset-backed security. Our Company continues to monitor the performance of our investment securities. Our Company does not intend to sell these investments and it is not likely that our Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity.

          Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2009 and December 31, 2008, were as follows:

		Less than 12 months								12 months or more												Total
																		Number of
		Fair				Unrealized				Fair				Unrealized				Investment				Fair				Unrealized
		Value				Losses				Value				Losses				Positions				Value				Losses
At September 30, 2009
Government sponsored enterprises		$	—			$	—			$	—			$	—				—			$	—			$	—
Asset-backed securities			7,033,374				(36,589	)			43,310				(1	)			9				7,076,684				(36,590	)
Obligations of states and political subdivisions			773,287				(7,046	)			—				—				5				773,287				(7,046	)
		$	7,806,661			$	(43,635	)		$	43,310			$	(1	)			14			$	7,849,971			$	(43,636	)

		Less than 12 months								12 months or more												Total
																		Number of
		Fair				Unrealized				Fair				Unrealized				Investment				Fair				Unrealized
		Value				Losses				Value				Losses				Positions				Value				Losses
At December 31, 2008
Government sponsored enterprises		$	—			$	—			$	—			$	—				—			$	—			$	—
Asset-backed securities			890,039				(1,904	)			210,667				(1,244	)			11				1,100,706				(3,148	)
Obligations of states and political subdivisions			7,674,965				(191,822	)			—				—				27				7,674,965				(191,822	)
		$	8,565,004			$	(193,726	)		$	210,667			$	(1,244	)			38			$	8,775,671			$	(194,970	)

Fair Value Measurements

          The FASB’s ASC, Fair Value Measurement, 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.

The fair value hierarchy is as follows:

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

Level 2 — Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, such as interest rates and yield curves that are observable at commonly quoted intervals.

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

          Fair Value Measurement also requires separate disclosure of assets and liabilities measured at fair value on a recurring basis, as documented above, 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 our Company’s valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

Available-for-sale securities

     Available-for-sale securities are recorded at fair value on a recurring basis. Available-for-sale securities is the only balance sheet category our Company is required, in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), to carry at fair value on a recurring basis. Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, our Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Fair Value Measurements

At September 30, 2009 Using

Quoted Prices

in Active

Markets for

Other

Significant

Identical

Observable

Unobservable

Fair Value

Assets

Inputs

Inputs

Description

September 30, 2009

(Level 1)

(Level 2)

(Level 3)

Available-for-Sale Securities

$

159,013,809

$

—

$

159,013,809

$

—

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

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

Impaired Loans

     Our Company does not record loans at fair value on a recurring basis other than loans that are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the FASB’s ASC, Accounting by Creditors for Impairment of a Loan. Impaired loans for which an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. At September 30, 2009, all impaired loans were evaluated based on the fair value of the collateral. In determining the fair value of the collateral, our Company relies on external appraisals and assessment of property values by our internal staff. Because many of these inputs are not observable, the measurements are classified as Level 3. As of September 30, 2009, our Company identified $27.4 million in impaired loans that had specific allowances for losses aggregating $5.3 million. Related to these loans, there was $1.8 million in charge-offs recorded in the first nine months of 2009.

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. Our Company relies on external appraisals and assessment of property values by our internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgment based on experience and expertise of internal specialists. Subsequent to foreclosure, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3.

						Fair Value Measurements
						At September 30, 2009 Using
						Quoted Prices
						in Active												Nine Months
						Markets for				Other				Significant				Ended
						Identical				Observable				Unobservable				Sept. 30, 2009
		Fair Value				Assets				Inputs				Inputs				Total Gains
Description		September 30, 2009				(Level 1)				(Level 2)				(Level 3)				(Losses)
Impaired loans		$	22,121,309			$	—			$	—			$	22,121,309			$	(1,805,526	)
Other real estate owned and repossessed assets		$	11,578,503			$	—			$	—			$	11,578,503			$	(1,099,383	)

Earnings per Share

     Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the three and nine-month periods ended September 30, 2009 and 2008, respectively. Diluted earnings per share gives effect to all dilutive potential common shares that were outstanding during the three and nine-month periods ended September 30, 2009 and 2008, respectively.

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

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Net income, basic and diluted		$	1,906,778			$	2,014,200			$	4,167,697			$	4,418,535
Less: preferred stock dividends			497,306				—				1,491,918				—
Net income available to common shareholders			1,409,472				2,014,200				2,675,779				4,418,535
Average shares outstanding			4,301,955				4,316,662				4,301,955				4,328,702
Effect of dilutive stock options			—				13,799				—				20,162
Average shares outstanding including dilutive stock options		$	4,301,955			$	4,330,461			$	4,301,955			$	4,348,864
Net income per share, basic		$	0.33			$	0.47			$	0.62			$	1.02
Net income per share, diluted			0.33				0.47				0.62				1.02

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

          The following options and warrant to purchase shares during the three and nine month-periods ended 2009 and 2008 were not included in the respective computations of diluted earnings per share because the exercise price, when combined with the effect of the unamortized compensation expense, was greater than the average market price of the common shares and were considered anti-dilutive.

Anti-dilutive shares		2009				2008
Three months ended September 30,			531,226				267,086
Nine months ended September 30,			531,226				212,595

Stock-Based Compensation

          Our Company’s stock option plan provides for the grant of options to purchase up to 450,000 shares of our Company’s common stock to officers and other key employees of our Company and its subsidiaries. All options have been granted at exercise prices equal to fair value and vest over periods ranging from four to five years, except 4,821 options issued in 2002, and 9,519 options issued in 2008 to acquire shares that vested immediately.

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

														Weighted
						Weighted				Aggregate				Average
						Average				Intrinsic				Contractual
						Exercise				Value				Term
		Options				Price				(000)				(in years)
Outstanding at January 1, 2009 - adjusted *			277,454			$	25.10
Granted			—				—
Exercised			—				—
Forfeited			(1,488	)			30.22
Canceled			—				—
Outstanding at September 30, 2009			275,966			$	25.07			$	—				5.2
Exercisable at September 30, 2009			215,711			$	24.70			$	—				4.5

*		On July 1, 2009 a 4% stock dividend was issued.

          Total stock-based compensation expense for the three months ended September 30, 2009 and 2008 was $31,000 and $86,000, respectively. Total stock-based compensation expense for the nine months ended September 30, 2009 and 2008 was $100,000 and $190,000, respectively. As of September 30, 2009, the total unrecognized compensation expense related to non-vested stock awards was $274,000 and the related weighted average period over which it is expected to be recognized is approximately two years.

Comprehensive Income

Comprehensive income for the three and nine-months ended September 30, 2009 and 2008 is summarized as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Net income		$	1,906,778			$	2,014,200			$	4,167,697			$	4,418,535
Other comprehensive income:
Unrealized loss on securities:
Unrealized gain (loss) on debt and equity securities available-for-sale, net of tax			808,079				250,158				558,218				(458,592	)
Adjustment on sales and calls of debt and equity securities, net of tax			—				—				—				(1,692	)
Defined benefit pension plan:
Amortization of prior service cost included in net periodic pension cost, net of tax			12,052				3,928				36,142				11,780
Total other comprehensive income (loss)			820,131				254,086				594,360				(448,504	)
Comprehensive income		$	2,726,909			$	2,268,286			$	4,762,057			$	3,970,031

Goodwill and Intangible Assets

          Our Company’s goodwill is tested annually for potential impairment. As a result of our 2008 review, we determined that the Company’s goodwill was fully impaired as of December 31, 2008, and recorded an impairment charge of $40,323,775, before tax, in the fourth quarter of 2008.

A summary of other intangible assets at September 30, 2009 and December 31, 2008 is as follows:

		September 30, 2009												December 31, 2008
		Gross												Gross
		Carrying				Accumulated				Net				Carrying				Accumulated				Net
		Amount				Amortization				Amount				Amount				Amortization				Amount
Amortizable intangible assets:
Core deposit intangible		$	7,060,224			$	(5,405,719	)		$	1,654,505			$	7,060,224			$	(4,930,127	)		$	2,130,097
Mortgage servicing rights			3,425,091				(1,543,736	)			1,881,355				2,767,180				(1,595,955	)			1,171,225
Total amortizable intangible assets		$	10,485,315			$	(6,949,455	)		$	3,535,860			$	9,827,404			$	(6,526,082	)		$	3,301,322

Changes in the net carrying amount of other intangible assets for the nine month period ended September 30, 2009 are as follows:

		Core Deposit				Mortgage
		Intangible				Servicing
		Asset				Rights
Balance at December 31, 2008		$	2,130,097			$	1,171,225
Additions			—				1,456,812
Amortization			(475,592	)			(746,682	)
Balance at September 30, 2009		$	1,654,505			$	1,881,355

          Mortgage loans serviced for others totaled approximately $258,101,000 and $213,074,000 at September 30, 2009 and December 31, 2008, respectively.

          Our Company’s amortization expense on intangible assets in any given period may be different from the estimated amounts depending upon the acquisition of intangible assets, changes in mortgage interest rates, prepayment rates and other market conditions. The following table shows the estimated future amortization expense based on existing asset balances and the interest rate environment as of September 30, 2009 and for the next five years:

		Core Deposit				Mortgage
		Intangible				Servicing
		Asset				Rights
2009		$	150,519			$	254,000
2010			526,477				405,000
2011			434,763				308,000
2012			408,062				234,000
2013			134,684				179,000
2014			—				137,000

          The aggregate amortization expense of intangible assets subject to amortization for the three and nine-month periods ended September 30, 2009 and 2008 is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Aggregate amortization expense		2009				2008				2009				2008
Core deposit intangible asset		$	150,519			$	168,543			$	475,592			$	532,900
Mortgage servicing rights			156,365				123,153				746,682				470,677

Income Taxes

          As of September 30, 2009 and December 31, 2008, our Company had $749,000 of gross unrecognized tax benefits of which $487,000 would impact the effective tax rate, if recognized. Our Company expects a reduction of $187,000 in gross unrecognized tax benefits during the remainder of 2009 as a result of the state statute of limitations closing for the 2005 tax year. Our Company and subsidiaries file income tax returns in the U. S. federal jurisdiction and the state of Missouri.

          As of September 30, 2009, interest accrued on unrecognized tax benefits was approximately $108,000. Our Company’s state and federal income tax returns for 2005 to 2008 are open tax years. As of September 30, 2009, there were no federal or state income tax examinations in process.

Employee Benefit Plans

          Employee benefits charged to operating expenses are summarized for the three and nine months ended September 30, 2009 and 2008 in the table below.

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Payroll taxes		$	246,232			$	193,391			$	855,229			$	869,491
Medical plans			370,113				354,704				1,127,477				1,093,697
401k match			81,045				79,120				227,902				229,888
Pension plan			229,000				218,337				687,000				655,010
Profit-sharing			99,000				87,600				233,350				191,415
Other			28,906				48,777				81,539				150,359
Total employee benefits		$	1,054,296			$	981,929			$	3,212,497			$	3,189,860

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

		Estimated				Actual
		2009				2008
Service cost — benefits earned during the year		$	851,000			$	820,401
Interest cost on projected benefit obligations			509,000				452,524
Expected return on plan assets			(523,000	)			(454,344	)
Amortization of prior service cost			79,000				78,628
Amortization of net gains			—				(42,802	)
Net periodic pension expense — Annual		$	916,000			$	854,407
Pension expense — three months ended September 30 (actual)		$	229,000			$	218,337
Pension expense — nine months ended September 30 (actual)		$	687,000			$	655,010

          Our Company made a $1,500,000 contribution to the defined benefit plan in 2008. Although there is no required minimum required contribution for 2009, our Company may contribute up to $5,560,000. As of September 30, 2009 we have not determined whether our Company will make any contributions for 2009.

Preferred Stock

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

          Participating in this program included our Company’s issuance of 30,255 shares of senior preferred stock (with a par value of $1,000 per share) and a ten year warrant to purchase approximately 255,260 shares of common stock (see below for additional information) to the U.S. Department of Treasury in exchange for $30,255,000. The proceeds received were allocated between the preferred stock and the common stock warrant based upon their relative fair values. This resulted in the recording of a discount on the preferred stock upon issuance that reflects the value allocated to the warrant. The discount on the preferred stock will be accreted over five years, consistent with management’s estimate of the life of the preferred stock. Such accretion will be treated as additional dividends on the preferred stock. The allocated carrying values of the senior preferred stock and common stock warrants at September 30, 2009 were $28,246,000 and $2,382,000, respectively.

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

          The common stock warrant is exercisable immediately with a ten year term, in whole or in part, at an exercise price of $17.78 per share. The amount of shares covered by the warrant will be reduced by one half if our Company raises equity capital of at least $30,255,000 by December 31, 2009. The Treasury Department may not exercise or transfer the common stock warrant with respect to more than half of the initial shares of common stock underlying the common stock warrant prior to the earlier of the date on which our Company receives aggregate

gross proceeds of not less than $30,255,000 from one or more qualified equity offerings or before December 31, 2009.

                The preferred stock and warrant are classified as stockholders’ equity in the consolidated balance sheets and qualify, for regulatory capital purposes, as Tier I capital. Through the nine months ended September 30, 2009, our Company had declared and paid dividends in the amount of $991,692 on the preferred stock.

Disclosures about Fair Value of Financial Instruments

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

Loans

          Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, such as real estate, installment and other consumer, commercial, and bankers’ acceptances. Each loan category is further segmented into fixed and adjustable interest rate terms and by performing and nonperforming categories.

          The fair value of performing loans is calculated by discounting scheduled cash flows through estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

          The fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market and specific borrower information.

Investment in Debt and Equity Securities

          Fair values are based on quoted market prices or dealer quotes.

Federal Funds Sold, Cash, and Due from Banks

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

Mortgage Servicing Rights

          The fair value of mortgage servicing rights is based on the discounted value of contractual cash flows utilizing servicing rate, constant prepayment rate, servicing cost, and discount rate factors.

Accrued Interest Receivable and Payable

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

Deposits

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

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

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

Other Borrowings

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

A summary of the carrying amounts and fair values of the Company’s financial instruments at September 30, 2009 and December 31, 2008 is as follows:

		September 30,								December 31,
		2009								2008
		Carrying				Fair				Carrying				Fair
		amount				value				amount				value
Assets:
Loans		$	979,524,887			$	987,863,000			$	996,436,986			$	1,000,594,000
Investment in debt and equity securities			167,889,059				167,889,059				158,276,179				158,276,179
Federal fund sold and securities purchased under agreements to resell			106,226				106,226				104,393				104,393
Cash and due from banks			21,834,033				21,834,033				53,723,075				53,723,075
Mortgage servicing rights			1,881,355				3,020,000				1,171,225				2,455,000
Accrued interest receivable			6,878,022				6,878,022				7,476,093				7,476,093
		$	1,178,113,582			$	1,187,590,340			$	1,217,187,951			$	1,222,628,740
Liabilities:
Deposits:
Demand		$	126,116,754			$	126,116,754			$	125,245,200			$	125,245,200
NOW			133,142,824				133,142,824				123,288,896				123,288,896
Savings			47,430,953				47,430,953				43,370,172				43,370,172
Money market			177,331,592				177,331,592				175,967,634				175,967,634
Time			484,112,749				495,854,000				487,424,487				494,427,000
Federal funds purchased and securities sold under agreements to repurchase			32,374,577				32,374,577				29,138,623				29,138,623
Subordinated notes			49,486,000				18,909,000				49,486,000				35,180,000
Other borrowings			71,481,166				76,303,000				129,057,483				130,454,000
Accrued interest payable			2,391,949				2,391,949				3,847,415				3,847,415
		$	1,123,868,564			$	1,109,854,649			$	1,166,825,910			$	1,160,918,940

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

Forward-Looking Statements

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

•		statements that are not historical in nature, and
•		statements preceded by, followed by or that include the words “believes,” “expects,” “may,” “will,” “should,” “could,” “anticipates,” “estimates,” “intends” or similar expressions.

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

•		competitive pressures among financial services companies may increase significantly,
•		changes in the interest rate environment may reduce interest margins,
•		general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,
•		increases in non-performing assets in our loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,
•		costs or difficulties related to the integration of the business of 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, 2008, and in other reports that we file with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that we have not identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.

Overview

          Our Company, Hawthorn Bancshares, Inc., is a community-based, financial institution bank holding company headquartered in Lee’s Summit, Missouri. Our Company was incorporated under the laws of the State of Missouri on October 23, 1992 as Exchange National Bancshares, Inc. and changed its name to Hawthorn Bancshares, Inc. in August 2007. Our Company owns all of the issued and outstanding capital stock of Union State Bancshares, Inc., which in turn owns all of the issued and outstanding capital stock of Hawthorn Bank. Our Company conducts operations primarily through our Bank. Our Bank, a state charted bank, had $1.24 billion in assets at September 30, 2009, and 24 full-service banking offices, including its principal office in Jefferson City, Missouri. Our Company is committed to providing the most up-to-date financial products and services and delivering these products and services to our market area with superior customer service.

          Through our branch network, our Company 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 continued strong loan demand in the communities within which we operate even 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.

Critical Accounting Policies

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

Allowance for Loan Losses

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

Income Taxes

          Our Company accounts for income taxes 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 been 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 our 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.

Goodwill and Other Intangible Assets

          Goodwill represents the excess of costs over fair value of net assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives and reviewed for impairment in accordance with Accounting Standard, Accounting for Impairment or Disposal of Long-Lived Assets.

          Our Company performs an annual review of goodwill and intangible assets for impairment to determine whether the carrying value of underlying assets may not be recoverable. Our Company measures recoverability based upon the 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, our 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. As a result of the 2008 annual review, our Company determined that goodwill was fully impaired and recorded an impairment charge of $40,323,775, before tax. See the notes to the consolidated financial statements (unaudited) for further discussion.

SELECTED CONSOLIDATED FINANCIAL DATA

          The following table presents selected consolidated financial information for our Company as of and for each of the three and nine-month periods ended September 30, 2009 and September 30, 2008, respectively. 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.

Selected Financial Data

		Three Months								Nine Months
		Ended								Ended
		September 30,								September 30,
(In thousands, except per share data)		2009				2008				2009				2008
Per Share Data
Basic earnings per common share		$	0.33			$	0.47			$	0.62			$	1.02
Diluted earnings per common share			0.33				0.47				0.62				1.02
Dividends paid on preferred stock			378				—				992				—
Amortization of discount on preferred stock			119				—				357				—
Dividends paid on common stock			455				873				2,192				2,626
Book value per common share											18.65				27.06
Market price common stock											9.75				23.95
Selected Ratios
(Based on average balance sheets)
Return on average total assets			0.60	%			0.63	%			0.44	%			0.48	%%
Return on average common stockholders’ equity			7.03	%			7.17	%			4.51	%			5.25	%
Average common stockholders’ equity to average total assets			6.33	%			8.85	%			6.28	%			9.07	%
(Based on end-of-period data)
Efficiency ratio (1)			69.34	%			68.85	%			72.58	%			71.40	%
Period-end stockholders’ equity to period-end assets											6.47	%			8.71	%
Period-end common stockholders’ equity to period-end assets											8.75	%			8.71	%
Total risk-based capital ratio											16.50				12.47
Tier 1 risk-based capital ratio											14.01				10.48
Leverage ratio											11.24				8.67

Results of Operations

Summary

						Three Months																Nine Months
		Ended September 30,																Ended September 30,
(Dollars in thousands)		2009				2008				$ Change				% Change				2009				2008				$ Change				% Change
Net interest income		$	10,436			$	9,855			$	581				5.9	%		$	29,984			$	28,915			$	1,069				3.7	%
Provision for loan losses			1,250				1,000				250				25.0				4,404				3,950				454				11.5
Noninterest income			2,600				2,321				279				12.0				8,173				7,008				1,165				16.6
Investment securities gains, net			—				—				—				—				—				3				(3	)			(100.0	)
Noninterest expense			9,040				8,382				658				7.9				27,696				25,652				2,044				8.0
Income before income taxes			2,746				2,794				(48	)			(1.7	)			6,057				6,324				(267	)			(4.2	)
Income taxes			840				780				60				7.7				1,889				1,905				(16	)			(0.8	)
Net income		$	1,906			$	2,014			$	(108	)			(5.4	)%		$	4,168			$	4,419			$	(251	)			(5.7	)%
Less: preferred dividends			497				—				497				—				1,492				—				1,492				—
Net income available to common shareholders		$	1,409			$	2,014			$	(605	)			(30.0	)%		$	2,676			$	4,419			$	(1,743	)			(39.4	)%

          Our Company’s consolidated net income of $1,906,000 for the quarter ended September 30, 2009 decreased $108,000, or 5.4%, compared to the quarter ended September 30, 2008. Our Company recorded preferred stock dividends of $497,000 in the third quarter of 2009, resulting in $1,409,000 of net income available to common shareholders, or $.33 per diluted common share, compared to $2,014,000, or $.47 per diluted common share for the third quarter ended September 30, 2008. For the third quarter of 2009, the annualized return on average assets was 0.60%, the annualized return on average common shareholders’ equity was 7.03%, and the efficiency ratio was 69.3%. Net interest margin increased 0.08% from 3.49% to 3.57%. Net interest income, on a tax equivalent basis, increased $554,000 or 5.5% from 2008 to 2009.

          Our Company’s consolidated net income of $4,168,000 for the first nine months of 2009 decreased $251,000, or 5.7%, compared to $4,419,000 for the first nine months of 2008. Our Company recorded preferred stock dividends of $1,492,000 in the first nine months of 2009, resulting in $2,676,000 of net income available to common shareholders, or $.62 per diluted common share, compared to $4,419,000, or $1.02 per diluted common share for the first nine months ended September 30, 2008. For the first nine months of 2009, the annualized return on average assets was 0.44%, the annualized return on average common shareholders’ equity was 4.51%, and the efficiency ratio was 72.6%. Our Company did experience substantial real estate refinancing activity in the first nine months of 2009, which contributed additional revenues of approximately $2,437,000. However, this was offset by an industry-wide increase in FDIC insurance assessments as well as an increase in our provision for loan losses. Net interest margin decreased 0.07% from 3.51% to 3.44%. Net interest income, on a tax equivalent basis, increased $972,000 or 3.3% from 2008 to 2009. Total assets at September 30, 2009 were $1,240,228,000, compared to $1,279,699,000 at December 31, 2008, a decrease of $39,471,000, or 3.1%.

Net Interest Income

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

Average Balance Sheets

          The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the three month periods ended September 30, 2009 and 2008, respectively.

		Three Months Ended September 30,
		2009												2008
						Interest				Rate								Interest				Rate
		Average				Income/				Earned/				Average				Income/				Earned/
(dollars in thousands)		Balance				Expense(1)				Paid(1)				Balance				Expense(1)				Paid(1)
ASSETS
Loans: (2) (4)		$	1,002,252			$	14,367				5.69	%		$	986,139			$	15,793				6.35	%
Investment in securities: (3)
Government sponsored enterprises			114,773				1,131				3.91				101,630				1,122				4.38
State and municipal			39,527				536				5.38				44,191				606				5.44
Other			8,875				54				2.41				9,851				111				4.47
Federal funds sold			262				—				—				3,118				14				1.78
Interest bearing deposits in other financial institutions			14,288				11				0.31				125				—				—
Total interest earning assets			1,179,977				16,099				5.41				1,145,054				17,646				6.11
All other assets			89,610												128,237
Allowance for loan losses			(13,857	)											(11,216	)
Total assets		$	1,255,730											$	1,262,075
LIABILITIES AND STOCKHOLDERS’ EQUITY
NOW accounts		$	138,149			$	268				0.77	%		$	118,360			$	343				1.15	%
Savings			47,199				35				0.29				44,894				58				0.51
Money market			178,719				389				0.86				162,322				699				1.71
Time deposits of $100,000 and over			141,791				950				2.66				141,917				1,334				3.73
Other time deposits			347,783				2,532				2.89				313,824				2,976				3.76
Total time deposits			853,641				4,174				1.94				781,317				5,410				2.75
Federal funds purchased and securities sold under agreements to repurchase			36,416				23				0.25				36,358				170				1.86
Subordinated notes			49,486				589				4.72				49,486				737				5.91
Other borrowed money			71,603				688				3.81				152,158				1,258				3.28
Total interest bearing liabilities			1,011,146				5,474				2.15				1,019,319				7,575				2.95
Demand deposits			125,092												122,421
Other liabilities			11,794												8,588
Total liabilities			1,148,032												1,150,328
Stockholders’ equity			107,698												111,747
Total liabilities and stockholders’ equity		$	1,255,730											$	1,262,075
Net interest income (FTE)						$	10,625											$	10,071
Net interest spread											3.26	%											3.16	%
Net interest margin											3.57	%											3.49	%