HAWTHORN BANCSHARES, INC. (Form: 10-K, Received: 03/16/2009 11:09:41)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission file number: 0-23636

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)


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

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

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


Title of Each Class		Name of Each Exchange on Which Registered

None		N/A

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, par value $1.00 per share
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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
(Do not check if a smaller reporting company)

Smaller reporting company o

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

The aggregate market value of the 3,413,693 shares of voting and non-voting common equity of the registrant held by non-affiliates computed by reference to the $25.27 closing price of such common equity on June 30, 2008, the last business day of the registrant’s most recently completed second fiscal quarter, was $86,264,022. Aggregate market value excludes an aggregate of 745,802 shares of common stock held by officers and directors and by each person known by the registrant to own 5% or more of the outstanding common stock on such date. Exclusion of shares held by any of these persons should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant. As of March 13, 2009, the registrant had 4,298,353 shares of common stock, par value $1.00 per share, issued and 4,136,495 shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following documents are incorporated by reference into the indicated parts of this report: (1) 2008 Annual Report to Shareholders — Part II and (2) definitive Proxy Statement for the 2009 Annual Meeting of Shareholders to be filed with the Commission pursuant to Regulation 14A — Part III.

TABLE OF CONTENTS


PART I
	Item 1 . Business .
	Item 1A . Risk Factors .
	Item 1B . Unresolved Staff Comments .
	Item 2 . Properties .
	Item 3 . Legal Proceedings .
	Item 4 . Submission of Matters to a Vote of Security Holders .
PART II
	Item 5 . Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities .
	Item 6 . Selected Financial Data .
	Item 7 . Management’s Discussion and Analysis of Financial Condition and Results of Operation .
	Item 7A . Quantitative and Qualitative Disclosures About Market Risk .
	Item 8 . Financial Statements and Supplementary Data .
	Item 9 . Changes in and Disagreements With Accountants on Accounting and Financial Disclosure .
	Item 9A . Controls and Procedures .
	Item 9B . Other Information .
PART III
	Item 10 . Directors, Executive Officers and Corporate Governance .
	Item 11 . Executive Compensation .
	Item 12 . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters .
	Item 13 . Certain Relationships and Related Transactions, and Director Independence .
	Item 14 . Principal Accounting Fees and Services .
PART IV
	Item 15 . Exhibits, Financial Statement Schedules.
SIGNATURES
EXHIBIT INDEX
EX-13
EX-21
EX-23
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I

Item 1 . Business .

This report and the documents incorporated by reference herein contain forward-looking statements, which are inherently subject to risks and uncertainties. See “Forward Looking Statements” under Item 7 of this report.

General

Our Company, Hawthorn Bancshares, Inc., is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Hawthorn 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. Hawthorn 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. Hawthorn and Union State Bancshares each received approval from the Federal Reserve and elected to become a financial holding company on October 21, 2001.

Hawthorn acquired Hawthorn Bank and its constituent predecessor banks, as well as Union State Bancshares, in a series of transactions that are summarized as follows:

	•		On April 7, 1993 our Company acquired all of the issued and outstanding capital stock of The Exchange National Bank of Jefferson City, a national banking association, pursuant to a corporate reorganization involving an exchange of shares;

	•		On November 3, 1997, our Company acquired Union State Bancshares, Inc., and Union’s wholly-owned subsidiary, Union State Bank and Trust of Clinton;

	•		Following the May 4, 2000 acquisition of Citizens State Bank of Calhoun by Union State Bank, Citizens State Bank merged into Union State Bank to form Citizens Union State Bank & Trust;

	•		On January 3, 2000, our Company acquired Osage Valley Bank;

	•		On June 16, 2000, Hawthorn acquired City National Savings Bank, FSB, which was then merged into Exchange National Bank; and

	•		On May 2, 2005, our Company acquired all of the issued and outstanding capital stock of Bank 10, a Missouri state bank.

On December 1, 2006, our Company announced its development of a strategic plan in which, among other things, Exchange National Bank, Citizens Union State Bank, Osage Valley Bank and Bank 10 would be consolidated into a single bank under a Missouri state trust charter. This consolidation was completed in October 2007, and our subsidiary bank is now known as Hawthorn Bank.

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.

Description of Business

Hawthorn. Hawthorn is a bank holding company registered under the Bank Holding Company Act that has elected to become a financial holding company. Our Company’s activities currently are limited primarily to ownership, indirectly through its subsidiary (Union State Bancshares, Inc.), of the outstanding capital stock of Hawthorn Bank. In addition to ownership of its subsidiaries, Hawthorn may seek expansion through acquisition and may engage in those activities (such as investments in banks or operations that are financial in nature) in which it is permitted to engage under applicable law. It is not currently anticipated that

Hawthorn will engage in any business other than that directly related to its ownership of its banking subsidiary or other financial institutions.

Union. Union State Bancshares, Inc. is a bank holding company registered under the Bank Holding Company Act that has elected to become a financial holding company. Union’s activities currently are limited to ownership of the outstanding capital stock of Hawthorn Bank. It is not currently anticipated that Union will engage in any business other than that directly related to its ownership of Hawthorn Bank.

Hawthorn Bank . Hawthorn Bank was founded in 1932 as a Missouri bank and converted to a Missouri trust company on August 16, 1989. However, its predecessors trace their lineage back to the founding of Exchange National Bank in 1865. Hawthorn Bank has 25 banking offices, including its principal office at 132 East High Street in Jefferson City’s central business district. See “Item 2. Properties”.

Hawthorn Bank is a full service bank conducting a general banking and trust business, offering its customers checking and savings accounts, internet banking, debit cards, certificates of deposit, trust services, brokerage services, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, single payment personal loans, installment loans and commercial and residential real estate loans.

Hawthorn Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the extent provided by law. Hawthorn Bank’s operations are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of Hawthorn 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 the holders of Hawthorn Bank’s common stock. See “Regulation Applicable to Bank Holding Companies” and “Regulation Applicable to our Bank”.

Hawthorn Real Estate . Hawthorn Real Estate, LLC. was formed in December, 2008 to purchase and hold various nonperforming assets of Hawthorn Bank. The purpose for holding these nonperforming assets in Hawthorn Real Estate is to allow for the orderly disposition of these assets and strengthen Hawthorn Bank’s financial position.

Employees

As of December 31, 2008, Hawthorn and its subsidiaries had approximately 310 full-time and 68 part-time employees. None of its employees is presently represented by any union or collective bargaining group, and our Company considers its employee relations to be satisfactory.

Competition

Bank holding companies and their subsidiaries and affiliates encounter intense competition from nonbanking as well as banking sources in all of their activities. Our Bank’s competitors include other commercial banks, thrifts, savings banks, credit unions and money market mutual funds. Thrifts and credit unions now have the authority to offer checking accounts and to make corporate and agricultural loans and were granted expanded investment authority by recent federal regulations. In addition, large national and multinational corporations have in recent years become increasingly visible in offering a broad range of financial services to all types of commercial and consumer customers. In our Bank’s service areas, new competitors, as well as the expanding operations of existing competitors, have had, and are expected to continue to have, an adverse impact on our Bank’s market share of deposits and loans in such service areas.

Our Bank experiences substantial competition for deposits and loans within both its primary service areas of Jefferson City, Clinton, Lee’s Summit, Warsaw, Springfield, and Branson, Missouri and its secondary service area of the nearby communities in Cole, Henry, Cass, Benton and Greene counties of Missouri.

Hawthorn Bank’s principal competition for deposits and loans comes from other banks within its primary service areas and, to an increasing extent, other banks in nearby communities. Based on publicly available information, management believes that Hawthorn Bank is the fourth largest (in terms of deposits) of the thirteen banks within Cole county, the largest (in terms of deposits) of the nine banks within Henry county, the fourth largest (in terms of deposits) of the nineteen banks within Cass county, and the largest (in terms of deposits) of the five banks within Benton county. The main competition for Hawthorn Bank’s trust services is from other commercial banks, including those of the Kansas City metropolitan area.

Regulation Applicable to Bank Holding Companies

General. As a registered bank holding company and a financial holding company under the Bank Holding Company Act (the “BHC Act”) and the Gramm-Leach-Bliley Act (the “GLB Act”), Hawthorn is subject to supervision and examination by the Board of Governors of the Federal Reserve System (the “FRB”). The FRB has authority to issue cease and desist orders against bank holding companies if it determines that their actions represent unsafe and unsound practices or violations of law. In addition, the FRB is empowered to impose civil money penalties for violations of banking statutes and regulations. Regulation by the FRB is intended to protect depositors of our Bank, not the shareholders of Hawthorn.

Limitation on Acquisitions . The BHC Act requires a bank holding company to obtain prior approval of the FRB before:

	•		taking any action that causes a bank to become a controlled subsidiary of the bank holding company;

	•		acquiring direct or indirect ownership or control of voting shares of any bank or bank holding company, if the acquisition results in the acquiring bank holding company having control of more than 5% of the outstanding shares of any class of voting securities of such bank or bank holding company, and such bank or bank holding company is not majority-owned by the acquiring bank holding company prior to the acquisition;

	•		acquiring substantially all of the assets of a bank; or

	•		merging or consolidating with another bank holding company.

Limitation on Activities. The activities of bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, under the GLB Act, a bank holding company, all of whose controlled depository institutions are “well capitalized” and “well managed” (as defined in federal banking regulations) with “satisfactory” Community Reinvestment Act ratings, may declare itself to be a “financial holding company” and engage in a broader range of activities. As noted above, Hawthorn is registered as a financial holding company.

A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental or complementary to activities that are financial in nature. “Financial in nature” activities include:

	•		securities underwriting, dealing and market making;

	•		sponsoring mutual funds and investment companies;

	•		insurance underwriting and insurance agency activities;

	•		merchant banking; and

	•		activities that the FRB determines to be financial in nature or incidental to a financial activity or which is complementary to a financial activity and does not pose a safety and soundness risk.

A financial holding company that desires to engage in activities that are financial in nature or incidental to a financial activity but not previously authorized by the FRB must obtain approval from the FRB before engaging in such activity. Also, a financial holding company may seek FRB approval to engage in an activity that is complementary to a financial activity, if it shows, among other things, that the activity does not pose a substantial risk to the safety and soundness of its insured depository institutions or the financial system.

A financial holding company generally may acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature without prior approval from the FRB. Prior FRB approval is required, however, before the financial holding company may acquire control of more than 5% of the voting shares or substantially all of the assets of a bank holding company, bank or savings association. In addition, under the FRB’s merchant banking regulations, a financial holding company is authorized to invest in companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment with the intention of limiting the duration of the investment, does not manage the company on a day-to-day basis, and the company does not cross-market its products or services with any of the financial holding company’s controlled depository institutions.

If any subsidiary bank of a financial holding company ceases to be “well-capitalized” or “well-managed” and fails to correct its condition within the time period that the FRB specifies, the FRB has authority to order the financial holding company to divest its subsidiary banks. Alternatively, the financial holding company may elect to limit its activities and the activities of its subsidiaries to those permissible for a bank holding company that is not a financial holding company. If any subsidiary bank of a financial holding company receives a rating under the Community Reinvestment Act (the “CRA”) of less than “satisfactory”, then the financial holding company is prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations until the rating is raised to “satisfactory” or better.

Regulatory Capital Requirements. The FRB has issued risk-based and leverage capital guidelines applicable to United States banking organizations. If a bank holding company’s capital falls below minimum required levels, then the bank holding company must implement a plan to increase its capital, and its ability to pay dividends and make acquisitions of new bank subsidiaries may be restricted or prohibited. The FRB’s risk-based guidelines define a two-tier capital framework. Tier 1 capital generally includes common shareholders’ equity, a limited amount of trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments. Tier 2 capital generally consists of preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for credit losses up to 1.25% of risk-weighted assets and other adjustments. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents our total capital.

The risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets (including certain off-balance sheet activities). The FRB’s capital adequacy guidelines require that bank holding companies maintain a Tier 1 risk-based capital ratio equal to at least 4% of its risk-weighted assets and a total risk-based capital ratio equal to at least 8% of its risk-weighted assets. In addition, the FRB has established a minimum leverage ratio for bank holding companies. The FRB’s capital adequacy guidelines require that bank holding companies meeting specified criteria (including having the highest regulatory rating) maintain a Tier 1 leverage ratio equal to at least 3% of its average total consolidated assets. All other bank holding companies generally will be required to maintain a Tier 1 leverage ratio of at least 4%.

On December 31, 2008, Hawthorn was in compliance with all of the FRB’s capital adequacy guidelines. Hawthorn’s capital ratios on December 31, 2008 are shown below:


Leverage Ratio (3% minimum requirement)	Tier 1 Risk-Based Capital Ratio (4% minimum requirement)	Total Risk-Based Capital Ratio (8% minimum requirement)

10.80%	13.55%	16.01%

Interstate Banking and Branching. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”), a bank holding company is permitted to acquire the stock or substantially all of the assets of banks located in any state regardless of whether such transaction is prohibited under the laws of any state. The FRB will not approve an interstate acquisition if, as a result of the acquisition, the bank holding company would control more than 10% of the total amount of insured deposits in the United States or would control more than 30% of the insured deposits in the home state of the acquired bank. The 30% of insured deposits state limit does not apply if the acquisition is the initial entry into a state by a bank holding company or if the home state waives such limit. The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. Banks are also permitted to acquire and to establish de novo branches in other states where authorized under the laws of those states.

Under the Riegle-Neal Act, individual states may restrict interstate acquisitions in two ways. A state may prohibit an out-of-state bank holding company from acquiring a bank located in the state unless the target bank has been in existence for a specified minimum period of time (not to exceed five years). A state may also establish limits on the total amount of insured deposits within the state which are controlled by a single bank holding company, provided that such deposit limit does not discriminate against out-of-state bank holding companies.

Source of Strength. FRB policy requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. Under this “source of strength doctrine,” a bank holding company is expected to stand ready to use its available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and to maintain resources and the capacity to raise capital which it can commit to its subsidiary banks. Furthermore, the FRB has the right to order a bank holding company to terminate any activity that the FRB believes is a serious risk to the financial safety, soundness or stability of any subsidiary bank.

Liability of Commonly Controlled Institutions. Under cross-guaranty provisions of the Federal Deposit Insurance Act (the “FDIA”), bank subsidiaries of a bank holding company are liable for any loss incurred by the Deposit Insurance Fund (the “DIF”), the federal deposit insurance fund for banks, in connection with the failure of any other bank subsidiary of the bank holding company.

Missouri Bank Holding Company Regulation . Missouri prohibits any bank holding company from acquiring ownership or control of any bank or Missouri depository trust company that has Missouri deposits if, after such acquisition, the bank holding company would hold or control more than 13% of total Missouri deposits. Because of this restriction, among others, a bank holding company, prior to acquiring control of a bank or depository trust company that has deposits in Missouri, must receive the approval of the Missouri Division of Finance.

Regulation Applicable to our Bank

General. Hawthorn Bank, a Missouri state non-member depository trust company, is subject to the regulation of the Missouri Division of Finance and the FDIC. The FDIC is empowered to issue cease and desist orders against our Bank if it determines that any activities of our Bank represent unsafe and unsound banking practices or violations of law. In addition, the FDIC has the power to impose civil money penalties

for violations of banking statutes and regulations. Regulation by these agencies is designed to protect the depositors of the Bank; not shareholders of Hawthorn.

Bank Regulatory Capital Requirements. The FDIC has adopted minimum capital requirements applicable to state non-member banks, which are similar to the capital adequacy guidelines established by the FRB for bank holding companies. Federal banking laws require the federal regulatory agencies to take prompt corrective action against undercapitalized financial institutions. A bank is identified as being “well-capitalized” if it has a total Tier 1 leverage ratio of 5% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a total risk-based capital ratio of 10% or greater (and is not subject to any order or written directive requiring the bank to adhere to a higher ratio).

On December 31, 2008, our Bank was classified as “well-capitalized,” which is required for Hawthorn to remain a financial holding company. The capital ratios and classifications of our Bank as of December 31, 2008 are shown on the following chart.


Leverage Ratio (5% minimum requirement)	Tier 1 Risk-Based Capital Ratio (6% minimum requirement)	Total Risk-Based Capital Ratio (10% minimum requirement)

8.82%	11.13%	12.35%

Limitations on Interest Rates and Loans to One Borrower. The rate of interest a bank may charge on certain classes of loans is limited by state and federal law. At certain times in the past, these limitations have resulted in reductions of net interest margins on certain classes of loans. Federal and state laws impose additional restrictions on the lending activities of banks. Generally, the maximum amount that a Missouri state-chartered bank may lend to any one person or entity is generally limited to 15% of the unimpaired capital of the bank located in a city having a population of 100,000 or more, 20% of the unimpaired capital of the bank located in a city having a population of less than 100,000 and over 7,000, and 25% of the unimpaired capital of the bank if located elsewhere in the state. In the case of Missouri state-chartered banks with a composite rating of 1 or 2 under the Capital, Assets, Management, Earnings, Liquidity and Sensitivity (CAMELS) rating system, the maximum amount is the greater of (i) the limits listed in the foregoing sentence or (ii) 25% of the unimpaired capital of the bank.

Payment of Dividends. Our Bank is subject to federal and state laws limiting the payment of dividends. Under the FDIA, an FDIC-insured institution may not pay dividends while it is undercapitalized or if payment would cause it to become undercapitalized. The National Bank Act and Missouri banking law also prohibit the declaration of a dividend out of the capital and surplus of the bank. Our Bank will be required to receive regulatory approval prior to paying dividends to our Company until such time as the Bank’s unappropriated retained earnings balance is restored to a positive balance. In addition to the above limitations, our ability to pay dividends on our common stock is limited by our participation in the U.S. Treasury’s Capital Purchase Program (CPP). Prior to December 19, 2011, unless we have redeemed the Series A preferred stock issued to the U.S. Treasury in the CPP or the U.S. Treasury has transferred the Series A preferred stock to a third party, we must receive the consent of the U.S. Treasury before we can pay quarterly dividends on our common stock of more than $0.21 per share. Furthermore, if we are not current in the payment of quarterly dividends on the Series A preferred stock, we can not pay dividends on our common stock.

Community Reinvestment Act. Our Bank is subject to the CRA and implementing regulations. CRA regulations establish the framework and criteria by which the bank regulatory agencies assess an institution’s record of helping to meet the credit needs of its community, including low- and moderate-income neighborhoods. CRA ratings are taken into account by regulators in reviewing certain applications made by Hawthorn and its banking subsidiary.

Limitations on Transactions with Affiliates. Hawthorn and its non-bank subsidiaries are “affiliates” within the meaning of the Federal Reserve Act. The amount of loans or extensions of credit which our Bank may make to non-bank affiliates, or to third parties secured by securities or obligations of the non-bank affiliates, are substantially limited by the Federal Reserve Act and the FDIA. Such acts further restrict the range of permissible transactions between a bank and an affiliated company. A bank and its subsidiaries may engage in certain transactions, including loans and purchases of assets, with an affiliated company only if the terms and conditions of the transaction, including credit standards, are substantially the same as, or at least as favorable to the bank as, those prevailing at the time for comparable transactions with non-affiliated companies or, in the absence of comparable transactions, on terms and conditions that would be offered to non-affiliated companies.

Other Banking Activities. The investments and activities of our Bank are also subject to regulation by federal banking agencies regarding investments in subsidiaries, investments for their own account (including limitations on investments in junk bonds and equity securities), loans to officers, directors and their affiliates, security requirements, anti-tying limitations, anti-money laundering, financial privacy and customer identity verification requirements, truth-in-lending, the types of interest bearing deposit accounts which it can offer, trust department operations, brokered deposits, audit requirements, issuance of securities, branching and mergers and acquisitions.

Changes in Laws and Monetary Policies

Recent Legislation. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide the enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws. The proposed changes are intended to allow shareholders to monitor the performance of companies and directors more easily and efficiently.

The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the Securities and Exchange Commission, or “SEC”, under the Securities and Exchange Act of 1934. Further, the Sarbanes-Oxley Act includes very specified additional disclosure requirements and new corporate governance rules, requires the SEC, securities exchanges and the Nasdaq Global Select Market to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC and the Comptroller General. Given the extensive SEC role in implementing rules relating to many of the Sarbanes-Oxley Act’s new requirements, the final scope of these requirements remains to be determined.

The Sarbanes-Oxley Act addresses, among other matters: audit committees; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses and profits made by directors and senior officers in the twelve month period covered by restated financial statements; a prohibition on insider trading during pension plan black out periods; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers (excluding federally insured financial institutions); expedited filing requirements for stock transaction reports by officers and directors; the formation of a public accounting oversight board; auditor independence; and various increased criminal penalties for violations of securities laws. Management has taken various measures to comply with the requirements of the Sarbanes-Oxley Act.

Future Legislation. Various pieces of legislation, including proposals to change substantially the financial institution regulatory system, are from time to time introduced and considered by the Missouri state legislature and the United States Congress. This legislation may change banking statutes and the operating environment of Hawthorn in substantial and unpredictable ways. If enacted, this legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. Hawthorn cannot predict

whether any of this potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, could have on Hawthorn’s business, results of operations or financial condition.

Fiscal Monetary Policies. Hawthorn’s business and earnings are affected significantly by the fiscal and monetary policies of the federal government and its agencies. Hawthorn is particularly affected by the policies of the FRB, which regulates the supply of money and credit in the United States. Among the instruments of monetary policy available to the FRB are:

	•		conducting open market operations in United States government securities;

	•		changing the discount rates of borrowings of depository institutions;

	•		imposing or changing reserve requirements against depository institutions’ deposits; and

	•		imposing or changing reserve requirements against certain borrowings by bank and their affiliates.

These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB have a material effect on Hawthorn’s business, results of operations and financial condition.

The references in the foregoing discussion to various aspects of statutes and regulation are merely summaries, which do not purport to be complete and which are qualified in their entirety by reference to the actual statutes and regulations.

Available Information

The address of our principal executive offices is 300 Southwest Longview Boulevard, Lee’s Summit, Missouri 64081 and our telephone number at this location is (816) 347-8100. Our common stock trades on the Nasdaq Global Select Market under the symbol “HWBK”.

We electronically file certain documents with the SEC. We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K (as appropriate), along with any related amendments and supplements. From time-to-time, we also may file registration and related statements pertaining to equity or debt offerings. You may read and download our SEC filings over the internet from several commercial document retrieval services as well as at the SEC’s internet website (www.sec.gov). You may also read and copy our SEC filings at the SEC’s public reference room located at 100 F Street, NE., Washington, DC 20549. Please call the SEC 1-800-SEC-0330 for further information concerning the public reference room and any applicable copy charges.

Our internet website address is www.hawthornbancshares.com. Under the “Documents” section of our website (www.hawthornbancshares.com), we make available, without charge, our public filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, or any amendments to those reports filed or furnished to the SEC pursuant to Section 13(a) of the Securities Exchange Act of 1934. Please note that any internet addresses provided in this report are for information purposes only and are not intended to be hyperlinks. Accordingly, no information found and/or provided at such internet addresses is intended or deemed to be incorporated by reference herein.

Item 1A . Risk Factors .

Risk Factors

We are identifying important risks and uncertainties that could affect our Company’s results of operations, financial condition or business and that could cause them to differ materially from our Company’s historical results of operations, financial condition or business, or those contemplated by forward-looking

statements made herein or elsewhere, by, or on behalf of, our Company. Factors that could cause or contribute to such differences include, but are not limited to, those factors described below. The risk factors highlighted below are not the only ones that our Company faces.

Because We Primarily Serve Central And West Central Missouri, A Decline In The Local Economic Conditions Could Lower Our Profitability . The profitability of Hawthorn is dependant on the profitability of its banking subsidiary, which operates out of central and west central Missouri. The financial condition of this bank is affected by fluctuations in the economic conditions prevailing in the portion of Missouri in which its operations are located. Accordingly, the financial conditions of both Hawthorn and its banking subsidiary would be adversely affected by deterioration in the general economic and real estate climate in Missouri.

An increase in unemployment, a decrease in profitability of regional businesses or real estate values or an increase in interest rates are among the factors that could weaken the local economy. With a weaker local economy:

	•		customers may not want or need the products and services of our Bank,

	•		borrowers may be unable to repay their loans,

	•		the value of the collateral security of our Bank’s loans to borrowers may decline,

	•		the number of loan delinquencies and foreclosures may increase, and

	•		the overall quality of our Bank’s loan portfolio may decline.

Making mortgage loans and consumer loans is a significant source of profits for Hawthorn’s banking subsidiary. If individual customers in the local area do not want or need these loans, profits may decrease. Although our Bank could make other investments, our Bank may earn less revenue on these investments than on loans. Also, our Bank’s losses on loans may increase if borrowers are unable to make payments on their loans.

Interest Rate Changes May Reduce Our Profitability . The primary source of earnings for Hawthorn’s banking subsidiary is net interest income. To be profitable, our Bank has to earn more money in interest and fees on loans and other interest-earning assets than it pays as interest on deposits and other interest-bearing liabilities and as other expenses. If prevailing interest rates decrease, as has already happened on several occasions in recent years, including in 2008, the amount of interest our Bank earn on loans and investment securities may decrease more rapidly than the amount of interest our Bank has to pay on deposits and other interest-bearing liabilities. This would result in a decrease in the profitability of Hawthorn and its banking subsidiary.

Changes in the level or structure of interest rates also affect

	•		our Bank’s ability to originate loans,

	•		the value of our Bank’s loan and securities portfolios,

	•		our Bank’s ability to realize gains from the sale of loans and securities,

	•		the average life of our Bank’s deposits, and

	•		our Bank’s ability to obtain deposits.

Fluctuations in interest rates will ultimately affect both the level of income and expense recorded on a large portion of our Bank’s assets and liabilities, and the market value of all interest-earning assets, other than interest-earning assets that mature in the short term. Our Bank’s interest rate management strategy is designed to stabilize net interest income and preserve capital over a broad range of interest rate movements by matching the interest rate sensitivity of assets and liabilities. Although Hawthorn believes that its Bank’s current mix of loans, mortgage-backed securities, investment securities and deposits is reasonable, significant fluctuations in interest rates may have a negative effect on the profitability of our Bank.

Our Profitability Depends On Our Bank’s Asset Quality And Lending Risks . Success in the banking industry largely depends on the quality of loans and other assets. The loan officers of Hawthorn’s banking subsidiary are actively encouraged to identify deteriorating loans. Loans are also monitored and categorized through an analysis of their payment status. For example, recent reviews by our 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. Our Bank’s failure to timely and accurately monitor the quality of its loans and other assets could have a materially adverse effect on the operations and financial condition of Hawthorn and its banking subsidiary. There is a degree of credit risk associated with any lending activity. Our Bank attempts to minimize its credit risk through loan diversification. Although our Bank’s loan portfolio is varied, with no undue concentration in any one industry, substantially all of the loans in the portfolio have been made to borrowers in central, west central, and southwest Missouri. Therefore, the loan portfolio is susceptible to factors affecting the central, west central, and southwest Missouri area and the level of non-performing assets is heavily dependant upon local conditions. There can be no assurance that the level of our Bank’s non-performing assets will not increase above current levels. High levels of non-performing assets could have a materially adverse effect on the operations and financial condition of Hawthorn and its banking subsidiary.

Our Provision For Probable Loan Losses May Need To Be Increased . Hawthorn’s banking subsidiary makes a provision for loan losses based upon management’s estimate of probable losses in the loan portfolio and its consideration of prevailing economic conditions. The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. Our Bank may need to increase the provision for loan losses through additional provisions in the future if, among other things, the financial condition of any of its borrowers deteriorates, if its borrower fails to perform its obligations to it, or if real estate values decline. Furthermore, various regulatory agencies, as an integral part of their examination process, periodically review the loan portfolio, provision for loan losses, and real estate acquired by foreclosure of our Bank. Such agencies may require our Bank to recognize additions to the provision for loan losses based on their judgments of information available to them at the time of the examination. Any additional provision for probable loan losses, whether required as a result of regulatory review or initiated by Hawthorn itself, may materially alter the financial outlook of Hawthorn and its banking subsidiary and may have a material adverse effect on our financial condition and results of operations.

The Continuation Of Adverse Market Conditions In The U.S. Economy And The Markets In Which We Operate Could Adversely Impact Our Business. Negative developments beginning in the latter half of 2007 in the sub-prime mortgage market and the securitization markets for such loans, together with substantial volatility in oil prices and other factors, have resulted in uncertainty in the financial markets in general and a related general economic downturn, which have continued in 2008 and in the first quarter of 2009. Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Competition among depository institutions for deposits has increased significantly. Financial institutions have experienced decreased access to deposits or borrowings.

A continued deterioration of overall market conditions, a continued economic downturn or prolonged economic stagnation in our markets may have a negative impact on our business, financial condition, results

of operations and the trading price of our common stock. If the strength of the U.S. economy in general and the strength of the economy in areas where we lend continue to decline, this could result in, among other things, a further deterioration in credit quality or a continued reduced demand for credit, including a resultant adverse effect on our loan portfolio and provision for losses on loans. In addition, the severity and duration of the economic downturn is unknown and may exacerbate our exposure to credit risk, impair our ability to assess the creditworthiness of our customers or to estimate the values of our assets and adversely affect the ability of borrowers to perform under the terms of their lending arrangements with us. Negative conditions in the real estate markets where we operate could adversely affect our borrowers’ ability to repay their loans and the value of the underlying collateral. Real estate values are affected by various factors, including general economic conditions, governmental rules or policies and natural disasters. These factors may adversely impact our borrowers’ ability to make required payments, which in turn, may negatively impact our financial results. As a result of the difficult market and economic conditions referred to above, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and for bank regulatory agencies to be very aggressive in responding to concerns and trends identified in examinations. This increased government action may increase our costs and limit our ability to pursue certain business opportunities.

We do not expect that the difficult market and economic conditions are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult conditions on us, our customers and the other financial institutions in our market. As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds, and our business, financial condition, results of operations and stock price may be adversely affected.

The Soundness Of Other Financial Institutions Could Adversely Affect Us. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.

Current And Further Deterioration In The Housing Market Could Cause Further Increases In Delinquencies And Non-Performing Assets, Including Loan Charge-Offs, And Depress Our Income And Growth. The volume of our one-to-four family residential mortgages and home equity lines of credit may decrease during economic downturns as a result of, among other things, a decrease in real estate values, an increase in unemployment, a slowdown in housing price appreciation or increases in interest rates. These factors could reduce our earnings and consequently our financial condition because:

	•		the borrowers may not be able to repay their loans;

	•		the value of the collateral securing our loans to borrowers may decline further;

	•		the quality of our loan portfolio may decline further; and

	•		customers may not want or need our products and services.

Any of these scenarios could cause an increase in delinquencies and non-performing assets, require us to charge-off a higher percentage of our loans, increase substantially our provision for losses on loans, or make fewer loans, which would reduce income.

Recent Legislative And Regulatory Actions To Address Difficult Market And Economic Conditions May Not Stabilize The U.S. Financial System. There can be no assurance as to the actual impact that the Emergency Economic Stabilization Act of 2008, the Treasury’s Capital Purchase Program, the FDIC’s Temporary Liquidity Guarantee Program, or any other governmental program will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of any such program or the U.S. government to stabilize the financial markets and a continuation or worsening of current financial market conditions and the national and regional economy could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

The FDIC’s Recent and Proposed Increases In Deposit Insurance Premiums Will Increase Our Non-Interest Expense And May Reduce Our Profitability. In response to the recent failures of FDIC-insured institutions and the expectation that the rate of institution failures will continue to be high in the next several years, in 2008 the FDIC adopted a plan to restore the Deposit Insurance Fund. The new rules raised the assessment rate for insured institutions by seven basis points (annualized) of insured deposits for the first quarter 2009 assessment period. Beginning April 1, 2009, the range of initial base assessment rates will be increased from 12 to 45 basis points depending on an institution’s risk category, with newly added financial measures resulting in increased assessment rates for institutions heavily relying on brokered deposits to support rapid asset growth. The FDIC also introduced three possible adjustments to an institution’s initial base assessment rate: (1) a decrease of up to 5 basis points for long-term unsecured and subordinated debt (excluding debt guaranteed under the Temporary Liquidity Program), (2) an increase of up to 50% for secured liabilities in excess of 25% of domestic deposits, and (3) for certain higher risk institutions, up to a 10 basis point increase if brokered deposits are in excess of 10% of domestic deposits.

In addition, the FDIC adopted an Interim Rule that imposes a 20 basis point emergency special assessment for all insured depository institutions on June 30, 2009. The Interim Rule also empowers the FDIC to impose an additional 10 basis point assessment after June 30, 2009 if the FDIC believes that the Deposit Insurance Fund is estimated to fall close to zero or to a level that would otherwise adversely affect public confidence. The Interim Rule is currently out for public comment. Moreover, the FDIC may continue to adopt actual rates that are higher without further notice-and-comment rulemaking (subject to certain limitations).

The increased deposit insurance premiums and the proposed emergency special assessments are expected to significantly increase our non-interest expense and may adversely affect our profitability.

Our Participation In The FDIC’s Temporary Liquidity Guaranty Program Would Increase Our Non-Interest Expense And Decrease Net Income. In October 2008, the FDIC implemented the Temporary Liquidity Guaranty Program to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and by providing full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. Under this program, a limited amount of senior unsecured debt that is newly issued on or before June 30, 2009 would be fully guaranteed by the FDIC if the issuing institution fails or if the issuing holding company files for bankruptcy. This guaranty lasts until June 30, 2012. Any issuer of FDIC guaranteed debt will be assessed fees determined by multiplying the amount of the debt by the number of years until the debt matures and then multiplying that number by an assessment rate ranging from 50 basis points to 100 basis points, depending upon the length of the term of the debt. Although we do not currently have any senior unsecured debt and do not presently anticipate issuing any such debt, we have not opted out of the program. If we elect to issue FDIC-guaranteed debt in the future, the assessments associated with any such issuance would reduce our net income and increase our non-interest expense and may adversely affect our profitability.

A second aspect of the Temporary Liquidity Guaranty Program is that the FDIC will, until December 31, 2009, fully guarantee all funds held in noninterest-bearing transaction deposit accounts (which includes all IOLTAs and functionally equivalent accounts, as well as negotiable order of withdrawal accounts with an

interest rate of .50 percent or less). In exchange for this guarantee, the FDIC charges a 10 basis point annual surcharge to noninterest-bearing transaction deposit amounts over $250,000. As a result of Hawthorn’s participation in this aspect of the program, the associated surcharge will increase our non-interest expense and may adversely affect our profitability.

Due To Our Participation In The Treasury’s Capital Purchase Program, We Are Subject To Several Restrictions Including Restrictions On Our Ability To Declare Or Pay Dividends And Repurchase Our Shares. In December 2008, we elected to participate in the Treasury’s Capital Purchase Program by issuing and selling to the Treasury shares of our Fixed Rate Cumulative Perpetual Preferred Stock and a warrant to purchase shares of our common stock. As a result of this participation, our ability to declare or pay dividends on our common stock is limited. Specifically, until December 19, 2011, we will not be permitted to increase dividends on our common stock without the Treasury’s approval unless the preferred stock issued to the Treasury has been redeemed or transferred. Further, we will not be able to declare dividends payments on common, junior preferred or pari passu shares if we are in arrears on the dividends on the preferred stock issued to the Treasury. In addition, our ability to repurchase our common stock and other securities is restricted. The Treasury’s consent generally will be required for us to repurchase any of our common stock or other securities until December 19, 2011 unless the preferred stock issued to the Treasury has been redeemed or transferred. Further, common, junior preferred or pari passu shares may not be repurchased if we are in arrears on the dividends payable to the Treasury on the preferred stock.

The Failure Of Our Bank To Restore Unappropriated Retained Earnings To A Positive Balance Or Receive Regulatory Approval To Pay Dividends Could Impair Our Company’s Liquidity And Ability To Pay Dividends. As a result of an impairment of goodwill in 2008, our Bank had an accumulated deficit at December 31, 2008. Our Bank will therefore be required to receive regulatory approval prior to paying dividends to our Company until such time as our Bank’s unappropriated retained earnings is restored to a positive balance. If our Bank is unable to receive such regulatory approval, it will impair our liquidity and we may not be able to pay dividends on our common stock.

We May Elect Or Be Compelled To Seek Additional Capital In The Future, But That Capital May Not Be Available When It Is Needed. We are required by our regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support the growth of our business or to finance acquisitions, if any, or we may elect to raise additional capital for other reasons. In that regard, a number of financial institutions have recently raised considerable amounts of capital as a result of a deterioration in their results of operations and financial condition arising from the turmoil in the mortgage loan market, deteriorating economic conditions, declines in real estate values and other factors. Should we elect or be required by regulatory authorities to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or securities convertible into our common stock, which could dilute your ownership interest in the Company. Although we remain “well-capitalized” and have not had a deterioration in our liquidity, the future cost and availability of capital may be adversely affected by illiquid credit markets, economic conditions and a number of other factors, many of which are outside of our control. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed or on terms acceptable to us, it may have a material adverse effect on our financial condition and results of operations.

If We Are Unable To Successfully Compete For Customers In Our Market Area, Our Financial Condition And Results Of Operations Could Be Adversely Affected . Hawthorn’s banking subsidiary faces substantial competition in making loans, attracting deposits and providing other financial products and services. Our Bank has numerous competitors for customers in its market area.

Such competition for loans comes principally from:

	•		other commercial banks

	•		savings banks

	•		savings and loan associations

	•		mortgage banking companies

	•		finance companies

	•		credit unions

Competition for deposits comes principally from:

	•		other commercial banks

	•		savings banks

	•		savings and loan associations

	•		credit unions

	•		brokerage firms

	•		insurance companies

	•		money market mutual funds

	•		mutual funds (such as corporate and government securities funds)

Many of these competitors have greater financial resources and name recognition, more locations, more advanced technology and more financial products to offer than our Bank. Competition from larger institutions may increase due to an acceleration of bank mergers and consolidations in Missouri and the rest of the nation. In addition, the Gramm-Leach-Bliley Act removes many of the remaining restrictions in federal banking law against cross-ownership between banks and other financial institutions, such as insurance companies and securities firms. The law will likely increase the number and financial strength of companies that compete directly with our Bank. The profitability of our Bank depends of its continued ability to attract new customers and compete in Missouri. New competitors, as well as the expanding operations of existing competitors, have had, and are expected to continue to have, an adverse impact on our Bank’s market share of deposits and loans in our Bank’s service areas. If our Bank is unable to successfully compete, its financial condition and results of operations will be adversely affected.

We May Experience Difficulties In Managing Our Growth And In Effectively Integrating Newly Acquired Companies . As part of our general strategy, Hawthorn may continue to acquire banks and businesses that it believes provide a strategic fit with its business. To the extent that our Company does grow, there can be no assurances that we will be able to adequately and profitably manage such growth. Acquiring other banks and businesses will involve risks commonly associated with acquisitions, including:

	•		potential exposure to liabilities of the banks and businesses acquired;

	•		difficulty and expense of integrating the operations and personnel of the banks and businesses acquired;

	•		difficulty and expense of instituting the necessary systems and procedures, including accounting and financial reporting systems, to manage the combined enterprises on a profitable basis;

	•		potential disruption to our existing business and operations;

	•		potential diversion of the time and attention of our management; and

	•		impairment of relationships with and the possible loss of key employees and customers of the banks and businesses acquired.

The success of our internal growth strategy will depend 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. There is no assurance that we will be successful in implementing our internal growth strategy.

We May Be Adversely Affected By Changes In Laws And Regulations Affecting The Financial Services Industry . Banks and bank holding companies such as Hawthorn are subject to regulation by both federal and state bank regulatory agencies. The regulations, which are designed to protect borrowers and promote certain social policies, include limitations on the operations of banks and bank holding companies, such as minimum capital requirements and restrictions on dividend payments. The regulatory authorities have extensive discretion in connection with their supervision and enforcement activities and their examination policies, including the imposition of restrictions on the operation of a bank, the classification of assets by an institution and requiring an increase in a bank’s allowance for loan losses. These regulations are not necessarily designed to maximize the profitability of banking institutions.

In December 2008, we elected to participate in the Treasury’s Capital Purchase Program. Congress has held hearings on implementation of, and the use of funds received in, the Capital Purchase Program and may adopt further legislation impacting financial institutions that have obtained funding under the program. Although it is unclear what, if any, additional legislation will be enacted into law or rules will be issued, certain laws or rules may be enacted or imposed administratively by the U.S. Treasury that could restrict our operations or increase governmental oversight of our business. The Special Inspector General for the Troubled Asset Relief Program has requested information from Capital Purchase Program participants, including a description of past and anticipated uses of the funds received and plans for addressing executive compensation requirements. We have responded to the Special Inspector General’s request, but it is unclear at this point what the ramifications of such disclosure are or may be in the future.

Future changes in the banking laws and regulations could have a material adverse effect on the operations and financial condition of Hawthorn and its banking subsidiary.

Our Success Largely Depends On The Efforts Of Our Executive Officers . The success of Hawthorn and its banking subsidiary has been largely dependant on the efforts of James Smith, Chairman and CEO and David Turner, President and the other executive officers. These individuals are expected to continue to perform their services. However, the loss of the services of Messrs. Smith or Turner, or any of the other key executive officers could have a materially adverse effect on Hawthorn and its subsidiary bank.

We Cannot Predict How Changes In Technology Will Affect Our Business. The financial services market, including banking services, is increasingly affected by advances in technology, including developments in:

	•		telecommunications

	•		data processing

	•		automation

	•		Internet-based banking

	•		telebanking

	•		debit cards and so-called “smart cards”

Our ability to compete successfully in the future will depend on whether they can anticipate and respond to technological changes. To develop these and other new technologies our Bank will likely have to make additional capital investments. Although our Bank continually invests in new technology, there can be no assurance that our Bank will have sufficient resources or access to the necessary proprietary technology to remain competitive in the future.

Additional Factors . Additional risks and uncertainties that may affect the future results of operations, financial condition or business of our Company and its banking subsidiary include, but are not limited to: (i) adverse publicity, news coverage by the media, or negative reports by brokerage firms, industry and financial analysts regarding our Bank or our Company; and (ii) changes in accounting policies and practices.

Item 1B . Unresolved Staff Comments .

None.

Item 2 . Properties .

Neither our Company nor Union State Bancshares owns or leases any property.

On February 14, 2007, our principal offices were relocated from Jefferson City, Missouri to Hawthorn Bank’s branch located at 300 Southwest Longview Boulevard, Lee’s Summit, Missouri. The Lee’s Summit location temporarily serves as our principal office until permanent facilities are located in the Kansas City metropolitan area.

The table below provides a list of our Bank’s facilities.


				Net Book Value at
	Approximate		Owned or	December 31, 2008
Location	Square Footage		Leased	(in thousands)

8127 East 171 ^st Street		13,000	Owned	$	2,447
Belton, Missouri
4675 Gretna Road		11,000	Owned	$	1,683
Branson, Missouri
1000 West Buchanan Street		2,270	Owned	$	395
California, Missouri
102 North Second Street		11,524	Owned	$	1,784
Clinton, Missouri
115 North Main Street		1,500	Owned	$	305
Clinton, Missouri
1603 East Ohio		5,760	Owned	$	162
Clinton, Missouri
1400 East Ohio Street		13,551	Owned	$	3,579
Clinton, Missouri
1712 East Ohio Street		600	Leased (1)		N/A
Clinton, Missouri (inside a Wal-Mart store)
1101 North Highway 13		1,500	Owned	$	23
Collins, Missouri
1110 Club Village Drive		5,000	Owned	$	1,809
Columbia, Missouri
115 South 2 ^nd Street		4,000	Owned	$	304
Drexel, Missouri
100 Plaza Drive		4,000	Owned	$	333
Harrisonville, Missouri
17430 East 39 ^th Street		4,070	Owned	$	789
Independence, Missouri
220 West White Oak		1,800	Owned	$	110
Independence, Missouri
132 East High Street		34,800	Owned	$	3,909
Jefferson City, Missouri
3701 West Truman Boulevard		21,000	Owned	$	387
Jefferson City, Missouri


					Net Book Value at
	Approximate			Owned or	December 31, 2008
Location	Square Footage			Leased	(in thousands)

211 West Dunklin Street		2,400		Owned	$	16
Jefferson City, Missouri
800 Eastland Drive		4,100		Owned	$	873
Jefferson City, Missouri
300 S.W. Longview Boulevard		11,700		Owned	$	2,500
Lee’s Summit, Missouri
335 Chestnut		1,580		Owned	$	61
Osceola, Missouri
500 North Mott Drive,		462		Leased (2)		N/A
# 103C Raymore, Missouri (in the Foxwood Springs Seniors Center)
595 VFW Memorial Drive		2,236		Owned	$	64
St. Robert, Missouri
321 West Battlefield		12,500	(3)	Owned	$	709
Springfield, Missouri
445 South Moreau		1,962		Owned	$	79
Tipton, Missouri
200 West Main Street		8,900		Owned	$	190
Warsaw, Missouri
1891 Commercial Drive		11,000		Owned	$	1,961
Warsaw, Missouri
125 South Main		3,600		Owned	$	344
Windsor, Missouri


(1)		The term of this lease began in January 1999 and ends in January 2014.

(2)		The term of this lease can be terminated at any time upon thirty days notice.

(3)		Of the 12,500 square feet of space, 6,600 square feet of space is leased to a non-affiliate.

Management believes that the condition of each of our Bank’s facilities presently is adequate for its business and that such facilities are adequately covered by insurance.

Item 3 . Legal Proceedings .

None of Hawthorn or its subsidiaries is involved in any material pending legal proceedings, other than routine litigation incidental to their business.

Item 4 . Submission of Matters to a Vote of Security Holders .

No matter was submitted to a vote of the holders of our Company’s common stock during the fourth quarter of the year ended December 31, 2008.

EXECUTIVE OFFICERS OF THE REGISTRANT

Executive officers of our Company are appointed by the board of directors and serve at the discretion of the board. The following table sets forth certain information with respect to all executive officers of our Company.

The business experience of the executive officers of our Company during the last five years is as follows:

James E. Smith has served as a director of Hawthorn Bank (or of its constituent predecessors) since 1975 and of our Company since 1997. He served as vice chairman of our Company from 1998 through March 2002 when he assumed the responsibilities of chairman and chief executive officer, as president and secretary of Hawthorn Bank from 1975 through May 2000 when he was promoted to chairman and chief executive officer, as president of a predecessor to Hawthorn Bank from January 2000 through October 2002, and as vice chairman of another predecessor to Hawthorn Bank from October 2002 through March 2007.

David T. Turner has served as a director of Hawthorn Bank (or of its constituent predecessors) and of our Company since January 1997. Mr. Turner served as vice chairman of our Company from June 1998 through March 2002 when he assumed the position of president. From 1993 until June 1998, he served as senior vice president of our Company. Mr. Turner served as president of a predecessor to Hawthorn Bank from January 1997 through March 2002 when he assumed the position of chairman, chief executive officer and president. He served as senior vice president of that same predecessor from June 1992 through December 1996 and as its vice president from 1985 until June 1992.

Richard G. Rose has served as Chief Financial Officer of our Company since June 2007 and Senior Vice President and Chief Financial Officer of Hawthorn Bank (or of one of its constituent predecessors) since June 2007. Mr. Rose served as Treasurer of our Company from July 1998 through June 2007 and Senior Vice President and Controller of our Bank from July 1998 through June 2007. Prior to joining Hawthorn Bank, he served as Senior Vice President and Controller of the First National Bank of St. Louis from June 1979 until June 1998.

Kathleen L. Bruegenhemke has served as Senior Vice President and Secretary of our Company since November 1997. From January 1992 until November 1997, she served as Internal Auditor of Hawthorn Bank (or of one of its constituent predecessors). Prior to joining our Bank, Ms. Bruegenhemke served as a Commissioned Bank Examiner for the Federal Deposit Insurance Corporation.

There is no arrangement or understanding between any executive officer and any other person pursuant to which such executive officer was selected as an officer.

PART II

Item 5 . Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities .

Pursuant to General Instruction G(2) to Form 10-K, the information required by this Item, other than that referred to below, is incorporated herein by reference to the information under the caption “Market Price

of and Dividends on Equity Securities and Related Matters” in our Company’s 2008 Annual Report to Shareholders.

We refer you to Item 12 of this report under the caption “Securities Authorized For Issuance Under Equity Compensation Plans” for certain equity plan information.

Our Purchases of Equity Securities

The following table summarizes the purchases made by or on behalf of our Company or certain affiliated purchasers of shares of our common stock during the fourth quarter of the year ended December 31, 2008:


							(d) Maximum Number
					(c) Total Number of		(or Approximate
					Shares (or Units)		Dollar Value) of
					Purchased as Part		Shares (or Units)
	(a) Total Number of		(b) Average Price		of Publicly		that May Yet Be
	Shares (or Units)		Paid per Share		Announced Plans or		Purchased Under the
Period	Purchased		(or Unit)		Programs		Plans or Programs *

October 1-31, 2008		—		—		—	$	333,038
November 1-30, 2008		—		—		—	$	333,038
December 1-31, 2008		—		—		—	$	333,038
Total		—		—		—	$	333,038


*		On August 22, 2001, our Company announced that our Board of Directors authorized the purchase, through open market transactions, of up to $2,000,000 market value of our Company’s common stock. Management was given discretion to determine the number and pricing of the shares to be purchased, as well as, the timing of any such purchases. On November 26, 2002, our Company announced that our board of directors authorized an additional $2,000,000 for the purchase of our Company’s stock through open market transactions. As a result of our participation in the U.S. Treasury’s Capital Purchase Program, however, our ability to redeem, purchase or acquire any shares of our common stock is limited. Specifically, until December 19, 2011 we will not be permitted to redeem, purchase or acquire any shares of our common stock without the Treasury’s approval unless the shares of our Fixed Rate Cumulative Perpetual Preferred Stock issued to the Treasury have been redeemed or transferred. Further, we will not be able to redeem, purchase or acquire any shares of our common stock if we are in arrears in the payment of dividends on the preferred stock issued to the Treasury.

Recent Issuance of Securities

As previously disclosed in our Company’s current report on Form 8-K filed with the SEC on December 23, 2008, as part of the Capital Purchase Program established by the U.S. Treasury under the Emergency Economic Stabilization Act of 2008, on December 19, 2008 our Company issued and sold to the Treasury, in exchange for the Treasury’s payment of $30,255,000 in cash:

	(i)		30,255 shares of our Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series 2008, $0.01 par value per share, having a liquidation preference of $1,000 per share; and

	(ii)		a warrant to purchase 245,443 shares of our Company’s common stock at an initial exercise price of $18.49 per share, subject to certain anti-dilution and other adjustments.

The preferred stock and the warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

Item 6 . Selected Financial Data .

Pursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the report of the independent auditors and the information under the caption “Selected Consolidated Financial Data” in our Company’s 2008 Annual Report to Shareholders.

Item 7 . Management’s Discussion and Analysis of Financial Condition and Results of Operation .

Pursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Company’s 2008 Annual Report to Shareholders.

Forward-Looking Statements

This report, including information included or incorporated by reference in this report, contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, strategy, 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 additional factors that could cause actual results to be materially different from those described in the forward-looking statements, which factors are identified in Item 1A of this report under the heading “Risk Factors.” 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 such statement is made. Except as otherwise required by law, we undertake no obligation to publicly update or revise any forward-looking statement to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

Item 7A . Quantitative and Qualitative Disclosures About Market Risk .

Our Company’s exposure to market risk is reviewed on a regular basis by our Bank’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, 2008, the rate shock scenario models indicated that annual net interest income could change by as much as 14.5 % should interest rates rise or fall within 300 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.

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item, other than that provided above, is incorporated herein by reference to:

	(i)		the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Sensitivity and Liquidity” in our Company’s 2008 Annual Report to Shareholders; and

	(ii)		the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Disclosures About Market Risk” in our Company’s 2008 Annual Report to Shareholders.

Item 8 . Financial Statements and Supplementary Data .

Pursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the report of the independent auditors and the information under the caption “Consolidated Financial Statements” in our Company’s 2008 Annual Report to Shareholders.

Item 9 . Changes in and Disagreements With Accountants on Accounting and Financial Disclosure .

None.

Item 9A . Controls and Procedures .

Evaluation of Disclosure Controls and Procedures .

Our Company’s management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures as of December 31, 2008. Based upon and as of the date of that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. It should be noted that any system of disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any system of disclosure controls and procedures is based in part upon assumptions about the likelihood of future events. Because of these and other inherent limitations of any such system, there can be no assurance that any design will always succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

Internal Controls Over Financial Reporting .

Management’s Report on Internal Control Over Financial Reporting .

Our Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework , our Company’s management concluded that our internal control over financial reporting was effective as of December 31, 2008. The effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.

Changes in Internal Controls .

There has been no change in our Company’s internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Report of Independent Registered Public Accounting Firm .

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Hawthorn Bancshares, Inc.:

We have audited Hawthorn Bancshares, Inc.’s (the Company’s) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control over financial reporting based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that

transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Hawthorn Bancshares, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control —Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Hawthorn Bancshares, Inc. and subsidiaries as of December 31, 2008 and 2007, 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, 2008, and our report dated March 13, 2009 expressed an unqualified opinion on those consolidated financial statements .

/s/ KPMG LLP
St. Louis, Missouri
March 13, 2009

Item 9B . Other Information .

None.

PART III

Item 10 . Directors, Executive Officers and Corporate Governance .

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item, other than that referred to below, is incorporated herein by reference to:

	(i)		the information under the caption “Item 1: Election of Directors—What is the structure of our board and how often are directors elected?” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A;

	(ii)		the information under the caption “Item 1: Election of Directors—Who are this year’s nominees?” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A;

	(iii)		the information under the caption “Item 1: Election of Directors—What is the business experience of the nominees and of our continuing board members?” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A;

	(iv)		the information under the caption “Executive Officers of the Registrant” in Part I of this report;

	(v)		the information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A;

	(vi)		the information under the caption “Corporate Governance and Board Matters—Consideration of Director Nominees” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A; and

	(vii)		the information under the caption “Corporate Governance and Board Matters—Committees of the Board—Audit Committee” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A.

Code of Ethics

Our Company has adopted a Code of Business Conduct and Ethics for directors, officers and employees including, our principal executive officer, principal financial officer, principal accounting officer, controller and persons performing similar functions. This Code of Business Conduct and Ethics is posted on our internet website (www.hawthornbancshares.com) under “Governance Documents” and is available for your examination. A copy of this Code will be furnished without charge upon written request to Kathleen L. Bruegenhemke, Secretary, Hawthorn Bancshares, Inc., 132 East High Street, Jefferson City, Missouri 65101. Any substantive amendment to, or waiver from, a provision of this Code that applies to our principal executive officer, principal financial officer, principal accounting officer, controller, or persons performing similar functions will be disclosed in a report on Form 8-K.

Item 11 . Executive Compensation .

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to:

	(i)		the information under the caption “Executive Compensation and Related Matters” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A;

	(ii)		the information under the caption “Corporate Governance and Board Matters—Director Compensation” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A; and

	(iii)		the information under the caption “Corporate Governance and Board Matters—Compensation Committee Interlocks and Insider Participation” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A.

Item 12 . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters .

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item, other than that presented below, is incorporated herein by reference to the information under the caption “Ownership of Common Stock” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A.

Securities Authorized For Issuance Under Equity Compensation Plans

Our Company has two equity compensation plans for its employees pursuant to which options, rights or warrants may be granted. The following is a summary of the shares reserved for issuance pursuant to outstanding options, rights or warrants granted under equity compensation plans as of December 31, 2008:

Number of

securities

remaining available

Number of

for future issuance

securities to be

under equity

issued upon

Weighted-average

compensation plans

exercise of

exercise price of

(excluding

outstanding

securities

options, warrants

reflected in column

Plan category

and rights

(a))

(a)

(b)

(c)

Equity compensation plans approved by security holders

266,835

26.10

569,980

Equity compensation plans not approved by security holders

-0-

Total

266,835

26.20

569,980


*		Consists of shares reserved for issuance pursuant to outstanding stock option grants under our Company’s incentive stock option plan.

**		Consists of 169,980 shares available for future issuance under our Company’s incentive stock option plan and 400,000 shares available for future issuance under our Company’s 2007 omnibus incentive plan.

Item 13 . Certain Relationships and Related Transactions, and Director Independence .

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to:

	(i)		the information under the caption “Related Party Transactions” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A;

	(ii)		the information under the caption “Item 1: Election of Directors—What is the structure of our board and how often are directors elected?” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A; and

	(iii)		the information under the caption “Corporate Governance and Board Matters—Committees of the Board” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A.

Item 14 . Principal Accounting Fees and Services .

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to the information under the caption “Independent Auditor Fees and Services” in our Company’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A.

PART IV

Item 15 . Exhibits, Financial Statement Schedules.

	(a)		Exhibits, Financial Statements and Financial Statement Schedules:

	1.		Financial Statements:

The following consolidated financial statements of our Company and reports of our Company’s independent auditors, included in our Annual Report to Shareholders for the year ended December 31, 2008 under the caption “Consolidated Financial Statements”, are incorporated herein by reference:

Report of Independent Registered Public Accounting Firm.

Consolidated Balance Sheets as of December 31, 2008 and 2007.

Consolidated Statements of Income for the years ended December 31, 2008, 2007 and 2006.

Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2008, 2007 and 2006.

Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006.

Notes to Consolidated Financial Statements.

Financial Statement Schedules:

Financial statement schedules have been omitted because they either are not required or are not applicable or because equivalent information has been included in the financial statements, the notes thereto or elsewhere herein.

Exhibits:


Exhibit No.		Description

3.1		Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to our Company’s current report on Form 8-K on August 9, 2007 and incorporated herein by reference).

3.1.1		Certificate of Designations of Fixed Rate Cumulative Perpetual Preferred Stock, Series 2008, dated December 17, 2008 (filed as Exhibit 3.1 to our Company’s current report on Form 8-K on December 23, 2008 and incorporated herein by reference).

3.2		Amended and Restated Bylaws of our Company (filed as Exhibit 3.2 to our Company’s current report on Form 8-K on November 1, 2007 and incorporated herein by reference).

4.1		Specimen certificate representing shares of our Company’s $1.00 par value Common Stock (filed as Exhibit 4 to our Company’s Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference).

4.2		Specimen certificate representing shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series 2008 (filed as Exhibit 4.2 to our Company’s current report on Form 8-K on December 23, 2008 and incorporated herein by reference).

4.3		Warrant to purchase shares of our Company’s $1.00 par value Common Stock, dated December 19, 2008 (filed as Exhibit 4.1 to our Company’s current report on Form 8-K on December 23, 2008 and incorporated herein by reference).

10.1		Employment Agreement, dated November 3, 1997, between our Company and James E. Smith (filed as Exhibit 10.4 to our Company’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference).*

10.2		Exchange National Bancshares, Inc. Incentive Stock Option Plan (filed as Exhibit 10.2 to our Company’s Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference).*


Exhibit No.		Description
10.3		Form of Change of Control Agreement and schedule of parties thereto (filed as Exhibit 10.2 to our Company’s Quarterly Report on Form 10-Q for the quarterly period March 31, 2005 and incorporated herein by reference).*

10.4		Letter Agreement dated December 19, 2008 by and between our Company and the United States Department of the Treasury, including the Securities Purchase Agreement — Standard Terms (filed as Exhibit 10.1 to our Company’s current report on Form 8-K on December 23, 2008 and incorporated herein by reference).

10.5		Form of Waiver of our Company’s Senior Executive Officers (filed as Exhibit 10.2 to our Company’s current report on Form 8-K on December 23, 2008 and incorporated herein by reference).*

10.6		Form of Letter Agreement between our Company’s Senior Executive Officers and our Company (filed as Exhibit 10.3 to our Company’s current report on Form 8-K on December 23, 2008 and incorporated herein by reference).*

13		Our Company’s 2008 Annual Report to Shareholders (only those portions of this Annual Report to Shareholders which are specifically incorporated by reference into this Annual Report on Form 10-K shall be deemed to be filed with the Commission).

14		Code of Business Conduct and Ethics of our Company (filed as Exhibit 14 to our Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).

21		List of Subsidiaries

23		Consent of Independent Registered Public Accounting Firm.

24		Power of Attorney (included on the signature page to this Annual Report on Form 10-K).

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Management contracts or compensatory plans or arrangements required to be identified by Item 15(a).

(b)		Exhibits.

		See exhibits identified above under Item 15(a)3.

(c)		Financial Statement Schedules.

		See financial statement schedules identified above under Item 15(a)2, if any.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	HAWTHORN BANCSHARES, INC.
Dated: March 13, 2009	By	/s/ James E. Smith
		James E. Smith, Chairman of the Board
		and Chief Executive Officer

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James E. Smith and Richard G. Rose, or either of them, his attorneys-in-fact, for such person in any and all capacities, to sign any amendments to this report and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that either of said attorneys-in-fact, or substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Date				Signature and Title

March 13, 2009				/s/ James E. Smith

				James E. Smith, Chairman of the Board and Chief Executive Officer (Principal Executive Officer)

March 13, 2009				/s/ Richard G. Rose
				Richard G. Rose, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

March 13, 2009				/s/ David T. Turner

				David T. Turner, Director

March13, 2009				/s/ Charles G. Dudenhoeffer, Jr.

				Charles G. Dudenhoeffer, Jr., Director

March 13, 2009				/s/ Philip D. Freeman

				Philip D. Freeman, Director

March 13, 2009				/s/ Kevin L. Riley

				Kevin L. Riley, Director

March 13, 2009				/s/ Julius F. Wall,

				Julius F. Wall, Director

March 13, 2009				/s/ Gus S. Wetzel, II

				Gus S. Wetzel, II, Director

EXHIBIT INDEX


Exhibit No.	Description	Page No.

13	Our Company’s 2008 Annual Report to Shareholders (only those portions of this Annual Report to Shareholders which are specifically incorporated by reference into this Annual Report on Form 10-K shall be deemed to be filed with the Commission).

21	List of Subsidiaries.

23	Consent of Independent Registered Public Accounting Firm.

24	Power of Attorney (included on the signature page to this Annual Report on Form 10-K).

31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit 13

2008

ANNUAL REPORT

SHAREHOLDERS

HAWTHORN BANCSHARES, INC.

Lee’s Summit, Missouri

March 13, 2009

Dear Investors:

With more than 100,000 customers throughout Missouri, 370 employees, and approximately 1,500 shareholders, Hawthorn Bancshares, Inc. is very much a part of the communities in which our 25 branches are located. Operating as Hawthorn Bank, we reflect the strong mid-western values of the communities we serve, and have avoided many of the issues plaguing the financial world. We have not participated in the exotic lending or investment products which appear to have triggered the recent financial downturn.

Goodwill Accounting

Since 1997, Hawthorn Bancshares, Inc. has acquired six community bank partners which generated goodwill on our books. Goodwill represents the amount by which our costs or carrying charges for the net assets acquired exceeds the fair value of such assets at the dates of acquisition. Accounting rules require an annual analysis of this goodwill. Since the value of practically everything that is sold in this economic climate has diminished, so too has the value of our goodwill. During the fourth quarter of 2008, we recognized a goodwill write-down of approximately $40.3 million. It is important to understand that the goodwill write-down did not affect cash, cash earnings, liquidity, or regulatory capital.

Our Results

In spite of the impact of the current recession, in 2008 we continued to have cash earnings and we continued to pay dividends. Many banks in Missouri and across the nation are unable to say this. Our 2008 cash earnings were $0.61 per common diluted share before recognizing a non-cash goodwill adjustment of $40.3 million which resulted in a $7.39 net loss per diluted common share. Hawthorn Bancshares, Inc. paid a dividend for each quarter of 2008 and, on April 1, 2009, will pay a common stock dividend of $.21 per share.

U.S. Treasury Program

During the fourth quarter of 2008, we were approved for and received $30.3 million from the U.S. Treasury as part of their Capital Purchase Program. Contrary to popular belief, this was neither a bailout nor free. This U.S. Treasury program was offered to strengthen already healthy institutions to ensure their continued ability to lend to creditworthy borrowers. While we already met the regulatory requirements for being “well capitalized” without participating in this program, we felt it is prudent during this recessionary period to obtain the additional capital and liquidity that the program offered.

2009

We are all seeing the impact of the recession descending on our communities. Layoffs and slowdowns are becoming a daily occurrence. Because this affects you, it affects us. We believe the financial downturn is not going to turn around quickly. Unless a customer has abandoned their business or home, our goal is to work with the customer to avoid a foreclosure or repossession. Since our founding in the 19 ^th Century, our bank and our customers have worked together through the Panic of 1907, The Great Depression, the recession of the early 1980’s and several recessions in between. As troubling as this recession may appear, we will again work through it together. We must keep in mind that economic ups and downs are always temporary.

Sincerely,
-S- JAMES E. SMITH

James E. Smith
Chairman & Chief Executive Officer

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.

•		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.

HAWTHORN BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Through its branch network, 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 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.

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 general economic conditions and during economic conditions that are 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.

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, 2008. 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)	2008			2007			2006			2005			2004

Interest income	$	69,715		$	74,207		$	71,423		$	57,340		$	41,091
Interest expense		31,599			37,175			32,766			23,673			13,387

Net interest income		38,116			37,032			38,657			33,667			27,704
Provision for loan losses		8,211			1,154			1,326			1,322			942

Net interest income after provision for loan losses		29,905			35,878			37,331			32,345			26,762

Security gains (losses), net		3			(2	)		(18	)		(25	)		(8	)
Other noninterest income		9,294			10,223			8,618			7,290			5,741

Total noninterest income		9,297			10,221			8,600			7,265			5,733
Noninterest expense		75,975			35,054			30,148			25,368			20,383

Income (loss) before income taxes		(36,773	)		11,045			15,783			14,242			12,112
Income taxes (benefit)		(6,146	)		3,245			4,908			4,327			3,807

Net income (loss)		(30,627	)		7,800			10,875			9,915			8,305
Less: preferred stock dividends		66			—			—			—			—

Net income available to common shareholders	$	(30,693	)	$	7,800		$	10,875		$	9,915		$	8,305


Dividends

Declared on common stock	$	3,486		$	3,504		$	3,503		$	3,503		$	3,378
Paid on common stock		3,486			3,504			3,503			3,378			3,378
Ratio of total dividends declared to net income		N.M.			44.92	%		32.21	%		35.33	%		40.67	%

Per Share Data

Basic earnings (loss) per common share	$	(7.39	)	$	1.87		$	2.61		$	2.38		$	1.99
Diluted earnings (loss) per common share		(7.39	)		1.85			2.59			2.36			1.98
Basic weighted average shares of common stock outstanding		4,155,749			4,171,163			4,169,847			4,169,847			4,169,847
Diluted weighted average shares of common stock outstanding		4,155,749			4,210,844			4,204,547			4,198,859			4,204,752


(In thousands, except per share data)	2008			2007			2006			2005			2004

Balance Sheet Data (at period end)
Total assets	$	1,279,699		$	1,195,804		$	1,142,712		$	1,126,470		$	923,874
Loans		1,009,104			911,278			812,312			813,535			636,637
Investment securities		158,276			157,368			189,773			179,692			171,718
Total deposits		955,296			921,257			899,865			881,455			726,649
Subordinated notes		49,486			49,486			49,486			49,486			25,774
Other borrowed money		129,057			77,915			47,368			52,180			39,525
Common stockholders’ equity		78,530			111,199			104,945			96,733			91,771
Total stockholders’ equity		106,418			111,199			104,945			96,733			91,771
Balance Sheet Data (average balances)
Total assets	$	1,251,496		$	1,156,500		$	1,146,150		$	1,083,746		$	896,044
Loans		963,252			848,771			824,706			743,382			601,363
Investment securities		165,310			177,062			189,720			208,760			197,933
Total deposits		914,218			921,257			899,865			982,360			799,787
Subordinated notes		49,486			49,486			49,486			44,614			20,352
Other borrowed money		124,025			53,626			56,757			48,430			35,502
Common stockholders’ equity		112,307			108,052			100,821			94,663			90,625
Total stockholders’ equity		113,375			108,052			100,821			94,663			90,625


Key Ratios


Earnings Ratios
Return (loss) on average total assets		(2.45	)%		0.67	%		0.95	%		0.91	%		0.01	%
Return (loss) on average common stockholders’ equity		(27.33	)		7.22			10.79			10.47			9.16
Efficiency ratio (3)		160.25			74.18			63.80			61.98			60.96

Asset Quality Ratios
Allowance for loan losses to loans		1.26			1.02			1.11			1.12			1.18
Nonperforming loans to loans (1)		2.46			0.67			0.62			1.11			0.96
Allowance for loan losses to nonperforming loans (1)		50.94			152.54			177.95			100.39			123.05
Nonperforming assets to loans and foreclosed assets (2)		3.21			0.92			0.96			1.30			0.97
Net loan charge-offs to average loans		0.50			0.10			0.17			0.15			0.29

Capital Ratios
Average stockholders’ equity to average total assets		9.06	%		9.34	%		8.80	%		8.73	%		10.11	%
Period-end common stockholders’ equity to period-end assets		6.14			9.30			9.18			8.59			9.93
Period-end tangible common stockholders’ equity to period-end tangible assets		5.89			5.81			5.42			6.07			7.16
Period-end stockholders’ equity to period-end assets		8.31			9.30			9.18			8.59			9.93
Total risk-based capital ratio		16.01			13.24			13.84			12.70			14.58
Tier 1 risk-based capital ratio		13.55			11.08			11.28			9.83			13.47
Leverage ratio		10.80			9.12			8.77			7.88			10.39


(1)		Nonperforming loans consist of nonaccrual loans 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 and non-interest income.

CRITICAL ACCOUNTING POLICIES

The following accounting policies are considered most critical to the understanding of our Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such polices affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 of our 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. 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

As more fully discussed in Notes 1 and 10 of the consolidated financial statements, our Company accounts for income taxes under the asset / liability method by recognizing the amount of taxes payable or refundable for the current year and deferred tax asset 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. Effective January 1, 2007, our Company adopted Financial Accounting Standards Board (FASB) Interpretation 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FAS No. 109 , Accounting for Income Taxes (FIN 48). The interpretation defines the threshold for recognizing the financial impact of uncertain tax provisions taken or expected to be taken in the tax return in accordance with FAS 109.

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 Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for Impairment or Disposal of Long-Lived Assets .

In accordance with SFAS No. 142, Goodwill and Other Intangible 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 annual review, our Company determined that goodwill was fully impaired and recorded an impairment charge of $40,323,775, before tax. See Note 6 to the consolidated financial statements for further discussion.

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)	2008			2007			2006			‘08-‘07			‘07-‘06			‘08-‘07			‘07-‘06


Net interest income (loss)	$	38,116		$	37,032		$	38,657		$	1,084		$	(1,625	)		2.9	%		(0.0	)%
Provision for loan losses		8,211			1,154			1,326			7,057			(172	)		611.5			(13.0	)
Noninterest income		9,294			10,223			8,618			(929	)		1,605			(9.1	)		18.6
Investment securities gains (losses), net		3			(2	)		(18	)		5			16			(250.0	)		(88.9	)
Noninterest expense		75,975			35,054			30,148			40,921			4,906			116.7			16.3
Income (loss) before income taxes		(36,773	)		11,045			15,783			(47,818	)		(4,738	)		(432.9	)		(30.0	)

Income taxes (benefit)		(6,146	)		3,245			4,908			(9,391	)		(1,663	)		(289.4	)		(33.9	)

Net income (loss)	$	(30,627	)	$	7,800		$	10,875		$	(38,427	)	$	(3,075	)		(492.7	)%		(28.3	)%

Less: preferred dividends		66			—			—			66			—			—			—

Net income (loss) available to common shareholders	$	(30,693	)	$	7,800		$	10,875		$	(38,493	)	$	(3,075	)		(493.5	)%		(28.3	)%

Our Company’s consolidated net loss available for common shareholders for the year ended December 31, 2008 was $(30,693,000), or $(7.39) per diluted common share, compared to net income of $7,800,000, or $1.85 per diluted common share for the year ended December 31, 2007. This $38,493,000 decrease from 2007 is a result of a one time $40,324,000 goodwill impairment charge to income. Excluding this one time goodwill impairment charge, $33,211,000 after tax, net income would have been $2,518,000, or $0.61 per diluted common share. This non-GAAP measure of operating results is discussed more fully below. The largest component of the decline in net income was a $8,211,000 provision for loan losses in 2008 compared with a provision of $1,154,000 in 2007. In addition, a lower net interest margin of 3.4% compared to 3.7% at December 31, 2007, was offset by an $114,481,000 increase in average loans increasing net interest income, on a tax equivalent basis, $958,000, or 2.5%, over 2007. Total assets at December 31, 2008 were $1,279,699,000, compared to $1,195,804,000 at December 31, 2007, an increase of $83,895,000, or 7.0%.

Our Company’s consolidated net income available for common shareholders for the year ended December 31, 2007 of $7,800,000, or $1.25 per diluted common share, decreased $3,075,000 or 28.3% compared to $10,875,000, or $2.76 per diluted common share for the year ended December 31, 2006. The decrease in net income in 2007 was primarily a result of $1,207,000 nonrecurring expenses due to consolidating four bank subsidiary charters under one charter, a major communications network conversion, outsourcing of data processing, and implementing new technologies. These expenses were partially offset by the proceeds from the sales of three of the bank charters to other institutions for $1,200,000. In addition, lower net interest margin of 3.7% compared to 3.9% at December 31, 2006, caused a $1,637,000, or 4.1%, on a tax equivalent basis, decline in net interest income during 2007. Total assets increased $53,092,000, or 4.7%, from December 31, 2006 to $1,195,804,000 at December 31, 2007.

Comparison of GAAP and Non-GAAP Information

As a supplement to our U.S. GAAP financial results, our Company has provided non-GAAP operating results for the year ended December 31, 2008. Our Company believes that these non-GAAP financial measures are useful because they allow investors to assess, on a consistent basis, our Company’s performance exclusive of items management believes are not indicative of the operations of our Company. Management uses non-GAAP financial measures to evaluate financials results and to establish operational goals. These non-GAAP financial measures should be considered a supplement to, and not a substitute for, financial measures determined in accordance with GAAP. The non-GAAP measures presented below exclude the non-recurring pre-tax charge to write-off our entire goodwill in the fourth quarter of 2008 which is explained in more detail in the “Non-interest Income and Expense” section of this discussion and Note 6 of the consolidated financial statements.


										$Change						%Change
(Dollars in thousands)	2008			2007			2006			‘08-‘07			‘07-‘06			‘08-‘07			‘07-‘06


Non-interest expense (GAAP)	$	75,975		$	35,054		$	30,148		$	40,921		$	4,906			116.7	%		0.2	%
Goodwill impairment		(40,324	)		—			—			(40,324	)		—			N.M			N.M

Non-interest expense (non-GAAP)		35,651			35,054			30,148			597			4,906			1.7			16.3

Net income (loss) (GAAP)	$	(30,627	)	$	7,800		$	10,875		$	(38,427	)	$	(3,075	)		(492.7	)%		(28.3	)%
Goodwill impairment, net of tax effect		33,211			—			—			33,211			—			N.M			N.M
Less: preferred dividends		66			—			—			66			—			N.M			N.M

Net income available to common shareholders (non-GAAP)	$	2,518		$	7,800		$	10,875		$	(5,282	)	$	(3,075	)		(67.7	)%		(28.3	)%

GAAP basis:
Basic earnings (loss) per share	$	(7.39	)	$	1.87		$	2.61		$	(9.26	)	$	(0.74	)		(495.2	)%		(28.4	)%
Diluted earnings (loss) per share		(7.39	)		1.85			2.59			(9.24	)		(0.74	)		(499.5	)		(28.6	)
Return (loss) on average assets		(2.45	)%		0.67	%		0.95	%
Return (loss) on average common equity		(27.33	)%		7.22	%		10.79	%
Efficiency ratio		160.25	%		74.18	%		63.80	%

Non-GAAP basis:
Basic earnings per share	$	0.61		$	1.87		$	2.61		$	(1.26	)	$	(0.74	)		(67.4	)%		(28.4	)%
Diluted earnings per share		0.61			1.85			2.59			(1.24	)		(0.74	)		(67.0	)		(28.6	)
Return on average assets		0.20	%		0.67	%		0.95	%
Return on average common equity		2.24	%		7.22	%		10.79	%
Efficiency ratio		75.20	%		74.18	%		63.80	%

Our Company’s diluted earnings per common share, based on non-GAAP operating results as shown above, were $0.61 in 2008 compared to $1.85 in 2007, a decrease of 67.0%. Consolidated net income for 2008 was $2,518,000, compared to $7,800,000 in 2007. Return on average total assets decreased from 0.67% in 2007 to 0.20% in 2008, and return on average common equity decreased from 7.22% in 2007 to 2.24% in 2008. The efficiency ratio was 75.20% in 2008 compared with 74.18% in 2007.

Our Company’s diluted earnings per common share, based on operating results as shown above, amounted to $1.85 in 2007 compared to $2.59 in 2006, a decrease of 28.6%. Consolidated net income for 2007 was $7,800,000, compared to $10,875,000 in 2006. Return on average total assets decreased from 0.95% in 2006 to 0.67% in 2006, and return on average equity decreased from 10.79% in 2007 to 7.22% in 2006. The efficiency ratio was 74.18% in 2007 compared with 63.80% in 2006.

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, 2008.


(Dollars In thousands)	2008								2007								2006
				Interest		Rate						Interest		Rate						Interest		Rate
	Average			Income/		Earned/			Average			Income/		Earned/			Average			Income/		Earned/
	Balance			Expense(1)		Paid(1)			Balance			Expense(1)		Paid(1)			Balance			Expense(1)		Paid(1)

ASSETS
Loans: (2) (4)	$	963,252		$	62,766		6.52	%	$	848,771		$	65,636		7.73	%	$	824,706		$	62,729		7.61	%
Investment in securities: (3)
Government sponsored enterprises		110,840			4,917		4.44			117,208			5,614		4.79			129,437			5,645		4.36
State and municipal		46,030			2,503		5.44			53,971			2,969		5.50			53,465			2,894		5.41
Other		8,440			316		3.74			5,883			312		5.30			6,818			316		4.63
Federal funds sold		2,925			60		2.05			11,313			615		5.44			14,737			748		5.08
Interest bearing deposits in other financial institutions		8,738			24		0.27			1,128			58		5.14			2,260			100		4.42

Total interest earning assets		1,140,225			70,586		6.19			1,038,274			75,204		7.24			1,031,423			72,432		7.02
All other assets		121,373								127,336								124,036
Allowance for loan losses		(10,102	)							(9,110	)							(9,309	)

Total assets	$	1,251,496							$	1,156,500							$	1,146,150

LIABILITIES AND STOCKHOLDERS’ EQUITY
NOW accounts	$	117,487		$	1,317		1.12	%	$	110,658		$	1,482		1.34	%	$	106,605		$	1,390		1.30	%
Savings		44,253			226		0.51			46,634			260		0.56			52,137			298		0.57
Money market		168,418			3,340		1.98			159,767			5,668		3.55			157,643			5,186		3.29
Time deposits of $100,000 and over		142,713			5,698		3.99			141,645			7,045		4.97			122,594			5,251		4.28
Other time deposits		319,919			12,872		4.02			318,469			14,826		4.66			314,966			12,466		3.96

Total time deposits		792,790			23,453		2.96			777,173			29,281		3.77			753,945			24,591		3.26
Federal funds purchased and securities sold under agreements to repurchase		41,633			869		2.09			31,061			1,381		4.45			42,350			1,811		4.28
Interest — bearing demand notes to U.S. Treasury		—			—		—			205			11		5.37			704			31		4.4
Subordinated notes		49,486			3,046		6.16			49,486			3,617		7.31			49,486			3,528		7.13
Other borrowed money		124,025			4,231		3.41			53,626			2,885		5.38			56,757			2,805		4.94

Total interest bearing liabilities		1,007,934			31,599		3.14			911,551			37,175		4.08			903,242			32,766		3.63
Demand deposits		121,428								126,708								132,912
Other liabilities		8,759								10,189								9,175

Total liabilities		1,138,121								1,048,448								1,045,329
Stockholders’ equity		113,375								108,052								100,821

Total liabilities and stockholders’ equity	$	1,251,496							$	1,156,500							$	1,146,150

Net interest income (FTE)				$	38,987							$	38,029							$	39,666

Net interest spread							3.05	%							3.16	%							3.39	%
Net interest margin							3.42	%							3.66	%							3.85	%


(1)		Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 35%, net of nondeductible interest expense. Such adjustments totaled $871,000, $997,000 and $1,009,000 for the years ended December 31, 2008, 2007 and 2006, 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.

Comparison of Years ended December 31, 2008 and 2007

Financial results for 2008 compared to 2007 included growth in net interest income. Average interest-earning assets increased $101,951,000, or 9.8% to $1,140,225,000 at December 31, 2008 compared to $1,038,274,000 at December 31, 2007. This increase to net interest income was offset by a higher provision for loan loss and an increase to non-interest expense including a goodwill impairment charge of $40,324,000. Net interest income, on a tax equivalent basis, increased $958,000, or 2.5%, reflecting growth in average loan balances.

Average loans outstanding increased $114,481,000 or 13.5% to $963,252,000 for 2008 compared to $848,771,000 for 2007. Average commercial loans outstanding decreased approximately $1,837,000 or 1.2% for 2008 compared to 2007. Average real estate loans outstanding increased approximately $113,555,000 or 17.0% for 2008 compared to 2007. Average consumer loans outstanding decreased approximately $1,032,000 or 3.0% for 2008 compared to 2007. 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 $20,140,000 or 10.7% to $168,235,000 for 2008 compared to $188,375,000 for 2007. The decrease in average investment securities during 2008 and 2007 reflects the use of investment liquidity to fund our Company’s growth in the loan portfolio.

Average interest bearing liabilities increased $96,383,000, or 10.6%, to $1,007,934,000 at December 31, 2008 compared to $911,551,000 at December 31, 2007. Average time deposits increased $15,617,000 or 2.0% to $792,790,000 for 2008 compared to $777,173,000 for 2007. The increase was primarily a result of a marketing campaign during the third quarter designed to attract new deposits and establish new customer relationships.

Average federal funds purchased and securities sold under agreements to repurchase increased $10,572,000 or 34.0% to $41,633,000 for 2008 compared to $31,061,000 for 2007. This reflects an increase in public funds received during 2008 over 2007. Average other borrowed money increased $70,399,000 or132.2% to $124,025,000 for 2008 compared to $53,626,000 for 2007. The increase in 2008 reflects a net increase in Federal Home Loan Bank advances to fund loan growth.

Average stockholders’ equity increased $5,328,000 or 4.9% to $113,375,000 for 2008 compared to $108,052,000 for 2007. The increase mainly resulted from the issuance of preferred stock in December, 2008.

Comparison of Years ended December 31, 2007 and 2006

Average interest-earning assets increased $6,851,000, or 7 basis points to $1,038,274,000 at December 31, 2007 compared to $1,031,423,000 at December 31, 2006.

Average loans outstanding increased $24,065,000 or 2.9% to $848,771,000 for 2007 compared to $824,706,000 for 2006.

Average commercial loans outstanding decreased approximately $1,184,000 or 8 basis points for 2007 compared to 2006. Average real estate loans outstanding increased approximately $27,633,000 or 4.33% for 2007 compared to 2006. Average consumer loans outstanding decreased approximately $2,384,000 or 6.7% for 2007 compared to 2006.

Average investment securities and federal funds sold decreased $16,082,000 or 7.9% to $188,375,000 for 2007 compared to $204,457,000 for 2006. The decrease in average investment securities during 2007 and 2006 reflects the use of investment liquidity to fund our Company’s growth in the loan portfolio.

Average interest bearing liabilities increased $8,309,000, or 9 basis points, to $911,551,000 at December 31, 2007 compared to $903,242,000 at December 31, 2006. Average time deposits increased $23,228,000 or 3.1% to $777,173,000 for 2007 compared to $753,946,000 for 2006. This increase was a result of the expansion of our Company’s branch network.

Average federal funds purchased and securities sold under agreements to repurchase decreased $11,289,000 or 26.7% to $31,061,000 for 2007 compared to $42,350,000 for 2006. Average subordinated notes was $49,486,000 in 2007 and 2006. Average other borrowed money decreased $3,131,000 or 5.5% to $53,626,000 for 2007 compared to $56,757,000 for 2006. The decrease in 2007 reflects a net decrease in Federal Home Loan Bank advances. The increase in 2006 reflects increased funding for loan growth.

Average stockholders’ equity increased $7,231,000 or 7.2% to $108,052,000 for 2007 compared to $100,821,000 for 2006. The increases represent net income retained in excess of dividends declared plus adjustments for unrealized gains or losses on debt and equity securities, net of taxes.

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, 2008, compared to December 31, 2007 and for the years ended December 31, 2007 compared to December 31, 2006. 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.


	2008									2007

				Change due to									Change due to
	Total			Average			Average			Total			Average			Average
(Dollars In thousands)	Change			Volume			Rate			Change			Volume			Rate

Interest income on a fully taxable equivalent basis:
Loans: (1) (3)	$	(2,870	)	$	8,212		$	(11,082	)	$	2,907		$	1,850		$	1,057
Investment securities:
Government sponsored entities		(697	)		(295	)		(402	)		(31	)		(558	)		527
State and municipal(2)		(466	)		(433	)		(33	)		75			27			48
Other		4			112			(108	)		(4	)		(46	)		42
Federal funds sold		(555	)		(302	)		(253	)		(133	)		(183	)		50
Interest bearing deposits in other financial institutions		(34	)		67			(101	)		(42	)		(56	)		14

Total interest income		(4,618	)		7,361			(11,979	)		2,772			1,034			1,738

Interest expense:
NOW accounts		(165	)		88			(253	)		92			54			38
Savings		(34	)		(13	)		(21	)		(38	)		(30	)		(8	)
Money market		(2,328	)		292			(2,620	)		482			71			411
Time deposits of 100,000 and over		(1,347	)		53			(1,400	)		1,794			881			913
Other time deposits		(1,954	)		68			(2,022	)		2,360			140			2,220
Federal funds purchased and securities sold under agreements to repurchase		(512	)		373			(885	)		(430	)		(500	)		70
Interest—bearing demand notes to U.S. Treasury		(11	)		(5	)		(6	)		(20	)		(26	)		6
Subordinated notes		(571	)		—			(571	)		89			—			89
Other borrowed money		1,346			2,708			(1,362	)		80			(160	)		240

Total interest expense		(5,576	)		3,564			(9,140	)		4,409			430			3,979

Net interest income on a fully taxable equivalent basis	$	958		$	3,797		$	(2,839	)	$	(1,637	)	$	604		$	(2,241	)


(1)		Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 35%, net of nondeductible interest expense. Such adjustments totaled $871,000, $997,000 and $1,009,000 for the years ended December 31, 2008, 2007 and 2006, 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 increased $958,000 or 2.5% to $38,987,000 for 2008 compared to $38,029,000 for 2007, and followed a $1,637,000 or 4.1% decrease for 2007 compared to 2006. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased from 3.85% for 2006 to 3.66% for 2007, and decreased to 3.42% for 2008. Although our Company’s loan growth remains strong, the current economic conditions continue to narrow the net interest spread as seen from the decrease of 3.05% in 2008 from 3.16% in 2007 and 3.39% in 2006.

While our Company was able to decrease the rate paid on interest bearing liabilities to 3.14% in 2008 versus 4.08% in 2007, this decrease was more than offset by a decrease in the rates earned on interest bearing assets to 6.19% versus 7.24% in 2007. The decrease in the net interest margin in 2007 reflects higher rates earned on net interest earning assets which were more than offset by higher rates paid on interest bearing liabilities.

Provision for loan losses

The provision for loan losses for 2008 was $8,211,000 compared to $1,154,000 for 2007. Loans charged off, net of recoveries, for 2008 were $4,826,000 compared to $887,000 for 2007. Approximately $3,418,000 of the 2008 net charge-offs is represented by various commercial loans, $1,097,000 is represented by increased real estate construction losses, and approximately $311,000 is represented by various consumer loans.

The provision for loan losses for 2007 was $1,154,000 compared to $1,326,000 for 2006. Loans charged off, net of recoveries, for 2007 were $887,000 compared to $1,396,000 for 2006.

Further discussion of managements’ methodology related to the allowance and provision for loan losses may be found in the “Lending and Credit Management” section of this report.

Non-interest Income and Expense

Non-interest income for the years ended December 31, 2008, 2007, and 2006 were as follows:


										$ Change						% Change
(Dollars in thousands)	2008			2007			2006			‘08-‘07			‘07-‘06			‘08-‘07			‘07-‘06

Non-interest Income
Service charges on deposit accounts	$	6,164		$	5,707		$	5,730		$	457		$	(23	)		8.0	%		(0.4	)%
Trust department income		827			968			799			(141	)		169			(14.6	)		21.2
Mortgage loan servicing fees, net		135			341			433			(206	)		(92	)		(60.4	)		(21.2	)
Gain on sales of mortgage loans		973			666			432			307			234			46.1			54.2
Other		1,195			2,541			1,224			(1,346	)		1,317			(53.0	)		107.6

Total non-interest income	$	9,294		$	10,223		$	8,618		$	(929	)	$	1,605			(9.1	)%		18.6	%


Investment securities gains (losses), net	$	3		$	(2	)	$	(18)		$	5		$	16			(250.0	)%		(88.9	)%


Non-interest income as a % of total revenue *		19.6	%		21.6	%		18.2	%
Total revenue per full time equivalent employee	$	137.8		$	135.4		$	133.2


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

Years Ended December 31, 2008 and 2007

Noninterest income decreased $929,000 or 9.1% to $9,294,000 for 2008 compared to $10,223,000 for 2007. Service charge income increased $457,000 or 8.0%. Trust department income decreased $141,000 or 14.6%. Mortgage loan servicing fees decreased $206,000 or 21.2%. This decrease in servicing fees was the result of an increase in the amortization of mortgage servicing rights due to increased refinancing of existing mortgage loans. However, gain on sales of mortgage loans increased $307,000 or 46.2% as a result of increased refinancing activity. Our Company was servicing $213,074,000 of mortgage loans at December 31, 2008 compared to $209,734,000 at December 31, 2007. Our Company recognized $3,000 in gain on sales and calls of debt securities during the 2008 compared to losses of $2,000 during 2007. Other income decreased $1,346,000 or 53.0% to $1,195,000. $1,200,000 of the decrease represents the amount received from the sales of Osage Valley Bank, Bank 10, and Exchange National Bank’s bank charters in 2007 and $254,000 of the decrease reflects recovery of prior years’ legal and collection costs as a result of settlement of a lawsuit in our Company’s favor in 2007.

Years Ended December 31, 2007 and 2006

Noninterest income increased $1,605,000 or 18.6% to $10,223,000 for 2007 compared to $8,618,000 for 2006. Trust department income increased $169,000 or 21.2% due primarily to the collection of more transactional based distribution fees during 2007 compared to 2006. Mortgage loan servicing fees decreased $91,000 or 21.2% as a result in a decrease in the amount of mortgage loans serviced. Our Company was servicing $209,734,000 of

mortgage loans at December 31, 2007 compared to $215,701,000 at December 31, 2006. Gain on sales of mortgage loans increased $234,000 or 54.2% due to an increase in volume of loans originated and sold to the secondary market. Even though the volume or loans originated and sold increased over the comparable period in the prior year, the total loan serving portfolio declined due to both increased prepayments of existing loans and an increase in the volume of loans sold without retention of the servicing rights. Our Company recognized $2,000 in loss on sales and calls of debt securities during the 2007 compared to $18,000 during 2006. Other income increased $1,317,000 or 107.6%. $1,200,000 of the increase represents the amount received from the sales of Osage Valley Bank, Bank 10, and Exchange National Bank’s bank charters and $254,000 of the increase reflects recovery of prior years’ legal and collection costs as a result of settlement of a lawsuit in our Company’s favor.

Non-interest expense for the years ended December 31, 2008, 2007, and 2006 were as follows:


										$ Change						% Change
(Dollars in thousands)	2008			2007			2006			‘08-‘07			‘07-‘06			‘08-‘07			‘07-‘06

Non-interest Expense
Salaries	$	14,099		$	14,261		$	12,833		$	(162	)	$	1,428			(1.1	)%		11.1	%
Goodwill impairment		40,324			—			—			40,324			—			N.M			N.M
Employee beneftis		4,151			4,472			4,186			(321	)		286			(7.2	)		6.8
Occupancy expense, net		2,440			2,202			1,994			238			208			10.8			10.4
Furniture and equipment expense		2,438			2,879			2,301			(441	)		578			(15.3	)		25.1
Legal, examination, and professional fees		1,193			1,583			1,431			(390	)		152			(24.6	)		10.6
Advertising and promotion		1,117			1,196			897			(79	)		299			(6.6	)		33.3
Postage, printing, and supplies		1,221			1,297			1,147			(76	)		150			(5.9	)		13.1
Processing expense		3,102			1,470			1,009			1,632			461			111.0			45.7
Donations		816			225			301			591			(76	)		262.7			(25.2	)
Amortization of intangible assets		701			922			1,033			(221	)		(111	)		(24.0	)		(10.7	)
Impairment and other real-estate owned expense		810			681			119			129			562			18.9			472.3
Other		3,563			3,866			2,897			(303	)		969			(7.8	)		33.4

Total non-interst expense	$	75,975		$	35,054		$	30,148		$	40,921		$	4,906			116.7	%		16.3	%

Efficiency ratio*		75.2	%		74.2	%		63.8	%
Salaries and benefits as a % of total non-interst expense *		51.2	%		53.4	%		56.5	%
Number of full-time equivalent employees		344			349			355


*		Goodwill impairment not included in ratio calculation

Years Ended December 31, 2008 and 2007

Noninterest expense increased $40,921,000 or 116.7% to $75,975,000 for 2008 compared to $35,054,000 for 2007. $40,324,000 of the increase reflects a goodwill impairment charge taken during the fourth quarter of 2008. Based upon an analysis of the fair value of our Company’s net assets, it was determined that the entire carrying value of goodwill was impaired requiring the impairment charge to earnings. Salaries decreased $162,000 or 1.1%, employee benefits decreased $321,000 or 7.2%, occupancy expense increased $238,000 or 10.8%, furniture and equipment expense decreased $441,000 or 15.3%, legal and professional fees decreased $390,000 or 24.6%, processing expense increased $1,632,000 or 111.0% and donations increased $591,000 or 262.7.9%. The $162,000 decrease in salaries reflects a reduction in incentive compensation expense. The $321,000 decrease in employee benefits primarily represents reductions in profitsharing expense as a result of lower earnings. The $1,632,000 increase in processing expense reflects both the cost of outsourcing our data processing function as well as investment in new technologies including remote deposit capture and document imaging. The $591,000 increase in donations reflects the donation of a large parcel of other real estate owned and an abandoned branch location to charitable organizations.

Years Ended December 31, 2007 and 2006

Our Company experienced higher noninterest expenses in 2007 compared to 2006 resulting from several events that took place during the fourth quarter 2007. A communications network conversion was completed, our data processing operation was outsourced and converted to a new system, a remote item capture system was installed to facilitate the outsourced data processing environment, and two Clinton branch locations were opened while two older Clinton locations were closed. These nonrecurring costs caused significant increases in furniture and equipment expense, advertising and promotion, processing expense, security, and conversion errors and omission. Other significant increases in noninterest expense were seen in real estate loan collection expenses, other real estate owned impairment charges, and donations.

Noninterest expense increased $4,906,000 or 16.3% to $35,054,000 for 2007 compared to $30,148,000 for 2006. Salaries and benefits increased $1,714,000 or 10.1%, furniture and equipment expense increased $578,000 or 25.1%, advertising and promotion increased $299,000 or 33.3%, other real-estate owned loan expense increased $562,000 or 472.3%, processing expense increased $461,000 or 45.7% and other noninterest expense increased $893,000 or 27.9%. Salaries and benefits reflect a $290,000 decrease in incentive payments, profit sharing and pension contributions for 2007 versus 2006. Excluding this decrease, salaries and employee benefits increased $2,004,000 or 11.8%. This increase reflects normal salary increases, additional personnel resulting from staffing for a newly opened branch facility in Columbia, Missouri, and additional holding company personnel required for the implementation of our Company’s strategic plan. The $578,000 increase in furniture and equipment expense primarily reflects $324,000 loss on dispositions of furniture and equipment resulting from software and equipment becoming obsolete after our Company completed a major network conversion. The remaining increase is a result of two new Clinton branch facilities opening during the fourth quarter of 2007. The $299,000 increase in advertising and promotion reflects nonrecurring costs associated with the re-branding of our Company’s name and logo. The $562,000 increase in other real-estate owned expense represents $378,000 impairment write-down on two properties in other real-estate owned and an $184,000 increase in additional expenses related to properties in other real estate. The $461,000 increase in processing expense reflects nonrecurring costs associated with the merger of the bank subsidiaries and software and network conversion. The $893,000 increase in other noninterest expense reflects expenses in various other categories including, but not limited to, conversion costs, travel, meals and entertainment, security, telephone and internet, directors fees, and insurance.

Income taxes

Income taxes as a percentage of earnings (loss) before income taxes as reported in the consolidated financial statements were 16.7% for 2008 compared to 29.4% for 2007. The decrease in the effective tax rate for 2008 is due to an increase in non-taxable income as a percentage of total income in the current year and a taxable loss before taxes. In addition, 2008 tax expense reflects the recognition of tax benefits as a result of the expiration of the statute of limitations on our Company’s 2004 and 2005 federal tax returns during the year. The decrease in 2008 earnings was due to a $40,323,775 goodwill impairment charge in the fourth quarter and an additional $7,056,784 increase in the loan provision in comparison to the year ended 2007. While goodwill impairment is normally a non-tax deductible item, $16,916,000 of our goodwill was related to asset purchases and therefore deductible for book tax purposes.

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 29.4% for 2007 compared to 31.1% for 2006. The decrease in the effective tax rate for 2007 is due to an increase in non-taxable income as a percentage of total income in the current year and a decrease in income before taxes. In addition, our Company reorganized its corporate structure in the 4 ^th quarter of 2007. This change in structure resulted in an increase in deferred tax assets at December 31, 2007 and a corresponding decrease in current state tax expense for the year then ended. As a result of this change in structure, our Company anticipates an increase in state income tax expense in future periods and a corresponding increase in the overall effective income tax rate.

Fourth Quarter Results for 2008

As mentioned above, our Company experienced higher noninterest expenses in the fourth quarter 2008 compared to third quarter 2007. The primary increases in noninterest expense in the fourth quarter of 2008 were the goodwill impairment charge of $40,324,000 and a loan loss provision of $4,261,000 in 2008 compared to $550,000 in 2007.

Comparing fourth quarter 2008 to third quarter 2008:

Our Company’s net loss of $(35,046,000) for the fourth quarter ended December 31, 2008 declined $37,060,000, compared to net income of $2,014,000 for the third quarter ended September 30, 2008. Net interest income of $9,201,000 decreased $654,000 from third quarter 2008 due to an decrease in net interest margin to 3.14% for the fourth quarter compared to 3.49% for the third quarter.

The fourth quarter 2008 provision for loan losses of $4,261,000 was $3,261,000 higher than third quarter 2008’s provision of $1,000,000 and was based upon management’s determination of the loan loss reserve required to cover probable losses in the loan portfolio at year-end and as a result of increased nonperforming loans at year-end.

Noninterest income of $2,286,000 for fourth quarter 2008 decreased slightly by $35,000 from third quarter 2008’s noninterest income of $2,321,000.

Noninterest expense of $50,323,000 for fourth quarter 2008 increased $41,941,000 from third quarter 2008’s noninterest expense of $8,323,000. $40,324,000 of the increase reflects the goodwill impairment charge taken during fourth quarter. Donations increased $674,000 in fourth quarter and reflects the donations of an other real estate owned (OREO) property and an abandoned bank property to charitable organizations. Expenses paid on OREO properties increased $295,000. The balance of the increase was in various other categories.

Comparing fourth quarter 2008 to fourth quarter 2007 :

Our Company’s net loss of $(35,046,000) for the fourth quarter ended December 31, 2008 declined $36,039,000, compared to net income of $993,000 for same period in 2007. Net interest income of $9,201,000 decreased $285,000 in the fourth quarter of 2008 compared to the fourth quarter of 2007 due to an decrease in net interest margin to 3.14% for 2008 compared to 3.64% for the same period of 2007.

The fourth quarter 2008 provision for loan losses of $4,261,000 was $3,711,000 higher than the fourth quarter 2007 provision of $550,000 and was based upon management’s determination of the loan loss reserve required to cover probable losses in the loan portfolio at year-end and as a result of increased nonperforming loans at year-end.

Noninterest income of $2,286,000 for fourth quarter 2008 decreased by $467,000 from noninterest income of $2,753,000 for fourth quarter 2007. $325,000 of the decrease reflects funds received from the sale of a bank charter in 2007 that was available as the result of the consolidation that took place during 2007. The balance of the decrease is represented by lower trust department income in fourth quarter 2008 compared to 2007.

Noninterest expense of $50,323,000 for fourth quarter 2008 increased $40,009,000 from fourth quarter 2007 noninterest expense of $10,314,000. The goodwill impairment charge of $40,324,000 represents the majority of the variance between periods.

Lending and Credit Management

Interest earned on the loan portfolio is a primary source of interest income for our Company. Net loans represented 77.8% of total assets as of December 31, 2008. Total loans increased steadily from December 31, 2004 through December 31, 2008 due to an expanded branch network as well a decrease in interest rates.

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.

The following table shows the composition of the loan portfolio by major category and each category as a percentage of the total portfolio as of the dates indicated.


	Balance at December 31,
(In thousands)	2008					2007					2006					2005					2004
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
Commercial, financial and agricultural	$	153,386		15.2	%	$	151,488		16.6	%	$	145,697		17.9	%	$	154,868		19.0	%	$	141,151		22.2	%
Real estate —
Construction		129,639		12.9			147,432		16.2			150,891		18.6			139,316		17.1			65,075		10.2
Real estate —
Mortgage		692,530		68.6			575,552		63.2			478,854		59.0			480,531		59.1			392,656		61.7
Installment loans to individuals		33,548		3.3			36,806		4.0			36,870		4.5			38,820		4.8			37,755		5.9

Total loans	$	1,009,103		100.0	%	$	911,278		100.0	%	$	812,312		100.0	%	$	813,535		100.0	%	$	636,637		100.0	%

Our Company experienced loan growth of $97,825,000 or 10.7% from 2007 to 2008. This growth is primarily in our Bank’s commercial and real estate mortgage lending. Commercial loans increased $1,898,000 or 1.3% from 2007 to 2008 and real estate mortgage loans increased $116,978,000 or 20.3%. Offsetting these increases were a decrease in real estate construction loans of $17,793,000 or 12.1% and a decrease in individual consumer loans of $3,258,000 or 8.9%. The demand for commercial real estate loans remained relatively strong in most of the regions our Company serves. Although management tightened underwriting standards during the year, our Company continued to find opportunities to lend to credit worthy borrowers with the capacity to service the debts. This growth was not centered in any one industry, region or borrower and included a fairly diversified portfolio of loans ranging from owner occupied and regional retail properties to include some hospitality properties. Our growth in real estate loans was also partially the result of loans moving from construction to amortizing loans, thus contributing to the decrease in our construction portfolio. In addition, the decrease in lending activities in the real estate construction market also reflects the slow down in the housing industry and residential construction industry as well as foreclosures on various residential construction properties during 2008. Construction lending will continue to be closely monitored during 2009.

Commercial loans increased $5,791,000 or 4.0% from 2006 to 2007 and real estate loans increased $96,698,000 or 20.2%. The increase in our Company’s commercial loan portfolio occurred throughout our Bank’s regions. This growth was the result of management’s intent to increase the variable rate asset base. The growth in the real estate mortgage area was primarily the result of our Company’s expansion into the Columbia, Missouri market. Additionally, our Company is continuing to experience loan growth in Branson and Springfield, Missouri markets as a result of lending activities for investment and income producing properties. Lending activities in the real estate construction market decreased $3,459,000 or 2.3% from 2006 to 2007 due to the slow down in the housing industry and residential construction industry.

Our Company does not participate in extending credit to sub-prime residential real estate markets. While much publicity has been directed at this market during the past year, our Company extends credit to its local community market through traditional mortgage products.

The contractual maturities of loan categories at December 31, 2008, and the break down of those loans between fixed rate and floating rate loans are as follows:


	Principal Payments Due
			Over One		Over
	One Year		Year Through		Five
	Or Less		Five Years		Years		Total

Commercial, financial, and agricultural	$	93,944	$	55,124	$	4,318	$	153,386
Real estate — construction		129,639		—		—		129,639
Real estate — mortgage		185,859		440,198		66,473		692,530
Installment loans to individuals		16,741		16,089		718		33,548

Total loans net of unearned income	$	426,183	$	511,411	$	71,509	$	1,009,103


Loans with fixed rates		333,301		438,301		38,053		809,655
Loans with floating rates		92,882		73,110		33,456		199,448

Total loans net of unearned income	$	426,183	$	511,411	$	71,509	$	1,009,103

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. At December 31, 2008 our Company was servicing approximately $213,000,000 of loans sold to the secondary market.

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.

The provision for loan losses is based on management’s evaluation of the loan portfolio in light of national and local economic conditions, changes in the composition and volume of the loan portfolio, changes in the volume of past due and nonaccrual loans, value of underlying collateral and other relevant factors. The allowance for loan losses which is reported as a deduction from loans is available for loan charge-offs. This allowance is increased by the provision charged to expense and is reduced by loan charge-offs net of loan recoveries.

Management, through the establishment of a senior loan committee, formally reviews all loans in excess of certain dollar amounts (periodically established) at least annually. Currently, loans in excess of $2,000,0000 in aggregate and all adversely classified credits identified by management as containing more than usual risk are reviewed. 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 what loans should be considered “impaired”. Management follows the guidance provided in Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, (SFAS 114) 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. Once a loan has been identified as impaired management generally measures impairment based upon the fair value of the underlying collateral. Management believes, but there can be no assurance, that these procedures keep management informed of possible problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered adequate by management for probable losses inherent in the loan portfolio.

Allowance for Loan Losses

The provision for loan losses increased $7,057,000 or 611.4% to $8,211,000 for 2008 compared to $1,154,000 for 2007 and followed a $172,000 or 12.9% decrease for 2007 compared to 2006. The provision reflects the amounts management determined necessary to maintain the allowance for loan losses at a level that was adequate to cover probable losses in the loan portfolio. The allowance for loan losses totaled $12,667,000 or 1.3% of loans outstanding at December 31, 2008 compared to $9,282,000 or 1.0% of loans outstanding at December 31, 2007 and $9,015,000 or 1.1% of loans outstanding at December 31, 2006. The allowance for loan losses expressed as a percentage of nonperforming loans was 50.9% at December 31, 2008, 152.5% at December 31, 2007 and 177.9% at December 31, 2006.

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


	Years Ended December 31,
(Dollars in thousands)	2008			2007			2006		2005		2004

Analysis of allowance for loan losses:
Balance beginning of year	$	9,282		$	9,015		$	9,085	$	7,496	$	8,267
Allowance for loan losses of acuired companies at date of acquisitions		—			—			—		1,418		—
Charge-offs:
Commercial, financial, and agricultural		3,571			524			809		589		1,596
Real estate — construction		681			56			84		185		—
Real estate — mortgage		532			413			474		286		26
Installment loans to individuals		656			314			484		261		236

Total charge-offs		5,440			1,307			1,851		1,321		1,858

Recoveries:
Commercial, financial, and agricultural		153			151			206		40		18
Real estate — construction		35			11			13		—		—
Real estate — mortgage		81			100			91		28		—
Installment loans to individuals		345			158			145		102		127

Total recoveries		614			420			455		170		145

Net charge-offs		4,826			887			1,396		1,151		1,713
Provision for loan losses		8,211			1,154			1,326		1,322		942

Balance at end of year	$	12,667		$	9,282		$	9,015	$	9,085	$	7,496

Loans outstanding:
Average	$	963,252		$	848,772		$	824,706	$	743,382	$	601,363
End of period		1,009,104			911,278			812,312		813,535		636,637
Allowance for loan losses to loans outstanding:
Average		1.32	%		1.09	%		1.09		%1.22		%1.25	%
End of period		1.26			1.02			1.11		1.12		1.18
Net charge-offs to average loans outstanding		0.50			0.10			0.17		0.15		0.29

The increased provision for loan losses was the result of an increased level of charged-off loans and an increase in the level of performing loans, especially during the fourth quarter of 2008. As shown in the table above, our Company experienced net loan charge-offs of $4,826,000 during 2008 compared to $887,000 in 2007 and $1,396,000 in 2006.

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)	2008			2007			2006			2005			2004

Allocation of allowance for loan losses at end of period:
Commercial, financial, and agricultural	$	1,712		$	3,762		$	3,114		$	2,687		$	3,700
Real estate — construction		2,490			590			755			764			288
Real estate — mortgage		6,571			3,873			3,526			4,138			2,563
Installment loans to individuals		391			419			529			473			429
Unallocated		1,503			638			1,091			1,023			516

Total	$	12,667		$	9,282		$	9,015		$	9,085		$	7,496

Percent of categories to total loans:
Commercial, financial, and agricultural		15.2	%		16.6	%		17.9	%		19.0	%		22.2	%
Real estate — construction		12.9			16.2			18.6			17.1			10.2
Real estate — mortgage		68.6			63.2			59.0			59.1			61.7
Installment loans to individuals		3.3			4.0			4.5			4.8			5.9

Total		100.0			100.0			100.0			100.0			100.0

Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due, and restructured loans totaled $24,866,000 or 2.46% of total loans at December 31, 2008 compared to $6,085,000 or 0.67% of total loans at December 31, 2007. The following table summarizes our Company’s nonperforming assets at the dates indicated:


	Years Ended December 31,
(Dollars in thousands)	2008			2007			2006			2005			2004

Nonaccrual loans:
Commercial, financial, and agricultural	$	2,071		$	2,983		$	2,495		$	5,705		$	4,213
Real estate — construction		10,347			866			1,657			1,760			—
Real estate — mortgage		7,850			658			644			1,090			1,246
Installment loans to individuals		119			32			73			56			30

Total nonaccrual loans		20,387			4,539			4,869			8,611			5,489

Loans contractually past — due 90 days or more and still accruing:
Commercial, financial, and agricultural		140			454			5			238			12
Real estate — construction		52			158			—			—			—
Real estate — mortgage		547			864			170			187			591
Installment loans to individuals		4			70			22			14			—

Total loans contractually past -due 90 days or more and still accruing		743			1,546			197			439			603
Restructured troubled loans		3,736			—			—			—			—

Total nonperforming loans		24,866			6,085			5,066			9,050			6,092
Other real estate		7,828			2,337			2,720			1,568			30
Repossessions		—			—			15			—			42

Total nonperforming assets	$	32,694		$	8,422		$	7,801		$	10,618		$	6,164


Loans	$	1,009,103			911,278			812,313			813,535			636,637
Allowance for loan losses to loans		1.26	%		1.02	%		1.11	%		1.12	%		1.18	%
Nonperforming loans to loans		2.46	%		0.67	%		0.62	%		1.11	%		0.96	%
Allowance for loan losses to nonperforming loans		50.94	%		152.54	%		177.95	%		100.39	%		123.05	%
Nonperforming assets to loans and foreclosed assets		3.21	%		0.92	%		0.96	%		1.30	%		0.97	%

It is our Company’s policy to discontinue the accrual of interest income on loans when the full collection of principal or interest is in doubt, or when the payment of principal or interest has become contractually 90 days past due unless the obligation is 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. Interest on year-end nonaccrual loans, which would have been recorded under the original terms of the loans, was approximately $1,522,000, $745,000 and $896,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Approximately $239,000, $330,000 and $63,000 was actually recorded as interest income on such loans for the year ended December 31, 2008, 2007 and 2006, respectively.

Total non-accrual loans at year end 2008 increased $15,848,000 over 2007. The increase resulted mainly from an increase of $9,481,000 in real estate construction non-accrual loans and an increase of $7,192,000 real estate mortgage non-accrual loans. Foreclosed real estate increased $5,491,000 to $7,828,000 and restructured loans increased $3,736,000 at year end 2008. Loans past due 90 days and still accruing interest decreased $803,000 at year end 2008 compared to 2007.

Our Company has experienced an increase in its loan delinquencies much like the rest of the banking industry as current economic conditions negatively impact our borrowers’ ability to keep their debt payments current. Management believes close monitoring of these credits will mitigate potential higher delinquency levels and/or losses. Management believes these loans are well secured and is actively focused on managing and collecting these accounts to prevent further deterioration.

A loan is considered impaired when it is probable a creditor will be unable to collect all amounts due — both principal and interest — according to the contractual terms of the loan agreement. In addition to nonaccrual loans at December 31, 2008 included in the table above, which were considered impaired, management has identified additional loans totaling approximately $9,546,000 which are not included in the nonaccrual table above but are considered by management to be impaired compared to $4,027,000 in December 31, 2007.

Once a loan has been identified as impaired (as defined by paragraph 8 of SFAS 114), Accounting by Creditors for Impairment of a Loan, management generally measures impairment based upon the fair value of the underlying collateral. In general, market prices for loans in our portfolio are not available, and we have found the fair value of the underlying collateral to be more readily available and reliable than discounting expected future cash flows to be received. Once a fair value of collateral has been determined and the impairment amount calculated, a specific reserve allocation is made. At December 31, 2008, $3,837,000 of our Company’s allowance for loan losses was allocated to impaired loans totaling approximately $29,934,000.

As of December 31, 2008 and 2007 approximately $13,389,000 and $11,645,000, respectively, of loans not included in the nonaccrual table above or identified by management as being “impaired” were classified by management as having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. The $1,744,000 increase in classified loans is the result of several borrowers who have experienced cash flow problems and as well as some deterioration in collateral value. Management elected to allocate non-specific reserves to these credits based upon the inherent risk present. This increase in reserves was the result of our Company’s internal loan review process which assesses credit risk. In addition to the classified list, our Company also maintains an internal loan watch list of loans which for various reasons, not all related to credit quality, management is monitoring more closely than the average loan in the portfolio. Loans may be added to this list for reasons which are temporary and correctable, such as the absence of current financial statements of the borrower, or a deficiency in loan documentation. Other loans are added as soon as any problem is detected which might affect the borrower’s ability to meet the terms of the loan. This could be initiated by the delinquency of a scheduled loan payment, deterioration in the borrower’s financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment within which the borrower operates. Once a loan is placed on our Company’s watch list, its condition is monitored closely. Any further deterioration in the condition of the loan is evaluated to determine if the loan should be assigned to a higher risk category.

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 three components: asset-specific reserves, reserves based on expected loss estimates, and unallocated reserves.

The asset-specific component applies to loans evaluated individually for impairment and is based on management’s best estimate of proceeds from liquidating collateral. The actual timing and amount of repayments and the ultimate realizable value of the collateral may differ from management’s estimate.

The expected loss component is generally determined by applying percentages to pools of loans by asset type. These pre-established percentages are based upon standard bank regulatory classification percentages as well as average 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 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.

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.

At December 31, 2008, management allocated $11,163,000 of the $12,666,000 total allowance for loan losses to specific loans and loan categories and $1,503,000 was unallocated. Considering the size of several of our Company’s lending relationships and the loan portfolio in total, management believes that the December 31, 2008 allowance for loan losses is adequate.

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 which 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.

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).

Debt securities classified as held-to-maturity are carried at amortized cost, while debt and equity securities classified as trading or 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, certain debt securities are classified as available-for-sale.

At December 31, 2008, debt and equity securities classified as available-for-sale represented 12.4% 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.


	December 31,
(In thousands)	2008		2007		2006

U.S. Treasuries	$	—	$	—	$	1,068
Government sponsored enterprises		55,545		87,370		121,769
Asset-backed securities		50,091		10,892		5,068
Obligations of states and political subdivisions		43,765		53,480		55,661
Other debt securities		—		—		—

Total available for sale debt securities		149,401		151,742		183,566

Federal Home Loan Bank of Des Moines Stock		7,228		3,979		3,808
Federal Reserve Bank Stock		—		—		752
Midwest Independent Bank Stock		151		151		151
Federal Agricultural Mortgage Corporation		10		10		10
Other equity securities		1,486		1,486		1,486

Total equity securities		8,875		5,626		6,207

Total available for sale investment securities	$	158,276	$	157,368	$	189,773

As of December 31, 2008, the maturity of debt securities in the investment portfolio was as follows:


				Over One			Over Five						Weighted
	One Year			Through			Through			Over			Average
(In thousands)	Or Less			Five Years			Ten Years			Ten Years			Yield (1)

Available-for-Sale

Government sponsored enterprises	$	14,466		$	38,023		$	2,805		$	251			4.06	%
Asset-backed (2)		580			46,636			2,095			779			4.63
States and political subdivisions (3)		3,454			16,273			16,892			7,146			5.49

Total available-for-sale debt securities	$	18,500		$	100,932		$	21,792		$	8,176			4.67	%


Weighted average yield (1)		3.71	%		4.66	%		5.27	%		5.40	%


(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, 2008 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, 2008, $236,000 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.

Risk Management

Market risk arises from exposure to changes in interest rates and other relevant market rate or price risk. Our Company faces market risk in the form of interest rate risk through transactions other than trading activities. Market risk from these activities, in the form of interest rate risk, is measured and managed through a number of methods. Our Company uses financial modeling techniques to measure interest rate risk. These techniques measure the sensitivity of future earnings due to changing interest rate environments. Guidelines established by our Company’s Asset/Liability Management Committee and approved by our Company’s Board of Directors are used to monitor exposure of earnings at risk. General interest rate movements are used to develop sensitivity as our Company feels it has no primary exposure to a specific point on the yield curve. For the year ended December 31,

2008, our Company utilized both a 300 basis point immediate and gradual move in interest rates (both upward and downward) applied to both a parallel and a proportional yield curve.

Interest Sensitivity

At December 31, 2008, our Company monitored its static gap report with the goal being to limit potential changes in net interest income due to changes in interest rates to acceptable limits. Our Company applied a plus or minus 3.00% interest rate change utilizing both an immediate and a gradual interest shock and measured against both parallel and proportional yield curves. The resulting net interest income changes ranged from approximately (13.5)% to 17.4% depending on the scenario.

The following table represents the estimated interest rate sensitivity and periodic and cumulative gap positions calculated as of December 31, 2008. 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.


												Over
												5 years or
												no stated
(Dollars in thousands)	Year 1			Year 2		Year 3		Year 4		Year 5		Maturity			Total
ASSETS
Investment securities	$	63,072		$	30,917	$	20,332	$	9,845	$	4,066	$	29,137		$	157,369
Interest-bearing deposits		133			—		—		—		—		—			133
Federal funds sold and securities purchased under agreements to resell		664			—		—		—		—		—			664
Loans		496,716			119,669		168,387		36,473		52,235		28,516			901,996

Total	$	560,585		$	150,586	$	188,719	$	46,318	$	56,301	$	57,653		$	1,060,162


LIABILITIES

Savings, Now deposits	$	—		$	—	$	—	$	—	$	—	$	111,175		$	111,175
Rewards checking, Super Now, money market deposits		153,934											64,113			218,047
Time deposits		379,927			36,868		27,912		5,790		3,053		130			453,680
Federal funds purchased and securities sold under agreements to repurchase		25,730			—		—		—		—		—			25,730
Subordinated notes		25,774			—		—		23,712		—		—			49,486
Other borrowed money		48,158			12,734		16,063		576		259		125			77,915

Total	$	633,523		$	49,602	$	43,975	$	30,078	$	3,312	$	175,543		$	936,033


Interest-sensitivity GAP
Periodic GAP	$	(72,938	)	$	100,984	$	144,744	$	16,240	$	52,989	$	(117,890	)	$	124,129

Cumulative GAP	$	(72,938	)	$	28,046	$	172,790	$	189,030	$	242,019	$	124,129		$	124,129


Ratio of interest-earnings assets to interest-bearing liabilities
Periodic GAP		0.88			3.04		4.29		1.54		17.00		0.33			1.13
Cumulative GAP		0.88			1.04		1.24		1.25		1.32		1.13			1.13

Liquidity

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. The deposit base, consisting of consumer and commercial deposits and large dollar denomination ($100,000 and over) certificates of deposit, is a source of funds. Our Company has an insignificant amount of deposits on which the rate paid exceeded the market rate by more that 50 basis points when the account was established.

At December 31, 2008 and 2007, our Company had certificates and other time deposits in denominations of $100,000 or more which mature as follows:


	December 31,
(Dollars in thousands)	2008		2007

Three months or less	$	39,041	$	41,533
Over three months through six months		27,215		35,565
Over six months through twelve months		48,556		44,271
Over twelve months		28,160		18,374

	$	142,972	$	139,743

Securities sold under agreements to repurchase generally mature the next business day; however, certain agreements with local political subdivisions and select businesses are fixed rate agreements with original maturities generally ranging from 30 to 120 days. Information relating to securities sold under agreements to repurchase is as follows:


	At End of Period					For the Period Ending
			Weighted			Maximum				Weighted
			Average			Month-end		Average		Average
(Dollars in thousands)	Balance		Interest Rate			Balance		Balance		Interest Rate

December 31, 2008	$	29,139		0.48	%	$	56,710	$	37,802		2.01	%
December 31, 2007		18,365		3.24			28,705		26,807		4.23
December 31, 2006		27,320		4.35			56,027		41,309		4.25

Other sources of funds available to meet daily needs include the sales of securities under agreements to repurchase and funds made available under a treasury tax and loan note agreement with the federal government. Also, 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. At December 31, 2008, the amount of available credit from the FHLB totaled $166,870,000. As of December 31, 2008, the Bank had $129,057,000 in outstanding borrowings with the FHLB. Under agreements with unaffiliated banks, the Bank may borrow up to $45,000,000 in federal funds on an unsecured basis and $13,000,000 on a secured basis at December 31, 2008. As of December 31, 2008, the Bank had no federal funds purchased.

Our Company’s liquidity depends primarily on the dividends paid to it as the sole shareholder of our subsidiary Bank. As discussed in Note 2 to the consolidated financial statements, the Bank will be required to receive regulatory approval prior to paying dividends to our Company until such time as the Bank’s unappropriated retained earnings balance is restored to a positive balance.

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, “Other Off-Balance Sheet Activities”, we disclose that our Company has $149,353,000 in unused loan commitments and standby letters of credit as of December 31, 2008. 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.

For the years ended December 31, 2008, 2007 and 2006, net cash provided by operating activities was $11,526,000 in 2008, $13,388,000 in 2007, and $16,637,000 in 2006. The variances in net cash provided by operating activities is primarily the result of differences in net income for the periods.

Net cash used in investing activities was $108,129,000 in 2008, $73,439,000 in 2007, and $14,565,000 in 2006. The increase in cash used in investing activities from 2008 to 2007 is primarily due to an increase in loans partially offset by proceeds received on the sales of other real estate owned. The increase in cash used in investing activities from 2007 to 2006 is primarily due to an increase in loans and purchases of premises and equipment for three new branch facilities partially offset by lower purchases of debt securities and lower proceeds received from maturities of debt securities.

Net cash provided by financing activities was $114,556,000 in 2008, $42,925,000 in 2007, and $3,198,000 in 2006. The increase in cash provided by financing activities from 2008 to 2007 is primarily the result of an increase in interest-bearing transaction accounts, time deposits, and a net increase in federal home loan borrowings partially offset by a decrease in demand deposits. In addition our Company received $30,255,000 form the issuance of preferred stock to the United States Treasury as further discussed in Note 13 to the consolidated financial statements. The increase in cash provided by financing activities from 2007 to 2006 is primarily the result of an increase in interest-bearing transaction accounts, time deposits, and a net increase in federal home loan borrowings partially offset by a decrease in demand deposits.

Other Off-Balance Sheet Activities

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, 2008 are as follows:


	Amount of Commitment Expiration per Period
			Less than 1		1-3		3-5		Over 5
(Dollars in thousands)	Total		Year		Years		Years		Years

Unused loan commitments	$	143,917	$	110,150	$	20,347	$	6,631	$	6,789
Standby letters of credit		5,436		1,856		769		2,811		—

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.

Contractual Cash Obligations

The required payments of time deposits and other borrowed money, not including interest, at December 31, 2008 are as follows:


	Payments due by Period
			Less than 1		1-3		3-5		Over 5
(Dollars in thousands)	Total		Year		Years		Years		Years

Time deposits	$	453,680	$	379,927	$	64,780	$	8,843	$	130
Other borrowed money		77,915		48,158		28,797		834		126

Capital

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.

Detail concerning our Company’s capital ratios at December 31, 2008 is included in Note 2 of our Company’s consolidated financial statements included elsewhere in this report.

Recent Accounting Pronouncements

In December 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP), Employers’ Disclosures about Postretirement Benefit Plan Assets, FSP FAS 132R-1, an amendment of Statement of Financial Accounting Standard (SFAS) No. 132R, Employers’ Disclosures about Pensions and Other Postretirement Benefits . This position will require more detailed disclosures regarding defined benefit pension plan assets including investment policies and strategies, major categories of plan assets, valuation techniques used to measure the fair value of plan assets and significant concentrations of risk within plan assets. This position becomes effective for fiscal years ending after December 15, 2009. Upon initial application, the provisions of this position are not required for earlier periods that are presented for comparative purposes. Our Company is currently evaluating the disclosure requirements of this new position.

Effective January 1, 2008, our Company adopted SFAS No. 157, Fair Value Measurement. SFAS 157 defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. SFAS 157 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, the FASB clarifies 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, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. In March 2008, the FASB issued FSP No. 157-2”, which delayed the effective date of SFAS No. 157 for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years and interim periods beginning after November 15, 2008. Our Company adopted the provisions of SFAS No. 157 related to financial assets and financial liabilities on January 1, 2008. The partial adoption of this statement did not have a material impact on the financial statements. In October 2008, the FASB issued FASB Staff Position (FSP) SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, (SFAS No. 157-3). This FSP clarifies the application of FASB No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This FSP was effective for our Company on September 30, 2008. The adoption of this FSP did not have an effect on the consolidated financial statements. It is expected that the remaining provisions of SFAS 157 will not have a material effect on the financial statements.

In December 2007, the FASB issued SFAS No. 141R , Business Combinations (Statement 141R) and FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment to ARB No. 51 (Statement 160). Statements 141R and 160 require most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value” and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. Statement 141R will be applied to business combinations occurring after the effective date. Statement 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. Our Company is currently evaluating the impact of adopting Statement 141R and SFAS160 on its results of operations and financial position. However, it is not expected to have a material impact on our Company’s financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 gives our Company the irrevocable option to carry most financial assets and liabilities at fair value that are not currently required to be measured at fair value. If the fair value option is elected, changes in fair value would be recorded in earnings at each subsequent reporting date. SFAS 159 is effective for our Company’s 2008 fiscal year. Our Company has not elected the fair value option for any financial assets or liabilities at December 31, 2008.

In September 2006, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4). EITF 06-4 provides guidance on the accounting for arrangements in which an employer owns and controls the insurance policy and has agreed to share a portion of the cash surrender value and/or death benefit with the employee. This guidance requires an employer to record a postretirement benefit, in accordance with FASB Statement No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion-1967 , if there is an agreement by the employer to share a portion of the proceeds of a life insurance policy with the employee during the postretirement period. The provisions of EITF 06-4 were adopted by our Company on January 1, 2008. The adoption of EITF 06-4 did not have a material impact on our Company’s financial position or results of operations.

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, 2008.

Quantitative and Qualitative Disclosures About Market Risk

Our Company’s exposure to market risk is reviewed on a regular 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, 2008, the rate shock scenario models indicated that annual net interest income could change by as much as 14.5% should interest rates rise or fall within 300 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.

CONSOLIDATED FINANCIAL STATEMENTS

The following consolidated financial statements of our Company and reports 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, 2008 and 2007.		32

Consolidated Statements of Operations for each of the years ended December 31, 2008, 2007 and 2006.		33

Consolidated Statements of Stockholders’ Equity and Comprehensive Income for each of the years ended December 31, 2008, 2007 and 2006.		34

Consolidated Statements of Cash Flows for each of the years ended December 31, 2008, 2007 and 2006.		35

Notes to Consolidated Financial Statements.		36

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, 2008 and 2007, 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, 2008. 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, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, 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, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 13, 2009 expressed an unqualified opinion on the effectiveness of Hawthorn Bancshares Inc.’s internal control over financial reporting.



/s/ KPMG LLP
St. Louis, Missouri
March 13, 2009

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets


	December 31,
	2008			2007

ASSETS

Loans	$	1,009,103,532		$	911,278,111
Allowances for loan losses		(12,666,546	)		(9,281,848	)

Net loans		996,436,986			901,996,263

Investment in available-for-sale securities, at fair value		149,400,929			151,742,455
Investment in equity securities, at cost		8,875,250			5,626,050

Total investment securities		158,276,179			157,368,505

Federal funds sold and securities purchased under agreements to resell		104,393			664,184
Cash and due from banks		53,723,075			35,209,201
Premises and equipment — net		39,260,220			40,543,546
Other real estate owned and repossessed assets		7,828,278			2,337,107
Accrued interest receivable		7,476,093			8,764,196
Mortgage servicing rights		1,171,225			1,184,868
Goodwill		—			40,323,775
Intangible assets — net		2,130,097			2,831,540
Cash surrender value — life insurance		1,852,902			1,820,532
Other assets		11,439,419			2,760,362

Total assets	$	1,279,698,867		$	1,195,804,079

LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits:
Non-interest bearing demand	$	125,245,200		$	138,355,520
Savings, interest checking and money market		342,626,702			329,221,663
Time deposits $100,000 and over		142,972,489			139,742,676
Other time deposits		344,451,998			313,937,432

Total deposits		955,296,389			921,257,291

Federal funds purchased and securities sold under agreements to repurchase		29,138,623			25,729,863
Subordinated notes		49,486,000			49,486,000
Other borrowed money		129,057,483			77,915,027
Accrued interest payable		3,847,415			4,723,965
Other liabilities		6,454,574			5,493,110

Total liabilities		1,173,280,484			1,084,605,256

Stockholders’ equity:
Preferred stock, $1000 par value Authorized and issued 30,255 shares at December 31, 2008, no shares issued at December 31, 2007		27,888,294			—
Common stock, $1 par value Authorized 15,000,000 shares; issued 4,298,353 shares		4,298,353			4,298,353
Surplus		25,144,323			22,530,191
Retained earnings		51,598,678			85,728,114
Accumulated other comprehensive income (loss), net of tax		1,005,553			1,356,538
Treasury stock; 161,858 and 128,858 shares, at cost		(3,516,818	)		(2,714,373	)

Total stockholders’ equity		106,418,383			111,198,823

Total liabilities and stockholders’ equity	$	1,279,698,867		$	1,195,804,079

See accompanying notes to consolidated financial statements.

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations


	Years ended December 31,
	2008			2007			2006

INTEREST INCOME
Interest and fees on loans	$	62,636,558		$	65,533,873		$	62,578,814
Interest on debt securities:
Taxable		4,989,794			5,702,806			5,750,751
Nontaxable		1,688,871			1,986,171			1,935,987
Interest on federal funds sold and securities purchased underagreements to resell		60,550			614,571			748,419
Interest on interest-bearing deposits		23,755			57,963			100,171
Dividends on equity securities		315,685			311,723			309,150

Total interest income		69,715,213			74,207,107			71,423,292

INTEREST EXPENSE
Interest on deposits:
Savings, interest checking and money market		4,883,042			7,411,043			6,874,535
Time deposit accounts $100,000 and over		5,698,073			7,045,209			5,251,329
Other time deposit accounts		12,871,957			14,825,176			12,465,782
Interest on federal funds purchased and securities sold under agreements to repurchase		868,528			1,380,328			1,810,667
Interest-bearing demand notes to U.S. Treasury		—			10,734			30,785
Interest on subordinated notes		3,046,238			3,617,254			3,528,418
Interest on other borrowed money		4,231,062			2,885,119			2,804,892

Total interest expense		31,598,900			37,174,863			32,766,408

Net interest income		38,116,313			37,032,244			38,656,884
Provision for loan losses		8,211,000			1,154,216			1,325,733

Net interest income after provision for loan losses		29,905,313			35,878,028			37,331,151

NON INTEREST INCOME
Service charges on deposit accounts		6,163,650			5,706,934			5,729,972
Trust department income		826,546			967,774			798,832
Mortgage loan servicing fees, net		135,322			341,377			432,517
Gain on sale of mortgage loans, net		973,095			665,817			432,112
Other		1,195,438			2,540,839			1,224,982

Total non interest income		9,294,051			10,222,741			8,618,415

INVESTMENT SECURITIES GAINS (LOSSES), NET		2,773			(1,747	)		(18,351	)

NON INTEREST EXPENSE
Salaries and employee benefits		18,250,469			18,733,125			17,019,086
Goodwill impairment		40,323,775			—			—
Occupancy expense, net		2,440,082			2,201,809			1,994,592
Furniture and equipment expense		2,437,558			2,878,810			2,300,872
Legal, examination, and professional fees		1,192,933			1,582,763			1,431,354
Advertising and promotion		1,117,403			1,196,216			896,686
Postage, printing, and supplies		1,220,938			1,296,518			1,146,896
Processing expense		3,101,562			1,470,475			1,008,673
Donations		816,416			224,855			300,935
Amortization of intangible assets		701,443			922,337			1,032,583
Impairment and other real-estate owned expense		809,488			680,832			119,171
Other		3,563,391			3,866,067			2,897,295

Total non-interest expense		75,975,458			35,053,807			30,148,143

Income (loss) before income taxes		(36,773,321	)		11,045,215			15,783,072
Less income taxes (benefit)		(6,145,965	)		3,245,239			4,907,867

Net income (loss)		(30,627,356	)		7,799,976			10,875,205

Preferred stock dividends		66,090			—			—

Net income (loss) available to common shareholders	$	(30,693,446	)	$	7,799,976		$	10,875,205

Basic earnings (loss) per share	$	(7.39	)	$	1.87		$	2.61
Diluted earnings (loss) per share	$	(7.39	)	$	1.85		$	2.59

See accompanying notes to consolidated financial statements.

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)


										Accumulated						Total
										other						Stock -
	Preferred		Common				Retained			Comprehensive			Treasury			holders’
	Stock		Stock		Surplus		Earnings			Income (Loss)			Stock			Equity

Balance, December 31, 2005	$	—	$	4,298,353	$	22,030,074	$	74,129,117		$	(1,072,170	)	$	(2,652,509	)	$	96,732,865

Net income		—		—		—		10,875,205			—			—			10,875,205
Change in unrealized gain (loss) on securities:
Unrealized gain on debt and equity securities available-for-sale, net of tax		—		—		—		—			392,712			—			392,712
Adjustment for loss on sales and calls of debt and equity securities, net of tax		—		—		—		—			11,928			—			11,928

Total other comprehensive loss																	404,640

Total comprehensive income																	11,279,845

Stock based compensation expense		—		—		218,245		—			—			—			218,245
Adjustment to initially apply SFAS No. 158, net of tax		—		—		—		(69,937	)		286,244			—			216,307
Cash dividends declared, $0.84 per share		—		—		—		(3,502,672	)		—			—			(3,502,672	)

Balance, December 31, 2006	$	—	$	4,298,353	$	22,248,319	$	81,431,713		$	(381,286	)	$	(2,652,509	)	$	104,944,590

Net income		—		—		—		7,799,976			—			—			7,799,976
Change in unrealized gain (loss) on securities:
Unrealized gain on debt and equity securities available-for-sale, net of tax		—		—		—		—			1,403,925			—			1,403,925
Adjustment for gain on sales and calls of debt and equity securities, net of tax		—		—		—		—			1,136			—			1,136
Defined benefit pension plans:
Prior service cost arising during period from plan amendment, net of tax		—		—		—		—			61,701			—			61,701
Net gain arising during period, net of tax		—		—		—		—			234,562			—			234,562
Amortization of prior service cost included in net periodic pension cost, net of tax		—		—		—		—			36,500			—			36,500

Total other comprehensive income (loss)																	1,737,824

Total comprehensive income (loss)																	9,537,800

Stock based compensation expense		—		—		264,881		—			—			—			264,881
Exercise of stock options		—		—		16,991		—			—			83,436			100,427
Treasury stock purchased		—		—		—		—			—			(145,300	)		(145,300	)
Cash dividends declared, $0.84 per share		—		—		—		(3,503,575	)		—			—			(3,503,575	)

Balance, December 31, 2007	$	—	$	4,298,353	$	22,530,191	$	8 5,728,114		$	1 ,356,538		$	(2,714,373	)	$	1 11,198,823

Net loss		—		—		—		(30,627,356	)		—			—			(30,627,356	)
Change in unrealized gain (loss) on securities:
Unrealized gain on debt and equity securities available-for-sale, net of tax		—		—		—		—			1,325,559			—			1,325,559
Adjustment for loss on sales and calls of debt and equity securities, net of tax		—		—		—		—			(1,692	)		—			(1,692	)
Defined benefit pension plans:
Net loss arising during the period, net of tax		—		—		—		—			(1,696,706	)		—			(1,696,706	)
Amortization of prior service cost included in net periodic pension cost, net of tax		—		—		—		—			21,854			—			21,854

Total other comprehensive income (loss)																	(350,985	)

Total comprehensive income (loss)																	(30,978,341	)

Stock based compensation expense		—		—		231,761		—			—			—			231,761
Issuance of 30,255 shares of preferred stock and 245,443 common stock warrants, net of expenses		27,872,629		—		2,382,371		—			—			—			30,255,000
Accretion of preferred stock discount		15,665		—		—		(15,665	)		—			—			—
Treasury stock purchased		—		—		—		—			—			(802,445	)		(802,445	)
Cash dividends declared, $0.84 per share		—		—		—		(3,486,415	)		—			—			(3,486,415	)

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

See accompanying notes to consolidated financial statements.

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


	Years ended December 31,
	2008			2007			2006

Cash flows from operating activities:
Net income (loss)	$	(30,627,356	)	$	7,799,976		$	10,875,205
Adjustments to reconcile net income to net cash provided by operating activities:
Goodwill impairment		40,323,775			—			—
Provision for loan losses		8,211,000			1,154,216			1,325,733
Depreciation expense		2,158,740			2,050,122			1,910,070
Net accretion of debt securities, premiums, and discounts		(15,372	)		(46,306	)		(13,488	)
Amortization of intangible assets		701,443			922,337			1,032,583
Stock based compensation expense		231,761			264,881			218,245
Decrease (increase) in accrued interest receivable		1,288,103			9,490			(1,001,113	)
Increase in cash surrender value -life insurance		(32,370	)		(70,112	)		(67,584	)
Increase in other assets		(2,007,842	)		(749,866	)		(199,226	)
(Decrease) increase in accrued interest payable		(876,550	)		357,715			1,227,120
(Decrease) increase in other liabilities		(1,820,022	)		7,232			472,775
(Gain) loss on sales of debt securities		(2,773	)		1,747			18,351
Origination of mortgage loans for sale		(54,892,543	)		(39,575,067	)		(20,457,303	)
Proceeds from the sale of mortgage loans		55,865,638			40,240,884			20,889,415
Gain on sale of mortgage loans, net		(973,095	)		(665,817	)		(432,112	)
Loss on sales and dispositions of premises and equipment		49,830			323,752			31,033
(Increase) decrease in deferred tax asset		(6,493,604	)		651,591			807,639
Other, net		437,681			710,763			—

Net cash provided by operating activities		11,526,444			13,387,538			16,637,343

Cash flows from investing activities:
Net increase in loans		(115,310,652	)		(103,830,110	)		(2,205,010	)
Purchase of available-for-sale debt securities		(280,670,587	)		(65,747,670	)		(146,710,971	)
Proceeds from maturities of available-for-sale debt securities		212,071,519			66,572,206			129,177,143
Proceeds from calls of available-for-sale debt securities		42,282,640			26,288,700			5,985,038
Proceeds from sales of available-for-sale debt securities		30,920,778			6,910,634			1,985,257
Purchase of equity securities		(5,040,800	)		(2,015,900	)		(1,008,150	)
Proceeds from sales of equity securities		1,791,600			2,597,025			1,103,700
Purchases of premises and equipment		(1,034,021	)		(8,948,850	)		(3,931,811	)
Proceeds from sales of premises and equipment		51,450			738,287			174,759
Proceeds from sales of other real estate owned and repossessions		6,809,258			3,996,405			865,151

Net cash used in investing activities		(108,128,815	)		(73,439,273	)		(14,564,894	)

Cash flows from financing activities:
Net (decrease) increase in demand deposits		(13,110,320	)		(530,363	)		4,521,095
Net increase (decrease) in interest-bearing transaction accounts		13,405,039			20,348,280			(14,949,968	)
Net increase in time deposits		33,744,379			1,574,640			28,838,401
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase		3,408,760			(3,730,629	)		(7,535,243	)
Net (decrease) increase in interest-bearing demand notes to U.S. Treasury		—			(1,735,638	)		637,301
Proceeds from Federal Home Loan Bank advances		345,300,000			137,000,000			176,624,684
Repayment of Federal Home Loan Bank advances		(294,157,544	)		(106,453,288	)		(181,436,030	)
Proceeds from sale of treasury stock, net of expenses		—			100,427			—
Proceeds from issuance of preferred stock and warrants		30,255,000			—			—
Purchase of treasury stock		(802,445	)		(145,300	)		—
Cash dividends paid		(3,486,415	)		(3,503,575	)		(3,502,672	)

Net cash provided by financing activities		114,556,454			42,924,554			3,197,568

Net increase (decrease) in cash and cash equivalents		17,954,083			(17,127,181	)		5,270,017
Cash and cash equivalents, beginning of year		35,873,385			53,000,566			47,730,549

Cash and cash equivalents, end of year	$	53,827,468		$	35,873,385		$	53,000,566


Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	32,475,450		$	36,817,148		$	31,524,523
Income taxes	$	2,240,000		$	3,507,000		$	5,033,881
Supplemental schedule of noncash investing and financing activities:
Other real estate and repossessions acquired in settlement of loans	$	12,658,929		$	3,977,012		$	2,031,998

See accompanying notes to consolidated financial statements.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

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

Principles of Consolidation

As further described in note 14, during 2007 the Company combined its banking subsidiaries into Hawthorn Bank (the Bank), a wholly owned subsidiary. In December of 2008, the Company formed Hawthorn Real Estate, LLC., a wholly owned subsidiary of the Company. The consolidated financial statements include the accounts of the Company, the Bank, and the Real Estate Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

Segment information

Prior to 2007, the Company defined its business segments to be each of its bank subsidiaries (Exchange National Bank, Citizens Union State Bank, Osage Valley Bank, and Bank 10). During 2007, the combination of the subsidiary banks into one bank resulted in the consolidation of the Company’s business segments into a single business segment.

Loans

Loans are stated at unpaid principal balance amount less unearned income and the allowance for loan losses. Income on loans is accrued on a simple-interest basis.

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. Subsequent interest payments received on such loans are applied to principal if doubt exists as to the collectibility of such principal; otherwise, such receipts are recorded as interest

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

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.

Loan origination fees and certain direct costs are deferred and recognized over the life of the loan as an adjustment to yield.

The Bank originates certain loans which are sold in the secondary mortgage market. These long-term, fixed-rate loans are sold on a note-by-note basis. Immediately upon locking in an interest rate, the Company enters into an agreement to sell the mortgage loan without recourse, thereby eliminating the Company’s exposure to interest rate fluctuations. At December 31, 2008 and 2007, $77,000 and $1,832,000 mortgage loans were held for sale, respectively. Mortgage loan servicing fees earned on loans sold are reported as income when the related loan payments are collected net of mortgage servicing right amortization. Operational costs to service such loans are charged to expense as incurred.

Allowance for Loan Losses

The allowance for loan losses is increased by provisions charged to expense and is reduced by loan charge-offs, net of recoveries. Management utilizes a systematic, documented approach in determining an adequate allowance for loan losses. Management’s approach, which provides for general and specific valuation allowances, is based on current economic conditions, past losses, collection experience, risk characteristics of the portfolio, assessment of collateral values by obtaining independent appraisals for significant properties, and such other factors, which, in management’s judgment, deserve current recognition in estimating loan losses.

Management believes the allowance for loan losses is adequate to absorb probable losses in the loan portfolio. While management uses available information to recognize loan losses, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Bank to increase the allowance for loan losses based on their judgment about information available to them at the time of their examination.

A loan is considered impaired when it is probable a creditor will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan’s effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan. Regardless of the historical measurement method used, the Company measures impairment based on the fair value of the collateral when foreclosure is probable. Additionally, impairment of a restructured loan is measured by discounting the total expected future cash flows at the loan’s effective rate of interest as stated in the original loan agreement.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

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 ability and positive intent to hold until maturity. All debt securities not classified as held-to-maturity are classified as available-for-sale.

Available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization of premiums or discounts. Unrealized gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and reported as accumulated other comprehensive income, a separate component of stockholders’ equity, until realized.

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.

A decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year-end, and forecasted performance of the investee.

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.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Goodwill

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the 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. The 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, 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. As a result of the 2008 annual review, the Company determined that goodwill was fully impaired and recorded an impairment charge of $40,323,775, before tax.

Intangible Assets

Intangible assets include core deposit intangible assets established in connection with prior acquisitions. Core deposit intangible assets are amortized over periods ranging from seven to ten years using straight-line and accelerated methods of amortization. Other intangible assets are amortized over periods up to seven years. The Company reviews intangible assets for impairment periodically to determine whether there have been any events or circumstances to indicate the recorded amount is not recoverable from projected undiscounted net operating cash flows. If the projected undiscounted net operating cash flows are less than the carrying amount, an impairment loss is recognized to reduce the carrying amount to fair value, and when appropriate, the amortization period is also reduced. No impairment losses were recognized during any of the three years ended December 31, 2008.

Impairment of Long-lived Assets

Long-lived assets, such as premises and equipment, and other intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.

Other Real Estate

Other real estate, included in other assets in the accompanying consolidated balance sheets, is recorded at fair value, less estimated selling costs. If the fair value of other real estate declines subsequent to foreclosure, the difference is recorded as a valuation allowance through a charge to

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

expense. Subsequent increases in fair value are recorded through a reversal of the valuation allowance. Expenses incurred in maintaining the properties are charged to expense.

Pension Plan

The Company has a noncontributory defined benefit pension plan covering all of its employees upon their retirement. 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.

Effective December 31, 2006, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of Financial Accounting Standards Board (FASB ) Statements No. 87, 88, 106, and 132(R) (SFAS No. 158) . SFAS No. 158 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 statement also requires an employer to measure the funded status of a plan as of the date of its fiscal year-end, with limited exceptions.

Income Taxes

The Company estimates income tax expense based on amounts expected to be owed to various tax jurisdictions. Accrued taxes represent the net estimated amount due or to be received from taxing jurisdictions either currently or in the future and are reported in other assets or other liabilities on the consolidated balance sheet. In estimating accrued taxes, the Company assesses the relative merits and risks of the appropriate tax treatment considering statutory, judicial and regulatory guidance in the context of the tax position. Because of the complexity of tax laws and regulations, interpretation can be difficult and subject to legal judgment given specific facts and circumstances. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions regarding the estimated amounts of accrued taxes.

Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by various taxing authorities, and newly enacted statutory, judicial and regulatory guidance that impact the relative merits and risks of tax positions. These changes, when they occur, affect accrued taxes and can be significant to the operating results of the Company. Management believes the accrual for tax liabilities is adequate for all open audit years based on its assessment of many factors, including past experience and interpretations of tax law applies to the fact of each matter. The Company’s state and federal income tax returns for 2005 to 2008 are open tax years. As of December 31, 2008, there were no federal or state income tax examinations in process.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Effective January 1, 2007, the Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FAS No. 109 , Accounting for Income Taxes (FIN 48). The Interpretation defines the threshold for recognizing the financial impact of uncertain tax provisions in accordance with FAS 109. An enterprise must recognize, in its financial statements, the best estimate of the impact of a tax position if that position is “more-likely-than-not” of being sustained on audit based solely on the technical merits of the position on the reporting date.

In evaluating whether the probable recognition threshold has been met, FIN 48 requires the presumption that the tax position will be evaluated during an audit by taxing authorities. The term “more-likely-than-not” is defined as a likelihood of more than 50 percent. Individual tax positions that fail to meet the recognition threshold will generally result in (a) reductions in deferred tax assets or increases in deferred tax liabilities or (b) increases in a liability for income taxes payable or reduction of an income tax refund receivable.

Trust Department

Property held by the Bank in 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.

Fair Value Measurements

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurement. SFAS 157 defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. SFAS 157 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, the Financial Accounting Standards Board (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, SFAS 157 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 the Company’s best information and assumptions that a market participant would consider.

The following disclosures exclude certain nonfinancial assets and liabilities which are deferred under the provisions of FASB issued Staff Position No. FAS 157-2 (FSP No. 157-2). These include foreclosed real estate, long-lived assets, goodwill, and core deposit intangible assets which are

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

written down to fair value upon impairment. The FASB’s deferral is intended to allow additional time to consider the effect of various implementation issues relating to these non-financial instruments, and defers disclosures under SFAS No. 157 until January 1, 2009. The Company does not expect the adoption of the remaining provisions of this statement to have a material effect on the consolidated financial statements. In October 2008, the FASB issued FASB Staff Position SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, (SFAS No. 157-3). This position clarifies the application of FASB No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This position was effective for the Company on September 30, 2008. The adoption of this position did not have an effect on the Company’s consolidated financial statements.

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

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, 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, 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.

Loans

The 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 SFAS 114, Accounting by Creditors for Impairment of a Loan, (SFAS 114). In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. At December 31, 2008, all impaired loans were evaluated based on the fair value of the collateral. The fair value of the collateral is based on an observable market price or current appraised value and therefore, the Company classifies these assets as nonrecurring Level 2. As of December 31, 2008, the Company identified $29.9 million in impaired loans. These impaired loans had specific allowances for losses aggregating $3.8 million.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

The following table presents information about the Company’s assets measured at fair value on a recurring basis as of December 31, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.


	Fair Value Measurements
	At December 31, 2008 Using
			Quoted Prices
			in Active
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Fair Value		Assets		Inputs		Inputs
Description	December 31, 2008		(Level 1)		(Level 2)		(Level 3)

Available-for-Sale Securities	$	149,400,929	$	—	$	149,400,929	$	—
Impaired loans	$	26,096,354	$	—	$	26,096,354	$	—

Earnings per Share

Basic earnings (loss) per share is computed by dividing income 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:


	2008			2007		2006

Net income (loss), basic and diluted	$	(30,627,356	)	$	7,799,976	$	10,875,205
Less: preferred stock dividends		66,090			—		—

Net income (loss) available to common shareholders		(30,693,446	)		7,799,976		10,875,205
Average shares outstanding		4,155,749			4,171,163		4,169,847
Effect of dilutive stock options		—			39,681		34,700

Average shares outstanding including dilutive stock options	$	4,155,749		$	4,210,844	$	4,204,547

Net income (loss) per share, basic	$	(7.39	)	$	1.87	$	2.61
Net income (loss) per share, diluted		(7.39	)		1.85		2.59

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

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.

The following option to purchase shares during the fiscal years ended 2008, 2007, and 2006 were not included in the respective computations of diluted earnings 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,

2008

2007

2006

Anti-Dilutive shares

58,371

6,082

4,482

Consolidated Statements of Cash Flows

For the purpose of the consolidated statements of cash flows, cash and cash equivalents consist of federal funds sold and securities sold or purchased under agreements to resell, cash, and due from banks.

Stock-Based Compensation

The Company’s stock-based employee compensation plan is described in Note 12, Stock Compensation. In accordance with provisions of SFAS No. 123(R) Share-Based Payment, 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. SFAS No. 123(R) 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. Upon subsequent reissuance, the treasury stock account is reduced by the average cost basis of such stock.

Comprehensive Income

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

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Recently Issued Accounting Standards

In December 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP), Employers’ Disclosures about Postretirement Benefit Plan Assets, FSP FAS 132R-1, an amendment of Statement of Financial Accounting Standard (SFAS) No. 132R, Employers’ Disclosures about Pensions and Other Postretirement Benefits . This position will require more detailed disclosures regarding defined benefit pension plan assets including investment policies and strategies, major categories of plan assets, valuation techniques used to measure the fair value of plan assets and significant concentrations of risk within plan assets. This position becomes effective for fiscal years ending after December 15, 2009. Upon initial application, the provisions of this position are not required for earlier periods that are presented for comparative purposes. The Company is currently evaluating the disclosure requirements of this new position.

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurement. SFAS 157 defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. SFAS 157 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, the FASB clarifies 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, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. In March 2008, the FASB issued FSP No. 157-2”, which delayed the effective date of SFAS No. 157 for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years and interim periods beginning after November 15, 2008. The Company adopted the provisions of SFAS No. 157 related to financial assets and financial liabilities on January 1, 2008. The partial adoption of this statement did not have a material impact on the financial statements. In October 2008, the FASB issued FASB Staff Position (FSP) SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, (SFAS No. 157-3). This FSP clarifies the application of FASB No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This FSP was effective for the Company on September 30, 2008. The adoption of this FSP did not have an effect on the consolidated financial statements. It is expected that the remaining provisions of SFAS 157 will not have a material effect on the financial statements.

In December 2007, the FASB issued SFAS No. 141R , Business Combinations (Statement 141R) and FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment to ARB No. 51 (Statement 160). Statements 141R and 160 require most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value” and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. Statement 141R will be applied to business combinations occurring after the effective date. Statement 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. The Company is currently evaluating the impact of adopting Statement 141R and SFAS160 on its results of operations and

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

financial position. However, it is not expected to have a material impact on the Company’s financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 gives the Company the irrevocable option to carry most financial assets and liabilities at fair value that are not currently required to be measured at fair value. If the fair value option is elected, changes in fair value would be recorded in earnings at each subsequent reporting date. SFAS 159 is effective for the Company’s 2008 fiscal year. The Company has not elected the fair value option for any financial assets or liabilities at December 31, 2008.

In September 2006, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4). EITF 06-4 provides guidance on the accounting for arrangements in which an employer owns and controls the insurance policy and has agreed to share a portion of the cash surrender value and/or death benefit with the employee. This guidance requires an employer to record a postretirement benefit, in accordance with FASB Statement No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion-1967 , if there is an agreement by the employer to share a portion of the proceeds of a life insurance policy with the employee during the postretirement period. The provisions of EITF 06-4 were adopted by the Company on January 1, 2008. The adoption of EITF 06-4 did not have a material impact on the Company’s consolidated financial position or results of operations.

Reclassifications

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

(2)		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, 2008 and 2007, the Company and the Bank meet all capital adequacy requirements to which they are subject.

		As of December 31, 2008, 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

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

		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.

		The actual and required capital amounts and ratios for the Company and the Bank as of December 31, 2008 and 2007 are as follows (dollars in thousands):


						Minimum					Well-Capitalized
	Actual					Capital requirements					Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio

December 31, 2008
Total capital (to risk-weighted assets):
Company	$	163,949		16.01	%	$	81,912		8.00	%		—		—
Hawthorn Bank		125,510		12.35			81,310		8.00		$	101,638		10.00	%

Tier I capital (to risk-weighted assets):
Company	$	138,756		13.55		$	40,956		4.00	%		—		—
Hawthorn Bank		113,158		11.13			40,655		4.00		$	60,983		6.00	%

Tier I capital (to adjusted average assets):
Company	$	138,756		10.80		$	38,543		3.00	%		—		—
Hawthorn Bank		113,158		8.82			38,497		3.00		$	64,162		5.00	%


						Minimum					Well-Capitalized
	Actual					Capital requirements					Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio

December 31, 2007
Total capital (to risk-weighted assets):
Company	$	123,970		13.24	%	$	74,925		8.00	%		—		—
Hawthorn Bank		115,395		12.35			74,740		8.00		$	93,425		10.00	%

Tier I capital (to risk-weighted assets):
Company	$	103,754		11.08	%	$	37,463		4.00	%		—		—
Hawthorn Bank		106,113		11.36			37,370		4.00		$	56,055		6.00	%

Tier I capital (to adjusted average assets):
Company	$	103,754		9.12	%	$	34,148		3.00	%		—		—
Hawthorn Bank		106,113		9.33			34,126		3.00		$	56,876		5.00	%

Bank dividends are the principal source of funds for payment of dividends by the Company to it stockholders. The Bank is subject to regulations which require the maintenance of minimum capital requirements. As a result of the goodwill impairment charge, as described in Note 1, the Bank’s unappropriated retained earnings balance at December 31, 2008 is negative. As a result, the Bank must obtain regulatory approval prior to paying dividends to the Company until such time as the unappropriated retained earnings balance is restored to a positive balance.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(3)		Loans and Allowance for Loan Losses

		A summary of loans, by major classification within the Company’s loan portfolio, at December 31, 2008 and 2007 are as follows:


	2008		2007

Commercial	$	153,386,062	$	151,487,677
Real estate — construction		129,638,759		147,432,123
Real estate — mortgage		692,530,252		575,551,891
Installment and other consumer		33,404,048		36,738,062
Unamortized loan origination fees and costs, net		144,411		68,358

Total loans	$	1,009,103,532	$	911,278,111

		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.

		Following is a summary of activity in 2008 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, 2007	$	6,476,314
New loans		6,327,756
Amounts collected		(5,196,048	)

Balance at December 31, 2008	$	7,608,022

Changes in the allowance for loan losses for 2008, 2007 and 2006 are as follows:


	2008			2007			2006

Balance, beginning of year	$	9,281,848			9,015,378			9,084,774
Provision for loan losses		8,211,000			1,154,216			1,325,733
Charge-offs		(5,439,827	)		(1,307,644	)		(1,850,904	)
Recoveries of loans previously charged off		613,525			419,898			455,775

Balance, end of year	$	12,666,546			9,281,848			9,015,378

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

A summary of nonaccrual and other impaired loans at December 31, 2008 and 2007 is as follows:


	2008		2007

Nonaccrual loans	$	20,387,859	$	4,538,364
Impaired loans continuing to accrue interest		9,545,914		4,026,976

Total impaired loans	$	29,933,773	$	8,565,340

Allowance for loan losses on impaired loans	$	3,837,419	$	3,256,342
Impaired loans with no specific allowance for loan losses		11,451,625		500,236

Loans past due 90 days or more continuing to accrue interest	$	744,123	$	1,545,030

Restructured troubled debt	$	3,736,105	$	—

		The average balance of impaired loans during 2008 and 2007 was $20,646,000 and $8,915,000, respectively.

		A summary of interest income on nonaccrual and other impaired loans for 2008, 2007, and 2006 is as follows:


			Impaired
			loans
	Nonaccrual		continuing to
	loans		accrue interest		Total

2008:
Income recognized	$	239,320	$	116,521	$	355,841
Interest income had interest accrued		1,521,701		116,521		1,638,222
2007:
Income recognized		329,566		359,229		688,795
Interest income had interest accrued		744,675		359,229		1,103,904
2006:
Income recognized		62,793		578,766		641,559
Interest income had interest accrued		896,102		578,766		1,474,868

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(4)		Investment in Debt and Equity Securities

		The amortized cost and fair value of debt securities classified as available-for-sale at December 31, 2008 and 2007 are as follows:


			Gross		Gross
	Amortized		unrealized		unrealized
	cost		gains		losses		Fair value

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 available for sale securities	$	146,021,586	$	3,574,313	$	194,970	$	149,400,929


			Gross		Gross
	Amortized		unrealized		unrealized
	cost		gains		losses		Fair value

December 31, 2007
Government sponsored enterprises	$	86,862,693	$	583,028	$	75,323	$	87,370,398
Asset-backed securities		10,861,809		50,869		20,442		10,892,236
Obligations of states and political subdivisions		52,883,289		646,153		49,621		53,479,821


Total available for sale securities	$	150,607,791	$	1,280,050	$	145,386	$	151,742,455

Equity securities in the amount of $8,875,250 and $5,626,050 as of December 31, 2008 and 2007, respectively, are recorded at cost, and consist primarily of Federal Home Loan Bank Stock and the Company’s interest in the statutory trusts described in Note 8. While other Federal Home Loan Banks have suspended dividends, the Bank is a member of the Federal Home Loan Bank of Des Moines and has continued to receive dividend payments each quarter.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

The amortized cost and fair value of debt securities classified as available-for-sale at 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	$	17,761,210		$	17,920,078
Due after one year through five years		52,711,226			54,295,654
Due after five years through ten years		19,295,127			19,696,890
Due after ten years		7,452,872			7,397,322

		97,220,435			99,309,944
Asset-backed securities		48,801,151			50,090,985

Total	$	146,021,586		$	149,400,929


Weighted average yield at end of period		4.67	%

Debt securities with carrying values aggregating approximately $136,057,000 and $110,551,000 at December 31, 2008 and 2007, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.


	2008		2007			2006

Proceeds from sales	$	30,920,778	$	6,910,634		$	1,985,257

Gains		2,733		—			—
Losses		—		(1,747	)		(18,351	)

Net gains (losses)	$	2,733	$	(1,747	)	$	(18,351	)

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, 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

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	)

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

		Government sponsored enterprises: The Company had no unrealized losses in any government sponsored enterprise securities.

		Asset-backed securities: The unrealized losses on asset-backed securities were caused by interest rate increases. The contractual cash flows of these securities are guaranteed by various government or government sponsored enterprises. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

		Obligations of states and political subdivisions: The unrealized losses on investments in obligations of states and political subdivisions were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

(5)		Premises and Equipment

		A summary of premises and equipment at December 31, 2008 and 2007 is as follows:


	2008		2007

Land and land improvements	$	10,136,974	$	10,155,282
Buildings and improvements		31,460,592		31,190,973
Furniture and equipment		11,096,332		11,241,357
Construction in progress		418,922		166,318

Total		53,112,820		52,753,930
Less accumulated depreciation		13,852,600		12,210,384

Net premises and equipment	$	39,260,220	$	40,543,546

Depreciation expense for the past three years is as follows:


	For the Years Ended December 31,
	2008		2007		2006

Depreciation expense	$	2,158,740	$	2,050,122	$	1,910,070

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(6)		Goodwill and Other Intangible Assets

		In accordance with SFAS No. 142, the Company’s goodwill is tested annually for potential impairment. SFAS No. 142 has a two-step process to test goodwill for impairment. The first step is to compare the Company’s estimated fair value, including goodwill, to its net book value. If the estimated fair value is less than the net book value, a second step is required. Under the second step, the estimated fair value of all the Company’s tangible and identifiable intangible net assets must be determined. That amount is compared to the Company’s estimated fair value to determine the amount of implied goodwill. Impairment, if any, is equal to the excess of the recorded goodwill over the implied goodwill. During the 2008 annual review, the results of the first step of the process gave an indication of probable goodwill impairment. This was primarily due to the deterioration of general market conditions experienced during the fourth quarter of 2008 and corresponding declines in the Company’s stock price to levels well below book value. In the second step of the process, the implied fair value of the Company’s goodwill (determined by comparing the estimated fair value of the Company to the sum of the fair values of the Company’s tangible and separately identifiable intangible net assets) was compared with the carrying value of goodwill in order to determine the amount of impairment. As a result of the second step of the process, the Company determined that the 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 goodwill and other intangible assets at and for the years ended December 31, 2008 and 2007 is as follows:


	For the Years Ended December 31,
	2008							2007
	Gross							Gross
	Carrying		Accumulated			Net		Carrying		Accumulated			Net
	Amount		Amortization			Amount		Amount		Amortization			Amount

Amortizable intangible assets:
Core deposit intangible	$	7,060,224	$	(4,930,127	)	$	2,130,097	$	7,060,224	$	(4,228,684	)	$	2,831,540
Mortgage servicing rights		2,767,180		(1,595,955	)		1,171,225		2,562,793		(1,377,925	)		1,184,868

Total amortizable intangible assets		9,827,404		(6,526,082	)		3,301,322		9,623,017		(5,606,609	)		4,016,408

Goodwill		—		—			—		40,323,775		—			40,323,775


Total intangible assets	$	9,827,404	$	(6,526,082	)	$	3,301,322	$	49,946,792	$	(5,606,609	)	$	44,340,183

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Changes in the net carrying amount of other intangible assets for the years ended December 31, 2008 and 2007 are shown in the following table:


	Core Deposit			Mortgage
	Intangible			Servicing
	Asset			Rights

Balance at December 31, 2006	$	3,753,877		$	1,350,375
Additions		—			285,273
Amortization		(922,337	)		(450,780	)

Balance at December 31, 2007		2,831,540			1,184,868
Additions		—			627,397
Amortization		(701,443	)		(641,040	)


Balance at December 31, 2008	$	2,130,097		$	1,171,225

Mortgage loans serviced for others totaled approximately $213,074,000 and $209,734,000 at December 31, 2008 and 2007, 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, 2008 for the next five years:


	Core Deposit		Mortgage
	Intangible		Servicing
	Asset		Rights

2009	$	626,111	$	371,000
2010		526,477		250,000
2011		434,763		191,000
2012		408,062		146,000
2013		134,684		112,000

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	2008		2007		2006

Core deposit intangible asset	$	701,443	$	922,337	$	1,032,583
Mortgage servicing rights		641,040		450,780		425,829

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(7)		Deposits

		The scheduled maturities of time deposits are as follows (in thousands):


(In thousands)	2008		2007

Due within:
One year	$	362,059	$	379,927
Two years		62,484		36,868
Three years		32,505		27,912
Four years		4,634		5,790
Five years		25,674		3,053
Thereafter		68		130

	$	487,424	$	453,680

(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			Average			Average		Maximum
	Weighted			Weighted			Balance		Outstanding at		Balance at
	Rate			Rate			Outstanding		any Month End		December 31,

2008
Federal funds purchased		—	%		2.8	%	$	3,831,120	$	17,757,000	$	—
Short-term repurchase agreements		0.5			2.0			37,802,343		56,709,965		29,138,623

Total												29,138,623

2007
Federal funds purchased		5.1	%		5.3	%	$	7,041,300	$	14,950,000	$	7,365,000
Short-term repurchase agreements		3.2			4.2			26,806,926		28,704,922		18,364,863

Total												25,729,863

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 $45,000,000 on an unsecured basis and $13,000,000 on a secured basis at December 31, 2008.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Other Borrowings

Other borrowings of the Company consisted of the following at December 31, 2008:


				Year End
		Maturity		Weighted			Year End
	Borrower	Date		Rate			Balance

FHLB advances	Subsidiary bank		2009		5.3	%	$	12,765
			2010		4.6	%		22,331
			2011		3.6	%		38,576
			2012		4.4	%		258
			2013		4.1	%		127
			2014-18		2.5	%		10,000
FHLB repurchase agreements			2009		1.0	%		45,000

Total								129,057

Subordinated notes	The Company		2034		4.6	%		25,774
			2035		6.3	%		23,712

Total							$	49,486

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 on collateral type) of the outstanding advance balance, to secure amounts borrowed by the Bank. The outstanding balance of $129,057,000 includes $27,000,000 which the FHLB may call for early payment within the next three years. The FHLB has also issued letters of credit totaling $100,000 at December 31, 2008, to secure the Company’s obligations to depositors of public funds.

Based upon the collateral pledged to the Federal Home Loan Bank of Des Moines at December 31, 2008, the Bank could borrow up to an additional $166,870,000 under the agreement.

On March 17, 2005, Exchange Statutory Trust II, a newly formed business trust issued $23,000,000 of 30-year floating rate Trust Preferred Securities (TPS) to a TPS Pool. The interest rate on the TPS is a fixed rate at 6.30% until March 17, 2010, at which time it converts to a floating rate based on a specific margin above three-month LIBOR. 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

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

		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 newly formed 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 (4.57% at December 31, 2008). 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 to a date not earlier than March 17, 2009 if certain conditions are met. A portion of the proceeds from the offering were used to repay outstanding indebtedness with the remaining available for cash operating reserves at the holding company level.

		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, 2008 and 2007 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)		Reserve Requirements and Compensating Balances

		The Federal Reserve Bank required the Bank to maintain cash or balances of $17,962,000 and $14,545,000 at December 31, 2008 and 2007, respectively, to satisfy reserve requirements. Average compensating balances held at correspondent banks were $899,000 and $1,333,000 at December 31, 2008 and 2007, respectively. The Bank maintains such compensating balances with correspondent banks to offset charges for services rendered by those banks.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(10)		Income Taxes

		The composition of income tax expense (benefit) for 2008, 2007, and 2006 is as follows:


	2008			2007			2006


Current:
Federal	$	1,236,327		$	3,549,527		$	4,252,932
State		—			60,297			177,491

Total current		1,236,327			3,609,824			4,430,423

Deferred:
Federal		(6,625,134	)		(364,585	)		477,444
State		(757,158	)		—			—

Total deferred		(7,382,292	)		(364,585	)		477,444


Total income tax (benefit) expense	$	(6,145,965	)	$	3,245,239		$	4,907,867

Applicable income tax expense (benefit) 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:


	2008						2007						2006
	Amount			%			Amount			%			Amount			%

Income (loss) before provision for income taxes	$	(36,773,321	)				$	11,045,215					$	15,783,072

Tax at statutory Federal income tax rate	$	(12,502,929	)		34.00	%	$	3,765,825			34.10	%	$	5,447,567			34.51	%
Goodwill impairment		7,112,827			(19.34	)		—			—			—			—
Tax-exempt income		(570,506	)		1.55			(628,158	)		(5.69	)		(685,580	)		(4.34	)
State income tax, net of Federal tax benefit		—			—			39,796			0.36			115,369			0.73
Other, net		(185,357	)		0.50			67,776			0.61			30,511			0.19


Provision for income taxes	$	(6,145,965	)		16.71	%	$	3,245,239			29.38	%	$	4,907,867			31.09	%

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

The components of deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are as follows:


	2008		2007


Deferred tax assets:
Allowance for loan losses	$	4,939,953	$	3,619,921
Nonaccrual loan interest		270,265		237,133
Core deposit intangible		697,040		560,243
Goodwill		3,979,134		—
Pension		—		126,670
Deferred compensation		142,715		136,789
Other		1,105,844		400,843


Total deferred tax assets		11,134,951		5,081,599


Deferred tax liabilities:
Premises and equipment		855,698		725,693
Mortgage servicing rights		176,175		111,849
FHLB stock dividend		102,921		102,921
Available-for-sale securities		1,317,944		443,228
Goodwill		—		2,260,390
Pension		139,083		—
Other		34,895		507,668


Total deferred tax liabilities		2,626,716		4,151,749


Net deferred tax asset	$	8,508,235	$	929,850

		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, 2008 and, therefore, has not established a valuation reserve.

		At December 31, 2008, 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. In accordance with SFAS No. 142, the Company’s goodwill is tested annually for potential impairment. As a result of the annual test, the Company determined that the goodwill was fully impaired and recorded an impairment charge of $40,323,775, before tax. The impairment write-down reduced the book basis of tax deductible goodwill to zero. Accordingly, the entire deferred tax liability was reversed and a deferred tax asset for the benefit of the remaining deductible goodwill was recognized.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

		Effective January 1, 2007, the Company adopted FIN 48. The interpretation defines the threshold for recognizing the financial impact of uncertain tax provisions in accordance with FAS 109. An enterprise must recognize, in its financial statements, the best estimate of the impact of a tax position if that position is “more-likely-than-not” of being sustained on audit based solely on the technical merits of the position on the reporting date.

		In evaluating whether the probable recognition threshold has been met, FIN 48 requires the presumption that the tax position will be evaluated during an audit by taxing authorities. The term “more-likely-than-not” is defined as a likelihood of more than 50 percent. Individual tax positions that fail to meet the recognition threshold will generally result in (a) reductions in deferred tax assets or increases in deferred tax liabilities or (b) increases in a liability for income taxes payable or reduction of an income tax refund receivable. As of December 31, 2008, the Company had $749,000 of gross unrecognized tax benefits of which $487,000 would impact the effective tax rate, if recognized. The Company expects a reduction of $187,000 in gross unrecognized tax benefits during 2009 as a result of the state statute of limitations closing for the 2005 tax year. At December 31, 2008, unrecognized tax benefits relate to various federal and state tax positions.

		FIN 48 also provides guidance on disclosure, accrual of interest and penalties, accounting in interim periods, and transition. As of December 31, 2008, interest accrued was approximately $131,000. The unrecognized tax benefits are as follows:


	2008			2007

Unrecognized tax benefits as of January 1,	$	956,577		$	1,015,361
Gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during prior years		—			(164,793	)
Gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during 2008		—			340,351
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		(207,635	)		(234,342	)


Unrecognized tax benefits as of December 31,	$	748,942		$	956,577

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(11)		Employee Benefit Plans

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


	2008		2007		2006

Payroll taxes	$	1,119,073	$	1,399,321	$	954,001
Medical plans		1,466,232		1,245,059		1,311,038
401k match		294,098		—		—
Pension plan		854,407		837,288		882,039
Profit-sharing		205,515		757,561		835,788
Other		211,500		232,929		203,312


Total employee benefits	$	4,150,825	$	4,472,158	$	4,186,178

		Prior to 2008, the Company provided a non-contributory profit-sharing plan which covered all full-time employees. Beginning in 2008, the Company’s profit-sharing plan was amended to include 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. In addition, employees were able to make additional tax-deferred contributions.

		The Company also provides a noncontributory defined benefit pension plan for all full-time employees. The following items are components of the net pension expense for the years ended December 31, 2008, 2007, and 2006:


	2008			2007			2006


Service cost—benefits earned during the year	$	820,401		$	797,675		$	620,564
Interest costs on projected benefit obligations		452,524			364,406			318,142
Expected return on plan assets		(454,344	)		(385,269	)		(369,164	)
Amortization of prior service cost		78,628			78,628			78,628
Amortization of net gains		(42,802	)		(18,152	)		(2,601	)


Net periodic pension expense	$	854,407		$	837,288		$	645,569

SFAS No. 158, Employers’ Accounting for Defined Pension and Other Postretirement Plans, requires an employer 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 $1,500,000 contribution to the defined benefit plan in 2008, and the minimum required contribution for 2009 is estimated to be $12,000. The company has not determined whether it will make any contributions other than the minimum required funding contribution for 2009.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

A summary of the activity in the Plan’s projected benefit obligation, assets, funded status, accumulated benefit obligation, and amounts recognized in the Company’s consolidated balance sheets at December 31, 2008 and 2007 are as follows:


	2008			2007


Change in projected benefit obligation:
Balance, January 1	$	7,293,000		$	6,855,269
Service cost		820,401			797,675
Interest cost		452,524			364,406
Actuarial loss (gain)		116,690			(451,125	)
Benefits paid		(261,768	)		(273,225	)


Balance, December 31		8,420,847			7,293,000


Change in plan assets:

Fair value, January 1		6,968,205			6,256,681
Actual (loss) return on plan assets		(2,210,452	)		359,932
Employer contribution		1,500,000			594,817
Benefits paid		(261,768	)		(273,225	)

Fair value, December 31		5,995,985			6,938,205


Funded status:

Projected benefit obligation		8,420,847			7,293,000
Plan assets at fair value		5,995,985			6,938,205

Pension benefit liability	$	2,424,862		$	354,795


Accumulated benefit obligation	$	6,269,427		$	5,495,000

Amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive income at December 31, 2008 and 2007 are shown below on a pre-tax basis:


	2008			2007

Prior service costs	$	78,628		$	78,628
Net actuarial gain		(42,802	)		(18,152	)


Accumulated other comprehensive loss	$	35,826		$	60,476

The prior service cost for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic benefit pension cost in 2009 is approximately $79,000. For 2009, there is no amount of actuarial gain or loss subject to amortization in the net periodic benefit pension cost.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Assumptions utilized to determine benefit obligations as of December 31, 2008, 2007 and 2006 and to determine pension expense for the year then ended are as follows:


	2008			2007			2006

Determination of Benefit obligation at year end:
Discount rate		6.15	%		6.25	%		5.50	%
Annual rate of compensation increase		4.50	%		4.50	%		4.50	%

Determination of Pension expense for year ended:
Discount rate for the service cost		6.25	%		5.50	%		5.25	%
Annual rate of compensation increase		4.50	%		4.50	%		5.00	%
Expected long-term rate of return on plan assets		7.00	%		7.00	%		7.00	%

The expected long-term rate of return is based on the portfolio as a whole and not on the sum of the returns on individual asset categories or plan assets. The approximate weighted-average asset allocation of the plan’s assets at December 31, 2008 and 2007 were as follows:


	2008			2007

Equity securities		54	%		79	%
Debt securities		15	%		14	%
Cash equivalents		31	%		7	%

Total		100	%		100	%

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. As noted in the above table, cash equivalents were more heavily weighted due to a large contribution at the end of 2008 that was in the process of being invested. The Company regularly reviews its policies on the investment mix and may make changes depending on economic conditions and perceived investment mix.

The following future benefit payments are expected to be paid:


Year	Pension benefits

2009	$	277,309
2010		309,765
2011		337,170
2012		335,289
2013		335,924
2014 to 2018		2,079,610

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(12)		Stock Compensation

		The Company’s stock option plan provides for the grant of options to purchase up to 450,000 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 exercised 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 the Company’s stock option activity:


										Weighted average
	Number of shares									exercise price
	December 31									December 31
	2008			2007			2006			2008		2007		2006

Outstanding, beginning of year		242,968			202,739			160,809		$	27.23	$	24.54	$	24.54
Granted		37,537			48,104			44,276			21.01		33.50		29.95
Exercised		—			(4,649	)		—			—		20.13		—
Forfeited		(13,670	)		—			—			32.08		—		—
Canceled		—			(3,226	)		(2,346	)		32.08		30.53		29.95

Outstanding, end of year		266,835			242,968			202,739		$	26.10	$	27.23	$	25.66

Exercisable, end of year		182,693			140,186			111,025		$	25.21	$	23.63	$	21.82

		Options outstanding at December 31, 2008 had a weighted average remaining contractual life of approximately six years and an intrinsic value of $31,000. Options outstanding at December 31, 2007 had a remaining contractual life of approximately seven years and an intrinsic value of $495,000.

		Options exercisable at December 31, 2008 had a weighted average remaining contractual life of approximately five years and an intrinsic value of approximately $31,000. Options exercisable at December 31, 2007 had a weighted average remaining contractual life of approximately five years and an intrinsic value of approximately $495,000. During 2007, 4,649 stock options were exercised. No stock options were exercised during 2008 or 2006.

		Total stock-based compensation expense for the years ended December 31, 2008, 2007, and 2006 was $232,000, $265,000, and $218,000, respectively. As of December 31, 2008, the total unrecognized compensation expense related to non-vested stock awards was $374,000 and the related weighted average period over which it is expected to be recognized is approximately two years.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

The weighted average grant-date fair values of stock options granted during the following years and the weighted average significant assumptions used to determine those fair values, using the Black-Scholes option-pricing model, are as follows:


	2008			2007			2006

Fair value per share at grant date	$	4.53		$	7.13		$	6.13
Significant assumptions:
Risk-free interest rate at grant date		3.14	%		4.49	%		4.61	%
Expected annual rate of quarterly dividends		4.00			2.50			2.80
Expected stock price volatility		30			20			20
Expected life to exercise (years)		6.24			6.25			6.25

(13)		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 plans to use 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 245,443 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 warrants 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 warrants on December 19, 2008 was $27,872,629 and $2,382,371, 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 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.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

		The common stock warrants are exercisable immediately with a ten year term, in whole or in part, at an exercise price of $18.49 per share. The amount of warrants is reduced by one half if the 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 warrants with respect to more than half of the initial shares of common stock underlying the common stock warrants prior to the earlier of the date on which the Company receives aggregate gross proceeds of not less than $30,255,000 from one or more qualified equity offerings or before December 31, 2009.

		Assumptions were used in estimating the fair value of common stock warrants on the date of its issuance. The weighted average expected life of the common stock warrant represents the period of time that common stock warrants are expected to be outstanding. The-risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of issuance. The expected volatility is based on the average expected life the warrants. The following assumptions were used in estimating the fair value for the common stock warrants using the Black-Scholes option-pricing model:


Fair value per warrant at issue date	$	7.02
Significant assumptions:
Risk-free interest rate at issue date		2.29	%
Expected stock price volatility		33.9
Expected life to exercise (years)		10.00

		The accounting for preferred stock and warrants is classified as permanent equity in the consolidated balance sheet and qualifies, for regulatory capital purposes, as Tier I capital. Through December 31, 2008, the Company had not declared any dividends on the preferred stock. The first quarterly dividend is due February 17, 2009.

		As of December 31, 2008, $10,000,000 of the CPP proceeds were used to capitalize a newly formed subsidiary, Hawthorn Real Estate, LLC, established to hold workout assets purchased from the Company’s subsidiary bank, Hawthorn Bank. Hawthorn Real Estate, LLC. purchased workout loans and other real estate owned properties from the Bank. The $20,255,000 balance of the CPP funds continues to be held in the Company’s non-interest bearing account at the Bank.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(14)		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,
	2008		2007

Assets
Cash and due from bank subsidiaries	$	29,968,196	$	10,388,672
Investment in equity securities		1,486,000		1,486,000
Investment in subsidiaries		127,148,243		150,009,972
Premises and equipment		7,864		13,106
Deferred tax asset		685,440		—
Other assets		336,364		424,959

Total assets	$	159,632,107	$	162,322,709


Liabilities and Stockholders’ Equity
Subordinated notes	$	49,486,000	$	49,486,000
Deferred tax liability		—		96,214
Other liabilities		3,727,724		1,541,672
Stockholders’ equity		106,418,383		111,198,823

Total liabilities and stockholders’ equity	$	159,632,107	$	162,322,709

Condensed Statements of Operations


	For the Years Ended December 31,
	2008			2007		2006

Revenue
Interest and dividends received from subsidiaries	$	8,188,422		$	8,086,795	$	6,079,171
Other		—			1,308,622		105,954


Total revenue		8,188,422			9,395,417		6,185,125


Expenses
Interest on subordinated notes		3,046,238			3,617,254		3,528,418
Other		3,564,043			3,692,462		819,721


Total expenses		6,610,281			7,309,716		4,348,139

Income before income tax benefit and equity in undistributed income of subsidiaries		1,578,141			2,085,701		1,836,986
Income tax benefit		1,980,100			1,908,564		1,349,640
Equity in undistributed income (loss) of subsidiaries		(34,185,597	)		3,805,711		7,688,579


Net income (loss)	$	(30,627,356	)	$	7,799,976	$	10,875,205

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

Condensed Statements of Cash Flows


	2008			2007			2006


Cash flows from operating activities:
Net income (loss)	$	(30,627,356	)	$	7,799,976		$	10,875,205
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		5,242			3,276			—
Equity in undistributed losses (income) of subsidiaries		34,185,596			(3,805,711	)		(7,688,579	)
Stock based compensation expense		231,761			264,881			218,245
Other, net		(181,859	)		973,726			22,750

Net cash provided by operating activities		3,613,384			5,236,148			3,427,621


Cash flows from investing activities:

Purchase of premise and equipment		—			(16,382	)		—
Investment in subsidiary		(10,000,000	)		—			—


Net cash used in investing activities		(10,000,000	)		(16,382	)		—


Cash flows from financing activities:

Proceeds from issuance of preferred stock and warrants		30,255,000			—			—
Proceeds from issuance of treasury stock		—			100,427			—
Purchase of treasury stock		(802,445	)		(145,300	)
Cash dividends paid		(3,486,415	)		(3,503,575	)		(3,502,672	)

Net cash provided by (used in) financing activities		25,966,140			(3,548,448	)		(3,502,672	)


Net increase (decrease) in cash and due from banks		19,579,524			1,671,318			(75,051	)

Cash and due from banks at beginning of year		10,388,672			8,717,354			8,792,405

Cash and due from banks at end of year	$	29,968,196		$	10,388,672		$	8,717,354

During 2007, the Company changed the name of Citizen Union State Bank to Hawthorn Bank, and combined Osage Valley Bank, Bank 10 and Exchange National Bank into Hawthorn Bank. Concurrent with each combination, the underlying bank charters were sold to unrelated third parties for cash. Included in other income for 2007 is a gain from the sales of charters aggregating $1,200,000.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(15)		Disclosures About Financial Instruments

		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, 2008, 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, 2008 and 2007 is as follows:


	2008		2007

Commitments to extend credit	$	143,936,230		141,414,349
Standby letters of credit		5,417,161		5,680,483

		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. Of the total commitments to extend credit at December 31, 2008, approximately $63,584,000 represents fixed-rate loan commitments. Of the total commitments to extend credit at December 31, 2007, approximately $78,012,000 represents fixed-rate loan commitments. 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 credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers. The approximate remaining term of standby letters of credit range from one month to ten years at December 31, 2008.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

A summary of the carrying amounts and fair values of the Company’s financial instruments at December 31, 2008 and 2007 is as follows:


	2008				2007
	Carrying		Fair		Carrying		Fair
	amount		value		amount		value

Assets:
Loans	$	996,436,986	$	1,000,594,000	$	901,996,263	$	911,309,000
Investment in debt and equity securities		158,276,179		158,276,179		157,368,505		157,368,505
Federal fund sold and securities purchased under agreements to resell		104,393		104,393		664,184		664,184
Cash and due from banks		53,723,075		53,723,075		35,209,201		35,209,201
Mortgage servicing rights		1,171,225		2,455,000		1,184,868		2,750,000
Accrued interest receivable		7,476,093		7,476,093		8,764,196		8,764,196

	$	1,217,187,951	$	1,222,628,740	$	1,105,187,217	$	1,116,065,086

Liabilities:
Deposits:
Demand	$	125,245,200	$	125,245,200	$	138,355,520	$	138,355,520
NOW		123,288,896		123,288,896		116,635,508		116,635,508
Savings		43,370,172		43,370,172		43,183,790		43,183,790
Money market		176,038,478		176,038,478		169,402,365		169,402,365
Time		487,353,643		494,427,000		453,680,108		458,141,000
Federal funds purchased and securities sold under agreements to repurchase		29,138,623		29,138,623		25,729,863		25,729,863
Subordinated notes		49,486,000		35,180,000		49,486,000		49,486,000
Other borrowings		129,057,483		130,454,000		77,915,027		78,821,000
Accrued interest payable		3,847,415		3,847,415		4,723,965		4,723,965

	$	1,166,825,910	$	1,160,989,784	$	1,079,112,146	$	1,084,479,011

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

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.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

			*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.

			*Commitments to Extend Credit and Standby Letters of Credit*

			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.

			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.

(16)		Litigation

		Various legal claims have arisen in the normal course of business, which, in the opinion of management of the Company, will not result in any material liability to the Company.

HAWTHORN BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2008, 2007, and 2006

(17)

Quarterly Financial Information


Year Ended December 31, 2008 (unaudited)

									Year
	First		Second		Third		Fourth		to
(In thousands except per share data)	quarter		quarter		quarter		quarter		Date

Interest income	$	18,425	$	17,121	$	17,430	$	16,739	$	69,715
Interest expense		8,881		7,605		7,575		7,538		31,599


Net interest income		9,544		9,516		9,855		9,201		38,116
Provision for loan losses		1,650		1,300		1,000		4,261		8,211
Noninterest income		2,368		2,322		2,321		2,286		9,297
Noninterest expense		8,644		8,626		8,382		50,323		75,975
Income taxes (benefit)		531		595		780		(8,052)		(6,146)

Net income (loss)	$	1,087	$	1,317	$	2,014	$	(35,045)	$	(30,627)

Preferred stock dividends		—		—		—		66		66
Net income (loss) available to common stockholders	$	1,087	$	1,317	$	2,014	$	(35,111)	$	(30,693)


Net income per share:
Basic earnings (loss) per share	$	0.26	$	0.32	$	0.49	$	(8.46)	$	(7.39)
Diluted earnings (loss) per share		0.26		0.31		0.48		(8.46)		(7.39)


Year Ended December 31, 2007 (unaudited)

									Year
	First		Second		Third		Fourth		to
(In thousands except per share data)	quarter		quarter		quarter		quarter		Date

Interest income	$	18,031	$	18,137	$	18,992	$	19,047		$74,207
Interest expense		8,895		9,052		9,667		9,561		37,175

Net interest income		9,136		9,085		9,325		9,486		37,032
Provision for loan losses		225		154		225		550		1,154
Noninterest income		2,524		2,849		2,095		2,753		10,221
Noninterest expense		8,134		8,445		8,161		10,314		35,054
Income taxes		994		972		897		382		3,245

Net income	$	2,307	$	2,363	$	2,137	$	993		$7,800


Net income per share:
Basic earnings per share	$	0.55	$	0.57	$	0.51		$0.24		$1.87
Diluted earnings per share		0.55		0.56		0.51		0.24		1.85

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.” Prior to our June 2007 name change, our stock symbol was “EXJF”. 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 2008 and 2007 in which the stock was traded.


2008	High		Low

First Quarter		29.50		23.78
Second Quarter		28.15		23.75
Third Quarter		26.48		19.27
Fourth Quarter		24.39		14.00


2007	High		Low

First Quarter		36.66		36.20
Second Quarter		36.30		31.04
Third Quarter		33.70		29.85
Fourth Quarter		31.85		24.50

Shares Outstanding . As of March 3, 2009, our Company had issued 4,298,353 shares of common stock, of which 4,136,495 shares were outstanding. The outstanding shares were held of record by approximately 1,436 persons. In addition to common stock, our Company has 30,255 shares of cumulative, perpetual preferred stock outstanding. The 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 2008 and 2007.


January, 2008	$	0.21
April, 2008		0.21
July, 2008		0.21
October, 2008		0.21

Total for 2008	$	0.84


January, 2007	$	0.21
April, 2007		0.21
July, 2007		0.21
October, 2007		0.21

Total for 2007	$	0.84

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. As discussed in Note 2 to our consolidated financial statements, the Bank will be required to receive regulatory approval prior to paying dividends to our Company until such time as the Bank’s unappropriated retained earnings balance is restored to a positive balance. 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). Prior to December 19, 2011, unless we have redeemed the Series A preferred stock issued to the U.S. Treasury in the CPP or the U.S. Treasury has transferred the Series A preferred stock to a third party, we must receive the consent of the U.S. Treasury before we can pay quarterly dividends on our common stock of more than $0.21 per share. Furthermore, if we are not current in the payment of quarterly dividends on the Series A preferred stock, we can not 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, 2003, through December 31, 2008. 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 January 1, 2003. The performance graph assumes that the value of an investment in our common stock and each index was $100 at December 31, 2002 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:


	12/31/03		12/31/04		12/31/05		12/31/06		12/31/07		12/31/08

Hawthorn Bancshares, Inc.	$	100.00	$	81.91	$	86.17	$	94.58	$	77.14	$	55.24
Nasdaq Composite (U.S. Companies)	$	100.00	$	108.59	$	110.08	$	120.56	$	132.39	$	78.72
Index of financial institutions ($1 billion to $5 billion)	$	100.00	$	123.42	$	121.31	$	140.38	$	102.26	$	84.81

DIRECTORS AND EXECUTIVE OFFICERS OF OUR COMPANY


Name	Position with Our Company	Position with Subsidiary Bank	Principal Occupation

James E. Smith	Chairman, Chief Executive Officer and Director-Class I	Chairman, Chief Executive Officer, and Director of Hawthorn Bank	Position with Hawthorn Bancshares and Hawthorn Bank

David T. Turner	President and Director-Class III	President of East Region and Director of Hawthorn Bank	Position with Hawthorn Bancshares and Hawthorn Bank

Charles G. Dudenhoeffer, Jr.	Director-Class I	Director of Hawthorn Bank	Retired

Philip D. Freeman	Director-Class I	Director of Hawthorn Bank	Owner/Manager, Freeman Mortuary, Jefferson City, Missouri

Kevin L. Riley	Director-Class III	Director of Hawthorn Bank	Co-owner, Riley Chevrolet, Inc. and Riley Toyota, Scion, Cadillac, Inc., Jefferson City, Missouri

Julius F. Wall	Director-Class II	Director of Hawthorn Bank	Attorney, Poague, Wall, Eshelman, Cox & Adams, Clinton, Missouri

Gus S. Wetzel, II	Director-Class II	Director of Hawthorn Bank	Physician, Wetzel Clinic, Clinton, Missouri

Richard G. Rose	Chief Financial Officer	Senior Vice President and Chief Financial Officer of Hawthorn Bank	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

ANNUAL REPORT ON FORM 10-K

A copy of our Company’s Annual Report on Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission, excluding exhibits, will be furnished without charge to shareholders entitled to vote at the 2009 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.

Exhibit 21

LIST OF SUBSIDIARIES


Name of Subsidiary		Jurisdiction of Organization

Union State Bancshares, Inc.		Missouri

Hawthorn Bank		Missouri

Hawthorn Real Estate, LLC.		Missouri (limited liability company)

Jefferson City IHC, LLC		Missouri (limited liability company)

Exchange National Statutory Trust I		Connecticut

Exchange National Statutory Trust II		Delaware

Exhibit 23

Consent of Independent Registered Public Accounting Firm

The Board of Directors
Hawthorn Bancshares, Inc.:

We consent to the incorporation by reference in the registration statement (No. 333-68388) on Form S-8 of Hawthorn Bancshares, Inc. of our report dated March 13, 2009, with respect to the consolidated balance sheets of Hawthorn Bancshares, Inc. as of December 31, 2008 and 2007, 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, 2008, and the effectiveness of internal control over financial reporting as of December 31, 2008, which reports appear in the December 31, 2008 annual report on Form 10-K of Hawthorn Bancshares, Inc.



/s/ KPMG St. Louis, Missouri
March 13, 2009

Exhibit 31.1

CERTIFICATIONS

I, James E. Smith, certify that:

1. I have reviewed this report on Form 10-K of Hawthorn Bancshares, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



Date: March 13, 2009	/s/ James E. Smith
	James E. Smith
	Chairman of the Board and Chief Executive Officer

Exhibit 31.2

CERTIFICATIONS

I, Richard G. Rose, certify that:

1. I have reviewed this report on Form 10-K of Hawthorn Bancshares, Inc.;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



Date: March 13, 2009	/s/ Richard G. Rose
	Richard G. Rose
	Chief Financial Officer

Exhibit 32.1

Certification of Chief Executive Officer

In connection with the Annual Report of Hawthorn Bancshares, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission (the “Report”), I, James E. Smith, Chairman of the Board and Chief Executive Officer of the Company, hereby certify in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(a) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(b) The information contained in the Report fairly presents, in all material aspects, the financial condition and results of operations of the Company.


Dated: March 13, 2009	/s/ James E. Smith
	James E. Smith
	Chairman of the Board and Chief Executive Officer

“A signed original of this written statement required by Section 906 has been provided to Hawthorn Bancshares, Inc. and will be retained by Hawthorn Bancshares, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.”

Exhibit 32.2

Certification of Chief Financial Officer

In connection with the Annual Report of Hawthorn Bancshares, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission (the “Report”), I, Richard G. Rose, Chief Financial Officer of the Company, hereby certify in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(a) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(b) The information contained in the Report fairly presents, in all material aspects, the financial condition and results of operations of the Company.


Dated: March 13, 2009	/s/ Richard G. Rose
	Richard G. Rose
	Chief Financial Officer

Position

James E. Smith

Chairman, Chief Executive Officer and Director

David T. Turner

President and Director

Richard G. Rose

Chief Financial Officer

Kathleen L. Bruegenhemke

Senior Vice President and Secretary