Executive Summary / Key Takeaways

• Hawthorn Bancshares, Inc. (NASDAQ:HWBK) delivered a strong first quarter 2025, with net income increasing 20.8% year-over-year, primarily driven by net interest margin expansion and disciplined expense management.
• Asset quality saw significant improvement, with non-performing assets decreasing substantially, contributing to a release of the provision for credit losses and highlighting effective risk management.
• The company maintains a robust liquidity position and strong regulatory capital ratios, exceeding well-capitalized thresholds, providing a solid foundation for stability and strategic initiatives.
• Strategic focus areas include growing commercial banking, retail mortgage, retail banking, and the newly segmented Wealth Management business, aiming to leverage local relationships and enhance customer offerings.
• While facing competitive pressures from larger, more technologically advanced regional banks and fintechs, HWBK's community-focused model and operational cost advantages provide a defensive moat, though continued investment in technology is crucial for future growth.

Setting the Scene: A Community Bank's Strategic Evolution

Hawthorn Bancshares, Inc., founded in 1865, stands as a long-standing regional bank holding company deeply embedded in the communities it serves across Missouri, including key areas like Jefferson City, Columbia, Springfield, and the greater Kansas City metropolitan area. Through its subsidiary, Hawthorn Bank, the company provides a comprehensive suite of commercial and personal banking services. This includes specialized offerings for small and mid-sized businesses, alongside traditional retail services like mortgage lending and deposit accounts.

The company's overarching strategy centers on fostering growth within these core banking areas while also expanding its financial services footprint. A notable strategic evolution is the increased focus on its Wealth Management business, which encompasses trust services, estate planning, and asset management. Recognizing this as a key opportunity, HWBK began reporting Wealth Management as a separate segment in the first quarter of 2025, supported by investments in management resources to enhance its structure and offerings. This strategic segmentation underscores the company's commitment to diversifying revenue streams and deepening customer relationships beyond traditional lending and deposit-taking.

In the competitive landscape, HWBK operates alongside larger regional and national banks, as well as increasingly agile fintech firms. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, HWBK's positioning is characterized by its strong local brand recognition and deep community ties, which can foster customer loyalty and retention. However, larger competitors often possess greater scale and resources for technological investment, impacting areas like digital service speed and product innovation. Industry trends, such as the move towards AI-driven banking, tend to favor these larger players, potentially increasing their efficiency and profitability margins.

HWBK acknowledges the strategic importance of technology, citing "utilizing improved technology" as a component of its growth strategy and aiming to enhance customer satisfaction through digital means. While specific proprietary technologies or quantifiable performance metrics of its technological infrastructure compared to peers are not detailed, the competitive analysis suggests HWBK may lag larger rivals in digital tool speed and innovation. For instance, some competitors offer faster online transaction processing or loan approvals. However, HWBK's community bank model may afford certain operational cost advantages, potentially translating to lower operating costs per branch compared to larger institutions. A past challenge in this area included costs associated with terminating a contract for a digital account opening project in the prior year. The "so what" for investors is that while HWBK leverages its local presence and potential cost efficiencies, its ability to compete effectively in the long term will increasingly depend on strategic investments in technology to meet evolving customer expectations and match the digital capabilities of its rivals.

Recent Performance: Margin Expansion and Asset Quality Strength

Hawthorn Bancshares delivered a solid performance in the first quarter of 2025, demonstrating financial resilience and operational effectiveness. Consolidated net income rose to $5.4 million, a significant 20.8% increase from $4.5 million in the first quarter of 2024, resulting in earnings per diluted share of $0.77 compared to $0.63. This improvement was primarily propelled by growth in net interest income and non-interest income, coupled with a slight decrease in non-interest expense.

Net interest income, the company's primary revenue source, increased by $0.50 million, or 3.4%, reaching $15.3 million for the three months ended March 31, 2025. This growth was underpinned by a notable expansion in the net interest margin on a fully taxable equivalent basis, which climbed to 3.67% from 3.39% in the prior year quarter. This margin improvement occurred despite a decrease in average interest-earning assets and interest-bearing liabilities. The average yield on interest-earning assets saw a modest increase to 5.60% from 5.50%, driven by higher yields on both loans (5.89% vs 5.75%) and securities (3.76% vs 3.22%). Concurrently, the average cost of interest-bearing liabilities decreased to 2.64% from 2.85%, reflecting lower costs for both deposits (2.44% vs 2.61%) and borrowings (4.38% vs 4.61%). The ability to expand net interest margin in the current rate environment highlights effective asset and liability management.

Non-interest income also contributed positively, increasing by $0.40 million, or 14.7%, to $3.5 million. This rise was largely attributable to a significant increase in earnings on bank-owned life insurance, which grew to $0.50 million from $0.10 million, following a $35.00 million purchase of policies in the first quarter of 2024. This was partially offset by a decrease in gains on sales of mortgage loans, which fell to $0.10 million from $0.30 million due to a lower volume of loans sold ($1.20 million vs $15.10 million).

Disciplined expense management was evident as total non-interest expense decreased slightly by $0.10 million, or 0.6%, to $12.5 million. This reduction was primarily driven by lower legal, examination, and professional fees ($0.50 million vs $0.80 million), largely due to a settlement agreement in the prior year, and decreased advertising and promotion costs ($0.20 million vs $0.30 million) as the company utilized internal resources. These decreases were partially offset by higher occupancy expense ($0.90 million vs $0.80 million) related to the opening of new branches and a new operations facility, and increased postage, printing, and supplies ($0.30 million vs $0.20 million) due to customer mailings for an account consolidation project. The resulting efficiency ratio of 66.6% reflects sound cost control relative to revenue generation.

Asset quality showed significant improvement during the quarter. Total non-performing assets decreased to $3.1 million, representing a low 0.21% of total loans, down from $4.2 million (0.29% of total loans) at December 31, 2024, and a substantial reduction from $10.5 million (0.69% of total loans) at March 31, 2024. Non-accrual loans also decreased to $2.4 million from $2.5 million. The company recorded net loan recoveries of $0.02 million in Q1 2025, a positive shift from net loan charge-offs of $0.07 million in the prior year quarter. The allowance for credit losses stood at 1.48% of loans outstanding, slightly down from 1.50% at year-end 2024, but the ratio of the allowance to non-performing loans significantly increased to 885.01%, indicating robust coverage of potential losses within the non-performing portfolio. This strong asset quality reflects sound underwriting practices and a favorable trend in credit risk.

Liquidity, Capital, and Risk Management

Maintaining strong liquidity and capital positions is paramount for a financial institution's stability and growth capacity. HWBK demonstrates strength in both areas. Cash and cash equivalents saw a significant increase, rising by $51.3 million to $102.3 million at March 31, 2025, compared to $51.0 million at December 31, 2024. This enhanced on-balance sheet liquidity is supplemented by a diversified set of funding sources.

Core customer deposits, considered less volatile, constitute the primary funding base, totaling $1.40 billion at March 31, 2025, representing 93.7% of total deposits. Estimated uninsured deposits stood at $349.4 million. The company also utilizes borrowings, with Federal Home Loan Bank advances and other borrowings increasing by $42.6 million to $124.1 million during the quarter. Beyond on-balance sheet resources, HWBK maintains substantial additional funding capacity through pledged collateral and approved lines of credit with the FHLB, Federal Reserve Bank, and federal funds lines, totaling an estimated $278.6 million at March 31, 2025. Management expresses confidence that these resources provide more than adequate liquidity to meet anticipated future needs, including potential draws on off-balance sheet commitments totaling $368.7 million, which are considered to have a very low likelihood of full funding demand.

From a capital perspective, HWBK and its subsidiary bank are well-capitalized according to regulatory requirements. At March 31, 2025, the company's total risk-based capital ratio was 14.94%, Tier 1 risk-based capital was 13.69%, Common Equity Tier 1 capital was 10.64%, and the Tier 1 leverage ratio was 11.64%. These ratios comfortably exceed the minimums required for a well-capitalized institution, providing a strong buffer against potential economic downturns and supporting future balance sheet growth. Capital allocation priorities include paying quarterly cash dividends, with $1.30 million distributed in Q1 2025, and share repurchases, with $0.40 million of common shares bought back during the quarter under a plan with $3.50 million remaining authorization.

Risk management is integral to HWBK's operations. Credit risk is managed through internal rating systems and review committees, with a focus on evaluating expected credit losses based on historical experience, current conditions, and forecasts. The allowance for credit losses methodology incorporates qualitative adjustments to account for macroeconomic factors. Interest rate risk is actively managed using simulation models to assess sensitivity to rate changes, and management views the current exposure as acceptable, though acknowledging the inherent uncertainty in forecasts. While the company faces standard industry risks including economic conditions, regulatory changes, and cybersecurity threats, there were no material changes to the previously disclosed risk factors in the most recent filing. Pending litigation is assessed, and management does not anticipate a material adverse effect on the company's financial condition or results of operations in the near term.

Competitive Dynamics and Strategic Outlook

HWBK operates in a competitive environment where its strategic positioning as a community bank is both a strength and a challenge. Compared to larger regional banks like First Horizon (FHN) and Regions Financial (RF), HWBK leverages its deep local relationships and brand loyalty, which can contribute to stable core deposits and customer retention. However, these larger players often exhibit higher revenue growth rates (e.g., FHN at 6%, RF at 5%) and profitability margins (e.g., RF net margin 20-22%, ROE 10-12%) than HWBK (TTM net margin 17.52%, ROE 12%). This disparity is partly attributable to scale and greater investment in advanced digital capabilities, where HWBK may lag, potentially impacting efficiency and customer acquisition in digitally-driven segments.

Against peers of a more comparable scale, such as Franklin Financial Services (FRAF), HWBK appears to hold advantages in growth rates and profitability metrics. HWBK's strategic focus on specific Missouri markets provides a clearer geographic concentration than some broader regional players. The decision to segment and invest in the Wealth Management business is a strategic move to diversify revenue and compete more effectively in providing comprehensive financial solutions, an area where larger competitors like RF and Pinnacle Financial Partners (PNFP) also have strong offerings. PNFP, in particular, demonstrates higher growth (8%) and profitability (ROE 12-14%), highlighting the competitive intensity in regional commercial banking.

HWBK's competitive moat lies in its established local presence and the personalized service inherent in a community banking model, which can be a key differentiator against larger, less localized institutions. Furthermore, potential operational cost advantages stemming from its structure could support competitive pricing in its core markets. However, the vulnerability to technological gaps and the limited scale compared to national and super-regional banks necessitate ongoing strategic evaluation and investment. The inclusion in the Russell 3000 and Russell 2000 indexes, effective June 30, 2025, is a positive development that could enhance visibility and liquidity for the stock.

Looking ahead, HWBK's outlook is tied to its ability to continue executing its growth strategy in its core banking segments and successfully build out the Wealth Management business. Maintaining net interest margin in a potentially changing interest rate environment will be crucial, as will disciplined expense management to preserve efficiency gains. The strong asset quality provides a favorable starting point, but ongoing monitoring of credit risk, particularly in commercial real estate and construction segments, remains important. While specific quantitative guidance was not provided, the expectation of continued quarterly dividends signals management's confidence in the company's ongoing profitability and capital generation.

Conclusion

Hawthorn Bancshares delivered a compelling first quarter 2025 performance, marked by robust earnings growth, expanding net interest margin, and significant improvement in asset quality. The company's foundational strength lies in its deep roots within its Missouri communities and a strategic focus on core banking services complemented by a growing Wealth Management segment. While operating in a competitive landscape with larger, technologically advanced rivals, HWBK's community-centric model and operational efficiency provide a degree of resilience.

The investment thesis for HWBK rests on its ability to leverage these strengths to drive sustainable growth, maintain strong asset quality, and effectively manage its balance sheet in a dynamic interest rate environment. Key factors for investors to monitor include the continued execution of the Wealth Management strategy, the ability to maintain net interest margin and control expenses, and strategic investments in technology necessary to compete effectively in the evolving digital banking landscape. The company's solid capital and liquidity positions provide a stable platform from which to pursue its strategic objectives and continue returning capital to shareholders through dividends and share repurchases.