HAWTHORN BANCSHARES, INC. quarterly report, Q1 FY2021

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Hawthorn Bancshares, Inc. — Q1 2021 Form 10-Q

Business context and period. Hawthorn Bancshares is a Missouri community bank holding company serving individuals and businesses through Hawthorn Bank. This unaudited report covers the three months ended March 31, 2021; comparisons are with Q1 2020 unless otherwise noted. Dollar amounts below are in millions, except per-share data.

Financial performance and position

  • Earnings and revenue: Net income was $5.84 million, or $0.92 per diluted share, versus $0.87 million, or $0.13 per share. Net interest income rose 14.9% to $14.39 million. Total revenue (net interest income plus non-interest income) was $18.83 million.
  • Margins and returns: Net interest margin was 3.62%, up from 3.55%; net interest spread was 3.44%, versus 3.28%. Return on average assets was 1.38% (0.23%); return on average equity was 18.03% (2.97%). The efficiency ratio improved to 61.9% from 70.8%.
  • Drivers and expenses: Non-interest income increased 93.9% to $4.44 million, led by mortgage-loan sale gains of $2.47 million, versus $0.42 million. Mortgage loan sales were $66.3 million versus $13.2 million. Non-interest expense increased 11.1% to $11.65 million, including higher salaries and benefits, in part associated with the expanded mortgage department.
  • Credit costs: The company recorded no loan-loss provision, compared with $3.30 million in Q1 2020. Net recoveries were $0.25 million versus net charge-offs of $0.08 million. The allowance for loan losses was $18.36 million, or 1.44% of loans, versus $18.11 million, or 1.41%, at year-end 2020.
  • Cash flow: Operating activities provided $3.56 million; investing activities used $32.41 million; financing activities used $4.81 million. Cash and cash equivalents decreased $33.66 million during the quarter to $146.70 million.
  • Balance sheet and liquidity: Total assets were $1.732 billion, little changed from year-end. Loans held for investment were $1.276 billion, down from $1.287 billion; available-for-sale securities were $238.14 million, up from $198.03 million. Deposits were $1.394 billion, up from $1.384 billion. Management reported $375.25 million of liquid assets and $235.83 million in available borrowing capacity at quarter-end.
  • Debt and capital: Borrowings totaled approximately $189.1 million, including $97.6 million of FHLB advances, $42.0 million of repurchase agreements and $49.5 million of subordinated notes. The company’s total risk-based capital ratio was 14.80%, Tier 1 risk-based ratio 13.21%, CET1 ratio 9.93%, and Tier 1 leverage ratio 10.22%. Management said the company and bank met applicable capital requirements; the bank met the well-capitalized thresholds.

Material changes and credit developments

  • Profit rose substantially, reflecting higher net interest income, the absence of the prior-year $3.30 million loan-loss provision, and growth in mortgage-loan sale gains. Mortgage-related gains and fees are activity-sensitive and contributed materially to the period’s results.
  • Average earning assets increased 15.1% to $1.65 billion. Lower funding costs helped offset lower yields on earning assets: the average cost of interest-bearing liabilities fell to 0.59% from 1.19%, while the average yield on earning assets declined to 4.03% from 4.47%.
  • Non-performing loans were $34.23 million, or 2.68% of loans, versus $34.56 million, or 2.69%, at year-end; they were $8.06 million, or 0.68%, a year earlier. Non-performing assets were $46.37 million, or 3.63% of loans, versus $20.83 million, or 1.76%, a year earlier. The year-over-year increase primarily reflects elevated problem loans.
  • At March 31, $72.8 million, or 5.7% of loans, remained under COVID-related modifications: $28.1 million interest-only, $39.6 million full deferral and $5.1 million extended amortization. Of the full-deferral balance, $29.3 million was on nonaccrual. The company reported $56.3 million of net PPP loans, which carry a 100% SBA guarantee and for which management recorded no allowance.
  • Available-for-sale securities had $2.37 million of gross unrealized losses, compared with $0.33 million at year-end. Management attributed the decline in fair value to interest-rate movements rather than credit quality and said it did not intend, and was not more likely than not required, to sell the affected securities before recovery.

Outlook, risks and contingencies

  • Management anticipated continued economic improvement as restrictions eased and vaccinations became available, but noted uncertainty from the pandemic and the possibility of renewed infections or restrictions. It continued to monitor borrowers in hospitality, restaurants, entertainment, retail, healthcare and commercial real estate, among other exposed sectors.
  • Management said the investment portfolio was intended to grow to $300 million by year-end 2021. It also described short-term liquidity needs as not expected to vary significantly, while identifying PPP forgiveness and possible customer redirection of deposits as liquidity considerations. These are management expectations, not guaranteed outcomes.
  • Interest-rate sensitivity modeling at March 31 showed projected net interest income changes of -1.06% for a 200-basis-point rise, -1.50% for a 100-basis-point rise, -2.73% for a 100-basis-point decline and -3.34% for a 200-basis-point decline. Management noted model assumptions and actual results may differ.
  • Key risks include local and national economic conditions, borrower repayment and collateral values, interest-rate and securities-market changes, competition, regulatory or tax changes, and COVID-19 effects. The company had $421.6 million of off-balance-sheet commitments, including commitments to extend credit, mortgage origination commitments and standby letters of credit; no loss accrual was recorded for these instruments.
  • The company disclosed pending legal actions incidental to its business, but management did not believe they were reasonably likely to materially adversely affect near-term financial condition or results. The filing reported no material change in previously disclosed risk factors.

Most important facts for investors to verify

  1. How much of the earnings improvement is repeatable, given the sharp increase in mortgage-sale gains and the absence of a loan-loss provision this quarter?
  2. Whether the $72.8 million of remaining COVID-related modifications, particularly the $29.3 million on nonaccrual, perform or migrate into further credit deterioration.
  3. Whether the allowance remains adequate as non-performing loans and criticized loans remain above pre-pandemic levels, and as collateral values and local economic conditions evolve.
  4. How deposit balances, PPP forgiveness and planned securities growth affect cash, funding costs, liquidity and interest-rate sensitivity.
  5. Whether capital, dividend and share-repurchase decisions remain consistent with regulatory requirements and the company’s risk and liquidity needs.