Hawthorn Bancshares, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Hawthorn Bancshares is a Missouri community bank holding company operating through Hawthorn Bank. Figures below are in U.S. dollars; financial statement amounts are shown in millions unless noted.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $13.84 | $12.36 | $39.71 | $36.15 |
| Provision for loan losses | $1.20 | $0.45 | $5.40 | $0.85 |
| Non-interest income | $5.08 | $2.42 | $9.96 | $6.64 |
| Non-interest expense | $11.62 | $9.59 | $33.11 | $29.15 |
| Net income | $4.96 | $3.86 | $9.11 | $12.05 |
| Diluted earnings per share | $0.77 | $0.59 | $1.40 | $1.85 |
| Net interest margin, fully taxable equivalent | 3.50% | 3.64% | 3.50% | 3.47% |
- Q3 net income rose 28.5% year over year, while nine-month net income fell 24.4%. The company reported non-GAAP nine-month net income of $12.59 million, excluding COVID-related incremental loan-loss provision and the prior-year branch-sale gain; this is a company-defined non-GAAP measure.
- Mortgage loan sale gains were a major contributor to non-interest income: $3.03 million in Q3 and $4.37 million year to date, compared with $0.22 million and $0.50 million, respectively. The company sold $133.2 million of mortgage loans in the first nine months, versus $28.3 million a year earlier, following expansion of its mortgage business.
- Q3 net interest income increased as funding costs fell, although lower asset yields reduced the quarterly margin. Nine-month margin edged up year over year. The effective tax rate was 18.9% for Q3 and 18.4% year to date.
Balance sheet, liquidity and capital
- At September 30, 2020, assets were $1.67 billion, up from $1.49 billion at December 31, 2019. Loans held for investment were $1.28 billion, including $85.6 million of net PPP loans; deposits were $1.33 billion, compared with $1.19 billion at year-end.
- Cash and cash equivalents totaled $129.4 million, versus $78.1 million at year-end. The company reported $308.6 million in selected liquid assets, including cash-like balances and available-for-sale securities, and $177.4 million of additional available funding capacity under listed facilities.
- Total borrowings were $197.6 million: $112.7 million of FHLB advances, $35.4 million of repurchase agreements and $49.5 million of subordinated notes. Stockholders’ equity was $124.4 million. The company reported total risk-based capital of 15.05%, Tier 1 risk-based capital of 13.28%, common equity Tier 1 of 9.97%, and a Tier 1 leverage ratio of 9.99%.
- For the first nine months, operating cash flow was $9.9 million, investing cash flow was negative $119.6 million and financing cash flow was positive $161.0 million, producing a $51.3 million increase in cash. Lending growth and securities purchases drove investing outflows; deposit growth and net FHLB advances supported financing inflows.
Credit quality and material changes
- The allowance for loan losses increased to $17.8 million, or 1.39% of loans, from $12.5 million, or 1.07%, at year-end. The nine-month provision was $5.4 million; management attributed $4.4 million of it to COVID-related economic uncertainty. Net charge-offs were $113,000 year to date, down from $324,000.
- Non-performing loans were $5.8 million, or 0.45% of loans, compared with $5.1 million, or 0.43%, at year-end. Non-performing assets were $18.4 million. Management noted increases in non-accrual commercial real estate and construction relationships.
- At September 30, 42 modified loans totaling $91.1 million, or 7.1% of the portfolio, remained under COVID-related payment modifications. The company had granted modifications on approximately 578 loans totaling $303.2 million to date. Remaining modifications included $44.6 million interest-only and $46.5 million full-deferral arrangements. The reported delinquency table excludes $91.1 million of loans still in forbearance.
- COVID-related PPP lending totaled $88.4 million. Management considered the loans fully SBA-guaranteed and did not establish a related loan-loss allowance. PPP fees also contributed to loan interest income.
- Non-interest expense rose 21.1% in Q3 and 13.6% year to date, including higher salaries and benefits as the mortgage department expanded. Q3 expense also included approximately $150,000 of disputed credit-card fraud losses from prior years. In Q2, a donation expense related to an out-of-service branch property was partly offset by a reported gain.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said the pandemic’s future effect remains highly uncertain and expects continued adverse effects on affected borrowers, asset quality, collateral values and results. Hotel, restaurant, gaming, long-term healthcare and retail exposures were identified as areas of concern.
- Management described liquidity as more than adequate, but identified possible short-term uncertainty if PPP forgiveness and customer deposit movements alter liquidity needs. The company also warned of credit, interest-rate, economic, regulatory, market and operational risks, including reliance on third-party vendors.
- The company’s board authorized up to $2.5 million of share repurchases in Q3; 5,540 shares were repurchased for approximately $97,000 during the quarter, with about $2.4 million of authorization remaining. A 4% special stock dividend was paid July 1, 2020; share and per-share data were retrospectively adjusted.
- Management concluded disclosure controls were not effective as of November 5, 2020 because of a previously disclosed material weakness in internal control over financial reporting. The remediation plan was ongoing, with completion expected before year-end 2020; management said the weakness would not be remediated until controls operated effectively and testing supported that conclusion.
- Pending legal matters were described as incidental to the business; management did not believe they were reasonably likely to materially adversely affect near-term financial condition or results. Some matters were too early to estimate a loss.
Important facts for investors to verify
- Whether pandemic-related payment modifications resume, expire or convert into delinquencies, and how the $91.1 million still modified performs.
- Whether the allowance remains adequate as economic conditions, borrower performance and collateral values evolve; review the company’s estimates and the impact of PPP treatment.
- Whether mortgage-sale gains and elevated mortgage production persist, and how the expanded department affects recurring earnings and costs.
- Progress and testing results for remediation of the material weakness in internal controls.
- Deposit stability, funding needs, available borrowing capacity, and capital ratios as PPP-related balances and loan growth change.