Hawthorn Bancshares, Inc. — 2019 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Hawthorn Bancshares is a Missouri community bank holding company. Unless stated otherwise, financial amounts are in U.S. dollars; balance-sheet comparisons are with December 31, 2018.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $12.36 million | $11.31 million | $36.15 million | $33.09 million |
| Net income | $3.86 million | $3.10 million | $12.05 million | $8.10 million |
| Diluted EPS | $0.62 | $0.49 | $1.92 | $1.29 |
| Net interest margin, fully taxable equivalent | 3.64% | 3.31% | 3.47% | 3.29% |
| Efficiency ratio | 64.86% | 72.62% | 68.13% | 75.23% |
Net income increased 24.6% in Q3 and 48.8% year to date. Excluding the after-tax Branson branch-sale gain, management reported non-GAAP net income of $3.77 million and $10.32 million, respectively, and non-GAAP diluted EPS of $0.61 and $1.65. These company-defined measures are not GAAP results.
Net interest income growth reflected higher average loan balances and yields. Loan yield was 5.12% in Q3 and 5.09% for the nine-month period, versus 4.81% and 4.74% a year earlier. Higher deposit and borrowing costs partly offset asset yield gains. Non-interest expense fell 3.4% in Q3 and 3.3% year to date; lower staffing costs contributed, while occupancy and card-processing costs increased.
Financial position, cash flow and credit
| Metric at September 30, 2019 | Value | Comparison |
|---|---|---|
| Total assets | $1.449 billion | $1.482 billion at Dec. 31, 2018 |
| Total loans | $1.152 billion | $1.147 billion |
| Total deposits | $1.137 billion | $1.198 billion |
| Cash and cash equivalents | $44.4 million | $42.1 million |
| Available-for-sale securities | $181.3 million | $218.2 million |
| Total stockholders’ equity | $112.8 million | $99.4 million |
| Borrowings, including subordinated notes | $183.7 million | $169.3 million |
For the first nine months, operating cash flow was $11.1 million, investing activities provided $29.2 million, and financing activities used $38.0 million. Cash increased $2.3 million from year-end. Investing cash flow included $60.6 million of security maturities, calls and sales, partly offset by security purchases, the branch-sale payment and loan growth. Financing cash use chiefly reflected reductions in interest-bearing transaction accounts and time deposits.
Credit indicators improved from year-end: nonperforming loans were $4.8 million, or 0.41% of loans, versus $5.6 million, or 0.49%; nonperforming assets were $17.6 million, or 1.22% of assets, versus $19.3 million, or 1.30%. The allowance for loan losses was $12.2 million, or 1.06% of loans, with coverage of nonperforming loans at 255.79%. Nine-month net charge-offs were $324,000, down from $494,000 a year earlier. Other real estate owned was $12.9 million. Watch-list loans rose to $71.8 million from $62.7 million at year-end; management also identified $5.9 million of substandard loans, including performing TDRs, as potential problem loans.
Reported September 30 capital ratios included total risk-based capital of 14.47%, Tier 1 risk-based capital of 12.60%, common equity Tier 1 of 9.50%, and Tier 1 leverage of 10.69%. The filing states the Company and Bank met applicable capital adequacy requirements; the Bank’s ratios also exceeded the stated well-capitalized thresholds.
Material changes, outlook and risks
- Branson branch sale: Completed February 8, 2019. The transaction transferred approximately $10.6 million of deposits, but no loans, and generated a $2.2 million pretax gain ($1.7 million after tax) year to date. A further $109,000 pretax gain was recognized in Q3 from contingent deposit accounts.
- Funding and liquidity: Core deposits were approximately $1.001 billion, or 88.0% of deposits, down from $1.068 billion at year-end. The Company reported $214.4 million of liquid assets under its stated measure and $174.2 million of estimated additional funding capacity. It had $107.0 million of FHLB advances and $27.2 million of repurchase agreements outstanding. Management said short-term liquidity needs were not expected to vary significantly during 2019.
- Off-balance-sheet exposure: Commitments to extend credit, originate residential mortgages and standby letters of credit totaled $325.9 million. The Company had not accrued estimated losses on these instruments and said commitment totals do not necessarily represent future cash requirements.
- Interest-rate sensitivity: The model showed projected net interest income declining 0.97% for an immediate, sustained 200-basis-point rate increase; a 100-basis-point increase projected a 0.21% rise. The filing cautions actual results may differ because of market conditions, rate timing and assumptions.
- Other notable items: A 4% special stock dividend was paid July 1, 2019. The board authorized up to $5 million of common-stock repurchases on September 18; none were made during Q3. The Company adopted lease accounting, recording approximately $2.3 million each of operating lease assets and liabilities, with no material broader financial-statement impact.
- Outlook and contingencies: No specific earnings or revenue guidance is provided. Management expected an effective tax rate of 18.5%–19.5% going forward. Litigation was described as incidental to the business, with management not believing it would materially adversely affect near-term financial condition or results; some early-stage matters could not yet be assessed for probability or amount. The Company identified competition, interest-rate movements, economic conditions, loan quality, regulation and securities markets as risks.
- Accounting uncertainty: The Company was assessing the impact of CECL credit-loss accounting and had not determined the size of any transition adjustment. The filing says implementation timing had been extended to 2022.
Important facts for investors to verify
- How much of the year-to-date earnings increase is recurring after excluding the Branson sale gain, and whether the non-GAAP reconciliation is applied consistently.
- Whether loan growth, deposit mix and funding costs support continued net interest margin performance, particularly given lower deposits and increased borrowings.
- Whether watch-list and substandard loan balances, impaired loans, collateral valuations and the allowance remain appropriate as economic conditions change.
- How the $325.9 million of commitments and available borrowing capacity affect liquidity under stressed funding or drawdown conditions.
- The eventual CECL transition impact and sensitivity of earnings and capital to rate changes, credit losses and securities valuations.