HAWTHORN BANCSHARES, INC. quarterly report, Q2 FY2020

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Hawthorn Bancshares, Inc. — Q2 2020 Form 10-Q

Business context and period. Hawthorn Bancshares is a Missouri community bank holding company operating through Hawthorn Bank. This unaudited quarterly filing covers the three and six months ended June 30, 2020; balance-sheet comparisons are to December 31, 2019. Unless stated otherwise, amounts below are in millions.

Financial performance and position

  • Q2 earnings: Net income was $3.28 million, or $0.51 per diluted share, versus $3.52 million, or $0.54, in Q2 2019. For the first half, net income was $4.15 million, or $0.64 per diluted share, versus $8.19 million, or $1.25.
  • Interest income and margins: Q2 net interest income increased 9.7% to $13.34 million; first-half net interest income increased 8.7% to $25.87 million. Fully taxable-equivalent net interest margin was 3.46% in Q2 (3.50% prior year) and 3.51% for the first half (3.39% prior year). Lower funding costs supported net interest income, while asset yields declined.
  • Credit costs: Provision for loan losses was $0.90 million in Q2 and $4.20 million for the first half, compared with $0.25 million and $0.40 million, respectively, in 2019. Management attributed $0.6 million of Q2 and $3.6 million of first-half provision to COVID-19 economic uncertainty. The allowance was $16.62 million, or 1.30% of loans, at June 30, up from $12.48 million, or 1.07%, at year-end.
  • Non-interest items and costs: Q2 non-interest income rose 24.1% to $2.63 million, mainly due to mortgage loan sale gains; first-half non-interest income rose 15.9% to $4.88 million. Q2 non-interest expense increased 14.2% to $11.05 million, and first-half expense increased 9.9% to $21.50 million. The efficiency ratio was 69.2% for Q2 and 69.9% for the first half.
  • Cash flow: First-half operating cash flow was $0.70 million, investing cash outflow was $126.77 million, and financing cash inflow was $182.61 million. Cash and cash equivalents increased $56.54 million to $134.66 million.
  • Balance sheet and funding: Total assets were $1.684 billion, up from $1.493 billion at year-end. Loans held for investment were $1.281 billion, up from $1.169 billion; deposits were $1.328 billion, up from $1.187 billion. Total borrowings were $217.49 million, versus $173.68 million at year-end, including $125.78 million of FHLB advances, $42.20 million of repurchase agreements, and $49.49 million of subordinated notes.
  • Liquidity and capital: Cash, overnight interest-bearing deposits, certificates at other banks, and available-for-sale securities totaled $318.66 million. Management reported $183.31 million of additional available funding capacity across FHLB, Federal Reserve, and federal-funds lines. Company regulatory ratios at June 30 included total risk-based capital of 14.64%, Tier 1 risk-based capital of 12.76%, common equity Tier 1 of 9.58%, and Tier 1 leverage of 9.82%; the filing says the Company and Bank exceeded applicable well-capitalized levels.

Material changes versus comparable periods

  • Q2 GAAP net income declined 6.8% year over year; first-half net income declined 49.3%. The first-half comparison includes a $2.07 million pretax gain on the Branson branch sale in 2019. Excluding that gain and COVID-related incremental provision, management’s non-GAAP first-half net income was $6.99 million versus $6.55 million in 2019; these company-defined measures are not GAAP.
  • Loan growth included $83.8 million of net SBA Paycheck Protection Program loans at June 30. Deposits rose substantially, including $106.7 million of demand deposits, with management citing PPP proceeds, stimulus payments, deferred tax payments, and precautionary customer savings.
  • Nonperforming loans increased to $8.91 million, or 0.70% of loans, from $5.07 million, or 0.43%, at year-end. Nonperforming assets were $21.43 million, or 1.27% of assets. Net loan recoveries were $29,000 in Q2; first-half net charge-offs were $55,000.
  • Mortgage activity expanded: first-half mortgage loan sales were $47.7 million versus $15.0 million in 2019, and mortgage sale gains were $1.34 million versus $0.28 million. Service charges declined, partly due to lower NSF activity and COVID-related fee waivers.

Outlook, risks, contingencies, and unusual items

  • COVID-19 and credit exposure: Management expects significant, uncertain adverse effects on the economy, the Company, capital, and results. It identified potential stress among hotel, restaurant, gaming, long-term healthcare, retail, and commercial real estate borrowers, as well as possible weaker collateral values and loan repayment capacity. The filing provides no earnings or financial guidance.
  • Loan modifications: At June 30, 568 loans totaling $286.8 million, or 22.4% of loans, had received COVID-related modifications. Forty loans totaling $58.3 million were granted or requested an additional three-month modification, representing 20.3% of the previously modified balance. The filing states $287 million of forbearance loans were excluded from reported past-due and nonaccrual balances.
  • PPP: The Bank reported $88.0 million in PPP loans approved through July 31. PPP loans carry a 100% SBA guarantee; management therefore recorded no related loan-loss allowance and expected substantial payoff or forgiveness. Fees are deferred and recognized over the loan term, or upon payoff or forgiveness as applicable.
  • Other notable items: The Company paid a 4% special stock dividend on July 1, 2020; reported share and EPS data were adjusted retroactively. The share repurchase program was temporarily suspended in Q2. An out-of-service OREO branch building was donated to a nonprofit, producing a $266,000 donation expense and approximately $210,000 net gain.
  • Controls and legal matters: Management concluded disclosure controls were not effective as of August 6, 2020 because of a previously reported material weakness in internal control over financial reporting. Remediation was underway and expected before year-end 2020, subject to testing. The Company disclosed a pending lawsuit at an early stage; management did not believe legal actions were reasonably likely to materially affect near-term results, but noted some matters were not yet estimable.
  • Other risks: The filing cites interest-rate, economic, competitive, regulatory, credit-quality, securities-market, vendor-continuity, and COVID-related risks. Management’s interest-rate model estimated projected net interest income would rise 2.57% under a 200-basis-point rate increase and decline 0.42% under a 200-basis-point decrease; actual outcomes may differ materially.

Important facts for investors to verify

  • Whether modified and forborne borrowers resume contractual payments, and how credit quality, nonaccrual loans, collateral values, and the allowance develop as pandemic effects become clearer.
  • PPP payoff, forgiveness, and fee-recognition timing, and the effect of deposit outflows as customers use or redirect program proceeds.
  • Whether loan and deposit growth, mortgage gains, and lower funding costs can offset pressure on loan yields, fee income, credit costs, and operating expenses.
  • Progress and independent testing of the material-weakness remediation, and any material development in the pending lawsuit.
  • Capital and liquidity capacity if credit losses, commitment draws, or funding needs rise; the filing reports $425.6 million in total off-balance-sheet commitments and standby letters of credit.