Hawthorn Bancshares, Inc. — Third-Quarter 2016 Form 10-Q
Business and period: The Missouri-based bank holding company provides commercial and consumer banking, mortgage lending, and trust services in communities across Missouri. This unaudited filing covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015 unless otherwise noted. Dollar amounts below are in millions unless specified.
Financial performance
- Third quarter: Net income was $1.884 million, down 25.8% from $2.539 million a year earlier. Diluted EPS was $0.33 versus $0.45. Net interest income was $10.147 million, down 3.9%; provision for loan losses was $0.300 million versus zero; noninterest income fell 9.0% to $2.125 million; and noninterest expense rose 1.2% to $9.085 million.
- Nine months: Net income was $5.294 million, down 19.8% from $6.605 million; diluted EPS was $0.94 versus $1.17. Net interest income declined 1.8% to $29.966 million, while provision expense rose to $0.975 million from $0.250 million. Noninterest income decreased 3.9% to $6.522 million and noninterest expense increased 2.1% to $27.522 million.
- Margins and efficiency: Fully taxable-equivalent net interest margin was 3.44% for the quarter versus 3.78% and 3.47% for the nine months versus 3.71%. The reported efficiency ratio worsened to 74.03% for the quarter from 69.62%, and to 75.43% for the nine months from 72.25%.
- Balance sheet and growth: Total assets were $1.278 billion, up 6.4%; loans were $947.8 million, up 9.6%; and deposits were $1.018 billion, up 7.5%. Stockholders’ equity was $92.8 million, up from $87.3 million. Commercial real estate mortgage loans were $423.8 million, or 44.7% of total loans.
- Credit quality: Allowance for loan losses was $9.470 million, or 1.00% of loans, versus $8.604 million, or 0.99%, at year-end. Nonperforming loans were $9.303 million (0.98% of loans), down from $10.274 million (1.19%). Nonperforming assets totaled $23.741 million, including $14.438 million of other real estate and repossessed assets. Nine-month net charge-offs were $0.109 million.
- Cash flow and liquidity: Operating activities provided $9.116 million for the nine months; investing activities used $68.853 million and financing activities provided $70.254 million. Cash and cash equivalents ended at $38.894 million, up $10.517 million from year-end. The company reported $241.612 million of cash and available-for-sale securities, although some securities were pledged.
- Debt and capital: At September 30, borrowings included $79.0 million of FHLB advances, $49.486 million of subordinated notes, and $28.504 million of repurchase agreements. The company reported regulatory ratios of 14.11% total risk-based capital, 11.63% Tier 1 risk-based capital, 8.73% Common Equity Tier 1, and 9.86% Tier 1 leverage; the bank was also above applicable well-capitalized thresholds.
Changes, commentary, and risks
- Management attributed margin pressure mainly to lower yields as higher-rate investment securities matured and were replaced at lower market yields. Average earning assets and loans grew, but asset yields declined and funding costs increased.
- Management increased the historical loan-loss look-back period from 12 to 15 quarters in 2016, with the intention of extending it to five years over two years. It cited this change and loan growth as primary reasons for higher provision expense.
- Noninterest income was affected by lower mortgage-sale gains and mortgage-servicing-right valuation losses. Nine-month securities sales generated $60.7 million of proceeds and $0.602 million of gains; management said the sales repositioned holdings without materially changing portfolio duration or yield.
- Liquidity sources included core deposits, securities, and borrowing capacity. Core deposits were $707.9 million, or 69.5% of deposits. Available borrowing capacity was reported at $281.0 million, subject to collateral and facility terms. Unfunded credit commitments and standby letters of credit totaled $237.9 million; management said current liquidity was adequate and expected actual draws to be low.
- Risks identified include competition, interest-rate changes and margin pressure, economic weakness affecting loan quality, higher credit-loss provisions, regulatory or legislative changes, securities-market changes, and acquisition-integration costs. The company reported no material change in internal control over financial reporting and no risk-factor updates in this filing.
- Management gave no specific earnings or financial guidance. It said routine short-term liquidity needs were not expected to vary significantly during 2016. Pending litigation was described as incidental to the business; management did not believe it was reasonably possible to materially adversely affect near-term results, while noting some matters were too early to estimate.
- Other notable items: the company paid a 4% stock dividend in July 2016 and repurchased 30,033 shares during the first nine months under its $2.0 million authorization. It also recorded a $0.772 million pension contribution in April.
Investor verification priorities
- Reconcile the filing’s return-on-assets disclosure: the selected financial data table reports 0.57% for the nine months of 2016, while the MD&A narrative reports 0.94%.
- Assess whether loan growth, especially commercial real estate exposure, is accompanied by stable underwriting and reserve adequacy; review the higher provision and the expanded loss look-back methodology.
- Track margin compression, deposit and borrowing costs, and the effect of interest-rate changes on earnings, securities values, and mortgage servicing rights.
- Review the composition and valuation of nonperforming assets, foreclosed real estate, TDRs, and the remaining potential problem loans.
- Confirm the availability and terms of contingent liquidity and collateral capacity, and monitor funding needs against the $237.9 million of off-balance-sheet commitments.