Hawthorn Bancshares, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unless otherwise noted, dollar amounts are in millions. Hawthorn is a Missouri community banking company operating through Hawthorn Bank.
Financial performance and position
- Q3 earnings: Net interest income was $10.1 million, down 6.3% year over year; noninterest income was $2.7 million, up 13.7%. A $4.7 million loan-loss provision and $10.4 million of noninterest expense contributed to a $2.3 million pretax loss and a $1.6 million net loss. Loss available to common shareholders was $1.9 million, or $0.39 per share, versus income available to common shareholders of $1.0 million, or $0.21 per share, in Q3 2011.
- Nine-month earnings: Net interest income was $31.1 million, down 3.0%; noninterest income was $7.1 million, up 7.7%; and noninterest expense was $30.0 million, up 9.7%. Net income was $0.6 million versus $3.9 million a year earlier; the loss available to common shareholders was $0.9 million, or $0.18 per share, versus income of $2.4 million, or $0.49 per share.
- Margins and returns: Net interest margin was 3.80% for Q3, compared with 3.98% a year earlier, and 3.84% for the nine months, compared with 3.92%. Q3 return on average assets was -0.54% and return on average common equity was -9.95%; nine-month figures were 0.07% and -1.54%, respectively. The efficiency ratio rose to 81.1% for Q3 from 67.8%.
- Balance sheet: Total assets were $1,157.3 million, down $13.9 million from December 31, 2011. Loans were essentially unchanged at $843.1 million; deposits were $956.4 million, also slightly lower. Stockholders’ equity declined to $90.4 million from $102.6 million, including the redemption of $12.0 million of preferred stock.
- Credit quality: The allowance for loan losses was $16.9 million, or 2.01% of loans, versus $13.8 million, or 1.64%, at year-end. Nine-month provision was $7.9 million; net charge-offs were $4.8 million. Nonperforming loans were $42.2 million, or 5.00% of loans, down from $53.7 million, or 6.37%, at year-end. Nonperforming assets were $67.4 million, or 7.76% of loans and foreclosed assets.
- Foreclosed assets: Other real estate owned and repossessed assets, net, increased to $25.2 million from $16.0 million at year-end. The company recorded $1.8 million of other-real-estate expense in the first nine months, including $1.8 million in provision for foreclosed property valuation.
- Cash flow and liquidity: Nine-month operating cash flow was $12.6 million, investing cash flow was negative $19.4 million, and financing cash flow was negative $16.1 million. Cash and cash equivalents fell $22.9 million to $20.3 million. Management reported $217.2 million of liquid assets, including available-for-sale securities, and $244.8 million of available FHLB capacity. Core deposits were $554.8 million, or 58% of deposits.
- Borrowings and capital: Repurchase agreements, FHLB advances, and subordinated notes totaled approximately $101.8 million. At September 30, company total risk-based capital was 16.71%, Tier 1 risk-based capital 13.36%, and leverage 10.09%. Hawthorn Bank’s respective ratios were 15.08%, 13.82%, and 10.46%; management said both company and bank met applicable capital requirements.
Changes versus comparable periods
- Q3 shifted from a $1.5 million net profit in 2011 to a $1.6 million net loss in 2012. The principal pressures were the higher loan-loss provision, lower net interest income, and higher operating costs, particularly foreclosed-property expense.
- For the first nine months, net income fell by $3.3 million year over year. Net interest margin and average loan balances declined, while provision expense rose 40.0% to $7.9 million.
- Mortgage-loan sale gains increased to $1.8 million for the nine months from $0.9 million. Management attributed higher mortgage production and gains to low rates and refinancing activity.
- Nonaccrual loans and total nonperforming loans declined from year-end, but foreclosed assets rose. Management attributed much of the reduction in nonaccrual loans to foreclosures, rather than solely to borrower cures or improved repayment.
Outlook, risks, and unusual items
- Management anticipated several more quarters of slow growth and a tight Missouri economy, citing soft loan demand, weak regional conditions, and uncertainty in its markets. The filing provides no formal earnings or revenue guidance.
- Key stated risks include credit deterioration and collateral-value changes, interest-rate effects on margins, competition, economic weakness, regulatory changes, and securities-market movements. Loans with a carrying value of $452.0 million were pledged to the FHLB; unused loan commitments and standby letters of credit totaled $142.4 million.
- On May 9, 2012, the company redeemed 12,000 Treasury CPP preferred shares for $12.0 million. It stated an intent to redeem the remaining preferred shares by December 2013; the remaining shares carry a 5% cumulative dividend through December 2013 and 9% thereafter.
- Effective January 1, 2012, the company elected fair-value accounting for mortgage servicing rights (MSRs), recording a $0.46 million cumulative-effect increase to opening retained earnings. Subsequent MSR fair-value changes are recognized in earnings. Nine-month MSR changes included a $0.37 million gain from model inputs and assumptions and a $1.36 million reduction from other fair-value changes; the filing also discloses a $0.54 million correction of an immaterial prior-period MSR error.
- The nine-month tax results included a $0.37 million immaterial prior-period correction. A separate $0.37 million credit to interest expense corrected imputed interest accounting for 2004–2011; management said the correction was immaterial.
- Pending litigation includes a putative class action challenging overdraft fees; management said it could not determine the probability or amount of a potential loss. In a separate loan-commitment case, an amended judgment of $0.51 million is under appeal; the company carried a $0.20 million liability. Management did not believe the legal matters would materially affect near-term results, but the class-action exposure was not estimable.
- The company reported no material changes in internal control over financial reporting and stated disclosure controls were effective as of September 30, 2012.
Important facts for investors to verify
- Whether elevated loan-loss provisioning, charge-offs, and foreclosed-property costs persist, especially in commercial real estate and the Branson market.
- How the $25.2 million foreclosed-asset balance and related valuation allowances develop, and whether further write-downs or disposal costs arise.
- Whether the decline in nonperforming loans reflects sustainable credit improvement, given foreclosures and the increase in foreclosed assets.
- Whether net interest margin and earnings stabilize as asset yields, deposit costs, and loan demand change.
- The timing and funding of the planned redemption of remaining Treasury preferred stock, and its implications for capital and common dividends.
- Developments in the overdraft-fee class action and the appealed loan-commitment judgment, including any change in estimated exposure.