HAWTHORN BANCSHARES, INC. quarterly report, Q1 FY2012

Hawthorn Bancshares, Inc. — Q1 2012 Form 10-Q

Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are to December 31, 2011 unless noted. The consolidated financial statements are unaudited. Hawthorn provides banking services in communities in and around several Missouri markets.

Financial performance

Metric	Q1 2012	Q1 2011
Net interest income	$10.815 million	$10.481 million
Provision for loan losses	$1.700 million	$1.750 million
Non-interest income	$1.970 million	$2.052 million
Non-interest expense	$9.480 million	$9.378 million
Income before taxes	$1.605 million	$1.405 million
Net income	$1.451 million	$0.954 million
Net income available to common shareholders	$0.962 million	$0.465 million
Diluted EPS	$0.21	$0.10

Tax-equivalent net interest income rose 3.0% to $10.957 million. Net interest margin increased to 3.98% from 3.84%; the spread rose to 3.85% from 3.66%.
Return on average assets was 0.49%, return on average common equity was 5.21%, and the efficiency ratio was 74.15% (74.80% in Q1 2011).
Cash provided by operations was $5.299 million; investing activities used $17.378 million and financing activities provided $32.437 million. Cash and cash equivalents ended the quarter at $63.567 million, up $20.358 million from year-end.

Financial position and liquidity

Total assets were $1.206 billion, up $34.820 million, or 3.0%, from year-end. Loans were $839.939 million, down $2.991 million; available-for-sale securities were $229.154 million.
Total deposits increased to $993.105 million from $958.224 million. Core deposits were $582.727 million, or 58.7% of deposits; time deposits of $100,000 and over were $126.986 million.
Borrowings included $22.748 million in repurchase agreements, $28.345 million in FHLB advances, and $49.486 million in subordinated notes. Total stockholders’ equity was $103.834 million.
Reported capital ratios included total risk-based capital of 18.28%, Tier 1 risk-based capital of 15.45%, and a leverage ratio of 11.43%. Management stated the company and Bank met applicable capital requirements.
Management reported $273.544 million in liquid assets, including available-for-sale securities and Federal Reserve excess reserves. Unused loan commitments and standby letters of credit totaled $119.709 million; management said the likelihood of full funding demand was very low.

Material changes and credit quality

Net income available to common shareholders increased 52.1% year over year. Lower funding costs supported net interest income despite lower interest income and average earning assets. Mortgage-loan sale gains rose to $519,000 from $246,000, while total non-interest income fell 4.0%, mainly due to lower real-estate servicing income.
Nonperforming loans were $49.718 million, or 5.92% of loans, versus $53.674 million, or 6.37%, at year-end. Nonaccrual loans declined to $42.493 million, but other real estate and repossessed assets increased to $20.177 million from $16.020 million.
Impaired loans totaled $49.718 million. Troubled debt restructurings were $30.508 million, including $23.283 million on nonaccrual status. The allowance for loan losses increased to $14.640 million; Q1 net charge-offs were $869,000, compared with approximately $3.9 million in Q1 2011.
Management cited weak economic conditions, soft loan demand, elevated unemployment, collateral-value uncertainty, and the Branson-area tornado. It said it was tightening underwriting and focusing on asset quality. Management anticipated several more quarters of slow growth and a tight economy.

Outlook, unusual items, and contingencies

The filing gives no quantified earnings or revenue guidance. It identifies interest-rate changes, competition, economic conditions, credit deterioration, regulatory changes, and Dodd-Frank implementation as risks.
Effective January 1, 2012, Hawthorn elected fair-value accounting for mortgage servicing rights (MSRs), recording a $459,890 cumulative-effect increase to beginning retained earnings. MSRs were $2.747 million at quarter-end; fair-value changes are now recognized in earnings rather than amortized.
The filing discloses immaterial prior-period error corrections: a $368,000 credit to interest expense for imputed interest on building-construction costs, and a $371,000 tax-related correction. The reported effective tax rate was 9.6%; excluding the tax correction, management reported 32.8%. These items affect comparison of reported earnings with underlying performance.
Q1 non-interest expense included a $177,000 donation of property held in other real estate owned and $88,000 of penalties. Other real estate expense included a $254,000 provision. The MSR fair-value disclosures also include a $538,032 correction of an immaterial prior-period amortization error.
On May 9, 2012, after quarter-end, Hawthorn redeemed $12 million of Treasury CPP preferred stock and paid $140,000 of accrued dividends. The filing reports $30.255 million of original CPP preferred stock issuance.
Pending matters include a class-action suit challenging overdraft fees, for which management could not estimate potential loss, and an appealed loan-commitment case with an amended $510,000 judgment. The company recorded a $157,000 liability for legal actions and said the near-term effect of litigation was not expected to be materially adverse, while noting uncertainty.

Important facts for investors to verify

How much Q1 earnings growth reflects recurring operations versus the disclosed tax and interest-expense corrections.
Whether MSR fair-value assumptions and the disclosed prior-period amortization correction materially affect future earnings volatility.
Trends in commercial real-estate nonaccruals, foreclosures, other real estate owned, impaired loans, and allowance coverage.
The outcome and potential financial exposure of the overdraft-fee class action and the appealed loan-commitment judgment.
The effect of the May 2012 CPP preferred-stock redemption on capital, preferred dividends, and common-shareholder returns.