Hawthorn Bancshares, Inc. — Q3 2011 Form 10-Q
Business context and period. Hawthorn Bancshares is a Missouri community bank holding company operating primarily through Hawthorn Bank, with 24 full-service offices. This unaudited filing covers the quarter and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010.
Financial results and position
| Metric | Q3 2011 / Sep. 30, 2011 | Comparable period / prior date |
|---|---|---|
| Net interest income | $10.80 million for Q3; $32.07 million for nine months | Q3 2010: $10.86 million; nine months 2010: $32.28 million |
| Net interest margin, fully taxable equivalent | 3.98% Q3; 3.92% nine months | 3.81% Q3 2010; 3.77% nine months 2010 |
| Net income | $1.52 million Q3; $3.88 million nine months | $1.42 million Q3 2010; $2.70 million nine months 2010 |
| Net income available to common shareholders; diluted EPS | $1.02 million and $0.22 Q3; $2.39 million and $0.51 nine months | $0.92 million and $0.20 Q3 2010; $1.21 million and $0.26 nine months 2010 |
| Provision for loan losses | $2.01 million Q3; $5.64 million nine months | $2.45 million Q3 2010; $7.11 million nine months 2010 |
| Total assets; total deposits | $1.170 billion; $952.95 million | Dec. 31, 2010: $1.200 billion; $946.66 million |
| Loans; allowance for loan losses | $849.80 million; $12.69 million (1.49% of loans) | Dec. 31, 2010: $898.47 million; $14.56 million (1.62%) |
| Cash and cash equivalents | $41.38 million at period-end; $13.99 million operating cash flow for nine months | $50.98 million at Dec. 31, 2010; $11.14 million operating cash flow for nine months 2010 |
| Borrowings | $104.17 million: $26.20 million repurchase agreements, $28.49 million FHLB advances, $49.49 million subordinated notes | $146.54 million at Dec. 31, 2010 |
| Regulatory capital | Company total risk-based capital 18.02%; Tier 1 risk-based 15.24%; leverage 11.60% | At Dec. 31, 2010: 17.05%, 14.25%, and 11.00%, respectively |
Q3 pretax income was $2.23 million, versus $1.95 million a year earlier. Noninterest income was $2.36 million for Q3 and $6.59 million for nine months, down 19.0% and 10.6%, respectively. Noninterest expense declined 4.7% in Q3 and 5.2% for nine months. The filing reports efficiency ratios of 67.8% for Q3 and 70.7% for nine months.
Material changes and operating trends
- Nine-month net income increased 43.7% and diluted EPS rose from $0.26 to $0.51. Management attributed improvement chiefly to lower loan-loss provisions and lower other real estate expense, rather than stronger net interest income.
- Net interest income was slightly lower, as reduced average earning assets and loan balances outweighed lower funding costs. The margin improved as deposit and borrowing costs fell more than asset yields.
- Mortgage-loan sale gains declined: $0.43 million for Q3 versus $1.01 million, and $0.89 million for nine months versus $1.53 million. Management cited reduced refinancing activity and lower loan-sale volume.
- Total loans fell 5.4% from year-end, reflecting repayments, charge-offs, transfers to foreclosed assets, and subdued loan demand. Available-for-sale securities increased to $205.45 million from $178.98 million.
- Nonperforming loans were $53.86 million, or 6.34% of loans, versus $56.30 million, or 6.27%, at year-end. Nonperforming assets increased to $71.93 million from $70.31 million; other real estate and repossessed assets rose to $18.50 million from $14.01 million.
- Troubled debt restructurings increased to $33.69 million from $22.08 million at year-end. Nonaccrual loans declined overall, but commercial real estate mortgage nonaccrual loans increased and represented 70% of nonaccrual loans.
Outlook, risks, contingencies, and unusual items
- No earnings or financial guidance is provided. Management said future short-term liquidity needs from daily operations were not expected to vary significantly during 2011, while noting that the $162.02 million of unused loan commitments and standby letters of credit could be difficult to fund if drawn in full; management considered the likelihood of that funding demand very low.
- Management cited economic weakness, unemployment, collateral-value deterioration, competition, interest-rate changes, regulation, and possible further nonperforming assets and provisions as risks. It said underwriting standards had been tightened and construction lending would continue to be closely monitored.
- Q3 net charge-offs were $3.18 million, compared with $0.73 million a year earlier; eight significant charge-offs totaled $3.09 million. For nine months, net charge-offs were $7.52 million, slightly below the prior-year $7.95 million.
- The company refined its allowance methodology in Q3, distributing the prior unallocated reserve across loan classes through qualitative adjustments. The allowance was $12.69 million, including $3.93 million for impaired loans; management judged it adequate, but emphasized that estimates depend on collateral values and economic conditions.
- Cash declined $9.60 million during the first nine months, in part as the company repaid $38.49 million of FHLB advances and invested in securities. Management reported $226.62 million of liquid assets, including securities, excess Federal Reserve reserves, and federal funds sold; $160.01 million of securities were pledged.
- The company paid a 4% special common-stock dividend on July 1, 2011. It also has $30.26 million of Treasury-issued preferred stock under the Capital Purchase Program, with cumulative dividends of 5% for the first five years and 9% thereafter if not redeemed; common dividends are restricted unless preferred dividends are paid.
- Pending litigation includes a customer class-action suit alleging unlawful interest through overdraft fees; management said a material outcome could not yet be assessed. A separate loan-funding case was in the appeals process, with a recorded liability of $183,000. The filing states that other pending legal matters were not expected to materially adversely affect near-term results.
- Management identified possible future revenue and expense effects from Dodd-Frank rules. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether commercial real estate nonaccruals, TDRs, and foreclosed-asset balances continue to improve or require additional charge-offs, provisions, or valuation allowances.
- How the revised allowance methodology and collateral appraisals support reserve adequacy, especially given the 1.49% allowance-to-loan ratio and 23.56% allowance-to-nonperforming-loan ratio.
- Whether loan demand, average earning assets, net interest margin, and mortgage refinancing and sale activity sustain or reverse their reported trends.
- Liquidity and funding exposure, including the composition and stability of deposits, pledged collateral, borrowing capacity, and potential draws on $162.02 million of commitments.
- Developments in the overdraft-fee class action and loan-funding appeal, and the status and potential cost of applicable regulatory changes.
- Capital implications and dividend restrictions associated with the Treasury preferred stock, including redemption prospects and the step-up in its dividend rate after five years.