Hawthorn Bancshares, Inc. — Q1 2020 Form 10-Q
Business context and reporting period. Hawthorn Bancshares is a Missouri community banking company operating through Hawthorn Bank. This unaudited report covers the three months ended March 31, 2020; balance-sheet comparisons are with December 31, 2019. Amounts below are in millions unless otherwise noted.
Key financial metrics
| Metric | Q1 2020 / March 31, 2020 | Comparable period / prior year-end |
|---|---|---|
| Total assets | $1,526.5 | $1,493.0 at Dec. 31, 2019 |
| Loans held for investment | $1,180.5 | $1,168.8 at Dec. 31, 2019 |
| Total deposits | $1,179.6 | $1,186.5 at Dec. 31, 2019 |
| Net interest income | $12.5 | $11.6 in Q1 2019 |
| Net interest margin, fully taxable equivalent | 3.55% | 3.27% in Q1 2019 |
| Provision for loan losses | $3.3 | $0.15 in Q1 2019 |
| Net income / diluted EPS | $0.9 / $0.14 | $4.7 / $0.74 in Q1 2019 |
| Operating cash flow | $(0.5) | $3.7 provided in Q1 2019 |
| Cash and cash equivalents | $75.3 | $78.1 at Dec. 31, 2019 |
| Total stockholders’ equity | $116.7 | $115.0 at Dec. 31, 2019 |
- Net interest income rose 7.7% year over year as lower deposit funding costs more than offset slightly lower total interest income. Net interest expense fell to $3.3 million from $4.3 million.
- Noninterest income was $2.25 million, up 7.5%; noninterest expense was $10.45 million, up 5.7%. The efficiency ratio improved to 70.7% from 72.1%.
- Reported return on average assets was 0.23%, and return on average equity was 2.96%. The filing’s non-GAAP presentation, excluding the COVID-related provision and the prior-year branch-sale gain, shows net income of $3.24 million versus $3.03 million and diluted EPS of $0.52 versus $0.48.
- Borrowings totaled $214.1 million, up from $173.7 million at year-end, including $133.8 million of FHLB advances, $30.8 million of repurchase agreements, and $49.5 million of subordinated notes. Available liquidity sources reported by the company totaled $267.8 million, including cash-like deposits, certificates of deposit, and available-for-sale securities.
- Allowance for loan losses was $15.7 million, or 1.33% of loans, compared with $12.5 million, or 1.07%, at year-end. Nonperforming loans were $8.1 million (0.68% of loans), versus $5.1 million (0.43%) at year-end; nonperforming assets totaled $20.8 million.
- Regulatory capital ratios remained above stated well-capitalized thresholds: company total risk-based capital 14.80%, Tier 1 risk-based capital 12.81%, common equity Tier 1 9.64%, and Tier 1 leverage 10.43%.
Material changes versus comparable periods
- Net income fell 81.4% from Q1 2019, chiefly reflecting the $3.3 million loan-loss provision, including an additional $3.0 million pre-tax COVID-19-related provision, and the absence of the prior-year $2.1 million pre-tax gain on the Branson branch sale.
- Asset quality weakened from year-end: nonaccrual loans increased to $7.8 million from $4.8 million, with the filing attributing much of the increase to one commercial and residential mortgage relationship. Net charge-offs were $84,000, compared with $43,000 of net recoveries in Q1 2019.
- Loan balances increased $11.7 million from year-end, while deposits declined $7.0 million. FHLB advances increased $37.0 million during the quarter.
- Mortgage-loan sale gains rose to $419,000 from $105,000 as mortgage loan sales increased to $13.2 million from $5.1 million. Mortgage servicing rights declined $275,000 in value, primarily due to higher prepayment assumptions amid falling rates.
- Noninterest expense increased partly because the company added 17 full-time-equivalent employees to expand its mortgage business.
Outlook, commentary, risks, and unusual items
- Management said COVID-19 had adversely affected results and expected a complex, significant adverse impact on the economy, banking industry, and company, with substantial uncertainty. It anticipated stress among borrowers in hotel, restaurant, gaming, long-term healthcare, and retail industries, with potential effects on repayments, credit-line draws, collateral values, earnings, and capital. No quantified earnings guidance was provided.
- As of May 1, 2020, customers had requested payment modifications totaling $310 million; the bank had processed $80 million of SBA-approved PPP loans. These are post-quarter developments disclosed in the filing. Management expected many modifications to run two to three months and PPP loans to be largely paid off within two to three months, while noting longer-term liquidity effects would be monitored.
- Management reported that Missouri’s pandemic-related business curtailments sharply increased unemployment; it noted effects had so far been less significant in the smaller communities where the bank primarily operates than in larger metropolitan areas. Branch lobbies were closed from March 18 until May 4, 2020, while banking services continued by appointment and drive-up.
- Management stated liquidity was more than adequate based on on-balance-sheet resources and additional borrowing capacity. Available additional funding capacity was reported at $133.0 million; $81.0 million of FHLB letters of credit and $133.8 million of FHLB advances were already outstanding against reported capacity.
- The filing reports an existing material weakness in internal control over financial reporting; management concluded disclosure controls were not effective as of May 7, 2020. No material control changes occurred in the quarter, and management expected remediation before year-end 2020, subject to successful operation and testing of controls.
- Other matters include $362.7 million of off-balance-sheet credit commitments and standby letters of credit, with no loss accrual recorded; pending legal actions were not believed reasonably likely to materially affect near-term results. The company repurchased 34,934 shares for $719,000 during the quarter and declared $0.12 per-share dividends.
Important facts for investors to verify
- How the COVID-19-related $3.0 million provision and the allowance will evolve as borrower conditions, unemployment, and loan performance become clearer.
- Current status, performance, and subsequent-period treatment of the $310 million of requested payment modifications and $80 million of PPP loans approved through May 1.
- Trends in nonaccrual loans, watch-list and substandard credits, impaired loans, and collateral values, particularly for exposed industries and the loan relationship cited by management.
- Whether deposit trends, FHLB borrowing, pledged collateral, and available liquidity remain adequate if customer draws or deposit outflows exceed management’s expectations.
- Progress and testing results for remediation of the material weakness in internal control over financial reporting.
- Whether the one-time trust fees, mortgage activity, and other contributors to noninterest income are sustainable; also distinguish GAAP results from the company’s non-GAAP adjustments.