Hawthorn Bancshares, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Hawthorn Bank provides commercial and personal banking, mortgage lending, and trust services in Missouri. Figures below are in millions of dollars unless otherwise noted.
Financial performance
- Second quarter: Net interest income was $11.0 million, up 1.9% from $10.8 million a year earlier. Net income rose 51.5% to $2.9 million, or $0.48 per diluted share, from $1.9 million, or $0.32 per share. Pretax income increased to $3.1 million from $2.9 million.
- First half: Net interest income increased 2.2% to $21.8 million. Net income rose 24.3% to $5.0 million, or $0.83 per diluted share, despite pretax income declining 7.6% to $5.6 million.
- Margins and returns: Fully taxable-equivalent net interest margin fell to 3.25% for Q2 from 3.50% and to 3.27% for the first half from 3.49%. Q2 return on average assets was 0.80% and return on average equity was 12.64%; first-half figures were 0.70% and 11.00%. The efficiency ratio was 73.49% for Q2 and 75.98% for the first half.
- Revenue and costs: Q2 noninterest income increased 18.4% to $2.5 million; noninterest expense rose 2.5% to $9.9 million. First-half noninterest income increased 6.2% to $4.8 million, while expense increased 6.0% to $20.2 million.
- Balance sheet at June 30: Assets were $1.449 billion, up from $1.429 billion at year-end 2017. Gross loans were $1.094 billion, up from $1.068 billion; deposits were $1.183 billion, up from $1.126 billion. Stockholders’ equity was $93.1 million.
- Cash flow and liquidity: First-half operating cash flow was $6.5 million; investing activities used $36.6 million and financing activities provided $18.0 million. Cash and equivalents ended at $50.8 million, down from $62.9 million at year-end. Reported liquid assets, including available-for-sale securities, totaled $273.2 million. Unpledged available-for-sale securities were approximately $40.3 million.
- Debt and capital: Borrowings totaled $159.9 million, down from $198.4 million at year-end; this included $74.2 million of FHLB advances, $36.1 million in repurchase agreements, and $49.5 million in subordinated notes. The company reported total risk-based capital of 13.41%, Tier 1 risk-based capital of 11.13%, and common equity Tier 1 capital of 8.44%; it said the company and bank exceeded applicable well-capitalized levels.
Changes, outlook, and risks
- Management attributed higher net interest income mainly to growth in earning assets, including loans. Margin compression reflected interest-bearing liability costs rising faster than asset yields; the cost of interest-bearing liabilities increased to 1.17% in Q2 from 0.75% a year earlier.
- Net income growth substantially reflected lower taxes: the effective tax rate was 7.2% in Q2 and 11.3% for the first half, versus 33.9% and 34.1% in 2017. The filing cites the federal corporate rate reduction, tax planning and release of a $46,000 capital-loss valuation allowance, and a pension contribution. Further adjustments to provisional Tax Cuts and Jobs Act accounting could be required in 2018.
- Credit measures were mixed. Nonperforming loans were $10.3 million, or 0.94% of loans, versus $10.7 million, or 1.00%, at year-end. Nonaccrual loans increased to $6.3 million from $5.7 million. First-half net charge-offs rose to $390,000 from $21,000, and the provision increased to $750,000 from $680,000. The allowance was $11.2 million, or 1.02% of loans.
- Management said current liquidity resources were adequate for $315.0 million of unused commitments and standby letters of credit, while noting that such commitments are not necessarily expected to be drawn. It expected short-term liquidity needs from daily operations not to vary significantly during 2018. No earnings or margin guidance was provided.
- Key disclosed risks include interest-rate and competitive pressures, weaker economic conditions affecting loan and asset quality, higher credit-loss provisions, regulatory or tax changes, and securities-market changes. Management said pending litigation was not expected to materially affect near-term financial condition or results. Adoption of the expected-credit-loss standard (CECL) was still under evaluation, with the impact undetermined.
- A 4% special stock dividend was paid July 1, 2018; share and EPS figures were retroactively adjusted. The company also made a $1.8 million pension contribution during Q2.
Important facts for investors to verify
- Whether deposit repricing continues to outpace loan and securities yield increases, further pressuring net interest margin.
- Whether lower effective tax rates persist after tax-planning effects and provisional tax accounting adjustments are finalized.
- Trends in nonaccrual loans, charge-offs, troubled debt restructurings, and commercial real estate exposure; commercial real estate mortgage loans were 43.8% of total loans.
- Liquidity and funding costs, including growth in higher-cost deposits, repurchase agreements, and the use of FHLB advances.
- The eventual CECL adoption impact and any further Tax Cuts and Jobs Act adjustments; neither impact was quantified clearly in the filing.