Hawthorn Bancshares, Inc. — Q1 2018 Form 10-Q
Business context and period. The company is a Missouri community banking holding company operating through Hawthorn Bank, serving communities including Jefferson City, Columbia, Springfield and the greater Kansas City area. This unaudited report covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Financial amounts below are in millions unless otherwise noted.
Financial performance and condition
- Earnings: Net income was $2.09 million, essentially unchanged from $2.10 million in Q1 2017. Diluted EPS was $0.36 in both periods. Pretax income declined 21.7% to $2.50 million, while income tax expense fell 62.4% to $0.41 million; the effective tax rate was 16.4% versus 34.2%.
- Revenue and margins: Net interest income increased 2.5% to $10.75 million; noninterest income declined 4.4% to $2.30 million. On a fully taxable-equivalent basis, net interest margin fell to 3.29% from 3.48%, as funding costs rose faster than asset yields. Average earning assets increased 8.7%, while the average cost of interest-bearing liabilities rose to 1.05% from 0.66%.
- Expenses and profitability: Noninterest expense rose 9.7% to $10.25 million, including higher salaries and benefits and professional fees. The efficiency ratio deteriorated to 78.54% from 72.52%. Return on average assets was 0.60%, versus 0.65%; return on average equity was 9.32%, versus 9.23%.
- Loans and credit: Gross loans were $1.084 billion, up $15.9 million from year-end; net loans were $1.073 billion. The allowance for loan losses was $10.95 million, or 1.01% of loans. Q1 provision was $0.30 million, compared with $0.35 million a year earlier; net charge-offs were $0.205 million, versus net recoveries of $0.026 million. Nonperforming loans were $10.1 million, or 0.93% of loans, down from $10.7 million, or 1.00%, at year-end. Nonperforming assets totaled $23.4 million, including $13.2 million of other real estate and repossessed assets.
- Cash flow and liquidity: Cash and cash equivalents increased to $81.4 million from $62.9 million at year-end. Operating activities provided $2.3 million; investing activities used $8.0 million; financing activities provided $24.2 million. Total deposits rose to $1.180 billion from $1.126 billion. Reported core deposits were $1.044 billion, or 88.4% of deposits. Available liquidity sources (including overnight deposits, certificates of deposit at other banks and available-for-sale securities) totaled $286.0 million.
- Debt and capital: Total borrowings, including repurchase agreements, FHLB advances and subordinated notes, were $168.6 million, down from $198.4 million at year-end. Stockholders’ equity was $91.3 million, approximately unchanged; period-end equity-to-assets was 6.28%. The company reported total risk-based capital of 12.87%, Tier 1 risk-based capital of 10.61%, common equity Tier 1 of 8.04%, and Tier 1 leverage of 9.17%; management stated the company and bank exceeded applicable well-capitalized thresholds.
Material changes versus comparable periods
- Interest income increased, supported by loan growth and higher yields, but interest expense increased faster, principally as deposit and borrowing costs rose; net interest margin contracted.
- Higher operating costs, including a one-time employee bonus, contributed to lower pretax income and a higher efficiency ratio. The lower tax rate largely offset that decline, keeping net income and EPS near prior-year levels.
- Noninterest income was lower mainly because net real estate servicing fees declined by $232,000, largely reflecting a smaller change in mortgage-servicing-right fair value. Processing expense declined following one-time network and provider-change costs in 2017.
- Available-for-sale securities declined to $215.7 million from $226.5 million. Their net unrealized loss increased to approximately $5.3 million from $3.2 million, primarily attributed by management to interest-rate changes rather than credit quality.
- Accumulated other comprehensive loss widened to $7.3 million from $5.7 million, principally reflecting the securities valuation decline. Total comprehensive income was $0.42 million versus $2.42 million in Q1 2017.
Outlook, commentary and risks
- No earnings or revenue guidance was provided. Management said short-term liquidity needs from daily operations were not expected to vary significantly during 2018.
- The company expected to contribute $1.8 million to its pension plan in Q2 2018; the stated minimum required contribution for 2018 was $1.0 million. The plan was soft-frozen to most new hires effective July 2017.
- Management identified sensitivity to competition, interest-rate changes, economic conditions in Missouri and nationally, credit quality and loan-loss provisions, regulatory or tax-law changes, securities-market changes, and integration costs related to acquisitions. Actual results may differ materially from forward-looking statements.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21%. Certain 2017 tax adjustments remained provisional at March 31, 2018, and the company anticipated possible further 2018 adjustments as guidance and tax-return information became available.
- Off-balance-sheet commitments totaled $308.6 million, including $228.6 million of commitments to extend credit and $76.5 million of standby letters of credit. No estimated losses were accrued for these instruments. The company reported pending litigation but did not expect it to materially adversely affect near-term financial condition or results.
- Other notable items: the company recorded a $98,000 gain on investment-security sales; it repurchased 5,468 shares in March at an average $20.51 per share, with approximately $1.85 million remaining under its repurchase plan. Adoption of Topic 606 had no material impact on revenue recognition.
Important facts for investors to verify
- Whether deposit pricing continues to rise faster than yields on loans and other earning assets, pressuring net interest margin.
- Whether elevated expense growth and the Q1 employee bonus are recurring, and how operating costs affect efficiency.
- Trends in charge-offs, nonperforming loans, TDRs, watch-list credits and the adequacy of the allowance, particularly in commercial real estate and construction lending.
- The sensitivity of available-for-sale securities, accumulated other comprehensive loss and liquidity to further interest-rate changes; $194.3 million of securities were pledged at quarter-end.
- The eventual impact of tax-law adjustments, the planned pension contribution, and the potential funding of off-balance-sheet commitments.
- Capital ratios and borrowing capacity as the company pursues loan growth, dividends and share repurchases.