Hawthorn Bancshares, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. Hawthorn Bancshares is a Missouri community bank holding company operating primarily through Hawthorn Bank, which had 24 full-service offices and $1.195 billion in consolidated assets at June 30, 2011. This unaudited filing covers the quarter and six months ended June 30, 2011; comparisons are with the same 2010 periods unless noted.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $10.783 million | $11.114 million | $21.263 million | $21.425 million |
| Provision for loan losses | $1.883 million | $2.150 million | $3.633 million | $4.655 million |
| Noninterest income | $2.179 million | $2.450 million | $4.231 million | $4.455 million |
| Noninterest expense | $9.008 million | $10.320 million | $18.386 million | $19.450 million |
| Net income | $1.408 million | $0.782 million | $2.362 million | $1.276 million |
| Net income available to common shareholders | $0.907 million | $0.281 million | $1.372 million | $0.286 million |
| Diluted EPS | $0.19 | $0.06 | $0.29 | $0.06 |
- Margins and returns: Tax-equivalent net interest margin was 3.95% for Q2 and 3.90% for the first half, versus 3.88% and 3.74%, respectively. Reported return on average assets was 0.47% for Q2 and 0.40% for the first half; return on average common equity was 4.93% and 3.75%. Efficiency ratios were 69.5% and 72.1%.
- Balance sheet at June 30: Assets were $1.195 billion, down 0.5% from year-end 2010. Loans were $868.8 million, down 3.3%; available-for-sale securities were $219.7 million, up from $179.0 million. Deposits were $962.1 million, compared with $946.7 million at year-end. Stockholders’ equity was $104.3 million.
- Cash flow, first half: Operating activities generated $9.5 million; investing activities used $14.8 million; financing activities used $10.5 million. Cash and cash equivalents declined $15.7 million to $35.2 million.
- Borrowings and liquidity: Repurchase agreements, FHLB advances and subordinated notes totaled $121.8 million, down from $146.5 million at year-end. The company reported $236.2 million in liquid assets, including available-for-sale securities, federal funds sold and Federal Reserve excess reserves. It also reported $98.6 million of unused loan commitments and standby letters of credit.
- Regulatory capital: At June 30, the company reported total risk-based capital of 17.54%, Tier 1 risk-based capital of 14.76%, and a leverage ratio of 11.31%. Hawthorn Bank’s respective ratios were 14.72%, 13.47%, and 10.31%; management said both company and bank met applicable capital requirements.
Changes versus the prior comparable periods
- Net income rose 80% in Q2 and 85% for the first half; common earnings per share increased from $0.06 to $0.19 and $0.29, respectively.
- Lower noninterest expense, especially lower other-real-estate expense, and lower loan-loss provisions supported earnings. Q2 other-real-estate expense fell to $0.548 million from $1.506 million; first-half expense fell to $1.041 million from $2.013 million.
- Net interest income declined despite higher net interest margins. Management attributed the decrease mainly to smaller average earning assets, including lower average loan balances; reduced funding costs partly offset lower asset yields.
- Loan balances contracted amid reduced demand, with repayments and payoffs exceeding new originations. Securities holdings expanded as management redeployed liquidity.
- Nonperforming loans were $56.2 million, or 6.47% of loans, versus $56.3 million, or 6.27%, at year-end. Nonperforming assets increased to $72.0 million from $70.3 million. Other real estate and repossessed assets were $15.8 million net.
- Net charge-offs for the first half fell to $4.3 million from $7.2 million, but the allowance for loan losses decreased to $13.9 million from $14.6 million. TDRs increased to $23.9 million from $22.1 million.
Outlook, risks and unusual items
- No earnings or revenue guidance is provided. Management said it did not expect daily operating liquidity needs to vary significantly during 2011.
- Management cited continued economic weakness, elevated unemployment and collateral-value deterioration as credit risks. It tightened underwriting, focused on creditworthy borrowers, and said construction lending would remain closely monitored. The loan portfolio is concentrated in real estate, including commercial real estate mortgages.
- Management identified interest-rate and competitive pressures, regulatory changes including Dodd-Frank, and potential increases in nonperforming assets and loan-loss provisions as risks. It was still assessing the potential effects of Dodd-Frank and related regulations.
- On July 1, 2011, the company paid a 4% common-stock dividend; share and per-share figures were adjusted retroactively. The company also has Treasury CPP preferred stock with a 5% cumulative dividend for the first five years and 9% thereafter if not redeemed, plus a warrant to purchase common shares.
- Pending litigation includes a putative class action alleging unlawful overdraft fees; management said the potential loss could not then be determined. Other disclosed matters include an appeal of a jury verdict concerning a loan-funding allegation and a property-disclosure suit. The company recorded liabilities for certain legal matters; it stated that the class-action outcome and potential loss were not estimable at this stage.
- Available-for-sale securities had $205,000 of gross unrealized losses at June 30, all in loss positions of less than 12 months; management attributed these to interest rates, not credit quality. No other-than-temporary impairment was reported.
- Management concluded disclosure controls were effective at June 30, 2011 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the filing’s allowance-to-loans disclosures: the table reports 1.60% at June 30, while a later MD&A passage states 1.42% after discussing charged-off loans.
- Track commercial real estate credit quality, nonaccrual loans, TDRs, foreclosed assets and the adequacy of the allowance; the filing notes collateral valuations and loss estimates are judgmental.
- Assess whether earnings improvement persists if reduced foreclosure-related expense and lower provisions do not continue, and whether loan demand and average earning assets stabilize.
- Review liquidity and funding exposure, including large time deposits, pledged securities and the potential drawdown of off-balance-sheet commitments.
- Monitor the overdraft class action, the appeal and other litigation, and the costs or revenue effects of Dodd-Frank implementation.