Hawthorn Bancshares, Inc. — Q3 2023 Form 10-Q
Business context and period: Unaudited consolidated results for the quarter and nine months ended September 30, 2023. Hawthorn Bancshares operates Hawthorn Bank, a Missouri community bank focused on commercial and real estate lending, retail banking, mortgage lending, and trust services. Figures below are in millions unless noted.
Financial results and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net interest income | $15.1 | $15.1 | $43.3 | $43.8 |
| Net income | $2.6 | $4.9 | $8.4 | $16.0 |
| Diluted EPS | $0.36 | $0.70 | $1.19 | $2.27 |
| Net interest margin, FTE | 3.35% | 3.56% | 3.23% | 3.57% |
| Efficiency ratio | 79.8% | 65.7% | 77.6% | 65.8% |
- Revenue, costs and margins: Q3 interest income rose, but higher deposit and borrowing costs absorbed the increase. Q3 interest expense was $8.7 million versus $2.8 million a year earlier; nine-month expense was $23.5 million versus $5.7 million. Nine-month non-interest income fell to $5.4 million from $10.9 million, while non-interest expense rose 5% to $37.8 million.
- Balance sheet at September 30: Total assets were $1.879 billion; loans held for investment were $1.557 billion, up from $1.521 billion at year-end 2022. Deposits were $1.580 billion, down from $1.632 billion at year-end; Q3 deposits increased $37.1 million from the prior quarter. Cash and cash equivalents were $27.9 million, compared with $83.7 million at year-end.
- Debt and liquidity: FHLB advances and other borrowings were $112.0 million, versus $98.0 million at year-end; subordinated notes were $49.5 million. Management reported $347.1 million of available borrowing capacity across FHLB, Federal Reserve and federal funds lines, and said liquidity was more than adequate. Core deposits were $1.423 billion, or 90% of deposits; estimated uninsured deposits were $358.7 million.
- Cash flow: For the first nine months, operating activities provided $12.3 million, investing activities used $28.0 million and financing activities used $40.2 million. Net cash and cash equivalents declined $55.9 million. Deposit outflows in demand and interest-bearing transaction accounts were partly offset by growth in time deposits and FHLB funding activity.
- Credit quality and capital: Non-performing loans were $3.8 million, or 0.25% of loans, versus $18.7 million at year-end 2022; management attributed much of the improvement to three large relationships returning to accrual status. The allowance for credit losses was $22.5 million, or 1.44% of loans. Total regulatory capital ratio was 14.20%, common equity Tier 1 was 10.09%, and Tier 1 leverage was 10.43%; the company reported capital above well-capitalized requirements.
Material changes, outlook and risks
- Year-to-date net income declined 47.6%. Net interest margin compressed as funding costs rose faster than asset yields; management noted Q3 margin improved from the prior quarter, partly due to $0.6 million of interest accretion on three loans returned to accrual in June.
- A $4.6 million OREO valuation allowance was recognized in the first nine months, including $2.8 million in Q3. This materially reduced non-interest income. Net OREO and repossessed assets were $3.6 million, down from $8.8 million at year-end, following valuation adjustments and asset sales.
- Available-for-sale securities had $56.5 million of aggregate unrealized losses at quarter-end, attributed by the company to interest rates rather than credit quality. These losses contributed to accumulated other comprehensive loss of $40.0 million. The company stated it did not intend, and was not more likely than not required, to sell the securities before recovery.
- CECL adoption on January 1, 2023 increased the loan allowance by $5.8 million and established a $1.3 million liability for unfunded commitments, producing a $5.6 million after-tax reduction in retained earnings. Prior-year credit-loss figures use the former incurred-loss method and are not fully comparable.
- No specific earnings or financial guidance is provided. Management identified interest-rate changes, deposit liquidity and funding costs, economic conditions and loan quality, securities markets, regulatory changes, and cybersecurity and other disruptions as risks. It highlighted potential industry-wide effects from peer-bank failures. The company reported $339.8 million of off-balance-sheet commitments and letters of credit; management said expected funding demand was low. Pending legal matters were not expected to materially adversely affect results in the near term.
- Management stated disclosure controls were effective and reported no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether deposit trends, uninsured-deposit levels and reliance on FHLB funding remain manageable, and whether reported borrowing capacity is available under changing conditions.
- How rising funding costs affect net interest margin and earnings in subsequent quarters.
- The assumptions supporting the CECL allowance and the substantial Q3/year-to-date OREO valuation allowance; monitor classified loans, non-accrual status and collateral values.
- Whether unrealized securities losses remain interest-rate-related and whether liquidity needs could require securities sales.
- The durability of the improvement in non-performing loans, given management’s attribution to a small number of large relationships returning to accrual.