Hawthorn Bancshares, Inc. — Q3 2018 Form 10-Q
Business context and period. Hawthorn Bancshares is a Missouri community banking holding company operating through Hawthorn Bank. This unaudited filing covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2018 / Sep. 30, 2018 | Comparable period / prior year-end |
|---|---|---|
| Interest income; net interest income | $14.75; $11.31 | Q3 2017: $12.94; $10.75 |
| Net interest margin, fully taxable equivalent | 3.30% for Q3; 3.28% for nine months | Q3 2017: 3.35%; nine months 2017: 3.44% |
| Noninterest income | $2.32 for Q3; $6.91 for nine months | Q3 2017: $2.18; nine months 2017: $6.69 |
| Net income; diluted EPS | $3.10; $0.51 for Q3. $8.10; $1.34 for nine months | Q3 2017: $1.77; $0.29. Nine months 2017: $5.79; $0.95 |
| Total assets; loans | $1,451.7; $1,115.8 | Dec. 31, 2017: $1,429.2; $1,068.4 |
| Deposits; borrowings | $1,182.7; $160.9 | Dec. 31, 2017: $1,125.8; $198.4 |
| Cash and cash equivalents | $36.8 | Dec. 31, 2017: $62.9 |
| Allowance for loan losses; nonperforming loans | $11.4; $6.0 | Allowance was $10.9 at Dec. 31, 2017; nonperforming loans were $5.7 |
| Stockholders’ equity | $94.9 | Dec. 31, 2017: $91.4 |
For the nine months, operating cash flow was $11.3, investing cash flow was negative $55.2, and financing cash flow was positive $17.9. The net $26.1 decrease in cash primarily reflected loan growth and securities purchases, partly offset by deposit growth and borrowing activity. The filing reports a 72.54% Q3 efficiency ratio and return on average assets/equity of 0.85%/13.02%; nine-month figures were 75.19% and 0.75%/11.69%.
Material changes and management commentary
- Q3 net income rose 75.4% year over year and nine-month net income rose 39.9%. Lower loan-loss provision and sharply lower income-tax expense contributed to the increase.
- Net interest income increased 5.2% in Q3 and 3.2% for the nine months, supported by loan and earning-asset growth. However, margin declined as funding costs rose faster than asset yields. Nine-month interest expense increased to $9.5 from $5.7; the average cost of interest-bearing liabilities rose to 1.16% from 0.76%.
- Loans grew $47.3 from year-end, notably in commercial real estate mortgage lending. Commercial real estate mortgage loans were $506.2, or 45.4% of total loans. Management reports no loan concentration exceeding 10% of total loans other than categories disclosed.
- Provision for loan losses was $1.0 for the nine months, versus $1.2 in 2017; net charge-offs increased to $494,000 from $121,000, primarily due to two commercial loan relationships. Nonperforming assets were $19.4, including $13.4 of other real estate owned and repossessed assets.
- The effective tax rate was 11.8% for the nine months, compared with 33.6% in 2017. The lower rate reflected the federal corporate rate reduction, tax planning, a $306,000 pension-related benefit, a $180,000 benefit from tax-return accounting-method changes, and release of a $46,000 capital-loss valuation allowance.
Outlook, risks, contingencies and unusual items
- The filing provides no quantified earnings or financial guidance. Management says near-term daily operating liquidity needs were not expected to vary significantly during 2018.
- Interest-rate exposure modeling at September 30 showed projected net interest income changes of positive 2.21% under an immediate +200-basis-point shock, positive 3.22% under +100 basis points, and positive 5.96% under −100 basis points. Actual outcomes may differ because of market conditions, rate timing, deposit behavior and other assumptions.
- Available-for-sale securities had $7.1 of gross unrealized losses, compared with $3.3 at year-end 2017. Management attributed the losses to interest-rate changes, considered them temporary, and said it did not intend, and was not more likely than not required, to sell the securities before recovery.
- Q3 and nine-month securities gains were $50,000 and $256,000, respectively, generated in part through short-term Treasury sales and repurchase agreements to offset capital losses expiring in 2018 and 2019. These gains and the tax benefits described above are unusual contributors to reported results.
- On October 18, 2018, the Bank announced an agreement to sell its Branson branch, with approximately $15 of deposits and excluding assigned loans. Closing was expected in Q1 2019, subject to regulatory approval and other conditions.
- Off-balance-sheet commitments to extend credit, originate residential mortgage loans and provide standby letters of credit totaled $297.5. No estimated loss was accrued. Management says litigation is not expected to materially adversely affect near-term financial condition or results, while noting some matters are too early to assess.
- Key risks cited include competition, interest-rate changes and margin pressure, economic conditions affecting Missouri borrowers and asset quality, higher credit-loss provisions, regulatory or tax-law changes, securities-market changes, and acquisition integration risks. Management identified the allowance for loan losses and collateral valuations as critical estimates.
- The company adopted Topic 606 in 2018 without material financial-statement impact. It was evaluating or preparing for forthcoming standards, including CECL; it had not determined CECL’s impact and planned parallel credit-risk modeling beginning in Q1 2019.
Important facts for investors to verify
- Whether higher deposit and borrowing costs continue to outpace loan-yield increases and further pressure net interest margin.
- Credit performance in commercial real estate and the trend in nonperforming loans, charge-offs, impaired loans and $13.4 of OREO.
- How much reported earnings depend on the lower tax rate, tax-planning benefits and securities gains, rather than recurring operating performance.
- Execution and regulatory approval of the Branson branch sale, including the effect of transferring approximately $15 of deposits while excluding loans.
- Liquidity and funding sensitivity, including the decline in cash, the level of large time deposits and brokered deposits, and availability of secured borrowing capacity.
- Potential effects of CECL adoption and the interest-rate and fair-value assumptions underlying securities and collateral valuations.