HAWTHORN BANCSHARES, INC. quarterly report, Q2 FY2019

Hawthorn Bancshares, Inc. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019. Hawthorn Bank provides community banking, lending, mortgage, and trust services in Missouri. Financial statements are unaudited.

Financial performance

MetricQ2 2019Q2 2018Six months 2019Six months 2018
Net interest income$12.2 million$11.0 million$23.8 million$21.8 million
Net income$3.52 million$2.91 million$8.19 million$5.00 million
Diluted EPS$0.56$0.46$1.30$0.80
Net interest margin, fully taxable equivalent3.50%3.25%3.39%3.28%
Efficiency ratio67.73%74.11%69.86%76.59%

Q2 pretax income was $4.36 million; provision for loan losses was $250,000 and noninterest expense was $9.67 million. For the first half, pretax income was $10.11 million and the loan-loss provision was $400,000. Noninterest income fell 11.3% in Q2 and 8.5% year to date, partly reflecting lower mortgage-servicing-rights valuation and mortgage-sale income. Noninterest expense declined 2.7% in Q2 and 3.2% year to date, with lower salaries and benefits contributing.

Balance sheet at June 30: Assets were $1.471 billion, down from $1.482 billion at year-end 2018. Loans were $1.157 billion, up from $1.147 billion; deposits were $1.186 billion, down from $1.198 billion. Stockholders’ equity was $109.4 million, up from $99.4 million. Cash and cash equivalents were $28.9 million, down from $42.1 million.

Cash flow and liquidity: First-half operating cash flow was $9.3 million; investing activities used $10.1 million and financing activities used $12.4 million, resulting in a $13.2 million decrease in cash and cash equivalents. Reported liquid assets totaled $232.6 million, including $213.2 million of available-for-sale securities. Core deposits were $1.044 billion, or 88.0% of deposits. Available borrowing capacity under stated collateral and lines was approximately $159.2 million.

Debt and capital: At June 30, borrowings included $85.0 million of FHLB advances, $49.5 million of subordinated notes, and $25.3 million of repurchase agreements. The company reported total risk-based capital of 13.74%, Tier 1 risk-based capital of 11.86%, Common Equity Tier 1 of 8.96%, and a Tier 1 leverage ratio of 10.03%; management stated the company and bank exceeded applicable well-capitalized levels.

Material changes and unusual items

  • Net interest income rose 10.2% in Q2 and 9.2% in the first half year over year. Higher loan balances and yields supported interest income; higher deposit and borrowing costs partly offset the benefit.
  • Q1 included a $2.1 million pretax ($1.6 million after-tax) gain on the February sale of the Branson branch, which transferred approximately $10.6 million of deposits. Excluding that gain, first-half net income was $6.55 million and diluted EPS was $1.04, versus reported GAAP figures of $8.19 million and $1.30.
  • Cash provided by operations included the branch-sale gain adjustment; investing cash flows included a $6.7 million net branch-sale payment. The filing does not explain that cash-flow line further in the text provided.
  • Effective January 1, 2019, lease accounting added $2.3 million of operating right-of-use assets and $2.3 million of lease liabilities; management said adoption had no material effect on other financial statements.
  • A 4% special stock dividend was paid July 1, 2019. Share information and EPS were retroactively adjusted for all periods presented.

Credit, risks, outlook, and contingencies

  • Allowance for loan losses was $11.9 million, or 1.03% of loans. First-half net charge-offs were $169,000, compared with $390,000 in the prior-year period. Nonperforming loans were reported at $5.84 million (0.50% of loans); nonperforming assets were $18.95 million, or 1.29% of assets.
  • Other real estate owned was $13.1 million. Commercial real estate mortgage loans comprised 45.7% of total loans. Management noted that collateral values and local economic conditions affect credit-loss estimates.
  • Management expanded the allowance methodology’s historical loss look-back to begin in Q1 2012, citing the extended economic recovery. The company was evaluating the upcoming CECL standard, had begun parallel credit-risk modeling, and had not determined the adoption impact.
  • Off-balance-sheet commitments totaled $363.3 million, including $236.7 million of credit commitments and $120.7 million of standby letters of credit. No estimated losses were accrued; management said current liquidity resources were adequate and that commitments are not necessarily expected to be drawn in full.
  • The company disclosed routine litigation and did not believe it would materially adversely affect near-term financial condition or results. No specific earnings or revenue guidance was provided.
  • Risks identified include competition, interest-rate and margin changes, economic deterioration and credit losses, regulatory or tax changes, securities-market changes, and execution risks related to acquisitions or integrations. Interest-rate models showed projected net interest income increasing under the disclosed rate-shock scenarios, but management cautioned actual outcomes may differ substantially.

Most important facts for investors to verify

  • How much of first-half earnings growth is sustainable after removing the Branson branch gain.
  • Whether loan growth, margin expansion, and deposit pricing trends continue as funding costs rise.
  • Credit quality trends, particularly commercial real estate exposure, nonperforming loans, watch-list loans, and collateral-dependent assets.
  • The adequacy of liquidity and pledged collateral, including the effect of sizable credit commitments and standby letters.
  • The eventual CECL transition impact and the assumptions supporting the allowance for loan losses.
  • Capital ratios, dividend capacity, and the effects of the July stock dividend on per-share comparisons.