Hawthorn Bancshares, Inc. — Q2 2017 Form 10-Q
Business context and period. Hawthorn is a Missouri community banking holding company operating through Hawthorn Bank. It provides commercial and consumer banking, mortgage lending, trust and cash-management services in communities across Missouri. This unaudited report covers the quarter and six months ended June 30, 2017; balance-sheet comparisons are to December 31, 2016 unless noted. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $10.82m | $9.97m | $21.31m | $19.82m |
| Provision for loan losses | $0.33m | $0.43m | $0.68m | $0.68m |
| Noninterest income | $2.10m | $1.95m | $4.51m | $4.40m |
| Noninterest expense | $9.69m | $9.35m | $19.04m | $18.44m |
| Net income | $1.92m | $1.41m | $4.02m | $3.41m |
| Diluted EPS | $0.33 | $0.24 | $0.69 | $0.58 |
- Q2 net income rose 35.9%; first-half net income rose 17.9%. Net interest income increased 8.5% and 7.5%, respectively.
- Fully taxable-equivalent net interest margin was 3.50% in Q2 versus 3.49% a year earlier; first-half margin was 3.49% versus 3.50%. Average loan balances grew 14.4% in both comparisons, while loan yields eased and deposit and borrowing costs increased.
- Q2 return on average assets was 0.58% and return on average equity 8.35%; first-half figures were 0.61% and 8.65%. Efficiency ratio improved to 74.98% for Q2 and 73.75% for the first half, from 78.46% and 76.13%.
Financial position, cash flow and credit
- At June 30, total assets were $1.384bn, up 7.5%; loans were $1.035bn, up 6.3%; and deposits were $1.083bn, up 7.1%. Stockholders’ equity was $95.1m, or 6.88% of assets, compared with 7.25% at year-end.
- Cash and cash equivalents were $61.3m, versus $27.0m at year-end. Available-for-sale securities were $216.4m; together with overnight interest-bearing deposits, management reported $256.9m in these principal liquid assets. Core deposits were $979.0m, or 90.4% of deposits.
- Six-month operating cash flow was $5.9m; investing activities used $62.9m, principally reflecting loan growth and securities purchases; financing activities provided $91.3m. Financing included deposit growth and increased FHLB advances.
- Borrowings totaled $194.0m, including $115.4m of FHLB advances, $49.5m of subordinated notes and $29.1m of repurchase agreements, compared with $173.9m at year-end. The filing reports $207.3m of available capacity across listed FHLB, Federal Reserve and federal funds lines, after stated advances and letters of credit.
- Regulatory capital ratios at June 30 included total risk-based capital of 13.47%, Tier 1 risk-based capital of 11.20%, common equity Tier 1 of 8.43%, and Tier 1 leverage of 9.77%. The company says it and the Bank exceeded applicable well-capitalized thresholds.
- The allowance for loan losses was $10.5m, or 1.02% of loans, versus $9.9m, or 1.01%, at year-end. First-half net charge-offs were $21,000, compared with net recoveries of $113,000 in the prior-year period.
- Nonperforming loans were $10.0m, or 0.97% of loans, versus $9.2m, or 0.95%, at year-end. Nonperforming assets were $23.4m, essentially unchanged, as lower other real estate assets offset higher nonperforming loans. Nonaccrual loans rose to $4.4m from $3.4m.
Material changes and unusual items
- Loan growth was concentrated notably in commercial real estate: commercial construction loans increased to $78.3m from $55.7m, and commercial mortgage loans to $461.1m from $426.5m. Commercial mortgage loans represented 44.5% of total loans.
- Noninterest expense grew 3.6% in Q2 and 3.3% in the first half. Furniture and equipment and processing/network costs rose substantially, which management attributed largely to data-processing infrastructure, network upgrades and provider changes. Lower FDIC assessments partly offset the increases.
- First-half 2016 included a $490,000 gain on securities sales; there were no such gains in 2017. Conversely, real-estate servicing income improved, largely reflecting slower mortgage prepayments in a higher-rate environment.
- On July 1, 2017, the company paid a special 4% stock dividend; share and per-share figures were retrospectively adjusted. The pension plan was also soft-frozen to new entrants effective July 1. Management expected a $1.2m pension contribution on September 15, 2017; the stated 2017 minimum was $842,000.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management’s stated strategy is to grow commercial banking, retail mortgage lending and retail banking while maintaining acceptable credit risk and controlling expense growth. Management said routine short-term liquidity needs were not expected to vary significantly during 2017 and considered current liquidity adequate for the reported commitment level.
- Key risks cited include competition, changes in interest rates that could reduce margins, weaker national or Missouri economic conditions, deterioration in loan and asset quality, higher loan-loss provisions, regulatory or legislative changes, securities-market changes, and acquisition integration costs.
- Off-balance-sheet commitments totaled $281.7m, including $220.1m of credit commitments, $4.6m of residential mortgage origination commitments and $57.0m of standby letters of credit. No estimated losses were accrued. Commitment totals do not necessarily represent future cash needs because some expire unused.
- The company and subsidiaries face ordinary-course litigation. Management did not believe the matters were reasonably likely to materially adversely affect near-term financial condition or results, while noting that some matters were too early to assess for probable loss or estimate.
- Management identifies loan-loss allowances and collateral values for impaired loans and foreclosed assets as significant estimation areas. It also cautions that actual results may differ from forward-looking statements and that interest-rate sensitivity estimates depend on assumptions about loan repayments and deposit behavior.
Important facts for investors to verify
- Whether loan growth—especially commercial real estate and construction growth—is being matched by stable underwriting, collateral quality and allowance coverage.
- Developments in nonaccrual loans, past-due balances, TDRs, classified/watch loans and other real estate assets, including the valuation of collateral.
- Deposit pricing and funding mix, further FHLB borrowing, and whether increased funding costs pressure net interest margin.
- The size, utilization and risk profile of the $281.7m off-balance-sheet commitments, particularly the increase in standby letters of credit from $2.7m at year-end to $57.0m.
- Execution and ongoing costs of the technology/network upgrades, and the expected pension contribution and effects of the plan freeze.
- Management’s assessment of future credit-loss accounting impacts; the filing says the eventual effect of the expected credit-loss standard had not yet been determined.