Hawthorn Bancshares, Inc. — Q2 2012 Form 10-Q
Business context and period. Hawthorn Bancshares, through Hawthorn Bank, provides commercial and consumer banking, lending, trust and mortgage services in communities in and around Missouri. This unaudited report covers the quarter and six months ended June 30, 2012; income comparisons are with the corresponding 2011 periods, while balance-sheet comparisons are principally with December 31, 2011.
Financial performance
| Metric | Three months ended June 30, 2012 | Six months ended June 30, 2012 |
|---|---|---|
| Net interest income | $10.17 million, down 5.7% year over year | $20.99 million, down 1.3% |
| Provision for loan losses | $1.50 million, down 20.3% | $3.20 million, down 11.9% |
| Noninterest income | $2.44 million, up 12.2% | $4.41 million, up 4.3% |
| Noninterest expense | $10.10 million, up 12.1% | $19.58 million, up 6.5% |
| Net income | $740,000, down 47.4% | $2.19 million, down 7.2% |
| Net income available to common shareholders | $48,000; diluted EPS $0.01 | $1.01 million; diluted EPS $0.21 |
| Net interest margin, fully taxable equivalent | 3.77%, versus 3.95% | 3.87%, versus 3.90% |
| Efficiency ratio | 80.0%, versus 69.5% | 77.1%, versus 72.1% |
For comparison, 2011 diluted EPS was $0.19 for Q2 and $0.28 for the first half. Lower loan interest income—reflecting lower average loan balances and yields—reduced net interest income. Lower funding costs partly offset the decline. Mortgage-loan sale gains increased, but were outweighed in profitability by higher operating expenses, including foreclosed-property costs and employee expenses. Preferred dividends and discount accretion further reduced earnings attributable to common shareholders.
Financial position, credit, liquidity and capital
- Balance sheet: Total assets were $1.187 billion at June 30, up 1.4% from year-end. Loans were $844.1 million, nearly unchanged; deposits were $984.6 million, up $26.4 million. Available-for-sale securities were $228.3 million, up from $213.8 million.
- Credit quality: The allowance for loan losses was $15.3 million, or 1.81% of loans, versus $13.8 million, or 1.64%, at year-end. Nonperforming loans were $45.1 million, or 5.34% of loans, down from $53.7 million, or 6.37%. Nonperforming assets were $66.7 million versus $69.7 million. However, other real estate and repossessed assets rose to $21.6 million from $16.0 million, and management-identified potential problem loans not included in nonperforming assets increased to $23.7 million from $11.7 million.
- Impaired and restructured loans: Impaired loans totaled $44.9 million, down from $53.6 million. Troubled debt restructurings were $28.3 million, of which $22.9 million were on nonaccrual status. Net charge-offs were $1.70 million for the half, compared with $4.34 million in 2011.
- Cash flow and liquidity: First-half operating cash flow was $10.45 million; investing activities used $25.60 million and financing activities provided $12.34 million. Cash and cash equivalents ended at $40.4 million, down $2.8 million from year-end. The company reported $247.9 million of liquid assets (including available-for-sale securities and excess Federal Reserve reserves); $166.2 million of securities were pledged. Unused loan commitments and standby letters of credit totaled $137.2 million.
- Borrowings and equity: Borrowings included $49.5 million of subordinated notes, $28.3 million of FHLB advances and $23.8 million of repurchase agreements. Total stockholders’ equity was $92.1 million, down from $102.6 million, principally reflecting the $12 million preferred-stock redemption.
- Regulatory capital: At June 30, company total risk-based capital was 16.90%, Tier 1 risk-based capital 13.63% and leverage 10.17%; each was lower than at year-end. Management stated the company and bank met applicable capital adequacy requirements. Hawthorn Bank’s ratios were 15.29%, 14.03% and 10.48%, respectively.
Changes, outlook, risks and unusual items
- On May 9, 2012, the company redeemed 12,000 Treasury CPP preferred shares for $12 million. It had 18,255 shares remaining, carrying a 5% cumulative dividend through December 2013 and 9% thereafter. Management said it intends to redeem the remaining shares by December 2013. The preferred-stock terms restrict common dividends if preferred dividends are unpaid.
- A 4% common-stock dividend was paid July 1, 2012, after quarter-end; share and per-share information was adjusted retroactively in the filing.
- The company elected fair-value accounting for mortgage servicing rights beginning January 1, 2012. The election increased opening retained earnings by $459,890 net of tax; subsequent fair-value changes are recognized in earnings. Management also disclosed a $538,032 immaterial prior-period MSR amortization-method correction.
- Management disclosed other immaterial prior-period corrections, including a $368,000 credit to time-deposit interest expense and a $371,000 tax-related correction. These affect period comparisons; the six-month effective tax rate was 16.5%, or 30.6% excluding the tax correction.
- Management described Missouri economic conditions as weak, with soft loan demand and expectations of several more quarters of slow growth and a tight economy. Low rates supported refinancing and mortgage-sale activity. The company cited a continuing focus on tighter underwriting and asset-quality improvement. It provided no numerical earnings or financial guidance.
- Foreclosed-property expenses increased; the company cited hotel maintenance costs, property donations totaling $309,000, and $88,000 of penalties in noninterest expense. A $116,000 ATM/debit-card income reclassification increased reported processing expense.
- Risks include credit deterioration and collateral valuations, interest-rate pressure on margins, economic conditions in Missouri, and regulatory changes that could reduce revenue or increase expense. Two legal matters remain: an overdraft-fee class-action case for which loss probability and amount could not be estimated, and a loan-commitment suit with an amended $510,000 judgment under appeal; a $200,000 liability was recorded for the latter.
Important facts for investors to verify
- Whether the rise in potential problem loans and foreclosed assets leads to further charge-offs, provisions or property write-downs; review collateral assumptions underlying the allowance.
- How sustainable earnings are given lower net interest income, higher efficiency ratios and the effect of the disclosed accounting corrections and MSR fair-value estimates.
- Progress and funding plans for the intended redemption of remaining Treasury preferred shares, and the associated dividend restrictions.
- Liquidity capacity if a significant portion of the $137.2 million in commitments is drawn, including the availability of pledged collateral and borrowing lines.
- Developments in the overdraft class action and the appeal of the loan-commitment judgment.