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HWBK > SEC Filings for HWBK > Form 10-Q on 15-May-2013All Recent SEC Filings

Show all filings for HAWTHORN BANCSHARES, INC. | Request a Trial to NEW EDGAR Online Pro



Quarterly Report

Item 2 - Management's Discussion and Analysis of Financial Condition

And Results of Operations

Forward-Looking Statements

This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company and its subsidiaries, including, without limitation:

statements that are not historical in nature, and

statements preceded by, followed by or that include the words believes, expects, may, will, should, could, anticipates, estimates, intends or similar expressions.

Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

competitive pressures among financial services companies may increase significantly,

changes in the interest rate environment may reduce interest margins,

general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,

increases in non-performing assets in the loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,

costs or difficulties related to the integration of the business of the Company and its acquisition targets may be greater than expected,

legislative or regulatory changes may adversely affect the business in which the Company and its subsidiaries are engaged, and

changes may occur in the securities markets.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, was enacted on July 21, 2010. Provisions of the Act address many issues including, but not limited to, capital, interchange fees, compliance and risk management, debit card overdraft fees, the establishment of a new consumer regulator, healthcare, incentive compensation, expanded disclosures and corporate governance. While many of the new regulations under the Act are expected to primarily impact financial institutions with assets greater than $10 billion, the Company expects these new regulations could reduce revenues and increase expenses in the future. Management is currently assessing the impact of the Act and of the regulations anticipated to be promulgated under the Act.

The Company has described under the caption Risk Factors in the Annual Report on Form 10-K for the year ended December 31, 2012 and in other reports that the company files with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.


Through the branch network of its subsidiary bank, the Company provides a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts, and money market accounts. The Company also provides a wide range of lending services, including real estate, commercial, installment, and other consumer loans. Other financial services that the Company provides include automated teller machines, trust services, credit-related insurance, and safe-deposit boxes. The geographic areas in which the Company provides products and services include the communities in and surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee's Summit, Missouri.

The Company's primary source of revenue is net interest income derived primarily from lending and deposit taking activities. A secondary source of revenue is investment income. The Company also derives income from trust, brokerage, credit card and mortgage banking activities and service charge income.

Much of the Company's business is commercial, commercial real estate development, and mortgage lending. The Company has experienced soft loan demand in the communities within which we operate during the current economic slowdown. The Company's income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancings.

The success of the Company's growth strategy depends primarily on the ability of the banking subsidiary to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. The Company's financial performance also depends, in part, on the ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of the Company's growth strategy depends on the ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control.

Hawthorn Bank (the Bank), the Company's subsidiary bank, is a full-service bank conducting a general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, the Bank provides trust services.

The deposit accounts of the Bank are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The operations of the Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of the Bank are conducted by representatives of the FDIC and the Missouri Division of Finance. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is subject to supervision and examination by the Federal Reserve Board.


The following accounting policies are considered most critical to the understanding of the Company's financial condition and results of operations. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to the critical accounting policies on the business operations are discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations, where such policies affect the reported and expected financial results.

Allowance for Loan Losses

Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of the Company's results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Further discussion of the methodology used in establishing the allowance and the impact of any associated risks related to these policies on the business operations is provided in Note 1 to the Company's consolidated financial statements and is also discussed in the Lending and Credit Management section below. Many of the loans are deemed collateral dependent for purposes of the measurement of the impairment loss, thus the fair value of the underlying collateral and sensitivity of such fair values due to changing market conditions, supply and demand, condition of the collateral and other factors can be volatile over periods of time. Such volatility can have an impact on the financial performance of the Company.

Income Taxes

Income taxes are accounted for under the asset / liability method by recognizing the amount of taxes payable or refundable for the current period and deferred tax assets and liabilities for future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Judgment is required in addressing the Company's future tax consequences of events that have been recognized in the consolidated financial statements or tax returns such as realization of the effects of temporary differences, net operating loss carry forwards and changes in tax laws or interpretations thereof. A valuation allowance is established when in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. In this case, the Company would adjust the recorded value of the deferred tax asset, which would result in a direct charge to income tax expense in the period that the determination was made. Likewise, the Company would reverse the valuation allowance when it is expected to realize the deferred tax asset. In addition, the Company is subject to the continuous examination of its tax returns by the Internal Revenue Service and other taxing authorities. The Company accrues for penalties and interest related to income taxes in income tax expense. As of March 31, 2013, the Company has not recognized any tax liabilities or any interest or penalties in income tax expense related to uncertain tax positions.

Other Real Estate Owned and Repossessed Assets

Other real estate owned and repossessed assets consist of loan collateral that has been repossessed through foreclosure. This collateral comprises commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Other real estate owned assets are initially recorded as held for sale at the fair value of the collateral less estimated selling costs. Any adjustment is recorded as a charge-off against the allowance for loan losses. The Company relies on external appraisals and assessment of property values by internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgment based on experience and expertise of internal specialists. Subsequent to foreclosure, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. The write-downs are recorded as other real estate expense. The Company establishes a valuation allowance related to other real estate owned on an asset-by-asset basis. The valuation allowance is created during the holding period when the fair value less cost to sell is lower than the cost of the property.


The following table presents selected consolidated financial information for the Company as of and for each of the three months ended March 31, 2013 and 2012, respectively. The selected consolidated financial data should be read in conjunction with the consolidated financial statements of the Company, including the accompanying notes, presented elsewhere herein.

Selected Financial Data

                                                                    Three Months Ended
                                                                         March 31,
(In thousands, except per share data)                             2013               2012
Per Share Data
Basic (loss) earnings per common share                          $   (0.09 )         $  0.20
Diluted (loss) earnings per common share                            (0.09 )            0.20
Dividends paid on preferred stock                                     228               378
Accretion of discount on preferred stock                               72               119
Dividends paid on common stock                                        242               233
Book value per common share                                         15.29             15.37
Market price per common share                                       11.52              7.22
Selected Ratios
(Based on average balance sheets)
Return on average total assets                                      (0.05 )%           0.49 %
Return on average common stockholders' equity                       (2.33 )%           5.21 %
Average common stockholders' equity to average total assets          7.85 %            8.68 %
(Based on end-of-period data)
Efficiency ratio(1)                                                 93.70 %           74.15 %
Period-end common stockholders' equity to period-end assets          7.66 %            8.61 %
Period-end stockholders' equity to period-end assets                 6.14 %            6.17 %
Total risk-based capital ratio                                      16.84 %           18.28 %
Tier 1 risk-based capital ratio                                     13.55 %           15.45 %
Leverage ratio                                                      10.09 %           11.43 %

(1) Efficiency ratio is calculated as non-interest expense as a percent of revenue. Total revenue includes net interest and non-interest income.


The Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.

                                                          Three Months Ended March 31,
(In thousands)                                 2013           2012        $ Change        % Change
Net interest income                          $  9,729       $ 10,815      $  (1,086 )         (10.0 )%
Provision for loan losses                       1,000          1,700           (700 )         (41.2 )
Noninterest income                              2,713          1,970            743            37.7
Investment securities gains, net                  294             -             294              NM
Total noninterest income                        3,007          1,970          1,037            52.6
Noninterest expense                            11,934          9,480          2,454            25.9
(Loss) income before income taxes                (198 )        1,605         (1,803 )         112.3

Income tax (benefit) expense                      (62 )          154           (216 )         140.3

Net (loss) income                            $   (136 )     $  1,451      $  (1,587 )        (109.4 )%

Less: preferred dividends                         223            370           (147 )         (39.7 )
and accretion of discount                          72            119            (47 )         (39.5 )

Net (loss) income available to common
shareholders                                 $   (431 )     $    962      $  (1,393 )        (144.8 )%

The Company's consolidated net loss of $136,000 for the three months ended March 31, 2013 decreased $1,587,000 compared to consolidated net income of $1,451,000 for the three months ended March 31, 2012. The Company recorded preferred stock dividends and accretion on preferred stock of $295,000 for the three months ended March 31, 2013, resulting in a net loss of $431,000 available for common shareholders compared to $962,000 of net income available for common shareholders for the three months ended March 31, 2012. Diluted (loss) earnings per share decreased from $0.20 per common share for the three months ended March 31, 2012 to $(0.09) per common share for the three months ended March 31, 2013. The Company's net interest income, on a tax equivalent basis, decreased $1,097,000, or 10.0%, to $9,860,000 for the three months ended March 31, 2013 compared to $10,957,000 for the three months ended March 31, 2012. This decrease was primarily due to a 33 basis point decrease in the net interest margin from 3.98% for the three months ended March 31, 2012 to 3.65% for the three months ended March 31, 2013, and a period over period decrease in average earning assets of $9.1 million, or 0.8%. The provision for loan losses decreased $0.7 million, or 41.2%, from the three months ended March 31, 2012 to the three months ended March 31, 2013 due to reduced levels of nonperforming assets in 2013 compared to 2012. Total noninterest income increased $1.0 million, or 52.6%, for the three months ended March 31, 2013 compared to March 31, 2012 primarily due to a $0.2 million increase in gain on sales of mortgage loans, a $0.4 million increase in mortgage servicing income related to changes in the fair value of mortgage servicing rights, and a $0.3 million gain on sale of investment securities. Noninterest expense increased $2.4 million, or 25.9%, from the three months ended March 31, 2012 to 2013. Included in this increase was a $2.3 million increase in other real estate expense due to costs incurred on foreclosed assets and an increase in the provision for the valuation allowance for other real estate owned primarily related foreclosed commercial real estate property consisting of two hotels located in the Branson area due to continued deterioration of value. The $216,000 decrease in income tax expense for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 is primarily due to a $1,803,000 decrease in income before income taxes. This decrease was partially offset by a $371,000 immaterial correction of a prior period error recorded in 2012 as further discussed below. For the three months ended March 31, 2013, the return on average assets was (0.05)%, the return on average common stockholders' equity was (2.33)%, and the efficiency ratio was 93.7%.

Total assets at March 31, 2013 were $1,186,319,000, compared to $1,181,606,000 at December 31, 2012, an increase of $4,713,000, or 0.4%. On July 1, 2012, the Company distributed a four percent stock dividend for the fourth consecutive year to common shareholders of record at the close of business on June 15, 2012. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect the stock dividend. On May 9, 2012, the Company redeemed 12,000 of the 30,255 shares of preferred stock issued under the U.S. Treasury's CPP program. The Company has approval and will redeem the remaining 18,255 shares on May 15, 2013.

Net Interest Income

Net interest income is the largest source of revenue resulting from the Company's lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities.

Average Balance Sheets

The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the three month periods ended March 31, 2013 and March 31, 2012, respectively.

                                                                      Three Months Ended March 31,
(In thousands)                                           2013                                             2012
                                                         Interest         Rate                            Interest         Rate
                                        Average          Income/         Earned/         Average          Income/         Earned/
                                        Balance         Expense(1)       Paid(1)         Balance         Expense(1)       Paid(1)
Commercial                            $   126,969      $      1,559          4.98 %    $   128,376      $      1,655          5.17 %
Real estate construction -
residential                                22,746               252          4.49           23,333               461          7.92
Real estate construction -
commercial                                 44,681               514          4.67           42,940               482          4.50
Real estate mortgage - residential        219,843             2,781          5.13          212,745             2,936          5.54
Real estate mortgage - commercial         400,681             4,928          4.99          403,846             5,265          5.23
Consumer                                   25,069               378          6.12           28,304               469          6.65

Total loans                           $   839,989      $     10,412          5.03 %    $   839,544      $     11,268          5.38 %

Investment securities:(3)
U.S. treasury                         $     2,029      $          8          1.60 %    $     2,071      $          8          1.55 %
Government sponsored enterprises           71,949               216          1.22           75,817               297          1.57
Asset backed securities                   117,396               670          2.31          109,429               800          2.93
State and municipal                        35,157               334          3.85           33,307               363          4.37

Total investment securities           $   226,531      $      1,228          2.20 %    $   220,624      $      1,468          2.67 %

Restricted investments                      3,924                22          2.27            4,335                31          2.87
Federal funds sold and other
overnight interest-bearing deposits        24,661                14          0.23           39,769                21          0.21

Total interest earning assets         $ 1,095,105      $     11,676          4.32 %    $ 1,104,272      $     12,788          4.64 %

All other assets                          105,301                                          101,964
Allowance for loan losses                 (15,271 )                                        (13,882 )

Total assets                          $ 1,185,135                                      $ 1,192,354

NOW accounts                          $   203,709      $        147          0.29 %    $   195,768      $        189          0.39 %
Savings                                    71,535                19          0.11           63,516                20          0.13
Money market                              159,549                95          0.24          154,053               116          0.30
Time deposits of $100,000 and over        119,511               247          0.84          135,522               229          0.68
Other time deposits                       271,682               884          1.32          275,158               784          1.14

Total time deposits                   $   825,986      $      1,392          0.68 %    $   824,017      $      1,338          0.65 %

Federal funds purchased and
securities sold under agreements to
repurchase                                 18,544                 5          0.11           22,528                 5          0.09
Subordinated notes                         49,486               320          2.62           49,486               354          2.87
Federal Home Loan Bank advances            20,104                99          2.00           28,388               134          1.89

Total borrowings                      $    88,134      $        424          1.95 %    $   100,402      $        493          1.97 %

Total interest bearing liabilities    $   914,120      $      1,816          0.81 %    $   924,419      $      1,831          0.79 %

Demand deposits                           171,398                                          156,047
Other liabilities                           6,595                                            8,411

Total liabilities                       1,092,113                                        1,088,877
Stockholders' equity                       93,022                                          103,477

Total liabilities and stockholders'
equity                                $ 1,185,135                                      $ 1,192,354

Net interest income (FTE)                                     9,860                                           10,957

Net interest spread                                                          3.51 %                                           3.85 %
Net interest margin                                                          3.65 %                                           3.98 %

(1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $131,000 and $142,000 for the three months ended March 31, 2013 and 2012, respectively.

(2) Non-accruing loans are included in the average amounts outstanding.

(3) Average balances are based on amortized cost.

(4) Fees and costs on loans are included in interest income.

Financial results for the three months ended March 31, 2012 compared to the three months ended March 31, 2012 reflected a decrease in net interest income, on a tax equivalent basis, of $1,097,000, or 10.0%. Average interest-earning assets decreased $9,167,000, or 0.83%, to $1,095,105,000 for the three months ended March 31, 2013 compared to $1,104,272,000 for the three months ended March 31, 2012 and average interest bearing liabilities decreased $10,299,000, or 1.1%, to $914,120,000 for the three months ended March 31, 2013 compared to $924,419,000 for the three months ended March 31, 2012.

Average loans outstanding decreased $445,000 or 0.05% to $839,989,000 for the three months ended March 31, 2013 compared to $839,544,000 for the three months ended March 31, 2012. See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio. Average investment securities increased $5,907,000, or 2.7% to $226,531,000 for the three months ended March 31, 2013 compared to $220,624,000 for the three months ended March 31, 2012. Average federal funds sold and interest bearing deposits in other financial institutions decreased $15,108,000 to $24,661,000 for the three months ended March 31, 2013 compared to $39,769,000 for the three months ended March 31, 2012. See the Liquidity Management section for further discussion.

Average time deposits decreased $1,969,000, or 0.2%, to $825,986,000 for the three months ended March 31, 2013 compared to $824,017,000 for the three months ended March 31, 2012. Average borrowings decreased $12,268,000 to $88,134,000 for the three months ended March 31, 2013 compared to $100,402,000 for the three months ended March 31, 2012. See the Liquidity Management section for further discussion.

. . .

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