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HWBK > SEC Filings for HWBK > Form 10-Q on 14-Nov-2013All Recent SEC Filings

Show all filings for HAWTHORN BANCSHARES, INC.

Form 10-Q for HAWTHORN BANCSHARES, INC.


14-Nov-2013

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 our Annual Report on Form 10-K for the year ended December 31, 2012 and in other reports filed 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.

Overview

Through the branch network of its subsidiary bank, the Company, with $1.1 billion in assets at September 30, 2013, 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.

CRITICAL ACCOUNTING POLICIES

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 September 30, 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 is comprised of 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.


SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected consolidated financial information for the Company as of and for each of the three and nine months ended September 30, 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              Nine Months Ended
                                                September 30,                   September 30,
(In thousands, except per share data)        2013            2012            2013            2012
Per Share Data
Basic earnings per common share          $       0.31    $      (0.37 )  $       0.52    $      (0.17 )
Diluted earnings per common share                0.31           (0.37 )          0.52           (0.17 )
Dividends paid on preferred stock                   -             229               -             975
Accretion of discount on preferred
stock                                               -              72             456             587
Dividends paid on common stock                    242             233             726             698
Book value per common share                                                     14.27           14.41
Market price per common share                                                   13.61            8.50
Selected Ratios
(Based on average balance sheets)
Return on total assets                           0.54 %         (0.54 )%         0.37 %          0.07 %
Return on common stockholders' equity            8.68 %         (9.95 )%         4.79 %         (1.54 )%
Common stockholders' equity to total
assets                                           6.26 %          6.41 %          7.04 %          6.31 %

Efficiency ratio (1)                            80.99 %         81.07 %         82.18 %         78.41 %

(Based on end-of-period data)
Common stockholders' equity to assets                                            6.35 %          6.27 %
Stockholders' equity to assets                                                   6.35 %          7.81 %
Total risk-based capital ratio                                                  15.36 %         16.71 %
Tier 1 risk-based capital ratio                                                 11.39 %         13.36 %
Leverage ratio                                                                   8.56 %         10.09 %



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


RESULTS OF OPERATIONS ANALYSIS

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                         Nine Months Ended
                             September 30,                             September 30,
                                         $        %                                $         %
(In thousands)    2013       2012     Change    Change      2013       2012      Change    Change
Net interest
income           $ 9,865   $ 10,122   $  (257 )   (2.5 )% $ 29,409   $ 31,108   $ (1,699 )   (5.5 )%
Provision for
loan losses            -      4,700    (4,700 ) (100.0 )     2,000      7,900     (5,900 )  (74.7 )
Noninterest
income             2,447      2,654      (207 )   (7.8 )     7,989      7,067        922     13.0
Investment
securities
gains, net             -         26       (26 )     NM         554         26        528       NM
Total
noninterest
income             2,447      2,680      (233 )   (8.7 )     8,543      7,093      1,450     20.4
Noninterest
expense            9,972     10,378      (406 )   (3.9 )    31,188     29,955      1,233      4.1
Income before
income taxes       2,340     (2,276 )   4,616    202.8       4,764        346      4,418       NM
Income tax
expense              771       (704 )   1,475    209.5       1,519       (273 )    1,792    656.4
Net income       $ 1,569   $ (1,572 ) $ 3,141   (199.8 )% $  3,245   $    619   $  2,626    424.2 %
Less:
preferred
dividends              -        228      (228 ) (100.0 )       337        894       (557 )  (62.3 )
and accretion
of discount            -         72       (72 ) (100.0 )       278        587       (309 )  (52.6 )
Total                  -        300      (300 ) (100.0 )       615      1,481       (866 )  (58.5 )
Net income
available to
common
shareholders     $ 1,569   $ (1,872 ) $ 3,441   (183.8 )% $  2,630   $   (862 ) $  3,492   (405.1 )%

Consolidated net income of $1.6 million for the quarter ended September 30, 2013 increased $3.1 million compared to a consolidated net loss of $1.6 million for the quarter ended September 30, 2012. Net income available to common shareholders for the quarter ended September 30, 2013 was $1.6 million, or $0.31 per diluted common share, compared to a net loss available to common shareholders of $1.9 million, or $(0.37) per diluted common share for the quarter ended September 30, 2012. For the quarter ended September 30, 2013, the return on average assets was 0.54%, the return on average common stockholders' equity was 8.68%, and the efficiency ratio was 80.99%.

For the nine months ended September 30, 2013, consolidated net income was $3.2 million compared to $619,000 for the nine months ended September 30, 2012. For the nine months ended September 30, 2013, net income available to common shareholders was $2.6 million, or $0.52 per diluted common share, compared to a net loss available to common shareholders of $862,000, or $(0.17) per diluted common share, for the nine months ended September 30, 2012. The lower level of dividends and accretion for the three and nine months ended September 30, 2013 resulted from the Company's redemption of the remaining 18,255 shares of preferred stock issued under the U.S. Treasury's CPP program on May 15, 2013. For the nine months ended September 30, 2013, the return on average assets was 0.37%, the return on average common stockholders' equity was 4.79%, and the efficiency ratio was 82.18%.

Net interest income, on a tax equivalent basis, decreased 2.6% to $10.0 million for the quarter ended September 30, 2013 compared to $10.3 million for the quarter ended September 30, 2012. For the nine months ended September 30, 2013, net interest income decreased 5.5% to $29.8 million compared to $31.5 million for the nine months ended September 30, 2012. These decreases were primarily a result of a decrease in the net interest margin due to a decrease in the Company's average earning assets partially offset by a decrease in average cost of deposits. The net interest margin decreased to 3.74% and 3.68% for the three and nine months ended September 30, 2013 respectively, compared to 3.80% and 3.85% for the three and nine months ended September 30, 2012, respectively.

The lower provision for loan losses for the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012 was primarily a result of the improving credit quality in the Company's historical loss analysis and reduced levels of nonperforming loans. Net charge-offs for the quarter ended September 30,


2013, were $1.1 million, or 0.17% of average loans compared to $3.1 million, or 0.37% of average loans for the quarter ended September 30, 2012. Net charge-offs for the nine months ended September 30, 2013, were $2.6 million, or 0.40% of average loans compared to $4.8 million, or 0.57% of average loans for the nine months ended September 30, 2012. Non-performing assets were 4.67% of total assets at September 30, 2013 compared to 5.33% at December 31, 2012, and 5.82% at September 30, 2012.

Noninterest income decreased $233,000, or 8.7%, for the quarter ended September 30, 2013 and increased $1.4 million, or 20.4%, for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. These changes are discussed in greater detail below under Noninterest Income.

Noninterest expense decreased $406,000, or 3.9 percent, for the quarter ended September 30, 2013, and increased $1.2 million, or 4.1%, for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. These increases are discussed in greater detail below under Noninterest Expense.

Business Events

On June 11, 2013 the common stock warrant issued under the U.S Treasury Department's CPP program was repurchased by the Company pursuant to a letter agreement between the Treasury and the Company for a total repurchase price of $540,000, or $1.88 per warrant share. The repurchase price was based on the fair market value of the warrant as agreed upon by the Company and the Treasury. The repurchase of the warrant ends the Company's participation in the U.S Treasury Department's CPP.

On July 1, 2013, the Company distributed a four percent stock dividend for the fifth consecutive year to common shareholders of record at the close of business on June 15, 2013. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect the stock dividend.

Average Balance Sheets

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. 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 and nine month periods ended September 30, 2013 and September 30, 2012, respectively.


                                               Three Months Ended September 30,
                                         2013                                     2012
                                         Interest       Rate                      Interest       Rate
                          Average        Income/      Earned/      Average        Income/      Earned/
(In thousands)            Balance       Expense(1)    Paid(1)      Balance       Expense(1)    Paid(1)
ASSETS
Loans: (2) (4)
Commercial              $    135,428   $      1,641       4.81 % $    126,092   $      1,620       5.11 %
Real estate
construction -
residential                   23,679            263       4.41         21,087            225       4.24
Real estate
construction -
commercial                    47,691            529       4.40         43,697            463       4.22
Real estate mortgage
- residential                218,365          2,746       4.99        221,191          2,842       5.11
Real estate mortgage
- commercial                 383,975          4,661       4.82        401,649          5,311       5.26
Consumer                      22,061            370       6.65         27,474            448       6.49
Total loans             $    831,199   $     10,210       4.87 % $    841,190   $     10,909       5.16 %
Investment
securities: (3)
U.S. treasury           $      1,009   $          3       1.18 % $      2,041   $          8       1.56 %
Government sponsored
enterprises                   64,455            199       1.22         69,656            231       1.32
Asset backed
securities                   116,223            660       2.25        118,773            765       2.56
State and municipal           34,905            328       3.73         34,790            346       3.96
Total investment
securities              $    216,592   $      1,190       2.18 % $    225,260   $      1,350       2.38 %
Restricted
investments                    4,074             21       2.05          4,287             23       2.13
Federal funds sold
and other overnight
interest-bearing
deposits                       8,117              6       0.29          4,112              6       0.58
Total interest
earning assets          $  1,059,982   $     11,427       4.28 % $  1,074,849   $     12,288       4.55 %
All other assets             100,452                                  108,898
Allowance for loan
losses                       (15,423 )                                (15,471 )
Total assets            $  1,145,011                             $  1,168,276
LIABILITIES AND
STOCKHOLDERS' EQUITY
NOW accounts            $    184,912   $        118       0.25 % $    176,904   $        136       0.31 %
Savings                       76,849             21       0.11         67,162             18       0.11
Money market                 160,865             99       0.24        152,488            111       0.29
Time deposits of
$100,000 and over            117,945            224       0.75        127,565            297       0.93
Other time deposits          247,349            535       0.86        278,305            980       1.40
Total time deposits     $    787,920   $        997       0.50 % $    802,424   $      1,542       0.76 %
Federal funds
purchased and
securities sold under
agreements to
repurchase                    22,335              7       0.12         24,170              7       0.12
Subordinated notes            49,486            323       2.59         49,486            346       2.78
Federal Home Loan
Bank advances                 24,837            106       1.69         28,258            134       1.89
Total borrowings        $     96,658   $        436       1.79 % $    101,914   $        487       1.90 %
Total interest
bearing liabilities     $    884,578   $      1,433       0.64 % $    904,338   $      2,029       0.89 %
Demand deposits              180,497                                  163,538
Other liabilities              8,209                                    7,697
Total liabilities          1,073,284                                1,075,573
Stockholders' equity          71,727                                   92,703
Total liabilities and
stockholders' equity    $  1,145,011                             $  1,168,276
Net interest income
(FTE)                                         9,994                                   10,259
Net interest spread                                       3.64 %                                   3.66 %
Net interest margin                                       3.74 %                                   3.80 %




(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 $129,000 and $137,000 for the three months ended September 30, 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.


                                                Nine Months Ended September 30,
. . .
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