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Section 1: 10-Q (FORM 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2018

 

OR

 

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______________to______________

 

Commission file number: 0-23636

 

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

Missouri   43-1626350
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)    

 

132 East High Street, Box 688, Jefferson City, Missouri 65102
(Address of principal executive offices) (Zip Code)

 

(573) 761-6100
(Registrant's telephone number, including area code)

 

N/A
(Former name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   x Yes   ¨ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨   Accelerated filer x Non-accelerated filer ¨
      (Do not check if a smaller reporting company)
Smaller reporting company ¨   Emerging growth company ¨  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes   x No

 

As of August 9, 2018, the registrant had 6,020,915 shares of common stock, par value $1.00 per share, outstanding

 

 

 

   

 

 

Part I - Financial Information

Item 1. Financial Statements

 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets (unaudited)

 

 

   June 30,   December 31, 
(In thousands, except per share data)  2018   2017 
ASSETS    
Cash and due from banks  $15,921   $23,325 
Federal funds sold and other interest-bearing deposits   34,863    39,553 
Cash and cash equivalents   50,784    62,878 
Certificates of deposit in other banks   10,746    3,460 
Investment in available-for-sale securities, at fair value   227,601    226,542 
Other investments and securities, at cost   9,323    11,037 
Total investment securities   236,924    237,579 
Loans   1,094,195    1,068,432 
Allowances for loan losses   (11,212)   (10,852)
Net loans   1,082,983    1,057,580 
Premises and equipment - net   34,586    34,811 
Mortgage servicing rights   2,813    2,713 
Other real estate owned and repossessed assets - net   13,236    13,182 
Accrued interest receivable   5,294    5,627 
Cash surrender value - life insurance   2,516    2,484 
Other assets   8,768    8,902 
Total assets  $1,448,650   $1,429,216 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Deposits          
Non-interest bearing demand  $250,232   $245,380 
Savings, interest checking and money market   614,976    584,468 
Time deposits $250,000 and over   98,638    63,176 
Other time deposits   219,540    232,788 
Total deposits   1,183,386    1,125,812 
Federal funds purchased and securities sold under agreements to repurchase   36,103    27,560 
Federal Home Loan Bank advances and other borrowings   74,270    121,382 
Subordinated notes   49,486    49,486 
Accrued interest payable   790    554 
Other liabilities   11,482    13,051 
Total liabilities   1,355,517    1,337,845 
Stockholders’ equity:          
Common stock, $1 par value, authorized 15,000,000 shares; issued 6,046,907 shares, respectively   6,047    6,047 
Surplus   50,456    45,442 
Retained earnings   49,594    50,595 
Accumulated other comprehensive loss, net of tax   (7,734)   (5,662)
Treasury stock; 257,566 and 248,898 shares, at cost, respectively   (5,230)   (5,051)
Total stockholders’ equity   93,133    91,371 
Total liabilities and stockholders’ equity  $1,448,650   $1,429,216 

 

See accompanying notes to the consolidated financial statements (unaudited).

 

 2 

 

 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income (unaudited)

 

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands, except per share amounts)  2018   2017   2018   2017 
INTEREST INCOME                    
Interest and fees on loans  $12,853   $11,671   $25,077   $22,721 
Interest on investment securities:                    
Taxable   984    737    1,930    1,491 
Nontaxable   147    168    305    325 
Federal funds sold, other interest-bearing deposits, and certificates of deposit in other banks   189    11    295    60 
Dividends on other securities   115    94    225    184 
Total interest income   14,288    12,681    27,832    24,781 
INTEREST EXPENSE                    
Interest on deposits:                    
Savings, interest checking and money market   1,347    475    2,431    864 
Time deposit accounts $250,000 and over   296    99    434    191 
Other time deposits   536    410    1,046    789 
Interest on federal funds purchased and securities sold under agreements to repurchase   189    27    360    49 
Interest on Federal Home Loan Bank advances   332    419    728    741 
Interest on subordinated notes   561    431    1,051    840 
Total interest expense   3,261    1,861    6,050    3,474 
Net interest income   11,027    10,820    21,782    21,307 
Provision for loan losses   450    330    750    680 
Net interest income after provision for loan losses   10,577    10,490    21,032    20,627 
NON-INTEREST INCOME                    
Service charges and other fees   941    851    1,817    1,687 
Bank card income and fees   709    663    1,365    1,277 
Trust department income   311    266    592    540 
Real estate servicing fees, net   161    34    381    487 
Gain on sale of mortgage loans, net   242    218    387    374 
Other   122    67    245    141 
Total non-interest income   2,486    2,099    4,787    4,506 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   5,813    5,336    11,870    10,774 
Occupancy expense, net   725    689    1,413    1,307 
Furniture and equipment expense   685    634    1,320    1,232 
Processing, network, and bank card expense   889    927    1,747    1,972 
Legal, examination, and professional fees   201    317    624    597 
FDIC insurance assessment   146    115    301    216 
Advertising and promotion   291    265    544    503 
Postage, printing, and supplies   224    252    492    475 
Other   957    1,152    1,875    1,961 
Total non-interest expense   9,931    9,687    20,186    19,037 
Income before income taxes   3,132    2,902    5,633    6,096 
Income tax expense   225    983    636    2,076 
Net income   2,907    1,919    4,997    4,020 
Basic earnings per share  $0.48   $0.32   $0.83   $0.66 
Diluted earnings per share  $0.48   $0.32   $0.83   $0.66 

 

See accompanying notes to the consolidated financial statements (unaudited).

 

 3 

 

  

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (unaudited)

 

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands)  2018   2017   2018   2017 
Net income  $2,907   $1,919   $4,997   $4,020 
Other comprehensive income, net of tax                    
Investment securities available-for-sale:                    
Unrealized (loss) gain on investment securities available-for-sale, net of tax   (442)   595    (2,157)   900 
Adjustment for gain on sale of investment securities, net of tax   0    0    0    0 
Defined benefit pension plans:                    
Amortization of prior service cost included in net periodic pension cost, net of tax   43    13    85    27 
Total other comprehensive (loss) income   (399)   608    (2,072)   927 
Total comprehensive income  $2,508   $2,527   $2,925   $4,947 

 

See accompanying notes to the consolidated financial statements (unaudited).

 

 4 

 

 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity (unaudited)

 

 

               Accumulated       Total 
               Other       Stock - 
   Common       Retained   Comprehensive   Treasury   holders' 
(In thousands)  Stock   Surplus   Earnings   Loss   Stock   Equity 
Balance, December 31, 2016  $5,822   $41,498   $51,671   $(3,801)  $(4,173)  $91,017 
Net income   0    0    4,020    0    0    4,020 
Other comprehensive income   0    0    0    927    0    927 
Stock based compensation expense   0    2    0    0    0    2 
Purchase of treasury stock   0    0    0    0    (89)   (89)
Stock dividend   0    4,165    (4,165)   0    0    0 
Cash dividends declared, common stock   0    0    (730)   0    0    (730)
Balance, June 30, 2017  $5,822   $45,665   $50,796   $(2,874)  $(4,262)  $95,147 
                               
Balance, December 31, 2017  $6,047   $45,442   $50,595   $(5,662)  $(5,051)  $91,371 
Net income   0    0    4,997    0    0    4,997 
Other comprehensive loss   0    0    0    (2,072)   0    (2,072)
Purchase of treasury stock   0    0    0    0    (179)   (179)
Stock dividend   0    5,014    (5,014)   0    0    0 
Cash dividends declared, common stock   0    0    (984)   0    0    (984)
Balance, June 30, 2018  $6,047   $50,456   $49,594   $(7,734)  $(5,230)  $93,133 

 

See accompanying notes to the consolidated financial statements (unaudited).

 

 5 

 

 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES        
Consolidated Statements of Cash Flows (unaudited)        

 

  Six Months Ended June 30, 
(In thousands)  2018   2017 
Cash flows from operating activities:          
Net income  $4,997   $4,020 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   750    680 
Depreciation expense   877    874 
Net amortization of investment securities, premiums, and discounts   752    828 
Stock based compensation expense   0    2 
Change in fair value of mortgage servicing rights   31    (67)
Gain on sale of investment securities   (206)   0 
(Gain) loss on sales and dispositions of premises and equipment   (13)   1 
Gain on sales and dispositions of other real estate and repossessed assets   (2)   (38)
Provision for other real estate owned   26    215 
Decrease in accrued interest receivable   333    429 
Increase in cash surrender value - life insurance   (32)   (39)
Decrease (increase) in other assets   873    (545)
Increase (decrease) in accrued interest payable   236    (69)
(Decrease) increase in other liabilities   (1,742)   290 
Origination of mortgage loans for sale   (19,597)   (17,101)
Proceeds from the sale of mortgage loans   19,722    16,154 
Gain on sale of mortgage loans, net   (387)   (374)
Other, net   (131)   (115)
Net cash provided by operating activities   6,487    5,145 
Cash flows from investing activities:          
Net (increase) decrease in certificates of deposit in other banks   (7,286)   1,000 
Net increase in loans   (26,272)   (59,846)
Purchase of available-for-sale debt securities   (74,275)   (21,874)
Proceeds from maturities of available-for-sale debt securities   16,445    16,132 
Proceeds from calls of available-for-sale debt securities   1,685    4,525 
Proceeds from sales of available-for-sale debt securities   51,810    0 
Purchases of FHLB stock   (1,370)   (1,203)
Proceeds from sales of FHLB stock   3,084    201 
Purchases of premises and equipment   (734)   (863)
Proceeds from sales of premises and equipment   13    0 
Proceeds from sales of other real estate and foreclosed assets   304    784 
Net cash used in investing activities   (36,596)   (61,144)
Cash flows from financing activities:          
Net increase in demand deposits   4,851    43,659 
Net increase in interest-bearing transaction accounts   30,509    48,947 
Net increase (decrease) in time deposits   22,214    (20,585)
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase   8,543    (2,389)
Repayment of FHLB advances and other borrowings   (141,112)   (130,277)
FHLB advances   94,000    152,740 
Purchase of treasury stock   (179)   (89)
Cash dividends paid - common stock   (811)   (674)
Net cash provided by financing activities   18,015    91,332 
Net (decrease) increase in cash and cash equivalents   (12,094)   35,333 
Cash and cash equivalents, beginning of period   62,878    25,995 
Cash and cash equivalents, end of period  $50,784   $61,328 

 

See accompanying notes to the consolidated financial statements (unaudited).

 

 6 

 

 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (continued) (unaudited)

 

 

  Six Months Ended June 30, 
(In thousands)  2018   2017 
Supplemental disclosures of cash flow information:        
Cash paid during the year for:          
Interest  $5,814   $3,542 
Income taxes  $50   $2,185 
Noncash investing activities:          
Other real estate and repossessed assets acquired in settlement of loans  $382   $155 

 

See accompanying notes to the consolidated financial statements (unaudited).

 

 7 

 

 

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

(1)Summary of Significant Accounting Policies

 

Hawthorn Bancshares, Inc. (the Company) through its subsidiary, Hawthorn Bank (the Bank), provides a broad range of banking services to individual and corporate customers located within the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and the greater Kansas City metropolitan area. The Company is subject to competition from other financial and nonfinancial institutions providing financial products. Additionally, the Company and its subsidiaries are subject to the regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies.

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

The preparation of the consolidated financial statements includes all adjustments that, in the opinion of management, are necessary in order to make those statements not misleading. Management is required to make estimates and assumptions, including the determination of the allowance for loan losses, real estate acquired in connection with foreclosure or in satisfaction of loans, and fair values of investment securities available-for-sale that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial statements.

 

Stock Dividend On July 1, 2018, the Company paid a special stock dividend of four percent to shareholders of record at the close of business on June 15, 2018. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

 

The following represents significant new accounting principles adopted in 2018:

 

Revenue from Contracts with Customers On January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with historic accounting under Topic 605.

 

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust department revenue, service charges and fees, debit card income, ATM surcharge income, and other real estate owned sales. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Noninterest revenue streams within the scope of Topic 606 are discussed in Footnote 16.

 

Financial Instruments The FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, in January 2016. The amendments require all equity investments to be measured at fair value with changes in the fair value recognized through net income, other than those accounted for under the equity method of accounting or those that result in the consolidation of the investee. Additionally, these amendments require presentation in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk for those liabilities measured at fair value. The amendments also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2018. The adoption of the ASU did not have a significant effect on the Company's consolidated financial statements.

 

 8 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

The FASB issued ASU 2018-04, Investments - Debt Securities (Topic 320) and Regulated Operations (Topic 980): The amendment in this ASU adds, amends and supersedes various paragraphs that contain SEC guidance in ASC 320, Investments-Debt Securities and ASC 980, Regulated Operations. The amendments in this ASU are effective when a registrant adopts ASU 2016-01, which for the Company was January 1, 2018. This amendment did not have a significant effect on the Company's consolidated financial statements.

 

Liabilities The FASB issued ASU 2016-04, Recognition of Breakage for Certain Prepaid Store-Value Products, in March 2016, in order to address current and potential future diversity in practice related to the derecognition of a prepaid store-value product liability. Such products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler's checks. The amendments require that the portion of the dollar value of prepaid stored-value products that is ultimately unredeemed (that is, the breakage) be accounted for consistent with the breakage guidance for stored-value product transactions provided in ASC Topic 606 - Revenue from Contracts with Customers. These amendments are effective for interim and annual periods beginning January 1, 2018. The adoption of the ASU did not have a significant effect on the Company's consolidated financial statements.

 

Pension The FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost in March 2017. Under the new guidance, employers will present the service cost component of the net periodic benefit cost in the same income statement line item (e.g., Salaries and Benefits) as other employee compensation costs arising from services rendered during the period. In addition, only the service cost component will be eligible for capitalization in assets. Employers will present the other components separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. The ASU is effective for interim and annual reporting periods beginning after December 15, 2017. Employers will apply the guidance on the presentation of the components of net periodic benefit cost in the income statement retrospectively. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component will be applied prospectively. The Company utilizes the ASU’s practical expedient allowing entities to estimate amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan footnote. The adoption of the ASU did not have a significant effect on the Company's consolidated financial statements.

 

(2)Loans and Allowance for Loan Losses

 

Loans

 

A summary of loans, by major class within the Company’s loan portfolio, at June 30, 2018 and December 31, 2017 is as follows:

 

   June 30,   December 31, 
(in thousands)  2018   2017 
Commercial, financial, and agricultural  $200,628   $192,238 
Real estate construction - residential   28,285    26,492 
Real estate construction - commercial   106,406    98,340 
Real estate mortgage - residential   246,415    246,754 
Real estate mortgage - commercial   479,571    472,455 
Installment and other consumer   32,890    32,153 
Total loans  $1,094,195   $1,068,432 

 

The Bank grants real estate, commercial, installment, and other consumer loans to customers located within the Missouri communities surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson and the greater Kansas City metropolitan area. As such, the Bank is susceptible to changes in the economic environment in these communities. The Bank does not have a concentration of credit in any one economic sector. Installment and other consumer loans consist primarily of the financing of automotive vehicles. At June 30, 2018, loans of $489.6 million were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit.

 

 9 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

Allowance for Loan Losses

 

The following is a summary of the allowance for loan losses during the periods indicated.

 

   Three Months Ended June 30, 2018 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   and Other   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Consumer   allocated   Total 
Balance at beginning of period  $3,261   $240   $895   $2,057   $4,008   $352   $134   $10,947 
Additions:                                        
Provision for loan losses   865    (52)   10    48    (388)   90    (123)   450 
Deductions:                                        
Loans charged off   193    0    0    12    15    49    0    269 
Less recoveries on loans   (10)   (13)   0    (16)   (25)   (20)   0    (84)
Net loan charge-offs (recoveries)   183    (13)   0    (4)   (10)   29    0    185 
Balance at end of period  $3,943   $201   $905   $2,109   $3,630   $413   $11   $11,212 

 

   Six Months Ended June 30, 2018 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   and Other   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Consumer   allocated   Total 
Balance at beginning of period  $3,325   $170   $807   $1,689   $4,437    345   $79   $10,852 
Additions:                                        
Provision for loan losses   898    54    128    416    (809)   131    (68)   750 
Deductions:                                        
Loans charged off   303    48    30    32    29    106    0    548 
Less recoveries on loans   (23)   (25)   0    (36)   (31)   (43)   0    (158)
Net loan charge-offs (recoveries)   280    23    30    (4)   (2)   63    0    390 
Balance at end of period  $3,943   $201   $905   $2,109   $3,630   $413   $11   $11,212 

 

   Three Months Ended June 30, 2017 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   and Other   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Consumer   allocated   Total 
Balance at beginning of period  $2,360   $99   $579   $2,125   $4,731   $322   $46   $10,262 
Additions:                                        
Provision for loan losses   226    (54)   36    (230)   139    89    124    330 
Deductions:                                        
Loans charged off   32    0    0    62    2    60    0    156 
Less recoveries on loans   (24)   (25)   0    (21)   (14)   (25)   0    (109)
Net loan charge-offs (recoveries)   8    (25)   0    41    (12)   35    0    47 
Balance at end of period  $2,578   $70   $615   $1,854   $4,882   $376   $170   $10,545 

 

   Six Months Ended June 30, 2017 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   and Other   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Consumer   allocated   Total 
Balance at beginning of period  $2,753   $108   $413   $2,385   $3,793    274   $160   $9,886 
Additions:                                        
Provision for loan losses   (157)   (113)   202    (507)   1,084    161    10    680 
Deductions:                                        
Loans charged off   60    0    0    81    16    111    0    268 
Less recoveries on loans   (42)   (75)   0    (57)   (21)   (52)   0    (247)
Net loan charge-offs (recoveries)   18    (75)   0    24    (5)   59    0    21 
Balance at end of period  $2,578   $70   $615   $1,854   $4,882   $376   $170   $10,545 

 

Loans, or portions of loans, are charged off to the extent deemed uncollectible or a loss is confirmed. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration.

 

 10 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

Beginning in the first quarter of 2016, the Company began to lengthen its look-back period with the intent to increase such period from three to five years. The Company believes that the five-year look-back period, which is consistent with the Company’s practices prior to the start of the economic recession in 2008, provides a representative historical loss period in the current economic environment. As of December 31, 2017, the Company utilized a five-year look-back period.

 

The following table provides the balance in the allowance for loan losses at June 30, 2018 and December 31, 2017, and the related loan balance by impairment methodology.

 

   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, and   Construction -   Construction -     Mortgage -     Mortgage -   and Other   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Consumer   allocated   Total 
June 30, 2018                                
Allowance for loan losses:                                        
Individually evaluated for impairment  $410   $0   $0   $668   $185   $19   $0   $1,282 
Collectively evaluated for impairment   3,533    201    905    1,441    3,445    394    11    9,930 
Total  $3,943   $201   $905   $2,109   $3,630   $413   $11   $11,212 
Loans outstanding:                                        
Individually evaluated for impairment  $2,887   $0   $169   $5,186   $1,705   $304   $0   $10,251 
Collectively evaluated for impairment   197,741    28,285    106,237    241,229    477,866    32,586    0    1,083,944 
Total  $200,628   $28,285   $106,406   $246,415   $479,571   $32,890   $0   $1,094,195 
                                         
December 31, 2017                                        
Allowance for loan losses:                                        
Individually evaluated for impairment  $500   $0   $48   $521   $243   $21   $0   $1,333 
Collectively evaluated for impairment   2,825    170    759    1,168    4,194    324    79    9,519 
Total  $3,325   $170   $807   $1,689   $4,437   $345   $79   $10,852 
Loans outstanding:                                        
Individually evaluated for impairment  $3,007   $0   $97   $5,072   $2,004   $176   $0   $10,356 
Collectively evaluated for impairment   189,231    26,492    98,243    241,682    470,451    31,977    0    1,058,076 
Total  $192,238   $26,492   $98,340   $246,754   $472,455   $32,153   $0   $1,068,432 

 

Impaired Loans

 

Loans evaluated under ASC 310-10-35 include loans which are individually evaluated for impairment. All other loans are collectively evaluated for impairment under ASC 450-20. Impaired loans individually evaluated for impairment totaled $10.3 million and $10.4 million at June 30, 2018 and December 31, 2017, respectively, and are comprised of loans on non-accrual status and loans which have been classified as troubled debt restructurings (TDRs).

 

The net carrying value of impaired loans is based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. At June 30, 2018 and December 31, 2017, $4.2 million and $4.0 million, respectively, of impaired loans were evaluated based on the fair value less estimated selling costs of the loan’s collateral. Once the impairment amount is calculated, a specific reserve allocation is recorded. At June 30, 2018, $1.3 million of the Company’s allowance for loan losses was allocated to impaired loans totaling $10.3 million compared to $1.3 million of the Company's allowance for loan losses allocated to impaired loans totaling approximately $10.4 million at December 31, 2017. Management determined that $3.3 million, or 33%, of total impaired loans required no reserve allocation at June 30, 2018 compared to $2.4 million, or 23%, at December 31, 2017 primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability.

 

 11 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

The categories of impaired loans at June 30, 2018 and December 31, 2017 are as follows:

 

   June 30,   December 31, 
(in thousands)  2018   2017 
Non-accrual loans  $6,311   $5,672 
Performing TDRs   3,940    4,684 
Total impaired loans  $10,251   $10,356 

 

The following tables provide additional information about impaired loans at June 30, 2018 and December 31, 2017, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.

 

       Unpaid     
   Recorded   Principal   Specific 
(in thousands)  Investment   Balance   Reserves 
June 30, 2018               
With no related allowance recorded:               
Commercial, financial and agricultural  $1,282   $1,351   $0 
Real estate - construction residential   0    0    0 
Real estate - construction commercial   169    188    0 
Real estate - residential   993    1,048    0 
Real estate - commercial   753    753    0 
Consumer   137    137    0 
Total  $3,334   $3,477   $0 
With an allowance recorded:               
Commercial, financial and agricultural  $1,605   $1,927   $410 
Real estate - construction residential   0    0    0 
Real estate - residential   4,193    4,287    668 
Real estate - commercial   952    1,078    185 
Installment and other consumer   167    189    19 
Total  $6,917   $7,481   $1,282 
Total impaired loans  $10,251   $10,958   $1,282 

 

       Unpaid     
   Recorded   Principal   Specific 
(in thousands)  Investment   Balance   Reserves 
December 31, 2017               
With no related allowance recorded:               
Commercial, financial and agricultural  $1,393   $1,445   $0 
Real estate - residential   674    688    0 
Real estate - commercial   366    395    0 
Total  $2,433   $2,528   $0 
With an allowance recorded:               
Commercial, financial and agricultural  $1,614   $1,834   $500 
Real estate - construction commercial   97    97    48 
Real estate - residential   4,398    4,500    521 
Real estate - commercial   1,638    1,743    243 
Consumer   176    196    21 
Total  $7,923   $8,370   $1,333 
Total impaired loans  $10,356   $10,898   $1,333 

 

 12 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

The following table presents by class, information related to the average recorded investment and interest income recognized on impaired loans during the periods indicated.

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2018   2017   2018   2017 
       Interest       Interest       Interest       Interest 
   Average   Recognized   Average   Recognized   Average   Recognized   Average   Recognized 
   Recorded   For the   Recorded   For the   Recorded   For the   Recorded   For the 
(in thousands)  Investment   Period Ended   Investment   Period Ended   Investment   Period Ended   Investment   Period Ended 
With no related allowance recorded:                                        
Commercial, financial and agricultural  $1,153   $0   $464   $-1   $1,302   $1   $519   $0 
Real estate - construction commercial   113    0    0    0    42    0    0    0 
Real estate - residential   933    3    852    3    900    6    912    7 
Real estate - commercial   116    10    395    -2    237    19    500    0 
Installment and other consumer   137    0    2    0    34    0    31    0 
Total  $2,452   $13   $1,713   $0   $2,515   $26   $1,962   $7 
With an allowance recorded:                                        
Commercial, financial and agricultural  $1,621   $8   $1,214   $8   $1,737   $15   $1,199   $19 
Real estate - construction residential   20    0    0    0    15    0    0    0 
Real estate - construction commercial   0    0    48    0    24    0    49    0 
Real estate - residential   4,118    14    4,790    42    4,247    47    4,595    87 
Real estate - commercial   1,732    5    1,604    14    1,691    10    1,505    29 
Installment and other consumer   172    1    51    0    167    1    48    0 
Total  $7,663   $28   $7,707   $64   $7,881   $73   $7,396   $135 
Total impaired loans  $10,115   $41   $9,420   $64   $10,396   $99   $9,358   $142 

 

The recorded investment varies from the unpaid principal balance primarily due to partial charge-offs taken resulting from current appraisals received. The amount recognized as interest income on impaired loans continuing to accrue interest, primarily related to troubled debt restructurings, was $41,000 and $99,000, for the three months and six months ended June 30, 2018, respectively compared to $64,000 and $142,000 for the three and six months ended June 30, 2017, respectively. The average recorded investment in impaired loans is calculated on a monthly basis during the periods reported.

 

Delinquent and Non-Accrual Loans

 

The delinquency status of loans is determined based on the contractual terms of the notes. Borrowers are generally classified as delinquent once payments become 30 days or more past due. The Company’s policy is to discontinue the accrual of interest income on any loan when, in the opinion of management, the ultimate collectability of interest or principal is no longer probable. In general, loans are placed on non-accrual when they become 90 days or more past due. However, management considers many factors before placing a loan on non-accrual, including the delinquency status of the loan, the overall financial condition of the borrower, the progress of management’s collection efforts and the value of the underlying collateral. Non-accrual loans are returned to accrual status when, in the opinion of management, the financial condition of the borrower indicates that the timely collectability of interest and principal is probable and the borrower demonstrates the ability to pay under the terms of the note through a sustained period of repayment performance, which is generally six months.

 

 13 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

The following table provides aging information for the Company’s past due and non-accrual loans at June 30, 2018 and December 31, 2017.

 

   Current or       90 Days         
   Less Than       Past Due         
   30 Days   30 - 89 Days   And Still         
(in thousands)  Past Due   Past Due   Accruing   Non-Accrual   Total 
June 30, 2018                         
Commercial, Financial, and Agricultural  $197,928   $271   $0   $2,429   $200,628 
Real Estate Construction - Residential   28,285    0    0    0    28,285 
Real Estate Construction - Commercial   106,237    0    0    169    106,406 
Real Estate Mortgage - Residential   242,937    695    8    2,775    246,415 
Real Estate Mortgage - Commercial   478,383    535    0    653    479,571 
Installment and Other Consumer   32,363    208    34    285    32,890 
Total  $1,086,133   $1,709   $42   $6,311   $1,094,195 
December 31, 2017                         
Commercial, Financial, and Agricultural  $189,537   $192   $2   $2,507   $192,238 
Real Estate Construction - Residential   25,930    287    275    0    26,492 
Real Estate Construction - Commercial   98,243    0    0    97    98,340 
Real Estate Mortgage - Residential   242,597    2,173    28    1,956    246,754 
Real Estate Mortgage - Commercial   471,476    43    0    936    472,455 
Installment and Other Consumer   31,715    239    23    176    32,153 
Total  $1,059,498   $2,934   $328   $5,672   $1,068,432 

 

Credit Quality

 

The Company categorizes loans into risk categories based upon an internal rating system reflecting management’s risk assessment. Loans are placed on watch status when one or more weaknesses that may result in the deterioration of the repayment exits or the Company’s credit position at some future date. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified may have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. Such loans are characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not corrected. A loan is classified as a troubled debt restructuring (TDR) when a borrower is experiencing financial difficulties that lead to the restructuring of a loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. Loans classified as TDRs which are accruing interest are classified as performing TDRs. Loans classified as TDRs which are not accruing interest are classified as nonperforming TDRs and are included with all other nonaccrual loans for presentation purposes. It is the Company’s policy to discontinue the accrual of interest income on loans when management believes that the collection of interest or principal is doubtful. Loans are placed on non-accrual status when (1) deterioration in the financial condition of the borrower exists for which payment of full principal and interest is not expected, or (2) payment of principal or interest has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income on a cash basis.

 

 14 

 

  

Hawthorn Bancshares, Inc. 

and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

The following table presents the risk categories by class at June 30, 2018 and December 31, 2017.

 

(in thousands)  Commercial,
 Financial, & 
Agricultural
   Real Estate
Construction
- Residential
   Real Estate
Construction -
Commercial
   Real Estate
Mortgage -
Residential
   Real Estate
Mortgage -
Commercial
   Installment 
and Other 
Consumer
   Total 
At June 30, 2018                                   
Watch  $7,378   $598   $3,581   $8,584   $33,482   $9   $53,632 
Substandard   94    0    0    1,371    718    6    2,189 
Performing TDRs   458    0    0    2,410    1,053    19    3,940 
Non-accrual   2,429    0    169    2,775    653    285    6,311 
Total  $10,359   $598   $3,750   $15,140   $35,906   $319   $66,072 
At December 31, 2017                                   
Watch  $9,868   $1,459   $1,284   $9,978   $49,197   $0   $71,786 
Substandard   658    462    0    2,262    723    16    4,121 
Performing TDRs   500    0    0    3,116    1,068    0    4,684 
Non-accrual   2,507    0    97    1,956    936    176    5,672 
Total  $13,533   $1,921   $1,381   $17,312   $51,924   $192   $86,263 

 

Troubled Debt Restructurings

 

At June 30, 2018, loans classified as TDRs totaled $5.9 million, of which $2.0 million were classified as nonperforming TDRs and included in non-accrual loans and $3.9 million were classified as performing TDRs. At December 31, 2017, loans classified as TDRs totaled $6.4 million, of which $1.7 million were classified as nonperforming TDRs and included in non-accrual loans and $4.7 million were classified as performing TDRs. Both performing and nonperforming TDRs are considered impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. Accordingly, specific reserves of $510,000 and $577,000 related to TDRs were allocated to the allowance for loan losses at June 30, 2018 and December 31, 2017, respectively.

 

The following table summarizes loans that were modified as TDRs during the periods indicated.

 

   Six Months Ended June 30, 
   2018   2017 
   Recorded Investment (1)   Recorded Investment (1) 
(in thousands)  Number of
Contracts
   Pre-
Modification
   Post-
Modification
   Number of
Contracts
   Pre-
Modification
   Post-
Modification
 
Troubled Debt Restructurings                              
Commercial, financial and agricultural   0   $0   $0    1   $131   $130 
Real estate mortgage - residential   1    75    75    0    0    0 
Real estate mortgage - commercial   1    68    64    1    56    52 
Consumer   4    48    47    0    0    0 
Total   6   $191   $186    2   $187   $182 

 

(1)  The amounts reported post-modification are inclusive of all partial pay-downs and charge-offs, and no portion of the debt was forgiven. Loans modified as a TDR that were fully paid down, charged-off or foreclosed upon during the period ended are not reported.

 

The Company’s portfolio of loans classified as TDRs include concessions for the borrower given financial condition such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. There were no loans and six loans meeting the TDR criteria that were modified during the three and six months ended June 30, 2018, respectively, compared to no loans and two loans during the three and six months ended June 30, 2017, respectively.

 

The Company considers a TDR to be in default when it is 90 days or more past due under the modified terms, a charge-off occurs, or it is the process of foreclosure. There were no loans modified as a TDR that defaulted during any of the three and six months ended June 30, 2018 and 2017, respectively, and within twelve months of their modification date. During 2018, one real estate mortgage loan went to foreclosure totaling $48,000 and one commercial real estate loan totaling $366,000 was sold at foreclosure. See Lending and Credit Management section for further information.

 

 15 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited) 

 

(3)Other Real Estate and Repossessed Assets

 

   June 30,   December 31, 
(in thousands)  2018   2017 
Commercial  $727   $727 
Real estate construction - residential   179    0 
Real estate construction - commercial   12,101    12,380 
Real estate mortgage - residential   317    382 
Real estate mortgage - commercial   2,934    2,909 
Repossessed assets   0    5 
Total  $16,258   $16,403 
Less valuation allowance for other real estate owned   (3,022)   (3,221)
Total other real estate and repossessed assets  $13,236   $13,182 

 

Changes in the net carrying amount of other real estate and repossessed assets were as follows for the periods indicated:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2018   2017   2018   2017 
Balance at beginning of period  $16,264   $16,669   $16,403   $17,291 
Additions   104    52    382    155 
Proceeds from sales   (80)   (126)   (304)   (784)
Charge-offs against the valuation allowance for other real estate owned, net   (30)   (53)   (225)   (170)
Net gain on sales   0    (12)   2    38 
Total other real estate and repossessed assets  $16,258   $16,530   $16,258   $16,530 
Less valuation allowance for other real estate owned   (3,022)   (3,174)   (3,022)   (3,174)
Balance at end of period  $13,236   $13,356   $13,236   $13,356 

 

At June 30, 2018, $246,000 of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to no loans at December 31, 2017.

 

Activity in the valuation allowance for other real estate owned was as follows for the periods indicated:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(in thousands)  2018   2017   2018   2017 
Balance, beginning of period  $3,025   $3,044   $3,221   $3,129 
Provision for other real estate owned   27    183    26    215 
Charge-offs   (30)   (53)   (225)   (170)
Balance, end of period  $3,022   $3,174   $3,022   $3,174 

 

 16 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(4)Investment Securities

 

The amortized cost and fair value of debt securities classified as available-for-sale at June 30, 2018 and December 31, 2017 were as follows:

 

   Total             
   Amortized   Gross Unrealized   Fair 
(in thousands)  Cost   Gains   Losses   Value 
June 30, 2018                    
U.S. Treasury  $1,983   $0   $(53)  $1,930 
U.S. government and federal agency obligations   11,443    0    (351)   11,092 
Government sponsored enterprises   46,773    4    (718)   46,059 
Obligations of states and political subdivisions   42,054    38    (633)   41,459 
Mortgage-backed securities:                    
Residential - government agencies   131,243    35    (4,217)   127,061 
Total available-for-sale securities  $233,496   $77   $(5,972)  $227,601 
                     
December 31, 2017                    
U.S. Treasury  $1,980   $0   $(13)  $1,967 
U.S. government and federal agency obligations   12,341    0    (268)   12,073 
Government sponsored enterprises   37,321    0    (424)   36,897 
Obligations of states and political subdivisions   47,019    114    (477)   46,656 
Mortgage-backed securities:                    
Residential - government agencies   131,045    44    (2,140)   128,949 
Total available-for-sale securities  $229,706   $158   $(3,322)  $226,542 

 

All of the Company’s investment securities are classified as available for sale. Agency bonds and notes, small business administration guaranteed loan certificates (SBA), residential and commercial agency mortgage-backed securities, and agency collateralized mortgage obligations (CMO) include securities issued by the Government National Mortgage Association (GNMA), a U.S. government agency, and the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal Home Loan Bank (FHLB), which are U.S. government-sponsored enterprises.

 

Other Investments and securities primarily consist of Federal Home Loan Bank stock, subordinated debt equity securities, and the Company’s interest in statutory trusts. These securities are reported at cost in the amount of $9.3 million and $11.0 million as of June 30, 2018 and December 31, 2017, respectively.

 

Debt securities with carrying values aggregating approximately $187.3 million and $181.7 million at June 30, 2018 and December 31, 2017, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

 

The amortized cost and fair value of debt securities classified as available-for-sale at June 30, 2018, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.

 

   Amortized   Fair 
(in thousands)  Cost   Value 
Due in one year or less  $12,173   $12,120 
Due after one year through five years   68,835    68,187 
Due after five years through ten years   18,243    17,287 
Due after ten years   3,002    2,946 
Total   102,253    100,540 
Mortgage-backed securities   131,243    127,061 
Total available-for-sale securities  $233,496   $227,601 

 

 17 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2018 and December 31, 2017 were as follows:

 

   Less than 12 months   12 months or more   Total   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(in thousands)  Value   Losses   Value   Losses   Value   Losses 
At June 30, 2018                        
U.S. Treasury  $1,930   $(53)  $0   $0   $1,930   $(53)
U.S. government and federal agency obligations   0    0    11,092    (351)   11,092    (351)
Government sponsored enterprises   17,776    (260)   25,333    (458)   43,109    (718)
Obligations of states and political subdivisions   22,974    (228)   12,371    (405)   35,345    (633)
Mortgage-backed securities:                              
Residential - government agencies   55,223    (1,367)   65,303    (2,850)   120,526    (4,217)
 Total  $97,903   $(1,908)  $114,099   $(4,064)  $212,002   $(5,972)
                               
(in thousands)                              
At December 31, 2017                              
U.S. Treasury  $1,967   $(13)  $0   $0   $1,967   $(13)
U.S. government and federal agency obligations   0    0    12,073    (268)   12,073    (268)
Government sponsored enterprises   16,471    (119)   20,426    (305)   36,897    (424)
Obligations of states and political subdivisions   22,013    (165)   12,570    (312)   34,583    (477)
Mortgage-backed securities:                              
Residential - government agencies   52,829    (488)   69,580    (1,652)   122,409    (2,140)
 Total  $93,280   $(785)  $114,649   $(2,537)  $207,929   $(3,322)

 

The total available for sale portfolio consisted of approximately 369 securities at June 30, 2018. The portfolio included 322 securities having an aggregate fair value of $212.0 million that were in a loss position at June 30, 2018. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $114.1 million at fair value. The $6.0 million aggregate unrealized loss included in accumulated other comprehensive income at June 30, 2018 was caused by interest rate fluctuations.

 

The total available for sale portfolio consisted of approximately 355 securities at December 31, 2017. The portfolio included 280 securities having an aggregate fair value of $207.9 million that were in a loss position at December 31, 2017. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer had a fair value of $114.6 million at December 31, 2017. The $3.3 million aggregate unrealized loss included in accumulated other comprehensive loss at December 31, 2017 was caused by interest rate fluctuations.

 

Because the decline in fair value is attributable to changes in interest rates and not credit quality, these investments were not considered other-than-temporarily impaired at June 30, 2018 and December 31, 2017, respectively. In the absence of changes in credit quality of these investments, the fair value is expected to recover on all debt securities as they approach their maturity date or re-pricing date, or if market yields for such investments decline. In addition, the Company does not have the intent to sell these investments over the period of recovery, and it is not more likely than not that the Company will be required to sell such investment securities.

 

The table presents the components of investment securities gains and losses, which have been recognized in earnings:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(in thousands)  2018   2017   2018   2017 
Gains realized on sales  $108   $0   $206   $0 
Losses realized on sales   0    0    0    0 
Other-than-temporary impairment recognized   0    0    0    0 
Investment securities gains  $108   $0   $206   $0 

 

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HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(5)Intangible Assets

 

Mortgage Servicing Rights

 

At June 30, 2018, the Company was servicing approximately $284.9 million of loans sold to the secondary market compared to $285.8 million at December 31, 2017, and $289.8 million at June 30, 2017. Mortgage loan servicing fees, reported as non-interest income, earned on loans sold were $210,000 and $413,000 for the three and six months ended June 30, 2018, respectively, compared to $211,000 and $420,000 for the three and six months ended June 30, 2017, respectively.

 

The table below presents changes in mortgage servicing rights (MSRs) for the periods indicated.

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(in thousands)  2018   2017   2018   2017 
Balance at beginning of period  $2,781   $2,877   $2,713   $2,584 
Originated mortgage servicing rights   81    66    131    115 
Changes in fair value:                    
Due to change in model inputs and assumptions (1)   30    (56)   133    319 
Other changes in fair value (2)   (79)   (121)   (164)   (252)
Balance at end of period  $2,813   $2,766   $2,813   $2,766 

 

(1)The change in fair value resulting from changes in valuation inputs or assumptions used in the valuation model reflects the change in discount rates and prepayment speed assumptions primarily due to changes in interest rates.
(2)Other changes in fair value reflect changes due to customer payments and passage of time.

 

The following key data and assumptions were used in estimating the fair value of the Company’s MSRs as of June 30, 2018 and 2017, respectively:

 

   Six Months Ended June 30, 
   2018   2017 
Weighted average constant prepayment rate   9.55%   9.28%
Weighted average note rate   3.90%   3.86%
Weighted average discount rate   10.34%   9.75%
Weighted average expected life (in years)   6.10    6.10 

 

(6)Federal funds purchased and securities sold under agreements to repurchase

 

   June 30,   December 31, 
   2018   2017 
Federal funds purchased  $0   $0 
Repurchase agreements   36,103    27,560 
Total  $36,103   $27,560 

 

The Company offers a sweep account program whereby amounts in excess of an established limit are “swept” from the customer’s demand deposit account on a daily basis into retail repurchase agreements pursuant to individual repurchase agreements between the Company and its customers. Repurchase agreements are agreements to sell securities subject to an obligation to repurchase the same or similar securities. They are accounted for as collateralized financing transactions, not as sales and purchases of the securities portfolio. The securities collateral pledged for the repurchase agreements with customers is maintained by a designated third party custodian. The collateral amounts pledged to repurchase agreements by remaining maturity in the table below are limited to the outstanding balances of the related asset or liability; thus amounts of excess collateral are not shown.

 

 19 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Repurchase Agreements  Remaining Contractual Maturity of the Agreements 
   Overnight   Less   Greater     
   and   than   than     
(in thousands)  continuous   90 days   90 days   Total 
At June 30, 2018                
U.S. Treasury  $1,445   $0   $0   $1,445 
Government sponsored enterprises   14,205    0    0    14,205 
Asset-backed securities   20,453    0    0    20,453 
Total  $36,103   $0   $0   $36,103 
                     
At December 31, 2017                    
U.S. Treasury  $1,964   $0   $0   $1,964 
U.S. government and federal agency obligations   2,977    0    0    2,977 
Government sponsored enterprises   8,382    0    0    8,382 
Asset-backed securities   14,237    0    0    14,237 
Total  $27,560   $0   $0   $27,560 

 

(7)Income Taxes

 

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 7.2% and 11.3% for the three and six months ended June 30, 2018, respectively, compared to 33.9% and 34.1% for the three and six months ended June 30, 2017, respectively. As further described below, the decrease in tax rate for the comparative periods is primarily due to a decrease in the federal corporate tax rate, the release of the valuation allowance related to capital losses as a result of the Company’s tax planning initiatives, a pension contribution made during the second quarter of 2018 that was attributable to the 2017 plan year, and the Company’s additional tax planning initiatives.

 

The federal corporate income tax rate declined from 34% to 21% effective January 1, 2018 as a result of the Tax Cuts and Jobs Act. The Company’s tax rate is lower than the federal statutory rate primarily as a result of tax-exempt income, the release of the valuation allowance related to capital loss carryforwards, and a pension contribution made during the second quarter of 2018 that was attributable to the 2017 plan year. The provisional adjustments recorded in the fourth quarter of 2017 related to the enactment of the Tax Cuts and Jobs Act have not been finalized as of June 30, 2018. The Company expects to finalize those adjustments within the one-year measurement period provided under Staff Accounting Bulletin No. 118 in regards to the application of FASB’s ASC Topic 740, Income Taxes. The impact of the Tax Cuts and Jobs Act is expected to require further adjustments in 2018 due to anticipated additional guidance from the U.S. Department of the Treasury, changes in our assumptions, completion of 2017 U.S. tax returns and further information and interpretations that become available.

 

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income of the appropriate character during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning initiatives in making this assessment. In management’s opinion, the Company will more likely than not realize the benefits of its deferred tax assets and, therefore, has not established a valuation allowance against its deferred tax assets as of June 30, 2018. Management arrived at this conclusion based upon the level of historical taxable income and projections for future taxable income of the appropriate character over the periods in which the deferred tax assets are deductible. As indicated above, the Company released a $46,000 valuation allowance against certain capital loss carryforwards during the second quarter of 2018 as a result of the execution of certain tax planning initiatives that generated sufficient capital gain income prior to the expiration of the carryforwards.

 

The Company follows ASC Topic 740, Income Taxes, which addresses the accounting for uncertain tax positions. For each of the three and six months ended June 30, 2018 and 2017, respectively, the Company did not have any uncertain tax provisions, and did not record any related tax liabilities.

 

 20 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(8)Stockholders’ Equity

 

Accumulated Other Comprehensive Loss

 

The following details the change in the components of the Company’s accumulated other comprehensive loss for the six months ended June 30, 2018 and 2017:

 

   Six months ended June 30, 2018 
       Unrecognized Net   Accumulated 
   Unrealized   Pension and   Other 
   Gain (Loss)   Postretirement   Comprehensive 
(in thousands)  on Securities (1)   Costs (2)   (Loss) Income 
Balance at beginning of period  $(2,500)  $(3,162)  $(5,662)
Other comprehensive (loss) income, before reclassifications   (2,730)   108    (2,622)
Amounts reclassified from accumulated other comprehensive (loss) income   0    0    0 
Current period other comprehensive (loss) income, before tax   (2,730)   108    (2,622)
Income tax expense (benefit)   573    (23)   550 
Current period other comprehensive (loss) income, net of tax   (2,157)   85    (2,072)
Balance at end of period  $(4,657)  $(3,077)  $(7,734)
     
   Six months ended June 30, 2017 
       Unrecognized Net   Accumulated 
   Unrealized   Pension and   Other 
   Gain (Loss)   Postretirement   Comprehensive 
(in thousands)  on Securities (1)   Costs (2)   Loss 
Balance at beginning of period  $(1,936)  $(1,865)  $(3,801)
Other comprehensive income, before reclassifications   1,452    45    1,497 
Amounts reclassified from accumulated other comprehensive income (loss)   0    0    0 
Current period other comprehensive income, before tax   1,452    45    1,497 
Income tax expense   (552)   (18)   (570)
Current period other comprehensive income, net of tax   900    27    927 
Balance at end of period  $(1,036)  $(1,838)  $(2,874)

 

(1) The pre-tax amounts reclassified from accumulated other comprehensive loss are included in gain on sale of investment securities in the consolidated statements of income.

(2) The pre-tax amounts reclassified from accumulated other comprehensive loss are included in the computation of net periodic pension cost.

 

(9)Employee Benefit Plans

 

Employee Benefits

 

Employee benefits charged to operating expenses are summarized in the table below for the periods indicated.

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(in thousands)  2018   2017   2018   2017 
Payroll taxes  $301   $288   $652   $644 
Medical plans   612    468    1,160    894 
401k match and profit sharing   237    226    423    476 
Periodic pension cost   405    335    810    671 
Other   10    9    25    25 
Total employee benefits  $1,565   $1,326   $3,070   $2,710 

 

The Company’s profit-sharing plan includes a matching 401k portion, in which the Company matches the first 3% of eligible employee contributions. The Company made annual contributions in an amount up to 6% of income before income taxes and before contributions to the profit-sharing and pension plans for all participants, limited to the maximum amount deductible for federal income tax purposes, for each of the periods shown. In addition, employees were able to make additional tax-deferred contributions.

 

 21 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Pension

 

The Company provides a noncontributory defined benefit pension plan for all full-time employees. Beginning January 1, 2018 and for all retrospective periods presented, the Company adopted the guidance under ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Under the new guidance only the service cost component of the net periodic benefit cost is reported in the same income statement line item as salaries and benefits, and the remaining components are reported as other non-interest expense. An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. The Company made a pension contribution in the amount of $1.8 million in the second quarter of 2018. The 2018 minimum required contribution is $1.0 million. Effective July 1, 2017, the Company amended the pension plan to effectuate a “soft freeze” such that no individual hired (or rehired in the case of a former employee) by the Company after September 30, 2017, whether or not such individual is or was a vested member in the plan, will be eligible to be an active member and be entitled to accrue any benefits under the plan. Certain individuals hired by the Company before July 1, 2017 are also not eligible to participate in the plan.

 

Components of Net Pension Cost and Other Amounts Recognized in Accumulated Other Comprehensive Income

 

The following items are components of net pension cost for the periods indicated:

 

   Pension Benefits 
(in thousands)  2018   2017 
Service cost - benefits earned during the year  $1,620   $1,343 
Interest costs on projected benefit obligations (a)   1,033    1,009 
Expected return on plan assets (a)   (1,267)   (1,124)
Expected administrative expenses (a)   93    88 
Amortization of prior service cost (a)   79    79 
Amortization of unrecognized net loss (a)   138    11 
Net periodic pension cost  $1,696   $1,406 
           
Net periodic pension cost for the three months ended June 30, (actual)  $405   $335 
Net periodic pension cost for the six months ended June 30, (actual)  $810   $671 

(a) The components of net periodic pension cost other than the service cost component are included in other non-interest expense.

 

(10)Stock Compensation

 

The Company has one equity compensation plan for its employees pursuant to which options were granted.

 

The following table summarizes the Company’s stock option activity:

 

           Weighted     
       Weighted   Average   Aggregate 
   Number   average   Contractual   Intrinsic 
   of   Exercise   Term   Value 
   Shares   Price   (in years)   ($000) 
Outstanding, beginning of period   20,909   $14.20           
Granted   0    0.00           
Exercised   0    0.00           
Forfeited or expired   0    0.00           
Outstanding, June 30, 2018   20,909   $14.20    0.23   $160,975 
Exercisable, June 30, 2018   20,909   $14.20    0.23   $160,975 

 

Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2018.

 

 22 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Total stock-based compensation expense was $0 for the three and six months ended June 30, 2018 compared to $1,000 and $2,000 for the three and six months ended June 30, 2017, respectively. As of December 31, 2017, there was no remaining unrecognized compensation expense related to non-vested stock awards. The Plan expired on February 28, 2010, except as to outstanding options under the Plan, and no further options may be granted pursuant to the Plan.

 

(11)Earnings per Share

 

Stock Dividend On July 1, 2018, the Company paid a special stock dividend of 4% to common shareholders of record at the close of business on June 15, 2018. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

 

Basic earnings per share is computed by dividing income available to shareholders by the weighted average number of shares outstanding during the year. Diluted earnings per share gives effect to all dilutive potential shares that were outstanding during the year.

 

Presented below is a summary of the components used to calculate basic and diluted earnings per common share, which have been restated for all stock dividends:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(dollars in thousands, except per share data)  2018   2017   2018   2017 
Basic earnings per share:                    
Net income available to shareholders  $2,907   $1,919   $4,997   $4,020 
Average shares outstanding   6,021,038    6,070,080    6,024,851    6,070,749 
Basic earnings per share  $0.48   $0.32   $0.83   $0.66 
                     
Diluted earnings per share:                    
Net income available to shareholders  $2,907   $1,919   $4,997   $4,020 
Average shares outstanding   6,021,038    6,070,080    6,024,851    6,070,749 
Effect of dilutive stock options   6,883    5,141    6,442    5,157 
Average shares outstanding including dilutive stock options   6,027,921    6,075,221    6,031,293    6,075,906 
Diluted earnings per share  $0.48    0.32   $0.83    0.66 

 

Under the treasury stock method, outstanding stock options are dilutive when the average market price of the Company’s common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during the period, except when the Company has a loss from continuing operations available to shareholders. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period. There were no outstanding stock options for any of the three and six months ended June 30, 2018 and 2017, respectively, that were omitted from the computation of diluted earnings per share as a result of being considered anti-dilutive.

 

Repurchase Program On August 6, 2015, the Board of Directors authorized a share repurchase plan (the plan) to purchase through open market transactions up to $2.0 million market value of the Company’s common stock. On August 8, 2017, the Board authorized the repurchase of an additional $1.5 million market value of the Company’s common stock. As of June 30, 2018, the Company had repurchased a total of 95,709 shares of common stock pursuant to the plan at an average price of $17.90 per share, including 8,668 shares of common stock repurchased pursuant to the plan during the six months ended June 30, 2018 at an average price of $20.63 per share. At June 30, 2018, approximately $1.8 million remained available for the purchase of shares under the plan. The current plan expires September 8, 2018 unless renewed.

 

(12)Fair Value Measurements

 

Fair value represents the amount expected to be received to sell an asset or paid to transfer a liability in its principal or most advantageous market in an orderly transaction between market participants at the measurement date.

 

 23 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Depending on the nature of the asset or liability, the Company uses various valuation methodologies and assumptions to estimate fair value. The measurement of fair value under US GAAP uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows. As of June 30, 2018 and December 31, 2017, respectively, there were no transfers into or out of Levels 1-3.

 

The fair value hierarchy is as follows:

 

Level 1 – Inputs are unadjusted quoted prices for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. A contractually binding sales price also provides reliable evidence of fair value.

 

Level 2 – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, such as interest rates and yield curves that are observable at commonly quoted intervals.

 

Level 3 – Inputs are unobservable inputs for the asset or liability and significant to the fair value. These may be internally developed using the Company’s best information and assumptions that a market participant would consider.

 

In accordance with fair value accounting guidance, the Company measures, records, and reports various types of assets and liabilities at fair value on either a recurring or non-recurring basis in the Consolidated Financial Statements. Nonfinancial assets measured at fair value on a nonrecurring basis would include foreclosed real estate, long-lived assets, and core deposit intangible assets, which are reviewed when circumstances or other events indicate that impairment may have occurred. 

 

Valuation Methods for Assets and Labilities Measured at Fair Value on a Recurring Basis

 

Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

 

Available-for-Sale Securities

 

The fair value measurements of the Company’s investment securities are determined by a third party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The fair value measurements are subject to independent verification to another pricing source by management each quarter for reasonableness.

 

Mortgage Servicing Rights

 

The fair value of mortgage servicing rights is based on the discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees. The valuation models estimate the present value of estimated future net servicing income. The Company classifies its servicing rights as Level 3.

 

 24 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

   Fair Value Measurements
      Quoted Prices      
      in Active      
      Markets for  Other  Significant
      Identical  Observable  Unobservable
      Assets  Inputs  Inputs
(in thousands)  Fair Value  (Level 1)  (Level 2)  (Level 3)
June 30, 2018            
Assets:                    
U.S. Treasury  $1,930   $1,930    0   $0 
U.S. government and federal agency obligations   11,092    0    11,092    0 
Government sponsored enterprises   46,059    0    46,059    0 
Obligations of states and political subdivisions   41,459    0    41,459    0 
Mortgage-backed securities   127,061    0    127,061    0 
Mortgage servicing rights   2,813    0    0    2,813 
Total  $230,414   $1,930   $225,671   $2,813 
                     
December 31, 2017                    
Assets:                    
U.S. Treasury  $1,967   $1,967    0   $0 
U.S. government and federal agency obligations   12,073    0    12,073    0 
Government sponsored enterprises   36,897    0    36,897    0 
Obligations of states and political subdivisions   46,656    0    46,656    0 
Mortgage-backed securities   128,949    0    128,949    0 
Mortgage servicing rights   2,713    0    0    2,713 
Total  $229,255   $1,967   $224,575   $2,713 

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:

 

    Fair Value Measurements Using  Fair Value Measurements Using 
    Significant Unobservable Inputs  Significant Unobservable Inputs 
    (Level 3)  (Level 3) 
    Mortgage Servicing Rights  Mortgage Servicing Rights 
(in thousands)   Three Months Ended June 30,  Six Months Ended June 30, 
    2018  2017  2018  2017 
Balance at beginning of period   $2,781  $2,877  $2,713  $2,584 
Total gains or losses (realized/unrealized):                  
Included in earnings    (49)  (177)  (31)  67 
Included in other comprehensive income    0   0   0   0 
Purchases    0   0   0   0 
Sales    0   0   0   0 
Issues    81   66   131   115 
Settlements    0   0   0   0 
Balance at end of period   $2,813  $2,766  $2,813  $2,766 

 

The change in valuation of mortgage servicing rights arising from inputs and assumptions increased $30,000 and $133,000 for the three and six months ended June 30, 2018, respectively, compared to a decrease of $56,000 and an increase of $319,000 for the three and six months ended June 30, 2017, respectively.

 

 25 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Valuation methods for Assets and Liabilities measured at fair value on a nonrecurring basis

 

Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

 

Collateral dependent impaired loans

 

While the overall loan portfolio is not carried at fair value, the Company periodically records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral dependent loans when establishing the allowance for loan losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan. In determining the value of real estate collateral, the Company relies on external and internal appraisals of property values depending on the size and complexity of the real estate collateral. The Company maintains staff that is trained to perform in-house evaluations and also review third party appraisal reports for reasonableness. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgments based on the experience and expertise of internal specialists. Values of all loan collateral are regularly reviewed by senior loan committee. Because many of these inputs are not observable, the measurements are classified as Level 3. As of June 30, 2018, the Company identified $4.2 million in collateral dependent impaired loans that had specific allowances for losses aggregating $911,000. Related to these loans, there was $192,000 and $250,000 in charge-offs recorded during the three and six months ended June 30, 2018, respectively. As of June 30, 2017, the Company identified $3.0 million in collateral dependent impaired loans that had specific allowances for losses aggregating $755,000. Related to these loans, there was $63,000 and $83,000 in charge-offs recorded during the three and six months ended June 30, 2017, respectively.

 

Other Real Estate and Foreclosed Assets

 

Other real estate owned (OREO) and foreclosed assets consisted 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. Subsequent to foreclosure, these assets initially are carried at fair value of the collateral less estimated selling costs. Fair value, when recorded, is generally based upon appraisals by approved, independent state certified appraisers. Like impaired loans, appraisals on OREO may be discounted based on the Company’s historical knowledge, changes in market conditions from the time of appraisal or other information available. During the holding period, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3.

 

 26 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

  

    Fair Value Measurements Using 
       Quoted Prices        Three  Six 
       in Active        Months  Months 
       Markets for  Other  Significant  Ended  Ended 
       Identical  Observable  Unobservable  June 30,  June 30, 
    Total  Assets  Inputs  Inputs  Total Gains  Total Gains 
(in thousands)   Fair Value  (Level 1)  (Level 2)  (Level 3)  (Losses)*  (Losses)* 
June 30, 2018                    
Assets:                          
Collateral dependent impaired loans:                          
Commercial, financial, & agricultural   $1,648  $0  $0  $1,648  $(166) $(166)
Real estate construction - commercial    169   0   0   169   0   (27)
Real estate mortgage - residential    998   0   0   998   (12)  (12)
Real estate mortgage - commercial    337   0   0   337   0   (20)
Consumer    137   0   0   137   (14)  (25)
Total   $3,289  $0  $0  $3,289  $(192) $(250)
Other real estate and foreclosed assets   $13,236  $0  $0  $13,236  $(27) $(26)
                           
June 30, 2017                          
Assets:                          
Collateral dependent impaired loans:                          
Commercial, financial, & agricultural   $523  $0  $0  $523  $0  $(1)
Real estate mortgage - residential    1,488   0   0   1,488   (62)  (65)
Real estate mortgage - commercial    220   0   0   220   0   (4)
Consumer    0   0   0   0   (1)  (13)
Total   $2,231  $0  $0  $2,231  $(63) $(83)
Other real estate and foreclosed assets   $13,356  $0  $0  $13,356  $(195) $(180)

 

* Total gains (losses) reported for other real estate and foreclosed assets includes charge-offs, valuation write downs, and net losses taken during the periods reported.

 

(13)Fair Value of Financial Instruments

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate such value:

 

Loans

 

Fair values are estimated for portfolios with similar financial characteristics. Loans are segregated by type, such as commercial, real estate, and consumer. Each loan category is further segmented into fixed and variable interest rate categories. The fair value of loans is estimated by using the future value of discounted cash flows using comparable market rates for similar types of loan products and adjusted for market factors. The discount rates used are estimated using comparable market rates for similar types of loan products adjusted to be commensurate with the credit risk, overhead costs, and optionality of such instruments.

 

Investment Securities

 

A detailed description of the fair value measurement of the debt instruments in the available-for-sale sections of the investment security portfolio is provided in the Fair Value Measurement section above. A schedule of investment securities by category and maturity is provided in the notes on Investment Securities.

 

Federal Home Loan Bank (FHLB) Stock

 

Ownership of equity securities of FHLB is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.

 

 27 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Federal Funds Sold, Cash, and Due from Banks

 

The carrying amounts of short-term federal funds sold, interest earning deposits with banks, and cash and due from banks approximate fair value. Federal funds sold classified as short-term generally mature in 90 days or less.

 

Certificates of Deposit in other banks

 

Certificates of deposit are other investments made by the Company with other financial institutions that are carried at cost.

 

Mortgage Servicing Rights

 

The fair value of mortgage servicing rights is based on the discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees.

 

Cash Surrender Value - Life Insurance

 

The fair value of Bank owned life insurance (BOLI) approximates the carrying amount. Upon liquidation of these investments, the Company would receive the cash surrender value which equals the carrying amount.

 

Accrued Interest Receivable and Payable

 

For accrued interest receivable and payable, the carrying amount is a reasonable estimate of fair value because of the short maturity for these financial instruments.

 

Deposits

 

The fair value of deposits with no stated maturity, such as noninterest-bearing demand, NOW accounts, savings, and money market, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

 

Securities Sold under Agreements to Repurchase

 

For securities sold under agreements to repurchase, the carrying amount is a reasonable estimate of fair value, as such instruments reprice in a short time period.

 

Subordinated Notes and Other Borrowings

 

The fair value of subordinated notes and other borrowings is based on the discounted value of contractual cash-flows. The discount rate is estimated using the rates currently offered for other borrowed money of similar remaining maturities.

 

 28 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

A summary of the carrying amounts and fair values of the Company’s financial instruments at June 30, 2018 and December 31, 2017 is as follows:

 

           June 30, 2018 
           Fair Value Measurements 
           Quoted Prices         
           in Active       Net 
           Markets for   Other   Significant 
   June 30, 2018   Identical   Observable   Unobservable 
   Carrying   Fair   Assets   Inputs   Inputs 
(in thousands)  amount   value   (Level 1)   (Level 2)   (Level 3) 
Assets:                    
Cash and due from banks  $15,921   $15,921   $15,921   $0   $0 
Federal funds sold and overnight interest-bearing deposits   34,863    34,863    34,863    0    0 
Certificates of deposit in other banks   10,746    10,746    10,746    0    0 
Investment in available-for-sale securities   227,601    227,601    1,930    225,671    0 
Loans, net   1,082,983    1,061,707    0    0    1,061,707 
Investment in FHLB stock   4,676    4,676    0    4,676    0 
Mortgage servicing rights   2,813    2,813    0    0    2,813 
Cash surrender value - life insurance   2,516    2,516    0    2,516    0 
Accrued interest receivable   5,294    5,294    5,294    0    0 
   $1,387,413   $1,366,137   $68,754   $232,863   $1,064,520 
Liabilities:                         
Deposits:                         
Non-interest bearing demand  $250,232   $250,232   $250,232   $0   $0 
Savings, interest checking and money market   614,976    614,976    614,976    0    0 
Time deposits   318,178    315,242    0    0    315,242 
Federal funds purchased and securities sold under agreements to repurchase   36,103    36,103    36,103    0    0 
Federal Home Loan Bank advances and other borrowings   74,270    73,846    0    73,846    0 
Subordinated notes   49,486    44,146    0    44,146    0 
Accrued interest payable   790    790    790    0    0 
   $1,344,035   $1,335,335   $902,101   $117,992   $315,242 

 

 29 

 

 

HAWTHORN BANCSHARES, INC.

AND SUBSIDIARIES

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

           December 31, 2017 
           Fair Value Measurements 
           Quoted Prices         
           in Active       Net 
           Markets for   Other   Significant 
   December 31, 2017   Identical   Observable   Unobservable 
   Carrying   Fair   Assets   Inputs   Inputs 
(in thousands)  amount   value   (Level 1)   (Level 2)   (Level 3) 
Assets:                    
Cash and due from banks  $23,325   $23,325   $23,325   $0   $0 
Federal funds sold and overnight interest-bearing deposits   39,553    39,553    39,553    0    0 
Certificates of deposit in other banks   3,460    3,460    3,460    0    0 
Investment in available-for-sale securities   226,542    226,542    1,967    224,575    0 
Loans, net   1,057,580    1,058,153    0    0    1,058,153 
Investment in FHLB stock   6,390    6,390    0    6,390    0 
Mortgage servicing rights   2,713    2,713    0    0    2,713 
Cash surrender value - life insurance   2,484    2,484    0    2,484    0 
Accrued interest receivable   5,627    5,627    5,627    0    0 
   $1,367,674   $1,368,247   $73,932   $233,449   $1,060,866 
Liabilities:                         
Deposits:                         
Non-interest bearing demand  $245,380   $245,380   $245,380   $0   $0 
Savings, interest checking and money market   584,468    584,468    584,468    0    0 
Time deposits   295,964    294,778    0    0    294,778 
Federal funds purchased and securities sold under agreements to repurchase   27,560    27,560    27,560    0    0 
Federal Home Loan Bank advances and other borrowings   121,382    121,291    0    121,291    0 
Subordinated notes   49,486    39,692    0    39,692    0 
Accrued interest payable   554    554    554    0    0 
   $1,324,794   $1,313,723   $857,962   $160,983   $294,778 

 

Off-Balance Sheet Financial Instruments

 

The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments, and the present creditworthiness of such counterparties. The Company believes such commitments have been made on terms that are competitive in the markets in which it operates.

 

Limitations

 

The fair value estimates provided are made at a point in time based on market information and information about the financial instruments. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the fair value estimates.

 

(14)Repurchase Reserve Liability

 

The Company’s repurchase reserve liability for estimated losses incurred on sold loans was $160,000 at both June 30, 2018 and December 31, 2017. This liability represents management’s estimate of the potential repurchase or make-whole liability for residential mortgage loans originated for sale that may arise from representation and warranty claims that could relate to a variety of issues, including but not limited to, misrepresentation of facts, appraisal issues, or program requirements that may not meet investor guidelines. At June 30, 2018, the Company was servicing 2,726 loans sold to the secondary market with a balance of approximately $284.9 million compared to 2,773 loans sold with a balance of approximately $285.8 million at December 31, 2017, and 2,826 loans sold with a balance of approximately $289.8 million at June 30, 2017.

 

 30 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(in thousands)  2018   2017   2018   2017 
Balance at beginning of year  $160   $160   $160   $160 
Provision for repurchase liability   0    0    0    0 
Reimbursement of expenses   0    0    0    0 
Balance at end of year  $160   $160   $160   $160 

  

(15)Commitments and Contingencies

 

The Company issues financial instruments with off-balance-sheet risk in the normal course of business of meeting the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

 

The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At June 30, 2018, no amounts have been accrued for any estimated losses for these financial instruments.

 

The contractual amount of off-balance-sheet financial instruments were as follows as of the dates indicated:

  

   June 30,   December 31, 
(in thousands)   2018    2017 
Commitments to extend credit  $235,159   $238,527 
Commitments to originate residential first and second mortgage loans   2,554    1,471 
Standby letters of credit   77,276    74,004 
Total   314,989    314,002 

  

Commitments

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments and letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, furniture and equipment, and real estate.

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support contractual obligations of the Company’s customers. The approximate remaining term of standby letters of credit range from one month to five years at June 30, 2018.

 

Pending Litigation

 

The Company and its subsidiaries are defendants in various legal actions incidental to the Company’s past and current business activities. Based on the Company’s analysis, and considering the inherent uncertainties associated with litigation, management does not believe that it is reasonably possible that these legal actions will materially adversely affect the Company’s consolidated financial condition or results of operations in the near term. The Company records a loss accrual for all legal matters for which it deems a loss is probable and can be reasonably estimated. Some legal matters, which are at early stages in the legal process, have not yet progressed to the point where a loss is deemed probable or an amount can be estimated.

  

 31 

 

  

Hawthorn Bancshares, Inc.
and subsidiaries 

 

Notes to the Consolidated Financial Statements 

 

(Unaudited)

 

(16)Revenue Recognition

 

On January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. As stated in Note 1 Summary of Significant Accounting Policies, the implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

 

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in the scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust department revenue, service charges and fees, debit card income, ATM surcharge income, and sales of other real estate owned. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Noninterest revenue streams within the scope of Topic 606 are discussed below.

 

Trust Department Revenue

 

Trust and asset management income is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customers’ accounts. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.

 

Service Charges on Deposit Accounts

 

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

 

Fees, Exchange, and Other Service Charges

 

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.

 

 Gains/Losses on Sales of Other Real Estate Owned (OREO)

 

The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. Two OREO sales for the six months ended June 30, 2018 and two sales for the six months ended June 30, 2017 were financed by the Bank, which financings were consistent with market terms.

  

 32 

 

  

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, Hawthorn Bancshares, Inc., 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 Company’s 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, regulatory or tax law changes may adversely affect the business in which the Company and its subsidiaries are engaged, and

·changes may occur in the securities markets.

  

We have described under the caption Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, 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

 

Crucial to the Company’s community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank, the Company, with $1.5 billion in assets at June 30, 2018, provides a broad range of commercial and personal banking services. The Bank’s specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate, Small Business Administration (SBA) loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts. Other financial services that the Company provides include trust services that include estate planning, investment and asset management services and a comprehensive suite of cash management services. The geographic areas in which the Company provides products and services include the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and the greater Kansas City metropolitan area.

 

The Company's primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the Company's business is commercial, commercial real estate development, and residential mortgage lending. The Company's income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing activity.

 

The success of the Company's growth strategy depends primarily on the ability of its 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 its 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 its ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control.

  

 33 

 

  

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 Board of Governors of the Federal Reserve System.

 

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 Company’s business operations is provided in note 1 to the Company’s unaudited 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.

  

 34 

 

  

SELECTED CONSOLIDATED FINANCIAL DATA

 

The following table presents selected consolidated financial information for the Company as of and for each of the three months ended June 30, 2018 and 2017, respectively. The selected consolidated financial data should be read in conjunction with the unaudited consolidated financial statements of the Company, including the related notes, presented elsewhere herein.

 

Selected Financial Data
   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands, except per share data)  2018   2017   2018   2017 
Per Share Data                    
Basic earnings per share  $0.48   $0.32   $0.83   $0.66 
Diluted earnings per share   0.48    0.32    0.83    0.66 
Dividends paid on common stock   405    338    811    674 
Book value per share             15.46    15.67 
Market price per share             21.90    20.14 
Selected Ratios                    
(Based on average balance sheets)                    
Return on total assets   0.80%   0.58%   0.70%   0.61%
Return on stockholders' equity   12.64%   8.10%   11.00%   8.65%
Stockholders' equity to total assets   6.33%   7.11%   6.37%   7.06%
Efficiency ratio (1)   73.49%   74.98%   75.98%   73.75%
                     
(Based on end-of-period data)                    
Stockholders' equity to assets             6.43%   6.88%
Total risk-based capital ratio             13.41%   13.47%
Tier 1 risk-based capital ratio             11.13%   11.20%
Common equity Tier 1 capital             8.44%   8.43%
Tier 1 leverage ratio (2)             9.09%   9.77%

 

(1)Efficiency ratio is calculated as non-interest expense as a percentage of revenue. Total revenue includes net interest income and non-interest income.
(2)Tier I leverage ratio is calculated by dividing Tier 1 capital by average total consolidated assets.

 

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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 June 30, Six Months Ended June 30, 
(In thousands)  2018   2017   $ Change   % Change   2018   2017   $ Change   % Change 
                                 
Net interest income  $11,027   $10,820   $207    1.9%  $21,782   $21,307   $475    2.2%
Provision for loan losses   450    330    120    36.4    750    680    70    10.3 
Noninterest income   2,486    2,099    387    18.4    4,787    4,506    281    6.2 
Noninterest expense   9,931    9,687    244    2.5    20,186    19,037    1,149    6.0 
Income before income taxes   3,132    2,902    230    7.9    5,633    6,096    (463)   (7.6)
Income tax expense   225    983    (758)   (77.1)   636    2,076    (1,440)   (69.4)
Net income  $2,907   $1,919   $988    51.5%  $4,997   $4,020   $977    24.3%

  

Consolidated net income of $2.9 million, or $0.48 per diluted share, for the three months ended June 30, 2018 increased $988,000 compared to $1.9 million, or $0.32 per diluted share, for the three months ended June 30, 2017. For the three months ended June 30, 2018, the return on average assets was 0.80%, the return on average stockholders’ equity was 12.64%, and the efficiency ratio was 73.49%.

 

Consolidated net income of $5.0 million, or $0.83 per diluted share, for the six months ended June 30, 2018 increased $977,000 compared to $4.0 million, or $0.66 per diluted share, for the six months ended June 30, 2017. For the six months ended June 30, 2018, the return on average assets was 0.70%, the return on average stockholders’ equity was 11.00%, and the efficiency ratio was 75.98%.

 

Net interest income was $11.0 million and $21.8 million for the three and six months ended June 30, 2018, respectively, compared to $10.8 million and $21.3 million for the three and six months ended June 30, 2017, respectively. The net interest margin (expressed on a fully taxable equivalent basis) decreased to 3.25% for the three months ended June 30, 2018, compared to 3.50% for the three months ended June 30, 2017, and decreased to 3.27% for the six months ended June 30, 2018 compared to 3.49% for the six months ended June 30, 2017. These changes are discussed in greater detail under the Average Balance Sheets and Rate and Volume Analysis section below.

 

A $450,000 and $750,000 provision for loan losses was recorded for the three and six months ended June 30, 2018, respectively, compared to a $330,000 and $680,000 provision for the three and six months ended June 30, 2017, respectively.

 

The Company’s net loan charge-offs were $185,000, or 0.02%, of average loans, and $390,000, or 0.04%, of average loans for the three and six months ended June 30, 2018, respectively, compared to $47,000, or 0.00%, of average loans, and $21,000, or 0.00%, of average loans for the three and six months ended June 30, 2017, respectively.

 

Non-performing loans totaled $10.3 million, or 0.94% of total loans, at June 30, 2018 compared to $10.7 million, or 1.00% of total loans, at December 31, 2017, and $10.0 million, or 0.97% of total loans, at June 30, 2017. These changes are discussed in greater detail under the Lending and Credit Management section below.

 

Non-interest income increased $387,000, or 18.4%, for the three months ended June 30, 2018 compared to the three months ended June 30, 2017, and increased $281,000, or 6.2%, for the six months ended June 30, 2018 compared to the six months ended June 30, 2017. These changes are discussed in greater detail below under Non-interest Income.

 

Non-interest expense increased $244,000, or 2.5%, for the three months ended June 30, 2018 compared to the three months ended June 30, 2017 and increased $1.1 million, or 6.0%, for the six months ended June 30, 2018 compared to the six months ended June 30, 2017. These changes are discussed in greater detail below under Non-interest Expense.

 

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 periods ended June 30, 2018 and 2017, respectively.

  

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   Three Months Ended June 30, 
(In thousands)  2018   2017 
       Interest   Rate       Interest   Rate 
   Average   Income/   Earned/   Average   Income/   Earned/ 
   Balance   Expense(1)   Paid(1)   Balance   Expense(1)   Paid(1) 
ASSETS                        
Loans: (2) (4)                        
Commercial  $203,512   $2,549    5.02%  $190,888   $2,229    4.68%
Real estate construction - residential   29,699    390    5.27    20,559    236    4.60 
Real estate construction - commercial   102,155    1,233    4.84    71,661    798    4.47 
Real estate mortgage - residential   247,360    2,967    4.81    258,958    2,959    4.58 
Real estate mortgage - commercial   475,326    5,524    4.66    451,185    5,204    4.63 
Consumer   32,664    313    3.84    31,801    309    3.90 
Total loans  $1,090,716   $12,976    4.77%  $1,025,052   $11,735    4.59%
Investment securities: (3)                              
U.S. Treasury  $22,020   $79    1.44%  $0   $0    0.00%
U.S. government and federal agency obligations   54,236    241    1.78    48,888    176    1.44 
Obligations of states and political subdivisions   41,319    234    2.27    47,721    266    2.24 
Mortgage-backed securities   126,842    646    2.04    120,012    544    1.82 
Total investment securities  $244,417   $1,200    1.97%  $216,621   $986    1.83%
Other investments and securities, at cost   9,458    115    4.88    10,588    94    3.56 
Federal funds sold and interest bearing deposits in other financial institutions   39,752    189    1.91    4,795    11    0.92 
Total interest earning assets  $1,384,343   $14,480    4.20%  $1,257,056   $12,826    4.09%
All other assets   83,987              88,361           
Allowance for loan losses   (11,100)             (10,385)          
Total assets  $1,457,230             $1,335,032           
LIABILITIES AND STOCKHOLDERS' EQUITY                              
NOW accounts  $229,171   $559    0.98%  $212,226   $272    0.51%
Savings   97,144    12    0.05    100,985    13    0.05 
Interest checking   3,894    6    0.62    1,523    2    0.53 
Money market   291,789    770    1.06    203,697    188    0.37 
Time deposits   314,620    832    1.06    286,461    509    0.71 
Total interest bearing deposits  $936,618   $2,179    0.93%  $804,892   $984    0.49%
Federal funds purchased and securities sold under agreements to repurchase   49,571    189    1.53    29,237    27    0.37 
Federal Home Loan advances and other   77,648    332    1.72    110,124    419    1.53 
Subordinated notes   49,486    561    4.55    49,486    431    3.49 
Total borrowings  $176,705   $1,082    2.46%  $188,847   $877    1.86%
Total interest bearing liabilities  $1,113,323   $3,261    1.17%  $993,739   $1,861    0.75%
Demand deposits   239,921              235,232           
Other liabilities   11,708              11,075           
Total liabilities   1,364,952              1,240,046           
Stockholders' equity   92,278              94,986           
Total liabilities and stockholders' equity  $1,457,230             $1,335,032           
Net interest income (FTE)        11,219              10,965      
Net interest spread             3.03%             3.34%
Net interest margin             3.25%             3.50%

 

(1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21% and 34%, net of nondeductible interest expense for the three months ended June 30, 2018 and 2017 respectively. Such adjustments totaled $192,000 and $145,000 for the three months ended June 30, 2018 and 2017, respectively.
(2)Non-accruing loans are included in the average amounts outstanding.
(3)Average balances based on amortized cost.
(4)Fees and costs on loans are included in interest income.

 

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   Six Months Ended June 30, 
(In thousands)  2018   2017 
       Interest   Rate       Interest   Rate 
   Average   Income/   Earned/   Average   Income/   Earned/ 
   Balance   Expense(1)   Paid(1)   Balance   Expense(1)   Paid(1) 
ASSETS                        
Loans: (2) (4)                        
Commercial  $197,141   $4,807    4.92%  $186,741   $4,290    4.63%
Real estate construction - residential   29,088    731    5.07    19,936    451    4.56 
Real estate construction - commercial   102,006    2,406    4.76    68,952    1,518    4.44 
Real estate mortgage - residential   247,469    5,826    4.75    259,750    5,882    4.57 
Real estate mortgage - commercial   473,635    10,884    4.63    442,219    10,097    4.60 
Consumer   32,504    607    3.77    31,022    609    3.96 
Total loans  $1,081,843   $25,261    4.71%  $1,008,620   $22,847    4.57%
Investment securities: (3)                              
U.S. Treasury  $19,773   $139    1.42%  $0   $0    0.00%
U.S. government and federal agency obligations   51,830    431    1.68    47,159    332    1.42 
Obligations of states and political subdivisions   43,054    503    2.36    45,738    516    2.28 
Mortgage-backed securities   126,152    1,325    2.12    122,154    1,126    1.86 
Total investment securities  $240,809   $2,398    2.01%  $215,051   $1,974    1.85%
Other investments and securities, at cost   9,683    225    4.69    10,189    184    3.64 
Federal funds sold and interest bearing deposits in other financial institutions   32,204    295    1.85    13,179    60    0.92