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HAWTHORN BANCSHARES, INC. - Quarter Report: 2015 September (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 September 30, 2015

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
incorporation or organization)   Identification No.)

 

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, or a smaller reporting company. See the definitions of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:

 

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

 

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 November 16, 2015, the registrant had 5,443,344 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)

 

   September 30,   December 31, 
(In thousands, except per share data)  2015   2014 
ASSETS          
Cash and due from banks  $17,664   $22,364 
Federal funds sold and other overnight interest-bearing deposits   14,463    20,445 
Cash and cash equivalents   32,127    42,809 
Investment in available-for-sale securities, at fair value   244,250    198,998 
Other investments and securities, at cost   9,237    4,722 
Total investment securities   253,487    203,720 
Loans   879,474    861,213 
Allowances for loan losses   (9,246)   (9,099)
Net loans   870,228    852,114 
Premises and equipment - net   36,727    37,498 
Mortgage servicing rights   2,774    2,762 
Other real estate and repossessed assets - net   15,148    11,885 
Accrued interest receivable   4,909    4,816 
Cash surrender value - life insurance   2,329    2,284 
Other assets   9,895    11,843 
Total assets  $1,227,624   $1,169,731 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Deposits          
Non-interest bearing demand  $209,714   $207,700 
Savings, interest checking and money market   452,878    442,059 
Time deposits $100,000 and over   138,891    134,945 
Other time deposits   170,685    184,810 
Total deposits   972,168    969,514 
Federal funds purchased and securities sold under agreements to repurchase   27,762    17,970 
Subordinated notes   49,486    49,486 
Federal Home Loan Bank advances   80,000    43,000 
Accrued interest payable   378    373 
Other liabilities   10,757    8,820 
Total liabilities   1,140,551    1,089,163 
Stockholders’ equity:          
Common stock, $1 par value, authorized 15,000,000 shares; issued 5,605,202 and 5,395,844 shares, respectively   5,605    5,396 
Surplus   38,544    35,901 
Retained earnings   46,979    44,016 
Accumulated other comprehensive loss, net of tax   (538)   (1,228)
Treasury stock; 161,858 shares, at cost   (3,517)   (3,517)
Total stockholders’ equity   87,073    80,568 
Total liabilities and stockholders’ equity  $1,227,624   $1,169,731 

 

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

 

 2 

 

  

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income (unaudited)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
(In thousands, except per share amounts)  2015   2014   2015   2014 
INTEREST INCOME                    
Interest and fees on loans  $10,713   $10,146   $30,891   $30,059 
Interest on investment securities:                    
Taxable   872    845    2,663    2,600 
Nontaxable   169    180    524    543 
Federal funds sold and other overnight interest-bearing deposits   3    5    24    23 
Dividends on other securities   72    20    139    59 
Total interest income   11,829    11,196    34,241    33,284 
INTEREST EXPENSE                    
Interest on deposits:                    
Savings, interest checking and money market   241    229    738    750 
Time deposit accounts $100,000 and over   222    237    653    723 
Other time deposits   269    331    831    1,067 
Interest on federal funds purchased and securities sold under agreements to repurchase   12    5    28    14 
Interest on subordinated notes   325    318    958    945 
Interest on Federal Home Loan Bank advances   202    120    513    328 
Total interest expense   1,271    1,240    3,721    3,827 
Net interest income   10,558    9,956    30,520    29,457 
Provision for loan losses   0    0    250    0 
Net interest income after provision for loan losses   10,558    9,956    30,270    29,457 
NON-INTEREST INCOME                    
Service charges and other fees   903    979    2,597    2,808 
Bank card income and fees   632    621    1,849    1,780 
Trust department income   235    211    714    641 
Real estate servicing fees, net   177    86    357    285 
Gain on sale of mortgage loans, net   322    330    1,103    778 
Other   67    86    165    290 
Total non-interest income   2,336    2,313    6,785    6,582 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   5,320    5,582    15,798    15,573 
Occupancy expense, net   685    705    2,064    1,997 
Furniture and equipment expense   464    438    1,379    1,334 
Processing, network, and bank card expense   806    780    2,402    2,359 
Legal, examination, and professional fees   332    341    943    849 
FDIC insurance assessment   175    244    673    724 
Advertising and promotion   273    305    780    852 
Postage, printing, and supplies   250    268    794    813 
Real estate foreclosure expense and (gains), net   (329)   361    (352)   657 
Other   1,001    875    2,472    2,259 
Total non-interest expense   8,977    9,899    26,953    27,417 
Income before income taxes   3,917    2,370    10,102    8,622 
Income tax expense   1,378    802    3,497    2,969 
Net income   2,539    1,568    6,605    5,653 
Basic earnings per share  $0.47   $0.29   $1.21   $1.04 
Diluted earnings per share  $0.47   $0.29   $1.21   $1.04 

 

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

 

 3 

 

  

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (unaudited)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
(In thousands)  2015   2014   2015   2014 
Net income  $2,539   $1,568   $6,605   $5,653 
Other comprehensive income, net of tax                    
Investment securities available-for-sale:                    
Unrealized gain (loss) on investment securities available-for-sale, net of tax   993    (328)   617    1,202 
Adjustment for gain on sale of investment securities, net of tax   0    0    5    0 
Defined benefit pension plans:                    
Amortization of prior service cost included in net periodic pension cost, net of tax   24    12    68    36 
Total other comprehensive income (loss)   1,017    (316)   690    1,238 
Total comprehensive income  $3,556   $1,252   $7,295   $6,891 

 

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

 

 4 

 

  

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity (unaudited)

 

               Accumulated         
               Other       Total 
               Comprehensive       Stock - 
   Common       Retained   Income   Treasury   holders' 
(In thousands)  Stock   Surplus   Earnings   (Loss)   Stock   Equity 
Balance, December 31, 2013  $5,195   $33,385   $40,086   $(769)  $(3,517)  $74,380 
Net income   0    0    5,653    0    0    5,653 
Other comprehensive income   0    0    0    1,238    0    1,238 
Stock dividend   201    2,496    (2,697)   0    0    0 
Stock based compensation expense   0    15    0    0    0    15 
Cash dividends declared, common stock   0    0    (765)   0    0    (765)
Balance, September 30, 2014  $5,396   $35,896   $42,277   $469   $(3,517)  $80,521 
                               
Balance, December 31, 2014  $5,396   $35,901   $44,016   $(1,228)  $(3,517)  $80,568 
Net income   0    0    6,605    0    0    6,605 
Other comprehensive income   0    0    0    690    0    690 
Stock dividend   209    2,638    (2,847)   0    0    0 
Stock based compensation expense   0    5    0    0    0    5 
Cash dividends declared, common stock   0    0    (795)   0    0    (795)
Balance, September 30, 2015  $5,605   $38,544   $46,979   $(538)  $(3,517)  $87,073 

 

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

 

 5 

 

  

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (unaudited)

 

   Nine Months Ended September 30, 
(In thousands)  2015   2014 
Cash flows from operating activities:          
Net income  $6,605   $5,653 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   250    0 
Depreciation expense   1,454    1,305 
Net amortization of investment securities, premiums, and discounts   1,007    809 
Stock based compensation expense   5    15 
Change in fair value of mortgage servicing rights   291    386 
Gain on sale of investment securities   (8)   0 
Gain on sales and dispositions of premises and equipment   (8)   (41)
Gain on sales and dispositions of other real estate and repossessed assets   (151)   (149)
Provision for other real estate owned   (6)   450 
Increase (decrease) in accrued interest receivable   (93)   264 
Increase in cash surrender value -life insurance   (45)   (56)
Decrease (increase) in other assets   2,224    (181)
Increase (decrease) in accrued interest payable   5    (44)
Increase in other liabilities   1,251    2,603 
Origination of mortgage loans for sale   (40,008)   (25,576)
Proceeds from the sale of mortgage loans   40,090    25,568 
Gain on sale of mortgage loans, net   (1,103)   (778)
Other, net   (194)   (377)
Net cash provided by operating activities   11,566    9,851 
Cash flows from investing activities:          
Net increase in loans   (21,892)   (24,155)
Purchase of available-for-sale debt securities   (81,595)   (41,321)
Proceeds from maturities of available-for-sale debt securities   24,188    18,015 
Proceeds from calls of available-for-sale debt securities   11,440    24,605 
Proceeds from sales of available-for-sale debt securities   720    0 
Proceeds from sales of FHLB stock   400    39 
Purchases of FHLB stock   (4,915)   (440)
Purchases of premises and equipment   (709)   (1,181)
Proceeds from sales of premises and equipment   11    45 
Proceeds from sales of other real estate and foreclosed assets   1,443    3,945 
Net cash used in investing activities   (70,909)   (20,448)
Cash flows from financing activities:          
Net increase in demand deposits   2,014    12,898 
Net increase in interest-bearing transaction accounts   10,819    14,748 
Net decrease in time deposits   (10,179)   (19,412)
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase   9,792    (11,541)
Repayment of FHLB advances   (55,000)   (10,000)
FHLB advances   92,000    21,000 
Cash dividends paid - common stock   (785)   (755)
Net cash provided by financing activities   48,661    6,938 
Net (decrease) increase in cash and cash equivalents   (10,682)   (3,659)
Cash and cash equivalents, beginning of period   42,809    28,439 
Cash and cash equivalents, end of period  $32,127   $24,780 

 

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

 

 6 

 

  

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (continued) (unaudited)

 

   Nine Months Ended September 30, 
(In thousands)  2015   2014 
Supplemental disclosures of cash flow information:          
Cash paid during the year for:          
Interest  $3,717   $3,872 
Income taxes  $1,559   $1,650 
Noncash investing activities:          
Other real estate and repossessed assets acquired in settlement of loans  $4,549   $1,817 

 

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 communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and Lee’s Summit, Missouri. 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, 2014. Certain amounts in the 2014 condensed consolidated financial statements have been reclassified to conform to the 2014 condensed consolidated presentation. Such reclassifications have no effect on previously reported net income or stockholders’ equity.

 

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, 2015, the Company paid a special stock dividend of four percent to shareholders of record at the close of business on June 15, 2015. 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 2015:

 

Investments - Equity Method and Joint Ventures

 

The FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, in January 2014. These amendments allow investors in low income housing tax credit entities to account for the investments using a proportional amortization method, provided that certain conditions are met, and recognize amortization of the investment as a component of income tax expense. In addition, disclosures are required that will enable users to understand the nature of the investments, and the effect of the measurement of the investments and the related tax credits on the investor's financial statements. This ASU was effective January 1, 2015, and the adoption of this pronouncement did not have a significant effect on the Company's consolidated financial statements.

 

Troubled Debt Restructurings by Creditors

 

The FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, in January 2014. These amendments require companies to disclose the amount of foreclosed residential real estate property held and the recorded investment in consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction. The ASU also defines when a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. This ASU was effective January 1, 2015, and the adoption of this pronouncement did not have a significant effect on the Company's consolidated financial statements.

 

The FASB issued ASU No. 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure in August 2014. The objective of this update is to reduce diversity in practice by addressing the classification of foreclosed mortgage loans that are fully or partially guaranteed under government programs, including those guaranteed by the FHA and the VA. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others

 

 8 

 

 

 Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

reclassify the loans to other receivables. The amendments in this ASU require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) The loan has a government guarantee that is not separable from the loan before foreclosure; (2) At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This ASU was effective January 1, 2015, and the adoption of this pronouncement 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 September 30, 2015 and December 31, 2014 is as follows:

 

   September 30,   December 31, 
(in thousands)  2015   2014 
Commercial, financial, and agricultural  $173,485   $154,834 
Real estate construction - residential   13,531    18,103 
Real estate construction - commercial   32,560    48,822 
Real estate mortgage - residential   249,512    247,117 
Real estate mortgage - commercial   388,220    372,321 
Installment and other consumer   22,166    20,016 
           
Total loans  $879,474   $861,213 

 

The Bank grants real estate, commercial, installment, and other consumer loans to customers located within the communities surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri. 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 September 30, 2015, loans with a carrying value of $396.4 million, or $330.5 million fair value, 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 September 30, 2015 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   Loans to   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Individuals   allocated   Total 
Balance at beginning of period  $3,124   $17   $414   $2,332   $3,870   $185   $44   $9,986 
Additions:                                        
Provision for loan losses   439    (27)   137    (233)   (503)   66    121    0 
Deductions:                                        
Loans charged off   591    0    0    87    126    80    0    884 
Less recoveries on loans   (28)   (28)   0    (45)   (5)   (38)   0    (144)
Net loans charged off   563    (28)   0    42    121    42    0    740 
Balance at end of period  $3,000   $18   $551   $2,057   $3,246   $209   $165   $9,246 

 

   Nine Months Ended September 30, 2015 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   Loans to   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Individuals   allocated   Total 
Balance at beginning of period  $1,779   $171   $466   $2,527   $3,846   $270   $40   $9,099 
Additions:                                        
Provision for loan losses   1,319    (475)   90    (277)   (598)   66    125    250 
Deductions:                                        
Loans charged off   741    0    5    298    159    241    0    1,444 
Less recoveries on loans   (643)   (322)   0    (105)   (157)   (114)   0    (1,341)
Net loans (recovered) charged off   98    (322)   5    193    2    127    0    103 
Balance at end of period  $3,000   $18   $551   $2,057   $3,246   $209   $165   $9,246 

 

 10 

 

  

Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

   Three Months Ended September 30, 2014 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   Loans to   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Individuals   allocated   Total 
Balance at beginning of period  $1,943   $473   $618   $2,405   $6,428   $274   $9   $12,150 
Additions:                                        
Provision for loan losses   (188)   (94)   (96)   313    7    38    20    0 
Deductions:                                        
Loans charged off   105    0    0    41    80    71    0    297 
Less recoveries on loans   (55)   0    0    (26)   (67)   (32)   0    (180)
Net loans charged off   50    0    0    15    13    39    0    117 
Balance at end of period  $1,705   $379   $522   $2,703   $6,422   $273   $29   $12,033 

 

   Nine Months Ended September 30, 2014 
   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, &   Construction -   Construction -   Mortgage -   Mortgage -   Loans to   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Individuals   allocated   Total 
Balance at beginning of period  $2,374   $931   $631   $2,959   $6,523   $294   $7   $13,719 
Additions:                                        
Provision for loan losses   (660)   (553)   382    (171)   891    89    22    0 
Deductions:                                        
Loans charged off   291    59    491    236    1,152    270    0    2,499 
Less recoveries on loans   (282)   (60)   0    (151)   (160)   (160)   0    (813)
Net loans charged off   9    (1)   491    85    992    110    0    1,686 
Balance at end of period  $1,705   $379   $522   $2,703   $6,422   $273   $29   $12,033 

 

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.

 

 11 

 

  

Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

The following table provides the balance in the allowance for loan losses at September 30, 2015 and December 31, 2014, and the related loan balance by impairment methodology.

 

   Commercial,   Real Estate   Real Estate   Real Estate   Real Estate   Installment         
   Financial, and   Construction -   Construction -   Mortgage -   Mortgage -   Loans to   Un-     
(in thousands)  Agricultural   Residential   Commercial   Residential   Commercial   Individuals   allocated   Total 
September 30, 2015                                        
Allowance for loan losses:                                        
Individually evaluated for impairment  $305   $0   $8   $1,178   $459   $20   $0   $1,970 
Collectively evaluated for impairment   2,695    18    543    879    2,787    189    165    7,276 
Total  $3,000   $18   $551   $2,057   $3,246   $209   $165   $9,246 
Loans outstanding:                                        
Individually evaluated for impairment  $3,643   $0   $54   $6,891   $3,481   $141   $0   $14,210 
Collectively evaluated for impairment   169,842    13,531    32,506    242,621    384,739    22,025    0    865,264 
Total  $173,485   $13,531   $32,560   $249,512   $388,220   $22,166   $0   $879,474 
                                         
December 31, 2014                                        
Allowance for loan losses:                                        
Individually evaluated for impairment  $134   $0   $0   $1,343   $246   $26   $0   $1,749 
Collectively evaluated for impairment   1,645    171    466    1,184    3,600    244    40    7,350 
Total  $1,779   $171   $466   $2,527   $3,846   $270   $40   $9,099 
Loans outstanding:                                        
Individually evaluated for impairment  $7,541   $1,750   $2,096   $7,878   $16,464   $234   $0   $35,963 
Collectively evaluated for impairment   147,293    16,353    46,726    239,239    355,857    19,782    0    825,250 
Total  $154,834   $18,103   $48,822   $247,117   $372,321   $20,016   $0   $861,213 

 

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 $14.2 million and $36.0 million at September 30, 2015 and December 31, 2014, 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 September 30, 2015 and December 31, 2014, $11.9 million and $15.6 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 September 30, 2015, $2.0 million of the Company’s allowance for loan losses was allocated to impaired loans totaling $14.2 million compared to $1.7 million of the Company's allowance for loan losses allocated to impaired loans totaling approximately $36.0 million at December 31, 2014. Management determined that $7.4 million, or 52%, of total impaired loans required no reserve allocation at September 30, 2015 compared to $28.5 million, or 79%, at December 31, 2014 primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability.

 

 12 

 

  

Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

The categories of impaired loans at September 30, 2015 and December 31, 2014 are as follows:

 

   September 30,   December 31, 
(in thousands)  2015   2014 
Non-accrual loans  $8,957   $18,243 
Troubled debt restructurings continuing to accrue interest   5,253    17,720 
Total impaired loans  $14,210   $35,963 

 

The following tables provide additional information about impaired loans at September 30, 2015 and December 31, 2014, 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 
September 30, 2015               
With no related allowance recorded:               
Commercial, financial and agricultural  $2,877   $3,403   $0 
Real estate - construction residential   0    0    0 
Real estate - construction commercial   0    0    0 
Real estate - residential   2,095    2,532    0 
Real estate - commercial   2,450    2,579    0 
Total  $7,422   $8,514   $0 
With an allowance recorded:               
Commercial, financial and agricultural  $766   $778   $305 
Real estate - construction commercial   54    56    8 
Real estate - residential   4,796    4,928    1,178 
Real estate - commercial   1,031    1,315    459 
Consumer   141    176    20 
Total  $6,788   $7,253   $1,970 
Total impaired loans  $14,210   $15,767   $1,970 

 

       Unpaid     
   Recorded   Principal   Specific 
(in thousands)  Investment   Balance   Reserves 
December 31, 2014               
With no related allowance recorded:               
Commercial, financial and agricultural  $6,021   $6,232   $0 
Real estate - construction residential   1,750    2,259    0 
Real estate - construction commercial   2,096    2,319    0 
Real estate - residential   3,213    3,270    0 
Real estate - commercial   15,409    18,950    0 
Consumer   36    36    0 
Total  $28,525   $33,066   $0 
With an allowance recorded:               
Commercial, financial and agricultural  $1,520   $1,528   $134 
Real estate - construction residential   0    0    0 
Real estate - construction commercial   0    0    0 
Real estate - residential   4,665    3,546    1,343 
Real estate - commercial   1,055    1,171    246 
Consumer   198    237    26 
Total  $7,438   $6,482   $1,749 
Total impaired loans  $35,963   $39,548   $1,749 

 

 13 

 

  

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 September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
       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  $3,416   $6   $2,618   $22   $4,033   $33   $2,592   $69 
Real estate - construction residential   0    0    16    2    1,101    0    65    2 
Real estate - construction commercial   0    0    6,524    0    2,002    0    6,737    0 
Real estate - residential   2,326    5    3,941    26    2,924    26    3,374    40 
Real estate - commercial   2,958    17    12,578    84    8,978    103    12,334    255 
Consumer   0    0    0    0    10    1    11    0 
Total  $8,700   $28   $25,677   $134   $19,048   $163   $25,113   $366 
With an allowance recorded:                                        
Commercial, financial and agricultural  $787   $5   $1,940   $4   $1,389   $18   $2,128   $19 
Real estate - construction residential   0    0    2,260    0    0    0    2,263    0 
Real estate - construction commercial   55    0    0    0    28    0    56    93 
Real estate - residential   4,850    30    5,458    0    4,713    80    5,384    11 
Real estate - commercial   1,228    0    4,587    28    1,216    0    4,695    0 
Consumer   162    0    310    11    209    0    324    0 
Total  $7,082   $35   $14,555   $43   $7,555   $98   $14,850   $123 
Total impaired loans  $15,782   $63   $40,232   $177   $26,603   $261   $39,963   $489 

 

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 $63,000 and $261,000, for the three months and nine months ended September 30, 2015, respectively, compared to $177,000 and $489,000 for the three and nine months ended September 30, 2014, 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 collectibility 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 collectibility 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.

 

 14 

 

 

 

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 September 30, 2015 and December 31, 2014.

 

   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 
September 30, 2015                         
Commercial, Financial, and Agricultural  $170,230   $424   $0   $2,831   $173,485 
Real Estate Construction - Residential   13,459    72    0    0    13,531 
Real Estate Construction - Commercial   32,447    59    0    54    32,560 
Real Estate Mortgage - Residential   244,144    1,431    348    3,589    249,512 
Real Estate Mortgage - Commercial   385,253    625    0    2,342    388,220 
Installment and Other Consumer   21,794    230    1    141    22,166 
Total  $867,327   $2,841   $349   $8,957   $879,474 
December 31, 2014                         
Commercial, Financial, and Agricultural  $149,366   $189   $0   $5,279   $154,834 
Real Estate Construction - Residential   16,352    0    0    1,751    18,103 
Real Estate Construction - Commercial   46,670    0    56    2,096    48,822 
Real Estate Mortgage - Residential   239,469    3,229    0    4,419    247,117 
Real Estate Mortgage - Commercial   366,653    1,203    0    4,465    372,321 
Installment and Other Consumer   19,551    230    2    233    20,016 
Total  $838,061   $4,851   $58   $18,243   $861,213 

 

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.

 

 15 

 

  

Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

The following table presents the risk categories by class at September 30, 2015 and December 31, 2014.

 

(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  September 30, 2015                            
Watch  $12,500    1,249   $1,146   $27,451   $28,987   $193   $71,526 
Substandard   332    0    98    2,841    2,577    38    5,886 
Performing TDRs   812    0    0    3,302    1,139    0    5,253 
Non-accrual   2,831    0    54    3,589    2,342    141    8,957 
Total  $16,475   $1,249   $1,298   $37,183   $35,045   $372   $91,622 
At December 31, 2014                                   
Watch  $13,651   $1,103   $4,757   $27,172   $18,191   $199   $65,073 
Substandard   926    90    1,211    3,124    4,102    139    9,592 
Performing TDRs   2,262    0    0    3,459    11,999    0    17,720 
Non-accrual   5,279    1,751    2,096    4,419    4,465    233    18,243 
Total  $22,118   $2,944   $8,064   $38,174   $38,757   $571   $110,628 

 

Troubled Debt Restructurings

 

At September 30, 2015, loans classified as TDRs totaled $6.7 million, of which $1.4 million were classified as nonperforming TDRs and included in non-accrual loans and $5.3 million were classified as performing TDRs. At December 31, 2014, TDRs totaled $19.3 million, of which $1.6 million were classified as nonperforming TDRs included in non-accrual loans and $17.7 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 $1.2 million and $1.0 million related to TDRs were allocated to the allowance for loan losses at September 30, 2015 and December 31, 2014, respectively.

 

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

 

   Nine Months Ended September 30, 
   2015   2014 
   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   3   $250   $240    3   $244   $225 
Real estate mortgage - residential   3    510    352    1    1,256    1,171 
Real estate mortgage - commercial   4    1,273    1,263    0    0    0 
Total   10   $2,033   $1,855    4   $1,500   $1,396 

 

(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 due to deteriorated financial condition such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. There were no modified loans that met the TDR criteria during the three months ended September 30, 2015 and 2014. During the nine months ended September 30, 2015, ten loans meeting the TDR criteria were modified compared to four loans during the nine months ended September 30, 2014.

 

 16 

 

  

Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Upon default of a TDR, which is considered to be 90 days or more past due under the modified terms, impairment is measured based on the fair value of the underlying collateral less applicable selling costs. The impairment amount is either charged off as a reduction to the allowance for loan losses, provided for as a specific reserve within the allowance for loan losses, or in the process of foreclosure. There were no TDRs that defaulted within twelve months of its modification date during the three and nine months ended September 30, 2015 and 2014, respectively.

 

(3)Other Real Estate and Repossessed Assets

 

   September 30,   December 31, 
(in thousands)  2015   2014 
Commercial, financial and agricultural  $585   $0 
Real estate construction - residential   0    23 
Real estate construction - commercial   12,380    9,831 
Real estate mortgage - residential   483    417 
Real estate mortgage - commercial   4,923    4,831 
Repossessed assets   10    38 
Total  $18,381   $15,140 
Less valuation allowance for other real estate owned   (3,233)   (3,255)
Total other real estate and repossessed assets  $15,148   $11,885 

 

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

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
Balance at beginning of period  $15,749   $15,231   $15,140   $19,542 
Additions   3,032    1,512    4,549    1,817 
Proceeds from sales   (407)   (821)   (1,443)   (3,945)
Charge-offs against the valuation allowance for other real estate owned   0    (199)   (16)   (1,843)
Repossessed assets impairment write-downs   0    0    0    0 
Net gain (loss) on sales   7    (3)   151    149 
Total other real estate and repossessed assets  $18,381   $15,720   $18,381   $15,720 
Less valuation allowance for other real estate owned   (3,233)   (3,282)   (3,233)   (3,282)
Balance at end of period  $15,148   $12,438   $15,148   $12,438 

 

Net charge-offs against the allowance for loan losses at the time of foreclosure were approximately $180,000 and $323,000 during the three and nine months ended September 30, 2015, respectively, compared to $51,000 and $280,000 during the three and nine months ended September 30, 2014, respectively.

 

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

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(in thousands)  2015   2014   2015   2014 
Balance, beginning of period  $3,233   $3,205   $3,255   $4,675 
Provision for other real estate owned   0    276    (6)   450 
Charge-offs   0    (199)   (16)   (1,843)
Balance, end of period  $3,233   $3,282   $3,233   $3,282 

 

 17 

 

  

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 September 30, 2015 and December 31, 2014 were as follows:

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized     
(in thousands)  Cost   Gains   Losses   Fair value 
September 30, 2015                    
Government sponsored enterprises  $87,618   $444   $12    88,050 
Asset-backed securities   122,348    1,046    668    122,726 
Obligations of states and political subdivisions   32,935    555    16    33,474 
Total available-for-sale securities  $242,901   $2,045   $696   $244,250 
                     
December 31, 2014                    
Government sponsored enterprises  $57,002   $240   $143    57,099 
Asset-backed securities   106,726    855    1,119    106,462 
Obligations of states and political subdivisions   34,925    583    71    35,437 
Total available-for-sale securities  $198,653   $1,678   $1,333   $198,998 

 

All of the Company’s investment securities are classified as available for sale. Agency bonds and notes, 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 securities, and the Company’s interest in statutory trusts. These securities are reported at cost in the amount of $9.2 million and $4.7 million as of September 30, 2015 and December 31, 2014, respectively.

 

Debt securities with carrying values aggregating approximately $208.9 million and $145.5 million at September 30, 2015 and December 31, 2014, 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 September 30, 2015, 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  $29,157   $29,204 
Due after one year through five years   77,519    78,157 
Due after five years through ten years   13,043    13,332 
Due after ten years   834    831 
Total   120,553    121,524 
Asset-backed securities   122,348    122,726 
Total available-for-sale securities  $242,901   $244,250 

 

 18 

 

  

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 September 30, 2015 and December 31, 2014 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 September 30, 2015                              
Government sponsored enterprises  $17,015   $(12)  $0   $0   $17,015   $(12)
Asset-backed securities   25,801    (136)   35,885    (532)   61,686    (668)
Obligations of states and political subdivisions   2,125    (14)   501    (2)   2,626    (16)
Total  $44,941   $(162)  $36,386   $(534)  $81,327   $(696)
                               
(in thousands)                              
At December 31, 2014                              
Government sponsored enterprises  $2,983   $(4)  $17,862   $(139)  $20,845   $(143)
Asset-backed securities   10,314    (50)   45,445    (1,069)   55,759    (1,119)
Obligations of states and political subdivisions   3,667    (15)   1,942    (56)   5,609    (71)
Total  $16,964   $(69)  $65,249   $(1,264)  $82,213   $(1,333)

 

The total available for sale portfolio consisted of approximately 317 securities at September 30, 2015. The portfolio included 62 securities having an aggregate fair value of $81.3 million that were in a loss position at September 30, 2015. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $36.4 million at fair value. The $696,000 aggregate unrealized loss included in accumulated other comprehensive income at September 30, 2015 was caused by interest rate fluctuations.

 

The total available for sale portfolio consisted of approximately 300 securities at December 31, 2014. The portfolio included 74 securities having an aggregate fair value of $82.2 million that were in a loss position at December 31, 2014. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $65.2 million at fair value. The $1.3 million aggregate unrealized loss included in accumulated other comprehensive income at December 31, 2014 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 September 30, 2015 and December 31, 2014, respectively. 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 it will be required to sell such investment securities. There have been no investment securities gains and losses which have been recognized in earnings for the three months ended September 30, 2015 and 2014.

 

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

 

   Three Months Ended  September 30,   Nine Months Ended September 30, 
(in thousands)  2015   2014   2015   2014 
Gains realized on sales  $0   $0   $8   $0 
Losses realized on sales   0    0    0    0 
Other-than-temporary impairment recognized   0    0    0    0 
Investment securities gains  $0   $0   $8   $0 

 

 19 

 

  

Hawthorn Bancshares, Inc.

and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(5)Intangible Assets

 

Mortgage Servicing Rights

 

At September 30, 2015, the Company was servicing approximately $311.8 million of loans sold to the secondary market compared to $313.9 million at December 31, 2014, and $315.3 million at September 30, 2014. Mortgage loan servicing fees, reported as non-interest income, earned on loans sold were $206,000 and $648,000 for the three and nine months ended September 30, 2015, respectively, compared to $226,000 and $672,000 for the three and nine months ended September 30, 2014, respectively.

 

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

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(in thousands)  2015   2014   2015   2014 
Balance at beginning of period  $2,727   $2,911   $2,762   $3,036 
Originated mortgage servicing rights   76    95    303    217 
Changes in fair value:                    
Due to change in model inputs and assumptions (1)   136    27    223    97 
Other changes in fair value (2)   (165)   (166)   (514)   (483)
Balance at end of period  $2,774   $2,867   $2,774   $2,867 

 

(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 the nine months ended September 30, 2015 and 2014:

 

   Nine Months Ended September 30, 
   2015   2014 
Weighted average constant prepayment rate   10.06%   10.05%
Weighted average note rate   3.92%   4.00%
Weighted average discount rate   9.35%   9.18%
Weighted average expected life (in years)   5.80    5.90 

 

(6)Income Taxes

 

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 35.2% for the three months ended September 30, 2015 compared to 33.8% for the three months ended September 30, 2014. Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 34.6% for the nine months ended September 30, 2015 compared to 34.4% for the nine months ended September 30, 2014

 

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, taxable income available in carryback years, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these temporary differences at September 30, 2015 and, therefore, did not establish a valuation reserve.

 

 20 

 

  

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(7)Stockholders’ Equity

 

Accumulated Other Comprehensive Income (Loss)

 

The following details the change in the components of the Company’s accumulated other comprehensive (loss) income for the nine months ended September 30, 2015 and 2014:

 

   Nine months ended September 30, 2015 
           Accumulated 
       Unrecognized Net   Other 
   Unrealized   Pension and   Comprehensive 
   Gain (Loss)   Postretirement   (Loss) 
(in thousands)  on Securities (1)   Costs (2)   Income 
Balance at beginning of period  $214   $(1,442)  $(1,228)
Other comprehensive income before reclassifications   996    0    996 
Amounts reclassified from accumulated other comprehensive income   8    108    116 
Current period other comprehensive income, before tax   1,004    108    1,112 
Income tax expense   (382)   (40)   (422)
Current period other comprehensive income, net of tax   622    68    690 
Balance at end of period  $836   $(1,374)  $(538)
                
   Nine months ended September 30, 2014 
           Accumulated 
       Unrecognized Net   Other 
   Unrealized   Pension and   Comprehensive 
   Gain (Loss)   Postretirement   (Loss) 
(in thousands)  on Securities (1)   Costs (2)   Income 
Balance at beginning of period  $(1,491)  $722   $(769)
Other comprehensive income before reclassifications   1,939    0    1,939 
Amounts reclassified from accumulated other comprehensive income   0    59    59 
Current period other comprehensive income, before tax   1,939    59    1,998 
Income tax expense   (737)   (23)   (760)
Current period other comprehensive income, net of tax   1,202    36    1,238 
Balance at end of period  $(289)  $758   $469 

 

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

 

 21 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(8)Employee Benefit Plans

 

Employee Benefits

 

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

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(in thousands)  2015   2014   2015   2014 
Payroll taxes  $261   $272   $860   $840 
Medical plans   491    510    1,462    1,512 
401k match and profit sharing   225    159    720    488 
Pension plan   348    236    1,044    708 
Other   56    42    99    81 
Total employee benefits  $1,381   $1,219   $4,185   $3,629 

 

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.

 

Pension

 

The Company provides a noncontributory defined benefit pension plan for all full-time employees. 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 pension contribution for the 2015 plan year of $716,000 is equal to the minimum annual required contribution and was paid April 15, 2015, which was determined under the pension relief provision of Moving Ahead for Progress in the 21st Century Act (MAP 21) and Highway and Transportation Funding Act of 2014 (HATFA). Without the pension relief provisions, the minimum required contribution for the 2015 plan year would have been approximately $1,034,000.

 

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:

 

   Estimated   Actual 
(in thousands)  2015   2014 
Service cost - benefits earned during the year  $1,325   $981 
Interest costs on projected benefit obligations   838    732 
Expected return on plan assets   (957)   (872)
Expected administrative expenses   40    40 
Amortization of prior service cost   79    79 
Amortization of unrecognized net loss   66    0 
Net periodic pension expense  $1,391   $960 
           
Pension expense - three months ended September 30, (actual)  $348   $236 
Pension expense - nine months ended September 30, (actual)  $1,044   $708 

 

 22 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(9)Stock Compensation

 

The Company’s stock option plan provides for the grant of options to purchase up to 592,168 shares of the Company’s common stock to officers and other key employees of the Company and its subsidiaries. All options have been granted at exercise prices equal to fair value and vest over periods ranging from four to five years.

 

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   100,361   $21.56           
Granted   0    0.00           
Exercised   0    0.00           
Forfeited or expired   (33,929)   21.66           
Outstanding, September 30, 2015   66,432   $21.51    1.70   $0.00 
Exercisable, September 30, 2015   58,949   $22.21    1.50   $0.00 

 

Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2015.

 

Total stock-based compensation expense was $1,000 and $5,000 for the three and nine months ended September 30, 2015, respectively, compared to $5,000 and $15,000 for the three and nine months ended September 30, 2014, respectively. As of September 30, 2015, the total unrecognized compensation expense related to non-vested stock awards was $25,000 and the related weighted average period over which it is expected to be recognized is approximately 1.0 years.

 

(10)Earnings per Share

 

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. The calculations of basic and diluted earnings per share are as follows for the periods indicated:

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(dollars in thousands, except per share data)  2015   2014   2015   2014 
Basic earnings per share:                    
Net income available to shareholders  $2,539   $1,568   $6,605   $5,653 
Basic earnings per share  $0.47   $0.29   $1.21   $1.04 
Diluted earnings per share:                    
Net income available to shareholders  $2,539   $1,568   $6,605   $4,085 
Average shares outstanding   5,443,344    5,443,344    5,443,344    5,443,344 
Effect of dilutive stock options   0    0    0    0 
Average shares outstanding including dilutive stock options   5,443,344    5,443,344    5,443,344    5,443,344 
Diluted earnings per share  $0.47    0.29   $1.21    1.04 

 

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

 

 23 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

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.

 

Options to purchase 66,432 shares during the three and nine months ended September 30, 2015, compared to 101,330 shares during the three and nine months ended September 30, 2014 were not included in the respective computations of diluted earnings per share because the exercise price of the option, when combined with the effect of the unamortized compensation expense, was greater than the average market price of the common shares and were considered anti-dilutive.

 

(11)Fair Value Measurements

 

The Company uses fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities. The FASB ASC Topic 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. The standard applies whenever other standards require (permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, FASB clarified the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. As of September 30, 2015 and December 31, 2014, 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.

 

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.

 

ASC Topic 820 also provides guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased and on identifying circumstances when a transaction may not be considered orderly.

 

The Company is required to disclose assets and liabilities measured at fair value on a recurring basis separate from those measured at fair value on a nonrecurring basis. 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 Instruments 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. Securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs.

 

 24 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

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.

 

       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) 
September 30, 2015                    
Assets:                    
Government sponsored enterprises  $88,050   $0   $88,050   $0 
Asset-backed securities   122,726    0    122,726    0 
Obligations of states and political subdivisions   33,474    0    33,474    0 
Mortgage servicing rights   2,774    0    0    2,774 
Total  $247,024   $0   $244,250   $2,774 
                     
December 31, 2014                    
Assets:                    
Government sponsored enterprises  $57,099   $0    57,099    0 
Asset-backed securities   106,462    0    106,462    0 
Obligations of states and political subdivisions   35,437    0    35,437    0 
Mortgage servicing rights   2,762    0    0    2,762 
Total  $201,760   $0   $198,998   $2,762 

 

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

 

   Fair Value Measurements Using 
   Significant Unobservable Inputs 
   (Level 3) 
   Mortgage Servicing Rights 
  Three Months Ended September 30,   Nine Months Ended September 30, 
(in thousands)   2015   2014   2015   2014 
Balance at beginning of period  $2,727   $2,911   $2,762   $3,036 
Total gains or losses (realized/unrealized):                    
Included in earnings   (29)   (139)   (291)   (386)
Included in other comprehensive income   0    0    0    0 
Purchases   0    0    0    0 
Sales   0    0    0    0 
Issues   76    95    303    217 
Settlements   0    0    0    0 
Balance at end of period  $2,774   $2,867   $2,774   $2,867 

 

 25 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

Total gains (losses) included in earnings attributable to the change in unrealized gains or losses related to assets still held were $136,000 and $223,000 for the three and nine months ended September 30, 2015, respectively, compared to $27,000 and $97,000 for the three and nine months ended September 30, 2014, respectively. MSR values have been falling steadily since 2014. The lower values are primarily related to faster prepay speed assumptions, consistent with lower long term interest rates. (See table below) The cost of compliance with new government regulations also has had an impact.

 

   Quantitative Information about Level 3 Fair Value Measurements        
   Valuation Technique  Unobservable Inputs  Input Value 
         Nine Months Ended September 30, 
         2015   2014 
Mortgage servicing rights   Discounted cash flows  Weighted average constant prepayment rate   10.06%   10.05%
      Weighted average discount rate   9.35%   9.18%
      Weighted average expected life (in years)   5.80    5.90 

 

Valuation methods for instruments 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:

 

Impaired Loans

 

The Company does not record loans at fair value on a recurring basis other than loans that are considered impaired. The net carrying value of impaired loans is generally based on fair values of the underlying collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. Once the fair value of the collateral has been determined and any impairment amount calculated, a specific reserve allocation is made. Because many of these inputs are not observable, the measurements are classified as Level 3. As of September 30, 2015, the Company identified $6.8 million in impaired loans that had specific allowances for losses aggregating $2.0 million. Related to these loans, there was $695,000 and $1.0 million in charge-offs recorded during the three and nine months ended September 30, 2015, respectively. As of September 30, 2014, the Company identified $14.7 million in impaired loans that had specific allowances for losses aggregating $4.7 million. Related to these loans, there was $204,000 and $2.1 million in charge-offs recorded during the three and nine months ended September 30, 2014, respectively.

 

Other Real Estate and Repossessed Assets

 

Other real estate and repossessed 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. Other real estate assets are recorded as held for sale initially at the lower of the loan balance or fair value of the collateral less estimated selling costs. The Company relies on external appraisals and assessment of property values by internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgment based on experience and expertise of internal specialists. Subsequent to foreclosure, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. 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   Nine 
       in Active           Months   Months 
       Markets for   Other   Significant   Ended   Ended 
       Identical   Observable   Unobservable   September 30,   September 30, 
   Total   Assets   Inputs   Inputs   Total Gains   Total Gains 
(in thousands)  Fair Value   (Level 1)   (Level 2)   (Level 3)   (Losses)*   (Losses)* 
September 30, 2015                              
Assets:                              
Impaired loans:                              
Commercial, financial, & agricultural  $462   $0   $0   $462   $(540)  $(561)
Real estate construction - residential   0    0    0    0    0    0 
Real estate construction - commercial   45    0    0    45    0    0 
Real estate mortgage - residential   3,618    0    0    3,618    (61)   (267)
Real estate mortgage - commercial   572    0    0    572    (89)   (118)
Consumer   121    0    0    121    (5)   (54)
Total  $4,818   $0   $0   $4,818   $(695)  $(1,000)
Other real estate and foreclosed assets  $15,148   $0   $0   $15,148   $(80)  $112 
                               
September 30, 2014                              
Assets:                              
Impaired loans:                              
Commercial, financial, & agricultural  $1,364   $0   $0   $1,364   $(28)  $(150)
Real estate construction - residential   1,767    0    0    1,767    0    (60)
Real estate construction - commercial   0    0    0    0    0    (491)
Real estate mortgage - residential   3,795    0    0    3,795    (41)   (179)
Real estate mortgage - commercial   2,887    0    0    2,887    (131)   (1,200)
Consumer   213    0    0    213    (4)   (74)
Total  $10,026   $0   $0   $10,026   $(204)  $(2,154)
Other real estate and repossessed assets  $12,438   $0   $0   $12,438   $(203)  $(1,733)

 

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

 

(12)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

 

The fair values of loans are estimated by discounting the expected future cash flows using the current rates at which similar loans could be made to borrowers with similar credit ratings and for the same remaining maturities. The net carrying amount of impaired loans is generally based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.

 

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 and securities purchased under agreements to resell, interest earning deposits with banks, and cash and due from banks approximate fair value. Federal funds sold and securities purchased under agreements to resell classified as short-term generally mature in 90 days or less.

 

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 and Interest-bearing Demand Notes to U.S. Treasury

 

For securities sold under agreements to repurchase and interest-bearing demand notes to U.S. Treasury, 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 cashflows. 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 September 30, 2015 and December 31, 2014 is as follows:

 

           September 30, 2015 
           Fair Value Measurements 
           Quoted Prices         
           in Active       Net 
           Markets for   Other   Significant 
   September 30, 2015   Identical   Observable   Unobservable 
   Carrying   Fair   Assets   Inputs   Inputs 
(in thousands)  Amount   Value   (Level 1)   (Level 2)   (Level 3) 
Assets:                         
Cash and due from banks  $17,664   $17,664   $17,664   $0   $0 
Federal funds sold and overnight interest-bearing deposits   14,463    14,463    14,463    0    0 
Investment in available-for-sale securities   244,250    244,250    0    244,250    0 
Loans, net   870,228    868,077    0    0    868,077 
Investment in FHLB stock   4,590    4,590    0    4,590    0 
Mortgage servicing rights   2,774    2,774    0    0    2,774 
Cash surrender value - life insurance   2,329    2,329    0    2,329    0 
Accrued interest receivable   4,909    4,909    4,909    0    0 
   $1,161,207   $1,159,056   $37,036   $251,169   $870,851 
Liabilities:                         
Deposits:                         
Non-interest bearing demand  $209,714   $209,714   $209,714   $0   $0 
Savings, interest checking and money market   452,878    452,878    452,878    0    0 
Time deposits   309,576    310,674    0    0    310,674 
Federal funds purchased and securities sold under agreements to repurchase   27,762    27,762    27,762    0    0 
Subordinated notes   49,486    35,056    0    35,056    0 
Federal Home Loan Bank advances   80,000    82,572    0    82,572    0 
Accrued interest payable   378    378    378    0    0 
   $1,129,794   $1,119,034   $690,732   $117,628   $310,674 

 

 29 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

           December 31, 2014 
           Fair Value Measurements 
           Quoted Prices         
           in Active       Net 
           Markets for   Other   Significant 
   December 31, 2014   Identical   Observable   Unobservable 
   Carrying   Fair   Assets   Inputs   Inputs 
(in thousands)  amount   value   (Level 1)   (Level 2)   (Level 3) 
Assets:                         
Cash and due from banks  $22,364   $22,364   $22,364   $0   $0 
Federal funds sold and overnight interest-bearing deposits   20,445    20,445    20,445    0    0 
Investment in available-for-sale securities   198,998    198,998    0    198,998    0 
Loans, net   852,114    854,062    0    0    854,062 
Investment in FHLB stock   3,075    3,075    0    3,075    0 
Mortgage servicing rights   2,762    2,762    0    0    2,762 
Cash surrender value - life insurance   2,284    2,284    0    2,284    0 
Accrued interest receivable   4,816    4,816    4,816    0    0 
   $1,106,858   $1,108,806   $47,625   $204,357   $856,824 
Liabilities:                         
Deposits:                         
Non-interest bearing demand  $207,700   $207,700   $207,700   $0   $0 
Savings, interest checking and money market   442,059    442,059    442,059    0    0 
Time deposits   319,755    321,041    0    0    321,041 
Federal funds purchased and securities sold under agreements to repurchase   17,970    17,970    17,970    0    0 
Subordinated notes   49,486    33,371    0    33,371    0 
Federal Home Loan Bank advances   43,000    44,396    0    44,396    0 
Accrued interest payable   373    373    373    0    0 
   $1,080,343   $1,066,910   $668,102   $77,767   $321,041 

 

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.

 

 30 

 

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

(13)Repurchase Reserve Liability

 

The Company’s repurchase reserve liability for estimated losses incurred on sold loans was $160,000 at September 30, 2015 and December 31, 2014, respectively. 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 September 30, 2015, the Company was servicing 3,024 loans sold to the secondary market with a balance of approximately $311.8 million compared to 3,057 loans sold with a balance of approximately $313.9 million at December 31, 2014.

 

(14)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 September 30, 2015, no amounts have been accrued for any estimated losses for these financial instruments.

 

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

 

   September 30,   December 31, 
(in thousands)  2015   2014 
Commitments to extend credit  $147,341   $135,137 
Commitments to originate residential first and second mortgage loans   5,097    1,640 
Standby letters of credit   1,432    1,621 
Total   153,870    138,398 

 

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 September 30, 2015.

 

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 

 

 

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 or regulatory changes may adversely affect the business in which the Company and its subsidiaries are engaged, and
·changes may occur in the securities markets.

 

We have described under the caption Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, 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 $1.2 billion in assets at September 30, 2015, 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 (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 communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and Lee's Summit, Missouri.

 

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

 

The success of the Company's growth strategy depends primarily on the ability of 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

 

 32 

 

 

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.

 

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.

 

Other Real Estate and Repossessed Assets

 

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

 

 33 

 

 

SELECTED CONSOLIDATED FINANCIAL DATA

 

The following table presents selected consolidated financial information for the Company as of and for each of the three and nine months ended September 30, 2015 and 2014, 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   Nine Months Ended 
   September 30,   September 30, 
(In thousands, except per share data)  2015   2014   2015   2014 
Per Share Data                
Basic earnings per share  $0.47   $0.29   $1.21   $1.04 
Diluted earnings per share   0.47    0.29    1.21    1.04 
Dividends paid on common stock   262    252    785    755 
Book value per share             16.00    14.79 
Market price per share             13.97    13.22 
Selected Ratios                    
(Based on average balance sheets)                    
Return on total assets   0.84%   0.54%   0.74%   0.65%
Return on stockholders' equity   11.82%   7.71%   10.55%   9.69%
Stockholders' equity to total assets   7.09%   6.97%   7.00%   6.74%
Efficiency ratio (1)   69.62%   80.68%   72.25%   76.08%
                     
(Based on end-of-period data)                    
Stockholders' equity to assets             7.09%   6.96%
Total Capital Ratio (to risk weighted assets)             14.91%   15.68%
Tier 1 Capital Ratio (to risk weighted assets)             12.01%   12.02%
Tier 1 Capital Ratio (to average assets) (2)             9.70%   9.18%
Common Equity Tier 1 Capital (to risk weighted assets) (3)             9.02%   NA%

 

(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 Capital (leverage) Ratio is calculated by dividing Tier 1 capital by average total consolidated assets.
(3)Calculated under Basel III rules, which became effective January 1, 2015.

 

 34 

 

 

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 September 30,   Nine Months Ended September 30, 
(In thousands)  2015   2014   $ Change   % Change   2015   2014   $ Change   % Change 
                                 
Net interest income  $10,558   $9,956   $602    6.0%  $30,520   $29,457   $1,063    3.6%
Provision for loan losses   -    -    -    -    250    -    250    - 
Noninterest income   2,336    2,313    23    1.0    6,785    6,582    203    3.1 
Noninterest expense   8,977    9,899    (922)   (9.3)   26,953    27,417    (464)   (1.7)
Income before income taxes   3,917    2,370    1,547    65.3    10,102    8,622    1,480    17.2 
Income tax expense   1,378    802    576    71.8    3,497    2,969    528    17.8 
Net income  $2,539   $1,568   $971    61.9%  $6,605   $5,653   $952    16.8%

 

Business Events For the seventh consecutive year, on July 1, 2015, the Company distributed a four percent stock dividend to shareholders of record at the close of business on June 15, 2015. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect the stock dividend.

 

Consolidated net income increased $971,000 to $2.5 million, or $0.47 per diluted share, for the three months ended September 30, 2015 compared to $1.6 million, or $0.29 per diluted share, for the three months ended September 30, 2014. For the three months ended September 30, 2015, the return on average assets was 0.84%, the return on average stockholders’ equity was 11.82%, and the efficiency ratio was 69.62%.

 

Consolidated net income increased $952,000 to $6.6 million, or $1.21 per diluted share, for the nine months ended September 30, 2015 compared to $5.7 million, or $1.04 per diluted share, for the nine months ended September 30, 2014. For the nine months ended September 30, 2015, the return on average assets was 0.74%, the return on average stockholders’ equity was 10.55%, and the efficiency ratio was 72.25%.

 

Net interest income was $10.6 million and $30.5 million for the three and nine months ended September 30, 2015, respectively, compared to $10.0 million and $29.4 million for the three and nine months ended September 30, 2014, respectively. The net interest margin (expressed on a fully taxable equivalent basis) increased to 3.78% for the three months ended September 30, 2015 compared to 3.71% for the three months ended September 30, 2014, respectively, and remained consistent at 3.71% for both the nine months ended September 30, 2015 and 2014, respectively. These changes are discussed in greater detail under the Average Balance Sheets and Rate and Volume Analysis section below.

 

No provision for loan losses was recorded for the third quarter of 2015 and $250,000 was recorded for the nine months ended September 30, 2015 compared to no provision for the three and nine months ended September 30, 2014. The increase over 2014 was primarily due to an increase in specific reserves primarily related to two loan relationships.

 

The Company’s net charge-offs were $740,000, or 0.08% of average loans, for the three months ended September 30, 2015 compared to $117,000, or 0.01% of average loans, for the three months ended September 30, 2014. The Company’s net charge-offs were $103,000 for the nine months ended September 30, 2015, or 0.01% of average loans, compared to net charge-offs of $1.7 million, or 0.20% of average loans, for the nine months ended September 30, 2014. Non-performing loans totaled $14.6 million, or 1.66% of total loans, at September 30, 2015 compared to $36.0 million, or 4.18% of total loans, at December 31, 2014, and $35.7 million, or 4.15% of total loans, at September 30, 2014. These changes are discussed in greater detail under the Lending and Credit Management section below.

 

Non-interest income increased $23,000, or 1.0%, for the three months ended September 30, 2015, and increased $203,000, or 3.1%, for the nine months ended September 30, 2015 compared to the three and nine months ended September 30, 2014, respectively. These changes are discussed in greater detail below under Non-interest Income.

 

Non-interest expense decreased $922,000, or 9.3%, for the three months ended September 30, 2015, and decreased $464,000, or 1.7%, for the nine months ended September 30, 2015 compared to the three and nine months ended September 30, 2014, respectively. These changes are discussed in greater detail below under Non-interest Expense.

 

 35 

 

 

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 September 30, 2015 and 2014, respectively.

 

 36 

 

 

 

   Three Months Ended  September 30, 
(In thousands)  2015   2014 
       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  $165,978   $1,938    4.63%  $146,143   $1,749    4.75%
Real estate construction - residential   14,102    385    10.83    21,603    260    4.77 
Real estate construction - commercial   41,977    709    6.70    63,071    657    4.13 
Real estate mortgage - residential   245,660    2,849    4.60    235,124    2,790    4.71 
Real estate mortgage - commercial   382,707    4,616    4.79    373,138    4,470    4.75 
Consumer   21,036    268    5.05    18,683    259    5.50 
Total loans  $871,460   $10,765    4.90%  $857,762   $10,185    4.71%
Investment securities: (3)                              
Government sponsored enterprises  $75,326   $261    1.37%  $63,211   $229    1.44%
Asset backed securities   125,188    598    1.90    112,350    601    2.12 
State and municipal   33,984    265    3.09    34,195    284    3.30 
Total investment securities  $234,498   $1,124    1.90%  $209,756   $1,114    2.11%
Other investments and securities, at cost   8,485    72    3.37    4,123    20    1.92 
Federal funds sold and interest bearing deposits in other financial institutions   8,347    3    0.14    7,056    5    0.28 
Total interest earning assets  $1,122,790   $11,964    4.23%  $1,078,697   $11,324    4.16%
All other assets   90,248              92,234           
Allowance for loan losses   (9,971)             (12,180)          
Total assets  $1,203,067             $1,158,751           
LIABILITIES AND STOCKHOLDERS' EQUITY                              
NOW accounts  $191,026   $114    0.24%  $195,162   $115    0.23%
Savings   90,851    12    0.05    83,837    12    0.06 
Money market   176,380    115    0.26    164,001    102    0.25 
Time deposits of $100,000 and over   137,542    222    0.64    142,806    237    0.66 
Other time deposits   172,945    269    0.62    194,144    331    0.68 
Total time deposits  $768,744   $732    0.38%  $779,950   $797    0.41%
Federal funds purchased and securities sold under agreements to repurchase   26,296    11    0.17    21,029    5    0.09 
Subordinated notes   49,486    326    2.61    49,486    318    2.55 
Federal Home Loan Bank Advances   61,207    202    1.31    28,043    120    1.70 
Total borrowings  $136,989   $539    1.56%  $98,558   $443    1.78%
Total interest bearing liabilities  $905,733   $1,271    0.56%  $878,508   $1,240    0.56%
Demand deposits   202,138              193,230           
Other liabilities   9,937              6,297           
Total liabilities   1,117,808              1,078,035           
Stockholders' equity   85,259              80,716           
Total liabilities and stockholders' equity  $1,203,067             $1,158,751           
Net interest income (FTE)        10,693              10,084      
Net interest spread             3.67%             3.60%
Net interest margin             3.78%             3.71%

 

(1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $135,000 and $128,000 for the three months ended September 30, 2015 and 2014, 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.

 

 37 

 

 

   Nine Months Ended September 30, 
(In thousands)  2015   2014 
       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  $157,077   $5,594    4.76%  $142,802   $5,060    4.74%
Real estate construction - residential   15,077    789    7.00    22,894    755    4.41 
Real estate construction - commercial   46,055    1,776    5.16    59,851    1,902    4.25 
Real estate mortgage - residential   246,399    8,633    4.68    231,493    8,312    4.80 
Real estate mortgage - commercial   378,344    13,455    4.75    373,427    13,351    4.78 
Consumer   20,304    798    5.25    18,972    789    5.56 
Total loans  $863,256   $31,045    4.81%  $849,439   $30,169    4.75%
Investment securities: (3)                              
U.S. Treasury  $0   $0    0.00%  $382   $3    1.05%
Government sponsored enterprises   73,680    772    1.40    66,627    697    1.40 
Asset backed securities   126,256    1,848    1.96    111,498    1,859    2.23 
State and municipal   34,834    828    3.18    33,319    854    3.43 
Total investment securities  $234,770   $3,448    1.96%  $211,826   $3,413    2.15%
Other investments and securities, at cost   6,252    138    2.95    4,044    59    1.95 
Federal funds sold and interest bearing deposits in other financial institutions   11,716    24    0.27    10,428    23    0.29 
Total interest earning assets  $1,115,994   $34,655    4.15%  $1,075,737   $33,664    4.18%
All other assets   89,568              94,310           
Allowance for loan losses   (9,757)             (12,895)          
Total assets  $1,195,805             $1,157,152           
LIABILITIES AND STOCKHOLDERS' EQUITY                              
NOW accounts  $205,448   $375    0.24%  $204,141   $406    0.27%
Savings   88,651    36    0.05    82,157    45    0.07 
Money market   173,014    328    0.25    162,753    299    0.25 
Time deposits of $100,000 and over   138,598    653    0.63    143,934    723    0.67 
Other time deposits   177,617    830    0.62    198,778    1,068    0.72 
Total time deposits  $783,328   $2,222    0.38%  $791,763   $2,541    0.43%
Federal funds purchased and securities sold under agreements to repurchase   22,589    28    0.17    20,085    13    0.09 
Subordinated notes   49,486    958    2.59    49,486    945    2.55 
Federal Home Loan Bank Advances   47,960    513    1.43    25,747    328    1.70 
Total borrowings  $120,035   $1,499    1.67%  $95,318   $1,286    1.80%
Total interest bearing liabilities  $903,363   $3,721    0.55%  $887,081   $3,827    0.58%
Demand deposits   198,690              185,843           
Other liabilities   10,085              6,231           
Total liabilities   1,112,138              1,079,155           
Stockholders' equity   83,667              77,997           
Total liabilities and stockholders' equity  $1,195,805             $1,157,152           
Net interest income (FTE)        30,934              29,837      
Net interest spread             3.60%             3.60%
Net interest margin             3.71%             3.71%

 

(1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $414,000 and $380,000 for the nine months ended September 30, 2015 and 2014, 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.

 

 38 

 

 

Rate and Volume Analysis

 

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates for the three and nine months ended September 30, 2015 compared to the three and nine months ended September 30, 2014. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each.

 

   Three Months Ended  September 30,   Nine Months Ended  September 30, 
   2015 vs. 2014   2015 vs. 2014 
       Change due to       Change due to 
   Total   Average   Average   Total   Average   Average 
(In thousands)  Change   Volume   Rate   Change   Volume   Rate 
Interest income on a fully taxable equivalent basis: (1)                              
Loans: (2) (4)                              
Commercial  $189   $232   $(43)  $534   $508   $26 
Real estate construction - residential   125    (115)   240    34    (314)   348 
Real estate construction - commercial   52    (268)   320    (126)   (487)   361 
Real estate mortgage - residential   59    123    (64)   321    526    (205)
Real estate mortgage - commercial   146    116    30    104    175    (71)
Consumer   9    31    (22)   9    53    (44)
Investment securities: (3)                              
U.S. Treasury   0    0    0    (3)   (1)   (2)
Government sponsored entities   32    42    (10)   75    74    1 
Asset backed securities   (3)   65    (68)   (11)   230    (241)
State and municipal   (19)   (2)   (17)   (26)   38    (64)
Other investments and securities, at cost   52    30    22    79    41    38 
Federal funds sold and interest bearing deposits in other financial institutions   (2)   1    (3)   1    3    (2)
Total interest income   640    255    385    991    846    145 
Interest expense:                              
NOW accounts   (1)   (2)   1    (31)   3    (34)
Savings   0    1    (1)   (9)   4    (13)
Money market   13    8    5    29    19    10 
Time deposits of $100,000 and over   (15)   (9)   (6)   (70)   (26)   (44)
Other time deposits   (62)   (34)   (28)   (238)   (107)   (131)
Federal funds purchased and securities sold under agreements to repurchase   6    1    5    15    2    13 
Subordinated notes   8    0    8    13    0    13 
Federal Home Loan Bank advances   82    115    (33)   185    245    (60)
Total interest expense   31    80    (49)   (106)   140    (246)
Net interest income on a fully taxable equivalent basis  $609   $175   $434   $1,097   $706   $391 

 

(1)Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $135,000 and $414,000 for the three and nine months September 30, 2015, respectively, compared to $128,000 and $380,000 for the three and nine months ended September 30, 2014, 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.

 

Financial results for the three months ended September 30, 2015 compared to the three months ended September 30, 2014, reflected an increase in net interest income, on a tax equivalent basis, of $609,000, or 6.04%, respectively, and financial results for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 reflected an increase of $1.1 million, or 3.68%, respectively.

 

Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) increased to 3.78% for the three months ended September 30, 2015 compared to 3.71% for the three months ended September 30, 2014, respectively, and remained consistent at 3.71% for both the nine months ended September 30, 2015 and 2014, respectively.

 

 39 

 

 

The increase in net interest income for the three and nine months ended September 30, 2015 over the three and nine months ended September 30, 2014 was primarily due to an increase in average earning assets. The increase in the net interest margin quarter over quarter was primarily due to interest recognized on two construction loans.

 

Average interest-earning assets increased $44.1 million, or 4.09%, to $1.12 billion for the three months ended September 30, 2015 compared to $1.08 billion for the three months ended September 30, 2014, and average interest bearing liabilities increased $27.2 million, or 3.10%, to $905.7 million for the three months ended September 30, 2015 compared to $878.5 million for the three months ended September 30, 2014.

 

Average interest-earning assets increased $40.3 million, or 3.74%, to $1.16 billion for the nine months ended September 30, 2015 compared to $1.08 billion for the nine months ended September 30, 2014, and average interest bearing liabilities increased $16.3 million, or 1.84%, to $903.4 million for the nine months ended September 30, 2015 compared to $887.1 million for the nine months ended September 30, 2014.

 

Total interest income (expressed on a fully taxable equivalent basis) increased to $12.0 million and $34.7 million for the three and nine months ended September 30, 2015, respectively, compared to $11.3 million and $33.7 million for the three and nine months ended September 30, 2014, respectively. The Company’s rates earned on interest earning assets were 4.23% and 4.15% for the three and nine months ended September 30, 2015, respectively, compared to 4.16% and 4.18% for the three and nine months ended September 30, 2014, respectively.

 

Interest income on loans was $10.8 million and $31.0 million for the three and nine months ended September 30, 2015, respectively, compared to $10.2 million and $30.2 million for the three and nine months ended September 30, 2014, respectively.

 

Average loans outstanding increased $13.7 million, or 1.6%, to $871.5 million for the three months ended September 30, 2015 compared to $857.8 million for the three months ended September 30, 2014. The average yield on loans receivable increased to 4.90% for the three months ended September 30, 2015 compared to 4.71% for the three months ended September 30, 2014.

 

For the nine months ended September 30, 2015, average loans outstanding increased $13.8 million, or 1.6%, to $863.3 million compared to $849.4 million for the nine months ended September 30, 2014. The average yield on loans receivable increased to 4.81% for the nine months ended September 30, 2015 compared to 4.75% for the nine months ended September 30, 2014. See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio.

 

Total interest expense was $1.3 million and $3.7 million for the three and nine months ended September 30, 2015, respectively, compared to $1.2 million and $3.8 million for the three and nine months ended September 30, 2014, respectively. The Company’s rates paid on interest bearing liabilities were 0.56% and 0.55% for the three and nine months ended September 30, 2015 compared to 0.56% and 0.58% for the three and nine months ended September 30, 2014, respectively. See the Liquidity Management section for further discussion.

 

Interest expense on deposits decreased to $732,000 and $2.2 million for the three and nine months ended September 30, 2015, respectively, compared to $797,000 and $2.5 million for the three and nine months ended September 30, 2014, respectively.

 

Average time deposits decreased $11.2 million, or 1.44%, to $768.7 million for the three months ended September 30, 2015 compared to $779.9 million for the three months ended September 30, 2014. The average cost of deposits decreased to 0.38% for the three months ended September 30, 2015 compared to 0.41% for the three months ended September 30, 2014 primarily as a result of lower market interest rates.

 

For the nine months ended September 30, 2015, average time deposits decreased $8.4 million, or 1.07%, to $783.3 million for the nine months ended September 30, 2015 compared to $791.7 million for the nine months ended September 30, 2014. The average cost of deposits decreased to 0.38% for the nine months ended September 30, 2015 compared to 0.43% for the nine months ended September 30, 2014 primarily as a result of lower market interest rates.

 

Interest expense on borrowings increased to $539,000 and $1.5 million for the three and nine months ended September 30, 2015, respectively, compared to $443,000 and $1.3 million for the three and nine months ended September 30, 2014, respectively. Average borrowings increased to $137.0 million and $120.0 million for the three and nine months ended September 30, 2015, respectively, compared to $98.6 million and $95.3 million for the three and nine months ended September 30, 2014, respectively. See the Liquidity Management section for further discussion.

 

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Non-interest Income and Expense

 

Non-interest income for the periods indicated was as follows:

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
           $   %           $   % 
(In thousands)  2015   2014   Change   Change   2015   2014   Change   Change 
Non-interest Income                                        
Service charges and other fees  $903   $979   $(76)   (7.8)%  $2,597   $2,808   $(211)   (7.5)%
Bank card income and fees   632    621    11    1.8    1,849    1,780    69    3.9 
Trust department income   235    211    24    11.4    714    641    73    11.4 
Real estate servicing fees, net   177    86    91    105.8    357    285    72    25.3 
Gain on sales of mortgage loans, net   322    330    (8)   (2.4)   1,103    778    325    41.8 
Other   67    86    (19)   (22.1)   165    290    (125)   (43.1)
Total non-interest income  $2,336   $2,313   $23    1.0%  $6,785   $6,582   $203    3.1%
                                        
Non-interest income as a % of total revenue *   18.1%   18.9%             18.2%   18.3%          
Total revenue per full time equivalent employee  $37.9   $35.7             $109.7   $104.8           

 

* Total revenue is calculated as net interest income plus non-interest income.

 

Total non-interest income was consistent at $2.3 million for both quarters ended September 30, 2015 and 2014, and increased $203,000, or 3.1%, to $6.8 million for the nine months ended September 30, 2015 compared to $6.6 million for the nine months ended September 30, 2014.

 

Real estate servicing fees, net of the change in the valuation of mortgage servicing rights increased $91,000 to $177,000 for the quarter ended September 30, 2015 compared to $86,000 for the quarter ended September 30, 2014, and increased $72,000 to $357,000 for the nine months ended September 30, 2015 compared to $285,000 for the nine months ended September 30, 2014.

 

Mortgage loan servicing fees earned on loans sold were $206,000 and $648,000 for the three and nine months ended September 30, 2015, respectively, compared to $226,000 and $672,000 for the three and nine months ended September 30, 2014.

 

The change in valuation of mortgage servicing rights arising from inputs and assumptions increased $136,000 for the quarter ended September 30, 2015 compared to a $27,000 increase for the quarter ended September 30, 2014, and increased $223,000 for the nine months ended September 30, 2015 compared to a $97,000 increase for the nine months ended September 30, 2014. Total realized losses included in earnings attributable to the change in unrealized gains or losses related to assets still held were $(165,000) for the quarter ended September 30, 2015 compared to $(166,000) for the quarter ended September 30, 2014, and $(514,000) for the nine months ended September 30, 2015 compared to $(483,000) for the nine months ended September 30, 2014. The Company was servicing $311.8 million of mortgage loans at September 30, 2015 compared to $313.9 million and $315.3 million at December 31, 2014 and September 30, 2014, respectively.

 

Gain on sales of mortgage loans decreased $8,000, or 2.4%, to $322,000 for the quarter ended September 30, 2015 compared to $330,000 for the quarter ended September 30, 2014, and increased $325,000, or 41.8%, to $1.1 million for the nine months ended September 30, 2015 compared to $778,000. The Company sold loans of $11.2 million and $40.1 million for the three and nine months ended September 30, 2015, respectively, compared to $11.0 million and $25.6 million for the three and nine months ended September 30, 2014, respectively. Refinancing activity during the first nine months of 2015 impacting both the volume of loans sold and gains recognized contributed to this increase.

 

Other income decreased $19,000, or 22.1%, to $67,000 for the quarter ended September 30, 2015 compared to $86,000 for the quarter ended September 30, 2014, and decreased $125,000, or 43.1%, to $165,000 for the nine months ended September 30, 2015 compared to $290,000. The decrease in other income primarily related to a decrease in rental income received on other real estate owned during 2014 and an increase in the servicing repurchase liability during the first quarter of 2015 for reimbursement of costs incurred by Freddie Mac related to a foreclosure.

 

 41 

 

  

Non-interest expense for the periods indicated was as follows:

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(In thousands)  2015   2014   $ Change   % Change   2015   2014   $ Change   % Change 
Non-interest Expense                                        
Salaries  $3,939   $4,363   $(424)   (9.7)%  $11,613   $11,944   $(331)   (2.8)%
Employee benefits   1,381    1,219    162    13.3    4,185    3,629    556    15.3 
Occupancy expense, net   685    705    (20)   (2.8)   2,064    1,997    67    3.4 
Furniture and equipment expense   464    438    26    5.9    1,379    1,334    45    3.4 
Processing, network, and bank card expense   806    780    26    3.3    2,402    2,359    43    1.8 
Legal, examination, and professional fees   332    341    (9)   (2.6)   943    849    94    11.1 
FDIC insurance assessment   175    244    (69)   (28.3)   673    724    (51)   (7.0)
Advertising and promotion   273    305    (32)   (10.5)   780    852    (72)   (8.5)
Postage, printing, and supplies   250    268    (18)   (6.7)   794    813    (19)   (2.3)
Real estate foreclosure expense and (gains), net   (329)   361    (690)   (191.1)   (352)   657    (1,009)   (153.6)
Other   1,001    875    126    14.4    2,472    2,259    213    9.4 
                                         
Total non-interest expense  $8,977   $9,899   $(922)   (9.3)%  $26,953   $27,417   $(464)   (1.7)%
Efficiency ratio *   69.6%   80.7%             72.3%   76.1%          
Salaries and benefits as a % of total non-interest expense   59.3%   56.4%             58.6%   56.8%          
Number of full-time equivalent employees   340    344              340    344           
 

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

 

Total non-interest expense decreased $922,000, or 9.3%, to $9.0 million for the quarter ended September 30, 2015 compared to $9.9 million for the quarter ended September 30, 2014, and decreased $464,000, or 1.7%, to $26.9 million for the nine months ended September 30, 2015 compared to $27.4 million for the nine months ended September 30, 2014.

 

Salary expense decreased $424,000, or 9.7%, to $3.9 million for the quarter ended September 30, 2015 compared to $4.4 million for the quarter ended September 30, 2014, and decreased $331,000, or 2.8%, to 11.6 million for the nine months ended September 30, 2015 compared to $11.9 million for the nine months ended September 30, 2014. The decrease for both the three and nine months ended September 30, 2015 was primarily due to the accrual of a new incentive program approved by the Board of Directors in the third quarter of 2014.

 

Employee benefits increased $162,000, or 13.3%, to $1.4 million for the quarter ended September 30, 2015 compared to $1.2 million for the quarter ended September 30, 2014, and increased $556,000, or 15.3%, to 2.8 million for the nine months ended September 30, 2015 compared to $3.6 million for the nine months ended September 30, 2014. The increase was primarily due to a $178,000 and $568,000 increase in the 401(k) profit-sharing and pension expenses for the three and nine months ended September 30, 2015, respectively.

 

FDIC insurance assessment decreased $69,000, or 28.3%, to 175,000 for the quarter ended September 30, 2015 compared to $244,000 for the quarter ended September 30, 2014, and decreased $51,000, or 07.0%, to $673,000 for the nine months ended September 30, 2015 compared to $724,000 for the nine months ended September 30, 2014. The decrease for the quarter and nine months ended September 30, 2015 over the prior periods primarily consisted of a decrease in the assessment base.

 

Real estate foreclosure expense and (gains), net decreased $690,000, or 191.1%, to $(329,000) for the quarter ended September 30, 2015 compared to $361,000 for the quarter ended September 30, 2014, and decreased $1.0 million, or 153.6%, to $(352,000) for the nine months ended September 30, 2015 compared to $657,000 for the nine months ended September 30, 2014.

 

Net gains recognized on other real estate owned were $435,000 and $690,000 for the three and nine months ended September 30, 2015 compared to net losses of $21,000 and $295,000 for the three and nine months ended September 30, 2014. Expenses to maintain these foreclosed properties were $107,000 and $338,000 for the three and nine months ended September 30, 2015 compared to $87,000 and $362,000 for the three and nine months ended September 30, 2014. Gains were recognized on two properties sold during the first quarter of 2015 and one new foreclosure in the third quarter resulting in a net gain for both the three and nine months ended September 30, 2015.

 

Other non-interest expense increased $126,000, or 14.4%, to $1.0 million for the quarter ended September 30, 2015 compared to $875,000 for the quarter ended September 30, 2014, and increased $213,000, or 9.4%, to $2.5 million for the nine months ended September 30, 2015 compared to $2.3 million for the nine months ended September 30, 2014. The increase was primarily due to a $176,000 impairment write-down on a building held for sale partially offset by the $136,000 loss recorded due to employee fraud that management discovered during the third quarter of 2014.

 

 42 

 

  

Income taxes

 

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 35.2% for the quarter ended September 30, 2015 compared to 33.8% for the quarter ended September 30, 2014, and 34.6% for the nine months ended September 30, 2015 compared to 34.4% for the nine months ended September 30, 2014.

 

Lending and Credit Management

 

Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 70.9% of total assets as of September 30, 2015 compared to 72.9% as of December 31, 2014.

 

Lending activities are conducted pursuant to an established loan policy approved by the Bank’s Board of Directors. The Bank’s credit review process is overseen by regional loan committees with established loan approval limits. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and is comprised of senior managers of the Bank.

 

A summary of loans, by major class within the Company’s loan portfolio as of the dates indicated is as follows:

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Commercial, financial, and agricultural  $173,485   $154,834 
Real estate construction - residential   13,531    18,103 
Real estate construction - commercial   32,560    48,822 
Real estate mortgage - residential   249,512    247,117 
Real estate mortgage - commercial   388,220    372,321 
Installment loans to individuals   22,166    20,016 
Total loans  $879,474   $861,213 
Percent of categories to total loans:          
Commercial, financial, and agricultural   19.7%   18.0%
Real estate construction - residential   1.5    2.1 
Real estate construction - commercial   3.7    5.7 
Real estate mortgage - residential   28.4    28.7 
Real estate mortgage - commercial   44.1    43.2 
Installment loans to individuals   2.6    2.3 
Total   100.0%   100.0%

 

The Company experienced positive trends in commercial, financial, and agricultural loans, and real estate mortgage loans at September 30, 2015 compared to December 31, 2014, and real estate construction loans saw a slight decrease. At both September 30, 2015 and December 31, 2014, the Company benefited from commercial borrowers being more willing to expand operations, and new calling programs resulted in new customers and expanded loan relationships with existing customers. The Company extends credit to its local community market through traditional real estate mortgage products. The Company does not participate in extending credit to sub-prime residential real estate markets. The Company does not lend funds for the type of transactions defined as “highly leveraged” by bank regulatory authorities or for foreign loans. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. The Company does not have any interest-earning assets that would have been included in nonaccrual, past due, or restructured loans if such assets were loans.

 

The Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers, but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price. During the three months ended September 30, 2015, the Company saw an increase in refinancing activity due to low interest rates and uncertainty of rate increases by the Federal Reserve. The Company sold loans of $11.2 million and $40.1 million for the three and nine months ended September 30, 2015, respectively, compared to $11.0 million and $25.6 million for the three and nine months ended September 30, 2014, respectively. Refinancing activity during the first nine months of 2015 impacting both the volume of loans sold and gains recognized contributed to this increase. At September 30, 2015, the Company was servicing approximately $311.8 million of loans sold to the secondary market compared to $313.9 million at December 31, 2014, and $315.3 million at September 30, 2014.

 

Risk Elements of the Loan Portfolio

 

Management, the senior loan committee, and internal loan review, formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Currently, loans in excess of $2.0 million in aggregate and all adversely classified credits identified by management are reviewed. In addition, all other loans are reviewed on a sample basis. The senior loan

 

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committee reviews and reports to the board of directors, on a monthly basis, past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines which loans should be considered impaired. Management follows the guidance provided in the FASB’s ASC Topic 310, Accounting by Creditors for Impairment of a Loan, in identifying and measuring loan impairment. 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 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. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered adequate by management to provide for probable losses inherent in the loan portfolio.

 

Nonperforming Assets

 

The following table summarizes nonperforming assets at the dates indicated:

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Nonaccrual loans:          
Commercial, financial, and agricultural  $2,831   $5,279 
Real estate construction - residential   0    1,751 
Real estate construction - commercial   54    2,096 
Real estate mortgage - residential   3,589    4,419 
Real estate mortgage - commercial   2,342    4,465 
Installment loans to individuals   141    233 
Total  $8,957   $18,243 
Loans contractually past - due 90 days or more and still accruing:          
Real estate construction - commercial  $0   $56 
Real estate mortgage - residential   348    0 
Installment loans to individuals   1    2 
Total  $349   $58 
Performing Troubled debt restructurings   5,253    17,720 
Total nonperforming loans   14,559    36,021 
Other real estate owned and repossessed assets   15,148    11,885 
Total nonperforming assets  $29,707   $47,906 
           
Loans  $879,474   $861,213 
Allowance for loan losses to loans   1.05%   1.06%
Nonperforming loans to loans   1.66%   4.18%
Allowance for loan losses to nonperforming loans   63.51%   25.26%
Allowance for loan losses to nonperforming loans, excluding performing TDR's   99.36%   49.72%
Nonperforming assets to loans, other real estate owned and repossessed assets   3.32%   5.49%

 

Total nonperforming assets totaled $29.7 million at September 30, 2015 compared to $47.9 million at December 31, 2014. Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and TDRs totaled $14.6 million, or 1.66%, of total loans at September 30, 2015 compared to $36.0 million, or 4.18%, of total loans at December 31, 2014. Non-accrual loans included $1.4 million and $1.6 million of loans classified as TDRs at September 30, 2015 and December 31, 2014, respectively.

 

As of September 30, 2015 and December 31, 2014, approximately $5.9 million and $9.6 million, respectively, of loans classified as substandard, not included in the nonperforming asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. Even though borrowers are experiencing moderate cash flow problems as well as some deterioration in collateral value, management believes the general allowance was sufficient to cover the risks and probable losses related to such loans at September 30, 2015 and December 31, 2014, respectively.

 

Total non-accrual loans decreased $9.3 million to $9.0 million at September 30, 2015 from December 31, 2014. This decrease primarily consisted of a $2.4 million decrease in commercial, financial and agricultural loans, $1.8 million decrease in real estate construction – residential loans, $2.0 million decrease in real estate construction – commercial loans, and a $2.1 million decrease in real estate mortgage – commercial loans. The decrease in non-accrual loans primarily resulted from the sale of a piece of collateral, transfers of impaired loans to other real estate owned and repossessed assets, and four loan relationships that returned to performing status.

 

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Loans past due 90 days and still accruing interest at September 30, 2015 were $349,000 compared to $58,000 at December 31, 2014. Other real estate and repossessed assets at September 30, 2015 were $15.1 million compared to $11.9 million at December 31, 2014. During the nine months ended September 30, 2015, $4.5 million of nonaccrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to $1.8 million during the nine months ended September 30, 2014.

 

The following table summarizes the Company’s TDRs at the dates indicated:

 

   September 30, 2015   December 31, 2014 
(In thousands)  Number of
Contracts
   Recorded
Investment
   Specific
Reserves
  

Number of

Contracts

   Recorded
Investment
   Specific Reserves 
Performing TDRs                              
Commercial, financial and agricultural   9   $812   $70    10   $2,262   $6 
Real estate mortgage - residential   6    3,302    832    6    3,459    752 
Real estate mortgage - commercial   2    1,139    -    8    11,999    - 
Total performing TDRs   17   $5,253   $902    24   $17,720   $758 
Nonperforming TDRs                              
Commercial, financial and agricultural   1   $56   $-    2   $71   $- 
Real estate mortgage - residential   2    467    44    2    347    140 
Real estate mortgage - commercial   5    886    223    3    1,167    10 
Total nonperforming TDRs   8   $1,409   $267    7   $1,585   $150 
Total TDRs   25   $6,662   $1,169    31   $19,305   $908 

 

At September 30, 2015, loans classified as TDRs totaled $6.7 million, of which $1.4 million were classified as nonperforming TDRs and included in non-accrual loans and $5.3 million were classified as performing TDRs. At December 31, 2014, TDRs totaled $19.3 million, of which $1.6 million were classified as nonperforming TDRs included in non-accrual loans and $17.7 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 $1.2 million and $1.0 million related to TDRs were allocated to the allowance for loan losses at September 30, 2015 and December 31, 2014, respectively. The net decrease in total TDRs from December 31, 2014 to September 30, 2015 was primarily due to $2.0 million additions to TDRs that were offset by $273,000 charged off, $100,000 moved to ORE, approximately $2.0 million of payments received, and $12.3 million from five loan relationships moved to performing loans due to subsequent restructuring at market rates and terms followed by satisfactory payment performance.

 

Allowance for Loan Losses and Provision

 

Allowance for Loan Losses

 

The following table is a summary of the allocation of the allowance for loan losses:

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Allocation of allowance for loan losses at end of period:          
Commercial, financial, and agricultural  $3,000   $1,779 
Real estate construction - residential   18    171 
Real estate construction - commercial   551    466 
Real estate mortgage - residential   2,057    2,527 
Real estate mortgage - commercial   3,246    3,846 
Installment loans to individuals   209    270 
Unallocated   165    40 
Total  $9,246   $9,099 

 

The allowance for loan losses was $9.2 million, or 1.05%, of loans outstanding at September 30, 2015 compared to $9.1 million, or 1.06%, of loans outstanding at December 31, 2014, and $12.0 million, or 1.40%, of loans outstanding at September 30, 2014. The ratio of the allowance for loan losses to nonperforming loans, excluding TDR’s – accruing, was 99.36% at September 30, 2015, compared to 49.72% at December 31, 2014, and 49.14% at September 30, 2014.

 

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Provision

 

No provision for loan losses was recorded for the third quarter of 2015 and $250,000 was recorded for the nine months ended September 30, 2015 compared to no provision for the three and nine months ended September 30, 2014. The increase over 2014 was primarily due to an increase in specific reserves primarily related to two loan relationships.

 

The following table summarizes loan loss experience for the periods indicated:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
(In thousands)  2015   2014   2015   2014 
Analysis of allowance for loan losses:                    
Balance beginning of period  $9,986   $12,150   $9,099   $13,719 
Charge-offs:                    
Commercial, financial, and agricultural   591    105    741    291 
Real estate construction - residential   -    -    -    59 
Real estate construction - commercial   -    -    5    491 
Real estate mortgage - residential   87    41    298    236 
Real estate mortgage - commercial   126    80    159    1,152 
Installment loans to individuals   80    71    241    270 
Total charge-offs   884    297    1,444    2,499 
Recoveries:                    
Commercial, financial, and agricultural  $28   $55   $643   $282 
Real estate construction - residential   28    -    322    60 
Real estate mortgage - residential   45    26    105    151 
Real estate mortgage - commercial   5    67    157    160 
Installment loans to individuals   38    32    114    160 
Total recoveries   144    180    1,341    813 
Net charge-offs   740    117    103    1,686 
Provision for loan losses   -    -    250    - 
Balance end of period  $9,246   $12,033   $9,246   $12,033 

 

Net Loan Charge-offs (Recoveries)

 

The Company’s net charge-offs were $740,000, 0.08% of average loans, for the quarter ended September 30, 2015 compared to $117,000, or 0.01%, of average loans, for the quarter ended September 30, 2014. Detailed in the table above, the increase in net charge-offs quarter over quarter was primarily due to a $513,000 increase in commercial, financial, and agricultural charge-offs related to one loan relationship.

 

The Company’s net charge-offs were $103,000 for the nine months ended September 30, 2015, or 0.01% of average loans, compared to net charge-offs of $1.7 million, or 0.20% of average loans, for the nine months ended September 30, 2014. Detailed in the table above, the Company’s recoveries increased for the nine months ended September 30, 2015 over the prior year primarily due to one loan relationship in commercial loans, and one loan relationship in real estate construction loans. In addition to the increase in recoveries recorded during the nine months ended September 30, 2015, the Company also noted a decrease in charge-offs of $1.0 million compared to the nine months ended September 30, 2014.

 

The following table is a summary of the general and specific allocations of the allowance for loan losses:

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Allocation of allowance for loan losses:          
Individually evaluated for impairment - specific reserves  $1,970   $1,749 
Collectively evaluated for impairment - general reserves   7,276    7,350 
Total  $9,246   $9,099 

 

Specific reserves increased to $2.0 million at September 30, 2015 compared to $1.7 million at December 31, 2014. The increase in reserves from December 31, 2014 primarily occurred in commercial, financial, and agricultural loans, and real estate mortgage commercial loans. The increase in commercial, financial, and agricultural reserves primarily related to one loan relationship due to increased exposure resulting from liquidation of collateral during the current quarter. The increase in real estate mortgage reserves was primarily due to additional reserves required for one loan relationship resulting from the reevaluation of collateral values.

 

The specific reserve component applies to loans evaluated individually for impairment. The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals and/or internal evaluations, or by discounting the total expected future cash flows. Once the impairment amount is calculated, a specific reserve allocation is

 

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recorded. At September 30, 2015, $2.0 million of the Company’s allowance for loan losses was allocated to impaired loans totaling approximately $14.2 million compared to $1.7 million of the Company’s allowance for loan losses (ALL) allocated to impaired loans totaling approximately $36.0 million at December 31, 2014. Management determined that $7.4 million, or 52%, of total impaired loans required no reserve allocation at September 30, 2015 compared to $28.5 million, or 79%, at December 31, 2014 primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability.

 

The incurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying percentages to pools of loans by asset type. 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 adjusted for certain qualitative factors to reflect current risk characteristics of the portfolio. In addition, the combined historical loan loss rates and qualitative factors are multiplied by loss emergence periods (LEP) which represent the estimated time period between a borrower first experiencing financial difficulty and the recognition of a loss. Management determined that the previous twelve quarters were reflective of the loss characteristics of the Company’s loan portfolio during the recent economic environment. These historical loss rates for each risk group are used as the starting point to determine allowance provisions. The Company’s methodology includes qualitative factors that allow management to adjust its estimates of losses based on the most recent information available. These factors reflect actual changes and anticipated changes such as changes in specific allowances on loans and real estate acquired through foreclosure, any gains and losses on final disposition of real estate acquired through foreclosure, changes in national and local economic conditions and developments, including general economic and business conditions affecting the Company’s key lending areas, credit quality trends, specific industry conditions within portfolio segments, bank regulatory examination results, and findings of the internal loan review department. These risk factors are generally reviewed and updated quarterly, as appropriate.

 

Loss Emergence Periods While the historical loss rates and qualitative factors (discussed above) provide a good foundation as to the incurred losses in the current portfolio, the portfolio is comprised of very unique loan categories that inherently may need more time to produce a loss than other loan categories (given these unique segments and workout periods). As such, a review of the Company’s LEP is necessary to ensure the ALL estimate is appropriately stated as of the balance sheet date, rather than relying on a singular annualized loss rate based upon the historical charge-off activity. Determination of the LEP allows for loans with effective useful lives other than twelve months, often loans with extended workout periods, to be incorporated into the reserve estimate, given the incurred loss event had occurred prior to the balance sheet date. This approach is consistent with the Interagency ALL Guidance noted above.

 

The specific and general reserve allocations represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

 

Liquidity and Capital Resources

 

Liquidity Management

 

The role of liquidity management is to ensure funds are available to meet depositors' withdrawal and borrowers' credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet the demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by the Company, management prefers to focus on transaction accounts and full service relationships with customers.

 

The Company’s Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for the Company's liquidity position and profile. A combination of daily, weekly, and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital, and exposure to contingent draws on the Company's liquidity.

 

The Company has a number of sources of funds to meet liquidity needs on a daily basis. The Company’s most liquid assets are comprised of available for sale investment securities, federal funds sold, and excess reserves held at the Federal Reserve.

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Federal funds sold and other overnight interest-bearing deposits  $14,463   $20,445 
Available-for-sale investment securities   244,250    198,998 
Total  $258,713   $219,443 

 

Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available-for-sale investment portfolio was $258.7 million at September 30, 2015 and included an unrealized net gain of $1.3 million. The portfolio includes projected maturities and mortgage backed securities pay-downs of

 

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approximately $31.0 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s deposit base.

 

The Company pledges portions of its investment securities portfolio to secure public fund deposits, federal funds purchase lines, securities sold under agreements to repurchase, borrowing capacity at the Federal Reserve Bank, and for other purposes required by law. At September 30, 2015 and December 31, 2014, the Company’s unpledged securities in the available for sale portfolio totaled approximately $35.3 million and $53.4 million, respectively.

 

Total investment securities pledged for these purposes were as follows:

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Investment securities pledged for the purpose of securing:          
Federal Reserve Bank borrowings  $3,502   $3,504 
Federal funds purchased and securities sold under agreements to repurchase   73,576    26,770 
Other deposits   131,851    115,272 
Total pledged, at fair value  $208,929   $145,546 

 

Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, and money market deposit accounts. At September 30, 2015, such deposits totaled $662.6 million and represented 68.2% of the Company’s total deposits. These core deposits are normally less volatile and are often tied to other products of the Company through long lasting relationships. Time deposits and certificates of deposit of $100,000 and over totaled $309.6 million at September 30, 2015. These accounts are normally considered more volatile and higher costing representing 31.8% of total deposits at September 30, 2015.

 

Core deposits at September 30, 2015 and December 31, 2014 were as follows:

 

   September 30,   December 31, 
(In thousands)  2015   2014 
Core deposit base:          
Non-interest bearing demand  $209,714   $207,700 
Interest checking   183,538    191,902 
Savings and money market   269,340    250,157 
Total  $662,592   $649,759 

 

Other components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company’s outside borrowings are comprised of securities sold under agreements to repurchase, Federal Home Loan Bank advances, and subordinated notes. Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines. As of September 30, 2015, under agreements with these unaffiliated banks, the Bank may borrow up to $40.0 million in federal funds on an unsecured basis and $8.6 million on a secured basis. There were no federal funds purchased outstanding at September 30, 2015. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At September 30, 2015, there was $27.8 million in repurchase agreements. The Company may periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window; although no such borrowings were outstanding at September 30, 2015.

 

The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB). As a member of the FHLB, the Bank has access to credit products of the FHLB. As of September 30, 2015, the Bank had $80.0 million in outstanding borrowings with the FHLB. In addition, the Company has $49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts.

 

Borrowings outstanding at September 30, 2015 and December 31, 2014 were as follows:

 

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   September 30,   December 31, 
(In thousands)  2015   2014 
Borrowings:          
Securities sold under agreements to repurchase  $27,762   $17,970 
Federal Home Loan Bank advances   80,000    43,000 
Subordinated notes   49,486    49,486 
Total  $157,248   $110,456 

  

The Company pledges certain assets, including loans and investment securities to the Federal Reserve Bank, FHLB, and other correspondent banks as security to establish lines of credit and borrow from these entities. Based on the type and value of collateral pledged, the Company may draw advances against this collateral.

 

The following table reflects the advance equivalent of the assets pledged, borrowings, and letters of credit outstanding in addition to the estimated future funding capacity available to the Company as follows:

 

   September 30,   December 31, 
   2015   2014 
(In thousands)  FHLB   Federal
Reserve
Bank
   Federal
Funds
Purchased
Lines
   Total   FHLB   Federal
Reserve
Bank
   Federal
Funds
Purchased
Lines
   Total 
Advance equivalent  $243,414   $3,432   $45,200   $292,046   $273,613   $3,433   $44,340   $321,386 
Advances outstanding   (80,000)   0    0    (80,000)   (43,000)   0    0    (43,000)
Total available  $163,414   $3,432   $45,200   $212,046   $230,613   $3,433   $44,340   $278,386 

 

At September 30, 2015, loans with a market value of $330.5 million were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At September 30, 2015, investments with a market value of $9.5 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.

 

Sources and Uses of Funds

 

Cash and cash equivalents were $32.1 million at September 30, 2015 compared to $42.8 million at December 31, 2014. The $10.7 million decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the nine months ended September 30, 2015. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $11.6 million for the nine months ended September 30, 2015.

 

Investing activities consisting mainly of purchases, sales and maturities of available-for-sale securities, and changes in the level of the loan portfolio used total cash of $70.9 million. The cash outflow primarily consisted of $81.6 million purchases of investment securities, and a $21.9 million increase in loans, partially offset by $35.6 million proceeds from maturities, calls, and pay-downs of investment securities.

 

Financing activities provided cash of $48.7 million, resulting primarily from a $37.0 million net increase in FHLB advances, a $10.8 million increase in interest bearing transaction accounts, and a $9.8 million increase in federal funds purchased and securities sold under agreements to repurchase, partially offset by a $10.2 million decrease in time deposits. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during 2015.

 

In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company's various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company's liquidity. The Company had $153.9 million in unused loan commitments and standby letters of credit as of September 30, 2015. Although the Company's current liquidity resources are adequate to fund this commitment level the nature of these commitments is such that the likelihood of such a funding demand is very low.

 

The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company’s ongoing liquidity needs primarily include funding its operating expenses and paying cash dividends to its shareholders. The Company paid cash dividends to its shareholders totaling approximately $785,000 and $755,000 for the nine months ended September 30, 2015 and 2014, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid $1.0 million in dividends to the Company during the nine months ended September 30, 2015. At September 30, 2015 and December 31, 2014, the Company had cash and cash equivalents totaling $5.5 million and $1.0 million, respectively.

 

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Capital Management

 

The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.

 

Quantitative measures established by regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets, and of Tier I capital to adjusted-average assets. The Company made a one-time election not to include accumulated other comprehensive income (AOCI) components in regulatory capital. Management believes, as of September 30, 2015 and December 31, 2014, the Company and the Bank each met all capital adequacy requirements.

 

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) must begin compliance on January 1, 2014. The final rules call for the following capital requirements:

 

·A minimum ratio of common tier 1 capital to risk-weighted assets of 4.5%.

·A minimum ratio of tier 1 capital to risk-weighted assets of 6%.

·A minimum leverage ratio of 4%.

 

In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016.

 

The following table summarizes regulatory capital information as of September 30, 2015 and December 31, 2014 on a consolidated basis and for the Bank, as defined. Regulatory capital ratios for September 30, 2015 were calculated in accordance with the Basel III rules, whereas the December 31, 2014 regulatory ratios were calculated in accordance with Basel I rules.

 

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                   Well-Capitalized Under 
           Required for Capital   Prompt Corrective Action 
   Actual   Adequacy Purposes   Provision 
(in thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio 
September 30, 2015                              
Total Capital (to risk-weighted assets):                              
Company  $144,837    14.91%  $77,721    8.00%  $N.A.    N.A.%
Bank   135,619    14.03    77,332    8.00    96,665    10.00 
Tier I Capital (to risk-weighted assets):                              
Company  $116,635    12.01%  $58,291    6.00%  N.A.    N.A.%
Bank   126,213    13.06    57,999    6.00    77,332    8.00 
Common Equity Tier I Capital (to risk-weighted assets)                              
Company  $87,611    9.02%  $43,718    4.50%  $N.A.    N.A.% 
Bank   126,213    13.06    43,499    4.50    62,832    6.50 
Tier I Capital (to adjusted average assets):                              
Company  $116,635    9.70%  $48,084    4.00%  $N.A.    N.A.% 
Bank   126,213    10.55    47,850    4.00    59,813    5.00 
                               
(in thousands)                              
December 31, 2014                              
Total Capital (to risk-weighted assets):                              
Company  $138,619    15.78%  $70,282    8.00%   N.A.    N.A.% 
Bank   128,311    14.78    69,430    8.00   $86,788    10.00 
Tier I Capital (to risk-weighted assets):                              
Company  $108,785    12.38%  $35,141    4.00%   N.A.    N.A.% 
Bank   119,212    13.74    34,715    4.00   $52,073    6.00 
Tier I capital (to adjusted average assets):                              
Company  $108,785    9.42%  $46,197    4.00%  N.A.    N.A.% 
Bank   119,212    10.42    45,784    4.00    57,230    5.00 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Interest Sensitivity

 

Market risk arises from exposure to changes in interest rates and other relevant market rate or price risk. The Company faces market risk in the form of interest rate risk through transactions other than trading activities. The Company uses financial modeling techniques to measure interest rate risk. These techniques measure the sensitivity of future earnings due to changing interest rate environments. Guidelines established by the Company's Asset/Liability Committee and approved by the board of directors are used to monitor exposure of earnings at risk. General interest rate movements are used to develop sensitivity as the Company feels it has no primary exposure to specific points on the yield curve. For the three months ended September 30, 2015, our Company utilized a 400 basis point immediate and gradual move in interest rates (both upward and downward) applied to both a parallel and proportional yield curve. However, there are no assurances that the change will not be more or less than this estimate.

 

The following table represents estimated interest rate sensitivity and periodic and cumulative gap positions calculated as of September 30, 2015. Significant assumptions used for this table included: loans will repay at historic repayment rates; certain interest-bearing demand accounts are interest sensitive due to immediate repricing, and fixed maturity deposits will not be withdrawn prior to maturity. A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the table.

 

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                       Over     
                       5 Years or     
                       No stated     
(In thousands)  Year 1   Year 2   Year 3   Year 4   Year 5   Maturity   Total 
ASSETS                                   
Investment securities  $36,986   $16,365   $29,971   $32,754   $24,071   $104,103   $244,250 
Federal funds sold and other over-night interest-bearing deposits   14,463    -    -    -    -    -    14,463 
Other restricted investments   6,237    -    -    -    3,000    -    9,237 
Loans   305,071    151,320    138,926    103,964    117,147    63,046    879,474 
Total  $362,757   $167,685   $168,897   $136,718   $144,218   $167,149   $1,147,424 
                                    
LIABILITIES                                   
Savings, interest checking, and money market deposits  $261,988   $-   $190,890   $-   $-   $-   $452,878 
Time deposits   203,067    61,693    32,029    6,896    5,891    -    309,576 
Federal funds purchased and securities sold under agreements to repurchase   27,762    -    -    -    -    -    27,762 
Subordinated notes   49,486    -    -    -    -    -    49,486 
Federal Home Loan Bank advances   38,000    5,000    22,000    4,000    11,000    -    80,000 
Total  $580,303   $66,693   $244,919   $10,896   $16,891   $-   $919,702 
Interest-sensitivity GAP                                   
Periodic GAP  $(217,546)  $100,992   $(76,022)  $125,822   $127,327   $167,149   $227,722 
Cumulative GAP  $(217,546)  $(116,554)  $(192,576)  $(66,754)  $60,573   $227,722   $227,722 
                                    
Ratio of interest-earning assets to interest-bearing liabilities                                   
Periodic GAP   0.63    2.51    0.69    12.55    8.54    NM    1.25 
Cumulative GAP   0.63    0.82    0.78    0.93    1.07    1.25    1.25 

 

Effects of Inflation

 

The effects of inflation on financial institutions are different from the effects on other commercial enterprises since financial institutions make few significant capital or inventory expenditures, which are directly affected by changing prices. Because bank assets and liabilities are virtually all monetary in nature, inflation does not affect a financial institution as much as do changes in interest rates. The general level of inflation does underlie the general level of most interest rates, but interest rates do not increase at the rate of inflation as do prices of goods and services. Rather, interest rates react more to changes in the expected rate of inflation and to changes in monetary and fiscal policy.

 

Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase capital at higher than normal rates to maintain an appropriate capital to asset ratio. In the opinion of management, inflation did not have a significant effect on the Company's operations for the three months ended September 30, 2015.

 

Item 4. Controls and Procedures

 

Our Company's management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures as defined in Rules 13a – 15(e) or 15d – 15(e) of the Securities Exchange Act of 1934 as of September 30, 2015.  Based upon and as of the date of that evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required.  It should be noted that any system of disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.  In addition, the design of any system of disclosure controls and procedures is based in part upon assumptions about the likelihood of future events. Because of these and other inherent limitations of any such system, there can be no assurance that any design will always succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

There has been no change in our Company's internal control over financial reporting that occurred during the three months ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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Impact of New Accounting Standards

 

Revenue from Contracts with Customers The FASB issued ASU 2014-09, Revenue from Contracts with Customers, in May 2014. The ASU supersedes revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance in the FASB Accounting Standards Codification. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies specific steps that entities should apply in order to achieve this principle. The amendments are effective for interim and annual periods beginning January 1, 2017 and must be applied retrospectively. The Company is in the process of evaluating the impact of the ASU's adoption on the Company’s consolidated financial statements.

 

Transfers and Servicing The FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, in September 2014. The amendments require that repurchase-to-maturity transactions and repurchase agreements that are part of financing arrangements be accounted for as secured borrowings. The amendments also require additional disclosures for certain transfers accounted for as sales. The accounting changes and the disclosures on sales are required to be presented in interim and annual periods beginning January 1, 2015. This ASU also requires disclosures about types of collateral, contractual tenor and potential risks for transactions accounted for as secured borrowings. These disclosures are required in interim and annual periods beginning April 1, 2015. The adoption is not expected to have a significant effect on the Company’s consolidated financial statements.

 

Presentation of Financial Statements - Going Concern Uncertainties. The FASB has issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern in August 2014. ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. Under Generally Accepted Accounting Principles (GAAP), financial statements are prepared under the presumption that the reporting organization will continue to operate as a going concern, except in limited circumstances. Financial reporting under this presumption is commonly referred to as the going concern basis of accounting. The going concern basis of accounting is critical to financial reporting because it establishes the fundamental basis for measuring and classifying assets and liabilities. Currently, GAAP lacks guidance about management’s responsibility to evaluate whether there is substantial doubt about the organization’s ability to continue as a going concern or to provide related footnote disclosures. This ASU provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes. The amendments are effective for interim and annual periods ending after December 15, 2016. The adoption is not expected to have a significant effect on the Company's consolidated financial statements.

 

Consolidation The FASB has issued ASU No. 2015-02, Amendments to the Consolidation Analysis. The amendment substantially changes the way reporting entities are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the new amendment. Specifically, the amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities, eliminate the presumption that a general partner should consolidate a limited partnership, and affect the consolidation analysis of reporting entities that are involved with VIEs. The amendments in this update are effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that ASU 2015-02 will have on its consolidated financial statements and related disclosures. The adoption is not expected to have a significant effect on the Company’s consolidated financial statements.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings  
     
  The information required by this Item is set forth in Commitments and Contingencies, Pending Litigation, in our Company’s Notes to Consolidated Financial Statements (unaudited).

 

Item 1A.   Risk Factors

None 

     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None
     
Item 3. Defaults Upon Senior Securities None
     
Item 4. Mine Safety Disclosures None
     
Item 5. Other Information None
     
Item 6. Exhibits  

 

Exhibit No.   Description
     
3.1   Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to our Company's current report on Form 8-K on August 9, 2007 and incorporated herein by reference).
     
3.2   Amended and Restated Bylaws of our Company (filed as Exhibit 3.1 to our Company's current report on Form 8-K on June 8, 2009 and incorporated herein by reference).
     
4.1   Specimen certificate representing shares of our Company’s $1.00 par value common stock (filed as Exhibit 4.1 to our Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (Commission file number 0-23636) and incorporated herein by reference).
     
31.1   Certificate of the Chief Executive Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2   Certificate of the Chief Financial Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1   Certificate of the Chief Executive Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2   Certificate of the Chief Financial Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
101   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail (XBRL)

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

HAWTHORN BANCSHARES, INC.

 

Date

 

  /s/ David T. Turner  
     
November 16, 2015 David T. Turner, Chairman of the Board and  
  Chief Executive Officer (Principal Executive Officer)  
     

 

 /s/ W. Bruce Phelps
     
November 16, 2015 W. Bruce Phelps, Chief Financial Officer (Principal Financial  
 

Officer and Principal Accounting Officer)

 

 

 

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HAWTHORN BANCSHARES, INC.

 

INDEX TO EXHIBITS

 

September 30, 2015 Form 10-Q

 

Exhibit No.   Description
     
3.1   Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to our Company's current report on Form 8-K on August 9, 2007 and incorporated herein by reference).
     
3.2   Amended and Restated Bylaws of our Company (filed as Exhibit 3.1 to our Company's current report on Form 8-K on June 8, 2009 and incorporated herein by reference).
     
4.1  

Specimen certificate representing shares of our Company’s $1.00 par value common stock (filed as Exhibit 4.1 to our Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (Commission file number 0-23636) and incorporated herein by reference).

     
31.1   Certificate of the Chief Executive Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2   Certificate of the Chief Financial Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1   Certificate of the Chief Executive Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2   Certificate of the Chief Financial Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
101   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail (XBRL)

 

 

*As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934, as amended.
**Incorporated by reference.

 

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