Hawthorn Bancshares - 10-Q quarterly report FY

 

 

(Exact name of registrant as specified in its charter)

(Registrant’s telephone number, including area code)

(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.þ Yes       o No

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

Large accelerated filer o      Accelerated filer þ      Non-accelerated filer o

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

As of May 10, 2007 the registrant had 4,169,847 shares of common stock, par value $1.00 per share, outstanding.

 

 

Index to Exhibits located on page 35

PART I — FINANCIAL INFORMATION

EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     The accompanying unaudited condensed consolidated financial statements include all adjustments that in the opinion of management are necessary in order to make those statements not misleading. Certain amounts in the 2006 condensed consolidated financial statements have been reclassified to conform to the 2007 condensed consolidated presentation. Such reclassifications have no effect on previously reported net income or stockholders’ equity. Operating results for the period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

     These unaudited condensed consolidated interim financial statements should be read in conjunction with our Company’s audited consolidated financial statements included in its 2006 Annual Report to Shareholders under the caption “Consolidated Financial Statements” and incorporated by reference into its Annual Report on Form 10-K for the year ended December 31, 2006 as Exhibit 13.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed and omitted. These financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our Company’s consolidated financial position as of March 31, 2007 and the consolidated statement of earnings for the three month-period ended March 31, 2007 and cash flows for the three month-period ended March 31, 2007.

     The following table reflects, for the three-month periods ended March 31, 2007 and 2006, the numerators (net income) and denominators (average shares outstanding) for the basic and diluted net income per share computations:

     Total stock-based compensation expense was $46,000 ($30,000 after tax) and $42,000 ($28,000 after tax) for the three-month period ended March 31, 2007 and 2006, respectively. As of March 31, 2007, the total unrecognized compensation expense related to non-vested stock awards was $345,000 and the related weighted average period over which it is expected to be recognized is approximately 1.4 years. For the three months ended March 31, 2007, there were no stock options exercised.

The following table summarizes our Company’s stock option activity for the three-month period ended March 31, 2007:

     Options outstanding at March 31, 2007 had an intrinsic value of $2,127,000. Options exercisable at March 31, 2007 had an intrinsic value of approximately $1,790,000. On April 27, 2007, 48,104 stock options were granted. On March 3, 2006, 46,380 stock options were granted.

     Comprehensive income for the three-month periods ended March 31, 2007 and 2006 is summarized as follows:

     The gross carrying amount and accumulated amortization of our Company’s amortized intangible assets as of March 31, 2007 and December 31, 2006 is as follows:

     The aggregate amortization expense of core deposit intangible subject to amortization for the three-month period ended March 31, 2007 and 2006 is as follows:

     The estimated amortization expense for the next five years is as follows:

     Mortgage loans serviced for others totaled approximately $215,133,000 and $216,697,000 at March 31, 2007 and 2006, respectively. Mortgage servicing rights totaled approximately $1,318,000 and $1,487,000 at March 31, 2007 and 2006, respectively.

     Changes in the balance of servicing assets related to the loans serviced by The Exchange National Bank of Jefferson City for the three-month period ended March 31, 2007 and 2006 are as follows:

     Our Company’s mortgage servicing rights are amortized in proportion to the related estimated net servicing income over the estimated lives of the related mortgages, which is seven years. Changes in mortgage servicing rights, net of amortization, for the periods indicated were as follows:

     On January 1, 2007, our Company adopted the provisions of FIN 48. As of January 1, 2007 our Company had $1,026,000 of gross unrecognized tax benefits of which $683,000 would impact the effective tax rate, if recognized. If these tax benefits are not recognized, the result would be cash tax payments. Our Company expects a reduction of $234,000 in gross unrecognized tax benefits during the remaining nine-month period ending December 31, 2007 as a result of the statute of limitations closing for the 2003 tax year. The unrecognized tax benefits are related to various federal and state tax strategies.

     In addition, our Company recognizes interest expense related to unrecognized tax positions as a component of the Income Tax Provision. As of January 1, 2007, interest accrued was approximately $124,000. There were no penalties related to tax matters accrued at January 1, 2007, nor did our Company recognize any penalties during the three months ended March 31, 2007.

     Our Company and subsidiaries file income tax returns in the U. S. federal jurisdiction and the state of Missouri. Management believes the accrual for tax liabilities is adequate for all open audit years based on its assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter. This assessment relies on estimates and assumptions. Our Company’s federal and state income tax returns for 2003 to 2006 are open tax years. As of March 31, 2007, there were no federal or state income tax examinations in process.

     Our Company provides a noncontributory defined benefit pension plan for all full-time employees over the age of 21 who have completed at least on year of qualified service.

     Pension expense for the three month-periods ended March 31, 2007 and 2006 is as follows:

Under the provisions of the Pension Protection Act of 2006 our Company may make a contribution to the defined benefit pension plan during 2007.

     Through the respective branch network, Exchange National Bank, Hawthorn Bank, and Bank 10 provide similar products and services in four defined geographic areas. The products and services offered include a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts and money market accounts. Loans include real estate, commercial, installment and other consumer loans. Other financial services include automatic teller machines, trust services, credit related insurance, and safe deposit boxes. The revenues generated by each business segment consist primarily of interest income, generated from the loan and debt and equity security portfolios, and service charges and fees, generated from the deposit products and services. The geographic areas are defined to be communities surrounding Jefferson City, Clinton, and Belton, Missouri. The products and services are offered to customers primarily within their respective geographical areas. The business segments results that follow are consistent with our Company’s internal reporting system which is consistent, in all material respects, with accounting principles generally accepted in the United States of America and practices prevalent in the banking industry.

     This overview of management’s discussion and analysis highlights selected information in this report and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, you should carefully read this entire report. These have an impact on our Company’s financial condition and results of operation.

     Business Strategy: On December 1, 2006, our Company announced its development of a strategic plan in which, among other things, Exchange National Bank, Citizens Union State Bank, Osage Valley Bank and Bank 10 would be consolidated into a single bank under a Missouri state trust charter.

     The first step in this consolidation process was accomplished on March 16, 2007 when Osage Valley Bank and Citizens Union State Bank were combined. Exchange National Bank and Bank 10 plan to complete the consolidation process before December 31, 2007 when they combine with Citizens Union State Bank.

     The second step was accomplished on April, 20, 2007, when our Company issued a press release announcing that Hawthorn Bank had been selected as the new name for its combined subsidiary banks. As of April 23, 2007 Citizens Union State Bank began using the name “Hawthorn Bank”. It was also announced that our shareholders would be asked to approve the change of our Company’s name to Hawthorn Bancshares, Inc. at the 2007 annual meeting of shareholders. It is anticipated that by the time the aforementioned consolidation is completed, the resulting consolidated bank would be known as “Hawthorn Bank.” Our Company’s name change is being proposed in anticipation of this consolidation and would reflect the name under which our consolidated bank is to operate. Our board of directors believes that the name change would provide continuity between us and our consolidated bank, and would allow us to better leverage the “Hawthorn” brand identity than if we were to retain our current name.

     Material Challenges and Risks: Our Company may experience difficulties managing growth and effectively integrating newly established branches. As part of our general strategy, our Company may continue to acquire banks and establish de novo branches that we believe provide a strategic fit. To the extent that our Company does grow, there can be no assurances that we will be able to adequately and profitably manage such growth. The successes of our Company’s growth strategy will depend primarily on the ability of our banking subsidiaries 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. Our Company’s financial performance also depends, in part, on our ability to manage various portfolios and to successfully introduce additional financial products and services. Furthermore, the success of our Company’s growth strategy will depend on our ability to maintain sufficient regulatory capital levels and on general economic conditions that are beyond our control.

     Revenue Source: Through the respective branch network, Exchange National Bank, Hawthorn Bank, and Bank 10 provide similar products and services in three defined geographic areas. The products and services offered include a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts, and money market accounts. Loans include real estate, commercial, installment, and other consumer loans. Other financial services include automatic teller machines, trust services, credit related insurance, and safe deposit boxes. The revenues generated by each business segment consist primarily of interest income, generated primarily from the loan and debt and equity security portfolios, and service charges and fees, generated from the deposit products and services. The geographic areas are defined to be communities surrounding Jefferson City, Clinton, and Belton, Missouri. The products and services are offered to customers primarily within their respective geographical areas. The business segment results are consistent with our Company’s internal reporting system which is consistent, in all material respects, with generally accepted accounting principles and practices prevalent in the banking industry.

     Much of our Company’s business is commercial, commercial real estate development, and mortgage lending. Our Company has experienced continued strong loan demand in the communities within which we operate even during economic slowdowns. Our Company’s income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing.

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

     Our Company has prepared the unaudited condensed consolidated financial statements 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, our 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.

     We have identified the accounting policy related to the allowance for loan losses as critical to the understanding of our Company’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts being reported if conditions or underlying circumstances were to change. The impact and any associated risks related to these policies on our business operations are discussed in the “Lending and Credit Management” section below.

     Net income for the three months ended March 31, 2007 of $2,307,000 decreased $382,000 when compared to the first quarter of 2006. Diluted earnings per common share for the first quarter of 2007 of $0.55 decreased 9 cents or 14.1% when compared to the first quarter of 2006.

     Net interest income (on a tax equivalent basis) was $9,382,000, or 3.75% of average earning assets, for the three months ended March 31, 2007, compared to $9,723,000, or 3.83% of average earning assets, for the same period in 2006. While the yield on earning assets increased 59 basis points from 6.71% at March 31, 2006 to 7.30% at March 31, 2007, the average rate paid on interest-bearing liabilities increased 78 basis points from 3.27% at March 31, 2006 to 4.05% at March 31, 2007.

     Average interest-earning assets for the three months ended March 31, 2007 were $1,015,528,000, a decrease of $14,787,000 or 1.4%, compared to average interest-earning assets of $1,030,315,000 for the same period of 2006. Average loans outstanding decreased approximately $17,838,000 while other earning assets increased $3,051,000. The decrease in average loans is primarily a result of a general slowdown in the real estate construction market. Our Company has experienced significant reductions in the amount of construction and land development loans outstanding in all our market areas over the past twelve months. Much of this reduction is the result of several large real estate construction loans obtaining permanent financing in the long term financing markets.

     Fully taxable equivalent net interest income decreased $341,000 or 3.5% for the three month period ended March 31, 2007 compared to the same period in 2006. The decrease in net interest income for the period ended March 31, 2007 compared to the period ended March 31, 2006 was the result of both decreased earning assets and decreased net interest margin.

     The following table presents average balance sheets, net interest income, average yields of earning assets, and average costs of interest bearing liabilities on a fully taxable equivalent basis for the three month periods ended March 31, 2007 and 2006.

     The following table presents, on a fully taxable equivalent basis, an analysis of changes in net interest income resulting from changes in average volumes of earning assets and interest bearing liabilities and average rates earned and paid. 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.

     Dollars expressed in thousands)

     Our Company’s primary source of earnings is net interest income, which is the difference between the interest earned on interest earning assets and the interest paid on interest bearing liabilities. Net interest income on a fully taxable equivalent basis decreased $341,000 or 3.5% to $9,382,000 or 3.75% of average earning assets for the first quarter of 2007 compared to $9,723,000 or 3.83% of average earning assets for the same period of 2006. The provision for loan losses was $225,000 and $318,000 for the three months ended March 31, 2007 and 2006 respectively. Net charge-offs were $77,000 for the first quarter of 2007 compared to $17,000 for the first quarter of 2006. The decrease in the provision for loan losses for the first quarter of 2007 compared to first quarter 2006 reflects the expected loss in the loan portfolio based upon managements’ analysis of the risk in the portfolio. See Lending and Credit Management in this report for further discussion of first quarter 2007 charge-offs.

     Noninterest income and noninterest expense for the three-month periods ended March 31, 2007 and 2006 were as follows:

     Noninterest income increased $497,000 or 24.5% to $2,523,000 for the first quarter of 2007 compared to $2,026,000 for the same period of 2006. Service charges on deposit accounts decreased $81,000 or 6.0% as a result of decreased overdraft and insufficient check fee income, ATM fee income, debit card fee income. Trust department income increased $56,000 or 31.1% due to the collection of additional trust distribution fees. Gain on sale of mortgage loans increased $17,000 or 15.2% due to an increase in volume of loans originated and sold to the secondary market from approximately $6,139,000 in the first quarter of 2006 to approximately $9,259,000 for the first quarter of 2007. Our Company recognized $2,000 in loss on sales and calls of debt securities during the first quarter of 2007 versus losses of $18,000 during the first quarter of 2006. Other noninterest income increased $508,000 or $183.4%. $425,000 of the increase represents the amount received from the sale of Osage Valley Bank’s state bank charter.

     Noninterest expense increased $823,000 or 11.3% to $8,134,000 for the first quarter of 2007 compared to $7,311,000 for the first quarter of 2006. Salaries and benefits increased $478,000 or 11.0%, occupancy expense increased $55,000 or 12.2%, furniture and equipment expense increased $60,000 or 11.5%, amortization expense decreased $30,000 or 10.9%, processing expense increased $55,000 or 25.8%, and other noninterest expense increased $213,000 or 23.2%. In addition to the increase in salaries and employees benefits represented by normal salary increases, additional hires resulting from staffing for a new branch facility to open during second quarter 2007 in a new market area and additional holding company hires required for the implementation of our Company’s strategic plan, $47,000 reflects increased pension expense. Partially offsetting these increases is a $27,000 decreased profit sharing expense. The $55,000 increase in occupancy expense is primarily reflected by higher property tax accruals as a result of the completion of several branch projects and the associated increase in assessed valuations. The $60,000 increase in furniture and equipment expense reflects additional depreciation expense, equipment repair expense, and equipment maintenance costs. The $55,000 increase in processing expense reflects higher costs associated with the various data processing systems utilized by our Company and costs associated with preparing for consolidation of the bank charters. The $213,000 increase in other noninterest expense reflects higher expenses in various other categories including, but not limited to, directors fees, travel, meals & entertainment, and other insurance.

     Income taxes as a percentage of earnings before income taxes as reported in the condensed consolidated financial statements were 30.1% for the first quarter of 2007 compared to 30.3% for the first quarter of 2006.

     Interest earned on the loan portfolio is a primary source of interest income for our Company. Net loans represented 70.2% of total assets as of March 31, 2007 compared to 70.3% as of December 31, 2006 and 70.4% as of March 31, 2006.

     Lending activities are conducted pursuant to written loan policies approved by our Banks’ Boards of Directors. Larger credits are reviewed by our Banks’ Discount Committees. These committees are comprised of members of senior management.

     Our 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 our Company has a non-recourse purchase commitment from the secondary market at a predetermined price. At March 31, 2007, our Company was servicing approximately $215,133,000 of loans sold to the secondary market.

     Mortgage loans retained in our Company’s portfolio generally include provisions for rate adjustments at one to three year intervals. Commercial loans and real estate construction loans generally have maturities of less than one year. Installment loans to individuals are primarily fixed rate loans with maturities from one to five years.

     The provision for loan losses is based on management’s evaluation of the loan portfolio in light of national and local economic conditions, changes in the composition and volume of the loan portfolio, changes in the volume of past due and nonaccrual loans, value of underlying collateral and other relevant factors. The allowance for loan losses which is reported as a deduction from loans is available for loan charge-offs. This allowance is increased by the provision charged to expense and is reduced by loan charge-offs net of loan recoveries. Management formally reviews all loans in excess of certain dollar amounts (periodically established) at least annually. In addition, on a monthly basis, management reviews past due, “classified”, and “watch list” loans in order to classify or reclassify loans as “loans requiring attention,” “substandard,” “doubtful,” or “loss”. During that review, management also determines which loans should be considered to be “impaired”. Management follows the guidance provided in Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, (SFAS 114) 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. Once a loan has been identified as impaired management generally measures impairment based upon the fair value of the underlying collateral. Management believes, but there can be no assurance, that these procedures keep management informed of possible 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 for probable losses inherent in the loan portfolio.

     The allowance for loan losses was decreased by net loan charge-offs of $77,000 for the first quarter of 2007 compared to $17,000 for the first quarter of 2006. The allowance for loan losses was increased by a provision charged to expense of $225,000 for the first quarter of 2007. That compares to a provision of $318,000 for the first quarter of 2006.

     The balance of the allowance for loan losses was $9,164,000 at March 31, 2007 compared to $9,015,000 at December 31, 2006 and $9,385,000 at March 31, 2006. The allowance for loan losses as a percent of outstanding loans was 1.13% at March 31, 2007 compared to 1.11% at December 31, 2006 and 1.14% at March 31, 2006. Based upon an analysis of the probable losses in the loan portfolio management believes the current balance of the allowance for loan losses is at an acceptable level.

     Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and restructured loans totaled $5,203,000 or 0.64% of total loans at March 31, 2007 compared to $5,066,000 or 0.62% of total loans at December 31, 2006. Detail of those balances plus other real estate and repossessions is as follows: