UNITED STATES


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended June 30, 2017March 31, 2018

or

OR

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

For the transition period from ______________ to ____________________________to______________

 

Commission File Number:file number: 0-23636

 

HAWTHORN BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

Missouri 43-1626350

(State or other jurisdiction of

(I.R.S. Employer Identification No.)
incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

132 East High Street, Box 688, Jefferson City, Missouri65102
(Address of principal executive offices)(Zip Code)

(573) 761-6100

(Registrant’sRegistrant'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.xYes¨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).xYes¨No

 

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

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨YesxNo

 

As of AugustMay 4, 2017,2018, the registrant had 5,831,2105,789,341 shares of common stock, par value $1.00 per share, outstanding

 

 

 

 

 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets(unaudited)
(In thousands, except per share data)

Part I - Financial Information

Item 1. Financial Statements

 

  June 30,  December 31, 
  2017  2016 
ASSETS        
Cash and due from banks $20,776  $25,589 
Federal funds sold and other overnight interest-bearing deposits  40,552   1,406 
Cash and cash equivalents  61,328   26,995 
Investment in available-for-sale securities, at fair value  216,353   214,512 
Other investments and securities, at cost  10,798   9,796 
Total investment securities  227,151   224,308 
Loans  1,035,020   974,029 
Allowances for loan losses  (10,545)  (9,886)
Net loans  1,024,475   964,143 
Premises and equipment - net  35,403   35,522 
Mortgage servicing rights  2,766   2,584 
Other real estate and repossessed assets - net  13,356   14,162 
Accrued interest receivable  4,754   5,183 
Cash surrender value - life insurance  2,448   2,409 
Other assets  11,869   11,742 
Total assets $1,383,550  $1,287,048 
LIABILITIES AND STOCKHOLDERS' EQUITY        
Deposits        
Non-interest bearing demand $279,634  $235,975 
Savings, interest checking and money market  517,678   468,731 
Time deposits $250,000 and over  56,534   73,523 
Other time deposits  228,841   232,437 
Total deposits  1,082,687   1,010,666 
Federal funds purchased and securities sold under agreements to repurchase  29,118   31,015 
Subordinated notes  49,486   93,392 
Federal Home Loan Bank advances  115,363   49,486 
Accrued interest payable  429   498 
Other liabilities  11,320   10,974 
Total liabilities  1,288,403   1,196,031 
Stockholders’ equity:        
Common stock, $1 par value, authorized 15,000,000 shares; issued 5,822,357 shares, respectively  5,822   5,822 
Surplus  45,665   41,498 
Retained earnings  50,796   51,671 
Accumulated other comprehensive loss, net of tax  (2,874)  (3,801)
Treasury stock; 210,465 and 205,750 shares, at cost  (4,262)  (4,173)
Total stockholders’ equity  95,147   91,017 
Total liabilities and stockholders’ equity $1,383,550  $1,287,048 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets(unaudited)

(In thousands, except per share data)

  March 31,  December 31, 
  2018  2017 
ASSETS        
Cash and due from banks $15,955  $23,325 
Federal funds sold and other interest-bearing deposits  65,449   39,553 
Cash and cash equivalents  81,404   62,878 
Certificates of deposit in other banks  4,812   3,460 
Investment in available-for-sale securities, at fair value  215,720   226,542 
Other investments and securities, at cost  9,725   11,037 
Total investment securities  225,445   237,579 
Loans  1,084,326   1,068,432 
Allowances for loan losses  (10,947)  (10,852)
Net loans  1,073,379   1,057,580 
Premises and equipment - net  34,777   34,811 
Mortgage servicing rights  2,781   2,713 
Other real estate owned and repossessed assets - net  13,239   13,182 
Accrued interest receivable  5,330   5,627 
Cash surrender value - life insurance  2,499   2,484 
Other assets  9,242   8,902 
Total assets $1,452,908  $1,429,216 
LIABILITIES AND STOCKHOLDERS' EQUITY        
Deposits        
Non-interest bearing demand $244,834  $245,380 
Savings, interest checking and money market  616,894   584,468 
Time deposits $250,000 and over  84,740   63,176 
Other time deposits  233,912   232,788 
Total deposits  1,180,380   1,125,812 
Federal funds purchased and securities sold        
under agreements to repurchase  34,795   27,560 
Federal Home Loan Bank advances and other borrowings  84,327   121,382 
Subordinated notes  49,486   49,486 
Accrued interest payable  588   554 
Other liabilities  12,061   13,051 
Total liabilities  1,361,637   1,337,845 
Stockholders’ equity:        
Common stock, $1 par value, authorized 15,000,000 shares;        
issued 6,046,907 shares, respectively  6,047   6,047 
Surplus  45,442   45,442 
Retained earnings  52,280   50,595 
Accumulated other comprehensive loss, net of tax  (7,335)  (5,662)
Treasury stock; 254,366 and 248,898 shares, at cost, respectively  (5,163)  (5,051)
Total stockholders’ equity  91,271   91,371 
Total liabilities and stockholders’ equity $1,452,908  $1,429,216 

 

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


2

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income(unaudited)

       
  Three Months Ended  Six Months Ended 
  June 30,  June 30, 
(In thousands, except per share amounts) 2017  2016  2017  2016 
INTEREST INCOME                
Interest and fees on loans $11,671  $10,308  $22,721  $20,295 
Interest on investment securities:                
Taxable  737   831   1,491   1,769 
Nontaxable  168   119   325   262 
Federal funds sold and                
other overnight interest-bearing deposits  11   17   60   50 
Dividends on other securities  94   75   184   151 
Total interest income  12,681   11,350   24,781   22,527 
INTEREST EXPENSE                
Interest on deposits:                
Savings, interest checking and money market  475   287   864   582 
Time deposit accounts $250,000 and over  99   85   191   153 
Other time deposits  410   383   789   764 
Interest on federal funds purchased and securities sold under agreements to repurchase  27   15   49   39 
Interest on subordinated notes  431   366   840   720 
Interest on Federal Home Loan Bank advances  419   243   741   450 
Total interest expense  1,861   1,379   3,474   2,708 
Net interest income  10,820   9,971   21,307   19,819 
Provision for loan losses  330   425   680   675 
Net interest income after provision for loan losses  10,490   9,546   20,627   19,144 
NON-INTEREST INCOME                
Service charges and other fees  851   828   1,687   1,662 
Bank card income and fees  663   648   1,277   1,282 
Trust department income  266   265   540   483 
Real estate servicing fees, net  34   (86)  487   (32)
Gain on sale of mortgage loans, net  218   222   374   387 
Gain on sale of investment securities  0   18   0  ��490 
Other  67   54   141   125 
Total non-interest income  2,099   1,949   4,506   4,397 
NON-INTEREST EXPENSE                
Salaries and employee benefits  5,352   5,305   10,806   10,655 
Occupancy expense, net  689   673   1,307   1,306 
Furniture and equipment expense  634   439   1,232   850 
Processing, network, and bank card expense  927   840   1,972   1,611 
Legal, examination, and professional fees  317   328   597   662 
FDIC insurance assessment  115   188   216   364 
Advertising and promotion  265   242   503   452 
Postage, printing, and supplies  263   291   495   527 
Real estate foreclosure expense, net  226   42   253   183 
Other  899   1,005   1,656   1,826 
Total non-interest expense  9,687   9,353   19,037   18,436 
Income before income taxes  2,902   2,142   6,096   5,105 
Income tax expense  983   730   2,076   1,695 
Net income  1,919   1,412   4,020   3,410 
Basic earnings per share $0.33  $0.24  $0.69  $0.58 
Diluted earnings per share $0.33  $0.24  $0.69  $0.58 

  Three Months Ended 
  March 31, 
(In thousands, except per share amounts) 2018  2017 
INTEREST INCOME        
Interest and fees on loans $12,223  $11,050 
Interest on investment securities:        
Taxable  947   754 
Nontaxable  158   157 
Federal funds sold, other interest-bearing deposits, and certificates of deposit in other banks  106   48 
Dividends on other securities  110   90 
Total interest income  13,544   12,099 
INTEREST EXPENSE        
Interest on deposits:        
Savings, interest checking and money market  1,084   389 
Time deposits  649   471 
Interest on federal funds purchased and securities sold under agreements to repurchase  171   22 
Interest on Federal Home Loan Bank advances  395   322 
Interest on subordinated notes  491   408 
Total interest expense  2,790   1,612 
Net interest income  10,754   10,487 
Provision for loan losses  300   350 
Net interest income after provision for loan losses  10,454   10,137 
NON-INTEREST INCOME        
Service charges and other fees  876   836 
Bank card income and fees  656   614 
Trust department income  280   274 
Real estate servicing fees, net  221   453 
Gain on sale of mortgage loans, net  146   155 
Other  122   75 
Total non-interest income  2,301   2,407 
NON-INTEREST EXPENSE        
Salaries and employee benefits  6,057   5,438 
Occupancy expense, net  689   619 
Furniture and equipment expense  635   598 
Processing, network, and bank card expense  859   1,045 
Legal, examination, and professional fees  422   280 
FDIC insurance assessment  154   101 
Advertising and promotion  252   239 
Postage, printing, and supplies  268   223 
Other  918   808 
Total non-interest expense  10,254   9,351 
Income before income taxes  2,501   3,193 
Income tax expense  411   1,093 
Net income  2,090   2,100 
Basic earnings per share $0.36  $0.36 
Diluted earnings per share $0.36  $0.36 

 

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


HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income(unaudited)3

 

  Three Months Ended  Six Months Ended 
  June 30,  June 30, 
(In thousands) 2017  2016  2017  2016 
Net income $1,919  $1,412  $4,020  $3,410 
Other comprehensive income, net of tax                
Investment securities available-for-sale:                
Unrealized gain on investment securities available-for-sale, net of tax  595   837   900   2,082 
Adjustment for gain on sale of investment securities, net of tax  0   (11)  0   (304)
Defined benefit pension plans:                
Amortization of prior service cost included in net periodic pension cost, net of tax  13   12   27   24 
Total other comprehensive income  608   838   927   1,802 
Total comprehensive income $2,527  $2,250  $4,947  $5,212 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income(unaudited)

  Three Months Ended 
  March 31, 
(In thousands) 2018  2017 
Net income $2,090  $2,100 
Other comprehensive income, net of tax        
Investment securities available-for-sale:        
Unrealized (loss) gain on investment securities available-for-sale, net of tax  (1,715)  306 
Adjustment for gain on sale of investment securities, net of tax  0   0 
Defined benefit pension plans:        
Amortization of prior service cost included in net periodic pension cost, net of tax  42   14 
Total other comprehensive (loss) income  (1,673)  320 
Total comprehensive income $417  $2,420 

 

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


HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity(unaudited)4

 

           Accumulated     Total 
           Other     Stock - 
  Common     Retained  Comprehensive  Treasury  holders' 
(In thousands) Stock  Surplus  Earnings  Loss  Stock  Equity 
Balance, December 31, 2015 $5,605  $38,549  $48,700  $(2,018) $(3,550) $87,286 
Net income  0   0   3,410   0   0   3,410 
Other comprehensive income  0   0   0   1,802   0   1,802 
Stock based compensation expense  0   11   0   0   0   11 
Purchase of treasury stock  0   0   0   0   (226)  (226)
Stock dividend  0   3,149   (3,149)  0   0   0 
Cash dividends declared, common stock  0   0   (542)  0   0   (542)
Balance, June 30, 2016 $5,605  $41,709  $48,419  $(216) $(3,776) $91,741 
                         
Balance, December 31, 2016 $5,822  $41,498  $51,671  $(3,801) $(4,173) $91,017 
Net income  0   0   4,020   0   0   4,020 
Other comprehensive income  0   0   0   927   0   927 
Stock based compensation expense  0   2   0   0   0   2 
Purchase of treasury stock  0   0   0   0   (89)  (89)
Stock dividend  0   4,165   (4,165)  0   0   0 
Cash dividends declared, common stock  0   0   (730)  0   0   (730)
Balance, June 30, 2017 $5,822  $45,665  $50,796  $(2,874) $(4,262) $95,147 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity(unaudited)

           Accumulated     Total 
           Other     Stock - 
  Common     Retained  Comprehensive  Treasury  holders' 
(In thousands) Stock  Surplus  Earnings  Loss  Stock  Equity 
Balance, December 31, 2016 $5,822  $41,498  $51,671  $(3,801) $(4,173) $91,017 
Net income  0   0   2,100   0   0   2,100 
Other comprehensive income  0   0   0   320   0   320 
Stock based compensation expense  0   1   0   0   0   1 
Purchase of treasury stock  0   0   0   0   (25)  (25)
Cash dividends declared, common stock  0   0   (336)  0   0   (336)
Balance, March 31, 2017 $5,822  $41,499  $53,435  $(3,481) $(4,198) $93,077 
                         
Balance, December 31, 2017 $6,047  $45,442  $50,595  $(5,662) $(5,051) $91,371 
Net income  0   0   2,090   0   0   2,090 
Other comprehensive loss  0   0   0   (1,673)  0   (1,673)
Purchase of treasury stock  0   0   0   0   (112)  (112)
Cash dividends declared, common stock  0   0   (405)  0   0   (405)
Balance, March 31, 2018 $6,047  $45,442  $52,280  $(7,335) $(5,163) $91,271 

 

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


HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows(unaudited)5

 

  Six Months Ended June 30, 
(In thousands) 2017  2016 
Cash flows from operating activities:        
Net income $4,020  $3,410 
Adjustments to reconcile net income to net cash provided by operating activities:        
Provision for loan losses  680   675 
Depreciation expense  874   962 
Net amortization of investment securities, premiums, and discounts  828   883 
Stock based compensation expense  2   11 
Change in fair value of mortgage servicing rights  (67)  453 
Gain on sale of investment securities  0   (490)
Loss (gain) on sales and dispositions of premises and equipment  1   (6)
Gain on sales and dispositions of other real estate and repossessed assets  (38)  (103)
Provision for other real estate owned  215   76 
Decrease in accrued interest receivable  429   227 
Increase in cash surrender value - life insurance  (39)  (31)
Increase in other assets  (613)  (715)
Decrease in accrued interest payable  (69)  (10)
Increase (decrease) in other liabilities  290   (546)
Origination of mortgage loans for sale  (17,101)  (17,017)
Proceeds from the sale of mortgage loans  16,861   17,520 
Gain on sale of mortgage loans, net  (374)  (387)
Other, net  (47)  (79)
Net cash provided by operating activities  5,852   4,833 
Cash flows from investing activities:        
Net increase in loans  (60,553)  (59,499)
Purchase of available-for-sale debt securities  (21,874)  (76,417)
Proceeds from maturities of available-for-sale debt securities  16,132   24,457 
Proceeds from calls of available-for-sale debt securities  4,525   10,035 
Proceeds from sales of available-for-sale debt securities  0   44,300 
Proceeds from sales of FHLB stock  201   0 
Purchases of FHLB stock  (1,203)  (1,003)
Purchases of premises and equipment  (863)  (592)
Proceeds from sales of premises and equipment  0   6 
Proceeds from sales of other real estate and foreclosed assets  784   2,399 
Net cash used in investing activities  (62,851)  (56,314)
Cash flows from financing activities:        
Net increase in demand deposits  43,659   9,742 
Net increase in interest-bearing transaction accounts  48,947   36,717 
Net (decrease) increase in time deposits  (20,585)  11,585 
Net decrease in federal funds purchased and securities sold under agreements to repurchase  (2,389)  (21,140)
Repayment of FHLB advances and other borrowings  (130,277)  (8,000)
FHLB advances  152,740   32,000 
Purchase of treasury stock  (89)  (226)
Cash dividends paid - common stock  (674)  (542)
Net cash provided by financing activities  91,332   60,136 
Net increase in cash and cash equivalents  34,333   8,655 
Cash and cash equivalents, beginning of period  26,995   28,377 
Cash and cash equivalents, end of period $61,328  $37,032 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows(unaudited)

  Three Months Ended March 31, 
(In thousands) 2018  2017 
Cash flows from operating activities:        
Net income $2,090  $2,100 
Adjustments to reconcile net income to net cash provided by operating activities:        
Provision for loan losses  300   350 
Depreciation expense  435   473 
Net amortization of investment securities, premiums, and discounts  356   406 
Stock based compensation expense  0   1 
Change in fair value of mortgage servicing rights  (18)  (244)
Gain on sale of investment securities  (98)  0 
(Gain) loss on sales and dispositions of premises and equipment  (13)  1 
Gain on sales and dispositions of other real estate and repossessed assets  (2)  (50)
Provision for other real estate owned  1   32 
Decrease in accrued interest receivable  297   481 
Increase in cash surrender value - life insurance  (15)  (21)
Decrease in other assets  156   58 
Increase (decrease) in accrued interest payable  34   (46)
Decrease in other liabilities  (989)  (742)
Origination of mortgage loans for sale  (7,587)  (7,341)
Proceeds from the sale of mortgage loans  7,587   6,789 
Gain on sale of mortgage loans, net  (146)  (155)
Other, net  (50)  (49)
Net cash provided by operating activities  2,338   2,043 
Cash flows from investing activities:        
Net (increase) decrease in certificates of deposit in other banks  (1,352)  1,000 
Net increase in loans  (16,231)  (35,523)
Purchase of available-for-sale debt securities  (28,134)  (15,346)
Proceeds from maturities of available-for-sale debt securities  9,119   9,750 
Proceeds from calls of available-for-sale debt securities  1,685   4,025 
Proceeds from sales of available-for-sale debt securities  25,723   0 
Purchases of FHLB stock  (1,370)  (263)
Proceeds from sales of FHLB stock  2,682   200 
Purchases of premises and equipment  (401)  (348)
Proceeds from sales of premises and equipment  13   0 
Proceeds from sales of other real estate and foreclosed assets  224   658 
Net cash used in investing activities  (8,042)  (35,847)
Cash flows from financing activities:        
Net (decrease) increase in demand deposits  (546)  3,084 
Net increase in interest-bearing transaction accounts  32,426   50,648 
Net increase (decrease) in time deposits  22,688   (21,394)
Net increase in federal funds purchased and securities sold under agreements to repurchase  7,235   497 
Repayment of FHLB advances and other borrowings  (131,055)  (38,232)
FHLB advances  94,000   36,740 
Purchase of treasury stock  (112)  (25)
Cash dividends paid - common stock  (406)  (336)
Net cash provided by financing activities  24,230   30,982 
Net increase (decrease) in cash and cash equivalents  18,526   (2,822)
Cash and cash equivalents, beginning of period  62,878   25,995 
Cash and cash equivalents, end of period $81,404  $23,173 

 

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


HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)(unaudited)6

 

  Six Months Ended  June 30, 
(In thousands) 2017  2016 
Supplemental disclosures of cash flow information:      
Cash paid during the year for:        
Interest $3,542  $2,718 
Income taxes $2,185  $1,975 
Noncash investing activities:        
Other real estate and repossessed assets acquired in settlement of loans $155  $1,634 

HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (continued)(unaudited)

  Three Months Ended March 31, 
(In thousands) 2018  2017 
Supplemental disclosures of cash flow information:        
Cash paid during the year for:        
Interest $2,755  $1,658 
Income taxes $0  $755 
Noncash investing activities:        
Other real estate and repossessed assets acquired in settlement of loans $278  $103 

 

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


7

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

(1)Summary of Significant Accounting Policies

 

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

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.2017.

 

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

Stock DividendOn July 1, 2017, the Company paid a special stock dividend of four percent to shareholders of record at the close of business on June 15, 2017. 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 2017:2018:

 

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

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

Financial InstrumentsThe FASB issued ASU 2016-09,2016-01,Improvements to Employee Share-Based Payment AccountingRecognition and Measurement of Financial Assets and Financial Liabilities, in March 2016, in orderJanuary 2016. The amendments require all equity investments to reduce complexity in this area and improve the usefulness of information provided to users. Amendments which will affect public companies include the recognition of excess tax benefits and deficiencies in income tax expense or benefitbe measured at fair value with changes in the fair value recognized through net income, statement, guidance as toother than those accounted for under the classificationequity method of excess tax benefits on the statement of cash flows, an election to account for award forfeitures as they occur, and the ability to withhold taxes up to the maximum statutory rateaccounting or those that result in the applicable jurisdictions without triggering liability classificationconsolidation of the award.investee. Additionally, these amendments require presentation in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk for those liabilities measured at fair value. The Company adoptedamendments also require use of the ASU onexit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2017 and elected to recognize forfeitures as they occur. As allowed by the ASU, the Company’s adoption was prospective, therefore prior periods have not been adjusted.2018. The adoption of the ASU could result in increased volatility to reported income tax expense related to excess tax benefits and tax deficiencies for employee share-based transactions, however, the actual amounts recognized in income tax expense will be dependent on the amount of employee share-based transactions and the stock price at the time of vesting or exercise. The adoption of the ASUASU's did not have a significant effect on the Company’sCompany's consolidated financial statements.


8

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

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

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

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

 

(2)Loans and Allowance for Loan Losses

 

Loans

 

A summary of loans, by major class within the Company’s loan portfolio, at June 30, 2017March 31, 2018 and December 31, 20162017 is as follows:

 

 June 30, December 31,  March 31, December 31, 
(in thousands) 2017  2016  2018  2017 
     
Commercial, financial, and agricultural $187,251  $182,881  $190,720  $192,238 
Real estate construction - residential  20,037   18,907   29,351   26,492 
Real estate construction - commercial  78,257   55,653   105,345   98,340 
Real estate mortgage - residential  255,426   259,900   250,131   246,754 
Real estate mortgage - commercial  461,062   426,470   476,511   472,455 
Installment and other consumer  32,987   30,218   32,268   32,153 
Total loans $1,035,020  $974,029  $1,084,326  $1,068,432 

 

The Bank grants real estate, commercial, installment, and other consumer loans to customers located within the Missouri communities surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson and the greater Kansas City metropolitan area. As such, the Bank is susceptible to changes in the economic environment in these communities. The Bank does not have a concentration of credit in any one economic sector. Installment and other consumer loans consist primarily of the financing of automotive vehicles. At June 30, 2017, $496.0March 31, 2018, loans of $479.4 million of loans were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit.

 

Allowance for Loan Losses

9

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

 

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

 

  Three Months Ended June 30, 2017 
  Commercial,  Real Estate  Real Estate  Real Estate  Real Estate  Installment       
  Financial, &  Construction -  Construction -  Mortgage -  Mortgage -  and Other  Un-    
(in thousands) Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total 
Balance at beginning of period $2,360  $99  $579  $2,125  $4,731  $322  $46  $10,262 
Additions:                                
Provision for loan losses  226   (54)  36   (230)  139   89   124   330 
Deductions:                                
Loans charged off  32   0   0   62   2   60   0   156 
Less recoveries on loans  (24)  (25)  0   (21)  (14)  (25)  0   (109)
Net loan charge-offs (recoveries)  8   (25)  0   41   (12)  35   0   47 
Balance at end of period $2,578  $70  $615  $1,854  $4,882  $376  $170  $10,545 
                                 
  Six Months Ended June 30, 2017 
  Commercial,  Real Estate  Real Estate  Real Estate  Real Estate  Installment       
  Financial, &  Construction -  Construction -  Mortgage -  Mortgage -  and Other  Un-    
(in thousands) Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total 
Balance at beginning of period $2,753  $108  $413  $2,385  $3,793   274  $160  $9,886 
Additions:                                
Provision for loan losses  (157)  (113)  202   (507)  1,084   161   10   680 
Deductions:                                
Loans charged off  60   0   0   81   16   111   0   268 
Less recoveries on loans  (42)  (75)  0   (57)  (21)  (52)  0   (247)
Net loan charge-offs (recoveries)  18   (75)  0   24   (5)  59   0   21 
Balance at end of period $2,578  $70  $615  $1,854  $4,882  $376  $170  $10,545 

Hawthorn Bancshares, Inc.
and subsidiaries

  Three Months Ended March 31, 2018 
  Commercial,  Real Estate  Real Estate  Real Estate  Real Estate  Installment       
  Financial, &  Construction -  Construction -  Mortgage -  Mortgage -  and Other  Un-    
(in thousands) Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total 
Balance at beginning of period $3,325  $170  $807  $1,689  $4,437   345  $79  $10,852 
Additions:                                
Provision for loan losses  33   106   118   369   (421)  40   55   300 
Deductions:                                
Loans charged off  110   48   30   20   14   57   0   279 
Less recoveries on loans  (13)  (12)  0   (19)  (6)  (24)  0   (74)
Net loan charge-offs (recoveries)  97   36   30   1   8   33   0   205 
Balance at end of period $3,261  $240  $895  $2,057  $4,008  $352  $134  $10,947 

 

Notes to the Consolidated Financial Statements

(Unaudited)

 Three Months Ended June 30, 2016  Three Months Ended March 31, 2017 
 Commercial, Real Estate Real Estate Real Estate Real Estate Installment       Commercial, Real Estate Real Estate Real Estate Real Estate Installment      
 Financial, & Construction - Construction - Mortgage - Mortgage - and Other Un-     Financial, & Construction - Construction - Mortgage - Mortgage - and Other Un-    
(in thousands) Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total  Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total 
Balance at beginning of period $2,135  $44  $687  $2,273  $3,190  $259  $43  $8,631  $2,753  $108  $413  $2,385  $3,793   274  $160  $9,886 
Additions:                                                                
Provision for loan losses  817   19   (929)  186   218   61   53   425   (384)  (59)  166   (276)  945   72   (114)  350 
Deductions:                                                                
Loans charged off  36   0   0   175   28   67   0   306   28   0   0   20   14   51   0   113 
Less recoveries on loans  (80)  0   (491)  (9)  (31)  (31)  0   (642)  (19)  (50)  0   (36)  (7)  (27)  0   (139)
Net loan charge-offs (recoveries)  (44)  0   (491)  166   (3)  36   0   (336)  9   (50)  0   (16)  7   24   0   (26)
Balance at end of period $2,996  $63  $249  $2,293  $3,411  $284  $96  $9,392  $2,360  $99  $579  $2,125  $4,731  $322  $46  $10,262 
                                
 Six Months Ended June 30, 2016 
 Commercial, Real Estate Real Estate Real Estate Real Estate Installment      
 Financial, & Construction - Construction - Mortgage - Mortgage - and Other Un-    
(in thousands) Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total 
Balance at beginning of period $2,153  $59  $644  $2,439  $2,935  $273  $101  $8,604 
Additions:                                
Provision for loan losses  804   4   (896)  218   495   55   (5)  675 
Deductions:                                
Loans charged off  138   0   1   381   111   123   0   754 
Less recoveries on loans  (177)  0   (502)  (17)  (92)  (79)  0   (867)
Net loan charge-offs (recoveries)  (39)  0   (501)  364   19   44   0   (113)
Balance at end of period $2,996  $63  $249  $2,293  $3,411  $284  $96  $9,392 

 

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.

 

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

10

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 June 30, 2017March 31, 2018 and December 31, 2016,2017, and the related loan balance by impairment methodology.


Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 Commercial, Real Estate Real Estate Real Estate Real Estate Installment       Commercial, Real Estate Real Estate Real Estate Real Estate Installment      
 Financial, and Construction - Construction - Mortgage - Mortgage - and Other Un-     Financial, and Construction - Construction - Mortgage - Mortgage - and Other Un-    
(in thousands) Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total  Agricultural  Residential  Commercial  Residential  Commercial  Consumer  allocated  Total 
June 30, 2017                                
March 31, 2018                 
Allowance for loan losses:                                                 
Individually evaluated for impairment $393  $0  $7  $450  $264  $11  $0  $1,125  $495  $9  $0  $580  $233  $19  $0  $1,336 
Collectively evaluated for impairment  2,185   70   608   1,404   4,618   365   170   9,420   2,766   231   895   1,477   3,775   333   134   9,611 
Total $2,578  $70  $615  $1,854  $4,882  $376  $170  $10,545  $3,261  $240  $895  $2,057  $4,008  $352  $134  $10,947 
Loans outstanding:                                                                
Individually evaluated for impairment $1,787  $0  $48  $5,787  $2,046  $52  $0  $9,720  $2,738  $59  $0  $5,158  $1,978  $160  $0  $10,093 
Collectively evaluated for impairment  185,464   20,037   78,209   249,639   459,016   32,935   0   1,025,300   187,982   29,292   105,345   244,973   474,533   32,108   0   1,074,233 
Total $187,251  $20,037  $78,257  $255,426  $461,062  $32,987  $0  $1,035,020  $190,720  $29,351  $105,345  $250,131  $476,511  $32,268  $0  $1,084,326 
                                                                
December 31, 2016                                
December 31, 2017                                
Allowance for loan losses:                                                                
Individually evaluated for impairment $469  $0  $7  $319  $277  $8  $0  $1,080  $500  $0  $48  $521  $243  $21  $0  $1,333 
Collectively evaluated for impairment  2,284   108   406   2,066   3,516   266   160   8,806   2,825   170   759   1,168   4,194   324   79   9,519 
Total $2,753  $108  $413  $2,385  $3,793  $274  $160  $9,886  $3,325  $170  $807  $1,689  $4,437  $345  $79  $10,852 
Loans outstanding:                                                                
Individually evaluated for impairment $1,617  $0  $49  $5,471  $1,918  $89  $0  $9,144  $3,007  $0  $97  $5,072  $2,004  $176  $0  $10,356 
Collectively evaluated for impairment  181,264   18,907   55,604   254,429   424,552   30,129   0   964,885   189,231   26,492   98,243   241,682   470,451   31,977   0   1,058,076 
Total $182,881  $18,907  $55,653  $259,900  $426,470  $30,218  $0  $974,029  $192,238  $26,492  $98,340  $246,754  $472,455  $32,153  $0  $1,068,432 

 

Impaired Loans

 

Loans evaluated under ASC 310-10-35 include loans which are individually evaluated for impairment. All other loans are collectively evaluated for impairment under ASC 450-20. Impaired loans individually evaluated for impairment totaled $9.7$10.1 million and $9.1$10.4 million at June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively, and are comprised of loans on non-accrual status and loans which have been classified as troubled debt restructurings (TDRs).

 

The net carrying value of impaired loans is based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. At June 30, 2017March 31, 2018 and December 31, 2016, $5.72017, $3.8 million and $4.5$4.0 million, respectively, of impaired loans were evaluated based on the fair value less estimated selling costs of the loan’s collateral. Once the impairment amount is calculated, a specific reserve allocation is recorded. At June 30, 2017, $1.1March 31, 2018, $1.3 million of the Company’s allowance for loan losses was allocated to impaired loans totaling $9.7$10.1 million compared to $1.1$1.3 million of the Company's allowance for loan losses allocated to impaired loans totaling approximately $9.1$10.4 million at December 31, 2016.2017. Management determined that $1.7$2.0 million, or 18%20%, of total impaired loans required no reserve allocation at June 30, 2017March 31, 2018 compared to $2.1$2.4 million, or 23%, at December 31, 20162017 primarily due to adequate collateral values,acceptable payment history and adequate cash flow ability.

 

The categories of impaired loans at June 30, 2017March 31, 2018 and December 31, 20162017 are as follows:

 

 June 30, December 31,  March 31, December 31, 
(in thousands) 2017  2016  2018  2017 
Non-accrual loans $4,434  $3,429  $5,482  $5,672 
Performing TDRs  5,286   5,715   4,611   4,684 
Total impaired loans $9,720  $9,144  $10,093  $10,356 


11

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

The following tables provide additional information about impaired loans at June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.

     Unpaid    
  Recorded  Principal  Specific 
(in thousands) Investment  Balance  Reserves 
March 31, 2018         
With no related allowance recorded:            
Commercial, financial and agricultural $1,091  $1,151  $0 
Real estate - residential  908   955   0 
Total $1,999  $2,106  $0 
With an allowance recorded:            
Commercial, financial and agricultural $1,647  $1,960  $495 
Real estate - construction residential  59   59   9 
Real estate - residential  4,250   4,344   580 
Real estate - commercial  1,978   2,123   233 
Installment and other consumer  160   179   19 
Total $8,094  $8,665  $1,336 
Total impaired loans $10,093  $10,771  $1,336 

 

     Unpaid    
  Recorded  Principal  Specific 
(in thousands) Investment  Balance  Reserves 
June 30, 2017            
With no related allowance recorded:            
Commercial, financial and agricultural $587  $751  $0 
Real estate - residential  795   813   0 
Real estate - commercial  366   395   0 
Total $1,748  $1,959  $0 
With an allowance recorded:            
Commercial, financial and agricultural $1,200  $1,234  $393 
Real estate - construction commercial  48   55   7 
Real estate - residential  4,992   5,062   450 
Real estate - commercial  1,680   1,767   264 
Installment and other consumer  52   69   11 
Total $7,972  $8,187  $1,125 
Total impaired loans $9,720  $10,146  $1,125 

    Unpaid        Unpaid    
 Recorded Principal Specific  Recorded Principal Specific 
(in thousands) Investment  Balance  Reserves  Investment  Balance  Reserves 
December 31, 2016            
December 31, 2017       
With no related allowance recorded:                        
Commercial, financial and agricultural $564  $706  $0  $1,393  $1,445  $0 
Real estate - residential  1,550   1,557   0   674   688   0 
Real estate - commercial  366   395   0 
Total $2,114  $2,263  $0  $2,433  $2,528  $0 
With an allowance recorded:                        
Commercial, financial and agricultural $1,053  $1,078  $469  $1,614  $1,834  $500 
Real estate - construction commercial  49   56   7   97   97   48 
Real estate - residential  3,921   3,990   319   4,398   4,500   521 
Real estate - commercial  1,918   1,988   277   1,638   1,743   243 
Installment and other consumer  89   116   8 
Consumer  176   196   21 
Total $7,030  $7,228  $1,080  $7,923  $8,370  $1,333 
Total impaired loans $9,144  $9,491  $1,080  $10,356  $10,898  $1,333 

 

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


12

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

 Three Months Ended June 30,  Six Months Ended June 30,  Three Months Ended March 31, 
 2017  2016  2017  2016  2018  2017 
    Interest     Interest     Interest     Interest     Interest     Interest 
 Average Recognized Average Recognized Average Recognized Average Recognized  Average Recognized Average Recognized 
 Recorded For the Recorded For the 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  Investment  Period Ended  Investment  Period Ended 
With no related allowance recorded:                                                
Commercial, financial and agricultural $464  $(1) $385  $19  $519  $0  $1,014  $29  $906  $0  $555  $1 
Real estate - construction commercial  0   0   0   0 
Real estate - residential  852   3   1,593   100   912   7   1,738   197   919   3   807   4 
Real estate - commercial  395   (2)  2,109   63   500   0   2,280   120   0   0   589   2 
Installment and other consumer  2   0   0   0   31   0   0   0   0   0   40   0 
Total $1,713  $0  $4,087  $182  $1,962  $7  $5,032  $346  $1,825  $3  $1,991  $7 
With an allowance recorded:                                                
Commercial, financial and agricultural $1,214  $8  $866  $108  $1,199  $19  $860  $135  $1,857  $8  $1,192  $11 
Real estate - construction residential  15   0   0   0 
Real estate - construction commercial  48   0   52   0   49   0   64   2   0   0   50   0 
Real estate - residential  4,790   42   3,442   62   4,595   87   3,977   141   4,379   32   4,511   43 
Real estate - commercial  1,604   14   260   13   1,505   29   560   20   2,012   15   1,494   15 
Installment and other consumer  51   0   114   5   48   0   129   9   139   0   51   0 
Total $7,707  $64  $4,734  $188  $7,396  $135  $5,590  $307  $8,402  $55  $7,298  $69 
Total impaired loans $9,420  $64  $8,821  $370  $9,358  $142  $10,622  $653  $10,227  $58  $9,289  $76 

 

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 $64,000$58,000 and $142,000,$76,000, for the three months ended March 31, 2018 and six months ended June 30, 2017, respectively, compared to $370,000 and $653,000 for the three and six months ended June 30, 2016, respectively. The average recorded investment in impaired loans is calculated on a monthly basis during the periods reported.

 

Delinquent and Non-Accrual Loans

 

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

 

The following table provides aging information for the Company’s past due and non-accrual loans at June 30, 2017March 31, 2018 and December 31, 2016.2017.


13

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 Current or     90 Days       Current or     90 Days      
 Less Than     Past Due       Less Than     Past Due      
 30 Days 30 - 89 Days And Still       30 Days 30 - 89 Days And Still      
(in thousands) Past Due  Past Due  Accruing  Non-Accrual  Total  Past Due  Past Due  Accruing  Non-Accrual  Total 
June 30, 2017                    
March 31, 2018                    
Commercial, Financial, and Agricultural $185,050  $1,078  $0  $1,123  $187,251  $188,436  $26  $0  $2,258  $190,720 
Real Estate Construction - Residential  20,037   0   0   0   20,037   29,292   0   0   59   29,351 
Real Estate Construction - Commercial  78,209   0   0   48   78,257   105,176   169   0   0   105,345 
Real Estate Mortgage - Residential  252,322   600   252   2,252   255,426   246,562   1,480   0   2,089   250,131 
Real Estate Mortgage - Commercial  460,103   0   0   959   461,062   475,349   246   0   916   476,511 
Installment and Other Consumer  32,767   131   37   52   32,987   31,730   340   38   160   32,268 
Total $1,028,488  $1,809  $289  $4,434  $1,035,020  $1,076,545  $2,261  $38  $5,482  $1,084,326 
December 31, 2016                    
December 31, 2017                    
Commercial, Financial, and Agricultural $181,609  $290  $0  $982  $182,881  $189,537  $192  $2  $2,507  $192,238 
Real Estate Construction - Residential  18,681   226   0   0   18,907   25,930   287   275   0   26,492 
Real Estate Construction - Commercial  55,603   0   0   50   55,653   98,243   0   0   97   98,340 
Real Estate Mortgage - Residential  254,758   3,200   54   1,888   259,900   242,597   2,173   28   1,956   246,754 
Real Estate Mortgage - Commercial  425,260   790   0   420   426,470   471,476   43   0   936   472,455 
Installment and Other Consumer  29,920   198   11   89   30,218   31,715   239   23   176   32,153 
Total $965,831  $4,704  $65  $3,429  $974,029  $1,059,498  $2,934  $328  $5,672  $1,068,432 

 

Credit Quality

 

The Company categorizes loans into risk categories based upon an internal rating system reflecting management’s risk assessment. Loans are placed onwatchstatus 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 assubstandardare 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 atroubled 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 onnon-accrualstatus when (1) deterioration in the financial condition of the borrower exists for which payment of full principal and interest is not expected, or (2) payment of principal or interest has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income on a cash basis.

 

 14

14

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

The following table presents the risk categories by class at June 30, 2017March 31, 2018 and December 31, 2016.2017.

 

(in thousands) Commercial,
Financial, &
Agricultural		  Real Estate
Construction -
Residential		  Real Estate
Construction -
Commercial		  Real Estate
Mortgage -
Residential		  Real Estate
Mortgage -
Commercial		  Installment
and Other
Consumer		  Total  Commercial,
Financial, &
Agricultural		  Real Estate
Construction -
Residential		  Real Estate
Construction -
Commercial		  Real Estate
Mortgage -
Residential		  Real Estate
Mortgage -
Commercial		  Installment
and Other
Consumer		  Total 
At June 30, 2017                            
At March 31, 2018               
Watch $9,266  $1,107  $1,318  $16,879  $46,861  $0  $75,431  $9,460  $1,227  $1,291  $8,079  $45,938  $147  $66,142 
Substandard  1,688   640   97   2,258   736   24   5,443   641   462   0   2,532   725   13   4,373 
Performing TDRs  664   0   0   3,535   1,087   0   5,286   481   0   0   3,068   1,062   0   4,611 
Non-accrual  1,123   0   48   2,252   959   52   4,434   2,258   59   0   2,089   916   160   5,482 
Total $12,741  $1,747  $1,463  $24,924  $49,643  $76  $90,594  $12,840  $1,748  $1,291  $15,768  $48,641  $320  $80,608 
                            
At December 31, 2016                            
At December 31, 2017                            
Watch $10,295  $665  $1,113  $16,577  $44,611  $0  $73,261  $9,868  $1,459  $1,284  $9,978  $49,197  $0  $71,786 
Substandard  798   640   0   2,159   426   24   4,047   658   462   0   2,262   723   16   4,121 
Performing TDRs  635   0   0   3,582   1,498   0   5,715   500   0   0   3,116   1,068   0   4,684 
Non-accrual  982   0   50   1,888   420   89   3,429   2,507   0   97   1,956   936   176   5,672 
Total $12,710  $1,305  $1,163  $24,206  $46,955  $113  $86,452  $13,533  $1,921  $1,381  $17,312  $51,924  $192  $86,263 

 

Troubled Debt Restructurings

 

At June 30, 2017,March 31, 2018, loans classified as TDRs totaled $6.3 million, of which $992,000$1.7 million were classified as nonperforming TDRs and included in non-accrual loans and $5.3$4.6 million were classified as performing TDRs. At December 31, 2016,2017, loans classified as TDRs totaled $6.3$6.4 million, of which $619,000$1.7 million were classified as nonperforming TDRs and included in non-accrual loans and $5.7$4.7 million were classified as performing TDRs. Both performing and nonperforming TDRs are considered impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. Accordingly, specific reserves of $450,000$662,000 and $410,000$577,000 related to TDRs were allocated to the allowance for loan losses at June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively.

 

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

 

 Six Months Ended June 30,  Three Months Ended March 31, 
 2017  2016  2018 2017 
 Recorded Investment (1)  Recorded Investment (1)  Recorded Investment (1) Recorded Investment (1) 
(in thousands) Number of
Contracts		  Pre-
Modification		  Post-
Modification		  Number of
Contracts		  Pre-
Modification		  Post-
Modification		  Number of
Contracts		  Pre-
Modification		  Post-
Modification		  Number of
Contracts		  Pre-
Modification		  Post-
Modification		 
Troubled Debt Restructurings                                                
Commercial, financial and agricultural  1  $131  $130   0  $0  $0   0  $0  $0   1  $131  $131 
Real estate mortgage - residential  0   0   0   1   78   78 
Real estate mortgage - commercial  1   56   52   0   0   0   0   0   0   1   56   56 
Total  2  $187  $182   1  $78  $78   0  $0  $0   2  $187  $187 

 

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

 

The Company’s portfolio of loans classified as TDRs include concessions for the borrower given financial condition such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. There wereDuring the three months ended March 31, 2018, no loans and two loans meeting the TDR criteria was modified compared to two loans during the three and six months ended June 30, 2017, respectively, compared to no loans and one loan during the three and six months ended June 30, 2016, respectively.March 31, 2017.

 

The Company considers a TDR to be in default when it is 90 days or more past due under the modified terms, a charge-off occurs, or it is the process of foreclosure. There were no loans modified as a TDR that defaulted during the three months ended June 30,March 31, 2018 and 2017, and 2016, respectively, and within twelve months of their modification date. During 2018, one real estate mortgage loan went to foreclosure totaling $48,000. SeeLending and Credit Managementsection for further information.


15

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

(3)Other Real Estate and Repossessed Assets

 

 June 30, December 31,  March 31, December 31, 
(in thousands) 2017  2016  2018  2017 
Commercial $761  $809  $727  $727 
Real estate construction - residential  179   0 
Real estate construction - commercial  12,380   12,380   12,101   12,380 
Real estate mortgage - residential  463   647   348   382 
Real estate mortgage - commercial  2,909   3,439   2,909   2,909 
Repossessed assets  17   16   0   5 
Total $16,530  $17,291  $16,264  $16,403 
Less valuation allowance for other real estate owned  (3,174)  (3,129)  (3,025)  (3,221)
Total other real estate and repossessed assets $13,356  $14,162  $13,239  $13,182 

 

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

 

 Three Months Ended June 30,  Six Months Ended June 30,  Three Months Ended March 31, 
 2017  2016  2017  2016  2018  2017 
Balance at beginning of period $16,669  $18,696  $17,291  $19,225  $16,403  $17,291 
Additions  52   892   155   1,634   278   103 
Proceeds from sales  (126)  (1,125)  (784)  (2,399)  (224)  (658)
Charge-offs against the valuation allowance for other real estate owned, net  (53)  (55)  (170)  (101)  (195)  (117)
Net gain on sales  (12)  54   38   103   2   50 
Total other real estate and repossessed assets $16,530  $18,462  $16,530  $18,462  $16,264  $16,669 
Less valuation allowance for other real estate owned  (3,174)  (3,208)  (3,174)  (3,208)  (3,025)  (3,044)
Balance at end of period $13,356  $15,254  $13,356  $15,254  $13,239  $13,625 

 

At June 30, 2017 $100,000March 31, 2018, $27,000 of consumer mortgage loans secured by residential real estate properties were in the process of foreclosure compared to $162,000no loans at December 31, 2016.2017.

 

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

 

 Three Months Ended June 30,  Six Months Ended June 30,  Three Months Ended March 31, 
(in thousands) 2017  2016  2017  2016  2018  2017 
Balance, beginning of period $3,044  $3,225  $3,129  $3,233  $3,221  $3,129 
Provision for other real estate owned  183   38   215   76   (1)  32 
Charge-offs  (53)  (55)  (170)  (101)  (195)  (117)
Balance, end of period $3,174  $3,208  $3,174  $3,208  $3,025  $3,044 


16

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

(4)Investment Securities

 

The amortized cost and fair value of debt securities classified as available-for-sale at June 30, 2017March 31, 2018 and December 31, 20162017 were as follows:

 

 Total         Total        
 Amortized  Gross Unrealized  Fair  Amortized  Gross Unrealized  Fair 
(in thousands) Cost  Gains  Losses  Value  Cost  Gains  Losses  Value 
June 30, 2017                
March 31, 2018         
U.S. Treasury $1,981  $0  $(42) $1,939 
U.S. government and federal agency obligations $12,945  $0  $(233) $12,712   11,798       (305)  11,493 
Government sponsored enterprises  37,568   0   (256)  37,312   38,819   0   (642)  38,177 
Obligations of states and political subdivisions  48,031   261   (298)  47,994   42,271   42   (709)  41,604 
Mortgage-backed securities:                                
Residential - government agencies  118,491   157   (1,315)  117,333   126,186   11   (3,690)  122,507 
Commercial - government agencies  990   12   0   1,002 
Total mortgage-backed securities  119,481   169   (1,315)  118,335 
Total available-for-sale securities $218,025  $430  $(2,102) $216,353  $221,055  $53  $(5,388) $215,720 
                                
December 31, 2016                
December 31, 2017                
U.S. Treasury $1,980  $0  $(13) $1,967 
U.S. government and federal agency obligations $13,667  $0  $(303) $13,364   12,341       (268)  12,073 
Government sponsored enterprises  32,786   2   (329)  32,459   37,321   0   (424)  36,897 
Obligations of states and political subdivisions  42,666   123   (757)  42,032   47,019   114   (477)  46,656 
Mortgage-backed securities:                                
Residential - government agencies  127,527   124   (1,995)  125,656   131,045   44   (2,140)  128,949 
Commercial - government agencies  989   12   0   1,001 
Total mortgage-backed securities  128,516   136   (1,995)  126,657 
Total available-for-sale securities $217,635  $261  $(3,384) $214,512  $229,706  $158  $(3,322) $226,542 

 

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

 

Other Investments and securities primarily consist of Federal Home Loan Bank stock, subordinated debt equity securities, and the Company’s interest in statutory trusts. These securities are reported at cost in other assets in the amount of $10.8$9.7 million and $9.8$11.0 million as of June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively.

 

Debt securities with carrying values aggregating approximately $155.1$194.3 million and $167.6$181.7 million at June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

 

The amortized cost and fair value of debt securities classified as available-for-sale at June 30, 2017,March 31, 2018, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.


17

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

 Amortized Fair  Amortized Fair 
(in thousands) Cost  Value  Cost  Value 
Due in one year or less $5,781  $5,832  $9,928  $9,883 
Due after one year through five years  60,749   60,531   60,479   59,974 
Due after five years through ten years  26,266   25,956   21,390   20,344 
Due after ten years  5,748   5,699   3,072   3,012 
Total  98,544   98,018   94,869   93,213 
Mortgage-backed securities  119,481   118,335   126,186   122,507 
Total available-for-sale securities $218,025  $216,353  $221,055  $215,720 

 

Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2017March 31, 2018 and December 31, 20162017 were as follows:

 

 Less than 12 months  12 months or more  Total  Total  Less than 12 months  12 months or more  Total  Total 
 Fair Unrealized Fair Unrealized Fair Unrealized  Fair Unrealized Fair Unrealized Fair Unrealized 
(in thousands) Value  Losses  Value  Losses  Value  Losses  Value  Losses  Value  Losses  Value  Losses 
At June 30, 2017                        
At March 31, 2018             
U.S. Treasury $1,939  $(42) $0  $0  $1,939  $(42)
U.S. government and federal agency obligations $7,788  $(133) $4,925  $(100) $12,713  $(233)  0   0   11,493   (305)  11,493   (305)
Government sponsored enterprises  32,339   (229)  2,473   (27)  34,812   (256)  14,881   (218)  23,295   (424)  38,176   (642)
Obligations of states and political subdivisions  22,886   (264)  1,912   (34)  24,798   (298)  22,906   (260)  12,379   (449)  35,285   (709)
Mortgage-backed securities:                                                
Residential - government agencies  77,979   (924)  20,188   (391)  98,167   (1,315)  53,183   (1,114)  66,854   (2,576)  120,037   (3,690)
Total $140,992  $(1,550) $29,498  $(552) $170,490  $(2,102) $92,909  $(1,634) $114,021  $(3,754) $206,930  $(5,388)
                                                
(in thousands)                                                
At December 31, 2016                        
At December 31, 2017                        
U.S. Treasury $1,967  $(13) $0  $0  $1,967  $(13)
U.S. government and federal agency obligations $13,365  $(303) $0  $0  $13,365  $(303)  0   0   12,073   (268)  12,073   (268)
Government sponsored enterprises  29,432   (329)  0   0   29,432   (329)  16,471   (119)  20,426   (305)  36,897   (424)
Obligations of states and political subdivisions  32,318   (757)  0   0   32,318   (757)  22,013   (165)  12,570   (312)  34,583   (477)
Mortgage-backed securities:                                                
Residential - government agencies  109,772   (1,848)  3,742   (147)  113,514   (1,995)  52,829   (488)  69,580   (1,652)  122,409   (2,140)
Total $184,887  $(3,237) $3,742  $(147) $188,629  $(3,384) $93,280  $(785) $114,649  $(2,537) $207,929  $(3,322)

 

The total available for sale portfolio consisted of approximately 324341 securities at June 30, 2017.March 31, 2018. The portfolio included 202298 securities having an aggregate fair value of $170.5$206.9 million that were in a loss position at June 30, 2017.March 31, 2018. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer totaled $29.5$114.0 million at fair value. The $2.1$5.4 million aggregate unrealized loss included in accumulated other comprehensive income at June 30, 2017March 31, 2018 was caused by interest rate fluctuations.

 

The total available for sale portfolio consisted of approximately 298355 securities at December 31, 2016.2017. The portfolio included 216280 securities having an aggregate fair value of $188.6$207.9 million that were in a loss position at December 31, 2016.2017. Securities identified as temporarily impaired which had been in a loss position for 12 months or longer had a fair value of $3.7$114.6 million at December 31, 2016.2017. The $3.4$3.3 million aggregate unrealized loss included in accumulated other comprehensive incomeloss at December 31, 20162017 was caused by interest rate fluctuations.

 

Because the decline in fair value is attributable to changes in interest rates and not credit quality, these investments were not considered other-than-temporarily impaired at June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively. In the absence of changes in credit quality of these investments, the fair value is expected to recover on all debt securities as they approach their maturity date or re-pricing date, or if market yields for such investments decline. In addition, the Company does not have the intent to sell these investments over the period of recovery, and it is not more likely than not that the Company will be required to sell such investment securities.


18

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

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

 

 Three Months Ended June 30, Six Months Ended June 30,  Three Months Ended March 31, 
(in thousands) 2017  2016  2017  2016  2018  2017 
Gains realized on sales $0  $18  $0  $490  $98  $0 
Losses realized on sales  0   0   0   0   0   0 
Other-than-temporary impairment recognized  0   0   0   0   0   0 
Investment securities gains $0  $18  $0  $490  $98  $0 

 

(5)Intangible Assets

 

Mortgage Servicing Rights

 

At June 30, 2017,March 31, 2018, the Company was servicing approximately $289.8$283.1 million of loans sold to the secondary market compared to $294.4$285.8 million at December 31, 2016,2017, and $304.7$291.0 million at June 30, 2016.March 31, 2017. Mortgage loan servicing fees, reported as non-interest income, earned on loans sold were $211,000 and $420,000$203,000 for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to $211,000 and $421,000$209,000 for the three and six months ended June 30, 2016,March 31, 2017, respectively.

 

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

 

 Three Months Ended June 30, Six Months Ended June 30,  Three Months Ended March 31, 
(in thousands) 2017  2016  2017  2016  2018  2017 
Balance at beginning of period $2,877  $2,745  $2,584  $2,847  $2,713  $2,584 
Originated mortgage servicing rights  66   63   115   117   50   49 
Changes in fair value:                        
Due to change in model inputs and assumptions (1)  (56)  (142)  319   (145)  103   375 
Other changes in fair value (2)  (121)  (155)  (252)  (308)  (85)  (131)
Balance at end of period $2,766  $2,511  $2,766  $2,511  $2,781  $2,877 

 

(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 sixthree months ended June 30, 2017March 31, 2018 and 2016:2017:

 

 Six Months Ended June 30,  Three Months Ended March 31, 
 2017  2016  2018  2017 
Weighted average constant prepayment rate  9.28%  12.16%  9.07%  8.29%
Weighted average note rate  3.86%  3.90%  3.87%  3.85%
Weighted average discount rate  9.75%  9.19%  10.39%  9.72%
Weighted average expected life (in years)  6.10   5.10   6.20   6.50 

 

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

 

 June 30, December 31,  March 31, December 31, 
 2017  2016  2018  2017 
Federal funds purchased $0  $992  $0  $0 
Repurchase agreements  29,118   30,023   34,795   27,560 
Total $29,118  $31,015  $34,795  $27,560 

 

19


Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

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

 

Repurchase Agreements Remaining Contractual Maturity of the Agreements  Remaining Contractual Maturity of the Agreements 
 Overnight Less Greater     Overnight Less Greater    
 and than than     and than than    
(in thousands) continuous  90 days  90 days  Total  continuous  90 days  90 days  Total 
At June 30, 2017                
At March 31, 2018         
U.S. Treasury $1,948  $0  $0  $1,948 
U.S. government and federal agency obligations $3,189  $0  $0  $3,189   2,987   0   0   2,987 
Government sponsored enterprises  7,882   0   0   7,882   9,220   0   0   9,220 
Asset-backed securities  18,047   0   0   18,047   20,640   0   0   20,640 
Total $29,118  $0  $0  $29,118  $34,795  $0  $0  $34,795 
                                
At December 31, 2016                
At December 31, 2017                
U.S. Treasury $1,964  $0  $0  $1,964 
U.S. government and federal agency obligations $3,489  $0  $0  $3,489   2,977   0   0   2,977 
Government sponsored enterprises  7,324   0   0   7,324   8,382   0   0   8,382 
Asset-backed securities  19,210   0   0   19,210   14,237   0   0   14,237 
Total $30,023  $0  $0  $30,023  $27,560  $0  $0  $27,560 

 

(7)Income Taxes

 

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 33.9%16.43% for the three months ended June 30, 2017March 31, 2018 compared to 34.1%34.2% for the three months ended June 30, 2016. Income taxesMarch 31, 2017. The federal corporate income tax rate declined from 34% to 21% effective January 1, 2018 as a percentageresult of earnings before income taxes as reported in the consolidated financial statements were 34.1% for the six months ended June 30, 2017 compared to 33.2% for the six months ended June 30, 2016.Tax Cuts and Jobs Act. The increase in theCompany’s tax rate foris lower than the six months ended June 30, 2017federal statutory rate primarily as a result of tax-exempt income. The decrease in comparison to the six months ended June 30, 2016tax rate quarter over quarter is primarily due to an immaterial return to provision adjustment madea decrease in the firstfederal corporate tax rate and the Company’s additional tax planning initiatives. The provisional adjustments recorded in the fourth quarter of 2016.2017 related to the enactment of the Tax Cuts and Jobs Act have not been finalized as of March 31, 2018. The Company expects to finalize those adjustments within the one-year measurement period provided under Staff Accounting Bulletin No. 118 in regards to the application of FASB’s ASC Topic 740,Income Taxes. The impact of the Tax Cuts and Jobs Act is expected to require further adjustments in 2018 due to anticipated additional guidance from the U.S. Department of the Treasury, changes in our assumptions, completion of 2017 U.S. tax returns and further information and interpretations that become available.

 

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income of the appropriate character during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, taxable income available in carryback years, and tax planning strategiesinitiatives in making this assessment. With the exception of certain capital losses generated during 2013 and 2014, it is management’s opinion that the Company will more likely than not realize the benefits of these temporary differences as of June 30, 2017March 31, 2018 and, therefore, only established a valuation reserve against the Company’s capital loss carry forward. Management arrived at this conclusion 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. As indicated above, the Company generated approximately $219,000 of capital losses during 2013 and 2014 as a result of disposing of certain limited partnership interests. The capital losses will expire between 2018 and 2019, and it is management’s opinion that it is more likely than not that the Company will not more likely than not generate the capital gain income necessary to utilize the capital loss carry forwards before the capital losses expire. As such, the Company has established an $83,000a $46,000 valuation reserve against its capital loss carry forward deferred tax asset.

 

The Company follows ASC Topic 740,Income Taxes,which addresses the accounting for uncertain tax positions. For the three months ended March 31, 2018 and 2017, the Company did not have any uncertain tax provisions.

(8)Stockholders’ Equity

Accumulated Other Comprehensive Loss

20

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

 

The following details the change in the components of the Company’s accumulated other comprehensive loss for the sixthree months ended June 30, 2017March 31, 2018 and 2016:


Hawthorn Bancshares, Inc.
and subsidiaries2017:

 

Notes to the Consolidated Financial Statements

(Unaudited)

  Three months ended March 31, 2018 
     Unrecognized Net  Accumulated 
  Unrealized  Pension and  Other 
  Gain (Loss)  Postretirement  Comprehensive 
(in thousands) on Securities (1)  Costs (2)  (Loss) Income 
Balance at beginning of period $(2,500) $(3,162) $(5,662)
Other comprehensive (loss) income, before reclassifications  (2,171)  54   (2,117)
Amounts reclassified from accumulated other comprehensive (loss) income  0   0   0 
Current period other comprehensive (loss) income, before tax  (2,171)  54   (2,117)
Income tax expense (benefit)  456   (12)  444 
Current period other comprehensive (loss) income, net of tax  (1,715)  42   (1,673)
Balance at end of period $(4,215) $(3,120) $(7,335)

 

 Six months ended June 30, 2017  Three months ended March 31, 2017 
    Unrecognized Net Accumulated     Unrecognized Net Accumulated 
 Unrealized Pension and Other  Unrealized Pension and Other 
 Gain (Loss) Postretirement Comprehensive  Gain (Loss) Postretirement Comprehensive 
(in thousands) on Securities (1)  Costs (2)  Loss  on Securities (1)  Costs (2)  Loss 
Balance at beginning of period $(1,936) $(1,865) $(3,801) $(1,936) $(1,865) $(3,801)
Other comprehensive income, before reclassifications  1,452   45   1,497   493   22   515 
Amounts reclassified from accumulated other comprehensive income (loss)  0   0   0   0   0   0 
Current period other comprehensive income, before tax  1,452   45   1,497   493   22   515 
Income tax expense  (552)  (18)  (570)  (187)  (8)  (195)
Current period other comprehensive income, net of tax  900   27   927   306   14   320 
Balance at end of period $(1,036) $(1,838) $(2,874) $(1,630) $(1,851) $(3,481)
            
 Six months ended June 30, 2016 
    Unrecognized Net Accumulated 
 Unrealized Pension and Other 
 Gain (Loss) Postretirement Comprehensive 
(in thousands) on Securities (1)  Costs (2)  Loss 
Balance at beginning of period $(591) $(1,427) $(2,018)
Other comprehensive income, before reclassifications  3,357   39   3,396 
Amounts reclassified from accumulated other comprehensive income (loss)  (490)  0   (490)
Current period other comprehensive income, before tax  2,867   39   2,906 
Income tax expense  (1,090)  (14)  (1,104)
Current period other comprehensive income, net of tax  1,777   25   1,802 
Balance at end of period $1,186  $(1,402) $(216)

 

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

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

 

(9)Employee Benefit Plans

 

Employee Benefits

 

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

 

 Three Months Ended June 30, Six Months Ended June 30,  Three Months Ended March 31, 
(in thousands) 2017  2016  2017  2016  2018  2017 
Payroll taxes $288  $336  $644  $632  $351  $356 
Medical plans  468   487   894   999   548   426 
401k match and profit sharing  226   203   476   384   186   250 
Pension plan  351   306   703   613 
Periodic pension cost  405   336 
Other  9   46   25   62   15   16 
Total employee benefits $1,342  $1,378  $2,742  $2,690  $1,505  $1,384 

 

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

 21

21

 

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

Pension

 

The Company provides a noncontributory defined benefit pension plan for all full-time employees. Beginning January 1, 2018 and for all retrospective periods presented, the Company adopted the guidance under ASU 2017-07,Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Under the new guidance only the service cost component of the net periodic benefit cost is reported in the same income statement line item as salaries and benefits, and the remaining components are reported as other non-interest expense. An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. The Company expects to make a pension contribution in the amount of $1.2$1.8 million on September 15, 2017.in the second quarter of 2018. The 2018 minimum required contribution for 2017 is $842,000.$1.0 million. Effective July 1, 2017, the Company amended the pension plan to effectuate a “soft freeze” such that no individual hired (or rehired in the case of a former employee) by the Company after JuneSeptember 30, 2017, whether or not such individual is or was a vested member in the plan, will be eligible to be an active member and be entitled to accrue any benefits under the plan. Certain individuals hired by the Company before July 1, 2017 are also not eligible to participate in the plan. Beginning in 2019, the Company anticipates that there may be a small reduction in the overall liability and service cost resulting from the closure of the plan to new entrants.

 

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  Pension Benefits 
(in thousands) 2017  2016  2018  2017 
Service cost - benefits earned during the year $1,343  $1,179  $1,620  $1,343 
Interest costs on projected benefit obligations(a)  1,008   956   1,033   1,009 
Expected return on plan assets(a)  (1,123)  (1,057)  (1,267)  (1,124)
Expected administrative expenses(a)  88   70   93   88 
Amortization of prior service cost(a)  79   79   79   79 
Amortization of unrecognized net loss(a)  11   0   138   11 
Net periodic pension expense $1,406  $1,227 
        
Pension expense - three months ended June 30, (actual) $351  $306 
Pension expense - six months ended June 30, (actual) $703  $613 
Net periodic pension cost $1,696  $1,406 
Net periodic pension cost for the three months ended March 31, (actual) $405  $336 

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

 

(10)Stock Compensation

 

The Company’s stock optionhas one equity compensation plan provides for the grant ofits employees pursuant to which options to purchase up to 601,627 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.were granted.


22

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

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

 

      Weighted          Weighted    
    Weighted Average Aggregate     Weighted Average Aggregate 
 Number average Contractual Intrinsic  Number average Contractual Intrinsic 
 of Exercise Term Value  of Exercise Term Value 
 Shares  Price  (in years)  ($000)  Shares  Price  (in years)  ($000) 
Outstanding, beginning of period  46,244  $19.33           20,103  $14.77         
Granted  0   0.00           0   0.00         
Exercised  0   0.00           0   0.00         
Forfeited or expired  (26,141)  22.84           0   0.00         
Outstanding, June 30, 2017  20,103  $14.77   1.23  $124,252 
Exercisable, June 30, 2017  18,784  $14.77   1.23  $116,100 
Outstanding, March 31, 2018  20,103  $14.77   0.48  $117,992 
Exercisable, March 31, 2018  20,103  $14.77   0.48  $117,992 

 

Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2017.

 

Total stock-based compensation expense was $1,000$0 and $2,000$1,000 for the three and six months ended June 30,March 31, 2018 and 2017, respectively, compared to $5,000 and $11,000 for the three and six months ended June 30, 2016, respectively. As of June 30,December 31, 2017, the totalthere was no remaining unrecognized compensation expense related to non-vested stock awards was $1,000awards. The Plan expired on February 28, 2010, except as to outstanding options under the Plan, and no further options may be granted pursuant to the related weighted average period over which it is expected to be recognized is approximately 0.23 years.Plan.

 

(11)Earnings per Share

 

Stock DividendOn July 1, 2017, the Company paid a special stock dividend of 4% to common shareholders of record at the close of business on June 15, 2017. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.

 

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

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

 

 Three Months Ended June 30, Six Months Ended June 30,  Three Months Ended March 31, 
(dollars in thousands, except per share data) 2017  2016  2017  2016  2018  2017 
Basic earnings per share:                     
Net income available to shareholders $1,919  $1,412  $4,020  $3,410  $2,090  $2,100 
Basic earnings per share $0.33  $0.24  $0.69  $0.58  $0.36  $0.36 
Diluted earnings per share:                        
Net income available to shareholders $1,919  $1,412  $4,020  $3,410  $2,090  $2,100 
Average shares outstanding  5,838,506   5,871,208   5,839,175   5,874,706   5,797,134   5,839,850 
Effect of dilutive stock options  4,929   0   4,948   0   5,720   4,916 
Average shares outstanding including dilutive stock options  5,843,435   5,871,208   5,844,123   5,874,706   5,802,854   5,844,766 
Diluted earnings per share $0.33   0.24   0.69   0.58  $0.36   0.36 

 

Under the treasury stock method, outstanding stock options are dilutive when the average market price of the Company’s common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during the period, except when the Company has a loss from continuing operations available to shareholders. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period.


23

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 

Options to purchase 46,2440 and 21,621 shares during the three and six months ended June 30, 2016,March 31, 2018 and 2017, respectively, 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. There were no anti-dilutive shares for the three and six months ended June 30, 2017.

Repurchase Program On August 6, 2015, the Board of Directors authorized a share repurchase plan (the plan) to purchase through open market transactions up to $2.0 million market value of the Company’s common stock. On August 8, 2017, the Board authorized the repurchase of an additional $1.5 million market value of the Company’s common stock. As of June 30, 2017,March 31, 2018, the Company had repurchased a total of 48,60892,509 shares of common stock pursuant to the plan at an average price of $15.34$17.80 per share, including 4,7155,468 shares of common stock repurchased pursuant to the plan during the sixthree months ended June 30, 2017March 31, 2018 at an average price of $19.01$20.51 per share. At June 30, 2017,March 31, 2018, approximately $1.3$1.8 million may be used toremained available for the purchase of shares under the plan.

The table below shows activity in the outstanding shares of the Company's common stock during the past three years. Shares in the table below are presented on a historical basis and have not been restated for the annual 4% stock dividends.

  Number of shares 
  June 30,  December 31,  June 30, 
  2017  2016  2016 
Outstanding, beginning of year  5,616,607   5,441,190   5,441,190 
Issuance of stock:            
4% stock dividend  224,550   217,155   217,155 
Purchase of treasury stock  (4,715)  (41,738)  (15,301)
Outstanding, end of year  5,836,442   5,616,607   5,643,044 

Except as noted in the above table, all share and per share amounts in this note have been restated for the 4% common stock dividend distributed July 1, 2017.current plan expires September 8, 2018 unless renewed.

 

(12)Fair Value Measurements

 

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

Depending on the nature of the asset or liability, the Company uses various valuation methodologies and assumptions to estimate fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities.value. 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 liabilitiesunder US GAAP uses a hierarchy intended to be measured at fair value but does not expandmaximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the 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.assets and liabilities as follows. As of June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively, there were no transfers into or out of Levels 1-3.

 

The fair value hierarchy is as follows:

 

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

 

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

 

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

 

ASC Topic 820 also provides guidance on determiningIn accordance with fair value whenaccounting guidance, the volumeCompany measures, records, and levelreports various types 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 either a recurring or non-recurring basis separate from those measured at fair value on a nonrecurring basis.in the Consolidated Financial Statements. Nonfinancial assets measured at fair value on a nonrecurring basis would include foreclosed real estate, long-lived assets, and core deposit intangible assets, which are reviewed when circumstances or other events indicate that impairment may have occurred. 

 24

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

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

 

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

 

Available-for-Sale Securities

 

The fair value measurements of the Company’s investment securities are determined by a third party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The fair value measurements are subject to independent verification to another pricing source by management each quarter for reasonableness. 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  Fair Value Measurements 
    Quoted Prices          Quoted Prices      
    in Active          in Active      
    Markets for Other Significant     Markets for Other Significant 
    Identical Observable Unobservable     Identical Observable Unobservable 
    Assets Inputs Inputs     Assets Inputs Inputs 
(in thousands) Fair Value  (Level 1)  (Level 2)  (Level 3)  Fair Value  (Level 1)  (Level 2)  (Level 3) 
June 30, 2017                
March 31, 2018                
Assets:                                
U.S. Treasury $1,939  $1,939   0  $0 
U.S. government and federal agency obligations $12,712  $0   12,712  $0   11,493   0   11,493   0 
Government sponsored enterprises  37,312   0   37,312   0   38,177   0   38,177   0 
Obligations of states and political subdivisions  47,994   0   47,994   0   41,604   0   41,604   0 
Mortgage-backed securities  118,335   0   118,335   0   122,507   0   122,507   0 
Mortgage servicing rights  2,766   0   0   2,766   2,781   0   0   2,781 
Total $219,119  $0  $216,353  $2,766  $218,501  $1,939  $213,781  $2,781 
                
December 31, 2016                
December 31, 2017                
Assets:                                
U.S. Treasury $1,967  $1,967   0  $0 
U.S. government and federal agency obligations $13,364  $0   13,364  $0   12,073   0   12,073   0 
Government sponsored enterprises  32,459   0   32,459   0   36,897   0   36,897   0 
Obligations of states and political subdivisions  42,032   0   42,032   0   46,656   0   46,656   0 
Mortgage-backed securities  126,657   0   126,657   0   128,949   0   128,949   0 
Mortgage servicing rights  2,584   0   0   2,584   2,713   0   0   2,713 
Total $217,096  $0  $214,512  $2,584  $229,255  $1,967  $224,575  $2,713 

 

25

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

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


Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

 Fair Value Measurements Using Fair Value Measurements Using  Fair Value Measurements Using 
 Significant Unobservable Inputs Significant Unobservable Inputs  Significant Unobservable Inputs 
 (Level 3) (Level 3)  (Level 3) 
 Mortgage Servicing Rights  Mortgage Servicing Rights  Mortgage Servicing Rights 
(in thousands) Three Months Ended June 30,  Six Months Ended June 30,  Three Months Ended March 31, 
 2017  2016  2017  2016  2018  2017 
Balance at beginning of period $2,877  $2,745  $2,584  $2,847  $2,713  $2,584 
Total gains or losses (realized/unrealized):                        
Included in earnings  (177)  (297)  67   (453)  18   244 
Included in other comprehensive income  0   0   0   0   0   0 
Purchases  0   0   0   0   0   0 
Sales  0   0   0   0   0   0 
Issues  66   63   115   117   50   49 
Settlements  0   0   0   0   0   0 
Balance at end of period $2,766  $2,511  $2,766  $2,511  $2,781  $2,877 

 

The change in valuation of mortgage servicing rights arising from inputs and assumptions decreased $56,000increased $103,000 and increased $319,000$375,000 for the three and six months ended June 30,March 31, 2018 and 2017, respectively, compared to decreases of $142,000 and $145,000 for the three and six months ended June 30, 2016, respectively.

 

  Quantitative Information about Level 3 Fair Value Measurements   
  Valuation Technique Unobservable Inputs Input Value 
      Six Months Ended June 30, 
      2017  2016 
Mortgage servicing rights Discounted cash flows Weighted average constant prepayment rate  9.28%  12.16%
    Weighted average note rate  3.86%  3.90%
    Weighted average discount rate  9.75%  9.19%
    Weighted average expected life (in years)  6.10   5.10 
  Quantitative Information about Level 3 Fair Value Measurements   
  Valuation Technique Unobservable Inputs Input Value 
      Three Months Ended March 31, 
      2018  2017 
Mortgage servicing rights  Discounted cash flows Weighted average constant prepayment rate  9.07%  8.29%
    Weighted average note rate  3.87%  3.85%
    Weighted average discount rate  10.39%  9.72%
    Weighted average expected life (in years)  6.20   6.50 

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

 

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

 

Impaired LoansCollateral dependent impaired loans

 

The Company doesWhile the overall loan portfolio is not record loanscarried at fair value, on a recurring basis other than loans that are considered impaired. The netthe Company periodically records nonrecurring adjustments to the carrying value of impaired loans isbased on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral dependent loans when establishing the allowance for loan losses. Such amounts are generally based on 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 underlying collateral has been determinedsupporting the loan. In determining the value of real estate collateral, the Company relies on external and any impairment amount calculated,internal appraisals of property values depending on the size and complexity of the real estate collateral. The Company maintains staff that is trained to perform in-house evaluations and also review third party appraisal reports for reasonableness. In the case of non-real estate collateral, reliance is placed on a specific reserve allocation is made.variety of sources, including external estimates of value and judgments based on the experience and expertise of internal specialists. Values of all loan collateral are regularly reviewed by senior loan committee. Because many of these inputs are not observable, the measurements are classified as Level 3. As of June 30, 2017,March 31, 2018, the Company identified $8.0$3.8 million in collateral dependent impaired loans that had specific allowances for losses aggregating $1.1 million.$952,000. Related to these loans, there was $63,000 and $83,000$57,000 in charge-offs recorded during the three and six months ended June 30, 2017, respectively.March 31, 2018. As of June 30, 2016,March 31, 2017, the Company identified $4.7$2.5 million in collateral dependent impaired loans that had specific allowances for losses aggregating $1.6 million.$677,000. Related to these loans, there was $208,000 and $768,000$20,000 in charge-offs recorded during the three and six months ended June 30, 2016, respectively.March 31, 2017.

26

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

 

Other Real Estate and Foreclosed Assets

 

Other real estate owned (OREO) and foreclosed assets consisted of loan collateral that has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Other real estateSubsequent to foreclosure, these assets initially are recorded as held for sale initiallycarried at the lower of the loan balance or fair value of the collateral less estimated selling costs. The Company reliesFair value, when recorded, is generally based upon appraisals by approved, independent state certified appraisers. Like impaired loans, appraisals 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 judgmentOREO may be discounted based on experience and expertisethe Company’s historical knowledge, changes in market conditions from the time of internal specialists. Subsequent to foreclosure,appraisal or other information available. During the holding period, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3.


Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

(Unaudited)

    Fair Value Measurements Using       Fair Value Measurements Using
    Quoted Prices       Three Six     Quoted Prices       Three 
    in Active       Months Months     in Active       Months 
    Markets for Other Significant Ended Ended     Markets for Other Significant Ended 
    Identical Observable Unobservable June 30, June 30,     Identical Observable Unobservable March 31, 
 Total Assets Inputs Inputs Total Gains Total Gains  Total Assets Inputs Inputs Total Gains 
(in thousands) Fair Value  (Level 1)  (Level 2)  (Level 3)  (Losses)*  (Losses)*  Fair Value  (Level 1)  (Level 2)  (Level 3)  (Losses)* 
June 30, 2017                        
March 31, 2018                    
Assets:                                            
Impaired loans:                        
Collateral dependent impaired loans:                            
Commercial, financial, & agricultural $807  $0  $0  $807  $0  $(1) $1,369  $0  $0  $1,369  $0 
Real estate construction - commercial  41   0   0   41   0   0   0   0   0   0   (27)
Real estate mortgage - residential  4,542   0   0   4,542   (62)  (65)  886   0   0   886   0 
Real estate mortgage - commercial  1,416   0   0   1,416   0   (4)  595   0   0   595   (20)
Consumer  41   0   0   41   (1)  (13)  0   0   0   0   (10)
Total $6,847  $0  $0  $6,847  $(63) $(83) $2,850  $0  $0  $2,850  $(57)
Other real estate and foreclosed assets $13,356  $0  $0  $13,356  $(195) $(180) $13,239  $0  $0  $13,239  $1 
                                            
June 30, 2016                        
March 31, 2017                    
Assets:                                            
Impaired loans:                        
Collateral dependent impaired loans:                    
Commercial, financial, & agricultural $723  $0  $0  $723  $0  $(359) $339  $0  $0  $339  $(1)
Real estate construction - commercial  44   0   0   44   0   0 
Real estate mortgage - residential  2,047   0   0   2,047   (181)  (216)  1,261   0   0   1,261   (3)
Real estate mortgage - commercial  198   0   0   198   (23)  (177)  220   0   0   220   (4)
Consumer  85   0   0   85   (4)  (16)  0   0   0   0   (12)
Total $3,097  $0  $0  $3,097  $(208) $(768) $1,820  $0  $0  $1,820  $(20)
Other real estate and foreclosed assets $15,254  $0  $0  $15,254  $16  $49  $13,625  $0  $0  $13,625  $15 

 

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

 

(13)Fair Value of Financial Instruments

 

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

 

27

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

Loans

 

Fair values are estimated for portfolios with similar financial characteristics. Loans are segregated by type, such as commercial, real estate, and consumer. Each loan category is further segmented into fixed and variable interest rate categories. The fair valuesvalue of loans areis estimated by discountingusing the expected future value of discounted cash flows using comparable market rates for similar types of loan products and adjusted for market factors.The discount rates used are estimated using comparable market rates for similar types of loan products adjusted to be commensurate with the current rates at which similar loans could be made to borrowers with similar credit ratingsrisk, overhead costs, and for the same remaining maturities. The net carrying amountoptionality 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.such instruments.

 

Investment Securities

 

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

 27

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

 

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.

 

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.

Certificates of Deposit in other banks

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

 

Mortgage Servicing Rights

 

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

 

Cash Surrender Value - Life Insurance

 

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

 

Accrued Interest Receivable and Payable

 

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

 

Deposits

 

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

 

28

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

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.cash-flows. The discount rate is estimated using the rates currently offered for other borrowed money of similar remaining maturities.


29

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

A summary of the carrying amounts and fair values of the Company’s financial instruments at June 30, 2017March 31, 2018 and December 31, 20162017 is as follows:

 

      June 30, 2017       March 31, 2018 
      Fair Value Measurements       Fair Value Measurements 
      Quoted Prices            Quoted Prices      
      in Active     Net       in Active     Net 
      Markets for Other Significant       Markets for Other Significant 
 June 30, 2017  Identical  Observable  Unobservable  March 31, 2018  Identical  Observable  Unobservable 
 Carrying Fair Assets Inputs Inputs  Carrying Fair Assets Inputs Inputs 
(in thousands) Amount  Value  (Level 1)  (Level 2)  (Level 3)  amount  value  (Level 1)  (Level 2)  (Level 3) 
Assets:                                        
Cash and due from banks $20,776  $20,776  $20,776  $0  $0  $15,955  $15,955  $15,955  $0  $0 
Federal funds sold and overnight interest-bearing deposits  40,552   40,552   40,552   0   0   65,449   65,449   65,449   0   0 
Certificates of deposit in other banks  4,812   4,812   4,812   0   0 
Investment in available-for-sale securities  216,353   216,353   0   216,353   0   215,720   215,720   1,939   213,781   0 
Loans, net  1,024,475   1,022,116   0   0   1,022,116   1,073,379   1,055,059   0   0   1,055,059 
Investment in FHLB stock  6,151   6,151   0   6,151   0   5,078   5,078   0   5,078   0 
Mortgage servicing rights  2,766   2,766   0   0   2,766   2,781   2,781   0   0   2,781 
Cash surrender value - life insurance  2,448   2,448   0   2,448   0   2,499   2,499   0   2,499   0 
Accrued interest receivable  4,754   4,754   4,754   0   0   5,330   5,330   5,330   0   0 
 $1,318,275  $1,315,916  $66,082  $224,952  $1,024,882  $1,391,003  $1,372,683  $93,485  $221,358  $1,057,840 
Liabilities:                                        
Deposits:                                        
Non-interest bearing demand $279,634  $279,634  $279,634  $0  $0  $244,834  $244,834  $244,834  $0  $0 
Savings, interest checking and money market  517,678   517,678   517,678   0   0   616,894   616,894   616,894   0   0 
Time deposits  285,375   285,155   0   0   285,155   318,652   315,994   0   0   315,994 
Federal funds purchased and securities sold under agreements to repurchase  29,118   29,118   29,118   0   0   34,795   34,795   34,795   0   0 
Federal Home Loan Bank advances and other borrowings  84,327   83,944   0   83,944   0 
Subordinated notes  49,486   35,712   0   35,712   0   49,486   42,166   0   42,166   0 
Federal Home Loan Bank advances  115,363   115,888   0   115,888   0 
Accrued interest payable  429   429   429   0   0   588   588   588   0   0 
 $1,277,083  $1,263,614  $826,859  $151,600  $285,155  $1,349,576  $1,339,215  $897,111  $126,110  $315,994 


30

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

      December 31, 2016       December 31, 2017 
      Fair Value Measurements       Fair Value Measurements 
      Quoted Prices            Quoted Prices      
      in Active     Net       in Active     Net 
      Markets for Other Significant       Markets for Other Significant 
 December 31, 2016  Identical  Observable  Unobservable  December 31, 2017  Identical  Observable  Unobservable 
 Carrying Fair Assets Inputs Inputs  Carrying Fair Assets Inputs Inputs 
(in thousands) amount  value  (Level 1)  (Level 2)  (Level 3)  amount  value  (Level 1)  (Level 2)  (Level 3) 
Assets:                                        
Cash and due from banks $25,589  $25,589  $25,589  $0  $0  $23,325  $23,325  $23,325  $0  $0 
Federal funds sold and overnight interest-bearing deposits  1,406   1,406   1,406   0   0   39,553   39,553   39,553   0   0 
Certificates of deposit in other banks  3,460   3,460   3,460   0   0 
Investment in available-for-sale securities  214,512   214,512   0   214,512   0   226,542   226,542   1,967   224,575   0 
Loans, net  964,143   959,929   0   0   959,929   1,057,580   1,058,153   0   0   1,058,153 
Investment in FHLB stock  5,149   5,149   0   5,149   0   6,390   6,390   0   6,390   0 
Mortgage servicing rights  2,584   2,584   0   0   2,584   2,713   2,713   0   0   2,713 
Cash surrender value - life insurance  2,409   2,409   0   2,409   0   2,484   2,484   0   2,484   0 
Accrued interest receivable  5,183   5,183   5,183   0   0   5,627   5,627   5,627   0   0 
 $1,220,975  $1,216,761  $32,178  $222,070  $962,513  $1,367,674  $1,368,247  $73,932  $233,449  $1,060,866 
Liabilities:                                        
Deposits:                                        
Non-interest bearing demand $235,975  $235,975  $235,975  $0  $0  $245,380  $245,380  $245,380  $0  $0 
Savings, interest checking and money market  468,731   468,731   468,731   0   0   584,468   584,468   584,468   0   0 
Time deposits  305,960   304,334   0   0   304,334   295,964   294,778   0   0   294,778 
Federal funds purchased and securities sold under agreements to repurchase  31,015   31,015   31,015   0   0   27,560   27,560   27,560   0   0 
Federal Home Loan Bank advances and other borrowings  121,382   121,291   0   121,291   0 
Subordinated notes  49,486   33,712   0   33,712   0   49,486   39,692   0   39,692   0 
Other borrowings  93,392   93,209   0   93,209   0 
Accrued interest payable  498   498   498   0   0   554   554   554   0   0 
 $1,185,057  $1,167,474  $736,219  $126,921  $304,334  $1,324,794  $1,313,723  $857,962  $160,983  $294,778 

 

Off-Balance Sheet Financial Instruments

 

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

 

Limitations

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

 

(14)Repurchase Reserve Liability

 

The Company’s repurchase reserve liability for estimated losses incurred on sold loans was $160,000 at both June 30, 2017March 31, 2018 and December 31, 2016.2017. This liability represents management’s estimate of the potential repurchase or make-whole liability for residential mortgage loans originated for sale that may arise from representation and warranty claims that could relate to a variety of issues, including but not limited to, misrepresentation of facts, appraisal issues, or program requirements that may not meet investor guidelines. At June 30, 2017,March 31, 2018, the Company was servicing 2,8102,743 loans sold to the secondary market with a balance of approximately $289.8$283.1 million compared to 2,8772,773 loans sold with a balance of approximately $294.4$285.8 million at December 31, 2016.2017.


31

Hawthorn Bancshares, Inc.
and subsidiaries

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

 

 Three Months Ended June 30, Six Months Ended June 30,  Three Months Ended March 31, 
(in thousands) 2017  2016  2017  2016  2018  2017 
Balance at beginning of year $160  $160  $160  $160  $160  $160 
Provision for repurchase liability  0   2   0   2   0   0 
Reimbursement of expenses  0   (2)  0   (2)  0   0 
Balance at end of year $160  $160  $160  $160  $160  $160 

 

(15)Commitments and Contingencies

 

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

 

The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At June 30, 2017,March 31, 2018, no amounts have been accrued for any estimated losses for these financial instruments.

 

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

 

 June 30, December 31,  March 31, December 31, 
(in thousands) 2017  2016  2018  2017 
Commitments to extend credit $220,119  $253,375  $228,595  $238,527 
Commitments to originate residential first and second mortgage loans  4,572   2,626   3,490   1,471 
Standby letters of credit  57,018   2,745   76,479   74,004 
Total  281,709   258,746   308,564   314,002 

Commitments

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

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support contractual obligations of the Company’s customers. The approximate remaining term of standby letters of credit range from one month to five years at June 30, 2017.March 31, 2018.

 

Pending Litigation

 

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

32

Hawthorn Bancshares, Inc.
and subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(16)Revenue Recognition

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

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

Trust Department Revenue

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

Service Charges on Deposit Accounts

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

Fees, Exchange, and Other Service Charges

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

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

The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. No OREO sales for the three months ended March 31, 2018 and two sales for the three months ended March 31, 2017 were financed by the Bank, which financings were consistent with market terms.

33

 

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 wordsbelieves,expects, may, will, should, could, anticipates, estimates, intends or similar expressions.

 

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

 

·competitive pressures among financial services companies may increase significantly,
·changes in the interest rate environment may reduce interest margins,
·general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,
·increases in non-performing assets in the Company’s loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,
·costs or difficulties related to the integration of the business of the Company and its acquisition targets may be greater than expected,
·legislative, regulatory, or regulatorytax law changes may adversely affect the business in which the Company and its subsidiaries are engaged, and
·changes may occur in the securities markets.

 

We have described under the captionRisk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016,2017, and in other reports filed with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.

 

Overview

 

Crucial to the Company’s community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank, the Company, with $1.4$1.5 billion in assets at June 30, 2017,March 31, 2018, provides a broad range of commercial and personal banking services. The Bank’s specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate, Small Business Administration (SBA) loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts. Other financial services that the Company provides include trust services that include estate planning, investment and asset management services and a comprehensive suite of cash management services. The geographic areas in which the Company provides products and services include the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, Branson, and the greater Kansas City metropolitan area.

 

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

 

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


34

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 throughoutManagement’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 theLending 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 Foreclosed Assets

35

 

Other real estate and foreclosed 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 vehicles, 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.


SELECTED CONSOLIDATED FINANCIAL DATA

 

The following table presents selected consolidated financial information for the Company as of and for each of the three and six months ended June 30,March 31, 2018 and 2017, and 2016, 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

Selected Financial Data     
 Three Months Ended Six Months Ended  Three Months Ended 
 June 30,  June 30,  March 31, 
(In thousands, except per share data) 2017  2016  2017  2016  2018  2017 
Per Share Data                        
Basic earnings per share $0.33  $0.24  $0.69  $0.58  $0.36  $0.36 
Diluted earnings per share  0.33   0.24   0.69   0.58   0.36   0.36 
Dividends paid on common stock  338   271   674   542   406   336 
Book value per share          16.29   15.63   15.74   15.94 
Market price per share          20.95   13.26   20.64   20.29 
Selected Ratios                        
(Based on average balance sheets)                        
Return on total assets  0.58%  0.46%  0.61%  0.56%  0.60%  0.65%
Return on stockholders' equity  8.35%  6.26%  8.65%  7.62%  9.32%  9.23%
Stockholders' equity to total assets  7.01%  7.31%  7.06%  7.29%  6.41%  7.01%
Efficiency ratio (1)  74.98%  78.46%  73.75%  76.13%  78.54%  72.52%
                        
(Based on end-of-period data)                        
Stockholders' equity to assets          6.88%  7.25%  6.28%  7.05%
Total risk-based capital ratio          13.47%  14.19%  12.87%  13.60%
Tier 1 risk-based capital ratio          11.20%  11.63%  10.61%  11.25%
Common equity Tier 1 capital          8.43%  8.73%  8.04%  8.47%
Tier 1 leverage ratio (2)          9.77%  9.88%  9.17%  9.74%

 

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


36

RESULTS OF OPERATIONS ANALYSIS

 

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

 

 Three Months Ended June 30,  Six Months Ended June 30, 
      $ %       $ %  Three Months Ended March 31, 
(In thousands) 2017 2016 Change Change 2017 2016 Change Change  2018  2017  $ Change  % Change 
                          
Net interest income $10,820  $9,971  $849   8.5% $21,307  $19,819  $1,488   7.5% $10,754  $10,487  $267   2.5%
Provision for loan losses  330   425   (95)  (22.4)  680   675   5   0.7   300   350   (50)  (14.3)
Noninterest income  2,099   1,949   150   7.7   4,506   4,397   109   2.5   2,301   2,407   (106)  (4.4)
Noninterest expense  9,687   9,353   334   3.6   19,037   18,436   601   3.3   10,254   9,351   903   9.7 
Income before income taxes  2,902   2,142   760   35.5   6,096   5,105   991   19.4 
Income before                
income taxes  2,501   3,193   (692)  (21.7)
Income tax expense  983   730   253   34.7   2,076   1,695   381   22.5   411   1,093   (682)  (62.4)
Net income $1,919  $1,412  $507   35.9% $4,020  $3,410  $610   17.9% $2,090  $2,100  $(10)  (0.5)%

Consolidated net income of $1.9$2.1 million, or $0.33$0.36 per diluted share, was consistent for both the three months ended June 30, 2017 increased $507,000 compared to $1.4 million, or $0.24 per diluted share, for the three months ended June 30, 2016.March 31, 2018 and 2017. For the three months ended June 30, 2017,March 31, 2018, the return on average assets was 0.58%0.60%, the return on average stockholders’ equity was 8.35%9.32%, and the efficiency ratio was 74.98%.

Consolidated net income increased $610,000 to $4.0 million, or $0.69 per diluted share, for the six months ended June 30, 2017 compared to $3.4 million, or $0.58 per diluted share, for the six months ended June 30, 2016. For the six months ended June 30, 2017, the return on average assets was 0.61%, the return on average stockholders’ equity was 8.65%, and the efficiency ratio was 73.75%78.54%.

 

Net interest income was $10.8 million and $21.3for the three months ended March 31, 2018 compared to $10.5 million for the three and six months ended June 30, 2017, respectively, compared to $10.0 million and $19.8 million for the three and six months ended June 30, 2016.March 31, 2017. The net interest margin (expressed on a fully taxable equivalent basis) increaseddecreased to 3.50%3.29% for the three months ended June 30, 2017,March 31, 2018, compared to 3.49%3.48% for the three months ended June 30, 2016, and decreased to 3.49% for the six months ended June 30, 2017 compared to 3.50% for the six months ended June 30, 2016.March 31, 2017. These changes are discussed in greater detail under theAverage Balance Sheets and Rate and Volume Analysis section below.

 

A $330,000 and $680,000$300,000provision for loan losseswas recorded for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to a $425,000 and $675,000$350,000 provision for the three and six months ended June 30, 2016, respectively.March 31, 2017.

 

The Company’s net charge-offs were $47,000,$205,000, or 0.02% of average loans, for the three months ended March 31, 2018 compared to net recoveries of $26,000, or 0.00% of average loans, for the three months ended June 30, 2017 compared to net recoveries of $336,000, or (0.04)% of average loans, for the three months ended June 30, 2016. For the six months ended June 30, 2017, the Company’s net charge-offs were $21,000, or 0.00% of average loans compared to net recoveries of $113,000, or (0.01)% of average loans for the six months ended June 30, 2016.

March 31, 2017. Non-performing loans totaled $10.0$10.1 million, or 0.97%0.93% of total loans, at June 30, 2017March 31, 2018 compared to $9.2$10.7 million, or 0.95%1.00% of total loans, at December 31, 2016,2017, and $9.5$9.4 million, or 1.02%0.93% of total loans, at June 30, 2016.March 31, 2017. These changes are discussed in greater detail under theLending and Credit Management section below.

 

Non-interest income increased $150,000,decreased $106,000, or 7.7%4.4%, for the three months ended June 30, 2017March 31, 2018 compared to the three months ended June 30, 2016, and increased $109,000, or 2.5%, for the six months ended June 30, 2007 compared to the six months ended June 30, 2016.March 31, 2017. These changes are discussed in greater detail below under Non-interest Income.

 

Non-interest expense increased $334,000,$903,000, or 3.6%9.7%, for the three months ended June 30, 2017March 31, 2018 compared to the three months ended June 30, 2016, and increased $601,000, or 3.3%, for the six months ended June 30, 2017 compared to the six months ended June 30,March 31, 2017. These changes are discussed in greater detail below under Non-interest Expense.


Average Balance Sheets

 

Net interest incomeis the largest source of revenue resulting from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the periods ended June 30,March 31, 2018 and 2017, and 2016, respectively.

 

 36

37

 

 

 Three Months Ended June 30,  Three Months Ended March 31, 
(In thousands) 2017  2016  2018  2017 
    Interest Rate     Interest Rate     Interest Rate     Interest Rate 
 Average Income/ Earned/ Average Income/ Earned/  Average Income/ Earned/ Average Income/ Earned/ 
 Balance  Expense(1)  Paid(1)  Balance  Expense(1)  Paid(1)  Balance  Expense(1)  Paid(1)  Balance  Expense(1)  Paid(1) 
ASSETS                                                
Loans: (2) (4)                                                
Commercial $190,888  $2,165   4.55% $154,509  $1,794   4.67% $190,698  $2,257   4.80% $182,548  $2,062   4.58%
Real estate construction - residential  20,559   236   4.60   18,207   206   4.55   28,470   342   4.87   19,307   215   4.52 
Real estate construction - commercial  71,661   798   4.47   42,980   540   5.05   101,856   1,172   4.67   66,214   720   4.41 
Real estate mortgage - residential  258,958   2,959   4.58   250,868   2,844   4.56   247,579   2,859   4.68   260,551   2,922   4.55 
Real estate mortgage - commercial  451,185   5,268   4.68   404,141   4,686   4.66   471,927   5,360   4.61   433,152   4,894   4.58 
Consumer  31,801   309   3.90   25,707   288   4.51   32,342   293   3.67   30,234   300   4.02 
Total loans $1,025,052  $11,735   4.59% $896,412  $10,358   4.65% $1,072,872  $12,283   4.64% $992,006  $11,113   4.54%
Investment securities: (3)                                                
                        
U.S. Treasury $17,502  $60   1.39% $0  $0   0.00%
U.S. government and federal agency obligations $48,888  $176   1.44% $40,925  $117   1.15%  49,399   190   1.56   45,410   156   1.39 
Obligations of states and political subdivisions  47,721   266   2.24   28,156   191   2.73   44,807   270   2.44   43,733   249   2.31 
Mortgage-backed securities  120,012   544   1.82   171,765   700   1.64   125,453   680   2.20   124,321   582   1.90 
Total investment securities $216,621  $986   1.83% $240,846  $1,008   1.68% $237,161  $1,200   2.05% $213,464  $987   1.88%
Other investments and securities, at cost  10,588   94   3.56   8,544   75   3.53   9,910   110   4.50   9,785   90   3.73 
Federal funds sold and interest bearing deposits in other financial institutions  4,795   11   0.92   16,140   18   0.45   24,573   106   1.75   21,657   48   0.90 
Total interest earning assets $1,257,056  $12,826   4.09% $1,161,942  $11,459   3.97% $1,344,516  $13,699   4.13% $1,236,912  $12,238   4.01%
All other assets  88,361           88,640           85,116           90,264         
Allowance for loan losses  (10,385)          (8,909)          (10,916)          (10,003)        
Total assets $1,335,032          $1,241,673          $1,418,716          $1,317,173         
LIABILITIES AND STOCKHOLDERS' EQUITY                        
LIABILITIES AND                        
STOCKHOLDERS' EQUITY                        
NOW accounts $212,226  $272   0.51% $205,801  $157   0.31% $243,245  $533   0.89% $216,075  $232   0.44%
Savings  100,985   13   0.05   97,027   12   0.05   94,356   12   0.05   99,828   12   0.05 
Commercial  1,523   2   0.53   0   0   0.00   1,604   4   1.01   1,655   2   0.49 
Money market  203,697   188   0.37   181,724   118   0.26   265,994   535   0.82   199,698   143   0.29 
Time deposits of $250,000 and over  57,095   99   0.70   61,636   85   0.55 
Other time deposits  229,366   410   0.72   235,801   383   0.65 
Time deposits  289,970   649   0.91   296,357   471   0.64 
Total interest bearing deposits $804,892  $984   0.49% $781,989  $755   0.39% $895,169  $1,733   0.79% $813,613  $860   0.43%
Federal funds purchased and securities sold under agreements to repurchase  29,237   27   0.37   36,333   15   0.17   43,060   171   1.61   29,078   22   0.31 
Federal Home Loan advances and other  93,041   395   1.72   92,578   322   1.41 
Subordinated notes  49,486   431   3.49   49,486   366   2.97   49,486   491   4.02   49,486   408   3.34 
Federal Home Loan Bank Advances  110,124   419   1.53   61,604   243   1.59 
Total borrowings $188,847  $877   1.86% $147,423  $624   1.70% $185,587  $1,057   2.31% $171,142  $752   1.78%
Total interest bearing liabilities $993,739  $1,861   0.75% $929,412  $1,379   0.60% $1,080,756  $2,790   1.05% $984,755  $1,612   0.66%
Demand deposits  235,232           212,569           234,129           228,765         
Other liabilities  11,075           8,902           12,892           11,322         
Total liabilities  1,240,046           1,150,883           1,327,777           1,224,842         
Stockholders' equity  94,986           90,790           90,939           92,331         
Total liabilities and stockholders' equity $1,335,032          $1,241,673          $1,418,716          $1,317,173         
Net interest income (FTE)      10,965           10,080           10,909           10,626     
Net interest spread          3.34%          3.37%          3.08%          3.35%
Net interest margin          3.50%          3.49%          3.29%          3.48%

 

(1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21% and 34%, net of nondeductible interest expense. Such adjustments totaled $145,000 and $109,000expense for the three months ended June 30,March 31, 2018 and 2017 respectively. Such adjustments totaled $155,000 and 2016,$139,000 for the three months ended March 31, 2018 and 2017, respectively.
(2)Non-accruing loans are included in the average amounts outstanding.
(3)Average balances based on amortized cost.
(4)Fees and costs on loans are included in interest income.

  Six Months Ended June 30, 
(In thousands) 2017  2016 
     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 $186,741  $4,164   4.50% $150,746  $3,509   4.68%
Real estate construction - residential  19,936   451   4.56   18,167   414   4.58 
Real estate construction - commercial  68,952   1,518   4.44   39,157   949   4.87 
Real estate mortgage - residential  259,750   5,882   4.57   252,190   5,754   4.59 
Real estate mortgage - commercial  442,219   10,223   4.66   396,282   9,208   4.67 
Consumer  31,022   609   3.96   24,794   562   4.56 
Total loans $1,008,620  $22,847   4.57% $881,336  $20,396   4.65%
Investment securities: (3)                        
U.S. government and federal agency obligations $47,159  $332   1.42% $52,692  $305   1.16%
Obligations of states and political subdivisions  45,738   516   2.28   29,901   419   2.82 
Mortgage-backed securities  122,154   1,126   1.86   161,195   1,437   1.79 
Total investment securities $215,051  $1,974   1.85% $243,788  $2,161   1.78%
Other investments and securities, at cost  10,189   184   3.64   8,291   151   3.66 
Federal funds sold and interest bearing deposits in other financial institutions  13,179   60   0.92   19,226   50   0.52 
Total interest earning assets $1,247,039  $25,065   4.05% $1,152,641  $22,758   3.97%
All other assets  89,308           89,571         
Allowance for loan losses  (10,195)          (8,748)        
Total assets $1,326,152          $1,233,464         
LIABILITIES AND STOCKHOLDERS' EQUITY                        
NOW accounts $214,140  $504   0.47% $207,720  $324   0.31%
Savings  100,409   25   0.05   94,627   24   0.05 
Commercial  1,589   4   0.51   0   0   0.00 
Money market  201,709   331   0.33   180,131   234   0.26 
Time deposits of $250,000 and over  60,623   191   0.64   58,779   153   0.52 
Other time deposits  230,759   789   0.69   236,692   764   0.65 
Total interest bearing deposits $809,229  $1,844   0.46% $777,949  $1,499   0.39%
Federal funds purchased and securities sold under agreements to repurchase  29,158   49   0.34   42,814   39   0.18 
Subordinated notes  49,486   840   3.42   49,486   720   2.93 
Federal Home Loan Bank Advances  101,399   741   1.47   55,802   450   1.62 
Total borrowings $180,043  $1,630   1.83% $148,102  $1,209   1.64%
Total interest bearing liabilities $989,272  $3,474   0.71% $926,051  $2,708   0.59%
Demand deposits  232,016           207,833         
Other liabilities  11,198           9,613         
Total liabilities  1,232,486           1,143,497         
Stockholders' equity  93,666           89,967         
Total liabilities and stockholders' equity $1,326,152          $1,233,464         
Net interest income (FTE)      21,591           20,050     
Net interest spread          3.34%          3.38%
Net interest margin          3.49%          3.50%

 

(1)38Interest 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 $284,000 and $231,000 for the six months ended June 30, 2017 and 2016, 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.

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 six months ended June 30, 2017March 31, 2018 compared to the three and six months ended June 30, 2016.March 31, 2017. 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  June 30, Six Months Ended  June 30,  Three Months Ended  March 31, 
 2017 vs. 2016  2017 vs. 2016  2018 vs. 2017 
    Change due to     Change due to     Change due to 
 Total Average Average Total Average Average  Total Average Average 
(In thousands) Change  Volume  Rate  Change  Volume  Rate  Change  Volume  Rate 
Interest income on a fully taxable equivalent basis: (1)                                    
Loans: (2) (4)                                    
Commercial $371  $413  $(42) $655  $808  $(153) $195  $94  $101 
Real estate construction - residential  30   27   3   37   40   (3)  127   109   18 
Real estate construction - commercial  258   325   (67)  569   663   (94)  452   408   44 
Real estate mortgage - residential  115   93   22   128   171   (43)  (63)  (148)  85 
Real estate mortgage - commercial  582   549   33   1,015   1,062   (47)  466   440   26 
Consumer  21   62   (41)  47   129   (82)  (7)  20   (27)
Investment securities: (3)                                    
U.S. Treasury  60   55   5 
U.S. government and federal agency obligations  59   26   33   27   (34)  61   34   15   19 
Obligations of states and political subdivisions  75   114   (39)  97   190   (93)  21   6   15 
Mortgage-backed securities  (156)  (228)  72   (311)  (358)  47   98   5   93 
Other investments and securities, at cost  19   18   1   33   35   (2)  20   1   19 
Federal funds sold and interest bearing deposits in other financial institutions  (7)  (18)  11   10   (19)  29   58   7   51 
Total interest income  1,367   1,381   (14)  2,307   2,687   (380)  1,461   1,012   449 
Interest expense:                                    
NOW accounts  115   5   110   180   10   170   301   32   269 
Savings  1   0   1   1   1   0   0   (1)  1 
Commercial  2   0   2   4   0   4   2   0   2 
Money market  70   15   55   97   30   67   392   60   332 
Time deposits of $250,000 and over  15   (6)  21   40   5   35 
Other time deposits  26   (10)  36   23   (19)  42 
Time deposits  178   (10)  188 
Federal funds purchased and securities sold under agreements to repurchase  12   (3)  15   10   (15)  25   149   16   133 
Federal Home Loan Bank advances and other  73   2   71 
Subordinated notes  65   0   65   120   0   120   83   0   83 
Federal Home Loan Bank advances  176   185   (9)  291   337   (46)
Total interest expense  482   186   296   766   349   417   1,178   99   1,079 
Net interest income on a fully taxable equivalent basis $885  $1,195  $(310) $1,541  $2,338  $(797) $283  $913  $(630)

 

(1)Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 21% and 34%, net of nondeductible interest expense.expense for the three month ended March 31, 2018 and 2017, respectively. Such adjustments totaled $145,000$155,000 and $284,000$139,000 for the three months ended March 31, 2018 and six months June 30, 2017, respectively, compared to $109,000 and $231,000 for the three and six months June 30, 2016, 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 June 30, 2017March 31, 2018 compared to the three months ended June 30, 2016,March 31, 2017, reflected an increase in net interest income, on a tax equivalent basis, of $885,000,$283,000, or 8.78%, and the financial results for the six months ended June 30, 2017 compared to the six months ended June 30, 2016 reflected an increase of $1.5 million, or 7.69%2.66%.

Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) increaseddecreased to 3.50%3.29% for the three months ended June 30, 2017March 31, 2018 compared to 3.49%3.48% for the three months ended June 30, 2016, and decreased to 3.49% for the six months ended June 30, 2017 compared to 3.50% for the six months ended June 30, 2016. The increase inMarch 31, 2017. Although net interest income wasincreased primarily due to an increase in average loans and theearning assets, net interest margin has remained relatively unchanged duringdecreased due to the periods reported. Due to loan growth and maintaining netcost of interest margin, netbearing liabilities repriced faster than the rate earned on interest income has continued to increase.


bearing assets.

Average interest-earning assets increased $95.1$107.6 million, or 8.19%8.70%, to $1.26$1.34 billion for the three months ended June 30, 2017March 31, 2018 compared to $1.16$1.24 billion for the three months ended June 30, 2016,March 31, 2017, and average interest bearing liabilities increased $64.3$96.0 million, or 6.92%9.75%, to $993.7$1.1 million for the three months ended June 30, 2017March 31, 2018 compared to $929.4$984.8 million for the three months ended June 30, 2016.March 31, 2017.

39

 

Average interest-earning assets increased $94.4 million, or 8.19%, to $1.25 billion for the six months ended June 30, 2017 compared to $1.15 billion for the six months ended June 30, 2016, and average interest bearing liabilities increased $63.2 million, or 6.83%, to $989.3 million for the six months ended June 30, 2017 compared to $926.1 million for the six months ended June 30, 2016.

 

Total interest income(expressed on a fully taxable equivalent basis) was $12.8 million and $25.1$13.7 million for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to $11.5 million and $22.8$12.2 million for the three and six months ended June 30, 2016, respectively.March 31, 2017. The Company’s rates earned on interest earning assets were 4.09% and 4.05%4.13% for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to 3.97%4.01% for both the three and six months ended June 30, 2016.March 31, 2017.

 

Interest income on loansincreased to $11.7 million and $22.8$12.3 million for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to $10.4 million and $20.4$11.1 million for the three and six months ended June 30, 2016, respectively.March 31, 2017.

 

Average loans outstanding increased $128.6$80.9 million, or 14.4%8.15%, to $1.0$1.1 billion for the three months ended June 30, 2017March 31, 2018 compared to $896.4$992.0 million for the three months ended June 30, 2016.March 31, 2017. The average yield on loans receivable decreasedincreased to 4.59%4.64% for the three months ended June 30, 2017March 31, 2018 compared to 4.65%4.54% for the three months ended June 30, 2016.

For the six months ended June 30, 2017, average loans outstanding increased $127.3 million, or 14.4%, to $1.0 billion compared to $881.3 million for the six months ended June 30, 2016. The average yield on loans receivable decreased to 4.57% for the six months ended June 30, 2017 compared to 4.65% for the six months ended June 30, 2016.March 31, 2017. See theLending and Credit Management section for further discussion of changes in the composition of the lending portfolio.

 

Total interest expense wasincreased to $1.9 million and $3.5$2.8 million for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to $1.4 million and $2.7$1.6 million for the three and six months ended June 30, 2016, respectivley.March 31, 2017. The Company’s rates paid on interest bearing liabilities was 0.75% and 0.71%1.05% for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to 0.60% and 0.59%0.66% for the three and six months ended June 30, 2016, respectively.March 31, 2017. See theLiquidity Managementsection for further discussion.

 

Interest expense on depositsincreased to $984,000 and $1.8$1.7 million for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to $755,000 and $1.5 million$860,000 for the three and six months ended June 30, 2016, respectively.March 31, 2017.

 

Average interest bearing deposits increased $22.9$81.6 million, or 2.93%10.02%, to $804.9$895.2 million for the three months ended June 30, 2017March 31, 2018 compared to $782.0$813.6 million for the three months ended June 30, 2016.March 31, 2017. The increase was primarily due to a new money market product that brought in new deposits in addition to new public funds. The average cost of deposits increased to 0.49%0.79% for the three months ended June 30, 2017March 31, 2018 compared to 0.39%0.43% for the three months ended June 30, 2016.

ForMarch 31, 2017. The increase was primarily due to the six months ended June 30, 2017, average interest bearing deposits increased $31.3 million, or 4.02%, to $809.2 million compared to $778.0 million forrate paid on the six months ended June 30, 2016. The average cost of deposits increased to 0.46% for the six months ended June 30, 2017 compared to 0.39% for the six months ended June 30, 2016 primarily as a result ofnew money market product and generally higher market interest rates.rates during the current quarter versus the prior year quarter ended March 31, 2017.

 

Interest expense on borrowingsincreased to $877,000 and $1.6 million for the three and six months ended June 30, 2017, respectively, compared to $624,000 and $1.2 million for the three and six months ended June 30, 2016, respectively.

Average borrowings increased $41.4 million, or 28.10%, to $188.8$1.1 million for the three months ended June 30, 2017March 31, 2018 compared to $147.4$752,000 for the three months ended March 31, 2017. Average borrowings increased to $185.6 million for the three months ended June 30, 2016.March 31, 2018 compared to $171.1 million for the three months ended March 31, 2017. The primary increase in average borrowings resulted from FHLB advances to fund loan growth and a tax initiative involving a short sale of a U.S. Treasury security funded by a repurchase agreement. The average cost of borrowings increased to 1.86%2.31% for the three months ended June 30, 2017March 31, 2018 compared to 1.70%1.78% for the three months ended June 30, 2016.

For the six months ended June 30, 2017, average borrowings increased $31.9 million, or 21.57%, to $180.0 million for the six months ended June 30, 2017 compared to $148.1 million for the six months ended June 30, 2016.March 31, 2017. The averageincrease in cost of borrowings increasedfunds, primarily resulted from higher interest rates and the additional interest cost of the repurchase agreement related to 1.83% for the six months ended June 30, 2017 compared to 1.64% for the six months ended June 30, 2016.short sale. See theLiquidity Managementsection for further discussion.

 

 40

Non-interest Income and Expense

 

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

 

 Three Months Ended June 30,  Six Months Ended June 30,  Three Months Ended March 31, 
(In thousands) 2017  2016  $
Change		  %
Change		  2017  2016  $
Change		  %
Change		  2018  2017  $ Change  % Change 
Non-interest Income                                                
Service charges and other fees $851  $828  $23   2.8% $1,687  $1,662  $25   1.5% $876  $836  $40   4.8%
Bank card income and fees  663   648   15   2.3   1,277   1,282   (5)  (0.4)  656   614   42   6.8 
Trust department income  266   265   1   0.4   540   483   57   11.8   280   274   6   2.2 
Real estate servicing fees, net  34   (86)  120   139.5   487   (32)  519   1,621.9   221   453   (232)  (51.2)
Gain on sales of mortgage loans, net  218   222   (4)  (1.8)  374   387   (13)  (3.4)  146   155   (9)  (5.8)
Gain on sale of investment securities  0   18   (18)  (100.0)  0   490   (490)  (100.0)
Other  67   54   13   24.1   141   125   16   12.8   122   75   47   62.7 
Total non-interest income $2,099  $1,949  $150   7.7% $4,506  $4,397  $109   2.5% $2,301  $2,407  $(106)  (4.4)%
                                                
Non-interest income as a % of total revenue *  16.2%  16.4%          17.5%  18.2%          17.6%  18.7%        
Total revenue per full time equivalent employee $38.8  $35.6          $77.7  $71.8         

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

Total non-interest income increased $150,000,decreased $106,000, or 7.7%4.4%, to $2.1$2.3 million for the quarterthree months ended June 30, 2017March 31, 2018 compared to $1.9$2.4 million for the quarter ended June 30, 2016, and increased $109,000, or 2.5%, to $4.5 million for the sixthree months ended June 30, 2017 compared to $4.4 million for the six months ended June 30, 2016.March 31, 2017.

 

Real estate servicing fees, netof the change in valuation of mortgage serving rights increased $120,000decreased $232,000 to $34,000$221,000 for the quarterthree months ended June 30, 2017March 31, 2018 compared to $(86,000)$453,000 for the quarter ended June 30, 2016, and increased $519,000 to $487,000 for the sixthree months ended June 30,March 31, 2017 compared to $(32,000) for the six months ended June 30, 2016. The increases in both periods were primarily due to slowera $226,000 decrease in the change in fair value quarter over quarter. This change in value is primarily the result of market-driven changes in interest rates and prepayment speeds resulting from a higher rate environment. speeds.

40

Mortgage loan servicing fees earned on loans sold were $211,000 for both the quarters ended June 30, 2017 and 2016, and $420,000$203,000 for the sixthree months ended June 30, 2017March 31, 2018 compared to $421,000$209,000 for the sixthree months ended June 30, 2016.

March 31, 2017. The Company was servicing $289.8$283.1 million of mortgage loans at June 30, 2017March 31, 2018 compared to $294.4$285.8 million and $304.7$291.0 million at December 31, 20162017 and June 30, 2016,March 31, 2017, respectively.

 

Gain on sales of mortgage loansdecreased $4,000$9,000, or 5.8%, to $218,000$146,000 for the quarterthree months ended June 30, 2017March 31, 2018 compared to $222,000$155,000 for the quarter ended June 30, 2016, and decreased $13,000 to $374,000 for the sixthree months ended June 30, 2017 comparedMarch 31, 2017. The decrease quarter over quarter was primarily due to $387,000 for the six months ended June 30, 2016.an increase in loan origination costs. The Company sold loans of $9.4$7.6 million for the quarterthree months ended June 30, 2017March 31, 2018 compared to $10.1$6.8 million for the quarterthree months ended June 30, 2016, and $16.2 millionMarch 31, 2017.

Other Income increased $47,000, or 62.7%, to $122,000 for the sixthree months ended June 30, 2017March 31, 2018 compared to $17.5 million$75,000 for the sixthree months ended June 30, 2016.

NoMarch 31, 2017 primarily due to a gain on the sale of investment securities was recognized during the three and six months ended June 30, 2017. During the six months ended June 30, 2016 the Company received $44.3 million from proceeds on sales of available-for-sale debt securities and recognized gains of $490,000. This transaction was the result of bond sales and purchases to replace several smaller holdings with fewer, larger investments without materially changing the duration or yield of the investment portfolio. partially offset by a decrease in brokerage income.

 41

 

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

 

 Three Months Ended June 30,  Six Months Ended June 30,  Three Months Ended March 31, 
(In thousands) 2017  2016  $ Change  % Change  2017  2016  $ Change  % Change  2018  2017  $ Change  % Change 
Non-interest Expense                                                
Salaries $4,010  $3,927  $83   2.1% $8,064  $7,965  $99   1.2% $4,552  $4,054  $498   12.3%
Employee benefits  1,342   1,378   (36)  (2.6)  2,742   2,690   52   1.9   1,505   1,384   121   8.7 
Occupancy expense, net  689   673   16   2.4   1,307   1,306   1   0.1   689   619   70   11.3 
Furniture and equipment expense  634   439   195   44.4   1,232   850   382   44.9   635   598   37   6.2 
Processing expense, network and bank card expense  927   840   87   10.4   1,972   1,611   361   22.4   859   1,045   (186)  (17.8)
Legal, examination, and professional fees  317   328   (11)  (3.4)  597   662   (65)  (9.8)  422   280   142   50.7 
FDIC insurance assessment  115   188   (73)  (38.8)  216   364   (148)  (40.7)  154   101   53   52.5 
Advertising and promotion  265   242   23   9.5   503   452   51   11.3   252   239   13   5.4 
Postage, printing, and supplies  263   291   (28)  (9.6)  495   527   (32)  (6.1)  268   223   45   20.2 
Real estate foreclosure expense, net  226   42   184   438.1   253   183   70   38.3 
Other  899   1,005   (106)  (10.5)  1,656   1,826   (170)  (9.3)  918   808   110   13.6 
Total non-interest expense $9,687  $9,353  $334   3.6% $19,037  $18,436  $601   3.3% $10,254  $9,351  $903   9.7%
Efficiency ratio *  75.0%  78.5%          73.8%  76.1%          78.5%  72.5%        
Salaries and benefits as a % of total non-interest expense  55.2%  56.7%          56.8%  57.8%        
Number of full-time equivalent employees  333   335           332   337           339   333         

*Efficiency ratio is calculated as non-interest expense as a percent of revenue.

Total revenue includes net interest income and non-interest income.

* Efficiency ratio is calculated as non-interest expense as a percent of revenue.

Total non-interest expense increased $334,000,$903,000, or 3.6%9.7%, to $9.7$10.3 million for the quarterthree months ended June 30, 2017March 31, 2018 compared to $9.4 million for the quarter ended June 30, 2016, and increased $601,000, or 3.3%, to $19.0 million for the sixthree months ended June 30, 2017 compared to $18.4 million for the six months ended June 30, 2016.March 31, 2017.

 

FurnitureSalaries increased $498,000, or 12.3%, to $4.6 million for the three months ended March 31, 2018 compared to $4.1 million for the three months ended March 31, 2017. The increase was primarily due to a bonus that was paid in February 2018 to all eligible full-time and equipmentpart-time employees as a result of the expected tax savings from the new tax reform.

Employee benefits increased $121,000, or 8.7%, to $1.5 million for the three months ended March 31, 2018 compared to $1.4 million for the three months ended March 31, 2017. The increase was primarily due to an increase in medical plan premiums effective July 1, 2017.

Occupancy expense increased $195,000,$70,000, or 44.4%11.3%, to $634,000$689,000 for the quarterthree months ended June 30, 2017March 31, 2018 compared to $439,000$619,000 for the quarter ended June 30, 2016, and increased $382,000, or 44.9%, to $1.2 million for the sixthree months ended June 30, 2017 comparedMarch 31, 2017. The increase was primarily due to $850,000 for the six months ended June 30, 2016. Beginning December 2016, the Company began upgrading its data processing infrastructure to a hosted cloud based network solution. The process included changes inincreased building repairs and maintenance, agreementsutilities, and service providers.real estate tax accruals.

 

Processing, network, and bank card expense increased $87,000,decreased $186,000, or 10.4%17.8%, to $927,000$859,000 for the quarterthree months ended June 30, 2017March 31, 2018 compared to $840,000 for the quarter ended June 30, 2016, and increased $361,000, or 22.4%, to $2.0$1.0 million for the sixthree months ended June 30, 2017 compared to $1.6 million for the six months ended June 30, 2016.March 31, 2017. The increase for both periodsdecrease was primarily due to additional one-time costs associated with a corporate wide network upgrade and changes in processing service providers.providers during 2017.

Legal, examination, and professional fees increased $142,000, or 50.7%, to $422,000 for the three months ended March 31, 2018 compared to $280,000 for the three months ended March 31, 2017. The increase was primarily related to an increase in consulting fees related to tax planning initiatives and audit fees partially offset by a decrease in legal fees.

41

FDIC insurance assessment increased $53,000, or 52.5%, to $154,000 for the three months ended March 31, 2018 compared to $101,000 for the three months ended March 31, 2017. The increase is primarily due to an increase in the Company’s total assessment base quarter over quarter.

 

FDIC insurance assessmentPostage, printing, and suppliesdecreased $73,000, increased $45,000, or 38.8%20.2%, to $115,000$268,000 for the quarterthree months ended June 30, 2017March 31, 2018 compared to $188,000$223,000 for the quarter ended June 30, 2016, and decreased $148,000, or 40.7%, to $216,000 for the sixthree months ended June 30, 2017 compared to $364,000 for the six months ended June 30, 2016. In February 2011, the FDIC adopted a rule that requires large institutions to bear the burden of raising the reserve ratio form 1.15% to 1.35% in accordance with the Dodd-Frank Act.March 31, 2017. The quarter after the reserve ratio reached 1.15%, lower assessment rates, surcharges, and new pricing for small institutions under $10 billion became effective July 1, 2016 and appeared on the December 31, 2016 invoicing. Once the reserve ratio reaches 1.38%, small institutions, such as Hawthorn, will receive credits to offset their contribution to raising the reserve ratio to 1.35%.

Real estate foreclosure expense, netincreased $184,000, or 438.1%, to $226,000 for the quarter ended June 30, 2017 compared to $42,000 for the quarter ended June 30, 2016, and increased $70,000, or 38.3%, to $253,000 for the six months ended June 30, 2017 compared to $183,000 for the six months ended June 30, 2016. Net losses (gains) recognized on other real estate owned were $190,000 for the quarter ended June 30, 2017 compared to $(26,000) for the quarter ended June 30, 2016, and $171,000 for the six months ended June 30, 2017 compared to $(47,000) for the six months ended June 30, 2016. Expenses to maintain foreclosed properties were $36,000 for the quarter ended June 30, 2017 compared to $68,000 for the quarter ended June 30, 2016, and $82,000 for the six months ended June 30, 2017 compared to $230,000 for the six months ended June 30, 2016. The decrease in expenses period over periodincrease was primarily due to sales of foreclosed assets.an increase in stationary and supplies.

 

Other non-interest expense decreased $106,000,increased $110,000, or 10.5%13.6%, to $899,000$918,000 for the quarterthree months ended June 30, 2017March 31, 2018 compared to $1.0 million$808,000 for the quarter ended June 30, 2016, and decreased $170,000, or 9.3%, to $1.7 million for the sixthree months ended June 30, 2017 compared to $1.8 million for the six months ended June 30, 2016.March 31, 2017. The decrease in both periodsincrease was primarily due to a decreasean increase in debit card charge offs due to fraudulent transactions in 2016, a decrease in directorsloan expense, correspondent bank and deposit fees, donations, employee training, education, and travel expenses, partially offset by a net loss on the sale of two branch buildings that were in other assets held for sale.miscellaneous charged off items.


Income taxes

 

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 33.9%16.4% for the quarter ended June 30, 2017March 31, 2018 compared to 34.1%34.2% for the quarter ended June 30, 2016. Income taxesMarch 31, 2017. The federal corporate income tax rate declined from 34% to 21% effective January 1, 2018 as a percentageresult of earnings before income taxes as reported in the consolidated financial statements were 34.1% for the six months ended June 30, 2017 compared to 33.2% for the six months ended June 30, 2016.Tax Cuts and Jobs Act. The increase in theCompany’s tax rate foris lower than the six months ended June 30, 2017federal statutory rate primarily as a result of tax-exempt income. The decrease in comparison to the six months ended June 30, 2016tax rate quarter over quarter is primarily due to an immaterial return to provision adjustment madea decrease in the firstfederal corporate tax rate and the Company’s additional tax planning initiatives. The provisional adjustments recorded in the fourth quarter of 2016.2017 related to the enactment of the Tax Cuts and Jobs Act have not been finalized as of March 31, 2018. The Company expects to finalize those adjustments within the one-year measurement period provided under Staff Accounting Bulletin No. 118 in regards to the application of FASB’s ASC Topic 740,Income Taxes. The impact of the Tax Cuts and Jobs Act is expected to require further adjustments in 2018 due to anticipated additional guidance from the U.S. Department of the Treasury, changes in our assumptions, completion of 2017 U.S. tax returns and further information and interpretations that become available.

 

Lending and Credit Management

 

Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 74.1%73.9% of total assets as of June 30, 2017March 31, 2018 compared to 74.9%74.0% as of December 31, 2016.2017.

 

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:

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Commercial, financial, and agricultural $187,251  $182,881  $190,720  $192,238 
Real estate construction - residential  20,037   18,907   29,351   26,492 
Real estate construction - commercial  78,257   55,653   105,345   98,340 
Real estate mortgage - residential  255,426   259,900   250,131   246,754 
Real estate mortgage - commercial  461,062   426,470   476,511   472,455 
Installment loans to individuals  32,987   30,218   32,268   32,153 
Total loans $1,035,020  $974,029  $1,084,326  $1,068,432 
Percent of categories to total loans:                
Commercial, financial, and agricultural  18.1%  18.8%  18.1%  18.0%
Real estate construction - residential  1.9   1.9   2.0   2.5 
Real estate construction - commercial  7.6   5.7   6.9   9.2 
Real estate mortgage - residential  24.7   26.7   26.1   23.1 
Real estate mortgage - commercial  44.5   43.8   43.8   44.2 
Installment loans to individuals  3.2   3.1   3.1   3.0 
Total  100.0%  100.0%  100.0%  100.0%

 

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 and six months ended June 30, 2017,March 31, 2018, the Company sold approximately $9.4 million and $16.2$7.6 million of loans to investors respectively, compared to $10.1 million and $17.5$6.8 million for the three and six months ended June 30, 2016, respectively.March 31, 2017. At June 30, 2017,March 31, 2018, the Company was servicing approximately $289.8$283.1 million of loans sold to the secondary market compared to $294.4$285.8 million at December 31, 2016,2017, and $304.7$291.0 million at June 30, 2016.March 31, 2017.

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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 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 310-10-35in310-10-35 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 necessary by management to provide for probable losses inherent in the loan portfolio.

 

Nonperforming Assets

The following table summarizes nonperforming assets at the dates indicated:

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Nonaccrual loans:                
Commercial, financial, and agricultural $1,123  $982  $2,258  $2,507 
Real estate construction - residential  59   0 
Real estate construction - commercial  48   50   0   97 
Real estate mortgage - residential  2,252   1,888   2,089   1,956 
Real estate mortgage - commercial  959   420   916   936 
Installment and other consumer  52   89   160   176 
Total $4,434  $3,429  $5,482  $5,672 
Loans contractually past - due 90 days or more and still accruing:                
Commercial, financial, and agricultural $0  $2 
Real estate construction - residential  0   275 
Real estate mortgage - residential $252  $54   0   28 
Installment and other consumer  37   11   38   23 
Total $289  $65  $38  $328 
Performing troubled debt restructurings  5,286   5,715   4,611   4,684 
Total nonperforming loans  10,009   9,209   10,131   10,684 
Other real estate owned and repossessed assets  13,356   14,162   13,239   13,182 
Total nonperforming assets $23,365  $23,371  $23,370  $23,866 
                
Loans $1,035,020  $974,029  $1,084,326  $1,068,432 
Allowance for loan losses to loans  1.02%  1.01%  1.01%  1.02%
Nonperforming loans to loans  0.97%  0.95%  0.93%  1.00%
Allowance for loan losses to nonperforming loans  105.36%  107.35%
Allowance for loan losses to        
nonperforming loans  108.05%  101.57%
Allowance for loan losses to nonperforming loans, excluding performing TDR's  223.27%  282.94%  198.32%  180.87%
Nonperforming assets to loans, other real estate owned and repossessed assets  2.23%  2.37%  2.13%  2.21%

 

Total nonperforming assets totaled $23.4 million at June 30, 2017March 31, 2018 compared to $23.4$23.9 million at December 31, 2016.2017. Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and TDRs totaled $10.0$10.1 million, or 0.97%0.93%, of total loans at June 30, 2017March 31, 2018 compared to $9.2$10.7 million, or 0.95%1.00%, of total loans at December 31, 2016.2017. Non-accrual loans included $992,000 and $619,000$1.7 million of loans classified as TDRs at June 30, 2017both March 31, 2018 and December 31, 2016,2017, respectively.

 

As of June 30, 2017March 31, 2018 and December 31, 2016,2017, approximately $5.4$4.4 million and $4.0$4.1 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. Management believes the general allowance was sufficient to cover the risks and probable losses related to such loans at June 30, 2017March 31, 2018 and December 31, 2016,2017, respectively.

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Total non-accrual loans at June 30, 2017 increased $1.0 millionMarch 31, 2018 decreased $190,000, or 3.3%, to $4.4$5.5 million compared to $3.4$5.7 million at December 31, 2016.2017. This increasedecrease primarily consisted of a $903,000 increasedecrease in commercial, financial, and agricultural loans and a decrease in real estate mortgage -construction – commercial loans, andpartially offset by an increase in real estate mortgage - residential loans, and a $141,000 increase in commercial, financial, and agricultural loans, partially offset by a $37,000 decrease in installmentreal estate construction – residential loans.

 

Loans past due 90 days and still accruing interest at June 30, 2017,March 31, 2018, were $289,000$38,000 compared to $65,000$328,000 at December 31, 2016.2017. Other real estate and repossessed assets at June 30, 2017 were $13.4 million compared to $14.2$13.2 million at both March 31, 2018 and December 31, 2016.2017. During the sixthree months ended June 30, 2017, $155,000March 31, 2018, $278,000 of nonaccrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to $1.6 million$103,000 during the sixthree months ended June 30, 2016.March 31, 2017.


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

 

 June 30, 2017  December 31, 2016  March 31, 2018  December 31, 2017 
(In thousands) Number of
Contracts		  Recorded
Investment		  Specific
Reserves		  Number of
Contracts		  Recorded
Investment		  Specific
Reserves		  

Number of

Contracts

 

Recorded

Investment

  Specific
Reserves		  

Number of

Contracts

  Recorded
Investment		  Specific
Reserves		 
Performing TDRs                                                
Commercial, financial and agricultural  8  $664  $29   8  $635  $11   6  $481  $19   6  $500  $20 
Real estate mortgage - residential  9   3,535   124   8   3,582   99   11   3,068   269   11   3,116   236 
Real estate mortgage - commercial  2   1,087   119   3   1,498   123   2   1,062   72   2   1,068   109 
Total performing TDRs  19  $5,286  $272   19  $5,715  $233   19  $4,611  $360   19  $4,684  $365 
Nonperforming TDRs                                                
Commercial, financial and agricultural  1  $65  $-  -  $-  $-   4  $827  $103   4  $838  $41 
Real estate mortgage - residential  5   327   56   6   430   58   3   242   60   4   290   61 
Real estate mortgage - commercial  4   600   122   2   189   119   4   581   139   4   589   110 
Total nonperforming TDRs  10  $992  $178   8  $619  $177   11  $1,650  $302   12  $1,717  $212 
Total TDRs  29  $6,278  $450   27  $6,334  $410   30  $6,261  $662   31  $6,401  $577 

 

At June 30, 2017,March 31, 2018, loans classified as TDRs totaled $6.3 million, with $450,000$662,000 of specific reserves, of which $992,000$1.7 million were classified as nonperforming TDRs and $5.3$4.6 million were classified as performing TDRs. This compared to $6.3$6.4 million of loans classified as TDRs, with $410,000$577,000 of specific reserves, of which $619,000$1.7 million were classified as nonperforming TDRs and $5.7$4.7 million were classified as performing TDRs at December 31, 2016.2017. 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. The net decrease in total TDRs from December 31, 20162017 to June 30, 2017March 31, 2018 was primarily due to $232,000one TDR totaling $48,000 that went to foreclosure and $95,000 of payments received partially offset by two newon TDR’s totaling $187,000.received.

 

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:

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Allocation of allowance for loan losses at end of period:                
Commercial, financial, and agricultural $2,578  $2,753  $3,261  $3,325 
Real estate construction - residential  70   108   240   170 
Real estate construction - commercial  615   413   895   807 
Real estate mortgage - residential  1,854   2,385   2,057   1,689 
Real estate mortgage - commercial  4,882   3,793   4,008   4,437 
Installment and other consumer  376   274   352   345 
Unallocated  170   160   134   79 
Total $10,545  $9,886  $10,947  $10,852 

 

The allowance for loan losses (ALL) was $10.5$10.9 million, or 1.01%, of loans outstanding at March 31, 2018 compared to $10.9 million, or 1.02%, at December 31, 2017, and $10.3 million, or 1.02%, of loans outstanding at June 30, 2017 compared to $9.9 million, or 1.01%, of loans outstanding at DecemberMarch 31, 2016, and $9.4 million, or 1.02%, of loans outstanding at June 30, 2016.2017. The ratio of the allowance for loan losses to nonperforming loans, excluding performing TDR’s, was 223.27%198.32% at June 30, 2017,March 31, 2018, compared to 282.94%180.87% at December 31, 2016.2017.

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

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Allocation of allowance for loan losses:                
Individually evaluated for impairment - specific reserves $1,125  $1,080  $1,336  $1,333 
Collectively evaluated for impairment - general reserves  9,420   8,806   9,611   9,519 
Total $10,545  $9,886  $10,947  $10,852 

  


Thespecific 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 recorded. At June 30, 2017, $1.1March 31, 2018, $1.3 million of the Company’s ALL was allocated to impaired loans totaling approximately $9.7$10.1 million compared to $1.1$1.3 million of the Company’s ALL allocated to impaired loans totaling approximately $9.1$10.4 million at December 31, 2016.2017. Management determined that $1.7$2.0 million, or 18%20%, of total impaired loans required no reserve allocation at June 30, 2017March 31, 2018 compared to $2.1$2.4 million, or 23%, at December 31, 20162017 primarily due to adequate collateral values,acceptable payment history and adequate cash flow ability.

 

Theincurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying loss rates 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. Beginning in the first quarter of 2016, the Company began to lengthen its look-back period with the intent to increase such period from three to five years over the next two years.by December 31, 2017. The Company believes that the five-year look-back period, which is consistent with the Company’s practices prior to the start of the economic recession in 2008, provides a representative historical loss period in the current economic environment. These historical loss rates for each risk group are used as the starting point to determine loss rates for measurement purposes. The historical loan loss rates 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.

 

The Company’s methodology includes qualitative risk factors that allow management to adjust its estimates of losses based on the most recent information available and to address other limitations in the quantitative component that is based on historical loss rates. Such risk factors are generally reviewed and updated quarterly, as appropriate, and are adjusted to reflect changes in national and local economic conditions and developments, the nature, volume and terms of loans in the portfolio, including changes in volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans, loan concentrations, assessment of trends in collateral values, assessment of changes in the quality of the Company’s internal loan review department, and changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices.

 

The specific and general reserve allocations represent management’s best estimate of probable losses inherent 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.

 

Provision

 

A $330,000 and $680,000$300,000 provision was required for the three and six months ended June 30, 2017, respectively,March 31, 2018 compared to a $425,000 and $675,000$350,000 provision for the three and six months ended June 30, 2016, respectively.March 31, 2017. The Company is using an eighteendecrease was primarily due to loan growth slowing during the current quarter look-back period compared to fourteen quarters, as discussed above.the quarter ended March 31, 2017.

45

 

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

 

 Three Months Ended Six Months Ended  Three Months Ended 
 June 30,  June 30,  March 31, 
(In thousands) 2017  2016  2017  2016  2018  2017 
Analysis of allowance for loan losses:                        
Balance beginning of period $10,262  $8,631  $9,886  $8,604  $10,852  $9,886 
Charge-offs:                        
Commercial, financial, and agricultural  32   36   60   138   110   28 
Real estate construction - residential  48   - 
Real estate construction - commercial  -   -   -   1   30   - 
Real estate mortgage - residential  62   175   81   381   20   20 
Real estate mortgage - commercial  2   28   16   111   14   14 
Installment and other consumer  60   67   111   123   57   51 
Total charge-offs  156   306   268   754   279   113 
Recoveries:                        
Commercial, financial, and agricultural $24  $80  $42  $177  $13  $19 
Real estate construction - residential  25   -   75   -   12   50 
Real estate construction - commercial  -   491   -   502 
Real estate mortgage - residential  21   9   57   17   19   36 
Real estate mortgage - commercial  14   31   21   92   6   7 
Installment and other consumer  25   31   52   79   24   27 
Total recoveries  109   642   247   867   74   139 
Net charge-offs (recoveries)  47   (336)  21   (113)  205   (26)
Provision for loan losses  330   425   680   675   300   350 
Balance end of period $10,545  $9,392  $10,545  $9,392  $10,947  $10,262 

Net Loan Charge-offs (Recoveries)

 

The Company’s net loan charge-offs were $47,000,$205,000, or 0.02%, of average loans for the three months ended March 31, 2018, compared to net loan recoveries of $26,000, or 0.00%, of average loans for the three months ended June 30, 2017, compared to net loan recoveries of $336,000, or (0.04)%, of average loans for the three months ended June 30, 2016.March 31, 2017. The decreaseincrease in charge-offs quarter over quarter primarily related to a decrease in real estate mortgage residential and commercial loans. The decrease in recoveries quarter over quarter was primarily due to a significant recovery in one real estate construction loan relationship during the quarter ended June 30, 2016.

The Company’s net loan charge-offs were $21,000, or 0.00%, of average loans for the six months ended June 30, 2017, compared to net loan recoveries of $113,000, or (0.01)%, of average loans for the six months ended June 30, 2016. The decrease in charge-offs year over year primarily related to a decrease in commercial, financial, and agricultural loans, and a decrease in real estate mortgage residential and commercial loans. The decrease in recoveries year over year was primarily due to a significant recovery in one commercial loan relationship and a recovery in onetwo real estate construction loan relationship during the six months ended June 30, 2016.loans.

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.

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Federal funds sold and other overnight interest-bearing deposits $40,552  $1,406  $65,449  $39,553 
Certificates of deposit in other banks  4,812   3,460 
Available-for-sale investment securities  216,353   214,512   215,720   226,542 
Total $256,905  $215,918  $285,981  $269,555 

 

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 $216.4$215.7 million at June 30, 2017March 31, 2018 and included an unrealized net loss of $1.7$5.3 million. The portfolio includes projected maturities and mortgage backed securities pay-downs of approximately $37.5$10.1 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s deposit base.

46

 

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 June 30, 2017March 31, 2018 and December 31, 2016,2017, the Company’s unpledged securities in the available for sale portfolio totaled approximately $61.3$21.5 million and $46.9$44.8 million, respectively.

 

Total investment securities pledged for these purposes were as follows:

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Investment securities pledged for the purpose of securing:                
Federal Reserve Bank borrowings $10,329  $9,211  $9,002  $9,570 
Federal funds purchased and securities sold under agreements to repurchase  42,971   43,054   47,728   40,931 
Other deposits  101,774   115,330   137,538   131,197 
Total pledged, at fair value $155,074  $167,595  $194,268  $181,698 

 

Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, money market deposit accounts, and time deposits less than $250,000, less all brokered deposits under $250,000. At June 30, 2017,March 31, 2018, such deposits totaled $979.0 million$1.0 billion and represented 90.4%88.4% 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 $250,000 and over totaled $103.6$136.4 million at June 30, 2017.March 31, 2018. These accounts are normally considered more volatile and higher costing representing 9.6%11.6% of total deposits at June 30, 2017.March 31, 2018.


Core deposits at June 30, 2017March 31, 2018 and December 31, 20162017 were as follows:

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Core deposit base:                
Non-interest bearing demand $279,634  $235,975  $244,835  $245,380 
Interest checking  207,521   177,414   246,008   229,862 
Savings and money market  290,110   276,295   364,779   345,593 
Other time deposits  201,777   206,088   188,361   191,563 
Total $979,042  $895,772  $1,043,983  $1,012,398 

The total amount of certificates of deposit of $250,000 and greater at March 31, 2018 and December 31, 2017 were $84.7 million and $63.2 million, respectively. The Company had brokered deposits totaling $48.9 million and $48.5 million at March 31, 2018 and December 31, 2017, respectively

 

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 June 30, 2017,March 31, 2018, under agreements with these unaffiliated banks, the Bank may borrow up to $40.0 million in federal funds on an unsecured basis and $18.4$16.2 million on a secured basis. There were no federal funds purchased outstanding at June 30, 2017.March 31, 2018. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At June 30, 2017,March 31, 2018, there was $29.1$34.8 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 June 30, 2017.March 31, 2018.

 

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 June 30, 2017,March 31, 2018, the Bank had $115.4$84.3 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.

 

47

Borrowings outstanding at June 30, 2017March 31, 2018 and December 31, 20162017 were as follows:

 

 June 30, December 31,  March 31, December 31, 
(In thousands) 2017  2016  2018  2017 
Borrowings:                
Federal funds purchased and securities sold under agreements to repurchase $29,118  $31,015  $34,795  $27,560 
Federal Home Loan Bank advances  115,363   92,900   84,296   121,352 
Subordinated notes  49,486   49,486   49,486   49,486 
Other borrowings  -   492   31   30 
Total $193,967  $173,893  $168,608  $198,428 

 

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 FHLB establishes a collateral value from which the Company may draw advances against this collateral. This collateral is also used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. The following table reflects collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company as follows:

 

 June 30, December 31,  March 31, December 31, 
 2017  2016  2018  2017 
(In thousands) FHLB  Federal
Reserve
Bank		  Federal
Funds
Purchased
Lines		  Total  FHLB  Federal
Reserve
Bank		  Federal
Funds
Purchased
Lines		  Total  FHLB  Federal
Reserve
Bank		  Federal
Funds
Purchased
Lines		  Total  FHLB  Federal
Reserve
Bank		  Federal
Funds
Purchased
Lines		  Total 
Advance equivalent $317,288  $10,105  $48,305  $375,698  $314,602  $9,015  $49,020  $372,637  $294,216  $8,796  $47,435  $350,447  $294,081  $9,364  $47,825  $351,270 
Letters of credit  (53,000)  0   0   (53,000)  0   0   0   0   (72,750)  0   0   (72,750)  (70,000)  0   0   (70,000)
Advances outstanding  (115,363)  0   0   (115,363)  (92,900)  0   (992)  (93,892)  (84,296)  0   0   (84,296)  (121,352)  0   0   (121,352)
Total available $148,925  $10,105  $48,305  $207,335  $221,702  $9,015  $48,028  $278,745  $137,170  $8,796  $47,435  $193,401  $102,729  $9,364  $47,825  $159,918 

 

At June 30, 2017,March 31, 2018, loans of $496.0$479.4 million were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At June 30, 2017,March 31, 2018, investments totaling $21.1$18.6 million were pledged to secure federal funds purchasedpurchase lines and borrowing capacity at the Federal Reserve Bank.

 

 48

Sources and Uses of Funds

 

Cash and cash equivalents were $61.3$81.4 million at June 30, 2017March 31, 2018 compared to $27.0$62.9 million at December 31, 2016.2017. The $34.3$18.5 million increase 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 sixthree months ended June 30, 2017.March 31, 2018. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $5.9$2.3 million for the sixthree months ended June 30, 2017.March 31, 2018.

 

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 $62.9$8.0 million. The cash outflow primarily consisted of a $60.6$16.2 million increase in loans and $21.9$28.1 million purchases of investment securities, partially offset by $20.7$36.5 million from maturities, calls, and callssales of investment securities.

 

Financing activities provided cash of $91.3$24.2 million, resulting primarily from a $43.7 million increase in demand deposits, a $48.9$32.4 million increase in interest bearing transaction accounts and a $22.5$22.7 million net increase in FHLB advances,time deposits, partially offset by a $20.6net $37.1 million decrease in time deposits.repayment of FHLB advances. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during 2017.2018.

 

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 $281.7$308.6 million in unused loan commitments and standby letters of credit as of June 30, 2017.March 31, 2018. 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 $674,000$406,000 and $542,000$336,000 for the sixthree months ended June 30,March 31, 2018 and 2017, and 2016, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank did not declare or paydeclared and paid $1.0 million and $0 in dividends to the Company during the sixthree months ended June 30,March 31, 2018 and 2017, and 2016.respectively. At June 30, 2017March 31, 2018 and December 31, 2016,2017, the Company had cash and cash equivalents totaling $2.3$1.6 million and $3.9$1.4 million, respectively.

48

 

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.

 

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 the Company began on January 1, 2015. The Federal Reserve System’s (FRB) capital adequacy guidelines require that bank holding companies maintain a Common Equity Tier 1 risk-based capital ratio equal to at least 4.5% of its risk-weighted assets, a Tier 1 risk-based capital ratio equal to at least 6% of its risk-weighted assets and a total risk-based capital ratio equal to at least 8% of its risk-weighted assets. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 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. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital conservation buffer requirement will be phased in over four years beginning in 2016. On January 1, 2016, the first phase of the requirement went into effect at 0.625% of risk-weighted assets, and the requirement will increase each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of risk weighted assets on January 1, 2019. Once fully phasephased in, , the capital conservation buffer requirement effectively raises the minimum required risk-based capital ratios to 7% Common Equity Tier 1 Capital, 8.5% Tier 1 Capital and 10.5% Total Capital on a fully phased-in basis.

 

Under the Basel III requirements, at June 30, 2017March 31, 2018 and December 31, 2016,2017, the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table as of periods indicated:


49
              Well-Capitalized Under 
        Required for Capital  Prompt Corrective Action 
  Actual  Adequacy Purposes  Provision 
(in thousands) Amount  Ratio  Amount  Ratio  Amount  Ratio 
June 30, 2017                        
Total Capital (to risk-weighted assets):                        
Company $156,726   13.47% $93,068   8.00% $N.A.   N.A.%
Bank  154,226   13.31   92,728   8.00   115,906   10.00 
Tier I Capital (to risk-weighted assets):                        
Company $130,349   11.20% $69,801   6.00% $N.A.   N.A.%
Bank  143,521   12.38   69,544   6.00   92,725   8.00 
Common Equity Tier I Capital (to risk-weighted assets)                        
Company $98,021   8.43% $52,351   4.50% $N.A.   N.A.%
Bank  143,521   12.38   52,158   4.50   75,339   6.50 
Tier I Capital (to adjusted average assets):                        
Company $130,349   9.77% $53,356   4.00% $N.A.   N.A.%
Bank  143,521   10.79   53,198   4.00   66,498   5.00 
                         
(in thousands)                        
December 31, 2016                        
Total Capital (to risk-weighted assets):                        
Company $152,864   13.88% $88,125   8.00% N.A.   N.A.%
Bank  148,304   13.51   87,810   8.00  $109,763   10.00 
Tier I Capital (to risk-weighted assets):                        
Company $125,779   11.42% $66,093   6.00% N.A.   N.A.%
Bank  138,258   12.60   65,858   6.00  $87,810   8.00 
Common Equity Tier I Capital (to risk-weighted assets)                        
Company $94,818   8.61% $49,570   4.50% $N.A.   N.A.%
Bank  138,258   12.60   49,393   4.50   71,346   6.50 
Tier I capital (to adjusted average assets):                        
Company $125,779   9.87% $50,998   4.00% $N.A.   N.A.%
Bank  138,258   10.88   50,810   4.00   63,513   5.00 

              Well-Capitalized Under 
        Required for Capital  Prompt Corrective Action 
  Actual  Adequacy Purposes  Provision 
(in thousands) Amount  Ratio  Amount  Ratio  Amount  Ratio 
March 31, 2018                  
Total Capital (to risk-weighted assets):                        
Company $157,713   12.87% $98,069   8.00% $N.A.   N.A.%
Bank  156,390   12.79   97,794   8.00   122,243   10.00 
Tier I Capital (to risk-weighted assets):                        
Company $130,070   10.61% $73,551   6.00% $N.A.   N.A.%
Bank  145,283   11.80   73,346   6.00   97,794   8.00 
Common Equity Tier I Capital                        
(to risk-weighted assets)                        
Company $98,606   8.04% $55,164   4.50% $N.A.   N.A.%
Bank  145,283   11.88   55,009   4.50   79,458   6.50 
Tier I Capital (to adjusted average assets):                        
Company $130,070   9.17% $56,715   4.00% $N.A.   N.A.%
Bank  145,283   10.37   56,028   4.00   70,035   5.00 
(in thousands)                        
December 31, 2017                        
Total Capital (to risk-weighted assets):                        
Company $156,045   12.93% $96,577   8.00% $N.A.   N.A.%
Bank  154,495   12.83   96,326   8.00   120,408   10.00 
Tier I Capital (to risk-weighted assets):                        
Company $129,369   10.72% $72,433   6.00% $N.A.   N.A.%
Bank  143,483   11.92   72,245   6.00   96,326   8.00 
Common Equity Tier I Capital                        
(to risk-weighted assets)                        
Company $97,033   8.04% $54,325   4.50% $N.A.   N.A.%
Bank  143,483   11.92   54,184   4.50   78,265   6.50 
Tier I leverage ratio:                        
Company $129,369   9.33% $55,488   4.00% $N.A.   N.A.%
Bank  143,483   10.38   55,315   4.00   69,144   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 June 30, 2017,March 31, 2018, 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 June 30, 2017.March 31, 2018. 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.


50
                 Over    
                 5 Years or    
                 No stated    
(In thousands) Year 1  Year 2  Year 3  Year 4  Year 5  Maturity  Total 
ASSETS                            
Investment securities $37,465  $41,240  $44,969  $30,347  $18,767  $43,565  $216,353 
Federal funds sold and other over-night interest-bearing deposits  40,552   -   -   -   -   -   40,552 
Other investments and securities, at cost  7,798   -   3,000   -   -   -   10,798 
Loans  368,407   166,142   156,756   125,208   116,554   101,953   1,035,020 
Total $454,222  $207,382  $204,725  $155,555  $135,321  $145,518  $1,302,723 
                             
LIABILITIES                            
Savings, interest checking, and money market deposits $296,949  $-  $220,729  $-  $-  $-  $517,678 
Time deposits  186,638   49,041   23,036   6,868   19,792   -   285,375 
Federal funds purchased and securities sold under agreements to repurchase  29,118   -   -   -   -   -   29,118 
Subordinated notes  49,486   -   -   -   -   -   49,486 
Federal Home Loan Bank advances  41,124   32,000   30,461   7,000   4,778   -   115,363 
Total $603,315  $81,041  $274,226  $13,868  $24,570  $-  $997,020 
Interest-sensitivity GAP                            
Periodic GAP $(149,093) $126,341  $(69,501) $141,687  $110,751  $145,518  $305,703 
Cumulative GAP $(149,093) $(22,752) $(92,253) $49,434  $160,185  $305,703  $305,703 
                             
Ratio of interest-earning assets to interest-bearing liabilities                            
Periodic GAP  0.75   2.56   0.75   11.22   5.51    NM   1.31 
Cumulative GAP  0.75   0.97   0.90   1.05   1.16   1.31   1.31 

                 Over    
                 5 Years or    
                 No stated    
(In thousands) Year 1  Year 2  Year 3  Year 4  Year 5  Maturity  Total 
ASSETS                            
Investment securities $51,824  $41,093  $36,763  $27,061  $19,751  $39,228  $215,720 
Federal funds sold and other over-night interest-bearing deposits  65,449   -   -   -   -   -   65,449 
Certificates of deposit in other banks  -   863   1,230   741   1,978   -   4,812 
Other investments and securities, at cost  6,725   -   3,000   -   -   -   9,725 
Loans  411,214   171,789   161,525   130,168   118,235   91,395   1,084,326 
Total $535,212  $213,745  $202,518  $157,970  $139,964  $130,623  $1,380,032 
                             
LIABILITIES                            
Savings, interest checking, and   money market deposits $358,209  $-  $258,685  $-  $-  $-  $616,894 
Time deposits  211,852   47,850   17,813   10,808   30,319   10   318,652 
Federal funds purchased and  securities sold under   agreements to repurchase  34,795   -   -   -   -   -   34,795 
Federal Home Loan Bank advances  26,227   28,232   21,237   4,242   4,389   -   84,327 
Subordinated notes  49,486   -   -   -   -   -   49,486 
Total $680,569  $76,082  $297,735  $15,050  $34,708  $10  $1,104,154 
Interest-sensitivity GAP                            
Periodic GAP $(145,357) $137,663  $(95,217) $142,920  $105,256  $130,613  $275,878 
Cumulative GAP $(145,357) $(7,694) $(102,911) $40,009  $145,265  $275,878  $275,878 
                             
Ratio of interest-earning  assets to interest-bearing liabilities                            
Periodic GAP  0.79   2.81   0.68   10.50   4.03    NM   1.25 
Cumulative GAP  0.79   0.99   0.90   1.04   1.13   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 June 30, 2017.March 31, 2018.

 

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 June 30, 2017.March 31, 2018.  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.

 

51

There has been no change in our Company's internal control over financial reporting that occurred during the three months ended June 30, 2017March 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 51

Impact of New Accounting Standards

 

Revenue from Contracts with Customers The FASB issued ASU 2014-09,Revenue from Contracts with Customers (Topic 606), 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, 2018 and must be applied retrospectively.

In March 2016, the FASB began to issue targeted guidance to clarify specific implementation issues of ASU 2014-09. The FASB issued ASU 2016-08,Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which provides guidance on determining an entity's role in providing goods and services as a principal versus an agent, and whether it controls each specified good or service before it is transferred to the customer. In April 2016, ASU 2016-10,Identifying Performance Obligations and Licensing, was issued which clarifies the guidance related to whether goods or services are distinct within the contract and therefore are a performance obligation, and clarifies the timing and pattern of revenue recognition for licenses of intellectual property. The effective date and transition requirements of these ASUs are the same as those of ASU 2014-09.

In May 2016, the FASB issued ASU 2016-12,Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients. The amendments in this update address narrow-scope improvements to the accounting guidance on collectability, noncash consideration, and completed contracts at transition. Additionally, the amendments in this Update provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The amendments also included a rescission issued in May 2016, ASU 2016-11,Revenue Recognition and Derivatives and Hedging: Rescission of SEC Guidance Because of ASU 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 Emerging Task Force meeting,and relates to revenue and expense recognition for freight services in process, accounting for shipping and handling fees and costs, and accounting for consideration given by a vendor to a customer.

The FASB continues to issue additional ASU’s clarifying the revenue recognition guidance for certain implementation issues. Under the ASU 2014-09 and related amendments, the guidance is effective for periods beginning January 1, 2018 and must be applied retroactively, whether through a full restatement of prior periods or a cumulative adjustment upon adoption of the ASU. The Company is currently evaluating certain non-interest income financial statement line items that contain revenue streams that are in the scope of this update such as service charges and fees, trust department revenue, bank card revenue, and real-estate sales, and expects to adopt the ASU in the first quarter of 2018. Based on preliminary analysis, the Company does not expect the adoption of this ASU to have a significant impact on the Company’s consolidated financial statements; however, the review is ongoing. The Company will continue to evaluate the impact of this accounting guidance, including any additional guidance issued, during the completion of this internal assessment.

Debt Instruments The FASB issued ASU 2016-06,Contingent Put and Call Options in Debt Instruments, in March 2016. The ASU clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. Under the new guidance, the embedded options should be assessed solely in accordance with a four-step decision sequence, with no additional assessment of whether the triggering event is indexed to interest rates or credit risk. The amendments are effective January 1, 2017 and are not expected to have a significant effect on the Company's consolidated financial statements.

Financial InstrumentsThe FASB issued ASU 2016-01,Recognition and Measurement of Financial Assets and Financial Liabilities, in January 2016. The amendments require all equity investments to be measured at fair value with changes in the fair value recognized through net income, other than those accounted for under the equity method of accounting or those that result in the consolidation of the investee. Additionally, these amendments require presentation in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk for those liabilities measured at fair value. The amendments also require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes. These amendments are effective for interim and annual periods beginning January 1, 2018. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements, including potential changes to the Company's note disclosure of the fair value of its loan portfolio.

In June 2016, the FASB issued ASU 2016-13,Financial Instruments - Credit Losses(Topic (Topic 326):Measurement of Credit Losses on Financial Instruments.Instruments(CECL). The revised accounting guidance will remove all recognition thresholds and will require a company to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument's contractual life. It also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. This new accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2019. While the Company generally expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, the Company has not determined the magnitude of any such one-time adjustment or the overall impact of the new guidance on the Company’s consolidated financial statements. The Company has formed a committee and is continuing to evaluate the impact of the ASU's adoption on the Company's consolidated financial statements.


LeasesIn February 2016, the FASB issued ASU 2016-02,Leases, in order to increase transparency and comparability by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU primarily affects lessee accounting, which requires the lessee to recognize a right-of-use asset and a liability to make lease payments for those leases classified as operating leases under previous GAAP. For leases with a term of 12 months or less, an election by class of underlying asset not to recognize lease assets and lease liabilities is permitted. The ASU also provides additional guidance as to the definition of a lease, identification of lease components, and sale and leaseback transactions. The amendments in the ASU are effective for interim and annual periods beginning January 1, 2019. The Company continuesexpects to evaluate the provision of the new lease standard, but due to the small number of lease agreements, the impact of the adoption is not expected to have a significant effect on the Company's consolidated financial statements.

LiabilitiesThe FASB issuedadopt this ASU 2016-04,Recognition of Breakage for Certain Prepaid Store-Value Products, in March 2016, in order to address current and potential future diversity in practice related to the derecognition of a prepaid store-value product liability. Such products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler's checks. The amendments require that the portion of the dollar value of prepaid stored-value products that is ultimately unredeemed (that is, the breakage) be accounted for consistent with the breakage guidance for stored-value product transactions provided in ASC Topic 606 - Revenue from Contracts with Customers. These amendments are effective for interim and annual periods beginning January 1, 2018. The Company is in the processfirst quarter of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements.

Statement of Cash FlowsThe FASB issued ASU 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts2019 and Cash Payments, in August 2016, in order to address concerns regarding diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. In particular, this ASU addresses eight specific cash flow issues in an effort to reduce this diversity in practice: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon bonds; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. The amendments are effective for annual periods beginning after December 15, 2017, and for interim periods within those annual periods. The Company is in the process of evaluating the impact of the ASU's adoption on the Company's consolidated financial statements.

 

TheIn January 2018, the FASB issued ASU 2016-18,2018-01Statement, Leases: Land Easement Practical Expedient for Transition to Topic 842. This update provides an optional practical expedient that affects entities with land easements that existed or expired before an entity's adoption of Cash Flows (Topic 230): Restricted Cash, in November 2016. The ASU addresses the current diversity in the classification and presentation of changes in restricted cash on the statement of cash flows. The ASU requiresTopic 842, provided that amounts described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning and end of period amounts shown on the statement of cash flows. Disclosures are to be provided on the nature of restrictions on cash and cash equivalents. When presented in more than one line item within the statement of financial position, the entity shall disclose the amounts, disaggregated by line item, of cash, cash equivalents, restricted cash, and restricted cash equivalents reported within the statement of financial position.does not account for those land easements as leases under Topic 840. The amendments in this ASU affect the amendments in ASU 2016-02, which are not yet effective January 1, 2018but may be early adopted. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in ASU 2016-02. The Company will adopt this guidance as required, in conjunction with the adoption of ASU 2016-02 described above, however this update is not expected to materially alter the implementation of ASU 2016-02, or to have a significant effectmaterial impact on the Company'sCompany’s consolidated financial statements.

 

PensionDerivatives and HedgingThe FASB issued guidance within ASU 2017-07,2017-12,ImprovingTargeted Improvements to Accounting for Hedging Activities (Topic 815)in August 2017. The amendments in ASU 2017-12 to Topic 815, Derivatives and Hedging, are intended to more closely align hedge accounting with companies' risk management strategies, simplify the Presentationapplication of Net Periodic Pension Costhedge accounting, and Net Periodic Postretirement Benefit Cost in March 2017.increase transparency as to the scope and results of hedging programs. The guidance also amends the presentation and disclosure requirements and changes how companies assess effectiveness. Under the new guidance, employerspublic companies will presenthave until the service cost componentend of the net periodic benefit costfirst quarter in which a hedge is designated to perform an initial assessment of a hedge's effectiveness. After initial qualification, the samenew guidance permits a qualitative effectiveness assessment for certain hedges instead of a quantitative test if the company can reasonably support an expectation of high effectiveness throughout the term of the hedge. Additional disclosures include cumulative basis adjustments for fair value hedges and the effect of hedging on individual income statement line item (e.g., Salaries and Benefits) as other employee compensation costs arising from services rendered during the period. In addition, only the service cost component will be eligible for capitalizationitems. The amendments in assets. Employers will present the other components separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. The ASU isthis Update are effective for interim and annual reporting periodsfiscal years beginning after December 15, 2017.2018, and interim periods within those fiscal years. Early adoption is permitted however, the Company has decided not to early adopt. Employers will apply the guidance on the presentationin any interim period after issuance of the components of net periodic benefit cost in the income statement retrospectively. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component will be applied prospectively. The Company expects to utilize the ASU’s practical expedient allowing entities to estimate amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan footnote.Update. The ASU is not expected to have a significant effect on the Company’s Consolidated Financial Statements.


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Callable Debt SecuritiesThe FASB issued ASU 2017-08,Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securitiesin March 2017. This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Today, entities generally amortize the premium over the contractual life of the security. The new guidance does not change the accounting for purchased callable debt securities held at a discount; the discount continues to be amortized to maturity. The ASU is effective for interim and annual reporting periods beginning after December 15, 2018 and early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the provisions of ASU 2017-08 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.

Stock CompensationThe FASB issued ASU 2017-09,Compensation – Stock Compensation (Topic 718): Scope of Modification Accountingin May 2017. Under the new guidance an entity may change the terms or conditions of a share-based payment award for many different reasons, and the nature and effect of the change can vary significantly. Modification is currently defined as "a change in any of the terms or conditions of a share-based payment award." The amendments in this ASU provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in accordance with Topic 718. The amendments will be effective for interim and annual reporting periods beginning after December 15, 2017. The ASU is not expected to have a significant effect on the Company’s Consolidated Financial Statements.


PART II - OTHER INFORMATION

 

Item 1.Legal Proceedings

 

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

  

Item 1A.Risk FactorsNone

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table summarizes the purchases made by or on behalf of the Company or certain affiliated purchasers of shares of the Company's common stock during the three months ended June 30, 2017:March 31, 2018:

 

Period (a) Total Number of
Shares (or Units)
Purchased		  (b) Average
Price Paid per
Share (or Unit)		  (c) Total Number of Shares
(or Units) Purchased as
Part of Publicly Announced
Plans or Programs		  (d) Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased
Under the Plans or
Programs *		 
April 1-30, 2017  1,461  $18.13   1,461  $1,292,466 
May 1-31, 2017  -  $-   -  $1,292,466 
June 1-30, 2017  1,854  $20.56   1,854  $1,254,354 
Total  3,315  $18.13   3,315  $1,254,354 
Period (a) Total Number of
Shares (or Units)
Purchased		  (b) Average
Price Paid per
Share (or Unit)		  

(c) Total Number of Shares

(or Units) Purchased as
Part of Publicly Announced
Plans or Programs

  

(d) Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased
Under the Plans or

Programs *

 
January 1-31, 2018  -  $-   -  $1,965,562 
February 1-28, 2018  -  $-   -  $1,965,562 
March 1-31, 2018  5,468  $20.51   -  $1,853,415 
Total  5,468  $20.51   -  $1,853,415 

 

*   On August 6, 2015, the Company announced that its Board of Directors authorized the purchase, through open market transactions, of up to $2,000,000$2.0 million market value of the Company's common stock. On August 8, 2017, the Board authorized the repurchase of an additional $1.5 million market value of the Company’s common stock Management was given discretion todetermine the number and pricing of the shares to be purchased, as well as, the timing of any such purchases.

 

Item 3.Defaults Upon Senior SecuritiesNone
   
Item 4.Mine Safety DisclosuresNone
   
Item 5.Other InformationNone
   
Item 6.Exhibits 

 

Exhibit
No.		 Description
   
3.1 Restated Articles of Incorporation of ourthe Company (filed as Exhibit 3.1 to ourthe Company's current report on Form 8-K on August 9, 2007 and incorporated herein by reference).
https://www.sec.gov/Archives/edgar/data/893847/000129993307004833/exhibit1.htm
   
3.2 Amended and Restated Bylaws of ourthe Company (filed as Exhibit 3.1 to ourthe Company's current report on Form 8-K on June 8, 2009 and incorporated herein by reference).
https://www.sec.gov/Archives/edgar/data/893847/000129993309002491/exhibit1.htm
   
4.1 Specimen certificate representing shares of our Company’sthe Company's $1.00 par value common stockCommon Stock (filed as Exhibit 4.1 to our Company’sthe Company's current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).
https://www.sec.gov/Archives/edgar/data/893847/000141588917001027/ex4-06232017_100639.htm


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31.1 Certificate of the Chief Executive Officer of ourthe Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certificate of the Chief Financial Officer of ourthe Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32.1 Certificate of the Chief Executive Officer of ourthe Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2 Certificate of the Chief Financial Officer of ourthe Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101Interactive 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).

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
August 14, 2017David T. Turner, Chairman of the Board and
Chief Executive Officer (Principal Executive Officer)
/s/ W. Bruce Phelps
August 14, 2017W. Bruce Phelps, Chief Financial Officer (Principal Financial
Officer and Principal Accounting Officer)

HAWTHORN BANCSHARES, INC.

INDEX TO EXHIBITS

June 30, 2017 Form 10-Q

Exhibit No.Description
3.1Restated 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).  https://www.sec.gov/Archives/edgar/data/893847/000129993307004833/exhibit1.htm
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).

https://www.sec.gov/Archives/edgar/data/893847/000129993309002491/exhibit1.htm

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 current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).

https://www.sec.gov/Archives/edgar/data/893847/000141588917001027/ex4-06232017_100639.htm

31.1Certificate of the Chief Executive Officer of our Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2Certificate of the Chief Financial Officer of our Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1Certificate of the Chief Executive Officer of our Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
32.2Certificate of the Chief Financial Officer of our Company pursuant to 18 U.S.C. Section 1350, as adopted 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).

 

54

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
May 10, 2018David T. Turner, Chairman of the Board and
Chief Executive Officer (Principal Executive Officer)
/s/ W. Bruce Phelps
May 10, 2018W. Bruce Phelps, Chief Financial Officer (Principal Financial

Officer and Principal Accounting Officer) 

55

HAWTHORN BANCSHARES, INC.

INDEX TO EXHIBITS

March 31, 2018 Form 10-Q

Exhibit
No.		Description
3.1Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to the Company's current report on Form 8-K on August 9, 2007 and incorporated herein by reference).
3.2Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company's current report on Form 8-K on June 8, 2009 and incorporated herein by reference).
4.1Specimen certificate representing shares of the Company’s $1.00 par value Common Stock (filed as Exhibit 4.1 to the Company’s current report on Form 8-K/A on June 23, 2017 and incorporated herein by reference).
31.1Certificate of the Chief Executive Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2Certificate of the Chief Financial Officer of the Company pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1Certificate of the Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
32.2Certificate of the Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
101Interactive 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).

 

* 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.


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