Blackhawk Bancorp Announces Third Quarter 2014 Results and Declares Quarterly Dividend

Blackhawk Bancorp, Inc. (OTCBB: BHWB) reports that its 2014 third quarter results include the recognition of a $2,611,000 impairment charge related to short-term securities, which were backed by loans and United States Department of Agriculture guarantees, that were found to be fraudulent. The after-tax loss recognized on these securities was $1,593,000 resulting in a net loss of $375,000 for the third quarter compared to net income of $980,000 earned in the third quarter of 2013. The net loss per diluted share for the quarter was $0.17, a $0.53 decrease compared to the $0.36 per diluted share earned the third quarter of last year.

The securities fraud loss caused year to date net income to drop to $1,308,000, a 37% decrease compared to net income of $2,076,000 for the first nine months of 2013. The earnings per diluted share for the nine months ended September 30, 2014 was $0.50, a $0.21 decrease compared to $0.71 per diluted share earned the first nine months of 2013.

“While the fraud loss was an isolated and unfortunate event, we are not letting it distract us from the growth and momentum we’ve achieved improving core earnings and credit quality”, said Rick Bastian, the Company’s chief executive officer. “Excluding the impairment charge, third quarter net income was up 24% to $1,218,000 and year to date net income was up 40% to $2,902,000. The after-tax impairment charge due to the fraud equaled $0.71 per diluted share. Excluding this charge, diluted earnings per share increased by 50% for the quarter and 69% year to date compared to 2013”, he added. “We’ve performed an extensive review of our processes and the due diligence surrounding the investments in question and found no breakdown in controls or warning signs that were missed. We recognized the impairment charge in the third quarter; however we do expect to ultimately recover a substantial portion of the loss in future periods”, said Bastian.

In addition, the Company’s Board of Directors has declared a cash dividend on the Company’s common stock. Shareholders of record on November 14, 2014 will be paid a dividend of $0.02 per share on November 29, 2014. This amounts to $0.08 per share on an annualized basis.

The following table summarizes key performance and asset quality measures for the quarter ended September 30, 2014 compared to the previous four quarters. The diluted earnings per share (Diluted EPS), return on average assets (ROAA), and return on average common equity (ROACE) are each presented based on actual results and the results, excluding after tax impact of the securities fraud.

* - The efficiency ratio calculation excludes net gains and losses on trading and available for sale securities, net gains and losses on other assets and the securities fraud loss.

The short-term securities, which incurred the impairment, were purchased through an arrangement with Pennant Management, Inc., a Milwaukee based investment advisor, as safe short-term investments, backed by loans and guarantees of the United States Department of Agriculture (USDA). Blackhawk has a twelve year history with Pennant, a recognized leader in dealing with government guaranteed loans and securities, and has participated in similar arrangements over the entire term of the relationship. The fraudulent activity was committed by a USDA approved lender with whom Pennant, on behalf of its clients, had entered into an agreement to purchase USDA guaranteed loans. It was discovered that the underlying loans and the USDA guarantees on 25 loans totaling approximately $176 million were fraudulent. Blackhawk had a $5.5 million interest in the underlying loans and USDA guarantees. The amount of the loss was mitigated by recovery efforts that resulted in a court approved agreement identifying and seizing assets that are to be liquidated for the benefit of investors. While the amount and timing of additional recoveries is uncertain, Blackhawk expects the recoveries in future periods to be substantial. Additional recovery is being sought from a number of sources including, but not limited to: claims being made on the USDA to honor their guarantees, continued seizure of assets from the perpetrator of the fraud, a potential claim on Blackhawk’s insurance, and the exercise of any other legal rights and remedies that may be available to Blackhawk.

Net Interest Income

Net interest income for the third quarter increased by 2% to $4,932,000 compared to $4,848,000 for the third quarter of 2013 with the net interest margin decreasing 3 basis points to 3.66% compared to 3.69% the third quarter last year.

Average total earning assets for the quarter increased by $13.1 million to $552.6 million compared to $539.5 million in the third quarter of 2013. The growth in earning assets includes an $11.8 million, or 3%, increase in average total loans. Average total deposits for the third quarter increased by $2.3 million to $507.9 million compared to $505.5 million the third quarter of last year. A $7.3 million, or 8%, increase in average demand deposits was offset by a decrease in time deposits.

Net interest income for the first three quarters of the year increased $94,000, or 1%, to $14,463,000 compared to $14,369,000 prior year. The net interest margin for the first nine months was $3.65%, down 5 basis points compared to the first nine months of last year.

Year to date average total earning assets increased $12.0 million to $547.5 million compared to $535.5 million for the first nine months of 2013. The increase was driven by a $14.8 million increase in average loans. Total average deposits increased by $10.4 million with $7.0 million of the growth occurring in demand deposits.

Provision for Loan Losses and Credit Quality

The provision for loan losses in the third quarter dropped by $98,000, or 20%, to $578,000 compared to $480,000 in third quarter of 2013. The provision for the nine months ended September 30, 2014 was $1,768,000, 50% less than the $3,540,000 provision recorded the first nine months of 2013.

Nonaccrual loans and other real estate owned totaled $7.0 million, or 1.79% of total loans, at September 30, 2014 compared to $8.1 million, or 2.10% of total loans, at December 31, 2013 and $10.4 million, or 2.68% of total loans, at September 30, 2013.

Net loan charge-offs for the first nine months of 2014 decreased by 42% to $2,276,000 compared to $3,930,000 the first three quarters of 2013. The following table summarizes the activity in the allowance for loan losses for the nine months ended September 30, 2014 and 2013 and the year ended December 31, 2013:

Non-Interest Income and Operating Expenses

Excluding the impairment charge on short-term securities, non-interest income for the third quarter of 2014 increased by 12% to $2,448,000 compared to $2,191,000 the third quarter of the prior year. The increase in non-interest income was driven by a $361,000 increase in net other gains (losses), primarily related to sale of assets acquired in foreclosure.

Excluding the impairment charge on short-term securities, non-interest income for the first nine months of the year totaled $6,393,000, a 14% decrease compared to $7,391,000 the nine months of 2013. The decrease reflects the slow- down in mortgage refinance activity. Revenue from the sale and servicing of secondary market mortgages dropped by $834,000 to $1,483,000 compared to $2,317,000 the first nine months last year.

Operating expenses for the third quarter decreased by $219,000, or 4%, to $5,147,000 compared to $5,366,000 the third quarter of last year. Year to date operating expenses are down $661,000, or 4%, to $15,416,000 compared to $16,077,000 the first three quarters of 2013.

Outlook

Blackhawk has created a strong credit culture and the processes to support it; however, economic uncertainties and depressed real estate values have resulted in an elevated level of losses and nonperforming loans. While the level of nonperforming loans has been decreasing and should result in improved earnings, the potential for continuing economic weakness presents a heightened level of risk. For that reason, the company expects to continue fortifying its balance sheet by conserving capital, strengthening the allowance for loan losses and maintaining ample liquidity to meet the demands of its customer base. The company will however continue to seek profitable growth opportunities in its Wisconsin and Illinois markets, without sacrificing profitability or credit quality. Blackhawk emphasizes the value of its personal attention and the service it provides that remain unmatched by larger competitors.

About Blackhawk Bancorp

Blackhawk Bancorp, Inc. is headquartered in Beloit, Wisconsin and is the parent company of Blackhawk Bank, which operates eight banking centers in south central Wisconsin and north central Illinois, along the I-90 corridor from Belvidere, Illinois to Janesville, Wisconsin. Blackhawk’s locations serve individuals and small businesses, primarily with fewer than 200 employees. The company offers a variety of value-added consultative services to small businesses and their employees related to its banking products such as health savings accounts and investment management.

Forward-Looking Statements

When used in this communication, the words “believes,” “expects,” and similar expressions are intended to identify forward-looking statements. The company’s actual results may differ materially from those described in the forward-looking statements. Factors which could cause such a variance to occur include, but are not limited to: heightened competition; adverse state and federal regulation; failure to obtain new or retain existing customers; ability to attract and retain key executives and personnel; changes in interest rates; unanticipated changes in industry trends; unanticipated changes in credit quality and risk factors, including general economic conditions; success in gaining regulatory approvals when required; changes in the Federal Reserve Board monetary policies; unexpected outcomes of new and existing litigation in which Blackhawk or its subsidiaries, officers, directors or employees is named defendants; technological changes; changes in accounting principles generally accepted in the United States; changes in assumptions or conditions affecting the application of “critical accounting policies”; inability to recover previously recorded losses as anticipated, and the inability of third party vendors to perform critical services for the company or its customers.

Further information is available on the Company’s website at www.blackhawkbank.com.