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Form 10-Q Tectonic Financial, Inc. For: Jun 30

August 15, 2022 2:03 PM EDT

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2022

 

OR

 

 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                     to                  

 

Commission File Number 001-38910

 

TECTONIC FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Texas

 

82-0764846

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

16200 Dallas Parkway, Suite 190

Dallas, Texas 75248

(Address of principal executive offices)

 

(972) 720 - 9000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Series B preferred stock, $0.01 par value per share

TECTP

The Nasdaq Stock Market, LLC

 

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 such shorter period that the registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

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

 

Large accelerated filer

Accelerated filer

       

Non-accelerated filer

Smaller reporting company

       
   

Emerging growth company

 

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

 

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

 

The number of shares outstanding of the registrant’s Common Stock as of August 12, 2022 was 7,062,319 shares.

 

 

 

 

TECTONIC FINANCIAL, INC.

 

TABLE OF CONTENTS

 

 

  Page

PART I. FINANCIAL INFORMATION

 

Item 1. 

Consolidated Financial Statements (Unaudited)

 

 

Consolidated Balance Sheets as of June 30, 2022 and December 31, 2021

3

 

Consolidated Statements of Income for the Three and Six Months Ended June 30, 2022 and 2021

4

 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2022 and 2021

5

 

Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2022 and 2021

6

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2022 and 2021

7

 

Notes to Consolidated Financial Statements

8

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

30

Item 3. 

Quantitative and Qualitative Disclosures about Market Risk

55

Item 4. 

Controls and Procedures

56

   

PART II. OTHER INFORMATION

 

Item 1. 

Legal Proceedings

57

Item 1A. 

Risk Factors

57

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

57

Item 3. 

Defaults upon Senior Securities

57

Item 4. 

Mine Safety Disclosures

57

Item 5. 

Other Information

57

Item 6. 

Exhibits

57

     

SIGNATURES 

58

 

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

 

   

June 30,

2022

   

December 31,

2021

 

(In thousands, except share amounts)

 

(Unaudited)

         

ASSETS

               

Cash and due from banks

  $ 9,259     $ 10,203  

Interest-bearing deposits

    31,626       35,311  

Federal funds sold

    628       478  

Total cash and cash equivalents

    41,513       45,992  

Securities available for sale

    20,174       17,156  

Securities held to maturity

    26,227       19,673  

Securities, restricted at cost

    3,485       2,432  

Securities, not readily marketable

    100       100  

Loans held for sale

    31,950       33,762  

Loans, net of allowance for loan losses of $4,235 and $4,152, respectively

    424,711       424,595  

Bank premises and equipment, net

    4,668       4,729  

Other real estate

    1,079       1,079  

Core deposit intangible, net

    674       777  

Goodwill

    21,440       21,440  

Deferred tax asset

    695       405  

Other assets

    12,108       12,871  

Total assets

  $ 588,824     $ 585,011  
                 

LIABILITIES

               

Demand deposits:

               

Non-interest-bearing

  $ 100,977     $ 88,876  

Interest-bearing

    144,849       147,909  

Time deposits

    228,801       207,384  

Total deposits

    474,627       444,169  

Borrowed funds

    -       34,521  

Subordinated notes

    12,000       12,000  

Other liabilities

    11,376       9,534  

Total liabilities

    498,003       500,224  

Commitments and contingencies (see Note 11)

   
 
     
 
 
                 

SHAREHOLDERS EQUITY

               
                 

Preferred stock, 9.00% fixed to floating rate Series B non-cumulative, perpetual ($0.01 par value; 1,725,000 shares authorized, issued and outstanding at June 30, 2022 and December 31, 2021)

    17       17  

Common stock, $0.01 par value; 40,000,000 shares authorized; 7,071,953 and 7,061,953 shares issued at June 30, 2022 and December 31, 2021, respectively, and 7,062,319 and 7,061,953 shares outstanding at June 30, 2022 and December 31, 2021, respectively

    71       71  

Additional paid-in capital

    50,446       50,176  

Treasury stock, at cost; 9,634 shares as of June 30, 2022, and no shares as of December 31, 2021

    (181

)

    -  

Retained earnings

    42,218       34,851  

Accumulated other comprehensive loss

    (1,750

)

    (328

)

Total shareholders’ equity

    90,821       84,787  

Total liabilities and shareholders’ equity

  $ 588,824     $ 585,011  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(In thousands, except per share data and share amounts)

 

2022

   

2021

   

2022

   

2021

 

Interest Income

                               

Loan, including fees

  $ 7,014     $ 5,993     $ 14,206     $ 12,156  

Securities

    417       207       752       353  

Federal funds sold

    1       -       1       -  

Interest-bearing deposits

    72       16       93       21  

Total interest income

    7,504       6,216       15,052       12,530  

Interest Expense

                               

Deposits

    686       587       1,336       1,248  

Borrowed funds

    230       301       471       590  

Total interest expense

    916       888       1,807       1,838  

Net interest income

    6,588       5,328       13,245       10,692  

Provision for loan losses

    -       141       327       569  

Net interest income after provision for loan losses

    6,588       5,187       12,918       10,123  

Non-interest Income

                               

Trust income

    1,557       1,532       3,154       2,972  

Gain on sale of loans

    -       101       -       101  

Advisory income

    3,358       3,276       6,932       6,293  

Brokerage income

    3,712       2,028       6,183       4,591  

Service fees and other income

    1,889       1,408       4,105       3,714  

Rental income

    88       88       189       176  

Total non-interest income

    10,604       8,433       20,563       17,847  

Non-interest Expense

                               

Salaries and employee benefits

    7,879       5,923       15,335       11,789  

Occupancy and equipment

    422       392       873       819  

Trust expenses

    560       595       1,158       1,159  

Brokerage and advisory direct costs

    498       491       1,026       997  

Professional fees

    353       332       753       782  

Data processing

    221       266       390       470  

Other

    1,346       834       2,703       1,609  

Total non-interest expense

    11,279       8,833       22,238       17,625  

Income before Income Taxes

    5,913       4,787       11,243       10,345  

Income tax expense

    1,172       1,070       2,217       2,330  

Net Income

    4,741       3,717       9,026       8,015  

Preferred stock dividends

    388       388       776       776  

Net income available to common stockholders

  $ 4,353     $ 3,329     $ 8,250     $ 7,239  
                                 

Earnings per common share:

                               

Basic

  $ 0.62     $ 0.51     $ 1.17     $ 1.10  

Diluted

    0.59       0.50       1.13       1.09  
                                 

Weighted average common shares outstanding

    7,062,319       6,568,750       7,060,669       6,568,750  

Weighted average diluted shares outstanding

    7,317,084       6,630,976       7,315,434       6,630,976  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(In thousands)

 

2022

   

2021

   

2022

   

2021

 

Net Income

  $ 4,741     $ 3,717     $ 9,026     $ 8,015  

Other comprehensive (loss) income:

                               

Change in unrealized (loss) gain on investment securities available for sale

    (701

)

    30       (1,800

)

    (260

)

Tax effect

    (147

)

    5       (378

)

    (56

)

Other comprehensive (loss) income

    (554

)

    25       (1,422

)

    (204

)

Comprehensive Income

  $ 4,187     $ 3,742     $ 7,604     $ 7,811  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

(Unaudited)

 

(In thousands)

 

Series B

Preferred Stock

   

Common

Stock

   

Additional

Paid-in Capital

   

Treasury Stock

   

Retained

Earnings

   

Accumulated Other

Comprehensive

Income (Loss)

   

Total

 

Balance at January 1, 2021

  $ 17     $ 66     $ 39,201     $ -     $ 20,661     $ 68     $ 60,013  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Net income

    -       -       -       -       4,298       -       4,298  

Other comprehensive loss

    -       -       -       -       -       (229

)

    (229

)

Stock based compensation

    -       -       85               -       -       85  

Balance at March 31, 2021

  $ 17     $ 66     $ 39,286     $ -     $ 24,571     $ (161

)

  $ 63,779  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (411

)

    -       (411

)

Net income

    -       -       -       -       3,717       -       3,717  

Other comprehensive income

    -       -       -       -       -       25       25  

Stock based compensation

    -       -       78       -       -       -       78  

Balance at June 30, 2021

  $ 17     $ 66     $ 39,364     $ -     $ 27,489     $ (136

)

  $ 66,800  
                                                         

Balance at January 1, 2022

  $ 17     $ 71     $ 50,176     $ -     $ 34,851     $ (328

)

  $ 84,787  

Exercise of stock options

    -       -       43       -       -       -       43  

Purchase of treasury stock at cost

    -       -       -       (181

)

    -       -       (181

)

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (441

)

    -       (441

)

Net income

    -       -       -       -       4,285       -       4,285  

Other comprehensive loss

    -       -       -       -       -       (868

)

    (868

)

Stock based compensation

    -       -       87               -       -       87  

Balance at March 31, 2022

  $ 17     $ 71     $ 50,306     $ (181

)

  $ 38,307     $ (1,196

)

  $ 87,324  

Recognition of stock issued related to reduction of note receivable utilized to exercise options

    -       -       50       -       -       -       50  

Dividends paid on common stock

    -       -       -       -       (442

)

    -       (442

)

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Net income

    -       -       -       -       4,741       -       4,741  

Other comprehensive loss

    -       -       -       -       -       (554

)

    (554

)

Stock based compensation

    -       -       90       -       -       -       90  

Balance at June 30, 2022

  $ 17     $ 71     $ 50,446     $ (181

)

  $ 42,218     $ (1,750

)

  $ 90,821  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   

Six months Ended June 30,

 

(In thousands)

 

2022

   

2021

 

Cash Flows from Operating Activities

               

Net income

  $ 9,026     $ 8,015  

Adjustments to reconcile net income to net cash used in operating activities:

               

Provision for loan losses

    327       569  

Depreciation and amortization

    115       163  

Accretion of discount on loans

    (12

)

    (40

)

Core deposit intangible amortization

    103       101  

Securities premium amortization, net

    6       103  

Origination of loans held for sale

    (34,721

)

    (22,682

)

Proceeds from payments and sales of loans held for sale

    224       1,415  

Gain on sale of loans

    -       (101

)

Stock based compensation

    177       163  

Deferred income taxes

    88       (153

)

Servicing assets, net

    138       -  

Net change in:

               

Other assets

    624       2,697  

Other liabilities

    1,842       (2,626

)

Net cash used in operating activities

    (22,063

)

    (12,376

)

Cash Flows from Investing Activities

               

Purchase of securities held to maturity

    (7,408

)

    -  

Purchase of securities available for sale

    (180,015

)

    (153,000

)

Principal payments, calls and maturities of securities available for sale

    175,169       152,161  

Principal payments of securities held to maturity

    877       2,932  

Purchase of securities, restricted

    (6,381

)

    (4,157

)

Proceeds from sale of securities, restricted

    5,328       4,157  

Net change in loans

    35,878       4,635  

Purchases of premises and equipment

    (54

)

    -  

Net cash provided by investing activities

    23,394       6,728  

Cash Flows from Financing Activities

               

Net change in demand deposits

    9,041       33,370  

Net change in time deposits

    21,417       2,611  

Proceeds from borrowed funds

    180,800       220,461  

Repayment of borrowed funds

    (215,321

)

    (216,607

)

Dividends paid on Series B preferred stock

    (776

)

    (776

)

Dividends paid on common stock

    (883

)

    (411

)

Exercise of stock options

    43       -  

Repayments on note receivable utilized to exercise stock options

    50       -  

Purchase of treasury stock at cost

    (181

)

    -  

Net cash (used in) provided by financing activities

    (5,810

)

    38,648  

Net change in cash and cash equivalents

    (4,479

)

    33,000  

Cash and cash equivalents at beginning of period

    45,992       46,868  

Cash and cash equivalents at end of period

  $ 41,513     $ 79,868  
                 

Non Cash Transactions

               

Transfers from loans held for sale to loans held for investment

  $ 36,309     $ 15,067  

Lease liabilities incurred in exchange for right-of-use assets

  $ 74     $ 56  

Supplemental disclosures of cash flow information

               

Cash paid during the period for:

               

Interest

  $ 1,852     $ 1,835  

Income taxes

  $ 2,120     $ 1,833  

 

See accompanying notes to consolidated financial statements.

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

Note 1. Organization and Significant Accounting Policies

 

Tectonic Financial, Inc. (the “Company,” “we,” “us,” or “our”) is a financial holding company that offers, through its subsidiaries, banking and other financial services including trust, investment advisory, securities brokerage, factoring, third-party administration, recordkeeping and insurance services to individuals, small businesses and institutions across the United States.

 

We operate through four main direct and indirect subsidiaries: (i) T Bancshares, Inc. (“TBI”), which was incorporated under the laws of the State of Texas on December 23, 2002 to serve as the bank holding company for T Bank, N.A., a national banking association (the “Bank”), (ii) Sanders Morris Harris LLC (“Sanders Morris”), a registered broker-dealer with the Financial Industry Regulatory Authority (“FINRA”) and registered investment advisor with the Securities and Exchange Commission, (“SEC”), (iii) Tectonic Advisors, LLC (“Tectonic Advisors”), a registered investment advisor registered with the SEC focused generally on managing money for relatively large, affiliated institutions, and (iv) HWG Insurance Agency LLC (“HWG”), an insurance agency registered with the Texas Department of Insurance (“TDI”).

 

We are headquartered in Dallas, Texas. The Bank operates through its main office located at 16200 Dallas Parkway, Dallas, Texas. Our other subsidiaries operate from offices in Houston, Dallas and Plano, Texas. Our Houston, Texas office is located at 600 Travis Street, 59th Floor, Houston, Texas, and includes the home offices of Sanders Morris and HWG, as well as Tectonic Advisors’ family office services team. Our other Dallas office, which is a branch office of Sanders Morris, is at 5950 Sherry Lane, Suite 470, Dallas, Texas. Our main office for Tectonic Advisors is in Plano, Texas at 6900 Dallas Parkway, Suite 625, Plano, Texas, and also includes a branch office of HWG.

 

The Bank offers a broad range of commercial and consumer banking and trust services primarily to small- to medium-sized businesses and their employees, and other institutions. The Nolan Company (“Nolan”), operating as a division within the Bank, offers third party administration (“TPA”) services, and Integra Funding Solutions (“Integra”), also operating as a division within the Bank, offers factoring services. The Bank’s technological capabilities, including worldwide free ATM withdrawals, sophisticated on-line banking capabilities, electronic funds transfer capabilities, and economical remote deposit solutions, allow most customers to be served regardless of their geographic location. The Bank serves its local geographic market which includes Dallas, Tarrant, Denton, Collin and Rockwall counties which encompass an area commonly referred to as the Dallas/Fort Worth Metroplex. The Bank also serves the dental and other health professional industries through a centralized loan and deposit platform that operates out of its main office in Dallas, Texas. In addition, the Bank serves the small business community by offering loans guaranteed by the U.S. Small Business Administration (“SBA”) and the U.S. Department of Agriculture (“USDA”).

 

The Bank offers a wide range of deposit services including demand deposits, regular savings accounts, money market accounts, individual retirement accounts, and certificates of deposit with fixed rates and a range of maturity options. Lending services include commercial loans to small- to medium-sized businesses and professional concerns as well as consumers. The Bank also offers trust services. The Bank’s traditional fiduciary services clients primarily consist of clients of Cain, Watters & Associates, LLC (“Cain Watters”). The Bank, Cain Watters and Tectonic Advisors entered into an advisory services agreement related to the trust operations in April 2006, which has been amended from time to time, most recently in July 2016. See Note 12, Related Parties, to these consolidated financial statements for more information. In addition, the Nolan division of the Bank offers TPA services and provides clients with retirement plan design and administrative services, specializing in ministerial recordkeeping, administration, actuarial and design services for retirement plans of small businesses and professional practices. We believe offering TPA services allows us to serve our clients more fully and to attract new clients to our trust platform.

 

Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q for the three and six months ended June 30, 2022 (this “Form 10-Q”) include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions and balances are eliminated in consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the SEC. Accordingly, the consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2021 in the audited financial statements included within our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 31, 2022.

 

In the opinion of management, all adjustments that were normal and recurring in nature, and considered necessary, have been included for the fair presentation of the Company’s consolidated financial position and results of operations. Operating results for the three and six months ended June 30, 2022 are not necessarily indicative of results that may be expected for the full year ending December 31, 2022.

 

 

Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period, as well as the disclosures provided. Actual results could be significantly different from those estimates. Changes in assumptions or in market conditions could significantly affect the estimates. The determination of the allowance for loan losses, the fair value of stock options, the fair values of financial instruments and other real estate owned, and the status of contingencies are particularly susceptible to significant change in recorded amounts.

 

Accounting Changes, Reclassifications and Restatements. Certain items in prior financial statements have been reclassified to conform to the current presentation.

 

Earnings per Share. Basic earnings per share (“EPS”) is computed based on the weighted-average number of shares outstanding during each year. Diluted EPS is computed using the weighted-average shares and all potential dilutive shares outstanding during the period. The following table sets forth the computation of basic and diluted EPS for the following periods:

 

   

Three months ended June 30,

   

Six months ended June 30,

 

(In thousands, except per share data)

 

2022

   

2021

   

2022

   

2021

 

Net income available to common shareholders

  $ 4,353     $ 3,329     $ 8,250     $ 7,239  

Average shares outstanding

    7,062       6,569       7,061       6,569  

Effect of dilutive shares

    255       62       254       62  
                                 

Average diluted shares outstanding

    7,317       6,631       7,315       6,631  
                                 

Basic earnings per share

  $ 0.62     $ 0.51     $ 1.17     $ 1.10  

Diluted earnings per share

  $ 0.59     $ 0.50     $ 1.13     $ 1.09  

 

As of June 30, 2022, options to purchase 180,000 shares of common stock, with a weighted average exercise price of $5.43, were included in the computation of diluted net earnings per share. In addition, as of June 30, 2022, 210,000 shares of restricted stock grants with a grant date fair value of $4.81 per share which vest from 2023 through 2025 were included in the diluted earnings per share calculation.

 

Note 2. Securities

 

A summary of amortized cost and fair value of securities is presented below as of the dates indicated.

 

   

June 30, 2022

 

(In thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Estimated

Fair Value

 

Securities available for sale:

                               

U.S. Treasuries

  $ 1,980     $ -     $ 15     $ 1,965  

U.S government agencies

    15,768       -       2,078       13,690  

Mortgage-backed securities

    4,641       -       122       4,519  

Total securities available for sale

  $ 22,389     $ -     $ 2,215     $ 20,174  
                                 

Securities held to maturity:

                               

Property assessed clean energy

  $ 2,593     $ -     $ -     $ 2,593  

Public improvement district/tax increment reinvestment zone

    23,634       -       -       23,634  

Total securities held to maturity

  $ 26,227     $ -     $ -     $ 26,227  

Securities, restricted:

                               

Other

  $ 3,485     $ -     $ -     $ 3,485  
                                 

Securities not readily marketable

  $ 100     $ -     $ -     $ 100  

 

 

   

December 31, 2021

 

(In thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Estimated

Fair Value

 

Securities available for sale:

                               

U.S. government agencies

  $ 15,847     $ 4     $ 449     $ 15,402  

Mortgage-backed securities

    1,724       30       -       1,754  

Total securities available for sale

  $ 17,571     $ 34     $ 449     $ 17,156  
                                 

Securities held to maturity:

                               

Property assessed clean energy

  $ 2,731     $ -     $ -     $ 2,731  

Public improvement district/tax increment reinvestment zone

    16,942       -       -       16,942  

Total securities held to maturity

  $ 19,673     $ -     $ -     $ 19,673  

Securities, restricted:

                               

Other

  $ 2,432     $ -     $ -     $ 2,432  
                                 

Securities not readily marketable

  $ 100     $ -     $ -     $ 100  

 

Securities available for sale consist of U.S. government agency securities and mortgage-backed securities guaranteed by U.S. government agencies. Securities held to maturity consist of Property Assessed Clean Energy (“PACE”) and Public Improvement District/Tax Increment Reinvestment Zone (“PID/TIRZ”) investments. These investment contracts or bonds located in Texas, California and Florida, originate under a contractual obligation between the property owners, the local county or city administration, and a third-party administrator and sponsor. PACE assessments are created to fund the purchase and installation of energy saving improvements to the property such as solar panels. PID/TIRZ assessments are used to pay for the development costs of a residential subdivision. Generally, as a property assessment, the total assessment is repaid in installments over a period of 5 to 32 years by the then current property owner(s). Each installment is collected by the County or City Tax Collector where the property is located. The assessments are an obligation of the property. Securities, restricted consist of Federal Reserve Bank of Dallas (“FRB”) and Federal Home Loan Bank of Dallas (“FHLB”) stock, which are carried at cost.

 

As of June 30, 2022 and December 31, 2021, securities available for sale with a fair value of $113,000 and $163,000, respectively, were pledged against trust deposit balances held at the Bank.

 

As of June 30, 2022 and December 31, 2021, the Bank held FRB stock in the amount of $2.2 million and $1.2 million, respectively. The Bank held FHLB stock in the amount of $1.3 million at each of June 30, 2022 and December 31, 2021. The FRB stock and FHLB stock were classified as restricted securities.

 

As of June 30, 2022 and December 31, 2021, the Company held an income interest in a private investment, which is not readily marketable, accounted for under the cost method in the amount of $100,000.

 

The table below indicates the length of time individual investment securities have been in a continuous loss position as of June 30, 2022:

 

   

Less than 12 months

   

12 months or longer

   

Total

 

(In thousands)

 

Fair Value

   

Unrealized
Losses

   

Fair Value

   

Unrealized
Losses

   

Fair Value

   

Unrealized
Losses

 

U.S. Treasuries

  $ 1,965     $ 15     $ -     $ -     $ 1,965     $ 15  

U.S. government agencies

    3,217       423       10,473     $ 1,655       13,690       2,078  

Mortgage-backed securities

    4,519       122       -       -       4,519       122  

Total

  $ 9,701     $ 560     $ 10,473     $ 1,655     $ 20,174     $ 2,215  

 

The number of investment positions in this unrealized loss position totaled twenty-four as of June 30, 2022. The Company does not believe these unrealized losses are “other than temporary” as (i) it does not have the intent to sell the securities prior to recovery and/or maturity and, (ii) it is more likely than not that the Company will not have to sell the securities prior to recovery and/or maturity. Accordingly, as of June 30, 2022, no impairment loss has been realized in the Company’s consolidated statements of income.

 

 

The amortized cost and estimated fair value of securities available for sale as of June 30, 2022 are presented in the table below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage-backed securities are shown separately since they are not due at a single maturity date.

 

   

Available for Sale

 

(In thousands)

 

Amortized

Cost

   

Estimated
Fair Value

 

Due in one year or less

  $ 988     $ 981  

Due after one year through five years

    5,994       5,446  

Due after five years through ten years

    7,120       6,288  

Due after ten years

    3,646       2,940  

Mortgage-backed securities

    4,641       4,519  

Total

  $ 22,389     $ 20,174  

 

Note 3. Loans and Allowance for Loan Losses

 

Major classifications of loans held for investment are as follows as of the dates indicated:

 

(In thousands)

 

June 30, 2022

   

December 31, 2021

 

Commercial and industrial

  $ 90,660     $ 83,348  

Consumer installment

    1,171       1,099  

Real estate – residential

    4,491       5,452  

Real estate – commercial

    57,992       62,966  

Real estate – construction and land

    3,539       2,585  

SBA:

               

SBA 7(a) guaranteed

    143,488       145,983  

SBA 7(a) unguaranteed

    58,231       52,524  

SBA 504

    35,016       35,348  

USDA

    813       806  

Factored Receivables

    33,545       38,636  

Gross Loans

    428,946       428,747  

Less:

               

Allowance for loan losses

    4,235       4,152  

Net loans

  $ 424,711     $ 424,595  

 

Beginning in the second quarter of 2020 and until funding expired on May 31, 2021, the Company participated in the Paycheck Protection Program (“PPP”) which was established by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in response to the COVID-19 pandemic and administered by the SBA. PPP loans may be forgiven by the SBA and are 100 percent guaranteed by the SBA. Therefore, no allowance for loan losses is allocated to PPP loans. Included in SBA 7(a) guaranteed loans at June 30, 2022 and December 31, 2021, were $363,000 and $34.1 million of PPP loans originated, respectively.

 

As of June 30, 2022, our loan portfolio included $81.0 million of loans, approximately 18.9% of our total funded loans, to the dental industry, as compared to $67.3 million of loans, or 15.7% of total funded loans (17.1% of total funded loans, net of PPP loans), as of December 31, 2021. The Bank believes that these loans are to credit worthy borrowers and are diversified geographically. 

 

The Company serves the small business community by offering loans promulgated under the SBA’s 7(a) and 504 loan programs, and loans guaranteed by the USDA. SBA 7(a) and USDA loans are typically guaranteed by each agency in amounts ranging from 75% to 80% of the principal balance. For SBA construction loans, the Company records the guaranteed funded portion of the loans as held for sale. When the SBA loans are fully funded, the Company may sell the guaranteed portion into the secondary market, on a servicing-retained basis, or reclassify from loans held for sale to loans held for investment if the Company determines that holding these loans provide better long-term risk adjusted returns than selling the loans. In calculating gain on the sale of loans, the Company performs an allocation based on the relative fair values of the sold portion and retained portion of the loan. The Company’s assumptions are validated by reference to external market information.

 

 

The Company had $32.0 million and $33.8 million of non-PPP SBA loans held for sale as of June 30, 2022 and December 31, 2021, respectively. There were no loans sold for the three and six months ended June 30, 2022. During the three and six months ended June 30, 2021, the Company sold $1.1 million of non-PPP SBA loans, resulting in a gain on sale of loans of $101,000. For the three and six months ended June 30, 2022, the Company elected to reclassify $13.0 million and $36.3 million, respectively, of the SBA 7(a) loans held for sale to loans held for investment.

 

Loan Origination/Risk Management.

 

The Company maintains written loan origination policies, procedures, and processes which address credit quality at several levels including individual loan level, loan type, and loan portfolio levels.

 

Commercial and industrial loans, which are predominantly loans to dentists, are underwritten based on historical and projected income of the business and individual borrowers and guarantors. The Company utilizes a comprehensive global debt service coverage analysis to determine debt service coverage ratios. This analysis compares global cash flow of the borrowers and guarantors on an individual credit to existing and proposed debt after consideration of personal and business-related other expenses. Collateral is generally a lien on all available assets of the business borrower including intangible assets. Credit worthiness of individual borrowers and guarantors is established through the use of credit reports and credit scores.

 

Consumer loans are evaluated on the basis of credit worthiness as established through the use of credit reports and credit scores. Additional credit quality indicators include borrower debt to income ratios based on verifiable income sources.

 

Real estate mortgage loans are evaluated based on collateral value as well as global debt service coverage ratios based on historical and projected income from all related sources including the collateral property, the borrower, and all guarantors where applicable.

 

The Company originates SBA loans which are sometimes sold into the secondary market. The Company continues to service these loans after sale and is required under the SBA programs to retain specified amounts. The two primary SBA loan programs that the Company offers are the basic SBA 7(a) loan guaranty program and the SBA 504 loan program in conjunction with junior lien financing from a Certified Development Company (“CDC”). The SBA has designated the Bank as a “Preferred Lender.” As an SBA Preferred Lender, the Bank has been delegated loan approval, closing and most servicing and liquidation authority from the SBA.

 

The SBA 7(a) program serves as the SBA’s primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. Loan proceeds under this program can be used for most business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements and debt refinancing. Loan maturity is generally up to 10 years for non-real estate collateral and up to 25 years for real estate collateral. The SBA 7(a) loan is approved and funded by a qualified lender, partially guaranteed by the SBA and subject to applicable regulations. In general, the SBA guarantees up to 75% (100% for PPP loans) of the loan amount depending on loan size. The Company is required by the SBA to service the loan and retain a contractual minimum of 5% on all SBA 7(a) loans, but generally retains 25% (the unguaranteed portion). The servicing spread is 1% of the guaranteed portion of the loan that is sold in the secondary market. Included in the SBA 7(a) loans reflected in this Form 10-Q are the PPP loans originated by the Company. PPP loans totaling $363,000 were outstanding as of June 30, 2022.

 

The SBA 504 program is an economic development-financing program providing long-term, low down payment loans to businesses. Typically, a 504 project includes a loan secured from a private-sector lender with a senior lien, a loan secured from a CDC (funded by a 100% SBA-guaranteed debenture) with a junior lien covering up to 40% of the total cost, and a contribution of at least 10% equity from the borrower. Debenture limits are $5.0 million for regular 504 loans and $5.5 million for those 504 loans that meet a public policy goal.

 

The Company also offers Business & Industry (“B&I”) program loans through the USDA. These loans are similar to the SBA product, except they are guaranteed by the USDA. The guaranteed amount is generally 80%. B&I loans are made to businesses in designated rural areas and are generally larger loans to larger businesses than the SBA 7(a) loans. Similar to the SBA 7(a) product, they can be sold into the secondary market. These loans can be utilized for rural commercial real estate and equipment. The loans can have maturities up to 30 years and the rates can be fixed or variable.

 

Construction and land development loans are evaluated based on the borrower’s and guarantor’s credit worthiness, past experience in the industry, track record and experience with the type of project being considered, and other factors. Collateral value is determined generally by independent appraisal utilizing multiple approaches to determine value based on property type.

 

 

The Bank engages in third-party factoring of certain business’s accounts receivable invoices. The Bank’s factoring clients are primarily in the transportation industry. Each account debtor is credit qualified, confirming credit worthiness and stability, because the underlying debtor represents the substantive underlying credit risk. Some factored receivables are full recourse to and personally guaranteed by the factoring client. In such cases, the client is credit qualified under specific policy guidelines. Concentration limits are set and monitored for aggregate factored receivables, account debtors, and individual factoring clients. In addition, we consider the overall state of each specific industry, currently over-the-road trucking, in our evaluation of the credit worthiness of the factoring client and the underlying debtor.

 

For all loan types, the Company establishes guidelines for its underwriting criteria including collateral coverage ratios, global debt service coverage ratios, and maximum amortization or loan maturity terms.

 

At the portfolio level, the Company monitors concentrations of loans based on several criteria including loan type, collateral type, industry, geography, and other factors. The Company also performs periodic market research and economic analysis at a local geographic and national level. Based on this research, the Company may from time to time change the minimum or benchmark underwriting criteria applied to the above loan types.

 

Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period of repayment performance by the borrower.

 

Non-accrual loans, segregated by class of loans, were as follows as of the dates indicated:

 

(In thousands)

 

June 30, 2022

   

December 31, 2021

 

Non-accrual loans:

               

Real estate – commercial

  $ 144     $ 149  

SBA guaranteed

    2,347       2,039  

SBA unguaranteed

    56       -  

Total

  $ 2,547     $ 2,188  

 

The restructuring of a loan is considered a “troubled debt restructuring” (“TDR”) if, due to the borrower’s financial difficulties, the Company has granted a concession that the Company would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modification of loan terms may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules, reductions in collateral and other actions intended to minimize potential losses.

 

Under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 310-40 Receivables Troubled Debt Restructurings by Creditors, and Interagency Statements issued by the federal banking regulators, in consultation with the FASB, certain short-term loan modifications and additional accommodations made on a good faith basis in response to COVID-19 (as defined by the guidance) to borrowers who were current prior to any relief are not considered TDRs. Additionally, under Section 4013 of the CARES Act, as amended by the Consolidated Appropriations Act, 2021, banks may elect to suspend the requirement for certain loan modifications to be categorized as a TDR. In response to the COVID-19 pandemic, the Company has implemented prudent modifications allowing for primarily short-term payment deferrals or other payment relief to borrowers with pandemic-related economic hardships, where appropriate, that complies with the above guidance. As such, the Company's TDR loans noted above do not include loans with modifications to borrowers impacted by COVID-19. As of June 30, 2022, there were no loans on deferment due to the COVID-19 pandemic.

 

As of June 30, 2022 and December 31, 2021, there were no loans identified as TDRs. There were no new TDRs during the three and six months ended June 30, 2022 or the year ended December 31, 2021.

 

 

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

The Company’s impaired loans and related allowance is summarized in the following table as of the dates indicated:

 

   

Unpaid

   

Recorded

   

Recorded

                                 
   

Contractual

   

Investment

   

Investment

   

Total

           

Average

   

Interest

 
   

Principal

   

With No

   

With

   

Recorded

   

Related

   

Recorded

   

Income

 

(In thousands)

 

Balance

   

Allowance

   

Allowance

   

Investment

   

Allowance

   

Investment

   

Recognized

 

June 30, 2022

                                         

Six Months Ended

 

SBA

  $ 2,759     $ 2,126     $ -     $ 2,126     $ -     $ 2,449     $ -  

Total

  $ 2,759     $ 2,126     $ -     $ 2,126     $ -     $ 2,449     $ -  
                                                         

December 31, 2021

                                         

Year Ended

 

Commercial and industrial

  $ -     $ -     $ -     $ -     $ -     $ 73     $ 4  

SBA

    3,658       3,071       -       3,071       -       6,333       21  

Total

  $ 3,658     $ 3,071     $ -     $ 3,071     $ -     $ 6,406     $ 25  

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The Company’s past due loans are as follows as of the dates indicated:

 

                                           

Total 90

 
   

30-89 Days

   

90 Days or

   

Total

   

Total

   

Total

   

Days Past Due

 

(In thousands)

 

Past Due

   

More Past Due

   

Past Due

   

Current

   

Loans

   

Still Accruing

 

June 30, 2022

                                               

Commercial and industrial

  $ -     $ -     $ -     $ 90,660     $ 90,660     $ -  

Consumer installment

    -       -       -       1,171       1,171       -  

Real estate – residential

    -       210       210       4,281       4,491       210  

Real estate – commercial

    -       -       -       57,992       57,992       -  

Real estate – construction and land

    -       -       -       3,539       3,539       -  

SBA

    -       2,403       2,403       234,332       236,735       -  

USDA

    -       -       -       813       813       -  

Factored Receivables

    1,105       170       1,275       32,270       33,545       170  

Total

  $ 1,105     $ 2,783     $ 3,888     $ 425,058     $ 428,946     $ 380  
                                                 

December 31, 2021

                                               

Commercial and industrial

  $ 4     $ -     $ 4     $ 83,344     $ 83,348     $ -  

Consumer installment

    -       -       -       1,099       1,099       -  

Real estate – residential

    -       -       -       5,452       5,452       -  

Real estate – commercial

    219       -       219       62,747       62,966       -  

Real estate – construction and land

    -       -       -       2,585       2,585       -  

SBA

    1,762       -       1,762       232,093       233,855       -  

USDA

    -       -       -       806       806       -  

Factored receivables

    1,743       400       2,143       36,493       38,636       400  

Total

  $ 3,728     $ 400     $ 4,128     $ 424,619     $ 428,747     $ 400  

 

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including internal credit risk based on past experiences as well as external statistics and factors. Loans are graded in one of six categories: (i) pass, (ii) pass-watch, (iii) special mention, (iv) substandard, (v) doubtful, or (vi) loss. Loans graded as loss are charged-off.

 

 

The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on credits quarterly. No significant changes were made to the loan risk grading system definitions and allowance for loan loss methodology during the past year. Ratings are adjusted to reflect the degree of risk and loss that is felt to be inherent in each credit. The Company’s methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

 

Credits rated pass are acceptable loans, appropriately underwritten, bearing an ordinary risk of loss to the Company. Loans in this category are loans to highly credit worthy borrowers with financial statements presenting a good primary source as well as an adequate secondary source of repayment.

 

Credits rated pass-watch loans have been determined to require enhanced monitoring for potential weaknesses which require further investigation. They have no significant delinquency in the past twelve months. This rating causes the loan to be actively monitored with greater frequency than pass loans and allows appropriate downgrade transition if verifiable adverse events are confirmed. This category may also include loans that have improved in credit quality from special mention but are not yet considered pass loans.

 

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness; however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

 

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed. Guaranteed portions of SBA loans graded substandard are generally on non-accrual due to the limited amount of interest covered by the guarantee, usually 60 days maximum. However, there typically will be no exposure to loss on the principal amount of these guaranteed portions of the loan.

 

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss.

 

Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this asset even though partial recovery may be affected in the future.

 

The following table summarizes the Company’s internal ratings of its loans as of the dates indicated:

 

            Pass-    

Special

                         

(In thousands)

 

Pass

    Watch    

Mention

   

Substandard

   

Doubtful

   

Total

 

June 30, 2022

                                               

Commercial and industrial

  $ 89,913     $ -     $ 747     $ -     $ -     $ 90,660  

Consumer installment

    1,171       -       -       -       -       1,171  

Real estate – residential

    4,281       -       -       210       -       4,491  

Real estate – commercial

    57,848       -       -       144       -       57,992  

Real estate – construction and land

    3,539       -       -       -       -       3,539  

SBA

    211,691       19,538       4,501       1,005       -       236,735  

USDA

    813       -       -       -       -       813  

Factored Receivables

    33,545       -       -       -       -       33,545  

Total

  $ 402,801     $ 19,538     $ 5,248     $ 1,359     $ -     $ 428,946  
                                                 

December 31, 2021

                                               

Commercial and industrial

  $ 82,105     $ 1,243     $ -     $ -     $ -     $ 83,348  

Consumer installment

    1,099       -       -       -       -       1,099  

Real estate – residential

    5,242       -       -       210       -       5,452  

Real estate – commercial

    62,817       -       -       149       -       62,966  

Real estate – construction and land

    2,585       -       -       -       -       2,585  

SBA

    213,630       16,265       2,659       1,301       -       233,855  

USDA

    806       -       -       -       -       806  

Factored Receivables

    38,636       -       -       -       -       38,636  

Total

  $ 406,920     $ 17,508     $ 2,659     $ 1,660     $ -     $ 428,747  

 

 

The activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2022 and 2021 is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio.

 

(In thousands)

 

Commercial

and Industrial

   

Consumer

Installment

   

Real Estate

Residential

   

Real Estate

Commercial

   

Real Estate

Construction

and Land

    SBA    

USDA

   

Factored

Receivables

   

Total

 

Three months ended:

                                                                       

June 30, 2022

                                                                       

Beginning Balance

  $ 1,213     $ 17     $ 29     $ 901     $ 50     $ 1,409     $ 20     $ 715     $ 4,354  

Provision for loan losses

    40       (2

)