10-Q 1 tectonic20230930_10q.htm FORM 10-Q tectonic20230930_10q.htm


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 September 30, 2023

 

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 November 10, 2023 was 7,028,564 shares.

 

 

 

 

TECTONIC FINANCIAL, INC.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

Page

     

Item 1. 

Consolidated Financial Statements (Unaudited)

 

 

Consolidated Balance Sheets as of September 30, 2023 and December 31, 2022

3

 

Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2023 and 2022

4

 

Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2023 and 2022

5

 

Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2023 and 2022

6

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2023 and 2022

7

 

Notes to Consolidated Financial Statements

8

Item 2. 

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

35

Item 3. 

Quantitative and Qualitative Disclosures about Market Risk

61

Item 4. 

Controls and Procedures

62

   

PART II. OTHER INFORMATION

63

Item 1. 

Legal Proceedings

63

Item 1A. 

Risk Factors

63

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

63

Item 3. 

Defaults upon Senior Securities

63

Item 4. 

Mine Safety Disclosures

63

Item 5. 

Other Information

63

Item 6. 

Exhibits

64

     

SIGNATURES 

65

 

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

TECTONIC FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

 

   

September 30,

2023

   

December 31,

2022

 

(In thousands, except share amounts)

 

(Unaudited)

         

ASSETS

               

Cash and due from banks

  $ 6,701     $ 8,549  

Interest-bearing deposits

    39,676       32,562  

Federal funds sold

    1,357       1,044  

Total cash and cash equivalents

    47,734       42,155  

Securities available for sale

    21,366       20,633  

Securities held to maturity

    24,186       25,262  

Securities, restricted at cost

    4,150       3,496  

Securities, not readily marketable

    317       100  

Loans held for sale

    15,433       33,902  

Loans, net of allowance for credit losses of $5,998 and $4,513, respectively

    473,196       445,819  

Bank premises and equipment, net

    4,829       4,629  

Core deposit intangible, net

    412       569  

Goodwill

    21,440       21,440  

Deferred tax asset

    1,001       636  

Other assets

    15,228       13,895  

Total assets

  $ 629,292     $ 612,536  
                 

LIABILITIES

               

Demand deposits:

               

Non-interest-bearing

  $ 86,875     $ 94,187  

Interest-bearing

    156,422       137,148  

Time deposits

    257,279       261,690  

Total deposits

    500,576       493,025  

Subordinated notes

    12,000       12,000  

Other liabilities

    11,849       11,013  

Total liabilities

    524,425       516,038  

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 each of September 30, 2023 and December 31, 2022)

    17       17  

Common stock, $0.01 par value; 40,000,000 shares authorized; 7,094,453 shares issued at each of September 30, 2023 and December 31, 2022 and 7,063,564 and 7,068,884 shares outstanding at September 30, 2023 and December 31, 2022, respectively

    71       71  

Additional paid-in capital

    51,071       50,695  

Treasury stock, at cost; 30,889 shares and 25,569 shares as of September 30, 2023 and December 31, 2022, respectively

    (581

)

    (481

)

Retained earnings

    56,694       48,564  

Accumulated other comprehensive loss

    (2,405

)

    (2,368

)

Total shareholders’ equity

    104,867       96,498  

Total liabilities and shareholders’ equity

  $ 629,292     $ 612,536  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 

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

 

2023

   

2022

   

2023

   

2022

 

Interest Income

                               

Loan, including fees

  $ 10,590     $ 7,877     $ 30,028     $ 22,083  

Securities

    513       538       1,527       1,290  

Federal funds sold

    12       4       31       5  

Interest-bearing deposits

    578       193       2,274       286  

Total interest income

    11,693       8,612       33,860       23,664  

Interest Expense

                               

Deposits

    4,788       1,378       12,428       2,714  

Borrowed funds

    339       242       1,000       713  

Total interest expense

    5,127       1,620       13,428       3,427  

Net interest income

    6,566       6,992       20,432       20,237  

Provision for credit losses

    (38

)

    150       732       477  

Net interest income after provision for credit losses

    6,604       6,842       19,700       19,760  

Non-interest Income

                               

Trust income

    1,664       1,470       4,764       4,624  

Gain on sale of loans

    -       -       581       -  

Advisory income

    3,643       3,317       10,803       10,249  

Brokerage income

    1,986       2,430       5,765       8,614  

Service fees and other income

    2,740       2,338       8,129       6,442  

Rental income

    92       79       218       268  

Total non-interest income

    10,125       9,634       30,260       30,197  

Non-interest Expense

                               

Salaries and employee benefits

    7,614       7,717       23,117       23,053  

Occupancy and equipment

    499       394       1,445       1,265  

Trust expenses

    648       537       1,711       1,695  

Brokerage and advisory direct costs

    497       488       1,440       1,514  

Professional fees

    367       298       1,428       1,051  

Data processing

    241       203       647       593  

Other

    1,537       1,224       4,987       3,927  

Total non-interest expense

    11,403       10,861       34,775       33,098  

Income before Income Taxes

    5,326       5,615       15,185       16,859  

Income tax expense

    1,156       1,154       3,280       3,372  

Net Income

    4,170       4,461       11,905       13,487  

Preferred stock dividends

    388       388       1,164       1,164  

Net income available to common stockholders

  $ 3,782     $ 4,073     $ 10,741     $ 12,323  
                                 

Earnings per common share:

                               

Basic

  $ 0.54     $ 0.58     $ 1.52     $ 1.75  

Diluted

    0.52       0.56       1.47       1.68  
                                 

Weighted average common shares outstanding

    7,063,564       7,062,319       7,066,117       7,061,225  

Weighted average diluted shares outstanding

    7,296,069       7,306,607       7,298,622       7,319,334  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 

(In thousands)

 

2023

   

2022

   

2023

   

2022

 

Net Income

  $ 4,170     $ 4,461     $ 11,905     $ 13,487  

Other comprehensive loss:

                               

Change in unrealized loss on securities available for sale

    (361

)

    (1,005

)

    (47

)

    (2,805

)

Tax effect

    (76

)

    (211

)

    (10

)

    (589

)

Other comprehensive loss

    (285

)

    (794

)

    (37

)

    (2,216

)

Comprehensive Income

  $ 3,885     $ 3,667     $ 11,868     $ 11,271  

 

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

Loss

   

Total

 

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  

Repayments of note receivable utilized to

exercise options

    -       -       50       -       -       -       50  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (442

)

    -       (442

)

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  

Exercise of stock options

    -       -       54       -       -       -       54  

Purchase of treasury stock at cost

    -       -       -       (235

)

    -               (235

)

Repayments of note receivable utilized to  exercise options

    -       -       50       -       -       -       50  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (442

)

    -       (442

)

Net income

    -       -       -       -       4,461       -       4,461  

Other comprehensive loss

    -       -       -       -       -       (794

)

    (794

)

Stock based compensation

    -       -       13       -       -       -       13  

Balance at September 30, 2022

  $ 17     $ 71     $ 50,563     $ (416

)

  $ 45,849     $ (2,544

)

  $ 93,540  
                                                         

Balance at January 1, 2023

  $ 17     $ 71     $ 50,695     $ (481

)

  $ 48,564     $ (2,368

)

  $ 96,498  

Cumulative change in accounting principle (adoption of ASC 326)

    -       -       -       -       (1,286

)

    -       (1,286

)

Balance at January 1, 2023, as adjusted for change in accounting principle (adoption of ASC 326)

    17       71       50,695       (481

)

    47,278       (2,368

)

    95,212  

Repayments of note receivable utilized to

exercise options

    -       -       50       -       -       -       50  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (442

)

    -       (442

)

Net income

    -       -       -       -       4,714       -       4,714  

Other comprehensive income

    -       -       -       -       -       338       338  

Stock based compensation

    -       -       75       -       -       -       75  

Balance at March 31, 2023

  $ 17     $ 71     $ 50,820     $ (481

)

  $ 51,162     $ (2,030

)

  $ 99,559  

Purchase of treasury stock at cost

    -       -       -       (100

)

    -       -       (100

)

Repayments of note receivable utilized to

exercise options

    -       -       50       -       -       -       50  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (442

)

    -       (442

)

Net income

    -       -       -       -       3,021       -       3,021  

Other comprehensive loss

    -       -       -       -       -       (90

)

    (90

)

Stock based compensation

    -       -       75       -       -       -       75  

Balance at June 30, 2023

  $ 17     $ 71     $ 50,945     $ (581

)

  $ 53,353     $ (2,120

)

  $ 101,685  

Repayments of note receivable utilized to

exercise options

    -       -       50       -       -       -       50  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Dividends paid on common stock

    -       -       -       -       (441

)

    -       (441

)

Net income

    -       -       -       -       4,170       -       4,170  

Other comprehensive loss

    -       -       -       -       -       (285

)

    (285

)

Stock based compensation

    -       -       76       -       -       -       76  

Balance at September 30, 2023

  $ 17     $ 71     $ 51,071     $ (581

)

  $ 56,694     $ (2,405

)

  $ 104,867  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   

Nine Months Ended September 30,

 

(In thousands)

 

2023

   

2022

 

Cash Flows from Operating Activities

               

Net income

  $ 11,905     $ 13,487  

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

               

Provision for credit losses

    732       477  

Depreciation

    183       170  

Accretion of discount on loans

    (14

)

    (23

)

Core deposit intangible amortization

    157       155  

Securities premium accretion, net

    (61

)

    (7

)

Origination of loans held for sale

    (34,859

)

    (39,416

)

Proceeds from payments and sales of loans held for sale

    6,565       402  

Loss on sale of other real estate owned

    -       6  

Gain on sale of loans

    (581

)

    -  

Stock based compensation

    226       190  

Deferred income taxes

    (13

)

    53  

Servicing assets, net

    4       155  

Net change in:

               

Other assets

    (1,299

)

    104  

Other liabilities

    589       1,790  

Net cash used in operating activities

    (16,466

)

    (22,457

)

Cash Flows from Investing Activities

               

Purchase of securities held to maturity

    -       (7,408

)

Purchase of securities available for sale

    (302,877

)

    (281,519

)

Principal payments, calls and maturities of securities available for sale

    302,119       275,285  

Principal payments of securities held to maturity

    1,115       877  

Purchase of securities, restricted

    (8,957

)

    (9,599

)

Proceeds from sale of securities, restricted

    8,303       8,543  

Proceeds from sales of real estate owned

    -       555  

Purchase of securities not readily marketable

    (217

)

    -  

Net change in loans

    17,830       41,690  

Purchases of premises and equipment

    (383

)

    (55

)

Net cash provided by investing activities

    16,933       28,369  

Cash Flows from Financing Activities

               

Net change in demand deposits

    11,962       18,879  

Net change in time deposits

    (4,411

)

    8,080  

Proceeds from borrowed funds

    348,400       284,300  

Repayment of borrowed funds

    (348,400

)

    (318,821

)

Dividends paid on common stock

    (1,325

)

    (1,325

)

Dividends paid on Series B preferred stock

    (1,164

)

    (1,164

)

Proceeds from exercise of stock options

    -       97  

Repayments on note receivable utilized to exercise stock options

    150       100  

Purchase of treasury stock at cost

    (100

)

    (416

)

Net cash provided by (used in) financing activities

    5,112       (10,270

)

Net change in cash and cash equivalents

    5,579       (4,358

)

Cash and cash equivalents at beginning of period

    42,155       45,992  

Cash and cash equivalents at end of period

  $ 47,734     $ 41,634  
                 

Non Cash Transactions

               

Transfers from loans held for sale to loans held for investment

  $ 47,305     $ 52,825  

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

  $ 61     $ 58  

Supplemental disclosures of cash flow information

               

Cash paid during the period for:

               

Interest

  $ 13,365     $ 3,646  

Income taxes

  $ 2,500     $ 3,515  

 

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 Texas corporation and 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 registered bank holding company for T Bank, N.A., a national banking association (the “Bank”), (ii) Sanders Morris LLC (“Sanders Morris”), a registered broker-dealer with the Financial Industry Regulatory Authority (“FINRA”) and registered investment advisor with the U.S. 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 Frisco, 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 located at 5950 Sherry Lane, Suite 470, Dallas, Texas. The main office for Tectonic Advisors is in Frisco, Texas, and is located at 17 Cowboys Way, Suite 250, Frisco, 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 from Nolan’s office in Overland Park, Kansas, offers third party administration (“TPA”) services, and Integra Funding Solutions, LLC (“Integra”), also operating as a division within the Bank from Integra’s office in Fort Worth, Texas, 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 in Texas 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 Bank’s 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 nine months ended September 30, 2023 (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, 2022 in the audited financial statements included within our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC on March 31, 2023.

 

 

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 nine months ended September 30, 2023, are not necessarily indicative of results that may be expected for the full year ending December 31, 2023.

 

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 credit 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.

 

New Accounting Pronouncements. The Company adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASC 326”), effective on January 1, 2023. The guidance replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. The CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance-sheet credit exposures based on historical experience, current conditions, and reasonable and supportable forecasts. ASC 326 requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses as well as the credit quality and underwriting standards of a company’s portfolio. ASU 2016-13 permits the use of estimation techniques that are practical and relevant to the Company’s circumstances, as long as they are applied consistently over time and faithfully estimate expected credit losses in accordance with the standard. In addition, ASC 326 made changes to the accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities management does not intend to sell or believes that it is more likely than not they will be required to sell. Management has made a policy election to exclude accrued interest receivable on available for sale securities from the estimate of credit losses and report accrued interest separately in other assets in the consolidated balance sheets.

 

The Company adopted ASC 326 using the modified retrospective method for loans and off-balance-sheet (“OBS”) credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable incurred loss model under GAAP. The Company recorded a one-time cumulative-effect adjustment to the allowance for credit losses of $1.4 million which was recognized through a $1.1 million adjustment to retained earnings, net of tax. This adjustment brought the beginning balance of the allowance for credit losses to $5.9 million as of January 1, 2023. In addition, the Company recorded a $237,505 reserve on unfunded commitments which is recorded in other liabilities in the Company’s consolidated balance sheet, and was recognized through a $188,000 adjustment to retained earnings, net of tax.

 

The Company adopted ASC 326 using the prospective transition approach for debt securities for which other-than-temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have any other-than-temporarily impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined that an allowance for credit losses for debt securities was not required.

 

ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”), eliminates the accounting guidance for troubled debt restructurings in ASC Subtopic 310-40, Receivables -Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Additionally, ASU 2022-02 requires entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of ASC Subtopic 326-20, Financial Instruments – Credit Losses – Measured at Amortized Cost. The Company adopted ASU 2022-02 on a modified retrospective basis effective on January 1, 2023. The adoption did not have a significant impact on the consolidated financial statements.

 

 

Earnings per Share. Basic earnings per share (“EPS”) is computed based on the weighted-average number of shares outstanding during the period. 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 September 30,

   

Nine months ended September 30,

 

(In thousands, except per share data)

 

2023

   

2022

   

2023

   

2022

 

Net income available to common shareholders

  $ 3,782     $ 4,073     $ 10,741     $ 12,323  

Weighted average shares outstanding

    7,064       7,062       7,066       7,061  

Effect of dilutive shares

    232       245       233       258  
                                 

Weighted average diluted shares outstanding

    7,296       7,307       7,299       7,319  
                                 

Basic earnings per share

  $ 0.54     $ 0.58     $ 1.52     $ 1.75  

Diluted earnings per share

  $ 0.52     $ 0.56     $ 1.47     $ 1.68  

 

As of September 30, 2023, options to purchase 167,500 shares of common stock, with a weighted average exercise price of $5.51, were included in the computation of diluted net earnings per share. In addition, as of September 30, 2023, 170,000 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, fair value and allowance for credit losses of securities is presented below as of the dates indicated.

 

   

September 30, 2023

 

(In thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Allowance for Credit Losses

   

Estimated

Fair Value

 

Securities available for sale:

                                       

U.S. Treasuries

  $ 3,956     $ -     $ 24     $ -     $ 3,932  

U.S. government agencies

    15,664       -       2,565       -       13,099  

Mortgage-backed securities

    4,790       -       455       -       4,335  

Total securities available for sale

  $ 24,410     $ -     $ 3,044     $ -     $ 21,366  
                                         

Securities held to maturity:

                                       

Property assessed clean energy

  $ 1,328     $ 110     $ -     $ -     $ 1,438  

Public improvement district/tax increment reinvestment zone

    22,858       1,134       28       -       23,964  

Total securities held to maturity

  $ 24,186     $ 1,244     $ 28     $ -     $ 25,402  
                                         

Securities, restricted:

                                       

Other

  $ 4,150     $ -     $ -     $ -     $ 4,150  
                                         

Securities not readily marketable

  $ 317     $ -     $ -     $ -     $ 317  

 

 

   

December 31, 2022

 

(In thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Allowance for Credit Losses

   

Estimated

Fair Value

 

Securities available for sale:

                                       

U.S. Treasuries

  $ 1,990     $ -     $ 37     $ -     $ 1,953  

U.S. government agencies

    15,715       -       2,627       -       13,088  

Mortgage-backed securities

    5,925       -       333       -       5,592  

Total securities available for sale

  $ 23,630     $ -     $ 2,997     $ -     $ 20,633  
                                         

Securities held to maturity:

                                       

Property assessed clean energy

  $ 1,596     $ 126     $ -     $ -     $ 1,722  

Public improvement district/tax increment reinvestment zone

    23,666       1,137       43       -       24,760  

Total securities held to maturity

  $ 25,262     $ 1,263     $ 43     $ -     $ 26,482  
                                         

Securities, restricted:

                                       

Other

  $ 3,496     $ -     $ -     $ -     $ 3,496  
                                         

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 are located in Texas, California and Florida, and 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.

 

During the three and nine months ended September, 2023 and 2022, no securities available for sale were sold, and there were no realized gains or losses recorded on sales for the three and nine months ended September, 2023 and 2022.

 

As of September 30, 2023 and December 31, 2022, securities available for sale with a fair value of $974,000 and $94,000, respectively, were pledged against trust deposit balances held at the Bank. During March 2023, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) created the Bank Term Funding Program (“BTFP”), which was made available to banks in response to liquidity concerns in the United States banking system. The BTFP allows the whole par value of available for sale securities to be included as the collateral value. As of September 30, 2023, securities with a par value of $23.3 million were pledged to the Federal Reserve under the BTFP, none of which was borrowed against.

 

As of September 30, 2023 and December 31, 2022, the Bank held FRB stock in the amount of $2.2 million. The Bank held FHLB stock in the amount of $1.9 million and $1.3 million as of September 30, 2023 and December 31, 2022, respectively, all of which were classified as securities, restricted.

 

As of September 30, 2023 and December 31, 2022, 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 $317,000 and $100,000, respectively.

 

 

The table below indicates the length of time individual investment securities have been in a continuous loss position as of September 30, 2023:

 

    September 30, 2023  
   

Less than 12 months

   

12 months or longer

   

Total

 

(In thousands)

 

Fair Value

   

Unrealized
Losses

   

Fair Value

   

Unrealized
Losses

   

Fair Value

   

Unrealized
Losses

 

Securities available for sale:

                                               

U.S. Treasuries

  $ 2,950     $ 7     $ 982     $ 17     $ 3,932     $ 24  

U.S. government agencies

    -       -       13,099       2,565       13,099       2,565  

Mortgage-backed securities

    -       -       4,335       455       4,335       455  

Total

  $ 2,950     $ 7     $ 18,416     $ 3,037     $ 21,366     $ 3,044  

Securities held to maturity:

                                               

Public improvement district/tax increment reinvestment zone

  $ 1,388     $ 28     $ -     $ -     $ 1,388     $ 28  

Total

  $ 1,388     $ 28     $ -     $ -     $ 1,388     $ 28  

 

Beginning January 1, 2023, the Company evaluates all securities quarterly to determine if any debt securities in a loss position require an allowance for credit losses in accordance with ASC 326. The Company had a total of twenty-three (23) investment positions in the unrealized loss position as of September 30, 2023. The Company evaluates whether the decline in fair value has resulted from credit losses or other factors based upon our analysis of the underlying risk characteristics, including credit ratings, such as bond ratings, and other qualitative factors related to our available for sale securities and in consideration of our historical credit loss experience and internal forecasts. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the uncollectability of a security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

 

As of September 30, 2023, no allowance for credit losses has been recognized on available for sale and held to maturity securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality. This is based upon our analysis of the underlying risk characteristics, including credit ratings, and other qualitative factors related to our securities and in consideration of our historical credit loss experience and internal forecasts. The issuers of these securities are U.S. government agencies who continue to make timely principal and interest payments under the contractual terms of the securities. Furthermore, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that we will not have to sell any such securities before a recovery of cost. The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline.

 

The amortized cost and estimated fair value of securities available for sale as of September 30, 2023 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

   

Held to Maturity

 

(In thousands)

 

Amortized Cost

   

Fair Value

   

Amortized Cost

   

Fair Value

 

Due in one year or less

  $ 3,956     $ 3,932     $ -     $ -  

Due after one year through five years

    10,997       9,526       1,416       1,388  

Due after five years through ten years

    1,092       946       367       390  

Due after ten years

    3,575       2,627       22,403       23,624  

Mortgage-backed securities

    4,790       4,335       -       -  

Total

  $ 24,410     $ 21,366     $ 24,186     $ 25,402  

 

 

Note 3. Loans and Allowance for Credit Losses

 

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

 

(In thousands)

 

September 30,

2023

   

December 31, 

2022

 

Commercial and industrial

  $ 82,273     $ 92,946  

Consumer installment

    879       1,058  

Real estate – residential

    7,953       5,566  

Real estate – commercial

    76,320       63,924  

Real estate – construction and land

    20,237       3,873  

SBA:

               

SBA 7(a) guaranteed

    166,195       149,374  

SBA 7(a) unguaranteed

    58,557       56,268  

SBA 504

    40,756       52,668  

USDA

    2,129       2,235  

Factored Receivables

    23,895       22,420  

Gross Loans

    479,194       450,332  

Less:

               

Allowance for credit losses

    5,998       4,513  

Net loans

  $ 473,196     $ 445,819  

 

As of September 30, 2023, our loan portfolio included $79.4 million of loans, or approximately 16.6%, of our total funded loans to the dental industry, as compared to $83.9 million of loans, or 18.63% of total funded loans, as of December 31, 2022. The Bank believes that these loans are to credit worthy borrowers and are diversified geographically.

 

Accrued interest receivable on loans totaled $2.6 million and $2.2 million at September 30, 2023 and December 31, 2022, respectively, and is included in accrued interest receivable and other assets in the Company’s consolidated balance sheets.

 

Loans with carrying amounts of $54.9 million and $40.0 million at September 30, 2023 and December 31, 2022, respectively, were pledged to secure FHLB borrowing capacity and FRB discount window borrowing capacity.

 

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 $15.4 million and $33.9 million of SBA/USDA loans held for sale as of September 30, 2023 and December 31, 2022, respectively. During the nine months ended September 30, 2023, the Company sold the guaranteed portion of one USDA loan totaling $5.8 million, resulting in a gain on sale loans of $581,000. There were no sales during the three months ended September 30, 2023 and the three and nine months ended September 30, 2022. For the three and nine months ended September 30, 2023, the Company elected to reclassify $19.6 million and $47.3 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 within an acceptable level of risk 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% 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.

 

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 the opinion of the Company’s management, 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)

 

September 30, 2023

   

December 31, 2022

 

Non-accrual loans:

               

Real estate – residential

  $ 130     $ 138  

SBA guaranteed

    1,574       2,221  

SBA unguaranteed

    140       107  

Total

  $ 1,844     $ 2,466  

 

There was no allowance for credit losses for non-accrual loans as of September 30, 2023. The Company did not recognize any interest income on non-accrual loans during the three and nine months ended September 30, 2023 and 2022.

 

From time to time, we may modify certain loans to borrowers who are experiencing financial difficulty. In some cases, these modifications may result in new loans. Loan modifications to borrowers experiencing financial difficulty may be in the form of a principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension or a combination thereof, among other things. During the three and nine months ended September 30, 2023, the Company provided one modification to extend the maturity date of a SBA loan with an outstanding balance of $357,000, or 0.08% of total loans.

 

The following table presents the amortized cost basis of collateral-dependent loans by class of loans as of September 30, 2023:

 

(In thousands)

 

Residential Real Estate

 

Real estate – residential

  $ 130  

SBA unguaranteed

    140  

Total

  $ 270  

 

Prior to the adoption of ASC 326, loans were 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 was allocated, if necessary, so that the loan was 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 December 31, 2022:

 

   

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

 
                                           

Year Ended December 31, 2022

 

Commercial and industrial

  $ -     $ -     $ -     $ -     $ -     $ 181     $ -  

SBA

    2,759       2,126       -       2,126       -       2,287       -  

Total

  $ 2,759     $ 2,126     $ -     $ 2,126     $ -     $ 2,468     $ -  

 

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 (including both accruing and non-accruing loans) are as follows as of the dates indicated:

 

   

30-89 Days

   

90 Days or

   

Total

   

Total

   

Total

   

90 Or More

Days Past Due

 

(In thousands)

 

Past Due

   

More Past Due

   

Past Due

   

Current

   

Loans

   

Still Accruing

 

September 30, 2023

                                               

Commercial and industrial

  $ -     $ -     $ -     $ 82,273     $ 82,273     $ -  

Consumer installment

    -       -       -       879       879       -  

Real estate – residential

    -       -       -       7,953       7,953       -  

Real estate – commercial

    -       -       -       76,320       76,320       -  

Real estate – construction and land

    -       -       -       20,237       20,237       -  

SBA 7a

    -       1,179       1,179       223,573       224,752       -  

SBA 504

    -       -       -       40,756       40,756       -  

USDA

    -       -       -       2,129       2,129       -  

Factored Receivables

    902       78       980       22,915       23,895       78  

Total

  $ 902     $ 1,257     $ 2,159     $ 477,035     $ 479,194     $ 78  
                                                 

December 31, 2022

                                               

Commercial and industrial

  $ 395     $ -     $ 395     $ 92,551     $ 92,946     $ -  

Consumer installment

    -       -       -       1,058       1,058       -  

Real estate – residential

    138       -       138       5,428       5,566       -  

Real estate – commercial

    -       206       206       63,718       63,924       206  

Real estate – construction and land

    -       -       -       3,873       3,873       -  

SBA 7a

    -       2,327       2,327       203,315       205,642       -  

SBA 504

    -       -