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EX-10.1 - EXHIBIT 10.1 - Tectonic Financial, Inc.ex_213683.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, 2020

 

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 and post 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 12, 2020 was 6,568,750 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, 2020 and December 31, 2019

3

 

Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2020 and 2019

4

 

Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2020 and 2019

5

 

Consolidated Statements of Changes in Shareholders' Equity for the Three and Nine Months Ended September 30, 2020 and 2019

6

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019

7

 

Notes to Consolidated Financial Statements

8

Item 2. 

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

31

Item 3. 

Quantitative and Qualitative Disclosures about Market Risk

51

Item 4. 

Controls and Procedures

53

   

PART II. OTHER INFORMATION

53

Item 1. 

Legal Proceedings

53

Item 1A. 

Risk Factors

53

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

55

Item 3. 

Defaults upon Senior Securities

55

Item 4. 

Mine Safety Disclosures

55

Item 5. 

Other Information

55

Item 6. 

Exhibits

55

     

SIGNATURES 

57

 

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS 

 

   

September 30,

2020

   

December 31,

2019

 

(In thousands, except share amounts)

 

(Unaudited)

         

ASSETS

               

Cash and due from banks

  $ 4,226     $ 5,669  

Interest-bearing deposits

    42,068       13,828  

Federal funds sold

    191       706  

Total cash and cash equivalents

    46,485       20,203  

Securities available for sale

    15,476       12,677  

Securities held to maturity

    5,784       6,349  

Securities, restricted at cost

    2,430       2,417  

Securities, not readily marketable

    100       100  

Loans held for sale

    22,483       9,894  

Loans, net of allowance for loan losses of $2,938 and $1,408, respectively

    399,230       289,671  

Bank premises and equipment, net

    4,921       5,200  

Core deposit intangible, net

    1,029       1,180  

Goodwill

    10,729       10,729  

Other assets

    7,650       6,637  

Total assets

  $ 516,317     $ 365,057  
                 

LIABILITIES

               

Demand deposits:

               

Non-interest-bearing

  $ 51,281     $ 33,890  

Interest-bearing

    124,046       65,359  

Time deposits

    180,143       184,352  

Total deposits

    355,470       283,601  

Borrowed funds

    87,036       12,000  

Subordinated notes

    12,000       12,000  

Deferred tax liabilities

    313       194  

Other liabilities

    4,647       6,787  

Total liabilities

    459,466       314,582  
                 

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 September 30, 2020 and December 31, 2019)

    17       17  

Common stock ($0.01 par value; 40,000,000 shares authorized; 6,568,750 shares issued and outstanding at September 30, 2020 and December 31, 2019)

    66       66  

Additional paid-in capital

    39,112       39,050  

Retained earnings

    17,537       11,288  

Accumulated other comprehensive income

    119       54  

Total shareholders’ equity

    56,851       50,475  

Total liabilities and shareholders’ equity

  $ 516,317     $ 365,057  

 

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)

 

2020

   

2019

   

2020

   

2019

 

Interest Income

                               

Loan, including fees

  $ 5,139     $ 4,471     $ 14,374     $ 12,475  

Securities

    160       157       682       571  

Federal funds sold

    -       3       2       9  

Interest-bearing deposits

    11       55       91       204  

Total interest income

    5,310       4,686       15,149       13,259  

Interest Expense

                               

Deposits

    973       1,324       3,444       3,668  

Borrowed funds

    264       325       751       899  

Total interest expense

    1,237       1,649       4,195       4,567  

Net interest income

    4,073       3,037       10,954       8,692  

Provision for loan losses

    445       1,004       1,709       1,486  

Net interest income after provision for loan losses

    3,628       2,033       9,245       7,206  

Non-interest Income

                               

Trust income

    1,391       1,286       3,863       3,716  

Gain on sale of loans

    290       -       722       -  

Advisory income

    2,775       2,728       7,580       7,396  

Brokerage income

    1,387       2,820       5,248       7,776  

Service fees and other income

    1,809       898       4,769       3,632  

Rental income

    85       85       232       249  

Total non-interest income

    7,737       7,817       22,414       22,769  

Non-interest Expense

                               

Salaries and employee benefits

    4,741       4,858       13,693       14,109  

Occupancy and equipment

    575       684       1,786       1,934  

Trust expenses

    533       506       1,460       1,482  

Brokerage and advisory direct costs

    517       448       1,563       1,318  

Professional fees

    381       429       1,057       1,292  

Data processing

    193       217       594       666  

Other

    794       921       2,067       2,230  

Total non-interest expense

    7,734       8,063       22,220       23,031  

Income before Income Taxes 

    3,631       1,787       9,439       6,944  

Income tax expense

    733       446       2,026       1,217  

Net Income

    2,898       1,341       7,413       5,727  

Preferred stock dividends

    388       393       1,164       798  

Net income available to common stockholders

  $ 2,510     $ 948     $ 6,249     $ 4,929  
                                 

Earnings per common share:

                               

Basic

  $ 0.38     $ 0.14     $ 0.95     $ 0.75  

Diluted

    0.38       0.14       0.95       0.75  
                                 

Weighted average common shares outstanding

    6,568,750       6,568,750       6,568,750       6,568,750  

Weighted average diluted shares outstanding

    6,568,750       6,568,750       6,568,750       6,568,750  

 

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) 

 

2020

   

2019

   

2020

   

2019

 

Net Income

  $ 2,898     $ 1,341     $ 7,413     $ 5,727  

Other comprehensive income:

 

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

    (8

)

    56       82       393  

Tax effect

    (2

)

    11       17       83  

Other comprehensive (loss) income

    (6

)

    45       65       310  

Comprehensive Income

  $ 2,892     $ 1,386     $ 7,478     $ 6,037  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

(In thousands)

 

Series A Preferred Stock

   

Series B Preferred Stock

   

Common Stock

   

Additional Paid-in Capital

   

Retained Earnings

   

Accumulated Other Comprehensive Income (Loss)

   

Total

 

Balance at January 1, 2019

  $ 1     $ -     $ 66     $ 31,485     $ 6,130     $ (209

)

  $ 37,473  

Distributions prior to Tectonic Merger

    -       -       -       -       (650

)

    -       (650

)

Dividends paid on Series A preferred stock

    -       -       -       -       (201

)

    -       (201

)

Net income

    -       -       -       -       2,194       -       2,194  

Other comprehensive income

    -       -       -       -       -       155       155  

Stock based compensation

    -       -       -       24       -       -       24  

Balance at March 31, 2019

    1       -       66       31,509       7,473       (54

)

    38,995  

Issuance of 9.00% fixed-to-floating rate Series B non-cumulative perpetual preferred stock

    -       17       -       15,489       -       -       15,506  

Distributions prior to Tectonic Merger

    -       -       -       -       (650

)

    -       (650

)

Dividends paid on Series A preferred stock

    -       -       -       -       (204

)

    -       (204

)

Net income

    -       -       -       -       2,192       -       2,192  

Other comprehensive income

    -       -       -       -       -       110       110  

Stock based compensation

    -       -       -       34       -       -       34  

Balance at June 30, 2019

    1       17       66       47,032       8,811       56       55,983  

Repurchase of Series A preferred stock

    (1

)

    -       -       (8,033

)

    -       -       (8,034

)

Dividends paid on Series A preferred stock

    -       -       -       -       (1

)

    -       (1

)

Dividends paid on Series B preferred stock

    -       -       -       -       (392

)

    -       (392

)

Net income

    -       -       -       -       1,341       -       1,341  

Other comprehensive income

    -       -       -       -       -       45       45  

Stock based compensation

    -       -       -       25       -       -       25  

Balance at September 30, 2019

  $ -     $ 17     $ 66     $ 39,024     $ 9,759     $ 101     $ 48,967  
                                                         

Balance at January 1, 2020

  $ -     $ 17     $ 66     $ 39,050     $ 11,288     $ 54     $ 50,475  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Net income

    -       -       -       -       2,401       -       2,401  

Other comprehensive income

    -       -       -       -       -       54       54  

Stock based compensation

    -       -       -       24       -       -       24  

Balance at March 31, 2020

    -       17       66       39,074       13,301       108       52,566  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Net income

    -       -       -       -       2,114       -       2,114  

Other comprehensive income

    -       -       -       -       -       17       17  

Stock based compensation

    -       -       -       21       -       -       21  

Balance at June 30, 2020

    -       17       66       39,095       15,027       125       54,330  

Dividends paid on Series B preferred stock

    -       -       -       -       (388

)

    -       (388

)

Net income

    -       -       -       -       2,898       -       2,898  

Other comprehensive loss

    -       -       -       -       -       (6

)

    (6

)

Stock based compensation

    -       -       -       17       -       -       17  

Balance at September 30, 2020

  $ -     $ 17     $ 66     $ 39,112     $ 17,537     $ 119     $ 56,851  

 

See accompanying notes to consolidated financial statements.

 

 

TECTONIC FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   

Nine Months Ended September 30,

 

(In thousands)

 

2020

   

2019

 

Cash Flows from Operating Activities

               

Net income

  $ 7,413     $ 5,727  

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

               

Provision for loan losses

    1,709       1,486  

Depreciation and amortization

    328       524  

Accretion of discount on loans

    (65

)

    (15

)

Core deposit intangible amortization

    151       151  

Securities premium amortization, net

    42       104  

Origination of loans held for sale

    (31,731

)

    (24,340

)

Proceeds from payments and sales of loans held for sale

    10,687       258  

Gain on sale of loans

    (722

)

    -  

Stock based compensation

    62       83  

Deferred income tax expense (benefit)

    102       (209

)

Net change in:

               

Servicing assets, net

    180       593  

Other assets

    (1,042

)

    (886

)

Other liabilities

    (2,139

)

    406  

Net cash used in operating activities

    (15,025

)

    (16,118

)

Cash Flows from Investing Activities

               

Acquisition of business

    -       (2,500

)

Purchase of securities available for sale

    (239,043

)

    (226,964

)

Principal payments, calls and maturities of securities available for sale

    236,307       229,035  

Principal payments of securities held to maturity

    542       1,280  

Purchase of securities, restricted

    (6,158

)

    (8,375

)

Proceeds from sale of securities, restricted

    6,145       7,892  

Proceeds from sale of real estate owned

    -       275  

Net change in loans

    (102,178

)

    (25,024

)

Purchases of premises and equipment

    (49

)

    (141

)

Net cash used in investing activities

    (104,434

)

    (24,522

)

Cash Flows from Financing Activities

               

Net change in demand deposits

    76,078       (17,255

)

Net change in time deposits

    (4,209

)

    40,042  

Proceeds from borrowed funds

    347,972       355,559  

Repayment of borrowed funds

    (272,936

)

    (345,474

)

Distributions to Tectonic Holdings members prior to Tectonic Merger

    -       (1,300

)

Proceeds from issuance of preferred stock

    -       15,506  

Dividends paid on Series A preferred shares

    -       (406

)

Dividends paid on Series B preferred shares

    (1,164

)

    (392

)

Purchase of Series A preferred stock

    -       (7,772

)

Net cash provided by financing activities

    145,741       38,508  

Net change in cash and cash equivalents

    26,282       (2,132

)

Cash and cash equivalents at beginning of period

    20,203       18,458  

Cash and cash equivalents at end of period

  $ 46,485     $ 16,326  
                 

Non Cash Transactions

               

Transfers from loans to other real estate owned

  $ -     $ 275  

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

  $ 86     $ 207  

Prepaid amounts applied toward purchase of Series A preferred stock

  $ -     $ (262

)

Supplemental disclosures of cash flow information

               

Cash paid during the period for

               

Interest

  $ 4,419     $ 4,478  

Income taxes

  $ 2,323     $ 1,690  

 

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, third-party administration, recordkeeping and insurance services to individuals, small businesses and institutions in all 50 states. The Company was formed in October 2016 for the purpose of acquiring T Bancshares, Inc. (“TBI”), which acquisition was completed on May 15, 2017.

 

On May 13, 2019, we completed a merger with Tectonic Holdings, LLC (“Tectonic Holdings”), through which we expanded our financial services to include investment advisory, securities brokerage and insurance services (the “Tectonic Merger”). Pursuant to the Amended and Restated Agreement and Plan of Merger dated March 28, 2019, by and between the Company and Tectonic Holdings (the “Tectonic Merger Agreement”), Tectonic Holdings merged with and into the Company, with the Company as the surviving institution. Immediately after the completion of the Tectonic Merger, the Company completed a 1-for-2 reverse stock split with respect to the outstanding shares of its common stock.

 

The Company consummated the initial public offering of its 9.00% Fixed-to-Float Rate Series B Non-Cumulative Perpetual Preferred Stock (“Series B preferred stock”) in May 2019 (the “initial public offering”). In connection with the initial public offering, the Company issued and sold 1,725,000 shares of its Series B preferred stock, including 225,000 shares sold pursuant to the underwriters’ full exercise of their option to purchase additional shares, at an offering price of $10.00 per share, for aggregate gross proceeds of $17.25 million before deducting underwriting discounts and offering expenses, and aggregate net proceeds of $15.5 million.

 

Following the Tectonic Merger, we operate through four main direct and indirect subsidiaries: (i) 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 a main office located at 16200 Dallas Parkway, Dallas, Texas. Our other subsidiaries operate from offices in Houston, Dallas and Plano, Texas. Our Houston 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 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 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 L.L.C. (“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 13, Related Parties, to these consolidated financial statements for more information.

 

 

In January 2019, the Bank acquired the assets of The Nolan Company (“Nolan”), a third-party administrator (“TPA”), based in Overland Park, Kansas. Founded in 1979, Nolan offers TPA services as a division of the Bank, 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. Nolan has clients in 50 states and is the administrator for retirement plans. Approximately half of the retirement plans are serviced by our trust department. We believe that the addition of TPA services allows us to serve our clients more fully and to attract new clients to our trust platform. Please see Note 18, Nolan Acquisition, to these consolidated financial statements for more information.

 

Basis of Presentation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, TBI, the Bank, Tectonic Advisors, Sanders Morris, and through Sanders Morris, HWG. Prior to the Tectonic Merger, Sanders Morris and Tectonic Advisors were wholly owned subsidiaries of Tectonic Holdings, which was under common control with the Company. The Tectonic Merger has been accounted for as a combination of businesses under common control in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Transactions Between Entities Under Common Control. Under Topic 805, all the assets and liabilities of Tectonic Holdings are carried over to the books of the Company at their then current carrying amounts, and the consolidated financial statements, including our earnings per share calculations, have been retrospectively adjusted to reflect the effect of the Tectonic Merger. This includes the acquisition of Sanders Morris, HWG and Tectonic Advisors described below under Note 2, Tectonic Merger and Initial Public Offering of Series B Preferred Stock, for all periods subsequent to May 15, 2017, the earliest date at which the entities were under common control. Therefore, the consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the nine months ended September 30, 2019, although a portion of the period falls prior to the Tectonic Merger, represent the combination of the results of operations of TFI and Tectonic Holdings over the full period. In addition, all intercompany transactions and balances are eliminated in consolidation. In addition, the computation of all share and per share amounts in this Quarterly Report on Form 10-Q (“Form 10-Q”) have been adjusted retroactively to reflect the reverse stock split, which the Company completed immediately after the completion of the Tectonic Merger.

 

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, 2019 in the audited financial statements included within our Annual Report on Form 10-K (File No 001-38910), filed with the SEC on March 31, 2020 (“Form 10-K”).

 

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, 2020 are not necessarily indicative of results that may be expected for the full year ending December 31, 2020.

 

In December 2019, a novel coronavirus (“COVID-19”) was reported in China, and, in March 2020, the World Health Organization declared COVID-19 to be a global pandemic, indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant and prolonged disruptions in the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates.

 

Although the Company’s current estimates are based on management’s evaluation of current conditions and how we expect them to change in the future, due to the impact that the COVID-19 pandemic has had on financial markets and the economy both locally and nationally, it is reasonably possible that the COVID-19 pandemic could materially affect these significant estimates and the Company’s results of operations and financial condition. See Part II, Item 1.A. “Risk Factors” of this Form 10-Q.

 

The Company is working with customers directly affected by the COVID-19 pandemic. The Company has been and continues to be prepared to offer short-term assistance in accordance with regulatory guidelines. Should economic conditions worsen, the Company could experience further increases in its required allowance for loan loss and as a result, recognize additional provision for loan loss expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of the COVID-19 pandemic continue to weigh on the economy.

 

In addition, the effects of the COVID-19 pandemic could cause what management would deem to be a triggering event that could, under certain circumstances, cause us to perform goodwill and intangible asset impairment tests and result in an impairment charge being recorded for that period. As of September 30, 2020, we determined that such impairment tests were not necessary.

 

 

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. The computation of all share and per share amounts in this Form 10-Q have been adjusted retroactively to reflect the reverse stock split. 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)

 

2020

   

2019

   

2020

   

2019

 

Net income available to common shareholders

  $ 2,510     $ 948     $ 6,249     $ 4,929  

Average shares outstanding

    6,569       6,569       6,569       6,569  

Effect of common stock-based compensation

    -       -       -       -  
                                 

Average diluted shares outstanding

    6,569       6,569       6,569       6,569  
                                 

Basic earnings per share

  $ 0.38     $ 0.14     $ 0.95     $ 0.75  

Diluted earnings per share

  $ 0.38     $ 0.14     $ 0.95     $ 0.75  

 

As of September 30, 2020, options to purchase 190,000 shares of common stock, with a weighted average exercise price of $5.37, were excluded from the computation of diluted net EPS because their effect was anti-dilutive.

 

Note 2. Tectonic Merger and Initial Public Offering of Series B Preferred Stock

 

Merger with Tectonic Holdings

 

On May 13, 2019, the Company completed the Tectonic Merger pursuant to the Tectonic Merger Agreement. In the Tectonic Merger, each common unit of Tectonic Holdings outstanding immediately prior to the effective time of the Tectonic Merger was converted into one share of Company common stock, and each option to purchase one Tectonic Holdings common unit was converted into an option to purchase one share of Company common stock. Immediately after the completion of the Tectonic Merger, the Company completed a 1-for-2 reverse stock split, which left 6,568,750 common shares issued and outstanding as of May 14, 2019. The computation of all share and per share amounts in this Form 10-Q have been adjusted retroactively to reflect the reverse stock split.

 

As a condition precedent to the Tectonic Merger, immediately prior to the merger, approximately $8.0 million of Tectonic Advisors subordinated debt held by Dental Community Financial Holdings, Ltd. (“DCFH”), an entity that has as its general partner a corporation owned by one of the directors of the Company, was converted into 80,338 non-cumulative, perpetual preferred units of Tectonic Holdings (“Tectonic Holdings preferred units”).

 

In the Tectonic Merger, each Tectonic Holdings preferred unit was converted into one share of 10.0% Series A Non-Cumulative Perpetual Preferred Stock of the Company (“Series A preferred stock”). Dividends were paid on the Series A preferred stock at a rate of 10% per annum (payable quarterly).

 

On July 12, 2019, the Company repurchased 80,338 shares of its Series A preferred stock, representing all of the outstanding shares of the Series A preferred stock, from DCFH for an aggregate purchase price of approximately $8.0 million. The repurchase was funded using a portion of the net proceeds from the initial public offering. The definitive terms of the Series A preferred stock were subject to the certificate of designation filed with our amended and restated certificate of formation. 

 

 

The Tectonic Merger has been accounted for as a combination of businesses under common control in accordance with Topic 805. Under Topic 805, all the assets and liabilities of Tectonic Holdings are carried over to the books of the Company at their then current carrying amounts. In addition, the Company’s consolidated financial statements have been retrospectively adjusted to reflect the merger with Tectonic Holdings, including the issuance of the Series A preferred stock in exchange for the Tectonic Holdings preferred units, for all prior periods during which the entities were under common control. All intercompany transactions and balances are eliminated in consolidation.

 

The balances shown below represent the assets and liabilities of Tectonic Holdings as of the date of the Tectonic Merger, May 13, 2019, that are reflected within the consolidated financial statements of the Company:

 

(In thousands)

 

May 13, 2019

 

Assets

       

Cash and cash equivalents

  $ 5,601  

Securities, not readily marketable, at cost

    100  

Premises and equipment, net

    761  

Other assets

    5,369  

Total assets

  $ 11,831  
         

Liabilities

       

Other liabilities

  $ 2,942  

Total liabilities

    2,942  
         

Shareholders’ Equity

       

Preferred stock, 10.0% Series A non-cumulative, perpetual ($0.01 par value; 80,338 shares authorized, 80,338 shares issued and outstanding at May 13, 2019)

    1  

Additional paid-in capital

    8,033  

Retained earnings

    855  

Total shareholders’ equity

    8,889  

Total liabilities and shareholders’ equity

  $ 11,831  

 

Initial Public Offering

 

On May 14, 2019, the Company completed its initial public offering of 1,500,000 shares of its Series B preferred stock at a price to the public of $10.00 per share. On May 29, 2019, the underwriters exercised their option to purchase 225,000 additional shares of Series B preferred stock at the initial offering price (less underwriting discounts). The initial public offering resulted in net proceeds to the Company of approximately $15.5 million, net of underwriting discounts and fees. The Series B preferred stock began trading on the NASDAQ Capital Market on May 28, 2019 under the symbol “TECTP.” See our IPO Registration Statement, initially filed with the SEC on April 18, 2019.

 

 

Note 3. Securities

 

A summary of amortized cost and fair value of securities is presented below.

 

   

September 30, 2020

 

(In thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Estimated

Fair Value

 

Securities available for sale:

                               

U.S. government agencies

  $ 12,762     $ 70     $ 2     $ 12,830  

Mortgage-backed securities

    2,564       82       -       2,646  

Total securities available for sale

  $ 15,326     $ 152     $ 2     $ 15,476  
                                 

Securities held to maturity:

                               

Property assessed clean energy

  $ 5,784     $ -     $ -     $ 5,784  

Securities, restricted:

                               

Other

  $ 2,430     $ -     $ -     $ 2,430  
                                 

Securities not readily marketable

  $ 100     $ -     $ -     $ 100  

 

   

December 31, 2019

 

(In thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Estimated

Fair Value

 

Securities available for sale:

                               

U.S. government agencies

  $ 10,684     $ 83     $ 36     $ 10,731  

Mortgage-backed securities

    1,925       21       -       1,946  

Total securities available for sale

  $ 12,609     $ 104     $ 36     $ 12,677  
                                 

Securities held to maturity:

                               

Property assessed clean energy

  $ 6,349     $ -     $ -     $ 6,349  
                                 

Securities, restricted:

                               

Other

  $ 2,417     $ -     $ -     $ 2,417  
                                 

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 consists of Property Assessed Clean Energy investments. These investment contracts or bonds located in California and Florida, originate under a contractual obligation between the property owners, the local county administration, and a third-party administrator and sponsor. The assessments are created to fund the purchase and installation of energy saving improvements to the property such as solar panels. Generally, as a property assessment, the total assessment is repaid in installments over a period of 10 to 15 years by the then current property owner(s). Each installment is collected by the County 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 September 30, 2020 and December 31, 2019, securities available for sale with a fair value of $579,000 and $902,000, respectively, were pledged against trust deposit balances held at the Bank. 

 

 

As of September 30, 2020 and December 31, 2019, the Bank held FRB stock in the amount of $1.2 million. The Bank held FHLB stock in the amount of $1.3 million and $1.2 million as of September 30, 2020 and December 31, 2019, respectively. The FRB stock and FHLB stock were classified as restricted securities.

 

As of September 30, 2020 and December 31, 2019, 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 September 30, 2020:

 

   

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. government agencies

  $ 1,999     $ 2     $ -     $ -     $ 1,999     $ 2  

 

The number of investment positions in this unrealized loss position totaled one as of September 30, 2020. 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 September 30, 2020, no impairment loss has been realized in the Company’s consolidated statements of income.

 

The amortized cost and estimated fair value of securities as of September 30, 2020 are presented 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

   

Estimated
Fair Value

   

Amortized

Cost

   

Estimated

Fair Value

 

Due after one year through five years

  $ 1,473     $ 1,484     $ 555     $ 555  

Due after five years through ten years

    10,000       10,022       2,477       2,477  

Due after ten years

    1,289       1,324       2,752       2,752  

Mortgage-backed securities

    2,564       2,646       -       -  

Total

  $ 15,326     $ 15,476     $ 5,784     $ 5,784  

 

Note 4. Loans and Allowance for Loan Losses

                          

Major classifications of loans held for investment are as follows:

 

(In thousands)

 

September 30,

2020 

   

December 31,

2019

 

Commercial and industrial

  $ 81,622     $ 85,476  

Consumer installment

    7,523       3,409  

Real estate – residential

    3,599       5,232  

Real estate – commercial

    48,020       46,981  

Real estate – construction and land

    10,471       7,865  

SBA:

               

SBA 7(a) guaranteed

    166,656       69,963  

SBA 7(a) unguaranteed

    50,839       47,132  

SBA 504

    32,636       22,591  

USDA

    800       2,430  

Other

    2       -  

 Gross Loans

    402,168       291,079  

Less:

               

Allowance for loan losses

    2,938       1,408  

Net loans

  $ 399,230     $ 289,671  

 

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed by the President of the United States in response to the COVID-19 pandemic, which established the Paycheck Protection Program (“PPP”). The PPP is administered by the SBA with support from the Department of the Treasury. The PPP is a federally-guaranteed, low-interest rate loan program that is designed to provide a direct incentive for small businesses to keep workers on the payroll. Businesses may use PPP loan funds to pay up to twenty-four weeks of payroll costs as well as to cover other eligible business expenses. PPP loans may be partially or fully forgiven by the SBA if the funds are used for eligible expenses during the relevant forgiveness period and the borrower meets the employee retention criteria. PPP loans will carry an interest rate of 1.00% to be paid either by the SBA in the event of forgiveness or by the borrower for the term of the loan, which may be two or five years. PPP loans that the SBA approved on or after June 5, 2020 will have a maturity date of five years. Payments for PPP loans are deferred until the SBA issues a forgiveness decision or ten months after the end of the forgiveness period if the borrower fails to apply for forgiveness. Included in SBA 7(a) guaranteed loans at September 30, 2020, were $98.3 million of loans originated under the PPP. As mentioned above, the 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.

 

As of September 30, 2020, our loan portfolio included $69.2 million of loans, approximately 17.2% of our total funded loans, and 22.8% of total funded loans, net of the SBA PPP loans of $98.3 million, to the dental industry. 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 $22.5 million and $9.9 million of SBA loans held for sale as of September 30, 2020 and December 31, 2019, respectively. During the three and nine months ended September 30, 2020, the Company sold $3.6 million and $9.8 million, respectively, of SBA loans, resulting in a gain on sale of loans of $290,000 and $722,000, respectively. The Company elected to reclassify $1.5 million and $9.0 million of the SBA 7(a) loans held for sale to loans held for investment during the three and nine months ended September 30, 2020, respectively.

 

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 7(a) loan guaranty program and the 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 a Preferred Lender, the Bank has been delegated loan approval, closing and most servicing and liquidation authority from the SBA.

 

 

The 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 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 7(a) loans reflected in this Form 10-Q are the PPP loans originated by the Company as of September 30, 2020.

 

The 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.

 

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:

 

(In thousands)

 

September 30,

2020

   

December 31,

2019

 

Non-accrual loans:

               

Commercial and industrial

  $ -     $ 60  

Real estate – commercial

    162       -  

SBA guaranteed

    1,118       4,892  

SBA unguaranteed

    517       1,039  

Total

  $ 1,797     $ 5,991  

 

The restructuring of a loan is considered a “troubled debt restructuring” 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.

 

 

The provisions of the CARES Act include an election to suspend accounting for troubled debt restructurings in certain circumstances, such as extensions or deferrals, related to the COVID-19 pandemic made between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared under the National Emergencies Act terminates. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company elected to adopt these provisions of the CARES Act. As of September 30, 2020, there were modifications made to 19 loans with a total outstanding balance of $22.8 million, or 5.7% of the total loan portfolio, down from 139 loans with a total outstanding balance of $92.8 million, or 23.7% of the loan portfolio, as of June 30, 2020. The modifications primarily included a delay of principal and/or interest payments for three months. These loans continue to accrue interest and are evaluated for past due status based on the revised payment terms. Under the applicable guidance, none of these loans were considered restructured as of September 30, 2020.

 

As of September 30, 2020 and December 31, 2019, there were no loans identified as troubled debt restructurings. There were no new troubled debt restructurings during the three and nine months ended September 30, 2020 and the year ended December 31, 2019.

 

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:

 

   

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

 

September 30, 2020

                                         

Nine Months Ended

 

Commercial and industrial

  $ -     $ -     $ -     $ -     $ -     $ 13     $ -  

Real estate – construction and land

    1,250       1,250       -       1,250       -       139       -  

SBA

    6,660       2,986       -       2,986       -       3,281       61  

Total

  $ 7,910     $ 4,236     $ -     $ 4,236     $ -     $ 3,433     $ 61  
                                                         

December 31, 2019

                                         

Year Ended

 

Commercial and industrial

  $ 70     $ 60     $ -     $ 60     $ -     $ 62     $ -  

SBA

    6,523       5,931       -       5,931       -       4,091       287  

Total

  $ 6,593     $ 5,991     $ -     $ 5,991     $ -     $ 4,153     $ 287  

 

 

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:

 

(In thousands)

 

 

30-89 Days

Past Due

   

 

90 Days or

More Past Due

   

 

Total

Past Due

   

 

Total

Current

   

 

Total

Loans

   

 

Total 90 Days Past Due

Still Accruing

 

September 30, 2020

                                               

Commercial and industrial

  $ -     $ -     $ -     $ 81,622     $ 81,622     $ -  

Consumer installment

    -       -       -       7,523       7,523       -  

Real estate – residential

    -       -       -       3,599       3,599       -  

Real estate – commercial

    -       87       87       47,933       48,020       -  

Real estate – construction and  land

    1,250       -       1,250       9,221       10,471       -  

SBA

    -       1,635       1,635       248,496       250,131       -  

USDA

    -       -       -       800       800       -  

Other

    -       -       -       2       2       -  

Total

  $ 1,250     $ 1,722     $ 2,972     $ 399,196     $ 402,168     $ -  
                                                 

December 31, 2019

                                               

Commercial and industrial

  $ 571     $ -     $ 571     $ 84,905     $ 85,476     $ -  

Consumer installment

    -       -       -       3,409       3,409       -  

Real estate – residential

    -       -       -       5,232       5,232       -  

Real estate – commercial

    521       -       521       46,460       46,981       -  

Real estate – construction and  land

    -       -       -       7,865       7,865       -  

SBA

    -       5,931       5,931       133,755       139,686       -  

USDA

    -       -       -       2,430       2,430       -  

Other

    -       -       -       -       -       -  

Total

  $ 1,092     $ 5,931     $ 7,023     $ 284,056     $ 291,079     $ -  

 

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

 

September 30, 2020

                                               

Commercial and industrial

  $ 80,799     $ 798     $ -     $ 25     $ -     $ 81,622  

Consumer installment

    7,523       -       -       -       -       7,523  

Real estate – residential

    3,599       -       -       -       -       3,599  

Real estate – commercial

    47,858       -       -       162       -       48,020  

Real estate – construction and land

    9,221       -       -       1,250       -       10,471  

SBA

    238,893       4,700       5,574       964       -       250,131  

USDA

    800       -       -       -       -       800  

Other

    2       -       -       -       -       2  

Total

  $ 388,695     $ 5,498     $ 5,574     $ 2,401     $ -     $ 402,168  
                                                 

December 31, 2019

                                               

Commercial and industrial

  $ 84,838     $ 578     $ -     $ 60     $ -     $ 85,476  

Consumer installment

    3,409       -       -       -       -       3,409  

Real estate – residential

    5,232       -       -       -       -       5,232  

Real estate – commercial

    46,981       -       -       -       -       46,981  

Real estate – construction and land

    7,865       -       -       -       -       7,865  

SBA

    127,004       9,506       2,137       1,039       -       139,686  

USDA

    2,430       -       -       -       -       2,430  

Other

    -       -       -       -       -       -  

Total

  $ 277,759     $ 10,084     $ 2,137     $ 1,099     $ -     $ 291,079  

 

 

The activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2020 and 2019 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

   

Other

   

Total

 

Three months ended:

                                                                       

September 30, 2020

                                                                       

Beginning Balance

  $ 1,099     $ 90     $ 58     $ 687     $ 179     $ 435     $ -     $ -     $ 2,548  

Provision for loan losses

    (168

)

    (33

)

    (15

)

    (129

)

    (71

)

    842       19       -       445  

Charge-offs

    -       -       -       -       -       (57

)

    -       -       (57

)

Recoveries

    -       -       -       -       -       2       -       -       2  

Net charge-offs

    -       -       -       -       -       (55

)

    -       -       (55

)

Ending balance

  $ 931     $ 57     $ 43     $ 558     $ 108     $ 1,222     $ 19     $ -     $ 2,938  
                                                                         

September 30. 2019

                                                                       

Beginning Balance

  $ 464     $ 26     $ 28     $ 268     $ 54     $ 267     $ -     $ -     $ 1,107  

Provision for loan losses

    29       2       (6

)

    109       22       848       -       -       1,004  

Charge-offs

    -       -       -       -       -       (576

)

    -       -       (576

)

Recoveries

    -       -       -       -       -       4       -       -       4  

Net charge-offs

    -       -       -       -       -       (572

)

    -       -       (572

)

Ending balance

  $ 493     $ 28     $ 22     $ 377     $ 76     $ 543     $ -     $ -     $ 1,539  

 

(In thousands)

 

Commercial and Industrial

   

Consumer Installment

   

Real Estate Residential

   

Real Estate Commercial

   

Real Estate Construction and Land

   

SBA

   

USDA

   

Other

   

Total

 

Nine months ended:

                                                                       

September 30, 2020

                                                                       

Beginning Balance

  $ 501     $ 27     $ 22     $ 347     $ 76     $ 435     $ -     $ -     $ 1,408  

Provision for loan losses

    397       30       21       211       32       999       19       -       1,709  

Charge-offs

    -       -       -       -       -       (218

)

    -       -       (218

)

Recoveries

    33       -       -       -       -       6       -       -       39  

Net recoveries (charge-offs)

    33       -       -       -       -       (212

)

    -       -       (179

)

Ending balance

  $ 931     $ 57     $ 43     $ 558     $ 108     $ 1,222     $ 19     $ -     $ 2,938  
                                                                         

September 30. 2019

                                                                       

Beginning Balance

  $ 419     $ 27     $ 27     $ 210     $ 34     $ 157     $ -     $ -     $ 874  

Provision for loan losses

    74       1       (5

)

    167       42       1,207       -       -       1,486  

Charge-offs

    -       -       -       -       -       (841

)

    -       -       (841

)

Recoveries

    -       -       -       -       -       20       -       -       20  

Net charge-offs

    -       -       -       -       -       (821

)

    -       -       (821

)

Ending balance

  $ 493     $ 28     $ 22     $ 377     $ 76     $ 543     $ -     $ -     $ 1,539  

 

 

The Company’s allowance for loan losses as of September 30, 2020 and December 31, 2019 by portfolio segment and detailed on the basis of the Company’s impairment methodology was as follows:

 

(In thousands)

 

Commercial and Industrial

   

Consumer Installment

   

Real Estate Residential

   

Real Estate Commercial

   

Real Estate Construction and Land

   

SBA

   

USDA

   

Other

   

Total

 

September 30, 2020

                                                                       

Loans individually evaluated for impairment

  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  

Loans collectively evaluated for impairment

    931       57       43       558       108       1,222       19       -       2,938  

Ending balance

  $ 931     $ 57     $ 43     $ 558     $ 108     $ 1,222     $ 19     $ -     $ 2,938  
                                                                         

December 31, 2019

                                                                       

Loans individually evaluated for impairment

  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  

Loans collectively evaluated for impairment

    501       27       22       347       76       435       -       -       1,408  

Ending balance

  $ 501     $ 27     $ 22     $ 347     $ 76     $ 435     $ -     $ -     $ 1,408  

 

The Company’s recorded investment in loans as of September 30, 2020 and December 31, 2019 related to each balance in the allowance for loan losses by portfolio segment and detailed on the basis of the Company’s impairment methodology was as follows:

 

(In thousands)

 

Commercial and Industrial

   

Consumer Installment

   

Real Estate Residential

   

Real Estate Commercial

   

Real Estate Construction and Land

   

SBA

   

USDA

   

Other

   

Total

 

September 30, 2020

                                                                       

Loans individually evaluated for impairment

  $ -     $ -     $ -     $ -     $ 1,250     $ 2,986     $ -     $ -     $ 4,236  

Loans collectively evaluated for impairment

    81,622       7,523       3,599       48,020       9,221       247,145       800       2       397,932  

Ending balance

  $ 81,622     $ 7,523     $ 3,599     $ 48,020     $ 10,471     $ 250,131     $ 800     $ 2     $ 402,168  
                                                                         

December 31, 2019

                                                                       

Loans individually evaluated for impairment

  $ 60     $ -     $ -     $ -     $ -     $ 5,931     $ -     $ -     $ 5,991  

Loans collectively evaluated for impairment

    85,416       3,409       5,232       46,981       7,865       133,755       2,430       -       285,088  

Ending balance

  $ 85,476     $ 3,409     $ 5,232     $ 46,981     $ 7,865     $ 139,686     $ 2,430     $ -     $ 291,079  

 

Note 5. Leases

 

The Company leases certain office facilities and office equipment under operating leases. Certain of the leases contain provisions for renewal options, escalation clauses based on increases in certain costs incurred by the lessor, as well as free rent periods and tenant improvement allowances. The Company amortizes office lease incentives and rent escalations on a straight-line basis over the life of the respective leases. The Company has obligations under operating leases that expire between 2020 and 2024 with initial non-cancellable terms in excess of one year.

 

On January 1, 2019, we adopted a new accounting standard which required the recognition of our operating leases on our balance sheet, under right-of-use assets and corresponding lease liabilities. See Note 1, Organization and Significant Accounting Policies, to these consolidated financial statements for more information. The right-of-use assets represent our right to utilize the underlying asset during the lease term, while the lease liability represents the obligation to make periodic lease payments over the life of the lease. As of September 30, 2020 and December 31, 2019, right-of-use assets totaled $740,000 and $1.2 million, respectively, and are reported as other assets on our accompanying consolidated balance sheets. The related lease liabilities totaled $826,000 and $1.4 million, respectively, and are reported in other liabilities on our accompanying consolidated balance sheet. As of September 30, 2020, the weighted average remaining lease term is two years, and the weighted average discount rate is 4.13%.

 

 

As of September 30, 2020, the minimum rental commitments under these noncancelable operating leases are as follows (in thousands):

 

2020

  $ 177  

2021

    429  

2022

    175  

2023

    76  

2024 and thereafter

    7  

Total minimum rental payments

    864  

Less: Minimum sublease rentals

    (2

)

Net minimum rental payments

    862  

Less: Interest

    (36

)

Present value of lease liabilities

  $ 826  

 

The Company currently receives rental income from seven tenants in its headquarters building for office space the Company does not occupy. Aggregate future minimum rentals to be received under non-cancelable leases as of September 30, 2020 were $1.0 million through 2027.

 

Note 6. Goodwill and Core Deposit Intangible

 

Goodwill and core deposit intangible assets were as follows:

 

(In thousands)

 

September 30,

2020

   

December 31,

2019

 

Goodwill

  $ 10,729     $ 10,729  

Core deposit intangible, net

    1,029       1,180  

 

The Company recorded goodwill of $2.4 million during the first quarter of 2019 in connection with the acquisition of the assets of Nolan. Please see Note 18, Nolan Acquisition, to these consolidated financial statements for more information.

 

Core deposit intangible is amortized on a straight line basis over the initial estimated lives of the deposits, which range from five to eight years. The core deposit intangible amortization totaled $50,000 for the three months ended September 30, 2020 and 2019, and $151,000 for the nine months ended September 30, 2020 and 2019.

 

The carrying basis and accumulated amortization of the core deposit intangible as of September 30, 2020 and December 31, 2019 were as follows:

 

(In thousands)

 

September 30,

2020

   

December 31,

2019

 

Gross carrying basis

  $ 1,708     $ 1,708  

Accumulated amortization

    (679

)

    (528

)

Net carrying amount

  $ 1,029     $ 1,180  

 

The estimated amortization expense of the core deposit intangible remaining as of September 30, 2020 is as follows:

 

(In thousands)

       

2020 remaining

  $ 51  

2021

    201  

2022

    208  

2023

    210  

2024

    210  

Thereafter

    149  

Total

  $ 1,029  

 

 

Note 7. Deposits

 

Deposits were as follows:

 

(In thousands, except percentages)

 

September 30, 2020

   

December 31, 2019

 

Non-interest bearing demand

  $ 51,281       15

%

  $ 33,890       12

%

Interest-bearing demand (NOW)

    4,744       1       4,546       1  

Money market accounts

    113,292       32       56,144       20  

Savings accounts

    6,010       1       4,669       2  

Time deposits $100,000 and over

    172,370       49       178,004       63  

Time deposits under $100,000

    7,773       2       6,348       2  

Total 

  $ 355,470       100

%

  $ 283,601       100

%

 

Time deposits of $250,000 and over totaled $60.1 million and $37.4 million as of September 30, 2020 and December 31, 2019, respectively.

 

As of September 30, 2020 the scheduled maturities of time deposits were as follows:

 

(In thousands)

       

2020

  $ 33,574  

2021

    87,872  

2022

    31,006  

2023

    15,994  

2024

    5,944  

Thereafter

    5,753  

Total

  $ 180,143  

 

The aggregate amount of demand deposit overdrafts that have been reclassified as loans as of September 30, 2020 and December 31, 2019 was insignificant.

 

Note 8. Borrowed Funds and Subordinated Notes

 

The Company has a blanket lien credit line with the FHLB with borrowing capacity of $35.4 million secured by commercial loans. The Company determines its borrowing needs and utilizes overnight advance accordingly at varying terms. The Company had no borrowings with FHLB as of September 30, 2020. As of December 31, 2019, the Company had $12.0 million in borrowings with FHLB, which consisted of an overnight advance of $2.0 million with an interest rate of 1.45%, and a $10.0 million six-month fixed term advance with an interest rate of 2.18% and maturity date of January 27, 2020. At maturity, the term advance was rolled into the overnight advance and subsequently paid off.

 

The Company also has a credit line with the FRB with borrowing capacity of $29.7 million, which is secured by commercial loans. The Company had no borrowings from the FRB at September 30, 2020 and December 31, 2019. As part of the CARES Act, the FRB offered secured discounted borrowings to banks who originated PPP loans through the Paycheck Protection Program Liquidity Facility (“PPPLF”). At September 30, 2020, the Bank pledged $87.0 million of PPP loans to the FRB under the PPPLF to borrow $87.0 million of funds at a rate of 0.35%, with maturities ranging from April 2022 through June 2022. PPP loans pledged as collateral for the PPPLF are excluded from the average assets used in the Company’s leverage ratio calculation.

 

As of September 30, 2020 and December 31, 2019, the Company also had subordinated notes totaling $12.0 million, consisting of $8.0 million issued in 2017 bearing an interest rate of 7.125% payable semi-annually and maturing on July 20, 2027, and $4.0 million issued in 2018 bearing an interest rate of 7.125% payable semi-annually and maturing on March 31, 2028. The subordinated notes are unsecured and subordinated in right of payment to the payment of our existing and future senior indebtedness and structurally subordinated to all existing and future indebtedness of our subsidiaries.

 

 

Note 9. Benefit Plans

 

The Company funds certain costs for medical benefits in amounts determined at the discretion of management. The Company has a retirement savings 401(k) plan covering substantially all employees of the Bank, and a second plan covering substantially all employees of Sanders Morris, Tectonic Advisors and the Company.

 

Under the 401(k) plan covering the Bank’s employees, the Company matches 100% of the employee’s contribution on the first 1% of the employee’s compensation, and 50% of the employee’s contribution on the next 5% of the employee’s compensation.

 

Under the safe harbor provision of the 401(k) plan adopted by Sanders Morris, Tectonic Advisors and the Company, the relevant employer is required to contribute 3% of eligible wages to the plan, up to the maximum amount under Internal Revenue Service (“IRS”) guidance, regardless of the level of the employee’s contributions. An eligible employee may contribute up to the annual maximum contribution allowed for a given year under IRS guidance. At its discretion, the Company may also make additional annual contributions to the plan. Any discretionary contributions are allocated to employees in the proportion of employee contributions to the total contributions of all participants in the plan. No discretionary contributions were made during the three and nine months ended September 30, 2020 and 2019.

 

The amount of employer contributions charged to expense under the two plans was $96,000 and $321,000 for the three and nine months ended September 30, 2020, respectively, and $106,000 and $280,000 for the three and nine months ended September 30, 2019, respectively, and is included in salaries and employee benefits on the consolidated statements of income. There was no accrual payable to the plans as of September 30, 2020 and December 31, 2019.

 

Note 10. Income Taxes

 

Income tax expense was $733,000 and $2.0 million for the three and nine months ended September 30, 2020, respectively and $446,000 and $1.2 million for the three and nine months ended September 30, 2019, respectively. The Company’s effective income tax rate was 20.2% and 21.5% for the three and nine months ended September 30, 2020, respectively, compared to 25.0% and 17.5% for the same periods in the prior year, respectively. The effective income tax rate differed materially from the U.S. statutory rate of 21% for the three and nine months ended September 30, 2019 due to Tectonic Advisor’s and Sanders Morris tax status as a partnership for the periods prior to May 13, 2019, the date the Tectonic Merger was completed.

 

Net deferred tax liabilities totaled $313,000 and $194,000 at September 30, 2020 and December 31, 2019, respectively.

 

The Company files U.S. federal and state income tax returns.

 

Note 11. Stock Compensation Plans

 

The board of directors and shareholders adopted the Tectonic Financial, Inc. 2017 Equity Incentive Plan (“Plan”) in May 2017 in connection with the Company’s acquisition of TBI. The Plan was amended and restated by the Company and its shareholders effective March 27, 2019 in connection with the Company’s initial public offering. The Plan is administered by the Compensation Committee of the Board and authorizes the granting of stock options, stock appreciation rights, restricted stock and restricted stock units to employees, directors and consultants in order to promote the success of the Company’s business. Incentive stock options may be granted only to employees of the Company, or a parent or subsidiary of the Company. The Company reserved 750,000 authorized shares of common stock for the Plan. The term of each stock option is no longer than 10 years from the date of the grant.

 

The Company accounts for stock-based employee compensation plans using the fair value-based method of accounting. The fair value of each stock option award is estimated on the date of grant by a third party using a closed form option valuation (Black-Scholes) model.

 

On September 30, 2020, the Company granted 210,000 shares of restricted stock under the Plan. The vesting schedule for such shares of restricted stock is: 10,000 at December 31, 2022, 107,000 at December 31, 2023, 79,000 at December 31, 2024 and 14,000 at December 31, 2025.

 

 

As of September 30, 2020, there were 50,000 stock options outstanding that vested on May 15, 2020, the third anniversary of the grant date, for which compensation has been fully recognized. In addition, there were 140,000 stock options outstanding as of September 30, 2020 that vest on May 15, 2021, the fourth anniversary of the grant date. The Company is recording compensation expense on a straight-line basis over the vesting periods. The Company recorded salaries and employee benefits expense on our consolidated statements of income in connection with the Plan of $17,000 and $62,000 for the three and nine months ended September 30, 2020, respectively, and $25,000 and $83,000 for the three and nine months ended September 30, 2019, respectively. As of September 30, 2020, there was $41,000 of total unrecognized compensation cost.

 

There were no forfeitures or exercises in the Plan for the three and nine months ended September 30, 2020 and 2019. The number of shares outstanding and the weighted average exercise price as of September 30, 2020 and December 31, 2019 was 190,000 and $5.37. The weighted average contractual life as of September 30, 2020 and December 31, 2019 was 6.62 years and 7.37 years, respectively.

 

Stock options outstanding at the end of the period had immaterial aggregate intrinsic values.

 

The weighted-average grant date fair value of the options as of September 30, 2020 and December 31, 2019 was $1.94. Under Topic 805, the grant date fair value has been restated as though the Tectonic Merger had occurred upon the date at which the entities came under common control.

 

Note 12. Commitments and Contingencies

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying balance sheets. The Company's exposure to credit loss in the event of non-performance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

The following table summarizes loan commitments:

 

(In thousands)

 

September 30,

2020 

   

December 31,

2019

 

Undisbursed loan commitments

  $ 23,627     $ 31,589  

Standby letters of credit

    172       172  
    $ 23,799     $ 31,761  

 

The Company is involved in various regulatory inspections, inquiries, investigations and proceedings, and litigation matters that arise from time to time in the ordinary course of business. The process of resolving matters through litigation or other means is inherently uncertain, and it is possible that an unfavorable resolution of these matters, will adversely affect the Company, its results of operations, financial condition and cash flows. The Company’s regular practice is to expense legal fees as services are rendered in connection with legal matters, and to accrue for liabilities when payment is probable.

 

The Company, through its wholly owned subsidiary Sanders Morris, has uncommitted financing arrangements with clearing brokers that finance its customer accounts, certain broker-dealer balances, and firm trading positions. Although these customer accounts and broker-dealer balances are not reflected on the consolidated balance sheets for financial reporting purposes, Sanders Morris has generally agreed to indemnify these clearing brokers for losses they may sustain in connection with the accounts, and therefore, retains risk on these accounts. Sanders Morris is required to maintain certain cash or securities on deposit with its clearing brokers. Deposits with clearing organizations were $250,000 as of September 30, 2020 and December 31, 2019.

 

 

Employment Agreements

 

In connection with the Tectonic Merger and the Company’s initial public offering (see Note 2, Tectonic Merger and Initial Public Offering of Series B Preferred Stock, to these consolidated financial statements for more information), the Company entered into amended and restated employment agreements with Patrick Howard, President and Chief Operating Officer of the Company, and Ken Bramlage, Executive Vice President and Chief Financial Officer of the Company. In addition, the Company entered into an employment agreement with A. Haag Sherman, Chief Executive Officer of the Company, in connection with the Company’s merger with Tectonic Holdings and its initial public offering. Messrs. Sherman and Howard’s employment agreements have a four year term and Mr. Bramlage’s employment agreement has a three year term. Each employment agreement is automatically renewable for an additional one-year term unless either party elects not to renew.

 

Note 13. Related Parties

 

Management agreements with Services:  Through May 2019, the Company had management services agreements (the “Tectonic Management Services Agreement”) with Tectonic Services, LLC (“Tectonic Services”). Tectonic Services was the Managing Member of Tectonic Holdings, Tectonic Advisors, Sanders Morris and HWG prior to the Tectonic Merger. Under the Tectonic Management Services Agreement, Tectonic Services was paid on a monthly basis for management services to assist in conducting business operations and accomplishing strategic objectives. The Tectonic Management Services Agreement was terminated upon the closing of the Tectonic Merger. The Company did not incur any expense under the Tectonic Management Services Agreement for the three months ended September 30, 2020 and 2019, and for the nine months ended September 30, 2020. The Company incurred expense of $118,000 under the Tectonic Management Services Agreement during the nine months ended September 30, 2019. There was no payable to Tectonic Services under these agreements as of September 30, 2020 or December 31, 2019.

 

Advisors’ service agreements: In January 2006, the Company entered into a services agreement (the “Tectonic Advisors-CWA Services Agreement”) with Cain Watters. The owners of Cain Watters together hold approximately 31% of the voting ownership in the Company. Under the Tectonic Advisors-CWA Services Agreement, Cain Watters pays the Company for due diligence and research services on investment alternatives available to Cain Watters’ clients. The Company earned $530,000 and $1.4 million during the three and nine months ended September 30, 2020, respectively, and $392,000 and $1.1 million during the three and nine months ended September 30, 2019, respectively, under the Tectonic Advisors-CWA Services Agreement. These fees are included in investment advisory and other related services in the accompanying consolidated statements of income. The Company had $221,000 and $193,000 in fees receivable related to these services at September 30, 2020 and December 31, 2019, respectively, which are included in other assets on the consolidated balance sheets.

 

CWA Fee Allocation Agreement:  In January 2006, Tectonic Advisors entered into an agreement (the “Fee Allocation Agreement”) with Cain Watters with reference to its advisory agreement with the Bank. Tectonic Advisors had $185,000 and $186,000 payable to Cain Watters related to this agreement at September 30, 2020 and December 31, 2019, respectively, which are included in other liabilities on the accompanying consolidated balance sheets. 

 

DCFH Series A Preferred Stock:  The Company had 80,338 shares of Series A preferred stock outstanding to DCFH as of December 31, 2018, representing all of the Series A preferred stock outstanding of the Company. DCFH has as its general partner an entity owned by a director of the Company. The Series A preferred stock was issued in exchange for the Tectonic Holdings preferred units in the Tectonic Merger.  The Tectonic Holdings preferred units were issued in an exchange that occurred prior to the Tectonic Merger, under which an unsecured note payable to DCFH was exchanged for the Tectonic Holdings preferred units.  See Note 2, Tectonic Merger and Initial Public Offerings of Series B Preferred Stock, to these consolidated financial statements for more information. Dividends were paid on the Series A preferred stock only when, as and if declared by our board of directors at a rate of 10% per annum (payable quarterly).

 

On July 12, 2019, the Company repurchased and retired the Series A preferred stock from DCFH. There was no Series A preferred stock outstanding as of December 31, 2019 or September 30, 2020.

 

Recruitment incentive compensation expense:  Amounts were provided to or paid on behalf of financial advisors upon employment primarily as a recruitment incentive. These amounts were recorded as notes receivable, related parties, and were forgiven on a fixed repayment schedule, with the forgiven amounts resulting in the recognition of compensation expense to the payee. The amortization period for the notes receivable, related parties did not exceed three years. Upon termination of employment of a payee financial advisor, any principal and interest outstanding would have been immediately due and payable. 

 

 

The notes receivable, related parties, were fully repaid as of December 31, 2019. Therefore, there was no amount receivable under the notes receivable, related parties as of September 30, 2020 or December 31, 2019. There was no expense recognized for the three or nine months ended September 30, 2020, and the Company recognized $15,000 and $44,000 in compensation expense for the three and nine months ended September 30, 2019, respectively, in relation to the forgiven notes receivable, including related interest income.

 

As of September 30, 2020, certain officers, directors and their affiliated companies had depository accounts with the Bank totaling approximately $5.6 million. None of those deposit accounts have terms more favorable than those available to any other depositor.

 

As of September 30, 2020, the Bank had PPP loans to certain of its directors and their affiliated companies totaling $2.9 million in the aggregate. These loans were made to the Bank’s directors and their affiliated companies on the same terms as all other loans originated by the Bank under the PPP, established by the CARES Act. In addition, these loans were approved by the board of directors of the Bank in accordance with the Bank’s regulatory and policy requirements.

 

Note 14. Regulatory Matters

 

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s and, accordingly, the Company’s business, results of operations and financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under GAAP, regulatory reporting requirements, and regulatory capital standards. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Furthermore, the Bank’s regulators could require adjustments to regulatory capital not reflected in these financial statements.

 

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and tier 1 capital to risk-weighted assets, common equity Tier 1 (“CET1”) capital to total risk-weighted assets, and of tier 1 capital to average assets. To be categorized as “well-capitalized” under the prompt corrective action framework, the Bank must maintain (i) a Total risk-based capital ratio of 10%; (ii) a Tier 1 risk-based capital ratio of 8%; (iii) a Tier 1 leverage ratio of 5%; and (iv) a CET1 risk-based capital ratio of 6.5%.

 

In addition, the Basel III regulatory capital reforms (“Basel III”) implemented a capital conservation buffer of 2.5% that was fully implemented as of January 1, 2019. The Basel III minimum capital ratio requirements as applicable to the Company and the Bank on January 1, 2019 are summarized in the table below.

 

   

BASEL III

Minimum for

Capital

Adequacy

Requirements

   

BASEL III

Additional Capital

Conservation

Buffer

   

BASEL III Ratio with

Capital Conservation

Buffer

 

Total Risk Based Capital (total capital to risk weighted assets)

    8.0

%

    2.5

%

    10.5

%

Tier 1 Risk Based Capital (tier 1 to risk weighted assets)

    6.0

%

    2.5

%

    8.5

%

Common Equity Tier 1 Risk Based ( CET1 to risk weighted assets)

    4.5

%

    2.5

%

    7.0

%

Tier 1 Leverage Ratio (tier 1 to average assets)

    4.0

%

    -

%

    4.0

%

 

Accordingly, a financial institution may be considered “well capitalized” under the prompt corrective action framework, but not satisfy the buffered Basel III capital ratios. As of September 30, 2020, the Bank’s regulatory capital ratios are in excess of the capital conservation buffer and the levels established for “well capitalized” institutions under the Basel III Rules.

 

 

The regulatory capital ratios of the Company and the Bank are as follows:

 

   

Actual

   

Minimum Capital Required - Basel III

   

Required to be Considered Well Capitalized

 

(In thousands, except percentages)

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of September 30, 2020

                                               

Total Capital (to Risk Weighted Assets)

                                               

Tectonic Financial, Inc. (consolidated)

  $ 47,692       17.43

%

  $ 28,731       10.50

%

  $ 27,363       10.00

%

T Bank, N.A.

    47,473       17.48       28,511       10.50       27,154       10.00  

Tier 1 Capital (to Risk Weighted Assets)

                                               

Tectonic Financial, Inc. (consolidated)

    44,754       16.36       23,259       8.50       21,891       8.00  

T Bank, N.A.

    44,535       16.40       23,081       8.50       21,723       8.00  

Common Equity Tier 1 (to Risk Weighted Assets)

                                               

Tectonic Financial, Inc. (consolidated)

    27,504       10.05       19,154       7.00       17,786       6.50  

T Bank, N.A.

    44,535       16.40       19,008       7.00       17,650       6.50  

Tier 1 Capital (to Average Assets)

                                               

Tectonic Financial, Inc. (consolidated)

    44,754       10.15       17,644       4.00       22,055       5.00  

T Bank, N.A.

    44,535       9.09       17,437       4.00       21,796       5.00  
                                                 

As of December 31, 2019

                                               

Total Capital (to Risk Weighted Assets)

                                               

Tectonic Financial, Inc. (consolidated)

  $ 39,709       15.47

%

  $ 26,950       10.50

%

  $ 25,667       10.00

%

T Bank, N.A.

    39,949       15.71       26,699       10.50       25,428       10.00  

Tier 1 Capital (to Risk Weighted Assets)

                                               

Tectonic Financial, Inc. (consolidated)

    38,301       14.92       21,817       8.50       20,534       8.00  

T Bank, N.A.

    38,541       15.16       21,614       8.50       20,342       8.00  

Common Equity Tier 1 (to Risk Weighted Assets)

                                               

Tectonic Financial, Inc. (consolidated)

    21,051       8.20       17,967       7.00       16,683       6.50  

T Bank, N.A.

    38,541       15.16       17,800       7.00       16,528       6.50  

Tier 1 Capital (to Average Assets)

                                               

Tectonic Financial, Inc. (consolidated)

    38,301       11.20       13,679       4.00       17,099       5.00  

T Bank, N.A.

    38,541       11.09       13,899       4.00       17,373       5.00  

 

Dividend Restrictions. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared (including those on the Series A preferred stock) would cause the regulatory capital of the Bank and/or the Company to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. As of September 30, 2020, approximately $15.1 million was available for the declaration of dividends by the Bank to the Company without prior approval of regulatory agencies and still maintain its “well capitalized” status. In addition, as a Texas corporation, we are restricted under the Texas Business Organizations Code from paying dividends under certain conditions. Under Texas law, we cannot pay dividends to shareholders if the dividends exceed our surplus or if after giving effect to the dividends, we would be insolvent.

 

In addition to the regulatory requirements of the federal banking agencies, Sanders Morris and Tectonic Advisors are subject to the regulatory framework applicable to registered investment advisors under the SEC’s Division of Investment Management, and additionally, Sanders Morris is regulated by FINRA, which, among other requirements, imposes minimums on its net regulatory capital.

 

 

Note 15. Operating Segments

 

The Company’s reportable segments consist of Banking, Other Financial Services, and HoldCo operations.

 

The Banking segment consists of operations relative to the Company’s full service banking operations, including providing depository and lending services to individual and business customers, and other related banking services.

 

The Other Financial Services segment includes managed and directed brokerage, investment advisory services, including related trust company operations, third party administration, and insurance brokerage services to both individuals and businesses.

 

The HoldCo operations include the operations and subordinated debt held at the Bank’s immediate parent, as well as the activities of the financial holding company which serves as TBI’s parent.

 

The tables below present the financial information for each segment that is specifically identifiable, or based on allocations using internal methods, for the three and nine months ended September 30, 2020 and 2019:

 

(In thousands)

 

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

 

Three Months Ended September 30, 2020

                               

Income Statement

                               

Total interest income

  $ 5,310     $ -     $ -     $ 5,310  

Total interest expense

    1,018       -       219       1,237  

Provision for loan losses

    445       -       -       445  

Net-interest income (loss) after provision for loan losses

    3,847       -       (219

)

    3,628  

Non-interest income

    604       7,133       -       7,737  

Depreciation and amortization expense

    92       43       -       135  

All other non-interest expense

    2,292       5,054       253       7,599  

Income (loss) before income tax

  $ 2,067     $ 2,036     $ (472

)

  $ 3,631  
                                 

Goodwill and other intangibles

  $ 9,408     $ 2,350     $ -     $ 11,758  

Total assets

  $ 506,861     $ 9,155     $ 301     $ 516,317  

 

(In thousands)

 

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

 

Nine Months Ended September 30, 2020

                               

Income Statement

                               

Total interest income

  $ 15,149     $ -     $ -     $ 15,149  

Total interest expense

    3,539       -       656       4,195  

Provision for loan losses

    1,709       -       -       1,709  

Net-interest income (loss) after provision for loan losses

    9,901       -       (656 )     9,245  

Non-interest income

    1,257       21,135       22       22,414  

Depreciation and amortization expense

    278       201       -       479  

All other non-interest expense

    5,691       15,323       727       21,741  

Income (loss) before income tax

  $ 5,189     $ 5,611     $ (1,361 )   $ 9,439  
                                 

Goodwill and other intangibles

  $ 9,408     $ 2,350     $ -     $ 11,758  

Total assets

  $ 506,861     $ 9,155     $ 301     $ 516,317  

 

 

(In thousands)

 

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

 

Three Months Ended September 30, 2019

                               

Income Statement

                               

Total interest income

  $ 4,686     $ -     $ -     $ 4,686  

Total interest expense

    1,430       -       219       1,649  

Provision for loan losses

    1,004       -       -       1,004  

Net-interest income (loss) after provision for loan losses

    2,252       -       (219 )     2,033  

Non-interest income

    151       7,909       (243 )     7,817  

Depreciation and amortization expense

    93       164       -       257  

All other non-interest expense

    1,991       5,606       209       7,806  

Income (loss) before income tax

  $ 319     $ 2,139     $ (671 )   $ 1,787  
                                 

Goodwill and other intangibles

  $ 9,609     $ 2,350     $ -     $ 11,959  

Total assets

  $ 347,017     $ 10,380     $ 268     $ 357,665  

 

(In thousands)

 

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

 

Nine Months Ended September 30, 2019

                               

Income Statement

                               

Total interest income

  $ 13,253     $ -     $ 6     $ 13,259  

Total interest expense

    3,862       -       705       4,567  

Provision for loan losses

    1,486       -       -       1,486  

Net-interest income (loss) after provision for loan losses

    7,905       -       (699 )     7,206  

Non-interest income

    223       22,760       (214 )     22,769  

Depreciation and amortization expense

    279       395       -       674  

All other non-interest expense

    5,720       16,088       549       22,357  

Income (loss) before income tax

  $ 2,129     $ 6,277     $ (1,462 )   $ 6,944  
                                 

Goodwill and other intangibles

  $ 9,609     $ 2,350     $ -     $ 11,959  

Total assets

  $ 347,017     $ 10,380     $ 268     $ 357,665  

 

Note 16. Fair Value of Financials Instruments

 

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. FASB ASC Topic 820, Fair Value Measurement, establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

 

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

  

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. The Company has no securities in the Level 1 or Level 3 inputs.

 

The following table summarizes securities available for sale measured at fair value on a recurring basis, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

(In thousands)

 

Level 1

Inputs

   

Level 2

Inputs

   

Level 3

Inputs

   

Total

Fair Value

 

As of September 30, 2020

                               

Securities available for sale:

                               

U.S. government agencies

  $ -     $ 12,830     $ -     $ 12,830  

Mortgage-backed securities

    -       2,646       -       2,646  

 

As of December 31, 2019

                               

Securities available for sale:

                               

U.S. government agencies

  $ -     $ 10,731     $ -     $ 10,731  

Mortgage-backed securities

    -       1,946       -       1,946  

 

Market valuations of our investment securities which are classified as level 2 are provided by an independent third party. The fair values are determined by using several sources for valuing fixed income securities. Their techniques include pricing models that vary based on the type of asset being valued and incorporate available trade, bid and other market information. In accordance with the fair value hierarchy, the market valuation sources include observable market inputs and are therefore considered Level 2 inputs for purposes of determining the fair values.

 

The Company considers transfers between the levels of the hierarchy to be recognized at the end of related reporting periods. During the three and nine months ended September 30, 2020, no assets for which fair value is measured on a recurring basis transferred between any levels of the hierarchy.

 

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

 

Financial assets measured at fair value on a non-recurring basis during the reported periods include impaired loans and loans held for sale.

 

Impaired loans. As of September 30, 2020 and December 31, 2019, there were no impaired loans that were reduced by specific valuation allowances.

 

The significant unobservable inputs (Level 3) used in the fair value measurement of collateral for collateral-dependent impaired loans primarily relate to the specialized discounting criteria applied to the borrower’s reported amount of collateral. The amount of the collateral discount depends upon the condition and marketability of the collateral, as well as other factors which may affect the collectability of the loan. As the Company’s primary objective in the event of default would be to liquidate the collateral to settle the outstanding balance of the loan, collateral that is less marketable would receive a larger discount. During the reported periods, there were no discounts for collateral-dependent impaired loans.

 

The valuation of our not readily marketable investment securities which are classified as Level 3 are based on the Company’s own assumptions and inputs that are both significant to the fair value measurement, and are unobservable.

 

Our assessment of the significance of a particular input to the Level 3 fair value measurements in their entirety requires judgment and considers factors specific to the assets. It is reasonably possible that a change in the estimated fair value for instruments measured using Level 3 inputs could occur in the future.

 

Loans held for sale. Loans held for sale include the guaranteed portion of SBA and USDA loans and are reported at the lower of cost or estimated fair value. Fair value for SBA and USDA loans is based on market indications available in the market. There were no impairments reported for the periods presented.

 

 

Non-financial assets measured at fair value on a non-recurring basis during the reported periods include other real estate owned which, upon initial recognition, was re-measured and reported at fair value through a charge-off to the allowance for loan losses. Additionally, foreclosed assets which, subsequent to their initial recognition, are re-measured at fair value through a write-down included in other non-interest expense. Regulatory guidelines require the Company to reevaluate the fair value of foreclosed assets on at least an annual basis. The fair value of foreclosed assets, upon initial recognition and impairment, are re-measured using Level 2 inputs based on observable market data. Estimated fair value of other real estate is based on appraisals. Appraisers are selected from the list of approved appraisers maintained by management. As of September 30, 2020 and December 31, 2019, there were no foreclosed assets. There were no foreclosed assets re-measured during the three and nine months ended September 30, 2020 and 2019.

 

The methods and assumptions used to estimate fair value of financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis are described as follows:

 

Carrying amount is the estimated fair value for cash and cash equivalents, restricted securities, accrued interest receivable and accrued interest payable. The estimated fair value of demand and savings deposits is the carrying amount since rates are regularly adjusted to market rates and amounts are payable on demand. For borrowed funds and variable rate loans or deposits that re-price frequently and fully, the estimated fair value is the carrying amount. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. For loans held for sale, the estimated fair value is based on market indications for similar assets in the active market. The estimated fair value of other financial instruments and off-balance-sheet loan commitments approximate cost and are not considered significant to this presentation.

 

The Company adds a servicing asset when loans are sold and the servicing is retained, and uses the amortization method for the treatment of the servicing asset. The servicing asset is carried at lower of cost or fair value. Loan servicing assets do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using a discounted cash flow model having significant inputs of discount rate, prepayment speed and default rate. Due to the nature of the valuation inputs, servicing rights are classified within Level 3 of the hierarchy. During the three and nine months ended September 30, 2020, the Company added servicing assets totaling $60,000 and $152,000, respectively, in connection with the sale of $3.6 million and $9.8 million, respectively, in loans during the three and nine months ended September 30, 2020. There were no sales of loans for the three and nine months ended September 30, 2019. For the three and nine months ended September 30, 2020, there was a credit provision of $150,000 and $250,000, respectively, to the valuation allowance for servicing assets. There was no allowance provision for the three months ended September 30, 2019. The allowance provision for servicing assets for the nine months ended September 30, 2019 was $162,000.

 

FASB ASC Topic 825, Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The estimated fair value approximates carrying value for cash and cash equivalents and accrued interest. The methodologies for other financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis are discussed below.

 

Securities held to maturity. The securities in this category are Property Assessed Clean Energy investments. These investment contracts or bonds originate under a contractual obligation between the property owners, the local county administration, and a third-party administrator and sponsor. These investments have no readily determinable fair value.

 

Loans. The estimated fair value approximates carrying value for variable-rate loans that reprice frequently and with no significant change in credit risk. The fair value of fixed-rate loans and variable-rate loans which reprice on an infrequent basis is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality.

 

Deposits. The fair values of demand deposits, savings deposits are, by definition, equal to the amount payable on demand and, therefore, approximate their carrying amounts. The fair values for time deposits are estimated using a discounted cash flow calculation that utilizes interest rates currently being offered on time deposits with similar contractual maturities.

 

Borrowed Funds. The estimated fair value approximates carrying value for short-term borrowings. The fair value of long-term fixed-rate borrowings is estimated using quoted market prices, if available, or by discounting future cash flows using current interest rates for similar financial instruments. The estimated fair value approximates carrying value for variable-rate junior subordinated deferrable interest debentures that reprice quarterly.

 

 

Loan Commitments, Standby and Commercial Letters of Credit. Our lending commitments have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the following table.

 

Carrying amounts and estimated fair values of other financial instruments by level of valuation input were as follows:

 

   

September 30, 2020

 

(In thousands)

 

Carrying

Amount

   

Estimated

Fair Value

 

Financial assets:

               

Level 1 inputs:

               

Cash and cash equivalents

  $ 46,485     $ 46,485  

Level 2 inputs:

               

Securities available for sale

    15,476       15,476  

Securities, restricted

    2,430       2,430  

Loans held for sale

    22,483       24,938  

Accrued interest receivable

    2,121       2,121  

Level 3 inputs:

               

Securities held to maturity

    5,784       5,784  

Securities not readily marketable

    100       100  

Loans, net

    399,230       394,698  

Servicing asset

    890       890  

Financial liabilities:

               

Level 1 inputs:

               

Non-interest bearing deposits

    51,281       51,281  

Level 2 inputs:

               

Interest bearing deposits

    304,189       304,286  

Borrowed funds

    99,036       99,036  

Accrued interest payable

    371       371  

Off-balance sheet assets:

               

Commitments to extend credit

    -       -  

Standby letters of credit

    -       -  

 

   

December 31, 2019

 

(In thousands)

 

Carrying

Amount

   

Estimated

Fair Value

 

Financial assets:

               

Level 1 inputs:

               

Cash and cash equivalents

  $ 20,203     $ 20,203  

Level 2 inputs:

               

Securities available for sale

    12,677       12,677  

Securities, restricted

    2,417       2,417  

Loans held for sale

    9,894       10,838  

Accrued interest receivable

    1,322       1,322  

Level 3 inputs:

               

Securities held to maturity

    6,349       6,349  

Securities not readily marketable

    100       100  

Loans, net

    289,671       287,823  

Servicing asset

    918       918  

Financial liabilities:

               

Level 1 inputs:

               

Non-interest bearing deposits

    33,890       33,890  

Level 2 inputs:

               

Interest bearing deposits

    249,711       249,524  

Borrowed funds

    24,000       24,000  

Accrued interest payable

    595       595  

Off-balance sheet assets:

               

Commitments to extend credit

    -       -  

Standby letters of credit

    -       -  

 

 

Note 17. Recent Accounting Pronouncements

 

ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 among other things, requires lessees to recognize a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model. ASU 2016-2 was effective on January 1, 2019. The Company adopted ASU 2016-02 as of January 1, 2019, and amounts recorded as right-of-use lease assets and lease liabilities were $1.6 million and $1.7 million, respectively, as of January 1, 2019.

 

ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and 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 an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 became effective for most public companies on January 1, 2020, subject to a company’s election to defer implementation due to the COVID-19 pandemic. On July 17, 2019, the FASB proposed to delay the implementation of the current expected credit loss standard (“CECL”) for certain companies including smaller reporting companies (“SRCs”) as defined by the SEC. The Company is designated as a SRC with the SEC. The proposed delay by FASB was subject to a comment period. At the October 16, 2019 FASB meeting, the FASB voted unanimously to delay the effective date of CECL adoption for SRCs to January 1, 2023. The Company has developed processes for assessment and documentation, model development and validation. While the Company generally expects that the implementation of ASU 2016-13 may increase their allowance for loan losses balance, the adoption will be significantly influenced by the composition, characteristics and quality of the loan portfolio along with the prevailing economic conditions and forecasts as of the adoption date.

 

ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates Step 2 from the goodwill impairment test which required entities to compute the implied fair value of goodwill. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 became effective for the Company on January 1, 2020, and did not have a significant impact on the Company’s consolidated financial statements.

 

ASU 2018-13, “Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 became effective for the Company on January 1, 2020, and did not have a significant impact on the Company’s consolidated financial statements.

 

ASU 2019-12, “Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes.” The guidance issued in this update simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 will be effective for the Company on January 1, 2021, with early adoption permitted, and is not expected to have a significant impact on the Company’s consolidated financial statements.

 

Note 18. Nolan Acquisition

 

In January 2019, the Company acquired the assets of Nolan, a TPA based in Kansas City, Kansas, with a cash payment of $2.5 million and offers the TPA services as a division of the Bank. Founded in 1979, Nolan provides clients with retirement plan design and administrative services, specializing in ministerial recordkeeping, administration, actuarial and design services for retirement plans for small businesses and professional practices. Nolan has clients in 50 states and Nolan shares many clients with our trust department. We believe that the addition of TPA services allows us to serve our clients more fully and to attract new clients to our trust platform.

 

The assets acquired consisted of furniture, fixtures and equipment with a fair value of $150,000. There were no liabilities acquired, resulting in goodwill of $2.4 million from the acquisition. The goodwill will not be amortized, but will be tested for impairment annually. The goodwill recorded is deductible for federal income tax purposes. In addition, the Bank entered into a consulting agreement with an entity controlled by Mr. Nolan and his family, pursuant to which Mr. Nolan agreed to serve as CEO of the division for three years after closing and provide mutually agreeable consulting services thereafter, in consideration for a monthly fee of $26,041 plus incentive payments based on certain performance metrics, for eight years after closing.

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto appearing in Item 1 of Part I of this Form 10-Q, as well as with our consolidated financial statements and notes thereto appearing in our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”).

 

Cautionary Notice Regarding Forward-Looking Statements

 

Statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including our expectations, intentions, beliefs, or strategies regarding the future. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” and similar expressions. It is important to note that our actual results may differ materially from those in or implied by such forward-looking statements due to the factors discussed under the section entitled “Risk Factors,” in our 2019 Form 10-K, and under the section entitled “Risk Factors” in this Form 10-Q, including, but not limited to, the following:

 

 

adverse effects of the COVID-19 pandemic on the Company and its customers, counterparties, employees, and third-party service providers, and the adverse impacts to our business, financial position, results of operations, and prospects;

 

risks associated with the government response to the COVID-19 pandemic, including the implementation of the PPP and the PPPLF and our participation therein;

 

risks associated with implementing aspects of our expansion strategy, whether through additional services and products or acquisitions;

 

the need to hold more capital in order to comply with consolidated capital ratios;

 

integration risks associated with the Tectonic Merger and other unknown risks;

 

risks associated with having one referral source, Cain Watters, comprise a substantial part of our business;

 

our reliance on key personnel and the ability to attract and retain the personnel necessary to implement our business plan;

 

changes in the economy generally and the regulatory response thereto;

 

changes in the economy of the State of Texas, our primary market;

 

risks specific to commercial loans and borrowers (particularly dental loans);

 

our ability to continue to originate loans (including SBA loans);

 

claims and litigation pertaining to our fiduciary responsibilities;

 

generating investment returns for our wealth management, brokerage and other customers that are satisfactory to them;

 

changes in interest rates;

 

liquidity risks;

 

our ability to maintain a strong core deposit base or other low-cost funding sources;

 

our ability to manage our credit risk;

 

the adequacy of our allowance for loan losses;

 

regulatory scrutiny related to our commercial real estate loan portfolio;

 

the earning capacity of our borrowers;

 

fluctuation in the value of our investment securities;

 

competition from other banks, financial institutions and wealth and investment management firms and our ability to retain our clients;

 

our inability to identify and address potential conflicts of business;

 

failure to maintain effective internal control over financial reporting;

 

the accuracy of estimates and assumptions;

 

our ability to raise additional capital;

 

the soundness of other financial institutions and certain securities brokerage firms;

 

technological change in the banking, investment, brokerage and insurance industry;

 

our ability to protect against and manage fraudulent activity, breaches of our information security, and cybersecurity attacks;

 

our reliance on communications, information, operating and financial control systems technology and related services from third-party service providers;

 

natural disasters;

 

environmental liabilities;

 

 

 

regulation of the financial services industry;

 

legislative changes or the adoption of tax reform policies;

 

tariffs and trade barriers;

 

compliance with laws and regulations, supervisory actions, the Dodd-Frank Wall Street Reform and Consumer Protection Act, Economic Growth, Regulatory Relief and Consumer Protection Act, capital requirements; the Bank Secrecy Act, anti-money laundering laws, consumer laws, and other statutes and regulations;

 

regulation of broker-dealers and investment advisors;

 

the enactment of regulations relating to privacy, information security and data protection;

 

legal and regulatory examinations, proceedings, investigations and inquiries, fines and sanctions;

 

the development of an active, liquid market for our common stock;

 

fluctuations in the market price of our common stock;

 

our ability to pay dividends;

 

risks related to being a “controlled company” under NASDAQ rules; and

 

the costs and expenses of being a public company.

 

You should not place undue reliance on any such forward-looking statements. Any forward-looking statement reflects only information known to us as of the date on which it is made and we do not undertake any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events, except as required by law. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement.

 

COVID-19 Update

 

The Company continues to actively monitor developments related to the COVID-19 pandemic and its impact on the Company’s business, customers, employees, vendors, and service providers. Through the third quarter of 2020, the most notable financial impact to the Company’s results of operations continues to be the building of the allowance for loan losses, primarily as a result of continued deterioration in macroeconomic variables such as unemployment, which are incorporated into our economic forecasts utilized to calculate our allowance for loan losses. See the section captioned “Allowance for Loan Losses” included elsewhere in this discussion for further analysis of the provision for loan losses.

 

In addition to the effect on our allowance for loan losses, the COVID-19 pandemic has resulted in a significant and continuing decrease in commercial activity throughout the State of Texas as well as nationally, which has or may have the following impacts on the Company:

 

 

Our customers and vendors, both businesses and individuals, may be unable to meet existing payment or other obligations to us, including service obligations.

 

Our support of customers impacted by the economic downturn through payment deferrals and extensions, combined with the potential for further decreases in the value of the Company’s client assets under management and the possibility of sustained decreases in trading activity in certain of our brokerage business segments, will decrease our net interest income, and our advisory and brokerage revenues.

 

Under the CARES Act, as an SBA Preferred Lender, the Bank funded approximately 922 loans, for approximately $98.3 million in funding under the PPP.

 

Pressure on consumers and the creation of uncertainty has impacted the creditworthiness of potential and current borrowers. These adverse effects correlate with deteriorating economic conditions (such as the unemployment rate), which, in turn, are likely to negatively impact our borrowers' creditworthiness and therefore our ability to make loans in the future.

 

The needs of a remote workforce have required adjustments to our hardware and applications, including upgrades to our internal systems to alleviate difficulties working remotely in certain business segments

 

The Company is also monitoring the activities of its vendors and other third-party service providers to mitigate risk associated with any potential service disruptions due to COVID-19 and its economic effects.

 

The Company continues to monitor and review the evolving risks and developments of the COVID-19 pandemic. The duration and scope of the disruptions due to the pandemic and their impact on the Company, its internal operations, including personnel on which we rely, our customers and the areas in which they operate, and the wider economy remain uncertain. See our Risk Factors in Part II, Item 1A of this Form 10-Q.

 

 

The impact of the COVID-19 pandemic on the Company for the periods covered by this Form 10-Q are detailed in each applicable section of “Management's Discussion and Analysis of Financial Condition and Results of Operations” included below.

 

General

 

We are a financial holding company headquartered in Dallas, Texas. We provide a wide array of financial products and services including banking, trust, investment advisory, securities brokerage, third party administration, recordkeeping and insurance to individuals, small businesses and institutions in all 50 states.

 

The following discussion and analysis presents our consolidated financial condition as of September 30, 2020 and December 31, 2019, and our consolidated results of operations for the three and nine months ended September 30, 2020 and 2019. The discussion should be read in conjunction with our financial statements and the notes related thereto in this Form 10-Q and in the audited financial statements in our Form 10-K filed with the SEC on March 31, 2020.

 

On May 13, 2019, we completed a merger with Tectonic Holdings, through which we expanded our financial services to include investment advisory, securities brokerage and insurance services. Pursuant to the Tectonic Merger Agreement, dated March 28, 2019, by and between the Company and Tectonic Holdings, Tectonic Holdings merged with and into the Company, with the Company as the surviving institution. Immediately after the completion of the Tectonic Merger, the Company completed a 1-for-2 reverse stock split with respect to the outstanding shares of its common stock. The computations of all share and per share amounts in this Form 10-Q have been adjusted retroactively to reflect the reverse stock split.

 

Following the Tectonic Merger, we operate through four main direct and indirect subsidiaries: (i) TBI, which was incorporated under the laws of the State of Texas on December 23, 2002 to serve as the bank holding company for the Bank, (ii) Sanders Morris, a registered broker-dealer with FINRA, and registered investment advisor with the SEC, (iii) Tectonic Advisors, a registered investment advisor registered with the SEC focused generally on managing money for relatively large, affiliated institutions, and (iv) HWG, an insurance agency registered with the TDI.

 

In January 2019, the Bank acquired Nolan, a TPA based in Overland Park, Kansas. Founded in 1979, Nolan 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. The addition of TPA services allows us to serve our clients more fully and to attract new clients to our trust platform. Please see Note 18, Nolan Acquisition, to the consolidated financial statements included in this Form 10-Q for more information.

 

The Company completed the underwritten initial public offering of its Series B preferred stock on May 14, 2019. In connection with the initial public offering, the Company issued and sold 1,725,000 shares of its Series B preferred stock, including 225,000 shares sold pursuant to the underwriters’ full exercise of their option to purchase additional shares, at an offering price of $10.00 per share, for aggregate gross proceeds of $17.25 million before deducting underwriting discounts and offering expenses, and aggregate net proceeds of $15.5 million after deducting underwriting discounts and offering expenses.

 

Prior to the Tectonic Merger, Sanders Morris and Tectonic Advisors were wholly owned subsidiaries of Tectonic Holdings, which was under common control with the Company. The Tectonic Merger has been accounted for as a combination of businesses under common control in accordance with Topic 805. Under Topic 805, all the assets and liabilities of Tectonic Holdings are carried over to the books of the Company at their then current carrying amounts, and the consolidated financial statements have been retrospectively adjusted to reflect the acquisition of Sanders Morris, HWG and Tectonic Advisors for all periods subsequent to the earliest date at which the entities were under common control, May 15, 2017. All intercompany transactions and balances are eliminated in consolidation.

 

Critical Accounting Policies and Estimates

 

We prepare consolidated financial statements based on GAAP and to customary practices within the financial services industry. These policies, in certain areas, require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

 

 

We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain at the time we make the accounting estimate and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the financial statements. Accounting policies related to the allowance for loan losses are considered to be critical as these policies involve considerable subjective judgment and estimation by management.

 

Performance Summary

 

Net income available to common shareholders increased $1.6 million, or 164.8%, to $2.5 million for the three months ended September 30, 2020, compared to $948,000 for the three months ended September 30, 2019. Earnings per diluted common share was $0.38 and $0.14 for the three months ended September 30, 2020 and 2019, respectively. Net income available to common shareholders increased $1.3 million, or 26.8%, to $6.2 million for the nine months ended September 30, 2020, compared to $4.9 million for the nine months ended September 30, 2019. Earnings per diluted common share was $0.95 and $0.75 for the nine months ended September 30, 2020 and 2019, respectively.

 

Our accounting and reporting policies conform to generally accepted accounting principles in the United States (“GAAP”) and the prevailing practices in the banking industry. However, this Form 10-Q contains financial information determined by methods other than in accordance with GAAP, which includes return on average tangible common equity. We calculate return on average tangible common equity as net income available to common shareholders (net income less dividends paid on preferred stock) divided by average tangible common equity. The most directly comparable GAAP financial measure for tangible common equity is average total shareholders’ equity. We believe these non-GAAP measures and ratios, when taken together with the corresponding GAAP measures and ratios, provide meaningful supplemental information regarding our performance. We believe investors benefit from referring to these non-GAAP measures and ratios in assessing our operating results and related trends, and when planning and forecasting future periods. However, these non-GAAP measures and ratios should be considered in addition to, and not as a substitute for or preferable to, measures and ratios prepared in accordance with GAAP.

 

For the three months ended September 30, 2020, annual return on average assets was 2.27%, compared to 1.56% for the same period in the prior year, and annual return on average tangible common equity was 39.22%, compared to 18.80% for the same period in the prior year. For the nine months ended September 30, 2020, annual return on average assets was 2.15%, compared to 2.34% for the nine months ended September 30, 2019, and annual return on average tangible common equity was 35.36%, compared to 34.88% for the same period in the prior year. The higher annual return ratios for the three months ended September 30, 2020, and the higher annual return on average tangible common equity for the nine months ended September 30, 2020, were primarily due to increases in income which outpaced increases in average assets and average tangible common equity compared to the same periods in the prior year. The lower annual return on average assets for the nine months ended September 30, 2020, was the result of an increase in average assets which outstripped the increase in income compared to the nine months ended September 30, 2020. The growth in average tangible common equity between the two periods is primarily related to earnings, net of preferred dividends paid, from September 30, 2019 to September 30, 2020. The growth in average assets is primarily attributable to growth in average interest-bearing deposits during the nine months ended September 30, 2020 to increase liquidity in anticipation of funding the PPP loans discussed in the “COVID-19 Update” section.

 

The following table presents non-GAAP reconciliations of annual return on average tangible common equity:

 

(Dollars in thousands)

 

As of and
for the
Three Months Ended

September 30, 2020

   

As of and
for the
Three Months Ended

September 30, 2019

   

As of and

for the

Nine Months Ended

September 30, 2020

   

As of and

for the

Nine Months Ended

September 30, 2019

 

Income available to common shareholders

  $ 2,510     $ 948     $ 6,249     $ 4,929  
                                 

Average shareholders’ equity

  $ 54,499     $ 49,250     $ 52,697     $ 44,400  

Less: average goodwill

    10,729       10,729       10,729       10,786  

Less: average core deposit intangible

    1,062       1,260       1,112       1,311  

Less: average preferred stock

    17,250       17,250       17,250       13,410  

Average tangible common equity

  $ 25,458     $ 20,011     $ 23,606     $ 18,893  

Annual return on average tangible common equity

    39.22

%

    18.80

%

    35.36

%

    34.88

%

 

 

Total assets grew by $151.2 million, or 41.4%, to $516.3 million as of September 30, 2020 from $365.1 million as of December 31, 2019. This increase was primarily due to an increase in our loans, net of allowance for loan losses, of $109.5 million, or 37.8%, to $399.2 million as of September 30, 2020, from $289.7 million as of December 31, 2019, due primarily to loans originated under the SBA’s PPP program, and an increase in interest-bearing deposits at the Bank from purchases of certificates of deposit in the wholesale market. Substantially all loans outside of those made under the SBA’s PPP program are secured by specific collateral, including business assets, consumer assets, and commercial real estate. We anticipate that as the majority of PPP loans are forgiven or paid off, which we believe will occur principally over the next nine months, and as customers spend down their PPP funds, this will result in a reduction in both loans and deposits.

 

Shareholders’ equity increased $6.4 million, or 12.6%, to $56.9 million as of September 30, 2020, from $50.5 million as of December 31, 2019. See analysis of shareholders’ equity in the section captioned “Capital Resources and Regulatory Capital Requirements” included elsewhere in this discussion.

 

Results of Operations for the Three and Nine Months Ended September 30, 2020 and 2019

 

Details of the changes in the various components of net income are discussed below.

 

Net Interest Income

 

Net interest income is the difference between interest income on interest-earning assets, such as loans, investment securities, and interest-bearing cash, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Changes in net interest income result from changes in volume and spread, and are reflected in the net interest margin, as well as changes in average interest rates. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

 

The following tables presents the changes in net interest income and identifies the changes due to differences in the average volume of interest-earning assets and interest–bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities.  The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.

 

Three Months Ended September 30, 2020 and 2019

 

   

Three Months Ended

September 30, 2020 vs. September 30, 2019

 
   

Increase (Decrease) Due to Change in

 

(In thousands)

 

Rate

   

Average

Volume

   

Total

 

Interest-bearing deposits and federal funds sold

  $ (55

)

  $ 8     $ (47

)

Securities

    (19

)

    22       3  

Loans, net of unearned discount (1)

    (918

)

    1,586       668  

Total earning assets

    (992

)

    1,616       624  
                         

Savings and interest-bearing demand

    (2

)

    2       -  

Money market deposit accounts

    (173

)

    59       (114

)

Time deposits

    (374

)

    137       (237

)

FHLB and other borrowings

    (92

)

    31       (61

)

Subordinated notes

    1       (1

)

    -  

Total interest-bearing liabilities

    (640

)

    228       (412

)

                         

Changes in net interest income

  $ (352

)

  $ 1,388     $ 1,036  

 

 

(1)

Average loans include non-accrual.

 

 

Net interest income increased $1.0 million, or 34.1%, from $3.0 million for the three months ended September 30, 2019, to $4.1 million for the three months ended September 30, 2020. Net interest margin for the three months ended September 30, 2020 and 2019 was 3.37% and 3.81%, a decrease of 44 basis points. The increase in net interest income was primarily due to an increase in the average volume of loans and decrease in average rates paid on interest-bearing deposits and borrowings, partly offset by a decrease in average yields on earning assets and increase in average volume of interest-bearing deposits and borrowings. Additionally, declines in yields were impacted by $98.3 million of SBA PPP loans originated for the year with a rate of 1.00%.

 

The average volume of loans increased $128.5 million, or 45.1%, from $285.2 million for the three months ended September 30, 2019 to $413.7 million for the three months ended September 30, 2020, and the average yield for loans decreased 128 basis points from 6.22% for the three months ended September 30, 2019 to 4.94% for the three months ended September 30, 2020. PPP loans account for $98.3 million of the average volume increase. The changes compared to the same period in the prior year have been impacted by the recent short-term interest rate cuts and the interest rate that the PPP loans carry of 1.00%, as well as the timing of recognition of the related SBA loan fees, and increased liquidity on the balance sheet. See Paycheck Protection Loans under Loan Portfolio Composition within the discussion of our financial position below for more information. The Company expects to see continued volatility in the economic markets and government responses to these changes as a result of the COVID-19 pandemic. These changing conditions and governmental responses could have impacts on the balance sheet and income statement of the Company for the remainder of the year.

 

Average volume of interest-bearing deposits increased $99.1 million, or 43.9%, from $225.5 million for the three months ended September 30, 2019, to $324.6 million for the three months ended September 30, 2020, and the average interest rate paid on interest-bearing deposits decreased 114 basis points from 2.33% for the three months ended September 30, 2019 to 1.19% for the three months ended September 30, 2020. The average cost of deposits during the three months ended September 30, 2020 was impacted by decreases in interest rates paid on money market and time deposits as a result of the decrease in market interest rates.

 

Nine Months Ended September 30, 2020 and 2019

 

   

Nine Months Ended

September 30, 2020 vs. September 30, 2019

 
   

Increase (Decrease) Due to Change in

 

(In thousands)

 

Rate

   

Average

Volume

   

Total

 

Interest-bearing deposits and federal funds sold

  $ (189

)

  $ 69     $ (120

)

Securities

    55       56       111  

Loans, net of unearned discount (1)

    (1,949

)

    3,848       1,899  

Total earning assets

    (2,083

)

    3,973       1,890  
                         

Savings and interest-bearing demand

    (2

)

    6       4  

Money market deposit accounts

    (413

)

    162       (251

)

Time deposits

    (767

)

    790       23  

FHLB and other borrowings

    (204

)

    57       (147

)

Subordinated notes

    (1

)

    -       (1

)

Total interest-bearing liabilities

    (1,387

)

    1,015       (372

)

                         

Changes in net interest income

  $ (696

)

  $ 2,958     $ 2,262  

 

 

(1)

Average loans include non-accrual.

 

Net interest income increased $2.3 million, or 26.4%, from $8.7 million for the nine months ended September 30, 2019, to $11.0 million for the nine months ended September 30, 2020. Net interest margin for the nine months ended September 30, 2020 and 2019 was 3.37% and 3.89%, respectively, a decrease of 52 basis points. The increase in net interest income was primarily due to an increase in the average volume of loans and decrease in average rates paid on interest-bearing deposits and borrowings, partly offset by a decrease in average yields on earning assets and increase in average volume of interest-bearing deposits and borrowings. The Company expects to see continued volatility in the economic markets and government responses to the COVID-19 pandemic.

 

 

The average volume of loans increased $97.3 million, or 36.7%, from $265.5 million for the nine months ended September 30, 2019, to $362.8 million for the nine months ended September 30, 2020, and the average yield for loans decreased 99 basis points from 6.28% for the nine months ended September 30, 2019 to 5.29% for the nine months ended September 30, 2020. The changes compared to the same period in the prior year have been impacted by the recent short-term interest rate cuts and increased liquidity on the balance sheet. The Company expects to see continued volatility in the economic markets and government responses to these changes as a result of the COVID-19 pandemic. These changing conditions and governmental responses could have impacts on the balance sheet and income statement of the Company for the remainder of the year.

 

Average volume of interest-bearing deposits increased $94.9 million, or 43.5%, from $218.1 million for the nine months ended September 30, 2019, to $313.0 million for the nine months ended September 30, 2020, and the average interest rate paid on interest-bearing deposits decreased 78 basis points from 2.25% for the nine months ended September 30, 2019 to 1.47% for the nine months ended September 30, 2020. The average cost of deposits during the nine months ended September 30, 2020 was impacted by decreases in interest rates paid on money market and time deposits as a result of the decrease in market interest rates.

 

The following table sets forth our average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and our net interest margin, for the three months ended September 30, 2020 and 2019.

 

   

Three Months Ended September 30,

 
   

2020

   

2019

 

(In thousands, except percentages)

 

Average

Balance

   

Interest

   

Average

Yield

   

Average

Balance

   

Interest

   

Average

Yield

 

Assets

                                               

Interest-bearing deposits and federal funds sold

  $ 43,532     $ 11       0.10

%

  $ 10,492     $ 58       2.19

%

Securities

    23,579       160       2.70       20,259       157       3.07  

Loans, net of unearned discount (1)

    413,661       5,139       4.94       285,224       4,471       6.22  

Total earning assets

    480,772       5,310       4.39       315,975       4,686       5.88  

Cash and other assets

    29,252                       27,022                  

Allowance for loan losses

    (2,553

)

                    (1,077

)

               

Total assets

  $ 507,471                     $ 341,920                  

Liabilities and Shareholders’ Equity

                                               

Savings and interest-bearing demand

  $ 10,372       7       0.27

%

  $ 7,440       7       0.37

%

Money market deposit accounts

    111,808       105       0.37       48,440       219       1.79  

Time deposits

    202,384       861       1.69       169,623       1,098       2.57  

Total interest-bearing deposits

    324,564       973       1.19       225,503       1,324       2.33  

FHLB and other borrowings

    55,230       45       0.32       17,554       106       2.40  

Subordinated notes

    12,000       219       7.26       12,000       219       7.24  

Total interest-bearing liabilities

    391,794       1,237       1.26       255,057       1,649       2.57  

Non-interest-bearing deposits

    55,388                       31,270                  

Other liabilities

    5,790                       6,343                  

Total liabilities

    452,972                       292,670                  

Shareholders’ equity

    54,499                       49,250                  

Total liabilities and shareholders’ equity

  $ 507,471                     $ 341,920                  
                                                 

Net interest income

          $ 4,073                     $ 3,037          

Net interest spread

                    3.13

%

                    3.31

%

Net interest margin

                    3.37

%

                    3.81

%

 

 

(1)

Includes non-accrual loans.

 

 

The following table sets forth our average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and our net interest margin, for the nine months ended September 30, 2020 and 2019.

 

   

Nine Months Ended September 30,

 
   

2020

   

2019

 

(In thousands, except percentages)

 

Average

Balance

   

Interest

   

Average

Yield

   

Average

Balance

   

Interest

   

Average

Yield

 

Assets

                                               

Interest-bearing deposits and federal funds sold

  $ 48,141     $ 93       0.26

%

  $ 12,031     $ 213       2.37

%

Securities

    23,243       682       3.92       21,303       571       3.58  

Loans, net of unearned discount (1)

    362,806       14,374       5.29       265,472       12,475       6.28  

Total earning assets

    434,190       15,149       4.66       298,806       13,259       5.93  

Cash and other assets

    29,302                       29,926                  

Allowance for loan losses

    (2,066

)

                    (970

)

               

Total assets

  $ 461,426                     $ 327,762                  

Liabilities and Shareholders’ Equity

                                               

Savings and interest-bearing demand

  $ 9,890       25       0.34

%

  $ 7,370       21       0.38

%

Money market deposit accounts

    92,312       402       0.58       55,237       653       1.58  

Time deposits

    210,776       3,017       1.91       155,519       2,994       2.57  

Total interest-bearing deposits

    312,978       3,444       1.47       218,126       3,668       2.25  

FHLB and other borrowings

    28,935       95       0.44       11,486       242       2.82  

Subordinated notes

    12,000       656       7.30       12,000       657       7.32  

Total interest-bearing liabilities

    353,913       4,195       1.58       241,612       4,567       2.53  

Non-interest-bearing deposits

    48,441                       35,754                  

Other liabilities

    6,375                       5,996                  

Total liabilities

    408,729                       283,362                  

Shareholders’ equity

    52,697                       44,400                  

Total liabilities and shareholders’ equity

  $ 461,426                     $ 327,762                  
                                                 

Net interest income

          $ 10,954                     $ 8,692          

Net interest spread

                    3.08

%

                    3.41

%

Net interest margin

                    3.37

%

                    3.89

%

 

 

(1)

Includes non-accrual loans.

 

Provision for Loan Losses

 

We determined a provision for loan losses that we consider sufficient to maintain an allowance to absorb probable losses inherent in our portfolio as of the balance sheet date. For additional information concerning this determination, see the section captioned “Allowance for Loan Losses” elsewhere in this discussion.

 

For the three and nine months ended September 30, 2020, the provision for loan losses totaled $445,000 and $1.7 million, respectively, compared to $1.0 million and $1.5 million for the three and nine months ended September 30, 2019, respectively. See the section captioned “Allowance for Loan Losses” included elsewhere in this discussion for further analysis of the provision for loan losses.

 

 

Non-Interest Income

 

The components of non-interest income were as follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 

(In thousands)

 

2020

   

2019

   

2020

   

2019

 

Trust income

  $ 1,391     $ 1,286     $ 3,863     $ 3,716  

Gain on sale of loans

    290       -       722       -  

Advisory income

    2,775       2,728       7,580       7,396  

Brokerage income

    1,387       2,820       5,248       7,776  

Service fees and other income

    1,809       898       4,769       3,632  

Rental income

    85       85       232       249  

Total

  $ 7,737     $ 7,817     $ 22,414     $ 22,769  

 

Total non-interest income for the three and nine months ended September 30, 2020 decreased $80,000, or 1.0%, and $355,000, or 1.6%, respectively, compared to the same periods in the prior year, respectively. Material changes in the various components of non-interest income are discussed below.

 

Trust Income. Trust income is earned for trust services on the value of managed and non-managed assets held in custody. Volatility in the bond and equity markets impacts the market value of trust assets and the related fees. Trust income for the three and nine months ended September 30, 2020 increased $105,000, or 8.2%, and $147,000, or 4.0%, respectively, compared to the same periods in the prior year. The increases in the fee income for the three and nine month periods ended September 30, 2020 is due to an increase in the average market value of the trust assets as compared to the three and nine month periods in the prior year. The economic disruption caused by the COVID-19 pandemic has increased market volatility, resulting in a decrease in trust assets, particularly during the second quarter of 2020, offset slightly by a recovery in the third quarter 2020. Continued volatility and the economic downturn related to the COVID-19 pandemic could result in future net decreases in our assets held in custody, which may be sustained and could materially worsen, causing material decreases in our trust income.

 

Gain on sale of loans. Gain on sale of loans is generally gain on sales of the guaranteed portion of loans within our SBA loan portfolio. There were no loan sales, and consequently, no gain on sale of loans for the three and nine months ended September 30, 2019. Gain on sale of loans for the three and nine months ended September 30, 2020 was $290,000 and $722,000, respectively, resulting from the sale of $3.6 million and $9.8 million of SBA loans, respectively.

 

Advisory income. Advisory fees are typically based on a percentage of the underlying average asset values for a given period, where each percentage point represents 100 basis points. These revenues are of a recurring nature, but are directly affected by increases and decreases in the values of the underlying assets. For the three and nine months ended September 30, 2020, advisory income increased $47,000, or 1.7%, and increased $184,000, or 2.5%, respectively, compared to the same periods in the prior year. The increases in advisory income between the two periods are due to increases in the average market value of the advisory assets during the three and nine months ended September 30, 2020 as compared to the same periods in the prior year. Similar to our trust income, changes in the value of our assets under management will result in comparable changes in our advisory income. The economic disruption caused by the COVID-19 pandemic has increased market volatility, which could result in future net decreases to our assets under management, which may be sustained, potentially decreasing advisory income materially.

 

Brokerage income. Brokerage revenues are generally based on a per share fee or commission to trade a share of a particular stock, bond or other security. In addition, brokerage revenues, in this context, include private placements, participation in syndication of public offerings, and certain other brokerage revenues, including interest earned on margin lending. Brokerage revenue is dependent on the volume of trading, and on private placement and syndication activity during the period, and in the case of margin lending, on interest rates. Brokerage income for the three and nine months ended September 30, 2020 decreased $1.4 million, or 50.8%, and $2.5 million, or 32.5%, respectively, compared to the same periods in the prior year. The economic disruption related to the COVID-19 pandemic has led to a dramatic slowing of activity in private placements and syndicated public offerings, on which margins have historically been higher. This activity may face a prolonged recovery, materially decreasing brokerage income. During the first quarter of 2020, this effect was offset by a temporary increase in certain segments of trading activity which are typically done at lower margins. This increase was not sustained through the second and third quarters, during which these same segments saw material decreases in activity.

 

 

The chart below reflects our advisory and brokerage assets as of September 30, 2020, December 31, 2019 and September 30, 2019.

 

(In thousands)

 

September 30, 2020

   

December 31, 2019

   

September 30, 2019

 

Advisory assets

                       

Tectonic Advisors

  $ 2,131,022     $ 2,057,570     $ 2,005,916  

Sanders Morris

    543,522       560,820       444,665  

Total advisory assets

  $ 2,674,544     $ 2,618,390     $ 2,450,581  
                         

Brokerage assets – Sanders Morris

  $ 1,364,048     $ 1,426,828     $ 1,659,665  
                         

Total advisory and brokerage assets

  $ 4,038,592     $ 4,045,218     $ 4,110,246  

 

Service fees and other income. Service fees includes fees for deposit-related services, loan servicing, and third party administration fees. Service fees and other income for the three and nine months ended September 30, 2020 increased $911,000, or 101.4%, and $1.1 million, or 31.3%, respectively, compared to the same periods in the prior year. These increases are the result of an increase in third party administration fees of $528,000 and $412,000, and in loan servicing fees of $156,000 and $318,000 primarily due to reversal of the servicing asset valuation allowance, during the three and nine months ended September 30, 2020, respectively, a loss recognized during the three months ended September 30, 2019 related to the redemption of our Series A preferred stock of approximately $234,000, an increase in other income of approximately $124,000 related to a non-recurring extinguishment of a retirement liability during the second quarter of 2020, and bad debt expense recognized during the second quarter of 2019 of approximately $51,000, as well as immaterial fluctuations in other income and gains and losses on marketable securities at Sanders Morris and a gain on lease termination in 2019 at Tectonic Advisors. The increase in third party administration fees during the three months ended September 30, 2020, as compared to the prior year, was in part due to the COVID-19 pandemic and the resulting lag in information from plan sponsors to complete annual plan administration work earlier in 2020 related to the shutdown of dental practices nationwide from March through June or July 2020, depending on state dental board advisories and mandates, which pushed a greater percentage of revenues into the third quarter of 2020 compared to the same period in the prior year.

 

Rental income. The Company receives monthly rental income from tenants leasing space in the Bank building. Rental income for the three months ended September 30, 2020 was unchanged from the same period in the prior year, and decreased $17,000, or 6.8%, for the nine months ended September 30, 2020 compared to the same period in the prior year, due to the granting of rent abatements related to the COVID-19 pandemic and one tenant’s lease reaching the end of its term and subsequent nonrenewal during the second quarter of 2020.

 

Non-Interest Expense

 

The components of non-interest expense were as follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 

(In thousands)

 

2020

   

2019

   

2020

   

2019

 

Salaries and employee benefits

  $ 4,741     $ 4,858     $ 13,693     $ 14,109  

Occupancy and equipment

    575       684       1,786       1,934  

Trust expenses

    533       506       1,460       1,482  

Brokerage and advisory direct costs

    517       448       1,563       1,318  

Professional fees

    381       429       1,057       1,292  

Data processing

    193       217       594       666  

Other

    794       921       2,067       2,230  

Total

  $ 7,734     $ 8,063     $ 22,220     $ 23,031  

 

Total non-interest expense for the three and nine months ended September 30, 2020 decreased $329,000, or 4.1%, and $811,000, or 3.5%, respectively, compared to the same periods in the prior year, primarily due to decreases in salaries and employee benefits, depreciation expense within our occupancy and equipment expense, and other expenses, as well as decreases in professional fees, partly offset by increases in brokerage and advisory direct costs. Material changes in the various components of non-interest income are discussed below.

 

 

Salaries and employee benefits. Salaries and employee benefits for the three and nine months ended September 30, 2020 decreased $117,000, or 2.4%, and $416,000, or 2.9%, respectively, compared to the same period in the prior year. The decreases were due to decreases in commissions, earnouts and incentive bonuses of $500,000 and $891,000 within our other financial services segment for the three and nine months ended September 30, 2020, respectively, compared to the same periods in the prior year, primarily related to decreases in brokerage activity, including private placement activity, at Sanders Morris. Salaries and employee benefits in our Banking segment increased $228,000 and decreased $89,000 for the three and nine months ending September 30, 2020, respectively. The increase for the three month period was the result of an increase in both salary and bonus expense of $78,000 and $87,000, respectively, and a proportional increase in payroll tax expense of $31,000, resulting from annual salary and bonus merit increases and an increase in staff, as well as an increase in contract labor expense of $25,000. The decrease for the nine month period resulted from recording a portion of fees received from the SBA as an offset to employee costs related to origination of PPP loans during the second quarter 2020, partly offset by annual merit increases and increase in staff. 

 

Occupancy and equipment expense. Occupancy and equipment expense for three and nine months ended September 30, 2020 decreased $109,000, or 15.9%, and $148,000, or 7.7%, respectively, compared to the same periods in the prior year, primarily due to a group of fixed assets and software costs reaching full depreciation/amortization during the three months ended June 30, 2020, slightly offset by increases in telephone expense for the three month period, and in facilities and telephone expenses for the nine month period, in our Banking segment.

 

Trust expenses. Trust expenses are advisory fees paid to a fund advisor to advise the Company on the common trust funds managed by the Company, and are based on the value of the assets held in custody. Volatility in the bond and equity markets impacts the market value of trust assets and the related expenses. The monthly advisory fees are assessed based on the market value of assets at month-end. Trust expenses increased $27,000, or 5.3%, and $22,000, or 1.5%, for the three and nine months ended September 30, 2020, respectively, due to an increase in the market value of trust assets for the three months ended September 30, 2020 over the market value during the three months ended September 30, 2019, which represented a recovery in asset values from the decreases seen during the three months ended June 30, 2020, partially offsetting the decrease for the nine month period ended September 30, 2020. These relate to the volatility discussed under “Non-Interest Income” and within “COVID-19 Update,” above.

 

Brokerage and advisory direct costs. Brokerage and advisory direct costs for three and nine months ended September 30, 2020 increased $69,000, or 15.4%, and $245,000, or 18.6%, compared to the same periods in the prior year. For the three months ended September 30, 2020, these increase related primarily to increases in advisory program fees at Sanders Morris related to increases in asset values, and increases in exchange clearing fees at Sanders Morris related to certain option trades which carried fees of approximately $61,000. The increases during the nine month period related to volume increases in certain segments of brokerage activity driven by market volatility, particularly during the first six months of 2020, leading to increases in ticket based charges, as well as an increase in clearing firm and other service fees. These increases were slightly offset by nominal decreases in information services and referral fees for the three and nine months ended September 30, 2020.

 

Professional fees. Professional fees, which include legal, consulting, audit and professional fees, for the three and nine months ended September 30, 2020 decreased $48,000, or 11.2%, and $235,000, or 18.2%, respectively, compared to the same periods in the prior year. For the three month period ended September 30, 2020, the decreases was the result of a decrease in legal fees related to legal and regulatory matters in our other financial services segment, primarily within Sanders Morris, of approximately $71,000, offset by increases in professional fees within the Bank’s Trust department of an equivalent amount, and decreases in our banking and holding company segments totaling $52,000. For the nine month period ended September 30, 2020, the decrease was the result of decreases in legal and audit fees related to the acquisition of Nolan during the three months ended March 31, 2019, and the preparation of our Registration Statement filed in April 2019 related to our initial public offering, and decreases in expenses related to legal and regulatory matters at Sanders Morris. These decreases were slightly offset by increases in legal and professional fees for our annual audit and periodic SEC filings.

 

Data processing. Data processing includes costs related to the Company’s operating systems. Data processing expense for three and nine months ended September 30, 2020 decreased $24,000, or 11.1%, and $72,000, or 10.8%, respectively, compared to the same periods in the prior year. The decreases were due to lower trust data processing for discounts received for the three and nine months ended September 30, 2020, and decreases in data processing and operating systems at Sanders Morris and Tectonic Advisors related to the completion of initiatives undertaken during 2018 and early 2019.

 

 

Other. Other expenses include costs for insurance, Federal Deposit Insurance Corporation (“FDIC”) and Office of the Comptroller of the Currency (“OCC”) assessments, director fees, regulatory filing fees related to our brokerage business, business travel, management fees, and other operational expenses. Other expenses for three and nine months ended September 30, 2020 decreased $127,000, or 13.8%, and $163,000, or 7.3%, respectively, compared to the same periods in the prior year. The decrease for the three months ended September 30, 2020 was primarily related to a legal settlement incurred during the three months ended September 30, 2019 totaling $300,000, and decreases in travel, meals, and entertainment costs of approximately $92,000, primarily related to decreased brokerage and private placement activity. The decreases were offset by increases in employee recruitment of $60,000 across the organization, and an increase in computer services and software licenses of $40,000 in our other financial services segment in order to increase efficiency within our participant directed and advisory services teams, as well as an increase in the Bank’s other operating costs of approximately $95,000 related to increases in our FDIC insurance premiums which was a result of a premium credit received from the FDIC in the prior year along with an increase in the FDIC rate for the current quarter, and increases in filing fees and insurance expense at our holding company as a result of our status as a public filing entity. The decrease for the nine months ended September 30, 2020 also includes decreases in management fees to third parties, which was somewhat offset by increases in our directors’ fees, directors’ and officers’ insurance costs as a result of our status as a public filing entity, increases in internet costs related to increasing bandwidth to accommodate network changes at Sanders Morris and Tectonic Advisors, and increases in compliance and advertising costs at Sanders Morris.

 

Income Taxes

 

The income tax expense for the three and nine months ended September 30, 2020 was $733,000 and $2.0 million, respectively, compared to $446,000 and $1.2 million for the three and nine months ended September 30, 2019, respectively. The effective income tax rate was 20.2% and 21.5% for the three and nine months ended September 30, 2020, respectively compared to 25.0% and 17.5% for the same periods in the prior year. The effective income tax rate differed from the U.S. statutory rate of 21% for the three and nine months ended September 30, 2019, primarily due to Tectonic Advisors and Sanders Morris’ tax status as partnerships for the periods prior to May 13, 2019, the date the Tectonic Merger was completed.

 

Segment Reporting

 

We have three operating segments: Banking, Other Financial Services and HoldCo. Our primary operating segments are Banking and Other Financial Services.

 

Our Banking operating segment includes both commercial and consumer banking services. Commercial banking services are provided primarily to small to medium-sized businesses and their employees, which includes a wide array of lending and cash management products. Consumer banking services include lending and depository services.

 

Our Other Financial Services segment includes Tectonic Advisors, Sanders Morris, the Bank’s Trust Division, which includes a TPA services unit, and HWG. Through these business divisions, we offer investment advisory and brokerage services to individuals and businesses, private trust services, and financial management services, including personal wealth management, retirement plan design and administrative services, and insurance brokerage services.

 

A third operating segment, HoldCo, includes the Bank’s immediate parent and related subordinated debt, as well as operations of the financial holding company that serves as parent for the group overall. Our principal source of revenue is dividends from our subsidiaries.

 

 

The following table presents key metrics related to our segments:

 

   

Three Months Ended September 30, 2020

   

Nine Months Ended September 30, 2020

 

(In thousands)

 

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

   

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

 

Revenue(1)

  $ 4,896     $ 7,133     $ (219

)

  $ 11,810     $ 12,867     $ 21,135     $ (634

)

  $ 33,368  

Income (loss) before taxes

  $ 2,067     $ 2,036     $ (472

)

  $ 3,631     $ 5,189     $ 5,611     $ (1,361

)

  $ 9,439  

 

   

Three Months Ended September 30, 2019

   

Nine Months Ended September 30, 2019

 

(In thousands)

 

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

   

Banking

   

Other Financial Services

   

HoldCo

   

Consolidated

 

Revenue(1)

  $ 3,407     $ 7,909     $ (462

)

  $ 10,854     $ 9,614     $ 22,760     $ (913

)

  $ 31,461  

Income (loss) before taxes

  $ 319     $ 2,139     $ (671

)

  $ 1,787     $ 2,129     $ 6,277     $ (1,462

)

  $ 6,944  

 

(1)

Net interest income plus non-interest income

 

Banking

 

Income before taxes for the three and nine months ended September 30, 2020 increased $1.7 million, or 548.0%, and increased $3.1 million, or 143.7%, respectively, compared to the same periods in the prior year. The increase during the three months ended September 30, 2020 was primarily the result of a $1.0 million increase in net interest income, a $559,000 decrease in the provision for loan losses and a $453,000 increase in non-interest income, partly offset by a $300,000 increase in non-interest expense. The increase during the nine months ended September 30, 2020 was primarily the result of a $2.2 million increase in net interest income, a $1.0 million increase in non-interest income and a $30,000 decrease in non-interest expense, partly offset by a $223,000 increase in the provision for loan losses.

 

Net interest income for the three and nine months ended September 30, 2020 increased $1.0 million, or 31.8%, and $2.2 million, or 23.6%, respectively, compared to the same periods in the prior year, due to an increase in the average volume of loans and a decrease in average rates paid on interest-bearing deposits and borrowings, partly offset by a decrease in average yields on earning assets and increase in average volume of interest-bearing deposits and borrowings. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.

 

The provision for loan losses for the three and nine months ended September 30, 2020, totaled $445,000 and $1.7 million, respectively, compared to $1.0 million and $1.5 million for the three and nine months ended September 30, 2019, respectively. See “Allowance for Loan Losses” included elsewhere in this discussion.

 

Non-interest income for the three months ended September 30, 2020 increased $453,000, or 300.0%, and $1.0 million, or 463.7% for the nine months ended September 30, 2020, compared to the same periods in the prior year. The increases were primarily due to a $290,000 and $722,000 increase in gain on sale of loans, respectively, and a $156,000 and $318,000 increase in net loan servicing income, respectively, for the three and nine months ended September 30, 2020. The increase in net loan servicing income was the result of reversing the allowance valuation allowance for loan servicing assets during the three and nine months ended September 30, 2020. See the analysis of non-interest income included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

 

 

Non-interest expense for the three months ended September 30, 2020 increased $300,000, or 14.4%, and decreased $30,000, or 0.5%, for the nine months ended September 30, 2020 compared to the same periods in the prior year, respectively. The increase for the three months ended September 30, 2020 included a $228,000 increase in salaries and employee benefits, due to annual merit increases and increases in staff and incentive bonuses, and a $110,000 increase in other expenses due to a $95,000 increase in FDIC insurance premiums and a $60,000 increase in recruiting fees, partly offset by a $33,000 decrease in travel and meals and various other expenses. The increases were also partly offset by a $25,000 decrease in professional fees related to a reimbursement from the SBA for legal fees for loan collection costs, and a $23,000 decrease in data processing. The decrease for the nine months ended September 30, 2020 included a $89,000 decrease in salaries and employee benefits resulting from recording a portion of fees received from the SBA to offset employee costs to originate PPP loans during the prior quarter, a $57,000 decrease in professional fees primarily related to the acquisition of the Nolan business and other new business activity during the three months ended March 31, 2019, and a $45,000 decrease in data processing. The decreases were partly offset by a $117,000 increase in other expenses primarily due to the increase in FDIC insurance premiums and employee recruiting fees, and a $44,000 increase in occupancy and equipment primarily due to increase in building maintenance and telephone expense. See the analysis of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.

 

Other Financial Services

 

Income before taxes for the three and nine months ended September 30, 2020 decreased $103,000, or 4.8%, and decreased $666,000, or 10.6%, respectively, compared to the same periods in the prior year. The decreases during the three and nine months ended September 30, 2020 were primarily the result of decreases of $776,000 and $1.6 million in non-interest income, offset by decreases of $673,000 and $959,000 in non-interest expense, respectively.

 

Non-interest income for the three and nine months ended September 30, 2020 decreased $776,000, or 9.8%, and decreased $1.6 million, or 7.1%, compared to the same periods in the prior year, respectively. The decrease for the three months ended September 30, 2020 was primarily due to a decrease in brokerage income of $1.4 million, offset by increases in trust and advisory income of $152,000 related to a recovery in the value of our assets under management at Tectonic Advisors and Sanders Morris, and net increases in services fees and other income of $505,000 primarily related to an increase in third party administration fees at Nolan. For the nine month period ended September 30, 2020, the decreases were the result of a decrease in brokerage income $2.5 million, offset by an increase in advisory and trust income of $331,000 related to increases in assets under management at Sanders Morris and Tectonic Advisors compared to those in the prior period, and an increase in services fees and other income of $572,000, primarily related to an increase in third party administration fees and also in other income related to a non-recurring extinguishment of a retirement liability during the three months ended March 31, 2020 and bad debt expense recognized during the three months ended March 31, 2019. See also the analysis of non-interest income included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

 

Non-interest expense for the three and nine months ended September 30, 2020 decreased $673,000, or 11.7%, and $959,000, or 5.8%, respectively, compared to the same periods in the prior year. These decreases were related to decreases in salaries and employee benefits of $336,000 and $490,000 for the three and nine months ended September 30, 2020, respectively, primarily related to decreases in brokerage activity, including private placement activity, at Sanders Morris leading to decreased commissions, earnouts and incentive bonuses compared to the same periods in the prior year, partially offset by staffing additions at Nolan during the first and second quarters of 2020 to add capacity for additional plan administration work, and staffing increases in the SBA lending group within the Bank during the three month period ending September 30, 2020. Occupancy and equipment expense decreased by $119,000 and $192,000 for the three and nine months ended September 30, 2020, respectively, related to software that became fully depreciated as of April 2020. The remaining variances for the three and nine months ended September 30, 2020 related to decreases in professional fees and other expenses, offset by increases in brokerage and advisory direct costs, from increases in certain segments of brokerage activity and related exchange and clearing firm service fees, and information services expense. The variance in trust expense was relatively immaterial. See also the analysis of non-interest income included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.

 

HoldCo

 

Loss before taxes for the three months ended September 30, 2020 decreased $199,000, or 29.7%, and decreased $101,000, or 6.9% for the nine months ended September 30, 2020, compared to the same periods in the prior year. The decrease in the loss for the three months ended September 30, 2020 was due to a loss of $234,000 on the redemption of our Series A preferred stock during the three months ended September 30, 2019 and a decrease in professional fees of $24,000 during the three months ended September 30, 2020, offset by an increase in other expenses of $77,000 related to increases in directors’ fees, filing fees, and directors’ and officers’ insurance, combined with minor variances in professional fees. The decrease in the loss for the nine months ended September 30, 2020 is related to the loss recognized in 2019 related to the redemption of the Series A preferred stock, as well as decreases in interest expense on borrowings of $49,000 and a decrease in professional fees of $91,000, partly offset by increases in salaries and employee benefits compensation expense of $163,000 other expenses of $105,000.

 

 

Financial Condition

 

Investment Securities

 

The primary purpose of the Company’s investment portfolio is to provide a source of earnings for liquidity management purposes, to provide collateral to pledge against borrowings, and to control interest rate risk. In managing the portfolio, the Company seeks to attain the objectives of safety of principal, liquidity, diversification, and maximized return on investment.

 

As of September 30, 2020, securities available for sale consisted of U.S. government agency securities and mortgage-backed securities guaranteed by U.S. government agencies. Securities held to maturity consisted of Property Assessed Clean Energy investments. These investment contracts or bonds, located in California and Florida, originate under a contractual obligation between the property owners, the local county administration, and a third-party administrator and sponsor. The assessments are created to fund the purchase and installation of energy saving improvements to the property, such as solar panels. Generally, as a property assessment, the total assessment is repaid in installments over a period of 10 to 15 years by the then current property owner(s). Each installment is collected by the County Tax Collector where the property is located. The assessments are an obligation of the property. Each assessment is equal in priority to the other property taxes and assessments associated with the property, including local school, city, and county ad-valorem taxes.

 

As of September 30, 2020 and December 31, 2019, the Bank held FRB stock in the amount of $1.2 million. The Bank held FHLB stock in the amount of $1.3 million and $1.2 million as of September 30, 2020 and December 31, 2019, respectively. The FRB stock and FHLB stock were classified as restricted securities.

 

Securities not readily marketable consists of an income interest in a private investment.

 

The following table presents the amortized cost and fair values of the securities portfolio as of the dates indicated:

 

   

As of September 30, 2020

   

As of December 31, 2019

 

(In thousands)

 

Amortized

Cost

   

Estimated

Fair Value

   

Amortized

Cost

   

Estimated

Fair Value

 

Securities available for sale:

                               

U.S. government agencies

  $ 12,762     $ 12,830     $ 10,684     $ 10,731  

Mortgage-backed securities

    2,564       2,646       1,925       1.946  

Total securities available for sale

  $ 15,326     $ 15,476     $ 12,609     $ 12,677  
                                 

Securities held to maturity:

                               

Property assessed clean energy

  $ 5,784     $ 5,784     $ 6,349     $ 6,349  
                                 

Securities, restricted:

                               

Other

  $ 2,430     $ 2,430     $ 2,417     $ 2,417  
                                 

Securities not readily marketable

  $ 100     $ 100     $ 100     $ 100  

 

 

The following table summarizes the maturity distribution schedule with corresponding weighted-average yields of securities available for sale and securities held to maturity as of September 30, 2020. Yields are calculated based on amortized cost. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Other securities classified as restricted include stock in the FRB and the FHLB, which have no maturity date. These securities have been included in the total column only and are not included in the total yield.

 

   

Maturing

 
   

One Year or Less

   

After One Year Through Five Years

   

After Five Years Through Ten Years

   

After Ten Years

   

Total

 

(In thousands, except percentages)

 

Amount

   

Yield

   

Amount

   

Yield

   

Amount

   

Yield

   

Amount

   

Yield

   

Amount

   

Yield

 

Securities available for sale:

                                                                               

U.S. government agencies

  $ -       -

%

  $ 1,473       1.11

%

  $ 10,000       1.35

%

  $ 1,289       1.85

%

  $ 12,762       1.37

%

Mortgage-backed securities

    -       -       1,097       2.92       -       -       1,467       2.11       2,564       2.46  

Total

  $ -       -

%

  $ 2,570       1.88

%

  $ 10,000       1.35

%

  $ 2,756       1.99

%

  $ 15,326       1.55

%

Securities held to maturity:

                                                                               

Property assessed clean energy

  $ -       -

%

  $ 555       6.34

%

  $ 2,477       5.71

%

  $ 2,752       7.32

%

  $ 5,784       6.54

%

Securities, restricted:

                                                                               

Other

  $ -       -

%

  $ -       -

%

  $ -       -

%

  $ -       -

%

  $ 2,430       -

%

Securities not readily marketable

  $ -       -

%

  $ -       -

%

  $ -       -

%

  $ -       -

%

  $ 100       -

%

 

Loan Portfolio Composition

 

Total loans excluding allowance for loan losses, increased $111.1 million, or 38.2%, to $402.2 million at September 30, 2020, compared to $291.1 million at December 31, 2019. The increase includes PPP loans totaling $98.3 million. SBA loans comprise the largest group of loans in our portfolio totaling $250.1 million, or 62.1% of the total loans at September 30, 2020, compared to $139.7 million, or 48.0% at December 31, 2019. Commercial and industrial loans totaled $81.6 million, or 20.3% of the total loans at September 30, 2020, compared to $85.5 million, or 29.4%, at December 31, 2019. Commercial and construction real estate loans totaled $58.5 million, or 14.5%, of the total loans at September 30, 2020, compared to $54.8 million, or 18.8%, at December 31, 2019.

 

The following table sets forth the composition of our loans held for investment:

 

(In thousands, except percentages)

 

September 30, 2020

   

December 31, 2019

 

Commercial and industrial

  $ 81,622       20.3

%

  $ 85,476       29.4

%

Consumer installment

    7,523       1.9       3,409       1.2  

Real estate – residential

    3,599       1.0       5,232       1.8  

Real estate – commercial

    48,020       11.9       46,981       16.1  

Real estate – construction and land

    10,471       2.6       7,865       2.7  

SBA 7(a) guaranteed

    166,656       41.4       69,963       24.0  

SBA 7(a) unguaranteed

    50,839       12.6       47,132       16.2  

SBA 504

    32,636       8.1       22,591       7.8  

USDA

    800       0.2       2,430       0.8  

Other

    2       -       -       -  

Total Loans 

  $ 402,168       100.0

%

  $ 291,079       100.0

%

 

At origination, the Company determines whether holding the guaranteed portion of SBA 7(a) and USDA loans provide better long-term risk adjusted returns than selling the loans, and records as either held for investment or held for sale. The Company records held for sale loans at the lower of cost or fair value. Loans held for sale totaled $22.5 million and $9.9 million at September 30, 2020 and December 31, 2019, respectively. During the three and nine months ended September 30, 2020, the Company elected to reclassify $1.5 million and $9.0 million, respectively, of the SBA 7(a) loans held for sale to held for investment.

 

 

Loan concentrations are considered to exist when there are amounts loaned to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. As of September 30, 2020, our loan portfolio included $69.2 million of loans, approximately 17.2% of our total funded loans (22.8% of total funded loans, net of the PPP loans), to the dental industry, compared to $69.2 million, or 23.8% of total funded loans, as of December 31, 2019. We believe that these loans are to credit worthy borrowers and are diversified geographically.

 

Paycheck Protection Program

 

In April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Loans covered by the PPP may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amounts is still fully guaranteed by the SBA. Terms of the PPP loans include the following (i) maximum amount limited to the lesser of $10 million or an amount calculated using a payroll-based formula, (ii) maximum loan term of two years, (iii) interest rate of 1.00%, (iv) no collateral or personal guarantees are required, (v) no payments are required for six months following the loan disbursement date and (vi) loan forgiveness up to the full principal amount of the loan and any accrued interest, subject to certain requirements including that no more than 40% of the loan forgiveness amount may be attributable to non-payroll costs. In return for processing and booking the loan, the SBA will pay the lender a processing fee tiered by the size of the loan (5% for loans of not more than $350 thousand; 3% for loans more than $350 thousand and less than $2 million; and 1% for loans of at least $2 million). During the three months ended June 30, 2020, we originated $98.3 million of PPP loans, and received $4.4 million of related fees from the SBA. We deferred $3.4 million of the fees, net of $966,000 which represented costs incurred to originate these loans. There were no PPP loans originated for the three months ended September 30, 2020.

 

We are also participating in the PPPLF which, through December 31, 2020 (originally was through September 30, 2020, but was changed to December 31, 2020), will extend loans to banks who are loaning money to small businesses under the PPP. The total amount borrowed under the PPPLF as of September 30, 2020 was $87.0 million and is non-recourse and secured by an equal amount of the PPP loans we originated. The maturity date of a borrowing under the PPPLF is equal to the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is sold to the SBA to realize on the SBA guarantee or (ii) to the extent that any loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF will bear interest at a rate of 0.35%. In addition, we may exclude all PPP loans pledged as collateral to the PPP Facility from our average total consolidated assets for the purposes of calculating our leverage ratio.

 

As of September 30, 2020, 34.2% of the loan portfolio, or $137.7 million, matured or re-priced within one year or less. The following table presents the contractual maturity ranges for the loan portfolio as of September 30, 2020 and December 31, 2019, and also presents for each maturity range the portion of loans that have fixed interest rates or variable interest rates over the life of the loan in accordance with changes in the interest rate environment as represented by the base rate:

 

   

As of September 30, 2020

 
           

Over 1 Year through 5 Years

   

Over 5 Years

         

(In thousands)

 

One Year or

Less

   

Fixed Rate

   

Floating or

Adjustable

Rate

   

Fixed Rate

   

Floating or

Adjustable

Rate

   

Total

 

Commercial and industrial

  $ 11,263     $ 9,058     $ 9,008     $ 52,293     $ -     $ 81,622  

Consumer installment

    5,356       2,153       -       14       -       7,523  

Real estate – residential

    772       2,827       -       -       -       3,599  

Real estate – commercial

    5,237       10,117       24,042       2,106       6,518       48,020  

Real estate – construction and land

    3,799       97       4,175       2,218       182       10,471  

SBA 7(a) guaranteed

    55,556       95,517       15,088       495       -       166,656  

SBA 7(a) unguaranteed

    44,595       32       5,482       730       -       50,839  

SBA 504

    10,307       -       16,403       -       5,926       32,636  

USDA

    800       -       -       -       -       800  

Other

    2       -       -       -       -       2  

Total

  $ 137,687     $ 119,801     $ 74,198     $ 57,856     $ 12,626     $ 402,168  

 

 

   

As of December 31, 2019

 
           

Over 1 Year through 5 Years

   

Over 5 Years

         

(In thousands)

 

One Year or

Less

   

Fixed Rate

   

Floating or

Adjustable

Rate

   

Fixed Rate

   

Floating or

Adjustable

Rate

   

Total

 

Commercial and industrial

  $ 15,117     $ 7,060     $ 8,880     $ 54,419     $ -     $ 85,476  

Consumer installment

    3,070       339       -       -       -       3,409  

Real estate – residential

    1,258       3,974       -       -       -       5,232  

Real estate – commercial

    4,602       12,974       21,287       1,998       6,120       46,981  

Real estate – construction and land

    4,121       99       3,645       -       -       7,865  

SBA 7(a) guaranteed

    59,065       115       10,004       779       -       69,963  

SBA 7(a) unguaranteed

    42,094       38       4,498       502       -       47,132  

SBA 504

    8,456       -       11,747       -       2,388       22,591  

USDA

    2,430       -       -       -       -       2,430  

Other

    -       -       -       -       -       -  

Total

  $ 140,213     $ 24,599     $ 60,061     $ 57,698     $ 8,508     $ 291,079  

 

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is less than their average contractual terms due to prepayments.

 

Loans acquired in acquisitions are initially recorded at fair value with no carryover of the related allowance for credit losses. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest.

 

Under the accounting model for acquired loans, the excess of cash flows expected to be collected over the carrying amount of the loans, referred to as the “accretable yield,” is accreted into interest income over the life of the loans.

 

Non-performing Assets

 

Our primary business segments are banking and other financial services, and as outlined above, the banking segment’s primary business is lending. That activity entails potential loan losses, the magnitude of which depends on a variety of economic factors affecting borrowers which are beyond our control. While we have instituted underwriting guidelines and policies and credit review procedures to protect us from avoidable credit losses, some losses will inevitably occur. The COVID-19 pandemic has contributed to an increased risk of delinquencies, defaults and foreclosures. Through the date of this filing, the Company has not experienced any loan charge-offs caused by the economic impact from COVID-19.

 

Non-performing assets include non-accrual loans, loans 90 days or more past due and still accruing and foreclosed assets. Non-performing assets totaled $1.8 million as of September 30, 2020, compared to $6.0 million as of December 31, 2019. As of September 30, 2020, non-performing assets consisted of SBA non-accrual loans totaling $1.8 million, of which $1.1 million was guaranteed by the SBA, and commercial real estate non-accrual loans totaling $162,000. As of December 31, 2019, non-performing assets consisted of SBA non-accrual loans totaling $5.9 million, of which $4.9 million was guaranteed by the SBA, and commercial and industrial non-accrual loans totaling $60,000. There were no foreclosed assets as of September 30, 2020 and December 31, 2019.

 

Loans are considered past due when principal and interest payments have not been received as of the date such payments are contractually due. Loans are placed on non-accrual status when management has concerns relating to the ability to collect the loan interest and generally when such loans are 90 days or more past due. A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the original loan contract.

 

Foreclosed assets represent property acquired as the result of borrower defaults on loans. Foreclosed assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for possible loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations. Write-downs are provided for subsequent declines in value and are included in other non-interest expense along with other expenses related to maintaining the properties.

 

 

The following table sets forth certain information regarding non-performing assets and restructured loans by type, including ratios of such loans to total assets as of the dates indicated:

 

   

September 30, 2020

   

December 31, 2019

 

(In thousands, except percentages)

 

Amount

   

Loan

Category to

Total Assets

   

Amount

   

Loan

Category to

Total Assets

 

Non-accrual loans:

                               

Commercial and industrial

  $ -       -

%

  $ 60       0.02

%

Real estate – commercial

    162       0.03       -       -  

SBA guaranteed

    1,118       0.22       4,892       1.34  

SBA unguaranteed

    517       0.10       1,039       0.28  

Total non-accrual loans

    1,797       0.35       5,991       1.64  

Loans past due 90 days and accruing

    -       -       -       -  

Foreclosed assets

    -       -       -       -  

Total non-performing assets

  $ 1,797       0.35

%

  $ 5,991       1.64

%

Restructured loans on non-accrual

  $ -       -

%

  $ -       -

%

 

Restructured loans are considered “troubled debt restructurings” if, due to the borrower’s financial difficulties, we have granted a concession that we 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. Modifications of terms that could potentially qualify as a troubled debt restructuring include reduction of contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current market rate for new debt with similar risk, or a reduction of the face amount of debt, either forgiveness of principal or accrued interest. As of September 30, 2020 and December 31, 2019, we had no loans considered to be a troubled debt restructuring.  

 

As noted in Note 4, "Loans and Allowance for Loan Losses," Section 4013 of the CARES Act provides financial institutions the option to suspend TDR accounting under GAAP in certain circumstances and the Company has elected that option. The Company has worked proactively with customers experiencing financial challenges from the COVID-19 pandemic. As of September 30, 2020, the Company had granted principal and interest payment deferrals related to COVID-19 to 19 borrowers representing approximately $22.8 million, or 5.7% of its outstanding loans, down from 139 loans with a total outstanding balance of $92.8 million, or 23.7% of the loan portfolio, as of June 30, 2020. All loans remain accruing.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses (“ALLL”) is a valuation allowance for credit losses in the loan portfolio. Management has adopted a methodology to properly analyze and determine an adequate loan loss allowance, which includes allowance allocations calculated in accordance with FASB ASC Topic 310, Receivables, and allowance allocations calculated in accordance with FASB ASC Topic 450, Contingencies. The analysis is based on sound, reliable and well documented information and is designed to support an allowance that is adequate to absorb all estimated incurred losses in our loan portfolio.

 

In estimating the specific and general exposure to loss on impaired loans, we have considered a number of factors, including the borrower’s character, overall financial condition, resources and payment record, the prospects for support from any financially responsible guarantors, and the realizable value of any collateral.

 

We also consider other internal and external factors when determining the allowance for loan losses, which include, but are not limited to, changes in national and local economic conditions, loan portfolio concentrations, and trends in the loan portfolio. Given the level of economic disruption and uncertainty within the State of Texas and the nation as a whole, arising from the COVID-19 pandemic and volatility, the Company qualitatively adjusted the analysis for the allowance for loan losses for these and other risk factors as discussed in the section captioned “COVID-19 Update” in Part II, Item 1.A. “Risk Factors” of this Form 10-Q and in our 2019 Form 10-K. Based on an analysis performed by management at September 30, 2020, the allowance for loan losses is believed to be adequate to cover estimated loan losses in the portfolio as of that date based on the loan loss methodology employed by management. However, management’s judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, charge-offs in future periods may exceed the allowance for loan losses or significant additional increases in the allowance for loan losses may be required.

 

 

Senior management and the Directors’ Loan Committee review this calculation and the underlying assumptions on a routine basis not less frequently than quarterly.

 

The allowance for loan losses totaled $2.9 million and $1.4 million, as of September 30, 2020 and December 31, 2019, respectively. During the three and nine months ended September 30, 2020, the Company had net charge-offs of $56,000 and $179,000, respectively.

 

The table below presents a summary of the Company’s net loan loss experience and provisions to the ALLL for the period indicated:

 

   

As of and for the Three Months Ended

   

As of and for the Nine Months Ended

 
   

September 30, 

   

September 30, 

 

(In thousands, except percentages)

 

2020

   

2019

   

2020

   

2019

 

Average loans outstanding

  $ 413,661     $ 285,224     $ 362,806     $ 265,472  

Gross loans outstanding at end of period

  $ 402,168     $ 286,364     $ 402,168     $ 286,364  

Allowance for loan losses at beginning of period

  $ 2,548     $ 1,107     $ 1,408     $ 874  

Provision for loan losses

    445       1,004       1,709       1,486  

Charge offs:

                               

Commercial and industrial

    -       -       -       -  

SBA 7(a)

    57       576       218       841  

Total charge-offs

    57       576       218       841  

Recoveries:

                               

Commercial and industrial

    -       -       33       -  

SBA 7(a)

    2       4       6       20  

Total recoveries

    2       4       39       20  

Net charge-offs

    55       572       179       821  

Allowance for loan losses at end of period

  $ 2,938     $ 1,539     $ 2,938     $ 1,539  

Ratio of allowance to end of period loan

    0.73

%

    0.54

%

    0.73

%

    0.54

%

Ratio of net charge-offs to average loans 

    0.01

%

    0.20

%

    0.05

%

    0.31

%

 

The following table sets forth the allocation of the allowance as of the date indicated and the percentage of allocated possible loan losses in each category to total gross loans as of the date indicated:

 

(In thousands, except percentages)

 

September 30, 2020

   

December 31, 2019

 

Allocated:

 

Amount

   

Loan

Category to

Gross Loans

   

Amount

   

Loan

Category to

Gross Loans

 

Commercial and industrial

  $ 931       20.3

%

  $ 501       29.4

%

Consumer installment

    57       1.9       27       1.2  

Real estate – residential

    43       1.0       22       1.8  

Real estate – commercial

    558       11.9       347       16.1  

Real estate – construction and land

    108       2.6       76       2.7  

SBA

    1,222       62.1       435       48.0  

USDA

    19       0.2       -       0.8  

Other

    -       -       -       -  

Total allowance for loan losses

  $ 2,938       100.0

%

  $ 1,408       100.0

%

 

 

Sources of Funds

 

General

 

Deposits, loan and investment security repayments and prepayments, proceeds from the sale of securities, and cash flows generated from operations are the primary sources of our funds for lending, investing, and other general purposes. Loan repayments are generally a relatively stable source of funds, while deposit inflows and outflows tend to fluctuate with prevailing interests rates, markets and economic conditions, and competition.

 

Deposits

 

Deposits are attracted principally from our primary geographic market area with the exception of time deposits, which, due to the Company’s attractive rates, are attracted from across the nation. The Company offers a broad selection of deposit products, including demand deposit accounts, NOW accounts, money market accounts, regular savings accounts, term certificates of deposit and retirement savings plans (such as IRAs). Deposit account terms vary, with the primary differences being the minimum balance required, the time period the funds must remain on deposit, and the associated interest rates. Management sets the deposit interest rates periodically based on a review of deposit flows and a survey of rates among competitors and other financial institutions. The Company relies primarily on customer service and long-standing relationships with customers to attract and retain deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Company’s ability to attract and retain deposits.

 

Total deposits increased $71.9 million, or 25.4%, to $355.5 million as of September 30, 2020, as compared to $283.6 million as of December 31, 2019. The following table sets forth our average deposit account balances, the percentage of each type of deposit to total deposits, and average cost of funds for each category of deposits for the periods indicated:

 

   

For the nine months ended September 30,

 
   

2020

   

2019

 

(In thousands, except percentages)

 

Average

Balance

   

Percent of

Deposits

   

Average

Rate

   

Average

Balance

   

Percent of

Deposits

   

Average

Rate

 

Non-interest-bearing deposits

  $ 48,441       13.4

%

    0.00

%

  $ 35,754       14.1

%

    0.00

%

Savings and interest-bearing demand

    9,890       2.7       0.34       7,370       2.9       0.38  

Money market accounts

    92,312       25.6       0.58       55,237       21.8       1.58  

Time deposits

    210,776       58.3       1.91       155,519       61.2       2.57  

Total deposits

  $ 361,419       100.00

%

    1.27

%

  $ 253,880       100.00

%

    1.93

%

 

Borrowings

 

As of September 30, 2020 and December 31, 2019, borrowings totaled $99.0 million and $24.0 million, respectively. During the three and nine months ended September 30, 2020, the Company borrowed $53.1 million and $87.0 million, respectively, in connection with the Federal Reserve PPPLF program.

 

The table below presents balances of each of the borrowing facilities as of the dates indicated:

 

   

September 30, 

   

December 31,

 

(In thousands)

 

2020

   

2019

 

Borrowings:

               

FHLB borrowings

  $ -     $ 12,000  

FRB borrowings (PPPLF)

    87,036       -  

Subordinated notes

    12,000       12,000  
    $ 99,036     $ 24,000  

 

The Company has a credit line with the FHLB with borrowing capacity of $35.4 million secured by commercial loans. The Company determines its borrowing needs and renews the advances accordingly at varying terms. The Company had no borrowings with FHLB as of September 30, 2020. As of December 31, 2019, the Company had an overnight advance of $2.0 million with an interest rate of 1.45% and a $10.0 million six month fixed term advance with an interest rate of 2.18% and maturity date of January 27, 2020. At maturity, the term advance was rolled into the overnight advance and subsequently paid off.

 

 

The Company also has a credit line with the FRB with borrowing capacity of $29.7 million, which is secured by commercial loans. There were no outstanding borrowings against the FRB line of credit as of September 30, 2020 and December 31, 2019.

 

In connection with the Federal Reserve PPPLF program, the Company has $98.3 million of PPP loans available to be pledged, of which $87.0 million was pledged to the Federal Reserve and borrowed as of September 30, 2020, at an interest rate of 0.35%.

 

As of September 30, 2020 and December 31, 2019, the Company also had subordinated notes totaling $12.0 million, consisting of $8.0 million issued in 2017 bearing an interest rate of 7.125% payable semi-annually and maturing on July 20, 2027, and $4.0 million issued in 2018 bearing an interest rate of 7.125% payable semi-annually and maturing on March 31, 2028. The subordinated notes are unsecured and subordinated in right of payment to the payment of our existing and future senior indebtedness and structurally subordinated to all existing and future indebtedness of our subsidiaries.

 

Capital Resources and Regulatory Capital Requirements

 

Shareholders’ equity increased $6.4 million, or 12.7%, to $56.9 million as of September 30, 2020, from $50.5 million as of December 31, 2019. The increase included net income of $7.4 million, $65,000 net after-tax increase in other comprehensive income related to the market value of the securities available for sale, and $62,000 related to stock compensation expense. Use of capital included $1.2 million of dividends paid on the Series B preferred stock.

 

Together with the Bank, the Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s and, accordingly, the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. As of September 30, 2020, the Company and the Bank met all capital adequacy requirements to which they were subject. As of September 30, 2020, the Bank qualified as "well capitalized" under the prompt corrective action regulations of Basel III and the OCC.

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), common equity Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital (as defined in the regulations) to average assets (as defined in the regulations). 

 

The following table presents our regulatory capital ratios, as well as those of the Bank, as of the dates indicated:

 

(In thousands, except percentages)

 

September 30, 2020

   

December 31, 2019

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

Tectonic Financial, Inc.

                               

Tier 1 Capital (to Average Assets)

  $ 44,754       10.15

%

  $ 38,301       11.20

%

Common Equity Tier 1 (to Risk Weighted Assets)

    27,504       10.05       21,051       8.20  

Tier 1 Capital (to Risk Weighted Assets)

    44,754       16.36       38,301       14.92  

Total Capital (to Risk Weighted Assets)

    47,692       17.43       39,709       15.47  
                                 

T Bank, N.A.

                               

Tier 1 Capital (to Average Assets)

  $ 44,535       9.09

%

  $ 38,541       11.09

%

Common Equity Tier 1 (to Risk Weighted Assets)

    44,535       16.40       38,541       15.16  

Tier 1 Capital (to Risk Weighted Assets)

    44,535       16.40       38,541       15.16  

Total Capital (to Risk Weighted Assets)

    47,473       17.48       39,949       15.71  

 

In addition to the regulatory requirements of the federal banking agencies, Sanders Morris and Tectonic Advisors are subject to the regulatory framework applicable to registered investment advisors under the SEC’s Division of Investment Management.

 

 

Sanders Morris is regulated by FINRA, which, among other requirements, imposes minimums on its net regulatory capital. As of September 30, 2020, Sanders Morris is in compliance with its net regulatory capital requirement.

 

Liquidity

 

Our liquidity relates to our ability to maintain a steady flow of funds to support our ongoing operating, investing and financing activities. Our board of directors establishes policies and analyzes and manages liquidity to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of a large, stable supply of core deposits and funds. Ultimately, public confidence is generated through profitable operations, sound credit quality and a strong capital position. Liquidity management is viewed from a long-term and a short-term perspective as well as from an asset and liability perspective. We monitor liquidity through a regular review of loan and deposit maturities and forecasts, incorporating this information into a detailed projected cash flow model.

 

The Bank’s liquidity is monitored by its management, the Asset-Liability Committee and its board of directors who review historical funding requirements, current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments.

 

The Company’s primary sources of funds are retail, small business, custodial, wholesale commercial deposits, loan repayments, maturity of investment securities, other short-term borrowings, and other funds provided by operations. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Company will maintain investments in liquid assets based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset/liability management program.

 

As of September 30, 2020, the Company had approximately $42.1 million held in an interest-bearing account at the Federal Reserve. The Company has the ability to borrow funds as members of the FHLB and the FRB. As of September 30, 2020, the Company’s borrowing capacity with the FHLB was $35.4 million based upon loan collateral pledged to the FHLB, of which none was utilized. In addition, the Company had $14.9 million of unpledged securities that could be pledged to the FHLB as collateral to increase the borrowing capacity. The borrowing capacity with the FRB was $29.7 million, of which none was utilized as of September 30, 2020. In addition, the Company has approximately $71.2 million of SBA guaranteed loans held for investment that could be sold to investors. In connection with the FRB PPPLF program, the Company has $11.3 million of PPP loans available which can be pledged for additional borrowing capacity.

 

Off-Balance Sheet Arrangements

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying balance sheets. Our exposure to credit loss in the event of non-performance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We follow the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of credit extended is based on management’s credit evaluation of the customer and, if deemed necessary, may require collateral.

 

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

As of September 30, 2020, we had commitments to extend credit and standby letters of credit of approximately $23.6 million and $172,000, respectively.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Interest Rate Sensitivity and Market Risk

 

As a financial institution, our primary component of market risk is interest rate volatility. Our asset liability management policy provides management with guidelines for effective funds management and we have established a measurement system for monitoring the net interest rate sensitivity position.

 

Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.

 

We manage exposure to interest rates by structuring the balance sheet in the ordinary course of business. We use no off-balance-sheet financial instruments to manage interest rate risk.

 

Our exposure to interest rate risk is managed by the Bank’s Asset Liability Committee in accordance with policies approved by the Bank’s board of directors. The committee formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the committee considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, liquidity, business strategies and other factors.

 

The committee meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the committee reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. We employ methodologies to manage interest rate risk which include an analysis of relationships between interest-earning assets and interest-bearing liabilities, and an interest rate shock simulation model.

 

We use interest rate risk simulation models and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.

 

On a semi-annual basis, we run various stress tests to measure the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static model, rates are shocked instantaneously and ramped rates change over a twelve-month and twenty-four month horizon based upon parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Additionally, we run non-parallel simulation involving analysis of interest income and expense under various changes in the shape of the yield curve.

 

The following table summarizes the impact of an instantaneous, sustained simulated change in net interest income over a 12-month horizon as of September 30, 2020:

 

Change in Interest Rates (basis points)

   

% Change in Net Interest Income

 

+200

      6.53  

+100

      3.45  
 -100       (3.21

)

 -200       (9.71

)

 

 

We have found that, historically, interest rates on deposits change more slowly than changes in the discount and federal funds rates. This assumption is incorporated into the simulation model and is generally not fully reflected in a gap analysis, meaning that process by which we measure the gap between interest rate sensitive assets verses interest rate sensitive liabilities. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various strategies.

 

Impact of Inflation

 

Our consolidated financial statements and related notes included elsewhere in this prospectus have been prepared in accordance with GAAP. These require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession. Inflation generally increases the costs of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on the performance of a financial institution than the effects of general levels of inflation. In addition, inflation affects a financial institution’s cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings and shareholders’ equity.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this Form 10-Q, an evaluation was performed by the Company, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective at the end of the period covered by this Form 10-Q.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2020 that has materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

We are involved, from time to time, as plaintiff or defendant in various legal actions arising in the normal course of its business. Based on the information presently available, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business’s financial condition or results of operations of the Company on a consolidated basis.

 

Item 1A. Risk Factors.

 

The following represents a material change in the Company’s risk factors from those disclosed in Part I, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2019. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. Further, to the extent that any of the information contained in this Form 10-Q constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.

 

The COVID-19 pandemic and the measures intended to prevent its spread are adversely affecting the Company and its customers, counterparties, employees, and third-party service providers, and the continued adverse impacts on its business, financial position, results of operations, and prospects could be significant.

 

The spread of COVID-19 has created a global public-health crisis that has resulted in widespread volatility and significant deteriorations in household, business, economic, and market conditions. The pandemic and the measures attempting to prevent the continued spread of the virus have led to a significant economic slowdown and a related increase in unemployment that may continue to adversely affect our business. COVID-19 does not yet appear to be contained and could affect significantly more households and businesses. The extent of the impact of the COVID-19 pandemic on the Company’s capital, liquidity, and other financial positions and on its business, results of operations, and prospects will depend on a number of factors that continue to evolve, including the duration, extent and severity of the COVID-19 pandemic, the effectiveness of the United States government’s efforts to mitigate the severity of the economic effects of the pandemic, and the magnitude of the pandemic’s effect on the Company’s customers, counterparties, employees, and third party service providers, and on the national, regional and local economies and the market overall, particularly the interest-rate environment. As a result, we are subject to a number of risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations, including the below:

 

 

We cannot fully eliminate credit risk, and as a result, credit losses may increase in the future. Increases in loan losses, and resulting increases in our allowance for future loan losses, could materially reduce our results of operations and our financial condition, including our capital ratios.

 

 

o

If the economy is unable to substantially reopen, national, regional, and local economies and markets could suffer disruptions that are lasting, thereby affecting our customers’ profitability and as a result, their ability to service their loan obligations, adversely affect existing loans.

 

 

o

Sustained unemployment levels, or increases in current levels, may result in the inability of certain customers to repay their loans, and the financial results of commercial clients in localities with higher unemployment levels may result in loan defaults and foreclosures.

 

 

o

The net worth and liquidity of our loan guarantors may decline, impairing their ability to honor guarantee commitments.

 

 

o

Deterioration in the valuations of assets used in our customers’ businesses as the result of a sustained economic slowdown could impact our customers’ profitability, and impair the value of assets held by us as collateral, both of which would negatively impact the credit profile of our existing loan portfolio.

 

 

A sustained economic slowdown could negatively impact the Company’s origination of new loans, including an overall decline in the demand for loans and refinancings or potential disruptions in third parties on whom we rely for loan processing, including real estate appraisers and recording offices or governmental agencies related to title work.

 

 

 

Given our business mix as represented through our reporting segments and the fact that most of our assets and liabilities are financial in nature, we tend to be sensitive to market interest rate fluctuations and the performance of the financial markets. Governmental actions are meaningfully impacting the interest-rate environment, and market interest rates have declined significantly during 2020. On March 15, 2020, the Federal Reserve reduced the target federal funds rate to 0.00% to 0.25% and announced a $700 billion quantitative easing program. We expect that these reduced interest rates will continue to adversely affect our net interest income margins and profitability. In addition to the general impact on the economy, changes in interest rates or in valuations in the debt or equity markets could directly impact us in one or more of the following ways:

 

 

o

The yield on earning assets and rates paid on interest bearing liabilities may change in disproportionate ways.

 

 

o

To the extent we access capital markets to raise funds to support our business, such changes could affect the cost of such funds or the ability to raise such funds.

 

 

o

The value of certain balance sheet and off-balance sheet financial instruments or the value of equity investments that we hold could decline.

 

 

o

The value of assets for which we provide processing services could decline.

 

 

The COVID-19 pandemic has significantly affected the financial markets. The course of the pandemic and the governmental actions that have been and are expected to be taken in an attempt to mitigate its effects are increasing volatility. As a result, the value of our assets under management and our brokerage assets and the level of our customers’ brokerage activity have been impacted. Decreases or volatility in the value of our assets under management directly affect our investment advisory revenue. Additionally, as a result of a decline in our customers’ level of brokerage activity, the Company has experienced significant decreases in brokerage revenue. Sustained decreases in advisory or brokerage revenues could negatively impact our liquidity and results of operations and our financial condition.

 

 

The modifications to our business practices in response to the COVID-19 pandemic, including the Company’s workforce working from remote locations and potential new restrictions on access to the Company’s facilities in response to the continued spread of the virus, has caused an increased reliance on technology.  This increase reliance introduces additional operations risk, particularly increased cybersecurity risk. This risk and the introduction of additional security measures to mitigate it could limit the Company’s ability to meet customer servicing expectations and have a material adverse effect on its operations, including exposing the Company to risks of data or financial loss, litigation and liability, and could seriously disrupt its operations and the operations of any impacted customers.

 

Any one or a combination of these factors could negatively affect our business, financial condition, liquidity and results of operations. The long-term effect of the pandemic and of the fiscal- and monetary-policy measures taken in response to the pandemic could cause the Company to experience higher credit losses in our lending portfolio, impairment of our goodwill and other financial assets, further reduce demand for our products and services, and have other negative effects on our financial position, results of operations, and prospects. Sustained adverse effects of the COVID-19 pandemic may also prevent the Company from satisfying our minimum regulatory capital ratios and other supervisory requirements, result in an inability to pay dividends to its shareholders, or result in downgrades in its credit ratings.

 

The Bank’s participation in the PPP may result in operational, credit or other shortfalls that may adversely affect our financial condition, results of operations, and future prospects.

 

In response to the COVID-19 pandemic, President Trump signed into law the CARES Act on March 27, 2020. Among other things, the CARES Act created a new facility, titled the “Paycheck Protection Program,” to the SBA’s 7(a) Loan Program. The small business loans are provided through participating financial institutions, such as the Bank, that process loan applications and service the loans. As of September 30, 2020, we had funded 922 loans totaling $98.3 million in of PPP loans. Due to the accelerated implementation of the PPP, there are several aspects of the PPP that remain subject to ambiguity or have not yet been addressed by the SBA or U.S. Department of Treasury, which exposes the Company to risks relating to noncompliance with the PPP. We cannot predict what operational, credit, or other shortfalls may arise as a result of the Bank making loans under the PPP or how such shortfalls may adversely affect our financial condition, results of operations and future prospects. Moreover, every PPP borrower is in a challenging financial position that may negatively impact their ability to repay if the loans are not subject to forgiveness. The borrowers may not be able to repay the loans when the COVID-19 pandemic subsides and they may not maintain the level of employees and salary levels required for forgiveness. If the borrowers are unable to repay their loans or the federal government does not pay timely the amounts that it would owe the Bank pursuant to the terms of the loans, the guarantees and the PPP, the Company’s business, financial condition and results of operations could be adversely affected.

 

 

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

 

None during the quarter ended September 30, 2020.

 

Item 3. Defaults Upon Senior Securities.

 

Not applicable.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits and Financial Statement Schedules.

  

Exhibit

No.

 

Description of Exhibit

     

3.1

 

Amended and Restated Certificate of Formation (incorporated by reference from Exhibit 3.1 to Amendment No. 2 to the Registration Statement on Form S-1/A filed with the SEC on May 9, 2019 (File No. 333-230949))

3.2

 

Certificate of Designation of 10.0% Series A Non-Cumulative Perpetual Preferred Stock (incorporated by reference from Exhibit 3.1 to the Current Report on Form 8-K filed with the SEC on May 16, 2019 (File No. 001-38910))

3.3

 

Certificate of Designation of 9.00% Fixed-to-Floating Rate Series B Non-Cumulative Perpetual Preferred Stock (incorporated by reference from Exhibit 3.2 to the Current Report on Form 8-K filed with the SEC on May 16, 2019 (File No. 001-38910))

3.4

 

Certificate of Amendment to effect Reverse Stock Split (incorporated by reference from Exhibit 3.3 to the Current Report on Form 8-K filed with the SEC on May 16, 2019 (File No. 001-38910))

3.5

 

Amended and Restated Bylaws (incorporated by reference from Exhibit 3.5 to Amendment No. 1 to the Registration Statement on Form S-1/A filed with the SEC on May 6, 2019 (File No. 333-230949))

10.1

 

Form of Restricted Stock Award Agreement under T Acquisition, Inc. Amended and Restated 2017 Equity Incentive Plan

31.1

 

Rule 13a-14(a) Certification of Principal Executive Officer*

31.2

 

Rule 13a-14(a) Certification of Principal Financial Officer*

32.1

 

Section 1350 Certification**

     

101.INS

 

XBRL Instance Document*

101.SCH

 

XBRL Taxonomy Extension Schema Document*

101.CAL

 

XBRL Taxonomy Extension Label Calculation Linkbase Document*

101.DEF

 

XBRL Taxonomy Definition Linkbase*

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document*

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase*

 

*

Filed herewith

**

Furnished herewith

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

TECTONIC FINANCIAL, INC.

   

   

   

Date: November 13, 2020

By:  

/s/ A. Haag Sherman

  

 

  

 

 

A. Haag Sherman

Chief Executive Officer/Principal Executive Officer

 

  

   

  

By: 

/s/ Ken Bramlage

 

 

 

 

 

Ken Bramlage

Executive Vice President and Chief Financial Officer/Principal Financial Officer

 

 

 

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