EDGAR 10-K Filing

Company CIK: 1766526
Filing Year: 2023
Filename: 1766526_10-K_2023_0001185185-23-000285.json

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ITEM 1. BUSINESS
Item 1.
Business.
Our Company
Tectonic Financial, Inc. (the “Company,” “we,” “us,” or “our”) is a financial holding company headquartered in Dallas, Texas offering banking, trust, investment advisory, third-party administration and recordkeeping, securities brokerage, underwriting, and insurance services to high net worth individuals, small businesses and institutions across the United States. The Company was formed in late 2016 for the purpose of acquiring T Bancshares, Inc. (“T Bancshares”), and its wholly owned subsidiary, T Bank, National Association (the “Bank”). T Bancshares was incorporated under the laws of the State of Texas on December 23, 2002 to serve as the bank holding company for the Bank. On May 13, 2019, we completed a merger with Tectonic Holdings, LLC (“Tectonic Holdings”), a company with whom we had common ownership (the “Tectonic Merger”). Through the Tectonic Merger, we acquired Tectonic Advisors, LLC (“Tectonic Advisors”) and Sanders Morris Harris LLC (“Sanders Morris”), as well as its subsidiary, HWG Insurance Agency LLC (“HWG”), which expanded our financial services to include investment advisory, securities brokerage, investment banking, and insurance services.
As of December 31, 2022, we had, on a consolidated basis, $612.5 million in assets, $445.8 million in total loans held for investment, $33.9 million in loans held for sale, $493.0 million in deposits and $96.5 million in shareholders’ equity. Net income for the year ended December 31, 2022 was $17.0 million. The Company’s Series B preferred stock is traded through the NASDAQ Capital Market under the symbol “TECTP”.
Operating Segments
Overview
We operate through three business segments: Banking, Other Financial Services, and HoldCo operations.
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Our Banking segment operates through the Bank, a full-service, nationally chartered commercial bank headquartered in Dallas, Texas providing traditional community banking services, as well as factoring services through the Bank’s Integra Factoring Division. The Bank’s Trust Division is within our Other Financial Services segment below.
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Our Other Financial Services segment includes Tectonic Advisors, Sanders Morris, HWG and the Bank’s Trust Division, which includes a third-party administrator (“TPA”) services unit:
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Tectonic Advisors is a registered investment advisor providing investment advisory services to individuals, institutions (including affiliates) and families. It advises on portfolios of assets for an asset-based fee. As of December 31, 2022, Tectonic Advisors had approximately $2.7 billion in client assets under management (“AUM”) (which includes $1.6 billion of AUM held by the Bank as a fiduciary).
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Sanders Morris is a registered broker-dealer with FINRA, and registered investment advisor with the Securities and Exchange Commission (the “SEC”). Through Sanders Morris, we serve clients on their investment portfolios as an advisor or broker (often with limited powers of attorney). We also execute trades for institutions and households, and provide investment banking services to corporate entities. As of December 31, 2022, Sanders Morris had approximately $739.3 million in client advisory assets under management, and client brokerage assets of $1.7 billion, bringing total client assets to $2.5 billion at Sanders Morris.
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HWG is an insurance agency registered with the Texas Department of Insurance (“TDI”), and is focused on offering life and disability coverages.
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The Bank’s Trust Division provides private trust services, and also includes a TPA services unit providing retirement plan design and administrative services.
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Our Holdco segment, HoldCo, includes the Bank’s immediate parent and related subordinated debt, as well as operations of Tectonic Financial, Inc., the financial holding company that serves as parent for the group overall. Its principal source of revenue is dividends from our subsidiaries.
Banking
General. The Bank is a full-service commercial bank offering a broad range of commercial and consumer banking services to small- to medium-sized businesses, single-family residential and commercial contractors and consumers. The Bank strives to generate an attractive risk-adjusted return on assets and capital by providing niche lending services and generating significant non-interest income through its factoring and trust services. Lending services include commercial loans to small- to medium-sized businesses and professional concerns as well as consumers. 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. The Bank also offers trust services. These services are provided through a variety of delivery systems including automated teller machines, mobile banking and internet banking.
Lending Services. From its single location, the Bank operates three lending verticals where it has established expertise: SBA and U.S. Department of Agriculture (“USDA”), dental and other professionals and traditional community banking. We believe our lending products provide an important diversity of risk and opportunity, which differentiates us from most community banks our size. The Bank also offers factoring services through its Integra Division. See the discussion of “Factored Receivables” below.
SBA and USDA. The Bank originates and services commercial and real estate loans under programs guaranteed by the SBA and the USDA representing approximately 57.9% of the Bank’s total lending services as of December 31, 2022. Generally 75% to 80% of the principal balance of these loans is guaranteed by these agencies. The CARES Act increased the SBA 7(a) guaranty on 7(a) loans to 90% for loans originated from February 1, 2020 through September 30, 2021. These loans generally offer borrowers more flexible terms and conditions than available through conventional commercial loans. Examples of more flexible terms include longer amortization periods, lower required down payments, and less borrower operating history. These loans are generally secured by equipment, real estate, and other tangible collateral. Loan-to-value ratios may, in some instances, be higher than conventional loans. Loans secured by business assets that do not include real estate have terms that are generally not more than 10 years and are fully amortizing. Loans secured by real estate as the principal collateral are generally 25 years or less and are also generally fully amortizing. Loans can be adjustable rate loans, but may also be fixed for the term of the loan. Repayment of the loans is based on an analysis of the borrower’s ability to generate sufficient income from operations. This analysis may rely more heavily on projected future earnings than on conventional loans. The Bank also analyzes the industry sector to determine the feasibility of the projected income.
There is generally an active secondary market for the guaranteed portion of these loans. Because the guaranteed portion carries the full faith and credit guarantee of an agency of the U.S. government, the guaranteed portion of the loan can generally be sold for a premium at the time of the sale. We may sell the guaranteed portion or retain the guaranteed portion on our balance sheet based on, among other things, our view of the premiums being paid for such guaranteed portions, our desire to generate additional capital for the Bank and/or the funding costs and sources to fund such loans. As the guaranteed portion of the SBA/USDA loans age, the premium that such portions can generate typically declines. Therefore, we typically make the determination about whether to sell the guaranteed portion of such loans shortly after such loans are certified as guaranteed by either the SBA or USDA, as applicable.
Dental and Other Professionals. The Bank offers loans to the dental industry and other small- to medium sized businesses. The principal referral source of the dental loans is Cain Watters. Most of the partners of Cain Watters are stockholders in the Company, and four partners serve on our board of directors. Cain Watters has been highly successful in providing a variety of consulting services to dentists and dental companies for over 30 years with a national client base. Cain Watters refers loans to a variety of lenders (including the Bank), who compete on price, terms and service. We view the dental lending vertical as highly competitive.
Traditional Community Banking. The Bank offers traditional lending services, including commercial and industrial, commercial real estate, construction and, on a very limited basis, consumer loans (each as further described below). The majority of these loans are to commercial enterprises in the Dallas, Texas area.
Commercial and Industrial Loans. Loans for commercial purposes in various lines of businesses are a major component of the Bank’s loan portfolio. The targets in the commercial loan markets are retail establishments, professional service providers, in particular dentists, and small- to medium-sized businesses. See “-Dental and Other Professionals” above. Commercial lending generally involves greater credit risk than residential mortgage or consumer lending and involves risks that are different from those associated with commercial real estate lending. The terms of these loans vary by purpose and by type of underlying collateral, if any. The commercial loans are primarily underwritten on the basis of the borrower’s ability to service the loan from income and their creditworthiness. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default may represent an insufficient source of repayment because equipment and other business assets may, among other things, be obsolete or of limited use. Accordingly, the repayment of a commercial loan depends primarily on the creditworthiness and projected cash flow of the borrower (and any guarantors), while liquidation of collateral is considered a secondary source of repayment. On some of these loans, the Bank takes a security interest in real estate as a prudent practice and measure and not as the principal collateral for the loan.
The Bank will typically make equipment loans for a fixed term of generally not more than 10 years at fixed or variable rates, with the loan fully amortized over the term. Loans to support working capital will typically have terms not exceeding one year and will usually be secured by accounts receivable, inventory or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid or reduced with cash generated as the accounts receivable and/or inventory is converted into cash, and for loans secured with other types of collateral, principal will typically be repaid over the term of the loan or due at maturity.
Real Estate Loans. The Bank makes owner occupied and non-owner occupied commercial real estate loans, residential and commercial construction and development loans, and residential real estate loans. The Bank often uses appraisals to assess the collateral value of such real estate. However, the Company’s use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral if it must ultimately be foreclosed upon and sold.
Commercial Real Estate. Commercial real estate loan terms generally are limited to 25 years or less. Interest rates may be fixed or adjustable, although rates typically are not fixed for loans with maturity dates exceeding 10 years. The Bank generally requires personal guarantees from the principal owners of the property supported by a review by the Bank’s management of the principal owners’ personal financial statements. Risks associated with commercial real estate loans include fluctuations in the value of real estate, tenant vacancy rates and the quality of the borrower’s management.
Residential Real Estate. The Bank’s residential real estate loans consist of loans to acquire and renovate existing homes for subsequent re-sale, residential new construction loans, residential loans purchased in the secondary market, residential rental properties, and on a limited basis, traditional mortgage lending for one-to-four family owner occupied property. Loans are generally made in accordance with the Bank’s appraisal and loan policy with the ratio of the loan principal to the value of collateral (typically established by independent appraisal).
Consumer Installment Loans. On a limited basis, the Bank makes loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. These loans are typically to the principals and employees of our business customers. Repayment of consumer loans depends upon the borrower’s financial stability and is more likely to be adversely affected by divorce, job loss, illness and personal hardships than repayment of other loans. Because many consumer loans are secured by depreciable assets such as boats, cars and trailers, the loan should be amortized over the useful life of the asset. The loan officer will review the borrower’s past credit history, past income level, debt history and, when applicable, cash flow and determine the impact of all these factors on the ability of the borrower to make future payments as agreed. The principal competitors for consumer loans are the established banks and finance companies in our market.
Lending Policy. The Bank’s delegations of authority, which are approved by its board of directors, provide for various levels of officer lending authority. The Bank has an independent third-party review that evaluates the quality of loans on a periodic basis and determines if loans are originated in accordance with the guidelines established by its board of directors. Additionally, our board of directors has formed a directors’ loan committee with members named by board resolution to provide the following oversight
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ensure compliance with loan policy, procedures and guidelines as well as appropriate regulatory requirements;
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approve loans with net Bank exposure over $2 million;
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monitor delinquent, non-accrual loans and classified loans;
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monitor loan portfolio concentrations and quality through a variety of metrics;
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monitor our loan servicing and review systems; and
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review the adequacy of the loan loss reserve.
We believe we follow a relatively conservative lending policy, but one that we believe permits prudent risks to assist businesses and consumers in our lending market. Interest rates vary depending on our cost of funds, the loan maturity, the degree of risk and other loan terms. The Bank does not make any loans to any of its directors, executive officers or their affiliates.
Lending Limits. The Bank’s lending activities are subject to a variety of lending limits. Differing limits apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the Bank. In general, however, the Bank is able to loan to any one borrower a maximum amount equal to either:
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15% of the Bank’s capital and surplus and allowance for loan losses;
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25% of its capital and surplus and allowance for loan losses if the amount that exceeds 15% is secured by cash or readily marketable collateral, as determined by reliable and continuously available price quotations; or
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any amount when the loan is fully secured by a segregated deposit at the Bank and the Bank has perfected its security interest in the deposit.
These legal limits will increase or decrease as the Bank’s capital increases or decreases as a result of its earnings or losses, among other reasons.
Credit Risks. The principal economic risk associated with each category of loans that the Bank makes is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the relevant business market segment. General economic factors affecting a borrower’s ability to repay include interest, inflation and employment rates, as well as other factors affecting a borrower’s customers, suppliers and employees. The well-established financial institutions in our primary service area currently make proportionately more loans to medium- to large-sized businesses than the Bank. Many of the Bank’s anticipated commercial loans will likely be made to small- to medium-sized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers.
Factored Receivables. The Bank’s factored receivables portfolio is originated by its Integra Division. The Bank acquired Integra Factoring Solutions, LLC (“Integra”) on July 1, 2021, and offers financing to smaller transportation companies across the United States primarily through factoring of accounts receivables through its Integra Division. We directly purchase the receivables generated by our clients, primarily transportation companies, at a discount to their face value. The transactions are structured to provide the clients with immediate working capital when there is a mismatch between trade payable payments to the client for services rendered and the required payment of operating costs, such as fuel and insurance costs, incurred to provide such good or service. The receivables are typically collected 30 to 60 days after delivery.
Investments. The Bank invests a portion of its assets available for sale securities, which include U.S. Treasuries, U.S. government agencies, mortgage-backed securities, direct obligations of quasi government agencies including Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. In addition, the Bank may make investments in held to maturity assets, including certain municipal or state obligations or securities that it believes have a similar risk profile thereto. These investments include, among other things, securities issued pursuant to Property Assessed Clean Energy programs and Public Improvement District/Tax Increment Reinvestment Zone (“PID/TIRZ”) investments. These investment contracts or bonds originate under a contractual obligation between the property owners, the local county or city administration, and a third-party administrator and sponsor. Generally, as a property assessment, the total assessment is repaid in installments over a period of 5 to 32 years by the then current property owner(s). Investments in instruments other than U.S. Treasuries carry a degree of risk, including risk of default, market fluctuations and lack of liquidity.
Deposit Services. To fund its loan and securities portfolio, 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. In addition, the Bank can access uninvested cash from customers of its trust department by moving portions of it into money market deposits. As of December 31, 2022, the Bank deposits included $32.5 million available from the funds of trust clients.
In addition, the Bank offers participant-directed retirement accounts in its trust line of business. The Bank offers its money market account insured by the Federal Deposit Insurance Corporation (“FDIC”) as an investment option for those retirement plans. We believe, based on management’s past experience, that up to 5% of retirement assets under participant direction are invested in FDIC insured accounts like those we offer.
In addition to traditional lobby banking services, the Bank offers robust e-banking services, via on-line and mobile devices, to both consumers and businesses. These services include remote check deposits, bill payment, electronic transfer of funds between financial institutions, person-to-person payments, positive pay, as well as traditional internet services such as balance inquiries and internal funds transfers. The Bank provides a courier and mobile banking concierge service throughout the Dallas MSA and offers its customers free usage of any automated teller machine in the world through its debit card. We are also in the early stages of implementing an on-line only option to open transaction, savings, and certificate deposits that will be marketed via the internet to attract consumer deposits.
As of December 31, 2022, the Bank had total deposits of approximately $499.6 million which includes $6.6 million of intercompany deposits of the parent company and other subsidiaries, for a net balance of $493.0 million. Time deposits of $250 thousand and over totaled $85.1 million as of December 31, 2022. The Bank had $40.0 million of brokered deposits through an Insured Cash Sweep One-Way Buy agreement as of December 31, 2022.
Borrowings. In addition to deposits, we utilize advances from the Federal Home Loan Bank of Dallas (the “FHLB”), and other borrowings, such as a line of credit with the Federal Reserve Bank of Dallas (the “FRB”), borrowings under the Paycheck Protection Program Liquidity Facility (“PPPLF”), and long-term subordinated notes as supplementary funding sources to finance our operations. At December 31, 2022, the Company had no borrowings with the FHLB or the FRB under the lines of credit. The bank repaid its PPPLF borrowings from the FRB during 2022 and subordinated debt at T Bancshares, net of debt issuance costs, totaled $12.0 million, or 2.33% of total liabilities.
Other Financial Services
General. We provide a variety of investment and insurance services to our clients through one or more subsidiaries, including investment advisory, asset management, stock and bond investments, institutional trading, private investments and access to public offerings and other investments. By providing our clients with a broad array of investment products and services, we believe that we can attract clients seeking differentiated investment solutions and retain them over a longer period of time. These services include:
Trust Services. The Company provides trust services to individuals and defined contribution and benefit plans established by small businesses for their owners and employees. We have approximately 1,900 trust accounts in 48 states. The Bank has established common pooled funds to comingle our clients’ capital to invest in stocks, bonds, exchange-traded funds or other investments and thereby provide a smaller investor with broader diversification and access to professional investment advisors. The Bank has approximately $1.6 billion in market value of trust assets as of December 31, 2022.
We currently have six common pooled funds for qualified plans and another three for personal trust (individual) investors. Each common pooled fund is established for a particular asset class or investment strategy, and each invests in stocks, bonds and/or exchange traded funds (depending on the fund’s strategy), often selected by a registered investment sub-advisor(s) retained by the Bank to serve the particular common pooled fund. The suite of common pooled funds provides an investor with the ability to diversify across asset classes (e.g., equities, fixed income or real assets) and managers. We also have common pooled funds that invest in ETFs (as selected by Tectonic Advisors), which provide our investors with the ability to invest in passive portfolios. We believe that the benefit of a common pooled fund is that it provides investors with access to managers that might not be accessible to individual or smaller investors, sometimes with a lower cost than in a mutual fund format.
The Bank has retained Tectonic Advisors under a long-term contract to provide investment advisory services in selecting managers and certain investments and constructing the allocations of the common pooled funds. The Bank generates fees by providing administrative services to the common pooled funds and providing trust services to the plans and the individual investors.
Cain Watters has referred substantially all of the clients of the Bank’s Trust Division. Cain Watters specializes in providing financial planning, accounting, tax and advisory services to small businesses, principally dental practices. Cain Watters refers certain of its clients to the trust department to provide custodial and fiduciary services for their defined benefit and contribution plans and also their personal assets. Cain Watters is not obligated to make such referrals and refers its clients to other service providers that are competitive with the Bank. The Bank competes on the basis of service and investment performance. However, the Bank and Cain Watters are parties to an agreement which, among other provisions, obligates each party to preserve the other’s business relationship with their mutual clients. This agreement was renewed on December 1, 2022 under an automatic extension clause, and was subsequently extended effective January 31, 2023 to a duration that terminates upon the dissolution of either party or upon a mutually agreeable date in the event of the sale of the Company. The partners of Cain Watters own approximately 29.5% of the Company, and four partners of Cain Watters serve on the board of directors of the Company.
Third Party Administration. In January 2019, the Bank acquired substantially all of the assets and liabilities of The Nolan Company (“Nolan”), a TPA based in Overland Park, Kansas. Nolan operates as a department within the Bank doing business under the name of The Nolan Company. 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. We believe that offering TPA services allows us to serve our clients more fully and to attract new clients to our trust platform.
Investment Advisory. Tectonic Advisors and Sanders Morris are registered investment advisors regulated by the SEC. They provide investment advisory and due diligence services to their respective clients for an asset-based or a performance-based fee.
Tectonic Advisors provides investment advice to the Bank’s Trust committee in the management of its $1.6 billion of common pooled funds under a long-term agreement that has been in effect since 2006, the current form of which renewed in December 2022 under an automatic extension clause within the agreement, and was subsequently extended effective January 31, 2023 to a duration that terminates upon the dissolution of either party or upon a mutually agreeable date in the event of a sale of the Company. Pursuant to this agreement, Tectonic Advisors provides investment advice, asset allocation advice and third party manager research for the construction of portfolios. Tectonic Advisors provides advice on six common pooled funds, which are combined in various manners to develop different portfolios for investors (ranging from a conservative allocation to an aggressive allocation). Tectonic Advisors works with the Bank’s trust department, and its trust committee, in the management of these common pooled funds and portfolios and meets with the trust department and trust committee on a quarterly basis. In addition to services provided to the Bank, Tectonic Advisors provides investment advisory research and due diligence services to Cain Watters under a continuing agreement.
In providing investment advisory services to individuals and families, Tectonic Advisors’ and Sanders Morris’ investment advisor representatives first determine the risk profile of the investor, which considers the age, investment time horizon, tolerance for risk and investment objectives. Once determined, the advisor makes a recommendation on asset allocation and populates each asset class (e.g., domestic equity, international equity, fixed income, etc.) among mutual funds, exchange traded funds, common stocks and/or bonds, and alternative investments to provide exposure to each such asset class. The asset allocation and investments populating each asset class are revisited periodically based on interaction with the client, his or her changing risk profile, investment performance, changing market conditions and/or other factors, as the advisor deems appropriate.
Brokerage. Through Sanders Morris, we purchase and sell stocks and other securities for high net worth clients, often on a discretionary basis, in consideration for brokerage commissions based on trading activity. In addition, we provide institutional trading and other services to money managers, institutions, and individual accounts. We also provide clients with access to private investments that are sourced by us in consideration for a placement fee or commission. Finally, we provide margin loans offered through our clearing firm (Pershing LLC) and periodically serve as a member of an underwriting or selling group member in public offerings, which we offer to our clients. As of December 31, 2022, Sanders Morris has approximately $3.0 million in net regulatory capital as defined by FINRA to support its broker-dealer activities.
Sanders Morris earns revenue by charging fees and trading commissions for managing the investment assets of clients. Fees and trading commissions are typically charged based on trading activity and/or portfolio size. In addition, we also generate substantial revenue from a traditional, commission-based structure where we earn commissions on client purchase and sale transactions. Sanders Morris also serves as a placement agent on a “best efforts” basis of private placements of equity and fixed income securities. Sanders Morris participates in syndicates of public offerings, typically as a selling group member. Sanders Morris can also participate in public offerings as an underwriter, which means that Sanders Morris takes principal risk on the placement of the securities but earns a higher fee.
Finally, Sanders Morris has an institutional trading business, which is based in Dallas, Texas. This group provides trading, proprietary trading ideas and research, structured solutions and other financial services to clients that include: registered investment advisors, high net worth families and individuals, money managers, hedge funds and others. This business typically charges a commission on trading activity. It competes on the basis of service and solutions.
Insurance. Through our insurance agency, HWG, we provide disability and life insurance as a broker. HWG is an insurance agency licensed under the Texas Department of Insurance. HWG generates its commissions through the sale of policies as a broker to clients and also receives renewal premiums from past policies sold (and which are renewing). HWG is currently generating most of its revenues from renewals, and continues to tailor its team to generate new business.
Competition
The market for financial services is rapidly changing and intensely competitive and is likely to become more competitive as the number and types of market entrants increases. The Bank competes in both lending and attracting funds with a wide range of financial institutions within our markets, including local, regional and national commercial banks, savings and loan associations, and credit unions. We also compete with consumer finance companies, pension trusts, mutual funds, insurance companies, mortgage bankers and brokers, brokerage and investment banking firms, asset management and advisory firms, online and discount brokers, private trust companies, venture capital, private equity and hedge funds, asset-based nonbank lenders, government agencies, third-party payment processors, financial technology companies and certain other non-financial institutions, which may offer more favorable financing alternatives than the Bank. We believe that our principal competitive advantages include our regional focus and our long-standing relationships with our clients.
In addition, the investment services business (including brokerage, private placements, syndication, and other financial advice) is highly competitive. The principal competitive factors influencing our businesses are:
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expertise and quality of the professional staff;
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reputation in the marketplace;
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existing client relationships;
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performance of investment strategies or product offerings;
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advertising and sales promotion efforts,
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types, quality, and price of our products and services; and
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the technology platform through which a customer accesses our products and services.
The financial services industry has become considerably more concentrated as many securities firms have either ceased operations, been acquired by, or merged into other firms. Many of these larger firms have significantly greater financial and other resources than we do and can offer their customers more product offerings, lower pricing, broader research capabilities, access to international markets, and other products and services we do not offer, which may give these firms a competitive advantage over us.
As we seek to expand our business, we face competition in the pursuit of clients interested in our services, the recruitment and retention of wealth management professionals, and the identification and acquisition of other wealth management firms that can be integrated into our group.
Our Market Area
We are based in Dallas, Texas, which is our largest market. The Bank’s principal banking markets include Dallas, Tarrant, Denton, Collin and Rockwall counties in North Texas. However, our business is also national in scope. Our national business includes: banking for small businesses (particularly dental practices), SBA and USDA loans, trust and custodial services, and participant directed recordkeeping and third-party administration. In addition, we provide investment advisory and brokerage services through Tectonic Advisors and Sanders Morris.
Human Capital Resources
We had approximately182 employees as of December 31, 2022. We believe our employee relations to be good and we have no collective bargaining agreements with any employees.
As part of our business philosophy, we believe that we must offer and maintain market competitive compensation and benefit programs in order to attract and retain employees who serve our customers, including competitive compensation, paid time off, an employee retirement plan, bonus and other incentive compensation plans, and modern equipment and support.
The health and well-being of our employees is a priority for our business. Our full-time officers and employees are provided hospitalization and major medical insurance. We pay a substantial portion of the premiums for these coverages. We also provide other basic insurance coverages including dental, life, and long-term disability insurance.
Other Available Information
We file or furnish with the SEC annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other reports required by Section 13(a) or 15(d) of the Exchange Act. Electronic copies of our SEC filings are available to the public at the SEC’s website at https://www.sec.gov. In addition, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and other reports required by Section 13(a) or 15(d) of the Exchange Act are available through our website, www.t.financial, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
The Company routinely posts important information for investors on its website, www.t.financial. The Company intends to use its website as a means of disclosing material non-public information and for complying with its disclosure obligations under SEC Regulation FD (Fair Disclosure). Accordingly, investors should monitor the Company’s website, in addition to following the Company’s press releases, SEC filings, public conference calls, presentations and webcasts.
Our website and the information contained on or accessible through our website is not incorporated by reference into, and is not a part of, this Form 10-K.
SUPERVISION AND REGULATION
Set forth below is a description of the significant elements of the laws and regulations applicable to the Company and its operating subsidiaries. The description is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are described. Moreover, these statutes, regulations and policies are continually under review by the U.S. Congress and state legislatures, and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Company or its operating subsidiaries could have a material effect on our business.
Regulatory Agencies
As a registered bank holding company, the Company is subject to the supervision and regulation of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and, acting under delegated authority, the Federal Reserve Bank of Dallas (the “Reserve Bank”), pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). As a national bank, the Bank is subject to the supervision and regulation of the Office of the Comptroller of the Currency (the “OCC”). Sanders Morris is a registered broker-dealer with the SEC and FINRA, and a registered investment advisor with the SEC. Tectonic Advisors is an SEC registered investment advisor. HWG is an insurance agency registered with the TDI.
Bank Holding Company Regulation
BHC Act. As a registered bank holding company, the Company is required to furnish to the Federal Reserve annual and quarterly reports of its operations and may also be required to furnish such additional information and reports as the Federal Reserve or the Reserve Bank may require. The Company elected to become a financial holding company in 2018, as further described under “-Financial Holding Company Status.”
Under the BHC Act, the Company must obtain the prior approval of the Federal Reserve before (i) acquiring direct or indirect ownership or control of any class of voting securities of any bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the class; (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.
Under the BHC Act, any company must obtain the approval of the Federal Reserve prior to acquiring control of the Company or the Bank. For purposes of the BHC Act, “control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise based on facts and circumstances even with ownership below 5.00% up to 24.99%. On September 30, 2020, the Federal Reserve’s final rule revising the Federal Reserve’s regulations related to determinations of whether a company has “control” over another company, including a bank holding company or a bank, for purposes of the BHC Act, became effective. The final rule created a tiered system of non-control presumptions based upon the percentage of any class of voting securities held by an acquirer and the presence of other indicia of control. The final rule’s four categories of tiered presumptions of non-control, based upon the percentage of ownership of any class of voting securities held by an acquirer, are (i) less than 5%, (ii) 5% to 9.99%, (iii) 10% to 14.99%, and (iv) 15% to 24.99%. By codifying the non-control presumptions, the final rule provides greater transparency with respect to the total level of equity, representative directors, management interlocks, limiting contractual provisions and business relationships that would be permissible to the Federal Reserve in order to avoid a determination of control. The Federal Reserve’s final rule applies to control determinations under the BHC Act, but does not apply to the Change in Bank Control Act, as amended (the “CIBCA”).
Change in Bank Control Act. The CIBCA and the related regulations of the Federal Reserve require any person or group of persons acting in concert (except for companies required to make application under the BHC Act), to file a written notice with the Federal Reserve before the person or group acquires control of the Company. The CIBCA provides that a person, which includes a natural person or entity, directly or indirectly, has “control” of a bank or bank holding company if it (i) owns, controls, or has the power to vote 25% or more of the voting securities of the bank or bank holding company, (ii) controls the election of directors, trustees, or general partners of the company, (iii) has a controlling influence over the management or policies of the company, or (iv) conditions in any manner the transfer of 25% or more of the voting securities of the company upon the transfer of 25% or more of the outstanding shares of any class of voting securities of another company. Accordingly, the CIBCA requires that prior to the acquisition of any class of voting securities of a bank or bank holding company that prior notice to the Federal Reserve be provided, if, immediately after the transaction, the acquiring person (or persons acting in concert) will own, control, or hold the power to vote 25% or more of any class of voting securities of the bank or bank holding company. A rebuttable presumption of control arises under the CIBCA where a person (or persons acting in concert) controls 10% or more, but less than 25%, of a class of the voting stock of a company or insured bank (i) which is a reporting company under the Exchange Act, such as the Company, or (ii) such ownership interest is greater than the ownership interest held by any other person (or persons acting in concert).
Permitted Activities. The BHC Act also limits the investments and activities of bank holding companies. In general, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, providing services for its subsidiaries and various non-bank activities that are deemed to be closely related to banking. The activities of the Company are subject to these legal and regulatory limitations under the BHC Act and the implementing regulations of the Federal Reserve.
Volcker Rule. Section 13 of the BHC Act, commonly known as the “Volcker Rule,” generally prohibits insured depository institutions and their affiliates (including their holding companies) from sponsoring or acquiring an ownership interest in certain investment funds, including hedge funds and private equity funds. The Volcker Rule also places restrictions on proprietary trading, which could impact certain hedging activities. However, Section 203 of the EGRRCPA, exempts community banks from the restrictions of the Volcker Rule if (i) the community bank, and every entity that controls it, has total consolidated assets equal to or less than $10 billion; and (ii) trading assets and liabilities of the community bank, and every entity that controls it, is equal to or less than 5% of its total consolidated assets. As the consolidated assets of the Company are less than $10 billion and the Company does not currently exceed the 5% threshold, this aspect of the Volcker Rule does not have any impact on the Company’s consolidated financial statements at this time.
Financial Holding Company Status. A bank holding company may also elect to become a “financial holding company,” by which a qualified bank holding company may engage, directly or through its non-bank subsidiaries, in any activity that is financial in nature or incidental to such financial activity or in any other activity that is complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. A bank holding company can successfully elect to be regulated as a financial holding company if all of its depository institution subsidiaries meet certain prescribed standards pertaining to management, capital adequacy and compliance with the Community Reinvestment Act (“CRA”), such as being “well-capitalized” and “well-managed,” and must have a CRA rating of at least “satisfactory.” Financial holding companies remain subject to regulation and oversight by the Federal Reserve.
If a financial holding company ceases to meet the above requirements, the Federal Reserve’s regulations provide that the financial holding company must enter into an agreement with the Federal Reserve to comply with all applicable capital and management requirements. Until the financial holding company returns to compliance, the Federal Reserve may impose limitations or conditions on its activities, and the company may not commence any of the broader financial activities permissible for financial holding companies or acquire a company engaged in such financial activities without prior approval of the Federal Reserve. Restrictions imposed on a financial holding company’s activities by the Federal Reserve may not necessarily be made known to the public. If the financial holding company does not return to compliance within 180 days, the Federal Reserve may require divestiture of the financial holding company’s depository institutions. Failure to satisfy the financial holding company requirements could also result in loss of financial holding company status. Tectonic Financial, Inc. made this election in 2019, and became a financial holding company.
Source of Strength. In accordance with the Dodd-Frank Act and long-standing Federal Reserve policy, a bank holding company is required to act as a source of financial and managerial strength to any subsidiary bank. The holding company is expected to commit resources to support its subsidiary bank, including at times when the holding company may not be in a financial position to provide such support. A bank holding company’s failure to meet its source-of-strength obligations may constitute an unsafe and unsound practice. The source-of-strength doctrine most directly affects bank holding companies in situations where the bank holding company’s subsidiary bank fails to maintain adequate capital levels.
Sound Banking Practice. The Federal Reserve also has the power to order a bank holding company to terminate any activity or investment, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or investment or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any subsidiary bank of the bank holding company. For example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.
The Federal Reserve has the power to assess civil money penalties for unsafe or unsound practices. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), expanded the Federal Reserve’s authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. FIRREA increased the amount of civil money penalties, which the Federal Reserve can assess for activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1.0 million for each day the activity continues. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed.
Dividends, Distributions, Stock Redemptions and Repurchases. Dividends and distributions from our subsidiary companies are the Company’s principal source of cash revenues. The Company’s earnings and activities are affected by legislation, regulations, local legislative and administrative bodies and decisions of courts in the jurisdictions in which we conduct business. These include limitations on the ability of the Bank to pay dividends to the Company and the Company’s ability to pay dividends to its shareholders. Consistent with its policy that bank and financial holding companies should serve as a source of financial strength for their subsidiary banks, it is the policy of the Federal Reserve that bank holding companies should pay cash dividends on preferred and common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiary. Consistent with such policy, a banking organization should have comprehensive policies on dividend payments that clearly articulate the organization’s objectives and approaches for maintaining a strong capital position and achieving the objectives of the policy statement.
In addition, we are subject to certain restrictions on the making of distributions as a result of the requirement that the Bank maintain an adequate level of capital as described below. As a Texas corporation, we are restricted under the Texas Business Organizations Code (the “TBOC”) 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 the event that the Board authorizes the payment of a dividend by the Company, any such dividend will be consistent with our capital needs, asset quality and overall financial condition (as a financial holding company). However, there can be no assurance that this will be the case in the future and, if it is found that our dividend is not consistent with our capital needs and/or asset quality or if our financial condition deteriorates, we may not be able to pay dividends on B preferred stock.
Bank holding companies must consult with the Federal Reserve before redeeming or repurchasing any equity or other capital instrument included in tier 1 or tier 2 capital prior to stated maturity, if (x) such redemption or repurchase could have a material effect on the level or composition of the organization’s capital base, or (y) as a result of such redemption or repurchase, there is a net reduction of the outstanding amount of common stock or preferred stock outstanding below the amounts outstanding at the beginning of the quarter in which the redemption or repurchase occurs. In addition, bank holding companies are unable to repurchase shares equal to 10% or more of their net worth if they would not be well-capitalized (as defined by the Federal Reserve) after giving effect to such repurchase. Bank holding companies experiencing financial weaknesses, or that are at significant risk of developing financial weaknesses, must consult with the Federal Reserve before redeeming or repurchasing common stock or other regulatory capital instruments.
Imposition of Liability for Undercapitalized Subsidiaries. The Federal Deposit Insurance Corporation Act of 1991 (“FDICIA”), requires bank regulators to take “prompt corrective action” to resolve problems associated with insured depository institutions. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company “having control of” the undercapitalized institution “guarantees” the subsidiary’s compliance with the capital restoration plan until it becomes “adequately capitalized.” For purposes of this statute, the Company has control of the Bank. Under FDICIA, the aggregate liability of all companies controlling a particular institution is limited to the lesser of 5% of the depository institution’s total assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDICIA grants greater powers to bank regulators in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed distributions, consent to a merger or divest the troubled institution or other affiliates.
Anti-Tying Restrictions. Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by the holding company or its affiliates. While we and our other affiliates offer services, no such services are tied to one another or conditioned upon one another.
Bank Regulation
The Bank is a national bank chartered under the National Bank Act. The Bank is a member of the Federal Reserve. In addition, its deposits are insured by the FDIC to the maximum extent permitted by law. National banks, such as the Bank, are subject to extensive regulation, supervision and examination by the OCC. As an insured depository institution and member bank, the Bank is also subject to regulation by the FDIC and the Federal Reserve, although the OCC is the Bank’s primary federal regulator. The bank regulatory agencies have the power to enforce compliance with applicable banking laws and regulations. These requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the Bank.
National Banking Associations. Banks organized as national banking associations under the National Bank Act are subject to regulation and examination by the OCC. The supervision and regulation by the OCC is primarily intended to protect the interests of depositors of the Bank, not the Bank’s shareholders. The National Bank Act, among other things:
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restricts investments and other activities of the Bank;
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restricts the nature and amount of loans that the Bank may make and the interest that may be charged; and
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requires the Bank to maintain reserves against deposits.
Deposit Insurance. The FDIC insures the deposits of federally insured banks, such as the Bank, and thrifts, up to prescribed statutory limits for each depositor through the Deposit Insurance Fund (the “DIF”), and safeguards the safety and soundness of the banking and thrift industries. The Dodd-Frank Act set the standard maximum deposit insurance amount as $250,000. The amount of FDIC assessments paid by each insured depository institution is based on the Bank’s total assets and its relative risk of default as measured by regulatory capital ratios and other supervisory factors. Under the Dodd-Frank Act, each institution’s assessment base is determined based on its average consolidated total assets less average tangible equity, and there is a scorecard method for calculating assessments that combines CAMELS (an acronym that refers to the five components of a bank’s condition that are addressed: capital adequacy, asset quality, management, earnings, and liquidity) ratings and specified forward-looking financial measures to determine each institution’s risk to the DIF.
In accordance with the Dodd-Frank Act, the FDIC adopted a plan to restore the DIF to the 1.35% ratio but did not change its assessment schedule. Under the FDIC's restoration plan, FDIC staff will update its projections for the DIF balance and DIF reserve ratio at least semiannually while the restoration plan is in effect. On October 18, 2022, the FDIC adopted a final rule applicable to all insured depository institutions increasing initial base deposit insurance assessment rate schedules by 2 basis points, beginning in the first quarterly assessment period of 2023. The FDIC also issued a notice maintaining a DIF reserve ratio of 2.0% for 2023. The increase in assessment rate schedules is intended to increase the likelihood that the DIF reserve ratio reaches the statutory minimum of 1.35% by September 30, 2028, the statutory deadline set by the Dodd-Frank Act. The new assessment rate schedules will remain in effect unless and until the DIF reserve ratio meets or exceeds 2.0% in order to support growth in the DIF in progressing toward the FDIC's long-term goal of a 2.0% designated reserve ratio for the DIF. FDIC staff may in the future recommend additional assessment rate adjustments if deemed necessary.
In addition, if there are additional bank or financial institution failures or if the FDIC otherwise determines to increase assessment rates, the Bank may be required to pay higher FDIC insurance premiums.
Additionally, under the Federal Deposit Insurance Act (the “FDIA”), the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Payment of Dividends. The Company is a legal entity separate and distinct from the Bank. The Company historically has received all of its revenue from distributions from Tectonic Advisors and Sanders Morris. However, to the extent the Company desires to have dividends paid by the Bank, the Bank may be limited in its ability to pay dividends without prior regulatory approval. The Bank is required by federal law to obtain the prior approval of the OCC to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) the Bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, the Bank may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation).
The payment of dividends by the Bank is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and the Bank is generally prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the payment of dividends by the Bank if the OCC determines such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain the capital conservation buffer.
Regulatory Capital Requirements. Under the Basel III capital regulations, the minimum capital level requirements are (i) a common equity Tier 1 (“CET1”) capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6.0%; (iii) a total capital ratio of 8.0%; and (iv) a Tier 1 leverage ratio of 4.0%. CET1 generally consists of common stock; retained earnings; accumulated other comprehensive income, or AOCI, unless an institution elects to exclude AOCI from regulatory capital; and certain minority interests; all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of CET1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and subordinated debt meeting certain conditions plus an amount of the allowance for loan and lease losses up to 1.25% of assets. Total capital is the sum of Tier 1 and Tier 2 capital. As of December 31, 2022, the Bank exceeded all Basel III regulatory minimum capital requirements.
In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer that consists of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares and paying discretionary bonuses.
The CET1 requirements also changed the risk-weighting of certain assets including a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition development and construction loans and for non-residential mortgage loans that are 90 days or more past due or otherwise on non-accrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; and a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital.
Community Bank Leverage Ratio. On September 17, 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9%, off-balance-sheet exposures of 25% or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed “qualifying community banking organizations” and are eligible to opt into the “Community Bank Leverage Ratio,” or CBLR, framework. A qualifying community banking organization that elects to use the CBLR framework and that maintains a leverage ratio of greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III Rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater-than-9% CBLR requirement, is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must comply with the generally applicable requirements under the Basel III Rules and file the appropriate regulatory reports.
Although the Company and the Bank are qualifying community banking organizations, the Company and the Bank have elected not to use the CBLR framework, but may make such an election in the future.
Prompt Corrective Regulatory Action. Under applicable federal statutes, the OCC is required to take “prompt corrective action” if the Bank does not meet specified minimum capital requirements. For these purposes, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the OCC’s prompt corrective action regulations, an institution is deemed to be:
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“well capitalized” if it has a total capital ratio of 10.0% or greater, a Tier 1 capital ratio of 8.0% or greater, a CET1 capital ratio of 6.5% or greater, a Tier 1 leverage ratio of 5.0% or greater and is not subject to a capital maintenance requirement;
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“adequately capitalized” if it has a total capital ratio of 8.0% or greater, a Tier 1 capital ratio of 6.0% or greater, a CET1 capital ratio of 4.5% or greater and a Tier 1 leverage ratio of 4.0% or greater;
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“undercapitalized” if it has a total capital ratio of less than 8.0%, a Tier 1 capital ratio of less than 6.0%, a CET1 capital ratio of less than 4.5% or a Tier 1 leverage ratio of less than 4.0%;
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“significantly undercapitalized” if it has a total capital ratio of less than 6.0%, a Tier 1 capital ratio of less than 4.0%, a CET1 capital ratio of less than 3.0% or a Tier 1 leverage ratio of less than 3.0%; and
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“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
If the Bank were to become undercapitalized, it would be subject to growth limitations and would be required to submit a capital restoration plan to the OCC. The OCC may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the Bank’s capital. In addition, for a capital restoration plan to be acceptable, the Company must guarantee that the Bank will comply with such capital restoration plan. If the Bank were to fail to submit an acceptable plan, it would be treated as if it were “significantly undercapitalized.” “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets and cessation of receipt of deposits from correspondent banks and other depositary sources, particularly if such deposits are higher cost deposits. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.
As of December 31, 2022, the Bank qualified as “well capitalized” under the prompt corrective action rules.
Interstate Banking and Branching. Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) amended the FDIA, and certain other statutes, to permit state and national banks with different home states to merge across state lines with approval of the appropriate federal banking agency, unless the home state of a participating bank had passed legislation prior to May 31, 1997 expressly prohibiting interstate mergers. Under the Riegle-Neal Act, once a state or national bank has established branches in a state, that bank may establish and acquire additional branches at any location in the state at which any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the state which has opted out, whether through an acquisition or de novo.
However, under the Dodd-Frank Act, the national branching requirements have been relaxed and national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state. The OCC accepts applications for interstate merger and branching transactions, subject to certain limitations on the ages of the banks to be acquired and the total amount of deposits within the state that a bank or financial holding company may control. Since our primary service area is Texas, we do not expect that the ability to operate in other states will have any material impact on our growth strategy. We may, however, face increased competition from out-of-state banks that branch or make acquisitions in our primary markets in Texas.
Restrictions on Transactions with Affiliates. The Bank is subject to the provisions of Section 23A and 23B of the Federal Reserve Act (the “Affiliates Act”). Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. In our case, Tectonic Advisors, Sanders Morris, HWG and Cain Watters are all considered affiliates.
These provisions place limits on the amount of:
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loans or extensions of credit to affiliates;
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investments in affiliates;
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assets that may be purchased from affiliates;
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the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and
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the guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the purchase or acquisition of low-quality assets from affiliates. The Dodd-Frank Act expanded the scope of Section 23A of the Affiliates Act, which now includes investment funds managed by an institution as an affiliate, as well as other procedural and substantive hurdles.
Section 23B of the Affiliates Act, among other things, prohibits the Bank from engaging in any transaction with an affiliate unless the transaction is on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
Loans to Insiders. Under federal law, the Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, (2) must follow credit underwriting procedures at least as stringent as those applicable to comparable transactions with third parties, and (3) must not involve more than the normal risk of repayment or present other unfavorable features. The Dodd-Frank Act expanded coverage of transactions with insiders by including credit exposure arising from derivative transactions (which are also covered by the expansion of Section 23A of the Affiliates Act). The Dodd-Frank Act prohibits an insured depository institution from purchasing or selling an asset to an executive officer, director, or principal shareholder (or any related interest of such a person) unless the transaction is on market terms, and, if the transaction exceeds 10% of the institution’s capital, it is approved in advance by a majority of the disinterested directors.
Commercial Real Estate Lending Concentrations. The federal banking agencies, including the OCC, have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm nonresidential properties (excluding loans secured by owner-occupied properties) and loans for construction, land development, and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. On December 18, 2015, the federal banking agencies jointly issued a “statement on prudent risk management for commercial real estate lending.” As of December 31, 2022, the Company did not exceed the levels to be considered to have a concentration in commercial real estate lending and believes its credit administration to be consistent with the recently published policy statement.
Brokered Deposit Restrictions. Well capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and are subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are generally not permitted to accept, renew, or roll over brokered deposits. As of December 31, 2022, the Bank qualified as “well capitalized” for purposes of the brokered deposit restrictions.
Technology Risk Management and Consumer Privacy. Federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology-related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology.
Under Section 501 of the Gramm-Leach-Bliley Act of 1999 (the “GLBA”), the federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records and protection against unauthorized access to or use of such records or information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information.
Under the GLBA, a financial institution must also provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing nonpublic personal information about a customer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution’s ability to disclose nonpublic personal information about customers to nonaffiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices which describe in general terms the bank’s information sharing practices. Banks that share nonpublic personal information about customers with nonaffiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, or deposit or transaction accounts to any nonaffiliated third party for use in marketing.
In November 2021, the federal bank regulatory agencies issued a joint rule establishing computer-security incident notification requirements for banking organizations and their service providers. Beginning May 1, 2022, a bank holding company, such as the Company, and an FDIC-supervised depository institution, such as the Bank, are required to notify the Federal Reserve or FDIC, respectively, as soon as possible and no later than 36 hours after a determination that a computer-security incident that rises to the level of a notification incident has occurred.
Anti-Money Laundering. Under federal law, including the Bank Secrecy Act (the “BSA”), as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), and as further amended by the National Defense Authorization Act for Fiscal Year 2021 (the “National Defense Authorization Act”), and implementing regulations, certain types of financial institutions, including insured depository institutions, must maintain anti-money laundering (“AML”) programs that include established internal policies, procedures and controls; a designated compliance officer; an ongoing training program; and testing of the program by an independent audit function. Financial institutions are restricted from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence, client identification and recordkeeping, including in their dealings with non-U.S. financial institutions and non-U.S. clients. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious information maintained by financial institutions.
On May 10, 2016, the Financial Crimes Enforcement Network (“FinCEN”) issued a final rule regarding customer due diligence requirements for covered financial institutions in connection with their BSA and anti-money laundering policies. The final rule adds a requirement that banks understand the nature and purpose of customer relationships and identify the “beneficial owner” (25% or more ownership interest) of legal entity customers. The formal implementation date was May 11, 2018. Bank regulators routinely examine institutions for compliance with these obligations and they must consider an institution’s anti-money laundering compliance when considering regulatory applications filed by the institution, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.
Further, on January 1, 2021, Congress passed the National Defense Authorization Act, which enacted the most significant overhaul of the BSA and related AML laws since the USA PATRIOT Act. Notable amendments include (1) significant changes to the collection of beneficial ownership information and the establishment of a beneficial ownership registry, which requires corporate entities (generally, any corporation, limited liability company, or other similar entity with 20 or fewer employees and annual gross income of $5 million or less) to report beneficial ownership information to FinCEN (which will be maintained by FinCEN and made available upon request to financial institutions); (2) enhanced whistleblower provisions, which provide that one or more whistleblowers who voluntarily provide original information leading to the successful enforcement of violations of the anti-money laundering laws in any judicial or administrative action brought by the Secretary of the Treasury or the Attorney General resulting in monetary sanctions exceeding $1 million (including disgorgement and interest but excluding forfeiture, restitution, or compensation to victims) will receive not more than 30 percent of the monetary sanctions collected and will receive increased protections; (3) increased penalties for violations of the BSA; (4) improvements to existing information sharing provisions that permit financial institutions to share information relating to suspicious activity reports (SARs) with foreign branches, subsidiaries, and affiliates (except those located in China, Russia, or certain other jurisdictions) for the purpose of combating illicit finance risks; and (5) expanded duties and powers of FinCEN. Many of the amendments, including those with respect to beneficial ownership, require the Department of Treasury and FinCEN to promulgate rules.
Office of Foreign Assets Control (“OFAC”) Regulation. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the OFAC rules based on their administration by OFAC. The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with, or investment in, a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) the blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. The Bank is responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and reputational consequences.
Consumer Financial Protection Bureau (“CFPB”). The CFPB was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking, supervision and enforcement authority over a wide range of consumer protection laws that apply to all banks and thrifts, including the Equal Credit Opportunity Act, Truth in Lending Act (“TILA”), Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Home Mortgage Disclosure Act, Truth in Savings Act, Fair Debt Collection Act, the consumer financial privacy provisions of the GLBA and certain other statutes. Banking institutions with total assets of $10.0 billion or less, such as the Bank, remain subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws and such additional regulations as may be adopted by the CFPB.
Community Reinvestment Act. The CRA and the regulations issued thereunder are intended to encourage banks to help meet the credit needs of their entire communities, including low- and moderate-income neighborhoods, consistent with safe and sound operations. The regulators examine banks and assign each bank a public CRA rating. The CRA then requires bank regulators to take into account the bank’s record of meeting the needs of its community when considering certain applications by a bank, including applications to establish a banking center or to conduct certain mergers or acquisitions. The Federal Reserve is also required to consider the CRA records of a bank holding company’s controlled banks when considering an application by the bank holding company to acquire a bank or to merge with another bank holding company.
The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance based evaluation system. This system bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.” The Bank had a CRA rating of “satisfactory” as of its most recent CRA assessment.
On May 5, 2022, the federal banking regulators issued a joint proposed rule to revise regulations implementing the CRA, which seeks to strengthen the purpose of the CRA, adapt to changes in the banking industry, including the expanded role of mobile and online banking, provide clarity and consistency in the application of CRA regulations, tailor performance standards to account for differences in bank size, business model, and local conditions, tailor data collection and reporting requirements, promote transparency and public engagement, confirm that CRA and fair lending are mutually reinforcing, and create a consistent regulatory approach that applies to banks regulated by all of the federal banking regulators. While the comment period for the proposed rule expired in August 2022, a final rule has not yet been implemented by the federal banking regulators. The Company and the Bank will continue to monitor these developments.
An unsatisfactory CRA record could substantially delay approval or result in denial of an application. See “Risk Factors-Risks Related to Our Regulatory Environment-We are subject to numerous laws designed to protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.”
Regulation Z. On April 5, 2011, the Federal Reserve’s final rule on loan originator compensation and steering (Regulation Z) became final. Regulation Z is more commonly known as the regulation that implements TILA. Regulation Z address two components of mortgage lending, i.e., loans secured by a dwelling, and implements restrictions and guidelines for: (i) prohibited payments to loan originators, and (ii) prohibitions on steering. Under Regulation Z, a creditor is prohibited from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction’s terms or conditions, except the amount of credit extended, which is deemed not to be a transaction term or condition. In addition, Regulation Z prohibits a loan originator from “steering” a consumer to a lender or a loan that offers less favorable terms in order to increase the loan originator’s compensation, unless the loan is in the consumer’s interest. Regulation Z also contains a record-retention provision requiring that, for each transaction subject to Regulation Z, the financial institution maintain records of the compensation it provided to the loan originator for that transaction as well as the compensation agreement in effect on the date the interest rate was set for the transaction. These records must be maintained for two years.
UDAP and UDAAP. Banking regulatory agencies have increasingly used a general consumer protection statute to address “unfair”, “deceptive” or “abusive” acts and business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act, referred to as the FTC Act, which is the primary federal law that prohibits unfair or deceptive acts or practices, referred to as UDAP, and unfair methods of competition in or affecting commerce. “Unjustified consumer injury” is the principal focus of the FTC Act. UDAP laws and regulations were expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” referred to as UDAAP, and were delegated to CFPB for rulemaking. The federal banking agencies have the authority to enforce such rules and regulations. Under the Dodd-Frank Act, CFPB looks to various factors to assess whether an act or practice is unfair, including whether it causes or is likely to cause substantial injury to consumers, the injury is not reasonably avoidable by consumers, and the injury is not outweighed by countervailing benefits to consumers or to competition. A key focus of CFPB is whether an act or practice hinders a consumer’s decision-making.
Incentive Compensation Guidance
The federal bank regulatory agencies have issued comprehensive guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of those organizations by encouraging excessive risk-taking. The incentive compensation guidance sets expectations for banking organizations concerning their incentive compensation arrangements and related risk-management, control and governance processes. The incentive compensation guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon three primary principles: (1) balanced risk-taking incentives; (2) compatibility with effective controls and risk management; and (3) strong corporate governance. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or take other actions. In addition, under the incentive compensation guidance, a banking organization’s federal supervisor may initiate enforcement action if the organization’s incentive compensation arrangements pose a risk to the safety and soundness of the organization. Further, the Basel III capital rules limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds.
In October 2022, the SEC adopted a final rule directing national securities exchanges and associations, including the NASDAQ, to implement listing standards that require listed companies to adopt policies mandating the recovery or “clawback” of excess incentive-based compensation earned by a current or former executive officer during the three fiscal years preceding the date the listed company is required to prepare an accounting restatement, including to correct an error that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period. The final rule requires the Company to adopt a clawback policy within 60 days after such listing standard becomes effective.
Other Regulations. The Bank’s operations are also subject to various federal laws such as the:
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Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
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Fair Credit Reporting Act of 1978 and its amendment, the Fair and Accurate Credit Transactions Act of 2003, governing the use and provision of information to credit reporting agencies;
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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
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Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
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Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to, and withdrawals from, deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
Effect of Governmental Monetary Policies. The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve. Some of the instruments of monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of, and changes in, reserve requirements against member banks’ deposits and assets of foreign branches, the imposition of, and changes in, reserve requirements against certain borrowings by banks and their affiliates and the placing of limits on interest rates that member banks may pay on time and savings deposits. Such policies influence to a significant extent the overall growth of bank loans, investments and deposits as well as the interest rates charged on loans or paid on time and savings deposits. We cannot predict the nature of future fiscal and monetary policies and the effect of such policies on our future business and our earnings.
Environmental Laws Potentially Impacting the Bank. We are subject to state and federal environmental laws and regulations. The Comprehensive Environmental Response, Compensation and Liability Act, (“CERCLA”), is a federal statute that generally imposes strict liability on all prior and present “owners and operators” of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan, which costs often substantially exceed the value of the property.
Regulatory Reform and Legislation. From time to time, various legislative and regulatory initiatives are introduced in Congress, as well as by regulatory agencies. These initiatives and others may at times include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company or the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company or our subsidiaries could have a material effect on the Company’s business, financial condition and results of operations.
Broker-Dealer Regulation
The securities industry is heavily regulated. The SEC is responsible for the administration of the federal securities laws and serves as a supervisory body over all national securities exchanges and associations. The regulation of broker-dealers has, to a large extent, been delegated by the federal securities laws to the FINRA and other self-regulatory organizations (“SROs”). These SROs include, among others, all the national securities and commodities exchanges and the FINRA. Subject to approval by the SEC and certain other regulatory authorities, SROs adopt rules that govern the industry and conduct periodic examinations of the operations of our broker-dealer subsidiary. Sanders Morris is registered in all 50 states and is also subject to regulation under the laws of these jurisdictions.
Broker-Dealer Net Capital Rules. As a registered broker-dealer and member of FINRA, Sanders Morris is subject to certain net capital requirements of Rule 15c3-1 under the Exchange Act. The net capital rules, which specify minimum net capital requirements for registered broker-dealers, are designed to measure the financial soundness and liquidity of broker-dealers. Failure to maintain the required net capital may subject a firm to suspension or revocation of registration by the SEC and suspension or expulsion by other regulatory bodies, and ultimately may require its liquidation. Further, a decline in a broker-dealer’s net capital below certain “early warning levels,” even though above minimum capital requirements, could cause material adverse consequences for the broker-dealer. Sanders Morris conducts business on a national basis as an introducing firm, using a third-party firm for securities clearing and custody functions.
Broker-Dealer Supervision. Sanders Morris is subject to other rules and regulations covering all aspects of the securities business, including sales and trading practices, public offerings, use and safekeeping of clients’ funds and securities, recordkeeping and reporting, and the conduct of directors, officers and employees. Broker-dealers are also regulated by state securities administrators in those jurisdictions where they do business. Compliance with many of the rules and regulations applicable to us involves a number of risks because the rules and regulations are subject to varying interpretations. Regulators make periodic examinations and review annual, monthly and other reports on Sanders Morris’ operations, track record and financial condition. Violations of rules and regulations governing a broker-dealer’s actions could result in censure, penalties and fines, the issuance of cease-and-desist orders, the suspension or expulsion from the securities industry of such broker-dealer or its officers or employees, or other similar adverse consequences. The rules of the Municipal Securities Rulemaking Board, which are enforced by the SEC and FINRA, apply to the municipal securities activities of Sanders Morris.
Anti-Money Laundering. Sanders Morris, like the Bank, is subject to the BSA and the USA PATRIOT Act. These acts contain anti-money laundering and financial transparency laws and mandate the implementation of various regulations applicable to broker-dealers and other financial services companies. Sanders Morris, like the Bank, has established policies, procedures and systems designed to comply with these regulations.
Securities Investor Protection Corporation (“SIPC”). As a registered broker-dealer and FINRA member organization, Sanders Morris is required by federal law to belong to the SIPC, which provides, in the event of the liquidation of a broker-dealer, protection for securities held in customer accounts held by the firm of up to $500,000 per customer, subject to a limitation of $250,000 on claims for cash balances. SIPC is principally funded through assessments on registered broker-dealers. SIPC protection does not insure against fluctuations in the market value of securities.
Regulation BI and Form CRS Relationship Summary (“Form CRS”). On June 5, 2019, the SEC adopted Regulation Best Interest (“Regulation BI”), elevating the standard of care for broker-dealers from the current “suitability” requirement to a “best interest” standard when making a recommendation of any securities transaction to a retail customer. The “best interest” standard requires a broker-dealer to make recommendations without putting its financial interests ahead of the interests of a retail customer. The SEC also adopted Form CRS, which requires registered investment advisors (“RIAs”) and broker-dealers to deliver to retail investors a succinct, plain English summary about the relationship and services provided by the firm and the required standard of conduct associated with the relationship and services. In connection with adopting Regulation BI, the SEC added new record-making and recordkeeping rules. The compliance date for Regulation BI and the related rules is June 30, 2020, and Sanders Morris and Tectonic Advisors met this requirement. Regulation BI imposes disclosure and policy and procedural obligations that could impact the compensation our wealth management business and its representatives receive for selling certain types of products, particularly those that offer different compensation across different share classes (such as mutual funds and variable annuities). In addition, Regulation BI prohibits a broker-dealer and its associated persons from using the term “adviser” or “advisor” if the broker-dealer is not an RIA or the associated person is not a supervised person of an RIA.
Investment Advisor Regulation
As registered investment advisors under the Investment Advisers Act of 1940 (the “Advisers Act”), Tectonic Advisors and Sanders Morris are subject to the requirements of regulations under both the Advisers Act and certain state securities laws and regulations. Such requirements relate to, among other things, limitations on the ability of investment advisors to charge performance-based or non-refundable fees to clients, record-keeping and reporting requirements, disclosure requirements, limitations on principal transactions between an advisor or its affiliates and advisory clients, and general anti-fraud prohibitions.
ERISA. Certain of our subsidiaries are subject to the Employee Retirement Income Security Act (“ERISA”) and Sections 4975(c)(1)(A), (B), (C) or (D) of the Internal Revenue Code of 1986, as amended (the “Code”), and to regulations promulgated thereunder, insofar as they are a “fiduciary” under ERISA with respect to benefit plan clients or otherwise deal with benefit plan clients. ERISA and applicable provisions of the Code impose certain duties on persons who are fiduciaries under ERISA, prohibit certain transactions involving ERISA plan clients (including, without limitation, employee benefit plans (as defined in Section 3(3) of ERISA), individual retirement accounts and Keogh plans) and provide monetary penalties for violations of these prohibitions.
Investment Advisor Supervision. The SEC is authorized to institute proceedings and impose sanctions for violations of the Advisers Act, ranging from fines and censure to termination of an investment adviser’s registration. Investment advisers also are subject to certain state securities laws and regulations. Non-compliance with the Advisers Act or other federal and state securities laws and regulations could result in investigations, sanctions, disgorgement, fines or other similar consequences.
Insurance Regulation
HWG is an insurance agency registered with the TDI. It provides life, disability, property and casualty insurance to clients. Regulation of insurance brokerage is generally performed at a state, rather than a national, level. HWG operates in multiple states/jurisdictions, and as a result, both HWG and its employees are subject to various state regulatory and licensing requirements. HWG monitors compliance with the various state insurance regulators, and also has relationships with third party vendors to ensure compliance and awareness among HWG and its employees of relevant requirements and changes, and emerging regulatory issues.

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ITEM 1A. RISK FACTORS
Item 1A.
Risk Factors.
Our business and results of operations are subject to numerous risks and uncertainties, many of which are beyond our control. The material risks and uncertainties that management believes affect the Company are described below. Additional risks and uncertainties that management is not aware of, or that management currently deems immaterial, may also impair the Company’s business operations. This Form 10-K is qualified in its entirety by these risk factors. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our securities could decline significantly, and you could lose all or part of your investment. Some statements in the following risk factors constitute forward-looking statements. Please refer to “Cautionary Note Regarding Forward-Looking Statements” elsewhere in this Form 10-K.
Summary of Risk Factors
Below is a summary of the principal factors that we believe make an investment in our securities risky. This summary does not address all of the risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found below and should be carefully considered, together with other information in this Form 10-K and our other filings with the SEC, before making an investment decision regarding our securities.
Risks Related to Our Business:
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Liquidity risk, including our ability to maintain our deposit base or other funding sources, could adversely affect our ability to fund operations and hurt our financial condition.
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We depend on wholesale funding sources, which causes our cost of funds to be higher and poses future funding risks if the Bank becomes less than “well capitalized”, which may require us to liquidate loans or impede our growth.
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We may not be able to maintain our deposit base or other funding sources.
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We are subject to interest rate risk and changes in interest rates could affect our net interest margins and net interest income, the value of assets and obligations, and the availability and cost of capital or liquidity.
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We are subject to consolidated capital ratio requirements and therefore have to hold additional capital.
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If we are unable to sell additional services and products to existing clients or attract new clients in a manner that is cost-effective and assures client success, we will not be able to grow our business.
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We may not be able to implement aspects of our expansion strategy, which may adversely affect our ability to maintain our historical earnings trends.
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Our securities portfolio is subject to risk of loss; the fair value of our investment securities can fluctuate due to factors outside of our control.
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New lines of business or new products and services may subject us to additional risks.
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Acquisitions may subject us to integration risks and other unknown risks. The soundness of other financial institutions could adversely affect us. Negative public opinion regarding us or failure to maintain our reputation in the communities we serve could adversely affect our business and prevent us from growing our business.
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Growth of our business could result in increased costs.
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Significant revenues and profits are generated as a result of our relationship with Cain Watters, and a change in the relationship or decline in Cain Watters’ business could adversely affect us.
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We depend on key personnel, and may have difficulty identifying, attracting and retaining necessary personnel to execute our business strategy and successfully expand our operations. This risk includes the risk of retirement of key professionals in leadership roles, including loan officers, members of our SBA team, and financial advisors and brokers.
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The employment market has become increasingly competitive; We may have difficulty attracting and retaining skilled personnel.
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A decline in general business and economic conditions and any regulatory responses to such conditions could have a material adverse effect on our business, financial position, results of operations and growth prospects.
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Lower trucking margins and revenues negatively impact trucking industry and factoring.
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Our business is concentrated in, and dependent upon, the continued growth and welfare of our primary market, and adverse economic conditions in such market could negatively impact our operations and clients.
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We have a loan concentration related to the acquisition and financing of dental practices.
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A governmental shutdown or curtailment of government guaranteed loan programs could affect a segment of our business.
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Our factoring services through the Bank’s Integra Division are concentrated in the transportation industry and economic conditions or other factors negatively impacting the transportation industry could adversely affect our factoring business.
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We face specific risks associated with retention of unguaranteed portions of SBA loans.
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The success of our trust services is dependent upon market fluctuations and a non-diversified source for its growth.
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We are subject to possible claims and litigation pertaining to fiduciary responsibility.
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We could suffer material credit losses. Our levels of nonperforming assets could increase, which could adversely affect our results of operations and financial condition, and could result in losses in the future.
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Our allowance for loan losses may not be sufficient to absorb actual losses.
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A new accounting standard will result in a significant change in how we recognize credit losses and may result in material increases to our allowance for loan losses. Our legal lending limits may impair our ability to attract borrowers and ability to compete with larger financial institutions.
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The level of our commercial real estate loan portfolio may subject us to heightened regulatory scrutiny.
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The small- to medium-sized businesses that we lend to may have fewer resources to weather adverse business conditions, which may impair their ability to repay a loan, and such impairment could adversely affect our results of operations and financial condition.
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Our commercial finance clients, particularly with respect to the Bank’s Integra Division, may lack the operating history, cash flows or balance sheet necessary to support other financing options and may expose us to additional credit risk, especially if our additional controls for such products are ineffective in mitigating such additional risks.
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Certain of our loans are not secured by property but dependent on the earning capacity of the borrower. The Company’s use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral.
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Fee revenue will represent a significant portion of our consolidated revenue and is subject to decline, among other things, in the event of a reduction in, or changes to, the level or type of investment activity by our clients and market declines.
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The business operations of Sanders Morris may face limitations due to net capital requirements.
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The wealth management, trust and brokerage business is highly competitive. If we are not able to compete successfully against current and future competitors, our business, financial condition, and results of operations will be adversely affected.
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Underperformance or declines in our investments may reduce the profitability of our wealth management and advisory business.
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Our wealth management and brokerage business is subject to reputational risk.
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Standard investment management contracts we have with our clients are terminable without cause and on relatively short notice by our clients.
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We continue to experience pricing pressures in areas of our business which may impair our future revenue and profitability.
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We face strong competition from other insurance agencies, which may adversely affect our operations and financial condition.
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A failure to appropriately identify and address potential conflicts of interest could adversely affect our businesses. We may incur significant losses due to ineffective risk management processes and strategies.
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If we fail to maintain effective internal control over financial reporting, we may not be able to report our financial results accurately and timely, in which case our business may be harmed.
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Our estimates and assumptions in the preparation of our financial statements may not be accurate.
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We may be required to recognize a significant charge to earnings if our goodwill or other intangible assets become impaired.
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We may elect or be compelled to seek additional capital, but that capital may not be available, or it may be dilutive.
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We face intense competition from larger banks and financial institutions that could hurt our business.
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Financial challenges at other banking institutions could lead to depositor concerns that spread within the banking industry causing disruptive deposit outflows and other destabilizing results. We continually encounter technological change, and we may have fewer resources than many of our competitors to invest in technological improvements.
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A third party systems failure could significantly disrupt our business, result in regulatory action against us, or limit our growth.
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Fraudulent activity, breaches of our information security, and cybersecurity attacks could adversely affect our ability to conduct our business, manage our exposure to risk, result in the disclosure or misuse of confidential or proprietary information, increase our costs to maintain and update our operational and security systems and infrastructure, and adversely impact our results of operations, liquidity and financial condition, as well as cause legal or reputational harm.
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Factoring products offered by the Bank’s Integra Division may expose us to an increased risk of fraud.
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We rely on client and counterparty information, which subjects us to risks if that information is not accurate or is incomplete.
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Climate change and related legislative and regulatory initiatives may materially affect the Company’s business and results of operations.
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The Company is subject to environmental risks associated with owning real estate or collateral.
Risks Related to Our Regulatory Environment:
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We are subject to extensive government regulation and supervision, which could constrain our growth and profitability.
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Recent bank failures will increase depository insurance and increase compliance costs. We are subject to stringent capital requirements that may limit our operations and potential growth.
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Federal banking agencies periodically conduct examinations of our banking business, and our failure to comply with any supervisory actions which we are, or may become, subject to as a result of such examinations may adversely affect us.
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We are subject to numerous laws designed to protect consumers and failure to comply with these laws could lead to a wide variety of sanctions.
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We face a risk of noncompliance and enforcement action with the BSA and other anti-money laundering laws.
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Additional regulations and rule making impacting the transportation industry may have a disproportionate impact on the small-to-mid-sized trucking businesses that comprise our primary transportation factoring clients and adversely affect the factoring business conducted by the Bank’s Integra Division.
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Sanders Morris and Tectonic Advisors are subject to substantial regulation and failure to comply with applicable requirements will adversely affect our business.
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Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how we collect and use personal information and adversely affect our business opportunities.
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We can be subject to legal and regulatory proceedings, investigations and inquiries related to conduct risk.
Risks Related to an Investment in the Series B Preferred Stock:
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The Series B preferred stock is subordinate to our existing and future indebtedness, which could adversely impact our ability to pay dividends on the Series B preferred stock.
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The Series B preferred stock may be junior in rights and preferences to our future preferred stock.Additional issuances of preferred stock or securities convertible into preferred stock may dilute existing holders.
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Dividends on the Series B preferred stock are discretionary and non-cumulative, and our future ability to pay dividends is subject to restrictions.
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Uncertainty related to the London Interbank Offer Rate (“LIBOR”) and its replacement may adversely affect the value of the Series B preferred stock.
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Dividends on the Series B preferred stock will vary beginning on May 15, 2024 and any dividends declared may be less than the initial fixed annual rate in effect prior to May 15, 2024.
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The Series B preferred stock may be redeemed at our option, and you may not be able to reinvest the redemption price you receive in a similar security.
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Investors should not expect us to redeem the Series B preferred stock on or anytime after the date it becomes redeemable.
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Holders of the Series B preferred stock have limited voting rights.
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A liquid market for the Series B preferred stock may not be sustained, which may impair your ability to sell your shares.
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The market price of the Series B preferred stock may become subject to substantial fluctuations.
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Securities analysts may not continue coverage on us.
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The Series B preferred stock is not rated.
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Subject to regulatory requirements and the terms of the Series B preferred stock, the Company may, and currently intends to, pay dividends on its common stock and any such payment reduces the capital of the Company available to the Series B preferred stock.
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Our management and board of directors have significant control over our business.
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We are a “controlled company” within the meaning of the rules of NASDAQ, and as such, we qualify for exemptions from certain corporate governance requirements. As a result, you may not have the same protections afforded to shareholders of companies that are subject to such requirements.
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The interests of our controlling shareholders may not coincide with yours and with whose decisions you may disagree.
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Our corporate organizational documents and provisions of federal and state law to which we are subject contain certain provisions that could have an anti-takeover effect and may delay, make more difficult or prevent an attempted acquisition that you may favor or an attempted replacement of our board of directors or management.
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We are an “emerging growth company,” and the reduced reporting requirements applicable to emerging growth companies may make the Series B preferred stock less attractive to investors.
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An investment in the Series B preferred stock is not an insured deposit and is subject to risk of loss.
Risks Related to Our Business
Liquidity risk, including our ability to maintain our deposit base or other funding sources, could adversely affect our ability to fund operations and hurt our financial condition.
Liquidity is essential to our banking business, as we use cash to make loans and purchase investment securities and other interest-earning assets and to fund deposit withdrawals that occur in the ordinary course of our business. Our principal sources of liquidity include earnings, deposits, repayment by clients of loans we have made to them, and the proceeds from sales by us of our equity securities or from borrowings that we may obtain. In addition, from time to time, we borrow from the FHLB. Potential alternative sources of liquidity include the sale of loans, the acquisition of national market non-core deposits, the issuance of additional collateralized borrowings such as the FHLB, advances, access to the Federal Reserve discount window, the Bank Term Funding Program (BTFP) and the issuance of additional equity securities and/or debt.
If our ability to obtain funds from these sources becomes limited, these sources become restricted or are eliminated, or the costs of those funds increase, whether due to factors that affect us specifically, including our financial performance, or due to factors that affect the financial services industry in general, including weakening economic conditions or negative views and expectations about the prospects for the financial services industry as a whole, then our ability to grow our banking and investment advisory and trust businesses would be harmed, which could have a material adverse effect on our business, financial condition, results of operations and prospects. Further, the Company may incur substantially higher funding costs in order to obtain the necessary funds to support the Company's operations and growth or may be required to sell or restrict operations, or restrict the payment of dividends. Furthermore, if the Company is unable to raise adequate funds through external sources, the Company may need to sell assets with unrealized losses in order to generate additional liquidity, which could decrease the capital of the Company and have an adverse effect on our business, financial condition and results of operations.
We depend on wholesale funding sources, which causes our cost of funds to be higher when compared to other financial institutions and poses future funding risks if the Bank becomes less than “well capitalized” under the prompt corrective action framework, or PCA, which may require us to liquidate loans or impede our growth.
We use certain non-core, wholesale funding sources, including the FHLB advances and deposit listing services. As of December 31, 2022, our use of such wholesale funding sources amounted to approximately $220 million, or 44.1% of total funding. Although we intend to increase our efforts to reduce our reliance on wholesale funding sources, we may not be able to increase our market share of core-deposit funding in our highly competitive market area. We further expect to increase our core funding as we develop the capacity for consumers to open on-line digital accounts. The rates on these digital accounts can be highly competitive and may increase our cost of funds, which could have a material adverse effect on our net interest income margins. Listing service deposit rates are very market sensitive. At times, the cost of these funds can exceed the cost of core deposits in our market area as well as digital deposits, which could have a material adverse effect on our net interest income margins. Wholesale funding is subject to certain practical limits such as the FHLB’s and BTFP’s maximum borrowing capacity and our liquidity targets. Our maximum borrowing capacity from the FHLB and BTFP is based on the amount and fair market value and face amount, respectively, of commercial loans and securities we can pledge. If we are unable to pledge sufficient collateral to secure funding from the FHLB, we may lose access to this source of liquidity that we have historically relied upon. Additionally, we are required to establish limits on certain types of deposits including brokered deposits and listing service deposits, as well as total wholesale funding sources. If we reach these limits, future asset growth may be reduced or halted. If we are unable to access any of these types of funding sources or if our costs related to them increase, our liquidity and ability to support demand for loans could be materially adversely affected. If we were not able to replace such wholesale funding, we may have to liquidate loans, which may be at losses that would have a material adverse effect on our capital, our business and your investment in the Company.
We may not be able to grow and maintain our deposit base, and deposit outflow may increase reliance on wholesale borrowings and brokered deposits.
Our future growth will largely depend on our ability to maintain and grow our deposit base and our ability to retain our trust clients, who provide deposits. As of December 31, 2022, the Bank had a loan to deposit ratio of 90.1%. In the current environment of rising interest rates, our deposits may not be as stable or as interest rate insensitive as similar deposits may have been in the past, and some existing or prospective deposit customers of banks generally, including the Bank, may be inclined to pursue other investment alternatives, which may negatively impact our net interest margin. The account and deposit balances can decrease when clients perceive alternative investments, such as the stock market or real estate, as providing a better risk/return tradeoff. In addition, as interest rates rise, competition for deposits may increase, which could result in clients moving money out of the Bank. As a general matter, deposits are typically a lower cost source of funds than external wholesale funding (brokered deposits and borrowed funds), because interest rates paid for deposits are typically less than interest rates charged for wholesale funding. If, as a result of competitive pressures, market interest rates, alternative investment opportunities that present more attractive returns to customers, general economic conditions or other events, the balance of the Company’s deposits decreases relative to the Company’s overall banking operations, the Company may have to rely more heavily on wholesale or other sources of external funding, or may have to increase deposit rates to maintain deposit levels in the future. Any such increased reliance on wholesale funding, or increases in funding rates in general, could have a negative impact on the Company’s net interest income and, consequently, on its results of operations and financial condition. Furthermore, the portion of our deposit portfolio that is comprised of large uninsured deposits may be more likely to be withdrawn rapidly under adverse economic conditions. If our clients, including our trust clients, move money out of bank deposits into investments or to other financial institutions, we could lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.
The Company is subject to interest rate risk and changes in interest rates could affect our net interest margins and net interest income, the value of our assets and obligations, and the availability and cost of capital or liquidity.
Our profitability is dependent to a large extent on our net interest income, which is the difference between interest income we earn as a result of interest paid to us on loans and investments and interest we pay to third parties such as our depositors and those from whom we borrow funds. As interest rates change, net interest income is affected.
Interest rates are highly sensitive to many factors that are beyond our control, including (among others) general and regional and local economic conditions, the monetary policies of the Federal Reserve, bank regulatory requirements, competition from other banks and financial institutions and a change over time in the mix of our loans and investment securities, on the one hand, and on our deposits and other liabilities, on the other hand. Sustained low levels of market interest rates, as we have experienced prior to 2022, would continue to place downward pressure on our net interest margins and, therefore, on our earnings. Conversely, increases in interest rates, though they could increase our interest margins absent a commensurate rise in our cost of funds, also have the potential to affect borrowers’ ability to repay, particularly for the small and medium sized businesses to which we lend, subjecting us to potential loan losses. This effect could be exacerbated by an inflationary environment. During the year ended December 31, 2022, the Federal Open Market Committee (“FOMC”) of the Federal Reserve repeatedly raised their target benchmark interest rate in response to the ongoing inflationary environment in the United States, resulting in subsequent prime rate increases of 425 basis points between March and December of 2022. The FOMC have raised interest rates another 75 basis points thus far in 2023. Further, substantially higher interest rates generally reduce loan demand and may result in slower loan growth and may encourage current borrowers to repay loans early. All of these factors are detrimental to our business, and the interplay between these factors can be complex and unpredictable.
Our net interest margins and earnings also could be adversely affected if we are unable to adjust our interest rates on loans and deposits on a timely basis in response to changes in economic conditions or monetary policies. For example, if the rates of interest we pay on deposits, borrowings and other interest-bearing liabilities increase faster than we are able to increase the rates of interest we charge on loans or the yields we realize on investments and other interest-earning assets, our net interest income and, therefore, our earnings will decrease. Conversely, in an environment of decreasing interest rates, loan originations may also decline, and our borrowers may experience difficulties meeting their obligations or seek to refinance their loans for lower rates, which may adversely affect income from these lending activities and negatively impact our net interest margin. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also reduce collateral values and necessitate further increases to the allowance for loan losses, which could have a material adverse effect on our business, financial condition and results of operations. Also, changes in interest rates might impact the values of equity and debt securities under management and administration, which may have a negative impact on fee income.
Further, rising short-term interest rates are likely to result in declines in both fixed income (bond) and stock prices. Declining fixed income and stock prices will result in a decline in the value and potentially the volume of both trust assets on which the Bank provides fiduciary services and the assets under management at Tectonic Advisors and Sanders Morris, as well as declining capital markets, private placement and brokerage activities of Sanders Morris - as does an economic recession. This will have an adverse impact on the revenues and earnings of the Company. An economic recession will also result in higher losses on the Bank’s loan portfolio and its factored receivables portfolio and decreased economic activity, both of which negatively impact Bank earnings and capital. Thus, an economic recession negatively impacts almost every aspect of the Company’s business and will have a negative and adverse effect on the earnings, capital and financial position of the Company.
We are subject to consolidated capital ratio requirements, and therefore have to hold additional capital.
Prior to our initial public offering in May 2019, the Company qualified as a “small bank holding company.” This meant, among other things, that the Company was not subject to minimum consolidated capital requirements. Upon consummation of the Tectonic Merger, we ceased to qualify as a small bank holding company and must maintain certain minimum capital ratios on a consolidated basis with the Bank. As described further below, our failure to meet capital requirements could, among other things, affect client and investor confidence, our ability to grow, our costs of funds, our ability to pay dividends on preferred and common stock, our ability to make acquisitions, and adversely affect our business, results of operations and financial condition.
If we are unable to sell additional services and products to existing clients or attract new clients in a manner that is cost-effective and assures client success, we will not be able to grow our business, which could adversely affect our results of operations and financial condition.
In order to grow our business, we must continue to attract new clients in a cost-effective manner and enable these clients to realize the benefits associated with our products and services. Part of our strategic plan is to market our suite of financial services and products across the clients of our subsidiaries. We may not be able to attract clients from one of our subsidiaries to use another subsidiary for different financial services or products. This could be for a variety of reasons, including as a result of their continued use of our competitors and/or other impediments that hinder their ability to migrate to or adopt our financial products or services. If we are unable to entice existing clients to expand their use of our financial products and services, we may see an increase in our client acquisition costs which could have a material adverse effect on our business, results of operations and financial condition.
We may not be able to implement aspects of our expansion strategy, which may adversely affect our ability to maintain our historical earnings trends.
We may not be able to sustain our growth at the rate we have enjoyed during the past several years. A downturn in local economic market conditions, particularly in the real estate market, a failure to attract and retain high performing personnel, heightened competition from other financial services providers, and an inability to attract additional deposits in a cost-effective manner and lending clients, among other factors, could limit our ability to grow as rapidly as we have in the past and as such may have a negative effect on our business, financial condition and results of operations. In addition, risks associated with failing to maintain effective financial and operational controls as we grow, such as maintaining appropriate loan underwriting procedures, determining adequate allowances and complying with regulatory accounting requirements, including increased loan losses, reduced earnings and potential regulatory penalties and restrictions on growth, all could have a negative effect on our business, financial condition and results of operations.
Our securities portfolio is subject to risk of loss; the fair value of our investment securities can fluctuate due to factors outside of our control.
As of December 31, 2022, the fair value of our investment securities portfolio was $49.5 million. The Bank invests a portion of its assets in U.S. Treasuries, U.S. government agencies, mortgage-backed securities, direct obligations of quasi government agencies including Fannie Mae, Freddie Mac, and the FHLB, and federal funds sold. In addition, the Bank may make investments in certain municipal or state obligations or securities that it believes have a similar risk profile thereto, or Other Securities. Other Securities include, among other things, securities issued pursuant to Property Assessed Clean Energy (“PACE”) and Public Improvement District/Tax Increment Reinvestment Zone (“PID/TIRZ”) programs. These programs are created by state and local municipalities to finance energy efficiency upgrades or renewable energy installations for residential, commercial and industrial property owners. Investments in instruments other than U.S. Treasuries carry a degree of risk, including risk of default, market fluctuations and lack of liquidity.
Factors beyond our control can significantly influence and cause adverse changes to occur in the fair values of securities in that portfolio. These factors include, but are not limited to, rating agency actions in respect of the investment securities in our portfolio, defaults by the issuers of such securities, concerns with respect to the enforceability of the payment or other key terms of such securities, changes in market interest rates, continued instability in the capital markets and lack of liquidity or marketability. Any of these factors, as well as others, could cause other-than-temporary impairments and realized or unrealized losses in future periods and declines in other comprehensive income, which could materially and adversely affect our business, results of operations, financial condition and prospects. As discussed above, the FOMC repeatedly raised their target benchmark interest rate in 2022, resulting in subsequent prime rate increases of 425 basis points between March and December of 2022, and further resulting in a significant increase in market interest rates during the year ended December 31, 2022. If market interest rates continue to rise, the market value of the fixed income bond portfolio will decrease, resulting in unrealized losses, and depending on the extent of the rise in interest rates, the increase in unrealized losses could be significant over the short-term. The non-credit portion of unrealized losses on the Bank’s available for sale securities portfolio are booked to Accumulated Other Comprehensive Income (“AOCI”), a component of shareholders' equity, and unrealized losses net of the related tax effect as of December 31, 2022 totaled $2.4 million, which represents approximately 3.0% of our total capital. A significant increase in market rates may have a negative impact on book value per common share and return on average shareholders' equity ratios. The Company’s bond portfolio is expected to mature at par and therefore the unrealized losses in the portfolio that result from higher market interest rates will decrease as the bonds become closer to maturity.
In addition, the process for determining whether an impairment of a security is other-than-temporary usually requires complex, subjective judgments, which could subsequently prove to have been wrong, regarding the future financial performance and liquidity of the issuer of the security, the fair value of any collateral underlying the security and whether and the extent to which the principal of and interest on the security will ultimately be paid in accordance with its payment terms. Further, any loss from any such Other Securities or any other securities in our portfolio would negatively impact the capital of the Bank and such impact could be material.
New lines of business or new products and services may subject us to additional risk.
From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In acquiring, developing and/or marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the integration, development and implementation of new lines of business and/or new products or services could have a material adverse effect on our business and, in turn, our financial condition and results of operations.
Acquisitions may subject us to integration risks and other unknown risks.
Although we plan to continue to grow our business organically, we also intend to pursue acquisition opportunities that we believe complement our activities and have the ability to enhance our profitability and provide attractive risk-adjusted returns. Acquisitions involve inherent uncertainty and we cannot determine all potential events, facts and circumstances that could result in loss or increased costs. Our due diligence or risk mitigation efforts may not be sufficient to protect against any such loss or increased costs. Moreover, any acquisitions may require the approval of our bank regulators and we may not be able to obtain such approvals on acceptable terms, if at all.
In addition, certain events may arise after the date of an acquisition, or we may learn of certain facts, events or circumstances after the closing of an acquisition, that may affect our financial condition or performance or subject us to risk of loss. These events include, but are not limited to: retaining key employees and clients, achieving anticipated synergies, meeting expectations and otherwise realizing the undertaking’s anticipated benefits; litigation resulting from circumstances occurring at the acquired entity prior to the date of acquisition; loan downgrades and credit loss provisions resulting from underwriting of certain acquired loans determined not to meet our credit standards; personnel changes that cause instability within a department; and other events relating to the performance of our business.
Mergers and acquisitions frequently result in the recording of goodwill and other intangible assets, which are subject to potential impairments in the future and that could harm our financial results. In addition, if we finance acquisitions by issuing convertible debt or equity securities, our existing shareholders may be diluted, which could affect the market price of the Series B preferred stock. As a result, if we fail to properly evaluate mergers, acquisitions or investments, we may not achieve the anticipated benefits of any such merger or acquisition, and we may incur costs in excess of what we anticipate. The failure to successfully evaluate and execute mergers, acquisitions or investments or otherwise adequately address these risks could materially harm our business, financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships, or the public’s perception of the soundness of the nation’s financial system. We have exposure to many different counterparties and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the receivable due us. Finally, if the public views the nation’s financial system (specifically, small banks and/or investment companies) as unstable, customers might withdraw their funds, resulting in losses. Any such forgoing losses could be material and could materially and adversely affect our business, financial condition, and results of operations.
In addition, we do not provide custodial services for our clients. Instead, client investment accounts are maintained under custodial arrangements with large, well established securities brokerage firms or bank institutions that provide custodial services, or, collectively, custodial firms, either directly or through arrangements made by us with those firms. As a result, the performance of, or even rumors or questions about the integrity or performance of, any of those custodial firms could adversely affect the confidence of our clients in the services provided by those firms or otherwise adversely impact their custodial holdings. Such an occurrence could negatively impact our ability to retain existing or attract new clients and, as a result, could have a material adverse effect on our business, financial condition, results of operations and prospects.
Negative public opinion regarding us or failure to maintain our reputation in the communities we serve could adversely affect our business and prevent us from growing our business.
Reputation risk, or the risk to our business, earnings and capital from negative public opinion is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract customers and employees and can expose us to litigation and regulatory action and adversely affect our results of operations. Furthermore, to the extent that depositors - particularly uninsured depositors - become concerned about the Bank’s financial condition or solvency, such depositors could withdraw they funds and create a ”run on the bank”. Although we take steps to minimize reputational risk in dealing with our customers and communities, this risk will always be present given the nature of our business. In addition, companies are facing increased scrutiny from customers, regulators, investors, and other stakeholders related to their environmental, social and governance (“ESG”) practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environment, health and safety, diversity, labor conditions and human rights. For example, certain investors are beginning to incorporate the business risks of climate change and the adequacy of companies’ responses to climate change and other ESG matters as part of their investment theses. These shifts in investing priorities may result in adverse effects on the trading price of the Company’s preferred stock if investors determine that the Company has not made sufficient progress on ESG matters. In addition, new government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure. Increased ESG-related compliance costs could result in increases to our overall operational costs.
Growth of our business could result in increased costs.
Our overall profitability would be negatively affected if investments and expenses associated with the growth of our business are not matched or exceeded by the revenue that is derived from such growth. Further, expanding existing and/or new business lines may involve recruiting and hiring new personnel. Hiring new personnel, especially professionals, is an inherently risky endeavor. The person needs to be a good fit within the organization, the person needs to be able to execute within the Company’s existing corporate structure (which may differ from his/her previous place of employment) and the person may need to attract his or her clients (and prospective clients) to the Company. If any of these (or other) factors do not occur, the Company may have to terminate such person’s employment and/or such person may leave the Company, which means that the cost of hiring, compensation paid and/or termination costs (including potential litigation) may impact the Company’s results of operations in a negative and adverse manner. In addition, such personnel may be employed by competitors, and the retention of such individuals may require us to enter into guaranteed compensation contracts for a period following commencement of employment. The compensation terms provided for in such contracts may be fixed in whole or in part. Any guaranteed compensation expenses that cannot be adjusted based on the success or profitability of the offices could reduce our operating margins. Expansion also creates a need for additional compliance, documentation, risk management and internal control procedures, and often involves the hiring of additional personnel to monitor such procedures. To the extent such procedures are not adequate to appropriately monitor any new or expanded business, we could be exposed to a material loss or regulatory sanction.
Significant revenues and profits are generated as a result of our relationship with Cain Watters, and a change in the relationship or decline in Cain Watters’ business could adversely affect us.
Cain Watters provides advisory services to approximately 2,750 dental practices across the United States and plays a meaningful role in referring trust, TPA, participant directed 401k plans and lending business to the Bank. In addition, Tectonic Advisors generates a substantial portion of its revenues and profits under a long-term contract to provide advisory and due diligence services to assist in the management of assets of clients of Cain Watters. In the event that the Cain Watters’ relationship does not continue (for whatever reason), such a change could have a material adverse effect on the profits and operations of the Company.
Historically, the partners of Cain Watters had most of the client relationships. Thus, most of the referrals to the Bank and Tectonic Advisors have historically been through the partners of Cain Watters, each of whom has a relatively long relationship with the Bank and Tectonic Advisors and also is a shareholder of the Company. However, Cain Watters has experienced significant growth over the past few years and has expanded its client service and planning teams to accommodate this growth. The leaders of these teams, called planners, are younger, have significant influence over clients’ decisions regarding service providers and are more technologically focused and, given this, may refer their clients to other providers at rates greater than historical averages, which would have (over time) a material adverse effect on the Bank and the Company.
In addition, Cain Watters is subject to, and has periodically faced, business challenges associated with litigation over private placements conducted by affiliates between 2006-2009, which were negatively impacted by the financial crisis and subsequent collapse in the energy markets, and lower assets under management resulting from the market correction. Further, to the extent that clients suffer losses or poor performance on these or other investments, they may move their money from Cain Watters to another advisor, which could have a material adverse impact on Cain Watters and also the Company.
We believe that any material adverse effect on the business of Cain Watters could have a material adverse effect on the Company. Cain Watters’ business is primarily focused on dental practices. To the extent that the dental industry is disrupted or dental practices are adversely impacted for whatever reason, the Company’s business may be adversely impacted as well.
We depend on key personnel, and may have difficulty identifying, attracting and retaining necessary personnel, to execute our business strategy and successfully expand our operations. This risk includes the risk of retirement of key professionals in leadership roles, including loan officers, members of our SBA team, and financial advisors and brokers.
We are reliant on key members of our senior management team, business development officers within the Bank (who are critical to generating loan growth) and financial advisors and brokers (who are critical to driving asset growth at Tectonic Advisors and Sanders Morris). Personnel changes will occur from time to time, and we cannot predict whether significant resignations and retirements will occur or whether we will be able to recruit additional qualified personnel. With the exception of certain members of senior management, none of our professionals are subject to employment agreements and are free to leave at any time. Further, certain of our executive officers, financial advisors and brokers and SBA loan production officers are either financially secure or, in some cases, beyond retirement age for many Americans, and do not have to work. Thus, these individuals are more susceptible to retirement. Departures, particularly of key employees in leadership or client development roles, may cause client defections due to close relationships between clients and such professionals. While we have succession plans in place, the loss of any key employee may have a material adverse effect on our business and prospects. If we are unable to retain our key employees or attract, recruit, integrate, or retain other skilled professionals in the future, our business could suffer materially in the future..
The employment market has become increasingly competitive; We may have difficulty attracting and retaining skilled personnel
The employment market has become increasingly competitive over the past two years. We derive a substantial portion of our revenue from the efforts of our professional team, including loan officers, members of our SBA team, and financial advisors and brokers. Therefore, our future success depends, in large part, on our ability to attract, recruit, and retain qualified financial services professionals. Competition for the best people in many activities engaged in by us is intense including with respect to compensation and emerging workplace practices, accommodations, and remote work options, and we may not be able to replace personnel promptly at acceptable compensation levels or at all, and may have difficulty retaining them. These circumstances have led to escalating compensation packages in the industry. Up-front payments, increased payouts, and guaranteed contracts have made recruiting and retaining these professionals more expensive and more difficult and can lead to departures by current professionals. The unexpected loss of personnel could impact our ability to serve our clients timely, and could also negatively impact our internal operations, including regulatory compliance. A lack of skilled, seasoned personnel with knowledge of our business and our market could reduce the performance of certain areas of our business, increase our error rate in key areas, affect our ability to grow our business, and lead to a lack of talented professionals ready to advance into leadership roles in the longer term. Due to these potential effects, the tightening employment market could have a material adverse impact on our business, financial condition and results of operations.
A decline in general business and economic conditions and any regulatory responses to such conditions could have a material adverse effect on our business, financial position, results of operations and growth prospects.
As a business operating in the bank and non-bank financial services industries, our business and operations are sensitive to general business and economic conditions in the United States, generally, and particularly the State of Texas. If the U.S. or Texas economies weaken, our growth and profitability from our lending, deposit and investment operations could be constrained. Unfavorable or uncertain economic and market conditions could lead to credit quality concerns related to borrower repayment ability and collateral protection as well as reduced demand for the products and services we offer. In addition, economic conditions in foreign countries, including global political hostilities, U.S. and foreign tariff policies and uncertainty over the stability of the euro currency, could affect the stability of global financial markets, which could hinder domestic economic growth. Concerns about the performance of international economies can impact the economy and financial markets here in the United States. If the national, regional and local economies experience worsening economic conditions, including high levels of unemployment, our growth and profitability could be constrained. Weak economic conditions are characterized by, among other indicators, deflation, elevated levels of unemployment, fluctuations in debt and equity capital markets, increased delinquencies on commercial, mortgage and consumer loans, residential and commercial real estate (“CRE”), price declines and lower home sales and commercial activity. A significant outbreak of disease pandemics or other adverse public health developments in the population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could adversely affect our customers’ businesses and results of operations. Our business is also significantly affected by monetary and related policies of the U.S. government and its agencies.
In addition, declines in the U.S. stock markets directly impact our Investment Services segment and also our trust assets. With any such declines, our assets under management and advisement and trust assets decline in value and clients are less apt to invest. Since our investment advisory revenues are based on assets, this leads to a decline in our Investment Services and trust revenues. In addition, even though our brokerage revenues are not based on assets, brokerage revenues may also be impacted by declines in the stock market because investors may be less inclined to trade stocks and/or bonds. Since our brokerage revenues are based on activity, we would likely see a decline in brokerage revenues as a result of stock market declines.
In recent years, economic growth has been uneven, and opinions vary on the strength and direction of the economy. Uncertainties continue regarding the potential for a renegotiation of international trade agreements and the effect of the legislation enacted by the recent presidential administration, and the impact such actions and the policies of the administration of President Joseph Biden may have on economic and market conditions. A trade war or other governmental action related to tariffs or international trade agreements or policies, as well as the current conflict in Ukraine and COVID-19 or other potential epidemics or pandemics, have the potential to negatively impact our and/or our customers’ costs, demand for our customers’ products, and/or the U.S. economy or certain sectors thereof and, thus, adversely affect our business, financial condition, and results of operations.
The Federal Reserve’s recent unprecedented rate hikes in response to the inflationary environment may further impact our ability to attract deposits, and could have an adverse effect on our business, financial condition and results of operations as increased interest rates could reduce the demand for loans and affect the ability of our borrowers to repay their indebtedness subjecting us to potential loan losses. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial condition, results of operations and growth prospects. All of these factors are detrimental to our business, and the interplay between these factors can be complex and unpredictable.
In addition, the inflationary outlook in the United States remains uncertain. Inflation, which at December 31, 2022, has been reported at the highest level in nearly 40 years, and could result in higher interest rates, which expose the Company to interest rate risk. In addition, higher interest rates could slow economic growth and lead to a recessionary environment, which could negatively impact the Company’s growth, credit quality, net interest margin and its financial results. The risks to our business from inflation depends on the durability of the current inflationary pressures in our markets. Transitory increases in inflation are unlikely to have a material impact on our business or earnings. However, more persistent inflation could lead to tighter-than-expected monetary policy which could, in turn, increase the borrowings costs of our customers, making it more difficult for them to repay their loans or other obligations. High interest rates may be needed to tame persistent inflationary price pressures, which could also push down asset prices and weaken economic activity. A deterioration in economic conditions in the United States and our markets could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, all of which, in turn, would adversely affect our business, financial condition and results of operations.
Lower Trucking Margins and Revenues Negatively Impact Trucking Industry and Factoring
The trucking industry, particularly over the road trucking, is a volatile industry and sees the freight rates increase or decline based on the state of the economy, customer demand and/or supply and demand considerations in the trucking industry. In the second half of 2022, freight rates - which are the rates that trucking companies charge customers for transportation services - declined by as much as 20% or more (generally) across the industry, for over-the-road trucking. Thus, revenues have declined, on a per truck basis, for most trucking companies by 20% or more, causing a significant decline in the amount of receivables factor Further, diesel prices - a key cost of trucking companies - has been at high levels.
Our business is concentrated in, and dependent upon, the continued growth and welfare of our primary market, and adverse economic conditions in such market could negatively impact our operations and clients.
Although we provide services nationwide, our business is concentrated primarily in the State of Texas. Our success depends to a certain extent upon the business activity, population, income levels, employment trends, deposits and real estate activity in this primary market. Although our clients’ business and financial interests may extend beyond our primary market, adverse conditions that affect our primary market could reduce our growth rate, affect the ability of our clients to repay their loans, affect the value of collateral underlying our loans, affect our ability to attract deposits, affect the ability of our clients to make additional investments or cause such clients to withdraw their investments, affect the value of our assets under management and generally affect our business, financial condition, results of operations and future prospects. Due to our geographic concentration within our primary market, we may be less able than other larger regional or national financial institutions to diversify our credit risks across multiple markets.
We have a loan concentration related to the acquisition and financing of dental practices.
Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. As of December 31, 2022, our loan portfolio included $83.9 million of loans to the dental industry, representing approximately 18.6% of our total funded loans. These loans include practice acquisition loans, dental equipment loans, and dental facility loans. We had no charge-offs during 2022 and 2021 in our dental portfolio assets. We believe that these loans are conservatively underwritten to credit worthy borrowers and are diversified geographically. However, to the extent that there is a decline in the dental industry in general, we may incur significant losses in our loan portfolio as a result of this concentration.
A governmental shutdown or curtailment of government guaranteed loan programs could affect a segment of our business.
A major segment of our business consists of originating and periodically selling government guaranteed loans, in particular those guaranteed by the USDA and SBA. From time to time, the government agencies that guarantee these loans reach their internal limits and cease to guarantee loans. In addition, these agencies may change their rules for loans or Congress may adopt legislation that would have the effect of discontinuing or changing the loan programs. Non-governmental programs could replace government programs for some borrowers, but the terms might not be equally acceptable. Therefore, if these changes occur, the volume of loans to small businesses and industrial borrowers of the types that now qualify for government guaranteed loans could decline. Also, the profitability of these loans could decline. As the funding of the guaranteed portion of 7(a) loans has historically been a major portion of our business, a long-term decrease or discontinuation in the funding for the 7(a) loan program may have an unfavorable impact on our future performance and results of operations. In addition, any default by the U.S. government on its obligations or any prolonged government shutdown could, among other things, impede our ability to originate SBA or USDA loans or sell such loans in the secondary market, which could materially and adversely affect our business, financial condition and results of operations.
Our factoring services through the Bank’s Integra factoring division are concentrated in the transportation industry and economic conditions or other factors negatively impacting the transportation industry could adversely affect our factoring business; factoring invoice levels are at historical highs.
Factoring for small-sized trucking businesses constituted the vast majority of our total factoring portfolio as of December 31, 2022, calculated based on the gross receivables from the purchase of invoices from such trucking businesses compared to our total gross receivables in the purchase of factored receivables as of such date. Given the concentration of our factoring business in the transportation industry, economic conditions or other factors that negatively impact the transportation industry could impact our factoring revenues, as the revenues we earn from purchasing transportation invoices are directly correlated with the amount of transportation activity generated by our factoring clients (i.e., the volume of transportation invoices they are able to generate by providing their services). Reductions in economic activity will typically cause a decrease in the volume of goods in commerce available to be transported by our factoring clients. Increased costs associated with operating a trucking business, such as may be caused by increases in the prices of oil and diesel fuel, may cause a diminished demand for trucking services as our clients pass those costs along to their customers. Conversely, decreases in the price of diesel fuel may cause the size of our factoring portfolio to decrease, as the price of diesel fuel typically directly correlates with the size of the invoices we purchase from our factoring clients. Additionally, the factoring industry may not continue its historical growth and we may face increased competition. Our failure to compete effectively in our market could restrain our growth or cause us to lose market share. Any of such events could impact the returns we realize on our factoring activity or result in a decrease in the overall amount of our factoring activity and could have an adverse effect on our business, financial condition and results of operations.
We face specific risks associated with retention of unguaranteed portions of SBA loans.
The Bank has historically sold a considerable portion of the guaranteed portion of its SBA loans within a short period of time of originating such loans. Upon sale, the Bank retains the unguaranteed portion of such loans. As of December 31, 2022, the unguaranteed portion of our SBA loans totaled $56.3 million, representing 12.5% of our total loan portfolio. Given that the SBA requires that the Bank only make loans to borrowers that do not have access to conventional bank financing, the unguaranteed portion of these loans carry greater risk than traditional loans. As the Bank’s loan portfolio of the unguaranteed portion of SBA loans grows, its risk of loss due to defaults also grows. The Bank has a reserve for such unguaranteed portion of SBA loans. To the extent that this reserve is not adequate to cover losses, the Bank will suffer losses to its capital base and such losses could be material.
The success of our trust services is dependent upon market fluctuations and a non-diversified source for its growth.
We offer traditional fiduciary services such as serving as executor, trustee, agent, administrator or custodian for individuals, nonprofit organizations, employee benefit plans and organizations. As of December 31, 2022, the Bank had approximately $1.6 billion in trust assets. The level of assets under management is significantly impacted by the market value of the assets. To date, virtually all of the growth in our assets under management relates to one registered investment advisor, Cain Watters, who has advised its clients of the existence of our trust services. We have not compensated the registered investment advisor in any way for making its clients aware of our trust services and cannot assure you that the investment advisor will continue to notify its clients of our trust services or that those clients will open trust accounts at the Bank. Related to this, the Bank and Cain Watters are parties to an agreement which includes a provision obligating each party to preserve the other’s business relationship with their mutual clients. However, in the event that the Cain Watters’ relationship does not continue (for whatever reason) to refer client to the Bank’s trust department, such a change could have a material adverse effect on the future growth and, thus, profits and operations of the Company. In addition, we are subject to regulatory supervision with respect to these trust services that may restrain our growth and profitability.
We are subject to possible claims and litigation pertaining to fiduciary responsibility.
Clients could make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Whether client claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect our market perception of our products and services as well as impact client demand for those products and services. Although we have not experienced any material claims or litigation pertaining to fiduciary responsibility, the occurrence of any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
We could suffer material credit losses.
There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of non-payment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions and increases in inflation and interest rates. Changes in the economy can cause the assumptions that we made at origination to change and can cause borrowers to be unable to make payments on their loans, and significant changes in collateral values can cause us to be unable to collect the full value of loans we make. Increases in interest rates and inflation increase costs and decrease profits, reducing the ability of a borrower to make payments on its loan. There is no assurance that our credit risk monitoring and loan approval procedures are or will be adequate or will reduce the inherent risks associated with lending. Our credit administration personnel and our policies and procedures may not adequately adapt to changes in economic or any other conditions affecting clients and the quality of our loan portfolio. Any failure to manage such credit risks may materially adversely affect our business, financial condition and results of operations.
Our levels of nonperforming assets could increase, which could adversely affect our results of operations and financial condition, and could result in losses in the future.
As of December 31, 2022, our nonperforming loans (which consist of non-accrual loans, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings that are not performing in accordance with their modified terms) totaled $2.8 million. We had no other real estate owned at December 31, 2022. However, our nonperforming assets may continue to remain at low levels or we may experience increases in nonperforming assets in the future. Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our net interest income, net income and returns on assets and equity, and our loan administration costs increase, which together with reduced interest income adversely affects our efficiency ratio. When we take collateral in foreclosure and similar proceedings, we are required to mark the collateral to its then-fair market value and estimate disposition costs, which may result in a loss. These nonperforming loans and other real estate owned also increase our risk profile and the level of capital our regulators believe is appropriate for us to maintain in light of such risks. The resolution of nonperforming assets requires significant time commitments from management and can be detrimental to the performance of their other responsibilities. Further, since many of our loans are located outside of our primary market area, collecting delinquent loans would be more difficult for our staff relative to our competitors. If we experience increases in nonperforming loans and nonperforming assets, our net interest income may be negatively impacted and our loan administration costs could increase, each of which could have an adverse effect on our net income and related ratios, such as returns on assets and equity.
Our allowance for loan losses may not be sufficient to absorb actual losses.
Experience in the banking industry indicates that a portion of our loans in all categories of our lending business will become delinquent, and some may only be partially repaid or may never be repaid at all. Our methodology for establishing the adequacy of the allowance for loan losses depends on subjective application of risk grades as indicators of borrowers’ ability to repay. Deterioration in general economic conditions and unforeseen risks affecting clients may have an adverse effect on borrowers’ capacity to repay timely their obligations before risk grades could reflect those changing conditions. In times of improving credit quality, with growth in our loan portfolio, the allowance for loan losses may decrease as a percent of total loans. Changes in economic and market conditions may increase the risk that the allowance would become inadequate if borrowers experience economic and other conditions adverse to their businesses. Maintaining the adequacy of our allowance for loan losses may require that we make significant and unanticipated increases in our provisions for loan losses, which could materially affect our results of operations and capital adequacy. Recognizing that many of our loans individually represent a significant percentage of our total allowance for loan losses, adverse collection experience in a relatively small number of loans could require an increase in our allowance.
Federal regulators, as an integral part of their respective supervisory functions, periodically review our allowance for loan losses. The regulatory agencies may require us to change classifications or grades on loans, increase the allowance for loan losses with large provisions for loan losses and recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our results of operations and financial condition.
A new accounting standard will result in a significant change in how we recognize credit losses and may result in material increases to our allowance for loan losses.
The Financial Accounting Standards Board (“FASB”) has adopted a new accounting standard referred to as Current Expected Credit Loss (“CECL”) for allowance for loan and lease losses (“ALLL”) CECL was promulgated in 2016 and currently scheduled to take effect for large reporting SEC registrants in 2020 and all other banks in 2023, which would include the Bank. This standard will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans at the time of origination or purchase and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses on our existing loan portfolio and increase the reserve as we originate and/or purchase loans in the future. In determining expected loan losses in accordance with CECL, we will have to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. In anticipation of the adoption of CECL, we have incurred, and will likely continue to incur, significant additional expense to comply with the new standard. In addition and more significantly, we believe that CECL, if implemented as currently promulgated, would result in a significantly greater reserve than we currently have in our ALLL, which will negatively impact our capital position and thus our Tier 1 leverage ratio and other capital ratios and may require us to raise additional capital. Further, to the extent that CECL requires us to book a greater reserve on future loan originations and/or purchases, our earnings will decline and our ability to build further capital will be reduced. Management expects the adoption of ASU 2016-13 will result in a combined 30% to 40% increase in our allowance for loan losses and our reserves for unfunded commitments and a cumulative-effect adjustment to reduce retained earnings by 1% to 2%. As we are currently finalizing the execution of our implementation controls and processes, the ultimate impact of the adoption of ASU 2016-13 as of January 1, 2023 could differ from our current expectation.
Our legal lending limits may impair our ability to attract borrowers and ability to compete with larger financial institutions.
Our per client lending limit at December 31, 2022 was approximately $12.2 million. Accordingly, the size of loans which we can offer to potential clients is less than the size which many of our competitors with larger lending limits are able to offer. This limit has affected and will continue to affect our ability to seek relationships with larger businesses in our market area. We accommodate loans in excess of our lending limit through the sale of portions of such loans to other banks. However, we may not be successful in attracting or maintaining clients seeking larger loans or in selling portions of such larger loans on terms that are favorable to us.
The level of our commercial real estate loan portfolio may subject us to heightened regulatory scrutiny.
The banking regulators have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under the guidance, a financial institution that is actively involved in commercial real estate lending should perform a risk assessment to identify potential concentrations in commercial real estate lending. A financial institution may have such a concentration if, among other factors: (i) total outstanding loans for construction, land development, and other land represent 100% or more of total risk-based capital (“CRE 1 Concentration”); or (ii) total outstanding loans for construction, land development and other land and loans secured by multifamily and non-owner occupied non-farm, non-residential properties (excluding loans secured by owner-occupied properties) represent 300% or more of total risk-based capital (“CRE 2 Concentration”), and the institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36-month period. In such an instance, management should employ heightened risk management practices, including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. As of December 31, 2022, our CRE 1 Concentration level was 22.5% and our CRE 2 Concentration level was 141.00%. We may, at some point, be considered to have a concentration in the future, or our risk management practices may be found to be deficient, which could result in increased reserves and capital costs as well as potential regulatory enforcement action.
The small- to medium-sized businesses that we lend to may have fewer resources to weather adverse business conditions, which may impair their ability to repay a loan, and such impairment could adversely affect our results of operations and financial condition.
Our business development and marketing strategies primarily serve the banking and financial services needs of small- to medium-sized businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities, frequently have smaller market shares than their competition, may be more vulnerable to economic downturns and/or increases in interest rates and inflationary pressure, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small- to medium-sized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have a material adverse impact on the business and its ability to repay its loans. If general economic conditions negatively impact Texas or the specific markets in which we operate and small- to medium-sized businesses are adversely affected or our borrowers are otherwise affected by adverse business conditions, our business, financial condition and results of operations could be adversely affected.
Our commercial finance clients, particularly with respect to the Bank’s Integra factoring division, may lack the operating history, cash flows or balance sheet necessary to support other financing options and may expose us to additional credit risk, especially if our additional controls for such products are ineffective in mitigating such additional risks.
A significant portion of our loan portfolio consists of commercial finance products. Some of these commercial finance products, particularly asset-based loans and our factored receivables through the Bank’s Integra division, arise out of relationships with clients who lack the operating history, cash flows or balance sheet necessary to qualify for other financing options. We attempt to control for the additional credit risk in these relationships through credit management processes employed in connection with these transactions. However, if such controls are ineffective in controlling this additional risk or if we fail to follow the procedures we have established for managing this additional risk, we could be exposed to additional losses with respect to such product lines that could have an adverse effect on our business, financial condition and results of operations.
Certain of our loans are not secured by property but dependent on the earning capacity of the borrower.
Certain of our loans are not collateralized or fully collateralized by tangible property, but are made on the basis of the cash flow (earnings) being generated by the borrower. These include, without limitation, certain loans to dentists to either buy out another dentist in a dental practice and/or to buy into a dental practice or to purchase or establish a dental practice. In this case, the borrower may be the dentist and/or the dental practice, neither of which may have sufficient tangible assets (cash, marketable securities, real estate or other tangible assets) to fully secure or even secure a portion of the loan being made. Rather, we look to the earning power and capacity of the dentist and/or dental practice as the primary source of repayment of the loan. In the event that the dentist or dental practice’s earning power is insufficient to service or repay the loan, the additional collateral is usually insufficient to cover the outstanding loan balance, in which case we lose substantially all of the loan balance. In the event that these loans default at a high rate, we will likely recover very little from the underlying collateral, in which case the Bank could suffer significant losses and you could lose some or all of your investment in your Series B preferred stock.
The Company’s use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and an error in fact or judgment could adversely affect the reliability of an appraisal. In addition, events occurring after the initial appraisal may cause the value of the real estate to decrease. As a result of any of these factors, the value of collateral backing a loan may be less than supposed, and if a default occurs, we may not recover the outstanding balance of the loan.
Fee revenue represents a significant portion of our consolidated revenue and is subject to decline, among other things, in the event of a reduction in, or changes to, the level or type of investment activity by our clients and market declines.
As a result of the Tectonic Merger, a significant portion of our revenue is the result of fee-based services related to investment advisory, trust services, insurance and brokerage activities. This contrasts with many commercial banks that may rely more heavily on interest-based sources of revenue, such as loans. For the year ended December 31, 2022, consolidated non-interest income represented approximately 59.3% of our consolidated gross revenue (which is net interest income plus non-interest income). The level of these fees is influenced by several factors, including the mix and volume of our assets under custody and administration and our assets under management, market declines (which reduce asset values), the value and type of securities positions held (with respect to assets under custody) and the volume of portfolio transactions, and the types of products and services used by our clients.
In addition, our combined clients include private investors, defined benefit and contribution plans, institutional investors, such as mutual funds, collective investment funds, hedge funds and other investment pools, and investment managers. Economic, market or other factors that reduce the level or rates of savings in or with those institutions, either through reductions in financial asset valuations or through changes in investor preferences, could materially reduce our fee revenue or have a material adverse effect on our consolidated results of operations. These clients also, by their nature, are often able to exert pricing pressure, and this, combined with strong competitive forces in the markets for our services, has resulted in, and may continue to result in, significant pressure to reduce the fees we charge for our services in both our asset servicing and asset management business lines.
The business operations of Sanders Morris may face limitations due to net capital requirements.
As a registered broker-dealer, Sanders Morris is subject to the net capital rules administered by the SEC and FINRA. These rules, which specify minimum net capital requirements for registered broker-dealers and FINRA members, are designed to assure that broker-dealers maintain adequate net capital in relation to their liabilities and the size of their client’s business. These requirements have the effect of requiring that a substantial portion of a broker-dealer’s assets be kept in cash or highly liquid investments. Failure to maintain the required net capital may subject a firm to suspension or revocation of its registration by the SEC and suspension or expulsion by FINRA and other regulatory bodies. Compliance with these net capital rules could limit operations that require extensive capital, such as underwriting or trading activities.
These net capital rules could also restrict our ability to withdraw capital in situations where Sanders Morris has more than the minimum required capital. We may be limited in our ability to pay dividends, implement our strategies, pay interest or repay principal on our debt, and redeem or repurchase our outstanding preferred or common stock. In addition, a change in these net capital rules or new rules affecting the scope, coverage, calculation, or amount of the net capital requirements, or a significant operating loss or significant charge against net capital, could have similar effects.
The wealth management, trust and brokerage business is highly competitive. If we are not able to compete successfully against current and future competitors, our business, financial condition, and results of operations will be adversely affected.
The wealth management, trust and brokerage business is highly competitive, and we expect it to remain so. We compete directly with many other national and regional full service financial services firms, banks, insurance companies, asset management and advisory firms, and, to a lesser extent, with on-line and discount brokers. Further, many online brokers have gone to a “no commission” structure, putting additional pressure on our brokerage operations. We also compete for wealth management services with commercial banks, private trust companies, sponsors of mutual funds, financial planning firms, venture capital, private equity and hedge funds, and other wealth managers. Moreover, we compete with ETFs that generally track passive investing strategies and charge lower management fees than active strategies, which may affect both the profitability of asset managers, on whose success we in part depend, and the perceived value of our investment services regarding ETFs. A continued lessening of investor interest in actively managed equity funds could decrease demand for and/or pricing on our investment services.
We are a small firm. Many of our competitors have more personnel and financial resources than we do. Larger competitors are able to advertise their products and services on a national or regional basis and may have a greater number and variety of products and distribution outlets for their products, larger client bases, and greater name recognition. These larger and better capitalized competitors may be better able to respond to changes in the wealth management and institutional services industries, to finance acquisitions, to fund internal growth, and to compete for market share generally.
Increased competition may result in pricing pressures, reduced revenue and loss of market share. Further, as a strategic response to changes in the competitive environment, we may from time to time make certain pricing, service, or marketing decisions or acquisitions that also could materially and adversely affect our business and results of operations. In addition, new technologies and the expansion of existing technologies may increase competitive pressures on us. The growth of online wealth management tools that provide automated, algorithm-based portfolio management advice, sometimes called robo-advice, may further accelerate the adoption of passively managed portfolios and reduce demand for and/or pricing on our investment services. Consequently, we may not be able to compete successfully against current and future competitors. If we are unable to compete effectively, our business, financial condition, and results of operations will be adversely affected.
Underperformance or declines in our investments, in either relative or absolute terms, may reduce the profitability of our wealth management and advisory business.
Investment performance is one of the most important factors in retaining existing clients and competing for new wealth management business. Underperformance or market declines in our investments could reduce our revenue and impair our growth in a number of ways:
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existing clients may withdraw funds from our wealth management business in favor of better performing products;
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asset-based advisory fees could decline as a result of a decrease in the value of assets under management;
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our ability to attract funds from existing and new clients might diminish;
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firms with which we have business relationships may terminate their relationships with us; and
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our wealth managers and investment advisors may depart, whether to join a competitor or otherwise.
Even when market conditions are generally favorable, our investment performance may be adversely affected by the investment style of our asset managers and the particular investments that they make. To the extent our investment style, security selection or investment results underperform other investment styles, selections or results, in either relative or absolute terms, the revenue and profitability of our wealth management business will likely be reduced and our ability to retain and attract new clients and funds will likely be impaired.
Standard investment management contracts we have with our clients are terminable without cause and on relatively short notice by our clients, which makes us vulnerable to short-term declines in the performance of the securities under our management.
Like most investment advisory and wealth management businesses, the investment advisory contracts we have with our clients are typically terminable by the client without cause upon less than 30 days’ notice. As a result, even short-term declines in the performance of the securities we manage, which can result from factors outside our control, such as adverse changes in market or economic condition or the poor performance of some of the investments we have recommended to our clients, could lead some of our clients to move assets under our management to other asset classes such as broad index funds or treasury securities, or to investment advisors which have investment product offerings or investment strategies different than ours. Therefore, our operating results are heavily dependent on the financial performance of our investment portfolios and the investment strategies we employ in our investment advisory businesses and even short-term declines in the performance of the investment portfolios we manage for our clients, whatever the cause, could result in a decline in assets under management and a corresponding decline in investment management fees, which would adversely affect our results of operations.
We continue to experience pricing pressures in areas of our business which may impair our future revenue and profitability.
We continue to experience pricing pressures on investment advisory fees, as well as trading margins and commissions in fixed income and equity trading. In the fixed income market, regulatory requirements have resulted in greater price transparency, leading to price competition and decreased trading margins. In the equity market, we experience pricing pressure from institutional clients to reduce commissions, partially due to the industry trend toward unbundling fees related to research and execution and the trend towards “no commission” trading. Our trading margins have been further compressed by the use of electronic and direct market access trading, which has created additional competitive pressure. In addition, we face pricing pressures in our advisory business, which has seen new entrants compete for clients on the basis of price. We believe that price competition and pricing pressures in these and other areas will continue as investors continue to reduce the amounts they are willing to pay, including by reducing the number of advisory and brokerage firms they use, and some of our competitors seek to obtain market share by reducing advisory fees, commissions or margins.
We face strong competition from other insurance agencies, which may adversely affect our operations and financial condition.
The insurance industry is highly competitive and has, historically, been characterized by periods of significant price competition, alternating with periods of greater pricing discipline during which competitors focus on other factors, including service, experience, the strength of agent and policyholder relationships, reputation, speed and accuracy of claims payment, perceived financial strength, ratings, scope of business, commissions paid and policy and contract terms and conditions. Our insurance business competes with many other insurers, including large national companies that have greater financial, marketing and management resources than HWG. Many of these competitors also have better ratings and market recognition than our insurance business.
In addition, a number of new, proposed or potential industry developments also could increase competition in HWG’s industry. These developments include changes in practices and other effects caused by the Internet (including direct marketing campaigns by HWG’s competitors in established and new geographic markets), which have led to greater competition in the insurance business and increased expectations for customer service. These developments could prevent our insurance business from expanding its book of business.
Our insurance business also faces competition from new entrants into the insurance market. New entrants do not have historic claims or losses to address and, therefore, may be able to price policies on a basis that is not favorable to our insurance business. New competition could reduce the demand for HWG’s insurance products, which could have a material adverse effect on our financial condition and results of operations.
A failure to appropriately identify and address potential conflicts of interest could adversely affect our businesses.
Due to the scope of our businesses and our client base, we regularly address potential conflicts of interest, including situations where our services to a particular client or our own investments or other interests conflict, or are perceived to conflict, with the interests of another client, as well as situations where one or more of our businesses have access to material non-public information that may not be shared with other businesses within the firm and situations where we may be a creditor of an entity with which we also have an advisory or other relationship. In addition, our status as a bank holding company subjects us to heightened regulation and increased regulatory scrutiny by the Federal Reserve with respect to transactions between our entities that are or could be viewed as affiliates of ours and, under the Volcker Rule, transactions between our subsidiaries (including Sanders Morris and Tectonic Advisors) and certain covered funds.
We may incur significant losses due to ineffective risk management processes and strategies.
We seek to monitor and control our risk exposures through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational and compliance systems, and internal control and management review processes. However, those systems and review processes and the judgments that accompany their application may not be effective and, as a result, we may not anticipate every economic and financial outcome in all market environments or the specifics and timing of such outcomes, particularly in the event of the kinds of dislocations in market conditions experienced in recent years, which highlight the limitations inherent in using historical data to manage risk. If those systems and review processes prove to be ineffective in identifying and managing risks, we could be subjected to increased regulatory scrutiny and regulatory restrictions could be imposed on our business, including on our potential future business lines, as a result of which our business and operating results could be adversely affected.
If we fail to maintain effective internal control over financial reporting, we may not be able to report our financial results accurately and timely, in which case our business may be harmed, investors may lose confidence in the accuracy and completeness of our financial reports, we could be subject to regulatory penalties and the price of the Series B preferred stock may decline.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for evaluating and reporting on that system of internal control. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. As a public company, we are required to comply with the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), and other rules that govern public companies, including making annual assessments of the effectiveness of our internal control over financial reporting. In addition, when we cease to be an emerging growth company, our independent registered public accounting firm may be required to report on the effectiveness of our internal control over financial reporting. We will continue to periodically test and update, as necessary, our internal control systems, including our financial reporting controls. Our actions, however, may not be sufficient to result in an effective internal control environment. In particular, we may not be able to maintain effective internal control over segment reporting, which we have implemented as a result of the merger. Any future failure to maintain effective internal control over financial reporting could impair the reliability of our financial statements which in turn could harm our business, impair investor confidence in the accuracy and completeness of our financial reports and our access to the capital markets, cause the price of the Series B preferred stock to decline and subject us to regulatory penalties and litigation.
We are required to make significant estimates and assumptions in the preparation of our financial statements and our estimates and assumptions may not be accurate.
The preparation of our consolidated financial statements in conformity with GAAP requires our management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income and expense during the reporting periods. The processes the Company uses to estimate its probable loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on the company’s financial condition and results of operations, depends upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models the Company uses for interest rate risk and asset-liability management are inadequate, the Company may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models the Company uses for determining its probable loan losses are inadequate, the allowance for loan losses may not be sufficient to support future charge-offs. If the models the Company uses to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what the Company could realize upon sale or settlement of such financial instruments. Any such failure in the Company’s analytical or forecasting models could have a material adverse effect on the Company’s business, financial condition and results of operations.
We may be required to recognize a significant charge to earnings if our goodwill or other intangible assets become impaired.
Goodwill and purchased intangible assets with indefinite lives are not amortized, but are reviewed for impairment annually and more frequently when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We assess the recoverability of the unamortized balance of our finite-lived intangible assets when indicators of potential impairment are present. Factors that may indicate that the carrying value of our goodwill or other intangible assets may not be recoverable include a decline in our stock price and market capitalization and slower growth rates in our industry. We will continue to evaluate the carrying value of our goodwill and other intangible assets. The recognition of a significant charge to earnings in our consolidated financial statements resulting from any impairment of our goodwill or other intangible assets could materially adversely impact our business, financial condition and results of operations.
We may elect or be compelled to seek additional capital, but that capital may not be available, or it may be dilutive.
Our ability to raise capital in the future, if needed, will depend on conditions in the capital markets, which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital when needed, on favorable terms or at all. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These outcomes could negatively impact our ability to operate or further expand our operations through acquisitions and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition and results of operations. In addition, in order to raise additional capital, we may need to issue shares of our preferred or common stock that would reduce our shareholders’ percentage ownership interest to the extent they do not participate in future offerings. Also, if we are unable to raise additional capital, we may be required to take alterative actions which may include the sale of income-producing assets to meet our capital requirements, which could have an adverse impact on our results of operations and ability to generate income.
We face intense competition from larger banks, financial institutions and financial technology (FinTech) companies that could hurt our business.
We conduct our business operations in markets where the banking business is highly competitive and is dominated by large multi-state and in-state banks with operations and offices covering wide geographic areas. We also compete with other financial service businesses, including investment advisory and wealth management firms, mutual fund companies, financial technology companies, and securities brokerage and investment banking firms that offer competitive banking and financial products and services as well as products and services that we do not offer. Larger banks and many of those other financial service organizations have greater financial, technology and marketing resources than we do that enable them to conduct extensive advertising campaigns, promote ease of use through technology and/or shift resources to regions or activities of greater potential profitability. They also have substantially more capital and higher lending limits than we do, which enable them to attract larger clients and offer financial products and services that we are unable to offer, putting us at a disadvantage in competing with them for loans and deposits and investment management clients. In addition, we face increased competition from financial technology firms that offer their solutions online and/or through the use of mobile phone apps and other technological means, which are increasingly preferred by younger consumers of financial services. If we are unable to compete effectively with those banking or other financial services businesses, we could find it more difficult to attract new and retain existing clients and our net interest margins, net interest income and investment management fees could decline, which could materially adversely affect our business, results of operations and prospects, and could cause us to incur losses in the future.
Financial challenges at other banking institutions could lead to depositor concerns that spread within the banking industry causing disruptive deposit outflows and other destabilizing results.
In March 2023, certain specialized banking institutions with elevated concentrations of uninsured deposits experienced large deposit outflows, resulting in the institutions being placed into FDIC receiverships. In the aftermath, there has been substantial market disruption and indications that deposit concerns could spread within the banking industry, leading to deposit outflows and other destabilizing results. These market events could materially adversely affect our business.
We continually encounter technological change, and we may have fewer resources than many of our competitors to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve clients and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many national vendors provide turn-key services that allow smaller banks to compete with institutions that have substantially greater resources to invest in technological improvements. However, these technology services many not be as sophisticated or adoptable as some of our larger competitors and we may be subject to long-term contracts that impede our ability to change vendors to adapt to a changing technology marketplace. Thus, we may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients.
We depend on third party systems, so a systems failure could significantly disrupt our business. These and other operational risks may disrupt our business, result in regulatory action against us, or limit our growth.
Our business depends highly on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets, and the transactions we process have become increasingly complex.
Consequently, we rely heavily on our communications and financial, accounting, and other data processing systems, including systems provided by our clearing brokers and service providers. We face operational risk arising from mistakes made in the confirmation or settlement of transactions or from transactions not being properly recorded, evaluated, or accounted.
If any of these systems do not operate properly or are disabled, we could suffer financial loss, a disruption of our business, liability to clients, regulatory intervention, or reputational damage. Any failure or interruption of our systems, the systems of our clearing brokers or custodians, or third party trading systems could cause delays or other problems in our securities trading activities, which could have a material adverse effect on our operating results. In addition, our clearing brokers and custodians provide our principal disaster recovery system. We cannot provide assurance that we or our clearing brokers or custodians will not suffer any systems failures or interruption, including ones caused by earthquake, fire, other natural disasters, power or telecommunications failure, act of God, act of war, terrorism, or otherwise, or that our or our clearing brokers’ back-up procedures and capabilities in the event of any such failure or interruption will be adequate. The inability of our or our clearing brokers’ or custodians’ systems to accommodate an increasing volume of transactions could also constrain our ability to expand our business.
The occurrence of fraudulent activity, breaches of our information security, and cybersecurity attacks could adversely affect our ability to conduct our business, manage our exposure to risk or expand our businesses, result in the disclosure or misuse of confidential or proprietary information, increase our costs to maintain and update our operational and security systems and infrastructure, and adversely impact our results of operations, liquidity and financial condition, as well as cause legal or reputational harm.
As a financial institution, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us, our clients, or third parties with whom we interact and that may result in financial losses or increased costs to us or our clients, disclosure or misuse of confidential information belonging to us or personal or confidential information belonging to our clients, misappropriation of assets, litigation, or damage to our reputation. The financial services industry has seen increases in electronic fraudulent activity, hacking, security breaches, sophisticated social engineering and cyber-attacks, including in the commercial banking sector, as cyber-criminals have been targeting commercial bank and brokerage accounts on an increasing basis.
Our business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact or on whom we rely. Our business relies on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. In addition, to access our network, products and services, our clients and other third parties may use personal mobile devices or computing devices that are outside of our network environment and are subject to their own cybersecurity risks. All of these factors increase our risks related to cyber-threats and electronic disruptions.
In addition to well-known risks related to fraudulent activity, which take many forms, such as check “kiting” or fraud, wire fraud, and other dishonest acts, information security breaches and cybersecurity-related incidents have become a material risk in the financial services industry. These threats may include fraudulent or unauthorized access to data processing or data storage systems used by us or by our clients, electronic identity theft, “phishing,” account takeover, denial or degradation of service attacks, and malware or other cyber-attacks. These electronic viruses or malicious code are typically designed to, among other things:
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obtain unauthorized access to confidential information belonging to us or our clients;
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manipulate or destroy data;
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disrupt, sabotage or degrade service on a financial institution’s systems; or
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steal money.
In recent periods, several governmental agencies and large corporations, including financial service organizations and retail companies, have suffered major data breaches, in some cases exposing not only their confidential and proprietary corporate information, but also sensitive financial and other personal information of their clients and their employees or other third parties, and subjecting those agencies and corporations to potential fraudulent activity and their clients, employees and other third parties to identity theft and fraudulent activity in their credit card and banking accounts. Therefore, security breaches and cyber-attacks can cause significant increases in operating costs, including the costs of compensating clients for any resulting losses they may incur and the costs and capital expenditures required to correct the deficiencies in and strengthen the security of data processing and storage systems.
Unfortunately, it is not always possible to anticipate, detect, or recognize these threats to our systems, or to implement effective preventative measures against all breaches, whether those breaches are malicious or accidental. Cybersecurity risks for banking organizations have significantly increased in recent years and have been difficult to detect before they occur due to the following, among other reasons:
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the proliferation of new technologies, and the use of the Internet and telecommunications technologies to conduct financial transactions;
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these threats arise from numerous sources, not all of which are in our control, including among others human error, fraud or malice on the part of employees or third parties, accidental technological failure, electrical or telecommunication outages, failures of computer servers or other damage to our property or assets, natural disasters or severe weather conditions, health emergencies or pandemics, or outbreaks of hostilities or terrorist acts;
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the techniques used in cyber-attacks change frequently and may not be recognized until launched or until well after the breach has occurred;
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the increased sophistication and activities of organized crime groups, hackers, terrorist organizations, hostile foreign governments, disgruntled employees or vendors, activists and other external parties, including those involved in corporate espionage;
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the vulnerability of systems to third parties seeking to gain access to such systems either directly or using equipment or security passwords belonging to employees, clients, third-party service providers or other users of our systems; and
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our frequent transmission of sensitive information to, and storage of such information by, third parties, including our vendors and regulators, and possible weaknesses that go undetected in our data systems notwithstanding the testing we conduct of those systems.
Although to date we have not experienced any losses or other material consequences relating to technology failure, cyber-attacks or other information, we may suffer such losses or other consequences in the future. While we invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and we conduct periodic tests of our security systems and processes, we may not succeed in anticipating or adequately protecting against or preventing all security breaches and cyber-attacks from occurring. Even the most advanced internal control environment may be vulnerable to compromise. Targeted social engineering attacks are becoming more sophisticated and are extremely difficult to prevent. Additionally, the existence of cyber-attacks or security breaches at third parties with access to our data, such as vendors, may not be disclosed to us in a timely manner. While we had insurance against losses related to cyber insurance as of the date of this Form 10-K, we may not be able to insure against losses related to cyber-threats in the future and our insurance may not insure against all possible losses. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities or incidents.
As is the case with non-electronic fraudulent activity, cyber-attacks or other information or security breaches, whether directed at us or third parties, may result in a material loss or have material consequences. Furthermore, the public perception that a cyber-attack on our systems has been successful, whether or not this perception is correct, may damage our reputation with clients and third parties with whom we do business. Although to date we have not experienced any material fraudulent activity, breaches of our information security or cyber-attack, a successful penetration or circumvention of system security could cause us negative consequences, including loss of clients and business opportunities, disruption to our operations and business, misappropriation or destruction of our confidential information and/or that of our clients, or damage to our clients’ and/or third parties’ computers or systems, and could expose us to additional regulatory scrutiny and result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, additional compliance costs, and could adversely impact our results of operations, liquidity and financial condition.
Factoring products offered by the Bank’s Integra factoring division may expose us to an increased risk of fraud.
We rely on the structural features embedded in the factoring products offered by the Bank’s Integra factoring division to mitigate the credit risk associated with such products. With respect to our factoring products, we purchase the underlying invoices of our customers and become the direct payee under such invoices, thus transferring the credit risk in such transactions from our customers to the underlying account debtors on such invoices. In the event one or more of our customers fraudulently represents the existence or validity of an invoice we purchase in the case of a factoring transaction, we may advance more funds to such customer than we otherwise would and lose the benefit of the structural protections of our products with respect to such advances. In such event we could be exposed to material additional losses with respect to such factoring products. Although we believe we have controls in place to monitor and detect fraud with respect to our factoring products, there is no guarantee such controls will be effective. Losses from such fraudulent activity could have a material impact on our business, financial condition and results of operations.
We rely on client and counterparty information, which subjects us to risks if that information is not accurate or is incomplete.
When deciding whether to extend credit or enter into other transactions with clients or counterparties, we may rely on information provided by or on behalf of those clients and counterparties, including audited financial statements and other financial information. We may also rely on representations made by clients and counterparties that the information they provide is accurate and complete. We conduct appropriate due diligence on such client information and, where practical and economical, we engage valuation and other experts or sources of information to assist with assessing collateral and other client risks. Our financial results could be adversely affected if the financial statements, collateral value or other financial information provided by clients or counterparties are incorrect.
Climate change and related legislative and regulatory initiatives may materially affect the Company’s business and results of operations.
The effects of climate change continue to create an alarming level of concern for the state of the global environment. As a result, the global business community has increased its political and social awareness surrounding the issue. Further, the U.S. Congress, state legislatures and federal and state regulatory agencies continue to propose numerous initiatives to supplement the global effort to combat climate change. Similar and even more expansive initiatives are expected under the current administration, including potentially increasing supervisory expectations with respect to banks’ risk management practices, accounting for the effects of climate change in stress testing scenarios and systemic risk assessments, revising expectations for credit portfolio concentrations based on climate-related factors and encouraging investment by banks in climate-related initiatives and lending to communities disproportionately impacted by the effects of climate change. The lack of empirical data surrounding the credit and other financial risks posed by climate change render it impossible to predict how specifically climate change may impact our financial condition and results of operations; however, the physical effects of climate change may also directly impact us. Specifically, unpredictable and more frequent weather disasters may adversely impact the value of real property securing the loans in our portfolios. Additionally, if insurance obtained by our borrowers is insufficient to cover any losses sustained to the collateral, or if insurance coverage is otherwise unavailable to our borrowers, the collateral securing our loans may be negatively impacted by climate change, which could impact our financial condition and results of operations. Further, the effects of climate change may negatively impact regional and local economic activity, which could lead to an adverse effect on our customers and impact the communities in which we operate. Overall, climate change, its effects and the resulting, unknown impact could have a material adverse effect on our financial condition and results of operations.
A natural disaster could harm our business.
We have clients across the United States, but concentrations in California (subject to earthquakes and wildfires), Florida (hurricanes) and Texas (hurricanes, tornadoes and flooding). The nature and level of natural disasters cannot be predicted. These natural disasters could harm our operations through interference with communications, including the interruption or loss of our computer systems, which could prevent or impede us from gathering deposits, originating loans and processing and controlling our flow of business, as well as through the destruction of facilities and our operational, financial and management information systems. Additionally, natural disasters could negatively impact the values of collateral securing our borrowers’ loans and interrupt our borrowers’ abilities to conduct their business in a manner to support their debt obligations, either of which could result in losses and increased provisions for loan losses for us.
The costs and effects of litigation, investigations or similar matters, or adverse facts and developments related thereto, could materially affect our business, operating results and financial condition.
We may be involved from time to time in a variety of litigation, investigations or similar matters arising out of our business. It is inherently difficult to assess the outcome of these matters, and we may not prevail in proceedings or litigation. Our insurance may not cover all claims that may be asserted against us and indemnification rights to which we are entitled may not be honored, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation or investigation significantly exceed our insurance coverage, they could have a material adverse effect on our business, financial condition and results of operations. In addition, premiums for insurance covering the financial and banking sectors are rising. We may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms or at historic rates, if at all.
The Company is subject to environmental risks associated with owning real estate or collateral.
The cost of cleaning up or paying damages and penalties associated with environmental problems could increase the Company’s operating expenses and result in a decline in the underlying collateral. When a borrower defaults on a loan secured by real property, the Company may purchase the property in foreclosure or accept a deed to the property surrendered by the borrower. The Company may also take over the management of commercial properties whose owners have defaulted on loans. The Company also owns and leases premises where banking and other facilities are located. While the Company’s lending, foreclosure and facilities policies and guidelines are intended to exclude properties with an unreasonable risk of contamination, hazardous substances could exist on some of the properties that the Company may own, acquire, manage or occupy. Environmental laws could force the Company to clean up the properties at the Company’s expense. It may cost much more to clean a property than the property is worth and it may be difficult or impossible to sell contaminated properties. The Company could also be liable for pollution generated by a borrower’s operations if the Company takes a role in managing those operations after a default.
Risks Related to Our Regulatory Environment
We are subject to extensive government regulation and supervision, which could constrain our growth and profitability.
We are subject to extensive regulation, supervision and legal requirements that govern almost all aspects of our operations. These laws and regulations are not intended to protect our shareholders. Rather, these laws and regulations are intended to protect customers, depositors, the DIF and the overall financial stability of the banking system in the United States. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business activities in which we can engage, limit the dividend or distributions that the Bank can pay to us, restrict the ability of institutions to guarantee any debt we may issue and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles would require. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs. Our failure to comply with these laws and regulations, even if the failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition and results of operations. The banking industry remains heavily regulated. Compliance with such regulations may increase our costs and limit our ability to pursue business opportunities.
See “Supervision and Regulation” for additional information regarding the supervisory and regulatory issues facing the Company.
Recent Bank Failures Will Increase Depository Insurance and Increase Compliance Costs
In March 2023, certain specialized banking institutions with elevated concentrations of uninsured deposits experienced large deposit outflows, resulting in the institutions being placed into FDIC receiverships. In the aftermath, there has been substantial market disruption and indications that deposit concerns could spread within the banking industry, leading to deposit outflows and other destabilizing results. The FDIC has sold one of the institutions, resulting in $20 billion in projected losses to the DIF. More losses may result from this institution or others. The resultant losses to the DIF will likely result in higher premiums for depository insurance and increased regulatory scrutiny, which will result in higher compliance costs and likely greater regulation. Each of these results will reduce the profitability and increase the regulatory costs of the Company.
We are subject to stringent capital requirements that may limit our operations and potential growth.
We are subject to various regulatory capital requirements on a consolidated basis, and at both the Bank and Sanders Morris separately. 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 our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet commitments as calculated under these regulations. The failure to meet the established capital requirements under the prompt corrective action framework could result in one or more of our regulators placing limitations or conditions on our activities, including our growth initiatives, or restricting the commencement of new activities, and such failure could subject us to a variety of enforcement remedies available to the federal regulatory authorities, including limiting our ability to pay dividends, issuing a directive to increase our capital and terminating the Bank’s FDIC deposit insurance. FDIC deposit insurance is critical to the continued operation of the Bank. In addition, an inability to meet the capital requirements under the Basel III regulatory capital reforms, would prevent us from being able to pay certain discretionary bonuses to our executive officers and dividends to our shareholders.
Many factors affect the calculation of our risk-based assets and our ability to maintain the level of capital required to achieve acceptable capital ratios. For example, changes in risk weightings of assets relative to capital and other factors may combine to increase the amount of risk-weighted assets in the Tier 1 risk-based capital ratio and the total risk-based capital ratio. Any increases in our risk-weighted assets will require a corresponding increase in our capital to maintain the applicable ratios. In addition, recognized loan losses in excess of amounts reserved for such losses, loan impairments and other factors will decrease our capital, thereby reducing the level of the applicable ratios.
Our failure to remain well-capitalized for bank regulatory purposes, either under the Basel III regime or the community bank leverage ratio framework, could affect client and investor confidence, our ability to grow, our costs of funds, our ability to pay competitive rates to attract and retain deposits, FDIC insurance costs, our ability to pay dividends on preferred and common stock, our ability to make acquisitions, and our business, results of operations and financial condition. In addition, if we cease to be a well-capitalized institution for bank regulatory purposes, the interest rates that we pay on deposits and our ability to accept brokered deposits may be restricted.
Federal banking agencies periodically conduct examinations of our banking business, including compliance with laws and regulations, and our failure to comply with any supervisory actions which we are, or may become, subject to as a result of such examinations may adversely affect us.
The OCC, the Federal Reserve and the FDIC may conduct examinations of our business, including for compliance with applicable laws and regulations. As a result of an examination, regulatory agencies may determine that the financial condition, capital resources, asset quality, asset concentrations, earnings prospects, management, liquidity, sensitivity to market risk, or other aspects of any of our operations are unsatisfactory, or that we or our management are in violation of any law, regulation or guideline in effect from time to time. Regulatory agencies may take a number of different remedial actions, including the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to change the composition of our concentrations in portfolio or balance sheet assets, to assess civil monetary penalties against officers or directors, to remove officers and directors and, if such conditions cannot be corrected or there is an imminent risk of loss to depositors, the FDIC may terminate our deposit insurance. A regulatory action against us could have a material adverse effect on our business, results of operations, financial condition and prospects.
We are subject to numerous laws designed to protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The U.S. Department of Justice, the CFPB, and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Any such actions could have a material adverse effect on our business, financial condition, results of operations and prospects.
We face a risk of noncompliance and enforcement action with the BSA and other anti-money laundering statutes and regulations.
The BSA, as amended by the USA PATRIOT Act, and as further amended by the National Defense Authorization Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. FinCEN, established by the U.S. Department of the Treasury to administer the BSA, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service (the “IRS”). There is also increased scrutiny of compliance with the sanctions rules enforced by OFAC. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of any financial institutions that we may acquire in the future are deemed deficient, we could be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, which could negatively impact our business, financial condition and results of operations. Although we have not been subject to fines or other penalties, or suffered business or reputational harm, as a result of money laundering activities, failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition, results of operations and prospects.
Additional regulations and rule making impacting the transportation industry may have a disproportionate impact on the small-to-mid-sized trucking businesses that comprise our primary transportation factoring clients and adversely affect the factoring business conducted by the Bank’s Integra factoring division.
Our primary transportation factoring clients are small-sized owner-operators and trucking fleets. Recently implemented federal regulations, and regulations proposed to be implemented in the future, may significantly increase the costs and expenses or reduce the ability to generate revenue associated with owning or operating a trucking fleet. These regulations include rule making proposed by the Federal Motor Carrier Safety Administration of the United States Department of Transportation (“FMCSA”) under the Compliance, Safety, Accountability (“CSA”) initiative, maximum hours of service limitations imposed by the FMCSA, electronic log requirements, and regulations proposed by the federal Food and Drug Administration (“FDA”) requiring increased labeling and monitoring by carriers of any commodity transported that is regulated by the FDA. The costs and burdens of compliance with these requirements will have a disproportionate impact on the small-to-mid-sized trucking businesses that comprise our client base and may force some or all of these businesses out of the market. Such an occurrence could impact the returns we realize on the factoring activity conducted by the Bank’s Integra factoring division or result in a decrease in the overall amount of factoring activity conducted by the Bank’s Integra factoring division and could have an adverse effect on our business, financial condition and results of operations.
Sanders Morris and Tectonic Advisors are subject to substantial regulation. If we fail to comply with applicable requirements, our business will be adversely affected.
Tectonic Advisors and Sanders Morris are subject to extensive regulation under both federal and state laws. Sanders Morris is registered as a broker-dealer with the SEC and FINRA; Tectonic Advisors and Sanders Morris are registered with the SEC as investment advisors. The SEC is the federal agency responsible for the administration of federal securities laws. In addition, SROs, principally FINRA and the securities exchanges, are actively involved in the regulation of broker-dealers. Tectonic Advisors and Sanders Morris are also subject to regulation by state securities commissions in those states in which we do business. The principal purpose of regulation and discipline of broker-dealers is the protection of clients and the securities markets rather than protection of creditors and shareholders of broker-dealers. Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of clients’ funds and securities, capital structure of securities firms, record-keeping, and the conduct of directors, officers, and employees.
As investment advisors, Sanders Morris and Tectonic Advisors are subject to the Advisers Act. The Advisers Act imposes numerous obligations on registered investment advisers, including fiduciary, record keeping, operational and disclosure obligations. Moreover, the Advisers Act grants broad administrative powers to regulatory agencies such as the SEC to regulate investment advisory businesses. Sanders Morris and Tectonic Advisors are also subject to the provisions and regulations of ERISA to the extent that they act as a “fiduciary” under ERISA with respect to certain of their clients. ERISA and the applicable provisions of the federal tax laws impose a number of duties on persons who are fiduciaries under ERISA and prohibit certain transactions involving the assets of each ERISA plan which is a client, as well as certain transactions by the fiduciaries (and certain other related parties) to such plans. Additionally, like other investment advisory and broker-dealer companies, Sanders Morris and Tectonic Advisors face the risks of lawsuits by clients. The outcome of regulatory proceedings and lawsuits is uncertain and difficult to predict. An adverse resolution of any regulatory proceeding or lawsuit could result in substantial costs or reputational harm to Sanders Morris or Tectonic Advisors and, therefore, could have an adverse effect on the ability to retain key relationship and wealth managers, and to retain existing clients or attract new clients, any of which could have a material adverse effect on our business, financial condition, results of operations and prospects.
Sanders Morris is subject to periodic examinations by the SEC and FINRA and Tectonic Advisors by the SEC. In these examinations, personnel from FINRA or the SEC (as applicable) make a visit to the office(s) of Sanders Morris or Tectonic Advisors and review the files, business practices and personnel. These reviews are often based on a pre-examination checklist or areas of interest, often based on the risks associated with Sanders Morris’ or Tectonic Advisors’ business. The examiners consult with their home office and, at the end of the examination, often issue a letter setting forth areas requiring attention. However, under certain circumstances, a poor examination or a violation brought to the SEC’s or FINRA’s attention can result in an administrative proceeding.
The SEC, FINRA, and state securities commissions may conduct administrative proceedings that can result in:
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censure, fines, or civil penalties;
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issuance of cease-and-desist orders;
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deregistration, suspension, or expulsion of a broker-dealer or investment advisor;
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suspension or disqualification of the broker-dealer’s officers or employees;
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prohibition against engaging in certain lines of business; and
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other adverse consequences.
In the last five years, neither Tectonic Advisors nor Sanders Morris has received what either believes is a poor examination by any of their federal or state regulators, been subject to any material administrative proceeding or been found to be in material violation by their federal or state regulators or experienced an imposition of any material penalties, censure, fines or cease-and-desist orders by such regulators. The imposition of any penalties or orders on us could have a material adverse effect on our business, financial condition, and results of operations. The investment banking and brokerage industries have recently come under scrutiny at both the state and federal levels, and the cost of compliance and the potential liability for noncompliance has increased as a result.
Our ability to comply with laws and regulations relating to our financial services businesses depends in large part upon maintaining a system to monitor compliance and our ability to attract and retain qualified compliance personnel. Although we believe we are in material compliance with all applicable laws and regulations, we may not be able to comply in the future. Any noncompliance could have a material adverse effect on our business, financial condition, and results of operations.
Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how we collect and use personal information and adversely affect our business opportunities.
We are subject to various privacy, information security and data protection laws, including requirements concerning security breach notification, and we could be negatively impacted by these laws. For example, our business is subject to the GLBA, which, among other things: (i) imposes certain limitations on our ability to share non-public personal information about our clients with non-affiliated third parties; (ii) requires that we provide certain disclosures to clients about our information collection, sharing and security practices and afford clients the right to “opt out” of any information sharing by us with non-affiliated third parties (with certain exceptions); and (iii) requires we develop, implement and maintain a written comprehensive information security program containing safeguards appropriate based on our size and complexity, the nature and scope of our activities, and the sensitivity of client information we process, as well as plans for responding to data security breaches. Various state and federal banking regulators and states and foreign countries have also enacted data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Moreover, legislators and regulators in the United States and other countries are increasingly adopting or revising privacy, information security and data protection laws that potentially could have a significant impact on our current and planned privacy, data protection and information security-related practices, our collection, use, sharing, retention and safeguarding of consumer or employee information, and some of our current or planned business activities. This could also increase our costs of compliance and business operations and could reduce income from certain business initiatives. This includes increased privacy-related enforcement activity at the federal level, by the Federal Trade Commission, as well as at the state level, such as with regard to mobile applications.
Compliance with current or future privacy, data protection and information security laws (including those regarding security breach notification) affecting client or employee data to which we are subject could result in higher compliance and technology costs and could restrict our ability to provide certain products and services, which could have a material adverse effect on our business, financial condition or results of operations. Our failure to comply with privacy, data protection and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions and damage to our reputation, which could have a material adverse effect on our business, financial condition or results of operations.
We can be subject to legal and regulatory proceedings, investigations and inquiries related to conduct risk.
U.S. authorities have been increasingly focused on “conduct risk,” a term that is used to describe the risks associated with behavior by employees and agents, including third-party vendors, that could harm clients, consumers, investors or the markets, such as failures to safeguard consumers’ and investors’ personal information, failures to identify and manage conflicts of interest and improperly creating, selling and marketing products and services. In addition to increasing compliance risks, this focus on conduct risk could lead to more regulatory or other enforcement proceedings and litigation, including for practices which historically were acceptable but are now receiving greater scrutiny. Further, while we take numerous steps to prevent and detect conduct by employees and agents that could potentially harm clients, investors or the markets, such behavior may not always be deterred or prevented. Banking regulators have also focused on the overall culture of financial services firms. In addition to regulatory restrictions or structural changes that could result from perceived deficiencies in our culture, such focus could also lead to additional regulatory proceedings. Although we have not been subject to any material conduct risk investigations or inquiries in the past eight years, the occurrence of such proceedings, investigations or inquiries could damage our reputation, disrupt our business, increase our costs and causes losses in the future.
Risks Related to an Investment in the Series B Preferred Stock
The Series B preferred stock is an equity security and is subordinate to our existing and future indebtedness, which could adversely impact our ability to pay dividends on the Series B preferred stock.
The shares of Series B preferred stock are equity interests and do not constitute indebtedness of ours. This means that the Series B preferred stock ranks junior to all our existing and future indebtedness and our other non-equity claims with respect to assets available to satisfy claims against us, including claims in the event of our liquidation.
As of December 31, 2022, our total liabilities were approximately $516.0 million, and we may incur additional indebtedness in the future to increase our capital resources or fund strategic acquisitions or other business efforts. Additionally, if our capital ratios or the capital ratios of the Bank fall below minimum ratios required by the Federal Reserve, we or the Bank could be required to raise additional capital by making additional offerings of debt securities, including senior or subordinated notes, or other applicable securities that could rank senior to the Series B preferred stock. The Series B preferred stock places no restrictions on our business or operations or on our ability to incur indebtedness or engage in any transactions, subject only to the limited voting rights referred to below. In addition, dividends on the Series B preferred stock are payable only when, as, and if declared by our board of directors out of assets legally available therefor. In the event of our liquidation, dissolution or winding-up of our affairs, our assets will be available to pay obligations on the Series B preferred stock only after all of our indebtedness and other liabilities have been paid. Accordingly, our existing and future indebtedness may restrict the payment of dividends on the Series B preferred stock. Further, if we are unable to or do not pay dividends on the Series B preferred stock, the market price of the Series B preferred stock may decline.
The Series B preferred stock may be junior in rights and preferences to our future preferred stock.
The Series B preferred stock may rank junior to preferred stock issued in the future that by its terms is expressly senior in rights and preferences to the Series B preferred stock, although the affirmative vote or consent of the holders of at least 662∕3% of all outstanding shares of the Series B preferred stock is required to authorize or issue any shares of stock senior in rights and preferences to the Series B preferred stock. The terms of any future preferred stock expressly senior to the Series B preferred stock may restrict dividend payments on the Series B preferred stock.
Additional issuances of preferred stock or securities convertible into preferred stock may further dilute existing holders of the Series B preferred stock.
We may determine that it is advisable, or we may encounter circumstances where we determine it is necessary, to issue additional shares of preferred stock, securities convertible into, exchangeable for or that represent an interest in preferred stock, or preferred stock-equivalent securities to fund strategic initiatives or other business needs or to build additional capital. Our board of directors is authorized to cause us to issue one or more classes or series of preferred stock from time to time without any action on the part of the shareholders, including issuing additional shares of Series B preferred stock. Our board of directors also has the power, without shareholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over the Series B preferred stock with respect to dividends or upon our dissolution, winding-up and liquidation and other terms.
Although the affirmative vote or consent of the holders of at least 662∕3% of all outstanding shares of the Series B preferred stock is required to authorize or issue any shares of capital stock senior in rights and preferences to the Series B preferred stock, if we issue preferred stock in the future with voting rights that dilute the voting power of the Series B preferred stock, the rights of holders of the Series B preferred stock or the market price of the Series B preferred stock could be adversely affected. The market price of the Series B preferred stock could decline as a result of these other offerings, as well as other sales of a large block of Series B preferred stock or similar securities in the market thereafter, or the perception that such sales could occur. Holders of the Series B preferred stock are not entitled to preemptive rights or other protections against dilution.
Payment of dividends by the Company on its common stock, corporate spin-offs or other corporate actions may diminish the amount of capital and/or earning power of the Company to pay dividends on, or redeem, its Series B preferred stock.
Subject to regulatory requirements and the terms of the Series B preferred stock, the Company may: (a) and currently intends to, pay dividends on its common stock and any such payment reduces the capital of the Company available to the Series B preferred stock and (b) undertake certain corporate actions, including, without limitation, spinning off subsidiaries and/or businesses to its stockholders, selling businesses to third parties, (c) making acquisitions using capital from the Company and (d) borrowing and/or investing its capital to make acquisitions and/or for other purposes (hiring key personnel, etc.). In each of these cases, the holders of the Series B preferred stock may not have the ability to block certain of such actions and, in such case, the capital base and/or earnings of the Company may be negatively impacted. In such case, the ability of the Company to pay dividends on and/or redeem the Series B preferred stock may be negatively impacted.
Dividends on the Series B preferred stock are discretionary and non-cumulative, and our future ability to pay dividends is subject to restrictions.
Although we intend to continue to pay dividends on the Series B preferred stock, dividends on the Series B preferred stock are discretionary and are not mandatory or cumulative. If our board of directors does not declare a dividend on the Series B preferred stock or if our board of directors authorizes and we declare less than a full dividend in respect of a Dividend Period, the holders of the Series B preferred stock will have no right to receive any dividend or a full dividend, as the case may be, for the Dividend Period, and we will have no obligation to pay a partial or full dividends for that Dividend Period at any time, whether or not our board of directors declares a dividend on the Series B preferred stock or any other class or series of our capital stock for any future Dividend Period. Any declaration and payment of dividends on the Series B preferred stock depends upon, among other factors, our earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to the Series B preferred stock, dividend restrictions contained in any credit agreements and other factors deemed relevant by our board of directors.
The Bank and Sanders Morris are subject to capital ratios. In addition, the Company is subject to consolidated capital ratios, which take into account its underlying subsidiaries’ capital position and the capital position of the Company. To the extent that Sanders Morris and/or the Bank suffer losses (including, without limitation, loan losses at the Bank), they may fail to meet their minimum capital requirements necessary for them to pay dividends to the Company, which would impact the Company’s ability to pay dividends on the preferred stock. In addition, to the extent that the Company and/or its underlying subsidiaries (including the Bank) suffer losses that cause the Company to be less than “well capitalized”, then the Company, even if it has cash available to it, would not be permitted to pay dividends on the preferred stock without regulatory approval, which may not be granted. Accordingly, any losses suffered by the Company or any of its subsidiaries, particularly loan losses at the Bank, might have a material adverse effect on the Company, including on the ability of the Company to pay dividends on the preferred stock.
The Federal Reserve has indicated that bank holding companies should carefully review their dividend policy in relation to the organization’s overall asset quality, current and prospective earnings and level, composition and quality of capital. The guidance provides that we inform and consult with the Federal Reserve prior to declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could result in an adverse change to our capital structure, including interest on any debt obligations.
In addition, the Company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends paid by or distributions made from its subsidiaries. These dividends and distributions are the principal source of funds to pay dividends on our preferred stock and common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends or distributions that our bank and nonbank subsidiaries may pay to the Company. In the event our subsidiaries are unable to pay dividends or make distributions to the Company, the Company may not be able to service debt or pay dividends on the Series B preferred stock. The inability to receive dividends and distributions from our subsidiaries could have a material adverse effect on the Company’s business, financial condition, results of operations and liquidity.
The replacement of the London Inter-bank Offered Rate (“LIBOR”) on our Series B preferred stock could increase our interest payments, may adversely affect the value of the Series B preferred stock and could adversely impact our business, financial condition and results of operations.
In 2017, the Chief Executive of the United Kingdom Financial Conduct Authority (the “Authority”) announced that the Authority intended to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the ICE Benchmark Administration Limited (together with any successor, “IBA”), as administrator of LIBOR In response to concerns regarding the future of LIBOR, Federal Reserve and the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee (“ARRC”) to identify alternatives to LIBOR. The ARRC first recommended a benchmark replacement waterfall that facilitated continued linkage to LIBOR while recognizing that the discontinuation of LIBOR would eventually occur. The initial steps in the ARRC's recommended waterfall referenced variations of the Secured Overnight Financing Rate (“SOFR”), and the ARRC has since recommended SOFR as the replacement rate for U.S. dollar denominated LIBOR. While market participants were warned that LIBOR may cease to exist after 2021, the IBA announced in early 2021 that it would continue to publish the most widely used tenors of U.S. dollar denominated LIBOR (such as one-month and three-month LIBOR) until June 30, 2023. While the IBA's announcement extended LIBOR's phase-out, there is no current expectation that LIBOR will continue beyond mid-2023, and U.S. banking regulators have issued guidance encouraging banking organizations to cease using U.S. dollar denominated LIBOR as a reference rate in new contracts.
At this time, it is not possible to predict whether SOFR will attain market acceptance as the standard replacement for LIBOR, whether alternative reference rates other than SOFR (such as Ameribor) will gain market traction or whether additional reforms to LIBOR may be enacted. Further, other central banks and regulators have convened working groups to evaluate other interest rate benchmarks (such as EURIBOR), and it is possible that a transition away from certain of these interest rate benchmarks will occur leading to the establishment of new market accepted reference rates. Uncertainty regarding the market standard replacement for LIBOR, and floating rate benchmarks generally, could have adverse impacts on floating-rate obligations, loans, deposits, derivatives and other financial instruments that currently use LIBOR as a benchmark rate and adversely affect the Company's business, financial condition or results of operations.
While the initial dividend rate on the Series B preferred stock is fixed, when, as and if declared by the board of directors, the dividend rate will be equal to three-month LIBOR plus a spread of 672.0 basis points per annum for each quarterly dividend period beginning May 15, 2024 (the “floating rate period”)-after the date when LIBOR will be discontinued. Holders of the Series B preferred stock should be aware that, when LIBOR is discontinued or otherwise unavailable, the dividend rate on the Series B preferred stock will be determined for the relevant period by the fallback provisions applicable to such stock. While the Series B preferred stock generally allows for the change to another index, the transition from LIBOR could increase our interest, dividend and other costs relative to the Series B preferred stock.
After the discontinuance of LIBOR and upon commencement of the floating rate period, we will appoint a calculation agent and will instruct the calculation agent to use a substitute or successor base rate that we have determined in our sole discretion is most comparable to three-month LIBOR, provided that if we determine there is an industry-accepted successor base rate, we will instruct the calculation agent to use that substitute or successor base rate. It is currently anticipated that the successor rate to be used by the calculation agent during the floating rate period will be SOFR.
SOFR has a very limited history, and its historical performance is not indicative of future performance. The Federal Reserve began to publish SOFR in April 2018; therefore, SOFR has limited performance history and no actual investment based on the performance of SOFR was possible before April 2018. The level of SOFR during the floating rate period for our Series B preferred stock may bear little or no relation to the historical level of SOFR. Furthermore, the future performance of SOFR is impossible to predict and, as a result, no future performance of SOFR or our Series B preferred stock may be inferred from any historical performance data. Changes in the levels of SOFR may affect the return on, and trading price of, our Series B preferred stock, but it is impossible to predict whether such levels will rise or fall. Since the initial publication of SOFR, daily changes in the rate have, on occasion, been more volatile than daily changes in other benchmark or market rates, such as U.S. dollar LIBOR, during corresponding periods.
The composition and characteristics of SOFR are not the same as those of U.S. dollar LIBOR and any failure of SOFR to gain market acceptance could adversely affect the Series B preferred stock. SOFR was developed for use in certain U.S. dollar derivatives and other financial contracts as an alternative to the U.S. dollar LIBOR in part because it is considered representative of general funding conditions in the overnight Treasury repo market. However, as a rate based on transactions secured by U.S. Treasury securities, it does not measure bank-specific credit risk and, as a result, is less likely to correlate with the unsecured short-term funding costs of banks. In addition, SOFR is an overnight rate, while U.S. dollar LIBOR represents interbank funding over different maturities. As a result, there can be no assurance that SOFR will perform in the same way as U.S. dollar LIBOR would have at any time, including, without limitation, as a result of changes in interest and yield rates in the market, market volatility, or global or regional economic, financial, political, regulatory, judicial or other events. The differences between SOFR and U.S. dollar LIBOR may mean that market participants would not consider SOFR a suitable substitute or successor for all of the purposes for which U.S. dollar LIBOR historically has been used, which may, in turn, lessen market acceptance of SOFR. If SOFR does not prove to be widely used in securities that are similar or comparable to the Series B preferred stock, the trading price of those securities may be adversely affected.
Potential conflicts of interest in connection with replacing LIBOR.
During the floating rate period, the calculation agent will make certain determinations in its own discretion, as described above and in the terms of the Series B preferred stock, in connection with choosing and implementing a replacement dividend rate. These determinations do not require the consent of the holders and, once made, may negatively affect the value of the Series B preferred stock and will be conclusive and binding on the holders of the Series B preferred stock.
Dividends on the Series B preferred stock will vary beginning on May 15, 2024 and any dividends declared may be less than the initial fixed annual rate in effect prior to May 15, 2024.
As described in further detail in the description of the Series B preferred stock attached to this Form 10-K, the annual dividend rate on the Series B preferred stock commencing on May 15, 2024 will equal three-month LIBOR or its replacement, plus a spread of 672.0 basis points per annum. Notwithstanding the foregoing, in the event that three-month LIBOR or its replacement is less than zero, three-month LIBOR shall be deemed to be zero. Therefore, any dividends declared on or after May 15, 2024 may vary from period to period and could be more or less than the fixed rate for the initial period. We have no control over a number of factors that may affect market interest rates, including geopolitical conditions and economic, financial, political, regulatory, judicial or other events that affect the markets generally and that are important in determining the existence, magnitude and longevity of market rate risk.
The Series B preferred stock may be redeemed at our option, and you may not be able to reinvest the redemption price you receive in a similar security.
Subject to the approval of the Federal Reserve (if then required), at our option, we may redeem the Series B preferred stock at any time, either in whole or in part, for cash, on any dividend payment date on or after May 15, 2024. We may also redeem the Series B preferred stock at our option, subject to the approval of the Federal Reserve (if then required), at any time, in whole, but not in part, within 90 days following the occurrence of a Regulatory Capital Treatment Event (as defined in the description of the Series B preferred stock attached to this Form 10-K), such as a proposed change in law or regulation with respect to whether the Series B preferred stock qualifies as an “additional Tier 1 capital” instrument.
Although the terms of the Series B preferred stock were established at issuance to satisfy the criteria for “additional Tier 1 capital” instruments consistent with Basel III as set forth in the joint final rulemaking issued in July 2013 by the Federal Reserve, the FDIC and the OCC, it is possible that the Series B preferred stock may not satisfy the criteria set forth in future rulemakings or interpretations. As a result, a Regulatory Capital Treatment Event could occur whereby we would have the right, subject to prior approval of the Federal Reserve (if then required), to redeem the Series B preferred stock in accordance with its terms prior to May 15, 2024, or any date thereafter.
If we redeem the Series B preferred stock for any reason, you may not be able to reinvest the redemption proceeds you receive in a similar security or earn similar rate of return on any investment. See the description of the Series B preferred stock attached to this Form 10-K for more information on redemption of the Series B preferred stock.
Investors should not expect us to redeem the Series B preferred stock on the date it becomes redeemable or on any particular date after it becomes redeemable.
The Series B preferred stock is a perpetual equity security. This means that it has no maturity or mandatory redemption date and is not redeemable at the option of the holders of the Series B preferred stock. The Series B preferred stock may be redeemed by us at our option, either in whole or in part, for cash, on any dividend payment date on or after May 15, 2024, or in whole, but not in part, at any time within 90 days following a Regulatory Capital Treatment Event. Any decision we may make at any time to propose a redemption of the Series B preferred stock will depend upon, among other things, our evaluation of our capital position, the composition of our shareholders’ equity and general market conditions at that time.
In addition, our right to redeem the Series B preferred stock is subject to limitations. Under the Federal Reserve’s current risk-based capital guidelines applicable to bank holding companies, any redemption of the Series B preferred stock is subject to prior approval of the Federal Reserve. We cannot assure you that the Federal Reserve will approve any redemption of the Series B preferred stock that we may propose. There also can be no assurance that, if we propose to redeem the Series B preferred stock without replacing such capital with common equity Tier 1 capital or additional Tier 1 capital instruments, the Federal Reserve will authorize such redemption. We understand that the factors that the Federal Reserve will consider in evaluating a proposed redemption, or a request that we be permitted to redeem the Series B preferred stock without replacing it with common equity Tier 1 capital or additional Tier 1 capital instruments, include its evaluation of the overall level and quality of our capital components, considered in light of our risk exposures, earnings and growth strategy, and other supervisory considerations, although the Federal Reserve may change these factors at any time.
Holders of the Series B preferred stock have limited voting rights.
Holders of the Series B preferred stock have no voting rights with respect to matters that generally require the approval of our common shareholders. Holders of the Series B preferred stock have voting rights only with respect to (i) authorizing, creating or issuing any capital stock ranking senior to the Series B preferred stock as to dividends and rights (including redemption payments) upon liquidation, dissolution or winding up, or reclassifying any authorized capital stock into any such shares of such capital stock or issuing any obligation or security convertible into or evidencing the right to purchase any such shares of capital stock, (ii) amending, altering or repealing any provision of our certificate of formation or the designation, including by merger, consolidation or otherwise, so as to adversely affect the rights, powers or preferences of the Series B preferred stock, (iii) the election of two directors, if dividends have not been declared or paid in an aggregate amount equal to the equivalent of at least six or more quarterly Dividend Periods, whether or not consecutive, (voting as a class with holders of shares of any other series of preferred stock ranking equally as to the payment of dividends and having equivalent voting rights), and (iv) as otherwise required by applicable law. See the description of the Series B preferred stock attached to this Form 10-K for more information.
An active, liquid market for the Series B preferred stock may not be sustained, which may impair your ability to sell your shares.
The Series B preferred stock is currently traded on the NASDAQ Global Market, but an active, liquid trading market for the Series B preferred stock may not exist or, if it exists, may not be sustained over time. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace and independent decisions of willing buyers and sellers of the Series B preferred stock, over which we have no control. Without an active, liquid trading market for the Series B preferred stock, shareholders may not be able to sell their shares at the volume, prices and times desired. Moreover, the lack of an established market could materially and adversely affect the value of the Series B preferred stock. The market price of the Series B preferred stock could decline significantly due to failure to pay dividends, actual or anticipated issuances or sales of the Series B preferred stock or other securities in the future.
The market price of the Series B preferred stock may become subject to substantial fluctuations, which may make it difficult for you to sell your shares at the volume, prices and times desired.
The market price of the Series B preferred stock may become highly volatile. There are many factors that may affect the market price and trading volume of the Series B preferred stock, including, without limitation:
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actual or anticipated fluctuations in our operating results, financial condition or asset quality;
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changes in economic or business conditions;
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the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve;
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recommendations by securities analysts;
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operating and stock price performance of companies that investors deemed comparable to us;
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additional or anticipated sales of the Series B preferred stock or other securities by us or our existing shareholders;
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additions or departures of key personnel;
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perceptions in the marketplace regarding our competitors or us;
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significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our competitors or us;
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other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and
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other news, announcements or disclosures (whether by us or others) related to us, our competitors, our primary markets or the financial services industry.
The stock market and, in particular, the market for financial institution stocks have experienced substantial fluctuations in recent years, which in many cases have been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in the trading volume in the Series B preferred stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of the Series B preferred stock, which could make it difficult to sell your shares at the volume, prices and times desired.
Securities analysts may not continue coverage on us, or may publish an unfavorable report.
The trading market for the Series B preferred stock depends, in part, on the research and reports that securities analysts publish about us and our business. We do not have any control over these securities analysts. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the financial markets, which could cause the price or trading volume of the Series B preferred stock to decline. If we are the subject of an unfavorable report, the price of the Series B preferred stock may decline.
The Series B preferred stock is not rated.
The Series B preferred stock is not rated by any rating agency. Unrated securities usually trade at a discount to similar, rated securities. As a result, there is a risk that the Series B preferred stock may trade at a price that is lower than they might otherwise trade if rated by a rating agency. It is possible, however, that one or more rating agencies might independently determine to assign a rating to the Series B preferred stock. In addition, we may elect to issue other securities for which we may seek to obtain a rating. If any ratings are assigned to the Series B preferred stock in the future or if we issue other securities with a rating, such ratings, if they are lower than market expectations or are subsequently lowered or withdrawn, could adversely affect the market for or the market value of the Series B preferred stock.
Our management and board of directors have significant control over our business.
As of March 29, 2023, our directors, executive officers and affiliates (including partners of Cain Watters) beneficially owned an aggregate of 5,099,160 shares, or approximately 72.14% of our outstanding shares of common stock. Consequently, our management and board of directors may be able to significantly affect our affairs and policies, including the outcome of the election of directors and the potential outcome of other matters submitted to a vote of our shareholders, such as mergers, the sale of substantially all of our assets and other extraordinary corporate matters. This influence may also have the effect of delaying or preventing changes of control or changes in management or limiting the ability of our other shareholders to approve transactions that they may deem to be in the best interests of our Company. The interests of these insiders could conflict with the interests of our other shareholders, including you.
We are a “controlled company” within the meaning of the rules of NASDAQ, and as such, we qualify for exemptions from certain corporate governance requirements. As a result, you may not have the same protections afforded to shareholders of companies that are subject to such requirements.
We are a “controlled company” under NASDAQ’s corporate governance listing standards, meaning that more than 50% of the voting power for the election of our board of directors is held by a single person, entity or group. As a controlled company, we are exempt from the obligation to comply with certain corporate governance requirements, including the requirements:
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that a majority of our board of directors consists of “independent directors,” as defined under NASDAQ rules;
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that director nominations are selected, or recommended for the board of directors’ selection, by either (i) the independent directors constituting a majority of the board of directors’ independent directors in a vote in which only independent directors participate, or (ii) a nominating and corporate governance committee that is composed entirely of independent directors; and
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that we have a compensation committee that is composed entirely of independent directors. We intend to avail ourselves of certain of these other exemptions for as long as we remain a “controlled company.” Accordingly, our shareholders may not have the same protections afforded to shareholders of companies that are subject to all of NASDAQ’s corporate governance requirements, which could make our stock less attractive to investors or otherwise harm our stock price.
We are controlled by the majority shareholders, whose interests may not coincide with yours and with whose decisions you may disagree.
A. Haag Sherman, George L. Ball, Darrell W. Cain, Steven B. Clapp, Thomas Sanders, Daniel C. Wicker, other members of management and partners of Cain Watters, and certain other existing shareholders (collectively, the “Majority Shareholders”) currently own more than 50% of our outstanding shares of common stock. So long as the Majority Shareholders continue to control more than 50% of our outstanding shares of common stock, they will have the ability, if they vote in the same manner, to determine the outcome of certain matters requiring only common shareholder approval, including the election of directors and certain amendments to our certificate of formation, bylaws and other corporate governance documents. In addition, this concentration of ownership may delay or prevent a change in control of our Company and make some transactions more difficult or impossible without the support of the Majority Shareholders. In any of these matters, the interests of the Majority Shareholders may differ from or conflict with our interests as a company or the interests of other shareholders. Accordingly, the Majority Shareholders could influence us to enter into transactions or agreements that other shareholders would not approve or make decisions with which other shareholders may disagree.
Our corporate organizational documents and provisions of federal and state law to which we are subject contain certain provisions that could have an anti-takeover effect and may delay, make more difficult or prevent an attempted acquisition that you may favor or an attempted replacement of our board of directors or management.
Our certificate of formation and our bylaws (each as amended and restated) may have an anti-takeover effect and may delay, discourage or prevent an attempted acquisition or change of control or a replacement of our incumbent board of directors or management. Our governing documents include provisions that:
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subject to the rights of the holders of the Series B preferred stock, empower our board of directors, without shareholder approval, to issue our preferred stock, the terms of which, including voting power, are to be set by our board of directors;
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eliminate cumulative voting in elections of directors;
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subject to certain exceptions, permit our board of directors to alter, amend or repeal our amended and restated bylaws or to adopt new bylaws;
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require shareholders that wish to bring business before annual or special meetings of shareholders, or to nominate candidates for election as directors at our annual meeting of shareholders, to provide timely notice of their intent in writing; and
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enable our board of directors to increase, between annual meetings, the number of persons serving as directors and to fill the vacancies created as a result of the increase by a majority vote of the directors present at a meeting of directors at which there is a quorum.
Banking laws also impose notice, approval, and ongoing regulatory requirements on any shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or its holding company. These laws include the BHC Act and the CIBCA. These laws could delay or prevent an acquisition.
Furthermore, our bylaws provide that the state or federal courts located in Dallas County, Texas, the county in which the city of Dallas is located, will be the exclusive forum for: (i) any actual or purported derivative action or proceeding brought on our behalf; (ii) any action asserting a claim of breach of fiduciary duty by any of our current or former directors or officers; (iii) any action asserting a claim against us or our current or former directors or officers arising pursuant to the TBOC, our certificate of formation, or our bylaws; or (iv) any action asserting a claim against us or our current or former officers or directors that is governed by the internal affairs doctrine, in each case subject to said courts having personal jurisdiction over the indispensable parties named as defendants therein. Any person purchasing or otherwise acquiring any interest in any shares of our capital stock will be deemed to have notice of and to have consented to this provision of our certificate of formation. The exclusive forum provision may limit a shareholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits. Alternatively, if a court were to find the exclusive forum provision to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
The obligations associated with being a public company require significant resources and management attention, which increase our costs of operations and may divert focus from our business operations.
We incur substantial legal, accounting, administrative and other costs and expenses related to operating as a public company, and these costs may be higher when we no longer qualify as an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”). We are subject to the reporting requirements of the Exchange Act, which requires that we file annual, quarterly and current reports with respect to our business and financial condition and proxy and other information statements, and the rules and regulations implemented by the SEC, the Sarbanes-Oxley Act, the Dodd-Frank Act, the Public Company Accounting Oversight Board (“PCAOB”) and NASDAQ, each of which imposes additional reporting and other obligations on public companies. As a public company, compliance with these reporting requirements and other SEC and NASDAQ rules make certain operating activities more time-consuming, and we also incur significant legal, accounting, insurance and other expenses. Additionally, any failure by us to file our periodic reports with the SEC in a timely manner could, among other things, harm our reputation, cause our investors and potential investors to lose confidence in us, restrict trading in or reduce the market price of the Series B preferred stock, and potentially limit our ability to access the capital markets. Furthermore, the corporate infrastructure demanded of a public company may divert management’s attention from implementing our operating strategy, which could prevent us from successfully implementing our strategic initiatives and improving our results of operations. We incur expenses to maintain our internal control and procedures for financial reporting and accounting systems to meet our reporting obligations as a public company. We cannot predict or estimate the amount of additional costs we may incur in the future in order to continue to comply with these requirements, and these costs may materially increase our general and administrative expenses over time, and such increases would reduce our profitability.
We are an “emerging growth company,” and the reduced reporting requirements applicable to emerging growth companies may make the Series B preferred stock less attractive to investors.
We are an “emerging growth company,” as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of reduced regulatory and reporting requirements that are otherwise generally applicable to public companies. These include, without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced financial reporting requirements, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding non-binding advisory votes on executive compensation and shareholder approval of any golden parachute payments not previously approved. The JOBS Act also permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to, and expect to continue to, take advantage of certain of these and other exemptions until we are no longer an emerging growth company. Further, the JOBS Act allows us to present only two years of audited financial statements and only two years of related management’s discussion and analysis of financial condition and results of operations in this Form 10-K.
We may take advantage of these provisions for up to five years from the date of our initial offering date in May 2019, unless we earlier cease to be an emerging growth company, which would occur if our annual gross revenues exceed $1.07 billion, if we issue more than $1.0 billion in non-convertible debt in a three-year period or if we become a “large accelerated filer,” in which case we would no longer be an emerging growth company as of the following December 31. We cannot predict if investors find the Series B preferred stock less attractive because we rely on these exemptions, or if we choose to rely on additional exemptions in the future. If some investors find the Series B preferred stock less attractive as a result, there may be a less active trading market for the Series B preferred stock and our share price may be more volatile.
An investment in the Series B preferred stock is not an insured deposit and is subject to risk of loss.
The Series B preferred stock is not a savings account, deposit or other obligation of any of our bank or nonbank subsidiaries and is not insured or guaranteed by the FDIC or any other government agency. Your investment is subject to investment risk, and you must be capable of affording the loss of your entire investment.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments.
Not applicable.

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ITEM 2. PROPERTIES
Item 2.
Properties.
Our main office is located in a two-story, approximately 33,000 square foot commercial office building located at 16200 Dallas Parkway, Dallas, Texas 75248, which is owned by the Bank. The Bank occupies approximately 36% of the building and leases out the remainder to other tenants.
We also lease space at: (a) 600 Travis, Houston, Texas 77002, comprising 14,402 square feet (expires in April 2026) for offices of Sanders Morris, Tectonic Advisors and HWG, (b) 17 Cowboys Way, Frisco, Texas 75034, comprising 2,141 square feet (expires in January 2034) for offices of Tectonic Advisors and HWG, (c) 5950 Sherry Lane, Suite 470, Dallas, Texas 75225, comprising 2,508 square feet, which lease expires in February 2024 for offices of Sanders Morris’s Dallas branch, (d) 8900 Indian Creek Parkway, Overland Park, Kansas 66210, comprising 4,947 square feet, which lease expires in May 2027 for offices of the Bank’s Nolan division, and (e) 6300 Ridglea Place, Fort Worth, Texas 76116, comprising 4,139 square feet, which lease expires in January 2027 for offices of the Bank’s Integra factoring division. Management believes that the principal terms of the leases are consistent with prevailing market terms and conditions and that these facilities are in good condition and adequate to meet our current needs.

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ITEM 3. LEGAL PROCEEDINGS
Item 3.
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. However, changes in circumstances or additional information could result in additional accruals or resolution of these matters in excess of established accruals, which could adversely affect our financial condition, results of operations or cash flows, potentially materially.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4.
Mine Safety Disclosures.
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5.
Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities.
Market Information
There is no established public trading market for our common stock. Our Series B preferred stock is quoted on the NASDAQ Global Market under the symbol “TECTP”.
Holders of Record
As of March 29, 2023, we had 98 holders of record of our common stock.
Dividends
Although we intend to pay dividends on the Series B preferred stock, dividends on the Series B preferred stock are not cumulative or mandatory. If our Board of Directors does not declare a dividend on the Series B preferred stock or if our Board of Directors authorizes and we declare less than a full dividend in respect of any Dividend Period, the holders of the Series B preferred stock will have no right to receive any dividend or a full dividend and we will have no obligation to pay a dividend or to pay full dividends for that Dividend Period at any time, whether or not dividends on the Series B preferred stock or any other class or series of our preferred stock or common stock are declared for any future Dividend Period.
It is the policy of our Board of Directors to reinvest earnings for such period of time as is necessary to ensure our successful operations. During the year ended 2022, and after declaring and paying dividends on our Series B preferred stock, our Board of Directors declared and paid certain quarterly dividends on our common stock, which is not registered with the SEC, and does not trade publicly. As a financial holding company, our ability to pay cash dividends is dependent upon the ability of our bank and non-bank subsidiaries to pay cash dividends. Future dividends will depend on our consolidated earnings, capital and regulatory requirements, financial condition, and other factors considered relevant by our Board of Directors. In addition, we are subject to regulatory restrictions on our payment of dividends. For more information regarding the Company’s ability to pay dividends, please refer to the “Supervision and Regulation” section under Item 1 of this Form 10-K.
Securities Authorized for Issuance Under Equity Compensation Plans
Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2022, segregated between stock-based compensation plans approved by shareholders and stock-based compensation plans not approved by shareholders, is presented in the table below.
Plan Category
Number of securities
to be issued upon
exercise of
outstanding options,
warrants, and rights
(a)
Weighted average
exercise price of
outstanding options,
warrants, and rights
(b)
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in (a))
Equity compensation plans approved by security holders:
2017 Equity Incentive Plan
337,500
$ 5.51
340,000

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ITEM 6. SELECTED FINANCIAL DATA
Item 6.
[RESERVED]

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation.
This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. Please see “Cautionary Statement Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K. Our actual results could differ significantly from those anticipated in these estimates and in the forward-looking statements as a result of certain factors, including those discussed in the section of this Form 10-K captioned “Risk Factors,” and elsewhere in this Form 10-K.
Company Overview
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, factoring, third-party administration, qualified plan recordkeeping and insurance services to individuals, small businesses and institutions across the United States.
We operate through four main direct and indirect subsidiaries: (i) T Bancshares, Inc. (“T Bancshares”) 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 Harris LLC (“Sanders Morris”), a registered broker-dealer with FINRA, and registered investment advisor with the 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 investment advisors, as well as for their clients, and (iv) HWG Insurance Agency LLC (“HWG”), an insurance agency registered with the Texas Department of Insurance (“TDI”).
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 traditional fiduciary services clients primarily consist of clients of Cain Watters & Associates L.L.C. (“Cain Watters”). The Bank also offers lending services, including commercial loans to small-to medium-sized businesses and professional concerns, as well as consumers, The Nolan Company (“Nolan”), operating from its office in Overland Park, Kansas as a division within the Bank, offers third party administration (“TPA”) services, and Integra Funding Solutions, LLC (“Integra”), operating from its Fort Worth, Texas office as a division within the Bank, offers factoring services.
The Bank’s technological capabilities, including worldwide free ATM withdrawals, sophisticated on-line banking capabilities, electronic funds transfer capabilities, and economical remote deposit solutions, allow most customers to be served regardless of their geographic location. The Bank serves its local geographic market which includes Dallas, Tarrant, Denton, Collin and Rockwall counties which encompass an area commonly referred to as the Dallas/Fort Worth Metroplex. The Bank also provides focused services to 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 Small Business Administration (“SBA”) and the U.S. Department of Agriculture (“USDA”).
Sanders Morris provides brokerage, advisory, and wealth management services to high and ultra-high net worth individuals in a broad geographic area that includes Texas, with a concentration of clients in the Houston, Texas metroplex area, as well as clients across the United States. Tectonic Advisors provides advisory and wealth management services primarily to affiliated institutions and their clients, including the Bank, Cain Watters, and their clients, under long-standing advisory and due diligence agreements.
We have three operating segments: Banking, Other Financial Services and HoldCo. Our banking operating segment encompasses both commercial and consumer banking services, as well as factoring services. Our Other Financial Services segment includes the activities of Tectonic Advisors, Sanders Morris, the Bank’s Trust Division, which includes Nolan, and HWG. Our HoldCo operating segment includes the Bank’s immediate parent, T Bancshares, and related subordinated debt, as well as operations of the financial holding company that serves as parent for the group overall. See the section entitled Segment Reporting, below, for more information.
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, T Bancshares, the Bank, Tectonic Advisors, Sanders Morris, and through Sanders Morris, HWG. 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.
Estimation of the allowance for loan losses
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. Based on an analysis performed by management at December 31, 2022, 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. See additional discussion of the allowance for loan losses in Note 1 to our Consolidated Financial Statements.
Integra Acquisition
On July 1, 2021, we, through our wholly-owned subsidiary T Bancshares, acquired Integra through the merger of Integra with and into T Bancshares, with T Bancshares surviving the merger. Integra’s activity is reported within our Banking segment. Integra is a factoring company that provides financing to smaller transportation companies across the United States principally by purchasing their accounts receivable at a discount and then collecting such receivables at face value. The acquisition of this small business lending vertical enables us to provide the Bank with additional breadth in its lending platform and enable the Bank to continue to prudently grow its balance sheet and generate relatively attractive returns on its assets.
For further information, see Note 18 - Integra Acquisition in the accompanying notes to the consolidated financial statements included elsewhere in this report.
Climate Change
Refer to Item 1. Business for background as it relates to the Company and climate change.
There have been significant completed and pending developments in federal and state legislation and regulation regarding climate change in recent years. Given our size and the nature of our business, the incurred direct impact and expected future direct impact of climate-related regulation is not material, nor expected to be material, to our business, financial condition, or results of operations. Further, we have not experienced any physical effects of climate change on our operations and results.
We recognize that, while not material to our operations to-date, indirect consequences of climate-related regulation could exist that might be associated with our lending to certain types of customers who engage in activity that some could deem potentially harmful to the environment. The Company notes that the climate change landscape is constantly evolving and at this time, it is not possible for us to know or predict the full universe or extent that these indirect effects will have on the Company's future operations.
While programs and initiatives focused on sustainability and resource conservation have been put in place by the Company, there have been no material past capital expenditures for climate-related projects. We do not plan to have material future capital expenditures for climate-related projects at this time. Additionally, we have not incurred any material compliance costs related to climate change.
Performance Summary
Net income available to common shareholders for the years ended December 31, 2022 and 2021 was unchanged at approximately $15.5 million. Earnings per diluted common share were $2.11 and $2.21 for the years ended December 31, 2022 and 2021, respectively. For the year ended December 31, 2022, changes in the components of net income compared to the prior year included a $1.7 million increase in net interest income, a $3.4 million increase in non-interest income, a $6.5 million increase in non-interest expense, a $950,000 decrease in the provision for loan losses and a $381,000 decrease in income tax expense.
Our accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, this Form 10-K 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 year ended December 31, 2022, annual return on average assets was 2.89%, compared to 3.06% for the prior year, and annual return on average equity was 18.88%, compared to 24.99% for the same period in the prior year. The lower annual returns on average assets and on average equity were primarily due to no change in net income for the years ended December 31, 2022 and 2021 which is explained in the “Results of Operations” section, and growth in average assets primarily related to the Company’s acquisition of Integra Funding Solutions, LLC, a Texas limited liability company (“Integra”) on July 1, 2021, and average equity during the year ended December 31, 2022. The annual return on average equity was impacted by the shares of Company common stock issued for the Company’s acquisition of Integra.
The following table reconciles net income to income available to common shareholders and presents the calculation of return on average tangible common equity:
(In thousands, except percentages)
As of and for the
Year Ended
December 31, 2022
As of and for the
Year Ended
December 31, 2021
Income available to common shareholders
$ 15,478
$ 15,482
Average shareholders’ equity
$ 90,194
$ 68,156
Less: average goodwill
21,440
16,129
Less: average core deposit intangible
Less: average preferred stock
17,250
17,250
Average tangible common equity
$ 50,823
$ 33,892
Return on average tangible common equity
30.45
%
45.68
%
Total assets grew by $27.5 million, or 4.7%, to $612.5 million as of December 31, 2022, from $585.0 million as of December 31, 2021. This increase was primarily due to increases of $21.2 million loans held for investment, $9.1 million for investments, partly offset by decrease of $3.8 million in cash and cash equivalents.
Shareholders’ equity increased $11.7 million, or 13.8%, to $96.5 million as of December 31, 2022, from $84.8 million as of December 31, 2021. See analysis of shareholders’ equity in the section captioned “Capital Resources and Regulatory Capital Requirements” included elsewhere in this discussion.
Results of Operations
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 Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities. As of December 31, 2022, the target range for the federal funds rate was 4.25% to 4.50%. The target range for the federal funds rate was increased 25 basis points from 4.50% to 4.75% effective February 2, 2023, and from 4.75% to 5.00% effective March 23, 2023.
The following table 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.
2022 vs 2021
Increase (Decrease) Due to Change in
(In thousands)
Rate
Average
Volume
Total
Interest-bearing deposits and federal funds sold
$
$ (27
)
$
Securities
Loans, net of unearned discount (1)
1,786
2,506
Total earning assets
2,729
1,272
4,001
Savings and interest-bearing demand
Money market deposit accounts
1,063
1,207
Time deposits
1,237
FHLB and other borrowings
(390
)
(217
)
Subordinated notes
-
Total interest-bearing liabilities
2,072
2,277
Changes in net interest income
$
$ 1,067
$ 1,724
(1)
Include non-accrual loans.
Net interest income increased $1.7 million, or 6.6% from $25.8 million for the year ended December 31, 2021, to $27.5 million for year ended December 31, 2022. Net interest margin for the year ended December 31, 2022 and 2021 was 5.06% and 4.96%, respectively, an increase of 10 basis points. The increase in net interest income was primarily due to an increase in the average yield and average volume on total earning assets (attributable to the factored receivables acquired in the Integra acquisition on July 1, 2021), partly offset by an increase in the average rate paid on money market deposit accounts and on time deposits.
The average volume of interest-earning assets increased $23.4 million, or 4.5%, from $519.2 million for the year ended December 31, 2021 to $542.6 million for the year ended December 31, 2022. The average volume of securities increased $14.3 million, or 44.3%, from $32.3 million for the year ended December 31, 2021, to $46.6 million for the year ended December 31, 2022, and the average volume of loans increased $10.7 million, or 2.4%, from $448.3 million for the year ended December 31, 2021 to $459.0 million for the year ended December 31, 2022. The increase in the average volume of loans included increases of $65.9 million for organic loan growth and $14.3 million for factored receivables related to the Integra acquisition during the third quarter of 2021, partly offset by a $69.5 million decrease of PPP loans. The average yield on interest-earning assets increased 49 basis points from 5.66% for the year ended December 31, 2021 to 6.15% for the year ended December 31, 2022. The average yield on interest earning assets was impacted by changes in market interest rates, which was attributed to the FOMC repeatedly raising their target benchmark interest rate during the year ended December 31, 2022, resulting in subsequent prime rate increases of 425 basis points between March and December of 2022, and changes in the mix of interest-earning assets. The average yield for loans increased 40 basis points from 6.33% for the year ended December 31, 2021, to 6.73% for the year ended December 31, 2022. During the year ended December 31, 2022, we recognized $175,000 in PPP related deferred fees (net of amortization of related deferred origination costs) as a yield adjustment and this amount is included in interest income on loans. This was a decrease of $4.6 million from the same period in the prior year. The decrease in PPP fees was partly offset by an increase in factored receivables interest income of $2.6 million from the same period in the prior year. The average yield on securities increased 109 basis points from 2.96% for the year ended December 31, 2021, to 4.05% for the year ended December 31, 2022, and the average yield on interest-bearing deposits increased 153 basis points from 0.13% for the year ended December 31, 2021, to 1.66% for the year ended December 31, 2022.
The average volume of interest-bearing liabilities decreased $21.0 million, or 5.2%, from $404.1 million for the year ended December 31, 2021 to $383.2 million for the year ended December 31, 2022. The average volume of interest-bearing deposits increased $43.3 million, or 13.6%, from $319.1 million for the year ended December 31, 2021, to $362.5 million for the year ended December 31, 2022. The average interest rate paid on interest-bearing liabilities increased 64 basis points from 0.90% for the year ended December 31, 2021, to 1.54% for the year ended December 31, 2022. The average interest rate paid on interest-bearing deposits increased 58 basis points from 0.78% for the year ended December 31, 2021, to 1.36% for the year ended December 31, 2022. Non-interest bearing deposits increased $27.9 million, or 36.6%, from $76.3 million for the year ended December 31, 2021, to $104.2 million for the year ended December 31, 2022. The average volume of FHLB and other borrowings decreased $64.3 million, or 88.1%, from $73.0 million for the year ended December 31, 2021, to $8.7 million for the year ended December 31, 2022, due to the decline in the PPPLF borrowings related to the decrease in PPP loan balances. The average cost of FHLB and other borrowings increased 24 basis points from 0.37% for the year ended December 31, 2021, to 0.61% for the year ended December 31, 2022, due to the aforementioned significant increases in the market interest rates during the year ended December 31, 2022 and the decrease in PPPLF borrowings during the period.
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 years ended December 31, 2022 and 2021.
Year Ended December 31,
(In thousands, except percentages)
Average
Balance
Interest
Average
Yield
Average
Balance
Interest
Average
Yield
Assets
Interest-bearing deposits and federal funds sold
$ 37,032
$
1.66
%
$ 38,634
$
0.13
%
Securities
46,576
1,887
4.05
32,292
2.96
Loans, net of unearned discount (1)
458,980
30,885
6.73
448,284
28,379
6.33
Total earning assets
542,588
33,385
6.15
519,210
29,384
5.66
Cash and other assets
49,995
41,652
Allowance for loan losses
(4,192
)
(3,344
)
Total assets
$ 588,391
$ 557,518
Liabilities and Shareholders’ Equity
Savings and interest-bearing demand
$ 16,287
0.30
%
$ 13,907
0.25
%
Money market deposit accounts
129,972
1,639
1.26
118,577
0.36
Time deposits
216,196
3,252
1.50
186,647
2,015
1.08
Total interest-bearing deposits
362,455
4,940
1.36
319,131
2,482
0.78
FHLB and other borrowings
8,730
0.61
73,015
0.37
Subordinated notes
12,000
7.59
12,000
7.29
Total interest-bearing liabilities
383,185
5,904
1.54
404,146
3,627
0.90
Non-interest-bearing deposits
104,170
76,328
Other liabilities
10,842
8,888
Total liabilities
498,197
489,362
Shareholders’ equity
90,194
68,156
Total liabilities and shareholders’ equity
$ 588,391
$ 557,518
Net interest income
$ 27,481
$ 25,757
Net interest spread
4.61
%
4.76
%
Net interest margin
5.06
%
4.96
%
(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 years ended December 31, 2022 and 2021, the provision for loan losses totaled $1.3 million and $2.2 million, 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:
Year Ended December 31,
(In thousands)
Trust income
$ 6,098
$ 6,252
Gain on sale of loans
-
Advisory income
13,549
13,472
Brokerage income
11,754
9,644
Service fees and other income
8,293
6,790
Rental income
Total
$ 40,040
$ 36,624
Total non-interest income for the year ended December 31, 2022, increased $3.4 million, or 9.3%, as compared to the year ended December 31, 2021. Changes in the various components of non-interest income are discussed below.
Trust Income. Trust income is earned from trust services on the value of managed and non-managed assets held in custody. The volatility of the bond and equity markets impacts the market value of trust assets and the related fees. Trust income for the year ended December 31, 2022, decreased $154,000, or 2.5%, compared to the year ended December 31, 2021. The fee income decreased between the two years due to a decrease in the average market value of the trust assets over the year ended December 31, 2022, due to decreases in asset values of $970 million which offset net asset inflows of $561 million.
Gain on sale of loans. The gain on sale of loans primarily reflects the gain from the sale of the guaranteed portion of SBA 7(a) and USDA loans originated by the Bank’s SBA lending group. Gain on sale of loans decreased $101,000 during the year ended December 31, 2022, during which there was no gain on sale of loans, compared to the same period in the prior year, when there was gain on sale of loans of $101,000 resulting from the sale of $1.1 million of SBA loans.
Advisory income. Advisory fees are typically based on a percentage of the underlying average asset value 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. In addition to fees based on a percentage of underlying assets, payments under certain advisory agreements at Sanders Morris are based on the performance of the respective account, measured as a percentage of the increase achieved in the asset values in the respective account. Performance-based fees, though the agreements may remain in place from year to year, are far less predictable, given the uncertainty of the ability to achieve an increase of the same level as in prior periods, or at all. For the year ended December 31, 2022, advisory income increased $77,000, or 0.6%, compared to the year ended December 31, 2021. This increase during the year ended December 31, 2022, was primarily due an increase in advisory fees based on a percentage of the underlying assets at Tectonic Advisors totaling $378,000, partially offset by a decrease in advisory fees based on a percentage of underlying assets at Sanders Morris Harris totaling $301,000.
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, cash held in brokerage accounts which funds margin lending, and on private placement and syndication activity during the period. Brokerage income for the year ended December 31, 2022, increased $2.1 million, or 21.9%, compared to the year ended December 31, 2021. This increase is primarily due to a recovery in private placement activity due to a recovery in demand for these investments and a backlog of this activity related to a loosening of the travel and contact restrictions put in place during the peak of the COVID-19 pandemic, and a recovery in traditional brokerage activity.
The table below reflects a rollforward of our client assets, which includes both advisory and brokerage assets, as of December 31, 2022 and 2021, and the inflows and outflows and market appreciation during the years then ended. Our brokerage and advisory assets experienced a decrease of approximately $409.8 million, or 7.3%, and an increase of $1.1 billion, or 24.0%, during the years ended December 31, 2022 and 2021, respectively. The decrease for the year ended December 31, 2022 was related to market depreciation of $970.4 million, or 17.3%, which offset positive net flows of $560.5 million, or 10.0%.
(In thousands)
Tectonic Advisors
Sanders Morris
Total
As of January 1, 2021
$ 2,334,037
$ 2,190,339
$ 4,524,376
Client inflows
531,768
2,110,859
2,642,627
Client outflows
(296,819
)
(1,906,936
)
(2,203,755
)
Net flows
234,949
203,923
438,872
Market appreciation
283,994
362,070
646,064
As of December 31, 2021
2,852,980
$ 2,756,332
$ 5,609,312
Client inflows
857,461
1,545,368
2,402,829
Client outflows
(492,064
)
(1,350,240
)
(1,842,304
)
Net flows
365,397
195,128
560,525
Market appreciation/(depreciation)
(494,912
)
(475,454
)
(970,366
)
As of December 31, 2022
$ 2,723,465
$ 2,476,006
$ 5,199,471
Service fees and other income. Service fees include fees for deposit-related services, and third-party administrative fees from the Bank’s Nolan division. Service fees and other income for the year ended December 31, 2022 increased $1.5 million, or 22.1%, compared to the year ended December 31, 2021, which was primarily due to an increase in the administrative fees recorded for services provided by Nolan of $1.4 million, increase in factoring service fees from the Bank’s Integra factoring division of $360,000 related to the Integra acquisition during the third quarter of 2021, increase in credit interest by Sanders Morris Harris of $57,000, as well as individually immaterial increases in other bank service fees totaling $32,000. These increases were offset by a decrease in income distributions from an interest in securities not readily marketable carried at cost basis totaling $191,000, a decrease in gains and losses on marketable securities at Sanders Morris totaling $74,000, a decrease in net loan servicing fees of $26,000, and other individually immaterial decreases in other income of $54,000.
Rental income. The Company receives monthly rental income from tenants leasing space in the Bank building. Rental income for the year ended December 31, 2022 decreased $19,000, or 5.2%, compared to the year ended December 31, 2021 due to a decrease in occupancy in 2022 compared to 2021 and to rent concessions given during 2022.
Non-Interest Expense
The components of non-interest expense were as follows:
Year Ended December 31,
(In thousands)
Salaries and employee benefits
$ 31,093
$ 24,947
Occupancy and equipment
1,707
1,837
Trust expenses
2,243
2,416
Brokerage and advisory direct costs
2,015
2,051
Professional fees
1,480
1,539
Data processing
Other expense
5,473
4,576
Total
$ 44,805
$ 38,330
Total non-interest expense for the year ended December 31, 2022 increased $6.5 million, or 16.9%, compared to the year ended December 31, 2021. Changes in the various components of non-interest income are discussed below.
Salaries and employee benefits. Salaries and employee benefits include employee payroll expense, incentive compensation, health insurance, benefit plans and payroll taxes. Salaries and employee benefits increased $6.1 million, or 24.6%, from $24.9 million for the year ended December 31, 2021 to $31.1 million for the year ended December 31, 2022. In our other financial services segment, salaries and employee benefits increased $2.8 million. The increase was primarily from a increase in incentive bonuses at Sanders Morris related to traditional brokerage, private placement, and syndicated offerings activity of $1.6 million, offset by a decrease in commission salaries of $559,000, and an increase in salaries, payroll taxes, and other benefits of $543,000 at Tectonic Advisors and $213,000 at Sanders Morris. Salaries, bonuses and payroll taxes at the Bank’s Nolan division increased $862,000 related to staff increases to accommodate the increase in the number of plans administered and merit increases. Salaries, taxes and other benefits in our trust group within our other financial services segment increased $186,000 related to staffing additions to accommodate additional recordkeeping clients, as well as a decrease in reliance on third-party consultants. Salaries and employee benefits in our banking segment increased $3.0 million, primarily driven by an accrual for severance expense of $532,000, increases in staff including a full year of Integra as compared to 2021, where Integra was acquired early in the third quarter 2021, and merit increases and incentive bonuses. Stock-based compensation decreased $113,000 primarily related to an offset to expense due to a forfeiture of stock grants due to separation prior to vesting, and salaries, taxes and other benefits increased $362,000. Health insurance related benefits overall increased approximately $372,000, primarily due to increases in headcount, including the addition of the Bank’s Integra factoring division.
Occupancy and equipment expense. Occupancy and equipment expenses include building, furniture, fixtures and equipment depreciation and maintenance costs. Occupancy and equipment expenses decreased $130,000, or 7.1%, from $1.8 million for the year ended December 31, 2021 to $1.7 million for the year ended December 31, 2022. The decrease is primarily due to a decrease occupancy and equipment expense in our other financial services division of $234,000, led by a decrease in rent of $103,000, due to Nolan giving up leased space and Sanders Morris Harris’s new lease agreement, a decrease in depreciation expense of $89,000 from certain fixed assets and software costs that reached full depreciation/amortization in 2021, and a decrease in rental and common area maintenance expense of $26,000 driven by lower costs related to the COVID-19 pandemic, and a decrease in property taxes and repairs and maintenance of 28,000. This was partially offset by increases in parking and facilities expenses totaling $12,000. Rent expenses in our banking segment increased $99,000, primarily from the addition of the Bank’s Integra factoring division, where rent expense increased $58,000, along with an increase of $41,000 in rent expense at the bank facility.
Trust expenses. Trust expenses are incurred in our other financial services segment, and include advisory fees paid on the common trust funds managed by the Company based on the value of the assets held in custody. The volatility of 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 decreased by $173,000 for the year ended December 31, 2022, as compared to the year ended December 31, 2021 based on decreases in asset values of the Bank’s common trust funds from decreases in asset values whit offset net inflows.
Brokerage and advisory direct costs. Brokerage and advisory direct costs decreased $36,000, or 1.8%, and were approximately $2.0 million for each the year ended December 31, 2021 and December 31, 2022. Brokerage and advisory direct costs are incurred primarily in our other financial services segment and include the cost of clearing firm services and fees on advisory assets from custodians and certain referral fees, as well as information services related to our advisory and trading activity. Expenses at Tectonic Advisors increased $36,000, related to increases in information services, which were offset by decreases in referral and service fees. The increase was offset by a decrease in brokerage and advisory direct costs at Sanders Morris and HWG of $72,000, related to a decrease in clearing firm service fees, fees on advisory assets and referral fees of $97,000, offset by an increase in information services and service fees of $25,000.
Professional fees. Professional fees, which include legal, consulting, audit and tax fees, decreased $59,000, or 3.8%, and were approximately $1.5 million for the years ended December 31, 2021, and December 31, 2022. The decrease included a decrease of $142,000 at the Bank’s trust department due to a decrease in consulting fees related to our participant directed plan services team, where staff increases have allowed us to reduce our reliance on consultants. In addition to a decrease of $81,000 in professional fees in Holdco, due to the acquisition of Integra in 2021, offset by in an increase in professional fees of $111,000 in the banking and other financial services divisions, due to a new lease at Tectonic Advisors, new deals at Sanders Morris Harris, a new pension portal consulting at Nolan. In addition, legal fees decreased $97,000, primarily in our Banking segment related to the acquisition of Integra during the year ended December 31, 2021. The decrease in legal fees was offset by an increase in audit and tax consulting fees of $151,000, primarily in our Banking and Parent segments related to the increase in complexity of our annual audit and tax preparation services.
Data processing. Data processing includes costs related to the Company’s operating systems. Data processing expenses decreased $170,000, or 17.6%, from $964,000 for the year ended December 31, 2021, to $794,000 for the year ended December 31, 2022. The decrease was due to decreases in data processing expenses within the Banking segment of $210,000, offset by an increase of $40,000 in our Other Financial Services segment. The decreases in our Banking segment were primarily related to the conversion of the Bank’s core accounting system during the same periods in the prior year, which increased expense during the earlier periods, and the offsetting increases were primarily related to increases at the Bank’s trust division related to increasing activity and improvements in the participant directed services group.
Other expense. Other expenses include costs for insurance, Federal Deposit Insurance Corporation (“FDIC”) and Office of the Comptroller of the Currency (“OCC”) assessments, director fees, and regulatory filing fees related to our brokerage business, business travel, management fees, and other operational expenses. Other expenses increased $897,000, or 19.6%, from $4.6 million for the year ended December 31, 2021 to $5.5 million for the year ended December 31, 2022. The increase includes increases in software costs and licensing primarily at the banking and other financial services divisions of $259,000, advertising and marketing expense across all segments of the Company of $190,000, including the initiative at Tectonic Advisors where we are investing in marketing costs related to assets under management associated with Cain Watters above $2.5 billion, travel and lodging expense at the banking and other financial services divisions of $161,000, increases in employee recruitment and office expense across all segments of the company of $127,000, increases in loan and other real estate operating costs at the Bank of $41,000, and other individually immaterial increases.
Income Taxes
The income tax expense for the years ended December 31, 2022 and 2021 was $4.4 million and $4.8 million, respectively. The effective income tax rate was 20.6% and 22.0% for the years ended December 31, 2022 and 2021, respectively.
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:
Year Ended December 31, 2022
(In thousands)
Banking
Other Financial Services
HoldCo
Consolidated
Revenue(1)
$ 29,630
$ 38,788
$ (897
)
$ 67,521
Net income (loss) before taxes
$ 13,106
$ 11,164
$ (2,818
)
$ 21,452
Year Ended December 31, 2021
(In thousands)
Banking
Other Financial Services
HoldCo
Consolidated
Revenue(1)
$ 27,639
$ 35,428
$ (686
)
$ 62,381
Net income (loss) before taxes
$ 13,605
$ 10,547
$ (2,315
)
$ 21,837
(1)
Net interest income plus non-interest income
Banking
Income before taxes for the year ended December 31, 2022 decreased $499,000, or 3.7%, compared to the year ended December 31, 2021. The decrease was primarily the result of a $3.4 million increase in non-interest expense, partly offset by a $1.7 million increase in net interest income, a $247,000 increase in non-interest income, and a $950,000 decrease in the provision for loan losses.
Net interest income for the year ended December 31, 2022 increased $1.7 million, or 6.5%, compared to the year ended December 31, 2021. The increase in net interest income was primarily due to an increase in the average yield and average volume on total earning assets, partly offset by an increase in the average rate paid on money market deposit accounts and time deposits and an increase in the average volume of deposits. The average yield on interest earning assets and average rate paid on deposits were impacted by changes in market interest rates and changes in the mix of interest-earning assets. 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 year ended December 31, 2022 decreased $950,000, or 43.2%, to $1.3 million, compared to $2.2 million for the year ended December 31, 2021. See “Allowance for Loan Losses” included elsewhere in this discussion.
Non-interest income for the year ended December 31, 2022 increased $247,000, or 24.9%, compared to the year ended December 31, 2021. The increase was primarily due to a $360,000 increase for factoring service fees related to the Integra acquisition during the third quarter of 2021, and a $33,000 increase in deposit service fees and other, partly offset by a $19,000 decrease in rental income, a $26,000 decrease in net loan servicing income and a $101,000 decrease in gain on sale of 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 year ended December 31, 2022 increased $3.4 million, or 29.1%, compared to the year ended December 31, 2021. The increase was primarily related to a $3.1 million increase in salaries and employee benefits for annual merit increases, increases in (including $1.3 million for the addition of Integra), and incentive bonuses. Other changes include a $99,000 increase in occupancy and equipment expense for increase in facilities expense (including $68,000 for the addition of Integra), a $16,000 increase in professional fees including increases in audit and tax consulting fees, partly offset by legal fees related to the acquisition of Integra during the prior year, a $211,000 decrease in data processing related to banking core system conversion costs in 2022 partly offset by expenses for the operations of Integra, and a $483,000 increase in other expenses including $169,000 for the addition of Integra, $138,000 for software development, $52,000 for FDIC premiums, $45,000 for employee recruitment, $50,000 for travel and a net of $29,000 for various other expenses. 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 year ended December 31, 2022 increased $617,000, or 5.9%, compared to the year ended December 31, 2021. The increase was primarily the result of a $3.4 million increase in non-interest income partly offset by a $2.8 million increase in non-interest expense.
Non-interest income for the year ended December 31, 2022 increased $3.4 million, or 9.5%, compared to the year ended December 31, 2021. The increase was due to increases in brokerage income of $2.1 million, primarily from increases in private placement activity at Sanders Morris, service fees and other income of $1.3 million, resulting from increases at the Bank’s Nolan division and increases in factoring fees due to having a full year of activity in the year ended December 31, 2022, and an increase of $76,000 in advisory fees, partially offset by a decrease in trust fees of $154,000. See the analysis of non-interest income included in the section captioned “Non-Interest Income” above in this discussion.
Non-interest expense for the year ended December 31, 2022 increased $2.7 million, or 11.0%, compared to the year ended December 31, 2021. The increase was primarily from an increase in salaries and employee benefits of $2.8 million, other operating costs of $360,000, and data processing expense of $41,000, which were offset by decreases in occupancy and equipment costs of $234,000, trust expense of $173,000, professional fees of $60,000, and brokerage and advisory direct costs of $36,000. The increase in salaries and employee benefits expense was primarily from an increase in incentive bonuses at Sanders Morris related to traditional brokerage, private placement, and syndicated offerings activity of $1.6 million, and at the Bank’s Nolan division of $862,000 related to staff increases to accommodate the increase in the number of plans administered and merit increases. The increase in other operating costs was primarily related to an increase in software costs and advertising and marketing expense across our advisory, brokerage, and third party administration businesses. The decrease in occupancy and equipment costs was the result of a decrease in office lease expense at Nolan related to a reduction in space at their home office location in Overland Park, Kansas, and the decrease in trust expense related to fluctuations in asset values during the year ended December 31, 2022. The decrease in professional fees related to a reduction in reliance on consultants, and the decrease in brokerage and advisory direct costs related to individually immaterial changes in these expenses at Sanders Morris Harris. See also the analysis of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.
HoldCo
The net loss before taxes at the HoldCo operating segment increased by $503,000 during the year ended December 31, 2022 compared to the year ended December 31, 2021. The increase is the result of an increase in salaries and employee benefits of $248,000, primarily related to annual bonuses and merit increases, as well as the addition of staff at the holding company. Other operating costs increased $54,000 related to increases in public relations expense and software and computer expenses for initiatives at the holding company to increase integration and efficiency of human resources and overlay management functions across the company. These increases were offset by a decrease in professional fees related to expenses incurred during the year ended December 31, 2021 related to the acquisition of Integra in 2021, which were offset by increases in tax and accounting fees related to an increase in complexity in our annual audit services and market increases in pricing for these services. See also the analysis of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.
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. Securities are classified as available for sale when we intend to hold for an indefinite period of time but might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported as a separate component of stockholders’ equity as other comprehensive income (loss), net of tax. Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity.
As of December 31, 2022 and 2021, 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 consist of Property Assessed Clean Energy (“PACE”) and Public Improvement District/Tax Increment Reinvestment Zone (“PID/TIRZ”) investments. These investment contracts or bonds located in Texas, California and Florida, originate under a contractual obligation between the property owners, the local county or city administration, and a third-party administrator and sponsor. PACE assessments are created to fund the purchase and installation of energy saving improvements to the property such as solar panels. PID/TIRZ assessments are used to pay for the development costs of a residential subdivision. Generally, as a property assessment, the total assessment is repaid in installments over a period of 5 to 32 years by the then current property owner(s). Each installment is collected by the County or City Tax Collector where the property is located. The assessments are an obligation of the property.
Restricted securities consisted of FRB stock, having an amortized cost and fair value of $2.2 million and $1.2 million as of December 31, 2022 and 2021, respectively, and FHLB stock, having an amortized cost and fair value of $1.3 million as of December 31, 2022 and 2021.
Securities not readily marketable consists of an income interest in a private investment.
The following presents the amortized cost and fair values of the securities portfolio as of the dates indicated:
As of December 31, 2022
As of December 31, 2021
(In thousands)
Amortized
Cost
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
Securities available for sale:
U.S. Treasuries
$ 1,990
$ 1,953
$ -
$ -
U.S. government agencies
15,715
13,088
15,847
15,402
Mortgage-backed securities
5,925
5,592
1,724
1,754
Total securities available for sale
$ 23,630
$ 20,633
$ 17,571
$ 17,156
Securities held to maturity:
Property assessed clean energy
$ 1,596
$ 1,722
$ 2,731
$ 2,731
Public improvement district/TIRZ
23,666
24,760
16,942
16,942
Total securities held to maturity
$ 25,262
$ 26,482
$ 19,673
$ 19,673
Securities, restricted:
Other
$ 3,496
$ 3,496
$ 2,432
$ 2,432
Securities not readily marketable
$
$
$
$
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 December 31, 2022. 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
After One Year
After Five Years
One Year
Through
Through
After
or Less
Five Years
Ten Years
Ten Years
Total
(In thousands, except percentages)
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Securities available for sale:
U.S Treasuries
$
2.16
%
$
2.62
%
$ -
-
%
$ -
-
%
$ 1,990
2.39
%
U.S. government agencies
-
-
10,098
0.98
2,000
1.00
3,617
0.83
15,715
0.94
Mortgage-backed securities
3.92
3,841
3.12
-
-
2,037
3.67
5,925
3.32
Total
$ 1,039
2.24
%
$ 14,937
1.63
%
$ 2,000
1.00
%
$ 5,654
1.85
%
$ 23,630
1.66
%
Securities held to maturity:
PACE
$ -
-
%
$ -
-
%
$ -
-
%
$ 1,596
7.16
%
$ 1,596
7.16
%
PID/TIRZ
-
-
2,172
4.12
-
-
21,494
6.26
23,666
6.33
Total
$ -
-
%
$ 2,172
4.12
%
$ -
-
%
$ 23,090
6.33
%
$ 25,262
6.14
%
Securities, restricted:
Other
$ -
-
%
$ -
-
%
$ -
-
%
$ -
-
%
$ 3,496
-
%
Securities not readily marketable
$ -
-
%
$ -
-
%
$ -
-
%
$ -
-
%
$
-
%
Loan Portfolio Composition
Total loans excluding allowance for loan losses, increased $21.6 million, or 5.0%, to $450.3 million at December 31, 2022, compared to $428.7 million at December 31, 2021. The increase includes $60.0 million for non-PPP SBA loans, $9.6 million for commercial and industrial loans and $2.4 million for real estate loans. The increases were partly offset by a $34.1 million decrease for SBA PPP loans and a $16.2 million decrease in factored receivables. PPP loans had a zero balance at December 31, 2022, compared to $34.1 million at December 31, 2021. SBA loans comprise the largest group of loans in our portfolio totaling $258.3 million, or 57.4% of the total loans at December 31, 2022, compared to $233.9 million, or 54.5% (50.6% excluding PPP) of the total loans at December 31, 2021. Commercial and industrial loans totaled $92.9 million, or 20.6% of the total loans at December 31, 2022, compared to $83.3 million, or 19.4% (21.1% excluding PPP) of the total loans at December 31, 2021. Commercial and construction real estate loans totaled $67.8 million, or 15.1% of the total loans at December 31, 2022, compared to $65.6 million, or 15.3% (16.6% excluding PPP), of the total loans at December 31, 2021.
The following table sets forth the composition of our loans held for investment:
(In thousands)
Loans held for investment at December 31,
Commercial and industrial
$ 92,946
$ 83,348
$ 79,864
$ 85,476
$ 88,915
Consumer installment
1,058
1,099
10,259
3,409
3,636
Real estate - residential
5,566
5,452
4,319
5,232
7,488
Real estate - commercial
63,924
62,966
44,484
46,981
35,221
Real estate - construction and land
3,873
2,585
8,396
7,865
4,653
SBA 7(a) guaranteed
149,374
145,983
164,687
69,963
33,884
SBA 7(a) unguaranteed
56,268
52,524
52,179
47,132
44,326
SBA 504
52,668
35,348
35,553
22,591
13,400
USDA
2,235
2,430
3,367
Factored receivables
22,420
38,636
-
-
-
Other
-
-
-
-
Total loans
$ 450,332
$ 428,747
$ 400,542
$ 291,079
$ 234,907
The Company initially records the guaranteed portion of the SBA 7(a) and USDA loans as held for sale at the lower of cost or fair value. Loans held for sale totaled $33.9 million and $33.8 million at December 31, 2022 and 2021, respectively. During the year ended December 31, 2022, the Company elected to reclassify $55.4 million of the SBA loans held for sale to held for investment. The Company determined that holding these loans provides better long-term risk adjusted returns than selling the loans.
Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies and procedures on an annual basis and makes changes as appropriate. Management receives and reviews monthly reports related to loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geographic location.
Commercial and industrial loans, which are predominantly loans to dentists, are underwritten based on historical and projected income of the business and individual borrowers and guarantors. The Company utilizes a comprehensive global debt service coverage analysis to determine debt service coverage ratios. This analysis compares global cash flow of the borrowers and guarantors on an individual credit to existing and proposed debt after consideration of personal and business related other expenses. Collateral is generally a lien on all available assets of the business borrower including intangible assets. Credit worthiness of individual borrowers and guarantors is established through the use of credit reports and credit scores.
Consumer loans are evaluated on the basis of credit worthiness as established through the use of credit reports and credit scores. Additional credit quality indicators include borrower debt to income ratios based on verifiable income sources.
Real estate mortgage loans are evaluated based on collateral value as well as global debt service coverage ratios based on historical and projected income from all related sources including the collateral property, the borrower, and all guarantors where applicable.
The Company originates SBA loans which are sometimes sold into the secondary market. The Company continues to service these loans after sale and is required under the SBA programs to retain specified amounts. The two primary SBA loan programs that the Company offers are the basic SBA 7(a) loan guaranty program and the SBA 504 loan program in conjunction with junior lien financing from a Certified Development Company (“CDC”).
The SBA 7(a) program serves as the SBA’s primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. Loan proceeds under this program can be used for most business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements and debt refinancing. Loan maturity is generally up to 10 years for non-real estate collateral and up to 25 years for real estate collateral. The SBA 7(a) loan is approved and funded by a qualified lender, partially guaranteed by the SBA and subject to applicable regulations. In general, the SBA guarantees up to 75% of the loan amount depending on loan size. The Company is required by the SBA to service the loan and retain a contractual minimum of 5% on all SBA 7(a) loans, but generally retains 25% (the unguaranteed portion). The servicing spread is 1% of the guaranteed portion of the loan that is sold in the secondary market.
The SBA 504 program is an economic development-financing program providing long-term, low down payment loans to businesses. Typically, an SBA 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 SBA 504 loans that meet a public policy goal.
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 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.
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 December 31, 2022, our loan portfolio included $83.9 million of loans, approximately 18.6% of our total funded loans to the dental industry, as compared to $67.3 million of loans, approximately 15.7% of our total funded loans (17.1% of total funded loans, net of the SBA PPP loans), at December 31, 2021. 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. During the year ended December 31, 2020, we funded $98.3 million of PPP loans which have been forgiven by the SBA and were paid off or repaid by the borrower as of December 31, 2021. The Consolidated Appropriations Act, 2021, which was signed into law on December 27, 2020, allocated an additional $284 billion to the SBA to fund a second round of PPP and extended the application period for the PPP to March 31, 2021. The PPP application period was later extended to the earlier of May 31, 2021, or such date when all PPP funds are exhausted. As of December 31, 2022, there were no PPP loans outstanding. During the year ended December 31, 2021, we originated $66.2 million of PPP loans. As of December 31, 2021, approximately $32.1 million of the PPP loans originated in 2021 have been forgiven by the SBA and were paid off or repaid by the borrower, leaving an outstanding balance of $34.1 million as of December 31, 2021, which was forgiven by the SBA and were paid off or repaid by the borrower during the year ended December 31, 2022.
We also participated in the PPPLF which, through June 30, 2021, extended loans to banks who are loaning money to small businesses under the PPP. There were no borrowings under the PPPLF as of December 31, 2022. The total amount borrowed under the PPPLF as of December 31, 2021 was $34.5 million and was non-recourse and secured by an equal amount of the PPP loans we originated. The borrowings under the PPPLF fully paid off during the year ended December 31, 2022.
As of December 31, 2022, 60.8% of the loan portfolio, or $274.0 million, matured or re-priced within one year or less. The following table presents the contractual maturity ranges for loans outstanding as of December 31, 2022, and also presents portion of loans that have fixed interest rates or floating adjustable interest rates over the life of the loan in accordance with changes in the interest rate environment:
Maturity Distribution of Loan Portfolio
(In thousands)
One Year
			or Less
Over One
			Year
			Through
			Five Years
Over Five
			Years
			Through
			Fifteen Years
Over Fifteen Years
Total Loans Receivable
Commercial and industrial
$ 7,259
$ 14,607
$ 70,944
$
$ 92,946
Consumer installment
-
-
1,058
Real estate - residential
4,568
-
-
5,566
Real estate - commercial
24,193
33,553
4,647
1,531
63,924
Real estate - construction and land
1,996
1,549
-
3,873
SBA 7(a) guaranteed
132,250
12,633
3,501
149,374
SBA 7(a) unguaranteed
47,462
6,782
1,472
56,268
SBA 504
34,916
14,158
3,594
-
52,668
USDA
2,235
-
-
-
2,235
Factored Receivables
22,420
-
-
-
22,420
Total
$ 274,001
$ 88,636
$ 84,486
$ 3,209
$ 450,332
Loans Due After One Year
(In thousands)
Fixed Rate
Floating or Adjustable Rate
Total
Commercial and industrial
$ 82,693
$ 2,994
$ 85,687
Consumer installment
-
Real estate - residential
4,568
-
4,568
Real estate - commercial
4,205
35,526
39,731
Real estate - construction and land
1,163
1,877
SBA 7(a) guaranteed
4,638
12,486
17,124
SBA 7(a) unguaranteed
1,970
6,836
8,806
SBA 504
-
17,752
17,752
USDA
-
-
-
Factored Receivables
-
-
-
Total
$ 99,574
$ 76,757
$ 176,331
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 the COVID-19 pandemic.
Non-performing assets include non-accrual loans, loans 90 days or more past due and still accruing, and foreclosed assets. Non-performing assets totaled $2.8 million as of December 31, 2022, compared to $3.7 million as of December 31, 2021. As of December 31, 2022, non-performing assets consisted of SBA non-accrual loans totaling $2.4 million, of which all except $100,000 was guaranteed by the SBA, and commercial real estate loans totaling $138,000.
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. Accrued interest is charged off and no further interest is accrued. Subsequent payments received on non-accrual loans are recorded as reductions of principal. 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. Loans past due 90 days or more and still accruing interest totaled $206,000 in residential real estate and $132,000 in factored receivables as of December 31, 2022, compared to $400,000 as of December 31, 2021, which solely included factored receivables.
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. There were no foreclosed assets as of December 31, 2022, compared to $1.1 million, which included two SBA loans that were foreclosed on during the year ended December 31, 2021 and subsequently sold during the year ended December 31, 2022.
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:
At December 31,
(In thousands, except percentages)
Non-accrual loans:
Commercial and industrial
$ -
$ -
$ -
$
$ -
Real estate - commercial
SBA guaranteed
2,221
2,039
1,118
4,892
2,252
SBA unguaranteed
-
1,039
Total non-accrual loans
2,466
2,188
1,793
5,991
2,545
Real estate - residential past due 90 days
-
-
-
-
Factored receivables past due 90 days
-
-
-
Foreclosed assets
-
1,079
-
-
-
Total non-performing assets
$ 2,804
$ 3,667
$ 1,793
$ 5,991
$ 2,545
As a % of total loans
0.65
%
0.86
%
0.45
%
2.06
%
1.08
%
As a % of total assets
0.48
0.63
0.35
1.64
0.82
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 December 31, 2022, there was one loan which was a SBA loan in the amount of $902,000 identified as TDR, of which $812,000 was guaranteed. The loan became a TDR during the three months ended December 31, 2022. The modification was for interest rate reduction. There was no payment default. There were no other TDRs during the year. There were no TDRs during the year ended December 31, 2021.
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. At December 31, 2022, there were no loans in COVID-19-related deferment. As of December 31, 2021, the Company had granted principal and interest payment deferrals related to COVID-19 to two borrowers representing approximately $679,000.
Allowance for Loan and Lease Losses
Loans are reported net of the allowance for loan losses on our balance sheet. The allowance for loan losses totaled $4.5 million and $4.2 million, at December 31, 2022 and 2021, respectively. During the year ended December 31, 2022, the Company had charge-offs of $998,000 and recoveries of $94,000. During the year ended December 31, 2021, the Company had charge-offs of $1.1 million and recoveries of $117,000.
Based on an analysis performed by management at December 31, 2022, 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.
The table below presents a summary of the Company’s net loan loss experience and provisions to the ALLL for the period indicated:
(In thousands, except percentages)
Balance at January 1,
$ 4,152
$ 2,941
$ 1,408
$
$
Charge-offs:
Commercial and industrial
-
-
Consumer installment
-
-
-
-
-
SBA 7(a)
Factored receivables
-
-
-
Total charge-offs
1,120
1,072
Recoveries:
Commercial and industrial
-
Consumer installment
-
-
-
-
-
Real estate - construction and land
-
-
-
-
-
SBA 7(a)
Factored receivables
-
-
-
Total recoveries
Net charge-offs
1,003
1,021
Provision for loan losses
1,264
2,214
1,709
1,555
Balance at December 31,
$ 4,513
$ 4,152
$ 2,941
$ 1,408
$
Loans at year-end
$ 450,332
$ 428,747
$ 400,542
$ 291,079
$ 234,907
Average loans
458,980
448,284
376,088
275,025
231,385
Net charge-offs/average loans
0.20
%
0.22
%
0.05
%
0.37
%
0.10
%
Allowance for loan losses/year-end loans
1.00
0.97
0.73
0.48
0.37
Total provision for loan losses/average loans
0.28
0.49
0.45
0.57
0.31
The following tables set forth the allocation of the allowance as of the date indicated and the percentage of loans in each category to total gross loans as of the date indicated:
At December 31,
(In thousands, except percentages)
Allowance Amount
Allowance Amount
Allowance Amount
Allowance Amount
Allowance Amount
Commercial and industrial
$ 1,301
$ 1,154
$
$
$
Consumer installment
Real estate - residential
Real estate - commercial
Real estate - construction and land
SBA
1,505
1,324
1,225
USDA
-
-
Factored receivables
-
-
-
Total allowance for loan losses
$ 4,513
$ 4,152
$ 2,941
$ 1,408
$
%(1)
%(1)
%(1)
%(1)
%(1)
Commercial and industrial
20.6 %
19.4 %
19.9 %
29.4 %
37.9 %
Consumer installment
0.2
0.3
2.6
1.2
1.5
Real estate - residential
1.2
1.3
1.1
1.8
3.2
Real estate - commercial
14.2
14.7
11.1
16.1
15.0
Real estate - construction and land
0.9
0.6
2.1
2.7
2.0
SBA
57.4
54.5
63.0
48.0
39.0
USDA
0.5
0.2
0.2
0.8
1.4
Factored receivables
5.0
9.0
-
-
-
Total allowance for loan losses
%
%
%
%
%
(1)
Percentage of loans in each category to total loans
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 on customer service and long-standing relationships with customers to attract and retain deposits, and also on CD listing services. During the second quarter of 2020, we received $40.0 million in brokered deposits through an Insured Cash Sweep One-Way Buy agreement to provide liquidity to fund PPP loan originations. This brokered deposit is included in our money market accounts as of December 31, 2022.
Total deposits increased $48.9 million, or 11.0%, to $493.0 million as of December 31, 2022, from $444.2 million as of December 31, 2021 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:
Year Ended December 31,
Year Ended December 31,
(In thousands, except percentages)
Average
Balance
Percent of
Deposits
Average
Rate
Average
Balance
Percent of
Deposits
Average
Rate
Non-interest-bearing deposits
$ 104,170
19.3
%
0.00
%
$ 76,328
19.3
%
0.00
%
Savings and interest-bearing demand
16,287
3.5
0.30
13,907
3.5
0.25
Money market accounts
129,972
30.0
1.26
118,577
30.0
0.36
Time deposits
216,196
47.2
1.50
186,647
47.2
1.08
Total deposits
$ 466,625
100.0
%
1.06
%
$ 395,459
100.0
%
0.63
%
The following table provides information on the maturity distribution of the insured time deposits and the time deposits exceeding the FDIC insurance limit as of December 31, 2022:
(In thousands)
Insured
Uninsured
Total
Maturing
Three months or less
$ 16,591
$ 10,671
$ 27,262
Over three months to six months
41,949
20,650
62,599
Over six months to 12 months
112,366
18,426
130,792
Over 12 months
37,399
3,638
41,037
Total
$ 208,305
$ 53,385
$ 261,690
Borrowings
The table below presents balances of each of the borrowing facilities as of the dates indicated:
December 31,
December 31,
(In thousands)
Borrowings:
FHLB borrowings
$ -
$ -
FRB borrowings (PPPLF)
-
34,521
Subordinated notes
12,000
12,000
$ 12,000
$ 46,521
The Company has a credit line with the FHLB with borrowing capacity of $56.0 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 December 31, 2022 and 2021.
The Company also has a credit line with the FRB with borrowing capacity of $30.0 million, which is secured by commercial loans. The company had no borrowings from the FRB at December 31, 2022 and 2021 under this credit line. 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”). During June 2022, the Bank repaid its PPPLF from the FRB and had no borrowings under the PPPLF as of December 31, 2022. As of December 31, 2021, the balance of PPPLF related borrowings was $34.5 million.
As of December 31, 2022 and 2021, the Company had subordinated notes totaling $12.0 million, consisting of $8.0 million issued in 2017 bearing an interest rate of three month LIBOR plus 5.125%, with interest payable quarterly and maturing on July 20, 2027, at which all principal is due, and $4.0 million issued in 2018 bearing interest rate of 7.125% payable semi-annually up to July 17, 2023, after which it converts to three month LIBOR plus 5.125%, with interest payable quarterly and maturing on March 31, 2028, at which all principal is due. 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 $11.7 million, or 13.8%, to $96.5 million as of December 31, 2022, from $84.8 million as of December 31, 2021. The increase included net income of $17.0 million, $272,000 related to stock compensation expense and the issuance of common stock related to exercise of stock options in the amount of $97,000. The increases were partly offset by a net after-tax other comprehensive loss of $2.0 million related to the decrease in market value of the securities available for sale due to the recent significant increases in market interest rates, the repurchase of common stock in the amount of $481,000 and dividends paid on the Series B Preferred stock and paid on the common stock in the amounts of $1.6 million and $1.8 million, respectively.
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 December 31, 2022, the Company and the Bank met all capital adequacy requirements to which they were subject. As of December 31, 2022, 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)
December 31, 2022
December 31, 2021
Amount
Ratio
Amount
Ratio
Tectonic Financial, Inc.
Tier 1 Capital (to Average Assets)
$ 76,805
13.27
%
$ 62,794
11.82
%
Common Equity Tier 1 (to Risk Weighted Assets)
59,555
14.80
45,544
12.62
Tier 1 Capital (to Risk Weighted Assets)
76,805
19.09
62,794
17.40
Total Capital (to Risk Weighted Assets)
81,317
20.21
66,946
18.55
T Bank, N.A.
Tier 1 Capital (to Average Assets)
$ 76,767
13.47
%
$ 63,302
12.06
%
Common Equity Tier 1 (to Risk Weighted Assets)
76,767
19.29
63,302
17.70
Tier 1 Capital (to Risk Weighted Assets)
76,767
19.29
63,302
17.70
Total Capital (to Risk Weighted Assets)
81,279
20.42
67,454
18.87
In addition to the regulatory requirements of the federal banking agencies, Sanders Morris is subject to the regulatory framework applicable to registered investment advisors under the SEC’s Division of Investment Management. Sanders Morris is also regulated by FINRA, which, among other requirements, imposes minimums on its net regulatory capital. As of December 31, 2022, Sanders Morris is in compliance with FINRA’s net regulatory capital requirements.
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. Liquid assets include cash, interest-bearing deposits primarily maintained at the Federal Reserve Bank of Dallas, federal funds sold and unpledged securities available for sale.
The Company’s primary sources of funds are retail, small business, custodial, commercial deposits, loan repayments, maturity of investment securities, other short-term borrowings, and other funds provided by operations. Our liquidity position is enhanced by our ability to raise additional funds as needed in the wholesale markets. 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.
The Company had cash and cash equivalents of $42.2 million, or 6.9% of total assets, as of December 31, 2022. In addition to the on balance sheet liquidity available, the Company has lines of credit with the FHLB and the FRB, which provide the Company with a source of off-balance sheet liquidity. As of December 31, 2022, the Company’s borrowing capacity with the FHLB was $56.0 million, or 9.2% of assets, none of which was utilized. The borrowing capacity with the FRB was $30.0 million, or 4.9% of assets, of which none was utilized or outstanding as of December 31, 2022. In addition, as of December 31, 2022, the Company had approximately $145.0 million of SBA guaranteed loans held for investment that could be sold to investors.
Off-Balance Sheet Arrangements and Contractual Obligations
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.
The following table presents future contractual obligations to make future payments, excluding interest, for the periods indicated:
As of December 31, 2022
(In thousands)
Less than
One Year
One to
Three Years
Over Three to
Five Years
Over Five
Years
Total
FHLB borrowings
$ -
$ -
$ -
$ -
$ -
FRB borrowings
-
-
-
-
-
Subordinated notes
-
-
-
12,000
12,000
Time deposits
220,653
31,451
5,203
4,383
261,690
Minimum lease payments
1,124
-
1,792
Total
$ 220,928
$ 32,575
$ 5,596
$ 16,383
$ 275,482
The following table presents contractual financial commitments for the periods indicated, however some of these commitments may expire unused or only partially used, so the total amounts do not necessarily reflect future cash requirements.
As of December 31, 2022
(In thousands)
Less than
One Year
One to
Three Years
Over Three to
Five Years
Over Five
Years
Total
Undisbursed loan commitments
$ 10,934
$
$
$ 31,388
$ 43,427
Standby letters of credit
-
-
-

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A.
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 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 at least an annual basis, we run various stress tests to measure the impact on net interest income 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 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 December 31, 2022:
Change in Interest Rates (basis points)
% Change in Net Interest Income
+200
9.20
+100
4.60
(3.51
)
(7.03
)
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 Form 10-K 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8.
Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Tectonic Financial, Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Tectonic Financial, Inc. (the “Company”) as of December 31, 2022, and 2021, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022, and 2021, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Whitley Penn LLP
We have served as the Company’s auditor since 2018.
Plano, Texas
March 31, 2023
TECTONIC FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
December 31,
(In thousands, except share amounts)
ASSETS
Cash and due from banks
$ 8,549
$ 10,203
Interest-bearing deposits
32,562
35,311
Federal funds sold
1,044
Total cash and cash equivalents
42,155
45,992
Securities available for sale
20,633
17,156
Securities held to maturity
25,262
19,673
Securities, restricted at cost
3,496
2,432
Securities, not readily marketable
Loans held for sale
33,902
33,762
Loans, net of allowance for loan losses of $4,513 and $4,152, respectively
445,819
424,595
Bank premises and equipment, net
4,629
4,729
Other real estate
-
1,079
Core deposit intangible, net
Goodwill
21,440
21,440
Deferred tax assets
Other assets
13,895
12,871
Total assets
$ 612,536
$ 585,011
LIABILITIES
Demand deposits:
Non-interest-bearing
$ 94,187
$ 88,876
Interest-bearing
137,148
147,909
Time deposits
261,690
207,384
Total deposits
493,025
444,169
Borrowed funds
-
34,521
Subordinated notes
12,000
12,000
Other liabilities
11,013
9,534
Total liabilities
516,038
500,224
SHAREHOLDERS’ EQUITY
Preferred Stock 9% fixed to floating rate series B non-cumulative, perpetual ($.01 par value; 1,725,000 shares authorized, 1,725,000 shares issued and outstanding at December 31, 2022 and 2021)
Common stock, $0.01 par value; 10,000,000 shares authorized; 7,094,453 and shares issued and 7,068,884 shares outstanding and at December 31, 2022, and 10,000,000 shares authorized and 7,061,593 shares issued and outstanding at December 31, 2021
Additional paid-in capital
50,695
50,176
Treasury stock, at cost; 25,569 shares as of December 31, 2022, no shares as of December 31, 2021
(481 )
-
Retained earnings
48,564
34,851
Accumulated other comprehensive loss
(2,368
)
(328
)
Total shareholders’ equity
96,498
84,787
Total liabilities and shareholders’ equity
$ 612,536
$ 585,011
See accompanying notes to consolidated financial statements.
TECTONIC FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
(In thousands, except per share data and share amounts)
Interest Income
Loan, including fees
$ 30,885
$ 28,379
Securities
1,887
Federal funds sold
Interest-bearing deposits
Total interest income
33,385
29,384
Interest Expense
Deposits
4,940
2,482
Borrowed funds
1,145
Total interest expense
5,904
3,627
Net interest income
27,481
25,757
Provision for loan losses
1,264
2,214
Net interest income after provision for loan losses
26,217
23,543
Non-interest Income
Trust income
6,098
6,252
Gain on sale of loans
-
Advisory income
13,549
13,472
Brokerage income
11,754
9,644
Service fees and other income
8,293
6,790
Rental income
Total non-interest income
40,040
36,624
Non-interest Expense
Salaries and employee benefits
31,093
24,947
Occupancy and equipment
1,707
1,837
Trust expenses
2,243
2,416
Brokerage and advisory direct costs
2,015
2,051
Professional fees
1,480
1,539
Data processing
Other
5,473
4,576
Total non-interest expense
44,805
38,330
Income before Income Taxes
21,452
21,837
Income tax expense
4,422
4,803
Net Income
17,030
17,034
Preferred stock dividends
1,552
1,552
Net income available to common stockholders
$ 15,478
$ 15,482
Earnings per common share:
Basic
$ 2.19
$ 2.28
Diluted
2.11
2.21
Weighted average common shares outstanding
7,061,519
6,804,228
Weighted average diluted shares outstanding
7,336,195
7,021,766
See accompanying notes to consolidated financial statements.
TECTONIC FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31,
(In thousands)
Net Income
$ 17,030
$ 17,034
Other Comprehensive Loss:
Change in unrealized loss on investment securities available for sale
(2,582
)
(502
)
Tax effect
(542
)
(106
)
Other comprehensive loss
(2,040
)
(396
)
Comprehensive Income
$ 14,990
$ 16,638
See accompanying notes to consolidated financial statements.
TECTONIC FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31,
(In thousands)
Series B
Preferred Stock
Common
Stock
Additional
Paid-in Capital
Treasury Stock
Retained
Earnings
Accumulated Other
Comprehensive
Income (Loss)
Total
Balance at January 1, 2021
$
$
$ 39,201
$ -
$ 20,661
$
$ 60,013
Issuance of common stock
-
10,645
-
-
-
10,650
Dividends paid on common stock
-
-
-
-
(1,292
)
-
(1,292
)
Dividends paid on Series B preferred stock
-
-
-
-
(1,552
)
-
(1,552
)
Net income
-
-
-
-
17,034
-
17,034
Other comprehensive loss
-
-
-
-
-
(396
)
(396
)
Stock based compensation
-
-
-
-
-
Balance at December 31, 2021
$
$
$ 50,176
$ -
$ 34,851
$ (328
)
$ 84,787
Issuance of common stock
-
-
-
-
-
Repurchase of stock
-
-
-
(481
)
-
-
(481
)
Reduction of note receivable utilized to exercise options
-
-
-
-
-
Dividends paid on common stock
-
-
-
-
(1,765
)
-
(1,765
)
Dividends paid on Series B preferred stock
-
-
-
-
(1,552
)
-
(1,552
)
Net income
-
-
-
-
17,030
-
17,030
Other comprehensive loss
-
-
-
-
-
(2,040
)
(2,040
)
Stock based compensation
-
-
-
-
-
Balance at December 31, 2022
$
$
$ 50,695
$ (481
)
$ 48,564
$ (2,368
)
$ 96,498
See accompanying notes to consolidated financial statements.
TECTONIC FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
(In thousands)
Cash Flows from Operating Activities
Net income
$ 17,030
$ 17,034
Adjustments to reconcile net income to net cash used in operating activities:
Provision for loan losses
1,264
2,214
Depreciation and amortization
Accretion of discount on loans
(104
)
Core deposit intangible amortization
Securities premium amortization, net
(14
)
Origination of loans held for sale
(56,050
)
(67,022
)
Proceeds from payments and sales of loans held for sale
5,449
Gain on sale of loans
-
(101
)
Gain on sale of other real estate owned
(33
)
-
Stock based compensation
Deferred income taxes
(216
)
Net change in:
Servicing assets, net
Other assets
(1,203
)
(1,178
)
Other liabilities
1,480
(428
)
Net cash used in operating activities
(35,787
)
(43,035
)
Cash Flows from Investing Activities
Acquisition of business
-
(3,185
)
Purchase of securities held to maturity
(7,408
)
(16,995
)
Purchase of securities available for sale
(381,514
)
(403,000
)
Principal payments, calls and maturities of securities available for sale
375,417
402,659
Principal payments of securities held to maturity
1,871
3,060
Purchase of securities, restricted
(12,818
)
(11,524
)
Proceeds from sale of securities, restricted
11,754
11,524
Proceeds from sales of real estate owned
1,112
-
Net change in loans
32,880
47,118
Purchases of premises and equipment
(128
)
(178
)
Net cash provided by investing activities
21,166
29,479
Cash Flows from Financing Activities
Net change in demand deposits
(5,450
)
60,861
Net change in time deposits
54,306
32,759
Proceeds from borrowed funds
387,800
556,793
Repayment of borrowed funds
(422,321
)
(634,889
)
Reduction for note receivable utilized to exercise options
-
Dividends paid on common stock
(1,765
)
(1,292
)
Dividends paid on Series B preferred shares
(1,552
)
(1,552
)
Sale of common stock
-
Repurchase of common stock
(481
)
-
Net cash provided by financing activities
10,784
12,680
Net change in cash and cash equivalents
(3,837
)
(876
)
Cash and cash equivalents at beginning of period
45,992
46,868
Cash and cash equivalents at end of period
$ 42,155
$ 45,992
Non Cash Transactions
Transfers from loans held for sale to loans held for investment
$ 55,401
$ 42,757
Common stock issued in Integra acquisition (Note 18)
$ -
$ 10,650
Stock options exercised in exchange for note receivable
$
$
Transfers from loans to other real estate owned
$ -
$ 1,079
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest
$ 5,875
$ 3,662
Income taxes
$ 4,715
$ 5,427
See accompanying notes to consolidated financial statements.
Notes to Consolidated Financial Statements
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations
Tectonic Financial, Inc. (the “Company,” “we,” “us,” or “our”) is a financial holding company that offers, through its subsidiaries, banking and other financial services including trust, investment advisory, securities brokerage, factoring, third-party administration, qualified plan recordkeeping and insurance services to individuals, small businesses and institutions across the United States.
We operate through four main direct and indirect subsidiaries: (i) T Bancshares, Inc. (“T Bancshares”), 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 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 as well as for their clients, which include individuals, businesses, and qualified plans, 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 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 Nolan Company (“Nolan”), operating from its office in Overland Park, Kansas as a division within the bank, offers third party administration (“TPA”) services, and Integra Funding Solutions, LLC (“Integra”), operating from its Fort Worth, Texas office as a division within the Bank, offers factoring services. The Bank’s technological capabilities, including worldwide free ATM withdrawals, sophisticated on-line banking capabilities, electronic funds transfer capabilities, and economical remote deposit solutions, allow most customers to be served regardless of their geographic location. The Bank serves its local geographic market which includes Dallas, Tarrant, Denton, Collin and Rockwall counties in Texas which encompass an area commonly referred to as the Dallas/Fort Worth Metroplex. The Bank also serves the dental and other health professional industries through a centralized loan and deposit platform that operates out of its main office in Dallas, Texas. In addition, the Bank serves the small business community by offering loans guaranteed by the U.S. Small Business Administration (“SBA”) and the U.S. Department of Agriculture (“USDA”).
The Bank offers a wide range of deposit services including demand deposits, regular savings accounts, money market accounts, individual retirement accounts, and certificates of deposit with fixed rates and a range of maturity options. Lending services include commercial loans to small- to medium-sized businesses and professional concerns as well as consumers. The Bank also offers wealth management and 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 addition, the Nolan division of the Bank offers TPA services and provides clients with retirement plan design and administrative services, specializing in ministerial recordkeeping, administration, actuarial and design services for retirement plans of small businesses and professional practices. We believe offering TPA services allows us to serve our clients more fully and to attract new clients to our trust platform.
Basis of Presentation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, T Bancshares, the Bank, Tectonic Advisors, Sanders Morris, and through Sanders Morris, HWG. All intercompany transactions and balances are eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles 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. 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.
Cash and Cash Equivalents
The Company maintains its cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe it is exposed to significant credit risk on cash and cash equivalents.
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, deposits with other financial institutions, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions.
Trust Assets
Property held for customers in a fiduciary capacity, other than trust cash on deposit at the Bank, is not included in the accompanying consolidated financial statements since such items are not assets of the Company.
Securities
Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them until maturity. Securities to be held for indefinite periods of time are classified as available for sale and carried at fair value, with the unrealized holding gains and losses reported as a component of other comprehensive income, net of tax. Securities held for resale are classified as trading and are carried at fair value, with changes in unrealized holding gains and losses included in income. Management determines the appropriate classification of securities at the time of purchase.
Securities with limited marketability, such as stock in the FRB and the FHLB are carried at cost. The Company has investments in stock of the FRB and the FHLB as is required for participation in the services offered. These investments are classified as restricted and are recorded at cost. Securities, not readily marketable are carried at cost.
Interest income includes amortization of purchase premiums and accretion of purchase discounts. Premiums and discounts on securities are amortized on the interest method with a constant effective yield without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Premiums on callable securities are amortized to their earliest call date. Gains and losses are recorded on the trade date and determined using the specific identification method. Declines in the fair value of available for sale securities below their cost that are deemed to be other-than-temporary-impairment (“OTTI”) are reflected in earnings as realized losses to the extent the impairment related to credit losses. The amount of impairment related to other factors is recognized in other comprehensive income. In estimating OTTI losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery of amortized cost. At December 31, 2022 and 2021, no securities were determined to be other-than-temporarily impaired.
Factored Receivables
Integra, operating as a division of the Bank, purchases invoices on completed work from its factoring clients. Integra also makes, from time to time, short-term advances to its clients on transportation contracts for upcoming loads or, to a much lesser extent, makes over-advances on the existing purchased invoices. Funds are advanced to the client based on the applicable advance rate, less fees, as agreed to in each individual factoring agreement. The gross amount (face value) of the invoices purchased are recorded by Integra as factored receivables, and the unadvanced portions of the invoices purchased, less discount and origination fees, are considered deferred client reserves and recorded as other liabilities in the Company’s consolidated balance sheets. The deferred client reserves are held to settle any payment disputes or collection short payments, and become reserves due to client when the receivables are collected. Reserves due to client may be used to pay clients’ obligations to various third parties as directed by the client, are periodically withdrawn by clients, and are reported as deposits in the Company’s consolidated balance sheets.
Unearned factoring fees and unearned net origination fees are deferred revenue and recognized as interest income in the Company’s consolidated income statements over the weighted average collection period for the entire portfolio of factored receivables. Subsequent factoring fees are recognized in interest income as incurred by the client and deducted from the clients’ reserve balances.
Other factoring-related fees, which include ACH and wire transfer fees, fuel card funding fees, carrier payment fees, fuel advance fees, and other similar fees, are recognized as incurred and are reported by the Company as non-interest income.
Loans Held for Sale
Loans which are originated or purchased and are intended for sale in the secondary market are carried at the lower of cost or estimated fair value determined on an aggregate basis. Valuation adjustments, if any, are recognized through a valuation allowance by charges to non-interest income and direct loan origination costs and fees are deferred at origination of the loan and are recognized in non-interest income upon sale of the loan. Loans held for sale are comprised of the guaranteed portion of SBA and USDA loans. The Company did not incur a lower of cost or market valuation provision in the years ended December 31, 2022 and 2021. The Company elected to reclassify $55.4 million and $42.8 million of the SBA 7(a) loans held for sale to loans held for investment during the year ended December 31, 2022 and 2021, respectively.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, unearned discount, deferred loan fees, and allowance for loan losses. Interest income is accrued on the unpaid principal balance. Discount on acquired loans and net loan origination fees are deferred and recognized in interest income using the level-yield method without anticipating prepayments.
Interest income on commercial business and commercial real estate loans is discontinued when the loan becomes 90 days delinquent unless the credit is well secured and in process of collection. Unsecured consumer loans are generally charged off when the loan becomes 90 days past due. Consumer loans secured by collateral other than real estate are charged off after a review of all factors affecting the ability to collect on the loan, including the borrower’s history, overall financial condition, resources, guarantor support, and the realizable value of any collateral. However, any consumer loan past due 180 days is charged off. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not received for loans placed on non-accrual are reversed against interest income. Interest received on such loans is accounted for on a cash-basis or cost-recovery method, until qualifying for return to accrual basis. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required by considering the collectability of loans based on historical experience and the borrower’s ability to repay, the nature and volume of the portfolio, information about specific borrower situations and the estimated value of any underlying collateral, economic conditions and other factors.
The allowance consists of general and specific reserves. The specific component relates to loans that are individually evaluated and determined to be impaired. This amount of allowance is often based on variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received. The general component relates to the entire group of loans that are evaluated in the aggregate based primarily on industry historical loss experience adjusted for current economic factors. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of the provision for loan loss, and related allowance can, and will, fluctuate.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include, among others, payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loan impairment on loans is generally based upon the present value of the expected future cash flows discounted at the loan’s initial effective interest rate, unless the loans are collateral dependent, in which case loan impairment is based upon the fair value of collateral less estimated selling costs.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 39 years. Furniture and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years. Land improvements are depreciated using the straight-line method with useful lives ranging from 3 to 10 years. Leasehold improvements are depreciated using the straight-line method over the lease term or estimated life, whichever is shorter. Repair and maintenance costs are expensed as incurred.
We lease certain office facilities and office equipment under operating leases. We also own certain office facilities which we lease to outside parties under operating lessor leases. Under the lease standards, for operating leases other than those considered to be short-term, we recognize lease right-of-use assets and related lease liabilities. Such amounts are reported as components of other assets and other liabilities, respectively, on our accompanying consolidated balance sheet. We do not recognize short-term operating leases on our balance sheet. A short-term operating lease has an original term of 12 months or less and does not have a purchase option that is likely to be exercised.
In recognizing lease right-of-use assets and related lease liabilities, we account for lease and non-lease components (such as taxes, insurance, and common area maintenance costs) separately as such amounts are generally readily determinable under our lease contracts. Lease payments over the expected term are discounted using our incremental borrowing rate referenced to the Federal Home Loan Bank Secure Connect advance rates for borrowings of similar term. We also consider renewal and termination options in the determination of the term of the lease. If it is reasonably certain that a renewal or termination option will be exercised, the effects of such options are included in the determination of the expected lease term. Generally, we cannot be reasonably certain about whether or not we will renew a lease until such time the lease is within the last two years of the existing lease term. However, renewal options related to our regional headquarters facilities or operations centers are evaluated on a case-by-case basis, typically in advance of such time frame. When we are reasonably certain that a renewal option will be exercised, we measure/remeasure the right-of-use asset and related lease liability using the lease payments specified for the renewal period or, if such amounts are unspecified, we generally assume an increase (evaluated on a case-by-case basis in light of prevailing market conditions) in the lease payment over the final period of the existing lease term.
Foreclosed Assets
Assets acquired through or instead of loan foreclosure are held for sale and are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions. The Company had no foreclosed assets at December 31, 2022 reported in other real estate in the Company’s consolidated balance sheets, and $1.1 million in foreclosed assets at December 31, 2021.
Servicing Rights
The guaranteed portion of certain SBA and USDA loans can be sold into the secondary market. Servicing rights are recognized as separate assets when loans are sold with servicing retained. Servicing rights are amortized in proportion to, and over the period of, estimated future net servicing income. The Company uses industry prepayment statistics in estimating the expected life of the loans. Management evaluates its servicing rights for impairment quarterly. Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is determined using discounted future cash flows calculated on a loan-by-loan basis and aggregated by predominant risk characteristics. The initial servicing rights and resulting gain on sale are calculated based on the difference between the actual par and bids on an individual loan basis.
Intangible Assets
Intangible assets consist of goodwill and core deposit intangibles. Goodwill represents the excess purchase price over the fair value of net assets acquired in business acquisitions. The core deposit intangible represents the excess intangible value of acquired deposit customer relationships as determined by valuation specialists. The core deposit intangibles are being amortized over 58 to 100 months on a straight-line basis. Goodwill is not amortized but rather is evaluated for impairment on at least an annual basis. The Company performed its annual impairment test of goodwill and core deposit intangibles during 2022 and 2021, as required by FASB ASC 350, Intangibles-Goodwill and Other. The 2022 and 2021 tests indicated no impairment of the Company’s goodwill or core deposit intangibles.
Stock Based Compensation
The Company has a share-based employee compensation plan, which is described more fully in Note 11. The Company accounts for it stock-based compensation in accordance with applicable accounting guidance for share-based payments. This guidance requires all share-based payments to be recognized on the consolidated statements of income based on their fair values. Compensation costs for awards with graded vesting are recognized on a straight-line basis over the vesting period.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs totaled $475,000 and $370,000 for the years ended December 31, 2022 and 2021, respectively, and are included in other expense on the consolidated statements of income.
Income Taxes
The Company accounts for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company accounts for uncertainties in income taxes in accordance with current accounting guidance which prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of cumulative benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. No uncertain tax positions have been recognized.
The Company files a consolidated income tax return with our subsidiaries. Federal income tax expense or benefit has been allocated to subsidiaries on a separate return basis.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive loss. Other comprehensive loss income includes net unrealized gains and losses on available for sale securities, which are recognized as a separate component of equity. Comprehensive income for the years ended December 31, 2022 and 2021 is reported in the accompanying consolidated statements of comprehensive income.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Company, (ii) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Transfer of financial assets are comprised of the guaranteed portion of SBA and USDA loans which have been sold.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 16. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Revenue Recognition
The Company recognizes revenue in accordance with FASB ASC 606, Revenue from Contracts with Customers (“Topic 606”). Topic 606 establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.
The Company derives a portion of its revenue from loan and investment income which are specifically excluded from the scope of this standard. Of the Company’s remaining sources of income, substantially all sources of banking revenue are recognized either by transaction (ATM, interchange, wire transfer, etc.) or when the Company charges a customer for a service that has already been rendered (monthly service charges, account fees, monthly trust management fees, monthly premise rental income, etc.). Payment for such performance obligations are generally received at the time the performance obligations are satisfied. Other non-interest income primarily includes items such as gains on the sale of loans held for sale and servicing fees, none of which are subject to the requirements of Topic 606.
Revenue from contracts with customers includes fees from asset management services and commission income and fees and commissions from investment banking services. Under Topic 606, the recognition and measurement of revenue is based on the assessment of individual contract terms. Significant judgment is required to determine whether performance obligations are satisfied at a point in time or over time; how to allocate transaction prices where multiple performance obligations are identified; when to recognize revenue based on the appropriate measure of the Company’s progress under the related agreement; and whether constraints on variable consideration should be applied due to uncertain future events.
Advisory Fees
Investment advisory fees: The Company provides investment advisory services on a daily basis. The Company believes the performance obligation for providing advisory services is satisfied over time because the customer is receiving and consuming the benefits as they are provided by the Company. For the majority of accounts, fee arrangements are based on a percentage applied to the customer’s assets under management. Fees calculated in this manner are generally received monthly or quarterly and are recognized as revenue ratably over the period as they relate specifically to the services provided in that period, which are distinct from the services provided in other periods.
Performance fees: The Company receives fees under certain of its agreements which vary based on specified performance measures, for example, when a separate account exceeds a specified benchmark or contractual hurdle over a contractual performance period. These performance fees may be paid in addition to standard investment advisory fees. Currently, most of the Company’s contracts of this nature specify an annual performance period. These fees are earned once account returns have exceeded these specified performance measures for the performance period, and are calculated as a percentage of account returns. These performance fees are considered variable consideration as the uncertainty is dependent on the value of the assets at future points in time as well as meeting a specified hurdle rate, both of which are highly susceptible to factors outside the Company’s influence. Revenues are recognized in the last period of the performance period specified in the respective contract since this is the point at which the Company can conclude that a significant reversal will not occur.
Other advisory fees: The Company provides general advisory services on an ongoing basis, which may include: operational advice, advice to management on strategic and other initiatives and/or advice on prospective mergers and acquisitions. Revenue is recognized over time for these advisory arrangements, given that under the relevant agreements, the performance obligations are simultaneously provided by the Company and consumed by the customer.
Commissions
Brokerage commissions: The Company buys and sells securities on behalf of its customers through its arrangements with its clearing firm. Each time a customer enters into a buy or sell transaction, the Company charges a commission. Commissions and clearing expenses are recorded each month based upon the trade date, which is the date that the Company fills the trade order by finding and contracting with a counterparty and confirms the trade with the customer. The Company believes that the performance obligation is satisfied on the trade date because that is when the underlying financial instrument or purchaser is identified, the pricing is agreed upon and the risks and rewards of ownership have been transferred to/from the customer.
Syndication and private placement commissions: The Company participates in the syndication of public securities offerings and in private placement offerings for business entities that want to raise funds through a sale of securities. With respect to public securities offerings, the Company may make a commitment to acquire securities from the issuer, or the Company may participate in the syndication group on a best efforts, non-committed basis. With respect to private placement offerings, the performance obligation is the consummation of the sale of securities of the issuer, typically on a “best efforts” basis. Revenues are earned from fees arising from these securities offerings, and are recognized when the performance obligation is satisfied, generally the trade date. The Company believes that the trade date is the appropriate point in time to recognize revenue for these securities transactions as there are no significant actions which the Company needs to take subsequent to this date and the issuer obtains the control and benefit of the capital markets offering at that point.
Reclassifications
Certain items in prior financial statements have been reclassified to conform to the current presentation but have no effect on the reported results of operations.
Earnings per Share
Basic earnings per share is computed based on the weighted-average number of shares outstanding during each year. Diluted earnings per share 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 earnings per share (“EPS”) for the following periods:
Years ended December 31,
(In thousands, except per share data)
Net income available to common shareholders
$ 15,478
$ 15,482
Weighted average shares outstanding
7,062
6,804
Effect of dilutive shares
Weighted average diluted shares outstanding
7,336
7,022
Basic earnings per share
$ 2.19
$ 2.28
Diluted earnings per share
$ 2.11
$ 2.21
As of December 31, 2022, options to purchase 167,500 shares of common stock, with a weighted average exercise price of $5.51, were included in the computation of diluted net earnings per share. In addition, as of December 31, 2022, 170,000 shares of restricted stock grants with a grant date fair value of $4.81 per share which vest from 2023 through 2025 were included in the diluted earnings per share calculation.
Note 2. Securities
A summary of amortized cost and cost and fair value of securities is presented below.
December 31, 2022
(In thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
Securities available for sale:
U.S. Treasuries
$ 1,990
$ -
$
$ 1,953
U.S government agencies
15,715
-
2,627
13,088
Mortgage-backed securities
5,925
-
5,592
Total securities available for sale
$ 23,630
$ -
$ 2,997
$ 20,633
Securities held to maturity:
Property assessed clean energy
$ 1,596
$
$ -
$ 1,722
Public improvement district/tax increment reinvestment zone
23,666
1,137
24,760
Total securities held to maturity
$ 25,262
$ 1,263
$
$ 26,482
Securities, restricted:
Other
$ 3,496
$ -
$ -
$ 3,496
Securities not readily marketable
$
$ -
$ -
$
December 31, 2021
(In thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
Securities available for sale:
U.S. government agencies
$ 15,847
$
$
$ 15,402
Mortgage-backed securities
1,724
-
1,754
Total securities available for sale
$ 17,571
$
$
$ 17,156
Securities held to maturity:
Property assessed clean energy
$ 2,731
$ -
$ -
$ 2,731
Public improvement district/tax increment reinvestment zone
16,942
-
-
16,942
Total securities held to maturity
$ 19,673
$ -
$ -
$ 19,673
Securities, restricted:
Other
$ 2,432
$ -
$ -
$ 2,432
Securities not readily marketable
$
$ -
$ -
$
Securities available for sale consist of U.S. government agency securities and mortgage-backed securities guaranteed by U.S. government agencies. Securities held to maturity consist of Property Assessed Clean Energy (“PACE”) and Public Improvement District/Tax Increment Reinvestment Zone (“PID/TIRZ”) investments. These investment contracts or bonds located in Texas, California and Florida, originate under a contractual obligation between the property owners, the local county or city administration, and a third-party administrator and sponsor. PACE assessments are created to fund the purchase and installation of energy saving improvements to the property such as solar panels. PID/TIRZ assessments are used to pay for the development costs of a residential subdivision. Generally, as a property assessment, the total assessment is repaid in installments over a period of 5 to 32 years by the then current property owner(s). Each installment is collected by the County or City Tax Collector where the property is located. The assessments are an obligation of the property. Securities, restricted consist of Federal Reserve Bank of Dallas (“FRB”) and Federal Home Loan Bank of Dallas (“FHLB”) stock, which are carried at cost.
As of December 31, 2022 and 2021, securities available for sale with a fair value of $94,000 and $163,000, respectively, were pledged against trust deposit balances held at the Bank. As of December 31, 2022 and 2021, there were no securities pledged to secure borrowings at the FHLB.
As of December 31, 2022 and 2021, the Bank held FRB stock in the amount of $2.2 million and $1.2 million, respectively. The Bank held FHLB stock in the amount of $1.3 million as of December 31, 2022 and 2021, all of which were classified as restricted securities.
As of December 31, 2022 and 2021, the Company held an income interest in a private investment, which is not readily marketable, accounted for under the cost less impairment method in the amount of $100,000. No allowance for impairment was recorded as of December 31, 2022 or 2021.
The table below indicates the length of time individual investment securities have been in a continuous loss position as of December 31, 2022:
Less than 12 months
12 months or longer
Total
(In thousands)
Fair Value
Unrealized
			Losses
Fair Value
Unrealized
			Losses
Fair Value
Unrealized
			Losses
U.S. Treasuries
$ 1,953
$
$ -
$ -
$ 1,953
$
U.S. government agencies
12,994
$ 2,620
13,088
2,627
Mortgage-backed securities
5,592
-
-
5,592
Public improvement district/tax increment reinvestment zone
2,272
-
-
2,272
Total
$ 9,911
$
$ 12,994
$ 2,620
$ 22,905
$ 3,040
The number of investment positions in this unrealized loss position totaled twenty-four as of December 31, 2022. The Company does not believe these unrealized losses are “other than temporary” as (i) it does not have the intent to sell the securities prior to recovery and/or maturity and, (ii) it is more likely than not that the Company will not have to sell the securities prior to recovery and/or maturity. Accordingly, as of December 31, 2022, no impairment loss has been realized in the Company’s consolidated statements of income.
In making this determination, the Company also considers the length of time and extent to which fair value has been less than cost and the financial condition of the issuer. Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The unrealized losses noted are primarily interest rate related due to the level of market interest rates as of December 31, 2022, compared to the time of purchase. The Company has reviewed the ratings of the issuers and has not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. The Company’s mortgage related securities are backed by the Government National Mortgage Association and the Federal National Mortgage Association, or are collateralized by securities backed by these agencies. Management believes the fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline.
The amortized cost and estimated fair value of securities at December 31, 2022 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 in one year or less
$
$
$ -
$ -
Due after one year through five years
10,995
9,582
2,172
2,129
Due after five years through ten years
2,101
1,789
-
-
Due after ten years
3,617
2,689
23,090
24,353
Mortgage-backed securities
5,925
5,592
-
-
Total
$ 23,630
$ 20,633
$ 25,262
$ 26,482
Note 3. Loans and Allowance for Loan Losses
Major classifications of loans held for investment are as follows:
(In thousands)
December 31,
December 31,
Commercial and industrial
$ 92,946
$ 83,348
Consumer installment
1,058
1,099
Real estate - residential
5,566
5,452
Real estate - commercial
63,924
62,966
Real estate - construction and land
3,873
2,585
SBA:
SBA 7(a) guaranteed
149,374
145,983
SBA 7(a) unguaranteed
56,268
52,524
SBA 504
52,668
35,348
USDA
2,235
Factored receivables
22,420
38,636
Gross loans
450,332
428,747
Less:
Allowance for loan losses
4,513
4,152
Net loans
$ 445,819
$ 424,595
Beginning in the second quarter of 2020 and until funding expired on May 31, 2021, the Company participating in the Paycheck Protection Program (“PPP”) which was established by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in response to the COVID-19 pandemic and administered by the SBA. 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. Included in SBA 7(a) guaranteed loans, there were no PPP loans outstanding at December 31, 2022, as compared to $34.1 million of PPP loans outstanding at December 31, 2021.
As of December 31, 2022, our loan portfolio included $83.9 million of loans, approximately 18.6% of our total funded loans to the dental industry, as compared to $67.3 million of loans, approximately 15.7% of our total funded loans (17.1% of total funded loans, net of the SBA PPP loans), at December 31, 2021. The Bank believes that these loans are to credit worthy borrowers and are diversified geographically.
The Company serves the small business community by offering loans promulgated under the SBA’s 7(a) and 504 loan programs, and loans guaranteed by the USDA. SBA 7(a) and USDA loans are typically guaranteed by each agency in amounts ranging from 75% to 80% of the principal balance. For SBA construction loans, the Company records the guaranteed funded portion of the loans as held for sale. When the SBA loans are fully funded, the Company may sell the guaranteed portion into the secondary market, on a servicing-retained basis, or reclassify from loans held for sale to loans held for investment if the Company determines that holding these loans provide better long-term risk adjusted returns than selling the loans. In calculating gain on the sale of loans, the Company performs an allocation based on the relative fair values of the sold portion and retained portion of the loan. The Company’s assumptions are validated by reference to external market information.
The Company had $33.9 million and $33.8 million of non-PPP SBA loans held for sale as of December 31, 2022 and 2021, respectively. There were no loans sold for the year ended December 31, 2022. During 2021, the Company sold one non-PPP SBA loan for $1.1 million, resulting in a gain on sale of loans of $101,000. In connection with the sale, the Company recorded a servicing asset of $19,000. The Company elected to reclassify $55.4 million and $42.8 million, respectively, of the SBA 7(a) loans held for sale to loans held for investment during the years ended December 31, 2022 and 2021.
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 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-K are the PPP loans originated by the Company and outstanding as of December 31, 2022 and 2021.
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 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 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)
December 31,
December 31,
Non-accrual loans:
Real estate - commercial
$
$
SBA guaranteed
2,221
2,039
SBA unguaranteed
-
Total
$ 2,466
$ 2,188
The restructuring of a loan is considered a “troubled debt restructuring” (“TDR”) if, due to the borrower’s financial difficulties, the Company has granted a concession that the Company would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modification of loan terms may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules, reductions in collateral and other actions intended to minimize potential losses.
As of December 31, 2022, there was one loan which was a SBA loan in the amount of $902,000 identified as TDR, of which $812,000 was guaranteed. The loan became a TDR during the three months ended December 31, 2022. The modification was for interest rate reduction. There was no payment default. There were no other TDRs during the year. There were no TDRs during the year ended December 31, 2021.
Under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 310-40 Receivables - Troubled Debt Restructurings by Creditors, and Interagency Statements issued by the federal banking regulators, in consultation with the FASB, certain short-term loan modifications and additional accommodations made on a good faith basis in response to COVID-19 (as defined by the guidance) to borrowers who were current prior to any relief are not considered TDRs. Additionally, under Section 4013 of the CARES Act, as amended by the Consolidated Appropriations Act, 2021, banks may elect to suspend the requirement for certain loan modifications to be categorized as a TDR. In response to the COVID-19 pandemic, the Company implemented prudent modifications allowing for primarily short-term payment deferrals or other payment relief to borrowers with pandemic-related economic hardships, where appropriate, that complied with the above guidance. As such, the Company's TDR loans noted above do not include loans with modifications to borrowers impacted by COVID-19. As of December 31, 2022, there were no loans on deferment due to the COVID-19 pandemic. As of December 31, 2021, there were two loans in COVID-19 related deferment with an aggregate outstanding balance of approximately $679,000.
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
December 31, 2022
Year Ended
Commercial and industrial
$ -
$ -
$ -
$ -
$ -
$
$ -
SBA
2,759
2,126
-
2,126
-
2,287
-
Total
$ 2,759
$ 2,126
$ -
$ 2,126
$ -
$ 2,468
$ -
December 31, 2021
Year Ended
Commercial and industrial
$ -
$ -
$ -
$ -
$ -
$
$
SBA
3,658
3,071
-
3,071
-
6,333
Total
$ 3,658
$ 3,071
$ -
$ 3,071
$ -
$ 6,406
$
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:
Total 90
30-89 Days
90 Days or
Total
Total
Total
Days Past Due
(In thousands)
Past Due
More Past Due
Past Due
Current
Loans
Still Accruing
December 31, 2022
Commercial and industrial
$
$ -
$
$ 92,551
$ 92,946
$ -
Consumer installment
-
-
-
1,058
1,058
-
Real estate - residential
-
5,428
5,566
-
Real estate - commercial
-
63,718
63,924
Real estate - construction and land
-
-
-
3,873
3,873
-
SBA
-
2,327
2,327
255,983
258,310
-
USDA
-
-
-
2,235
2,235
-
Factored receivables
1,098
21,322
22,420
Total
$ 1,499
$ 2,665
$ 4,164
$ 446,168
$ 450,332
$
December 31, 2021
Commercial and industrial
$
$ -
$
$ 83,344
$ 83,348
$ -
Consumer installment
-
-
-
1,099
1,099
-
Real estate - residential
-
-
-
5,452
5,452
-
Real estate - commercial
-
62,747
62,966
-
Real estate - construction and land
-
-
-
2,585
2,585
-
SBA
1,762
-
1,762
232,093
233,855
-
USDA
-
-
-
-
Factored receivables
1,743
2,143
36,493
38,636
Total
$ 3,728
$
$ 4,128
$ 424,619
$ 428,747
$
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
December 31, 2022
Commercial and industrial
$ 92,551 $ 395 $ - $ - $ - $ 92,946
Consumer installment
1,058 - - - - 1,058
Real estate - residential
5,428 - - 138 - 5,566
Real estate - commercial
63,718 - - 206 - 63,924
Real estate - construction and land
3,873 - - - - 3,873
SBA
231,914 20,665 4,778 953 - 258,310
USDA
2,235 - - - - 2,235
Factored receivables
22,420 - - - - 22,420
Total
$ 423,197 $ 21,060 $ 4,778 $ 1,297 $ - $ 450,332
December 31, 2021
Commercial and industrial
$ 82,105 $ 1,243 $ - $ - $ - $ 83,348
Consumer installment
1,099 - - - - 1,099
Real estate - residential
5,242 - - 210 - 5,452
Real estate - commercial
62,817 - - 149 - 62,966
Real estate - construction and land
2,585 - - - - 2,585
SBA
213,630 16,265 2,659 1,301 - 233,855
USDA
806 - - - - 806
Factored receivables
38,636 - - - - 38,636
Total
$ 406,920 $ 17,508 $ 2,659 $ 1,660 $ - $ 428,747
The activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2022 and 2021 is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio.
(In thousands)
Commercial and Industrial
Consumer Installment
Real Estate Residential
Real Estate Commercial
Real Estate Construction and Land
SBA
USDA
Factored
Receivables
Total
December 31, 2022
Beginning Balance
$ 1,154
$
$
$
$
$ 1,324
$
$
$ 4,152
Provision for loan losses
(1
)
1,264
Charge-offs
(337
)
-
-
-
-
(43
)
-
(617
)
(997
)
Recoveries
-
-
-
-
-
Net charge-offs
(306
)
-
-
-
-
(21
)
-
(576
)
(903
)
Ending balance
$ 1,302
$
$
$
$
$ 1,505
$
$
$ 4,513
December 31, 2021
Beginning Balance
$
$
$
$
$
$ 1,225
$
$ -
$ 2,941
Provision for loan losses
(76
)
(60
)
1,031
2,214
Charge-offs
-
-
-
-
-
(952
)
-
(168
)
(1,120
)
Recoveries
-
-
-
-
-
Net recoveries (charge-offs)
-
-
-
-
(932
)
-
(108
)
(1,003
)
Ending balance
$ 1,154
$
$
$
$
$ 1,324
$
$
$ 4,152
The Company’s allowance for loan losses as of December 31, 2022 and 2021 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
Factored
Receivables
Total
December 31, 2022
Loans individually evaluated for impairment
$ -
$ -
$ -
$ -
$ -
$ -
$ -
$ -
$ -
Loans collectively evaluated for impairment
1,302
1,505
4,513
Ending balance
$ 1,302
$
$
$
$
$ 1,505
$
$
$ 4,513
December 31, 2021
Loans individually evaluated for impairment
$ -
$ -
$ -
$ -
$ -
$ -
$ -
$ -
$ -
Loans collectively evaluated for impairment
1,154
1,324
4,152
Ending balance
$ 1,154
$
$
$
$
$ 1,324
$
$
$ 4,152
The Company’s recorded investment in loans as of December 31, 2022 and 2021 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
Factored
Receivables
Total
December 31, 2022
Loans individually evaluated for impairment
$ -
$ -
$ -
$ -
$ -
$ 2,126
$ -
$ -
$ 2,126
Loans collectively evaluated for impairment
92,946
1,058
5,566
63,924
3,873
256,184
2,235
22,420
448,206
Ending balance
$ 92,946
$ 1,058
$ 5,566
$ 63,924
$ 3,873
$ 258,310
$ 2,235
$ 22,420
$ 450,332
December 31, 2021
Loans individually evaluated for impairment
$ -
$ -
$ -
$ -
$ -
$ 3,071
$ -
$ -
$ 3,071
Loans collectively evaluated for impairment
83,348
1,099
5,452
62,966
2,585
230,784
38,636
425,676
Ending balance
$ 83,348
$ 1,099
$ 5,452
$ 62,966
$ 2,585
$ 233,855
$
$ 38,636
$ 428,747
Note 4. Premises and Equipment and Leases
Year-end premises and equipment were as follows:
(In thousands)
December 31,
December 31,
Land
$
$
Leasehold improvements
Building
4,455
4,438
Furniture and equipment
1,767
5,850
7,098
Less: accumulated depreciation
1,221
2,369
Balance at end of period
$ 4,629
$ 4,729
Depreciation of premises and equipment totaled $228,000 and $322,000 for the years ended December 31, 2022 and 2021, respectively. During 2022, there were disposals of equipment with fully depreciated cost of $1.4 million.
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 2022 and 2028 with initial non-cancellable terms in excess of one year.
Under the lease accounting standards, 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 December 31, 2022 and 2021, right-of-use assets and related lease liabilities totaled $1.6 million and $1.7 million, and $1.4 million and $1.4 million, respectively, and are included in other assets and other liabilities, respectively, on our accompanying consolidated balance sheets. As of December 31, 2022 and 2021, the weighted average remaining lease term was 46 months and 47 months, respectively, and the weighted average discount rate was 3.74% and 3.71%, respectively.
As of December 31, 2022, the minimum rental commitments under these noncancelable operating leases are as follows:
(In thousands)
$
2027 and thereafter
Total minimum rental payments
1,792
Less: Interest
(127
)
Present value of lease liabilities
$ 1,665
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 December 31, 2022 through 2028 were as follows.
(In thousands)
$
2027 and thereafter
Total minimum rental payments
$
Note 5. Other Real Estate Owned
A summary of the activity in OREO during the years ended December, 2022 and 2021 is as follows:
For the years ended December 31,
(In thousands)
Beginning balance
$ 1,079
$ -
Transfers from loan portfolio, at fair value
-
1,079
Sales
1,079
-
Ending balance
$ -
$ 1,079
Note 6. Goodwill and Core Deposit Intangible
Goodwill and core deposit intangible assets were as follows:
For the years ended December 31,
(In thousands)
Goodwill
$ 21,440
$ 21,440
Core deposit intangible
The Company recorded goodwill of $10.7 million during the third quarter of 2021 in connection with the acquisition of Integra. Please see Note 18. Integra Acquisition, to these consolidated financial statements for more information.
Core deposit intangible is amortized on a straight-line basis over the estimated lives of the deposits, which range from five to twelve years. The core deposit intangible amortization totaled $208,000 and $202,000 for the years ended December 31, 2022 and 2021, respectively.
The carrying basis and accumulated amortization of the core deposit intangible as of December 31, 2022 and 2021 were as follows:
For the years ended December 31,
(In thousands)
Gross carrying basis
$ 1,708
$ 1,708
Accumulated amortization
(1,139
)
(931
)
Net carrying amount
$
$
The estimated amortization expense of the core deposit intangible for each of the following five years is as follows:
(In thousands)
$
Total
$
The aggregate amount of time deposits that exceeded the $250,000 FDIC insurance limit totaled $53.4 million at December 31, 2022.
Note 7. Deposits
Deposits were as follows:
(In thousands, except percentages)
December 31, 2022
December 31, 2021
Non-interest bearing demand
$ 94,187
%
$ 88,876
%
Interest-bearing demand (NOW)
6,216
6,459
Money market accounts
122,880
133,536
Savings accounts
8,052
7,914
Time deposits
261,690
207,384
Total
$ 493,025
%
$ 444,169
%
The aggregate amount of demand deposit overdrafts that have been reclassified as loans as of December 31, 2022 and 2021 was insignificant.
As of December 31, 2022 the scheduled maturities of time deposits were as follows:
(In thousands)
$ 220,653
31,451
5,203
2,024
2,359
Total
$ 261,690
Note 8. Borrowed Funds and Subordinated Notes
The Company has a blanket lien credit line with the FHLB with borrowing capacity of $56.0 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 December 31, 2022 and December 31, 2021.
The Company also has a credit line with the FRB with borrowing capacity of $30.0 million, which is secured by commercial loans. The Company had no borrowings from the FRB at December 31, 2022 and December 31, 2021 under this credit line. 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”). The Bank repaid its PPPLF borrowings from the FRB during 2022 and had no borrowings under the PPPLF as of December 31, 2022. As of December 31, 2021, borrowings under the PPPLF was $34.5 million.
As of December 31, 2022 and 2021, the Company had subordinated notes totaling $12.0 million, consisting of $8.0 million issued in 2017 bearing an interest rate of three month LIBOR plus 5.125%, with interest payable quarterly and maturing on July 20, 2027, at which all principal is due, and $4.0 million issued in 2018 bearing interest rate of 7.125% payable semi-annually up to July 17, 2023, after which it converts to three month LIBOR plus 5.125%, with interest payable quarterly and maturing on March 31, 2028, at which all principal is due. 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 and Tectonic Advisors.
Under both the 401(k) plans covering the Company’s employees, an employee may contribute up to the annual maximum contribution allowed for a given year under IRS regulations. 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, up to the maximum amount under Internal Revenue Service regulations.
At its discretion, the Company may also make additional annual contributions to the plan. The Plan is a participant directed plan, and as such, contributions to the plan are invested as directed by the respective plan participant.
The amount of employer contributions charged to expense under the two plans was $575,000 and $503,000 for the years ended December 31, 2022 and 2021, respectively, and is included in salaries and employee benefits on the consolidated statements of income. There was no accrual payable to either plan as of December 31, 2022 and 2021.
Note 10. Income Taxes
The provision (benefit) for income taxes consists of the following:
(In thousands)
Current:
Federal income tax
$ 3,986
$ 4,860
State income tax
Total current
4,111
5,019
Deferred federal
(216
)
Income tax expense
$ 4,422
$ 4,803
The effective tax rate differs from the U. S. statutory tax rate due to the following for 2022 and 2021:
U.S. statutory rate
21.0 %
21.0
%
Non-deductible stock compensation and various other
(0.4 )
1.0
Effective tax rate
20.6
%
22.0
%
A reconciliation between reported income tax expense and the amounts computed by applying the U.S. federal statutory income tax rate of 21% to income before income taxes is presented in the following table.
(In thousands)
Income tax expense computed at the statutory rate
$ 4,479
$ 4,552
State income tax
Other
(182
)
Income tax expense, as reported
$ 4,422
$ 4,803
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2022 and 2021 are as follows:
(In thousands)
Deferred tax assets:
Allowance for loan losses
$
$
Non-accrual loan interest
Servicing asset valuation allowance
Accrued liabilities
Stock compensation
Paycheck protection program deferred loan fees
-
Lease liabilities under operating leases
-
Available for sale securities discount accretion
Net unrealized loss on securities available for sale
Total deferred tax assets
1,858
1,541
Deferred tax liabilities:
Net deferred loan costs
(592
)
(471
)
Depreciation and amortization
(248
)
(233
)
Held-to-maturity securities premium
(42
)
(45
)
Loan discount
(87
)
(125
)
Adjustment for FHLB stock
(2
)
-
Intangible assets
(251
)
(262
)
Total deferred tax liabilities
(1,222
)
(1,136
)
Net deferred tax asset
$
$
Projections for continued levels of profitability will be reviewed quarterly and any necessary adjustments to the deferred tax assets will be recognized in the provision or benefit for income taxes. In assessing the realization rate of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. No valuation allowance for deferred tax assets was recorded at December 31, 2022 and 2021, as management believes it is more likely than not that all of the deferred tax assets will be realized against deferred tax liabilities and projected future taxable income.
Note 11. Stock Compensation Plans
The board of directors and shareholders adopted the Amended and Restated Tectonic Financial, Inc. 2017 Equity Incentive Plan (“Plan”). The Plan is administered by the Compensation Committee of the Board and authorizes the granting of 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 option is no longer than 10 years from the date of the grant. At December 31, 2022, the Company had 340,000 shares of common stock remaining available for future grants.
The Company accounts for stock-based employee compensation plans using the fair value-based method of accounting. The fair value of each option award is estimated on the date of grant by a third party using a closed form option valuation (Black-Scholes) model. The fair value of each grant award is estimated on the date of grant by a third party using the market approach based on the application of latest 12-month Company metrics to guideline public company multiples.
On September 27, 2021, 40,000 shares of restricted stock of the Company with an exercise price of $10.00 and an intrinsic value of $6.92 were granted with a contract life through December 31, 2021. Sanders Morris issued a full recourse secured promissory note at the time of the grant. These shares of restricted stock vested immediately, and were exercised on October 29, 2021, with the grantees utilizing the proceeds of the promissory note from Sanders Morris to fund the exercise price. This note receivable is recognized within a contra-equity account, with payments by the grantees reducing this balance as they occur. Once exercised, the shares are subject to a right of repurchase by the Company under certain circumstances through December 31, 2023.
During the year ended December 31, 2022, options on 22,500 shares of the Company’s common stock were exercised at $4.30 per share for a total exercise price of $96,750. There were no stock options granted or forfeited during the year ended December 31, 2022 or 2021.
The number of option shares outstanding was 167,500 and 190,000 as of December 31, 2022 and 2021, respectively, and the weighted average exercise price was $5.51 and $5.37, respectively. The weighted average contractual life of the stock awards as of December 31, 2022 and 2021 was 4.37 years and 5.62 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 December 31, 2022 and 2021 was $1.98. Under Topic 805, the grant date fair value has been restated as though the Tectonic Merger, under which Tectonic Holdings, LLC merged with and into Tectonic Financial, Inc., had occurred upon the date at which the entities came under common control.
As of December 31, 2022, all 167,500 stock options outstanding were vested, and unrecognized compensation cost totaled $81,000, all of which was related to the right of repurchase period for the 40,000 shares of restricted stock issued and exercised in 2021. The Company recorded compensation expense on a straight-line basis over the vesting periods, and for the 40,000 shares of restricted stock granted September 27, 2021, over the right of repurchase period. The Company recorded salaries and employee benefits expense on our consolidated statements of income in connection with the options issued and restricted stock issued under the plan of $78,000 and $48,000 for the years ended December 31, 2022 and 2021, respectively.
On September 30, 2020, the Company granted restricted stock awards totaling 210,000 shares of common stock. The fair value of each grant award was estimated on the date of grant by a third party using the market approach based on the application of latest 12-month Company metrics to guideline public company multiples. The vesting schedules vary by award, with all of the awards vesting over a three year period from 2023 through 2025. The restricted stock awards are subject to accelerated vesting due to death, total disability, or change in control of the Company.
As of December 31, 2022, 170,000 awarded shares of restricted stock were outstanding, and the grant date fair value was $4.81. During the year ended December 31, 2022, 10,000 awarded shares became vested and were issued, and 30,000 restricted stock awards were forfeited with a grant date fair value of $4.81 per share. The weighted average contractual life as of December 31, 2022 and 2021 was 1.54 years and 2.46 years, respectively. The Company is recording compensation expense on a straight-line basis over the respective vesting periods. There was a $78,000 reversal in compensation expense for the year ended December 31, 2022, which was related to the forfeiture of 30,000 unvested restricted stock awards. For the years ended December 31, 2022 and 2021, the Company recorded $193,000 and $211,000, respectively, related to the restricted stock awards. As of December 31, 2022, there was $319,000 of unrecognized compensation cost related to the restricted stock awards.
As of December 31, 2022 and 2021, 170,000 restricted shares awarded were outstanding and the weighted average contractual life was 1.54 and 2.46 years, respectively. The weighted average grant date fair value of the awards as of December 31, 2022 was $4.81.
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)
December 31, 2022
December 31, 2021
Undisbursed loan commitments
$ 43,427
$ 33,704
Standby letters of credit
$ 43,588
$ 33,986
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 December 31, 2022 and 2021.
Employment Agreements
The Company is party to 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 are in their last year, and Mr. Bramlage’s employment agreement had a three year term and now is year to year.
Note 13. Related Parties
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 29.5% 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 $291,000 and $919,000 during the years ended December 31, 2022 and 2021, 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 $21,000 and $76,000 in fees receivable related to these services at December 31, 2022 and 2021, 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 $193,000 and $225,000 payable to Cain Watters related to this agreement at December 31, 2022 and 2021, respectively, which are included in other liabilities on the accompanying consolidated balance sheets.
Certain officers, directors and their affiliated companies had depository accounts with the Bank as of December 31, 2022 and 2021, totaling approximately $8.3 million and $9.2 million, respectively. None of those deposit accounts have terms more favorable than those available to any other depositor. As of December 31, 2022, there were no loans outstanding to directors of the Bank or their affiliated companies.
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%. The Basel III minimum capital ratio requirements as applicable to the Company and the Bank 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 Basel III capital ratios. As of December 31, 2022, 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 December 31, 2022
Total Capital (to Risk Weighted Assets)
Tectonic Financial, Inc. (consolidated)
$ 81,317
20.21
%
$ 42,243
10.50
%
$ 40,232
10.00
%
T Bank, N.A.
81,279
20.42
41,786
10.50
39,796
10.00
Tier 1 Capital (to Risk Weighted Assets)
Tectonic Financial, Inc. (consolidated)
76,805
19.09
34,197
8.50
32,185
8.00
T Bank, N.A.
76,767
19.29
33,826
8.50
31,837
8.00
Common Equity Tier 1 (to Risk Weighted Assets)
Tectonic Financial, Inc. (consolidated)
59,555
14.80
28,162
7.00
26,150
6.50
T Bank, N.A.
76,767
19.29
27,857
7.00
25,867
6.50
Tier 1 Capital (to Average Assets)
Tectonic Financial, Inc. (consolidated)
76,805
13.27
23,153
4.00
28,941
5.00
T Bank, N.A.
76,767
13.47
22,795
4.00
28,494
5.00
As of December 31, 2021
Total Capital (to Risk Weighted Assets)
Tectonic Financial, Inc. (consolidated)
$ 66,946
18.55
%
$ 37,894
10.50
%
$ 36,089
10.00
%
T Bank, N.A.
67,454
18.87
37,542
10.50
35,754
10.00
Tier 1 Capital (to Risk Weighted Assets)
Tectonic Financial, Inc. (consolidated)
62,794
17.40
30,676
8.50
28,871
8.00
T Bank, N.A.
63,302
17.70
30,391
8.50
28,604
8.00
Common Equity Tier 1 (to Risk Weighted Assets)
Tectonic Financial, Inc. (consolidated)
45,544
12.62
25,263
7.00
23,458
6.50
T Bank, N.A.
63,302
17.70
25,028
7.00
23,240
6.50
Tier 1 Capital (to Average Assets)
Tectonic Financial, Inc. (consolidated)
62,794
11.82
21,245
4.00
26,557
5.00
T Bank, N.A.
63,302
12.06
21,002
4.00
26,252
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 December 31, 2022, approximately $13.1 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, as well as operations of the Bank’s Integra factoring division.
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 T Bancshares’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 years ended December 31, 2022 and 2021:
(In thousands)
Banking
Other Financial Services
HoldCo
Consolidated
Year Ended December 31, 2022
Income Statement
Total interest income
$ 33,385
$ -
$ -
$ 33,385
Total interest expense
4,993
-
5,904
Provision for loan losses
1,264
-
-
1,264
Net interest income (loss) after provision for loan losses
27,128
-
(911
)
26,217
Non-interest income
1,238
38,788
40,040
Depreciation and amortization expense
-
All other non-interest expense
14,878
27,569
1,921
44,368
Income (loss) before income tax
$ 13,106
$ 11,164
$ (2,818
)
$ 21,452
Goodwill and other intangibles
$ 19,659
$ 2,350
$ -
$ 22,009
Total assets
$ 599,305
$ 12,316
$
$ 612,536
(In thousands)
Banking
Other Financial Services
HoldCo
Consolidated
Year Ended December 31, 2021
Income Statement
Total interest income
$ 29,384
$ -
$ -
$ 29,384
Total interest expense
2,736
-
3,627
Provision for loan losses
2,214
-
-
2,214
Net interest income (loss) after provision for loan losses
24,434
-
(891
)
23,543
Non-interest income
35,428
36,624
Depreciation and amortization expense
-
All other non-interest expense
11,441
24,737
1,629
37,807
Income (loss) before income tax
$ 13,605
$ 10,547
$ (2,315
)
$ 21,837
Goodwill and other intangibles
$ 19,867
$ 2,350
$ -
$ 22,217
Total assets
$ 573,726
$ 10,833
$
$ 585,011
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 December 31, 2022
Securities available for sale:
U.S. Treasuries
$ -
$ 1,953
$ -
$ 1,953
U.S. government agencies
-
13,088
-
13,088
Mortgage-backed securities
-
5,592
-
5,592
As of December 31, 2021
Securities available for sale:
U.S. government agencies
$ -
$ 15,402
$ -
$ 15,402
Mortgage-backed securities
-
1,754
-
1,754
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 year ended December 31, 2022, 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 December 31, 2022 and 2021, 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 years ended December 31, 2022 and 2021, 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 December 31, 2022, there were no foreclosed assets. As of December 31, 2021, foreclosed assets totaled $1.1 million consisting of two loans that were foreclosed during 2021 and were recorded at fair value. There were no foreclosed assets re-measured during the years ended December 31, 2022 and 2021.
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 year ended December 31, 2022, there were no loans sold. During the year ended December 31, 2021, the Company added a servicing asset of $19,000 in connection with the sale of $1.1 million in loans. For the years ended December 31, 2022 and 2021, the Company amortized $168,000 and $326,000, respectively, using the amortization method for the treatment of servicing loans. The Company recorded an allowance provision of $10,000 for the year ended December 31, 2022. There was no provision for the year ended December 31, 2021.
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 and Public Improvement District/Tax Increment Reinvestment Zone 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. The fair value of these investments are estimated using observable market inputs in a discounted cash flow analysis.
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:
December 31, 2022
(In thousands)
Carrying
Amount
Estimated
Fair Value
Financial assets:
Level 1 inputs:
Cash and cash equivalents
$ 42,155
$ 42,155
Level 2 inputs:
Securities available for sale
20,633
20,633
Securities, restricted
3,496
3,496
Loans held for sale
33,902
36,470
Accrued interest receivable
3,102
3,102
Level 3 inputs:
Securities held to maturity
25,262
26,482
Securities not readily marketable
Loans, net
445,819
438,956
Servicing asset
Financial liabilities:
Level 1 inputs:
Non-interest bearing deposits
94,187
94,187
Level 2 inputs:
Interest bearing deposits
398,838
389,806
Borrowed funds
12,000
12,000
Accrued interest payable
December 31, 2021
(In thousands)
Carrying
Amount
Estimated
Fair Value
Financial assets:
Level 1 inputs:
Cash and cash equivalents
$ 45,992
$ 45,992
Level 2 inputs:
Securities available for sale
17,156
17,156
Securities, restricted
2,432
2,432
Loans held for sale
33,762
37,549
Accrued interest receivable
2,268
2,268
Level 3 inputs:
Securities held to maturity
19,673
19,673
Securities not readily marketable
Loans, net
424,595
430,810
Servicing asset
Financial liabilities:
Level 1 inputs:
Non-interest bearing deposits
88,876
88,876
Level 2 inputs:
Interest bearing deposits
355,293
359,606
Borrowed funds
46,521
46,521
Accrued interest payable
Note 17. Recent Accounting Pronouncements
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 falls within the definition of an SRC under applicable rules promulgated by 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. We currently expect the adoption of ASU 2016-13 will result in a combined 30% to 40% increase in our allowance for loan losses and our reserves for unfunded commitments and a cumulative-effect adjustment to reduce retained earnings by 1% to 2%. As we are currently finalizing the execution of our implementation controls and processes, the ultimate impact of the adoption of ASU 2016-13 as of January 1, 2023 could differ from our current expectation. The expected increase is a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses for certain debt securities and other financial assets; however, we do not expect these allowances to be significant. The adoption of ASU 2016-13 is not expected to have a significant impact on our regulatory capital ratios.
ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 eliminates the accounting guidance for troubled debt restructurings in ASC Subtopic 310-40, Receivables - Troubled Debt Restructurings by Creditors and enhances disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Additionally, ASU 2022-02 requires entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of ASC Subtopic 3126-20, Financial Instruments - Credit Losses - Measured at Amortized Cost. ASU 2022-02 will be effective for us on January 1, 2023 though early adoption is permitted. The adoption of ASU 2022-02 will have no impact on our financial statements.
Note 18. Integra Acquisition
On July 1, 2021, we, through our wholly-owned subsidiary T Bancshares, acquired Integra through the merger of Integra with and into T Bancshares, with T Bancshares surviving the merger. Integra’s activity will be reported within our Banking segment. Integra is a factoring company that provides financing to smaller transportation companies across the United States principally by purchasing their accounts receivable at a discount and then collecting such receivables at face value. We believe that the addition of this small business lending vertical will provide the Bank with additional breadth in its lending platform and enable the Bank to continue to prudently grow its balance sheet and generate relatively attractive returns on its assets.
Pursuant to the terms of and subject to the conditions set forth in the Agreement and Plan of Merger by and between the Company and Integra (the “Merger Agreement”), the transaction provided for the payment to the members of Integra of (a) an amount of cash equal to (i) approximately $2.5 million, subject to certain adjustments described in the Merger Agreement which totaled $726,721, and (b) 453,203 shares of the Company’s common stock. In addition, the Company incurred $115,726 of expenses related to the acquisition of Integra, which is reported in non-interest expense on our consolidated statements of income.
A summary of the fair values of assets acquired, liabilities assumed, consideration transferred, and the resulting goodwill, which represents the expected synergies from the Integra merger, and is not deductible for tax purposes, is as follows:
(In thousands)
Assets acquired:
Factored receivables
$ 33,442
Other assets
Premises and equipment
Loans receivable
1,103
34,839
Liabilities assumed:
Deposits
2,535
Other liabilities
Borrowings
28,927
31,715
Fair value of net assets acquired
3,124
Consideration:
Cash paid
3,185
Common stock
10,650
Total consideration
13,835
Goodwill
$ 10,711
The contractual value of the factored receivables acquired was $34.3 million. The amount above represents the contractual value of the receivables less the purchased deferred discount of $397,000 and the fair value adjustment of $492,000. The value for the common stock was based on an earnings based multiple plus a control premium.
Supplemental Pro Forma Information (unaudited)
The following table presents financial information regarding the former Integra operations included in the Company’s consolidated Statements of Income for the year ended December 31, 2022. In addition, the table presents unaudited condensed pro forma financial information assuming that the Integra acquisition was completed as of January 1, 2021. Integra was a subchapter S corporation and as such, income tax on its earnings was paid by its shareholders. The results shown below for the period prior to the acquisition include an estimate for income tax at the Company’s statutory rate.
The table has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been obtained had the acquisition occurred on January 1, 2021, nor is it indicative of future results.
(In thousands)
Pro Forma Combined
for the Year Ended
December 31, 2021
Net interest income
$ 25,916
Noninterest income
36,872
Noninterest expense
39,707
Net income after income taxes
18,017
Note 19. Parent Company Condensed Financial Statements
TECTONIC FINANCIAL, INC.
CONDENSED BALANCE SHEETS
(In thousands)
December 31,
December 31,
ASSETS
Cash and due from banks
$ 2,664
$ 3,464
Securities, not readily marketable
Investment in subsidiaries
93,788
81,907
Other assets
Total assets
$ 97,221
$ 85,739
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities
$
$
Shareholders’ equity
96,748
85,187
Total liabilities and shareholders’ equity
$ 97,221
$ 85,739
TECTONIC FINANCIAL, INC.
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
(In thousands)
Income from subsidiaries
$ 18,211
$ 18,158
Other income
Total income
18,803
18,894
Non-interest expense:
Salaries and employee benefits
1,194
Occupancy and equipment
-
Professional and administrative
Data processing
-
Other
Total non-interest expense
2,242
2,069
Income before income taxes
16,561
16,825
Income tax benefit
(469
)
(209
)
Net Income
$ 17,030
$ 17,034
TECTONIC FINANCIAL, INC.
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31,
(In thousands)
Net Income
$ 17,030
$ 17,034
Other comprehensive loss:
Change in unrealized loss on investment securities available for sale
(2,582
)
(502
)
Tax effect
(542
)
(106
)
Other comprehensive loss
(2,040
)
(396
)
Comprehensive income
$ 14,990
$ 16,638
TECTONIC FINANCIAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
(In thousands)
Cash Flows from Operating Activities
Net income
$ 17,030
$ 17,034
Adjustments to reconcile net income to net cash used in operating activities:
Equity in income of subsidiaries
(18,211
)
(18,158
)
Stock based compensation
Net change in other assets
(401
)
1,907
Net change in other liabilities
(79
)
Net cash (used in) provided by operating activities
(1,469
)
1,535
Cash Flows from Investing Activities
Contributions to subsidiaries
(200
)
(9,310
)
Distributions from subsidiaries
4,570
13,461
Net cash provided by investing activities
4,370
4,151
Cash Flows from Financing Activities
Proceeds from issuance of common shares
Dividends paid on Series B Preferred Shares
(1,552
)
(1,552
)
Dividends on common shares
(1,765
)
(1,291
)
Repurchase of common stock
(481
)
-
Net cash used in financing activities
(3,701
)
(2,443
)
Net change in cash and cash equivalents
(800
)
3,243
Cash and cash equivalents at beginning of period
3,464
Cash and cash equivalents at end of period
$ 2,664
$ 3,464
Supplemental disclosures of cash flow information
Cash paid during the year for:
Income taxes
$ 4,715
$ 5,427
Note 20. Subsequent Events
On March 12, 2023, in response to liquidity concerns in the United States banking system, the Federal Reserve and U.S. Department of Treasury, along with banking regulators, collaboratively approved certain actions with a stated intention to reduce stress across the financial system, support financial stability and minimize any impact on business, households, taxpayers, and the broader economy. Among other actions, the Federal Reserve Board created a new Bank Term Funding Program (BTFP) to make additional funding available to eligible depository institutions, to help assure institutions can meet the needs of their depositors. Eligible institutions may obtain liquidity against a wide range of collateral. BTFP advances can be requested through at least March 11, 2024. Through the date the financial statements were available to be issued, the Company was in the process of pledging eligible securities to the BTFP for future liquidity funding, if needed.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9.
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
None.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A.
Controls and Procedures.
Our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act, “Disclosure Controls”) as of the end of the period covered by this Form 10-K. Our management, including the principal executive officer and principal financial officer, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this Form 10-K, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
This Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal controls over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this Form 10-K.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act. The Company’s internal control over financial reporting system is designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of the Company’s financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of December 31, 2022, management assessed the effectiveness of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control-Integrated Framework,” issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in 2013. Based on this assessment, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2022.
Whitley Penn LLP, Dallas, Texas, (U.S. PCAOB Auditor Firm I.D.: 726) an independent registered public accounting firm, audited the consolidated financial statements of the Company for the years ended December 31, 2022 and 2021 included in this Annual Report on Form 10-K. Their report is included in “Item 8. Financial Statements and Supplementary Data.” This Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm on the Company’s internal control over financial reporting due to the Company’s status as a Smaller Reporting Company.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2022, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

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ITEM 9B. OTHER INFORMATION
Item 9B.
Other Information.
None.

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10.
Directors, Executive Officers, and Corporate Governance.
General
We have an experienced executive management team and board of directors. Our board of directors is comprised of ten directors who are elected by our shareholders at each annual meeting of shareholders for a term of one year. Our directors hold office until the next annual meeting of shareholders following their election and thereafter until their successors shall have been duly elected and qualified. Our executive officers are appointed by our board of directors and hold office until their successors are duly appointed and qualified, or until their earlier death, resignation or removal.
Pursuant to our certificate of formation and bylaws, our board of directors must be comprised of no less than one nor more than 15 directors, and is currently comprised of ten directors. The exact number of directors may be fixed from time to time within the range set forth in our bylaws by resolution of our board of directors.
As discussed in greater detail below, our board of directors has affirmatively determined that Eric Langford, Thomas McDougal and Barb Bomersbach qualify as independent directors based upon the rules of NASDAQ and the SEC. There are no arrangements or understandings between any of the directors, executive officers and any other person pursuant to which he or she was selected as a director.
Directors and Executive Officers
Directors. The following table sets forth certain information regarding our directors, including their ages and the years that they began serving as directors of the Company:
Name
Position with the Company
Age at
			March 1,
Director
			Since
George L. Ball
Executive Co-Chairman
Nov 2018
Barb Bomersbach
Director
Mar 2019
Darrell W. Cain
Co-Chairman
Nov 2018
Steven B. “Brad” Clapp
Director
May 2017
Patrick Howard
Director; President & Chief Operating Officer
May 2017
Eric Langford
Director
May 2017
Thomas McDougal
Director
May 2017
Thomas R. Sanders
Director
May 2017
A. Haag Sherman
Director; Chief Executive Officer
Oct 2016
Daniel C. Wicker
Director
May 2017
Executive Officers. The following table sets forth certain information regarding our executive officers, including their positions and length of service with the Company.
Name
Position with the Company
Age at
			March 1,
Director
			Since
George L. Ball
Executive Co-Chairman
Nov 2018
Ken Bramlage
Executive Vice President & Chief Financial Officer
-
Patrick Howard
President & Chief Operating Officer
May 2017
A. Haag Sherman
Chief Executive Officer
Oct 2016
The following is a brief discussion of the business and banking background and experience of our directors and executive officers for at least the past five years. With respect to directors, the biographies also contain information regarding the person’s experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director. Unless otherwise indicated, directors and senior officers have held their positions for the past five years. No director or executive officer has any family relationship, as defined in Item 401 of Regulation S-K, with any other director or with any of our executive officers.
Board of Directors
George L. Ball. Mr. Ball is Executive Co-Chairman of the Company. Mr. Ball has served as a director of the Company since May 2017 and former Co-Chairman of Tectonic Holdings from 2015 to May 2019. He has served as Chairman of Sanders Morris, and its predecessor, Sanders Morris Mundy Inc., from May 1992 to present, and served as Chief Executive Officer of Sanders Morris from 2008 to 2011. He previously served as Chairman of The Edelman Financial Group, or Edelman, a financial services holding company, from 2008 until its sale to Hellman and Friedman in 2015. During his tenure, Edelman experienced significant growth (from $3 billion to $18 billion in assets under management). From September 1992 to January 1994, Mr. Ball was a Senior Executive Vice President of Smith Barney Shearson Inc. From September 1991 to September 1992, he was a consultant to J. & W. Seligman & Co. Incorporated. Mr. Ball served as Chairman and Chief Executive Officer of Prudential-Bache Securities, Inc. from 1982 to 1991 and Chairman of the Board from 1986 to 1991. He also served a member of the Executive Office of Prudential Insurance Company of America from 1982 to 1991. Before joining Prudential, Mr. Ball served as President of E.F. Hutton & Co. Mr. Ball is a former governor of the American Stock Exchange and the Chicago Board Options Exchange, and served on the Executive Committee of the Securities Industries Association. He is a graduate of Brown University with honors in economics and served as an officer in the U.S. Navy. We believe Mr. Ball’s broker-dealer expertise and leadership of public companies, both as an executive and as a director, and stock exchanges qualifies him to serve on our board of directors.
Barb Bomersbach. Ms. Bomersbach has served as a director of the Company since March 2019. Ms. Bomersbach currently serves as a financial advisor to Tristate Midstream, a natural gas gathering company where she served as Chief Financial Officer from 2010 to 2021 Prior to that, Ms. Bomersbach was the Chief Financial Officer of Wynn Crosby, an upstream oil and gas company, in 2009. Ms. Bomersbach is a Certified Public Accountant and Chartered Financial Analyst, and graduated summa cum laude from Texas A&M University with a BBA and MS in Accounting. We believe Ms. Bomersbach brings to the Board of Directors experience in financial and accounting matters, internal controls and compliance (from an accounting standpoint) and is our audit committee financial expert.
Darrell W. Cain. Mr. Cain is the non-executive Co-Chairman of the Company. Mr. Cain has served as a director of the Company since November 2018, former Chairman of Tectonic Holdings from 2015 to May 2019 and a partner at Cain Watters since 1983. Mr. Cain founded Cain Watters in 1983 as an accounting and investment advisory firm specializing in financial planning, working exclusively with members of the dental profession, and served as its President from 1983 until 2008; he is currently a partner of Cain Watters. Mr. Cain previously served on the board of directors of T Bancshares and the Bank from their formation until October 2005. Mr. Cain is a graduate of Baylor University where he received both a Bachelor of Business Administration and Master of Public Accounting degree. He holds certified public accountant and investment advisor representative designations. We believe Mr. Cain brings to our board of directors significant investment, financial planning and financial skills important to the oversight of enterprise and operational risk management of the Company.
Steven B. “Brad” Clapp. Mr. Clapp has served as a director of the Company, T Bancshares and the Bank since May 2017 and served as a board member of Tectonic Holdings from 2015 until its merger with the Company in May 2019. Mr. Clapp is a partner of Cain Watters and currently serves as the Partner in Charge of Information Technology, in addition to his duties of managing the financial plans of approximately 60-70 families. He has served the clients of the firm in various planning roles including the development of financial plans, tax planning and practice valuations. He joined Cain Watters in 1998 and became a partner in 2008. Mr. Clapp started his career at the international accounting firm KPMG in 1996. Mr. Clapp is a graduate of The University of Arkansas and The University of Denver. We believe Mr. Clapp brings to the board of directors strong investment, accounting and financial skills important to the oversight of our financial reporting and operational risk management.
Patrick Howard. Mr. Howard serves as President, Chief Operating Officer and a director of the Company. Prior to such appointment in connection with the Tectonic Merger, Mr. Howard served as President and Chief Executive Officer of the Company since May 2017, President and Chief Executive Officer of the Bank since 2010 and as the Chief Operating Officer and director of the Bank and T Bancshares since 2007. During his tenure at the Bank, he has overseen the growth of the trust platform to over $1.7 billion in assets, more than tripled the size of the loan portfolio in the last eight years through organic growth and successfully recruited and integrated a national Small Business Administration, or SBA, lending platform. He accomplished this while developing and ensuring an operating culture based on strong internal controls and regulatory compliance. In addition, prior to its acquisition by the Company in May 2017, T Bancshares was an SEC reporting company, and Mr. Howard was jointly responsible for T Bancshares’ SEC filings and compliance. Mr. Howard previously served as the Executive Vice President and Chief Operating Officer of a savings bank that he helped grow from $50 million to $2.2 billion over an 11-year period. Mr. Howard graduated magna cum laude from the University of Texas at San Antonio.
Eric Langford. Mr. Langford is a founding director of T Bancshares and the Bank since February 2003 and a director of the Company since May 2017. He has been active in the real estate industry for almost 40 years as an investor and developer. Since 1995, he has managed Langford Property Company. He previously served as Senior Vice President for two leading national real estate firms, Opus West Corporation from 2003 to 2006 and Koll Development Company from 1993 to 2000. A 60-year resident of Dallas, Mr. Langford was the founding President of North Texas Commercial Association of Realtors, which awarded him with the Stemmons Service Award, the highest honor in the Dallas real estate industry. Mr. Langford is a magna cum laude graduate from Texas A&M University. We believe that Mr. Langford’s expansive business experience in the real estate industry provides leadership and management experience that is beneficial to the board of directors.
Thomas McDougal, DDS. Dr. McDougal has been a director of T Bancshares and the Bank since February 2003 and a director of the Company since May 2017. He served as Captain in the United States Air Force for two years. Dr. McDougal is a practicing dentist, having been in private practice since 1970. In 1970, Dr. McDougal founded his dental practice in Richardson, Texas which today is McDougal and Richards Dentistry. He received a Bachelor of Science degree from Oklahoma State University and his Doctor of Dental Surgery degree from Baylor University. He serves on the board of directors of several national dental associations, and served as President of the Dallas County Dental Society and the American Academy of Dental Practice. He has been an adjunct professor at Baylor College of Dentistry since 2008 and has been on the teaching faculty at the Center for Aesthetic and Restorative Dentistry since 2005. We believe Dr. McDougal’s experience as a practicing dentist and leadership roles in the dental community provide particular benefit in overseeing our dental lending program and trust line of business as well as his corporate governance experience.
Thomas R. Sanders. Mr. Sanders has served as a director of the Company, T Bancshares and the Bank since May 2017 and was a director of Tectonic Holdings from 2015 until the Tectonic Merger. Mr. Sanders has been a partner of Cain Watters since 2008 after joining the firm in 2002. He currently serves as Partner in Charge of Tax Services, overseeing a department with over 70 employees that is responsible for filing over 4,200 federal tax returns plus state returns, extensions and personal property tax returns for clients. Mr. Sanders also manages the financial planning relationship for more than 70 of the firm’s clients representing assets under management in excess of $250 million. Mr. Sanders started his career at Deloitte where he spent four years in their tax department including several international assignments. Mr. Sanders graduated from Baylor University in 1998 with a Bachelor of Business Administration and a Masters of Science in Taxation. We believe that Mr. Sanders’ tax expertise enhances the skill set of our board of directors.
A. Haag Sherman. In connection with the Tectonic Merger, Mr. Sherman was appointed as a director and the Chief Executive Officer of the Company. Prior to such appointment, Mr. Sherman served as Chairman of the Company from November 2017 until the Tectonic Merger, and as Chairman of T Bancshares and the Bank since May 2017. Mr. Sherman was also the Chief Executive Officer and a director of Tectonic Holdings from 2015 until May 2019. Prior to joining the Company, Mr. Sherman co-founded Salient Partners, LP (a Houston-based investment firm) in 2002 and served in various executive positions, including Chief Executive Officer and Chief Investment Officer, through October 2011. In addition, he previously served as an executive officer and partner of The Redstone Companies from 1998 to 2002 where he, among other things, managed a private equity portfolio (where he was responsible for two finance companies). Mr. Sherman has served as a director of Hilltop Holdings, Inc. since its acquisition of PlainsCapital Corporation in November 2012. He previously served as a director of PlainsCapital from September 2009 to November 2012. Mr. Sherman has served as a member of the board of directors of CBIZ, Inc. since August 2020. He currently serves on private company boards and as Executive Chairman of the board of trustees of Episcopal High School in Bellaire, Texas. Mr. Sherman graduated cum laude from Baylor University in 1988 with a Bachelors of Business Administration with majors in Accounting and Economics and received a Juris Doctorate, with honors, from the University of Texas School of Law in 1992. Mr. Sherman previously served as an adjunct professor of law at The University of Texas School of Law. Mr. Sherman previously practiced corporate law at Akin, Gump, Strauss, Hauer & Feld, LLP from 1992 to 1996 and was an auditor at Price Waterhouse, a public accounting firm, from 1988 to 1989. Mr. Sherman is an attorney and certified public accountant. We believe that Mr. Sherman’s leadership, board expertise, legal background and experience in financial services, including banking, trust and finance companies, qualify him to serve on our board of directors.
Daniel C. Wicker. Mr. Wicker has served as a director of the Company, T Bancshares and the Bank since May 2017. In addition, Mr. Wicker was a director of Tectonic Holdings from 2015 until May 2019. Mr. Wicker has been a partner of Cain Watters since 2008 after joining the firm in 1997. Mr. Wicker currently serves as the Partner in Charge of Operations, overseeing the financial planning process as well as the Cain Watters planners, among other operational responsibilities. He has served the clients of the firm in various planning roles including the development of financial plans, tax planning and practice valuations. Mr. Wicker started his career at the international accounting firm KPMG where he worked from 1993 to 1997. Mr. Wicker graduated from Kansas State University in 1993. We believe that Mr. Wicker’s leadership and strategic planning abilities qualify him to serve on our board of directors.
Executive Officers and Other Significant Employees
Ken Bramlage. Mr. Bramlage has served as Executive Vice President and Chief Financial Officer of the Company since May 2017 and holds the same positions at T Bancshares and the Bank. He joined the Bank in July 2008 as Vice President and Controller and was promoted to Senior Vice President and Chief Financial Officer in April 2010 and Executive Vice President and Chief Financial Officer in 2013. Prior to joining the Company, Mr. Bramlage was Vice President and Controller for a $1.0 billion savings bank headquartered in Olathe, Kansas since April 1999. Mr. Bramlage earned a Bachelor of Administration degree in Accounting at Kansas State University in 1984 and became licensed as a certified public accountant in the state of Texas in 1985.
Code of Business Conduct and Ethics
We have adopted a Code of Business Conduct and Ethics, which is applicable to all directors, officers and employees of the Company and the Bank. The full text of our Code of Business Conduct and Ethics is posted to the Company’s website which is located at https://www.t.financial/investors#corporategovernance. We will post any amendments to our Code of Business Conduct and Ethics, or waivers of its requirements, on our website.
Audit Committee
The members of our Audit Committee are Eric Langford, Thomas McDougal, and Barb Bomersbach, with Barb Bomersbach serving as chair of our Audit Committee. Our board of directors has evaluated the independence of each of the members of our Audit Committee and has affirmatively determined that each of the members of our Audit Committee (1) is an “independent director” under the rules of NASDAQ, (2) satisfies the additional independence standards under applicable SEC rules for audit committee service, and (3) has the ability to read and understand fundamental financial statements. The board of directors has determined that Barb Bomersbach qualifies as an “audit committee financial expert,” as defined by the SEC. The board of directors believes that the members of the Audit Committee are able to read and understand the consolidated financial statements of the Company and are familiar with the Company and its business.
Delinquent Section 16(a) Reports
Section 16(a) of the Exchange Act requires our directors and executive officers and persons who own more than 10% of our outstanding common stock to file reports of ownership and changes in ownership of our equity securities, including our common stock with the SEC. Such persons are required by the SEC’s regulations to furnish us with copies of all reports they file pursuant to Section 16.
Based solely on a review of the reports furnished to us, or written representations from reporting persons that all reportable transactions were reported, we believe that during the fiscal year ended December 31, 2022, our officers, directors and greater than 10% owners timely filed all reports they were required to file under Section 16(a), except that Darrell Cain inadvertently failed to timely report the repurchase by the Company of the Series A preferred stock held by DCFH, Ltd. on July 12, 2019 and the purchase of 1,000 shares of Series B preferred stock on May 11, 2022, for which a Form 4 was not filed until May 17, 2022. The failure to file was inadvertent and has been reported.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11.
Executive Compensation.
We are an “emerging growth company,” as defined in the JOBS Act and a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. As such, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies or smaller reporting companies. These include, but are not limited to, reduced disclosure obligations regarding executive compensation.
Our “named executive officers,” which consist of our principal executive officer and the two other most highly compensated executive officers, are A. Haag Sherman, Chief Executive Officer, Patrick Howard, President and Chief Operating Officer, and Ken Bramlage, Chief Financial Officer.
Summary Compensation Table
The following table sets forth information regarding the compensation paid to, awarded to, or earned by our named executive officers for the fiscal years indicated.
Name and Principal Position
Year
Salary
			($)
Bonus
			($)
Stock Awards
			($)
Option
			Awards
			($)
Non-Equity
			Incentive Plan
			Compensation
			($)
All Other
			Compensation(1)
			($)
Total
			($)
A. Haag Sherman
Chief Executive Officer
360,000
300,000
375,000
250,000
-
-
-
-
-
-
11,222
10,601
746,222
560,601
Patrick Howard
President and Chief Operating Officer
328,333
285,000
175,000
142,500
-
-
-
-
-
-
14,273
13,861
517,606
441,361
Ken Bramlage
Chief Financial Officer
178,833
166,500
92,500
83,250
-
-
-
-
-
-
9,965
9,474
281,298
259,224
(1)
The amounts shown in this column are composed of the following items:
Name
Year
Company 401(k) Match
Life Insurance Premiums
Total “All Other Compensation”
Haag Sherman
$
10,500
10,063
$
$
11,222
10,601
Patrick Howard
$
10,675
10,150
$
3,598
3,711
$
14,273
13,861
Ken Bramlage
$
9,173
8,741
$
$
9,965
9,474
General
We compensate our named executive officers through a combination of base salary, annual discretionary bonuses, equity awards and other benefits, including perquisites. Our board of directors believes the executive compensation packages that we provide to our executives, including the named executive officers, should reward performance. Each element of compensation is designed to achieve a specific purpose and to contribute to a total package that is competitive with similar packages provided by other institutions that compete for the services of individuals like our named executive officers.
Base Salary
We provide each of our named executive officers with a competitive fixed annual base salary. The base salaries for our named executive officers are reviewed annually by the board of directors by taking into account the results achieved by each executive, his or her future potential, scope of responsibilities and experience and competitive pay practices. Based upon the comprehensive review, the board of directors has determined the base salaries to be equitable and competitive for our market.
Bonuses
Our named executive officers receive incentive and/or bonus payments based on their employment agreements, as described below.
Stock-Based Compensation Awards
Stock-based compensation awards may consist of options to acquire shares of our common stock, restricted stock awards, restricted stock units or performance stock units issued pursuant to the Amended and Restated T Acquisition, Inc. 2017 Equity Incentive Plan (the “Amended and Restated Equity Plan”), which, as described more fully below, allows the Compensation Committee to establish the terms and conditions of the awards, subject to the terms of the Amended and Restated Equity Plan.
Other Benefits and Perquisites
The named executive officers participate in our broad-based employee welfare benefit plans, such as medical, dental, vision, supplemental disability and term life insurance. The named executive officers also participate in our 401(k) plans. Under the T Bank, N.A. Employees Savings Plan, in which Mr. Howard and Mr. Bramlage are participants, we match 100% of an employee’s contribution up to the first 1% and 50% up to next 5% of such employee’s salary up to the 401(k) limit. For the year ended December 31, 2020, the Tectonic Retirement Plan and Trust, in which Haag Sherman was a participant, contained a safe harbor provision under which all employees receive 3% of compensation up to the 401(a) limit, regardless of the level of their deferrals. Effective January 1, 2021, the Tectonic Retirement Plan and Trust was amended. Under the amended plan, we match 100% of an employee’s contribution up to the first 1% and 50% up to next 5% of such employee’s salary up to the 401(k) limit, identical to the T Bank, N.A. Employees Savings Plan. The named executive officers are provided the same benefits, and participate in the cost at the same rate, as all other employees.
We provide our named executive officers with certain perquisites that we believe are reasonable and consistent with our overall compensation program to better enable us to attract and retain superior employees for key positions. The Compensation Committee will review the levels of perquisites and other personal benefits provided to named executive officers. Based on this periodic review, perquisites will be awarded or adjusted on an individual basis. The perquisites received by our named executive officers in 2022 and 2021 included $2,839 for each year paid by the Company on behalf of Mr. Howard toward a $3,000,000 key man life insurance policy for Mr. Howard. In accordance with his employment agreement, 50% of the death benefit of this policy is payable to Mr. Howard’s named beneficiaries.
Employment Agreements
We have entered into an employment agreement with Mr. Sherman and amended and restated the employment agreements with Messrs. Howard and Bramlage. The following is a summary of the material terms of each such agreement.
Haag Sherman. Mr. Sherman’s employment agreement has an initial term of four years and automatic one-year renewals thereafter unless either party provides written notice of its intent not to renew at least 90 days prior to the renewal date. Under Mr. Sherman’s employment agreement, he is entitled to an annual base salary that is currently $360,000 and is eligible to receive an annual performance-based bonus payment to the extent the applicable performance criteria are satisfied.
Mr. Sherman is also eligible to receive certain other employee benefits and perquisites in accordance with our established policies, as described above. In addition, Mr. Sherman’s employment agreement provides for certain restrictive covenants and severance benefits in the event of a qualifying termination of employment and certain payments in connection with a “change in control” of the Company. See “-Potential Payments upon a Termination of Employment or a Change in Control.”
Patrick Howard. As amended and restated, the employment agreement is for a term expiring on May 14, 2023 and automatic one-year renewals thereafter unless either party provides written notice of its intent not to renew at least 90 days prior to the renewal date. Under Mr. Howard’s amended and restated employment agreement, he is entitled to an annual base salary that is currently $350,000 and is eligible to receive an annual performance-based bonus payment to the extent the applicable performance criteria are satisfied.
In connection with the execution of his original employment agreement, Mr. Howard received options to purchase 50,000 shares of our common stock with an exercise price equal to $2.15, which vested on May 15, 2020 (the “3-Year Tectonic Financial Options”), and options to purchase 50,000 shares of our common stock with an exercise price equal to $2.15, which vested on May 15, 2021 (the “4-Year Tectonic Financial Options”). In addition, Mr. Howard entered into a unit option agreement with Tectonic Holdings and received options to purchase 50,000 membership units of Tectonic Holdings with an exercise price equal to $3.55, which vested on May 15, 2020 (the “3-Year Tectonic Holdings Options”), and he received options to purchase 50,000 membership units of Tectonic Holdings with an exercise price equal to $3.55, which vested on May 15, 2021 (the “4-Year Tectonic Holdings Options”). As a result of the Tectonic Holdings Merger and the 1-for-2 reverse stock split of the Company’s common stock, the 3-Year Tectonic Holding Options were converted into options to purchase 25,000 shares of the Company’s common stock at an exercise price of $5.70, which is the sum of the exercise prices of the 3-Year Tectonic Holdings Options and the 3-Year Tectonic Financial Options, and the 4-Year Tectonic Holding Options were converted into options to purchase 25,000 shares of the Company’s common stock at an exercise price of $5.70, which is the sum of the exercise prices of the 4-Year Tectonic Holdings Options and the 4-Year Tectonic Financial Options. Additionally, as a result of the Tectonic Holdings Merger and the 1-for-2 reverse stock split of the Company’s common stock, the 3-Year Tectonic Financial Options became exercisable for 25,000 shares of the Company’s common stock at an exercise price of $5.70 and the 4-Year Tectonic Financial Options became exercisable for 25,000 shares of the Company’s common stock at an exercise price of $5.70.
Mr. Howard is also eligible to receive certain other employee benefits and perquisites in accordance with our established policies, as described above. In addition, Mr. Howard’s amended and restated employment agreement provides for certain restrictive covenants and severance benefits in the event of a qualifying termination of employment and certain payments in connection with a “change in control” of the Company. See “-Potential Payments upon a Termination of Employment or a Change in Control.”
Ken Bramlage. As amended and restated, the employment agreement is for a term expiring on May 14, 2020 and automatic one-year renewals thereafter unless either party provides written notice of its intent not to renew at least 90 days prior to the renewal date. Under Mr. Bramlage’s amended and restated employment agreement, he is entitled to an annual base salary that is currently $185,000 and is eligible to receive an annual performance-based bonus payment to the extent the applicable performance criteria are satisfied.
Mr. Bramlage is also eligible to receive certain other employee benefits and perquisites in accordance with our established policies, as described above. In addition, Mr. Bramlage’s amended and restated employment agreement provides for certain restrictive covenants and severance benefits in the event of a qualifying termination of employment and certain payments in connection with a “change in control” of the Company. See “-Potential Payments upon a Termination of Employment or a Change in Control.”
Amended and Restated T Acquisition, Inc. 2017 Equity Incentive Plan
The board of directors and Company shareholders have adopted the Amended and Restated Equity Plan. The Amended and Restated Equity Plan is intended to enable the Company to remain competitive and innovative in its ability to attract, motivate, reward, and retain the services of key employees and outside directors. The Amended and Restated Equity Plan allows for the granting of incentive stock options, non-qualified stock options, stock appreciation rights (“SARs”), restricted stock, restricted stock units, performance awards, dividend equivalent rights, and other awards which may be granted singly, in combination, or in tandem. The Amended and Restated Equity Plan is expected to provide flexibility to the Company’s compensation methods in order to adapt the compensation of key employees and outside directors to a changing business environment (after giving due consideration to competitive conditions and the impact of accounting rules and federal tax laws).
The following is a brief description of the Amended and Restated Equity Plan and is qualified in its entirety by reference to the Amended and Restated Equity Plan that is filed as an exhibit to this Form 10-K.
Purpose. The purpose of our Amended and Restated Equity Plan is to attract, motivate, reward, and retain the services of key employees and outside directors by providing them with additional incentives, and to promote the success of our Company’s business.
Administration. Our board of directors or one or more committees appointed by our board of directors will administer the Amended and Restated Equity Plan.
Eligibility. Persons eligible to receive awards under the Amended and Restated Equity Plan include our officers, employees, consultants and members of our board of directors. Our board of directors or one or more committees appointed by our board of directors will determine from time to time the participants to whom awards will be granted.
Authorized Shares; Limits on Awards. The maximum number of common shares that may be issued or transferred pursuant to awards under the Amended and Restated Equity Plan equals 750,000 shares, all of which may be subject to incentive stock option treatment. The Current Plan reserves 750,000 shares of our common stock, of which 230,000 stock options and 210,000 restricted stock grants have been awarded, however 30,000 were forfeited and thus returned to the reserve under the Amended and Restated Equity Plan, leaving 340,000 remaining available for issuance.
The maximum aggregate number of common shares that may be issued pursuant to all awards under the Amended and Restated Equity Plan shall increase annually on the first day of each fiscal year following the adoption of the Amended and Restated Equity Plan by the number of common shares equal to the lesser of (i) three percent of the total issued and outstanding common shares on the first day of such fiscal year, or (ii) such lesser amount determined by our board of directors.
Adjustments or Changes in Capitalization. In the event of any change in the outstanding common shares by reason of a stock split, stock dividend or other non-recurring dividends or distributions, recapitalization, merger, consolidation, spin-off, combination, repurchase or exchange of stock, reorganization, liquidation, dissolution or other similar corporate transaction that affects our common stock, the aggregate number of shares of common stock available under the Amended and Restated Equity Plan or subject to outstanding awards (including the exercise price of any awards) shall be adjusted as our board of directors deems necessary or appropriate.
Incentive Awards. The Amended and Restated Equity Plan authorizes stock options, SARs, restricted stock, restricted stock units, performance-based awards, as well as other awards (described in the Amended and Restated Equity Plan) that are responsive to changing developments in management compensation. The Amended and Restated Equity Plan retains the flexibility to offer competitive incentives and to tailor benefits to specific needs and circumstances. Any award may be paid or settled in cash. An option or SAR will expire, or other award will vest, in accordance with the schedule set forth in the applicable award agreement.
Stock Option. A stock option is the right to purchase common shares at a future date at a specified price per share generally equal to, but no less than, the fair market value of a share on the date of grant. An option may either be an Incentive Stock Option, or ISO, or a nonstatutory stock option, or NSO. ISO benefits are taxed differently from NSOs, and are subject to more restrictive terms and are limited in amount by the Code and the Amended and Restated Equity Plan. Full payment for shares purchased on the exercise of any option must be made at the time of such exercise in a manner approved by our board of directors.
SARs. A SAR is the right to receive payment of an amount equal to the excess of the fair market value of a common share on the date of exercise of the SAR over the base price of the SAR. The base price will be established by our board of directors at the time of grant of the SAR but will not be less than the fair market value of a share on the date of grant. SARs may be granted in connection with other awards or independently.
Restricted Stock. A restricted stock award is typically for a fixed number of common shares subject to restrictions. Our board of directors specifies the price, if any, the participant must pay for such shares and the restrictions (which may include, for example, continued service and/or performance standards) imposed on such shares. A stock bonus may be granted by our board of directors to any eligible person to reward exceptional or special services, contributions or achievements in the manner and on such terms and conditions (including any restrictions on such shares) as determined from time to time by our board of directors. The number of shares so awarded shall be determined by our board of directors and may be granted independently or in lieu of a cash bonus.
Restricted Stock Units. A restricted stock unit is similar to a SAR except that it entitles the recipient to receive an amount equal to the fair market value of a common share.
Performance-Based Awards. Our board of directors may designate any award, the exercisability or settlement of which is subject to the achievement of performance conditions, as a performance-based award. In order to qualify as performance-based compensation, the performance objective(s) used for the performance-based award must be from the list of performance objectives set forth in the Amended and Restated Equity Plan. The performance objectives set forth in the Amended and Restated Equity Plan are: interest income and expense; net earnings or net income; net interest margin; efficiency ratio; reduction in non-accrual loans and non-interest expense; growth in non-interest income and ratios to earnings assets; net revenue growth and ratio to earning assets; capital ratios; asset or liability interest rate sensitivity and gap; effective tax rate; deposit growth and composition; liquidity management; securities portfolio (value, yield, spread, maturity, or duration); asset growth and composition (loans, securities); non-interest income (e.g., fees, premiums and commissions, loans, wealth management, treasury management, insurance, funds management) and expense; overhead ratios, productivity ratios; credit quality measures; return on assets; return on equity; economic value of equity; compliance and CAMELS or other regulatory ratings; internal controls; enterprise risk measures (e.g., interest rate, loan concentrations, portfolio composition, credit quality, operational measures, compliance ratings, balance sheet, liquidity, insurance); volume in production or loans; non-performing asset or non-performing loan levels or ratios or loan delinquency levels; provision for loan losses or net charge-offs; cash flow; cost; revenues; sales; ratio of debt to debt plus equity; net borrowing, credit quality or debt ratings; profit before tax; economic profit; earnings before interest and taxes; earnings before interest, taxes, depreciation and amortization; gross margin; profit margin; earnings per share; operating earnings; capital expenditures; expenses or expense levels; economic value added; ratio of operating earnings to capital spending or any other operating ratios; free cash flow; net profit; net sales; net asset value per share; the accomplishment of mergers, acquisitions, dispositions, public offerings or similar extraordinary business transactions; sales growth; price of the Company’s stock; return on investment; equity or shareholders’ equity; market share; inventory levels, inventory turn or shrinkage; customer satisfaction; or total shareholder return. Our board of directors may select any number of performance objectives from this list of performance objectives when establishing the performance measures of a performance-based award, but such objectives must be set no later than 90 days after the beginning of the applicable performance period. The Amended and Restated Equity Plan allows performance objectives to be described in terms of objectives that are related to an individual participant or objectives that are company-wide or related to a subsidiary, division, department, region, function or business unit and may be measured on an absolute or cumulative basis or on the basis of percentage of improvement over time, and may be measured in terms of company performance (or performance of the applicable subsidiary, division, department, region, function or business unit) or measured relative to selected peer companies or a market index.
Acceleration of Awards; Possible Early Termination of Awards. Upon a change in control of our Company, outstanding awards under the Amended and Restated Equity Plan will be assumed or substituted on the same terms. However, if the successor corporation does not assume or substitute the outstanding awards, then vesting of these awards will fully accelerate, and in the case of options or SARs, will become immediately exercisable. For this purpose, a change in control is defined to include certain changes in the majority of our board of directors, the sale of all or substantially all of our Company’s assets, and the consummation of certain mergers or consolidations.
Transfer Restrictions. Subject to certain exceptions, awards under the Amended and Restated Equity Plan are not transferable by the recipient other than by will or the laws of descent and distribution and are generally exercisable, during the recipient’s lifetime, only by him or her.
Termination of or Changes to the Amended and Restated Equity Plan. Our board of directors may amend or terminate the Amended and Restated Equity Plan at any time and in any manner. Unless required by applicable law or listing agency rule, stockholder approval for any amendment will not be required. Unless previously terminated by our board of directors, the Amended and Restated Equity Plan will terminate on March 27, 2029. Generally speaking, outstanding awards may be amended, subject, however, to the consent of the holder if the amendment materially and adversely affects the holder.
Federal Income Tax Treatment of Awards under the Amended and Restated Equity Plan
Federal income tax consequences (subject to change) relating to awards under the Amended and Restated Equity Plan are summarized in the following discussion. This summary is not intended to be exhaustive and, among other considerations, does not describe the deferred compensation provisions of Section 409A of the Code to the extent an award is subject to and does not satisfy those rules, nor does it describe state, local, or international tax consequences.
For NSOs, the Company is generally entitled to deduct (and the optionee recognizes taxable income in) an amount equal to the difference between the option exercise price and the fair market value of the shares at the time of exercise. For ISOs, our Company is generally not entitled to a deduction nor does the participant recognize income at the time of exercise. The current federal income tax consequences of other awards authorized under the Amended and Restated Equity Plan generally follow certain basic patterns: SARs are taxed and deductible in substantially the same manner as NSOs; nontransferable restricted stock subject to a substantial risk of forfeiture results in income recognition equal to the excess of the fair market value over the price paid (if any) only at the time the restrictions lapse (unless the recipient elects to accelerate recognition as of the date of grant); bonuses and performance share awards are generally subject to tax at the time of payment; cash-based awards are generally subject to tax at the time of payment; and compensation otherwise effectively deferred is taxed when paid. Our Company will generally have a corresponding deduction at the time the participant recognizes income. However, as for those awards subject to ISO treatment, our Company would generally have no corresponding compensation deduction.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth our outstanding equity awards as of December 31, 2022:
Option Awards
Stock Awards
Name
Number of
			Securities
			Underlying
			Unexercised
			Options
			Exercisable
			(#)
Number of
			Securities
			Underlying
			Unexercised
			Options
			Unexercisable
			(#)
Option
			Exercise
			Price
Option
			Expiration
			Date
Number of
			Shares or
			Units of Stock
			That Have
			Not Vested
			(#)
Market
			Value of
			Shares or
			Units of Stock
			That Have
			Not Vested
			($)
A. Haag Sherman
-
-
$ -
-
-
-
Patrick Howard
50,000 (1)(2)
-
$ 5.70 (2)
05/15/2027
60,000 (5)
$ 1,015,200
50,000 (1)(3)
-
5.70 (3)
05/15/2027
-
-
Ken Bramlage
10,000 (4)
-
$ 4.30 (4)
05/15/2027
25,000 (6)
$ 423,000
(1)
25,000 stock options vested on May 15, 2020, and 25,000 stock options vested May 15, 2021.
(2)
Represents 3-Year Tectonic Holding Options to purchase 25,000 shares of the Company’s common stock at an exercise price of $5.70 and 3- Year Tectonic Financial Options to purchase 25,000 shares of the Company’s common stock at an exercise price of $5.70.
(3)
Represents 3-Year Tectonic Holding Options to purchase 25,000 shares of the Company’s common stock at an exercise price of $5.70 and 3-Year Tectonic Financial Options to purchase 25,000 shares of the Company’s common stock at an exercise price of $5.70.
(4)
Prior to the 1-for-2 reverse stock split of the Company’s common stock, Mr. Bramlage held options to purchase 20,000 shares of the Company’s common stock at an exercise price of $2.15. As a result of the reverse stock split, such options became exercisable for 10,000 shares of the Company’s common stock at an exercise price of $4.30.
(5)
30,000 of these stock awards vest on December 31, 2023 and 30,000 vest on December 31, 2024.
(6)
12,500 of these stock awards vest on December 31, 2023 and 12,500 vest on December 31, 2024.
Potential Payments Upon a Termination of Employment or a Change in Control
Below we have described the severance and other change in control benefits to which Mr. Sherman, Mr. Howard and Mr. Bramlage would be entitled upon a termination of employment and in connection with certain terminations of their employment or a change in control.
Severance. If we terminate Mr. Sherman’s employment for any reason other than for “cause” (as defined in each respective employment agreement), or the executive terminates his employment for “good reason” (as defined in each respective employment agreement), the executive shall be entitled to (A) receive base salary through the date of such termination, (B) pay in lieu of any unused vacation in accordance with our normal practice, (C) any health benefits to which the executive is receiving immediately prior to such termination at the same expense as other employees for such selected employee benefit plans and programs for a period of 24 months (unless otherwise covered by another plan), and (D) a severance payment to be paid in 24 equal monthly installments, which equals an amount of cash equal to two times the sum of (x) the executive’s base salary at the time of termination, (y) the average annual bonus (excluding change of control payments) paid to the executive with respect to each of the three prior fiscal years, plus (z) a pro-rated annual bonus for the year in which the executive’s employment terminates. All of the amounts and benefits described above are conditioned upon the executive executing a general release and waiver of claims in a form provided by us at the time of termination.
If we terminate Mr. Howard’s employment for any reason other than for “cause,” or the executive terminates his employment for “good reason,” the executive shall be entitled to (A) receive base salary through the date of such termination, (B) pay in lieu of any unused vacation in accordance with our normal practice, (C) any health benefits to which the executive is receiving immediately prior to such termination at the same expense as other employees for such selected employee benefit plans and programs for a period of 24 months (unless otherwise covered by another plan), and (D) a severance payment to be paid in 24 equal monthly installments, which equals an amount of cash equal to two times the sum of (x) the executive’s base salary at the time of termination, (y) the average annual bonus (excluding change of control payments) paid to the executive with respect to each of the three prior fiscal years, plus (z) a pro-rated annual bonus for the year in which the executive’s employment terminates. All of the amounts and benefits described above are conditioned upon the executive executing a general release and waiver of claims in a form provided by us at the time of termination.
If we terminate Mr. Bramlage’s employment for any reason other than for “cause,” or the executive terminates his employment for “good reason,” the executive shall be entitled to (A) receive base salary through the date of such termination, (B) pay in lieu of any unused vacation in accordance with our normal practice, (C) any health benefits to which the executive is receiving immediately prior to such termination at the same expense as other employees for such selected employee benefit plans and programs for a period of 12 months (unless otherwise covered by another plan), and (D) a severance payment to be paid in 12 equal monthly installments, which equals an amount of cash equal to the sum of (x) the executive’s base salary at the time of termination, (y) the average annual bonus (excluding change of control payments) paid to the executive with respect to each of the three prior fiscal years, plus (z) a pro-rated annual bonus for the year in which the executive’s employment terminates. All of the amounts and benefits described above are conditioned upon the executive executing a general release and waiver of claims in a form provided by us at the time of termination.
Change in Control. Subject to the terms of the respective employment agreements, in the event of a change in control (as defined in the respective employment agreement of Messrs. Howard and Bramlage), Mr. Howard will be eligible to receive a cash lump sum payment equal to 2.99 times his base amount (as defined in Section 280G(b)(3) of the Code) payable by us within 30 days upon a change in control or under such other terms as may be mutually agreed, and Mr. Bramlage will be eligible to receive a cash lump sum payment equal to 1.0 times his base amount payable by us within 30 days upon a change in control or under such other terms as may be mutually agreed. In the event that the executive is also entitled to any of the severance payments and benefits discussed above, any change in control will be offset by such amount.
Director Compensation
The following table shows compensation paid to members of our board of directors and the board of directors of T Bancshares and the Bank during 2022. The Company’s non-employee directors received a fee of $3,750 per meeting paid in cash. For the joint board meetings held by T Bancshares and the Bank, non-employee directors received a fee of $1,000 per meeting paid in cash, as well as the following committee meeting fees: $250 per audit committee meeting, $250 per ALCO committee meeting, $250 per technology committee meeting, $250 per trust committee meeting, $125 per loan committee meeting, $125 per executive committee meeting and $125 per compensation committee meeting, all paid in cash.
Fees Earned or
			Paid in Cash
Stock/Option
			Awards(1)
Total
George L. Ball
$ -
$ -
$ -
Barb Bomersbach
15,000
15,000
Darrell W. Cain
-
-
-
Steven B. Clapp
11,750 (2)
11,750
Patrick Howard
-
-
-
Eric Langford
29,125 (3)
-
29,125 (3)
Thomas McDougal
27,500 (4)
-
27,500 (4)
Thomas R. Sanders
14,000 (5)
-
14,000 (5)
A. Haag Sherman
-
-
-
Daniel C. Wicker
14,375 (6)
-
14,375 (6)
(1)
No stock/option awards were made to the directors during 2022.
(2)
Represents fees paid in cash for serving on the boards of directors of T Bancshares and the Bank.
(3)
Includes $14,125 in fees paid in cash for serving on the boards of directors of T Bancshares and the Bank.
(4)
Includes $12,500 in fees paid in cash for serving on the boards of directors of T Bancshares and the Bank.
(5)
Represents fees paid in cash for serving on the boards of directors of T Bancshares and the Bank.
(6)
Represents fees paid in cash for serving on the boards of directors of T Bancshares and the Bank.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
The following table provides information regarding the beneficial ownership of our capital stock as of March 29, 2023 for:
●
each of our directors;
●
each of our named executive officers;
●
all of our directors and executive officers as a group; and
●
each shareholder who beneficially owns more than 5% of our common stock.
We have determined beneficial ownership in accordance with the rules of the SEC. These rules generally provide that a person is the beneficial owner of securities if such person has or shares the power to vote or direct the voting of securities, or to dispose or direct the disposition of securities, or has the right to acquire such powers within 60 days. Except as disclosed in the footnotes to this table and subject to applicable community property laws, we believe that each person identified in the table has sole voting and investment power over all of the shares shown opposite such person’s name. Other than the directors and executive officers and entities affiliated with such directors and executive officers set forth in the table below, no person is known to us to be the beneficial owner of more than 5% of our outstanding common stock.
The percentage of beneficial ownership is based on (x) 7,178,884 shares of our common stock outstanding as of March 29, 2023, which includes options covering an aggregate of 110,000 shares held by Messrs. Howard and Bramlage, which are vested; and (y) 1,725,000 shares of Series B preferred stock outstanding as of March 29, 2023.
Except as indicated below, the address for each shareholder listed in the table below is: 16200 Dallas Parkway, Suite 190, Dallas, Texas 75248.
Common Stock
			Beneficially Owned
Series B Preferred Stock
			Beneficially Owned
Name of Beneficial Owner
Number
Percentage
Number
Percentage
Directors and Named Executive Officers
George L. Ball
208,457
2.90
%
*
Barb Bomersbach
-
*
2,500
*
Darrell W. Cain(1)
215,100
3.00
%
2,000
-
Steven B. “Brad” Clapp(1),(2)
215,100
3.00
%
-
-
Patrick Howard
100,250
(3),(4)
1.40
%
7,500
*
Eric Langford
(4)
*
-
-
Thomas McDougal
(4)
*
29,967
1.74
%
Thomas R. Sanders
215,100
3.00
%
-
-
A. Haag Sherman(5)
2,121,000
29.54
%
5,000
*
Daniel C. Wicker
215,100
3.00
%
5,000
*
Ken Bramlage
10,000
(6)
*
-
-
Directors and Executive Officers as a Group (11 Persons)
3,300,607
45.98
%
52,467
3.04
%
*
Represents beneficial ownership of less than 1%.
(1)
All shares of our common stock are pledged to a third party bank under the terms of a loan agreement, which loan is current.
(2)
Includes 5,000 shares held in an IRA for the benefit of Mr. Clapp’s spouse.
(3)
Includes options covering 100,000 shares of our common stock, 50,000 of which vested on May 15, 2020 and 50,000 of which vested on May 15, 2021.
(4)
250 of these shares are subject to a repurchase right by the Company upon (i) the retirement of such individual as a director of the Bank, (ii) notice by either party of its desire to sell or repurchase the shares, as the case may be, or (iii) the filing of a bankruptcy petition affecting the director.
(5)
Includes 1,739,000 shares held by The Sherman 2018 Irrevocable Trust for which Mr. Sherman serves as trustee and 370,000 shares held by Sherman Tectonic FLP LP for which Mr. Sherman serves as the Chief Executive Officer of the general partner. Mr. Sherman has granted an option to certain other employees of Cain Watters to purchase from him or one of his affiliates up to 25,000 shares of our common stock at an exercise price of $2.15.
(6)
Includes options covering 10,000 shares of our common stock, which vested on May 15, 2021.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13.
Certain Relationships and Related Transactions and Director Independence.
Controlled Company
We are a “controlled company” within the meaning of the NASDAQ corporate governance standards. As a result, although the members of our Audit Committee are required to be independent, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function under the NASDAQ rules. We intend to avail ourselves of the controlled company exemptions while we remain a controlled company.
Director Independence
Our Series B preferred stock is listed on the NASDAQ Global Market and, consequently, we are required to comply with the rules of the NASDAQ Stock Market with respect to the independence of directors who serve on our board of directors and its committees. Under the rules of NASDAQ, a majority of the members of the board of directors must be “independent directors” by the one-year anniversary of the time we cease to be a controlled company. The rules of NASDAQ, as well as those of the SEC, impose several other requirements with respect to the independence of our directors. Applying these standards, our board of directors has determined that each of Eric Langford, Thomas McDougal and Barb Bomersbach is an “independent director” as that term is defined in Rule 5605(a)(2) of the NASDAQ rules. The board of directors has also determined that the members of the Audit Committee are independent under the heightened standards of independence required by Section 5605(c)(2)(A) of the NASDAQ rules. In making these determinations, the board of directors considered the banking relationships with directors and their related interests which we enter into in the ordinary course of our business, the arrangements which are disclosed below in this Item 13 and the compensation arrangements described in Item 12 of this Form 10-K.
Certain Relationships and Related Party Transactions
Policies and Procedures Regarding Related Person Transactions
Transactions by us or the Bank with related persons are subject to regulatory requirements and restrictions. These requirements and restrictions include the Affiliates Act and the Federal Reserve’s Regulation W (which governs certain transactions by the Bank with its affiliates) and the Federal Reserve’s Regulation O (which governs certain loans by the Bank to its executive officers, directors and principal shareholders). We have adopted policies to comply with these regulatory requirements and restrictions.
In addition, our board of directors has adopted a written policy governing the approval of related person transactions that complies with all applicable requirements of the SEC and NASDAQ concerning related person transactions. Related person transactions are transactions in which we are a participant, the amount involved exceeds $120,000 and a related person has or will have a direct or indirect material interest. Related persons of the Company include directors (including nominees for election as directors), executive officers, beneficial holders of more than 5% of our capital stock and the immediate family members of these persons. Our executive management team, in consultation with outside counsel, as appropriate, will review potential related person transactions to determine if they are subject to the policy. In determining whether to approve a related person transaction, that committee will consider, among other factors, the fairness of the proposed transaction, the direct or indirect nature of the related person’s interest in the transaction, the appearance of an improper conflict of interest for any director or executive officer taking into account the size of the transaction and the financial position of the related person, whether the transaction would impair an outside director’s independence, the acceptability of the transaction to our regulators and the potential violations of other corporate policies.
In addition to the compensation arrangements with directors and executive officers described in “Executive Compensation” above, the following is a description of each transaction since January 1, 2022, and each proposed transaction in which:
●
we have been or are to be a participant;
●
the amount involved exceeds or will exceed $120,000; and
●
any of our directors, executive officers or beneficial holders of more than five percent of our capital stock, or any immediate family member, of or person sharing the household with, any of these individuals (other than tenants or employees), had or will have a direct or indirect material interest.
Other Transactions
The Company. The following are related party agreements and transactions to which the Company and/or any of its subsidiaries are a party and which are discussed in the next section.
Cain Watters Services Agreement. Darrell W. Cain, the founder of Cain Watters, was a co-founder of T Bancshares, the predecessor, and served on the board of directors of T Bancshares when it was founded in 2003. At his request, the Bank established the trust department to serve clients of Cain Watters, which was accomplished in 2006. Since that time, the Bank has served as a fiduciary and custodian on behalf of clients referred by Cain Watters and, given the importance of this strategic relationship for both parties, partners of Cain Watters currently occupy four board seats of the Company and own approximately 31.20% of the issued and outstanding common stock of the Company. Notwithstanding the foregoing, the Company and Cain Watters have sought to have their relationship, as it relates to the trust services provided by the Bank, to be defined by an agreement. The Cain Watters - T Bank Agreement (the “Cain Watters Services Agreement”) was entered into as of August 23, 2012 by and between the Bank and Cain Watters. Under this agreement, each party agrees to preserve one another’s business relationships with their respective clients, including mutual clients, and agrees not to solicit or otherwise encourage clients to change service providers with respect to the services provided to such clients by one another. This provision includes Cain Watters’ best efforts to preserve the Bank’s business relationships with clients of Cain Watters with respect to the Bank CIFs. This agreement provided for automatic one-year renewals, and was amended effective January 31, 2023 such that the termination clause coincides with the Support Services Agreement (see below). The Cain Watters Service Agreement can be terminated earlier, among other events, upon the termination of the Tectonic Advisors Agreement, which can be terminated upon (among other things) a change of control of the Bank. No fee is payable under this agreement.
As Successor in Interest to Tectonic Holdings. The following are related party agreements and transactions to which Tectonic Holdings and/or each of its subsidiaries (Tectonic Advisors, Sanders Morris, HWG and/or Miller-Green) were a party and which are not previously described in the preceding section.
Due Diligence Agreement. On February 15, 2006, III:I Financial Management Research, L.P. (since renamed Tectonic Advisors) and Cain Watters entered into an agreement pursuant to which Tectonic Advisors would provide the following services to Cain Watters: (a) research on investments and securities, (b) asset selection and allocation analysis, (c) due diligence on asset management companies and managers, (d) research on long and short-term prospects for investments in all markets and in all forms, (e) capital market analysis, (f) research on anticipated national and global economic issues and outlooks, (g) research on the economic environment, investments and securities of other countries, (h) assistance in coordination, implementation, and management of investment solutions, (i) performance of a defined list of investment related “global services,” specifically for pension clients of Cain Watters and (j) certain other services. In addition, Tectonic Advisors provides certain reporting and other information. The fees paid under this agreement are set forth in the Support Services Agreement described below. The term of this agreement is through January 14, 2026, with automatic one-year renewals unless terminated by either party.
Support Services Agreement. The Support Services Agreement, dated February 5, 2015 (the “Support Services Agreement”), was entered into by and between Tectonic Advisors and Cain Watters. Pursuant to the Support Services Agreement, Tectonic Advisors provides certain financial advisory and research services to CWA, including: asset management services, investment management oversight and management and trading of model portfolios and shall be paid a fee from revenues (“CWA Revenues”) generated from all CWA assets under management (“CWA Asset Base”). The CWA Revenue split shall be as follows: (i) Tectonic Advisors shall be entitled to receive an asset based fee of 35 basis points on the CWA Asset Base and (ii) CWA shall be entitled to receive the remainder; provided, however, that 25 basis points on the CWA Asset Base above $2.5 billion shall be taken ratably from Tectonic Advisors and CWA and shall be allocated to CWA, consistent with past practices. During the year ended December 31, 2022, Tectonic Advisors earned $291,000 under the Support Services Agreement. These fees are included in investment advisory and other related services in the accompanying consolidated statements of operations. Tectonic Advisors had $21,000 in fees receivable related to these services at December 31, 2022.
Fee Allocation Agreement. In January 2006, Tectonic Advisors entered into an agreement with Cain Watters with reference to its advisory agreement with the Bank. Tectonic Advisors had $225,000 payable to Cain Watters related to this agreement at December 31, 2021, which is included in the accounts payable, related parties line items in the consolidated balance sheet. This agreement was amended effective January 31, 2023 such that the termination clause coincides with the Support Services Agreement (see below).
Other Related Transactions. Other miscellaneous related party transactions resulted in other amounts due from related parties of less than $1,000, included within accounts receivable, related parties on the consolidated balance sheet as of December 31, 2022.
Ordinary Banking Relationships
Certain of our officers, directors and principal shareholders, as well as their immediate family members and affiliates, are customers of, or have or have had transactions with us or the Bank in the ordinary course of business. These transactions include deposits, loans, wealth management products and other financial services related transactions. Related party transactions are made in the ordinary course of business, on substantially the same terms, including interest rates and collateral (where applicable), as those prevailing at the time for comparable transactions with persons not related to us, and do not involve more than normal risk of collectability or present other features unfavorable to us. Any loans we originate with officers, directors and principal shareholders, as well as their immediate family members and affiliates, are approved by our board of directors in accordance with the Bank’s regulatory requirements.
As of the date of this Form 10-K, no related party loans were categorized as nonaccrual, past due, restructured or potential problem loans. We expect to continue to enter into transactions in the ordinary course of business on similar terms with our officers, directors and principal shareholders, as well as their immediate family members and affiliates.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14.
Principal Accountant Fees and Services.
Audit Committee Pre-Approval
The Audit Committee’s charter authorizes the Audit Committee to approve, in advance, all auditing services and non-audit services that are otherwise permitted by law that are provided to the Company by its independent auditors. In addition, the Audit Committee has the authority to review and, in its sole discretion, approve in advance the Company’s independent auditors’ annual engagement letter, including the proposed fees contained therein.
Fees Billed by Independent Registered Public Accounting Firm
The Audit Committee has reviewed the following audit and non-audit fees billed to the Company by Whitley Penn LLP for 2022 and 2021 for purposes of considering whether such fees are compatible with maintaining the auditor’s independence, and concluded that such fees did not impair Whitley Penn LLP’s independence. The policy of the Audit Committee is to pre-approve all audit and non-audit services performed by Whitley Penn LLP before the services are performed, including all of the services described under “Audit Fees” and “Tax Fees” and “All Other Fees” below. The Audit Committee has pre-approved all of the services provided by Whitley Penn LLP in accordance with the policies and procedures described in the section titled “-Audit Committee Pre-Approval.”
For the Year Ended
December 31,
Audit Fees(1)
$ 223,647
$ 171,234
Tax Fees(2)
55,020
50,800
All Other Fees(3)
23,400
21,000
Total Fees
$ 302,067
$ 243,034
(1)
Audit fees consist of the aggregate fees billed for professional services rendered for the audit of our annual financial statements included in our Annual Report on Form 10-K and a review of financial statements included in our Quarterly Reports on Form 10-Q.
(2)
Tax compliance fees consisted of tax return filing fees and miscellaneous state and federal income tax related issues. Tax consulting services include routine tax advice and consultation.
(3)
Other fees are those associated with services not captured in the other categories, such as operational reviews.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15.
Exhibits and Financial Statement Schedules.
Exhibit
No.
Description of Exhibit
2.1
Amended and Restated Agreement and Plan of Merger by and between T Acquisition, Inc. and Tectonic Holdings, LLC, dated March 28, 2019 (schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K; however, the registrant hereby agrees to furnish a copy of any omitted schedule or similar attachment to the SEC upon request)(incorporated by reference from Exhibit 2.1 to the Registration Statement on Form S-1 filed with the SEC on April 18, 2019 (File No. 333-230949))
2.2
Purchase and Sale Agreement by and between Tectonic Holdings, LLC and Summer Wealth Management, LLC, dated August 3, 2016, as amended (schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K; however, the registrant hereby agrees to furnish a copy of any omitted schedule or similar attachment to the SEC upon request)(incorporated by reference from Exhibit 2.2 to the Amendment No. 1 to the Registration Statement on Form S-1/A filed with the SEC on May 6, 2019 (File No. 230949))
2.3
Agreement and Plan of Merger by and among Tectonic Financial, Inc., T Bancshares, Inc. and Integra Funding Solutions, LLC, and joined in by The Bolt Family Irrevocable Trust, IF Holdings, LLC, Doug Waidelich, The Crane Basin Irrevocable Trust, The Hamilton Irrevocable Trust, Tracy A. Bolt, and Randall W. Woods, dated June 18, 2021 (schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K; however, the registrant hereby agrees to furnish a copy of any omitted schedule or similar attachment to the SEC upon request.) (incorporated by reference from Exhibit 2.1 to the Current Report on Form 8-K filed with the SEC on June 24, 2021 (File No. 001-38910))
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))
4.1
Specimen common stock certificate of Tectonic Financial, Inc. (incorporated by reference from Exhibit 4.1 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))
4.2
Subordinated Note Purchase Agreement for 7.125% Fixed-to-Floating Subordinated Notes due 2027, dated July 17, 2017 (incorporated by reference from Exhibit 4.2 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))
4.3
Description of Series B Preferred Stock (incorporated by reference from Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on March 31, 2020 (File No. 001-38910))
10.1†
Employment Agreement of A. Haag Sherman, dated May 1, 2019 (incorporated by reference from Exhibit 10.1 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))
10.2†
Amended and Restated Employment Agreement of Patrick Howard, dated May 1, 2019 (incorporated by reference from Exhibit 10.2 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))
10.3†
Amended and Restated Employment Agreement of Ken Bramlage, dated May 1, 2019 (incorporated by reference from Exhibit 10.4 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))
10.4†
T Acquisition, Inc. Amended and Restated 2017 Equity Incentive Plan (incorporated by reference from Exhibit 10.4 to the Registration Statement on Form S-1 filed with the SEC on April 18, 2019 (File No. 333-230949))
10.5†
Form Notice of Stock Option Award and of Stock Option Award Agreement under T Acquisition, Inc. 2017 Equity Incentive Plan (incorporated by reference from Exhibit 10.5 to the Registration Statement on Form S-1 filed with the SEC on April 18, 2019 (File No. 333-230949))
10.6
Advances and Security Agreement by and between the Federal Home Loan Bank of Dallas and T Bank, N.A., dated June 29, 2006 (incorporated by reference from Exhibit 10.6 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))
10.7
Fee Allocation Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC (f/k/a III: I Financial Management Research, L.P.), dated July 17, 2008 (incorporated by reference from Exhibit 10.7 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))
10.7.1
First Amendment to the Fee Allocation Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC (f/k/a III: I Financial Management Research, L.P.), effective January 31, 2023
10.8
Due Diligence Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC (f/k/a III:I Financial Management Research, L.P.), dated February 15, 2006 (incorporated by reference from Exhibit 10.8 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))
10.8.1
Supplement to Due Diligence Agreement by and between Cain, Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC (f/k/a III:I Financial Management Research, L.P.), dated November 5, 2007 (incorporated by reference from Exhibit 10.8.1 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))
10.8.2
First Amendment to the Due Diligence Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC (f/k/a III:I Financial Management Research, L.P.), effective January 31, 2023
10.9
Investment Advisory Agreement by and between T Bank, N.A. and III:I Financial Management Research, L.P., dated August 23, 2012 (incorporated by reference from Exhibit 10.9 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))
10.10
Agreement by and between T Bank, N.A. and Cain Watters & Associates, P.L.L.C., dated August 23, 2012 (incorporated by reference from Exhibit 10.10 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))
10.10.1
Second Amendment to the Agreement by and between T Bank, N.A. and Cain Watters & Associates, P.L.L.C., effective January 31, 2023
10.11
Unit Option - Buy Down Agreement by and between A. Haag Sherman and the optionees named therein, dated February 5, 2015 (incorporated by reference from Exhibit 10.11 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))
10.12
Management Services Agreement by and between Tectonic Advisors, LLC and Tectonic Services, LLC, dated February 5, 2015 (incorporated by reference from Exhibit 10.12 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))
10.13
Amended and Restated Promissory Note payable to TIB The Independent BankersBank, N. A., dated May 11, 2017 (incorporated by reference from Exhibit 10.13 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))
10.14
Loan Agreement by and among Tectonic Merger Sub, Inc., T Bancshares, Inc. and TIB The Independent Bankers Bank, N.A., dated May 11, 2017 (incorporated by reference from Exhibit 10.14 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))
10.15
Guaranty Agreement by and between Sanders Morris Harris LLC and TIB The Independent BankersBank, N.A., dated May 11, 2017 (incorporated by reference from Exhibit 10.15 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))
10.16
Guaranty Agreement by and between Tectonic Advisors, LLC and TIB The Independent BankersBank, N.A., dated May 11, 2017 (incorporated by reference from Exhibit 10.16 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))
10.17
Guaranty Agreement by and between Tectonic Holdings, LLC and TIB The Independent BankersBank, N.A., dated May 11, 2017 (incorporated by reference from Exhibit 10.17 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))
10.18
Renewal, Extension, and Modification of Loan by and among Tectonic Merger Sub, Inc., T Bancshares, Inc. and TIB The Independent BankersBank, N.A., dated May 11, 2018 (incorporated by reference from Exhibit 10.18 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))
10.19
Management Services Agreement by and between Tectonic Holdings, LLC and Tectonic Services, LLC, dated February 5, 2015 (incorporated by reference from Exhibit 10.19 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))
10.19.1
Amendment to Management Services Agreement by and between Tectonic Advisors, LLC, Sanders Morris Harris LLC, Miller-Green Financial Services, LLC, HWG Insurance Agency, LLC and Tectonic Services, LLC, dated March 1, 2017 (incorporated by reference from Exhibit 10.19.1 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))
10.19.2
Second Amendment to Management Services Agreement by and between Tectonic Services, LLC, Tectonic Advisors, LLC, Sanders Morris Harris LLC, Miller-Green Financial Services LLC and HWG Insurance Agency LLC, dated October 1, 2017 (incorporated by reference from Exhibit 10.19.2 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))
10.20
Support Services Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC, dated February 5, 2015 (schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Tectonic Financial agrees to furnish supplementally to the SEC a copy of any omitted schedule upon request) (incorporated by reference from Exhibit 10.20 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))
10.20.1
First Amendment to the Support Services Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Advisors, LLC (f/k/a III: I Financial Management Research, L.P.), effective January 31, 2023
10.21
Insurance Contribution Agreement by and between Cain Watters & Associates, P.L.L.C. and Tectonic Holdings, LLC, dated February 5, 2015 (incorporated by reference from Exhibit 10.21 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))
10.22
Amended and Restated Investment Advisory Agreement by and between T Bank, N.A. and Tectonic Advisors, LLC, dated May 14, 2015 (incorporated by reference from Exhibit 10.22 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))
10.22.1
Third Amendment to the Amended and Restated Investment Advisory Agreement by and between T Bank, N.A. and Tectonic Advisors, LLC (f/k/a III: I Financial Management Research, L.P.), effective January 31, 2023
10.23
Loan Agreement by and between Dental Community Financial Holdings, Ltd., and Tectonic Advisors, LLC, dated January 1, 2017 (incorporated by reference from Exhibit 10.23 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))
10.23.1
Promissory Note made payable to Dental Community Financial Holdings, Ltd. by Tectonic Advisors, LLC, dated January 1, 2017 (incorporated by reference from Exhibit 10.23.1 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))
10.24
Tax Sharing Agreement by and between T Acquisition, Inc., T Bancshares, Inc. and T Bank N.A., dated May 15, 2017 (incorporated by reference from Exhibit 10.24 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))
10.25
Tax Sharing Agreement by and between T Acquisition, Inc. and Tectonic Holdings, LLC, effective May 15, 2017 (incorporated by reference from Exhibit 10.25 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))
10.26
Expense Sharing Agreement by and between T Bank N.A. and Tectonic Holdings, LLC, effective May 15, 2017 (incorporated by reference from Exhibit 10.26 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))
21.1
Subsidiaries of Tectonic Financial, Inc.*
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
Inline XBRL Instance Document*
101.SCH
Inline XBRL Taxonomy Extension Schema Document*
101.CAL
Inline XBRL Taxonomy Extension Label Calculation Linkbase Document*
101.DEF
Inline XBRL Taxonomy Definition Linkbase*
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document*
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase*
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
*
Filed herewith
**
Furnished herewith
†
Management contract or compensatory plan or arrangement