TECTONIC FINANCIAL, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto appearing in Item 1 of Part I of this Quarterly Report on Form 10-Q for the three and six months endedJune 30, 2022 (this "Form 10-Q"), as well as with our consolidated financial statements and notes thereto appearing in our Annual Report on Form 10-K for the year endedDecember 31, 2021 filed with theSecurities and Exchange Commission (the "SEC") onMarch 31, 2022 (the "2021 Form 10-K").
Cautionary Notice Regarding Forward-Looking Statements
Statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including our expectations, intentions, beliefs, or strategies regarding the future. These statements are often, but not always, made through the use of words or phrases such as "may," "should," "could," "predict," "potential," "believe," "will likely result," "expect," "anticipate," "seek," "estimate," "intend," "plan," "projection," "would" and "outlook," and similar expressions. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may differ materially from those in or implied by such forward-looking statements due to the factors discussed under the section entitled "Risk Factors," in our 2021 Form 10-K, including, but not limited to, the following:
? changes in interest rates, including the recent significant increases in
market interest rates experienced in the first half of 2022, which could
negatively impact bond market values and result in a lower net book value;
? our ability to successfully manage the current rising market interest rate
environment, our credit risk and the level of future non-performing assets and
charge-offs;
? risks associated with the uncertain inflationary outlook in
and our market areas and its impact on market interest rates, the economy and
credit quality;
? the potential for a recession in
the negative and adverse impact a recession would have on our earnings,
capital and financial position resulting from higher losses on the Bank's loan
and factored receivables portfolios; a decline in the equity and fixed income
markets that would reduce assets under management and capital markets
activity, thereby reducing the earnings at Sanders Morris and Tectonic
Advisors , as well as earnings on trust assets at the Bank;
? changes in
thereto;
? changes in the economy of the State of Texas , our primary market;
? risks associated with the ongoing COVID-19 global pandemic ("COVID-19"), or
any current or future variants of COVID-19, including, among others, business
disruption for our customers, customers' ability to fulfill their financial
obligations to the Company, our employees' ability to conduct banking and
other transactions, the response of governmental authorities to the COVID-19
pandemic, or any current or future variants thereof, and our participation in
COVID-19-related government programs such as the Paycheck Protection Program
(the "PPP") administered by the
created under the Coronavirus Aid, Relief, and Economic Security Act (the
"CARES Act");
? risks associated with implementing aspects of our expansion strategy, whether
through additional services and products or acquisitions;
? liquidity risks, including those related to having enough liquid assets to
meet depositor demands;
? the need to hold more capital in order to comply with consolidated capital
ratios;
? competition from other banks, financial institutions and wealth and investment
management firms and our ability to retain our clients;
? the adequacy of our allowance for loan losses;
? risks associated with generating deposits from retail sources without a branch
network so that we can fund our loan portfolio and growth;
? risks associated with higher cost deposits relative to our peer group, which
has an impact on our net interest margin and profits;
? risks associated with having one referral source,
LLC ("Cain Watters"), comprise a substantial part of our business;
? our reliance on key personnel and the ability to attract and retain the
personnel necessary to implement our business plan;
? risks specific to commercial loans and borrowers (particularly dental and SBA
loans);
? our ability to continue to originate loans (including SBA loans);
? impairment of our goodwill or other intangible assets;
? claims and litigation pertaining to our fiduciary responsibilities;
? generating investment returns for our wealth management, brokerage and other
customers that are satisfactory to them;
? our ability to maintain a strong core deposit base or other low-cost funding
sources;
? our ability to manage our credit risk;
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? regulatory scrutiny related to our loan portfolio, including commercial real
estate;
? the earning capacity of our borrowers;
? fluctuation in the value of our investment securities;
? our inability to identify and address potential conflicts of interest;
? our ability to maintain effective internal control over financial reporting;
? the accuracy of estimates and assumptions;
? the development of an active, liquid market for the Series B preferred stock;
? fluctuations in the market price of the Series B preferred stock;
? our ability to raise additional capital, particularly during times of stress;
? the soundness of other counterparty financial institutions and certain
securities brokerage firms;
? technological change in the banking, investment, brokerage and insurance
industry;
? our ability to protect against and manage fraudulent activity, breaches of our
information security, and cybersecurity attacks;
? our reliance on communications, information, operating and financial control
systems technology and related services from third-party service providers;
? natural disasters and epidemics and pandemics, such as COVID-19, or any
current or future variants thereof;
? the effects of terrorism and acts of war or threat thereof, including the
current conflict in Ukraine , and efforts by the U.S. to combat it;
? environmental liabilities;
? regulation of the financial services industry;
? legislative changes or the adoption of tax reform policies;
? political instability and changes in tariffs and trade barriers;
? compliance with laws and regulations, supervisory actions, the Dodd-Frank Wall
Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), the Economic
Growth, Regulatory Relief and Consumer Protection Act ("EGRRCPA"), capital
requirements, the Bank Secrecy Act, anti-money laundering laws, consumer laws,
and other statutes and regulations;
? regulation of broker-dealers and investment advisors;
? the enactment of regulations relating to privacy, information security and
data protection;
? legal and regulatory examinations, proceedings, investigations and inquiries,
fines and sanctions;
? future issuances of preferred stock or debt securities and its impact on the
Series B preferred stock;
? our ability to manage our existing and future preferred stock and
indebtedness;
? our ability to pay dividends;
? the continuation of securities analysts coverage of the company;
? our management and board of directors have significant control over our
business;
? risks related to being a "controlled company" under NASDAQ rules;
? the costs and expenses of being a public company; and
? changes in the laws, rules, regulations, interpretations or policies relating
to financial institutions, accounting, tax, trade, monetary and fiscal
matters, including the policies of the
Reserve System ("Federal Reserve") and as a result of initiatives of the Biden
administration.
In addition, financial markets and global supply chains may be adversely
affected by the current or anticipated impact of military conflict, including
the current Russian invasion of
You should not place undue reliance on any such forward-looking statements. Any forward-looking statement reflects only information known to us as of the date on which it is made and we do not undertake any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events, except as required by law. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Other Available Information We file or furnish with theSEC 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 ourSEC filings are available to the public at theSEC'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, proxy statements 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, theSEC . 31
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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-Q.
General We are a financial holding company headquartered inDallas, Texas . We provide a wide array of financial products and services including banking, trust, investment advisory, securities brokerage, third party administration, qualified plan recordkeeping and insurance services to individuals, small businesses and institutions acrossthe United States . The following discussion and analysis presents our consolidated financial condition as ofJune 30, 2022 andDecember 31, 2021 , and our consolidated results of operations for the three and six months endedJune 30, 2022 and 2021. The discussion should be read in conjunction with our financial statements and the notes related thereto in this Form 10-Q and in the audited financial statements in our 2021 Form 10-K. We operate through four main direct and indirect subsidiaries: (i)T Bancshares, Inc. ("TBI"), which was incorporated under the laws of theState of Texas onDecember 23, 2002 to serve as the bank holding company forT Bank, N.A. a national banking association (the "Bank"), (ii)Sanders Morris Harris LLC ("Sanders Morris"), a registered broker-dealer with theFinancial Industry Regulatory Authority ("FINRA"), and registered investment advisor with theSEC , (iii)Tectonic Advisors, LLC ("Tectonic Advisors "), a registered investment advisor registered with theSEC focused generally on managing money for relatively large, affiliated institutions, and (iv)HWG Insurance Agency LLC ("HWG"), an insurance agency registered with theTexas Department of Insurance ("TDI").
Critical Accounting Policies and Estimates
We prepare consolidated financial statements based on accounting principles generally accepted inthe United States ("GAAP") and to customary practices within the financial services industry. These policies, in certain areas, require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates. We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain at the time we make the accounting estimate and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the financial statements. Accounting policies related to the allowance for loan losses are considered to be critical as these policies involve considerable subjective judgment and estimation by management. Management has adopted a methodology to properly analyze and determine an adequate loan loss allowance, which includes allowance allocations calculated in accordance withFinancial Accounting Standards Board ("FASB") Accounting Standards Codification ("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. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. Refer to the 2021 Form 10-K for additional information regarding critical accounting policies. 32
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Table of Contents Performance Summary Net income available to common shareholders increased$1.0 million , or 30.3%, to$4.4 million for the three months endedJune 30, 2022 , compared to$3.3 million for the three months endedJune 30, 2021 . Earnings per diluted common share were$0.59 and$0.50 for the three months endedJune 30, 2022 and 2021, respectively. Net income available to common shareholders increased$1.0 million , or 13.9%, to$8.3 million for the six months endedJune 30, 2022 , compared to$7.2 million for the six months endedJune 30, 2021 . Earnings per diluted common share were$1.13 and$1.09 for the six months endedJune 30, 2022 and 2021, respectively. The increases in net income available to common shareholders for the three and six months endedJune 30, 2022 resulted primarily from increases in net interest income and non-interest income, partly offset by an increase in noninterest expense. For the three months endedJune 30, 2022 , annual return on average assets was 3.32%, compared to 2.71% for the same period in the prior year, and annual return on average equity was 21.48%, compared to 20.91% for the same period in the prior year. For the six months endedJune 30, 2022 , annual return on average assets was 3.14%, compared to 3.04% for the same period in the prior year, and annual return on average equity was 23.37%, compared to 26.11% for the same period in the prior year. The higher annual return on average assets ratios for the three and six months endedJune 30, 2022 was due to an increase in income which outpaced the increase in average assets compared to the same period in the prior year. The lower annual return on average equity ratios for the three and six months endedJune 30, 2022 was due to the increase in equity which outpaced the increase in income compared to the same period in the prior year. The growth in average equity between the two periods is primarily related to shares of Company common stock issued for the Company's acquisition ofIntegra Funding Solutions, LLC , aTexas limited liability company ("Integra"), onJuly 1, 2021 . Our accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, this Form 10-Q contains financial information determined by methods other than in accordance with GAAP, which includes return on average tangible common equity. We calculate return on average tangible common equity as net income available to common shareholders (net income less dividends paid on preferred stock) divided by average tangible common equity. We calculate average tangible common equity as average shareholders' equity less average goodwill, average core deposit intangible and average preferred stock. 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.
The following table presents non-GAAP reconciliations of annual return on average tangible common equity:
As of and As of and
for the for the As of and As of and
Three Three for the for the
Months Months Six Months Six Months
Ended June Ended June Ended June Ended June
(Dollars in thousands) 30, 2022 30, 2021 30, 2022 30, 2021
Income available to common shareholders
(a) $ 4,353 $ 3,329 $ 8,250 $ 7,239
Average shareholders' equity $ 88,534 $ 63,806 $ 87,051 $ 61,904
Less: average goodwill 21,440 10,729 21,440 10,729
Less: average core deposit intangible 708 910 734 935
Less: average preferred stock 17,250 17,250 17,250 17,250
Average tangible common equity (b) $ 49,136 $ 34,917 $ 47,627 $ 32,990
Annual return on average tangible common
equity (a)/(b) 35.53 % 38.24 % 34.93 % 44.25 %
Total assets increased $3.8 million , or 0.7%, to $588.8 million as of June 30,
2022 , from $585.0 million as of December 31, 2021 . This increase was primarily
due to increases of $3.0 million in securities available for sale and $6.6
million in securities held to maturity, partly offset by decreases of $4.5
million in cash and cash equivalents and $1.8 million in loans held for sale.
Substantially all loans outside of those made under the PPP are secured by
specific collateral, including business assets, consumer assets, and commercial
real estate.
Shareholders' equity increased $6.0 million , or 7.1%, to $90.8 million as of
June 30, 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.
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Results of Operations for the Three and Six Months Ended
Details of the changes in the various components of net income are discussed below.
Net Interest Income Net interest income is the difference between interest income on interest-earning assets, such as loans, investment securities, and interest-bearing cash, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Changes in net interest income result from changes in volume and spread, and are reflected in the net interest margin, as well as changes in average interest rates. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. The following tables present the changes in net interest income and identifies the changes due to differences in the average volume of interest-earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.
Three Months Ended
Three Months Ended
June 30, 2022 vs June 30, 2021
Increase(Decrease) Due to Change in
Average
(In thousands) Rate Volume Total
Interest-bearing deposits and federal funds sold $ 114 $
(57 ) $ 57
Securities 33 177 210
Loans, net of unearned discount (1) 814 207 1,021
Total earning assets 961 327 1,288
Savings and interest-bearing demand - 2 2
Money market deposit accounts 78 28 106
Time deposits (88 ) 79 (9 )
FHLB and other borrowings 67 (138 ) (71 )
Total interest-bearing liabilities 57 (29 ) 28
Changes in net interest income $ 904 $ 356 $ 1,260
(1) Average loans include non-accrual.
Net interest income increased $1.3 million , or 24.5%, from $5.3 million for the
three months ended June 30, 2021 to $6.6 million for the three months ended June
30, 2022 . The increase in net interest income was primarily due to the increase
in the average yield on loans, and to a lesser extent an increase in the average
yield in the interest-bearing deposits (which are held at the Federal Reserve
Bank of Dallas (the "FRB")), and to an increase in the average volume of
securities and loans. Net interest margin for the three months ended June 30,
2022 and 2021 was 5.03% and 4.11%, respectively, an increase of 92 basis points.
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The average volume of interest-earning assets increased$6.1 million , or 1.2%, from$519.7 million for the three months endedJune 30, 2021 to$525.8 million for the three months endedJune 30, 2022 . The average volume of securities increased$18.6 million , or 73.8%, from$25.2 million for the three months endedJune 30, 2021 , to$43.8 million for the three months endedJune 30, 2022 , and the average volume of loans increased$13.3 million , or 3.0%, from$436.0 million for the three months endedJune 30, 2021 to$449.2 million for the three months endedJune 30, 2022 . The increases were partly offset by a decrease in the average volume of interest-bearing deposits of$25.7 million , or 44.0%, from$58.4 million for the three months endedJune 30, 2021 to$32.7 million for the three months endedJune 30, 2022 . The increase in the average volume of loans included increases of$69.8 million for organic loan growth and$34.5 million for factored receivables related to the Integra acquisition during the third quarter of 2021, partly offset by a$91.1 million decrease of PPP loans. The average yield on interest-earning assets increased 92 basis points from 4.80% for the three months endedJune 30, 2021 to 5.72% for the three months endedJune 30, 2022 . The average yield on interest earning assets was impacted by changes in market interest rates and changes in the mix of interest-earning assets. The average yield for loans increased 75 basis points from 5.51% for the three months endedJune 30, 2021 to 6.26% for the three months endedJune 30, 2022 . During the three months endedJune 30, 2022 , we recognized$1.9 million of interest income related to the factored receivables, with an average yield of 22.5%. During the three months endedJune 30, 2022 , we recognized$3,000 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$1.2 million from the same period in the prior year. As a result of the inclusion of these net fees in interest income, the average yield on PPP loans decreased to 1.2% for the three months endedJune 30, 2022 , from 6.1% for the same period in the prior year. The average yield on securities increased 52 basis points from 3.30% for the three months endedJune 30, 2021 , to 3.82% for the three months endedJune 30, 2022 , and the average yield on interest-bearing deposits increased 78 basis points from 0.11% for the three months endedJune 30, 2021 , to 0.89% for the three months endedJune 30, 2022 . The average volume of interest-bearing liabilities decreased$31.9 million , or 7.9%, from$405.9 million for the three months endedJune 30, 2021 , to$374.0 million for the three months endedJune 30, 2022 . The average volume of interest-bearing deposits increased$55.5 million , or 18.5%, from$299.5 million for the three months endedJune 30, 2021 , to$355.0 million for the three months endedJune 30, 2022 . The average interest rate paid on interest-bearing liabilities increased 10 basis points from 0.88% for the three months endedJune 30, 2021 , to 0.98% for the three months ended June, 2022. The average interest rate paid on interest-bearing deposits decreased just 1 basis point from 0.79% for the three months endedJune 30, 2021 , to 0.78% for the three months ended June, 2022. The average volume of non-interest bearing deposits increased$28.3 million , or 39.6%, from$71.5 million for the three months endedJune 30, 2021 to$99.8 million for the three months endedJune 30, 2022 . The average volume of FHLB and other borrowings decreased$87.5 million , or 92.6%, from$94.4 million for the three months endedJune 30, 2021 to$6.9 million for the three months endedJune 30, 2022 , consisting mostly of funding from the PPPLF, at an interest rate of 0.35%, used to fund the PPP loans. The average cost of FHLB and other borrowings increased 28 basis points from 0.35% for the three months endedJune 30, 2021 , to 0.63% for the three months endedJune 30, 2022 .
Six Months Ended
Six Months Ended
June 30, 2022 vs June 30, 2021
Increase (Decrease) Due to Change in
Average
(In thousands) Rate Volume Total
Interest-bearing deposits and federal funds sold $ 74 $ (1 ) $ 73
Securities 106 293 399
Loans, net of unearned discount (1) 1,629 421 2,050
Total earning assets 1,809 713 2,522
Savings and interest-bearing demand 2 3 5
Money market deposit accounts 72 57 129
Time deposits (200 ) 154 (46 )
FHLB and other borrowings 29 (148 ) (119 )
Total interest-bearing liabilities (97 ) 66 (31 )
Changes in net interest income $ 1,906 $ 647 $ 2,553
(1) Average loans include non-accrual.
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Net interest income increased$2.6 million , or 24.0%, from$10.7 million for the six months endedJune 30, 2021 to$13.2 million for the six months endedJune 30, 2022 . The increase in net interest income was primarily due to an increase in the average yield on loans and an increase in the average volume of loans, and to a lesser extent an increase in average volume of securities and a decrease in the average rate paid on time deposits. Net interest margin for the six months endedJune 30, 2022 and 2021 was 5.01% and 4.28%, respectively, an increase of 73 basis points. The average volume of interest-earning assets increased$29.1 million , or 5.8%, from$503.5 million for the six months endedJune 30, 2021 to$532.6 million for the six months endedJune 30, 2022 . The average volume of securities increased$16.3 million , or 63.7%, from$25.6 million for the six months endedJune 30, 2021 , to$41.9 million for the six months endedJune 30, 2022 , and the average volume of loans increased$13.4 million , or 3.1%, from$437.4 million for the six months endedJune 30, 2021 to$450.8 million for the six months endedJune 30, 2022 . The increase in the average volume of loans included increases of$66.2 million for organic loan growth and$35.8 million for factored receivables related to the Integra acquisition during the third quarter of 2021, partly offset by a$85.6 million decrease of PPP loans. The average yield on interest-earning assets increased 68 basis points from 5.02% for the six months endedJune 30, 2021 to 5.70% for the six months endedJune 30, 2022 . The average yield on interest earning assets was impacted by changes in market interest rates and changes in the mix of interest-earning assets. The average yield for loans increased 76 basis points from 5.60% for the six months endedJune 30, 2021 , to 6.36% for the six months endedJune 30, 2022 . During the six months endedJune 30, 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$2.7 million from the same period in the prior year. As a result of the inclusion of these net fees in interest income, the average yield on PPP loans decreased to 3.5% for the six months endedJune 30, 2022 , from 6.8% for the same period in the prior year. The average yield on securities increased 84 basis points from 2.78% for the six months endedJune 30, 2021 , to 3.62% for the six months endedJune 30, 2022 , and the average yield on interest-bearing deposits increased 37 basis points from 0.10% for the six months endedJune 30, 2021 , to 0.47% for the six months endedJune 30, 2022 . The average volume of interest-bearing liabilities decreased$14.2 million , or 3.6%, from$398.1 million for the six months endedJune 30, 2021 to$383.9 million for the six months endedJune 30, 2022 . The average volume of interest-bearing deposits increased$57.6 million , or 19.3%, from$297.8 million for the six months endedJune 30, 2021 , to$355.4 million for the six months endedJune 30, 2022 . The average interest rate paid on interest-bearing liabilities increased 2 basis points from 0.93% for the six months endedJune 30, 2021 , to 0.95% for the six months ended June, 2022. The average interest rate paid on interest-bearing deposits decreased 9 basis points from 0.85% for the six months endedJune 30, 2021 , to 0.76% for the six months endedJune 30, 2022 . Non-interest bearing deposits increased$33.9 million , or 52.8%, from$64.2 million for the six months endedJune 30, 2021 , to$98.1 million for the six months endedJune 30, 2022 . The average volume of FHLB and other borrowings decreased$71.9 million , or 81.4%, from$88.3 million for the six months endedJune 30, 2021 , to$16.4 million for the six months endedJune 30, 2022 , consisting mostly of funding from the PPPLF program, at an interest rate of 0.35%, used to fund the PPP loans. The average cost of FHLB and other borrowings increased 7 basis points from 0.35% for the six months endedJune 30, 2021 , to 0.42% for the six months endedJune 30, 2022 . 36
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The following table sets forth our average balances of assets, liabilities and shareholders' equity, in addition to the major components of net interest income and our net interest margin, for the three months endedJune 30, 2022 and 2021. Three Months Ended June 30, 2022 2021 (In thousands, except Average Average Average Average percentages) Balance Interest Yield Balance Interest Yield Assets Interest-bearing deposits and federal funds sold$ 32,734 $ 73 0.89 %$ 58,444 $ 16 0.11 % Securities 43,756 417 3.82 25,197 207 3.30 Loans, net of unearned discount (1) 449,289 7,014 6.26 436,020 5,993 5.51 Total earning assets 525,779 7,504 5.72 519,661 6,216 4.80 Cash and other assets 51,310 32,761 Allowance for loan losses (4,322 ) (3,193 ) Total assets$ 572,767 $ 549,229 Liabilities and Shareholders' Equity Savings and interest-bearing demand$ 17,952 11 0.25 %$ 15,371 9 0.23 % Money market deposit accounts 130,007 206 0.64 112,089 100 0.36 Time deposits 207,047 469 0.91 172,000 478 1.11 Total interest-bearing deposits 355,006 686 0.78 299,460 587 0.79 FHLB and other borrowings 6,964 11 0.63 94,455 82 0.35 Subordinated notes 12,000 219 7.32 12,000 219 7.32 Total interest-bearing liabilities 373,970 916 0.98 405,915 888 0.88 Non-interest-bearing deposits 99,754 71,547 Other liabilities 10,509 7,961 Total liabilities 484,233 485,426 Shareholders' equity 88,534 63,806 Total liabilities and shareholders' equity$ 572,767 $ 549,229 Net interest income$ 6,588 $ 5,328 Net interest spread 4.74 % 3.92 % Net interest margin 5.03 % 4.11 % (1) Includes non-accrual loans. 37
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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 six months endedJune 30, 2022 and 2021. Six Months Ended June 30, 2022 2021 (In thousands, except Average Average Average Average percentages) Balance Interest Yield Balance Interest Yield Assets Interest-bearing deposits and federal funds sold$ 39,973 $ 94 0.47 %$ 40,555 $ 21 0.10 % Securities 41,873 752 3.62 25,566 353 2.78 Loans, net of unearned discount (1) 450,754 14,206 6.36 437,395 12,156 5.60 Total earning assets 532,600 15,052 5.70 503,516 12,530 5.02 Cash and other assets 50,685 31,951 Allowance for loan losses (4,226 ) (3,070 ) Total assets$ 579,059 $ 532,397 Liabilities and Shareholders' Equity Savings and interest-bearing demand$ 16,275 21 0.26 %$ 13,740 16 0.23 % Money market deposit accounts 132,542 327 0.50 109,602 198 0.36 Time deposits 206,617 988 0.96 174,470 1,034 1.20 Total interest-bearing deposits 355,434 1,336 0.76 297,812 1,248 0.85 FHLB and other borrowings 16,459 34 0.42 88,318 153 0.35 Subordinated notes 12,000 437 7.34 12,000 437 7.34 Total interest-bearing liabilities 383,893 1,807 0.95 398,130 1,838 0.93 Non-interest-bearing deposits 98,117 64,205 Other liabilities 9,998 8,158 Total liabilities 492,008 470,493 Shareholders' equity 87,051 61,904 Total liabilities and shareholders' equity$ 579,059 $ 532,397 Net interest income$ 13,245 $ 10,692 Net interest spread 4.75 % 4.09 % Net interest margin 5.01 % 4.28 % Provision for Loan Losses There was no provision for loan losses for the three months endedJune 30, 2022 . The provision for loan losses totaled$141,000 for the three months endedJune 30, 2021 . For the six months endedJune 30, 2022 , the provision for loan losses totaled$327,000 , compared to$569,000 for the six months endedJune 30, 2021 . 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. Nevertheless, there is continued uncertainty in the forecasted economic conditions due to the rising interest rate environment and persistent high inflation levels, and additional or reversal provisions for loan losses may be necessary in future periods.
For additional information concerning this determination, see the section captioned "Allowance for Loan Losses" elsewhere in this discussion.
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Table of Contents Non-Interest Income
The components of non-interest income were as follows:
Three Months Ended June 30, Six Months Ended June 30,
(In thousands) 2022 2021 2022 2021
Trust income $ 1,557 $ 1,532 $ 3,154 $ 2,972
Gain on sale of loans - 101 - 101
Advisory income 3,358 3,276 6,932 6,293
Brokerage income 3,712 2,028 6,183 4,591
Service fees and other income 1,889 1,408 4,105 3,714
Rental income 88 88 189 176
Total $ 10,604 $ 8,433 $ 20,563 $ 17,847
Total non-interest income for the three months ended June 30, 2022 increased
$2.2 million , or 25.7%, and $2.7 million , or 15.2%, compared to the same periods
in the prior year. Material changes in the various components of non-interest
income are discussed below.
Trust Income. Trust income is earned for trust services on the value of managed
and non-managed assets held in custody. Volatility in the bond and equity
markets impacts the market value of trust assets and the related fees. Trust
income for the three and six months ended June 30, 2022 increased $25,000 , or
1.6%, and increased $182,000 , or 6.1%, respectively, compared to the same
periods in the prior year. The increase in trust income between the periods is
due to an increase in the average market value of the trust assets for the three
and six months ended June 30, 2022 compared to the three and six months ended
June 30, 2021 . The increase in the average market value of the trust assets
between the two periods was primarily due to an increase in net flows of assets,
which offset a decrease in average market values of trust assets from market
declines during early 2022. Such decrease deepened during the three months ended
June 30, 2022 and is attributed to the Federal Open Market Committee of the
Board of Governors of the Federal Reserve System raising their target benchmark
interest rate during the three months ended June 30, 2022 , and the ensuing
increases in market interest rates during the period. In addition, asset values
during the three and six months ended June 30, 2021 reflected the continued
uncertainty related to the economic impacts of the ongoing COVID-19 pandemic,
which led to volatility in asset values, negatively impacting trust income,
whereas the uncertainty around the COVID-19 pandemic abated during the remainder
of 2021. Volatility related to impacts of geo-political instability related to
the war in Ukraine , regulatory action, including further increases in market
interest rates by the Federal Reserve in response to the persistence of the
inflationary environment in the United States , or continuing effects of the
COVID-19 pandemic, including supply-chain disruptions, all of which are likely
to impact the bond and equity markets, could result in future net decreases in
the average values of our assets held in custody, and/or in a decrease in net
flows to our assets held in custody, decreasing our trust income.
Gain on sale of loans. Gain on sale of loans is generally gain on sales of the
guaranteed portion of loans within our SBA loan portfolio. Gain on sale of loans
decreased $101,000 during the three and six months ended June 30, 2022 , when
there were no loans sold and therefore 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
in each the three and six months ended June 30, 2021 , 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 values for a given period, where each percentage point
represents 100 basis points. These revenues are of a recurring nature, but are
directly affected by increases and decreases in the values of the underlying
assets. For the three and six months ended June 30, 2022 , advisory income
increased $82,000 , or 2.5%, and $639,000 , or 10.2%, respectively, compared to
the same periods in the prior year. The increase in advisory income between the
two periods is due to an increase in the average market value of the advisory
assets for the three and six months ended June 30, 2022 as compared to the same
periods in the prior year. Similar to our trust income, changes in the value of
our assets under management will result in comparable changes in our advisory
income. Net inflows to our assets under management throughout 2021 and during
the first quarter of 2022 offset a decrease in average market values of trust
assets from market declines during the six months ended June 30, 2022 , resulting
in a net increase in the average market value of our advisory assets. This was
partially due to a decrease in volatility related to decreased uncertainty as to
the effects of the ongoing COVID-19 pandemic between the two periods, which
resulted in less pressure on asset values and therefore less pressure on
advisory income from factors related to the COVID-19 pandemic. As with trust
income, volatility related to regulatory action, including further increases in
market interest rates by the Federal Reserve in response to the persistence of
the inflationary environment in the United States , as well as supply chain
disruptions related to geo-political instability, including the war in Ukraine ,
and/or disruptions in the supply chain related to continuing world-wide effects
of the COVID-19 pandemic, are likely to impact the financial markets and the
value of and/or net inflows to our assets under management, potentially
decreasing our advisory income.
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Brokerage income. Brokerage revenues are generally based on a per share fee or commission to trade a share of a particular stock, bond or other security. In addition, brokerage revenues, in this context, include private placements, participation in syndication of public offerings, and certain other brokerage revenues, including interest earned on margin lending. Brokerage revenue is dependent on the volume of trading, and on private placement and syndication activity during the period, and in the case of margin lending, on interest rates. Brokerage income for the three and six months endedJune 30, 2022 increased$1.7 million , or 83.0%, and$1.6 million , or 34.7%, compared to the same periods in the prior year. The vast majority of the increase was related to an increase in commission income from private placement activity of$1.7 million and$2.0 million during the three and six months endedJune 30, 2022 , respectively, from a recovery in private placement activity from the economic uncertainty that persisted during the three and six months endedJune 30 , 2021from the COVID-19 pandemic and dampened private offering activity, and also influenced by the possibility of further increases in interest rates leading to market volatility later in 2022. In addition, income from money market rebates and margin lending increased$155,000 and$134,000 , and$156,000 and$280,000 , respectively, during the three and six months endedJune 30, 2022 and 2021, respectively, related to increases in interest rates and rising cash balances, increasing the availability of funds and related margin lending and corresponding revenue. Commissions from options trading also increased by$166,000 and$217,000 during the three and six months endedJune 30, 2022 , respectively, over the same periods in the prior year. These increases were offset by a decrease in brokerage commissions from general over-the-counter trading of$386,000 and$1.1 million for the three and six months endedJune 30, 2022 , respectively, as well as other immaterial fluctuations in brokerage income netting to a decrease of$89,000 and an increase of$15,000 during the three and six months endedJune 30, 2022 , respectively compared to the same periods in the prior year. Private offering activity in particular did recover somewhat during the three and six months endedJune 30, 2022 , but expectations of economic disruption related to geo-political factors and further increases in market interest rates by the Federal Reserve Reserve in response to the persistence of the inflationary environment inthe United States , among other factors, have led to economic uncertainty, which has the potential to decrease offering activity and general brokerage activity in future periods given price uncertainty in the face of volatile markets. The table below reflects a rollforward of our client assets fromJune 30, 2021 throughJune 30, 2022 , which includes both advisory and brokerage assets, and the inflows and outflows and net market appreciation fromDecember 31, 2020 throughJune 30, 2022 . Our brokerage and advisory assets experienced a decrease of approximately$312.4 million , or 5.9%, betweenJune 30, 2021 andJune 30, 2022 , related to positive net flows offset by market depreciation. (In thousands) Client Assets As of December 31, 2020$ 4,524,376 Client inflows 1,515,091 Client outflows (1,299,643 ) Net flows 215,448 Market appreciation 549,635 As of June 30, 2021$ 5,289,459 Client inflows 1,127,536 Client outflows (904,112 ) Net flows 223,424 Market appreciation 96,429 As of December 31, 2021$ 5,609,312 Client inflows 1,750,576 Client outflows (1,247,399 ) Net flows 503,177 Market depreciation (1,135,447 ) As of June 30, 2022$ 4,977,042 Service fees and other income. Service fees includes fees for deposit-related services, loan and factored receivables servicing, third-party administration fees, and other income. Service fees and other income for the three and six months endedJune 30, 2022 increased$481,000 , or 34.2%, and$391,000 , or 10.5%, respectively, compared to the same periods in the prior year. The increases for the three and six months endedJune 30, 2022 over the same periods in the prior year were the result of increases in third party pension administration fees from the Bank's Nolan division of$347,000 and$314,000 , respectively and increases in the servicing fees from the Bank's Integra factoring division of$159,000 and$313,000 , respectively, which was acquired effectiveJuly 1, 2021 and therefore had no revenue during the same periods in the prior year, as well as an increase in income distributions from an interest in securities not readily marketable of$14,000 for the three months endedJune 30, 2022 . These increases were offset for the three and six months endedJune 30, 2022 by decreases in net loan servicing fees of$2,000 and$107,000 , respectively, consulting fees of$34,000 and$56,000 , respectively, and from losses on errors of$11,000 and$44,000 , respectively, over the same periods in the prior year, as well as a decrease in income distributions from an interest in securities not readily marketable of$71,000 for the six months endedJune 30, 2022 over the same period in the prior year. Immaterial fluctuations accounted for the remaining differences. The increase in third-party administration fees for the periods was primarily due to timing differences in completion of plan administration work compared to the same periods in the earlier year, during which the COVID-19 pandemic and related shutdowns led to a slowdown in submission of records from plan sponsors, delaying completion of work, as well as from an increase in third party administration clients. 40
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Rental income. The Company receives monthly rental income from tenants leasing space in the Bank building. Rental income for the three months endedJune 30, 2022 showed no material variance, and rental income for the six months endedJune 30, 2022 increased$13,000 , or 7.4%. The increase was primarily due to a new tenant moving into vacant space during the second quarter 2021. Non-Interest Expense
The components of non-interest expense were as follows:
Three Months Ended June 30, Six Months Ended June 30,
(In thousands) 2022 2021 2022 2021
Salaries and employee benefits $ 7,879 $ 5,923 $ 15,335 $ 11,789
Occupancy and equipment 422 392 873 819
Trust expenses 560 595 1,158 1,159
Brokerage and advisory direct costs 498 491 1,026 997
Professional fees 353 332 753 782
Data processing 221 266 390 470
Other 1,346 834 2,703 1,609
Total $ 11,279 $ 8,833 $ 22,238 $ 17,625
Total non-interest expense for the three and six months ended June 30, 2022
increased $2.4 million , or 27.7%, and $4.6 million , or 26.2%, respectively,
compared to the same periods in the prior year, primarily due to increases in
salaries and employee benefits, trust expenses, other expenses, and professional
fees, as well as in data processing fees, which were partially offset by a
decrease in depreciation expense within our occupancy and equipment expense and
in brokerage and advisory direct costs. Material changes in the various
components of non-interest income are discussed below.
Salaries and employee benefits. Salaries and employee benefits for the three and
six months ended June 30, 2022 increased $2.0 million , or 33.0%, and $4.5
million , or 30.1%, compared to the same periods in the prior year. The increases
were primarily due to increases in bonuses, salaries, and related payroll
expenses in our Banking segment, the majority of which are related to the
increase staff from the acquisition of the Integra factoring division, and in
our Other Financial Services segment, primarily from increases in incentive
bonuses and earnouts at Sanders Morris Harris , and increase in staff and merit
increases in the Bank's Nolan division, Tectonic Advisors and the Bank's Trust
department. In addition, health insurance and other employee benefits costs
increased for the three and six months ended June 30, 2022 across the Company by
$99,000 and $204,000 , respectively, compared to the same periods in the prior
year due primarily to increases in headcount and rate increases. The increases
in salary, bonus, and other related payroll costs during the three and six
months ended June 30, 2022 in our Banking segment of $546,000 and $1.5 million ,
respectively, related to increases of $511,000 and $1.0 million from the
acquisition of the Bank's Integra division in July 2021 , and increases of
$36,000 and $480,000 elsewhere in our Banking segment, related to merit
increases in salaries and an increase in headcount, including within the Bank's
SBA division. Salaries and bonuses in our Other Financial Services segment
increased $1.2 million and $1.7 million for the three and six months ended June
30, 2022 , respectively, compared to the same periods in the prior year, of which
$1.0 million and $1.1 million , respectively, is related to increases in
commissions, incentive bonuses and earnouts related to increases in brokerage
and private placement activity, $93,000 and $191,000 is related to Tectonic
Advisors for increases in headcount in our investment operations team resulting
from increases in net flows of assets under management and merit raises, $44,000
and $347,000 is related to the Bank's Nolan division for increases in headcount,
promotions and merit increases, and production related bonuses, and $31,000 and
$41,000 is related to the Bank's Trust department for increases in headcount and
merit increases and promotions. In addition, stock compensation expense across
the Company increased by $12,000 and $13,000 over the same periods in the prior
year.
Occupancy and equipment expense. Occupancy and equipment expense for the three
and six months ended June 30, 2022 increased $30,000 , or 7.7%, and $54,000 , or
6.6%, compared to the same periods in the prior year. The increases were related
to increases totaling $55,000 and $126,000 at our Banking segment, offset by
decreases of $25,000 and $72,000 in our Other Financial Services segment. The
increases for the three and six months ended June 30, 2022 at our Banking
segment included increases of $39,000 and $89,000 related to the acquisition of
the Bank's Integra division in July 2021 , as well as increases in the Bank's
facilities expense of $16,000 and $37,000 , respectively, compared to the same
periods in the prior year. The decreases of in our Other Financial Services
segment for the three and six months ended June 30, 2022 included decreases in
depreciation expense of $23,000 and $45,000 and in facilities expense of $24,000
and $35,000 , offset by individually immaterial fluctuations netting to increases
of $22,000 and $8,000 , compared to the same periods in the prior year.
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Trust expenses. Trust expenses are advisory fees paid to a fund advisor to advise the Company on the common trust funds managed by the Company, and are based on the value of the assets held in custody. Volatility in the bond and equity markets impacts the market value of trust assets and the related expenses. The monthly advisory fees are assessed based on the market value of assets at month-end. Trust expenses for the three and six months endedJune 30, 2022 decreased$35,000 , or 5.9%, and$1,000 , or less than 1%, compared to the same periods in the prior year due to a decrease in the value of trust assets for the three and six months endedJune 30, 2022 over the value during the same period in the prior year. This was due to a decrease in the valuation of trust assets, primarily during the three months endedJune 30, 2022 , which was partially offset by the increase in asset values and net flows earlier in 2022, compared to the same periods in the prior year. Brokerage and advisory direct costs. Brokerage and advisory direct costs for the three and six months endedJune 30, 2022 increased$7,000 , or 1.4%, and$29,000 , or 2.9%, compared to the same periods in the prior year. The increases for the three and six months endedJune 30, 2022 related primarily to increases in information services fees atTectonic Advisors of$24,000 and$54,000 , respectively, which were offset by a decrease in clearing firm service fees at Sanders Morris of$21,000 and$42,000 , combined with other individually immaterial fluctuations at Sanders Morris, including HWG, netting to decreases of$17,000 and$25,000 , respectively, compared to the same periods in the prior year. Professional fees. Professional fees, which include legal, consulting, audit and tax fees, for the three and six months endedJune 30, 2022 increased$21,000 , or 6.3%, and decreased$29,000 , or 3.7%, compared the same periods in the prior year. The increase for the three months endedJune 30, 2022 , was the result of increases in audit and tax consulting fees totaling$75,000 , the majority of which was in ourHoldco segment related to an increase in complexity of our annual audit from an increase in our activity overall, offset by a decrease in legal and professional fees of$15,000 and$40,000 , respectively, from decreases in consulting fees related to our participant directed plan services team, and increases in our legal fees during the same period in the prior year related to the acquisition of Integra. The decrease for the six months endedJune 30, 2022 related to an increase in audit and audit and tax consulting services of$108,000 , shared across all segments related to the increase in complexity of our annual audit and tax preparation services, which was partially offset by decreases in professional fees of$115,000 , a decrease of$137,000 at the Bank's trust department primarily 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, and a decrease in legal fees$22,000 compared to the same period in the prior year related primarily to the acquisition of Integra. Data processing. Data processing includes costs related to the Company's operating systems. Data processing expense for the three and six months endedJune 30, 2022 decreased$45,000 , or 16.9%, and$80,000 , or 17.0%, compared to the same periods in the prior year. The decreases were the result of decreases of$55,000 and$97,000 in our Banking segment, offset by increases of$11,000 and$17,000 in ourOther 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 of$9,000 and$20,000 , and other immaterial fluctuations. Other. Other expenses include costs for insurance,Federal Deposit Insurance Corporation ("FDIC") andOffice of the Comptroller of the Currency ("OCC") assessments, director fees, regulatory filing fees related to our brokerage business, business travel, management fees, and other operational expenses. Other expenses for the three and six months endedJune 30, 2022 increased$512,000 , or 61.4%, and$1.1 million , or 68.0%, compared to the same period in the prior year. The increases for the three and six months endedJune 30, 2022 included increases of$291,000 and$630,000 in our Banking segment, of$112,000 and$272,000 in ourOther Financial Services segment, and in ourHoldCo segment of$109,000 and$191,000 , respectively. The increases in our Banking segment include increases of$134,000 and$257,000 related to other expenses at the Bank's Integra division which was acquired inJuly 2021 , and includes increases in marketing and advertising costs of$35,000 and$74,000 , correspondent bank charges of$45,000 and$76,000 , software costs of$10,000 and$22,000 , and other individually immaterial operating costs of$44,000 and$86,000 , respectively. Other increases in our Banking segment included increases of$29,000 and$118,000 in software licenses, of$4,000 and$40,000 in employee recruitment related primarily to growth, and other individually immaterial increases. The increases of$112,000 and$272,000 in ourOther Financial Services segment were related to increases in our marketing, advertising and public relations costs of$28,000 and$117,000 , which includes marketing initiatives atTectonic Advisors related to assets under management attributable toCain Watters clients, and other marketing initiatives across the Company, as well as increases in travel, meals, and lodging of$20,000 and$46,000 , and net increases of$44,000 and$63,000 in software, licenses, and computer services related to technology initiatives across the company, and other individually smaller fluctuations which increased other expenses by$20,000 and$46,000 , respectively. The increases of$109,000 and$191,000 in ourHoldCo segment for the three and six months endedJune 30, 2022 were primarily the result of increases of$64,000 and$136,000 in marketing and public relations initiatives across the Company, an increase inTexas franchise tax expense of$25,000 for each the three and six months endedJune 30, 2022 , as well as other immaterial fluctuations netting to increases of$31,000 and$20,000 compared to the same periods in the prior year. 42
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Table of Contents Income Taxes Income tax expense for the three and six months endedJune 30, 2022 was approximately$1.2 million and$2.2 million , respectively, compared to$1.1 million and$2.3 million , respectively, for the same periods in the prior year. The effective income tax rate was 19.8% and 19.7% for the three and six months endedJune 30, 2022 , respectively, compared to 22.4% and 22.5%, respectively, for the same periods in the prior year. Segment Reporting
We have three operating segments: Banking,
Our banking operating segment includes both commercial and consumer banking services, and factoring services through the Bank's Integra division. 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. Factoring services are provided primarily to small over-the-road trucking businesses. Our other financial services segment includesTectonic Advisors , Sanders Morris, the Bank's Trust Division, which includes the Nolan division and a participant directed recordkeeping team, 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,
The following table presents key metrics related to our segments as of the dates indicated:
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