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, 2021 (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, 2020 filed with theSecurities and Exchange Commission (the "SEC") onMarch 31, 2021 and amended on Form 10-K/A onMay 5, 2021 (as amended, the "2020 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 2020 Form 10-K, and under the section entitled "Risk Factors" in this Form 10-Q, including, but not limited to, the following:
? risks associated with the ongoing COVID-19 global pandemic ("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, and the emerging Delta
variant, and our participation in COVID-19-related government programs such as
the Paycheck Protection Program (the "PPP") administered by the Small Business
Administration (the "SBA") and 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;
? changes in the economy generally and the regulatory response thereto;
? changes in the economy of the State of Texas , our primary market;
? risks specific to commercial loans and borrowers (particularly dental 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;
? changes in interest rates;
? our ability to maintain a strong core deposit base or other low-cost funding
sources;
? our ability to manage our credit risk;
? 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;
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Table of Contents ? 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 the ongoing COVID-19
pandemic and the emerging Delta variant;
? the effects of terrorism and efforts 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.
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 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, 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, 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-Q.
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Table of Contents COVID-19 Update The Company continues to actively monitor developments related to the COVID-19 pandemic including the progress of COVID-19 vaccines, the emergence of the so-called Delta variant, the effects of the CARES Act and the American Rescue Plan Act of 2021 and the prospects for additional fiscal stimulus programs; however, the extent to which each will impact our operations and financial results in 2021 remains uncertain. The Consolidated Appropriations Act, 2021, which was signed into law onDecember 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 toMarch 31, 2021 . The application period was later extended to the earlier ofMay 31, 2021 , or such date when all PPP funds are exhausted. The Company actively participated in the second round of the PPP and began submitting applications to the SBA for borrowers onJanuary 15, 2021 when the application window opened. The PPP was adjusted for the second round to allow applications from both first time borrowers and those that obtained loans during the first round of the PPP. The revised PPP, among other things, required that borrowers demonstrate or certify that they experienced a 25% or greater reduction in gross receipts from a quarter in 2020 compared to the same quarter in 2019 and certify that current economic uncertainty makes the loan request necessary to support their ongoing operations. The Bank funded 694 PPP loans, for$66.2 million related to the second round of PPP during the six months endedJune 30, 2021 , and as ofJune 30, 2021 , the Bank had$86.3 million of total outstanding PPP loans in its loan portfolio. Management believes that the majority of these PPP loans will ultimately be forgiven by the SBA or repaid in accordance with the terms of the PPP over the coming quarters. While all industries could experience adverse effects related to the COVID-19 pandemic, the loan portfolio includes customers in industries such as dental, travel, hotel, leisure, retail, convenience store, restaurant and entertainment, which industries have all been adversely impacted by the COVID-19 pandemic. While the Company has not experienced any material losses related to such industries in the portfolio, management recognizes that these industries may take longer to recover and continues to monitor these customers closely. The commercial credit area continues to communicate regularly with the borrowers and monitors their activity closely. This information is used to analyze the performance of these loans and to anticipate any potential issues that these loans may develop so that risk ratings may be appropriately adjusted in a timely manner. During the course of the COVID-19 pandemic, the Company increased its allowance for loan losses from$2.2 million as ofMarch 31, 2020 to$3.3 million as ofJune 30, 2021 , due in part to the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic. The Company recorded a provision of approximately$141,000 during the three months endedJune 30, 2021 . AtJune 30, 2021 , there were 2 loans in COVID-19-related deferment with an aggregate outstanding balance of approximately$3.2 million . For more information on the COVID-19 pandemic, see "Recent Developments Related to the COVID-19 Pandemic" in Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 1A., "Risk Factors," in our 2020 Form 10-K.
The impact of the COVID-19 pandemic on the Company for the periods covered by this Form 10-Q is detailed in each applicable section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" included below.
General We are a financial holding company headquartered inDallas, Texas . We provide a wide array of financial products and services including banking, trust, investment advisory, securities brokerage, third party administration, recordkeeping and insurance to individuals, small businesses and institutions in all 50 states. The following discussion and analysis presents our consolidated financial condition as ofJune 30, 2021 andDecember 31, 2020 , and our consolidated results of operations for the three and six months endedJune 30, 2021 and 2020. 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 2020 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. 32
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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 2020 Form 10-K for additional information regarding critical accounting policies. Performance Summary Net income available to common shareholders increased$1.6 million , or 94.1%, to$3.3 million for the three months endedJune 30, 2021 , compared to$1.7 million for the three months endedJune 30, 2020 . Earnings per diluted common share were$0.50 and$0.26 for the three months endedJune 30, 2021 and 2020, respectively. Net income available to common shareholders increased$3.5 million , or 94.6%, to$7.2 million for the six months endedJune 30, 2021 , compared to$3.7 million for the six months endedJune 30, 2020 . Earnings per diluted common share was$1.09 and$0.57 for the six months endedJune 30, 2021 and 2020, respectively. The increase in earnings was primarily due to increased revenue in the Banking andOther Financial Services segments. 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. For the three months endedJune 30, 2021 , annual return on average assets was 2.71%, compared to 1.68% for the same period in the prior year, and annual return on average tangible common equity was 38.24%, compared to 29.23% for the same period in the prior year. For the six months endedJune 30, 2021 , annual return on average assets was 3.04%, compared to 2.07% for the same period in the prior year, and annual return on average tangible common equity was 44.25%, compared to 33.42% for the same period in the prior year. The higher annual return ratios for the three and six months endedJune 30, 2021 was due to an increase in income which outpaced the increases in average assets and average tangible common equity compared to the same period in the prior year. The growth in average tangible common equity between the two periods is primarily related to earnings, net of preferred dividends paid, fromJune 30, 2020 toJune 30, 2021 . The growth in average assets is primarily attributable to growth in loans.
The following table presents non-GAAP reconciliations of annual return on average tangible common equity:
As of and As of and As of and As of and
for the for the for the for the
Three Months Three Months Six Months Six Months
Ended June Ended June Ended June Ended June(Dollars in thousands) 30, 2021 30, 2020 30, 2021 30, 2020 Income available to common shareholders$ 3,329 $ 1,726 $ 7,239 $ 3,739
Average shareholders' equity
61,904$ 51,618 Less: average goodwill 10,729 10,729 10,729 10,729 Less: average core deposit intangible 910 1,112 935 1,137 Less: average preferred stock 17,250 17,250 17,250 17,250
Average tangible common equity
32,990$ 22,502 Annual return on average tangible common equity 38.24 % 29.23 % 44.25 % 33.42 % 33
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Total assets grew by$44.0 million , or 8.6%, to$557.4 million as ofJune 30, 2021 from$513.4 million as ofDecember 31, 2020 . This increase was primarily due to an increase of$36.0 million for interest-bearing deposits,$9.9 million for loans, net of allowance for loan losses, and$6.3 million for loans held for sale. The increases were offset by decreases of$2.8 million for cash and due from banks,$3.0 million for securities held to maturity and$2.7 million for other assets. Substantially all loans outside of those made under the PPP are secured by specific collateral, including business assets, consumer assets, and commercial real estate. We anticipate that as the majority of PPP loans are forgiven or paid off, which we believe will occur principally over the next six months, and as customers spend down their PPP funds, this will result in a reduction in both loans and borrowings. Shareholders' equity increased$6.8 million , or 11.3%, to$66.8 million as ofJune 30, 2021 , from$60.0 million as ofDecember 31, 2020 . See analysis of shareholders' equity in the section captioned "Capital Resources and Regulatory Capital Requirements" included elsewhere in this discussion.
Results of Operations for the Three and 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. TheFederal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The effective federal funds rate decreased 150 basis points duringMarch 2020 (50 basis points onMarch 3, 2020 and 100 basis points onMarch 15, 2020 ) to zero to 0.25%, where it remained throughJune 30, 2021 . 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, 2021 vs June 30, 2020
Increase(Decrease) Due to Change in
Average
(In thousands) Rate Volume Total Interest-bearing deposits and federal funds sold $ 2 $ (5 )$ (3 ) Securities (11 ) 8 (3 ) Loans, net of unearned discount (1) 674 826 1,500 Total earning assets 665 829 1,494 Savings and interest-bearing demand (2 ) 3 1 Money market deposit accounts (8 ) 10 2 Time deposits (437 ) (192 ) (629 ) FHLB and other borrowings (4 ) 59 55 Subordinated notes (1 ) 1 - Total interest-bearing liabilities (452 )
(119 ) (571 )
Changes in net interest income$ 1,117 $ 948$ 2,065 (1) Average loans include non-accrual. 34
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Net interest income increased$2.1 million , or 63.6%, from$3.3 million for the three months endedJune 30, 2020 to$5.3 million for the three months endedJune 30, 2021 . Net interest margin for the three months endedJune 30, 2021 and 2020 was 4.11% and 2.74%, respectively, an increase of 137 basis points. The increase in net interest income and margin was primarily due to the timing of recognition of PPP-related SBA fees. Other changes included an increase in the average volume of loans, a decrease in average rates paid on interest-bearing deposits and decrease in average volume of interest-bearing deposits which were replaced by non-interest-bearing deposits and Paycheck Protection Program Liquidity Facility ("PPPLF") borrowings. The average volume of interest-earning assets increased$41.5 million , or 8.7%, from$478.2 million for the three months endedJune 30, 2020 to$519.7 million for the three months endedJune 30, 2021 . The average volume of loans increased$59.2 million , or 15.7%, from$376.8 million for the three months endedJune 30, 2020 to$436.0 million for the three months endedJune 30, 2021 . PPP loans accounted for$31.1 million of the average volume increase. The average yield for loans increased 71 basis points from 4.80% for the three months endedJune 30, 2020 to 5.51% for the three months endedJune 30, 2021 . InApril 2020 , we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. In 2020, we funded$98.3 million of PPP loans, all during the second quarter of 2020. As ofJune 30, 2021 , approximately$75.6 million of the PPP loans originated in 2020 have been forgiven by the SBA and were paid off or repaid by the borrower, leaving an outstanding balance of$22.7 million as ofJune 30, 2021 . During the six months endedJune 30, 2021 , we funded an additional$66.2 million of PPP loans, of which$2.6 million have been forgiven by the SBA and were paid off or repaid by the borrower, leaving an outstanding balance of$63.6 million as ofJune 30, 2021 . Total outstanding PPP loans were$86.3 million as ofJune 30, 2021 . During the three months endedJune 30, 2021 , we recognized$1.2 million in PPP loan 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. As a result of the inclusion of these net fees in interest income, the average yield on PPP loans was 6.1% during the three months endedJune 30, 2021 . For the balance of PPP loans outstanding as ofJune 30, 2021 , we expect to recognize additional PPP loan related deferred fees (net of deferred origination costs) totaling approximately$2.1 million as a yield adjustment over the remaining expected lives of these loans, with the majority being in 2021. The average volume of interest-bearing liabilities increased$13.4 million , or 3.4%, from$392.5 million for the three months endedJune 30, 2020 to$405.9 million for the three months endedJune 30, 2021 . The average volume of interest-bearing deposits decreased$53.9 million , or 15.3%, from$353.4 million for the three months endedJune 30, 2020 to$299.5 million for the three months endedJune 30, 2021 , and the average interest rate paid on interest-bearing deposits decreased 59 basis points from 1.38% for the three months endedJune 30, 2020 to 0.79% for the three months endedJune 30, 2021 . Non-interest bearing deposits increased$17.5 million , or 32.4%, from$54.0 million for the three months endedJune 30, 2020 to$71.5 million for the three months endedJune 30, 2021 . The average cost of deposits during the three months endedJune 30, 2021 was impacted by decreases in interest rates paid on money market and time deposits as a result of the aforementioned decrease in market interest rates. The average volume of FHLB and other borrowings increased$67.4 million , or 248.6%, from$27.1 million for the three months endedJune 30, 2020 to$94.5 million for the three months endedJune 30, 2021 , consisting entirely of funding from the PPPLF, at an interest rate of 0.35%, used to fund the PPP loans. There were no borrowings from the FHLB for the three months endedJune 30, 2021 and 2020.
Six Months Ended
Six Months Ended
June 30, 2021 vs June 30, 2020
Increase (Decrease) Due to Change in
Average
(In thousands) Rate Volume TotalInterest-bearing deposits and federal funds sold $ (56 ) $
(5 ) $ (61 )
Securities (203 ) 34 (169 )
Loans, net of unearned discount (1) 131 2,791 2,922
Total earning assets (128 ) 2,820 2,692
Savings and interest-bearing demand (7 ) 5 (2 )
Money market deposit accounts (148 ) 49 (99 )
Time deposits (881 ) (241 ) (1,122 )
FHLB and other borrowings (23 ) 126 103
Subordinated notes - - -
Total interest-bearing liabilities (1,059 ) (61 ) (1,120 )
Changes in net interest income $ 931$ 2,881 $ 3,812 (1) Average loans include non-accrual. 35
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Net interest income increased$3.8 million , or 55.1%, from$6.9 million for the six months endedJune 30, 2020 to$10.7 million for the six months endedJune 30, 2021 . Net interest margin for the six months endedJune 30, 2021 and 2020 was 4.28% and 3.37%, respectively, an increase of 91 basis points. The increase in net interest income and margin was primarily due to the timing of recognition of PPP-related SBA fees. Other changes included an increase in the average volume of loans, a decrease in average rates paid on interest-bearing deposits and borrowings and decrease in average volume of interest-bearing deposits which were replaced by non-interest-bearing deposits and PPPLF borrowings. The average volume of interest-earning assets increased$92.9 million , or 22.6%, from$410.6 million for the six months endedJune 30, 2020 to$503.5 million for the six months endedJune 30, 2021 . The average volume of loans increased$100.3 million , or 29.8%, from$337.1 million for the six months endedJune 30, 2020 to$437.4 million for the six months endedJune 30, 2021 . PPP loans accounted for$67.2 million of the average volume increase. The average yield for loans increased 9 basis points from 5.51% for the six months endedJune 30, 2020 to 5.60% for the six months endedJune 30, 2021 . InApril 2020 , we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. See discussion above in the three months endedJune 30, 2021 and 2020. During the six months endedJune 30, 2021 , we recognized$2.9 million in PPP loan 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. As a result of the inclusion of these net fees in interest income, the average yield on PPP loans was 6.8% during the six months endedJune 30, 2021 . The average volume of interest-bearing liabilities increased$63.4 million , or 18.9%, from$334.8 million for the six months endedJune 30, 2020 to$398.1 million for the six months endedJune 30, 2021 . The average volume of interest-bearing deposits decreased$9.3 million , or 3.1%, from$307.1 million for the six months endedJune 30, 2020 to$297.8 million for the six months endedJune 30, 2021 , and the average interest rate paid on interest-bearing deposits decreased 77 basis points from 1.62% for the six months endedJune 30, 2020 to 0.85% for the six months endedJune 30, 2021 . Non-interest bearing deposits increased$19.2 million , or 42.6%, from$45.0 million for the six months endedJune 30, 2020 to$64.2 million for the six months endedJune 30, 2021 . The average cost of deposits during the six months endedJune 30, 2021 was impacted by decreases in interest rates paid on money market and time deposits as a result of the aforementioned decrease in market interest rates. The average volume of FHLB and other borrowings increased$72.7 million , or 466.0%, from$15.6 million for the six months endedJune 30, 2020 to$88.3 million for the six months endedJune 30, 2021 , consisting mostly of funding from the PPPLF, at an interest rate of 0.35%, used to fund the PPP loans. The average cost of FHLB and other borrowings decreased 29 basis points from 0.64% for the six months endedJune 30, 2020 to 0.35% for the six months endedJune 30, 2021 . The following table sets forth our average balances of assets, liabilities and shareholders' equity, in addition to the major components of net interest income and our net interest margin, for the three months endedJune 30, 2021 and 2020. Three Months Ended June 30, 2021 2020 (In thousands, except Average Average Average Average percentages) Balance Interest Yield Balance Interest Yield Assets Interest-bearing deposits and federal funds sold$ 58,444 $ 16 0.11 %$ 77,139 $ 19 0.10 % Securities 25,197 207 3.30 24,281 210 3.48 Loans, net of unearned discount (1) 436,020 5,993 5.51 376,803 4,493 4.80 Total earning assets 519,661 6,216 4.80 478,223 4,722 3.97 Cash and other assets 32,761 29,830 Allowance for loan losses (3,193 ) (2,216 ) Total assets$ 549,229 $ 505,837 Liabilities and Shareholders' Equity Savings and interest-bearing demand$ 15,371 9 0.23 %$ 10,036 8 0.32 % Money market deposit accounts 112,089 100 0.36 101,161 98 0.39 Time deposits 172,000 478 1.11 242,220 1,107 1.84 Total interest-bearing deposits 299,460 587 0.79 353,417 1,213 1.38 FHLB and other borrowings 94,455 82 0.35 27,093 27 0.40 Subordinated notes 12,000 219 7.32 12,000 219 7.34 Total interest-bearing liabilities 405,915 888 0.88 392,510 1,459 1.50 Non-interest-bearing deposits 71,547 54,009 Other liabilities 7,961 6,477 Total liabilities 485,423 452,996 Shareholders' equity 63,806 52,841 Total liabilities and shareholders' equity$ 549,229 $ 505,837 Net interest income$ 5,328 $ 3,263 Net interest spread 3.92 % 2.47 % Net interest margin 4.11 % 2.74 % (1) Includes non-accrual loans. 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 six months endedJune 30, 2021 and 2020. Six Months Ended June 30, 2021 2020 (In thousands, except Average Average Average Average percentages) Balance Interest Yield Balance Interest Yield Assets Interest-bearing deposits and federal funds sold$ 40,555 $ 21 0.10 %$ 50,471 $ 82 0.33 % Securities 25,566 353 2.78 23,073 522 4.55 Loans, net of unearned discount (1) 437,395 12,156 5.60 337,100 9,234 5.51 Total earning assets 503,516 12,530 5.02 410,644 9,838 4.82 Cash and other assets 31,951 29,309 Allowance for loan losses (3,070 ) (1,820 ) Total assets$ 532,397 $ 438,133 Liabilities and Shareholders' Equity Savings and interest-bearing demand$ 13,740 16 0.23 %$ 9,646 18 0.38 % Money market deposit accounts 109,602 198 0.36 82,456 297 0.72 Time deposits 174,470 1,034 1.20 215,018 2,156 2.02 Total interest-bearing deposits 297,812 1,248 0.85 307,120 2,471 1.62 FHLB and other borrowings 88,318 153 0.35 15,643 50 0.64 Subordinated notes 12,000 437 7.34 12,000 437 7.32 Total interest-bearing liabilities 398,130 1,838 0.93 334,763 2,958 1.78 Non-interest-bearing deposits 64,205 45,034 Other liabilities 8,158 6,718 Total liabilities 470,493 386,515 Shareholders' equity 61,904 51,618 Total liabilities and shareholders' equity$ 532,397 $ 438,133 Net interest income$ 10,692 $ 6,880 Net interest spread 4.09 % 3.04 % Net interest margin 4.28 % 3.37 % (1) Includes non-accrual loans. Provision for Loan Losses For the three and six months endedJune 30, 2021 , the provision for loan losses totaled$141,000 and$569,000 , respectively, compared to$475,000 and$1.3 million for the three and six months endedJune 30, 2020 , respectively. Included in the provision for the six months endedJune 30, 2021 was$130,000 , which represents the amount of reserve for loan loss required in excess of the discount balance on loans acquired, compared to$409,000 for the six months endedJune 30, 2020 . 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.
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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) 2021 2020 2021 2020
Trust income $ 1,532 $ 1,196 $ 2,972 $ 2,472
Gain on sale of loans 101 - 101 432
Advisory income 3,276 2,311 6,293 4,805
Brokerage income 1,895 1,790 4,360 3,861
Service fees and other income 1,408 1,222 3,714 2,959
Rental income 88 57 176 148
Total $ 8,300 $ 6,576 $ 17,616 $ 14,677
Total non-interest income for the three months ended June 30, 2021 increased
$1.7 million , or 25.8%, and $2.9 million , or 19.7%, 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, 2021 increased $336,000 , or
28.1%, and increased $500,000 , or 20.2%, respectively, compared to the same
periods in the prior year. The increase in the fee income between the periods is
due to an increase in the average market value of the trust assets during the
three and six months ended June 30, 2021 , compared to the three and six months
ended June 30, 2020 . The expectation of an economic recovery from the COVID-19
pandemic has increased market values of trust assets over those experienced
during the three and six months ended June 30, 2020 , when the impacts of the
COVID-19 pandemic were affecting expectations, causing extreme volatility and
decreasing fees during the three and six month periods in the prior year.
Volatility related to an uneven recovery from the economic downturn and/or
renewed fears of resurgent strains of the COVID-19 virus, including the
emergence of the Delta variant, could result in future net decreases in the
average values of our assets held in custody, and/or continued volatility in
asset values, potentially 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
increased $101,000 during the three months ended June 30, 2021 compared to the
same period in the prior year, when there was no gain on sale of loans, and
decreased $331,000 , or 76.6%, for the six months ended June 30, 2021 compared to
the same period in the prior year. Gain on sale of loans for the three and six
months ended June 30, 2021 was $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 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, 2021 , advisory income
increased $965,000 , or 41.8%, and $1.5 million , or 31.0%, 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
during the three and six months ended June 30, 2021 as compared to the same
periods in the prior year. Similar to our trust income, changes in the value of
our assets under management will result in comparable changes in our advisory
income. The expectation of an economic recovery from the COVID-19 pandemic has
increased market values of our advisory assets, whereas the economic disruption
caused by the start of the COVID-19 pandemic during the three and six months
ended June 30, 2020 increased market volatility leading to lower advisory fees
in the same periods in the prior year. Volatility related to an uneven recovery
from the economic downturn and/or renewed fears of resurgent strains of the
COVID-19 virus, including the emergence of the Delta variant, could result in
future net decreases in the average values of our advisory assets, and/or
continued volatility in asset values, potentially decreasing our advisory
income.
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 ended June 30, 2021
increased $105,000 , or 5.9%, and $499,000 , or 12.9%, compared to the same
periods in the prior year. The economic disruption related to the COVID-19
pandemic led to a dramatic slowing of activity that began late in the first
quarter 2020 and continued throughout the remainder of the year. This led to
delays in the timing of private placements and syndicated public offerings,
along with volatility in the volume of general trading activity. Private
offering and syndicated public offering activity may face a prolonged recovery,
and in the event of economic volatility related to an uneven recovery or
concerns over new strains of the COVID-19 virus, including the emergence of the
Delta variant, the recovery in trading activity may stall, potentially
decreasing brokerage income overall.
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The table below reflects a rollforward of our client assets, which includes both advisory and brokerage assets, as ofJune 30, 2021 andDecember 31, 2020 , and the inflows and outflows and net market appreciation during the three and six months endedJune 30, 2021 . Our brokerage and advisory assets experienced an increase of approximately$348 million , or 7.0%, and$765 million , or 16.9%, during the three and six months endedJune 30, 2021 , respectively, related to positive net flows and market appreciation. (In thousands) Client Assets As of December 31, 2020$ 4,524,376 Client inflows 519,177 Client outflows (437,760 ) Net flows 81,417 Market appreciation 335,882 As of March 31, 2021$ 4,941,675 Client inflows 995,914 Client outflows (861,884 ) Net flows 134,030 Market appreciation 213,754 As of June 30, 2021$ 5,289,459 Service fees and other income. Service fees includes fees for deposit-related services, loan servicing, and third-party administration fees. Service fees and other income for the three and six months endedJune 30, 2021 increased$186,000 , or 15.2%, and$755,000 , or 25.5%, respectively, compared to the same period in the prior year. These increases are primarily the result of increases in third party administration fees of$203,000 and$662,000 for the three and six months endedJune 30, 2021 over the same periods in the prior year. The increase in third-party administration fees was in part due to the COVID-19 pandemic and the resulting lag in information from plan sponsors to complete annual plan administration work related to the shutdown of dental practices nationwide, which began inMarch 2020 , whereas during the three and six months endedJune 30, 2021 , information was received timely and therefore, a larger percentage of plan administration work was able to be completed earlier; this effect was more pronounced during the first quarter 2021. Loan and other bank servicing fees decreased$48,000 and increased$110,000 during the three and six months endedJune 30, 2021 , respectively, over the same periods in the prior year, primarily due to the amortization of the remaining servicing asset valuation allowance on loans repaid during the three and six months endedJune 30, 2021 of$45,000 and$70,000 , respectively. In addition, other income increased$30,000 and decreased$16,000 for the three and six months endedJune 30, 2021 related to variances in income distributions from an interest in securities not readily marketable which decreased$22,000 and increased$63,000 during the three and six months endedJune 30, 2021 , respectively, compared to the same periods in the prior year, and an increase in consulting fees earned at Sanders Morris of$34,000 and$56,000 for the three and six months endedJune 30, 2021 , respectively, and a decrease in other income of approximately$124,000 related to a non-recurring extinguishment of a retirement liability during the first quarter of 2020, and immaterial fluctuations in miscellaneous income netting to an increase of$20,000 and a decrease of$11,000 for the three and six months endedJune 30, 2021 , respectively. Rental income. The Company receives monthly rental income from tenants leasing space in the Bank building. Rental income for the three and six months endedJune 30, 2021 increased$31,000 , or 54.4% and$28,000 or 18.9%, respectively, compared to the same periods in the prior year. 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) 2021 2020 2021 2020
Salaries and employee benefits $ 5,790 $ 4,049 $ 11,558 $ 8,953
Occupancy and equipment 392 560 819 1,094
Trust expenses 595 372 1,159 927
Brokerage and advisory direct costs 491 560 997 1,046
Professional fees 332 267 782 642
Data processing 266 194 470 385
Other 834 661 1,609 1,439
Total $ 8,700 $ 6,663 $ 17,394 $ 14,486
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Total non-interest expense for the three and six months endedJune 30, 2021 increased$2.0 million , or 29.9%, and$2.9 million , or 20.0%, 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 endedJune 30, 2021 increased$1.7 million , or 43.0%, and$2.6 million , or 29.1%, respectively, compared to the same period in the prior year. The increases were primarily due to annual merit increases, increases in bonuses, and related payroll taxes at our Banking segment, in addition to annual merit increases and increases in commissions and incentive bonuses and payroll taxes in ourOther Financial Services segment. In addition, stock compensation expense increased in ourHoldCo segment, and our health insurance costs increase across the Company, compared to the same periods in the prior year. In our Banking segment,$1.1 million and$1.2 million of the increase for the three and six months endedJune 30, 2021 , respectively, related to merit increases in salaries and an increase in headcount in the Bank's SBA lending division and elsewhere related to overall growth in the Bank. In our Other Financial Services segment,$162,000 and$386,000 of the increase for the three and six months endedJune 30, 2021 , respectively, related to merit increases in salaries and an increase in headcount related to growth inThe Nolan Company ("Nolan"), operating as a division within the Bank, which provides third party administration ("TPA") services, and$215,000 and$272,000 related to salary increases at Sanders Morris. In addition, there was a net increase in earnouts and incentive bonuses at Sanders Morris related to increases in brokerage commission activity of$158,000 and$250,000 during the three and six months endedJune 30, 2021 compared to the same periods in the prior year, during which the COVID-19 pandemic had begun to suppress private placements and syndicated offerings, as well as certain trading activity on which Sanders Morris earns higher margins, which recovered somewhat during the three and six months endedJune 30, 2021 . These increases at Sanders Morris were partially offset by a decrease in certain incentive bonuses at Sanders Morris. Stock compensation expense increased by$58,000 and$118,000 for the three and six months endedJune 30, 2021 , respectively, related to stock grants made onSeptember 30, 2020 , offset by a decrease in expense related to options granted, and bonus expense in ourHoldco segment decreased$12,500 and increased$25,000 , respectively, related to variations in bonus accrued compared to the same periods in the prior year. Increases in health insurance expense led increased benefit costs across the Company, which increased by$74,000 and$121,000 during the three and six months endedJune 30, 2021 , respectively, compared to the same periods in the prior year. Occupancy and equipment expense. Occupancy and equipment expense for three and six months endedJune 30, 2021 decreased$168,000 , or 30.0%, and$275,000 , or 25.1%, respectively, compared to the same periods in the prior year. The decrease is attributable to decreases of$16,000 and$84,000 for the three and six months endedJune 30, 2021 , respectively, in depreciation expense at ourOther Financial Services segment related primarily to a group of fixed assets and software costs reaching full depreciation/amortization during the three months endedJune 30, 2020 , and decreases in rent, utilities and common area maintenance expenses in that segment of$67,000 and$101,000 for the three and six month periods, respectively, slightly offset by an increase in repairs and maintenance expense of$7,000 for the six months endedJune 30, 2021 , and decreases in facilities telephone and depreciation of$16,000 and$8,000 , respectively, in our Banking segment. Trust expenses. Trust expenses are advisory fees paid to a fund advisor to advise the Company on the common trust funds managed by the Company, and are based on the value of the assets held in custody. Volatility in the bond and equity markets impacts the market value of trust assets and the related expenses. The monthly advisory fees are assessed based on the market value of assets at month-end. Trust expenses increased$223,000 , or 59.9%, and$232,000 , or 25.0%, due to an increase in the market value of trust assets for the three and six months endedJune 30, 2021 over the market values during the same periods in the prior year, which represented a recovery in asset values based on expectations that the effects of the COVID-19 pandemic were easing. Brokerage and advisory direct costs. Brokerage and advisory direct costs for three and six months endedJune 30, 2021 decreased$69,000 , or 12.3%, and$49,000 , or 4.7%, respectively, compared to the same periods in the prior year. The decreases related primarily to decreases in brokerage and exchange clearing fees at Sanders Morris of approximately$66,000 and$28,000 , for the three and six months endedJune 30, 2021 , respectively, and in information services and referral fees of$3,000 and$21,000 , respectively, compared to the same periods in the prior year. In addition, 40
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Professional fees. Professional fees, which include legal, consulting, audit and tax fees, for the three and six months endedJune 30, 2021 increased$65,000 , or 24.3%, and$140,000 , or 21.8%, compared to the same periods in the prior year. The increases were the result of increases of$56,000 and$60,000 , and$89,000 and$35,000 in our banking andHoldCo segments, respectively, for the three and six months endedJune 30, 2021 , respectively. The increases were the result of legal and professional fees related to attempts to recover amounts on liquidated loans in the Bank's SBA division, and to the acquisition of a factoring company which was completed onJuly 1, 2021 . Please see Note 17. Subsequent Events within our financial statements elsewhere within this Form 10-Q for more information on this acquisition. These increases were partially offset by decreases in audit and tax consulting fees in these segments of$25,000 and$53,000 for the three and six months endedJune 30, 2021 , respectively. Professional fees in our other financial services segment decreased$28,000 and increased$68,000 for the three and six months endedJune 30, 2021 . The decrease for the three month period was primarily due to a decrease in consulting fees related to our participant directed plan services team, and the increase for the six month period related to an increase in professional fees in our Nolan division related to an agreement with the former owner of Nolan under which payments increased by$44,000 due to an increase in the earnings from our Nolan division over the same period in the prior year, and an increase in tax consulting expense related to the completion of the tax returns for the trust department's pooled funds earlier in the year compared to the prior period of$9,000 , and other individually immaterial increases. Data processing. Data processing includes costs related to the Company's operating systems. Data processing expense for three and six months endedJune 30, 2021 increased$72,000 , or 37.1%, and$85,000 , or 22.1%, compared to the same periods in the prior year. The increases were the result of increases of$53,000 and$19,000 , and$53,000 and$32,000 in our banking and other financial services segments, respectively, for the three and six months endedJune 30, 2021 , respectively. The$53,000 increase in our banking segment was due to costs related to the conversion of the Bank's core accounting system. The increases in our other financial services segment were primarily related to increased trust data processing fees, and discounts received during the three and six months endedJune 30, 2020 , which decreased expense for those earlier periods. 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 three and six months endedJune 30, 2021 increased$173,000 , or 26.2%, and 170,000, or 11.8%, compared to the same periods in the prior year. The increase was primarily related to increases in computer software costs in our banking and other financial services segments totaling$160,000 and$196,000 , related to technology initiatives across the Company. We also experienced an increase in our directors' and officers' insurance coverage of$11,000 and$30,000 for the three and six months endedJune 30, 2021 , respectively. Other increases which were individually immaterial included employee recruitment costs, directors fees, and office expenses at Sanders Morris. These increases were partially offset by a decrease in payroll processing fees of$13,000 and$24,000 for the three and six months endedJune 30, 2021 , respectively, and a decrease in travel expense for the six month period endedJune 30, 2021 of$32,000 , and other individually immaterial decreases. Income Taxes Income tax expense for the three and six months endedJune 30, 2021 was$1.1 million and$2.3 million , respectively, compared to$587,000 and$1.3 million for the same periods in the prior year. The effective income tax rate was 22.4% and 21.2% for the three and six months endedJune 30, 2021 , respectively, compared to 21.7% and 22.3% 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. 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.
OurOther Financial Services segment includesTectonic 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. 41
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A third operating segment,
The following table presents key metrics related to our segments:
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