Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on April 6, 2018

Registration No. 333-          

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Spirit of Texas Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Texas   6022   90-0499552

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification No.)

 

(I.R.S. Employer

Identification No.)

1836 Spirit of Texas Way

Conroe, Texas 77301

(936) 521-1836

(Address, Including Zip Code, of Registrant’s Principal Executive Offices)

 

 

Dean O. Bass

Chairman and Chief Executive Officer

Spirit of Texas Bancshares, Inc.

1836 Spirit of Texas Way

Conroe, Texas 77301

(936) 521-1836

(Name, Address and Telephone Number, Including Area Code, of Agent For Service)

 

 

 

Alex Frutos

Michael F. Meskill

James L. Pledger

Jackson Walker L.L.P

100 Congress, Suite 1100

Austin, Texas 78701

(512) 236-2000

(512) 236-2002 (facsimile)

 

William S. Anderson

Jason M. Jean

Joshua T. McNulty

Bracewell LLP
711 Louisiana, Suite 2300
Houston, Texas 77002
(713) 223-2300
(713) 437-5370 (facsimile)

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 under the Exchange Act. (check one)

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☒  (Do not check if a smaller reporting company)    Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☐

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Proposed

Maximum
Aggregate

Offering Price(1)

 

Amount of

Registration Fee

Common Stock, no par value

  $46,000,000   $5,727

 

 

(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended. Includes offering price of shares that the underwriters have the option to purchase.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED APRIL 6, 2018

PRELIMINARY PROSPECTUS

                    Shares

 

LOGO

Spirit of Texas Bancshares, Inc.

COMMON STOCK

 

 

This is the initial public offering of shares of common stock of Spirit of Texas Bancshares, Inc., the holding company for Spirit of Texas Bank SSB, a Texas state savings bank headquartered in Conroe, Texas. We are offering                shares of our common stock.

Prior to this offering, there has been no established public market for our common stock. We currently estimate the public offering price per share of our common stock will be between $                and $                . We have applied to list our common stock on the NASDAQ Global Market under the symbol “STXB.”

Investing in our common stock involves risks. See “Risk Factors” beginning on page 15 of this prospectus to read about factors you should consider before investing in our common stock.

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, and are subject to reduced public company disclosure standards.

 

     Per
share
     Total  

Initial public offering price

   $               $               

Underwriting discounts and commissions(1)

     

Proceeds, before expenses, to us

     

 

(1) See “Underwriting” for additional information regarding the underwriting discounts and commissions and certain expenses payable to the underwriters by us.

We have granted the underwriters the option to purchase up to an additional                shares of our common stock from us within 30 days of the date of this prospectus on the same terms and conditions set forth above, to cover over allotments, if any. See “Underwriting.”

The shares of our common stock that you purchase in this offering will not be savings accounts, deposits or other obligations of any of our bank or non-bank subsidiaries and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other governmental agency and are subject to investment risks, including the possible loss of the entire amount you invest.

None of the Securities and Exchange Commission, any state securities commission, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, the Texas Department of Savings and Mortgage Lending or any other regulatory authority has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares to purchasers on or about                 , 2018, subject to customary closing conditions.

 

 

 

Stephens Inc.     Keefe, Bruyette & Woods

A Stifel Company

 

Piper Jaffray   Sandler O’Neill + Partners, L.P.

 

 

The date of this prospectus is                 , 2018


Table of Contents

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Table of Contents

TABLE OF CONTENTS

 

     Page  

SUMMARY

     1  

RISK FACTORS

     15  

USE OF PROCEEDS

     39  

CAPITALIZATION

     40  

DILUTION

     42  

DIVIDEND POLICY

     44  

BUSINESS

     45  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     63  

REGULATION AND SUPERVISION

     98  

MANAGEMENT

     112  

EXECUTIVE COMPENSATION AND OTHER MATTERS

     121  

PRINCIPAL SHAREHOLDERS

     136  

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     138  

DESCRIPTION OF CAPITAL STOCK

     140  

SHARES ELIGIBLE FOR FUTURE SALE

     145  

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES FOR NON-U.S. HOLDERS

     147  

UNDERWRITING

     150  

LEGAL MATTERS

     154  

EXPERTS

     154  

WHERE YOU CAN FIND MORE INFORMATION

     154  

INDEX TO FINANCIAL STATEMENTS

     F-1  

 

 

About this Prospectus

You should rely only on the information contained in this prospectus and any free writing prospectus we may authorize to be delivered to you. We and the underwriters have not authorized anyone to provide you with additional or different information. If anyone provides you with additional, different or inconsistent information, you should not rely on it. We and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, and only under circumstances and in jurisdictions where it is lawful to do so. We are not making an offer of these securities in any state, country or other jurisdiction where the offer is not permitted. You should not assume that the information in this prospectus or any free writing prospectus is accurate as of any date other than the date of the applicable document regardless of its time of delivery or the time of any sales of our common stock. Our business, financial condition, results of operations and cash flows may have changed since the date of the applicable document. Information contained on or accessible through our website is not a part of this prospectus.

 

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Unless we state otherwise or the context otherwise requires, references in this prospectus to “we,” “our,” “us” and “our company” refer to Spirit of Texas Bancshares, Inc., a Texas corporation, and our wholly-owned banking subsidiary, Spirit of Texas Bank SSB, a Texas state savings bank. References in this prospectus to “Bank” refer to Spirit of Texas Bank SSB.

 

 

Note Regarding Reverse Stock Split and Preferred Stock Conversion and Restatement

On February 23, 2017, we issued 170,236 shares of common stock to our holders of Series A preferred stock in connection with the conversion of 170,236 shares of our issued and outstanding Series A preferred stock into common stock. Our Series A preferred stock was economically equivalent to our common stock. On March 16, 2017, we effected a one-for-two reverse stock split. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Charter Amendments.” This prospectus reflects the impact of the foregoing preferred stock conversion and reverse stock split at the dates and for the periods presented unless otherwise noted.

As further discussed in Note 20, Correction of Errors and Restatement, in the notes to our consolidated financial statements included elsewhere in this prospectus, we identified prior period accounting errors which resulted in a restatement of certain prior period amounts within our consolidated financial statements as of and for the year ended December 31, 2017. All financial information as of and for the years ended December 31, 2016 and 2015 presented in this prospectus has been restated to reflect these changes.

 

 

Market Data

This prospectus includes industry and trade association data, forecasts and information that we have prepared based, in part, upon data, forecasts and information obtained from independent trade associations, industry publications and surveys, government agencies and other information available to us, which information may be specific to particular markets or geographic locations. Some data is also based on our good faith estimates, which are derived from management’s knowledge of the industry and independent sources. Industry publications and surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable. Although we believe these sources are reliable, we have not independently verified the information. Statements as to our market position are based on market data currently available to us. While we are not aware of any misstatements regarding our industry data presented herein, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading “Risk Factors” in this prospectus. Similarly, we believe our internal research is reliable, even though such research has not been verified by any independent sources.

 

 

Implications of Being an Emerging Growth Company

As a company with less than $1.07 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. We will continue to be an emerging growth company until the earliest to occur of: (1) the last day of the fiscal year following the fifth anniversary of this offering; (2) the last day of the fiscal year in which we have more than $1.07 billion in annual revenues; (3) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act; or (4) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities. Until we cease to be an emerging growth company, we may take advantage of specified reduced reporting and other regulatory requirements generally unavailable to other public companies. Those provisions allow us to present only two

 

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years of audited financial statements, discuss only our results of operations for two years in related Management’s Discussions and Analyses and provide less than five years of selected financial data in an initial public offering registration statement; not to provide an auditor attestation of our internal control over financial reporting; to choose not to comply with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and our audited financial statements; to provide reduced disclosure regarding our executive compensation arrangements pursuant to the rules applicable to smaller reporting companies, which means we do not have to include a compensation discussion and analysis and certain other disclosure regarding our executive compensation; and not to seek a non-binding advisory vote on executive compensation or golden parachute arrangements. We may choose to take advantage of some or all of these reduced reporting and other regulatory requirements. We have elected in this prospectus to take advantage of scaled disclosure related to the presentation of financial information and the reduced disclosure requirements relating to executive compensation arrangements.

The JOBS Act also permits an “emerging growth company” to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies.

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Information set forth in this prospectus may contain various “forward-looking statements.” These forward-looking statements describe our future plans, results, strategies and expectations and are subject to business, economic, and other risks and uncertainties, both known and unknown, that could cause our actual operating results and financial position to differ materially from the forward-looking statements. Such forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “could,” “would,” “goal,” “plan,” “potential,” “expect,” “anticipate,” “estimate,” “project,” “target,” “aim,” “believe,” or “continue,” or the negative thereof or other variations thereof or comparable terminology.

We have made the forward-looking statements in this prospectus based on assumptions and estimates that we believe to be reasonable in light of the information available to us at this time. However, these forward-looking statements are subject to significant risks and uncertainties, and could be affected by many factors. These factors include, but are not limited to, the following:

 

    risks related to the concentration of our business in Texas, and in the Houston and Dallas/Fort Worth metropolitan areas in particular, including risks associated with any downturn in the real estate sector and risks associated with a decline in the values of single family homes in our Texas markets;

 

    general market conditions and economic trends nationally, regionally and particularly in our Texas markets, including a decrease in or the volatility of oil and gas prices;

 

    risks related to our concentration in our primary markets, which are susceptible to severe weather events that could negatively impact the economies of our markets, our operations or our customers, any of which could have a material adverse effect on our business, financial condition and results of operations;

 

    our ability to implement our growth strategy, including identifying and consummating suitable acquisitions;

 

    risks related to the integration of any acquired businesses, including exposure to potential asset quality and credit quality risks and unknown or contingent liabilities, the time and costs associated with integrating systems, technology platforms, procedures and personnel, the need for additional capital to finance such transactions, and possible failures in realizing the anticipated benefits from acquisitions;

 

    changes in Small Business Administration, or SBA, loan products, including specifically the Section 7(a) program and Section 504 loans, or changes in SBA standard operating procedures;

 

    risks associated with our loans to and deposit accounts from foreign nationals;

 

    our ability to develop, recruit and retain successful bankers that meet our expectations in terms of customer relationships and profitability;

 

    our dependence on our management team, including our ability to retain executive officers and key employees and their customer and community relationships;

 

    risks associated with the relatively unseasoned nature of a significant portion of our loan portfolio;

 

    risks related to our strategic focus on lending to small to medium-sized businesses;

 

    the accuracy and sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses and other estimates;

 

    the risk of deteriorating asset quality and higher loan charge-offs;

 

    the time and effort necessary to resolve nonperforming assets;

 

    risks associated with our commercial loan portfolio, including the risk for deterioration in value of the general business assets that generally secure such loans;

 

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    risks associated with our nonfarm nonresidential and construction loan portfolios, including the risks inherent in the valuation of the collateral securing such loans;

 

    potential changes in the prices, values and sales volumes of commercial and residential real estate securing our real estate loans;

 

    risks related to the significant amount of credit that we have extended to a limited number of borrowers and in a limited geographic area;

 

    our ability to maintain adequate liquidity and to raise necessary capital to fund our acquisition strategy and operations or to meet increased minimum regulatory capital levels;

 

    material decreases in the amount of deposits we hold, or a failure to grow our deposit base as necessary to help fund our growth and operations;

 

    changes in market interest rates that affect the pricing of our loans and deposits and our net interest income;

 

    potential fluctuations in the market value and liquidity of our investment securities;

 

    the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

 

    our ability to maintain an effective system of disclosure controls and procedures and internal controls over financial reporting;

 

    risks associated with fraudulent, negligent, or other acts by our customers, employees or vendors;

 

    our ability to keep pace with technological change or difficulties when implementing new technologies;

 

    risks associated with system failures or failures to protect against cybersecurity threats, such as breaches of our network security;

 

    risks associated with data processing system failures and errors;

 

    potential impairment on the goodwill we have recorded or may record in connection with business acquisitions;

 

    the initiation and outcome of litigation and other legal proceedings against us or to which we become subject;

 

    our ability to comply with various governmental and regulatory requirements applicable to financial institutions, including regulatory requirements to maintain minimum capital levels;

 

    the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, such as further implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act;

 

    governmental monetary and fiscal policies, including the policies of the Board of Governors of the Federal Reserve System, or the Federal Reserve, as well as legislative and regulatory changes, including as a result of initiatives of the administration of President Donald J. Trump;

 

    our ability to comply with supervisory actions by federal and state banking agencies;

 

    changes in the scope and cost of Federal Deposit Insurance Corporation, or the FDIC, insurance and other coverage; and

 

    systemic risks associated with the soundness of other financial institutions.

 

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Other factors not identified above, including those described under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may also cause our results to differ materially from the anticipated or estimated results described in our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these factors in connection with considering any forward-looking statements that may be made by us. You should not rely on any forward-looking statements, which represent our beliefs, assumptions and estimates only as of the dates on which they were made, as predictions of future events. We undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events unless we are required to do so by law. We qualify all of our forward-looking statements by these cautionary statements.

 

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SUMMARY

This summary provides an overview of selected information contained elsewhere in this prospectus and does not contain all the information that may be important to you. Before making an investment decision to purchase shares of our common stock, you should carefully read this prospectus and the registration statement of which this prospectus is a part in their entirety, including the information discussed under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” along with our consolidated financial statements and notes thereto that are included herein. Unless we state otherwise or the context otherwise requires, references in this prospectus to “we,” “our,” “us” and “our company” refer to Spirit of Texas Bancshares, Inc., a Texas corporation, and our wholly-owned banking subsidiary, Spirit of Texas Bank SSB, a Texas state savings bank. References in this prospectus to “Bank” refer to Spirit of Texas Bank SSB. References in this prospectus to “Houston metropolitan area,” “Dallas/Fort Worth metropolitan area” and “Bryan/College Station metropolitan area” refer to the Houston-The Woodlands-Sugar Land Metropolitan Statistical Area, the Dallas-Fort Worth- Arlington Metropolitan Statistical Area and the College Station-Bryan Metropolitan Statistical Area, respectively.

Our Company

We are a Texas corporation and a registered bank holding company located in the Houston metropolitan area with headquarters in Conroe, Texas. We offer a broad range of commercial and retail banking services through our wholly-owned bank subsidiary, Spirit of Texas Bank SSB. We operate through 15 full-service branches located primarily in the Houston and Dallas/Fort Worth metropolitan areas. As of December 31, 2017, we had total assets of $1.03 billion, loans held for investment of $869.1 million, total deposits of $835.4 million and total stockholders’ equity of $99.1 million.

We are a business-focused bank that delivers relationship-driven financial services to small and medium-sized businesses and individuals in our market areas. Our philosophy is to target commercial customers whose businesses generate between $3 – $30 million of annual revenue. Our product offerings consist of a wide range of commercial products, including term loans and operating lines of credit to commercial and industrial companies; commercial real estate loans; construction and development loans; SBA loans; commercial deposit accounts; and treasury management services. In addition, our retail offerings include consumer loans, 1-4 single family residential real estate loans and retail deposit products.

We pride ourselves on our strong credit culture and responsiveness to our customers’ banking needs. We are guided by an experienced and proven executive management team, led by founder Dean O. Bass, our Chairman and Chief Executive Officer, and David M. McGuire, our President and the Bank’s President and Chief Lending Officer. Since our inception in 2008, we have implemented a growth strategy that includes organic loan and deposit generation through the establishment of de novo branches, as well as strategic acquisitions that have either strengthened our presence in existing markets or expanded our operations into new markets with attractive business prospects.

We operate in one reportable segment of business, Community Banking, which includes Spirit of Texas Bank SSB, our sole banking subsidiary.

Our History and Growth

Dean O. Bass founded our company after successfully establishing, operating and selling, Royal Oaks Bank, a high growth de novo institution in the Central Houston area. We began operations in November 2008 with the acquisition of First Bank of Snook, a community bank with two branches, one in the Bryan/College Station metropolitan area and one in Snook, Texas. Immediately following this initial acquisition, we opened a business banking office with an established commercial lending team and SBA team with whom our management group worked at Royal Oaks Bank. We quickly expanded into the Central Houston and North Houston markets through de novo branching and branch acquisitions. Early in our development, we identified the Dallas/Fort Worth metropolitan area as a strategic opportunity for expansion and an area with strong growth potential based on



 

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attractive demographics and market characteristics. In 2012, we expanded into Dallas with a team of bankers with whom our management team had previously worked, by establishing two loan production offices, or LPOs. We further expanded our presence in the Dallas/Fort Worth metropolitan area in 2013 through a whole-bank acquisition and subsequently converted the LPOs into two full-service de novo branches. At the end of 2013, we acquired a bank in The Woodlands, which is located in North Houston, in a FDIC-assisted transaction. Most recently, in 2016, we acquired an additional branch in a strategic location in The Woodlands.

Today, we have 15 full-service branches located in three Texas markets—the Houston, Dallas/Fort Worth and Bryan/College Station metropolitan areas. We believe our exposure to these dynamic and complementary markets provides us with economic diversification and the opportunity for expansion across Texas. We have experienced significant growth since our formation while maintaining strong credit metrics, as demonstrated by:

 

    Our balance sheet growth, with a compound annual growth rate, or CAGR, of 10.5% in assets, 12.3% in loans held for investment and 12.4% in deposits from December 31, 2015 to December 31, 2017;

 

    Our noninterest bearing deposit growth, with a CAGR of 24.1% from December 31, 2015 to December 31, 2017; and

 

    Our earnings growth, with a CAGR of 9.8% in net income and 10.1% in diluted earnings per common share for the twelve months ended December 31, 2015 to the twelve months ended December 31, 2017. The decrease in net income and diluted earnings per common share for the twelve months ended December 31, 2016 compared to the twelve months ended December 31, 2015 was partially as a result of expenditures for additional personnel and infrastructure as part of and to support our growth efforts.

 

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We have supplemented our strong organic growth through strategic bank acquisitions. Since our formation, we have completed three whole-bank acquisitions, three branch acquisitions consisting of six branches, and one FDIC-assisted acquisition. These transactions result in us being the most active acquirer among private Texas-based banks and third most active acquirer among Texas-based banks (in each case, based on number of transactions) since 2008, according to data obtained through S&P Global. These acquisitions demonstrate our ability to identify acquisition targets, negotiate and execute definitive agreements, and integrate different systems and cultures into our own. In addition, we have proven our ability to leverage the new capabilities obtained through these acquisitions as evidenced by strong organic growth in acquired markets and continuously enhanced product offerings for our customers. We evaluate acquisitions based on a defined set of criteria, including earnings per share accretion, reasonable tangible book value per share earn back periods and enhanced shareholder value.

The following table summarizes the acquisitions that we have completed since our inception and excludes cash received and paid and other acquired liabilities:

 

Target Company / Seller

  

Acquisition Type

    

Market Area

     Completion
Date
       Acquired
Assets
       Acquired
Deposits
 
                            (Dollars in Millions)  

Snook Bancshares

   Whole-Bank      College Station        11/17/2008        $ 38.6        $ 35.9  

Third Coast Bank, SSB

   2 Branches      Houston        10/23/2009          9.2          18.6  

Texas Community Bank, N.A.

   3 Branches      Houston        10/29/2011          42.9          58.9  

Oasis Bank, SSB

   Whole-Bank      Houston        11/30/2012          79.3          69.0  

Peoples Bank

   Whole-Bank      Dallas/Fort Worth        7/13/2013          70.8          60.8  

Texas Community Bank, N.A.

   FDIC-Assisted      Houston        12/13/2013          134.1          118.7  

PlainsCapital Bank

   1 Branch      Houston        6/24/2016          4.4          36.7  

Our Banking Strategy

We are a business-focused bank that delivers relationship-driven financial services to small and medium-sized businesses as well as individuals in our market areas. The following further articulates our banking strategy:

 

   

Diverse Lending Platform. Our strategy is to provide a broad array of financial services, which results in a diverse loan portfolio that consists primarily of: commercial and industrial loans; 1-4 single family residential real estate loans; construction, land and development loans; and commercial real estate loans. We focus on delivering superior customer service, responsive decision-making and personal customer relationships. We believe our target customer base is underserved by larger financial institutions, and our ability to execute our relationship banking model and respond quickly to customers gives us an advantage over our competition. Our approach is to equip commercial lenders



 

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with the tools and support necessary to serve their clients, including advanced training, treasury management support, quick access to lending management and timely credit decisions. Our lenders are evaluated on their ability not only to originate loans but also to gather deposits and maintain a portfolio with sound credit quality.

 

    Small Business Administration (SBA) Lending. During the SBA’s fiscal year ended September 30, 2017, the Bank was the leading SBA lender among community banks in Texas, based on the number of loans closed. We primarily lend through the SBA 7(a) program and we have a dedicated team focused on origination, documentation and closing of SBA loans. SBA lending has been a core competency since our inception, and our SBA leadership team has an average of 15 years of experience dedicated to the program. Our strategy is to sell the government-guaranteed portion of the loan (generally 75% to 85% of the principal balance), on which we generate an up-front premium. In addition to selling the guaranteed portion of the loan, we retain the servicing rights to the loans that we sell, and we collect the associated servicing fees, which are typically 1% of the principal balance of the loan. For the years ended December 31, 2015 through 2017, we originated 243, 202 and 270 SBA loans totaling $53.9 million, $46.7 million and $71.2 million, respectively. During these periods, we generated gains on sales of SBA loans of $4.4 million, $4.4 million and $5.7 million, respectively. As of December 31, 2017, we had SBA loans on our balance sheet of $67.1 million, and we serviced $275.2 million of SBA loans. We maintain strict underwriting guidelines in our SBA program, which has contributed to our success. More than 75% of our SBA customers are national franchisees, which we believe leads to fewer losses because we are able to mitigate risk by analyzing loss histories of similar businesses and the national franchise provides greater support to our borrowers. Additionally, our SBA loans are subject to the same credit review process as our conventional lending customers. We believe these factors have contributed to our SBA portfolio performing better than the national SBA three year average loss rate.

We are a Preferred Lenders Program participant with the SBA, which allows us to accelerate the SBA documentation process. To date, we have not been notified of any denial or repair of the SBA guaranty on any loan submitted for liquidation. An annual review by an independent third party validates the performance of the portfolio and the integrity of the documentation. This lending channel provides us with a competitive advantage and opportunity to earn a borrower’s banking relationship early in the business’s life cycle. Once we have originated an SBA loan, we believe we are optimally positioned to continue to service the customer as the customer’s business matures.

 

    Deposit Gathering Focus. We are focused on generating core deposits from our business customers. We improved our treasury management services by hiring additional personnel and offering more products to enable us to more effectively attract and service the operating accounts of larger, more sophisticated businesses. These efforts have produced desirable results, as evidenced by our growth in non-interest bearing deposits from $114.8 million at December 31, 2015 to $176.7 million at December 31, 2017, a 53.9% increase. We believe that over time we will continue to successfully grow our core deposit base through commercial customers as well as our strategically located retail branches. In addition to our organic deposit efforts, we will continue to place an emphasis on the acquisition of banks with high-quality funding profiles to enhance our core deposit base.

 

    Scalable Infrastructure. Throughout our history, we have been strategic in the hiring of key personnel and implementation of systems and processes that we believe are advanced for a bank of our size, which we expect will allow us to scale our business model without significant additional noninterest expense going forward. This includes a sophisticated loan review process, dedicated senior credit and compliance officers, and robust internal and external loan review programs. As we are able to leverage our current expense base as a larger company, we expect to experience enhanced shareholder returns through operational efficiencies.


 

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Our Growth Strategy

We believe we have managed our growth successfully since inception, and plan to continue our strategy of organic and acquisitive growth, as outlined below:

 

    Organic Growth. Our organic growth strategy involves building upon the relationships of our 41 commercial lenders and SBA lenders as of December 31, 2017, who we believe have additional capacity to grow the loan portfolio. We have designed our incentive plans to emphasize strong credit quality, loan growth and deposit growth. From December 31, 2015 to December 31, 2017, we have grown loans held for investment and deposits by $180.3 million and $174.0 million, or 26.2% and 26.3%, respectively. With the exception of the acquisition of one branch in June 2016 with $36.7 million in deposits and no loans, we achieved our loan and deposit growth since January 2014 organically. We intend to further penetrate our current market areas by leveraging our lending relationships and continuing to hire additional junior and senior lenders. Our senior lenders typically have 15 – 30 years of experience and are supported by our junior lenders. We hire junior lenders, initially in a credit analyst support capacity, so that we may conduct training in-house and in accordance with our lending methodologies. We incentivize our senior lenders to incorporate our junior lenders into their book of business by compensating our senior lenders, in part, based on region-wide performance, as opposed to compensation based entirely on the senior lender’s individual portfolio. This program is an integral part of our lending and credit culture.

During late 2017 and year-to-date 2018, to expand our lending capacities, we hired four senior lenders in the Houston and Dallas/Fort Worth metropolitan areas. We expect these professionals will generate and maintain meaningful loan portfolios, while also continuing our focus on increasing core deposits to fund loan growth. We intend to continue to seek out talented bankers that are a good cultural fit and have long standing business relationships in our markets. In addition to leveraging our current platform and hiring key personnel to drive organic growth, we also look for opportunities to open de novo branches in existing and new markets. Before entering a new market, we have historically identified a lending team that is experienced and seasoned in that market and opened an LPO, with the ultimate goal of establishing a full-service branch.

 

    Growth Through Acquisitions. Throughout our history, we have supplemented our organic growth through both whole-bank and branch acquisitions, as well as an FDIC-assisted acquisition, and we intend to continue our strategy of opportunistically acquiring Texas-based community banks and branches within and outside our current footprint. We believe having a publicly traded stock and enhanced access to the capital markets will improve our ability to compete for quality acquisitions. We seek acquisitions that provide meaningful financial and strategic benefits, long-term organic growth opportunities and expense reductions, without compromising our risk profile. When evaluating acquisition targets, we focus our efforts on banks with successful operating histories, stable core deposits, sound asset quality, and strong banking talent. We seek banking markets with attractive demographics, favorable competitive dynamics and potential consolidation opportunities. We are currently focused on acquisitions in and surrounding the four major Texas metropolitan areas of Houston, Dallas/Fort Worth, San Antonio and Austin. In an effort to source future potential acquisitions, our management team maintains an active calling effort with banks that fit our acquisition criteria. With approximately 370 banks headquartered in Texas with total assets less than $1 billion, we believe we will have opportunities for acquisitions both within and outside our current footprint.

Our Competitive Strengths

We believe the following competitive strengths support our banking and growth strategies:

 

   

Management Depth and Experience. Our executive management team has more than 39 years of banking experience on average with proven track records, experience and deep customer relationships



 

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in our markets. Our Chairman and Chief Executive Officer, Dean O. Bass, and our President and the Bank’s President and Chief Lending Officer, David M. McGuire, worked together previously to successfully build a de novo banking franchise, Royal Oaks Bank, through organic growth and strategic acquisitions. Royal Oaks Bank was sold for over three times tangible book value in 2007, just six years after its formation. Eight of our senior officers are former presidents of Texas banks, offering decades of market knowledge and relationships. Our management team has significant depth of leadership in areas such as lending, credit administration, finance, operations, compliance, internal audit and information technology. Key executives of our company include:

 

    Dean O. Bass—Chairman, Founder and Chief Executive Officer of our Company and of the Bank. Our senior management team is led by Dean O. Bass, a 44-year banking veteran. In 2001, he founded Royal Oaks Bank and served as the President and Chief Executive Officer. Following the 2007 sale of Royal Oaks Bank, Mr. Bass led the formation of the Bank in 2008. Prior to co-founding Royal Oaks Bank, Mr. Bass served as a Senior Vice President at Horizon Capital Bank and was a National Bank Examiner for the Office of the Comptroller of the Currency. Mr. Bass has been involved in the formation of several de novo banking offices and branches.

 

    David M. McGuire—President and Director of our Company and President and Chief Lending Officer of the Bank. Mr. McGuire has 37 years of banking experience and was previously the Co-Founder, President and Chief Lending Officer of Royal Oaks Bank. Prior to Royal Oaks Bank, Mr. McGuire served as the Office Chief Executive Officer-Fort Bend for Sterling Bank.

 

    Jerry D. Golemon—Executive Vice President and Chief Operating Officer of our Company and the Bank. Mr. Golemon is a 37-year banker and a Certified Public Accountant. Mr. Golemon’s prior experience includes serving as the Chief Financial Officer and a founding director at Texas National Bank, which was sold in 2006 to First Community Bank. Additionally, Mr. Golemon has previously worked for a Houston-based certified public accounting firm focused on bank audits as well as served in a chief financial officer or similar capacity for other banks.

 

    Jeffrey A. Powell—Executive Vice President and Chief Financial Officer of our Company and the Bank. Mr. Powell has worked in the banking industry for 38 years and has served as chief financial officer or chief accounting officer for multiple commercial banks and their respective holding corporations, both public and private, since 2005, including Hamilton State Bancshares, Inc., IBERIABANK Corporation and Citizen Republic Bancorp, Inc.

For additional information regarding our executive management and board of directors, see “ManagementExecutive Officers and Directors.”

 

    Acquisition Experience. We believe we have a talent for identifying, acquiring and integrating acquisition targets which are accretive to our earnings per share, as evidenced by the successful execution and integration of three whole-bank acquisitions, three branch acquisitions and one FDIC-assisted acquisition. These transactions result in our being the most active acquirer among private Texas-based banks and third most active acquirer among Texas-based banks (in each case, based on number of transactions) since 2008, according to data obtained through S&P Global. We believe that we have a disciplined approach to acquisitions and continue to seek companies and branches that will be additive to our franchise and accretive to our earnings per share.

 

   

Strong Credit Culture. Credit culture has always been a core tenet of the Bank and, as a result, our loss history has been minimal. No lender has sole authority for any loan originated, regardless of credit size or relationship depth. Our credit review process is led by our Chief Credit Officer and two Deputy Chief Credit Officers, each having over 30 years of experience in credit analysis. Every credit in the Bank must be reviewed and approved by one of these officers. Additionally, every borrowing relationship that exceeds $1.5 million must be approved by the Directors Loan Committee. We strive to balance our focus on credit quality with our customer’s interest in having a rapid credit response. We have developed



 

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compensation packages for our lenders which include incentives based on the credit quality of their portfolios. We have averaged 0.09% net charge-offs as a percent of average loans in the years 2015 through 2017 and, as of December 31, 2017, our non-performing assets to assets ratio was 0.35%.

 

    Limited Oil and Gas Exposure. We are not an active lender to oil and gas exploration and production companies. We have no direct oil and gas exploration or production loan exposure with respect to our outstanding loans as of December 31, 2017. However, we have a small amount of direct and indirect lending exposure to the oil and gas industry, which we monitor closely. We define direct exposure as companies that derive more than 50% of their respective gross revenue from providing services or products to the oil and gas industry. Based on this criteria, as of December 31, 2017, we had 25 direct oil and gas loans totaling $15.4 million, or 1.8% of outstanding loans. We define indirect exposure as individuals whose primary source of earnings are from the oil and gas industry, or companies that derive less than 50% of their revenues from providing services or products to the oil and gas industry. Based on this criteria, as of December 31, 2017, we had 68 indirect oil and gas loans totaling $22.2 million, or 2.6% of outstanding loans.

Our Markets

Our primary markets are the Houston, Dallas/Fort Worth and Bryan/College Station metropolitan areas. We expect to continue to grow within our current markets, as well as expand into new markets. We believe the markets that we serve are a key factor in our growth and success, and offer stability and steady growth as well as economic diversification.

We believe that our three markets are economically insulated from one another, and economic hardships in one market may have little or no impact on the other markets. For example, during the period from 2015 through the end of 2016, the Houston metropolitan area experienced a slowdown in economic activity, in part, due to a prolonged period of lower crude oil and natural gas prices. While we did not experience heightened losses on our loan portfolio in the Houston metropolitan area, we observed a slowdown in lending opportunities in that market. Conversely, in the Dallas/Fort Worth metropolitan area and the Bryan/College Station metropolitan area, we exceeded our loan growth expectations over the same time period, leading to overall robust loan growth. We expect that the diversification of our markets will continue to benefit us in the future.

We have demonstrated our ability to operate successfully in the event of a natural disaster. In August 2017, Hurricane Harvey produced between 36 and 48 inches of rainfall, causing widespread damage to the Houston metropolitan area and surrounding markets. While the flooding was devastating to much of the areas we serve, there was minimal immediate impact to our business, and none of our branches flooded. Our Houston area branches were fully operational on August 30, just three days after the storm made landfall. Our Houston area branches were closed for two work days, with the exception of one Houston branch which was closed for three days, while our operations center in College Station remained open for business throughout the disaster. Our lenders promptly reached out to customers to determine any damages or disruptions to their households or businesses. We offered payment extensions to customers impacted by the disaster and followed up with them to determine their progress. Although the Houston metropolitan area continues to recover from Hurricane Harvey, as of the date of this prospectus, we have identified no significant losses or deterioration in our loan portfolio. We are unable to predict with certainty the long-term impact that Hurricane Harvey may have on the markets in which we operate. We will continue to monitor the residual effects of Hurricane Harvey on our business and customers.

According to S&P Global, Texas is the second most populous state in the country with a population of 28.5 million as of January 2018. Over 50% of the Texas population lives in the three markets in which we operate. Additionally, the five-year population growth from 2018 to 2023 is projected to be 7.1% compared to 3.5% for the nation as a whole over the same period.



 

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                               Market Demographics  
                               January 2018
Population(3)
       2018 – 2023 Projected  
    Spirit of Texas Bancshares, Inc.(1)             Population
Growth(3)
     Household
Income
Growth(3)
 

Market

  Branches        Loans(2)        Deposits(2)               
         (Dollars in thousands)               

Houston MSA

    10        $ 369,013        $ 505,226          6,980,780          8.3      7.7

Dallas/Fort Worth MSA

    4          171,342          124,149          7,418,556          7.7      9.8

Bryan/College Station MSA

    1          119,120          112,799          263,260          7.8      13.6

Texas

    15                    28,531,603          7.1      9.5

United States

                   326,533,070          3.5      8.9

 

(1) Amounts as of December 31, 2017
(2) Excludes SBA loans, loans to foreign nationals, and mortgage loans (as well as associated deposits)
(3) According to S&P Global

 

    Houston. According to the U.S. Bureau of Economic Analysis, the Houston metropolitan area had the sixth largest gross domestic product in the U.S. in 2016. The Houston metropolitan area is the corporate headquarters for 20 Fortune 500 companies, ranking fourth among metro areas according to the Greater Houston Partnership. Notable corporate headquarters include ConocoPhillips, Sysco, Waste Management and Phillips 66. Over the past several years, the Houston metropolitan area has grown to be a diverse economy. While Houston is known as the “Energy Capital of the World,” Houston also boasts the largest medical complex in the world, has the second busiest port in the United States in 2017, and is a leader in international business. Houston’s economic success is projected to continue, with employment growth of 1.74% annually through the year 2040, according to the Perryman Group.

The northern portion of our Houston franchise includes our branches in The Woodlands, Conroe, Magnolia and Tomball. According to S&P Global, these four cities have experienced a combined population growth of over 65% over the past six years. Additionally, Conroe, Texas was named the fastest growing city in the country in 2016, according to the U.S. Census Bureau. This robust population expansion over the last several years is largely a result of the companies headquartered in the area, such as Anadarko Petroleum, Aon Hewitt, Waste Connections, Inc. and Baker Hughes, among others, according to The Houston Chronicle. Additionally, The Woodlands area is expected to continue to see increased economic activity due to the opening of ExxonMobil’s new corporate campus in 2015, which is designed to accommodate over 9,000 employees.

 

   

Dallas/Fort Worth. We have four branches located in the Dallas/Fort Worth metropolitan area, including in Central Dallas, Grapevine, Colleyville, and Fort Worth. Home to a major international airport and many large corporations, the diverse and sprawling Dallas/Fort Worth metropolitan area is the largest metropolitan statistical area in Texas and fourth largest in the nation as of 2018, according to S&P Global. Out of the top twenty metropolitan statistical areas in the nation in 2017, the Dallas/Fort Worth metropolitan area saw the second highest population growth from 2010 – 2018 and third highest employment growth from 2015 – 2018, according to S&P Global. According to the Dallas Regional Chamber of Commerce, the area also serves as the corporate headquarters for 22 Fortune 500 companies including Southwest Airlines, AT&T, Exxon Mobil and Kimberly-Clark, ranking the Dallas/Fort Worth metropolitan area third in the nation for Fortune 500 corporate headquarters. According to Forbes, the Dallas/Fort Worth metropolitan area was named the best city for jobs in 2017. Additionally, Toyota relocated its North American headquarters to the area, adding 4,000 jobs, according to a statement by Toyota’s North America CEO, while a State Farm expansion is expected to contribute approximately 10,000 jobs to the Dallas/Fort Worth area, according to the Dallas Business Journal. According to the U.S. Bureau of Economic Analysis, the Dallas/Fort Worth metropolitan area is responsible for producing nearly 32% of the state’s total gross domestic product in 2016 and, according to the Dallas Economic Development, the Dallas/Fort Worth metropolitan area is home to



 

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over 65,000 businesses, adding over 300 jobs per day on average over the 12 months ended February 2017, according to Transwestern. The Dallas/Fort Worth metropolitan area is also home to six professional sports teams and several major universities as well as multiple community college districts, with total student enrollment of over 370,000.

 

    Bryan/College Station. According to Forbes, the Bryan/College Station metropolitan area ranked first in Texas and third nationwide for Best Small Places for Business and Careers in 2017 with job growth of 10.3% from 2015 to 2018. In 2016, total construction project valuation in Bryan/College Station was over $750 million. The Bryan/College Station metropolitan area is also home to Texas A&M University, which enrolls over 68,000 students and is the largest university in the state. Notable ongoing projects include the Texas A&M RELLIS Campus, a $250 million, 2,000 acre campus dedicated to technology development, as well as the continued development of ATLAS, a master planned community and business complex specifically constructed for companies engaged in medical technology and pharmaceuticals.

Our Corporate Information

Our principal executive offices are located at 1836 Spirit of Texas Way, Conroe, Texas 77301, and our telephone number is (936) 521-1836. We changed our name from ST Financial Group, Inc. to Spirit of Texas Bancshares, Inc. on February 24, 2017. Through the Bank, we maintain an Internet website at www.sotb.com. The information contained on or accessible from our website does not constitute a part of this prospectus and is not incorporated by reference herein.



 

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THE OFFERING

 

Common stock we are offering

                    shares (                 shares if the underwriters exercise their option to purchase additional shares in full)

Common stock to be outstanding after this offering

                    shares (                shares if the underwriters exercise their option to purchase additional shares in full)

Use of proceeds

  

We estimate that the net proceeds to us from the sale of common stock in this offering will be approximately $        million (or approximately $         million if the underwriters exercise their option to purchase additional shares in full), after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We intend to use the net proceeds from this offering to fund organic growth in new and existing markets, potential future merger and acquisition activity, and general corporate purposes. We may use a portion of the net proceeds from this offering to repay outstanding indebtedness under our line of credit, plus accrued and unpaid interest, which was $7.8 million as of December 31, 2017. We have no current agreements or understandings with respect to any acquisitions. See “Use of Proceeds.”

Dividend policy

   We have not historically declared or paid any dividends on our common stock, and we currently intend to retain all future retained earnings, if any, in our business to fund growth. We do not anticipate paying any dividends on our common stock in the foreseeable future. See “Dividend Policy.”

Rank

   Our common stock is subordinate to balances outstanding under our revolving credit facilities and any debt that we may issue in the future and may be subordinate to any series of preferred stock that we may issue in the future.

Directed share program

   At our request, the underwriters have reserved up to                  shares of the common stock that we are offering in this prospectus, for sale, at the initial public offering price, to our directors, officers, employees, and certain other persons who have expressed interest in purchasing our common stock in this offering. The number of shares available for sale to the general public in this offering will be reduced to the extent these persons purchase the reserved shares. Any


 

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   reserved shares that are not purchased will be offered by the underwriters to the general public on the same terms as the other shares.

Risk factors

   Investing in our common stock involves risks. See “Risk Factors” for a discussion of factors you should carefully consider before deciding to invest in our common stock.

Listing

   We have applied to list our common stock on the NASDAQ Global Market under the symbol “STXB.”

 

 

Except as otherwise indicated, all of the information in this prospectus:

 

    gives effect to the preferred stock conversion and reverse stock split described under the heading “Note Regarding Reverse Stock Split and Preferred Stock Conversion and Restatement,” unless otherwise noted;

 

    assumes no exercise of the underwriters’ option to purchase up to                additional shares of common stock from us;

 

    excludes 1,415,350 shares of common stock issuable upon the exercise of outstanding options at a weighted average exercise price of $12.59 per share (1,070,475 shares of which were exercisable), under our 2008 Stock Plan as of December 31, 2017;

 

    excludes 127,927 shares of common stock issuable upon the exercise of outstanding options at a weighted average exercise price of $15.00 per share (65,000 shares of which were exercisable), under our 2017 Stock Plan as of December 31, 2017;

 

    excludes 281,625 shares of common stock reserved for issuance in connection with stock options available for issuance under our 2008 Stock Plan as of December 31, 2017 (we do not intend to grant any further awards under the 2008 Stock Plan);

 

    excludes 872,073 shares of common stock reserved for issuance in connection with stock options available for issuance under our 2017 Stock Plan as of December 31, 2017;

 

    excludes 105,000 shares of common stock issuable upon the exercise of outstanding warrants at an exercise price of $10.00 per share (all of which were exercisable), as of December 31, 2017;

 

    excludes 12,072 shares of common stock issuable upon the exercise of outstanding warrants at an exercise price of $10.50 per share (all of which were exercisable), as of December 31, 2017;

 

    excludes 19,140 shares of common stock issuable upon the exercise of outstanding warrants at an exercise price of $12.84 per share (all of which were exercisable), as of December 31, 2017;

 

    does not attribute to any director, executive officer or principal shareholder any purchase of shares of our common stock in this offering, including through the directed share program described in “Underwriting—Directed Share Program;” and

 

    assumes an initial offering price of $         per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus.


 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

The following selected historical consolidated financial data as of and for the years ended December 31, 2017 and 2016 have been derived from our audited consolidated financial statements appearing elsewhere in this prospectus, and the selected historical consolidated financial data as of and for the year ended December 31, 2015 have been derived from our audited consolidated financial statements not appearing in this prospectus.

You should read the selected historical consolidated financial data set forth below in conjunction with the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     As of and for the Years Ended
December 31,
 
     2017      2016
Restated
     2015
Restated(8)
 
    

(Dollars in thousands,

except per share data)

 

Selected Balance Sheet Data:

        

Total assets

   $ 1,030,298      $ 980,489      $ 843,768  

Loans held for sale

     3,814        4,003        6,320  

Loans held for investment

     869,119        772,861        688,850  

Allowance for loan and lease losses

     (5,652      (4,357      (3,076

Loans, net

     863,467        768,504        685,774  

Total deposits

     835,368        814,438        661,391  

Short-term borrowings

     15,000        5,000        40,000  

Long-term borrowings

     76,411        66,016        51,850  

Total stockholders’ equity

     99,139        92,896        87,927  

Selected Income Statement Data:

        

Total interest income

   $ 46,907      $ 40,210      $ 38,767  

Total interest expense

     8,328        6,730        5,526  
  

 

 

    

 

 

    

 

 

 

Net interest income

   $ 38,579      $ 33,480      $ 33,241  
  

 

 

    

 

 

    

 

 

 

Provision for loan losses

     2,475        1,617        1,580  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

   $ 36,104      $ 31,863      $ 31,661  
  

 

 

    

 

 

    

 

 

 

Total noninterest income

     9,638        8,342        7,871  

Total noninterest expense

     37,402        34,881        33,496  

Income before income tax expense

     8,340        5,324        6,036  

Income tax expense

     3,587        1,609        2,094  
  

 

 

    

 

 

    

 

 

 

Net income

   $ 4,753      $ 3,715      $ 3,942  
  

 

 

    

 

 

    

 

 

 

Adjusted net income(1)

   $ 5,587        N/A        N/A  
  

 

 

       

Selected Share and Per Share Data:(2)

        

Earnings per common share - Basic

   $ 0.65      $ 0.51      $ 0.55  

Adjusted earnings per common share - Basic(1)

   $ 0.77        N/A        N/A  

Earnings per common share - Diluted

   $ 0.63      $ 0.50      $ 0.52  

Adjusted earnings per common share - Diluted(1)

   $ 0.74        N/A        N/A  

Book value per share(3)

   $ 13.62      $ 12.83      $ 12.15  

Tangible book value per share(4)

   $ 12.52      $ 11.63      $ 10.95  

Weighted average common shares outstanding - Basic

     7,268,297        7,235,479        7,230,023  

Weighted average common shares outstanding - Diluted

     7,554,458        7,375,945        7,578,755  

Shares outstanding at end of period

     7,280,183        7,239,763        7,234,738  


 

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     As of and for the Years Ended
December 31,
 
     2017     2016
Restated
    2015
Restated(8)
 
    

(Dollars in thousands,

except per share data)

 

Selected Performance Ratios:

      

Return on average assets

     0.47     0.41     0.49

Adjusted return on average assets(1)

     0.55       N/A       N/A  

Return on average stockholders’ equity

     4.88       4.09       4.49  

Adjusted return on average stockholders’ equity(1)

     5.74       N/A       N/A  

Net interest margin(5)

     4.19       4.09       4.54  

Noninterest expense to average assets

     3.71       3.86       4.15  

Efficiency ratio(6)

     76.04       81.98       80.77  

Average interest-earning assets to average interest-bearing liabilities

     126.42       125.04       125.69  

Loans to deposits

     104.04       94.90       104.15  

Yield on interest-earning assets

     4.97       4.79       5.18  

Cost of interest-bearing liabilities

     1.12       1.00       0.93  

Interest rate spread

     3.85       3.79       4.25  

Asset and Credit Quality Ratios:

      

Nonperforming loans to loans held for investment

     0.41       0.49       0.35  

Nonperforming assets to loans plus OREO

     0.42       0.50       0.39  

Nonperforming assets to total assets

     0.35       0.39       0.32  

Net charge-offs to average loans

     0.14       0.05       0.08  

Allowance for loan losses to nonperforming loans

     157.22       114.45       128.49  

Allowance for loan losses to loans held for investment

     0.65       0.56       0.45  

Capital Ratios:

      

Average equity to average total assets

     9.66       10.04       10.88  

Tangible equity to tangible assets(7)

     8.92       8.67       9.49  

Tier 1 leverage ratio

     8.71       8.75       9.32  

Common equity tier 1 capital ratio

     10.07       10.83       11.21  

Tier 1 risk-based capital ratio

     10.07       10.83       11.21  

Total risk-based capital ratio

     10.72       11.41       11.65  

 

(1) Amounts are non-GAAP financial measures that exclude the 2017 impact of remeasurement of our deferred tax assets following the passage of H.R.1, originally known as the Tax Cuts and Jobs Act, which was enacted on December 22, 2017, or the Tax Reform. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”
(2) All share and per share information reflects the conversion of 170,236 shares of our issued and outstanding Series A preferred stock into common stock on February 23, 2017 and the one-for-two reverse stock split that occurred on March 16, 2017 as if they had occurred on January 1, 2015.
(3) We calculate book value per share as total stockholders’ equity at the end of the relevant period divided by the outstanding number of shares of our common stock at the end of the relevant period.
(4) We calculate tangible book value per share as total stockholders’ equity less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, divided by the outstanding number of shares of our common stock at the end of the relevant period. Tangible book value per share is a non-GAAP financial measure. The most directly comparable GAAP financial measure is book value per share. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.” 


 

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(5) Net interest margin is shown on a fully taxable equivalent basis, which is a non-GAAP financial measure. We calculate the GAAP-based net interest margin as interest income divided by average interest-earning assets. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Non-GAAP Financial Measures.”
(6) Efficiency ratio, as we calculate it, is a non-GAAP financial measure. We calculate efficiency ratio as noninterest expense, less the amortization of intangible assets, divided by the net interest income plus noninterest income, less gains on sales of premises and equipment and gains on sales of securities. The GAAP-based efficiency ratio is calculated as noninterest expense divided by net income plus noninterest income. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”
(7) We calculate tangible equity as total stockholders’ equity less goodwill and other intangible assets, net of accumulated amortization, and we calculate tangible assets as total assets less goodwill and other intangible assets, net of accumulated amortization. Tangible equity to tangible assets is a non-GAAP financial measure. The most directly comparable GAAP financial measure is total stockholders’ equity to total assets. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.” Tangible equity reflects the conversion of 170,236 shares of our issued and outstanding Series A preferred stock into common stock on February 23, 2017 and the one-for-two reverse stock split that occurred on March 16, 2017.
(8) December 31, 2015 reflects the correction of errors as further discussed in Note 20, Correction of Errors and Restatements, in the notes to our consolidated financial statements for the years ended December 31, 2017 and 2016. For the year ended December 31, 2015, total assets, loans held for investment and total stockholders’ equity increased by $633 thousand, $783 thousand, and $613 thousand, respectively. Additionally, total interest income increased by $413 thousand, and total noninterest income and noninterest expense decreased by $457 thousand and $704 thousand, respectively. Income tax expense and net income increased by $215 thousand and $445 thousand, respectively.


 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. Before you decide to invest in our common stock, you should carefully consider the risks described below, together with all other information included in this prospectus, including our consolidated financial statements and the related notes included elsewhere in this prospectus. We believe the risks described below are the risks that are material to us as of the date of this prospectus. If any of the following risks actually occur, our business, financial condition, results of operations and growth prospects could be materially and adversely affected. In that case, you could experience a partial or complete loss of your investment. This prospectus also contains forward-looking statements, estimates and projections that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements, estimates and projections as a result of specific factors, including the risk factors described below.

Risks Related to Our Business

We conduct our operations almost exclusively in Texas, specifically in the Houston and Dallas/Fort Worth metropolitan areas, which imposes risks and may magnify the consequences of any regional or local economic downturn affecting our Texas markets, including any downturn in the energy, technology or real estate sectors.

We conduct our operations almost exclusively in Texas, specifically in the Houston and Dallas/Fort Worth metropolitan areas, and, as of December 31, 2017, the substantial majority of the loans in our loan portfolio were made to borrowers who live and/or conduct business in our Texas markets. Likewise, as of such date, the substantial majority of our secured loans were secured by collateral located in Texas. Accordingly, we are exposed to risks associated with a lack of geographic diversification. The economic conditions in Texas significantly affect our business, financial condition, results of operations and future prospects, and any adverse economic developments, among other things, could negatively affect the volume of loan originations, increase the level of non-performing assets, increase the rate of foreclosure losses on loans and reduce the value of our loans and loan servicing portfolio. Any regional or local economic downturn that affects our Texas markets, our existing or prospective borrowers or property values in our market areas may affect us and our profitability more significantly and more adversely than our competitors whose operations are less geographically focused.

The economies in our Texas markets are also highly dependent on the energy sector as well as the technology and real estate sectors. In particular, a decline in or volatility of the prices of crude oil or natural gas could adversely affect many of our customers. Any downturn or adverse development in our Texas markets, including as a result of a downturn in the energy, technology or real estate sectors could have a material adverse impact on results of operations and financial condition.

We may not be able to implement aspects of our growth strategy, which may affect our ability to maintain our historical earnings trends.

Our strategy focuses on organic growth, supplemented by acquisitions. We may not be able to execute on aspects of our growth strategy to sustain our historical rate of growth or may not be able to grow at all. More specifically, we may not be able to generate sufficient new loans and deposits within acceptable risk and expense tolerances, obtain the personnel or funding necessary for additional growth or find suitable acquisition candidates. Various factors, such as economic conditions and competition, may impede or prohibit the growth of our operations, the opening of new branches and the consummation of acquisitions. Further, we may be unable to attract and retain experienced bankers, which could adversely affect our growth. The success of our strategy also depends on our ability to effectively manage growth, which is dependent upon a number of factors, including our ability to adapt our existing credit, operational, technology and governance infrastructure to accommodate expanded operations. If we fail to implement one or more aspects of our strategy, we may be unable to maintain our historical earnings trends, which could have an adverse effect on our business.

 

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Difficult market conditions and economic trends have adversely affected the banking industry and could adversely affect our business, financial condition and results of operations.

We are operating in a challenging and uncertain economic environment, including generally uncertain conditions nationally and locally in our industry and markets. Although economic conditions have improved in recent years, financial institutions continue to be affected by volatility in the real estate market in some parts of the country, prolonged period of lower crude oil and natural gas prices and uncertain regulatory and interest rate conditions. We retain direct exposure to the residential and commercial real estate markets in Texas, particularly in the Houston and Dallas/Fort Worth metropolitan areas, and are affected by these conditions. In addition, financial institutions in Texas have been affected by a prolonged period of lower crude oil and natural gas prices. Our markets have also recently been affected by Hurricane Harvey, which could have a materially adverse impact on our business, financial condition and operations. See “—Our primary markets are susceptible to severe weather events that could negatively impact the economies of our markets, our operations or our customers, any of which impacts could have a material adverse effect on our business, financial condition and results of operations.”

Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio is made more complex by uncertain market and economic conditions, including a prolonged period of lower crude oil and natural gas prices and market and economic conditions resulting from severe weather events. Another national economic recession or deterioration of conditions in our markets could drive losses beyond that which is provided for in our allowance for loan and lease losses and result in the following consequences:

 

    increases in loan delinquencies;

 

    increases in non-performing assets and foreclosures;

 

    decreases in demand for our products and services, which could adversely affect our liquidity position; and

 

    decreases in the value of the collateral securing our loans, especially real estate, which could reduce customers’ borrowing power and repayment ability.

Although real estate markets have stabilized in portions of the U.S., a resumption of declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, including a prolonged period of lower crude oil and natural gas and market and economic conditions resulting from severe weather events, could have an adverse effect on our borrowers or their customers, which could adversely affect our business, financial condition and results of operations.

Our primary markets are susceptible to severe weather events that could negatively impact the economies of our markets, our operations or our customers, any of which impacts could have a material adverse effect on our business, financial condition and results of operations.

Tornadoes, droughts, wildfires, flooding, hurricanes, hailstorms, damaging winds, tropical storms, and other natural disasters and severe weather events can have an adverse impact on our business, financial condition and operations, cause widespread property damage and have the potential to significantly depress the local economies in which we operate. We operate banking locations in the Houston, Dallas/Fort Worth and Bryan/College Station metropolitan areas, which are susceptible to hurricanes, tropical storms and other natural disasters and severe weather conditions. For example, in late August 2017, Hurricane Harvey, a Category 4 hurricane when it made landfall on the Texas gulf coast, caused extensive and costly damage across Southeast Texas. The Houston area received between 36 and 48 inches of rainfall, which resulted in catastrophic flooding and unprecedented damage to residences and businesses. As of the date of this prospectus, we are unable to predict with certainty the full impact of the storm on the markets in which we operate, including any adverse impact on our customers and our loan and deposit activities and credit exposures.

Future severe weather events in our market could potentially result in extensive and costly property damage to businesses and residences, force the relocation of residents and significantly disrupt economic activity in our

 

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market. We cannot predict the extent of damage that may result from such severe weather events, which will depend on a variety of factors that are beyond our control, including, but not limited to, the severity and duration of the event, the timing and level of government responsiveness and the pace of economic recovery. If the economies in our primary markets experience an overall decline as a result of a catastrophic event, demand for loans and our other products and services could decline. In addition, the rates of delinquencies, foreclosures, bankruptcies and losses on our loan portfolios may increase substantially after events such as hurricanes, as uninsured property losses, interruptions of our customers’ operations or sustained job interruption or loss may materially impair the ability of borrowers to repay their loans. Moreover, the value of real estate or other collateral that secures our loans could be materially and adversely affected by a catastrophic event. A severe weather event, therefore, could have a materially adverse impact on our financial condition, results of operations and business, as well as potentially increase our exposure to credit and liquidity risks.

Our strategy of pursuing acquisitions exposes us to financial, execution and operational risks that could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

We intend to continue pursuing a strategy that includes acquisitions. An acquisition strategy involves significant risks, including the following:

 

    finding suitable candidates for acquisition;

 

    attracting funding to support additional growth within acceptable risk tolerances;

 

    maintaining asset quality;

 

    retaining customers and key personnel;

 

    obtaining necessary regulatory approvals, which we may have difficulty obtaining or be unable to obtain;

 

    conducting adequate due diligence and managing known and unknown risks and uncertainties;

 

    integrating acquired businesses; and

 

    maintaining adequate regulatory capital.

The market for acquisition targets is highly competitive, which may adversely affect our ability to find acquisition candidates that fit our strategy and standards. We face significant competition in pursuing acquisition targets from other banks and financial institutions, many of which possess greater financial, human, technical and other resources than we do. Our ability to compete in acquiring target institutions will depend on our available financial resources to fund the acquisitions, including the amount of cash and cash equivalents we have and the liquidity and market price of our common stock. In addition, increased competition may also drive up the acquisition consideration that we will be required to pay in order to successfully capitalize on attractive acquisition opportunities. To the extent that we are unable to find suitable acquisition targets, an important component of our growth strategy may not be realized.

Acquisitions of financial institutions also involve operational risks and uncertainties, such as unknown or contingent liabilities with no available manner of recourse, exposure to unexpected problems such as asset quality, the retention of key employees and customers, and other issues that could negatively affect our business. We may not be able to complete future acquisitions or, if completed, we may not be able to successfully integrate the operations, technology platforms, management, products and services of the entities that we acquire or successfully eliminate redundancies. The integration process may also require significant time and attention from our management that would otherwise be directed toward servicing existing business and developing new business. Failure to successfully integrate the entities we acquire into our existing operations in a timely manner may increase our operating costs significantly and adversely affect our business, financial condition and results of operations. Further, acquisitions in Texas typically involve the payment of a premium over book and market

 

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values. Therefore, some dilution of our tangible book value and earnings per share may occur in connection with any future acquisition, and the carrying amount of any goodwill that we currently maintain or may acquire may be subject to impairment in future periods.

SBA lending is an important part of our business. Our SBA lending program is dependent upon the federal government and our status as a participant in the SBA’s Preferred Lenders Program, and we face specific risks associated with originating SBA loans and selling the guaranteed portion thereof.

We have been approved by the SBA to participate in the SBA’s Preferred Lenders Program. As an SBA Preferred Lender, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things, whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose enforcement actions, including revocation of the lender’s Preferred Lender status. If we lose our status as a Preferred Lender, we may lose some or all of our customers to lenders who are SBA Preferred Lenders, which could adversely affect our business, financial condition and results of operations.

We generally sell the guaranteed portion of our SBA 7(a) loans in the secondary market. These sales have resulted in both premium income for us at the time of sale, and created a stream of future servicing income. There can be no assurance that we will be able to continue originating these loans, that a secondary market for these loans will continue to exist or that we will continue to realize premiums upon the sale of the guaranteed portion of these loans. When we sell the guaranteed portion of our SBA 7(a) loans, we incur credit risk on the non-guaranteed portion of the loans, and if a customer defaults on the non-guaranteed portion of a loan, we share any loss and recovery related to the loan pro-rata with the SBA.

The laws, regulations and standard operating procedures that are applicable to SBA loan products may change in the future. We cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies and especially our organization, changes in the laws, regulations and procedures applicable to SBA loans could adversely affect our ability to operate profitably. In addition, the aggregate amount of SBA 7(a) and 504 loan guarantees by the SBA must be approved each fiscal year by the federal government. We cannot predict the amount of SBA 7(a) loan guarantees in any given fiscal year. If the federal government were to reduce the amount of SBA loan guarantees, such reduction could adversely impact our SBA lending program, including making and selling the guaranteed portion of fewer SBA 7(a) and 504 loans.

The SBA may not honor its guarantees if we do not originate loans in compliance with SBA guidelines.

As of December 31, 2017, SBA 7(a) and 504 program loans of $67.1 million comprised 7.7% of our loan portfolio and we intend to grow this segment of our portfolio in the future. SBA lending programs typically guarantee 75% of the principal on an underlying loan. If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies in the manner in which the loan was originated, funded or serviced by us, the SBA may seek recovery of the principal loss related to the deficiency from us notwithstanding that a portion of the loan was guaranteed by the SBA, which could adversely affect our business, financial condition and results of operations. While we follow the SBA’s underwriting guidelines, our ability to do so depends on the knowledge and diligence of our employees and the effectiveness of controls we have established. If our employees do not follow the SBA guidelines in originating loans and if our loan review and audit programs fail to identify and rectify such failures, the SBA may reduce or, in some cases, refuse to honor its guarantee obligations and we may incur losses as a result.

Loans to and deposits from foreign nationals are an important part of our business and we face specific risks associated with foreign nationals.    

As of December 31, 2017, loans to foreign nationals of $107.6 million comprised 12.4% of our loan portfolio and deposits from foreign nationals of $11.3 million comprised 1.4% of our total deposits. We define

 

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foreign nationals as those who derive more than 50% of their personal income from non-U.S. sources. We intend to grow this segment of our loan and deposit portfolio in the future. These borrowers typically lack a U.S. credit history and have a potential to leave the U.S. without fulfilling their mortgage obligation and leaving us with little recourse to them personally. Additionally, transactions with foreign nationals place additional pressure on our policies, procedures and systems for complying with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

Our ability to develop bankers, retain bankers and recruit additional successful bankers is critical to the success of our business strategy, and any failure to do so could adversely affect our business, financial condition, results of operations and growth prospects.

Our ability to retain and grow our loans, deposits and fee income depends upon the business generation capabilities, reputation and relationship management skills of our bankers, many of whom we develop internally. If we were to lose the services of any of our bankers, including successful bankers employed by financial institutions that we may acquire, to a new or existing competitor or otherwise, or fail to successfully develop bankers internally, we may not be able to retain valuable relationships and some of our customers could choose to use the services of a competitor instead of our services. Our growth strategy also relies on our ability to attract and retain additional profitable bankers. We may face difficulties in recruiting and retaining bankers of our desired caliber due to competition from other financial institutions. In particular, many of our competitors are significantly larger with greater financial resources, and may be able to offer more attractive compensation packages and broader career opportunities. Additionally, we may incur significant expenses and expend significant time and resources on training, integration and business development before we are able to determine whether a new banker will be profitable or effective. If we are unable to develop, attract or retain successful bankers, or if our bankers fail to meet our expectations in terms of customer relationships and profitability, we may be unable to execute our business strategy and our business, financial condition, results of operations and growth prospects may be adversely affected.

Loss of our executive officers or other key employees could impair our relationships with our customers and adversely affect our business.

Our success is dependent upon the continued service and skills of our executive management team. Our goals, strategies and marketing efforts are closely tied to the banking philosophy and strengths of our executive management, including our Chairman and Chief Executive Officer, Dean O. Bass, and our President, David M. McGuire. Our success is also dependent in part on the continued service of our market presidents and relationship managers. The loss of services of any of these key personnel could adversely affect our business because of their skills, years of industry experience, relationships with customers and the difficulty of promptly finding qualified replacement personnel. Although we have employment agreements with many of our executive officers and key employees, we cannot guarantee that these executive officers or key employees will continue to be employed with us in the future.

Greater seasoning of our loan portfolio could expose us to increased credit risks.

The business of lending is inherently risky, including risks that the principal of or interest on any loan will not be repaid timely or at all or that the value of any collateral supporting the loan will be insufficient to cover our outstanding exposure. Our loan portfolio has grown to $869.1 million as of December 31, 2017, from $772.9 million as of December 31, 2016, and $688.9 million as of December 31, 2015. It is difficult to assess the future performance of acquired or recently originated loans because our relatively limited experience with such loans does not provide us with a significant payment history from which to judge future collectability. These loans may experience higher delinquency or charge-off levels than our historical loan portfolio experience, which could adversely affect our business, financial condition and results of operations.

 

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The small- to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrower’s ability to repay a loan, and such impairment could adversely affect our results of operations and financial condition.

We focus our business development and marketing strategy primarily on small- to medium-sized businesses, which we define as commercial borrowing relationships with customers with revenues of $3 million to $30 million. Small- to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have a material adverse impact on the business and its ability to repay its loan. If general economic conditions negatively impact our primary service areas specifically or Texas generally and small- to medium-sized businesses are adversely affected or our borrowers are otherwise affected by adverse business developments, our business, financial condition and results of operations could be adversely affected.

If our allowance for loan and lease losses is not sufficient to cover actual loan losses, our earnings may be affected.

We establish our allowance for loan and lease losses and maintain it at a level considered adequate by management to absorb probable loan losses based on our analysis of our loan portfolio and market environment. Management maintains an allowance for loan and lease losses based upon, among other things, (1) historical experience, (2) an evaluation of local, regional and national economic conditions, (3) regular reviews of delinquencies and loan portfolio quality, (4) current trends regarding the volume and severity of past due and problem loans, (5) the existence and effect of concentrations of credit, and (6) results of regulatory examinations. Based on such factors, management makes various assumptions and judgments about the ultimate collectability of the respective loan portfolios. Although we believe that the allowance for loan and lease losses is adequate, there can be no assurance that the allowance will prove sufficient to cover future losses. Future adjustments may be necessary if economic conditions differ or adverse developments arise with respect to nonperforming or performing loans. Material additions to the allowances for loan losses would result in a decrease in our net income and our capital balance. The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control and these losses may exceed current estimates.

As of December 31, 2017, our allowance for loan and lease losses was $5.7 million, which represents 0.65% of our loans held for investment and 157.22% of our total nonperforming loans. Loans acquired are initially recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan and lease losses is recorded for these loans at acquisition. Additional loan losses will likely occur in the future and may occur at a rate greater than we have previously experienced. We may be required to take additional provisions for loan losses in the future to further supplement the allowance for loan and lease losses, either due to management’s decision to do so or requirements by our banking regulators. In addition, bank regulatory agencies will periodically review our allowance for loan and lease losses and the value attributed to nonaccrual loans or to real estate acquired through foreclosure. Such regulatory agencies may require us to recognize future charge-offs. These adjustments could adversely affect our business, financial condition and results of operations.

A large portion of our loan portfolio is comprised of commercial loans secured by receivables, promissory notes, inventory, equipment or other commercial collateral, the deterioration in value of which could increase the potential for future losses.

As of December 31, 2017, $135.0 million, or 15.5% of our loans held for investment, was comprised of commercial loans to businesses. In general, these loans are collateralized by general business assets including,

 

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among other things, accounts receivable, promissory notes, inventory and equipment and most are backed by a personal guaranty of the borrower or principal. These commercial loans are typically larger in amount than loans to individuals and, therefore, have the potential for larger losses on a single loan basis. Additionally, the repayment of commercial loans is subject to the ongoing business operations of the borrower. The collateral securing such loans generally includes moveable property such as equipment and inventory, which may decline in value more rapidly than we anticipate exposing us to increased credit risk. A portion of our commercial loans are secured by promissory notes that evidence loans made by us to borrowers that in turn make loans to others that are secured by real estate. Accordingly, negative changes in the economy affecting real estate values and liquidity could impair the value of the collateral securing these loans. Significant adverse changes in the economy or local market conditions in which our commercial lending customers operate could cause rapid declines in loan collectability and the values associated with general business assets resulting in inadequate collateral coverage that may expose us to credit losses and could adversely affect our business, financial condition and results of operations.

Because a portion of our loan portfolio is comprised of 1-4 single family residential real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.

As of December 31, 2017, $232.5 million, or 26.8% of our loans held for investment, was comprised of loans with 1-4 single family residential real estate as a primary component of collateral. As a result, adverse developments affecting real estate values in Texas, particularly in the Houston and Dallas/Fort Worth metropolitan areas, could increase the credit risk associated with our real estate loan portfolio. Real estate values in many Texas markets have experienced periods of fluctuation over the last five years. The market value of real estate can fluctuate significantly in a short period of time. Adverse changes affecting real estate values and the liquidity of real estate in one or more of our markets could increase the credit risk associated with our loan portfolio, and could result in losses that adversely affect credit quality, financial condition, and results of operations. Negative changes in the economy affecting real estate values and liquidity in our market areas could significantly impair the value of property pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Collateral may have to be sold for less than the outstanding balance of the loan, which could result in losses on such loans. Such declines and losses could have a material adverse impact on our business, results of operations and growth prospects. If real estate values decline, it is also more likely that we would be required to increase our allowance for loan and lease losses, which could adversely affect our business, financial condition and results of operations.

Our commercial real estate and construction, land and development loan portfolios expose us to credit risks that could be greater than the risks related to other types of loans.

As of December 31, 2017, $285.7 million, or 32.9% of our loans held for investment, was comprised of commercial real estate loans (including owner-occupied commercial real estate loans and multifamily loans) and $139.5 million, or 16.0% of our loans held for investment, was comprised of construction, land and development loans. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. The availability of such income for repayment may be adversely affected by changes in the economy or local market conditions. These loans expose a lender to greater credit risk than loans secured by other types of collateral because the collateral securing these loans is typically more difficult to liquidate due to the fluctuation of real estate values. Additionally, nonowner-occupied commercial real estate loans generally involve relatively large balances to single borrowers or related groups of borrowers. Unexpected deterioration in the credit quality of our nonowner-occupied commercial real estate loan portfolio could require us to increase our allowance for loan and lease losses, which would reduce our profitability and could have a material adverse effect on our business, financial condition and results of operations.

Construction, land and development loans also involve risks attributable to the fact that loan funds are secured by a project under construction, and the project is of uncertain value prior to its completion. It can be

 

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difficult to accurately evaluate the total funds required to complete a project, and this type of lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, we may be unable to recover the entire unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time, any of which could adversely affect our business, financial condition and results of operations.

A failure in or breach of our operational or security systems, or those of our third party service providers, including as a result of cyber-attacks, could disrupt our business, result in unintentional disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.

As a financial institution, our operations rely heavily on the secure data processing, storage and transmission of confidential and other information on our computer systems and networks. Any failure, interruption or breach in security or operational integrity of these systems could result in failures or disruptions in our online banking system, customer relationship management, general ledger, deposit and loan servicing and other systems. The security and integrity of our systems could be threatened by a variety of interruptions or information security breaches, including those caused by computer hacking, cyber-attacks, electronic fraudulent activity or attempted theft of financial assets. We cannot assure you that any such failures, interruptions or security breaches will not occur, or if they do occur, that they will be adequately addressed. While we have certain protective policies and procedures in place, the nature and sophistication of the threats continue to evolve. We may be required to expend significant additional resources in the future to modify and enhance our protective measures.

Additionally, we face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems. Any failures, interruptions or security breaches in our information systems could damage our reputation, result in a loss of customer business, result in a violation of privacy or other laws, or expose us to civil litigation, regulatory fines or losses not covered by insurance.

Our business is dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third party providers. The failure of these systems, or the termination of a third party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third party systems, we could experience service denials if demand for such services exceeds capacity or such third party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could materially adversely affect our business, financial condition, results of operations and prospects.

We may be subject to additional credit risk with respect to loans that we make to other lenders.

As a part of our commercial lending activities, we may make loans to customers that, in turn, make commercial and residential real estate loans to other borrowers. When we make a loan of this nature, we take as collateral the promissory notes issued by the end borrowers to our customer, which are themselves secured by the underlying real estate. Although the loans to our customers are subject to the risks inherent in commercial lending generally, we are also exposed to additional risks, including those related to commercial and residential real estate lending, as the ability of our customer to repay the loan from us can be affected by the risks associated with the value and liquidity of the real estate underlying our customer’s loans to the end borrowers. Moreover, because we are not lending directly to the end borrower, and because our collateral is a promissory note rather than the underlying real estate, we may be subject to risks that are different from those we are exposed to when we make a loan directly that is secured by commercial or residential real estate. Because the ability of the end

 

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borrower to repay its loan from our customer could affect the ability of our customer to repay its loan from us, our inability to exercise control over the relationship with the end borrower and the collateral, except under limited circumstances, could expose us to credit losses that adversely affect our business, financial condition and results of operations.

We have a concentration of loans outstanding to a limited number of borrowers, which may increase our risk of loss.

We have extended significant amounts of credit to a limited number of borrowers, and as of December 31, 2017, the aggregate amount of loans to our 10 and 20 largest borrowers (including related entities) amounted to $78.8 million, or 9.1% of loans held for investment, and $126.4 million, or 14.5% of loans held for investment, respectively. In the event that one or more of these borrowers is not able to make payments of interest and principal in respect of such loans, the potential loss to us is more likely to have a material adverse effect on our business, financial condition and results of operations.

Our municipal loan portfolio may be impacted by the effects of economic stress on municipalities and political subdivisions.

As of December 31, 2017, $53.3 million, or 6.1% of our loans held for investment, was comprised of loans outstanding to municipalities and political subdivisions. Widespread concern currently exists regarding the stress on local governments emanating from declining revenues, large unfunded liabilities to government workers, and entrenched cost structures. Debt-to-gross domestic product ratios for many municipalities and political subdivisions have been deteriorating due to, among other factors, declines in federal monetary assistance provided as the United States is currently experiencing the largest deficit in its history and lower levels of sales and property tax revenue. We may not be able to mitigate the exposure in our municipal loan portfolio if municipalities and political subdivisions are unable to fulfill their obligations. The risk of widespread borrower defaults may also increase if there are changes in legislation that permit municipalities and political subdivisions to file for bankruptcy protection or if there are judicial interpretations that, in a bankruptcy or other proceeding, lessen the value of any structural protections.

A lack of liquidity could impair our ability to fund operations and adversely affect our operations and jeopardize our business, financial condition, and results of operations.

Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, the sale of loans, and other sources could have a substantial negative effect on our liquidity. Our most important source of funds is deposits. Deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments such as money market funds, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.

Other primary sources of funds consist of cash flows from operations, maturities and sales of investment securities, and proceeds from the issuance and sale of our equity and debt securities to investors. Additional liquidity is provided by the ability to borrow from the Federal Reserve Bank of Dallas and the Federal Home Loan Bank of Dallas, or the FHLB. We also may borrow funds from third party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us specifically or the financial services industry or economy generally, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. Our access to funding sources could also be affected by a decrease in the level of our business activity as a result of a downturn in the Texas economy, particularly the local economies in the Houston or Dallas/Fort Worth metropolitan areas, or by one or more adverse regulatory actions against us.

 

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Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity and could, in turn, adversely affect our business, financial condition and results of operations.

We may need to raise additional capital in the future, and if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain regulatory compliance, could be adversely affected.

We face significant capital and other regulatory requirements as a financial institution. We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, which could include the possibility of financing acquisitions. In addition, we, on a consolidated basis, and the Bank, on a stand-alone basis, must meet certain regulatory capital requirements and maintain sufficient liquidity. Importantly, regulatory capital requirements could increase from current levels, which could require us to raise additional capital or reduce our operations. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital to meet regulatory requirements, our liquidity, business, financial condition and results of operations could be adversely affected.

Fluctuations in interest rates could reduce net interest income and otherwise negatively impact our financial condition and results of operations.

The majority of our banking assets are monetary in nature and subject to risk from changes in interest rates. Our profitability depends to a great extent upon the level of our net interest income, or the difference between the interest income we earn on loans, investments and other interest-earning assets, and the interest we pay on interest-bearing liabilities, such as deposits and borrowings. Changes in interest rates can increase or decrease our net interest income, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. When interest-bearing liabilities mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly, or to a greater degree than interest-bearing liabilities, falling interest rates could reduce net interest income. Our interest sensitivity profile was asset sensitive as of December 31, 2017, meaning that we estimate our net interest income would increase more from rising interest rates than from falling interest rates.

Additionally, an increase in interest rates may, among other things, reduce the demand for loans and our ability to originate loans and decrease loan repayment rates. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan portfolio and increased competition for deposits. Accordingly, changes in the level of market interest rates affect our net yield on interest-earning assets, loan origination volume, loan portfolio and our overall results. Although our asset-liability management strategy is designed to control and mitigate exposure to the risks related to changes in market interest rates, those rates are affected by many factors outside of our control, including governmental monetary policies, inflation, deflation, recession, changes in unemployment, the money supply, international disorder and instability in domestic and foreign financial markets.

We face strong competition from financial services companies and other companies that offer banking services, which could adversely affect our business, financial condition, and results of operations.

We conduct our operations almost exclusively in Texas, particularly the Houston and Dallas/Fort Worth metropolitan areas. Many of our competitors offer the same, or a wider variety of, banking services within our market area. These competitors include banks with nationwide operations, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings banks, credit

 

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unions, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, asset-based non-bank lenders and certain other non-financial entities, such as retail stores which may maintain their own credit programs and certain governmental organizations which may offer more favorable financing or deposit terms than we can. In addition, a number of out-of-state financial intermediaries have production offices or otherwise solicit loan and deposit products in our market areas. Increased competition in our markets may result in reduced loans and deposits, as well as reduced net interest margin, fee income and profitability. Ultimately, we may not be able to compete successfully against current and future competitors. If we are unable to attract and retain banking customers, we may be unable to continue to grow our loan and deposit portfolios, and our business, financial condition and results of operations could be adversely affected.

Our ability to compete successfully depends on a number of factors, including, among other things:

 

    the ability to develop, maintain and build long-term customer relationships based on top quality service, high ethical standards and safe, sound assets;

 

    the scope, relevance and pricing of products and services offered to meet customer needs and demands;

 

    the rate at which we introduce new products and services relative to our competitors;

 

    customer satisfaction with our level of service;

 

    the ability to expand our market position; and

 

    industry and general economic trends.

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could adversely affect on our business, financial condition and results of operations.

We may not be able to compete with larger competitors for larger customers because our lending limits are lower than our competitors.

Our legal lending limit is significantly less than the limits for many of our competitors, and this may hinder our ability to establish relationships with larger businesses in our primary service area. Based on the capitalization of the Bank, our legal lending limit was approximately $23.6 million as of December 31, 2017. This legal lending limit will increase or decrease as the Bank’s capital increases or decreases, respectively, as a result of its earnings or losses, among other reasons. Based on our current legal lending limit, we may need to sell participations in our loans to other financial institutions in order to meet the lending needs of our customers requiring extensions of credit above these limits. However, our ability to accommodate larger loans by selling participations in those loans to other financial institutions may not be successful.

Negative public opinion regarding our company or failure to maintain our reputation in the communities we serve could adversely affect our business and prevent us from growing our business.

As a community bank, our reputation within the communities we serve is critical to our success. We believe we have set ourselves apart from our competitors by building strong personal and professional relationships with our customers and being active members of the communities we serve. As such, we strive to enhance our reputation by recruiting, hiring and retaining employees who we believe share our core values of being an integral part of the communities we serve and delivering superior service to our customers. If our reputation is negatively affected by the actions of our employees or otherwise, we may be less successful in attracting new customers, and our business, financial condition, results of operations and prospects could be materially and adversely affected. Further, negative public opinion can expose us to litigation and regulatory action or delay in acting as we seek to implement our growth strategy.

 

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If we fail to maintain an effective system of disclosure controls and procedures and internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

Ensuring that we have adequate disclosure controls and procedures, including internal control over financial reporting, in place so that we can produce accurate financial statements on a timely basis is costly and time-consuming and needs to be reevaluated frequently. We are in the process of documenting, reviewing and, if appropriate, improving our internal controls and procedures in anticipation of being a public company and being subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and having total assets of $1 billion or more and being subject to the requirements of The Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDICIA”), which, among other things, will require annual management assessments of the effectiveness of our internal control over financial reporting and, in the case of the Sarbanes-Oxley Act, when we cease to be an emerging growth company under the JOBS Act, a report by our independent auditors addressing these assessments. Our management may conclude that our internal control over financial reporting is not effective due to our failure to cure any identified material weakness or otherwise. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may not conclude that our internal control over financial reporting is effective. In the future, our independent registered public accounting firm may not be satisfied with our internal control over financial reporting or the level at which our controls are documented, designed, operated or reviewed, or it may interpret the relevant requirements differently from us. In addition, during the course of the evaluation, documentation and testing of our internal control over financial reporting, we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by the Securities and Exchange Commission, or the SEC, for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act or the FDIC for compliance with the requirement of FDICIA. Any such deficiencies may also subject us to adverse regulatory consequences. If we fail to achieve and maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may be unable to report our financial information on a timely basis, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act or FDICIA, and we may suffer adverse regulatory consequences or violations of listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in the reliability of our financial statements.

We could be subject to losses, regulatory action or reputational harm due to fraudulent, negligent or other acts on the part of our loan customers, employees or vendors.

Employee errors or employee or customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors or employee or customer misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.

We maintain a system of internal controls to help mitigate against operational risks, including data processing system failures and errors and fraud, as well as insurance coverage designed to protect us from material losses associated with these risks including losses resulting from any associated business interruption. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could adversely affect our business, financial condition and results of operations.

In addition, in deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, property appraisals, title information, employment and income documentation, account information and other financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of such information and, with respect to financial statements,

 

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on reports of independent auditors. Any such misrepresentation or incorrect or incomplete information may not be detected prior to funding a loan or during our ongoing monitoring of outstanding loans. In addition, one or more of our employees or vendors could cause a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our loan documentation, operations or systems. Any of these developments could have a material adverse effect on our business, financial condition, results of operations and future prospects.

We have a continuing need for technological change, and we may not have the resources to effectively implement new technology, or we may experience operational challenges when implementing new technology.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, at least in part, upon our ability to respond to future technological changes and our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our product and service offerings. We may experience operational challenges as we implement these new technology enhancements or products, which could result in us not fully realizing the anticipated benefits from such new technology or require us to incur significant costs to remedy any such challenges in a timely manner.

These changes may be more difficult or expensive than we anticipate. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products compared to those that we will be able to provide, which would put us at a competitive disadvantage. Accordingly, we may lose customers seeking new technology-driven products and services to the extent we are unable to provide such products and services.

Our operations could be interrupted if our third party service providers experience difficulty, terminate their services or fail to comply with banking regulations.

We depend on a number of relationships with third party service providers. Specifically, we receive certain third party services including, but not limited to, core systems processing, essential web hosting and other Internet systems, online banking services, deposit processing and other processing services. If these third party service providers experience difficulties, or terminate their services, and we are unable to replace them with other service providers, particularly on a timely basis, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be adversely affected, perhaps materially. Even if we are able to replace third party service providers, it may be at a higher cost to us, which could adversely affect our business, financial condition and results of operations.

We are subject to environmental liability risk associated with lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could adversely affect our business, financial condition and results of operations.

 

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Risks Related to Our Industry and Regulation

We operate in a highly regulated environment and the laws and regulations that govern our operations, corporate governance, executive compensation and accounting principles, or changes in them, or our failure to comply with them, could adversely affect us.

We are subject to extensive regulation, supervision and legal requirements that govern almost all aspects of our operations. These laws and regulations are not intended to protect our shareholders. Rather, these laws and regulations are intended to protect customers, depositors, the Deposit Insurance Fund, and the overall financial stability of the banking system in the United States. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business activities in which we can engage, limit the dividend or distributions that the Bank can pay to us, restrict the ability of institutions to guarantee any debt we may issue, and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles would require. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs. Our failure to comply with these laws and regulations, even if the failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition and results of operations. The banking industry remains heavily regulated. Compliance with such regulations may increase our costs and limit our ability to pursue business opportunities.

The ongoing implementation of the Dodd-Frank Act could adversely affect our business, financial condition, and results of operations.

On July 21, 2010, the Dodd-Frank Act was signed into law, and the process of implementation is ongoing. The Dodd-Frank Act imposes significant regulatory and compliance changes on many industries, including ours. There remains significant uncertainty surrounding the manner in which several of the provisions of the Dodd-Frank Act will ultimately be implemented by the various regulatory agencies, and the full extent of the impact of the requirements on our operations is unclear. However, the legal and regulatory changes that have resulted from the Dodd-Frank Act impacted the profitability of our business activities, required changes to certain of our business practices, required the development of new compliance infrastructure, imposed upon us more stringent capital, liquidity and leverage requirements and adversely affected our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the resulting new requirements or with any future changes in laws or regulations may negatively impact our business, financial condition and results of operations.

Compliance with new increased minimum capital thresholds established by our regulators as part of their implementation of Basel III may require us to raise additional capital in the future, which could be dilutive to our existing shareholders and failure to comply with such requirements may result in regulatory actions against us.

The Dodd-Frank Act requires the federal banking agencies to establish stricter risk-based capital requirements and leverage limits to apply to banks and bank and savings and loan holding companies. In July 2013, the federal banking agencies published final capital rules in connection with the implementation of Basel III that revised their risk-based and leverage capital requirements and their method for calculating risk-weighted assets. The Basel III capital rules will apply to all bank holding companies with $1 billion or more in consolidated assets and all banks regardless of size.

As a result of the enactment of the Basel III capital rules, we are and will continue to be subject to increased required capital levels. The Basel III capital rules became effective as applied to us on January 1, 2015, with a phase-in period that generally extends from January 1, 2015 through January 1, 2019. In addition, the application

 

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of more stringent capital requirements on us could, among other things, result in lower returns on equity, limit dividends, require the raising of additional capital at an inopportune time, which could be dilutive to our shareholders, and result in regulatory actions such as the inability to pay dividends or repurchase shares if we were to be unable to comply with such requirements.

State and federal banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any supervisory actions to which we become subject as a result of such examinations could adversely affect us.

Texas and federal banking agencies, including the Texas Department of Savings and Mortgage Lending, the FDIC and the Federal Reserve, periodically conduct examinations of our business, including compliance with laws and regulations. If, as a result of an examination, a Texas or federal banking agency were to determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that our company, the Bank or their respective management were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital levels, to restrict our growth, to assess civil monetary penalties against us, the Bank or our respective officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate the Bank’s deposit insurance, with the result that the Bank would be closed. If we become subject to such regulatory actions, our business, financial condition, results of operations and reputation could be adversely affected.

Many of our new activities and expansion plans require regulatory approvals, and failure to obtain them may restrict our growth.

We intend to complement and expand our business by pursuing strategic acquisitions of financial institutions and other complementary businesses. Generally, we must receive state and federal regulatory approval before we can acquire an FDIC-insured depository institution or related business. In determining whether to approve a proposed acquisition, federal banking regulators will consider, among other factors, the effect of the acquisition on competition, our financial condition, our future prospects, and the impact of the proposal on U.S. financial stability. The regulators also review current and projected capital ratios and levels, the competence, experience and integrity of management and its record of compliance with laws and regulations, the convenience and needs of the communities to be served (including our record of compliance with the Community Reinvestment Act, or the CRA) and our effectiveness in combating money laundering activities. Such regulatory approvals may not be granted on terms that are acceptable to us, or at all. We may also be required to sell branches or other business lines as a condition to receiving regulatory approval, which condition may not be acceptable to us or, if acceptable to us, may reduce the benefit of any acquisition.

Financial institutions, such as the Bank, face a risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations, and associated enforcement actions.

The Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, established by the U.S. Department of the Treasury, or the Treasury Department, to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements, and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. There is also increased scrutiny of compliance with the sanctions programs and rules administered and enforced by the Treasury Department’s Office of Foreign Assets Control.

 

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In order to comply with regulations, guidelines and examination procedures in this area, the dedication of significant resources to an anti-money laundering program is required. Additionally, our business relationships with foreign nationals may expose us to greater risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations than other financial institutions who have less expansive business relationships with foreign nationals than us. If our policies, procedures and systems are deemed deficient, we could be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and on expansion opportunities, including acquisitions.

We are subject to numerous lending laws designed to protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to material sanctions and penalties and restrictions on our expansion opportunities.

The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Consumer Financial Protection Bureau, or the CFPB, the FDIC, the Justice Department and other federal agencies are responsible for enforcing these laws and regulations. A successful challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity, and restrictions on expansion activity. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation.

The FDIC’s restoration plan and the related increased assessment rate could adversely affect our earnings and results of operations.

As a result of economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased deposit insurance assessment rates, which in turn raised deposit premiums for many insured depository institutions. If these increases are insufficient for the Deposit Insurance Fund to meet its funding requirements, further special assessments or increases in deposit insurance premiums may be required. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional financial institution failures that affect the Deposit Insurance Fund, we may be required to pay FDIC premiums higher than current levels. Our FDIC insurance related costs were $764 thousand, $547 thousand and $431 thousand for the years ended December 31, 2017, 2016 and 2015, respectively. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could adversely affect our earnings and results of operations.

The Federal Reserve may require us to commit capital resources to support the Bank.

The Dodd-Frank Act and Federal Reserve require a bank holding company to act as a source of financial and managerial strength to its subsidiary banks and to commit resources to support its subsidiary banks. Under the “source of strength” doctrine, a bank holding company may be required to make capital injections into a troubled subsidiary bank at times when the bank holding company may not be inclined to do so and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. Accordingly, we could be required to provide financial assistance to the Bank if it experiences financial distress.

Such a capital injection may be required at a time when our resources are limited and we may be required to raise capital or borrow the funds to make the required capital injection. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of any note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and

 

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expensive and will adversely impact the holding company’s business, financial condition and results of operations.

We could be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due. Any such losses could adversely affect our business, financial condition and results of operations.

Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.

In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the U.S. money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of both the discount rate and the federal funds rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.

The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Although we cannot determine the effects of such policies on us at this time, such policies could adversely affect our business, financial condition and results of operations.

Risks Related to this Offering and an Investment in our Common Stock

An active trading market for our common stock may not develop, and you may not be able to sell your common stock at or above the initial public offering price.

Prior to this offering there has been no public market for our common stock. An active trading market for shares of our common stock may never develop or be sustained following this offering. If an active trading market does not develop, you may have difficulty selling your shares of common stock at an attractive price, or at all. The initial public offering price for our common stock will be determined by negotiations between us and the representative of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell your common stock at or above the initial public offering price or at any other price or at the time that you would like to sell. An inactive market may also impair our ability to raise capital by selling our common stock and may impair our ability to expand our business by using our common stock as consideration in an acquisition.

The market price of our common stock may fluctuate significantly.

The market price of our common stock could fluctuate significantly due to a number of factors, including, but not limited to:

 

    our quarterly or annual earnings, or those of other companies in our industry;

 

    actual or anticipated fluctuations in our operating results;

 

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    changes in accounting standards, policies, guidance, interpretations or principles;

 

    the perception that investment in Texas is unattractive or less attractive during periods of low oil or gas prices;

 

    the public reaction to our press releases, our other public announcements or our filings with the SEC;

 

    announcements by us or our competitors of significant acquisitions, dispositions, innovations or new programs and services;

 

    threatened or actual litigation;

 

    any major change in our board of directors or management;

 

    changes in financial estimates and recommendations by securities analysts following our stock, or the failure of securities analysts to cover our common stock after this offering;

 

    changes in earnings estimates by securities analysts or our ability to meet those estimates;

 

    the operating and stock price performance of other comparable companies;

 

    general economic conditions and overall market fluctuations;

 

    the trading volume of our common stock;

 

    changes in business, legal or regulatory conditions, or other developments affecting participants in our industry, or publicity regarding our business or any of our significant customers or competitors;

 

    changes in governmental monetary policies, including the policies of the Federal Reserve;

 

    future sales of our common stock by us, directors, executives and significant shareholders; and

 

    changes in economic conditions in and political conditions affecting our target markets.

In particular, the realization of any of the risks described in this “Risk Factors” section could have a material adverse effect on the market price of our common stock and cause the value of your investment to decline. In addition, the stock market in general, and the market for banks and financial services companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These fluctuations might be even more pronounced in the trading market for our stock shortly following this offering. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in substantial costs, divert our management’s attention and resources, and harm our business, operating results, and financial condition.

The obligations associated with being a public company will require significant resources and management attention.

As a public company, we will face increased legal, accounting, administrative and other costs and expenses that we have not incurred as a private company, particularly after we are no longer an emerging growth company. We expect to incur significant incremental costs related to operating as a public company, particularly when we no longer qualify as an emerging growth company. After the completion of this offering, we will be subject to the reporting requirements of the Exchange Act, which require that we file annual, quarterly and current reports with respect to our business and financial condition and proxy and other information statements, and the rules and regulations implemented by the SEC, the Sarbanes-Oxley Act, the Dodd-Frank Act, the PCAOB and the NASDAQ Stock Market, each of which imposes additional reporting and other obligations on public companies. As a public company, we will be required to:

 

    prepare and distribute periodic reports, proxy statements and other shareholder communications in compliance with the federal securities laws and rules;

 

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    expand the roles and duties of our board of directors and committees thereof;

 

    maintain an internal audit function;

 

    institute more comprehensive financial reporting and disclosure compliance procedures;

 

    involve and retain to a greater degree outside counsel and accountants in the activities listed above;

 

    enhance our investor relations function;

 

    establish new internal policies, including those relating to trading in our securities and disclosure controls and procedures;

 

    retain additional personnel;

 

    comply with NASDAQ Stock Market listing standards; and

 

    comply with the Sarbanes-Oxley Act.

We expect these rules and regulations and changes in laws, regulations and standards relating to corporate governance and public disclosure, which have created uncertainty for public companies, to increase legal and financial compliance costs and make some activities more time consuming and costly. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. Our investment in compliance with existing and evolving regulatory requirements will result in increased administrative expenses and a diversion of management’s time and attention from revenue- generating activities to compliance activities, which could have a material adverse effect on our business, financial condition and results of operations. These increased costs could require us to divert a significant amount of money that we could otherwise use to expand our business and achieve our strategic objectives.

In connection with the audit of our 2016 financial statements, a material weakness in our internal control over financial reporting was identified.

In connection with the audit of our 2016 financial statements, control deficiencies were identified in our financial reporting process that constituted a material weakness for the years ended December 31, 2015 and 2016. The material weakness related to the lack of appropriate level of knowledge, experience and training in Generally Accepted Accounting Principles, or GAAP, and SEC reporting requirements with respect to equity transactions and our SBA servicing asset, resulting in several adjustments to our financial statements and also a restatement of our previously issued financial statements as of and for the years ended December 31, 2016 and 2015.

We have since initiated certain measures to remediate this material weakness. For example, we hired a new Chief Financial Officer, a new Chief Accounting Officer and a new Controller, each with what we believe are the necessary skills and expertise to facilitate our compliance with FDICIA, the requirements of GAAP, SEC reporting requirements, the Sarbanes-Oxley Act and other regulatory requirements for a publicly-traded financial institution. We believe that we have fully remediated this material weakness and no additional material weaknesses have been identified. However, there can be no assurance that our remedial actions will prevent this weakness from re-occurring in the future.

Further, there can be no assurance that we will not suffer from other material weaknesses or significant deficiencies in the future. If we fail to maintain effective internal controls over financial reporting in the future, such failure could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and that could cause investors and other users of our financial statements to lose confidence in our financial statements, limit our ability to raise capital or make acquisitions and have a negative effect on the trading price of our common stock. Additionally, failure to maintain effective

 

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internal controls over financial reporting may also negatively impact our operating results and financial condition, impair our ability to timely file our periodic and other reports with the SEC, subject us to additional litigation and regulatory actions and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.

You will incur immediate dilution as a result of this offering.

If you purchase our common stock in this offering, you will pay more for your shares than the tangible book value per share immediately prior to consummation of this offering. As a result, you will incur immediate dilution of $        per share representing the difference between the offering price of $        , the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, and our tangible book value per share as of December 31, 2017 of $12.52. Accordingly, if we are liquidated at our tangible book value, you would not receive the full amount of your investment.

If securities or industry analysts change their recommendations regarding our stock or if our operating results do not meet their expectations, our stock price could decline.

The trading market for our common stock could be influenced by the research and reports that industry or securities analysts may publish about us or our business. We cannot predict whether any research analysts will cover us and our common stock nor do we have any control over these analysts. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline and our common stock to be less liquid. Moreover, if one or more of the analysts who cover us downgrade our stock or if our operating results do not meet their expectations, either absolutely or relative to our competitors, our stock price could decline significantly.

Future sales or the possibility of future sales of a substantial amount of our common stock may depress the price of shares of our common stock.

We may seek to raise additional funds, finance acquisitions, or develop strategic relationships by issuing additional shares of common stock. Future sales or the availability for sale of substantial amounts of our common stock in the public market could adversely affect the prevailing market price of our common stock and could impair our ability to raise capital through future sales of equity securities.

Our second amended and restated certificate of formation authorizes us to issue up to 5,000,000 shares of preferred stock, none of which is outstanding, and 50,000,000 shares of common stock,                of which will be outstanding upon consummation of this offering (or                shares if the underwriters exercise their option to purchase additional shares in full). This number includes                shares that we are selling in this offering (or                 shares if the underwriters exercise their option to purchase additional shares in full), which will be freely transferable without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act. Holders of approximately     % of the shares of our common stock outstanding prior to this offering, including all of our executive officers and directors, have agreed not to sell any shares of our common stock for a period of at least 180 days from the date of this prospectus, subject to certain exceptions. Following the expiration of the applicable lock-up period, all of these shares will be eligible for resale under Rule 144 of the Securities Act, subject to any remaining holding period requirements and, if applicable, volume limitations. The remaining shares of common stock outstanding prior to this offering are not subject to lock-up agreements and substantially all of such shares have been held by our non-affiliates for at least one year and therefor may be freely sold by such persons upon the completion of this offering.

We may issue shares of our common stock or other securities from time to time as consideration for future acquisitions and investments and pursuant to compensation and incentive plans. If any such acquisition or investment is significant, the number of shares of our common stock, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial. We may also grant

 

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registration rights covering those shares of our common stock or other securities in connection with any such acquisitions and investments.

We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares of our common stock issued in connection with an acquisition or under a compensation or incentive plan), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through future sales of our securities.

We may issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise materially adversely affect holders of our common stock, which could depress the price of our common stock.

Our second amended and restated certificate of formation authorizes us to issue up to 5,000,000 shares of one or more series of preferred stock. Our board of directors has the authority to determine the preferences, limitations and relative rights of shares of preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by our shareholders. Our preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our common stock. The potential issuance of preferred stock may delay or prevent a change in control of us, discouraging bids for our common stock at a premium over the market price, and materially adversely affect the market price and the voting and other rights of the holders of our common stock.

We currently have no plans to pay dividends on our common stock, so you may not receive funds without selling your common stock.

We do not anticipate paying any dividends on our common stock in the foreseeable future. Our ability to pay dividends on our common stock is dependent on the Bank’s ability to pay dividends to us, which is limited by applicable laws and banking regulations, and may in the future be restricted by the terms of any debt or preferred securities we may incur or issue. Payments of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion and any legal or contractual limitations on our ability to pay dividends. In addition, our current line of credit restricts our ability to pay dividends and in the future we may enter into other borrowing or other contractual arrangements that restrict our ability to pay dividends. Accordingly, shares of common stock should not be purchased by persons who need or desire dividend income from their investment.

We are an “emerging growth company,” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. These exemptions allow us, among other things, to present only two years of audited financial statements and discuss our results of operations for only two years in related Management’s Discussions and Analyses; not to provide an auditor attestation of our internal control over financial reporting; to choose not to comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and our audited financial statements; to provide reduced disclosure regarding our executive compensation arrangements pursuant to the rules applicable to smaller reporting companies, which means we do not have to include a compensation discussion and analysis and certain other disclosure regarding our executive compensation; and not to seek a non-binding advisory vote on executive compensation or golden parachute arrangements. In addition, even if we comply with the greater disclosure obligations of public companies that are not emerging growth companies

 

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immediately after this offering, we may avail ourselves of these reduced requirements applicable to emerging growth companies from time to time in the future, so long as we are an emerging growth company. We will remain an emerging growth company for up to five years, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700.0 million). Investors and securities analysts may find it more difficult to evaluate our common stock because we may rely on one or more of these exemptions, and, as a result, investor confidence and the market price of our common stock may be materially and adversely affected.

We are dependent upon the Bank for cash flow, and the Bank’s ability to make cash distributions is restricted, which could impact our ability to satisfy our obligations.

Our primary asset is the Bank. As such, we depend upon the Bank for cash distributions through dividends on the Bank’s stock to pay our operating expenses and satisfy our obligations, including debt obligations. There are numerous laws and banking regulations that limit the Bank’s ability to pay dividends to us. If the Bank is unable to pay dividends to us, we will not be able to satisfy our obligations. Federal and state statutes and regulations restrict the Bank’s ability to make cash distributions to us. These statutes and regulations require, among other things, that the Bank maintain certain levels of capital in order to pay a dividend. Further, federal and state banking authorities have the ability to restrict the Bank’s payment of dividends through supervisory action.

We have broad discretion in the use of the net proceeds from this offering, and our use of those proceeds may not yield a favorable return on your investment.

We expect to use the net proceeds of this offering to support our continued growth, including organic growth and potential future acquisitions, and for general corporate purposes. From time to time, we evaluate and conduct due diligence with respect to potential acquisition candidates and may enter into letters of intent, although we do not have any current arrangements or understandings to make a material acquisition. There can be no assurance that we will enter into any definitive agreements in respect of any such transaction. Our management has broad discretion over how the proceeds of this offering are used and could spend the proceeds in ways with which you may not agree. In addition, we may not use the proceeds of this offering effectively or in a manner that increases our market value or enhances our profitability. We have not established a timetable for the effective deployment of the proceeds, and we cannot predict how long it will take to deploy the proceeds. Investing the offering proceeds in securities until we are able to deploy the proceeds will provide lower margins than we generally earn on loans, potentially adversely affecting shareholder returns, including earnings per share, return on assets and return on equity.

Shareholders may be deemed to be acting in concert or otherwise in control of us, which could impose notice, approval and ongoing regulatory requirements and result in adverse regulatory consequences for such holders.

We are subject to the Bank Holding Company Act of 1956, as amended, or BHC Act, and federal and state banking regulation, that will impact the rights and obligations of owners of our common stock, including, for example, our ability to declare and pay dividends on our common stock. Shares of our common stock are voting securities for purposes of the BHC Act and any bank holding company or foreign bank that is subject to the BHC Act may need approval to acquire or retain 5% or more of the then outstanding shares of our common stock, and any holder (or group of holders deemed to be acting in concert) may need regulatory approval to acquire or retain 10% or more of the shares of our common stock. A holder or group of holders may also be deemed to control us if they own 25% or more of our total equity. Under certain limited circumstances, a holder or group of holders acting in concert may exceed the 25% threshold and not be deemed to control us until they own 33% or more of our total equity. The amount of total equity owned by a holder or group of holders acting in concert is calculated by

 

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aggregating all shares held by the holder or group, whether as a combination of voting or non-voting shares or through other positions treated as equity for regulatory or accounting purposes and meeting certain other conditions. Holders of our common stock should consult their own counsel with regard to regulatory implications.

Our directors and executive officers could have the ability to influence shareholder actions in a manner that may be adverse to your personal investment objectives.

Immediately following the offering, we expect that our directors and executive officers collectively will own approximately                 shares of common stock, which represents     % of shares of total shares outstanding. Additionally, we have issued warrants to our organizers and stock options to our executive officers and directors. Due to their significant ownership interests, our organizers, directors and executive officers are able to exercise significant influence over our management and affairs. For example, our organizers, directors and executive officers may be able to influence the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be approved by the shareholders.

An investment in our common stock is not an insured deposit and is not guaranteed by the FDIC, so you could lose some or all of your investment.

An investment in our common stock is not a bank deposit and, therefore, is not insured against loss or guaranteed by the FDIC, any other deposit insurance fund or by any other public or private entity. An investment in our common stock is inherently risky for the reasons described herein. As a result, if you acquire our common stock, you could lose some or all of your investment.

Our corporate organizational documents and certain corporate and banking provisions of Texas law to which we are subject contain certain provisions that could have an anti-takeover effect and may delay, make more difficult or prevent an attempted acquisition of us that you may favor.

Our second amended and restated certificate of formation and amended and restated bylaws contain certain provisions that may have an anti-takeover effect and may delay, discourage or prevent an attempted acquisition or change of control of our company. These provisions include:

 

    staggered terms for directors, who may only be removed for cause;

 

    authorization for our board of directors to issue shares of one or more series of preferred stock without shareholder approval and upon such terms as the board of directors may determine;

 

    a prohibition of shareholder action by less than unanimous written consent;

 

    a prohibition of cumulative voting in the election of directors;

 

    a provision establishing certain advance notice procedures for nomination of candidates for election of directors and for shareholder proposals; and

 

    a limitation on the ability of shareholders to call special meetings to those shareholders or groups of shareholders owning at least 50% of our shares of common stock that are issued, outstanding and entitled to vote.

These provisions could discourage potential acquisition proposals and could delay or prevent a change in control of our company, even in the case where our shareholders may consider such proposals, if effective, desirable.

Our second amended and restated certificate of formation does not provide for cumulative voting for directors and authorizes our board of directors to issue shares of preferred stock without shareholder approval and upon such terms as the board of directors may determine. The issuance of our preferred stock, while providing desirable flexibility in connection with possible acquisitions, financings and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from

 

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acquiring, a controlling interest in us. In addition, certain provisions of Texas law, including a provision which restricts certain business combinations between a Texas corporation and certain affiliated shareholders, may delay, discourage or prevent an attempted acquisition or change in control.

In addition, banking laws impose notice, approval, and ongoing regulatory requirements on any shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. These laws include the BHC Act and the Change in Bank Control Act. These laws could delay or prevent an acquisition.

Our corporate charter contains an exclusive forum provision that limits the judicial forums where our shareholders may initiate derivative actions and certain other legal proceedings against us and our directors and officers.

Our second amended and restated certificate of formation provides that the state and federal courts located in Montgomery County, Texas will, to the fullest extent permitted by law, be the sole and exclusive forum for (a) any actual or purported derivative action or proceeding brought on our behalf, (b) any action asserting a claim of breach of a fiduciary duty, (c) any action asserting a claim against us or any of our directors or officers arising pursuant to the Texas Business Organizations Code, our second amended and restated certificate of formation, or our amended and restated bylaws, (d) any action to interpret, apply, enforce or determine the validity of our second amended and restated certificate of formation or amended and restated bylaws, or (e) any action asserting a claim against us or any of our directors or officers that is governed by the internal affairs doctrine. The choice of forum provision in our second amended and restated certificate of formation may limit our shareholders’ ability to obtain a favorable judicial forum for disputes with us. Alternatively, if a court were to find the choice of forum provision contained in our second amended and restated certificate of formation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could harm our business, operating results, and financial condition.

 

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USE OF PROCEEDS

Assuming an initial public offering price of $         per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, we estimate that the net proceeds to us from the sale of our common stock in this offering will be $         million (or $         million if the underwriters exercise in full their option to purchase additional shares of common stock from us), after deducting estimated underwriting discounts and commissions and estimated offering expenses payable to us.

We intend to initially retain the net proceeds from this offering at our holding company and to use such proceeds as needed to support our continued growth, including organic growth and potential future acquisitions, and for general corporate purposes. We may use a portion of net proceeds from this offering to repay outstanding indebtedness under our line of credit described below, plus accrued and unpaid interest, which was $7.8 million as of December 31, 2017. At any given time, we may be evaluating and conducting due diligence with respect to potential acquisition candidates. We cannot assure you that we will enter into any definitive agreements in respect of any such potential transactions. Our management will retain broad discretion to allocate the net proceeds of this offering. Although we intend to initially retain the net proceeds of this offering at our holding company, we may elect to contribute a portion of the net proceeds to the Bank as regulatory capital. The precise amounts and timing of our use of the proceeds will depend upon market conditions and other factors and will be in the discretion of our management.

We entered into our line of credit with a third party lender in May 2017. It allows for borrowing of up to $20 million. The interest rate on this line of credit is based upon 90-day LIBOR plus 4.00% per annum, and unpaid principal and interest is due at the stated maturity on May 12, 2022. This line of credit is secured by a pledge of all of the common stock of the Bank. This line of credit may be prepaid at any time without penalty, so long as such prepayment includes the payment of all interest accrued through the date of the repayments, and, in the case of prepayment of the entire loan, the amount of attorneys’ fees and disbursements of the lender. We are subject to various financial covenants under this line of credit, and as of December 31, 2017 we were in compliance with all covenants. As of December 31, 2017, total borrowing capacity of $12.2 million was available under this line of credit and $7.8 million was drawn, with an average interest rate of 5.24%.

Each $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering by $         million (or $         million if the underwriters elect to exercise in full their purchase option), assuming the number of shares we sell, as set forth on the cover of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

A 100,000 share increase (decrease) in the number of shares of common stock offered by us, would increase (decrease) the net proceeds from the sale of the shares of common stock by us by approximately $        million, assuming an initial public offering price of $        per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2017:

 

    on an actual basis; and

 

    on an as adjusted basis to give effect to the sale of                 shares of common stock by us in this offering (assuming the underwriters do not exercise their purchase option), at an assumed initial public offering price of $         per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

This table should be read in conjunction with “Use of Proceeds,” “Selected Historical Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     As of December 31, 2017  
     Actual     As Adjusted  
     (Dollars in thousands,
except share and per share data)
 

Long-term borrowings

   $ 76,411    

Stockholders’ equity:

    

Common stock (no par value; 50,000,000 shares authorized; 7,280,183 issued and outstanding)

     82,615    

Preferred stock ($1.00 par value; 5,000,000 shares authorized; no shares of Series A preferred stock issued and outstanding)

     —      

Additional paid-in capital

     —      

Retained earnings

     17,025    

Accumulated other comprehensive income (loss)

     (501  

Total stockholders’ equity

     99,139    
  

 

 

   

Total capitalization

   $ 274,689    
  

 

 

   

Per Share Data:

    

Book value per share(1)

   $ 13.62    

Tangible book value per share(2)

   $ 12.52    

Capital Ratios:

    

Tangible equity to tangible assets(3)

     8.92%    

Common equity tier 1 capital ratio

     10.07%    

Tier 1 leverage ratio(4)

     8.71%    

Tier 1 capital to risk-weighted assets(4)

     10.07%    

Total capital to risk-weighted assets(4)

     10.72%    

 

(1) We calculate book value per share as stockholders’ equity divided by the outstanding number of shares of our common stock at the end of the relevant period.
(2) We calculate tangible book value per share as total stockholders’ equity less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, divided by the outstanding number of shares of our common stock at the end of the relevant period. Tangible book value per share is a non-GAAP financial measure. The most directly comparable GAAP financial measure is book value per share. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”
(3)

We calculate tangible equity as total stockholders’ equity less goodwill and other intangible assets, net of accumulated amortization at the end of the relevant period, and we calculate tangible assets as total assets

 

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  less goodwill and other intangible assets, net of accumulated amortization. Tangible equity to tangible assets is a non-GAAP financial measure. The most directly comparable GAAP financial measure is total stockholders’ equity to total assets. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”
(4) We calculate our risk-weighted assets using the standardized method of the Basel III Framework, as implemented by the Federal Reserve and the FDIC.

 

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DILUTION

If you invest in our common stock, your ownership interest will be diluted to the extent that the initial public offering price per share of our common stock in this offering exceeds the tangible book value per share of common stock upon completion of this offering. Tangible book value per share is a non-GAAP financial measure. The most directly comparable GAAP financial measure is book value per share. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”

Tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock outstanding. Our tangible book value as of December 31, 2017 was $91.2 million, or $12.52 per share of common stock.

Investors participating in this offering will incur immediate, substantial dilution. After giving effect to the sale of                 shares of our common stock by us at the initial public offering price of $         per share, the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our tangible book value as of December 31, 2017 would have been approximately $        million, or approximately $        per share of common stock. This represents an immediate increase in tangible book value of $        per share to existing common shareholders, and an immediate dilution of $        per share to investors participating in this offering. If the initial public offering price is higher or lower, the dilution to new shareholders will be greater or less, respectively.

The following table illustrates the calculation of the amount of dilution per share that a purchaser of our common stock in this offering will incur given the assumptions above:

 

Assumed initial public offering price per share of common stock

      $           

Tangible book value per share as of December 31, 2017

   $ 12.52     

Increase in tangible book value per share attributable to this offering

     
  

 

 

    

As adjusted tangible book value per share after this offering

     
     

 

 

 

Dilution in tangible book value per share to new investors(1)

      $  
     

 

 

 

 

(1) Dilution is determined by subtracting tangible book value per share after giving effect to this offering from the initial public offering price paid by a new investor.

A $1.00 increase (or decrease) in the assumed initial public offering price of $        per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, would increase (or decrease) the as adjusted tangible book value per share after this offering by approximately $        , and dilution in tangible book value per share to new investors by approximately $        , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise in full their option to purchase additional shares of our common stock in this offering, the as adjusted tangible book value per share after this offering would be $        per share, the increase in tangible book value to existing shareholders would be $        per share and the dilution to new investors would be $        per share, in each case assuming an initial public offering price of $        per share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus.

The following table summarizes, as of December 31, 2017, the differences between our existing shareholders and new investors with respect to the number of shares of our common stock purchased from us, the total consideration paid to us and the average price per share paid by existing shareholders and investors purchasing common stock in this offering. The calculations with respect to shares purchased by new investors in this offering assume an initial public offering price of $                per share, which is the midpoint of the

 

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estimated initial public offering price range set forth on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us:

 

     Shares Purchased     Total Consideration     Average Price
Per Share
 
     Number      Percentage     Amount      Percentage    
     (Dollars in thousands except per share amounts)  

Existing shareholders

     7,280,183        $ 76,732        $ 10.54  

New investors

            
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

        100   $            100   $  
  

 

 

    

 

 

   

 

 

    

 

 

   

The discussion and tables above assume no exercise of the underwriters’ option to purchase additional shares. In addition, if the underwriters’ option to purchase additional shares is exercised in full, the number of shares of common stock held by existing shareholders will be further reduced to     % of the total number of shares of common stock to be outstanding upon the completion of this offering, and the number of shares of common stock held by investors participating in this offering will be further increased to                shares or     % of the total number of shares of common stock to be outstanding upon the completion of this offering.

The discussion and tables above exclude 1,543,277 shares of common stock issuable upon the exercise of outstanding options at a weighted average exercise price of $12.79 per share (1,135,475 shares of which were exercisable), as of December 31, 2017. The discussion and tables above also exclude 136,212 shares of common stock issuable upon the exercise of outstanding warrants. As of December 31, 2017, we had outstanding warrants to purchase 136,212 shares of common stock at exercise prices ranging from $10.00 per share to $12.84 per share. To the extent any of these options or warrants are exercised, investors purchasing common stock in this offering will experience further dilution.

 

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DIVIDEND POLICY

We have not declared or paid any dividends on our common stock. We currently intend to retain all of our future earnings, if any, for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future. Payments of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion and any legal or contractual limitations on our ability to pay dividends.

As a bank holding company, our ability to pay dividends is affected by the policies and enforcement powers of the Federal Reserve. In addition, because we are a holding company, we are dependent upon the payment of dividends by the Bank to us as our principal source of funds to pay dividends in the future, if any, and to make other payments. The Bank is also subject to various legal, regulatory and other restrictions on its ability to pay dividends and make other distributions and payments to us. See “Regulation and Supervision—Holding Company Regulation—Restrictions on Bank Holding Company Dividends” and “—Bank Regulation—Bank Dividends.” In addition, our current line of credit restricts our ability to pay dividends and in the future we may enter into other borrowing or other contractual arrangements that restrict our ability to pay dividends.

 

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BUSINESS

Our Company

We are a Texas corporation and a registered bank holding company located in the Houston metropolitan area with headquarters in Conroe, Texas. We offer a broad range of commercial and retail banking services through our wholly-owned bank subsidiary, Spirit of Texas Bank SSB. We operate through 15 full-service branches located primarily in the Houston and Dallas/Fort Worth metropolitan areas. As of December 31, 2017, we had total assets of $1.03 billion, loans held for investment of $869.1 million, total deposits of $835.4 million and total stockholders’ equity of $99.1 million.

We are a business-focused bank that delivers relationship-driven financial services to small and medium-sized businesses and individuals in our market areas. Our philosophy is to target commercial customers whose businesses generate between $3 – $30 million of annual revenue. Our product offerings consist of a wide range of commercial products, including term loans and operating lines of credit to commercial and industrial companies; commercial real estate loans; construction and development loans; SBA loans; commercial deposit accounts; and treasury management services. In addition, our retail offerings include consumer loans, 1-4 single family residential real estate loans and retail deposit products.

We pride ourselves on our strong credit culture and responsiveness to our customers’ banking needs. We are guided by an experienced and proven executive management team, led by founder Dean O. Bass, our Chairman and Chief Executive Officer, and David M. McGuire, our President and the Bank’s President and Chief Lending Officer. Since our inception in 2008, we have implemented a growth strategy that includes organic loan and deposit generation through the establishment of de novo branches, as well as strategic acquisitions that have either strengthened our presence in existing markets or expanded our operations into new markets with attractive business prospects.

We operate in one reportable segment of business, Community Banking, which includes Spirit of Texas Bank SSB, our sole banking subsidiary.

Our History and Growth

Dean O. Bass founded our company after successfully establishing, operating and selling, Royal Oaks Bank, a high growth de novo institution in the Central Houston area. We began operations in November 2008 with the acquisition of First Bank of Snook, a community bank with two branches, one in the Bryan/College Station metropolitan area and one in Snook, Texas. Immediately following this initial acquisition, we opened a business banking office with an established commercial lending team and SBA team with whom our management group worked at Royal Oaks Bank. We quickly expanded into the Central Houston and North Houston markets through de novo branching and branch acquisitions. Early in our development, we identified the Dallas/Fort Worth metropolitan area as a strategic opportunity for expansion and an area with strong growth potential based on attractive demographics and market characteristics. In 2012, we expanded into Dallas with a team of bankers with whom our management team had previously worked, by establishing two loan production offices, or LPOs. We further expanded our presence in the Dallas/Fort Worth metropolitan area in 2013 through a whole-bank acquisition and subsequently converted the LPOs into two full-service de novo branches. At the end of 2013, we acquired a bank in The Woodlands, which is located in North Houston, in a FDIC-assisted transaction. Most recently, in 2016, we acquired an additional branch in a strategic location in The Woodlands.

Today, we have 15 full-service branches located in three Texas markets—the Houston, Dallas/Fort Worth and Bryan/College Station metropolitan areas. We believe our exposure to these dynamic and complementary markets provides us with economic diversification and the opportunity for expansion across Texas. We have experienced significant growth since our formation while maintaining strong credit metrics, as demonstrated by:

 

    Our balance sheet growth, with a compound annual growth rate, or CAGR, of 10.5% in assets, 12.3% in loans held for investment and 12.4% in deposits from December 31, 2015 to December 31, 2017;

 

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    Our noninterest bearing deposit growth, with a CAGR of 24.1% from December 31, 2015 to December 31, 2017; and

 

    Our earnings growth, with a CAGR of 9.8% in net income and 10.1% in diluted earnings per common share for the twelve months ended December 31, 2015 to the twelve months ended December 31, 2017. The decrease in net income and diluted earnings per common share for the twelve months ended December 31, 2016 compared to the twelve months ended December 31, 2015 was partially as a result of expenditures for additional personnel and infrastructure as part of and to support our growth efforts.

 

LOGO    LOGO
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We have supplemented our strong organic growth through strategic bank acquisitions. Since our formation, we have completed three whole-bank acquisitions, three branch acquisitions consisting of six branches, and one FDIC-assisted acquisition. These transactions result in us being the most active acquirer among private Texas-based banks and third most active acquirer among Texas-based banks (in each case, based on number of transactions) since 2008, according to data obtained through S&P Global. These acquisitions demonstrate our ability to identify acquisition targets, negotiate and execute definitive agreements, and integrate different systems and cultures into our own. In addition, we have proven our ability to leverage the new capabilities obtained through these acquisitions as evidenced by strong organic growth in acquired markets and continuously enhanced product offerings for our customers. We evaluate acquisitions based on a defined set of criteria, including earnings per share accretion, reasonable tangible book value per share earn back periods and enhanced shareholder value.

The following table summarizes the acquisitions that we have completed since our inception and excludes cash received and paid and other acquired liabilities:

 

Target Company / Seller

   Acquisition Type    Market Area    Completion
Date
     Acquired
Assets
     Acquired
Deposits
 
                 (Dollars in Millions)  

Snook Bancshares

   Whole-Bank    College Station      11/17/2008      $ 38.6      $ 35.9  

Third Coast Bank, SSB

   2 Branches    Houston      10/23/2009        9.2        18.6  

Texas Community Bank, N.A.

   3 Branches    Houston      10/29/2011        42.9        58.9  

Oasis Bank, SSB

   Whole-Bank    Houston      11/30/2012        79.3        69.0  

Peoples Bank

   Whole-Bank    Dallas/Fort Worth      7/13/2013        70.8        60.8  

Texas Community Bank, N.A.

   FDIC-Assisted    Houston      12/13/2013        134.1        118.7  

PlainsCapital Bank

   1 Branch    Houston      6/24/2016        4.4        36.7  

Our Banking Strategy

We are a business-focused bank that delivers relationship-driven financial services to small and medium-sized businesses as well as individuals in our market areas. The following further articulates our banking strategy:

 

    Diverse Lending Platform. Our strategy is to provide a broad array of financial services, which results in a diverse loan portfolio that consists primarily of: commercial and industrial loans; 1-4 single family residential real estate loans; construction, land and development loans; and commercial real estate loans. We focus on delivering superior customer service, responsive decision-making and personal customer relationships. We believe our target customer base is underserved by larger financial institutions, and our ability to execute our relationship banking model and respond quickly to customers gives us an advantage over our competition. Our approach is to equip commercial lenders with the tools and support necessary to serve their clients, including advanced training, treasury management support, quick access to lending management and timely credit decisions. Our lenders are evaluated on their ability not only to originate loans but also to gather deposits and maintain a portfolio with sound credit quality.

 

   

Small Business Administration (SBA) Lending. During the SBA’s fiscal year ended September 30, 2017, the Bank was the leading SBA lender among community banks in Texas, based on the number of loans closed. We primarily lend through the SBA 7(a) program and we have a dedicated team focused on origination, documentation and closing of SBA loans. SBA lending has been a core competency since our inception, and our SBA leadership team has an average of 15 years of experience dedicated to the program. Our strategy is to sell the government-guaranteed portion of the loan (generally 75% to 85% of the principal balance), on which we generate an up-front premium. In addition to selling the guaranteed portion of the loan, we retain the servicing rights to the loans that we sell, and we collect the associated servicing fees, which are typically 1% of the principal balance of the loan. For the years ended December 31, 2015 through 2017, we originated 243, 202 and 270 SBA loans totaling $53.9 million, $46.7 million and $71.2 million, respectively. During these periods, we generated gains on sales of SBA loans of $4.4 million, $4.4 million and $5.7 million, respectively.

 

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As of December 31, 2017, we had SBA loans on our balance sheet of $67.1 million, and we serviced $275.2 million of SBA loans. We maintain strict underwriting guidelines in our SBA program, which has contributed to our success. More than 75% of our SBA customers are national franchisees, which we believe leads to fewer losses because we are able to mitigate risk by analyzing loss histories of similar businesses and the national franchise provides greater support to our borrowers. Additionally, our SBA loans are subject to the same credit review process as our conventional lending customers. We believe these factors have contributed to our SBA portfolio performing better than the national SBA three year average loss rate.

We are a Preferred Lenders Program participant with the SBA, which allows us to accelerate the SBA documentation process. To date, we have not been notified of any denial or repair of the SBA guaranty on any loan submitted for liquidation. An annual review by an independent third party validates the performance of the portfolio and the integrity of the documentation. This lending channel provides us with a competitive advantage and opportunity to earn a borrower’s banking relationship early in the business’s life cycle. Once we have originated an SBA loan, we believe we are optimally positioned to continue to service the customer as the customer’s business matures.

 

    Deposit Gathering Focus. We are focused on generating core deposits from our business customers. We improved our treasury management services by hiring additional personnel and offering more products to enable us to more effectively attract and service the operating accounts of larger, more sophisticated businesses. These efforts have produced desirable results, as evidenced by our growth in non-interest bearing deposits from $114.8 million at December 31, 2015 to $176.7 million at December 31, 2017, a 53.9% increase. We believe that over time we will continue to successfully grow our core deposit base through commercial customers as well as our strategically located retail branches. In addition to our organic deposit efforts, we will continue to place an emphasis on the acquisition of banks with high quality funding profiles to enhance our core deposit base.

 

    Scalable Infrastructure. Throughout our history, we have been strategic in the hiring of key personnel and implementation of systems and processes that we believe are advanced for a bank of our size, which we expect will allow us to scale our business model without significant additional noninterest expense going forward. This includes a sophisticated loan review process, dedicated senior credit and compliance officers, and robust internal and external loan review programs. As we are able to leverage our current expense base as a larger company, we expect to experience enhanced shareholder returns through operational efficiencies.

Our Growth Strategy

We believe we have managed our growth successfully since inception, and plan to continue our strategy of organic and acquisitive growth, as outlined below:

 

    Organic Growth. Our organic growth strategy involves building upon the relationships of our 41 commercial lenders and SBA lenders as of December 31, 2017, who we believe have additional capacity to grow the loan portfolio. We have designed our incentive plans to emphasize strong credit quality, loan growth and deposit growth. From December 31, 2015 to December 31, 2017, we have grown loans held for investment and deposits by $180.3 million and $174.0 million, or 26.2% and 26.3%, respectively. With the exception of the acquisition of one branch in June 2016 with $36.7 million in deposits and no loans, we achieved our loan and deposit growth since January 2014 organically. We intend to further penetrate our current market areas by leveraging our lending relationships and continuing to hire additional junior and senior lenders. Our senior lenders typically have 15 – 30 years of experience and are supported by our junior lenders. We hire junior lenders, initially in a credit analyst support capacity, so that we may conduct training in-house and in accordance with our lending methodologies. We incentivize our senior lenders to incorporate our junior lenders into their book of business by compensating our senior lenders, in part, based on region-wide performance, as opposed to compensation based entirely on the senior lender’s individual portfolio. This program is an integral part of our lending and credit culture.

 

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During late 2017 and year-to-date 2018, to expand our lending capacities, we hired four senior lenders in the Houston and Dallas/Fort Worth metropolitan areas. We expect these professionals will generate and maintain meaningful loan portfolios, while also continuing our focus on increasing core deposits to fund loan growth. We intend to continue to seek out talented bankers that are a good cultural fit and have long standing business relationships in our markets. In addition to leveraging our current platform and hiring key personnel to drive organic growth, we also look for opportunities to open de novo branches in existing and new markets. Before entering a new market, we have historically identified a lending team that is experienced and seasoned in that market and opened an LPO, with the ultimate goal of establishing a full-service branch.

 

    Growth Through Acquisitions. Throughout our history, we have supplemented our organic growth through both whole-bank and branch acquisitions, as well as an FDIC-assisted acquisition, and we intend to continue our strategy of opportunistically acquiring Texas-based community banks and branches within and outside our current footprint. We believe having a publicly traded stock and enhanced access to the capital markets will improve our ability to compete for quality acquisitions. We seek acquisitions that provide meaningful financial and strategic benefits, long-term organic growth opportunities and expense reductions, without compromising our risk profile. When evaluating acquisition targets, we focus our efforts on banks with successful operating histories, stable core deposits, sound asset quality, and strong banking talent. We seek banking markets with attractive demographics, favorable competitive dynamics and potential consolidation opportunities. We are currently focused on acquisitions in and surrounding the four major Texas metropolitan areas of Houston, Dallas/Fort Worth, San Antonio and Austin. In an effort to source future potential acquisitions, our management team maintains an active calling effort with banks that fit our acquisition criteria. With approximately 370 banks headquartered in Texas with total assets less than $1 billion, we believe we will have opportunities for acquisitions both within and outside our current footprint.

Our Competitive Strengths

We believe the following competitive strengths support our banking and growth strategies:

 

    Management Depth and Experience. Our executive management team has more than 39 years of banking experience on average with proven track records, experience and deep customer relationships in our markets. Our Chairman and Chief Executive Officer, Dean O. Bass, and our President and the Bank’s President and Chief Lending Officer, David M. McGuire, worked together previously to successfully build a de novo banking franchise, Royal Oaks Bank, through organic growth and strategic acquisitions. Royal Oaks Bank was sold for over three times tangible book value in 2007, just six years after its formation. Eight of our senior officers are former presidents of Texas banks, offering decades of market knowledge and relationships. Our management team has significant depth of leadership in areas such as lending, credit administration, finance, operations, compliance, internal audit and information technology. Key executives of our company include:

 

    Dean O. Bass—Chairman, Founder and Chief Executive Officer of our Company and of the Bank. Our senior management team is led by Dean O. Bass, a 44-year banking veteran. In 2001, he founded Royal Oaks Bank and served as the President and Chief Executive Officer. Following the 2007 sale of Royal Oaks Bank, Mr. Bass led the formation of the Bank in 2008. Prior to co-founding Royal Oaks Bank, Mr. Bass served as a Senior Vice President at Horizon Capital Bank and was a National Bank Examiner for the Office of the Comptroller of the Currency. Mr. Bass has been involved in the formation of several de novo banking offices and branches.

 

    David M. McGuire—President and Director of our Company and President and Chief Lending Officer of the Bank. Mr. McGuire has 37 years of banking experience and was previously the Co-Founder, President and Chief Lending Officer of Royal Oaks Bank. Prior to Royal Oaks Bank, Mr. McGuire served as the Office Chief Executive Officer-Fort Bend for Sterling Bank.

 

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    Jerry D. Golemon—Executive Vice President and Chief Operating Officer of our Company and the Bank. Mr. Golemon is a 37-year banker and a Certified Public Accountant. Mr. Golemon’s prior experience includes serving as the Chief Financial Officer and a founding director at Texas National Bank, which was sold in 2006 to First Community Bank. Additionally, Mr. Golemon has previously worked for a Houston-based certified public accounting firm focused on bank audits as well as served in a chief financial officer or similar capacity for other banks.

 

    Jeffrey A. Powell—Executive Vice President and Chief Financial Officer of our Company and the Bank. Mr. Powell has worked in the banking industry for 38 years and has served as chief financial officer or chief accounting officer for multiple commercial banks and their respective holding corporations, both public and private, since 2005, including Hamilton State Bancshares, Inc., IBERIABANK Corporation and Citizen Republic Bancorp, Inc.

For additional information regarding our executive management and board of directors, see “ManagementExecutive Officers and Directors.”

 

    Acquisition Experience. We believe we have a talent for identifying, acquiring and integrating acquisition targets which are accretive to our earnings per share, as evidenced by the successful execution and integration of three whole-bank acquisitions, three branch acquisitions and one FDIC-assisted acquisition. These transactions result in our being the most active acquirer among private Texas-based banks and third most active acquirer among Texas-based banks (in each case, based on number of transactions) since 2008, according to data obtained through S&P Global. We believe that we have a disciplined approach to acquisitions and continue to seek companies and branches that will be additive to our franchise and accretive to our earnings per share.

 

    Strong Credit Culture. Credit culture has always been a core tenet of the Bank and, as a result, our loss history has been minimal. No lender has sole authority for any loan originated, regardless of credit size or relationship depth. Our credit review process is led by our Chief Credit Officer and two Deputy Chief Credit Officers, each having over 30 years of experience in credit analysis. Every credit in the Bank must be reviewed and approved by one of these officers. Additionally, every borrowing relationship that exceeds $1.5 million must be approved by the Directors Loan Committee. We strive to balance our focus on credit quality with our customer’s interest in having a rapid credit response. We have developed compensation packages for our lenders which include incentives based on the credit quality of their portfolios. We have averaged 0.09% net charge-offs as a percent of average loans in the years 2015 through 2017 and as of December 31, 2017, our non-performing assets to assets ratio was 0.35%.

 

    Limited Oil and Gas Exposure. We are not an active lender to oil and gas exploration and production companies. We have no direct oil and gas exploration or production loan exposure with respect to our outstanding loans as of December 31, 2017. However, we have a small amount of direct and indirect lending exposure to the oil and gas industry, which we monitor closely. We define direct exposure as companies that derive more than 50% of their respective gross revenue from providing services or products to the oil and gas industry. Based on this criteria, as of December 31, 2017, we had 25 direct oil and gas loans totaling $15.4 million, or 1.8% of outstanding loans. We define indirect exposure as individuals whose primary source of earnings are from the oil and gas industry, or companies that derive less than 50% of their revenues from providing services or products to the oil and gas industry. Based on this criteria, as of December 31, 2017, we had 68 indirect oil and gas loans totaling $22.2 million, or 2.6% of outstanding loans.

Our Banking Services

We offer quality products and personalized services while providing our customers with the financial sophistication and array of products typically offered by a larger bank. Our lending services include commercial loans to small- to medium-sized businesses and professional practices, real estate-related loans, and consumer

 

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loans to individuals. Our current working capital and our ability to generate, maintain and increase our deposits continues to be our primary source of funding for such loans. We offer a broad range of competitively-priced deposit services including demand deposits, regular savings accounts, money market deposits, certificates of deposit and individual retirement accounts. To complement our lending and deposit services, we also offer direct deposit, wire transfers, night depository, treasury management services, safe-deposit boxes, debit cards and automatic drafts.

Lending Activities

We offer a variety of loans, including commercial and industrial loans, SBA loans, 1-4 single family residential real estate loans, construction, land and development real estate loans, commercial real estate loans (including multifamily) and municipal loans. We also offer various loans and leases to individuals and professionals including residential real estate loans, home equity loans, installment loans, personal lines of credit, and standby letters of credit.

We support the small- to medium-sized business community throughout our market areas and lend money to creditworthy borrowers within those markets. Our ability to attract deposits serves as our primary source of working capital to fund loans. To provide additional sources of working capital, we maintain a federal funds borrowing line of credit with one or more correspondent banks and we are a member of the Federal Home Loan Bank of Dallas which permits us to borrow against our loan portfolio at preferred rates.

Our SBA loan program is a key element of our ability to serve the small- to medium-sized business community in our markets. We also provide SBA loans nationwide to well-known national franchises. Generally, these loans have a more flexible structure than conventional loans and we use our Preferred Lender status with the SBA to expedite the loan approval process for our customers. During the SBA’s fiscal year ended September 30, 2017, the Bank was the leading SBA lender among community banks in Texas, based on the number of loans closed.

In addition to traditional 1-4 single family residential real estate loans, we have a team dedicated to making 1-4 single family residential real estate loans to foreign nationals residing in Texas. Generally, these loans are made to borrowers who derive more than 50% of their personal income from foreign sources and do not qualify for traditional conforming mortgage products readily available to most home buyers in Texas.

As of December 31, 2017, we had loans held for investment of $869.1 million, representing 84.4% of our total assets. As of December 31, 2016, we had loans held for investment of $772.9 million, representing 78.8% of our total assets. Our loan portfolio consisted of the following loan categories as of the dates indicated:

 

     As of December 31,  
     2017     2016
as Restated
 
     Amount      % of Total     Amount      % of Total  
     (Dollars in thousands)  

Commercial and industrial loans(1)

   $ 135,040        15.5   $ 117,762        15.2

Real estate:

          

1-4 single family residential loans

     232,510        26.8     206,641        26.7

Construction, land and development loans

     139,470        16.0     113,316        14.7

Commercial real estate loans (including multifamily)

     285,731        32.9     251,870        32.6

Consumer loans and leases

     22,736        2.6     26,676        3.5

Municipal and other loans

     53,632        6.2     56,596        7.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans held for investment

   $ 869,119        100.0   $ 772,861        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Balance includes $67.1 million and $58.7 million of the unguaranteed portion of SBA loans as of December 31, 2017 and December 31, 2016, respectively.

 

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Loan Types. The following is a description of the types of loans we offer to our customers.

 

    Commercial and Industrial Loans. A primary component of our loan portfolio is loans for commercial purposes. Our commercial loan portfolio consists of loans principally to retail trade, service, and manufacturing firms located in our market areas. The terms of these loans vary by purpose and by type of underlying collateral, if any. We typically make equipment loans for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term. Equipment loans are generally secured by the financed equipment, and the ratio of the loan principal to the value of the financed equipment or other collateral is generally 80% or less. Loans to support working capital typically have terms not exceeding one year and are usually secured by accounts receivable, inventory, or other collateral, as well as personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and for loans secured with other types of collateral, principal will typically be due at maturity. The primary risk for commercial loans is the failure of the business due to economic and financial factors. As a result, the quality of the commercial borrower’s management and its ability both to properly evaluate changes in the supply and demand characteristics affecting its markets for products and services and to effectively respond to such changes are significant factors in a commercial borrower’s creditworthiness and our decision to make a commercial loan. Commercial and industrial loans totaled $135.0 million as of December 31, 2017, or 15.5% of our loans held for investment.

SBA Loans

We originate loans to customers in Texas and, in some instances, nationwide in support of some well-known national franchises under an SBA program that generally provides for SBA guarantees of between 75% and 85% of each loan. We routinely sell the guaranteed portion of SBA loans to a third party and retain the servicing rights, holding the nonguaranteed portion in our portfolio. When the guaranteed portion of an SBA loan is sold, the premium received on the sale is recognized in noninterest income, and the revenue associated with the servicing rights is recognized as service is performed. SBA servicing assets are recognized separately when rights are acquired through the sale of the SBA guaranteed portion. These servicing rights are initially measured at fair value at the date of sale and included in the gain on sale. Updated fair values are obtained from an independent third party on a quarterly basis and adjustments are presented as SBA servicing fees on the consolidated statements of income. To determine the fair value of SBA servicing rights, we use market prices for comparable servicing contracts, when available, or alternatively, we use a valuation model that calculates the present value of estimated future net servicing income.

During the SBA’s fiscal year ended September 30, 2017, the Bank was the leading SBA lender among community banks in Texas, based on the number of loans closed. We are also the 27th largest provider of SBA loans nationally, among all banks, based upon number of loans originated in 2017. We focus our primary SBA lending efforts on financing well-known national franchises in Texas and nationwide. Our deep relationship with each of these franchises allows us the privilege of being the preferred lender for their respective franchises, providing us a steady pipeline of new SBA loan opportunities both in Texas and nationwide. The unguaranteed portion of SBA loans on our balance sheet totaled $67.1 million as of December 31, 2017, or 49.7% of total commercial and industrial loans.

 

    1-4 Single Family Residential Real Estate Loans

Traditional 1-4 Single Family Loans

We provide mortgages for the financing of 1-4 single family residential homes for primary occupancy, vacation, or rental purpose. Generally these loans are 30 year adjustable rate mortgages. All borrowers are underwritten with standard policy guidelines to provide a homogenous and predictable portfolio of performing loans. As of December 31, 2017, 1-4 single family residential real estate loans totaled $232.5 million, or 26.8% of our loans held for investment.

 

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We are located near five major Texas public and private universities where on-campus housing is not sufficient to house their current and growing student populations. This is an ideal opportunity for us to provide financing for homes near each of the universities to be used for borrower-related student housing and/or rental to other students. In addition, we cater to borrowers who specialize in renting homes to students, with the financing of multiple 1-4 single family residential properties for their business. These loans are underwritten to standard policy guidelines with amortizations typically shorter than homes used for primary occupancy.

Foreign National Loans

In addition to traditional 1-4 single family residential loans, we have a team dedicated to making 1-4 single family residential real estate loans to foreign nationals in Texas. We provide mortgages to foreign nationals in Texas for the purpose of primary occupancy or as secondary homes while travelling to the U.S. Generally we define foreign nationals as those who derive more than 50% of their personal income from non-U.S. sources. All of our markets have experienced an influx of foreign nationals from outside the U.S. as they move their families to Texas for business, education, personal safety, or employment reasons. We have developed relationships with other traditional mortgage companies and local real estate agents who refer foreign national home buyers to us for financing. Because more than 50% of their personal income sources are derived from outside of the U.S., these foreign nationals do not qualify for traditional market financing; therefore they must seek financing from banks that specialize in this type of non-standard product.

We believe we are one of the most active providers of loans to foreign nationals in Texas. We have developed an enhanced due diligence process designed to meet or exceed any regulatory guidelines. Typical loan terms include larger down payments than would normally be required, minimum reserves equal to an amount of mortgage payments over a specified period held in our Bank, and monthly escrows for taxes and insurance. Foreign national loans totaled $107.6 million as of December 31, 2017, or 46.3% of our total 1-4 single family residential real estate loans.

 

    Construction, Land and Development Loans. Our construction and development loans are made both on a pre-sold and speculative basis. If the borrower has entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a pre-sold basis. If the borrower has not entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a speculative basis. Construction and development loans are generally made with a term of twelve months and interest is paid periodically. The ratio of the loan principal to the value of the collateral, as established by independent appraisal, does not generally exceed 80%. Additionally, speculative loans are based on the borrower’s financial strength and cash flow position. Loan proceeds are disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or appraiser.

Construction and development loans generally carry a higher degree of risk than long-term financing of existing properties. We attempt to reduce risk by generally requiring personal guarantees and by keeping the loan-to-value ratio of the completed project below specified percentages. We also require additional borrower reserves if the project will have an extended marketing period. We may also reduce risk by selling participations in larger loans to other institutions when possible. As of December 31, 2017, construction loans totaled $139.5 million, or 16.0% of our loans held for investment.

 

   

Commercial Real Estate Loans (Including Multifamily). Our commercial real estate loan terms are generally limited to seven years or less, although payments may be structured on a longer amortization basis. Interest rates may be fixed or adjustable, with an origination fee generally being charged on each loan funded. We attempt to reduce credit risk on our commercial real estate loans by emphasizing loans on owner-occupied office and retail buildings where the ratio of the loan principal to the value of the collateral as established by independent appraisal does not exceed 80%. We also project minimum levels of net projected cash flow available for debt service based on the type of loan. In addition, we generally require personal guarantees from

 

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the principal owners of the property supported by a review by our management of the principal owners’ personal financial statements. As of December 31, 2017, commercial real estate loans (including multifamily) totaled $285.7 million, or 32.9% of our loans held for investment.

Owner-occupied Commercial Real Estate Loans

Owner-occupied commercial real estate is a key component of the Bank’s lending strategy to owner- operated businesses, representing a large percentage of its total commercial real estate loans. The Bank’s philosophy is that owner-occupied property loans are desirable since they are our borrower’s business “home” representing a safer investment of the Bank’s funds, as we are usually able to monitor the borrower’s business financial results on a regular basis. These loans are competitively sought after by the other community banks in our markets. Owner-occupied commercial real estate loans totaled $100.6 million, or 35.2% of total commercial real estate loans as of December 31, 2017.

Other Commercial Real Estate Loans

The Bank possesses the experience, expertise and on-going monitoring capabilities to originate loans for income producing properties. Generally these loans are for retail strip centers, hotels, office buildings, self-storage facilities, and multi and single tenant office warehouses, all within our markets. Generally, our income producing property loans require experienced and deep management, premium locations, proven debt service ability, strong equity positions, alternative repayment sources, and the personal guarantee of the principals. We monitor our exposures to these loan types to maintain adequate concentration levels in relation to our capital position, our market geographies and as a percentage of the entire loan portfolio. Nonowner-occupied commercial real estate loans totaled $164.3 million, or 57.5% of total commercial real estate loans as of December 31, 2017.

Multifamily Loans and Farmland

Multifamily loans are generally not a focus of the Bank’s lending strategy as evidenced by its current low level of multifamily loan exposures outstanding and we do not expect this portion of our loan portfolio to represent a large portion of the growth going forward. Given the large dollar requirements for most multifamily projects exceed the Bank’s legal lending limit, either as construction or as completed, the Bank has elected not to pursue multifamily lending as a part of its core business strategy. The Bank’s current multifamily loans are to seasoned and successful multifamily operators who possess quality alternative repayment sources. Multifamily loans totaled $18.3 million, or 6.4% of total commercial real estate loans as of December 31, 2017. Farmland loans totaled $2.7 million as of December 31, 2017, or 0.9% of total commercial real estate loans as of December 31, 2017.

 

    Consumer Loans and Leases. We make a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. Consumer loans are generally made at a fixed rate of interest. While we believe our policies help minimize losses in the consumer loan category, because of the nature of the collateral, if any, it may be more difficult to recover any loan losses.

The majority of our consumer loans are related to the financing of vehicle leases to individuals, originated by a well-known third party leasing company and subsequently purchased by us after our final credit review. We limit our exposure to individuals living in Texas, within our defined local markets. Underwriting for each lease is performed by our credit department, within our policies and is approved by a senior credit officer of the Bank. Consumer loans and leases totaled $22.7 million, or 2.6% of our loans held for investment as of December 31, 2017. Leases totaled $18.0 million, or 79.2% of total consumer loans as of December 31, 2017.

 

   

Municipal and Other Loans. We provide financing for municipalities, emergency service districts, hospital districts, school districts and some counties in Texas. Generally the financing opportunities are for equipment and facilities, such as fire engines, fire stations, hospitals, municipal water treatment

 

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facilities, or other public needs. The loans are typically secured by a lien on the tax revenues of the borrower. These loans earn a tax-exempt rate to the Bank. Total loans to municipalities, emergency service, hospital and school districts totaled $53.3 million, or 6.1% of loans held for investment as of December 31, 2017.

The Bank provides loans for agricultural purposes resulting from relationships in our first several years of operation. As the focus of our business has shifted to the major metropolitan areas of Texas, the focus on agricultural lending has declined; therefore, while we do not actively pursue this line of business, we continue to service our existing active agriculture customers.

Credit Administration, Lending Limits, Credit Department and Loan Review

Certain credit risks are inherent in making loans and managing these risks is a company-wide process. These include repayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to strong internal credit policies and procedures.

We have several procedures in place to assist us in maintaining the overall quality of our loan portfolio. Our strategy for credit risk management includes a conservative underwriting process. Our board of directors has established underwriting guidelines to be followed by our officers, and we monitor delinquency levels for any negative or adverse trends.

We implement our underwriting policy through a tiered system of combined loan authority for our loan officers with the Chief Credit Officer and a loan committee approval structure. Generally, our loan officers do not have single signature loan authority and must have the additional approval of their immediate lending supervisor and the Chief or Deputy Chief Credit Officer. Approval of loans with relationships over the lending authority of the Chief Credit Officer must be approved by a structured concurrence approval process including executive management or, based on the loan relationship size, by the Bank’s Director Loan Committee, comprised of executive management and two outside directors of the Bank. The Bank’s Director Loan Committee meets weekly, or more frequently if required, to evaluate applications for new and renewed loans, or modifications to loans, in which the loan relationship total exposure exceeds predefined limits. Our strategy in considering a loan is to follow conservative and consistent underwriting practices, which include:

 

    knowing our customers to ensure a complete understanding of their financial condition and ability to repay the loan;

 

    verifying that primary and secondary sources of repayment are adequate in relation to the amount of the loan;

 

    developing and maintaining targeted levels of diversification for our loan portfolio as a whole and for loans within each category; and

 

    ensuring that each loan is properly documented with perfected liens on collateral, and that any insurance coverage requirements are satisfied.

As part of the underwriting process, we seek to minimize risk in a variety of ways, including the following:

 

    analyzing the borrower’s financial condition, cash flow, liquidity, and leverage;

 

    assessing the borrower’s operating history, operating projections, location and condition;

 

    reviewing appraisals, title commitment and environmental reports;

 

    considering the management experience and financial strength of the principals of the borrower; and

 

    evaluating economic trends and industry conditions.

 

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Lending Limits

Our lending activities are subject to a variety of lending limits imposed by state and federal law. In general, we are subject to a legal limit on loans to a single borrower equal to 25% of the Bank’s tier 1 capital. This limit increases or decreases as the Bank’s capital increases or decreases. As of December 31, 2017, our legal lending limit was $23.6 million, and our largest relationship was $15.1 million. In order to ensure compliance with legal lending limits and in accordance with our strong risk management culture, we maintain internal lending limits that are significantly less than the legal lending limits. We are able to sell participations in our larger loans to other financial institutions, which allows us to manage the risk involved in these loans and to meet the lending needs of our customers requiring extensions of credit in excess of these limits.

Credit Department

The Bank maintains a large credit department under the direction of the Bank’s Chief Credit Officer. The credit department prepares and provides in-depth credit administration reporting to the Bank’s Asset Quality Committee on a quarterly basis to aid the committee in monitoring and adjusting the Bank’s loan focus as it grows. In addition, the credit department provides analytical and underwriting services in support of the loan officers developing their respective loan portfolios. The credit department also serves as a training ground for the Bank’s newest credit analysts who will be used to support our most senior loan officers as they are further trained to be our future lending officers.

Loan Review

The Bank has developed an internal loan review system called the Relationship Review Process. Generally, all loan relationships greater than $500 thousand are reviewed by the loan officer at least annually. The loan officer will prepare a Relationship Review Memo that updates the credit file with new financials, review of the collateral status, and provide any meaningful commentary that documents changes in the borrower’s overall condition. For loan relationships greater than $2 million, the Relationship Review Process is done semi-annually. Upon completion of the Relationship Review Memo, the loan officer must present the memo to the Chief or Deputy Chief Credit Officer for final review, appropriate grade change if needed and then approval to place in the credit file for future reference. We believe this process gives the Chief Credit Officer and executive management strong insight into the underlying performance of the Bank’s loan portfolio allowing for accurate and proper real-time grading of the loan portfolio.

Additionally, we employ an external third party loan review team to review up to a 70% penetration of the Bank’s entire loan portfolio on an annual basis. This review will include all large loan relationships, insider loans, all criticized loans and the Bank’s allowance for loan and lease losses calculations.

Nonperforming Loans

We stringently monitor loans that are classified as nonperforming. Nonperforming loans include nonaccrual loans, loans past due 90 days or more, and loans renegotiated or restructured because of a debtor’s financial difficulties. Loans are generally placed on nonaccrual status if any of the following events occur: (a) the classification of a loan as nonaccrual internally or by regulatory examiners; (b) delinquency on principal for 90 days or more unless we are is in the process of collection; (c) a balance remains after repossession of collateral; (d) notification of bankruptcy; or (e) we determine that nonaccrual status is appropriate.

 

     As of December 31,  
     2017      2016  
     (Dollars in thousands)  

Loans accounted for on a nonaccrual basis

   $ 3,562      $ 3,807  

Accruing loans past due 90 days or more

     33        —    

 

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Allowance for Loan and Lease Losses

The allowance for loan and lease losses is maintained at a level that we believe is adequate to absorb all probable losses on loans then present in the loan portfolio. The amount of the allowance is affected by: (1) loan charge-offs, which decrease the allowance; (2) recoveries on loans previously charged-off, which increase the allowance; and (3) the provision of possible loan losses charged to income, which increases the allowance. In determining the provision for possible loan losses, we monitor fluctuations in the allowance resulting from actual charge-offs and recoveries, and we periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions in an effort to evaluate portfolio risks. The amount of the provision is based on our judgment of those risks.

Deposits

Our core deposits include checking accounts, money market accounts, savings accounts, a variety of certificates of deposit and IRA accounts. To attract deposits, we employ an aggressive marketing plan in our primary service areas and feature a broad product line and competitive offerings. The primary sources of deposits are residents and businesses located in the markets we serve. We obtain these deposits through personal solicitation by our lenders, officers and directors, direct mail solicitations and advertisements in the local media.

The following table sets forth the amount of our total deposits and percentage of total deposits based on balances as of the dates indicated.

 

     As of December 31,  
     2017     2016  
     Amount      % of Total     Amount      % of Total  
     (Dollars in thousands)  

Noninterest-bearing demand deposits

   $ 176,726        21.2   $ 171,475        21.1

Interest-bearing NOW accounts

     7,318        0.9     8,302        1.0

Savings and money market accounts

     243,173        29.1     215,432        26.4

Time deposits

     408,151        48.8     419,229        51.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 835,368        100.0   $ 814,438        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Other Banking Services

We offer banking products and services that we believe are attractively priced and easily understood by our customers. In addition to traditional bank accounts such as checking, savings, money markets, and CDs, we offer a full range of ancillary banking services, including a full suite of treasury management services, consumer and commercial online banking services, mobile applications, safe deposit boxes, wire transfer services, debit cards and ATM access. Merchant services (credit card processing) and co-branded credit card services are offered through a correspondent bank relationship. We do not exercise trust powers.

Investments

We maintain a portfolio of investments, primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States and other taxable securities, to provide liquidity and an additional source of income, to manage interest rate risk, to meet pledging requirements and to meet regulatory capital requirements.

We invest in U.S. Treasury bills and notes, as well as in securities of federally sponsored agencies, such as Federal Home Loan Bank bonds. We may invest in federal funds, negotiable certificates of deposit, banker’s acceptances, mortgage-backed securities, corporate bonds and municipal or other tax-free bonds. No investment in any of those instruments will exceed any applicable limitation imposed by law or regulation. Our asset/liability/investment committee reviews the investment portfolio on an ongoing basis in order to ensure that the investments conform to our internal policy set by our board.

 

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Our Markets

Our primary markets are the Houston, Dallas/Fort Worth and Bryan/College Station metropolitan areas. We expect to continue to grow within our current markets, as well as expand into new markets. We believe the markets that we serve are a key factor in our growth and success, and offer stability and steady growth as well as economic diversification.

We believe that our three markets are economically insulated from one another, and economic hardships in one market may have little or no impact on the other markets. For example, during the period from 2015 through the end of 2016, the Houston metropolitan area experienced a slowdown in economic activity, in part, due to a prolonged period of lower crude oil and natural gas prices. While we did not experience heightened losses on our loan portfolio in the Houston metropolitan area, we observed a slowdown in lending opportunities in that market. Conversely, in the Dallas/Fort Worth metropolitan area and the Bryan/College Station metropolitan area, we exceeded our loan growth expectations over the same time period, leading to overall robust loan growth. We expect that the diversification of our markets will continue to benefit us in the future.

According to S&P Global, Texas is the second most populous state in the country with a population of 28.5 million as of January 2018. Over 50% of the Texas population lives in the three markets in which we operate. Additionally, the five-year population growth from 2018 to 2023 is projected to be 7.1% compared to 3.5% for the nation as a whole over the same period.

 

                          Market Demographics  
                                 2018 – 2023 Projected  
     Spirit of Texas Bancshares, Inc. (1)      January 2018
Population(3)
     Population
Growth(3)
    Household
Income
Growth(3)
 

Market

   Branches      Loans(2)      Deposits(2)          
            (Dollars in thousands)                      

Houston MSA

     10      $ 369,013      $ 505,226        6,980,780        8.3     7.7

Dallas/Fort Worth MSA

     4        171,342        124,149        7,418,556        7.7     9.8

Bryan/College Station MSA

     1        119,120        112,799        263,260        7.8     13.6

Texas

     15              28,531,603        7.1     9.5

United States

              326,533,070        3.5     8.9

 

(1) Amounts as of December 31, 2017
(2) Excludes SBA loans, loans to foreign nationals, and mortgage loans (as well as associated deposits)
(3) According to S&P Global

 

    Houston. According to the U.S. Bureau of Economic Analysis, the Houston metropolitan area had the sixth largest gross domestic product in the U.S. in 2016. The Houston metropolitan area is the corporate headquarters for 20 Fortune 500 companies, ranking fourth among metro areas according to the Greater Houston Partnership. Notable corporate headquarters include ConocoPhillips, Sysco, Waste Management and Phillips 66. Over the past several years, the Houston metropolitan area has grown to be a diverse economy. While Houston is known as the “Energy Capital of the World,” Houston also boasts the largest medical complex in the world, has the second busiest port in the United States in 2017, and is a leader in international business. Houston’s economic success is projected to continue, with employment growth of 1.74% annually through the year 2040, according to the Perryman Group.

The northern portion of our Houston franchise includes our branches in The Woodlands, Conroe, Magnolia and Tomball. According to S&P Global, these four cities have experienced a combined population growth of over 65% over the past six years. Additionally, Conroe, Texas was named the fastest growing city in the country in 2016, according to the U.S. Census Bureau. This robust population expansion over the last several years is largely a result of the companies headquartered in the area, such as Anadarko Petroleum, Aon Hewitt, Waste Connections, Inc. and Baker Hughes, among others, according to The Houston Chronicle. Additionally, The Woodlands area is expected to continue to see increased economic activity due to the opening of ExxonMobil’s new corporate campus in 2015, which is designed to accommodate over 9,000 employees.

 

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    Dallas/Fort Worth. We have four branches located in the Dallas/Fort Worth metropolitan area, including in Central Dallas, Grapevine, Colleyville, and Fort Worth. Home to a major international airport and many large corporations, the diverse and sprawling Dallas/Fort Worth metropolitan area is the largest metropolitan statistical area in Texas and fourth largest in the nation as of 2018, according to S&P Global. Out of the top twenty metropolitan statistical areas in the nation in 2017, the Dallas/Fort Worth metropolitan area saw the second highest population growth from 2010 – 2018 and third highest employment growth from 2015 – 2018, according to S&P Global. According to Forbes, the Dallas/Fort Worth metropolitan area was named the best city for jobs in 2017. According to the Dallas Regional Chamber of Commerce, the area also serves as the corporate headquarters for 22 Fortune 500 companies including Southwest Airlines, AT&T, Exxon Mobil and Kimberly-Clark, ranking the Dallas/Fort Worth metropolitan area third in the nation for Fortune 500 corporate headquarters. Additionally, Toyota relocated its North American headquarters to the area, adding 4,000 jobs, according to a statement by Toyota’s North America CEO, while a State Farm expansion is expected to contribute approximately 10,000 jobs to the Dallas/Fort Worth area, according to the Dallas Business Journal. According to the U.S. Bureau of Economic Analysis, the Dallas/Fort Worth metropolitan area is responsible for producing nearly 32% of the state’s total gross domestic product in 2016 and, according to the Dallas Economic Development, the Dallas/Fort Worth metropolitan area is home to over 65,000 businesses, adding over 300 jobs per day on average over the 12 months ended February 2017, according to Transwestern. The Dallas/Fort Worth metropolitan area is also home to six professional sports teams and several major universities as well as multiple community college districts, with total student enrollment of over 370,000.

 

    Bryan/College Station. According to Forbes, the Bryan/College Station metropolitan area ranked first in Texas and third nationwide for Best Small Places for Business and Careers in 2017 with job growth of 10.3% from 2015 to 2018. In 2016, total construction project valuation in Bryan/College Station was over $750 million. The Bryan/College Station metropolitan area is also home to Texas A&M University, which enrolls over 68,000 students and is the largest university in the state. Notable ongoing projects include the Texas A&M RELLIS Campus, a $250 million, 2,000 acre campus dedicated to technology development, as well as the continued development of ATLAS, a master planned community and business complex specifically constructed for companies engaged in medical technology and pharmaceuticals.

Information Technology Systems

We continue to make significant investments in our information technology systems for our banking and lending operations and treasury management activities. We believe this is a necessary investment in order to enhance our capabilities to offer new products and overall customer experience, to provide scale for future growth and acquisitions, and to increase controls and efficiencies in our back office operations. We outsource our core data processing services to a nationally recognized bank software vendor providing us with capabilities to support the continued growth of the Bank. Our internal network and e-mail systems are maintained in-house. We leverage the capabilities of a third party service provider to provide the technical expertise around network design and architecture that is required for us to operate as an effective and efficient organization. We actively manage our business continuity plan, and we follow recommendations outlined by the Federal Financial Institutions Examination Council to ensure that we have effectively identified our risks and documented contingency plans for key functions and systems including providing for back up sites for all critical applications. We also perform tests to ensure the adequacy of these contingency plans.

The majority of our other systems, including our electronic funds transfer, transaction processing and online banking services, are also hosted by the vendor to whom we outsource our core data processing services. The scalability of this infrastructure is designed to support our growth strategy. These critical business applications and processes are included in the business continuity plans referenced above.

Competition

The banking business is highly competitive, and our profitability will depend principally upon our ability to compete with other banks and non-bank financial institutions located in each of our banking center locations for

 

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lending opportunities, deposit funds, bankers and acquisition candidates. Our banking competitors in our target markets include various community banks and national and regional banks. There were over 300 FDIC-insured depository institutions that operate in our combined markets as of December 31, 2017. We compete with other commercial banks, savings associations, credit unions, finance companies and money market mutual funds operating in our markets.

We are subject to vigorous competition in all aspects of our business from banks, savings banks, savings and loan associations, finance companies, credit unions and other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, asset-based non-bank lenders, insurance companies and certain other non-financial entities, including retail stores which may maintain their own credit programs and certain governmental organizations which may offer more favorable financing than we can. Many of the banks and other financial institutions with which we compete have significantly greater financial resources, marketing capability and name recognition than us and operate on a local, statewide, regional or nationwide basis.

Our strategy to compete effectively in our markets is to emphasize our identity as a community-oriented bank in contrast to large, national and regional banks. As a community bank, we can respond to loan requests quickly and flexibly through decisions made locally. Our marketing strategy is relationship and referral-based. We rely heavily on our bankers and the efforts of our officers and directors for building and strengthening those relationships. Additionally, our bankers, directors and officers are actively involved in our primary markets and are a strong source of introductions and referrals.

Employees

As of December 31, 2017, we had 195 employees of which 187 were full-time employees. None of our employees are represented by a union. Management believes that our relationship with employees is good.

Properties

Our principal offices and headquarters are located at 1836 Spirit of Texas Way, Conroe, Texas 77301. All of our branches are located in Texas. We own six of our branch locations and lease the remaining nine locations and we own one building that is currently held for sale. We moved from one owned location in The Woodlands to a newly acquired office location in The Woodlands in February 2018, we moved from one leased office location to a newly acquired office location in Fort Worth during April 2018 and we expect to move from another leased office location to a newly acquired office location in Dallas during the first half of 2018. The terms of our leases range from five to 10 years and generally give us the option to renew for subsequent terms of equal duration or otherwise extend the lease term subject to price adjustment based on market conditions at the time of renewal. The following table sets forth a list of our locations as of the date of this prospectus.

 

Houston-The Woodlands-Sugar Land MSA

 

Location

   Own or Lease      Sq. Ft. (1)  

Houston

     

Post Oak Banking Center

     Lease        10,853  

720 N. Post Oak Road, Suites 101, 620 and 650, Houston, Texas 77024

     

Stafford Banking Center

     Lease        6,372  

12840 Southwest Freeway, Stafford, Texas 77477

     

Richmond Banking Center

     Lease        5,890  

3100 Richmond Avenue, Suite 100, Houston, Texas 77098

     

Clear Lake Banking Center

     Lease        2,592  

1010 Bay Area Boulevard, Unit 1010, Houston, Texas 77058

     

The Woodlands

     

Woodlands North Banking Center

     Own        24,000  (2) 

16610 IH-45 North, The Woodlands, Texas 77384

     

 

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Houston-The Woodlands-Sugar Land MSA

 

Location

   Own or Lease      Sq. Ft. (1)  

Woodlands Central Center

     Own        14,925  (2) 

1525 Lake Front Circle, The Woodlands, Texas 77380

     

Woodlands West Banking Center

     Own        6,700  (3) 

30350 F.M. 2978, Magnolia, Texas 77354

     

Conroe

     

Conroe Banking Center

     Own        24,000  (2) 

1836 Spirit of Texas Way (815 W. Davis St.), Conroe, Texas 77301

     

Tomball

     

Tomball Banking Center

     Own        12,798  (2) 

1100 West Main, Tomball, Texas 77375

     

Magnolia

     

Magnolia Banking Center

     Lease        3,600  

6910 FM 1488, Suites 1, 2, 3 & 4, Magnolia, Texas 77354

     

 

Dallas-Fort Worth-Arlington MSA

 

Location

   Own or Lease      Sq. Ft.   

Dallas

     

Dallas Branch

     Lease        5,726  (4) 

3100 Monticello Avenue, Suites 125 and 980, Dallas, Texas 75205

     

Fort Worth

     

Fort Worth Branch

     Lease        7,483  (5) 

1120 Summit Avenue, Fort Worth, Texas 76102

     

Colleyville

     

Colleyville Banking Center

     Lease        4,100  

5712 Colleyville Boulevard, Suite 100, Colleyville, Texas 76034

     

Grapevine

     

Grapevine Banking Center

     Lease        3,327  

601 W. Northwest Hwy, Suite 100, Grapevine, Texas 76051

     

 

College Station-Bryan MSA

 

Location

   Own or Lease      Sq. Ft.  

College Station

     

College Station Banking and Operations Center

     Own        12,358  

625 University Drive East, College Station, Texas 77840

     

 

(1) Square footage does not include drive thru.
(2) We lease a portion of this owned space to third party tenants.
(3) In April 2017, we completed the purchase of a building at 30350 F.M. 2978, The Woodlands, Texas 77354 consisting of approximately 6,700 square feet. We moved from The Woodlands location at 6886 Woodlands Parkway to this new building in February 2018. We intend to lease approximately 3,000 square feet of this new building to third party tenants, but no leases have been signed for this space. We intend to sell The Woodlands building at 6886 Woodlands Parkway, which consists of 6,322 square feet, and began actively marketing the building in March 2018. We currently do not have a definitive agreement to sell the building. We currently lease a portion of the old Woodlands location to third party tenants.
(4)

In November 2017, we completed the purchase of a building at 5301 Spring Valley, Dallas, Texas 75254 consisting of 23,602 square feet. We currently lease approximately 16,000 square feet of this owned space to a third party tenant and intend to lease another 4,000 square feet to other third party tenants, but no leases

 

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  have been signed for this space. We expect to move the Dallas branch from its current leased location to the new owned location during the first half of 2018.
(5) In September 2017, we completed the purchase of this building. We intend to lease approximately 4,040 square feet of this owned space to third party tenants but no leases have been signed for this space. We moved the Fort Worth branch from its prior leased location at 2718 S. Hulen St., Fort Worth, Texas 76109 to the new owned location during April 2018.

Legal Proceedings

We, from time to time, are involved as plaintiff or defendant in various legal actions arising in the normal course of business. While the ultimate outcome of any such proceedings cannot be predicted with certainty, it is the opinion of management, based upon advice of legal counsel, that no proceedings exist, either individually or in the aggregate, which, if determined adversely to us, would have a material effect on our consolidated balance sheet, results of operations or cash flows.

Effects of Hurricane Harvey

We have demonstrated our ability to operate successfully in the event of a natural disaster. In August 2017, Hurricane Harvey produced between 36 and 48 inches of rainfall, causing widespread damage to the Houston metropolitan area and surrounding markets. While the flooding was devastating to much of the areas we serve, there was minimal immediate impact to our business, and none of our branches flooded. Our Houston area branches were fully operational on August 30, just three days after the storm made landfall. Our Houston area branches were closed for two work days, with the exception of one Houston branch which was closed for three days, while our operations center in College Station remained open for business throughout the disaster. Our lenders promptly reached out to customers to determine any damages or disruptions to their households or businesses. We offered payment extensions to customers impacted by the disaster and followed up with them to determine their progress.

Although the Houston metropolitan area continues to recover from Hurricane Harvey, as of the date of this prospectus, we have identified no significant losses or deterioration in our loan portfolio. As of the date of this prospectus, the Bank has not identified any loan relationships with significant loss related to the disaster. Additionally, as of December 31, 2017, we had granted temporary payment deferrals on loans with an aggregate principal amount of approximately $39.8 million, largely to temporarily assist customers who were impacted by Hurricane Harvey. The majority of the payment deferrals were 90-day principal or principal and interest deferrals. As of February 28, 2018, the aggregate principal amount of loan subject to payment deferrals fell to $6.8 million. We are unable to predict with certainty the long-term impact that Hurricane Harvey may have on the markets in which we operate. We will continue to monitor the residual effects of Hurricane Harvey on our business and customers.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Historical Consolidated Financial Data” and our consolidated financial statements and the accompanying notes included elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that we believe are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements,” “Risk Factors” and elsewhere in this prospectus, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. We assume no obligation to update any of these forward-looking statements.

Overview

We are a Texas corporation and a registered bank holding company located in the Houston metropolitan area with headquarters in Conroe, Texas. We offer a broad range of commercial and retail banking services through our wholly-owned bank subsidiary, Spirit of Texas Bank SSB. We operate through 15 full-service branches located primarily in the Houston and Dallas/Fort Worth metropolitan areas. As of December 31, 2017, we had total assets of $1.03 billion, loans held for investment of $869.1 million, total deposits of $835.4 million and total stockholders’ equity of $99.1 million.

As a bank holding company, we generate most of our revenues from interest income on loans, gains on sale of the guaranteed portion of SBA loans, customer service and loan fees, brokerage fees derived from secondary mortgage originations and interest income from investments in securities. We incur interest expense on deposits and other borrowed funds and noninterest expenses, such as salaries and employee benefits and occupancy expenses. Our goal is to maximize income generated from interest earning assets, while also minimizing interest expense associated with our funding base to widen net interest spread and drive net interest margin expansion. Net interest margin is a ratio calculated as net interest income divided by average interest-earning assets. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings that are used to fund those assets. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities.

Changes in market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Texas, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target markets and throughout Texas.

Charter Amendments

On February 23, 2017, we reclassified our 170,236 shares of Series A preferred stock into common stock on a one-for-one basis. We issued shares of Series A preferred stock in August 2011 as a reclassification of each share of common stock held by a record holder of fewer than 5,000 shares of common stock into one share of Series A preferred stock. The non-voting Series A preferred stock was economically equivalent to our common stock. Furthermore, on February 23, 2017, our shareholders approved an amendment to our Amended and

 

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Restated Certificate of Formation to effect a reverse stock split at a one-for-two ratio. On February 24, 2017, we changed our name from ST Financial Group, Inc. to Spirit of Texas Bancshares, Inc., and we increased the number of authorized shares of capital stock from 25,000,000 shares to 55,000,000 shares and increased the number of authorized shares of common stock from 20,000,000 shares to 50,000,000 shares. We effected the reverse stock split on March 16, 2017. Shareholders that would have otherwise received fractional shares as a result of the reverse stock split received cash payments in lieu of fractional shares of $7.50. Except for adjustments that resulted from the treatment of fractional shares, each shareholder held the same percentage of common stock outstanding after such reverse stock split as that shareholder held immediately prior to such reverse stock split.

Restatement

As further discussed in Note 20, Correction of Errors and Restatement, in the notes to our consolidated financial statements included elsewhere in this prospectus, we identified prior period accounting errors which resulted in a restatement of certain prior period amounts within our consolidated financial statements as of and for the year ended December 31, 2017. All financial information as of and for the years ended December 31, 2016 and 2015 presented in this prospectus has been restated to reflect these changes.

Results of Operations

Our results of operations depend substantially on net interest income and noninterest income. Other factors contributing to our results of operations include our level of our noninterest expenses, such as salaries and employee benefits, occupancy and equipment and other miscellaneous operating expenses.

Net Interest Income

Net interest income represents interest income less interest expense. We generate interest income from interest, dividends and fees received on interest-earning assets, including loans and investment securities we own. We incur interest expense from interest paid on interest-bearing liabilities, including interest-bearing deposits and borrowings. To evaluate net interest income, we measure and monitor (1) yields on our loans and other interest-earning assets, (2) the costs of our deposits and other funding sources, (3) our net interest spread, (4) our net interest margin and (5) our provisions for loan losses. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as the annualized net interest income divided by average interest-earning assets. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and stockholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources.

Changes in market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing deposits and stockholders’ equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. We measure net interest income before and after provision for loan losses required to maintain our allowance for loan and lease losses at acceptable levels.

Noninterest Income

Our noninterest income includes the following: (1) service charges and fees; (2) SBA loan servicing fees; (3) mortgage referral fees; (4) gain on the sales of loans, net; (5) gain (loss) on sales of premises and equipment; (6) gain (loss) on sales of investment securities; and (7) other.

Noninterest Expense

Our noninterest expense includes the following: (1) salaries and employee benefits; (2) occupancy and equipment expenses; (3) loan and other real estate related expenses; (4) professional services; (5) data processing and network; (6) regulatory assessments and insurance; (7) amortization of core deposit intangibles; (8) advertising; (9) marketing; (10) telephone expenses; and (11) other.

 

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Financial Condition

The primary factors we use to evaluate and manage our financial condition include liquidity, asset quality and capital.

Liquidity

We manage liquidity based upon factors that include the amount of core deposits as a percentage of total deposits, the level of diversification of our funding sources, the allocation and amount of our deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets to be readily converted into cash without undue loss, the amount of cash and liquid securities we hold, and the repricing characteristics and maturities of our assets when compared to the repricing characteristics of our liabilities, the ability to securitize and sell certain pools of assets and other factors.

Asset Quality

We manage the diversification and quality of our assets based upon factors that include the level, distribution, severity and trend of problem, classified, delinquent, nonaccrual, nonperforming and restructured assets, the adequacy of our allowance for loan and lease losses, discounts and reserves for unfunded loan commitments, the diversification and quality of loan and investment portfolios and credit risk concentrations.

Capital

We manage capital based upon factors that include the level and quality of capital and our overall financial condition, the trend and volume of problem assets, the adequacy of discounts and reserves, the level and quality of earnings, the risk exposures in our balance sheet, the levels of Tier 1 (core), risk-based and tangible equity capital, the ratios of tier 1 (core), risk-based and tangible equity capital to total assets and risk-weighted assets and other factors.

Analysis of Results of Operations

Net income for the year ended December 31, 2017 totaled $4.8 million, which generated diluted earnings per common share of $0.63 for the year ended December 31, 2017. Net income for the year ended December 31, 2016 totaled $3.7 million, which generated diluted earnings per common share of $0.50 for the year ended December 31, 2016. The increase in net income was driven by an increase in interest income of $6.7 million that was primarily attributable to loan growth, partially offset by an increase in interest expense of $1.6 million, which was mainly the result of increased interest expense on deposits and increased rates on FHLB advances and other borrowings. Our results of operations for the year ended December 31, 2017 produced a return on average assets of 0.47% and an adjusted return on average assets of 0.55% compared to a return on average assets of 0.41% for the year ended December 31, 2016. We had a return on average stockholders’ equity of 4.88% and an adjusted return on average stockholders’ equity of 5.74% compared to a return on average stockholders’ equity of 4.09% for the year ended December 31, 2016.

 

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Net Interest Income and Net Interest Margin

The following table presents, for the periods indicated, information about (1) average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (2) average balances, the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (3) the interest rate spread; (4) net interest income and margin; and (5) net interest income and margin (tax equivalent). Interest earned on loans that are classified as nonaccrual is not recognized in income, however the balances are reflected in average outstanding balances for that period. Any nonaccrual loans have been included in the table as loans carrying a zero yield.

 

     Years Ended December 31,  
     2017     2016  
     Average
Balance(1)
     Interest/
Expense
     Yield/
Rate
    Average
Balance(1)
     Interest/
Expense
     Yield/
Rate
 
    

(Dollars in thousands)

 

Interest-earning assets:

                

Interest-earning deposits in other banks

   $ 82,630      $ 847        1.03   $ 104,763      $ 508        0.49

Loans, including loans held for sale(2)

     830,664        45,411        5.47     718,291        39,455        5.49

Investment securities and other

     29,731        649        2.18     16,055        247        1.54
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-earning assets

     943,025        46,907        4.97     839,109        40,210        4.79
  

 

 

    

 

 

      

 

 

    

 

 

    

Noninterest-earning assets

     65,539             64,833        
  

 

 

         

 

 

       

Total assets

   $ 1,008,564           $ 903,942        
  

 

 

         

 

 

       

Interest-bearing liabilities:

                

Interest-bearing NOW accounts

   $ 8,419      $ 13        0.15   $ 9,668      $ 14        0.15

Savings and money market accounts

     233,574        1,348        0.58     189,516        972        0.51

Time deposits

     426,787        5,241        1.23     388,386        4,496        1.16

FHLB advances and other borrowings

     77,153        1,726        2.24     83,527        1,248        1.49
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing liabilities

     745,933        8,328        1.12     671,097        6,730        1.00
  

 

 

    

 

 

      

 

 

    

 

 

    

Noninterest-bearing liabilities and shareholders’ equity:

                

Noninterest-bearing demand deposits

     162,722             132,801        

Other liabilities

     2,503             9,273        

Stockholders’ equity

     97,406             90,771        
  

 

 

         

 

 

       

Total liabilities and stockholders’ equity

   $ 1,008,564           $ 903,942        
  

 

 

         

 

 

       

Net interest rate spread

           3.85           3.79
                

Net interest income and margin

      $ 38,579        4.09      $ 33,480        3.99
     

 

 

         

 

 

    

Net interest income and margin (tax equivalent)(3)

      $ 39,514        4.19      $ 34,291        4.09
                

 

(1) Average balances presented are derived from daily average balances.
(2) Includes loans on nonaccrual status.
(3) In order to make pretax income and resultant yields on tax-exempt loans comparable to those on taxable loans, a tax-equivalent adjustment has been computed using a federal tax rate of 34% for the years ended December 31, 2017 and 2016, which is a non-GAAP financial measure. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities for the periods indicated. The effect of changes in volume is determined by multiplying the change in volume by the prior period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume.

 

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A summary of increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and average interest rates follows:

 

     Years Ended December 31,
2017 compared to 2016
 
     Increase (Decrease) Due to         
     Volume(1)      Rate(1)      Total  
     (Dollars in thousands)  

Interest-earning assets:

        

Interest-earning deposits in other banks

   $ (127    $ 466      $ 339  

Loans, including loans held for sale(2)

     6,102        (146      5,956  

Investment securities and other

     270        132        402  
  

 

 

    

 

 

    

 

 

 

Total change in interest income

   $ 6,245      $ 452      $ 6,697  
  

 

 

    

 

 

    

 

 

 

Interest-bearing liabilities:

        

Interest-bearing NOW accounts

     (1      —          (1

Savings and money market accounts

     236        140        376  

Time deposits

     462        283        745  

FHLB advances and other borrowings

     (102      580        478  
  

 

 

    

 

 

    

 

 

 

Total change in interest expenses

     595        1,003        1,598  
  

 

 

    

 

 

    

 

 

 

Total change in net interest income

   $ 5,650      $ (551    $ 5,099  
  

 

 

    

 

 

    

 

 

 

 

(1) Variances attributable to both volume and rate are allocated on a consistent basis between rate and volume based on the absolute value of the variances in each category.
(2) Includes loans on nonaccrual status.

Year ended December 31, 2017 compared to year ended December 31, 2016

Net interest income was $38.6 million for the year ended December 31, 2017 compared to $33.5 million for the year ended December 31, 2016, representing an increase of $5.1 million, or 15.2%. The increase in net interest income was primarily due to an increase in interest income of $6.7 million partially offset by an increase in interest expense of $1.6 million. Interest income on loans increased by $6.0 million for the year ended December 31, 2017. The growth in average loans of $112.4 million, including loans held for sale, for the year ended December 31, 2017, was the primary driver of the increase in interest income on loans, partially offset by a decrease in average rate on loans of 2 basis points over the same period.

Interest expense was $8.3 million for the year ended December 31, 2017 compared to $6.7 million for the year ended December 31, 2016, representing an increase of $1.6 million, or 23.7%. This increase was mainly due to an increase in interest expense on deposits and FHLB borrowings. Interest expense on deposits totaled $6.6 million for the year ended December 31, 2017 compared to $5.5 million for the year ended December 31, 2016, representing an increase of $1.1 million, resulting primarily from an increase in the average volume of deposits of $81.2 million. Cost of funds, which we define as the average interest rate paid on deposits, increased 4 basis points for the year ended December 31, 2017 compared to the year ended December 31, 2016.

The average cost of deposits for the year ended December 31, 2017 was 0.80%. This represents an increase

of 4 basis points compared to the average cost of deposits of 0.76% for the year ended December 31, 2016. The

increase in cost of deposits was primarily attributable to the increase in interest rates by the Federal Open Market

Committee during 2017. For the year ended December 31, 2017, the average rate paid on time deposits was

1.23% compared to 1.16% for the year ended December 31, 2016.

Interest expense on FHLB advances and other borrowings increased by $478 thousand for the year ended December 31, 2017 compared to the year ended December 31, 2016. The increase was primarily attributable to an increase in the average rate paid on FHLB advances and other borrowings of 75 basis points for the year

 

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ended December 31, 2017. The increase in the average rate on borrowings was primarily attributable to rising interest rates during 2017 as well as an increase in the average maturity of our FHLB advances and other borrowings.

The net interest margin was 4.09% for the year ended December 31, 2017 compared to 3.99% for the year ended December 31, 2016, representing an increase of 10 basis points. The tax equivalent net interest margin was 4.19% for the year ended December 31, 2017 compared to 4.09% for the year ended December 31, 2016, representing an increase of 10 basis points. The average yield on interest-earning assets increased by 18 basis points for the year ended December 31, 2017 compared to the year ended December 31, 2016 while the average rate paid on interest-bearing liabilities increased by 12 basis points, resulting in a 6 basis point increase in the interest rate spread. The increase in both net interest margin and interest rate spread primarily resulted from the increased average loan balance of $112.4 million for the year ended December 31, 2017, combined with flat loan yields for the years ended December 31, 2017 and 2016.

Provision for Loan Losses

The provision for loan losses represents the amount determined by management to be necessary to maintain the allowance for loan and lease losses at a level capable of absorbing inherent losses in the loan portfolio. See the discussion under “—Critical Accounting Policies—Allowance for Loan and Lease Losses.” Our management and board of directors review the adequacy of the allowance for loan and lease losses on a quarterly basis. The allowance for loan and lease losses calculation is segregated by call report code and then further segregated into various segments that include classified loans, loans with specific allocations and pass rated loans. A pass rated loan is generally characterized by a very low to average risk of default and in which management perceives there is a minimal risk of loss. Loans are rated using a nine-point risk grade scale by loan officers that are subject to validation by a third party loan review or our internal credit committee. Risk ratings are categorized as pass, watch, special mention, substandard, doubtful and loss, with some general allocation of reserves based on these grades. Impaired loans are reviewed specifically and separately under the Financial Accounting Standards Board (“FASB”)’s Accounting Standards Codification (“ASC”) 310, “Receivables”, to determine the appropriate reserve allocation. Management compares the investment in an impaired loan with the present value of expected future cash flow discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral-dependent, to determine the specific reserve allowance. Reserve percentages assigned to non-impaired loans are based on historical charge-off experience adjusted for other risk factors. To evaluate the overall adequacy of the allowance to absorb losses inherent in our loan portfolio, our management considers historical loss experience based on volume and types of loans, trends in classifications, volume and trends in delinquencies and nonaccruals, economic conditions and other pertinent information. Based on future evaluations, additional provisions for loan losses may be necessary to maintain the allowance for loan and lease losses at an appropriate level.

Year ended December 31, 2017 compared to Year ended December 31, 2016

The provision for loan losses was $2.5 million for the year ended December 31, 2017 and $1.6 million for the year ended December 31, 2016. The increase of the provision for the year ended December 31, 2017 was primarily due to organic loan growth and total net charge-offs of $1.2 million during 2017 primarily in our SBA loan portfolio. These losses were anticipated and provided for as the SBA loan portfolio matures. Additionally, our management performed a loan level assessment of the effects of Hurricane Harvey and determined that no increases in our reserves were necessary. We will continue to actively monitor these credits.

Our management maintains a proactive approach in managing nonperforming loans, which were $3.6 million, or 0.41% of loans held for investment, at December 31, 2017, and $3.8 million, or 0.49% of loans held for investment, at December 31, 2016. During 2017, we had net charged-off loans totaling $1.2 million, compared to net charged-off loans of $336 thousand for the year ended December 31, 2016. The ratio of net charged-off loans to average loans was 0.14% for 2017 compared to 0.05% for 2016. The allowance for loan and

 

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lease losses totaled $5.7 million, or 0.65% of loans held for investment, at December 31, 2017, compared to $4.4 million, or 0.56% of loans held for investment, at December 31, 2016. The ratio of allowance for loan and lease losses to nonperforming loans was 157.22% at December 31, 2017, compared to 114.45% at December 31, 2016.

Noninterest Income

Our noninterest income includes the following: (1) service charges and fees; (2) SBA loan servicing fees; (3) mortgage referral fees; (4) gain on the sales of loans, net; (5) gain (loss) on sales of premises and equipment; (6) gain (loss) on sales of investment securities; and (7) other.

The following table presents a summary of noninterest income by category, including the percentage change in each category, for the periods indicated:

 

     Years Ended December 31,  
     2017      2016
Restated
     Change from the
Prior Year
 
     (Dollars in thousands)  

Noninterest income:

        

Service charges and fees

   $ 1,501      $ 1,216        23.4

SBA loan servicing fees

     1,794        1,831        (2.0 %) 

Mortgage referral fees

     634        751        (15.6 %) 

Gain on sales of loans, net

     5,684        4,437        28.1

Gain (loss) on sales of premises and equipment

     (45      21        (314.3 %) 

Gain (loss) on sales of investment securities

     —          69        (100.0 %) 

Other noninterest income

     70        17        311.8
  

 

 

    

 

 

    

Total noninterest income

   $ 9,638      $ 8,342        15.5
  

 

 

    

 

 

    

Year ended December 31, 2017 compared to Year ended December 31, 2016

For the year ended December 31, 2017, noninterest income totaled $9.6 million, a $1.3 million, or 15.5%, increase from $8.3 million for the prior year. This increase was primarily due to an increase in gain on sales of loans, net of $1.2 million and an increase of $285 thousand in service charges and fees.

Gain on sales of loans, net, was $5.7 million for the year ended December 31, 2017 compared to $4.4 million for the year ended December 31, 2016, primarily due to increased volume of SBA loan originations.

Service charges and fees were $1.5 million for the year ended December 31, 2017 compared to $1.2 million for the year ended December 31, 2016. The $285 thousand increase was due to improved treasury management services through more product offerings.

Noninterest Expense

Noninterest expenses have increased at a nominal rate of 7.2% from 2016, as we have managed the growth of our infrastructure in anticipation of further growth.

 

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The following table presents a summary of noninterest expenses by category, including the percentage change in each category, for the periods indicated:

 

     Years Ended December 31,  
     2017      2016
Restated
     Change from the
Prior Year
 
     (Dollars in thousands)  

Noninterest expense:

        

Salaries and employee benefits

   $ 23,338      $ 21,094        10.6

Occupancy and equipment expenses

     5,123        4,736        8.2

Loan and other real estate related expenses

     254        30        746.7

Professional services

     1,845        1,745        5.7

Data processing and network

     1,266        1,518        (16.6 %) 

Regulatory assessments and insurance

     924        742        24.5

Amortization of intangibles

     703        671        4.8

Advertising

     551        303        81.8

Marketing

     579        634        (8.7 %) 

Telephone expense

     409        606        (32.5 %) 

Other operating expenses

     2,410        2,802        (14.0 %) 
  

 

 

    

 

 

    

Total noninterest expense

   $ 37,402      $ 34,881        7.2
  

 

 

    

 

 

    

Year ended December 31, 2017 compared to Year ended December 31, 2016

For the year ended December 31, 2017, noninterest expenses totaled $37.4 million, a $2.5 million, or 7.2%, increase from $34.9 million for the prior year. This increase was primarily due to increases in salaries and employee benefits of $2.2 million, occupancy and equipment expenses of $387 thousand, advertising expenses of $248 thousand and increases in loan and other real estate related expenses of $224 thousand. These expenses were partially offset by decreases in other operating expenses of $392 thousand and data processing and network expenses of $252 thousand.

Salaries and employee benefits totaled $23.3 million for the year ended December 31, 2017, which included $1.5 million of stock-based compensation expense. By comparison, salaries and employee benefits totaled $21.1 million for the year ended December 31, 2016, which included $1.1 million of stock-based compensation expense. During 2017, we incurred a one-time expense of $757 thousand in connection with the accelerated vesting of all stock options held by our board of directors and the board of directors of the Bank approved by our board of directors in February 2017. Additionally, we hired several key employees during 2017.

Occupancy and equipment expenses increased $387 thousand for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to the increased depreciation taken on two additional buildings purchased in September and November of 2017 in the Dallas and Fort Worth area. We expect that occupancy and equipment expenses will decrease after we move from our leased office locations to our new owned office locations during the first half of 2018.

Advertising expense increased $248 thousand for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to additional marketing efforts to drive loan growth within the SBA portfolio. Loan and other real estate related expenses increased $224 thousand for the year ended December 31, 2017 compared to the year ended December 31, 2016 due to increased loan growth.

Other operating expense decreased $392 thousand for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to our efforts to reduce operating expenses.

Data processing and network expense decreased $252 thousand for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to improved contract terms with our outsourced IT provider.

 

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Income Tax Expense

The provision for income taxes includes both federal and state taxes. Fluctuations in effective tax rates reflect the differences in the inclusion or deductibility of certain income and expenses for income tax purposes. Our future effective income tax rate will fluctuate based on the mix of taxable and tax-free investments we make, periodic increases in surrender value of bank-owned life insurance policies for certain former executive officers and our overall taxable income.

Year ended December 31, 2017 compared to Year ended December 31, 2016

Income tax expense was $3.6 million, an increase of $2.0 million for the year ended December 31, 2017 compared income tax expense of $1.6 million for to the year ended December 31, 2016. Our effective tax rates for the years ended December 31, 2017 and 2016 were 43.0% and 30.2%, respectively, primarily due to the impact of changes in the United States tax law during the year ended December 31, 2017. On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act (“Tax Reform”) resulting in significant modifications to existing law. We completed the accounting for the effects of the Tax Reform during the quarter ended December 31, 2017. Our financial statements for the year ended December 31, 2017 reflect certain effects of the Tax Reform, which include a reduction in the corporate tax rate from 34.0% to 21.0%. As a result of the changes to tax laws and tax rates under the Tax Reform, we incurred incremental income tax expense of $834 thousand during the year ended December 31, 2017, which consisted primarily of the remeasurement of deferred tax assets and liabilities based on the change in the tax rate from 34.0% to 21.0%. The remaining portion of the increase in income tax expense is primarily related to increased net income during the year ended December 31, 2017.

Financial Condition

Our total assets increased $49.8 million, or 5.1%, from $980.5 million as of December 31, 2016 to $1.03 billion as of December 31, 2017. Our asset growth was mainly due to the execution of our growth strategy resulting in new customer accounts and growth in balances from existing loan and deposit customers.

Investment Securities

We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements. The balance in our securities portfolio as of December 31, 2016 was $5 thousand following the liquidation of our securities portfolio to generate funds to finance our increased loan demand. We used cash on hand and funds from operations to increase our securities portfolio in 2017. The balance in our securities portfolio as of December 31, 2017 was $37.2 million. In accordance with regulatory and accounting requirements, we are prohibited from classifying security purchases as held-to-maturity for a period of two years. The average balance of the securities portfolio including FHLB and The Independent Bankers Bank, or TIB, stock for the years ended December 31, 2017 and 2016 was $29.7 million and $16.1 million, respectively, with a pre-tax yield of 2.18% and 1.54%, respectively. We held 50 securities classified as available for sale with an amortized cost of $37.9 million as of December 31, 2017.    

Management evaluates securities for other-than-temporary impairment, or OTTI, at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. No securities were determined to be OTTI as of December 31, 2017 and 2016.

 

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The following table summarizes our available for sale securities portfolio as of the dates presented.

 

     As of December 31,  
     2017      2016  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Available for sale:

           

U.S. Government agencies

   $ 2,010      $ 1,949      $ —        $ —    

Residential mortgage-backed securities

     30,156        29,629        5        5  

Corporate bonds and other debt securities

     5,711        5,665        —          —  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale

   $ 37,877      $ 37,243      $ 5      $ 5  
  

 

 

    

 

 

    

 

 

    

 

 

 

The following tables show contractual maturities and the weighted average yields on our investment securities as of the dates presented. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Weighted average yields are not presented on a taxable equivalent basis:

 

    Maturity as of December 31, 2017  
    One Year or Less     One to Five Years     Five to Ten Years     After Ten Years  
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
 
    (Dollars in thousands)  

Available for sale:

               

U.S. Government agencies

  $ —         —     $ —         —     $ 1,535       2.18   $ 475       2.99

Residential mortgage-backed securities

    —         —       2       2.75     —         —       30,154       2.01

Corporate bonds and other debt securities

    —         —       4,142       2.45     1,569       2.72     —         —  
 

 

 

     

 

 

     

 

 

     

 

 

   

Total available for sale

  $ —         —     $ 4,144       2.45   $ 3,104       2.45   $ 30,629       2.03
 

 

 

     

 

 

     

 

 

     

 

 

   
    Maturity as of December 31, 2016  
    One Year or Less     One to Five Years     Five to Ten Years     After Ten Years  
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
 
    (Dollars in thousands)  

Available for sale:

               

U.S. Government agencies

  $ —         —     $ —         —     $ —         —     $ —         —  

Residential mortgage-backed securities

    —         —       —         —       3       2.22     2       4.52

Corporate bonds and other debt securities

    —         —       —         —       —         —       —         —  
 

 

 

     

 

 

     

 

 

     

 

 

   

Total available for sale

  $ —         —     $ —         —     $ 3       2.22   $ 2       4.52
 

 

 

     

 

 

     

 

 

     

 

 

   

As a member institution of the FHLB and TIB, the Bank is required to own capital stock in the FHLB and TIB. As of December 31, 2017 and 2016, the Bank held approximately $4.8 million and $4.7 million, respectively, in FHLB and TIB bank stock. No market exists for this stock, and the Bank’s investment can be liquidated only through repurchase by the FHLB or TIB. Such repurchases have historically been at par value. We monitor our investment in FHLB and TIB stock for impairment through review of recent financial results, dividend payment history and information from credit agencies. As of December 31, 2017 and 2016, management did not identify any indicators of impairment of FHLB and TIB stock.

 

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Except for securities issued by U.S. government agencies, we did not have any concentrations where the total outstanding balances issued by a single issuer exceed 10% of our stockholders’ equity as of December 31, 2017 or 2016.

Our securities portfolio had a weighted average life of 5.00 years and an effective duration of 5.03 years as of December 31, 2017 and a weighted average life of 2.34 years and an effective duration of 1.51 years as of December 31, 2016.

Loans Held for Sale

Loans held for sale consist of the guaranteed portion of SBA loans that we intend to sell after origination. Our loans held for sale were $3.8 million as of December 31, 2017 and $4.0 million as of December 31, 2016.

Loan Concentrations

Our primary source of income is interest on loans to individuals, professionals, small and medium-sized businesses and commercial companies located in the Houston and Dallas/Fort Worth metropolitan areas. Our loan portfolio consists primarily of commercial and industrial loans, 1-4 single family residential real estate loans and loans secured by commercial real estate properties located in our primary market areas. Our loan portfolio represents the highest yielding component of our earning asset base.

Our loans of $869.1 million as of December 31, 2017 represented an increase of $96.3 million, or 12.5%, compared to $772.9 million as of December 31, 2016. This increase was primarily due to the execution of our growth strategy and our continued penetration in our primary market areas.

Our loans as a percentage of assets were 84.4% and 78.8% as of December 31, 2017 and 2016, respectively.

The current concentrations in our loan portfolio may not be indicative of concentrations in our loan portfolio in the future. We plan to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral. The following table summarizes the allocation of loans by type as of the dates presented.

 

     As of December 31,  
     2017     2016
Restated
 
     Amount      % of Total     Amount      % of Total  
     (Dollars in thousands)  

Commercial and industrial loans(1)

   $ 135,040        15.5   $ 117,762        15.2

Real estate:

          

1-4 single family residential loans

     232,510        26.8     206,641        26.7

Construction, land and development loans

     139,470        16.0     113,316        14.7

Commercial real estate loans (including multifamily)

     285,731        32.9     251,870        32.6

Consumer loans and leases

     22,736        2.6     26,676        3.5

Municipal and other loans

     53,632        6.2     56,596        7.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans held in portfolio

   $ 869,119        100.0   $ 772,861        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)    Balance includes $67.1 million and 58.7 million of the unguaranteed portion of SBA loans as of December 31, 2017 and 2016, respectively.

Commercial and Industrial Loans (including SBA loans)

Commercial and industrial loans, including SBA loans, are underwritten after evaluating and understanding the borrower’s ability to repay the loan through operating profitably and effectively growing its business. Our management

 

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examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the credit quality and cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee to add strength to the credit and reduce the risk on a transaction to an acceptable level; however, some short-term loans may be made on an unsecured basis to the most credit worthy borrowers.

In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Due to the nature of accounts receivable and inventory secured loans, we closely monitor credit availability and collateral through the use of various tools, including but not limited to borrowing-base formulas, periodic accounts receivable agings, periodic inventory audits, and/or collateral inspections.

Commercial and industrial loans, including SBA loans, totaled $135.0 million as of December 31, 2017 and represented an increase of $17.3 million, or 14.7%, from $117.8 million as of December 31, 2016. This increase was primarily due to organic growth.

SBA Loans

The primary focus of our SBA lending program is financing well-known national franchises for which the United States generally will guarantee between 75% and 85% of the loan. We are a SBA preferred lender, and originate SBA loans to national franchises in Texas and nationwide. We routinely sell the guaranteed portion of SBA loans to third parties for a premium and retain the servicing rights, for which we earn a 1% fee, and maintain the nonguaranteed portion in our loan portfolio.

SBA loans held in our loan portfolio totaled $67.1 million and $58.7 million at December 31, 2017 and 2016, respectively. We intend to continue to expand our SBA lending program in the future.

Real estate loans

1-4 single family residential real estate loans (including loans to foreign nationals)

1-4 single family residential real estate loans, including foreign national loans, are subject to underwriting standards and processes similar to commercial and industrial loans. We provide mortgages for the financing of 1-4 single family residential homes for primary occupancy, vacation or rental purposes. The borrowers on these loans generally qualify for traditional market financing. We also specialize in 1-4 single family residential real estate loans to foreign national customers, in which the borrower does not qualify for traditional market financing.

We define our foreign national loans as loans to borrowers who derive more than 50% of their personal income from outside the U.S. We provide mortgages for these foreign nationals in Texas for primary occupancy or secondary homes while travelling to the U.S. Because more than 50 percent of the borrower’s income is derived from outside of the U.S., they do not qualify for traditional market financing. We have developed an enhanced due diligence process for foreign national loans that includes larger down payments than a traditional mortgage, as well as minimum reserves equal to an amount of mortgage payments over a specified period held in the Bank and monthly escrows for taxes and insurance.

1-4 single family residential real estate loans totaled $232.5 million as of December 31, 2017 and represented an increase of $25.9 million, or 12.5%, from $206.6 million as of December 31, 2016. Foreign national loans comprised $107.6 million, or 46.3%, of 1-4 single family residential real estate loans as of December 31, 2017, compared to $85.3 million, or 41.3%, of 1-4 single family residential real estate loans as of December 31, 2016. The increase was primarily due to increased productivity and portfolio size of existing lenders in response to an increase in market demand.

 

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Construction, land and development loans

With respect to loans to developers and builders, we generally require the borrower to have a proven record of success and expertise in the building industry. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment primarily dependent on the success of the ultimate project.

Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from us until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing. Due to the nature of the real estate industry, we evaluate the borrower’s ability to service the interest of the debt from other sources other than the sale of the constructed property.

Construction loans totaled $139.5 million as of December 31, 2017 and represented an increase of $26.2 million, or 23.1%, from $113.3 million as of December 31, 2016. The increase was primarily due to an increase in market demand in our Dallas/Fort Worth metropolitan area market as well as increased demand in our Houston metropolitan area market as a result of the stabilization of that market area.

Commercial real estate loans

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.

Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. As a general rule, we avoid financing special use projects unless strong secondary support is present to help mitigate risk.

Commercial real estate loans consist of owner and nonowner-occupied commercial real estate loans, multifamily loans and farmland. Total commercial real estate loans of $285.7 million as of December 31, 2017 represented an increase of $33.9 million, or 13.4%, from $251.9 million as of December 31, 2016. The increase was primarily due to increased productivity and portfolio size of existing lenders in response to an increase in market demand.

Owner and nonowner-occupied commercial real estate loans

Owner-occupied commercial real estate loans totaled $100.6 million as of December 31, 2017, compared to $102.3 million as of December 31, 2016. Owner-occupied real estate loans comprised 35.2% and 40.6% of total commercial real estate loans as of December 31, 2017 and December 31, 2016, respectively.

Nonowner-occupied commercial real estate loans totaled $164.3 million as of December 31, 2017 compared to $136.6 million as of December 31, 2016. Nonowner-occupied commercial real estate loans comprised 57.5% and 54.2% of total commercial real estate loans as of December 31, 2017 and December 31, 2016, respectively.

Multifamily loans and Farmland

Multifamily loans totaled $18.3 million at December 31, 2017 compared to $10.3 million at December 31, 2016. Multifamily loans comprised 6.4% and 4.1% of total commercial real estate loans as of December 31, 2017 and 2016, respectively.

 

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Multifamily loans are not a focus of the Bank, and we do not expect this portion of the portfolio to represent a large portion of our growth going forward. Farmland loans totaled $2.7 million at both December 31, 2017 and 2016.

Consumer loans and leases

Our non-real estate consumer loans are based on the borrower’s proven earning capacity over the term of the loan. We monitor payment performance periodically for consumer loans to identify any deterioration in the borrower’s financial strength. To monitor and manage consumer loan risk, management develops and adjusts policies and procedures as needed. This activity, coupled with a relatively small volume of consumer loans, minimizes risk.

All of our leases are related to the financing of vehicle leases to individuals. These loans are originated by a well-known third party leasing company and subsequently purchased by us after our final credit review. We limit our exposure to individuals living in Texas, within our defined local markets.

Consumer loans and leases totaled $22.7 million as of December 31, 2017 and represented a decrease of $3.9 million, or 14.8%, from $26.7 million as of December 31, 2016. Leases comprised $18.0 million and $21.5 million of total consumer loans and leases at December 31, 2017 and 2016, respectively. We have not actively grown our consumer portfolio because we believe current pricing on these loans do not adequately cover the inherent risk.

Municipal and other loans

Municipal and other loans consist primarily of loans made to municipalities and emergency service, hospital and school districts as well as agricultural loans.

We make loans to municipalities and emergency service, hospital and school districts primarily throughout Texas. The majority of these loans have tax or revenue pledges and in some cases are additionally supported by collateral. Municipal loans made without a direct pledge of taxes or revenues are usually made based on some type of collateral that represents an essential service. Lending money directly to these municipalities allows us to earn a higher yield for similar durations than we could if we purchased municipal securities. Total loans to municipalities and emergency service, hospital and school districts and others were $53.6 million and $56.6 million as of December 31, 2017 and 2016, respectively. We have not actively grown our municipal loan portfolio as we were awaiting the outcome of the tax reform and the impact that it would have on pricing.

For a more detailed discussion of the type of loans in our loan portfolio, see “Business—Our Banking Services—Lending Activities.”

Direct and indirect oil and gas exploration and production (E&P) and oil field service company loans

We are not an active lender to oil and gas exploration and production companies. As of December 31, 2017, we had no loan commitments directly to E&P companies. However, we have a small amount of direct and indirect lending exposure to the oil and gas industry, which we monitor closely. We monitor certain loans in the following two categories we established:

Direct oil and gas related exposure:

We define direct exposure as companies that derive more than 50% of their respective gross revenue from providing services or products to the oil and gas industry. Based on that criteria, we had 25 direct oil and gas loans as of December 31, 2017 totaling $15.4 million, or 1.8% of outstanding loans. As of December 31, 2017, all but one such loan were performing as agreed. Additionally, based on that criteria, we had 21 direct oil and gas loans as of December 31, 2016 totaling $10.7 million, or 1.4% of outstanding loans. As of December 31, 2016, all such loans were performing as agreed.

 

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Indirect oil and gas related exposure:

We consider indirect oil and gas exposure to be exposure to individuals that derive less than 50% of their income from the oil and gas industry, or companies which derive less than 50% of their revenues from providing services or products to the oil and gas industry. Based on that criteria, we had 68 indirect oil and gas loans as of December 31, 2017 totaling $22.2 million, or 2.6% of outstanding loans. As of December 31, 2017, all such loans were performing as agreed. Additionally, based on that criteria, we had 75 indirect oil and gas loans as of December 31, 2016 totaling $25.0 million, or 3.2% of outstanding loans. As of December 31, 2016, all such loans were performing as agreed.

The following table summarizes the loan contractual maturity distribution by type and by related interest rate characteristics as of the date indicated:

 

     As of December 31, 2017  
     One Year or
Less
     After One
but Within
Five Years
     After Five
Years
     Total  
     (Dollars in thousands)  

Commercial and industrial loans

   $ 28,062      $ 36,218      $ 70,760      $ 135,040  

Real estate:

           

1-4 single family residential loans

     20,446        87,342        124,722        232,510  

Construction, land and development loans

     67,427        58,086        13,957        139,470  

Commercial real estate loans (including multifamily)

     32,285        188,063        65,383        285,731  

Consumer loans and leases

     2,585        20,087        64        22,736  

Municipal and other loans

     531        6,791        46,310        53,632  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans held in portfolio

   $ 151,336      $ 396,587      $ 321,196      $ 869,119  
  

 

 

    

 

 

    

 

 

    

 

 

 

Predetermined (fixed) interest rates

      $ 288,926      $ 100,126     

Floating interest rates

        107,661        221,070     
     

 

 

    

 

 

    

Total

      $ 396,587      $ 321,196     
     

 

 

    

 

 

    

The information in the table above is limited to contractual maturities of the underlying loans. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without prepayment penalties.

 

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Asset Quality

The following table sets forth the composition of our nonperforming assets, including nonaccrual loans, accruing loans 90 days or more days past due, other real estate owned and repossessed assets and restructured loans as of the dates indicated:

 

     As of December 31,  
     2017      2016  
     (Dollars in thousands)  

Nonperforming assets

     

Nonaccrual loans:

     

Commercial and industrial loans

   $ 1,927      $ 1,638  

Real estate:

     

1-4 single family residential loans

     1,135        1,296  

Construction, land and development loans

     —          —    

Commercial real estate loans (including multifamily)

     447        778  

Consumer loans and leases

     53        95  

Municipal and other loans

     —          —    
  

 

 

    

 

 

 

Total nonaccrual loans

     3,562        3,807  

Accruing loans 90 days or more past due

     33        —    
  

 

 

    

 

 

 

Total nonperforming loans

     3,595        3,807  
  

 

 

    

 

 

 

Other real estate owned and repossessed assets

     21        23  
  

 

 

    

 

 

 

Total nonperforming assets

   $ 3,616      $ 3,830  
  

 

 

    

 

 

 

Restructured loans(1)

   $ 270      $ 261  

 

(1) Performing troubled debt restructurings represent the balance at the end of the respective period for those performing loans modified in a troubled debt restructuring that are not already presented as a nonperforming loan.

Nonperforming loans totaled $3.6 million at December 31, 2017, a decrease of $212 thousand, or 5.6%, from $3.8 million at December 31, 2016. Nonperforming assets totaled $3.6 million at December 31, 2017, a decrease of $214 thousand, or 5.6%, from $3.8 million at December 31, 2016.

We classify loans as past due when the payment of principal or interest is greater than 30 days delinquent based on the contractual next payment due date. Our policies related to when loans are placed on nonaccrual status conform to guidelines prescribed by bank regulatory authorities. Loans are placed on nonaccrual status when it is probable that principal or interest is not fully collectible, or when principal or interest becomes 90 days past due, whichever occurs first. Loans are removed from nonaccrual status when they become current as to both principal and interest and concern no longer exists as to the collectability of principal and interest.

Loans are identified for restructuring based on their delinquency status, risk rating downgrade, or at the request of the borrower. Borrowers that are 90 days delinquent and/or have a history of being delinquent, or experience a risk rating downgrade, are contacted to discuss options to bring the loan current, cure credit risk deficiencies, or other potential restructuring options that will reduce the inherent risk and improve collectability of the loan. In some instances, a borrower will initiate a request for loan restructure. We require borrowers to provide current financial information to establish the need for financial assistance and satisfy applicable prerequisite conditions required by us. We may also require the borrower to enter into a forbearance agreement.

Modification of loan terms may include the following: reduction of the stated interest rate; extension of maturity date or other payment dates; reduction of the face amount or maturity amount of the loan; reduction in accrued interest; forgiveness of past-due interest; or a combination of the foregoing.

 

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We engage an external consulting firm to complete an independent loan review and validate our credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk ratings and credit quality assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

The following table sets forth our asset and credit quality ratios for the periods presented:

 

     Years Ended
December 31,
 
         2017             2016      

Asset and Credit Quality Ratios

    

Nonperforming loans to loans held for investment(1)

     0.41     0.49

Nonperforming assets to loans plus OREO

     0.42     0.50

Nonperforming assets to total assets(2)

     0.35     0.39

Net charge-offs to average loans

     0.14     0.05

Allowance for loan losses to nonperforming loans

     157.22     114.45

Allowance for loan losses to loans held for investment

     0.65     0.56

 

(1) Nonperforming loans include loans on nonaccrual status and accruing loans 90 or more days past due.
(2) Nonperforming assets include loans on nonaccrual status, accruing loans 90 days or more past due and other real estate owned and repossessed assets.

For a more detailed discussion of nonperforming loans, see “Business—Our Banking Services—Lending Activities—Nonperforming Loans.”

Analysis of the Allowance for Loan and Lease Losses

Allowance for loan and lease losses reflects management’s estimate of probable credit losses inherent in the loan portfolio. The computation of the allowance for loan and lease losses includes elements of judgment and high levels of subjectivity.

 

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The following tables summarize the allocation of allowance for loan and lease losses related to our loans as of the dates and for the periods presented. This allocation is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans:

 

     Allowance Rollforward  

Year Ended December 31, 2017

   Beginning
Balance
     Charge-
offs
    Recoveries      Provision      Ending
Balance
 
    

(Dollars in thousands)

 

Commercial and industrial loans

   $ 2,347      $ (974   $ 7      $ 1,666      $ 3,046  

Real estate:

             

1-4 single family residential loans

     647        (23     —          278        902  

Construction, land and development loans

     364        —         —          77        441  

Commercial real estate loans (including multifamily)

     667        (34     —          265        898  

Consumer loans and leases

     186        (156     —          168        198  

Municipal and other loans

     146        —         —          21        167  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Ending Allowance Balance

   $ 4,357      $ (1,187   $ 7      $ 2,475      $ 5,652  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

     Allowance Rollforward  

Year Ended December 31, 2016

   Beginning
Balance
     Charge-
offs
    Recoveries      Provision     Ending
Balance
 
    

(Dollars in thousands)

 

Commercial and industrial loans

   $ 1,119      $ (282   $ 58      $ 1,452     $ 2,347  

Real estate:

            

1-4 single family residential loans

     623        (3     —          27       647  

Construction, land and development loans

     398        (32     30        (32     364  

Commercial real estate loans (including multifamily)

     670        —         —          (3     667  

Consumer loans and leases

     89        (113     6        204       186  

Municipal and other loans

     177        —         —          (31     146  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Ending Allowance Balance

   $ 3,076      $ (430   $ 94      $ 1,617     $ 4,357  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

In determining the allowance for loan and lease losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan and lease losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates.

During 2017, we refined our allowance for loan loss methodology based upon management judgement and applicable regulatory guidance. The calculation of reserves on loans collectively evaluated for impairment was altered to reflect five years of historical loss experience which more appropriately matches the weighted average life of loans in the portfolio. Additionally, the calculated historical loss experience is now allocated across the portfolio’s risk rates using a probability of default curve constructed from the Bank’s historical default data. We also updated the qualitative component of the reserve on loans collectively evaluated for impairment to allow for a greater sensitivity to current trends.

The allowance for loan and lease losses increased $1.3 million to $5.7 million at December 31, 2017 from $4.4 million at December 31, 2016, primarily due to the increase in loans held for investment of $96.3 million. The allowance for loan and lease losses as a percentage of nonperforming loans and allowance for loan and lease losses as a percentage of loans held for investment was 157.22% and 0.65%, respectively, as of December 31, 2017, compared to 114.45% and 0.56%, respectively, as of December 31, 2016.

Net loan charge-offs for the year ended December 31, 2017 totaled $1.2 million, an increase from $336 thousand of net loan charge-offs for the same period of 2016. The increase in net charge-offs for the year

 

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ended December 31, 2017 primarily related to charge-offs in our SBA loan portfolio. These losses were anticipated and provided for as the SBA loan portfolio matures. The ratio of net loan charge-offs to average loans outstanding during the years ended December 31, 2017 and 2016 was 0.14% and 0.05%, respectively.

The following table provides the allocation of the allowance for loan and lease losses as of the dates presented:

 

     As of December 31,  
     2017     2016  
     Amount      % Loans
in each
category
    Amount      % Loans
in each
category
 
    

(Dollars in thousands)

 

Commercial and industrial loans

   $ 3,046        15.5   $ 2,347        15.2

Real estate:

          

1-4 single family residential loans

     902        26.8     647        26.7

Construction, land and development loans

     441        16.0     364        14.7

Commercial real estate loans (including multifamily)

     898        32.9     667        32.6

Consumer loans and leases

     198        2.6     186        3.5

Municipal and other loans

     167        6.2     146        7.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 5,652        100.0   $ 4,357        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Deposits

We expect deposits to be our primary funding source in the future as we optimize our deposit mix by continuing to shift our deposit composition from higher cost time deposits to lower cost demand deposits. Non-time deposits include demand deposits, NOW accounts, and savings and money market accounts.

The following table shows the deposit mix as of the dates presented:

 

     As of December 31,  
     2017     2016  
     Amount      % of Total     Amount      % of Total  
    

(Dollars in thousands)

 

Noninterest-bearing demand deposits

   $ 176,726        21.2   $ 171,475        21.1

Interest-bearing NOW accounts

     7,318        0.9     8,302        1.0

Savings and money market accounts

     243,173        29.1     215,432        26.4

Time deposits

     408,151        48.8     419,229        51.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 835,368        100.0   $ 814,438        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits at December 31, 2017 were $835.4 million, an increase of $20.9 million, or 2.57%, from total deposits at December 31, 2016 of $814.4 million.

The average cost of deposits for the year ended December 31, 2017 was 0.80%. This represents an increase of 4 basis points compared to the average cost of deposits of 0.76% for the year ended December 31, 2016. The increase in cost of deposits was primarily attributable to the increase in interest rates by the Federal Open Market Committee during 2017. For the year ended December 31, 2017, the average rate paid on time deposits was 1.23% compared to 1.16% for the year ended December 31, 2016.

 

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The following table shows the remaining maturity of time deposits of $100,000 and greater as of the date indicated:

 

     As of December 31, 2017  
     (Dollars in thousands)  

Time deposits $100,000 or greater with remaining maturity of:

  

Three months or less

   $ 56,650  

After three months through six months

     52,629  

After six months through twelve months

     106,296  

After twelve months

     98,527  
  

 

 

 

Total

   $ 314,102  
  

 

 

 

Borrowings

In addition to deposits, we utilize advances from the FHLB and other borrowings as a supplementary funding source to finance our operations.

FHLB borrowings: The FHLB allows us to borrow, both short and long-term, on a blanket floating lien status collateralized by certain securities and loans. As of December 31, 2017 and 2016, total remaining borrowing capacity of $274.0 million and $263.2 million, respectively, was available under this arrangement. As of December 31, 2017, we had $15.0 million of short-term FHLB borrowings, with an average interest rate of 1.69%. We had no short-term FHLB borrowings as of December 31, 2016. We had long-term FHLB borrowings of $68.6 million and $66.0 million as of December 31, 2017 and 2016, respectively, with an average interest rate of 2.31% and 2.04%, respectively. Our current FHLB borrowings mature within fourteen years.

Line of credit: We entered into a line of credit with a third party lender in May 2017 that allows us to borrow up to $20 million. The interest rate on this line of credit is based upon 90-day LIBOR plus 4.0%, and unpaid principal and interest is due at the stated maturity of May 12, 2022. This line of credit is secured by a pledge of all of the common stock of the Bank. This line of credit may be prepaid at any time without penalty, so long as such prepayment includes the payment of all interest accrued through the date of the repayments, and, in the case of prepayment of the entire loan, the amount of attorneys’ fees and disbursements of the lender. At December 31, 2017, total borrowing capacity of $12.2 million was available under this line of credit and $7.8 million was drawn.

Total borrowings consisted of the following as of the dates presented:

 

     As of December 31,  
     2017      2016  
     (Dollars in thousands)  

Short-term FHLB borrowings

   $ 15,000      $ —    

Long-term FHLB borrowings

     68,623        66,016  

Third party lender line of credit

     7,788        5,000  
  

 

 

    

 

 

 

Total borrowings

   $ 91,411      $ 71,016  
  

 

 

    

 

 

 

At December 31, 2017, total borrowings were $91.4 million, an increase of $20.4 million, or 28.7%, from $71.0 million at December 31, 2016. The increase in total borrowings was primarily driven by the $15.0 million increase in short-term FHLB borrowings used to fund new loan originations.

 

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Short-term borrowings consist of debt with maturities of one year or less. Our short-term borrowings consist of FHLB borrowings and a third party line of credit. The following table is a summary of short-term borrowings as of and for the periods presented:

 

     As of and for the
Years Ended
December 31,
 
     2017     2016  
     (Dollars in thousands)  

Short-term borrowings:

    

Maximum outstanding at any month-end during the period

   $ 15,000     $ 40,000  

Balance outstanding at end of period

     15,000       5,000  

Average outstanding during the period

     6,247       27,240  

Average interest rate during the period

     2.17     1.56

Average interest rate at the end of the period

     1.69     4.00

We maintained four, unsecured Federal Funds lines of credit with commercial banks which provide for extensions of credit with an availability to borrow up to an aggregate $35.0 million as of December 31, 2017 and as of December 31, 2016. There were no advances under these lines of credit outstanding as of December 31, 2017 or 2016.

Stockholders’ Equity

The following table summarizes the changes in our stockholders’ equity for the periods indicated:

 

     Years Ended
December 31,
 
     2017      2016
Restated
 
     (Dollars in thousands)  

Balance at beginning of period

   $ 92,896      $ 87,927  

Net income

     4,753        3,715  

Exercise of stock options

     471        59  

Stock-based compensation

     1,520        1,069  

Other comprehensive income

     (501      126  
  

 

 

    

 

 

 

Balance at end of period

   $ 99,139      $ 92,896  
  

 

 

    

 

 

 

Net income totaled $4.8 million for the year ended December 31, 2017, an increase of $1.0 million, compared to $3.7 million for the year ended December 31, 2016. Our results of operations for the year ended December 31, 2017 produced a return on average assets of 0.47% compared to 0.41% for the prior year. Our results of operations for the year ended December 31, 2017 produced a return on average stockholders’ equity of 4.88% compared to 4.09% for the prior year.

Stockholders’ equity was $99.1 million as of December 31, 2017, an increase of $6.2 million from $92.9 million as of December 31, 2016. The increase was primarily driven by net income of $4.8 million.

Contractual Obligations

The following table presents information regarding our outstanding contractual obligations and other commitments to make future payments as of December 31, 2017, which consist of our future cash payments associated with our time deposits, operating lease obligations and contractual obligations pursuant to our FHLB

 

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advances and other borrowings. Payments related to our leases are based on actual payments specified in the underlying contracts.

 

As of December 31, 2017

   Total
Amounts
Committed
     One Year
or Less
     Over One
Year
Through
Three Years
     Over Three
Years
Through
Five Years
     Over
Five Years
 
     (Dollars in thousand)  

Contractual obligations:

              

Time deposits

   $ 408,151      $ 276,401      $ 112,677      $ 19,073      $ —    

Operating lease obligations

     4,985        1,497        2,038        1,276        174  

FHLB advances and other borrowings

     91,411        16,713        22,439        26,194        26,065  

Construction in process

     1,858        1,858        —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 506,405      $ 296,469      $ 137,154      $ 46,543      $ 26,239  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Off-Balance Sheet Arrangements

In the normal course of business, we enter into various transactions, which, in accordance with Generally Accepted Accounting Principles (“GAAP”), are not included on our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and commercial and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized on our consolidated balance sheets.

We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent our future cash requirements. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We seek to minimize our exposure to loss under these commitments by subjecting them to prior credit approval and ongoing monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and establish a liability for probable credit losses. As of December 31, 2017 and 2016, our reserve for unfunded commitments totaled $40 thousand and $33 thousand, respectively.

Commercial and standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

The following table summarizes our commitments as of the dates presented:

 

     As of December 31,  
     2017      2016  
     (Dollars in thousands)  

Unfunded loan commitments

   $ 134,536      $ 107,443  

Commercial and standby letters of credit

     91        1,156  
  

 

 

    

 

 

 

Total

   $ 134,627      $ 108,599  
  

 

 

    

 

 

 

Management believes that we have adequate liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments over the next twelve months. Additionally, management believes that our off-balance sheet arrangements have not had or are not reasonably likely to have a current or

 

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future material effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

Capital Resources

We are required to comply with certain “risk-based” capital adequacy guidelines issued by the FRB and the FDIC. The risk-based capital guidelines assign varying risk weights to the individual assets held by a bank. The guidelines also assign weights to the “credit-equivalent” amounts of certain off-balance sheet items, such as letters of credit and interest rate and currency swap contracts.

In July 2013, the federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. The final rules generally implemented higher minimum capital requirements, added a new common equity tier 1 capital requirement, and established criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements were a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”), and the total capital ratio remained at 8.0% under the new rules (10.0% to be considered “well capitalized”). Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common phased-in equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement is being phased in over three years beginning in 2016. We have included the 0.625% increase for 2016 and 2017 in our minimum capital adequacy ratios in the table below. The capital buffer requirement effectively raises the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019.

The risk-based capital ratios measure the adequacy of a bank’s capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for “prompt corrective action” or other regulatory enforcement action. In assessing a bank’s capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level of earnings; concentrations of credit, quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management’s overall ability to monitor and control risks.

The following table sets forth the regulatory capital ratios, excluding the impact of the capital conservation buffer, as of the dates indicated:

 

     Minimum
Capital

Requirement
    Minimum
Capital
Requirement
with Capital

Buffer
    Minimum
To Be Well

Capitalized
     December 31,  
              2017         2016  
Restated
 

Capital ratios (Company):

           

Tier 1 leverage ratio

     4.0     4.00     N/A        8.71     8.75

Common equity tier 1 capital ratio

     4.5     5.75     N/A        10.07     10.83

Tier 1 risk-based capital ratio

     6.0     7.25     N/A        10.07     10.83

Total risk-based capital ratio

     8.0     9.25     N/A        10.72     11.41

Capital ratios (Bank):

           

Tier 1 leverage ratio

     4.0     4.00     5.0%        9.29     9.16

Common equity tier 1 capital ratio

     4.5     5.75     6.5%        10.74     11.34

Tier 1 risk-based capital ratio

     6.0     7.25     8.0%        10.74     11.34

Total risk-based capital ratio

     8.0     9.25     10.0%        11.39     11.92

 

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At December 31, 2017, both we and the Bank met all the capital adequacy requirements to which we and the Bank were subject. At December 31, 2017, we and the Bank were “well capitalized” under the regulatory framework for prompt corrective action. Management believes that no conditions or events have occurred since December 31, 2017 that would materially adversely change such capital classifications. From time to time, we may need to raise additional capital to support our and the Bank’s further growth and to maintain our “well capitalized” status.

As of December 31, 2017, we had a tier 1 leverage ratio of 8.71%. As of December 31, 2017, the Bank had a tier 1 leverage ratio of 9.29%, which provided $43.4 million of excess capital relative to the minimum requirements to be considered well capitalized.

For a discussion of the changes in our total stockholders’ equity at December 31, 2017 as compared with December 31, 2016, please see the discussion under “—Stockholders’ Equity” above.

Liquidity

Liquidity involves our ability to raise funds to support asset growth and acquisitions or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate on an ongoing basis and manage unexpected events. For the years ended December 31, 2017 and 2016, our liquidity needs were primarily met by core deposits, security and loan maturities and amortizing investment and loan portfolios. Although access to brokered deposits, purchased funds from correspondent banks and overnight advances from the FHLB are available and have been utilized on occasion to take advantage of investment opportunities, we do not generally rely on these external funding sources. The Bank maintained four Federal Funds lines of credit with commercial banks which provide for extensions of credit with an availability to borrow up to an aggregate $35.0 million as of December 31, 2017 and 2016. There were no advances under these lines of credit outstanding as of December 31, 2017 or 2016.

The following table illustrates, during the periods presented, the mix of our funding sources and the average assets in which those funds are invested as a percentage of our average total assets for the periods indicated. Average assets were $1.01 billion for the year ended December 31, 2017 and $903.9 million for the year ended December 31, 2016.

 

     As of and for the
Year Ended
December 31,
 
     2017     2016  

Sources of funds:

    

Deposits:

    

Noninterest-bearing

     16.1     14.7

Interest-bearing

     66.3     65.0

Advances from FHLB and other borrowings

     7.6     9.3

Other liabilities

     0.2     1.0

Stockholders’ equity

     9.8     10.0
  

 

 

   

 

 

 

Total

     100.0     100.0
  

 

 

   

 

 

 

Uses of funds:

    

Loans

     82.4     79.4

Investment securities and other

     2.9     1.8

Interest-bearing deposits in other banks

     8.2     11.6

Other noninterest-earning assets

     6.5     7.2
  

 

 

   

 

 

 

Total

     100.0     100.0
  

 

 

   

 

 

 

Average noninterest-bearing deposits to average deposits

     19.6     18.4

Average loans to average deposits

     99.9     99.7

 

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Our primary source of funds is deposits, and our primary use of funds is loans. We do not expect a change in the primary source or use of our funds in the foreseeable future. Our average loans, including loans held for sale, increased 15.6% for the year ended December 31, 2017 compared to the year ended December 31, 2016. We predominantly invest excess deposits in overnight deposits with the Federal Reserve, securities, interest-bearing deposits at other banks or other short-term liquid investments until needed to fund loan growth. Our securities portfolio had a weighted average life of 5.00 years and an effective duration of 5.03 years as of December 31, 2017.

As of December 31, 2017, we had outstanding $134.5 million in commitments to extend credit and $91 thousand in commitments associated with outstanding commercial and standby letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.

As of December 31, 2017, we believe we had no exposure to future cash requirements associated with known uncertainties. Capital expenditures, including buildings and construction in process, for the years ended December 31, 2017 and 2016 were $11.4 million and $3.7 million, respectively. In 2017, we completed the purchase of a building at 5301 Spring Valley, Dallas, Texas consisting of 23,602 square feet for approximately $4.9 million and the purchase of a building at 1120 Summit Avenue, Fort Worth, Texas consisting of 7,483 square feet for approximately $3.0 million. Total capital expenditures related to the renovation of both locations as well as the construction of a new building at our principal executive offices at 1836 Spirit of Texas Way was $336 thousand for the year ended December 31, 2017, and we estimate the remaining capital expenditures to complete these projects will be approximately $1.9 million. We moved the Fort Worth branch location from our prior leased location to the newly acquired location during April 2018 and we expect to move the Dallas branch location from our current leased location to the newly acquired location during the first half of 2018. We plan to fund capital expenditures for these properties with cash flow from operations.

As of December 31, 2017, we had cash and cash equivalents of $57.9 million compared to $152.2 million as of December 31, 2016. The decrease was primarily due to an increase in our investment portfolio and funding new loan originations.

Interest Rate Sensitivity and Market Risk

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

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

We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, interest rate swaps, financial options, financial future contracts or forward delivery contracts for the purpose of reducing interest rate risk. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.

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

 

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

We use interest rate risk simulation models and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities, prepayment assumptions and repricing opportunities of loans are incorporated in the model as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of our non-maturity deposit accounts are based on standard regulatory decay assumptions and are incorporated into the model. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.

On a quarterly basis, we run two simulation models including a static balance sheet and dynamic growth balance sheet. These models test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic growth models, rates are shocked instantaneously and ramped rate changes over a 12-month horizon based upon parallel and non-parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulation involves analysis of interest income and expense under various changes in the shape of the yield curve. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one-year period should not decline by more than 5.0% for a 100 basis point shift, 10.0% for a 200 basis point shift, and 15.0% for a 300 basis point shift.

The following table summarizes the simulated change in net interest income over a 12-month horizon:

 

     December 31, 2017  

Change in interest rates (basis points)

   % Change in Net Interest Income  

+300

     1.81

+200

     1.10

+100

     2.56

Base

     0.00

-100

     (4.03 %) 

The following table summarizes an immediate shock in the fair value of equity as of the date indicated:

 

     December 31, 2017  

Change in interest rates (basis points)

   % Change in Fair Value of Equity  

+300

     (5.08 %) 

+200

     (3.26 %) 

+100

     (0.74 %) 

Base

     0.00

-100

     1.68

The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, interest rates on these deposits change more slowly than changes in the discount and federal funds rates. This assumption is incorporated into the simulation model and is

 

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generally not fully reflected in a gap analysis. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various strategies.

Impact of Inflation

Our consolidated financial statements and related notes included elsewhere in this prospectus have been prepared in accordance with GAAP. These require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.

Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.

Non-GAAP Financial Measures

Our accounting and reporting policies conform to GAAP, and the prevailing practices in the banking industry. However, we also evaluate our performance based on certain additional financial measures discussed in this prospectus as being non-GAAP financial measures. We classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively financial measures calculated in accordance with GAAP.

The non-GAAP financial measures that we discuss in this prospectus should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this prospectus may differ from that of other banking organizations reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have discussed in this prospectus when comparing such non-GAAP financial measures.

Adjusted Earnings per Common Share – Basic and Diluted

Adjusted earnings per common share – basic and diluted is a non-GAAP financial measure that excludes the 2017 impact of the remeasurement of our deferred tax assets following the passage of the Tax Reform enacted on December 22, 2017.

We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in basic and diluted earnings per common share.

 

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The following table reconciles, as of the date set forth below, basic and diluted earnings per common share and presents our basic and diluted earnings per common share exclusive of the impact of the remeasurement of our deferred tax assets:

 

     As of and for the Year Ended
December 31, 2017
 
     (Dollars in thousands, except
per share data)
 

Basic and diluted earnings per common share - GAAP basis:

  

Net income

   $ 4,753  

Less:

  

Participated securities share of undistributed earnings

     23  
  

 

 

 

Net income available to common stockholders

   $ 4,730  
  

 

 

 

Weighted average number of common shares - basic

     7,233,783  

Weighted average number of common shares - diluted

     7,519,944  

Basic earnings per common share

   $ 0.65  
  

 

 

 

Diluted earnings per common share

   $ 0.63  
  

 

 

 

Basic and diluted earnings per common share - Non-GAAP basis:

  

Net income

   $ 4,753  

Plus:

  

Deferred tax asset revaluation expense

     834  
  

 

 

 

Adjusted net income

   $ 5,587  
  

 

 

 

Weighted average number of common shares - basic(1)

     7,268,297  

Weighted average number of common shares - diluted(1)

     7,554,458  

Basic earnings per common share - Non-GAAP basis

   $ 0.77  
  

 

 

 

Diluted earnings per common share - Non-GAAP basis

   $ 0.74  
  

 

 

 

 

  (1) All per share information reflects the conversion of 170,236 shares of our issued and outstanding Series A preferred stock into common stock on February 23, 2017 and the one-for-two reverse stock split that occurred on March 16, 2017 as if they occurred on January 1, 2015.

Adjusted Return on Average Assets

Adjusted return on average assets is a non-GAAP financial measure that excludes the 2017 impact of the remeasurement of our deferred tax assets following the passage of the Tax Reform enacted on December 22, 2017.

We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in the return on average assets.

 

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The following table reconciles, as of the date set forth below, return on average assets and presents our return on average assets exclusive of the