Texas Community Bancshares, Inc. TCBS US Equity☆

ITEM 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the consolidated financial statements, which appear elsewhere in this annual report. You should read the information in this section in conjunction with the other business and financial information provided in this annual report.

Overview

Our business consists primarily of taking deposits from the general public and investing those deposits, together with funds generated from operations and borrowings from the Federal Home Loan Bank of Dallas, in residential real estate loans and commercial real estate loans and, to a lesser extent, commercial loans, construction and land loans, and consumer and other loans. Substantially all of our loans are fixed-rate loans. We also invest in securities, which have historically consisted primarily of mortgage-backed securities and obligations issued by U.S. government sponsored enterprises, state and municipal securities, and Federal Home Loan Bank stock. We offer a variety of deposit accounts, including checking accounts, savings accounts and certificate of deposit accounts. Mineola Community Bank is subject to comprehensive regulation and examination by the Texas Department of Savings and Mortgage Lending and the Federal Deposit Insurance Corporation and is a member of the Federal Home Loan Bank system.

Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. Our results of operations also are affected by our provisions for loan and lease losses, non-interest income and non-interest expense. Non-interest income currently consists primarily of service charges on deposit accounts, other service charges and fees, and income from bank owned life insurance. Non-interest expense currently consists primarily of expenses related to salaries and employee benefits, occupancy and equipment, data processing, contract services, director fees, and other expenses.

We invest in bank owned life insurance to provide us with a funding source to offset some costs of our benefit plan obligations. Bank owned life insurance provides us with non-interest income that is nontaxable. Federal regulations generally limit our investment in bank owned life insurance to 25% of our Tier 1 capital plus our allowance for loan and lease losses. At December 31, 2022, our investment in bank owned life insurance was $6.1 million, which was within this investment limit.

Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

Business Strategy

Our current business strategy consists of the following:

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Our commercial real estate loans and construction and land loans have higher credit risk than our residential mortgage loans.

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Summary of Critical Accounting Policies and Critical Accounting Estimates

The discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which are prepared in conformity with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be critical accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We determined not to take advantage of the benefits of this extended transition period.

The following represent our critical accounting policies:

Allowance for Loan and Lease Losses. The allowance for loan and lease losses is a reserve for estimated probable credit losses on individually evaluated loans determined to be impaired as well as estimated probable credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the allowance for loan and lease losses. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance for loan and lease losses. A provision for loan and lease losses, which is a charge against earnings, is recorded to bring the allowance for loan and lease losses to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the allowance for loan and lease losses is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan and lease losses and therefore the appropriateness of the allowance for loan and lease losses could change significantly.

The allocation methodology applied by Mineola Community Bank is designed to assess the appropriateness of the allowance for loan and lease losses and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and

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quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the allowance for loan and lease losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the allowance for loan and lease losses was adequate at December 31, 2022. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the allowance for loan and lease losses. As a result of such reviews, we may have to adjust our allowance for loan and lease losses. However, regulatory agencies are not directly involved in the process of establishing the allowance for loan and lease losses as the process is the responsibility of Mineola Community Bank and any increase or decrease in the allowance is the responsibility of management.

Income Taxes. The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the results of operations and reported earnings.

Texas Community Bancshares files consolidated federal income tax returns with Mineola Community Bank. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. We may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the consolidated financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.

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Selected Financial Data

The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

​

​ ​ ​ ​ ​ ​ ​

​ At December 31,

​ ​ (In thousands)

Selected Financial Condition Data: ​ ​ ​ ​

Cash and cash equivalents ​ ​ 8,927 ​ ​ 21,915

Interest bearing deposits in banks ​ 2,055 ​ 14,955

Premises and equipment, net ​ 6,299 ​ 6,215

Foreclosed assets ​ — ​ 209

Restricted investments carried at cost ​ 2,805 ​ 2,037

Bank owned life insurance ​ 6,125 ​ 6,020

Core deposit intangible ​ 397 ​ 529

Advances from the Federal Home Loan Bank ​ 62,494 ​ 27,571

​

​ ​ ​ ​ ​ ​ ​

​ For the Years Ended December 31,

​ ​ (In thousands)

Selected Operating Data: ​ ​ ​ ​

Provision for loan and lease losses ​ ​ 208 ​ 50

Net interest income after provision for loan and lease losses ​ ​ 10,075 ​ 8,368

Income before income taxes ​ ​ 2,177 ​ 611

Income tax expense ​ ​ 423 ​ 93

​

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​ ​ ​ ​ ​ ​

​ At or For the Years Ended

​ ​ December 31, ​

​ ​ ​ ​ ​

Performance Ratios: ​ ​

Return on average assets ​ 0.47 % 0.15 %

Return on average equity ​ 4.01 % 1.39 %

Interest rate spread (1) ​ 2.70 % 2.49 %

Net interest margin (2) ​ 2.89 % 2.66 %

Noninterest expense to average assets 2.59 % 2.80 %

​ ​ ​ ​ ​ ​

Capital Ratios: ​

Average equity to average assets 11.61 % 11.05 %

Total capital to risk-weighted assets 28.93 % 27.59 %

Tier 1 capital to risk-weighted assets 27.92 % 26.68 %

Common equity tier 1 capital to risk-weighted assets 27.92 % 26.68 %

Tier 1 capital to average assets 12.31 % 12.89 %

​ ​ ​ ​ ​ ​

Asset Quality Ratios: ​

Allowance for loan and lease losses as a percentage of total loans 0.69 % 0.72 %

Non-accrual loans as a percentage of total loans 0.47 % 0.72 %

Non-performing loans as a percentage of total loans 0.47 % 0.72 %

Non-performing loans as a percentage of total assets 0.28 % 0.44 %

Total non-performing assets as a percentage of total assets 0.28 % 0.49 %

​ ​ ​ ​ ​ ​

Other Data: ​

Number of offices ​ 6 6 ​

Number of full-time employees ​ 61 60 ​

Number of part-time employees ​ 5 2 ​

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The following table summarizes securities available for sale:

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ December 31, ​

​ ​ Fair ​ Percentage of ​ Fair ​ Percentage of ​

​ Value Total Value Total ​

Securities available for sale: ​ ​ ​ ​ ​

​

The following table sets forth information regarding fair values, weighted average yields and maturities of available for sale investments. The yields have been computed on a tax equivalent basis. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur.

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​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ Value Yield Value Yield Value Yield Value Yield Value Yield ​

Securities available for sale: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​

The following table summarizes securities held to maturity:

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ December 31, ​

​ ​ Amortized ​ Percentage of ​ Amortized ​ Percentage of ​

​ Cost Total ​ Cost Total ​

Securities held to maturity: ​ ​ ​ ​ ​ ​

​

The following table sets forth information regarding amortized costs, weighted average yields and maturities of all held to maturity investments. The yields have been computed on a tax equivalent basis. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur.

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​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield ​

Securities held to maturity: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​

​

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Comparison of Financial Condition at December 31, 2022 and December 31, 2021

Total Assets. Total assets were $417.3 million as of December 31, 2022, an increase of $52.5 million, or 14.4%, when compared to total assets of $364.8 million as of December 31, 2021. The increase was due primarily to an increase in securities of $44.5 million, or 49.2%, to $135.0 million at December 31, 2022 from $90.5 million at December 31, 2021 and an increase in net loans and leases of $31.0 million, or 14.1%, to $251.3 million at December 31, 2022 from $220.3 million at December 31, 2021, partially offset by decreases in cash, cash equivalents and interest bearing deposits in banks by a combined $25.9 million, or 70.2%, to $11.0 million at December 31, 2022 from $36.9 million at December 31, 2021. Asset growth was primarily due to increases in deposits, including $12.0 million in callable brokered deposits, and FHLB advances being invested in securities as part of a strategic purchase plan and loan growth.

Cash, Cash Equivalents and Due From Banks. Total cash, cash equivalents and due from banks (which includes fed funds sold) decreased $13.0 million, or 59.4%, to $8.9 million (including $2.0 million in Fed Funds sold) at December 31, 2022 from $21.9 million (including $16.3 million in Fed Funds sold) at December 31, 2021. This decrease is primarily due to an increase in securities of $44.5 million, or 49.2%, and an increase in net loans and leases of $31.0 million, or 14.1%, partially offset by increase in deposits of $21.2 million, or 7.7%, and an increase in Federal Home Loan Bank (FHLB) borrowings of $34.9 million, or 126.4%.

Interest Bearing Deposits in Banks. Interest bearing deposits in banks were $2.1 million at December 31, 2022 compared to $15.0 million as of December 31, 2021, a decrease of $12.9 million, or 86.0%. The decrease was due primarily to the net increases in securities and net loans and leases, partially offset by increased deposits and FHLB borrowings.

Securities Available for Sale. Securities available for sale (AFS) increased by $50.4 million, or 88.7%, to $107.2 million at December 31, 2022 from $56.8 million at December 31, 2021. The increase in securities included the investment of $75.3 million in AFS securities, including purchases of $13.8 million in US Treasuries, $9.8 million in mortgage-backed securities (MBS), $43.6 million in collateralized mortgage obligations (CMO), $4.8 million in municipals, and $3.3 million in bank subordinated debt, partially reduced by sales of $10.8 million, paydowns of $5.9 million, and increases in unrealized losses on the AFS portfolio of $8.0 million. Securities purchases were part of a strategic plan funded by excess cash, brokered deposits and FHLB advances.

Securities Held to Maturity. Securities held to maturity decreased by $5.9 million, or 17.5%, to $27.8 million at December 31, 2022 from $33.7 million at December 31, 2021. This decrease is primarily due to principal repayments of $5.3 million and a call on a municipal security totaling $365,000.

Loans and Leases Receivable, Net. Net loans and leases receivable increased $31.0 million, or 14.1%, to $251.3 million at December 31, 2022 from $220.3 million at December 31, 2021, including a reduction in PPP loans of $11,000, or 84.6%, from $13,000 at December 31, 2021 to $2,000 at December 31, 2022. During the year ended December 31, 2022, loans were originated totaling $109.7 million of which $13.6 million were renewals or refinancings of existing Mineola Community Bank loans, resulting in net originations of $96.1 million. Loan originations consisted primarily of $32.8 million of 1-4 family home loans, $54.7 million of construction loans (upon completion), including residential speculative construction loans of $11.9 million, $10.1 million in multi-family construction, $7.5 million in commercial real estate, $2.1 million in land and development, $4.2 million of consumer and other loan originations, $4.8 million in commercial and industrial, $3.4 million in farmland and $112,000 in other agricultural loan originations. During the year ended December 31, 2022, there were $13.0 million in loan principal paydowns and $48.3 million in loan payoffs. During the year ended December 31, 2022, total construction loans (including the 43.1% remaining in process) increased by $30.7 million from $23.3 million at December 31, 2021 to $54.0 million at December 31, 2022. Construction loans continue to be a growing segment of our portfolio with the majority of the loans being originated in our primary market. Demand for construction, development and 1-4 family home loan purchases continued to grow in 2022.

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Deposits. Deposits increased $21.1 million, or 7.7%, to $296.1 million at December 31, 2022 from $274.9 million at December 31, 2021. Core deposits (defined as all deposits other than certificates of deposit) increased $4.3 million, or 2.1%, to $206.7 million at December 31, 2022 from $202.4 million at December 31, 2021. The large growth in deposits includes $12.0 million in brokered deposits issued to partially fund an investment strategy. Retail certificates of deposit increased $4.7 million, or 6.5%, to $77.3 million at December 31, 2022 from $72.5 million at December 31, 2021. The increase in retail deposits is primarily due to the large increase in market interest rates and a strategic effort to retain deposits in a competitive environment during 2022.

Advances from the Federal Home Loan Bank. Advances from the Federal Home Loan Bank increased by $34.9 million, or 126.7%, to $62.5 million at December 31, 2022 from $27.6 million at December 31, 2021 primarily due to funding a strategic securities purchase plan while providing funds to mitigate deposit fluctuations and deposit pricing volatility.

Shareholders’ Equity. Total shareholders’ equity decreased $4.2 million, or 7.0%, to $55.9 million at December 31, 2022 from $60.1 million at December 31, 2021. The decrease was primarily the result of the unrealized loss on available for sale securities and the corresponding accumulated other comprehensive loss increasing by $6.3 million, or 920.3%, to $7.0 million at December 31, 2022 from $686,000 at December 31, 2021 primarily due to the rising interest rate environment and $297,000 in benefits cost related to the 2022 funding of the Mineola Community Bank leveraged ESOP plan and the 2022 equity incentive plan. At December 31, 2022, the ESOP contra equity account was $2.3 million.

At December 31, 2022, Mineola Community Bank opted to use the community bank leverage ratio framework (Tier 1 capital to average assets) for regulatory capital purposes. At December 31, 2022 a community bank leverage ratio of at least 9.0% is required to be considered “well capitalized” under regulatory requirements. At December 31, 2022, Mineola Community Bank’s community bank leverage ratio was 12.31%.

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Average Balance Sheets

The following tables set forth average balance sheets, average yields and costs, and certain other information at and for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. Non-accrual loans are included in the computation of average balances. Average yields for loans (excluding PPP loans) include loan fees of $399,000 and $579,000 for the years ended December 31, 2022 and 2021, respectively. There were no loan fees for PPP loans included in the average yield for the years ended December 31, 2022 or 2021. We have not recorded deferred loan fees, as we have determined them to be immaterial.

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​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ For the Years Ended December 31,

​ ​ Average ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ ​

​ ​ Outstanding ​ ​ ​ ​ Average ​ Outstanding ​ ​ ​ ​ Average ​

​ ​ Balance Interest Yield/Rate Balance Interest Yield/Rate ​

​ ​ (Dollars in thousands)

Interest-earning assets: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Allowance for loan and lease losses ​ ​ (1,641) ​ — — ​ (1,576) ​ — — ​

Noninterest-earning assets ​ ​ 21,628 ​ ​ ​ ​ 21,357 ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Interest-bearing liabilities: ​ ​ ​ ​ ​ ​ ​ ​ ​

Noninterest-bearing demand deposits ​ 57,280 ​ ​ ​ ​ 43,454 ​ ​ ​ ​

Other noninterest-bearing liabilities ​ 3,805 ​ ​ ​ ​ 3,840 ​ ​ ​ ​

Total shareholders' equity ​ 43,737 ​ ​ ​ ​ 37,384 ​ ​ ​ ​

Total liabilities and shareholders' equity ​ $ 376,830 ​ ​ ​ ​ $ 338,402 ​ ​ ​ ​

Net interest income ​ ​ ​ $ 10,283 ​ ​ ​ ​ $ 8,418 ​

Net interest rate spread (1) ​ ​ ​ ​ ​ 2.70 % ​ ​ ​ 2.49 %

Net interest-earning assets (2) ​ $ 83,194 ​ ​ ​ ​ ​ $ 63,321 ​ ​ ​ ​

Net interest margin (3) ​ ​ ​ ​ ​ 2.89 % ​ ​ ​ 2.66 %

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Rate/Volume Analysis

The following tables present the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by current year volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. There were no out-of-period items or adjustments required to be excluded from the table below.

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Increase (Decrease) Due to ​ Total Increase

​ ​ Volume ​ Rate ​ (Decrease)

​ ​ ​ (In thousands) ​ ​

Interest-earning assets: ​ ​ ​

Loans (excluding PPP loans) ​ $ 824 ​ $ (319) ​ $ 505

PPP loans ​ (6) ​ — ​ (6)

Restricted stock ​ 1 ​ 15 ​ 16

Interest-bearing deposits in banks ​ (43) ​ 26 ​ (17)

Federal funds sold and other ​ (12) ​ 87 ​ 75

​ ​ ​ ​ ​ ​ ​ ​ ​

Interest-bearing liabilities: ​ ​ ​ ​ ​ ​

Interest-bearing demand deposits ​ 18 ​ 12 ​ 30

Regular savings and other deposits ​ 32 ​ (18) ​ 14

Money market deposits ​ 15 ​ 56 ​ 71

Certificates of deposit ​ (44) ​ (65) ​ (109)

Total deposits ​ 21 ​ (15) ​ 6

Advances from the Federal Home Loan Bank ​ 80 ​ 82 ​ 162

Other interest-bearing liabilities ​ 3 ​ (4) ​ (1)

Total interest-bearing liabilities ​ 104 ​ 63 ​ 167

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Change in net interest income ​ $ 1,321 ​ $ 544 ​ $ 1,865

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Comparison of Operating Results for the Years Ended December 31, 2022 and December 31, 2021

Net Income. Net income was $1.8 million for the year ended December 31, 2022, compared to net income of $518,000 for the year ended December 31, 2021, an increase of $1.2 million, or 238.6%. The increase was primarily due to a $1.9 million, or 22.2%, increase in net interest income and a $151,000, or 8.8%, increase in noninterest income. This increase was partially offset by a $292,000, or 3.1%, increase in noninterest expense, a $158,000, or 316.0%, increase in the provision for loan and lease losses and a $330,000, or 354.8%, increase in income tax expense.

Interest Income. Interest income increased $2.1 million, or 20.0%, to $12.6 million for the year ended December 31, 2022 from $10.5 million at December 31, 2021. This increase resulted primarily from an increase in average interest earning assets of $38.2 million, or 12.1%, from $317.0 million at December 31, 2021 to $355.2 million at December 31, 2022 and an increase of 22 basis points, or 6.5%, in average yield on interest–earning assets from 3.32% at December 31, 2021 to 3.54% at December 31, 2022.

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The interest income increase is primarily due to an increase in the average balance of securities of $45.5 million, or 77.0%, from $59.1 million, for the year ended December 31, 2021 to $104.6 million for the year ended December 31, 2022 and an increase in the average yield on securities of 76 basis points, or 52.6%, from 1.45% for the year ended December 31, 2021 to 2.21% for the year ended December 31, 2022. The yield increase is reflective of an increase in market interest rate increases and the diversification of the securities portfolio to include higher yielding commercial mortgage-backed securities, subordinated bank debt and other bonds that are not tied to conventional residential mortgages. Securities interest income increased $1.5 million, or 170.2%, from $857,000 for the year ended December 31, 2021 to $2.3 million for the year ended December 31, 2022.

Interest income on net loans and leases, excluding PPP loan interest, increased $505,000, or 5.3%, to $10.1 million for the year ended December 31, 2022 from $9.6 million for the year ended December 31, 2021 primarily due to an increase of $18.6 million, or 8.6%, increase in the average balance of the loan portfolio from $216.2 million for the year ended December 31, 2021 to $234.8 million for the year ended December 31, 2022, partially offset by a decrease of 14 basis points, or 3.1%, in the average yield on loans from 4.43% for the year ended December 31, 2021 to 4.29% for the year ended December 31, 2022. The decreased yield on loans is primarily due to decreased loan fees and a full 12 months of interest on lower rate mortgage loans for the year ended December 31, 2022 that were originated in 2021.

Interest on Federal Home Loan Bank and Texas Independent Bank (TIB) stock increased $16,000, or 72.7%, from $22,000 for the year ended December 31, 2021 to $38,000 for the year ended December 31, 2022. This increase resulted primarily from an increase in yield of 72 basis points, or 66.6%, from 1.08% for the year ended December 31, 2021 to 1.81% for the year ended December 31, 2022 and an increase in average balance of $75,000, or 3.7%, from $2.0 million for the year ended December 31, 2021 to $2.1 million for the year ended December 31, 2022.

Interest bearing deposits in banks and cash and cash equivalents experienced an interest rate increase from December 31, 2021 to December 31, 2022 due to overall market interest rate increases. Interest income from interest bearing deposits in banks decreased $17,000 or 30.4%, from $56,000 for the year ended December 31, 2021 to $39,000 for the year ended December 31, 2022. This decline resulted from a decrease in average balance of $14.2 million, or 76.0%, from $18.7 million for the year ended December 31, 2021 to $4.5 million for the year ended December 31, 2022, partially offset by a 57 basis point, or 190.7%, increase in average yield from 0.30% for the year ended December 31, 2021 to 0.87% for the year ended December 31, 2022.

Fed funds interest increased $75,000, or 312.5%, to $99,000 at December 31, 2022 from $24,000 at December 31, 2021. There was an increase of 81 basis points, or 744.0%, in average yield on fed funds from 0.11% for the year ended December 31, 2021 to 0.92% for the year ended December 31, 2022, which was offset by a $11.3 million, or 51.1%, decrease in average balance from $22.1 million for the year ended December 31, 2021 to $10.8 million for the year ended December 31, 2022.

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Interest Expense. Interest expense increased $167,000, or 7.9%, to $2.3 million for the year ended December 31, 2022 from $2.1 million for the year ended December 31, 2021 due primarily to an increase in the average balance of interest-bearing liabilities of $18.3 million, or 7.2%, from $253.7 million for the year ended December 31, 2021 to $272.0 million for the year ended December 31, 2022.

Interest expense on deposit accounts increased $6,000, or 0.4%, for the year ended December 31, 2022, due primarily to an increase in average deposit account balances of $14.4 million, or 6.4%, from $224.3 million for the year ended December 31, 2021 to $238.7 million for the year ended December 31, 2022. This was partially offset by a decrease in average yield of four basis points, or 5.7%, from 0.66% for the year ended December 31, 2021 to 0.63% for the year ended December 31, 2022. The decrease in yield is primarily due to lower deposit costs during the first three quarters of the year.

Interest expense on Federal Home Loan Bank (FHLB) advances increased $162,000, or 26.3%, to $777,000 for the year ended December 31, 2022 from $615,000 for the year ended December 31, 2021, primarily due to the increase in average balances of FHLB advances of $3.7 million, or 12.7%, to $32.8 million for the year ended December 31, 2022 from $29.1 million for the year ended December 31, 2021 and an increase in average yield of 25 basis points, or 11.9%, from 2.12% for the year ended December 31, 2021 to 2.37% for the year ended December 31, 2022.

Net Interest Income. Net interest income increased $1.9 million, or 22.6%, to $10.3 million for the year ended December 31, 2022 from $8.4 million for the year ended December 31, 2021, primarily due to an increase of $19.9 million, or 31.4%, in average balance of net interest earning assets from $63.3 million for the year ended December 31, 2021 to $83.2 million for the year ended December 31, 2022. The net interest rate spread increased 21 basis points, or 8.4%, from 2.49% for the year ended December 31, 2021 to 2.70% for the year ended December 31, 2022. Net interest margin increased 24 basis points, or 9.0%, to 2.89% for the year ended December 31, 2022 from 2.66% for the year ended December 31, 2021.

Provision for Loan and Lease Losses. Based on management’s analysis of the adequacy of the allowance for loan and lease losses, the provision for loan and lease losses increased $158,000, or 316.0%, from $50,000 for the year ended December 31, 2021 to $208,000 for the year ended December 31, 2022. The allowance for loan and lease losses was $1.8 million at December 31, 2022 compared to $1.6 million at December 31, 2021. The increase in the provision was primarily due to an increase in net loans and leases of $31.0 million, or 14.1%, and an increase in net loan chargeoffs of $9,000 to a total of $16,000 for the year ended December 31, 2022 and an increase in losses related to overdrawn deposit accounts of $15,000 to a total of $30,000 for the year ended December 31, 2022. The loan portfolio was also diversified during the year ended December 31, 2022 with increases in loan types requiring a slightly higher allowance.

Noninterest Income. Noninterest income increased $151,000, or 8.8%, to $1.9 million for the year ended December 31, 2022 from $1.7 million for the year ended December 31, 2021, primarily the result of increased service charges on deposits of $88,000, or 15.2%, from $578,000 for the year ended December 31, 2021 to $666,000 for the year ended December 31, 2022 primarily resulting from increases in nonsufficient funds and overdraft fees resulting primarily from increases in the number of checking accounts. Other service charges and fees increased by $44,000 primarily from an increase of $12,000 in ATM fees and $15,000 in loan fees generated through secondary market wholesale lending. There were a three items exclusive to the year ended December 31, 2022 including a gain of $42,000 on the sale of bank property classified as foreclosed assets and a $6,000 gain on the sale of a fixed asset, partially offset by a $29,000 loss on securities sold in 2022.

Noninterest Expense. Noninterest expense increased $292,000, or 3.1%, to $9.8 million for the year ended December 31, 2022 from $9.5 million for the year ended December 31, 2021 primarily due to the increase in salary and employee benefits, data processing, and director fees, partially offset by decreases in contract services and other expenses.

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Salary and employee benefit expenses increased by $652,000, or 12.7%, totaling $5.8 million for the year ended December 31, 2022 and $5.1 million for the year ended December 31, 2021, due primarily to an increase in wages of $487,000 for the year ended December 31, 2022 from $4.0 million to $4.5 million and additional compensation expense of $84,000 for the year ended December 31, 2022 related to equity compensation awards. Directors’ fees increased $77,000, or 25.2%, from $306,000 for the year ended December 31, 2021 to $383,000 for the year ended December 31, 2022 due to the addition of four new directors and two new advisory directors. Data (core) processing expense increased by $404,000, or 48.5%, to $1.2 million for the year ended December 31, 2022 from $833,000 for the year ended December 31, 2021 primarily due to increases in the number of accounts and a price increase levied by our core processor. Contract services and other expenses combined decreased $885,000, or 35.9%, from $2.5 million for the year ended December 31, 2021 to $1.6 million for the year ended December 31, 2022. This decrease in expenses was primarily due to increased expenses for the year ended December 31, 2021 related to our initial public offering.

Income Tax Expense. Income tax expense increased by $330,000, or 354.8%, to $423,000 for the year ended December 31, 2022 from $93,000 for the year ended December 31, 2021 due primarily to the increase in taxable income. The effective tax rate was 19.43% and 15.22% for the years ended December 31, 2022 and 2021, respectively. The increase in the effective tax rate was primarily due to taxable income increasing at a faster rate than nontaxable income.

Management of Market Risk

General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our Risk Management and Interest Rate Risk Management Officer is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our board of directors. We currently utilize a third-party modeling program, prepared on a monthly basis, to evaluate our sensitivity to changing interest rates, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:

● maintaining a high level of liquidity;

● growing our volume of core deposit accounts;

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By following these strategies, we believe that we are better positioned to react to increases and decreases in market interest rates.

We have not engaged in hedging activities, such as engaging in futures or options. We do not anticipate entering into similar transactions in the future.

Net Interest Income. We analyze our sensitivity to changes in interest rates through a net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under the assumptions that the United States Treasury yield curve increases or decreases instantaneously by 200 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below.

The tables below set forth the calculation of the estimated changes in our net interest income that would result from the designated immediate changes in the United States Treasury yield curve.

​

​ ​ ​ ​ ​ ​ ​

Change in Interest Rates Net Interest Income Year Year 1 Change from

(basis points) (1) ​ 1 Forecast ​ Level

(Dollars in thousands)

(1) Assumes an immediate uniform change in interest rates at all maturities.

The table above indicates that at December 31, 2022, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a 2.48% increase in net interest income, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 7.85% decrease in net interest income.

Net Economic Value. We also compute amounts by which the net present value of our assets and liabilities (net economic value of equity or “EVE”) would change in the event of a range of assumed changes in market interest rates. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumptions that the United States Treasury yield curve increases or decreases instantaneously by 200 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve.

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The tables below set forth the calculation of the estimated changes in our EVE that would result from the designated immediate changes in the United States Treasury yield curve.

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ EVE as a Percentage of

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Present Value of Assets (3)

​ ​ ​ ​ ​ Estimated Increase ​ ​ ​ Increase

Change in Interest ​ Estimated ​ (Decrease) in EVE ​ ​ ​ (Decrease)

Rates (basis points) (1) EVE (2) Amount Percent EVE Ratio (4) (basis points)

(Dollars in thousands)

(1) Assumes an immediate uniform change in interest rates at all maturities.

(4) EVE Ratio represents EVE divided by the present value of assets.

The table above indicates that at December 31, 2022, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a 7.46% decrease in EVE, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 0.20% decrease in EVE.

Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The net interest income and net economic value tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates, and actual results may differ.

Interest rate risk calculations also may not reflect the fair values of financial instruments. For example, increases in market interest rates can decrease the fair values of our loans, mortgage servicing rights, deposits and borrowings.

Liquidity and Capital Resources

Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, and proceeds from maturities of securities. We are also able to borrow from the Federal Home Loan Bank of Dallas. At December 31, 2022, we had outstanding advances of $62.5 million from the Federal Home Loan Bank of Dallas. At December 31, 2022, we had unused borrowing capacity of $73.4 million with the Federal Home Loan Bank of Dallas. In addition, at December 31, 2022, we had a $10.0 million line of credit with Texas Independent Bankers Bank, a $5.0 million line of credit with First Horizon Bank, and an $8.5 million unsecured line of credit with Zions/Amegy Bank. At December 31, 2022, there was no outstanding balance with any of these facilities.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our

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most liquid assets are cash and short-term investments including interest-bearing demand deposits. The levels of these assets depend on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. For additional information, see the consolidated statements of cash flows for the years ended December 31, 2022 and 2021 included as part of the consolidated financial statements appearing elsewhere in this annual report.

We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of maturing time deposits will be retained.

Texas Community Bancshares, Inc. is a separate legal entity from Mineola Community Bank and it must provide for its own liquidity to pay any dividends to stockholders and for other corporate purposes. At December 31, 2022, Texas Community Bancshares, Inc. (on an unconsolidated basis) had cash and cash equivalents totaling $13.3 million.

At December 31, 2022, Mineola Community Bank exceeded all of its regulatory capital requirements, and was categorized as well-capitalized at that date. Management is not aware of any conditions or events since the most recent notification of well-capitalized status that would change our category. See Note 19 of the notes to consolidated financial statements.

Off-Balance Sheet Arrangements

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit, unused lines of credit and swap transactions. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At December 31, 2022, we had outstanding commitments to originate loans of $43.3 million. We anticipate that we will have sufficient funds available to meet our current lending commitments. Time deposits that are scheduled to mature in less than one year from December 31, 2022 totaled $49.1 million. Management expects that a substantial portion of these time deposits will be retained. However, if a substantial portion of these time deposits is not retained, we may utilize advances from the Federal Home Loan Bank of Dallas or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.

Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.

Recent Accounting Pronouncements

For a discussion of the impact of recent accounting pronouncements, see Note 23 of the notes to our consolidated financial statements beginning on page F-1 of this annual report.

Impact of Inflation and Changing Prices

The consolidated financial statements and related data presented in this prospectus have been prepared in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

​

ITEM 7A.Quantitative and Qualitative Disclosures About Market Risk

The information regarding this Item is contained in Item 7 under the heading “Management of Market Risk.”

​

​

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ITEM 8.Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm (PCAOB ID 686)

​

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Shareholders, Board of Directors and Audit Committee

Texas Community Bancshares, Inc. and Subsidiaries

Mineola, Texas

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated statements of financial condition of Texas Community Bancshares, Inc. and Subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive (loss) income, shareholders' and members' equity, and cash flows for each of the years in the two-year period ended December 31, 2022, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. Federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ FORVIS, LLP

We have served as the Company's auditor since 2020.

Houston, Texas

March 30, 2023

​

​

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Texas Community Bancshares, Inc. and Subsidiaries

Consolidated Statements of Financial Condition

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

​

​

​ ​ ​ ​ ​ ​ ​

Assets ​ ​ ​ ​

Cash and cash equivalents ​ ​ 8,927 ​ ​ 21,915

Interest bearing deposits in banks ​ ​ 2,055 ​ ​ 14,955

Net investment in direct financing leases ​ ​ 64 ​ ​ 105

Accrued interest receivable ​ ​ 1,327 ​ ​ 931

Premises and equipment, net ​ ​ 6,299 ​ ​ 6,215

Bank-owned life insurance ​ ​ 6,125 ​ ​ 6,020

Foreclosed assets ​ ​ — ​ ​ 209

Restricted investments carried at cost ​ ​ 2,805 ​ ​ 2,037

Core deposit intangible ​ ​ 397 ​ ​ 529

Mortgage servicing rights, net ​ ​ 7 ​ ​ 8

Deferred income taxes ​ ​ 2,304 ​ ​ 651

Liabilities and Shareholders' Equity ​ ​ ​ ​

Liabilities ​ ​ ​ ​

Advances from Federal Home Loan Bank (FHLB) ​ ​ 62,494 ​ ​ 27,571

Accrued expenses and other liabilities ​ ​ 2,905 ​ ​ 2,190

Shareholders' Equity ​ ​ ​ ​ ​ ​

Accumulated other comprehensive loss ​ ​ (6,999) ​ ​ (686)

​

See Notes to Consolidated Financial Statements

​

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Texas Community Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

Years Ended December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

​

​

​ ​ ​ ​ ​ ​ ​

Interest Income ​

Debt securities ​ ​ ​ ​

Dividends on restricted investments ​ 38 ​ 22

Federal funds sold ​ 99 ​ 24

Deposits with banks ​ 39 ​ 56

Interest Expense ​ ​ ​ ​

Provision for Loan and Lease Losses ​ 208 ​ 50

Net Interest Income After Provision for Loan and Lease Losses ​ 10,075 ​ 8,368

Noninterest Income ​ ​ ​ ​

Service charges on deposit accounts ​ 666 ​ 578

Other service charges and fees ​ 1,051 ​ 1,007

Net gain (loss) on securities transactions ​ (29) ​ —

Net gain on sale of foreclosed assets ​ 42 ​ —

Net gain on sale of fixed assets ​ 6 ​ —

Net appreciation on bank-owned life insurance ​ 105 ​ 111

Other income ​ 27 ​ 21

Noninterest Expenses ​ ​ ​ ​

Salaries and employee benefits ​ 5,798 ​ 5,146

Occupancy and equipment expense ​ 769 ​ 725

Total noninterest expenses ​ 9,766 ​ 9,474

Income Before Income Taxes ​ 2,177 ​ 611

Income Tax Expense ​ 423 ​ 93

Earnings per share - basic ​ $ 0.58 ​ $ 0.17

Earnings per share - diluted ​ $ 0.58 ​ $ 0.17

Weighted-average shares outstanding - basic ​ ​ 3,028,214 ​ ​ 3,002,129

Weighted-average shares outstanding - diluted ​ ​ 3,028,214 ​ ​ 3,002,129

​

See Notes to Consolidated Financial Statements

​

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Texas Community Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Loss

Years Ended December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

​

​

​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​

Other items of comprehensive loss ​ ​ ​ ​ ​ ​

Total other items of comprehensive loss, before tax ​ (7,991) ​ (1,031)

​ ​ ​ ​ ​ ​ ​

Income tax benefit related to other items of comprehensive loss ​ 1,678 ​ 217

Total other items of comprehensive loss, after tax ​ (6,313) ​ (513)

​ ​ ​ ​ ​ ​ ​

Comprehensive Loss ​ $ (4,559) ​ $ (296)

​

See Notes to Consolidated Financial Statements

​

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Texas Community Bancshares, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity

Years Ended December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

​

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​

​ ​ ​ ​ ​ ​ Additional ​ ​ ​ ​ Other ​ Unearned ​ Total

​ ​ Stock ​ Stock ​ Capital ​ Earnings ​ Loss ​ Shares ​ Equity

Net income ​ — ​ — ​ — ​ ​ 1,754 ​ — ​ — ​ 1,754

Stock based compensation expense ​ ​ — ​ ​ — ​ ​ 84 ​ ​ — ​ ​ — ​ ​ — ​ ​ 84

ESOP shares earned, 13,031 shares ​ — ​ — ​ 83 ​ — ​ — ​ 130 ​ 213

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Net income ​ — ​ — ​ — ​ 518 ​ — ​ — ​ 518

Leveraged ESOP shares, 2,606,210 shares ​ — ​ — ​ — ​ — ​ — ​ (2,606) ​ (2,606)

ESOP shares earned, 13,031 shares ​ — ​ — ​ 72 ​ — ​ — ​ 130 ​ 202

​

See Notes to Consolidated Financial Statements

​

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Texas Community Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Years Ended December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

​

​

​ ​ ​ ​ ​ ​ ​

Operating Activities ​ ​

Adjustments to reconcile net income to net cash from operating activities ​ ​

Provision for loan and lease losses ​ 208 ​ 50

Net amortization of securities ​ 421 ​ 443

Depreciation and amortization ​ 431 ​ 437

Net realized loss on sales of securities available for sale ​ 29 ​ —

Stock dividends on restricted securities ​ ​ (28) ​ ​ —

Loss on sale of fixed assets ​ (6) ​ —

Gain on sale of foreclosed assets ​ (42) ​ —

Appreciation on bank-owned life insurance ​ (105) ​ (111)

ESOP compensation expense for allocated shares ​ ​ 213 ​ ​ 202

Stock-based compensation ​ 84 ​ —

Deferred income tax expense (benefit) ​ 25 ​ (188)

Net change in ​ ​ ​

Accrued interest receivable ​ (396) ​ 32

Mortgage servicing rights ​ 1 ​ 4

Other assets ​ (175) ​ (56)

Accrued expenses and other liabilities ​ 715 ​ 426

Net Cash from Operating Activities ​ 3,129 ​ 1,757

Investing Activities ​ ​

Net change in interest bearing deposits in banks ​ 12,900 ​ (940)

Activity in available for sale securities ​ ​ ​ ​ ​ ​

Maturities, prepayments and calls ​ 5,839 ​ 34,362

Activity in held to maturity securities ​ ​ ​

Maturities, prepayments and calls ​ 5,694 ​ 14,210

Purchases of restricted investments ​ (740) ​ (13)

Loan originations and principal collections, net ​ (31,312) ​ (6,973)

Net decrease (increase) in net investment in direct financing leases ​ 41 ​ (73)

Proceeds from sales of foreclosed assets ​ 243 ​ —

Proceeds from sales of fixed assets ​ 16 ​ —

Purchases of premises and equipment ​ (393) ​ (137)

Net Cash used for Investing Activities ​ (72,184) ​ (52,798)

Financing Activities ​ ​

Advances from FHLB and other borrowings ​ 192,500 ​ —

Payments on long-term FHLB and other borrowings ​ (157,577) ​ (3,197)

Proceeds from issuance of common stock net of conversion costs ​ — ​ 30,893

Loan to ESOP for purchase of common stock ​ — ​ (2,606)

Net Cash from Financing Activities ​ 56,067 ​ 64,883

Net Change in Cash and Cash Equivalents ​ (12,988) ​ 13,842

Cash and Cash Equivalents at Beginning of Year ​ 21,915 ​ 8,073

Cash and Cash Equivalents at End of Year ​ $ 8,927 ​ $ 21,915

​

See Notes to Consolidated Financial Statements

​

​

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Texas Community Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

Note 1 - Summary of Significant Accounting Policies

General

Texas Community Bancshares, Inc. (the “Company”), a Maryland corporation and registered bank holding company, was incorporated on March 5, 2021 to become the holding company for Mineola Community Bank, SSB (the “Bank”) upon the conversion of Mineola Community Mutual Holding Company (“MHC”) from a mutual holding company to a stock holding company (the “Conversion”). The Conversion was completed on July 14, 2021. The Company’s shares began trading on the NASDAQ under the symbol TCBS on July 15, 2021. In connection with the Conversion, the Company acquired 100% ownership of the Bank and the Company offered and sold 3,207,759 shares of its common stock at $10.00 per share, for gross offering proceeds of $32,078. The cost of the Conversion and issuance of common stock was approximately $1,684, which was deducted from the gross offering proceeds. The Company also contributed 50,000 shares of its common stock and $75 of cash to Texas Community Bancshares Foundation, Inc. (the “Foundation”), a charitable foundation formed in connection with the Conversion. The Bank’s ESOP purchased 260,621 shares of the common stock sold by the Company, which was 8% of the 3,257,759 shares of common stock issued by the Company, including the shares contributed to the Foundation. The ESOP purchased the shares using a loan from the Company. The Company contributed $15,276 of the net proceeds from the offering to the Bank, loaned $2,606 of the net proceeds to the ESOP, contributed $75 to the Foundation and retained approximately $12,436 of the net proceeds.

Following the Conversion, voting rights in the Company are held and exercised exclusively by the shareholders of the Company. Deposit account holders continue to be insured by the FDIC. In connection with the Conversion, liquidation accounts were established by the Company and the Bank in an aggregate amount equal to (i) the MHC’s ownership interest in the shareholders’ equity of Mineola Community Financial Group, Inc. (the former subsidiary holding company of the Bank) as of the date of the latest statement of financial condition included in the Company’s definitive prospectus dated May 14, 2021, plus (ii) the value of the net assets of the MHC as of the date of the MHC’s latest statement of financial condition before the consummation of the Conversion (excluding the MHC’s ownership interest in Mineola Community Financial Group, Inc.). Each eligible account holder and supplemental eligible account holder is entitled to a proportionate share of the liquidation accounts in the event of a liquidation of (i) the Company and the Bank or (ii) the Bank, and only in such events. This share will be reduced if the eligible account holder’s or supplemental account holder’s deposit balance falls below the amounts on the date of record and will cease to exist if the account is closed. The liquidation account will never be increased despite any increase after the Conversion in the related deposit balance. The Bank may not pay a dividend on its capital stock if the effect thereof would cause retained earnings to be reduced below the liquidation account amount or regulatory capital requirements. In addition, the Company is subject to certain regulations related to the payment of dividends and the repurchase of its capital stock. The Conversion was accounted for as a change in corporate form with the historic basis of the Bank’s assets, liabilities and equity unchanged as a result.

The Bank’s primary source of revenue is providing loans and banking services to consumers and commercial customers in Mineola, Texas, and the surrounding area and the Dallas Fort Worth Metroplex. The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America (GAAP) and to general practices of the banking industry. Policies and practices which materially affect the determination of financial position, results of operations and cash flows are summarized as follows:

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which include Mineola Community Bank, S.S.B. and its wholly-owned subsidiary Mineola Financial Service Corporation,

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Texas Community Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

which is not actively being utilized. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

In preparing consolidated financial statements in conformity with generally accepted accounting principles in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statements of financial condition and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease losses.

Significant Group Concentration of Credit Risk

Most of the Company’s activities are with customers located within the Wood, Smith, and Van Zandt County areas and the Dallas Fort Worth Metroplex. Note 3 discusses the types of securities in which the Company invests. Note 4 discusses the types of lending in which the Company engages. Approximately 95% of the loan balance at December 31, 2022 and 2021, is secured by real estate. The Company does not have any other significant concentrations to any one industry or customer.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, balances due from banks and federal funds sold, all of which mature within ninety days.

The Company is required to maintain average balances on hand or with the Federal Reserve Bank. As of December 31, 2022 and 2021, the Company was not required to maintain any amounts in excess of required reserves.

Balances in transaction accounts at other financial institutions may exceed amounts covered by federal deposit insurance. Management regularly evaluates the credit risk associated with other financial institutions and believes that the Company is not exposed to any significant credit risks on cash and cash equivalents. At December 31, 2022 and 2021, the Company had $1,750 and $13,655, respectively, that exceeded amounts covered by federal deposit insurance.

Interest Bearing Deposits in Banks

Interest bearing deposits in banks are carried at cost.

Debt Securities

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Debt securities not classified as held to maturity are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive loss.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary, if any, are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the

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Texas Community Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

​

intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Investments in other restricted stock are carried at cost. Any changes to the cost basis of these investments are recorded in the statements of income. These investments are reviewed annually to determine if an impairment charge is necessary.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) evaluation by the Company of (a) its intent to sell a debt security prior to recovery and (b) whether it is more likely than not the Company will have to sell the debt security prior to recovery.

As of December 31, 2022 and 2021, no impairment charges were recorded for any debt security.

Federal Home Loan Bank Stock

The Company’s investment in Federal Home Loan Bank stock is a restricted investment carried at cost ($100 per share par value), which approximates its fair value. As a member of the FHLB system, the Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding FHLB advances. The Company may request redemption at par value of any stock in excess of the amount it is required to hold. Stock redemptions are made at the discretion of FHLB. Due to requirements for additional advances for the year ended December 31, 2022 there were purchases and dividend reinvestments of $583 and $28, respectively. For the year ended December 31, 2021, there were purchases of $13 due to requirements for additional advances. There were no sales during 2022 or 2021. Additionally, the Company periodically evaluates FHLB stock for impairment. As of December 31, 2022 or 2021, no impairment charges were recorded.

Loans and Leases

The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by loans secured by real estate throughout the Wood, Smith, and Van Zandt Counties and the Dallas Fort Worth Metroplex area. The ability of the Company’s debtors to honor their contracts is dependent upon the general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off which are measured at historical cost are generally reported at their outstanding unpaid principal balances net of any unearned income, charge-offs, and unamortized deferred fees and costs on originated loans. Interest income is accrued on the unpaid principal balance. The deferral of all loan origination fees and origination costs is quantified annually. In 2022 and 2021, management determined the deferral of these fees and costs to be immaterial to the consolidated financial statements. Unearned income is amortized to interest income using a level yield methodology.

The Company makes disclosures of loans and other financing receivables and the related allowance in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 310, Receivables. The accounting guidance defines a portfolio segment as the level at which an entity develops and documents a systematic methodology to determine the allowance for credit losses, and a class of financing receivables as the level of disaggregation of portfolio segments based on the initial measurement attributes, risk characteristics and methods for assessing risk. The Company’s portfolio segments are real estate, agriculture, commercial, and consumer and other. The classes of financing receivables within the real estate segment are Construction and Land, Farmland, 1-4 Residential and

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Texas Community Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

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Multifamily, and Commercial Real Estate. The remaining portfolio segments contain a single class of financing receivables. Under this accounting guidance, the allowance is presented by portfolio segment.

Allowance for Loan and Lease Losses

The allowance for credit losses, which includes the allowance for loan and lease losses and the reserve for unfunded lending commitments, represents management’s estimate of probable losses inherent in the Company’s lending activities. The allowance for loan and lease losses does not include amounts related to the accrued interest receivable as any accrued interest receivable is reversed when a loan is placed on nonaccrual status.

The allowance for loan and lease losses represents the estimated probable credit losses in funded consumer and commercial loans while the reserve for unfunded lending commitments, including standby letters of credit and binding unfunded loan commitments, represents estimated probable credit losses on these unfunded credit instruments based on utilization assumptions. Credit exposures deemed to be uncollectible are charged against these accounts. Cash recovered on previously charged off amounts is recorded as a recovery to these accounts.

Management evaluates the adequacy of the allowance for credit losses based on the combined total of these two components. The Company performs periodic and systematic detailed reviews of its lending portfolios to identify credit risks and assess the overall collectability of those portfolios. The allowance on certain homogenous loan portfolios is based on aggregated portfolio segment evaluations. Loss models are utilized for these portfolios which consider a variety of factors including, but not limited to, historical loss experience, estimated defaults or foreclosures based on portfolio trends, delinquencies, bankruptcies, economic conditions and credit scores.

The Company’s real estate portfolio segment is comprised primarily of homogenous loans secured by residential and commercial real estate. The amount of losses incurred in the homogenous loan pools is estimated based upon how many of the loans will default and the loss in the event of default. Using modeling methodologies, the Company estimates how many of the homogenous loans will default based on the individual loans’ attributes aggregated into pools of homogenous loans with similar attributes. The attributes that are most significant to the probability of default and are used to estimate default include the loan-to-value, borrower credit score, months since origination, geography, and present collection status. The estimate is based on the Company’s historical experience with the loan portfolio. The estimate is adjusted to reflect an assessment of environmental factors that are not reflected in the historical data, such as changes in real estate values, local and national economies, underwriting standards and the regulatory environment.

The allowance on the remaining portfolio segments (agriculture, commercial, and consumer) is calculated using loss rates delineated by risk rating and product type. Factors considered when assessing loss rates include the value of the underlying collateral, the industry of the obligor, the obligor’s liquidity and other financial and qualitative factors. These statistical models are updated regularly for changes in economic and business conditions. Included in the analysis of these loan portfolios are reserves which are maintained to cover uncertainties that affect the Company’s estimate of probable losses including economic uncertainty and large single defaults.

Nonperforming loans are reviewed in accordance with applicable accounting guidance on impaired loans and troubled debt restructurings (TDRs). If necessary, a specific allowance is established for these loans if they are deemed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all the

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Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

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circumstances surrounding the loan and the borrower, including the length of delay, the reason for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of the loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are subject of a restructuring agreement.

In addition to the allowance for loan and lease losses, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit and financial guarantees, and binding unfunded loan commitments. Unfunded lending commitments are subject to individual reviews and are analyzed and segregated by risk according to the Company’s internal risk rating scale. These risk classifications, in conjunction with an analysis of historical loss experience, utilization assumptions, current economic conditions, performance trends within the portfolio and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments.

The allowance for loan and lease losses related to the loan portfolio is reported as a part of loans in the consolidated statements of condition whereas the reserve for unfunded lending commitments is reported on the consolidated statements of condition in accrued expenses and other liabilities. Provisions for credit losses related to the loan portfolio and unfunded lending commitments is reported separately in the consolidated statements of income.

Nonperforming Loans, Charge-Offs and Delinquencies

Nonperforming loans generally include loans that have been placed on nonaccrual status including nonaccrual loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties.

The entire balance of a loan is contractually delinquent if the minimum payment is not received by the specified due date on the customer’s billing statement. Interest and fees continue to accrue on past due loans until the date the loan goes into nonaccrual status, if applicable.

The outstanding balance of real estate secured loans, including all classes of financing receivables within the real estate portfolio segment, that is in excess of the estimated property value, less estimated costs to sell, is generally charged off no later than the end of the month in which the account becomes 180 days past due. The estimated property value, less estimated costs to sell, is determined utilizing appraisals or broker price opinions of the fair value of the collateral.

The outstanding balance of loans within the remaining loan segments (agriculture, commercial, and consumer) are generally charged off no later than the end of the month in which the account becomes 120 days past due. For secured loans, accounts are written down to the collateral value.

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Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

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The fair value of the collateral is estimated by management based on current financial information, inspections, and appraisals. For unsecured loans, the outstanding balance is written off.

Loans within all portfolio segments are generally placed on nonaccrual status and classified as nonperforming at 90 days past due. Accrued interest receivable is reversed when a loan is placed on nonaccrual status. Interest collections on non-accruing loans for which the ultimate collectability of principal is uncertain are applied as principal reductions; otherwise, such collections are credited to interest income when received. These loans may be restored to accrual status when all principal and interest is current and full repayment of the remaining contractual principal and interest is expected, or when the loan otherwise becomes well-secured and is in the process of collection.

Loans whose contractual terms have been modified in a TDR and are current at the time of the restructuring remain on accrual status if there is demonstrated performance prior to the restructuring and repayment in full under the restructured terms is expected. Otherwise, the loans are placed on nonaccrual status and reported as nonperforming until there is sustained repayment performance for a reasonable period, generally six months. TDRs that are on accrual status are reported as performing TDRs through the end of the calendar year in which the restructuring occurred or the year in which the loans are returned to accrual status. In addition, if accruing TDRs bear less than a market rate of interest at the time of modification, they are reported as performing TDRs throughout the remaining lives of the loans.

The allowance for loan and lease losses is established as losses are estimated to have occurred through a provision for loan and lease losses charged to earnings. Loan and lease losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans and leases in light of historical experience, the nature and volume of the loan and lease portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revisions as more information becomes available.

Troubled Debt Restructured Loans

A TDR loan is a loan which the Company, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The loan terms which have been modified or restructured due to a borrower’s financial difficulty include, but are not limited to, a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-aging, extensions, deferrals, renewals and rewrites. A TDR loan would generally be considered impaired.

Wholesale Lending

The Company has entered into a wholesale lending agreement with a wholesale lender and correspondent bank, TIB. The Company originates the loan and interacts with the customer while the wholesale lender underwrites, funds, closes and services the loan. The Company receives a fee from the wholesale lender at closing for the services provided which is included in noninterest income.

Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit, including commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.

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Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

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Derivative Loan Commitments

Mortgage loan commitments that relate to the origination of a mortgage that will be held for sale upon funding are considered derivative instruments under the derivatives and hedging accounting guidance (FASB ASC 815, Derivatives and Hedging). Loan commitments that are derivatives are recognized at fair value on the consolidated statements of condition in other assets and other liabilities with changes in their fair values recorded in noninterest income.

Forward Loan Sale Commitments

The Company evaluates all loan sales agreements to determine whether they meet the definition of a derivative under FASB ASC 815 as facts and circumstances may differ significantly. If agreements qualify, to protect against the price risk inherent in derivative loan commitments, the Company uses "best efforts" forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments. Accordingly, forward loan sale commitments are recognized at fair value on the consolidated statements of condition in other assets and liabilities with changes in their fair values recorded in other noninterest income.

The Company estimates the fair value of its forward loan sales commitments using a methodology similar to that used for derivative loan commitments.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Cash Surrender Value of Bank-owned Life Insurance

Life insurance policies are initially recorded at cost at the date of purchase. Subsequent to purchase, the policies are periodically adjusted for changes in cash surrender value. The adjustment to cash surrender value increases or decreases the carrying value of the policies and is recorded as income or expense on the consolidated statements of income.

Foreclosed Assets

Assets acquired through, or in lieu of, loan foreclosure are initially recorded at fair value less estimated costs to sell at the date of foreclosure. All write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, property held for sale is carried at the lower of the new cost basis or estimated fair value less costs to sell.

Impairment losses on property to be held and used are measured at the amount by which the carrying amount of a property exceeds its fair value. Costs of significant property improvements are capitalized, whereas costs related to holding property are expensed. Valuations are periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of the property to the lower of its cost or fair value less costs to sell.

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Notes to Consolidated Financial Statements

December 31, 2022 and 2021

(Amounts in thousands, except for share and per share data)

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Premises and Equipment

Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 7 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line or accelerated method with useful lives ranging from 3 to 20 years.

Leases

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Leases are classified as operating or finance leases at the lease commencement date. The Company leases certain locations and equipment. The Company records leases on the statements of financial condition in the form of a lease liability for the present value of future minimum payments under the lease terms and a right-of-use asset equal to the lease liability adjusted for items such as deferred or prepaid rent, lease incentives, and any impairment of the right-of-use asset. The discount rate used in determining the lease liability is based upon incremental borrowing rates the Company could obtain for similar loans as of the date of commencement or renewal. The Company does not record leases on the consolidated statements of financial condition that are classified as short term (less than one year).

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At lease inception, the Company determines the lease term by considering the minimum lease term and all optional renewal periods that the Company is reasonably certain to renew. The lease term is also used to calculate straight-line rent expense. The depreciable life of leasehold improvements is limited by the estimated lease term, including renewals if they are reasonably certain to be renewed. The Company’s leases do not contain residual value guarantees or material variable lease payments that will impact the Company's ability to pay dividends or cause the Company to incur additional expenses.

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Operating lease expense consists of a single lease cost allocated over the remaining lease term on a straight-line basis, variable lease payments not included in the lease liability, and any impairment of the right-of-use asset. Rent expense and variable lease expense are included in occupancy and equipment expense on the Company's consolidated statements of income.

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The Company has elected to treat property leases that include both lease and non-lease components as a single component and account for it as a lease.

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Mortgage Servicing Rights

Mortgage servicing rights are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Mortgage servicing rights are capitalized and amortized into income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Mortgage servicing rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined by using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum.

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