Executive Summary / Key Takeaways

• Texas Community Bancshares, Inc. ($TCBS) is executing a strategic pivot, shifting its loan portfolio mix towards higher-yielding commercial assets after a significant residential loan sale in 2024, aiming to improve net interest margin and better align asset and liability repricing.
• This strategy contributed to a substantial turnaround in Q1 2025 financial performance, reporting net income of \$643,000 compared to a net loss of \$2.7 million in Q1 2024, largely due to the absence of prior period nonrecurring losses and an increase in net interest income.
• While TCBS leverages its local market presence and relationship banking, it faces intense competition from larger regional players with greater scale and more advanced digital capabilities, which could impact operational efficiency and market share capture in certain segments.
• The bank maintains a strong capital position, exceeding regulatory requirements with a Community Bank Leverage Ratio of 11.09% at March 31, 2025, and possesses ample liquidity resources, including significant unused borrowing capacity.
• Key risks include potential volatility from interest rate fluctuations impacting securities portfolio unrealized losses and net interest income, managing credit quality in the evolving loan portfolio, and retaining core deposits in a competitive rate environment.

A Texas Foundation Undergoing Transformation

Texas Community Bancshares, Inc. traces its roots back to 1934 through its subsidiary, Broadstreet Bank, SSB, formerly known as Mineola Community Bank, SSB. For decades, the bank served its local community in Mineola, Texas, building a foundation of relationship banking. A pivotal moment arrived on July 14, 2021, with the completion of the bank's mutual to stock conversion, establishing Texas Community Bancshares as the publicly traded holding company (NASDAQ: TCBS) and marking a new era of strategic possibilities, including expansion into the dynamic Dallas-Fort Worth Metroplex.

The core business remains traditional banking: gathering deposits and originating loans for consumers and commercial customers. However, recent periods have seen deliberate strategic actions aimed at optimizing the balance sheet and enhancing profitability in a challenging interest rate environment. A significant move in 2024 involved a strategic sale of residential mortgage loans. This decision, while resulting in a nonrecurring loss at the time, was intended to rebalance the portfolio, allowing the company to reinvest funds into higher-yielding assets and improve the alignment of asset and liability repricing.

The banking landscape in Texas is highly competitive, featuring a mix of large national banks, established regional players, and smaller community banks. Key rivals include larger regional institutions like Independent Bank Group (IBTX), Ameris Bancorp (ABCB), Banner Corporation (BANR), First Financial Bancorp (FFBC), and Hope Bancorp (HOPE). Compared to these larger peers, TCBS operates at a smaller scale, which can sometimes translate to higher operating costs per unit. For instance, some larger competitors reportedly achieve 10-20% lower operating costs per transaction or loan due to economies of scale.

While TCBS benefits from its deep local relationships, potentially leading to higher customer loyalty and retention in its core markets, it faces competitive pressure in areas like digital banking capabilities. The company invests in technology, as indicated by its R&D spending relative to revenue, but the competitive analysis suggests that larger rivals possess more advanced digital platforms offering faster processing speeds and greater scalability, which can be a factor in customer acquisition, particularly in online segments. The strategic shift towards commercial lending is partly a response to this competitive environment, targeting loan types that typically offer better yields and shorter maturities compared to traditional residential mortgages, helping to manage interest rate risk and enhance revenue generation.

Early Returns on Strategic Repositioning

The strategic actions undertaken in 2024 began to show tangible results in the first quarter of 2025. Texas Community Bancshares reported net income of \$643,000 for the three months ended March 31, 2025, a significant improvement from a net loss of \$2.7 million in the same period of 2024. This dramatic swing was primarily attributable to the absence of nonrecurring losses from the 2024 strategic loan sale (\$3.8 million) and branch construction activities.

Adjusting for these nonrecurring items from the prior year, the underlying pre-tax income saw a modest increase of \$98,000. This improvement was driven by a \$365,000 increase in net interest income and a \$143,000 decrease in noninterest expenses, partially offset by a decrease in other noninterest income (excluding the nonrecurring items) and a higher provision for credit losses. Net interest income rose to \$3.3 million in Q1 2025 from \$3.0 million in Q1 2024, primarily due to a 45 basis point expansion in the net interest margin, reaching 3.24%.

The improved margin reflects the impact of balance sheet restructurings, including the reinvestment of funds from the 2024 loan sale into higher-yielding assets and a more disciplined approach to deposit pricing. Interest income on loans increased by \$691,000, or 18.6%, driven by both higher average loan balances (\$299.4 million in Q1 2025 vs. \$281.3 million in Q1 2024) and a 61 basis point increase in the average loan yield to 5.88%. This yield improvement is a direct result of the strategic diversification towards higher-yielding commercial real estate and other commercial loans.

Interest expense decreased by \$149,000, or 6.1%, despite an increase in average interest-bearing deposits. This was mainly due to a significant decrease in higher-cost Federal Home Loan Bank (FHLB) advances, with the average balance falling by \$26.9 million. The average cost of interest-bearing liabilities decreased by 11 basis points to 2.68%. Noninterest expense saw a reduction, partly due to lower occupancy costs after the completion of branch construction activities in 2024 and a notable 50% decrease in technology expenses attributed to a contract negotiation.

Balance Sheet Dynamics and Liquidity Strength

The balance sheet at March 31, 2025, reflected the ongoing strategic adjustments. Total assets decreased slightly by \$1.3 million to \$442.2 million compared to December 31, 2024. This was primarily due to decreases in securities and cash balances, partially offset by growth in the loan portfolio. Net loans and leases receivable increased by \$3.8 million, or 1.3%, to \$297.5 million, demonstrating continued loan origination activity, particularly in the targeted commercial segments.

The loan portfolio composition at March 31, 2025, showed 92.3% in real estate loans, with commercial real estate (CRE) representing 20.6% and construction and development loans totaling 20.3%. Commercial and industrial loans accounted for 1.9%, and municipal loans were 4.1%. This mix reflects the deliberate shift away from a higher concentration in lower-yielding residential mortgages seen prior to the 2024 sale.

Deposit balances increased modestly by \$1.7 million to \$337.5 million. However, core deposits (excluding certificates of deposit) saw a slight decrease, while certificates of deposit increased. The bank actively manages its deposit base in a competitive rate environment, with the average cost of interest-bearing deposits decreasing to 2.45% year-to-date. The bank monitors its large depositors, noting that potentially uninsured deposits (balances exceeding the \$250,000 FDIC limit) totaled \$47.2 million, or 14.0% of deposits, at quarter-end.

Liquidity remains a key focus. The bank maintains significant unused borrowing capacity, including \$98.7 million with the FHLB of Dallas and additional lines with correspondent banks. Expected cash flows from the securities portfolio are projected to be \$43.7 million over the next 24 months, providing further liquidity. The bank also holds a strong capital position, with Broadstreet Bank's Community Bank Leverage Ratio of 11.09% well above the 9.00% requirement for being considered well-capitalized.

Risks and Outlook

Despite the positive momentum in Q1 2025, Texas Community Bancshares faces inherent risks common to the banking industry, particularly for a smaller regional player. Interest rate risk remains significant, as evidenced by the unrealized losses in the securities portfolio, totaling \$7.7 million at March 31, 2025. While management believes these losses are primarily due to market rate changes and not credit deterioration, sustained higher rates could impact future earnings and capital. The bank's interest rate sensitivity modeling indicates potential impacts on net interest income and economic value of equity (EVE) from shifts in the yield curve, though current modeling suggests a positive impact on NII from rate increases and a negative impact on EVE from rate decreases.

Credit risk is another critical area, particularly as the loan portfolio mix shifts towards commercial lending, which can carry different risk profiles than residential mortgages. The allowance for credit losses is a key estimate, subject to economic conditions and portfolio performance. At March 31, 2025, the allowance stood at 1.09% of total loans. The bank monitors credit quality through internal risk ratings and aging analyses, noting that collateral-dependent loans and loans in criticized categories require careful management and can impact the provision for credit losses.

Competition for both loans and deposits is intense and could impact future growth and margins. Attracting and retaining core deposits in a rising rate environment is challenging. The bank's ability to effectively compete on digital platforms and operational efficiency against larger, more technologically advanced rivals is also a factor to watch.

Management has not provided specific quantitative earnings guidance for the full year 2025, noting that Q1 results are not necessarily indicative of future performance. However, the strategic direction is clear: continue diversifying the loan portfolio, manage interest rate risk, maintain strong liquidity and capital, and focus on disciplined pricing. The decision not to renew \$3.5 million in FHLB advances maturing in 2025, if executed, would reduce funding costs but requires careful liquidity management. The company's ongoing stock repurchase program also signals a commitment to returning capital to shareholders.

Conclusion

Texas Community Bancshares is executing a deliberate strategic shift, moving beyond its traditional residential mortgage focus to build a more diversified and potentially higher-yielding commercial loan portfolio. The significant improvement in Q1 2025 results, driven by enhanced net interest income and reduced noninterest expenses, provides early validation of this strategy, albeit benefiting from the absence of prior-year nonrecurring items.

While the bank's smaller scale and digital capabilities may present competitive challenges against larger regional peers, its strong local presence and relationship banking model offer a foundational advantage. Maintaining asset quality, managing interest rate exposure, and effectively competing for deposits will be crucial for sustaining momentum. For investors, the story of TCBS is one of a community bank adapting its strategy to the current economic and competitive climate, with the early financial performance suggesting potential upside if the strategic pivot continues to yield positive results and risks are effectively managed. The focus on portfolio diversification and margin improvement, coupled with a solid capital base, positions TCBS to navigate the evolving banking landscape in its Texas markets.