UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2023
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to to
Commission file number: 001-38817
MainStreet Bancshares, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Virginia
81-2871064
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
10089 Fairfax Boulevard, Fairfax, VA 22030
(Address of Principal Executive Offices and Zip Code)
(703) 481-4567
(Registrant’s Telephone Number, Including Area Code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act.
Title of each class
Trading
Symbol(s)
Name of each exchange
on which registered
Common Stock
MNSB
The Nasdaq Stock Market LLC
MNSBP
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
Non-accelerated filer
☒
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of November 8, 2023, there were 7,527,295 outstanding shares, par value $4.00 per share, of the issuer’s common stock.
INDEX
PART I – FINANCIAL INFORMATION
Item 1 – Consolidated Financial Statements
Notes to Consolidated Financial Statements
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
Item 4 – Controls and Procedures
PART II – OTHER INFORMATION
Item 1 – Legal Proceedings
Item 1A – Risk Factors
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Item 6 – Exhibits
SIGNATURES
Item 1 – Consolidated Financial Statements – Unaudited
MAINSTREET BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition as of September 30, 2023 and December 31, 2022 (Dollars in thousands, except share data)
Assets
Cash and due from banks
Federal funds sold
Cash and cash equivalents
Investment securities available-for-sale, at fair value
Investment securities held-to-maturity, at amortized cost, net of allowance for credit losses of $0 and $0, respectively.
Restricted securities, at amortized cost
Loans, net of allowance for credit losses of $15,626 and $14,114, respectively
Premises and equipment, net
Accrued interest and other receivables
Bank owned life insurance
Computer software, net of amortization
Other assets
Total Assets
Liabilities and Stockholders’ Equity
Liabilities
Non-interest bearing deposits
Interest bearing demand deposits
Savings and NOW deposits
Money market deposits
Time deposits
Total deposits
Federal Home Loan Bank advances
Subordinated debt, net
Allowance for credit losses on off-balance sheet credit exposure
Other liabilities
Total Liabilities
Stockholders’ Equity
Preferred stock, $1.00 par value, 2,000,000 shares authorized; 28,750 shares issued and outstanding at September 30, 2023 and December 31, 2022
Common stock, $4.00 par value, 10,000,000 shares authorized; issued and outstanding 7,524,877 shares (including 228,300 nonvested shares) at September 30, 2023 and 7,442,743 shares (including 259,036 nonvested shares) at December 31, 2022
Capital surplus
Retained earnings
Accumulated other comprehensive loss
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
* Derived from audited consolidated financial statements.
See Notes to the Unaudited Consolidated Financial Statements
Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2023 and 2022 (Dollars in thousands, except per share data)
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
2023
2022
Interest Income
Interest and fees on loans
Interest on investments securities
Taxable securities
Tax-exempt securities
Interest on federal funds sold and interest-bearing deposits
Total Interest Income
Interest Expense
Interest on interest-bearing DDA deposits
Interest on savings and NOW deposits
Interest on money market deposits
Interest on time deposits
Interest on federal funds borrowed
Interest on Federal Home Loan Bank advances
Interest on subordinated debt
Total Interest Expense
Net Interest Income
Provision For (Recovery of) Credit Losses - Loans
Provision for Credit Losses - Off-Balance Sheet Credit Exposure
Net Interest Income After Provision For (Recovery of) Credit Losses
Non-Interest Income
Deposit account service charges
Bank owned life insurance income
Loan swap fee income
Net gain on held-to-maturity securities
Net loss on sale of loans
Other fee income
Total Non-Interest Income
Non-Interest Expense
Salaries and employee benefits
Furniture and equipment expenses
Advertising and marketing
Occupancy expenses
Outside services
Administrative expenses
Other operating expenses
Total Non-Interest Expense
Income Before Income Taxes
Income Tax Expense
Net Income
Preferred Stock Dividends
Net Income Available To Common Shareholders
Earnings Per Common Share:
Basic
Diluted
Unaudited Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2023 and 2022 (Dollars in thousands)
Comprehensive Income, net of taxes
Other comprehensive loss, net of tax benefit:
Unrealized losses on available for sale securities arising during the period (net of tax benefit, $687 and $850, respectively, for the three months ended September 30, and $687 and $2,641, respectively for the nine months ended September 30).
Add: reclassification adjustment for amortization of unrealized losses on securities transferred from available for sale to held to maturity (net of tax, $0 and $1, respectively, for the three months ended September 30, and $1 and $3, respectively, for the nine months ended September 30).
Other comprehensive loss
Comprehensive Income
Unaudited Consolidated Statements of Stockholders’ Equity for the Three and Nine months ended September 30, 2023 and 2022 (Dollars in thousands)
Accumulated Other
Preferred
Common
Capital
Retained
Comprehensive
Stock
Surplus
Earnings
Loss
Total
Balance, June 30, 2023
Vesting of restricted stock
Stock based compensation expense
Dividends on preferred stock - ($0.47 per depositary share)
Dividends on common stock - ($0.10 per share)
Net income
Balance, September 30, 2023
Income (Loss)
Balance, December 31, 2022
Cumulative change in accounting principle (Note 3)
Common stock repurchased
Dividends on preferred stock - ($0.94 per depositary share)
Dividends on common stock - ($0.30 per share)
Balance, June 30, 2022
Dividends on common stock - ($0.05 per share)
Balance, September 30, 2022
Balance, December 31, 2021
Dividends on common stock - ($0.15 per share)
Unaudited Consolidated Statements of Cash Flows (Dollars in thousands)
For the nine months ended September 30,
Cash Flows from Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion, net
Deferred income tax expense (benefit)
Provision for credit losses
Writedown of other real estate owned
Loss on sale of other real estate owned
Loss on sale of loans
Income from bank owned life insurance
Subordinated debt amortization expense
Gain on disposal of premises and equipment
Loss on New Market Tax Credit investment operations
Gain on call of held-to-maturity securities
Amortization of operating lease right-of-use assets
Change in:
Accrued interest receivable and other receivables
Net cash provided by operating activities
Cash Flows from Investing Activities
Activity in available-for-sale securities:
Payments
Maturities
Purchases
Activity in held-to-maturity securities:
Called
Purchases of equity securities
Proceeds on sale of loans
Proceeds on sale of other real estate owned
Purchases of restricted investment in bank stock
Redemption of restricted investment in bank stock
Net increase in loan portfolio
Computer software developed
Proceeds from sale of premises and equipment
Purchases of premises and equipment
Net cash used in investing activities
Cash Flows from Financing Activities
Net increase (decrease) in non-interest deposits
Net increase in interest bearing demand, savings, and time deposits
Net decrease in Federal Home Loan Bank advances
Net increase in subordinated debt, net issuance costs
Cash dividends paid on preferred stock
Cash dividends paid on common stock
Repurchases of common stock
Net cash provided by financing activities
Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents, beginning of period
Cash and Cash Equivalents, end of period
Supplementary Disclosure of Cash Flow Information
Cash paid during the period for interest
Cash paid during the period for income taxes
Net unrealized loss on securities available-for-sale
Net cumulative change in accounting principle
Notes to Unaudited Consolidated Financial Statements
Note 1. Organization, Basis of Presentation and Impact of Recently Issued Accounting Pronouncements
Organization
MainStreet Bancshares, Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose primary activity is the ownership and management of MainStreet Bank (the “Bank”). On October 12, 2021, the Company filed an election with the Federal Reserve Board to be a financial holding company in order to engage in a broader range of financial activities than are permitted for bank holding companies generally. The Company is authorized to issue 10,000,000 shares of common stock with a par value of $4.00 per share. Additionally, the Company is authorized to issue 2,000,000 shares of preferred stock at a par value $1.00 per share. There are currently 28,750 shares of preferred stock outstanding. The Company is regulated under the Bank Holding Company Act of 1956, as amended (“BHC Act”) and is subject to inspection, examination, and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).
On April 18, 2019, the Company completed the registration of its common stock with the Securities Exchange Commission (the “SEC”) through its filing of a General Form for Registration of Securities on Form 10 (“Form 10”), pursuant to Section 12(b) of the Securities Exchange Act of 1934. The Company is considered an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the “JOBS Act,” and as defined in Section 2(a) of the Securities Act of 1933, as amended, or the “Securities Act.” We are also a “smaller reporting company” as defined in Exchange Act Rule 12b-2. As such, we may elect to comply with certain reduced public company reporting requirements in future reports that we file with the SEC.
The Company was approved to list shares of our common stock on the Nasdaq Capital Market under our current symbol “MNSB” as of April 22, 2019. We were approved to list depositary shares of preferred stock on the Nasdaq Capital Market under the symbol “MNSBP” as of September 16, 2020. Each depositary share represents a 1/40th ownership interest in a share of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock.
The Bank is headquartered in Fairfax, Virginia where it also operates a branch. The Bank was incorporated on March 28, 2003, and received its charter from the Bureau of Financial Institutions of the Commonwealth of Virginia (the “Bureau”) on March 16, 2004. The Bank commenced regular operations on May 26, 2004, and is supervised by the Bureau and the Federal Reserve. The Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation. The Bank places special emphasis on serving the needs of retail customers, small and medium-sized businesses and professionals in the Washington, D.C. metropolitan area.
In September 2021, MainStreet Bancshares, Inc. established MainStreet Community Capital, LLC, a wholly owned subsidiary, to be a community development entity (“CDE”). This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”). In January 2022, the Community Development Financial Institutions Fund (“CDFI”) of the United States Department of the Treasury certified MainStreet Community Capital, LLC as a registered CDE. MainStreet Community Capital's primary business objective will be to apply for and receive New Market Tax Credit ("NMTC") allocations that are awarded and distributed annually.
On October 25, 2021, MainStreet Bancshares, Inc. formally introduced Avenu, a division of MainStreet Bank. Avenu provides an embedded banking solution that connects our partners (fintechs, application developers, money movers, and entrepreneurs) directly and seamlessly to our Software as a Service (SaaS) solution. Our SaaS solution has launched with our first beta client.
Basis of Presentation
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) for interim information and with the instructions to the Quarterly Report on Form 10-Q, as applicable to a smaller reporting company. Accordingly, they do not include all the information and notes required by US GAAP for complete financial statements.
The financial statements are unaudited; but in the opinion of management include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation thereof. The balances as of December 31, 2022 have been derived from the audited consolidated financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes thereto contained in the Form 10-K filed by the Company with the SEC on March 23, 2023. The results of operations for the three and nine months ended September 30, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023, or any other period.
Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from the estimates.
The Company’s critical accounting policies relate to (1) the allowance for credit losses on loans, (2) fair value of financial instruments, and (3) derivative financial instruments. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions, and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. In connection with the determination of the allowances for credit losses on loans management obtains independent appraisals for significant properties.
Summary of Significant Accounting Policies
Adoption of New Accounting Standards: On January 1, 2023, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by the lessor in accordance with Topic 842 on leases. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities management does not intend to sell or believes that is more likely than not they will be required to sell.
The Company adopted ASC 326 and all the subsequent amendments effective January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost, and off-balance-sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior periods amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $1.7 million as of January 1, 2023 for the cumulative effect of adopting ASC 326. The transition adjustment includes an increase in allowance for credit reserves of $2.2 million and an increase in net deferred tax assets of $506,000.
Impact of Recently Issued Accounting Pronouncements
In March 2023, the Financial Accounting Standards Board (FASB) issued ASU 2023-02, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method”. These amendments allow reporting entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. The ASU is effective for public business entities for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for all entities in any interim period. The Company does not expect the adoption of ASU 2023-02 to have a material impact on its consolidated financial statements.
In July 2023, the Financial Accounting Standards Board (FASB) issued ASU 2023-03, “Presentation of Financial Statements (Topic 205), Income Statement—Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation—Stock Compensation (Topic 718)”. This ASU amends the FASB Accounting Standards Codification for SEC paragraphs pursuant to SEC Staff Accounting Bulletin No. 120, SEC Staff Announcement at the March 24, 2022 EITF Meeting, and Staff Accounting Bulletin Topic 6.B, Accounting Series Release 280—General Revision of Regulation S-X: Income or Loss Applicable to Common Stock. ASU 2023-03 is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2023-03 to have a material impact on its consolidated financial statements.
In October 2023, the Financial Accounting Standards Board (FASB) issued ASU 2023-06, “Disclosure Improvements: Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative”. This ASU incorporates certain U.S. Securities and Exchange Commission (SEC) disclosure requirements into the FASB Accounting Standards Codification. The amendments in the ASU are expected to clarify or improve disclosure and presentation requirements of a variety of Codification Topics, allow users to more easily compare entities subject to the SEC’s existing disclosures with those entities that were not previously subject to the requirements, and align the requirements in the Codification with the SEC’s regulations. For entities subject to the SEC’s existing disclosure requirements and for entities required to file or furnish financial statements with or to the SEC in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer, the effective date for each amendment will be the date on which the SEC removes that related disclosure from its rules. For all other entities, the amendments will be effective two years later. However, if by June 30, 2027, the SEC has not removed the related disclosure from its regulations, the amendments will be removed from the Codification and not become effective for any entity. The Company does not expect the adoption of ASU 2023-06 to have a material impact on its consolidated financial statements.
Recently Adopted Accounting Developments
In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration. ASU 2016-13 was effective for the Company on January 1, 2023. The adjustment recorded at adoption to the overall allowance for credit losses, which consisted of adjustments to the allowance for credit losses on loans and an adjustment to the Company’s reserve for unfunded loan commitments, was $2.2 million. The adjustment net of tax recorded to stockholders’ equity totaled $1.7 million.
In March 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments in this ASU should be applied prospectively, except for the transition method related to the recognition and measurement of TDRs. An entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. ASU 2022-02 was effective for the Company on January 1, 2023. There was no material impact to the Company's consolidated financial statements or related disclosures.
Note 2. Investment Securities
The following tables summarize the amortized cost and fair value of securities available-for-sale and securities held-to-maturity at September 30, 2023 and December 31, 2022 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss). Upon further analysis, the Company did not record an allowance for credit losses on its securities held-to-maturity portfolio as of September 30, 2023.
Investment securities available-for-sale was comprised of the following:
September 30, 2023
(Dollars in thousands)
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Collateralized Mortgage Backed
Subordinated Debt
Municipal Securities:
Taxable
Tax-exempt
U.S. Governmental Agencies
Investment securities held-to-maturity was comprised of the following:
December 31, 2022
Credit Quality Indicators and Allowance for Credit Losses - HTM
For HTM securities, the Company evaluates the credit risk of its securities on at least a quarterly basis. The Company estimates expected credit losses on HTM debt securities on an individual basis using security-level credit ratings. The Company’s HTM securities ACL was immaterial at September 30, 2023. The primary indicators of credit quality for the Company’s HTM portfolio are security type and credit rating, which is influenced by a number of factors including obligor cash flow, geography, seniority, and others. The majority of the Company’s HTM securities with credit risk are obligations of states and political subdivisions.
The following table presents the amortized cost of HTM securities as of September 30, 2023 and December 31, 2022 by security type and credit rating:
Municipal Securities
Total HTM securities
Credit Rating:
AAA/AA/A
Not Rated - Non Agency
The scheduled maturities of securities available-for-sale and held-to-maturity at September 30, 2023 were as follows:
Available-for-Sale
Held-to-Maturity
Due in one year or less
Due from one to five years
Due from after five to ten years
Due after ten years
The scheduled maturities of securities available-for-sale and held-to-maturity at December 31, 2022 were as follows:
Securities with a fair value of $15.8 million and $3.6 million were pledged at September 30, 2023 and December 31, 2022, respectively,
The following tables summarize the unrealized loss positions of securities available-for-sale and held-to-maturity as of September 30, 2023 and December 31, 2022:
Less than 12 Months
12 Months or Longer
Unrealized Loss
Available-for-sale:
Municipal securities:
U.S Governmental Agencies
U.S Government Agencies
Held-to-maturity:
Unrealized losses on each of the major categories of securities have not been recognized into income because all the securities are of high credit quality (rated A or higher, if rated). Management does not intend to sell and it is unlikely management will be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the securities. The fair value is expected to recover as the securities approach maturity. The following description provides the number of investment positions in an unrealized loss position and approximate duration of that loss position.
At September 30, 2023, there was one collateralized mortgage backed security with a fair value totaling approximately $72,000 in an unrealized loss position of less than 12 months and twenty-four collateralized mortgage backed securities totaling $19.0 million in an unrealized loss position of more than 12 months and there were twenty-one subordinated debt securities totaling $7.5 million in an unrealized loss position of more than 12 months. At September 30, 2023 nine municipal securities with fair values totaling approximately $14.2 million were in an unrealized loss position of less than 12 months and thirty-seven securities totaling $26.4 million in an unrealized loss position of more than 12 months. At September 30, 2023 seven government agency securities with a fair value of approximately $870,000 were in an unrealized loss position of more than 12 months.
Certain municipal securities originally purchased as available for sale were transferred to held to maturity during 2013. The unrealized loss on the securities transferred to held to maturity is being amortized over the expected life of the securities. The unamortized, unrealized loss, before tax, at September 30, 2023 and December 31, 2022 was $2,056 and $8,228, respectively.
The Company periodically invests in New Market Tax Credit opportunities, related primarily to certain community development projects. The Company receives tax credits related to these investments, for which the Company typically acts as a limited partner and therefore does not exert control over the operating or financial policies of the partnerships. These tax credits are subject to recapture by taxing authorities based on compliance features required to be met at the project level. Recognition of tax credits and any associated losses on operations associated with these entities are recorded as a reduction to the carrying value of these investments. Proportional operational losses associated with these investments are included in non-interest income. As of and for the three and nine months ended September 30, 2023 , the Company recorded approximately $87,000 and $176,000, respectively, in tax credit investment operational losses.
Note 3. Loans Receivable
Loans receivable were comprised of the following:
Residential Real Estate:
Single family
Multifamily
Farmland
Commercial Real Estate:
Owner-occupied
Non-owner occupied
Construction and Land Development
Commercial – Non Real-Estate:
Commercial & Industrial
Consumer – Non Real-Estate:
Unsecured
Secured
Total Gross Loans
Less: unearned fees, net
Less: allowance for credit losses - loans
Net Loans
The unsecured consumer loans above include $177,000 and $2.0 million of overdrafts reclassified as loans at September 30, 2023 and December 31, 2022, respectively.
The following tables summarize the activity in the allowance for credit losses on loans by loan class for the three and nine months ended September 30, 2023 and 2022.
Allowance for Credit Losses By Portfolio Segment
Real Estate
For the three months ended September 30, 2023
Residential
Commercial
Construction
Consumer
Beginning Balance
Charge-offs
Recoveries
Provision for (recovery of) credit losses
Ending Balance
Ending Balance:
Individually evaluated for credit loss
Collectively evaluated for credit loss
For the nine months ended September 30, 2023
Beginning Balance, prior to adoption of ASC 326
Impact of adopting ASC 326
For the three months ended September 30, 2022
For the nine months ended September 30, 2022
Credit quality risk ratings include regulatory classifications of Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Loans classified as Pass have quality metrics to support that the loan will be repaid according to the terms established. Loans classified as Watch have similar characteristics as Pass loans with some emerging signs of financial weaknesses that should be monitored closer. Loans classified as Special Mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of prospects for repayment. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, based on current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for credit losses. Loans not classified are rated pass.
The following tables summarize the amortized cost basis by aggregate Pass and criticized categories of Watch, Special Mention, and Substandard within the Company’s internal risk rating system as of September 30, 2023 and December 31, 2022.
Term Loans Amortized Cost Basis by Origination Year
2021
2020
2019
Prior
Revolving Loans
Residential Real Estate - Single Family
Pass
Watch
Special Mention
Substandard
Total Residential Real Estate - Single Family
Residential Real Estate - Multifamily
Total Residential Real Estate - Multifamily
Residential Real Estate - Farmland
Total Residential Real Estate - Farmland
Commercial Real Estate - Owner Occupied
Total Commercial Real Estate - Owner Occupied
Commercial Real Estate - Non-Owner Occupied
Total Commercial Real Estate - Non-Owner Occupied
Construction & Land Development
Total Construction & Land Development
Doubtful
Total Commercial & Industrial
Consumer - Unsecured
Total Consumer - Unsecured
Consumer - Secured
Total Consumer - Secured
Single Family
Owner occupied
Commercial – Non Real Estate:
Consumer – Non Real Estate:
The following tables present the amortized cost basis by segments of the loan portfolio summarized by aging categories as of September 30, 2023 and December 31, 2022:
30-59 Days Past Due
60-89 Days Past Due
Greater than 90 Days
Total Past Due
Current
Total Loans Receivable
Nonaccrual
There were no loans placed on nonaccrual with an allowance for credit losses as of September 30, 2023 and December 31, 2022.
The Company has certain loans for which repayment is dependent upon the operation or sale of collateral, as the borrower is experiencing financial difficulty. The underlying collateral can vary based upon the type of loan. The following provides more detail about the types of collateral that secure collateral dependent loans:
The following table details the amortized cost of collateral dependent loans:
Commercial and Industrial
The Company did not modify any loans to borrowers experiencing financial distress during the three and nine months ended September 30, 2023.
As of September 30, 2023 there were no real estate loans in the process of foreclosure.
Prior to the adoption of ASC 326 on January 1, 2023, the Company calculated the allowance for loan losses under the incurred loss methodology. The following tables are disclosures related to the allowance for loan losses in prior periods.
Loans Receivable
Ending Balance: Individually Evaluated for Impairment
Ending Balance: Collectively Evaluated for Impairment
Residential Real Estate
Commercial Real Estate
Prior to the adoption of ASU 2016-13, loans were considered impaired when, based on current information and events, it was probable the Company would be unable to collect all amounts due in accordance with the original contractual terms of the loan agreements. Impaired loans could include loans on nonaccrual status and accruing troubled debt restructurings. When determining if the Company would be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement, the Company considered the borrower’s capacity to pay, which included such factors as the borrower’s current financial statements, an analysis of global cash flow sufficient to pay all debt obligations and an evaluation of secondary sources of repayment, such as guarantor support and collateral value. The tables below include all loans that were individually assessed for impairment. If a loan was deemed impaired, a specific valuation allowance was allocated, if necessary, so that the loan was reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment was expected solely from the collateral. Interest payments on impaired loans were typically applied to principal unless collectability of the principal amount was reasonably assured, in which case interest was recognized on a cash basis.
The following table presents loans individually evaluated for impairment by class of loans, as of December 31, 2022:
Recorded Investment
Unpaid Principal Balance
Related Allowance
With no related allowance recorded
The following table presents information related to the average recorded investment and interest income recognized on impaired loans, for the three months ended September 30, 2023:
For the three months ended September 30,
Average Record Investment
Interest Income Recognized
Owner Occupied
Non-owner Occupied
The following table presents information related to the average recorded investment and interest income recognized on impaired loans, for the nine months ended September 30, 2023:
Unfunded Commitments
The Company maintains an allowance for credit losses on off-balance sheet credit exposures such as unfunded balances for existing lines of credit, commitments to extend future credit, as well as both standby and commercial letters of credit when there is a contractual obligation to extend credit and when this extension of credit is not unconditionally cancellable (i.e. commitment cannot be canceled at any time). The allowance for credit losses on off-balance sheet credit exposures is adjusted as a provision for credit loss expense. The estimate includes consideration of the likelihood that funding will occur, which is based on a historical funding study derived from internal information, and an estimate of expected credit losses on commitments expected to be funded over its estimated life, which are the same loss rates that are used in computing the allowance for credit losses on funded loans. The allowance for credit losses for off-balance sheet credit exposure of $1.6 million and $0 million at September 30, 2023 and December 31, 2022, respectively, is classified on the balance sheet within Other Liabilities.
The following table presents the balance and activity in the allowance for credit losses for off-balance sheet credit exposure for the three months ended September 30, 2023.
Total Allowance for Credit Losses on Off-Balance Sheet Credit Exposure
Provision for off-balance sheet credit losses
The following table presents the balance and activity in the allowance for credit losses for off-balance sheet credit exposure for the nine months ended September 30, 2023.
Adjustment to allowance for off-balance sheet credit losses upon adoption of ASU 2016-13
Provision for off-balance sheet credit losses, net
Note 4. Intangible Assets
The carrying amount of computer software developed was $13.4 million and $9.1 million at September 30, 2023 and December 31, 2022. The following table presents the carrying amount of computer software developed as of September 30, 2023 and December 31, 2022.
As of September 30, 2023
As of December 31, 2022
Gross Carrying Amount
Accumulated Amortization
Amortizable intangible assets:
Computer software
The Company is still in the development stage of computer software where costs are capitalized. Capitalization ceases when the software is substantially complete and ready for its intended use. At that time the intangible asset will be amortized on a straight-line basis over the estimated useful life of the asset. As of September 30, 2023, the Company has not recorded any amortization on its intangible computer software. We anticipate the amortization period for intangible computer software to be ten years, once placed in service, which is expected to begin in the first quarter of 2024.
Note 5. Derivatives and Risk Management Activities
The Company uses derivative financial instruments (“derivatives”) primarily to assist customers with their risk management objectives. The Company classifies these items as free standing derivatives consisting of customer accommodation interest rate loan swaps (“interest rate loan swaps”). The Company enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Company simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Company receives a floating rate. These back-to-back interest rate loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the consolidated financial statements. Changes in fair value are recorded in other noninterest expense and net to zero because of the identical amounts and terms of the interest rate loan swaps.
The following tables summarize key elements of the Company’s derivative instruments as of September 30, 2023 and December 31, 2022.
Customer-related interest rate contracts
Dollars in thousands)
Notional Amount
Number of Positions
Collateral Pledges
Matched interest rate swap with borrower
Matched interest rate swap with counterparty
The Company is able to recognize fee income upon execution of the interest rate swap contract. The Company did not record any interest rate swap fee income for the three and nine months ended September 30, 2023. $518,000 and $619,000 was recorded for the three and nine months ended September 30, 2022.
Note 6. Fair Value Presentation
In accordance with FASB ASC 820, “Fair Value Measurements and Disclosure”, the Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is the most representative of fair value under current market conditions.
In accordance with the guidance, a hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The three levels of the fair value hierarchy under FASB ASC 820 based on these two types of inputs are as follows:
Level 1 –Valuation is based on quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 –Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
The following describes the valuation techniques used by the Bank to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
Securities available for sale
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. As of September 30, 2023, and December 31, 2022, the Bank’s entire portfolio of available for sale securities are considered to be Level 2 securities, with the exception of one subordinated debt security which is considered a Level 3.
Derivative asset (liability) – interest rate swaps on loans
As discussed in “Note 5: “Derivative Financial Instruments”, the Bank recognizes interest rate swaps at fair value on a recurring basis. The Bank has contracted with a third party vendor to provide valuations for these interest rate swaps using standard valuation techniques and therefore classifies such interest rate swaps as Level 2.
The following tables provide the fair value for assets required to be measured and reported at fair value on a recurring basis as of September 30, 2023 and December 31, 2022:
Level 1
Level 2
Level 3
Assets:
Investment securities available-for-sale:
U.S. Government Agencies
Derivative asset – interest rate swap on loans
Liabilities:
Derivative liability – interest rate swap on loans
During the nine months ended September 30, 2023, there were no changes to the fair value of level three instruments.
Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The Company did not have any assets that were measured at fair value on a nonrecurring basis as of September 30, 2023 and December 31, 2022.
Fair Value of Financial Instruments
FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. In accordance with ASU 2016-01, the Company uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis.
The following tables reflect the carrying amounts and estimated fair values of the Company’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.
Carrying
Estimated
Quoted Prices in Active Markets for Identical Assets
Significant Other Observable Inputs
Significant Unobservable Inputs
Amount
Securities:
Available for sale
Held to maturity
Restricted securities
Loans, net
Accrued interest receivable
Deposits
Derivative liability – interest rate swaps on loans
Accrued interest payable
Advances from the FHLB
The above information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. Assumptions utilized in the aggregation of fair value of our loan portfolio include prepayment rates, probability of default and loss given default, and discount rates on cash flows. Our third party valuation utilizes average data by homogenous loan segments nationwide and may not properly reflect the characteristics of our specific portfolio. There were no changes in methodologies or transfers between levels at September 30, 2023 and December 31, 2022.
Note 7. Earnings Per Common Share
Basic earnings per common share excludes dilution and is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock which then shared in the earnings of the Company. There were no such potentially dilutive securities outstanding in 2023 or 2022.
The weighted average number of shares used in the calculation of basic and diluted earnings per common share includes unvested restricted shares of the Company’s common stock outstanding. Applicable guidance requires that outstanding un-vested share-based payment awards that contain voting rights and rights to non-forfeitable dividends participate in undistributed earnings with common shareholders.
(Dollars in thousands, except for share and per share data)
Preferred stock dividends
Net income available to common shareholders
Weighted average number of common shares issued, basic and diluted
Earnings per common share:
Basic and diluted earnings per common share
Note 8. Accumulated Other Comprehensive Loss
The following table presents the cumulative balances of the components of accumulated other comprehensive loss, net of deferred taxes, as of September 30, 2023 and December 31, 2022:
Unrealized loss on investment securities available-for-sale
Unrealized loss on securities transferred to HTM
Tax benefit
Total accumulated other comprehensive loss
Note 9. Leases
Right-of-use assets and lease liabilities are included in other assets and other liabilities, respectively, in the Consolidated Statements of Financial Condition. Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. The incremental borrowing rate was equal to the rate of borrowing from the FHLB that aligned with the term of the lease contract. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs, and any incentives received from the lessor.
Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.
Cash paid for amounts included in the measurement of lease liabilities during the nine months ended September 30, 2023 was $336,000. During the nine months ended September 30, 2023 and 2022, the Company recognized lease expense of $363,000 and $363,000, respectively.
As of September 30,
As of December 31,
Lease liabilities
Right-of-use assets
Weighted-average remaining lease term – operating leases (in months).
Weighted-average discount rate – operating leases
Lease Cost
Operating lease cost
Total lease costs
Cash paid for amounts included in measurement of lease liabilities
The Company is the lessor for three operating leases. One lease is extended on a month-to-month basis while two of these leases have arrangements for over twelve months with an option to extend the lease terms. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations. Total rent income on these operating leases is approximately $6,000 per month.
As of September 30, 2023, all of the Company’s lease obligations are classified as operating leases. The Company does not have any finance lease obligations.
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities as of September 30, 2023 is as follows:
2024
2025
2026
2027
Thereafter
Total undiscounted cash flows
Discount
The following discussion and analysis is intended as a review of significant factors affecting the Company’s consolidated financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the related notes and the Company’s Annual Report on Form 10-K, which contains audited consolidated financial statements of the Company as of and for the year ended December 31, 2022, previously filed with the SEC on March 23, 2023. Results for the three and nine months ended September 30, 2023 are not necessarily indicative of results for the year ending December 31, 2023 or any future period.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements and information relating to the Company within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on the beliefs of management as well as assumptions made by and information currently available to management. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe,” “expect,” “anticipate,” “estimate,” and “intend” or future or conditional verbs such as “will,” “should,” “could,” or “may” and similar expressions or the negative thereof. Important factors that could cause actual results to differ materially from those in the forward–looking statements included herein include, but are not limited to:
●
general economic conditions, either nationally or in our market area, that are worse than expected;
competition among depository and other financial institutions, particularly intensified competition for deposits;
inflation and an interest rate environment that may reduce our margins or reduce the fair value of certain of our financial instruments;
adverse changes in the securities markets;
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory structure and in regulatory fees and capital requirements;
the impact of significant changes in accounting procedures or requirements on our financial condition or results of operations;
our ability to enter new markets successfully and capitalize on growth opportunities;
our ability to successfully integrate acquired and newly organized entities;
changes in consumer spending, borrowing and savings habits;
changes in accounting policies and practices;
changes in our organization, compensation and benefit plans;
our ability to attract and retain key employees;
changes in our financial condition or results of operations that reduce capital;
changes in the financial condition or future prospects of issuers of securities that we own;
the concentration of our business in the Northern Virginia as well as the greater Washington, DC metropolitan area and the effect of changes in the economic, political and environmental conditions on those markets;
adequacy of or increases in the allowance for credit losses;
cyber threats, attacks or other data security events;
fraud or misconduct by internal or external parties;
reliance on third parties for key services;
deterioration of our asset quality, including an increase in loan delinquencies, problem assets and foreclosures;
future performance of our loan portfolio with respect to recently originated loans;
additional risks related to new lines of business, products, product enhancements or services;
results of examination of us by our regulators, including the possibility that our regulators may require us to increase our allowance for credit losses or to write-down assets or take other supervisory action;
the effectiveness of our internal controls over financial reporting and our ability to remediate any future material weakness in our internal controls over financial reporting;
liquidity, interest rate and operational risks associated with our business;
implications of our status as a smaller reporting company and as an emerging growth company;
a work stoppage, forced quarantine, or other interruption or the unavailability of key employees; and
other risk factors and information included in our Annual Report on Form 10-K for the year ended December 31, 2022 and this Quarterly Report on Form 10-Q.
Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein. We caution readers not to place undue reliance on forward-looking statements. The Company disclaims any obligation to revise or update any forward-looking statements contained in this Form 10-Q to reflect future events or developments.
Overview
As used herein, the “Company,” “we,” “our,” and “us” refer to MainStreet Bancshares, Inc. and its subsidiaries, and the “Bank” refers to MainStreet Bank.
MainStreet Bancshares, Inc. is a bank holding company that owns 100% of MainStreet Bank and MainStreet Community Capital, LLC.
The Company and its subsidiaries are incorporated in and chartered by the Commonwealth of Virginia. The Company’s executive offices are located at 10089 Fairfax Boulevard, Fairfax, Virginia. Our telephone number is (703) 481-4567, and our internet address is www.mstreetbank.com. The information contained on our website shall not be considered part of this Quarterly Report on Form 10-Q, and the reference to our website does not constitute incorporation by reference of the information contained on the website.
MainStreet Bank
MainStreet Bank is a community commercial bank incorporated in and chartered by the Commonwealth of Virginia. The Bank is a member of the Federal Reserve Bank of Richmond, and its deposits are insured by the FDIC. The Bank opened for business on May 26, 2004, and is headquartered in Fairfax, Virginia. We currently operate six Bank branches; located in Herndon, Fairfax, McLean, Clarendon, Leesburg in Virginia, and one in Washington D.C.
We emphasize providing responsive and personalized services to our clients. Due to the consolidation of financial institutions in our primary market area, we believe there is a significant opportunity for a local bank to provide a full range of financial services. By offering highly professional, personalized banking products and service delivery methods and employing advanced banking technologies, we seek to distinguish ourselves from larger, regional banks operating in our market area and believe we are able to compete effectively with other community banks.
We believe we have a solid franchise that meets the financial needs of our clients and communities by providing an array of personalized products and services delivered by seasoned banking professionals with decisions made at the local level. We believe a significant customer base in our market prefers to do business with a local institution that has a local management team, a local Board of Directors and local founders and that this customer base may not be satisfied with the responsiveness of larger regional banks. By providing quality services, coupled with the opportunities provided by the economies in our market area, we have generated and expect to continue to generate organic growth.
We service Northern Virginia as well as the greater Washington, D.C. metropolitan area. Our goal is to deliver a customized and targeted mix of products and services that meets or exceeds customer expectations. To accomplish this goal, we have deployed a premium operating system that gives customers access to up-to-date banking technology. These systems and our highly skilled staff have allowed us to compete with larger financial institutions. The combination of sophisticated technology and personal service sets us apart from our competition. We strive to be the leading community bank in our market.
We offer a full range of banking services to individuals, small to medium-sized businesses and professionals through both traditional and electronic delivery. We were the first community bank in the Washington, D.C. metropolitan area to offer a full online business banking solution, including remote check scanners on a business customer’s desktop. We offer mobile banking apps for iPhones, iPads and Android devices that provide for remote deposit of checks. In addition, we were the first bank headquartered in the Commonwealth of Virginia to offer CDARS, the Certificate of Deposit Account Registry Service, an innovative deposit insurance solution that provides FDIC insurance on deposits up to $150 million. We believe that enhanced electronic delivery systems and technology increase profitability through greater productivity and cost control and allow us to offer new and better products and services.
Our products and services include: business and consumer checking, premium interest-bearing checking, business account analysis, savings, certificates of deposit and other depository services, as well as a broad array of commercial, real estate and consumer loans. Internet account access is available for all personal and business accounts, internet bill payment services are available on most accounts, and a robust online cash management system is available for business customers.
Avenu
On October 25, 2021, MainStreet Bancshares, Inc. formally introduced Avenu, a division of MainStreet Bank. Avenu represents the Company’s suite of Banking as a Service (“BaaS”) solutions designed to meet the banking needs of Fintech customers. We believe our approach to providing a proprietary BaaS solution is unique. Our transformational subledger combined with our high-touch compliance training goes beyond the industry standards to ensure that our Fintech partners will prosper. This division of MainStreet Bank currently serves money service businesses, payment processers, and BaaS customers and provides the Bank with valuable low-cost deposits and additional streams of fee income. A major component of the BaaS solution includes a fintech core, which is Software as a Service (SaaS). Our SaaS solution has launched with our first beta client.
MainStreet Community Capital, LLC
In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company, to apply for NMTC allocations from the U.S. Department of Treasury’s Community Development Financial Institutions Fund. To promote development in economically distressed areas, the NMTC program was established under the Community Renewal Tax Relief Act of 2000 to provide tax incentives for capital investment in disadvantaged market areas that have not experienced economic expansion. The program establishes a tax credit for investment in a CDE and ongoing compliance with the program is accomplished through a governing board and an advisory board which maintains accountability to residents and businesses in the aforementioned disadvantaged areas. This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”).
Effects of Inflation
The United States is experiencing elevated inflation. In response, the Federal Open Markets Committee (FOMC) raised the Federal Funds rate 425 basis points throughout 2022 and an additional 100 basis points during the first nine months of 2023. In addition to raising the Federal Funds rate, the Federal Reserve may take other means necessary to fulfill its dual mandate.
The effects of rising inflation and the actions of the Federal Reserve, as well as the economy at large may impact the Bank’s customers, including their willingness and ability to repay their obligations, to invest, to save or to spend. This impact could affect the Bank’s customer's general appetite for banking products and the credit health of the Bank’s customer base. The timing and impact of inflation and rising interest rates on our business and related financial results will depend on future developments, which are highly uncertain and difficult to predict.
Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. Critical accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the current period or in future periods.
Following the announcement by the U.K.’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for the London InterBank Offered Rate (LIBOR) after 2021, the Company has opted to use the published Secured Overnight Funding Rate (SOFR) as a substitute and replacement for any financial instruments that are or would otherwise be tied to the LIBOR index. The Bank has officially transitioned all instruments away from LIBOR.
Our critical accounting policies involving significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2023, have remained unchanged since our Annual Report on Form 10-K for the year ended December 31, 2022 was filed, unless noted herein. As of January 1, 2023, we have adopted the current expected credit loss standard. Any additional changes are discussed in our Recently Issued Accounting Pronouncements.
Comparison of Statements of Income for the Three Months Ended September 30, 2023 and 2022
General
Total revenue increased $9.4 million to $32.7 million for the three months ended September 30, 2023 from $23.3 million for the three months ended September 30, 2022. These increases in total revenue were offset by increases in total expenses. Total expenses increased $10.8 million to $24.5 million for the three months ended September 30, 2023 from $13.7 million for the three months ended September 30, 2022. The increase in revenue for the three months ended September 30, 2023 was primarily due to increases in loan interest income of $9.5 million over the same period in 2022. Income was positively impacted by interest earned on federal funds sold, which earned $204,000 in additional interest for the three months ended September 30, 2023 than the same period in 2022. These increases in income were offset by increases in interest expense of $9.3 million and $1.1 million in salaries and employee benefits for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Net income decreased $1.4 million to $6.3 million for the three months ended September 30, 2023 from $7.7 million for the three months ended September 30, 2022.
Total interest income increased $9.8 million, or 44.6%, to $31.7 million for the three months ended September 30, 2023 from $21.9 million for the three months ended September 30, 2022, on a tax equivalent basis. The increase was primarily the result of an increase in interest and fees on loans of $9.5 million and an increase in interest on federal funds sold of $204,000. Total average interest-earning assets increased $124.6 million, to $1.87 billion for the three months ended September 30, 2023 from $1.74 billion for the same period in 2022 primarily because of an increase of $218.8 million in the average balance of loans and was offset by a decrease of $87.5 million in the average balance of federal funds sold and a $6.7 million decrease in the average balance of investment securities. The average yield on our interest-earning assets increased 175 basis points to 6.76% for the three months ended September 30, 2023 as compared to 5.01% for the three months ended September 30, 2022 primarily because of higher average yields on interest earning assets due to market conditions, and the Federal Reserve increasing the benchmark interest rates by 525 basis points over the course of the previous eighteen months.
Interest and fees on loans increased $9.5 million, to $29.8 million for the three months ended September 30, 2023 from $20.3 million for the same period in 2022. This increase was primarily due to an increase in the average yield on loans and the average loans outstanding increasing $218.8 million, which increased to $1.67 billion for the three months ended September 30, 2023 from $1.45 billion for the three months ended September 30, 2022. The average yield on loans increased 153 basis points, or 27.5%, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. The Federal Reserve increased the federal funds target interest rate by 25 basis points during the quarter so we expect our asset sensitive balance sheet to continue to benefit from the current rate environment.
Interest income on federal funds sold and interest-earning deposits increased by $0.2 million to $1.2 million for the three months ended September 30, 2023, from $1.0 million for the three months ended September 30, 2022. The increase was primarily due to an increase in the average yield on these deposits despite the average balances decreasing over the same time period. The average balance of interest-earning deposits and federal funds sold decreased $87.5 million to $94.8 million for the three months ended September 30, 2023 from $182.3 million for the same period in 2022. The average yield increased to 5.09% for the three months ended September 30, 2023 from 2.20% for the same period in 2022.
Interest on investment securities increased by $90,000 to $798,000 for the three months ended September 30, 2023 from $708,000 for the three months ended September 30, 2022 on a fully tax-equivalent basis. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals increased in total $60,000, or 19.0%, to $377,000 for the three months ended September 30, 2023, from $317,000 for the three months ended September 30, 2022. Interest on mortgage-backed securities decreased by $5,000, or 4.5%, to $108,000 for the three months ended September 30, 2023, from $114,000 for the three months ended September 30, 2022. Subordinated debt interest income increased by $3,000, or 2.0%, to $135,000 for the three months ended September 30, 2023, from $132,000 for the three months ended September 30, 2022. The average yield on taxable securities increased 67 basis points, to 2.70% and the average yield on tax-exempt securities increased 12 basis points, to 3.56% on a tax equivalent basis for the three months ended September 30, 2023, from 2.03% and 3.44%, respectively, for the same period in 2022. Increased market rates resulted in investment income rising despite the average balance of investment securities decreasing by $6.7 million, to $105.3 million for the three months ended September 30, 2023, from $112.0 million for the three months ended September 30, 2022.
Total interest expense increased $9.3 million, to $13.1 million for the three months ended September 30, 2023 from $3.8 million for the three months ended September 30, 2022, primarily due to a $5.3 million increase in interest expense on time deposits and a $3.7 million increase in interest expense on money market deposits. There were additional increases in interest expense primarily due to the increase in average outstanding balances of advances on FHLB borrowings that were included in the three months ended September 30, 2023 over the three months ended September 30, 2022
Interest expense on deposits increased $9.1 million to $12.1 million for the three months ended September 30, 2023 from $3.0 million for the three months ended September 30, 2022 primarily as a result of an increase in average interest-bearing deposit yields and balances. The increase in average deposit balances was $258.2 million to $1.24 billion during the three months ended September 30, 2023 as compared to $981.6 million for the three months ended September 30, 2022. The increase in the average balance of interest-bearing deposits was primarily a result of a $156.6 million increase in the average balance of money market deposit accounts and by a $124.6 million increase in the average balance of time deposits. The average cost of deposits was 386 basis points for the three months ended September 30, 2023, compared to 121 basis points for the three months ended September 30, 2022. The average rate paid on money market deposits increased 322 basis points to 3.99% for the three months ended September 30, 2023 from 0.77% for the three months ended September 30, 2022. The average rate paid on interest-bearing demand deposits increased 50 basis points to 1.24% for the three months ended September 30, 2023 from 0.74% for the three months ended September 30, 2022 primarily due to market competition and the interest rate environment. The average cost of certificates of deposit increased by 269 basis points to 4.26% for the three months ended September 30, 2023 as compared to 1.57% for the three months ended September 30, 2022. The decrease in the average balance of non interest-bearing demand deposits for the three months ended September 30, 2023, primarily was the result of depositors looking for higher yielding products and market competition.
Net interest income increased approximately $0.5 million, or 2.7%, to $18.6 million for the three months ended September 30, 2023 from $18.1 million for the three months ended September 30, 2022 despite our net interest-earning assets decreasing $149.9 million to $537.4 million for the three months ended September 30, 2023 from $687.3 million for the three months ended September 30, 2022. The interest rate spread tightened by 73 basis points to 2.84% for the three months ended September 30, 2023 from 3.57% for the three months ended September 30, 2022, on a tax equivalent basis. The net interest margin compressed by 17 basis points from 4.14% for the three months ended September 30, 2022 to 3.97% for the three months ended September 30, 2023 on a tax equivalent basis. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net interest margin.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are based on daily balances.
Average Balance
Interest Income/ Expense(6)
Interest-earning assets:
Loans(1)
Investment securities:
Federal funds and interest-bearing deposits
Total interest-earning assets
Non-interest-earning assets
Total assets
Interest-bearing liabilities:
Interest-bearing demand deposits
Total interest-bearing deposits
Federal funds purchased
Subordinated debt
Total interest-bearing liabilities
Non-interest-bearing liabilities:
Demand deposits and other liabilities
Total liabilities
Stockholders’ equity
Total liabilities and stockholders’ equity
Net interest income
Interest rate spread(2)
Net interest-earning assets(3)
Net interest margin(4)
Average interest-earning assets to average interest-bearing liabilities
(1)
Includes loans classified as non-accrual
(2)
Interest rate spread represents the difference between the average yield on average interest–earning assets and the average cost of average interest-bearing liabilities.
(3)
Net interest earning assets represent total average interest–earning assets less average interest–bearing liabilities.
(4)
Net interest margin represents net interest income divided by total average interest-earning assets.
(6)
Income and yields for all periods presented are reported on a tax-equivalent basis using the federal statutory tax rate of 21%. Refer to “Use of Certain Non-GAAP Financial Measures.”
Rate/ Volume Analysis
The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior average volume). The volume column shows the effects attributable to changes in volume (changes in average volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, . The Total Increase (Decrease) column represents the sum of the prior columns.
For the Three Months Ended
September 30, 2023 and 2022
Increase (Decrease) Due to
Total Increase
Volume
Rate
(Decrease)
Loans
Savings and NOW accounts
Money market deposit accounts
Fed funds purchased
Change in net interest income
Provision for Credit Losses
Management believes that the provision recorded for the period ended September 30, 2023 reflects a balance sufficient to provide for each allowance segment, using objective data and information available to us at this time in evaluating our standard analysis of local/national economic data, changes in underwriting quality, portfolio concentrations, experience of lending team, credit quality and supportable forecasts. We will continuously review the credit portfolio to determine the depth and breadth of potential credit losses. As we obtain additional information and to more accurately assess the full nature and extent of elevated risk to the credit portfolio that may arise, additional provision expenses may be required.
The provision for credit losses, which is an operating expense, is maintained to ensure that the allowance for credit losses is maintained at levels we consider necessary and appropriate to absorb expected credit losses at a balance sheet date. In determining the level of the allowance for credit losses on loans and off-balance sheet credit exposure, we consider past and current loss experience, evaluations of real estate collateral, current and future economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available over time or economic conditions change. This evaluation is inherently subjective, as it requires estimates and assumptions that are susceptible to significant revision as circumstances change or as more information becomes available. The allowance for credit losses is assessed monthly and provisions are made for credit losses as required in order to maintain the overall allowance.
The provision for credit losses on loans decreased by $98,000 to a recovery for credit losses on loans of $98,000 for the three months ended September 30, 2023 from a provision for credit losses on loans of $0 for the three months ended September 30, 2022. Loan originations, which totaled approximately $83.2 million for the three months ended September 30, 2022 increased $8.8 million to $92.0 million for the three months ended September 30, 2023. Despite loan originations increasing, the Company noted that many lines of credit were paid down during the quarter, which lowered the provision for loan losses for the period ended 2023 compared to 2022. The Company noted that a majority of this provision just shifted and increased the provision for unfunded commitments as of September 30, 2023. The Company did not have any non-performing loans at September 30, 2022 and non-performing loans to gross loans was only 0.02% as of September 30, 2023.
The provision for credit losses on off-balance sheet credit exposure increased by $353,000 for the three months ended September 30, 2023.
During the three months ended September 30, 2023, there was one loan downgraded to special mention for $16.0 million. Substandard and doubtful loans remained consistant as of September 30, 2023 for a collective balance of $10.7 million. Of the substandard loans as of September 30, 2023, 79% are connected to the hospitality industry. These loans were initially impacted by the pandemic and were downgraded out of an abundance of caution while cash flows and occupancy levels have continued to increase to pre-pandemic levels. Management does not believe there will be losses associated with these credits. During the three months ended September 30, 2023, watch list loans, which are considered pass credits, improved by $35.6 million to $56.3 million as of September 30, 2023. As interest rates have risen significantly over the last eighteen months, management believes in taking a proactive approach to risk management in the loan portfolio. While these credits do not represent expected losses, management will take a more active monitoring role to ensure any potential risk is mitigated. During the three months ended September 30, 2023, there was $324,000 in charge-offs incurred for one credit, and recoveries of $1,000 were received.
Non-interest income decreased $385,000, or 28.6%, to $963,000 for the three months ended September 30, 2023 from $1.3 million for the three months ended September 30, 2022. The decrease in non-interest income was primarily due to decreases in fee income earned on originating loan swaps in the three months ended September 30, 2023 compared to the same period in 2022. The Company also recognized a nonrecurring operating loss on a new market tax credit equity investment during the quarter of $87,000. The Company continues to focus on increasing fee income as it strategically benefits our customers.
Non-interest expense increased $1.5 million, or 15.5%, to $11.4 million for the three months ended September 30, 2023 from $9.9 million for the three months ended September 30, 2022 primarily because of increases in salary and employee benefits of $1.1 million and other various operating expenses of $1.3 million. Salaries and employee benefits expense increased by $1.1 to $6.9 million for the three months ended September 30, 2023 from $5.9 million for the three months ended September 30, 2022 primarily as a result of twenty-eight new employees and the related salary and benefit expenses for these additional employees. Franchise taxes increased approximately $93,000 to $459,000 for the three months ended September 30, 2023 from $366,000 for the three months ended September 30, 2022 because of the make up of the Company’s capital as of September 30, 2023 compared to the balance sheet as of September 30, 2022. Offsetting these increases was a decrease in advertising and marketing expenses decreased $127,000, or 18.0%, to $577,000 for the three months ended September 30, 2023 from $704,000 for the three months ended September 30, 2022 due to timing and new initiatives to further enhance the Company's brand.
Income tax expense decreased $292,000, or 16.2%, to a tax expense of $1.5 million for the three months ended September 30, 2023 from a tax expense of $1.8 million for the three months ended September 30, 2022. The decrease in federal income tax expense for the three months ended September 30, 2023 compared to the same period a year ago was driven by the decrease in income before income taxes of $1.7 million, to income before income tax of $7.9 million for the three months ended September 30, 2023 compared to income before income tax expense of $9.6 million for the same period in the prior year. The Company was able to apply and claim a research and development tax credit of approximately $242,000 for its associated work in developing a software platform in 2022. The Company also invests in projects that have tax credit benefits in order to help reduce it's overall tax liability. As a result of expanding its footprint, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $212,000 for the three months ended September 30, 2023. For the three months ended September 30, 2023, the Company had an effective income tax expense rate of 19.3%, compared to an effective income tax expense rate of 18.9% for the three months ended September 30, 2022.
Comparison of Statements of Income for the Nine Months Ended September 30, 2023 and 2022
Total revenue increased $32.0 million to $93.8 million for the nine months ended September 30, 2023 from $61.8 million for the nine months ended September 30, 2022. These increases in total revenue were offset by increases in total expenses. Total expenses increased $29.1 million to $66.1 million for the nine months ended September 30, 2023 from $37.0 million for the nine months ended September 30, 2022. The increase in revenue for the nine months ended September 30, 2023 was primarily due to increases in net interest income of $9.5 million over the same period in 2022. Income was positively impacted by interest earned on federal funds sold, which earned $2.3 million in additional interest for the nine months ended September 30, 2023 than the same period in 2022. These increases in income were offset by increases of $4.1 million in salaries and employee benefits for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Net income increased $2.3 million to $21.4 million for the nine months ended September 30, 2023 from $19.1 million for the nine months ended September 30, 2022.
Total interest income increased $33.0 million, or 56.8%, to $91.0 million for the nine months ended September 30, 2023 from $58.1 million for the nine months ended September 30, 2022 ,on a tax equivalent basis. The increase was primarily the result of an increase in interest and fees on loans of $30.4 million and an increase in interest on federal funds sold of $2.3 million. Total average interest-earning assets increased $192.6 million, to $1.85 billion for the nine months ended September 30, 2023 from $1.65 billion for the same period in 2022 primarily because of an increase of $220.4 million in the average balance of loans and was offset by a decrease of $22.8 million in the average balance of federal funds sold and interest-earning deposits and a $5.1 million decrease in the average balance of investment securities. The average yield on our interest-earning assets increased 190 basis points to 6.61% for the nine months ended September 30, 2023 as compared to 4.71% for the nine months ended September 30, 2022 primarily because of higher average yields on interest earning assets due to market conditions, loans related to PPP lending with a rate of 1% paying off, and the Federal Reserve increasing the benchmark interest rates by 525 basis points over the course of the previous eighteen months.
Interest and fees on loans increased $30.4 million, to $85.3 million for the nine months ended September 30, 2023 from $54.9 million for the same period in 2022. This increase was primarily due to an increase in the average yield on loans and the average loans outstanding increasing $220.4 million, which increased to $1.64 billion for the nine months ended September 30, 2023 from $1.42 billion for the nine months ended September 30, 2022. The average yield on loans increased 178 basis points, or 34.4%, for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022. The Federal Reserve increased the federal funds target interest rate by 100 basis points throughout the first nine months of 2023 and we expect our asset sensitive balance sheet to continue to benefit from the current rate environment.
Interest income on federal funds sold and interest-earning deposits increased by $2.3 million to $3.5 million for the nine months ended September 30, 2023, from $1.2 million for the nine months ended September 30, 2022. The increase was primarily due to an increase in the average yield on these deposits despite the average balances decreasing over the same time period. The average balance of interest-earning deposits and federal funds sold decreased $22.8 million to $99.0 million for the nine months ended September 30, 2023 from $121.8 million for the same period in 2022. The average yield increased to 4.76% for the nine months ended September 30, 2023 from 1.36% for the same period in 2022.
Interest on investment securities increased by $249,000 to $2.4 million for the nine months ended September 30, 2023 from $2.1 million for the nine months ended September 30, 2022 on a fully tax-equivalent basis. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals increased in total $161,000, or 16.6%, to $1.1 million for the nine months ended September 30, 2023, from $969,000 for the nine months ended September 30, 2022. Interest on mortgage-backed securities decreased by $13,000, or 4.0%, to $308,000 for the nine months ended September 30, 2023, from $321,000 for the nine months ended September 30, 2022. Subordinated debt interest income increased by $7,000, or 1.8%, to $395,000 for the nine months ended September 30, 2023, from $388,000 for the nine months ended September 30, 2022. The average yield on taxable securities increased 60 basis points, to 2.67% and the average yield on tax-exempt securities increased 8 basis points, to 3.56% on a tax equivalent basis for the nine months ended September 30, 2023, from 2.07% and 3.48%, respectively, for the same period in 2022. Increased market rates resulted in investment income rising despite the average balance of investment securities decreasing by $5.1 million, to $107.1 million for the nine months ended September 30, 2023, from $112.2 million for the nine months ended September 30, 2022.
Total interest expense increased $23.4 million, to $32.1 million for the nine months ended September 30, 2023 from $8.7 million for the nine months ended September 30, 2022, primarily due to a $13.5 million increase in interest expense on time deposits and a $7.5 million increase in interest expense on money market deposits. There were additional increases in interest expense primarily due to the increase in average outstanding balance of our FHLB advances that were included in the nine months ended September 30, 2023 over the nine months ended September 30, 2022.
Interest expense on deposits increased $21.8 million to $28.3 million for the nine months ended September 30, 2023 from $6.5 million for the nine months ended September 30, 2022 primarily as a result of an increase in average interest-bearing deposit yields and balances. The increase in average interest-bearing deposit balances was $238.0 million to $1.16 billion during the nine months ended September 30, 2023 as compared to $917.8 million for the nine months ended September 30, 2022. The increase in the average balance of interest-bearing deposits was primarily a result of a $75.0 million increase in the average balance of money market deposit accounts and by a $188.1 million increase in the average balance of time deposits. The average cost of deposits was 327 basis points for the nine months ended September 30, 2023, compared to 94 basis points for the nine months ended September 30, 2022. The average rate paid on money market deposits increased 298 basis points to 3.38% for the nine months ended September 30, 2023 from 0.40% for the nine months ended September 30, 2022. The average rate paid on interest-bearing demand deposits increased 90 basis points to 1.43% for the nine months ended September 30, 2023 from 0.53% for the nine months ended September 30, 2022 primarily due to market competition and the interest rate environment. The average cost of time deposits increased by 221 basis points to 3.58% for the nine months ended September 30, 2023 as compared to 1.37% for the nine months ended September 30, 2022. The decrease in the average balance of interest-bearing demand deposits for the nine months ended September 30, 2023, primarily was the result of depositors looking for higher yielding products and market competition.
The average balance of subordinated debt increased $9.6 million for the nine months ended September 30, 2023, due to an additional $43.9 million issued in late March of 2022 and was fully captured in the nine months ended September 30, 2023.
Net interest income increased approximately $9.5 million, or 19.8%, to $58.9 million for the nine months ended September 30, 2023 from $49.4 million for the nine months ended September 30, 2022 despite our net interest-earning assets decreasing $68.5 million to $581.0 million for the nine months ended September 30, 2023 from $649.4 million for the nine months ended September 30, 2022. The interest rate spread decreased by 34 basis points to 3.22% for the nine months ended September 30, 2023 from 3.56% for the nine months ended September 30, 2022, on a tax equivalent basis. The net interest margin increased by 27 basis points from 4.01% for the nine months ended September 30, 2022 to 4.28% for the nine months ended September 30, 2023 on a tax equivalent basis. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net interest margin.
Interest Income/ Expense (6)
Yield/ Cost(5)(6)
The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior average volume). The volume column shows the effects attributable to changes in volume (changes in average volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately. The Total Increase (Decrease) column represents the sum of the prior columns.
For the Nine Months Ended
(In thousands)
The provision for credit losses on loans decreased by $346,000 to a provision for credit losses on loans of $934,000 for the nine months ended September 30, 2023 from a provision for credit losses on loans of $1.3 million for the nine months ended September 30, 2022. Loan originations, which totaled approximately $227.7 million for the nine months ended September 30, 2022 increased $108.0 million to loan originations of $335.7 million for the nine months ended September 30, 2023. The Company did not have any non-performing loans at September 30, 2022 and non-performing loans to gross loans was only 0.02% as of September 30, 2023.
The provision for credit losses on off-balance sheet credit exposure increased by $242,000 for a provision of credit losses on off-balance sheet credit exposure of $1.6 million for the nine months ended September 30, 2023.
During the nine months ended September 30, 2023, there was one loan downgraded to special mention for $16.0 million. Substandard and doubtful loans increased $1.2 million as of September 30, 2023 for a balance of $10.4 million. Of the substandard loans as of September 30, 2023, 79% are connected to the hospitality industry. These loans were initially impacted by the pandemic and were downgraded out of an abundance of caution while cash flows and occupancy levels have continued to increase to pre-pandemic levels. Management does not believe there will be losses associated with these credits. During the nine months ended September 30, 2023, watch list loans, which are considered pass credits, increased $32.7 million. As the rates have risen significantly over the last eighteen months, management believes in taking a proactive approach to risk management in the loan portfolio. While these credits do not represent expected losses, management will take a more active monitoring role to ensure any potential risk is mitigated. During the nine months ended September 30, 2023, there were $331,000 in charge-offs incurred, and recoveries of $14,000 were received.
Non-interest income decreased $996,000, or 26.4%, to $2.8 million for the nine months ended September 30, 2023 from $3.8 million for the nine months ended September 30, 2022. The decrease in non-interest income was primarily due to decreases in mortgage origination and fee income on loan swaps originated in the nine months ended September 30, 2023 compared to the same period in 2022. The Company also recognized operating losses on a new market tax credit equity investments during the year of $176,000. The Company continues to focus on increasing fee income as it strategically benefits our customers.
Non-interest expense increased $5.6 million, or 19.9%, to $34.0 million for the nine months ended September 30, 2023 from $28.3 million for the nine months ended September 30, 2022 primarily because of increases in salary and employee benefits of $4.1 million and advertising and marketing expenses of $388,000. Salaries and employee benefits expense increased by $4.1 million to $21.1 million for the nine months ended September 30, 2023 from $17.0 million for the nine months ended September 30, 2022 primarily as a result of twenty-eight new employees and the related salary and benefit expenses for these additional employees. Advertising and marketing expenses increased $388,000, or 23.0%, to $2.1 million for the nine months ended September 30, 2023 from $1.7 million for the nine months ended September 30, 2022 due to timing and new initiatives to further enhance the Company's brand. Franchise taxes increased approximately $311,000 to $1.4 million for the nine months ended September 30, 2023 from $1.1 million for the nine months ended September 30, 2022 because of the make up of the Company’s capital as of September 30, 2023 compared to the balance sheet as of September 30, 2022. Offsetting these increases was a decrease in furniture and equipment expenses of $93,000, or 4.4%, to $2.0 million for the nine months ended September 30, 2023 from $2.1 million for the nine months ended September 30, 2022 due to more normalized expense levels for furniture and equipment.
Income tax expense increased $657,000, or 14.7%, to a tax expense of $5.1 million for the nine months ended September 30, 2023 from a tax expense of $4.5 million for the nine months ended September 30, 2022. The increase in federal income tax expense for the nine months ended September 30, 2023 compared to the same period a year ago was driven by the increase in income before income taxes of $3.0 million, to income before income tax of $26.6 million for the nine months ended September 30, 2023 compared to income before income tax expense of $23.6 million for the same period in the prior year. The Company was able to apply and claim a research and development tax credit of approximately $242,000 for its associated work in developing a software platform in 2022. The Company also invests in projects that have tax credit benefits in order to help reduce it's overall tax liability. As a result of expanding its footprint, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $675,000 for the nine months ended September 30, 2023. For the nine months ended September 30, 2023, the Company had an effective income tax expense rate of 19.3%, compared to an effective income tax expense rate of 18.9% for the nine months ended September 30, 2022.
Comparison of Statements of Financial Condition at September 30, 2023 and December 31, 2022
Total assets increased $95.7 million, or 5.0%, to $2.0 billion at September 30, 2023 from $1.93 billion at December 31, 2022. The increase was primarily the result of increases in the loan portfolio of $101.5 million and was offset by a decrease in federal funds sold of $9.4 million as of September 30, 2023.
Investment Securities
Investment securities decreased $9.7 million, or 9.3%, from $104.6 million at December 31, 2022 to $94.9 million at September 30, 2023. The decrease was primarily due to normal paydown of available-for-sale securities, amortization of certain restricted stock securities, and fluctuations in balances of restricted stock held in connection to FHLB advances. At September 30, 2023, our held-to-maturity portion of the securities portfolio, at amortized cost, was $17.6 million, and our available-for-sale portion of the securities portfolio, at fair value, was $56.7 million compared to our held-to-maturity portion of the securities portfolio of $17.6 million and our available-for-sale portion of the securities portfolio of $62.6 million at December 31, 2022.
Net loans increased $101.5 million, or 6.4%, to $1.68 billion at September 30, 2023 from $1.58 billion at December 31, 2022. Residential real estate loans increased $68.5 million, or 17.4%, to $462.9 million at September 30, 2023 from $394.4 million at December 31, 2022. Commercial real estate loans increased by $33.9 million from $700.7 million at December 31, 2022 to $734.6 million at September 30, 2023. Commercial and industrial loans decreased by $23.5 million from $97.4 million at December 31, 2022 to $73.9 million at September 30, 2023. Paycheck Protection Program ("PPP") loans comprised $1.0 million of this portfolio as of September 30, 2023. Construction loans increased $32.9 million to $426.7 million at September 30, 2023 from $393.8 million at December 31, 2022. Consumer loans decreased by $8.7 million from $13.3 million at December 31, 2022 to $4.6 million at September 30, 2023. The $8.7 million decrease in consumer loans is primarily a result of management’s decision to let the indirect lending portfolio amortize off the balance sheet.
Allowance for Credit Losses - Loans
The allowance for credit losses on loans represents an amount that, in our judgment, will be adequate to absorb current and expected losses in the loan portfolio. The provision for credit losses on loans increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The table below summarizes the allowance activity for the periods indicated:
For the Year Ended December 31,
Balance at beginning of year
Charge-offs:
Commercial and industrial
Total charge-offs
Recoveries:
Residential real estate
Total recoveries
Net (charge-offs) recoveries
Provision for credit losses - loans
Balance at end of period
Ratios:
Net (charge-offs) recoveries to average loans outstanding
Non-performing loans to allowance for credit losses on loans at end of period
Allowance for credit losses on loans to gross loans at end of period
Nonperforming Assets
The following table presents information regarding nonperforming assets at the dates indicated:
September 30,
December 31,
Loans accruing past 90 days:
Consumer - secured
Total loans accruing past 90 days
Non-accrual loans
Total non-accrual loans
Total non-performing loans
Other real estate owned
Total non-performing assets
Total non-performing loans to gross loans receivable
Total non-performing loans to total assets
Total non-performing assets to total assets
Deposits increased $170.3 million, or 11.3% to $1.68 billion at September 30, 2023 from $1.51 billion at December 31, 2022. Our core deposits decreased $20.0 million, or 1.7%, to $1.14 billion at September 30, 2023 from $1.16 billion at December 31, 2022. Non-interest bearing demand deposits decreased $155.8 million, or 28.3%, to $394.9 million at September 30, 2023 from $550.7 million at December 31, 2022. Interest bearing demand deposits decreased $3.7 million, or 4.6%, to $76.4 million at September 30, 2023 from $80.1 million at December 31, 2022. Time deposits increased $95.8 million, or 15.8%, to $704.0 million at September 30, 2023 from $608.1 million at December 31, 2022. Money market demand deposits increased $238.9 million, or 107.3%, to $461.4 million at September 30, 2023 from $222.5 million at December 31, 2022. The increase in money market deposit accounts and time deposits were primarily the result of the higher rate environment, deposit competition, and customers looking for additional interest-bearing options.
Liquidity and Capital Resources
Liquidity Management. 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. Deposits are the primary source of funds for lending and investing activities. The Company uses wholesale deposits in addition to customer deposits, as funding sources. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB secured advances, other secured borrowings, federal funds purchased, and other short-term unsecured borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. Additional liquidity can be obtained through the Federal Reserve Bank Term Funding Program and discount window. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process. MainStreet Bank had no federal funds purchased outstanding and an additional secured borrowing capacity of $560.3 million as of September 30, 2023. Additionally, at September 30, 2023, we had the ability to borrow up to $129.0 million from other financial institutions.
The Board of Directors, management, and the Asset Liability Committee (ALCO) are responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as of September 30, 2023.
We monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand; expected deposit flows; yields available on interest-earning deposits and securities; and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short-and intermediate-term securities.
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 most liquid assets are cash and cash equivalents, which include federal funds sold and interest-earning deposits in other banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2023, cash and cash equivalents totaled $121.2 million. The Company has availability on secured and unsecured lines for an additional $689.3 million. Finally, securities classified as available-for-sale, which provide additional sources of liquidity, totaled $56.7 million at September 30, 2023.
Our cash flows are provided by and used in three primary activities: operating activities, investing activities, and financing activities. Net cash provided by operating activities was $26.3 million and $22.9 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. There were no sales of securities in the nine months ended September 30, 2023 or for nine months ended September 30, 2022. Net cash used in investing activities, which consist primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans and proceeds from maturing securities, was $102.1 million and $186.2 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. Net cash provided by financing activities was $66.4 million and $174.9 for the nine months ended September 30, 2023 and 2022, respectively, which consisted primarily of increases in interest bearing deposits of $326.1 million for the nine months ended September 30, 2023, partially offset by repayments of Federal Home Loan Bank advances of $100.0 million and decreased non-interest bearing deposits of $155.8 million.
We are committed to maintaining a strong liquidity position. We monitor our liquidity position daily. We anticipate that we have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of September 30, 2023, totaled $470.8 million of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other deposits, Federal Home Loan Bank advances and commitments from other financial institutions. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on experience that a significant portion of such deposits will remain with us. We can attract and retain deposits by adjusting the interest rates offered.
Effects of Inflation. In an effort to combat inflation, the Federal Reserve, through the FOMC, increased rates a total of 5.25% during 2022 and through September 30, 2023, which has had a negative effect on the price of existing securities. As a result of rising interest rates, the Company recorded an accumulated other comprehensive loss on securities available for sale of approximately $10.8 million as of September 30, 2023, compared to recording accumulated other comprehensive loss in the amount of $8.5 million as of December 31, 2022. This unrealized loss is counter to total equity growth during 2022 and 2023 that had otherwise strong net earnings. Management does not anticipate the unrealized losses to be other than temporary and they do not reflect credit deterioration within the portfolio.
Capital Management. MainStreet Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2023, MainStreet Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory guidelines.
Regulatory Capital
Information presented for September 30, 2023 and December 31, 2022, reflects the Basel III capital requirements that became effective January 1, 2015 for the Bank. Under these capital requirements and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk- weightings and other factors.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Bank must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer for 2023 and 2022 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2023, the Bank meet all capital adequacy requirements to which each is subject.
The Bank’s actual capital amounts and ratios are presented in the table (dollars in thousands):
Actual
Capital Adequacy Purposes
To Be Well Capitalized Under the Prompt Corrective Action Provision
Ratio
Total capital (to risk-weighted assets)
Common equity tier 1 capital (to risk-weighted assets)
Tier 1 capital (to risk-weighted assets)
Tier 1 capital (to average assets)
Off-Balance Sheet Arrangements and Contractual Obligations
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 and unused lines of credit. 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 September 30, 2023, we had outstanding loan commitments of $361.8 million and $586,000 in outstanding stand-by letters of credit. We anticipate that we will have sufficient funds available to meet our current lending commitments.
Use of Certain Non-GAAP Financial Measures
The accounting and reporting policies of the Company conform to U.S. GAAP and prevailing practices in the banking industry. However, certain non-GAAP measures are used by management to supplement the evaluation of the Company’s performance. These measures include adjusted net interest income and net interest margin.
Management believes that the use of these non-GAAP measures provides meaningful information about operating performance by enhancing comparability with other financial periods and other financial institutions. The non-GAAP measures used by management enhance comparability by excluding the effects of items that do not reflect ongoing operating performance, including non-recurring gains or charges. These non-GAAP financial measures should not be considered an alternative to U.S. GAAP-basis financial statements, and other bank holding companies may define or calculate these or similar measures differently. A reconciliation of the non-GAAP financial measures used by the Company to evaluate and measure the Company’s performance to the most directly comparable U.S. GAAP financial measures is presented below.
(Dollars in thousands, except for per share data)
Net interest margin, fully-taxable equivalent (FTE)
Net interest income (GAAP)
FTE adjustment on tax-exempt securities
Net interest income (FTE) (non-GAAP)
Average interest earning assets
Net interest margin (GAAP)
Net interest margin (FTE) (non-GAAP)
Market Risk Management
The effective management of market risk is essential to achieving the Company’s strategic financial objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in the Company’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value.
Interest Rate Market Risk
The Company’s net interest income and the fair value of its financial instruments are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Committee. The Asset/Liability Committee meets regularly and has responsibility for approving asset/liability management policies, formulating strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company.
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 different interest rate assumptions. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturity and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on our net interest income.
The table below reflects the results of our Earnings-at-Risk (EaR) stress simulation. The EaR stress simulation is a financial risk management tool that we use to assess our raw exposure to an immediate and sustained change in interest rates up and down 400 basis points. The results focus specifically on the potential impact of each scenario to our net interest income, and help us understand how various risks, such as market fluctuations, economic downturns, or specific events, could affect our ability to generate profits.
Our simulation model uses actual data as of September 30, 2023, and dynamically incorporates Board-approved budget assumptions in order to forecast the impact of stress factors. It is important to note that no other changes are made. The purpose of this simulation is so that management and the Board can make informed decisions that enhance our resilience and long-term viability. In other words, we examine the results of the stress test first to ensure that they are within Board-approved risk tolerance limits and second to determine whether we should make changes to the structure of our earning assets and interest-bearing liabilities.
Finally, as we consider simulation model outputs, we also consider their impact to other risk factors and ultimately to determine whether our capital provides a sufficient cushion to our risk profile.
Basis Point Change in
Year 1 Change
Interest Rates (1)
Year 1 Forecast (2)
From Level
+400
+300
+200
+100
Level
(1) Interest rate changes are immediate and sustained for the entire 12-month period
(2) Simulation model assumptions are locked for the entire 12-month period.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2023. Based on their evaluation of the Company’s disclosure controls and procedures, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and regulations are designed and operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) occurred during the third fiscal quarter of 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. There has been no significant effect or impact on internal controls over financial reporting as the Company implemented the current expected credit loss accounting standard.
At September 30, 2023, the Company was not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which involve amounts in the aggregate believed by management to be immaterial to the financial condition and operating results of the Company. In addition, no material proceedings are pending or known to be threatened or contemplated against the Company or its subsidiary by governmental authorities.
For detailed information about certain risk factors that could materially affect our business, financial condition, results of operations or prospects, see “Risk Factors” in Part I, Item 1A of our 2022 Annual Report on Form 10-K. Set forth below are additional risk factors.
Defaults by or deteriorating asset quality of other financial institutions could adversely affect us.
Financial institutions are often interrelated as a result of trading, clearing, counterparty, or other relationships. For example, we execute transactions with financial institution counterparties. These transactions may expose us to counterparty credit risk that could ultimately result in a loss on default. Such a loss could have an effect on our financial condition. Further, actions taken by governments and/or regulatory bodies in response to financial crises affecting the banking system and financial markets, such as nationalization, conservatorship, receivership, or other intervention could have an adverse effect.
The results of mainstream media and social media contagion and speculation could impact the banking system and have an adverse effect on us.
The results of poorly executed decisions in a financial institution of significant size can negatively impact other financial institutions, despite the quality of leadership and decision making of the other financial institutions or their ability to effectively identify, measure, manage and control risk.
Misinformed or inaccurate reporting regarding an incident or incidents can impact the broader banking industry. Any adverse financial market or economic condition could be reported in a way to exert downward pressure on the price of financial institution securities and could negatively impact credit availability for certain issuers without regard to their underlying financial strength.
This contagion risk can also occur when a perceived lack of trust in the banking system spreads throughout the industry based upon the results of a few poorly managed larger financial institutions.
The following table summarized the common shares repurchased during the nine months ended September 30, 2023.
(Dollars in thousands, except for per share amounts)
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under the Plans or Programs
July 1, 2023 - July 31, 2023
August 1, 2023 - August 31, 2023
September 1, 2023 - September 30, 2023
31.1
Rule 13a-14(a) Certification of the Chief Executive Officer *
31.2
Rule 13a-14(a) Certification of the Chief Financial Officer *
32.0
Section 1350 Certification *
101.INS
101.SCH
101.CAL
101.DEF
101.LAB
101.PRE
101
The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2023 formatted in Inline XBRL, filed herewith: (i) the Consolidated Balance Sheets (unaudited), (ii) the Consolidated Statements of Income (unaudited), (iii) the Consolidated Statements of Comprehensive Income (unaudited), (iv) the Consolidated Statements of Stockholders’ Equity (unaudited), (v) the Consolidated Statements of Cash Flows (unaudited) and (vi) the Notes to Consolidated Financial Statements (unaudited)
104
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline XBRL (included with Exhibit 101)
* Filed herewith
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MAINSTREET BANCHSHARES, INC
(Registrant)
Date: November 13, 2023
By:
/s/ Jeff W. Dick
Jeff W. Dick
Chairman & Chief Executive Officer
(Principal Executive Officer)
/s/ Thomas J. Chmelik
Thomas J. Chmelik
Senior Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)