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, 2021
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 StockDepositary Shares (each representing a 1/40thinterest in a share of 7.50% Series A Fixed-RateNon-Cumulative Perpetual Preferred 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 2, 2021, there were 7,594,781 outstanding shares, par value $4.00 per share, of the issuer’s common stock.
INDEX
2
PART I – FINANCIAL INFORMATION
3
Item 1 – Consolidated Financial Statements
Notes to Consolidated Financial Statements
10
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
27
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
44
Item 4 – Controls and Procedures
PART II OTHER INFORMATION
45
Item 1 – Legal Proceedings
Item 1A – Risk Factors
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Item 5 – Other Information
Item 6 – Exhibits
46
SIGNATURES
47
Item 1 – Consolidated Financial Statements – Unaudited
MAINSTREET BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition as of September 30, 2021 and December 31, 2020 (Dollars in thousands, except share and per share data)
At September 30,
2021
(unaudited)
At December 31,
2020
(*)
Assets
Cash and due from banks
$
67,992
75,935
Federal funds sold
65,725
31,593
Cash and cash equivalents
133,717
107,528
Investment securities available-for-sale, at fair value
171,603
147,414
Investment securities held-to-maturity, at amortized cost
26,081
22,520
Restricted securities, at cost
5,039
4,616
Loans held for sale
—
57,006
Loans, net of allowance for loan losses of $11,428 and $12,877, respectively
1,246,331
1,230,379
Premises and equipment, net
14,795
14,289
Other real estate owned, net
1,158
1,180
Accrued interest and other receivables
4,718
9,604
Bank owned life insurance
35,987
25,341
Computer software, net of amortization
1,165
Other assets
16,605
23,288
Total Assets
1,657,199
1,643,165
Liabilities and Stockholders’ Equity
Liabilities
Non-interest bearing deposits
475,157
370,497
Interest bearing demand deposits
63,622
70,307
Savings and NOW deposits
79,556
74,099
Money market deposits
310,776
426,600
Time deposits
485,255
496,743
Total deposits
1,414,366
1,438,246
Subordinated debt, net
40,635
14,834
Other liabilities
18,169
22,420
Total Liabilities
1,473,170
1,475,500
Stockholders’ Equity
Preferred stock, $1.00 par value, 2,000,000 shares authorized; 28,750 shares issued and
outstanding as of September 30, 2021 and December 31, 2020
27,263
Common stock, $4.00 par value, 10,000,000 shares authorized; issued and outstanding
7,593,749 shares (including 228,257 nonvested shares) for September 30, 2021 and
7,443,842 shares (including 161,435 nonvested shares) for December 31, 2020
29,462
29,130
Capital surplus
67,152
66,116
Retained earnings
59,920
44,179
Accumulated other comprehensive income
232
977
Total Stockholders’ Equity
184,029
167,665
Total Liabilities and Stockholders’ Equity
*
Derived from audited consolidated financial statements.
See Notes to the Unaudited Consolidated Financial Statements
4
Unaudited Consolidated Statements of Income for the Three and Nine months ended September 30, 2021 and 2020 (Dollars in thousands, except per share data)
For the Three Months
Ended September 30,
For the Nine Months
Interest Income
Interest and fees on loans
15,162
15,083
46,211
43,702
Interest on investments securities
585
491
1,712
1,488
Interest on federal funds sold
38
12
73
416
Total Interest Income
15,785
15,586
47,996
45,606
Interest Expense
Interest on interest bearing DDA deposits
60
56
170
209
Interest on savings and NOW deposits
55
127
169
Interest on money market deposits
148
490
645
1,742
Interest on time deposits
1,795
2,841
6,039
9,740
Interest on Federal Home Loan Bank advances and other borrowings
13
107
Interest on subordinated debt
541
245
1,346
727
Total Interest Expense
2,582
3,700
8,327
12,694
Net Interest Income
13,203
11,886
39,669
32,912
Provision for (Recovery of) Loan Losses
290
635
(1,470
)
6,560
Net Interest Income After (Recovery of) Provision For Loan Losses
12,913
11,251
41,139
26,352
Non-Interest Income
Deposit account service charges
642
487
1,802
1,407
Bank owned life insurance income
252
199
646
595
Loan swap fee income
1,851
2,677
Net gain on held-to-maturity securities
Net gain (loss) on sale of loans
(40
33
434
Other fee income
632
288
1,602
878
Total Non-Interest Income
1,486
2,858
4,487
5,590
Non-Interest Expense
Salaries and employee benefits
4,847
4,495
14,276
13,191
Furniture and equipment expenses
716
574
1,743
1,528
Advertising and marketing
438
266
1,115
713
Occupancy expenses
399
332
1,092
910
Outside services
292
215
908
696
Administrative expenses
202
167
493
508
Other operating expenses
1,567
1,589
4,517
4,595
Total Non-Interest Expense
8,461
7,638
24,144
22,141
Income Before Income Taxes
5,938
6,471
21,482
9,801
Income Tax Expense
1,155
1,299
4,124
1,793
Net Income
4,783
5,172
17,358
8,008
Preferred Stock Dividends
539
1,617
Net Income Available To Common Shareholders
4,244
15,741
Net Income Per Common Share:
Basic
0.56
0.63
2.09
0.97
Diluted
5
Unaudited Consolidated Statements of Comprehensive Income for the Nine Months Ended September 30, 2021 and 2020 (Dollars in thousands)
Comprehensive Income, net of taxes
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on available for sale securities arising during the period (net of tax (benefit) expense, ($90) and ($1), respectively, for the three months ended September 30, and ($213) and $136, respectively for the nine months ended September 30).
(349
(7
(760
514
Add: reclassification adjustment for amortization of unrealized losses on securities transferred from available for sale to held to maturity (net of tax, $1 and $1, respectively, for the three months ended September 30, and $4 and $4, respectively, for the nine months ended September 30).
15
Other comprehensive income (loss)
(344
(2
(745
529
Comprehensive Income
4,439
5,170
16,613
8,537
6
Unaudited Consolidated Statements of Stockholders’ Equity for the Three and Nine months ended September 30, 2021 and 2020 (Dollars in thousands)
Accumulated
Other
Preferred
Common
Capital
Retained
Comprehensive
Stock
Surplus
Earnings
Income
Total
Balance, June 30, 2021
29,446
66,667
55,676
576
179,628
Vesting of restricted stock
16
(16
Stock based compensation expense
501
Dividends on preferred stock
(539
Net income
Other comprehensive loss
Balance, September 30, 2021
Balance, December 31, 2020
(332
1,368
(1,617
Balance, June 30, 2020
32,433
74,850
31,933
954
140,170
Preferred stock issued, net
27,527
(27
394
Balance, September 30, 2020
32,460
75,217
37,105
952
173,261
Balance, December 31, 2019
32,397
75,117
29,097
423
137,034
303
(303
1,153
Common stock repurchased
(240
(750
(990
Other comprehensive income
7
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
1,390
1,284
Deferred income tax expense (benefit)
239
(2,208
Provision for (recovery of) loan losses
Writedown of other real estate owned
22
32
Gain on sale of loans
(434
(33
Income from bank owned life insurance
(646
(595
Subordinated debt amortization expense
164
Gain on disposal of premises and equipment
(30
(36
Gain on call of held-to-maturity securities
(3
Proceeds from sale of loans
31,264
Amortization of operating lease right-of-use assets
357
287
Change in:
Accrued interest receivable and other receivables
4,789
(3,159
6,253
(10,686
(4,251
11,159
Net cash provided by operating activities
56,370
11,788
Cash Flows from Investing Activities
Activity in available-for-sale securities:
Payments
4,980
6,209
Maturities
317,000
160,000
Purchases
(347,449
(191,968
Activity in held-to-maturity securities:
(5,499
(1,005
Called
1,775
1,700
Purchases of restricted investment in bank stock
(1,222
Redemption of restricted investment in bank stock
327
2,763
Net (increase) decrease in loan portfolio
11,694
(256,406
Purchase of bank owned life insurance
(10,000
Computer software developed
(1,165
Proceeds from sale of premises and equipment
51
Purchases of premises and equipment
(1,285
(1,159
Net cash used in investing activities
(30,321
(281,037
Cash Flows from Financing Activities
Net increase in non-interest deposits
104,660
163,941
Net increase (decrease) in interest bearing demand, savings, and time deposits
(128,540
181,481
Net decrease in Federal Home Loan Bank advances and other borrowings
(40,000
Net increase in subordinated debt, net issuance costs
25,637
Issuance of preferred stock, net
Cash dividends paid on preferred stock
Repurchases of common stock
Net cash provided by financing activities
140
331,959
Increase in Cash and Cash Equivalents
26,189
62,710
Cash and Cash Equivalents, beginning of period
64,844
Cash and Cash Equivalents, end of period
127,554
Supplementary Disclosure of Cash Flow Information
Cash paid during the period for interest
7,801
12,803
Cash paid during the period for income taxes
5,291
2,255
Right of use assets obtained in exchange for new operating lease liabilities
1,907
8
Transfers from loans to other real estate owned
405
Loans transferred from held-for-sale to held-for-investment
26,046
9
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 financial 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 declared itself to be a financial holding company in place of a bank holding company. The Company elected this change in order to engage in nonbanking activities that are deemed to be closely related to banking. 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 is 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 Securities and Exchange Commission, or the “SEC.”
We were 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 on the symbol “MNSBP” as of September 16, 2020. Each depositary share represents a 140th 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 individuals, and small and medium-sized business and professional concerns in the Washington, D.C. metropolitan area.
In August 2021, MainStreet Bancshares, Inc. established the subsidiary MainStreet Community Capital, LLC, 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”).
On October 25, 2021, MainStreet Bancshares, Inc. formally introduced AvenuTM, a division of MainStreet Bank. AvenuTM represents the Company’s suite of Banking as a Service (“BaaS”) solutions designed to meet the banking needs of Fintech customers. Our BaaS program is currently in development.
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 footnotes 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, 2020 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, 2021. The results of operations for the three and nine months ended September 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021, 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 loan losses and (2) fair value of 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 losses on loans and valuation of other real estate owned management obtains independent appraisals for significant properties.
Capitalization of software development costs - We capitalize certain costs incurred to develop commercial software products. For software services that are to be sold, significant areas of judgment include: establishing when technological feasibility has been met and costs should be capitalized, determining the appropriate period over which to amortize the capitalized costs based on the estimated useful lives, estimating the marketability of the commercial software products and related future revenues, and assessing the unamortized cost balances for impairment. Costs incurred prior to establishing technological feasibility are expensed as incurred. Amortization begins on the date of general release and the appropriate amortization period is based on estimates of future revenues from sales of the products. We consider various factors to project marketability and future revenues, including an assessment of alternative solutions or products, current and historical demand for a similar product, and anticipated changes in technology that may make the product obsolete.
For internal use software, capitalization begins after the preliminary project stage is complete. Costs incurred prior to this are expensed as incurred. Significant estimates and assumptions include determining the appropriate amortization period based on the estimated useful life and assessing the unamortized cost balances for impairment. Amortization begins on the date the software is placed in service and the amortization period is based on estimated useful life.
A significant change in an estimate or assumptions related to one or more software products could result in a material change to our results of operations.
Impact of Recently Issued Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the SEC and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has formed a Committee to oversee the accounting impact of this ASU. In anticipation of the ASU, the Company is working with a third party to compile data and develop an estimate using historical and qualitative data based on the requirements of ASU 2016-13 and have begun to test parallel models.
11
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
In March 2020, the FASB issued Accounting Standards Update (ASU) No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is monitoring developments into rates that may be acceptable alternatives to LIBOR and working with those we have a relationship with that could be impacted by a change in reference rate from LIBOR. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
In August 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-06 “Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The ASU simplifies accounting for convertible instruments by removing major separation models required under current U.S. GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The ASU also simplifies the diluted earnings per share (EPS) calculation in certain areas. In addition, the amendment updates the disclosure requirements for convertible instruments to increase the information transparency. For public business entities, excluding smaller reporting companies, the amendments in the ASU are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements.
In May 2021, the FASB issued ASU 2021-04, “Earnings Per Share (Topic 260), Debt - Modifications and Extinguishments (Subtopic 470-50), Compensation - Stock Compensation (Topic 718), and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity – Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force).” The ASU addresses how an issuer should account for modifications or an exchange of freestanding written call options classified as equity that is not within the scope of another Topic. The ASU is effective for fiscal years beginning after December 15, 2021. Transition is prospective. Early adoption is permitted. The Company does not expect the adoption of ASU 2021-04 to have a material impact on its consolidated financial statements.
In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021-06 to have a material impact on its consolidated financial statements.
Recently Adopted Accounting Developments
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. ASU 2019-12 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should re-evaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In December 2020, the Consolidated Appropriations Act of 2021 (the “CAA”) was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. There was no material impact on the Company’s consolidated financial statements.
Note 2. Investment Securities
Investment securities available-for-sale was comprised of the following:
September 30, 2021
(Dollars in thousands)
Amortized
Cost
Gross
Unrealized
Gains
Losses
Fair Value
U.S. Treasury Securities
100,000
Collateralized Mortgage Backed
32,234
222
(661
31,795
Subordinated Debt
5,720
39
(17
5,742
Municipal Securities
27,423
1,148
28,268
U.S. Governmental Agencies
5,911
(113
5,798
171,288
1,409
(1,094
Investment securities held-to-maturity was comprised of the following:
18,144
856
19,000
7,937
26,937
December 31, 2020
90,000
24,743
282
(129
24,896
3,250
29
(1
3,278
21,348
1,257
22,605
6,785
(150
6,635
146,126
1,568
(280
20,015
1,058
21,073
2,505
23,578
The scheduled maturities of securities available-for-sale and held-to-maturity at September 30, 2021 were as follows:
Available-for-Sale
Held-to-Maturity
Due in one year or less
100,002
Due from one to five years
1,004
1,013
2,089
1,642
Due from after five to ten years
7,349
7,357
8,521
9,385
Due after ten years
62,933
63,231
15,471
15,910
Securities with a fair value of $677,834 and $269,075 at September 30, 2021 and December 31, 2020, respectively, were pledged to secure FHLB advances.
There were no securities sold from the available-for-sale portfolio for both the nine months ended September 30, 2021 and 2020. During the nine months ended September 30, 2021, one held-to-maturity security was called and resulted in a gain of $3,197.
The following tables summarize the unrealized loss positions of securities available-for-sale and held-to-maturity as of September 30, 2021 and December 31, 2020:
Less than 12 Months
12 Months or Longer
Fair
Value
Loss
Available-for-sale:
11,173
(85
13,221
(576
24,394
2,133
Municipal securities
9,887
U.S Governmental Agencies
23,193
(405
19,019
(689
42,212
14,971
749
U.S Government Agencies
15,720
(130
22,505
The factors considered in evaluating securities for impairment include whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. These unrealized losses are primarily attributable to current financial market conditions for these types of investments, particularly changes in interest rates, causing bond prices to decline, and are not attributable to credit deterioration.
14
At September 30, 2021, there were seven collateralized mortgage backed securities with fair values totaling $11.2 million were in an unrealized loss position of less than 12 months and one security totaling $13.2 million in an unrealized loss position of more than 12 months. At September 30, 2021 five subordinated debt securities with fair values totaling approximately $2.1 million were in an unrealized loss position of less than 12 months. At September 30, 2021 eleven municipal securities with fair values totaling approximately $9.9 million were in an unrealized loss position of less than 12 months. At September 30, 2021 nine U.S. government agencies with fair values totaling approximately $5.7 million were in an unrealized loss position of more than 12 months. At September 30, 2021, there were no held-to-maturity securities in an unrealized loss position. The Bank does not consider any of the securities in the available for sale or held to maturity portfolio to be other-than-temporarily impaired at September 30, 2021 and December 31, 2020.
All 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, 2021 and December 31, 2020 was $35,471 and $54,836, respectively.
Note 3. Loans Receivable
Loans receivable were comprised of the following:
September 30,
December 31,
Residential Real Estate:
Single family
155,377
139,338
Multifamily
66,323
43,332
Farmland
1,329
861
Commercial Real Estate:
Owner-occupied
154,801
141,813
Non-owner occupied
339,965
325,085
Construction and Land Development
327,004
324,906
Commercial – Non Real-Estate:
Commercial & Industrial
191,281
230,027
Consumer – Non Real-Estate:
Unsecured
76
241
Secured
27,664
43,832
Total Gross Loans
1,263,820
1,249,435
Less: unearned fees, net
(6,061
(6,178
Less: unamortized discount on consumer secured loans
Less: allowance for loan losses
(11,428
(12,877
Net Loans
The unsecured consumer loans above include $76,000 and $241,000 of overdrafts reclassified as loans at September 30, 2021 and December 31, 2020, respectively.
The commercial and industrial loans above include $88.5 million and $135.2 million in Paycheck Protection Program loans at September 30, 2021 and December 31, 2020, respectively.
The Company held $0 and $57.0 million in loans for sale at September 30, 2021 and December 31, 2020, respectively.
The following tables summarize the activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2021 and 2020.
Allowance for Credit Losses By Portfolio Segment
Real Estate
For the three months ended September 30, 2021
Residential
Commercial
Construction
Consumer
Beginning Balance
1,160
5,822
2,621
132
1,398
11,133
Recoveries
Provision
184
17
(5
(24
118
Ending Balance
1,344
5,839
2,616
108
1,521
11,428
Ending Balance:
Individually evaluated for Impairment
Collectively evaluated for Impairment
For the nine months ended September 30, 2021
1,223
6,552
3,326
371
1,405
12,877
Charge-offs
(4
25
121
(713
(710
(273
105
For the three months ended September 30, 2020
1,084
7,023
2,873
1,330
1,421
13,731
(35
114
466
(191
1,098
7,137
3,339
1,109
1,663
14,346
329
1,334
14,017
For the nine months ended September 30, 2020
1,030
4,254
2,180
568
1,552
9,584
(1,793
(1,829
23
31
68
2,884
1,159
1,881
The Company maintains a general allowance for loan losses based on evaluating known and inherent risks in the loan portfolio, including management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. The reserve is an estimate based upon factors and trends identified by management at the time the financial statements are prepared.
The following tables summarize information in regards to the recorded investment in loans receivable by loan class as of September 30, 2021 and December 31, 2020:
Loans Receivable
Ending
Balance
Balance:
Individually
Evaluated
for
Impairment
Collectively
Residential Real Estate
223,029
222,881
Commercial Real Estate
494,766
1,076
493,690
191,256
27,740
1,249
1,262,571
182,499
301
182,198
467,930
1,088
466,842
58
229,969
44,073
1,447
1,247,988
The following table summarizes information in regard to impaired loans by loan portfolio class as of September 30, 2021 and December 31, 2020:
Recorded
Investment
Unpaid
Principal
Related
Allowance
With no related allowance recorded
Non-owner Occupied
The following table presents additional information regarding the impaired loans for the three and nine months ended September 30, 2021:
Three Months Ended September 30,
Average
Record
Interest
Recognized
150
1,097
28
253
1
115
1,254
18
1,766
With an allowance recorded
268
2,034
Nine Months Ended September 30,
225
305
1,080
49
1,099
129
57
1,890
40
2,057
If interest on nonaccrual loans had been accrued, such income would have been $0 and $71,549 for the nine months ended September 30, 2021 and 2020.
The following table presents nonaccrual loans by classes of the loan portfolio as of September 30, 2021 and December 31, 2020:
149
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 loan losses. Loans not classified are rated pass.
The following tables summarize the aggregate Pass and criticized categories of Watch, Special Mention, and Substandard within the Company’s internal risk rating system as of September 30, 2021 and December 31, 2020:
Pass
Watch
Special
Mention
Substandard
Single Family
153,318
738
1,321
Owner occupied
150,691
3,239
871
252,322
53,721
15,275
18,647
Construction & Land Development
307,154
19,850
Commercial – Non Real Estate:
184,396
3,149
304
3,432
Consumer – Non Real Estate:
1,143,273
79,959
16,317
24,271
137,937
663
136,257
5,556
264,546
59,453
1,086
322,149
2,757
225,012
4,059
591
365
1,174,167
71,825
2,114
19
The following tables present the segments of the loan portfolio summarized by aging categories as of September 30, 2021 and December 31, 2020:
30-59
Days Past
Due
60-89
Greater
than 90
Days
Total Past
Current
Loans
Receivable
Nonaccrual
52
27,612
1,263,768
139,189
42,300
326,117
43,764
1,249,218
The Company may grant a concession or modification for economic or legal reasons related to a borrower’s financial condition that it would not otherwise consider resulting in a modified loan that is then identified as a troubled debt restructuring (“TDR”). The Company may modify loans through rate reductions, extensions of maturity, interest only payments, or payment modifications to better match the timing of cash flows due under the modified terms with the cash flows from the borrowers’ operations. Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses. TDRs are restored to accrual status when the obligation is brought current, has performed in accordance with the modified contractual terms for a reasonable period, generally six months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
20
Troubled Debt Restructuring
According to United States generally accepted accounting principles, restructuring a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The CARES Act states that from March 1, 2020, until the end of the year (unless the President terminates the COVID-19 emergency declaration sooner), financial institutions may elect to suspend the TDR accounting principles for loan modifications related to COVID-19. The Consolidated Appropriations Act of 2021, enacted in December 2020, extended this relief to the earlier of January 1, 2022 or the first day of a bank’s fiscal year that begins after the national emergency ends.
The Company may identify loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions and negative trends may result in a payment default in the near future.
As of September 30, 2021, and December 31, 2020, the Company did not have any TDRs.
Note 4. Intangible Assets
The carrying amount of computer software developed was $1.2 million at September 30, 2021 and December 31, 2020. The following table presents the changes in the carrying amount of computer software developed during the nine months ended September 30, 2021.
As of September 30, 2021
As of December 31, 2020
Gross Carrying Amount
Accumulated Amortization
Amortizable intangible assets:
Computer software
The Company is still in the development stage of the 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 bases over the estimated useful life of the asset. As of September 30, 2021, the Company has not recorded any amortization on its intangible computer software.
Note 5. Derivatives and Risk Management Activities
The Bank 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 Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank 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 Bank 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 Banks’s derivative‘s as of September 30, 2021 and December 31, 2020.
Customer-related interest rate
contracts
Dollars in thousands)
Notional
Amount
Positions
Collateral
Pledges
Matched interest rate swap with borrower
208,872
3,011
15,120
Matched interest rate swap with counterparty
21
210,314
12,152
The Company is able to recognize fee income upon execution of the interest rate swap contract. Interest rate swap fee income for the three and nine months ended September 30, 2021 were both $0, respectively. Interest rate swap income for the same period for 2020 was $1.9 million and $2.7 million, respectively.
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, 2021, and December 31, 2020, the Bank’s entire portfolio of available for sale securities are considered to be Level 2 securities.
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, 2021 and December 31, 2020:
Level 1
Level 2
Level 3
Assets:
Investment securities available-for-sale:
U.S. Government Agencies
Derivative asset – interest rate swap on loans
174,614
Liabilities:
Derivative liability – interest rate swap on loans
159,566
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 following describes the valuation techniques used by the Bank to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Most of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Bank because of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Statements of Income.
Other real estate owned
Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Bank. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Bank because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Statements of Income.
The following table summarizes the value of the Bank’s assets as of September 30, 2021 and December 31, 2020 that were measured at fair value on a nonrecurring basis during the period:
Other Real Estate Owned
The following table summarizes the value of the Bank’s assets as of September 30, 2021 that were measured at fair value on a nonrecurring basis during the period:
Fair Value Measurements at September 30, 2021
Valuation Technique(s)
Unobservable Inputs
Range of
Inputs
Other Real Estate Owned, net
Appraisals
Discount to reflect current market
conditions and estimated selling costs.
6% - 10%
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.
24
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
Significant
Observable
Unobservable
Restricted equity securities
Securities:
Available for sale
Held to maturity
Loans, net
1,267,566
Accrued interest receivable
4,131
Deposits
1,420,669
929,111
491,558
Derivative liability – interest rate swaps on loans
Accrued interest payable
1,016
1,259,671
58,930
9,154
1,451,708
941,503
510,205
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. There were no changes in methodologies or transfers between levels at September 30, 2021 from December 31, 2020.
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 Bank. There were no such potentially dilutive securities outstanding in 2021 or 2020.
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.
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
(Dollars in thousands, except for per share data)
Net income available to common shareholders
Weighted average number of common shares issued,
basic and diluted
7,571,214
8,272,570
7,547,254
8,275,344
Net income per common share:
Basic and diluted income per common share
Note 8. Accumulated Other Comprehensive Income
The following table presents the cumulative balances of the components of accumulated other comprehensive income, net of deferred taxes, as of September 30, 2021 and December 31, 2020:
Unrealized gain on securities
315
1,287
Unrealized loss on securities transferred to HTM
(55
Tax effect
(48
(255
Total accumulated other comprehensive income
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.
The Company’s long-term lease agreements are classified as operating leases. 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.
26
Cash paid for amounts included in the measurement of lease liabilities during the nine months ended September 30, 2021 was $437,000. During the nine months ended September 30, 2021 and 2020, the Company recognized lease expense of $514,000 and $442,000, respectively.
As of September 30,
Lease liabilities
7,843
Right-of-use assets
7,268
Weighted-average remaining lease term – operating leases
(in months).
175.6
Weighted-average discount rate – operating leases
2.81
%
For the nine months
ended September 30,
Lease Cost
Operating lease cost
Total lease costs
Cash paid for amounts included in measurement of lease
liabilities
437
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.
During the nine months ended September 30, 2021, the Company entered into one new operating lease. This lease is intended to be used as an operation center to accommodate the growing efforts of the Company.
As of September 30, 2021, 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, 2021 is as follows:
161
2022
607
2023
638
2024
654
2025
671
Thereafter
6,837
Total undiscounted cash flows
9,568
Discount
(1,725
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, 2020, previously filed with the SEC on March 23, 2021. Results for the three and nine months ended September 30, 2021 are not necessarily indicative of results for the year ending December 31, 2021 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:
•
the continuing impact of the novel coronavirus disease (COVID-19) outbreak and measures taken in response for which future developments are highly uncertain and difficult to predict;
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 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 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 loan 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 loan 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; and
a work stoppage, forced quarantine, or other interruption or the unavailability of key employees.
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 subsidiary, and the “Bank” refers to MainStreet Bank.
MainStreet Bancshares, Inc. is a financial holding company that owns 100% of MainStreet Bank, a community bank focused on serving the borrowing, cash management and depository needs of small to medium-sized businesses and professional practices and retail customers. On October 12, 2021, the Company declared itself to be a financial holding company, in place of a bank holding company, in order to engage in nonbanking activities that are deemed to be closely related to banking.
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 professional service organizations 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 Federal Deposit Insurance Corporation (“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.
The Company and its subsidiaries are incorporated in and chartered by the Commonwealth of Virginia. The Bank is a member of the Federal Reserve System, 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, and Leesburg Virginia, and one in Washington D.C.
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.
In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company, to apply for New Market Tax Credit (“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. While the legal entity has been established, the CDE is still in the process of seeking certification by the CDFI Fund as well as selecting members of the advisory board.
On October 25, 2021, MainStreet Bancshares, Inc. formally introduced AvenuTM, a division of MainStreet Bank. AvenuTM 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. We believe partnering with Fintechs will provide access to untapped markets, and become a fresh source for growth in low-cost deposits and fee income.
COVID-19 Pandemic
The continuing effects of the COVID-19 pandemic and resulting economic conditions have impacted our business and financial results and could continue to impact our business and results of operations in several ways in the future, including without limitation in areas related to credit, collateral, customer demand, operations, interest rate risk, liquidity and litigation, as described in more detail below. The extent to which the Company’s business will continue to be negatively affected by the pandemic will depend on future developments, which are highly uncertain and cannot be reasonably predicted.
Credit Risk. The risk of timely loan repayment and the value of collateral supporting our loans are affected by the strength of our borrowers’ businesses. New concerns about the additional spread of COVID-19 have caused, and are likely to continue to cause, business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. To date the effects of COVID-19 have not resulted in widespread and sustained repayment shortfalls on loans in our portfolio. However, if these negative effects continue, and are widespread and sustained, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is not sufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, our ability to liquidate real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for, or profitability of, our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making business decisions or may delay our taking certain remediation actions. In addition, we have unfunded commitments to extend credit to customers. Increased borrowings under these commitments could adversely impact our liquidity.
To support our communities and actively assist our customers during the pandemic, we participated in the Paycheck Protection Program (“PPP”), a program established by the CARES Act to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. PPP loans are fully guaranteed by the Small Business Administration (“SBA”) and provide for full forgiveness of the loans during a specified forgiveness period that meet specific guidelines provided by the SBA. The deadline to apply for PPP loans was initially June 30, 2020 and was later extended to August 8, 2020; the CAA, enacted in December 2020, reopened and expanded the PPP. Small businesses and other entities and individuals can apply for PPP loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. Since the PPP was expanded in December 2020, the Company has originated 572 additional PPP loans in the amount of $87.3 million, as we continue to help our community recover from the pandemic.
PPP loans are subject to regulatory requirements that would require forbearance of loan payments for a specified time or that could limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, or if the borrower defaults and the SBA determines there is a deficiency in the way any PPP loans were originated, funded or serviced by the Bank, we would be subject to repayment risk as well as the heightened risk of holding these loans at unfavorable interest rates as compared to loans that we would have otherwise made.
Business Continuity Planning Risk. Our financial condition and results of operations may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various responses of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to severe disruption and volatility in capital markets. Furthermore, many of the governmental actions in response to the pandemic have been directed toward curtailing household and business activity to contain COVID-19. These actions have been rapidly changing. Future effects of COVID-19 on economic activity could negatively affect the future banking products we provide and could result in a decline in loan originations.
Operational Risk. As of September 30, 2021, 94% of our employees have been vaccinated for the coronavirus. Nevertheless, current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we modified our business practices with a portion of our employees working remotely from their homes to minimize interruptions of our operations. Technology in employees’ homes may be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk.
We rely on many third parties in our business operations. Many of these parties may limit the availability and access of their services. If third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
Interest Rate Risk. Our net interest income, lending activities, deposits, investment portfolio, cash flows and profitability are and are likely to continue to be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. On March 15, 2020, the
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Federal Reserve lowered its target range for the federal funds rate to a range from 0 to 0.25 percent, and has since maintained that range, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices will likely cause a loss of future net interest income and a decrease in current fair market values of our investment portfolio and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.
Liquidity. Federal, state and local governments have mandated or encouraged financial institutions to accommodate borrowers and other customers affected by the COVID-19 pandemic. Legal and regulatory responses to concerns about the COVID-19 pandemic could result in additional regulation or restrictions affecting the conduct of our business in the future. In addition to our measures to address the potential effects from negative economic conditions noted above, the Company has instituted a program to help COVID-19 impacted customers. This program includes waiving certain fees and charges and offering payment deferment and other loan relief, as appropriate, for customers impacted by COVID-19. The Company’s liquidity could be negatively impacted if a significant number of customers apply and are approved for the deferral of payments or request additional deferrals. In addition, if these deferrals are not effective in mitigating the effect of COVID-19 on our customers, the negative effects on our business and results of operations may be more substantial and may continue over a longer period. A significant amount of loan growth during 2020 was a direct result of PPP loans. This loan growth is likely to end in the near-term.
Litigation Risk. Although the Company has taken and continues to take precautions to protect the safety and well-being of its employees, no assurance can be given that the steps being taken will be adequate or appropriate. Concerns have been expressed regarding possible employee lawsuits for tort claims related to the COVID-19 pandemic, including class action lawsuits alleging that unsafe workplaces have caused employees to contract COVID-19 or subjected them to the risk of exposure. Possible statutory defenses may mitigate the risk of liability in any such lawsuits; however, the availability of such defenses is uncertain and cannot be predicted at this time.
The PPP has also attracted interest from federal and state enforcement authorities, oversight agencies, regulators, and Congressional committees. Offices of state attorneys general and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations that entitle the Bank to rely on borrower certifications, and they may take more aggressive actions against the Bank for alleged violations of the provisions governing the Bank’s participation in the PPP. Federal and state regulators can impose or request that we consent to substantial sanctions, restrictions and requirements if they determine there are violations of laws, rules or regulations or weaknesses or failures with respect to general standards of safety and soundness, which could adversely affect our business, reputation, results of operation and financial condition.
Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of litigation, from both clients and non-clients that solicited the Bank for PPP loans, regarding its process and procedures used to process applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition, and results of operations. On Friday, March 13, 2020, then-President Trump declared a national emergency caused by the COVID-19 pandemic. The federal and state guidelines issued in connection with this national emergency to curb the spread of the COVID-19 pandemic have caused economic disruption across nearly every industry as well as significant unemployment. The Commonwealth of Virginia and the District of Columbia instituted stay at home guidelines with an exception made for essential businesses. Both jurisdictions consider banking to be an essential business.
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, central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates (IBOR) and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates (ARRs) and could cause disruptions in a variety of markets, as well as adversely impact our business, operations, and financial results.
To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, the Company has established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs.
Our critical accounting policies involving significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2021 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K, for the year ended December 31, 2020, other than the items discussed in our Recently Issued Accounting Pronouncements.
Comparison of Statements of Income for the Three Months Ended September 30, 2021 and 2020
General
Net income decreased $389,000 to $4.8 million for the three months ended September 30, 2021 from $5.2 million for the three months ended September 30, 2020. The decrease in net income for the three months ended September 30, 2021 was primarily due to a decrease in fees recognized on individual interest rate swap income of $1.9 million over the same period in 2020, despite increasing our net interest income. During the three months ended September 30, 2021, the Company’s net interest income increased $1.3 million over the same period in 2020. Net income was also affected by increases of $352,000 in salaries and employee benefits for the three months ended September 30, 2021 compared to the same period in 2020.
Total interest income increased $199,000, or 1.3%, to $15.8 million for the three months ended September 30, 2021 from $15.6 million for the three months ended September 30, 2020. The increase was primarily the result of an increase in interest and fees on loans of $79,000 and an increase in interest on investment securities of $94,000. Total average interest-earning assets increased $121.0 million, to $1.60 billion for the three months ended September 30, 2021 from $1.47 billion for the same period in 2020 primarily because of an increase in the average balance of federal funds sold and interest-earning deposits of $125.7 million, a $29.4 million increase in the average balance of investment securities and despite a decrease in the average balance of loans of $34.1 million as part of our PPP portfolio is being paid off. The average yield on our interest-earning assets decreased 27 basis points to 3.92% for the three months ended September 30, 2021 as compared to 4.19% for the three months ended September 30, 2020 primarily because of lower average yields on interest earning assets due to market conditions, loans related to PPP lending with a rate of 1%, and the Federal Reserve lowering the federal interest rates to near 0%.
Interest and fees on loans increased $79,000, to $15.2 million for the three months ended September 30, 2021 from $15.1 million for the same period in 2020. This increase was primarily due to an increase in the average yield on loans despite the average loans outstanding decreasing $34.1 million, which decreased to $1.26 billion as of September 30, 2021 from $1.29 billion as of September 30, 2020. The average yield on loans increased 15 basis points, or 3.2%, for the three months ended September 30, 2021 as compared to the three months ended September 30, 2020. Included in average loans for the three months ended September 30, 2021, $105.2 million was attributable to average PPP loans. PPP loans have an interest rate of 1% and as the level of PPP loan repayments accelerate, the Bank is seeing loan yields rise to a normalized level despite average loan balances decreasing.
Interest income on federal funds sold and interest-earning deposits increased by $26,000 to $38,000 for the three months ended September 30, 2021, from $12,000 for the three months ended September 30, 2020. The increase was primarily due to a significant increase in the average balance on these deposits. The average balance of interest-earning deposits and federal funds sold increased $125.7 million to $234.4 million for the three months ended September 30, 2021 from $108.7 million for the same period in 2020. The average yield increased slightly to 0.06% for the three months ended September 30, 2021 from 0.04% for the same period in 2020. The Bank held higher average balances in these accounts during the third quarter of 2021 while determining strategic alternatives to deploy this capital.
Interest on investment securities increased by $94,000 to $584,000 for the three months ended September 30, 2021 from $490,000 for the three months ended September 30, 2020. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals decreased in total $9,000, or 2.7 to $325,000 for the three months ended September 30, 2021, from $334,000 for the three months ended September 30, 2020. Interest on mortgage-backed securities increased by $66,000, or 186.5%, to $101,000 for the three months ended September 30, 2021, from $35,000 for the three months ended September 30, 2020. Subordinated debt interest income increased by $31,000, or 50.0%, to $93,000 for the three months ended September 30, 2021, from $62,000 for the three months ended September 30, 2020. The average yield on total securities decreased 39 basis points, to 2.26% for the three months ended September 30, 2021, from 2.65% for the same period in 2020. As a decrease in market rates resulted in stagnant yielding investments, investment income increased accordingly due to the average balance of investment securities increasing by $29.4 million, to $102.9 million for the three months ended September 30, 2021, from $73.5 million for the three months ended September 30, 2020
Total interest expense decreased $1.1 million, to $2.6 million for the three months ended September 30, 2021 from $3.7 million for the three months ended September 30, 2020, primarily due to a $1.0 million decrease in interest expense on time deposits and a $342,000 decrease in
interest expense on money market deposits. These decreases were offset by an increase of $296,000 increase in interest expense primarily due to newly issued subordinated debt in 2021 and included in the three months ended September 30, 2021 over the three months ended September 30, 2020
Interest expense on deposits decreased $1.4 million, to $2.0 million for the three months ended September 30, 2021 from $3.4 million for the three months ended September 30, 2020 primarily as a result of a decrease in average interest-bearing deposit yields. The decrease of expenses due to average yields was offset by an increase in average deposit balances of $6.8 million to $951.0 million during the three months ended September 30, 2021 as compared to $944.3 million for the three months ended September 30, 2020. The increase in the average balance of interest-bearing deposits was primarily a result of a $38.5 million increase in the average balance of interest-bearing demand deposit accounts offset by a $15.7 million decrease in the average balance of time deposits. The large increase in interest-bearing demand deposits was primarily driven by accounts opened and funded in connection with PPP loans as well as our business bankers executing on our deposit gathering strategy. The average cost of deposits was 85 basis points for the three months ended September 30, 2021, compared to 145 basis points for the three months ended September 30, 2020. The average rate paid on money market deposits decreased 39 basis points to 0.19% for the three months ended September 30, 2021 from 0.58% for the three months ended September 30, 2020. The average rate paid on interest-bearing demand deposits decreased 47 basis points to 0.37% for the three months ended September 30, 2021 from 0.84% for the three months ended September 30, 2020. The average cost of certificates of deposit decreased by 76 basis points to 1.40% for the three months ended September 30, 2021 as compared to 2.16% for the three months ended September 30, 2020. The decrease in the average cost of interest-bearing demand deposits for the three months ended September 30, 2021, in addition to a low-rate environment, was the result of our continued effort to attract and retain low-cost deposits and reducing our reliance on wholesale deposits as compared to the three months ended September 30, 2020.
Interest expense on advances from the Federal Home Loan Bank decreased $13,000 to $0 for the three months ended September 30, 2021, from $13,000 for the three months ended September 30, 2020 as a result of no outstanding advances on the Federal Home Loan Bank advances for the three months ended September 30, 2021 from $4.5 million for the three months ended September 30, 2020. The average balance of subordinated debt increased $25.8 million for the three months ended September 30, 2021, due to an additional $30 million in new low cost subordinated debt issued in 2021 and included in the three months ended September 30, 2021.
Net interest income increased approximately $1.3 million, or 11.1%, to $13.2 million for the three months ended September 30, 2021 from $11.9 million for the three months ended September 30, 2020 because of our net interest-earning assets increasing $93.0 million to $604.1 million for the three months ended September 30, 2021 from $511.1 million for the three months ended September 30, 2020. The interest rate spread increased by 22 basis points to 2.89% for the three months ended September 30, 2021 from 2.67% for the three months ended September 30, 2020. The net interest margin increased by 8 basis points from 3.28% for the three months ended September 30, 2020 to 3.20% for the three months ended September 30, 2021. The net interest margin, excluding PPP loans for the three months ended September 30, 2021, was 3.14%, a decrease of 15 basis points from the same period in 2020. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net interest margin excluding PPP income, which is a non-GAAP financial measure, to the most directly comparable financial measures calculated in accordance with U.S. GAAP.
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.
Income/
Expense
Yield/
Cost (5)
Interest-earning assets:
Loans (1)
1,258,485
4.78
1,292,566
4.63
Investment securities
102,893
2.26
73,486
2.65
Federal funds and interest-bearing
deposits
234,363
0.06
108,666
0.04
Total interest-earning assets
1,595,741
3.92
1,474,718
4.19
Non-interest-earning assets
88,521
65,665
Total assets
1,684,262
1,540,383
Interest-bearing liabilities:
Interest-bearing demand deposits
64,966
0.37
26,469
0.84
302,848
0.19
332,750
0.58
75,968
0.20
62,066
0.35
507,254
1.40
522,995
2.16
Total interest-bearing deposits
951,036
2,041
0.85
944,280
3,442
1.45
Federal funds purchased
Federal Home Loan Bank advances
4,511
1.14
Subordinated debt
40,609
5.29
14,823
6.56
Total interest-bearing liabilities
991,647
1.03
963,614
1.52
Non-interest-bearing liabilities:
Demand deposits and other liabilities
510,008
428,726
Total liabilities
1,501,655
1,392,340
Stockholders’ equity
182,607
148,043
Total liabilities and stockholders’
equity
Net interest income
Interest rate spread (2)
2.89
2.67
Net interest-earning assets (3)
604,094
511,104
Net interest margin (4)
3.28
3.20
Net interest margin, excluding PPP loans
3.14
3.29
Average interest-earning assets to
average interest-bearing liabilities
160.92
153.04
(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 total interest–bearing liabilities.
(4)
Net interest margin represents net interest income divided by total average interest-earning assets.
(5)
Annualized.
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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 volume and rate are allocated between the volume and rate categories. The net column represents the sum of the prior columns.
For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.
For the Three Months Ended
September 30, 2021 and 2020
Increase (Decrease) Due to
Increase
Volume
Rate
(Decrease)
(In thousands)
(1,705
1,784
79
488
(394
94
Federal funds and interest-bearing deposits
(1,199
182
(178
Money market deposit accounts
(302
(342
Savings and NOW accounts
(75
(82
(964
(1,046
(1,519
(1,401
(13
605
(309
296
710
(1,828
(1,118
Change in net interest income
(1,909
3,226
1,317
Provision for Loan Losses
Management believes that the provision recorded for the period ended September 30, 2021 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, and credit quality. In performing our assessment of the allowance for loan losses as of September 30, 2021, management compiled and analysed extensive amounts of information, including additional relief requested and conversations with borrowers, to make an objective estimate of potential losses caused by the COVID-19 pandemic. Using that information, we stressed the portfolio through the lens of an escalated economic shutdown that is above and beyond a normal operating environment. Because this stressed economy is the result of a health pandemic, there is uncertainty about the duration COVID-19 will have on our borrowers. In response to this uncertainty, we created and incorporated a COVID-19 qualitative factor within our allowance to isolate and monitor going forward the heightened stresses our borrowers are facing. Since our loan portfolio has remained strong and continues to perform, we have recovered a substantial portion of this special COVID provision as of September 30, 2021. We will continuously review the loan portfolio to determine the depth and breadth of potential loan losses associated with the pandemic. As we obtain additional information and to more accurately assess the full nature and extent of elevated risk to the loan portfolio that may arise from this crisis, additional provision expenses may be required. The Board and management agreed to continue to work expeditiously with borrowers to analyze the loan portfolio with a goal of timely identifying, provisioning, and reporting probable losses that could occur throughout the course of the pandemic.
The provision for loan losses, which is an operating expense, is maintained to ensure that the allowance for loan losses is maintained at levels we consider necessary and appropriate to absorb both probable and reasonably estimated credit losses at a balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current 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 as more information becomes available. The allowance for loan losses is assessed monthly and provisions are made for loan losses as required in order to maintain the allowance.
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Provision for loan losses decreased by $345,000 to a provision of loan losses of $290,000 for the three months ended September 30, 2021 from provision expense of $635,000 for the three months ended September 30, 2020 primarily as a result of how strong the loan portfolio has endured the pandemic. The provision expense was needed for additional loan growth. The increase in loan originations, which totaled approximately $51.7 million for the three months ended September 30, 2020 compared to loan originations, of $85.2 million for the three months ended September 30, 2021. The Company has not provisioned any allowance for loan losses for PPP loans as they are guaranteed by SBA. Non-performing loans decreased $1.2 million from $1.2 million at September 30, 2020 to $0 at September 30, 2021. During the three months ended September 30, 2021, special mention loans increased $15.4 million for a balance of $16.3 million, compared to the same period in 2020. Substandard loans increased $21.0 million as of September 30, 2021 compared to September 30, 2020. Of the substandard loans as of June 30, 2021, 80.4% 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, 2021, there were no charge-offs incurred, and recoveries of $5,000 were received.
Non-interest income decreased $1.4 million, or 48.0%, to $1.5 million for the three months ended September 30, 2021 from $2.9 million for the three months ended September 30, 2020. The decrease in non-interest income was primarily due to a decrease in fees recognized on individual interest rate swap income but was offset by increases in deposit account service fees of $155,000 and $344,000 in other fee income for the three months ended September 30, 2021. The deposit account services fees increased primarily due to more customer activity in the three months ended September 30, 2021 than the same period in 2020. The Company continues to focus on increasing fee income through loan swaps as it strategically benefits our customers.
Non-interest expense increased $823,000, or 10.8%, to $8.5 million for the three months ended September 30, 2021 from $7.6 million for the three months ended September 30, 2020 primarily because of increases in salary and employee benefits of $352,000 and advertising and marketing expenses of $172,000. Salaries and employee benefits expense increased by $352,000 to $4.9 million for the three months ended September 30, 2021 from $4.5 million for the three months ended September 30, 2020. Advertising and marketing expenses increased $172,000, or 64.7%, to $438,000 for the three months ended September 30, 2021 from $266,000 for the three months ended September 30, 2020 due to new strategic partnerships and timing of initiatives. Franchise taxes increased approximately $44,000 to $386,000 for the three months ended September 30, 2021 from $342,000 for the three months ended September 30, 2020 because of the increase in the Company’s capital as of September 30, 2021 compared to the balance sheet as of September 30, 2020. FDIC insurance premiums decreased approximately $85,000 to $315,000 for the three months ended September 30, 2021 from $400,000 for the three months ended September 30, 2020.
Income tax expense decreased $144,000, or 11.1%, to a tax expense of $1.2 million for the three months ended September 30, 2021 from a tax expense of $1.3 million for the three months ended September 30, 2020. The decrease in federal income tax expense for the three months ended September 30, 2021 compared to the same period a year ago was driven by the decrease in income before income taxes of $533,000, to income before income tax of $5.9 million as of September 30, 2021 compared to income before income tax expense of $6.5 million for the same period in the prior year. As a result of expanding into the District of Columbia, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $90,000 for the three months ended September 30, 2021. For the three months ended September 30, 2021, the Company had an effective tax expense rate of 19.5%, compared to effective tax expense rate of 20.1% for the three months ended September 30, 2020.
Comparison of Statements of Income for the Nine Months Ended September 30, 2021 and 2020
Net income increased $9.4 million, to $17.4 million for the nine months ended September 30, 2021, from $8.0 million for the nine months ended September 30, 2020. The increase in net income for the nine months ended September 30, 2021 was primarily due to a recovery in provision for loan losses in response to the strong credit profile through the pandemic. In addition to the recovery in provision for loan losses, the Bank saw an increase in net interest income of $6.8 million.
Total interest income increased $2.4 million, or 5.2%, to $48.0 million for the nine months ended September 30, 2021, from $45.6 million for the nine months ended September 30, 2020. The increase was primarily the result of an increase in interest and fees on loans of $2.5 million, an increase in interest on investment securities of $224,000 and offset by a decrease on interest on federal funds sold and interest-earning deposits of $343,000. Total average interest-earning assets increased $227.2 million, to $1.6 billion for the nine months ended September 30, 2021, from $1.4 billion for the same period in 2020 primarily as a result of an increase in the average balance of loans of $104.8 million, a $21.1 million increase in the average balance of investment securities and an increase in the average balance of federal funds sold and interest-earning deposits with banks of $101.3 million. The average yield on our interest-earning assets decreased 42 basis points to 3.98% for
36
the nine months ended September 30, 2021 as compared to 4.40% for the nine months ended September 30, 2020 primarily as a result of a lower average yield on the loan portfolio and excess balances in federal funds sold and interest-earning deposits.
Interest and fees on loans increased $2.5 million to $46.2 million for the nine months ended September 30, 2021 from $43.7 million for the same period in 2020. This increase was primarily due to an increase in average loans outstanding of $104.8 million, which increased to $1.3 billion as of September 30, 2021 from $1.2 billion as of September 30, 2020. During the nine months ended September 30, 2021, the Federal Reserve kept the federal funds interest rate to a range of 0 - 25 basis points, which decreased yields on the Bank’s asset sensitive balance sheet. The average yield on loans decreased 14 basis points, to 4.78% for the nine months ended September 30, 2021 as compared 4.92% for the nine months ended September 30, 2020.
Interest income on federal funds sold and interest-earning deposits decreased by $343,000 to $73,000 for the nine months ended September 30, 2021, from $416,000 for the nine months ended September 30, 2020. The decrease was primarily due to a significant decrease average yield despite an increase in average balance on these deposits. The average yield decreased 41 basis points, to 0.04% for the nine months ended September 30, 2021 from 0.45% for the nine months ended September 30, 2020. The average balance of interest-earning deposits and federal funds sold increased $101.3 million to $224.5 million for the nine months ended September 30, 2021 from $123.2 million for the nine months ended September 30, 2020.
Interest on investment securities increased by $224,000 to $1.7 million for the nine months ended September 30, 2021 from $1.5 million for the nine months ended September 30, 2020. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals increased in total $46,000, or 5.0%, to $972,000 for the nine months ended September 30, 2021, from $925,000 for the nine months ended September 30, 2020. Interest on mortgage-backed securities increased by $85,000, or 45.6%, to $271,000 for the nine months ended September 30, 2021, from $186,000 for the nine months ended September 30, 2020. Subordinated debt interest income increased by $96,000, or 54.9%, to $271,000 for the nine months ended September 30, 2021, from $175,000 for the nine months ended September 30, 2020. The average yield on securities decreased 29 basis points to 2.42% for the nine months ended September 30, 2021 from 2.71% for the same period in 2020, as decreased market rates resulted in lower yielding investments. The average balance of investment securities increased by $21.1 million to $94.6 million for the nine months ended September 30, 2021, from $73.5 million for the nine months ended September 30, 2020.
Total interest expense decreased $4.4 million to $8.3 million for the nine months ended September 30, 2021 from $12.7 million for the nine months ended September 30, 2020, primarily due to a $3.7 million decrease in interest expense on time deposits and a $1.1 million decrease in interest expense on money market deposits. These decreases were offset by an increase in interest expense on subordinated of $619,000.
Interest expense on deposits decreased $4.9 million, to $7.0 million for the nine months ended September 30, 2021 from $11.9 million for the nine months ended September 30, 2020 primarily as a result of a decrease in average interest-bearing deposit yields despite an increase in average interest bearing balances of $71.6 million to $1.0 billion during the nine months ended September 30, 2021 as compared to $922.7 million for the nine months ended September 30, 2020. The increase in the average balance of interest-bearing deposits was primarily as a result of a $56.8 million increase in the average balance of our money market deposit accounts and a $41.5 million increase in the average balance of our interest-bearing demand deposits. The large increase in money market and demand deposits was primarily driven by accounts opened and funded in connection with PPP loans. The decrease in the average balance of our time deposits was primarily a result of a focused effort to replace wholesale deposits with lower cost core deposits. The average cost of deposits was 94 basis points for the nine months ended September 30, 2021 compared to 172 basis points for the nine months ended September 30, 2020. The average rate paid on money market deposits decreased 56 basis points to 0.25% for the nine months ended September 30, 2021 from 0.81% for the nine months ended September 30, 2020. The decrease in the average balance of our certificates of deposits of $34.8 million from $543.5 million for the nine months ended September 30, 2020 to $508.7 million for the nine months ended September 30, 2021 was primarily the result of the Company’s strategy to replace wholesale deposits with core deposits. The average cost of certificates of deposit decreased by 81 basis points to 1.59% for the nine months ended September 30, 2021 as compared to 2.40% for the nine months ended September 30, 2020. The increase in the average balance of our interest-bearing demand deposits of $41.5 million from $25.8 million for the nine months ended September 30, 2020 to $67.3 million for the nine months ended September 30, 2021, was primarily driven by the Bank’s effort to increase our low cost deposits and reduce our reliance on wholesale deposits.
Interest expense on advances from the Federal Home Loan Bank decreased $107,000 to $0 for the nine months ended September 30, 2021, from $107,000 for the nine months ended September 30, 2020, as a result of an decrease in the average balance of the Federal Home Loan Bank advances of $8.3 million to $0 for the nine months ended September 30, 2021 from $8.3 million for the nine months ended September 30, 2020.
Net interest income increased approximately $6.8 million, or 20.5%, to $39.7 million for the nine months ended September 30, 2021 from $32.9 million for the nine months ended September 30, 2020 as a result of our net interest-earning assets increasing $146.8 million to $586.3 million for the nine months ended September 30, 2021 from $439.5 million for the nine months ended September 30, 2020. Our interest rate spread increased by 29 basis points to 2.90% for the nine months ended September 30, 2021 from 2.61% for the nine months ended September 30, 2020. Our net interest margin increased by 11 basis points from 3.18% for the nine months ended September 30, 2020 to 3.29% for the nine months ended September 30, 2021.
37
1,293,359
1,188,565
4.92
94,575
2.42
73,504
2.71
224,521
123,217
0.45
1,612,455
3.98
1,385,286
4.40
76,758
65,368
1,689,213
1,450,654
67,345
0.34
25,847
1.08
345,662
0.25
288,836
0.81
72,591
0.23
64,513
508,722
1.59
543,531
2.40
994,320
6,981
0.94
922,727
11,860
1.72
8,266
1.73
31,815
5.66
14,816
1,026,136
945,809
1.79
486,510
361,771
1,512,646
1,307,580
176,567
143,074
Total liabilities and Stockholders’
2.90
2.61
586,319
439,477
3.18
Net interest margin, excluding PPP loans (5)
3.15
3.22
157.14
146.47
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 volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns.
For the Nine Months Ended
Total Increase
4,413
(1,904
2,509
473
(249
224
316
(659
(343
5,202
(2,812
2,390
240
(279
(39
(1,570
(1,097
(72
(42
(590
(3,111
(3,701
153
(5,032
(4,879
(107
791
(172
619
837
(5,204
(4,367
4,365
2,392
6,757
Provision for loan losses decreased by $8.0 million, to a recovery of loan loss provision of $1.5 million for the nine months ended September 30, 2021, from loan loss provision expense of $6.6 million for the nine months ended September 30, 2020 primarily as a direct result of additional provisions added due to uncertainty around the COVID-19 pandemic in 2020 and subsequent recoveries of that special pandemic provision in 2021. In addition, loan originations decreased $106.7 million, from $371.6 million for the nine months ended September 30, 2020 compared to loan originations of $264.9 million for the nine months ended September 30, 2021. Non-performing loans decreased $1.2 million from $1.2 million at September 30, 2020 to $0 at September 30, 2021. During the nine months ended September 30, 2021, there were $4,000 in total charge-offs and recoveries of $25,000 were received. During the nine months ended September 30, 2020, total charge-offs of $1.8 million were recorded and recoveries received totaled $31,000.
Non-interest income decreased $1.1 million, or 19.7%, to $4.5 million for the nine months ended September 30, 2021 from $5.6 million for the nine months ended September 30, 2020. The decrease in non-interest income was primarily due to a decrease in fees recognized on individual interest rate swap income of $2.7 million but was offset by increases in gains on sale of loans of $401,000 and $723,000 in other fee income for the nine months ended September 30, 2021. Of the $434,000 gains on sold loans, $130,000 was related to the sale of SBA guaranteed portions of loans. In addition, deposit account service fees increased $395,000 to $1.8 million for the nine months ended September 30, 2021 from $1.4 million for the nine months ended September 30, 2020 primarily as a result of an increased customer deposit portfolio and activity.
Non-interest expense increased $2.0 million or 9.0% to $24.1 million for the nine months ended September 30, 2021, from $22.1 million for the nine months ended September 30, 2020, primarily as a result of increases in salary and employee benefits of $1.1 million and advertising and marketing expenses of $402,000. Salaries and employee benefits expense increased by $1.1 million to $14.3 million for the nine months ended September 30, 2021 from $13.2 million for the nine months ended September 30, 2020 primarily as a result of adding five employees and the related salary and benefit expenses for these additional employees. Advertising and marketing expenses increased $402,000, or 56.4%, to $1.1 million for the nine months ended September 30, 2021 from $713,000 for the nine months ended September 30, 2020 due to new strategic partnerships and timing of marketing initiatives. Outside service and professional fees increased approximately $212,000 to $908,000 for the nine months ended September 30, 2021 from $696,000 for the nine months ended September 30, 2020. The increase in non-interest expense was offset by decreases in other operating expenses which decreased approximately $78,000 to $4.5 million for the nine months ended September 30, 2021, from $4.6 million for the nine months ended September 30, 2020.
Income tax expense increased $2.3 million, or 130.0%, to $4.1 million for the nine months ended September 30, 2021 from $1.8 million for the nine months ended September 30, 2020. The increase in federal income tax expense for the nine months ended September 30, 2021 compared to the same period a year ago is driven by the increase in income before income taxes of $11.7 million, or 119.2%, to $21.5 million for the nine months ended September 30, 2021 compared to $9.8 million for the same period in the prior year. As a result of expanding into the District of Columbia, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $240,000 for the nine months ended September 30, 2021. For the nine months ended September 30, 2021, the Bank had an effective federal tax rate of 19.2%, compared to effective federal tax rate of 18.3% for the nine months ended September 30, 2020.
Comparison of Statements of Financial Condition at September 30, 2021 and at December 31, 2020
Total assets increased $14.0 million, or 0.85%, to $1.7 billion at September 30, 2021 from $1.6 billion at December 31, 2020. The increase was primarily the result of increases in the loan portfolio of $16.0 million, $10.6 million in bank owned life insurance and $26.2 million in cash equivalents. These increases were offset by a decrease of $57.0 million in loans held for sale as of September 30, 2021.
Investment Securities
Investment securities increased $27.8 million, or 16.3%, from $169.9 million at December 31, 2020 to $197.7 million at September 30, 2021. The increase was primarily in the available-for-sale portfolio, particularly in U.S treasury and collateralized mortgage-backed securities. At September 30, 2021, our held-to-maturity portion of the securities portfolio, at amortized cost, was $26.1 million, and our available-for-sale portion of the securities portfolio, at fair value, was $171.6 million compared to our held-to-maturity portion of the securities portfolio of $22.5 million and our available-for-sale portion of the securities portfolio of $147.4 million at December 31, 2020.
Net loans increased $16.0 million, or 1.3%, to $1.25 billion at September 30, 2021 from $1.23 billion at December 31, 2020. Residential real estate loans increased $39.5 million, or 21.5%, to $223.0 million at September 30, 2021 from $183.5 million at December 31, 2020. Commercial real estate loans increased by $27.9 million from $466.9 million at December 31, 2020 to $494.8 million at September 30, 2021. Commercial and industrial loans decreased by $38.7 million from $230.0 million at December 31, 2020 to $191.3 million at September 30, 2021. Paycheck Protection Program loans comprised $88.5 million of this portfolio as of September 30, 2021. Commercial and industrial loans, excluding PPP loans, increased by $7.9 million from December 31, 2020 to September 30, 2021. Construction loans increased $2.1 million to $327.0 million at September 30, 2021 from $324.9 million at December 31, 2020. Consumer loans decreased by $16.3 million from $44.1 million at December 31, 2020 to $27.7 million at September 30, 2021. The $16.3 million decrease in consumer loans is a result of management’s decision to let indirect lending portfolio amortize off the balance sheet.
Allowance for Loan Losses
The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses 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 real estate
Commercial and industrial
(1,792
(60
Total charge-offs
(1,853
Recoveries:
Residential real estate
1,526
Total recoveries
1,536
Net (charge-offs) recoveries
(317
Provision for loan losses
3,610
Balance at end of period
Ratios:
Net charge offs to average loans outstanding
0.00
0.03
Allowance for loan losses to non-performing loans at end of
period
N/A
8,642.28
Allowance for loan losses to gross loans at end of period
0.90
Allowance for loan losses to gross loans at end of period, excluding PPP loans
1.16
Deposits decreased $23.9 million, or 1.7% to $1.41 billion at September 30, 2021 from $1.44 billion at December 31, 2020. Our core deposits increased $51.9 million, or 5.0%, to $1.10 billion at September 30, 2021 from $1.05 billion at December 31, 2020. The increase in core deposits primarily was driven by accounts generated to service the PPP loans the Bank generated and new deposit growth initiatives. Non-interest bearing demand deposits increased $104.7 million, or 28.2%, to $475.2 million at September 30, 2021 from $370.5 million at December 31, 2020. Savings and NOW deposits increase $5.5 million, or 7.4% to $79.6 million at September 30, 2021 from $74.1 million at September 30, 2020. Offsetting these increases were decreases in certificates of deposits of $11.5 million, or 2.3%, to $485.3 million at September 30, 2021 from $496.7 million at December 31, 2020 and in money market deposits of $115.8 million, or 27.2%, to $310.8 million at September 30, 2021 from $426.6 million at December 31, 2020. The decrease in money market deposit accounts and time deposits were primarily the result of executing on a strategy to continue decreasing our cost of funds.
Nonperforming Assets
The following table presents information regarding nonperforming assets at the dates indicated:
Non-accrual loans:
Total non-accrual loans
Total non-performing loans
Total non-performing assets
Total non-performing loans to gross loans receivable
0.01
Total non-performing loans to total assets
Total non-performing assets to total assets
0.07
0.08
41
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; however, the Company also utilizes wholesale deposits as a funding source in addition to customer deposits. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, federal funds purchased, and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process. MainStreet Bank had no Federal Home Loan Bank advances outstanding and unused borrowing capacity of $426.9 million as of September 30, 2021. The Company has the ability to borrow up to 100% of our PPP outstanding loan balances as of September 30, 2021, through the Paycheck Protection Program Lending Facility, however we were able to fund these loans through our own capital. Additionally, at September 30, 2021, we had the ability to borrow up to $104.0 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, 2021.
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, 2021, cash and cash equivalents totaled $133.7 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $171.6 million at September 30, 2021.
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 $56.4 million and $11.8 million for the nine months ended September 30, 2021 and September 30, 2020, respectively. There were no sales of securities in the nine months ended September 30, 2021, however one held-to maturity security was called while in a gain position of $3,000. There were no sales of securities for the nine months ended September 30, 2020. 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 $30.3 million and $281.1 million for the nine months ended September 30, 2021 and September 30, 2020, respectively. Net cash provided by financing activities was $140,000 and $332.0 million for the nine months ended September 30, 2021 and 2020, respectively, which consisted primarily of increases in non-interest bearing deposits of $104.7 million and subordinated debt net of issuance costs of $25.6 million offset by decreases in interest-bearing deposits of $128.5 million for the nine months ended September 30, 2021
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, 2021, totaled $230.5 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.
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, 2021, MainStreet Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory guidelines.
Regulatory Capital
Information presented for September 30, 2021 and December 31, 2020, 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 Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Company must hold a capital
42
conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer for 2021 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Company 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, 2021, the Company and 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
Ratio
Total capital (to risk-weighted assets)
217,388
16.55
105,051
≥ 8.0%
131,313
> 10.0%
Common equity tier 1 capital (to risk-weighted assets)
205,960
15.68
59,091
≥ 4.5%
> 8.0%
Tier 1 capital (to risk-weighted assets)
78,788
≥ 6.0%
Tier 1 capital (to average assets)
12.23
67,348
≥ 4.0%
84,185
> 5.0%
189,534
14.60
103,872
129,840
≥ 10.0%
176,657
13.61
58,428
77,904
10.78
65,557
81,946
≥ 5.0%
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, 2021, we had outstanding loan commitments of $278.0 million and outstanding stand-by letters of credit of $230,000. 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.
For the three months ended September 30,
Net interest margin adjusted
Net interest income (GAAP)
Less: PPP fees recognized
1,136
644
3,958
1,235
Less: PPP interest income earned
263
432
1,052
772
Net interest income, excluding PPP income (non-GAAP)
11,804
10,810
34,659
30,905
Average interest earning assets (GAAP)
Less: average PPP loans
105,153
172,659
140,210
102,891
Average interest earning assets, excluding PPP (non-GAAP)
1,490,588
1,302,059
1,472,245
1,282,395
Net interest margin, excluding PPP (non-GAAP)
43
Allowance for loan losses, adjusted
Allowance for loan losses (GAAP)
Total gross loans (GAAP)
1,301,699
Less: PPP loans
88,534
173,075
Total gross loans, excluding PPP loans (non-GAAP)
1,175,286
1,128,624
Allowance for loan losses to total loans, excluding PPP (non-GAAP)
1.27
Not required for smaller reporting companies
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, 2021. 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 2021 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 with the Company’s transition to a remote/work from home environment.
PART II – OTHER INFORMATION
At September 30, 2021, 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.
Not required for smaller reporting companies. Reference is made to “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 23, 2021. For a discussion of certain risk factors affecting the Company, see our disclosure under “Forward-Looking Statements” and “COVID-19 Pandemic” is Part I, Item 2 in this Form 10-Q.
The Company did not repurchase common shares during the three months ended September 30, 2021.
The Company has elected to be deemed a financial holding company under the Bank Holding Company Act. The Company sought this new status from the Board of Governors of the Federal Reserve System to provide increased flexibility to engage in nonbanking opportunities. As a financial holding company, the Company may engage in permissible activities that are financial in nature or incidental to a financial activity.
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
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Label Linkbase Document
101.PRE
XBRL Taxonomy Presentation Linkbase Document
101
The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 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, 2021, 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 5, 2021
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)