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MainStreet Bancshares, Inc. - Quarter Report: 2020 September (Form 10-Q)

 

 

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, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to                      to                     

Commission file number: 001-38817

 

 

MainStreet Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

 

Virginia

 

81-2871064

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

10089 Fairfax Boulevard, Fairfax, VA 22030

(Address of Principal Executive Offices and Zip Code)

(703) 481-4567

(Registrant’s Telephone Number, Including Area Code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Securities registered pursuant to Section 12(b) of the Act.

 

 

 

 

 

 

Title of each class

 

Trading

Symbol(s)

 

Name of each exchange

on which registered

Common Stock

 

MNSB

 

The Nasdaq Stock Market LLC

Depositary Shares (each representing a 1/40th

 

 

 

 

interest in a share of 7.50% Series A Fixed-Rate

 

MNSBP

 

The Nasdaq Stock Market LLC

Non-Cumulative Perpetual Preferred Stock)

 

 

 

 

 

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 9, 2020, there were 7,528,052 outstanding shares, par value $4.00 per share, of the issuer’s common stock.

 

 

 

 


 

INDEX

 

 

 

 

PART I – FINANCIAL INFORMATION

 

3

 

 

Item 1 – Consolidated Financial Statements

 

3

 

 

Notes to Consolidated Financial Statements

 

8

 

 

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

30

 

 

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

 

48

 

 

Item 4 – Controls and Procedures

 

48

 

 

PART II OTHER INFORMATION

 

49

 

 

Item 1 – Legal Proceedings

 

49

 

 

Item 1A – Risk Factors

 

49

 

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

 

52

 

 

Item 6 – Exhibits

 

53

 

 

SIGNATURES

 

54

 

2


 

PART I – FINANCIAL INFORMATION

Item 1 – Consolidated Financial Statements – Unaudited

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Financial Condition as of September 30, 2020 and December 31, 2019 (Dollars in thousands, except share and per share data)

 

 

 

At September 30,

2020

(unaudited)

 

 

At December 31,

2019

(*)

 

Assets

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

102,480

 

 

$

53,376

 

Federal funds sold

 

 

25,074

 

 

 

11,468

 

Cash and cash equivalents

 

 

127,554

 

 

 

64,844

 

Investment securities available-for-sale, at fair value

 

 

118,844

 

 

 

92,791

 

Investment securities held-to-maturity

 

 

23,114

 

 

 

23,914

 

Restricted securities, at cost

 

 

4,616

 

 

 

6,157

 

Loans, net of allowance for loan losses of $14,346 and $9,584, respectively

 

 

1,279,899

 

 

 

1,030,425

 

Premises and equipment, net

 

 

14,474

 

 

 

14,153

 

Other real estate owned, net

 

 

1,580

 

 

 

1,207

 

Accrued interest and other receivables

 

 

8,579

 

 

 

5,420

 

Bank owned life insurance

 

 

25,157

 

 

 

24,562

 

Other assets

 

 

26,371

 

 

 

13,885

 

Total Assets

 

$

1,630,188

 

 

$

1,277,358

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Non-interest bearing deposits

 

$

416,648

 

 

$

252,707

 

Interest bearing demand deposits

 

 

72,807

 

 

 

53,707

 

Savings and NOW deposits

 

 

69,015

 

 

 

63,015

 

Money market deposits

 

 

348,146

 

 

 

141,337

 

Time deposits

 

 

510,429

 

 

 

560,857

 

Total deposits

 

 

1,417,045

 

 

 

1,071,623

 

Federal Home Loan Bank advances

 

 

 

 

 

40,000

 

Subordinated debt, net

 

 

14,827

 

 

 

14,805

 

Other liabilities

 

 

25,055

 

 

 

13,896

 

Total Liabilities

 

 

1,456,927

 

 

 

1,140,324

 

Stockholders’ Equity

 

 

 

 

 

 

 

 

Preferred stock, $1.00 par value, 2,000,000 shares authorized; 28,750 shares issued and

   outstanding as of September 30, 2020 and no shares issued and outstanding as of

   December 31, 2019

 

 

27,527

 

 

 

 

Common stock, $4.00 par value, 10,000,000 shares authorized; issued and outstanding

   8,277,837 shares (including 162,917 nonvested shares) for September 30, 2020 and

   8,260,259 shares (including 160,961 nonvested shares) for December 31, 2019

 

 

32,460

 

 

 

32,397

 

Capital surplus

 

 

75,217

 

 

 

75,117

 

Retained earnings

 

 

37,105

 

 

 

29,097

 

Accumulated other comprehensive income

 

 

952

 

 

 

423

 

Total Stockholders’ Equity

 

 

173,261

 

 

 

137,034

 

Total Liabilities and Stockholders’ Equity

 

$

1,630,188

 

 

$

1,277,358

 

 

*

Derived from audited consolidated financial statements.

See Notes to the Unaudited Consolidated Financial Statements

3


 

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Income for the Three and Nine months ended September 30, 2020 and 2019 (Dollars in thousands, except per share data)

 

 

 

For the Three Months

Ended September 30,

 

 

For the Nine Months

Ended September 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Interest Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

15,083

 

 

$

14,192

 

 

$

43,702

 

 

$

40,985

 

Interest on investments securities

 

 

491

 

 

 

497

 

 

 

1,488

 

 

 

1,668

 

Interest on federal funds sold

 

 

12

 

 

 

412

 

 

 

416

 

 

 

1,132

 

Total Interest Income

 

 

15,586

 

 

 

15,101

 

 

 

45,606

 

 

 

43,785

 

Interest Expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on interest bearing DDA deposits

 

 

56

 

 

 

275

 

 

 

209

 

 

 

803

 

Interest on savings and NOW deposits

 

 

55

 

 

 

71

 

 

 

169

 

 

 

218

 

Interest on money market deposits

 

 

490

 

 

 

539

 

 

 

1,742

 

 

 

1,889

 

Interest on time deposits

 

 

2,841

 

 

 

3,900

 

 

 

9,740

 

 

 

10,466

 

Interest on Federal Home Loan Bank advances and other borrowings

 

 

13

 

 

 

76

 

 

 

107

 

 

 

457

 

Interest on subordinated debt

 

 

245

 

 

 

244

 

 

 

727

 

 

 

723

 

Total Interest Expense

 

 

3,700

 

 

 

5,105

 

 

 

12,694

 

 

 

14,556

 

Net Interest Income

 

 

11,886

 

 

 

9,996

 

 

 

32,912

 

 

 

29,229

 

Provision for Loan Losses

 

 

635

 

 

 

185

 

 

 

6,560

 

 

 

1,260

 

Net Interest Income After Provision For Loan Losses

 

 

11,251

 

 

 

9,811

 

 

 

26,352

 

 

 

27,969

 

Non-Interest Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposit account service charges

 

 

487

 

 

 

392

 

 

 

1,407

 

 

 

1,208

 

Bank owned life insurance income

 

 

199

 

 

 

106

 

 

 

595

 

 

 

317

 

Loan swap fee income

 

 

1,851

 

 

 

407

 

 

 

2,677

 

 

 

878

 

Net gain on available-for-sale securities

 

 

 

 

 

 

 

 

 

 

 

5

 

Net gain on sale of loans

 

 

33

 

 

 

303

 

 

 

33

 

 

 

566

 

Other fee income

 

 

288

 

 

 

228

 

 

 

878

 

 

 

730

 

Total Non-Interest Income

 

 

2,858

 

 

 

1,436

 

 

 

5,590

 

 

 

3,704

 

Non-Interest Expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

4,495

 

 

 

3,890

 

 

 

13,191

 

 

 

11,597

 

Furniture and equipment expenses

 

 

574

 

 

 

451

 

 

 

1,528

 

 

 

1,271

 

Advertising and marketing

 

 

266

 

 

 

235

 

 

 

713

 

 

 

531

 

Occupancy expenses

 

 

332

 

 

 

214

 

 

 

910

 

 

 

644

 

Outside services

 

 

215

 

 

 

306

 

 

 

696

 

 

 

694

 

Administrative expenses

 

 

167

 

 

 

190

 

 

 

508

 

 

 

533

 

Other operating expenses

 

 

1,589

 

 

 

1,203

 

 

 

4,595

 

 

 

3,404

 

Total Non-Interest Expense

 

 

7,638

 

 

 

6,489

 

 

 

22,141

 

 

 

18,674

 

Income Before Income Taxes

 

 

6,471

 

 

 

4,758

 

 

 

9,801

 

 

 

12,999

 

Income Tax Expense

 

 

1,299

 

 

 

1,049

 

 

 

1,793

 

 

 

2,612

 

Net Income Available To Common Shareholders

 

$

5,172

 

 

$

3,709

 

 

$

8,008

 

 

$

10,387

 

Net Income Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.63

 

 

$

0.45

 

 

$

0.97

 

 

$

1.26

 

Diluted

 

$

0.63

 

 

$

0.45

 

 

$

0.97

 

 

$

1.26

 

 

See Notes to the Unaudited Consolidated Financial Statements

4


 

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2020 and 2019 (Dollars in thousands)

 

 

 

For the Three Months

Ended September 30,

 

 

For the Nine Months

Ended September 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Comprehensive Income (Loss), net of taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

5,172

 

 

$

3,709

 

 

$

8,008

 

 

$

10,387

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on available for sale securities arising

   during the period (net of tax (benefit), ($1) and $54, respectively, for the three months

   ended September 30, and $136 and $205, respectively, for the nine months ended September 30).

 

 

(7

)

 

 

205

 

 

 

514

 

 

 

771

 

Less: reclassification adjustment for securities gains included in

   net income (net of tax, $0 and $1 for both the three and nine months ended September 30).

 

 

 

 

 

 

 

 

 

 

 

4

 

Add: reclassification adjustment for amortization of unrealized

   losses on securities transferred from available for sale to held

   to maturity (net of tax, $1 and $2, respectively, for the three months ended September 30, and $4 and $5, respectively, for the nine months ended September 30).

 

 

5

 

 

 

6

 

 

 

15

 

 

 

17

 

Other comprehensive income (loss)

 

 

(2

)

 

 

211

 

 

 

529

 

 

 

792

 

Comprehensive Income

 

$

5,170

 

 

$

3,920

 

 

$

8,537

 

 

$

11,179

 

 

See Notes to the Unaudited Consolidated Financial Statements

5


 

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Stockholders’ Equity for the Three and Nine months ended September 30, 2020 and 2019 (Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

Other

 

 

 

 

 

 

 

Preferred

 

 

Common

 

 

Capital

 

 

Retained

 

 

Comprehensive

 

 

 

 

 

 

 

Stock

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Income (Loss)

 

 

Total

 

Balance, June 30, 2020

 

$

 

 

$

32,433

 

 

$

74,850

 

 

$

31,933

 

 

$

954

 

 

$

140,170

 

Preferred stock issued, net

 

 

27,527

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27,527

 

Common stock issued

 

 

 

 

 

16

 

 

 

37

 

 

 

 

 

 

 

 

 

53

 

Vesting of restricted stock

 

 

 

 

 

11

 

 

 

(11

)

 

 

 

 

 

 

 

 

 

Stock based compensation expense

 

 

 

 

 

 

 

 

341

 

 

 

 

 

 

 

 

 

341

 

Net income

 

 

 

 

 

 

 

 

 

 

 

5,172

 

 

 

 

 

 

5,172

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2

)

 

 

(2

)

Balance, September 30, 2020

 

$

27,527

 

 

$

32,460

 

 

$

75,217

 

 

$

37,105

 

 

$

952

 

 

$

173,261

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

Other

 

 

 

 

 

 

 

Preferred

 

 

Common

 

 

Capital

 

 

Retained

 

 

Comprehensive

 

 

 

 

 

 

 

Stock

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Income

 

 

Total

 

Balance, December 31, 2019

 

$

 

 

$

32,397

 

 

$

75,117

 

 

$

29,097

 

 

$

423

 

 

$

137,034

 

Preferred stock issued, net

 

 

27,527

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27,527

 

Common stock issued

 

 

 

 

 

31

 

 

 

75

 

 

 

 

 

 

 

 

 

106

 

Vesting of restricted stock

 

 

 

 

 

272

 

 

 

(272

)

 

 

 

 

 

 

 

 

 

Stock based compensation expense

 

 

 

 

 

 

 

 

1,047

 

 

 

 

 

 

 

 

 

1,047

 

Common stock repurchased

 

 

 

 

 

(240

)

 

 

(750

)

 

 

 

 

 

 

 

 

(990

)

Net income

 

 

 

 

 

 

 

 

 

 

 

8,008

 

 

 

 

 

 

8,008

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

529

 

 

 

529

 

Balance, September 30, 2020

 

$

27,527

 

 

$

32,460

 

 

$

75,217

 

 

$

37,105

 

 

$

952

 

 

$

173,261

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

Other

 

 

 

 

 

 

 

Common

 

 

Capital

 

 

Retained

 

 

Comprehensive

 

 

 

 

 

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Income

 

 

Total

 

Balance, June 30, 2019

 

$

32,387

 

 

$

74,609

 

 

$

21,826

 

 

$

214

 

 

$

129,036

 

Vesting of restricted stock

 

 

10

 

 

 

(10

)

 

 

 

 

 

 

 

 

 

Stock based compensation expense

 

 

 

 

 

261

 

 

 

 

 

 

 

 

 

261

 

Net income

 

 

 

 

 

 

 

 

3,709

 

 

 

 

 

 

3,709

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

211

 

 

 

211

 

Balance, September 30, 2019

 

$

32,397

 

 

$

74,860

 

 

$

25,535

 

 

$

425

 

 

$

133,217

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

Other

 

 

 

 

 

 

 

Common

 

 

Capital

 

 

Retained

 

 

Comprehensive

 

 

 

 

 

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Income (Loss)

 

 

Total

 

Balance, December 31, 2018

 

$

32,176

 

 

$

74,256

 

 

$

15,186

 

 

$

(367

)

 

$

121,251

 

Vesting of restricted stock

 

 

221

 

 

 

(221

)

 

 

 

 

 

 

 

 

 

Stock based compensation expense

 

 

 

 

 

787

 

 

 

 

 

 

 

 

 

787

 

Net income

 

 

 

 

 

 

 

 

10,387

 

 

 

 

 

 

10,387

 

Change related to restricted stock awards

 

 

 

 

 

38

 

 

 

(38

)

 

 

 

 

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

792

 

 

 

792

 

Balance, September 30, 2019

 

$

32,397

 

 

$

74,860

 

 

$

25,535

 

 

$

425

 

 

$

133,217

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to the Unaudited Consolidated Financial Statements

6


 

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows (Dollars in thousands)

 

For the nine months ended September 30,

 

2020

 

 

2019

 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

 

Net income

 

$

8,008

 

 

$

10,387

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation, amortization, and accretion, net

 

 

1,284

 

 

 

1,215

 

Deferred income tax benefit

 

 

(2,208

)

 

 

(240

)

Provision for loan losses

 

 

6,560

 

 

 

1,260

 

Writedown of other real estate owned

 

 

32

 

 

 

 

Stock based compensation expense

 

 

1,047

 

 

 

787

 

Income from bank owned life insurance

 

 

(595

)

 

 

(317

)

Subordinated debt amortization expense

 

 

22

 

 

 

22

 

Gain on disposal of premises and equipment

 

 

(36

)

 

 

(67

)

Gain on sale of available-for-sale securities

 

 

 

 

 

(5

)

Amortization of operating lease right-of-use assets

 

 

287

 

 

 

166

 

Change in:

 

 

 

 

 

 

 

 

Accrued interest receivable and other receivables

 

 

(3,159

)

 

 

(213

)

Other assets

 

 

(10,686

)

 

 

(8,301

)

Other liabilities

 

 

11,159

 

 

 

7,248

 

Net cash provided by operating activities

 

 

11,715

 

 

 

11,942

 

Cash Flows from Investing Activities

 

 

 

 

 

 

 

 

Activity in available-for-sale securities:

 

 

 

 

 

 

 

 

Payments

 

 

6,209

 

 

 

3,233

 

Maturities

 

 

160,000

 

 

 

84,844

 

Purchases

 

 

(191,968

)

 

 

(119,592

)

Activity in held-to-maturity securities:

 

 

 

 

 

 

 

 

Purchases

 

 

(1,005

)

 

 

 

Called

 

 

1,700

 

 

 

1,650

 

Purchases of restricted investment in bank stock

 

 

(1,222

)

 

 

(3,239

)

Redemption of restricted investment in bank stock

 

 

2,763

 

 

 

4,251

 

Purchases of bank owned life insurance

 

 

 

 

 

(5,000

)

Net increase in loan portfolio

 

 

(256,439

)

 

 

(77,951

)

Proceeds from sale of premises and equipment

 

 

51

 

 

 

77

 

Purchases of premises and equipment

 

 

(1,159

)

 

 

(706

)

Net cash used in investing activities

 

 

(281,070

)

 

 

(112,433

)

Cash Flows from Financing Activities

 

 

 

 

 

 

 

 

Net increase in non-interest deposits

 

 

163,941

 

 

 

6,338

 

Net increase in interest bearing demand, savings, and time deposits

 

 

181,481

 

 

 

138,089

 

Net decrease in Federal Home Loan Bank advances and other borrowings

 

 

(40,000

)

 

 

(30,000

)

Issuance of preferred stock, net

 

 

27,527

 

 

 

 

Issuance of common stock

 

 

106

 

 

 

 

Repurchases of common stock

 

 

(990

)

 

 

 

Net cash provided by financing activities

 

 

332,065

 

 

 

114,427

 

Increase in Cash and Cash Equivalents

 

 

62,710

 

 

 

13,936

 

Cash and Cash Equivalents, beginning of period

 

 

64,844

 

 

 

58,076

 

Cash and Cash Equivalents, end of period

 

$

127,554

 

 

$

72,012

 

Supplementary Disclosure of Cash Flow Information

 

 

 

 

 

 

 

 

Cash paid during the period for interest

 

$

12,803

 

 

$

14,223

 

Cash paid during the period for income taxes

 

$

2,255

 

 

$

3,019

 

Right of use assets obtained in exchange for new operating lease liabilities

 

$

 

 

$

2,647

 

Transfers from loans to other real estate owned

 

$

405

 

 

$

1,207

 

 

See Notes to the Unaudited Consolidated Financial Statements

7


 

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

Note 1. Organization, Basis of Presentation and Impact of Recently Issued Accounting Pronouncements

Organization

MainStreet Bancshares Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose principal activity is the ownership and management of MainStreet Bank. 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 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 shares of preferred stock on the Nasdaq Capital Market on the symbol “MNSBP” as of September 16, 2020.

MainStreet Bank (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 Bank. 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.

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, 2019 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 U.S. Securities and Exchange Commission on March 23, 2020. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020, or any other period.

Principles of Consolidation – The unaudited interim consolidated financial statements include accounts of the Company and its wholly-owned subsidiary, the Bank. All significant intercompany transactions and balances have been eliminated in consolidation.

Cash and cash equivalents – For the purpose of presentation in the Statements of Cash Flows, the Bank has defined cash and cash equivalents as those amounts included in the balance sheet captions “Cash and due from banks” and “Federal funds sold.”

Investment securities – The Bank’s investment securities are classified as either held to maturity, available for sale or trading. At September 30, 2020 and December 31, 2019, the Bank held approximately $23.1 million and $23.9 million, respectively, in securities classified as held to maturity. The Bank held no securities classified as trading. Municipal securities that were 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. At September 30, 2020 and December 31, 2019, the unamortized unrealized loss was $61,397 and $81,076, respectively, before tax, and remains in accumulated other comprehensive income, net of tax.

 

8


 

Securities which are not classified as held to maturity or trading are classified as securities available for sale. Securities available for sale are reported at fair value. Any unrealized gain or loss, net of applicable income taxes, is reported as a separate addition to or reduction from stockholders’ equity. Gains and losses arising from the sale of securities available for sale are recognized based on the specific identification method on a trade-date basis and included in results of operations.

Securities held to maturity include securities purchased with the ability and positive intent to hold to maturity. Debt securities are stated at historical cost adjusted for amortization of premiums and accretion of discount. Any investment security, for which there has been a value impairment deemed by management to be other than temporary, is written down to its estimated fair value with a charge to current operations.

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

Restricted equity securities consist of the Federal Reserve Bank of Richmond and Federal Home Loan Bank of Atlanta (“FHLB”) stock in the amount of $3.3 million and $1.1 million respectively, as of September 30, 2020, compared to $3.3 million and $2.7 million, respectively, as of December 31, 2019. Restricted equity securities also consisted of $126,800 in Community Bankers Bank stock at September 30, 2020 and December 31, 2019. This restricted stock is recorded at cost because its ownership is restricted and it lacks a market for resale. The Bank is required to maintain Federal Reserve Bank stock at a level of 6% of capital and surplus. The FHLB requires the Bank to maintain stock, at a minimum, in an amount equal to 4.5% of outstanding borrowings and 0.20% of total assets. When evaluating restricted stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Bank does not consider these investments to be impaired at September 30, 2020 or December 31, 2019 and no previous impairment has been recognized.

Loans - The Bank makes commercial and consumer loans to customers. Our recorded investment in loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are reported at their unpaid principal balances adjusted for charge-offs, unearned discounts, any deferred fees or costs on originated loans, and the allowance for loan losses. Interest on loans is credited to operations based on the principal amount outstanding. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the effective interest method. The Bank is amortizing these amounts over the contractual life of the related loans.

A loan’s past due status is based on the contractual due date of the most delinquent payment due. All loans which are 30 or more days past due at the end of the month are reported to the Board of Directors. Commercial loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Consumer loans are generally placed on nonaccrual status when the collection of principal or interest is 120 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. It is Bank policy to charge-off loans whose collectability is sufficiently questionable and can no longer be justified as an asset on the balance sheet. To determine if a loan should be charged-off, all possible sources of repayment are analysed, including: (1) the potential for future cash flow, (2) the value of the Bank’s collateral, and (3) the strength of co-makers or guarantors. All principal and previously accrued interest is charged to the allowance for loan losses. All future payments received on the loan are credited to the allowance for loan losses as a recovery. These policies are applied consistently across our loan portfolio.

Impairment of a loan - The Bank considers a loan impaired when it is probable that the Bank will be unable to collect all interest and principal payments as scheduled in the loan agreement. A loan is not considered impaired during a period of an insignificant delay in payment if the ultimate collectability of all amounts due is expected. Impairment is measured on a loan by loan basis for all commercial, construction and residential loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Consistent with the Bank’s method for nonaccrual loans, payments on impaired loans are first applied to principal outstanding. Smaller balance consumer loans are not individually evaluated for impairment.

9


 

Troubled Debt Restructuring (TDR) occurs when the Bank agrees to modify the original terms of a loan due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. Upon designation as a TDR, the Bank evaluates the borrower’s payment history, past due status and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Bank concludes that the borrower is able to continue making such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on nonaccrual status at the time of the TDR, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. As of September 30, 2020, and December 31, 2019, the Bank had $0 and $1.5 million of loans classified as TDR, respectively. At December 31, 2019, TDR loans consisted of one loan. For additional discussion see “Note 3. Loans Receivable” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Allowance for Loan Losses - The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when:

 

Management believes that the collectability of the principal is unlikely regardless of delinquency status.

 

The loan is a consumer loan and is 120 days past due.

 

The loan is a non-consumer loan, and is 90 days past due, unless the loan is well secured and recovery is probable.

 

The borrower is in bankruptcy, unless the debt has been reaffirmed, is well secured and recovery is probable.

Subsequent recoveries, if any, are credited to the allowance.

The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The evaluation also considers the following risk characteristics of each loan portfolio segment:

 

Real estate residential mortgage loans, including equity lines of credit, carry risks associated with the continued credit-worthiness of the borrower and the changes in the value of the collateral.

 

Real estate construction loans and land improvement carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

 

Commercial real estate loans carry risks of the client’s ability to repay the loan from the cash flow derived from the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate. Real estate security diminishes risks only to the extent that a market exists for the subject collateral. These risks are attempted to be mitigated by carefully underwriting loans of this type and by following appropriate loan-to-value standards.

 

Commercial and industrial loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.

 

Consumer secured loans (indirect lending) carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles). These risks are attempted to be mitigated by following appropriate loan-to-value standards and an experienced management team for this type of portfolio.

 

Consumer unsecured loans (credit cards) carry risks associated with the continued credit-worthiness of the borrower. Consumer unsecured loans are more likely to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.

10


 

The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with the relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when appropriate. The general component covers non-classified or performing loans and those loans classified as substandard or special mention that are not impaired. The general component is based on historical loss experience adjusted for qualitative factors, such as current economic conditions, including current home sales and foreclosures, unemployment rates and retail sales. Non-impaired classified loans are assigned a higher allowance factor based on an internal migration analysis, which increases with the severity of classification, than non-classified loans. The characteristics of the loan ratings are as follows:

 

Pass rated loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

 

Watch rated loans have all the characteristics of pass rated loans but show signs of emerging financial weaknesses which the Bank will continue monitoring more closely. Watch rated loans are still performing as agreed.

 

Special mention loans have a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history is characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

 

Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due.

 

Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high.

 

Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

Other Real Estate Owned (“OREO”) - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, and recent sales of like properties, length of time the properties have been held and our ability and intention with regard to continued ownership of the properties. The Bank may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further deterioration in market values. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets and improvements are capitalized.

Interest income on loans – Interest on loans is accrued and credited to income on daily balances of the principal amount outstanding. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed.

Generally, the Bank will return a loan to accrual status when all delinquent interest and principal becomes current and remains current for six consecutive months under the terms of the loan agreement or the loan is well-secured or in process of collection. Upon returning to accrual status, interest payments applied to the principal balance of a loan while in nonaccrual status are recognized as a yield adjustment over the remaining life.

Loan origination and commitment fees and certain related direct costs - Loan origination and commitment fees charged by the Bank and certain direct loan origination costs are deferred and the net amount is amortized as a yield adjustment. The Bank amortizes these net amounts over the life of the related loans or, in the case of demand loans, over the estimated life. Net fees related to standby letters of credit are recognized over the commitment period.

Premises and equipment – Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and amortization computed principally on the straight-line basis over the estimated useful life of each asset, which ranges from 3 to 39 years. Leasehold improvements are amortized over the shorter of the related lease term or the estimated useful lives of the improvements. Construction in progress includes assets which will be reclassified and depreciated once placed into service.

11


 

Income taxes The Bank uses an asset and liability approach in financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. The principal items relate primarily to differences between the allowance for loan losses, deferred loan fees, and accumulated depreciation and amortization. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense (benefit) is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. As of September 30, 2020, and December 31, 2019, there were no such liabilities recorded.

 

Interest and penalties associated with unrecognized tax benefits, if any, would be classified as additional income taxes in the statement of operations.

Comprehensive income – Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although, certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Stock compensation plans Stock compensation accounting guidance (FASB ASC 718, “Compensation – Stock Compensation”) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued.

The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the market price of the Bank’s common stock at the date of grant is used for restricted stock awards. No stock options were granted during 2020 and 2019.

Earnings per share Net income per common share has been determined under the provisions of FASB ASC 260, “Earnings Per Share” and has been computed based on the weighted average common shares outstanding during the quarter and nine months ended September 30, (8,272,570 and 8,274,419, respectively, for 2020 and 8,251,672 and 8,248,284, respectively, for 2019). Diluted earnings per share reflect additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.

The only potential dilutive stock of the Company as defined in FASB ASC 260 would be stock options granted to various directors, officers, and employees of the Company. There were no such options outstanding at September 30, 2020 or December 31, 2019. Restricted stock is included in the computation of basic earnings per share as the holder is entitled to full benefits of a stockholder during the vesting period.

Off-balance sheet instruments – In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded, or related fees are incurred or received.

Advertising and marketing expense – Advertising and marketing costs are expensed as incurred.

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, (2) fair value of financial instruments, (3) derivative financial instruments, (4) income taxes, and (5) other real estate owned. 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.

12


 

Fair value of financial instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Derivative Financial Instruments – The Company recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated balance sheet. The Company’s derivative financial instruments include interest rate swaps with certain qualifying commercial loan customers and dealer counterparties. Because the interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Company’s interest rate swaps with loan customers and dealer counterparties are described more fully in Note 4.

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

 

Revenue Recognition

During 2018, the Company adopted Accounting Standards Update (ASU) 2014-09, “Revenue from Contracts with Customers (Topic 606),” and all amendments thereto (collectively, ASU 2014-09), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain/loss from the transfer of nonfinancial assets, such as other real estate owned (OREO). The Company adopted ASU 2014-09 using the modified retrospective method applied to all contracts not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASU 2014-09. The adoption of ASU 2014-09 did not result in a change to the accounting for any of the in-scope revenue streams; therefore, no cumulative effect adjustment was recorded.

 

Most revenue associated with the Company’s financial instruments, including interest income and gains/losses on investment securities, derivatives and sales of financial instruments are outside the scope of ASU 2014-09. The Company’s services that fall within the scope of ASU 2014-09 are presented within noninterest income and are recognized as revenue. A description of the primary revenue streams accounted for under ASU 2014-09 follows:

Service Charges on Deposit Accounts. The Company earns fees from its deposit customers for overdraft and account maintenance services. Overdraft fees are recognized when the overdraft occurs. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the company satisfies the performance obligation.

Other Service Charges and Fees. The Company earns fees from its customers for transaction-based services. Such services include safe deposit box, ATM, stop payment, wire transfer, Small Business Administration (“SBA”) loan originations and mortgage originations. In each case, these service charges and fees are recognized in income at the time or within the same period that the Company’s performance obligation is satisfied.

Interchange Income. The Company earns interchange fees from debit and credit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services.

Swap Fee Income. The Company earns fees from certain qualifying commercial loan customers for entering into interest rate swaps in order for the customer to receive a fixed rate of interest while the Company receives a floating rate. In each case, there are fees that are recognized in income as the time or within the same period that the Company’s performance obligation is satisfied.

 

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 U.S. Securities and Exchange Commission (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.  

13


 

 

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 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.  For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years.  Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-12 will have on its 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. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years.  Early adoption is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its consolidated financial statements.

 

In March 2020, the Financial Accounting Standards Board (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. 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.

 

On March 12, 2020, the SEC finalized amendments to the definitions of its “accelerated filer” and “large accelerated filer” definitions. The amendments increase the threshold criteria for meeting these filer classifications and are effective on April 27, 2020. Any changes in filer status are to be applied beginning with the filer’s first annual report filed with the SEC subsequent to the effective date. The rule change expands the definition of “smaller reporting companies” to include entities with public float of less than $700 million and less than $100 million in annual revenues. The Company expects to meet this expanded category of smaller reporting company and should not be considered an accelerated filer.  If the Company’s annual revenues exceed $100 million, its category will change to “accelerated filer”.  The classifications of “accelerated filer” and “large accelerated filer” require a public company to obtain an auditor attestation concerning the effectiveness of internal control over financial reporting (ICFR) and include the opinion on ICFR in its annual report on Form 10-K.  Smaller reporting companies also have additional time to file quarterly and annual financial statements. All public companies are required to obtain and file annual financial statement audits, as well as provide management’s assertion on effectiveness of internal control over financial reporting, but the external auditor attestation of internal control over financial reporting is not required for smaller reporting companies.  The Company has total assets exceeding $1.0 billion and remains subject to Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), which requires an auditor attestation concerning internal controls over financial reporting.  As such, other than the additional time provided to file quarterly and annual financial statements, this change would not significantly change the Company’s annual reporting and audit requirements.

 

In March 2020 (Revised in April 2020), various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus pandemic. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” (“ASC 310-40”), a restructuring of debt constitutes a troubled debt restructuring (“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 agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance is expected to have a material impact on the Company’s financial statements as modifications were needed to ensure our borrowers had some relief; however, this impact cannot be quantified at this time.  

14


 

 

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 reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years.  Early adoption is not permitted. All entities should apply ASU No. 2020-08 on a prospective basis as of the beginning of the period of adoption for existing or newly purchased callable debt securities. The Company does not expect the adoption of ASU 2020-06 would have a material impact on its consolidated financial statements.

Note 2. Investment Securities

Investment securities available-for-sale was comprised of the following:

 

 

 

September 30, 2020

 

(Dollars in thousands)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair Value

 

U.S. Treasury Securities

 

$

75,000

 

 

$

 

 

$

 

 

$

75,000

 

Collateralized Mortgage Backed

 

 

12,306

 

 

 

339

 

 

 

(2

)

 

 

12,643

 

Subordinated Debt

 

 

3,000

 

 

 

54

 

 

 

(1

)

 

 

3,053

 

Municipal Securities

 

 

20,337

 

 

 

1,072

 

 

 

(39

)

 

 

21,370

 

U.S. Governmental Agencies

 

 

6,941

 

 

 

 

 

 

(163

)

 

 

6,778

 

Total

 

$

117,584

 

 

$

1,465

 

 

$

(205

)

 

$

118,844

 

 

Investment securities held-to-maturity was comprised of the following:

 

 

 

September 30, 2020

 

(Dollars in thousands)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair Value

 

Municipal Securities

 

$

20,609

 

 

$

1,021

 

 

$

 

 

$

21,630

 

Subordinated Debt

 

 

2,505

 

 

 

 

 

 

 

 

 

2,505

 

Total

 

$

23,114

 

 

$

1,021

 

 

$

 

 

$

24,135

 

 

Investment securities available-for-sale was comprised of the following:

 

 

 

December 31, 2019

 

(Dollars in thousands)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair Value

 

U.S. Treasury Securities

 

$

49,999

 

 

$

 

 

$

(1

)

 

$

49,998

 

Collateralized Mortgage Backed

 

 

17,659

 

 

 

82

 

 

 

(68

)

 

 

17,673

 

Subordinated Debt

 

 

2,500

 

 

 

55

 

 

 

(1

)

 

 

2,554

 

Municipal Securities

 

 

13,888

 

 

 

743

 

 

 

 

 

 

14,631

 

U.S. Governmental Agencies

 

 

8,135

 

 

 

 

 

 

(200

)

 

 

7,935

 

Total

 

$

92,181

 

 

$

880

 

 

$

(270

)

 

$

92,791

 

 

Investment securities held-to-maturity was comprised of the following:

 

 

 

December 31, 2019

 

(Dollars in thousands)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair Value

 

Municipal Securities

 

$

22,414

 

 

$

766

 

 

$

(2

)

 

$

23,178

 

Subordinated Debt

 

 

1,500

 

 

 

 

 

 

 

 

 

1,500

 

Total

 

$

23,914

 

 

$

766

 

 

$

(2

)

 

$

24,678

 

 

15


 

The scheduled maturities of securities available-for-sale and held-to-maturity at September 30, 2020 were as follows:

 

 

 

September 30, 2020

 

 

 

Available-for-Sale

 

 

Held-to-Maturity

 

(Dollars in thousands)

 

Amortized

Cost

 

 

Fair Value

 

 

Amortized

Cost

 

 

Fair Value

 

Due in one year or less

 

$

75,002

 

 

$

75,002

 

 

$

 

 

$

 

Due from one to five years

 

 

 

 

 

 

 

 

2,014

 

 

 

2,061

 

Due from after five to ten years

 

 

4,011

 

 

 

4,091

 

 

 

9,416

 

 

 

9,868

 

Due after ten years

 

 

38,571

 

 

 

39,751

 

 

 

11,684

 

 

 

12,206

 

Total

 

$

117,584

 

 

$

118,844

 

 

$

23,114

 

 

$

24,135

 

 

Securities with a fair value of $269,526 and $267,899 at September 30, 2020 and December 31, 2019, respectively, were pledged to secure FHLB advances.

There were no securities sold from the available-for-sale portfolio for the nine months ended September 30, 2020 and seven securities sold from the same portfolio for the nine months ended September 30, 2019. Of the seven securities sold during 2019; four were sold at a loss of $18,000 and there were three sold at a gain of $23,000 for a net gain of $5,000.

The following tables summarize the unrealized loss positions of securities available-for-sale and held-to-maturity as of September 30, 2020 and December 31, 2019:

 

 

 

September 30, 2020

 

 

 

Less than 12 Months

 

 

12 Months or Longer

 

 

Total

 

(Dollars in thousands)

 

Fair

Value

 

 

Unrealized

Loss

 

 

Fair

Value

 

 

Unrealized

Loss

 

 

Fair

Value

 

 

Unrealized

Loss

 

Available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized Mortgage Backed

 

$

52

 

 

$

(2

)

 

$

 

 

$

 

 

$

52

 

 

$

(2

)

Subordinated Debt

 

 

499

 

 

 

(1

)

 

 

 

 

 

 

 

 

499

 

 

 

(1

)

Municipal securities

 

 

4,296

 

 

 

(39

)

 

 

 

 

 

 

 

 

4,296

 

 

 

(39

)

U.S Governmental Agencies

 

 

 

 

 

 

 

 

6,778

 

 

 

(163

)

 

 

6,778

 

 

 

(163

)

Total

 

$

4,847

 

 

$

(42

)

 

$

6,778

 

 

$

(163

)

 

$

11,625

 

 

$

(205

)

 

 

 

December 31, 2019

 

 

 

Less than 12 Months

 

 

12 Months or Longer

 

 

Total

 

(Dollars in thousands)

 

Fair

Value

 

 

Unrealized

Loss

 

 

Fair

Value

 

 

Unrealized

Loss

 

 

Fair

Value

 

 

Unrealized

Loss

 

Available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Securities

 

$

49,998

 

 

$

(1

)

 

$

 

 

$

 

 

$

49,998

 

 

$

(1

)

Collateralized Mortgage Backed

 

 

6,223

 

 

 

(67

)

 

 

834

 

 

 

(1

)

 

 

7,057

 

 

 

(68

)

Subordinated Debt

 

 

499

 

 

 

(1

)

 

 

 

 

 

 

 

 

499

 

 

 

(1

)

U.S Government Agencies

 

 

 

 

 

 

 

 

7,857

 

 

 

(200

)

 

 

7,857

 

 

 

(200

)

Total

 

$

56,720

 

 

$

(69

)

 

$

8,691

 

 

$

(201

)

 

$

65,411

 

 

$

(270

)

Held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal Securities

 

$

537

 

 

$

(2

)

 

$

 

 

$

 

 

$

537

 

 

$

(2

)

Total

 

$

537

 

 

$

(2

)

 

$

 

 

$

 

 

$

537

 

 

$

(2

)

 

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.

16


 

At September 30, 2020, there were two collateralized mortgage backed securities with fair values totaling $52,000 in an unrealized loss position of less than 12 months. At September 30, 2020 one subordinated debt security with a fair value totaling approximately $499,000 was in an unrealized loss position of less than 12 months. At September 30, 2020 three municipal securities with fair values totaling approximately $4.3 million were in an unrealized loss position of less than 12 months. At September 30, 2020 nine U.S. government agencies with fair values totaling approximately $6.7 million were in an unrealized loss position of more than 12 months. At September 30, 2020, 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, 2020 and December 31, 2019.

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, 2020 and December 31, 2019 was $61,397 and $81,076, respectively.

Note 3. Loans Receivable

Loans receivable were comprised of the following:

 

(Dollars in thousands)

 

September 30,

2020

 

 

December 31,

2019

 

Residential Real Estate:

 

 

 

 

 

 

 

 

Single family

 

$

139,730

 

 

$

143,535

 

Multifamily

 

 

16,922

 

 

 

6,512

 

Farmland

 

 

866

 

 

 

801

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

Owner-occupied

 

 

134,012

 

 

 

134,116

 

Non-owner occupied

 

 

371,189

 

 

 

287,754

 

Construction and Land Development

 

 

325,516

 

 

 

272,620

 

Commercial – Non Real-Estate:

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

261,959

 

 

 

121,225

 

Consumer – Non Real-Estate:

 

 

 

 

 

 

 

 

Unsecured

 

 

522

 

 

 

599

 

Secured

 

 

50,983

 

 

 

74,984

 

Total Gross Loans

 

 

1,301,699

 

 

 

1,042,146

 

Less: unearned fees

 

 

(7,451

)

 

 

(2,118

)

Less: unamortized discount on consumer secured loans

 

 

(3

)

 

 

(19

)

Less: allowance for loan losses

 

 

(14,346

)

 

 

(9,584

)

Net Loans

 

$

1,279,899

 

 

$

1,030,425

 

 

The unsecured consumer loans above include $54,000 and $599,000 of overdrafts reclassified as loans at September 30, 2020 and December 31, 2019, respectively.

 

The commercial and industrial loans above include $173.1 million and $0 in Paycheck Protection Program loans at September 30, 2020 and December 31, 2019, respectively.

The Company held no loans for sale at September 30, 2020 and December 31, 2019.

The following tables summarize the activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2020 and 2019.

17


 

Allowance for Credit Losses By Portfolio Segment

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30, 2020

 

Residential

 

 

Commercial

 

 

Construction

 

 

Consumer

 

 

Commercial

 

 

Total

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Balance

 

$

1,084

 

 

$

7,023

 

 

$

2,873

 

 

$

1,330

 

 

$

1,421

 

 

$

13,731

 

Charge-offs

 

 

 

 

 

 

 

 

 

 

 

(35

)

 

 

 

 

 

(35

)

Recoveries

 

 

 

 

 

 

 

 

 

 

 

5

 

 

 

10

 

 

 

15

 

Provision

 

 

14

 

 

 

114

 

 

 

466

 

 

 

(191

)

 

 

232

 

 

 

635

 

Ending Balance

 

$

1,098

 

 

$

7,137

 

 

$

3,339

 

 

$

1,109

 

 

$

1,663

 

 

$

14,346

 

Ending Balance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for Impairment

 

$

 

 

$

 

 

$

 

 

$

 

 

$

329

 

 

$

329

 

Collectively evaluated for Impairment

 

$

1,098

 

 

$

7,137

 

 

$

3,339

 

 

$

1,109

 

 

$

1,334

 

 

$

14,017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the nine months ended September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Balance

 

$

1,030

 

 

$

4,254

 

 

$

2,180

 

 

$

568

 

 

$

1,552

 

 

$

9,584

 

Charge-offs

 

 

 

 

 

(1

)

 

 

 

 

 

(35

)

 

 

(1,793

)

 

 

(1,829

)

Recoveries

 

 

 

 

 

 

 

 

 

 

 

8

 

 

 

23

 

 

 

31

 

Provision

 

 

68

 

 

 

2,884

 

 

 

1,159

 

 

 

568

 

 

 

1,881

 

 

 

6,560

 

Ending Balance

 

$

1,098

 

 

$

7,137

 

 

$

3,339

 

 

$

1,109

 

 

$

1,663

 

 

$

14,346

 

Ending Balance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for Impairment

 

$

 

 

$

 

 

$

 

 

$

 

 

$

329

 

 

$

329

 

Collectively evaluated for Impairment

 

$

1,098

 

 

$

7,137

 

 

$

3,339

 

 

$

1,109

 

 

$

1,334

 

 

$

14,017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30, 2019

 

Residential

 

 

Commercial

 

 

Construction

 

 

Consumer

 

 

Commercial

 

 

Total

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Balance

 

$

1,220

 

 

$

4,026

 

 

$

1,689

 

 

$

907

 

 

$

1,343

 

 

$

9,185

 

Charge-offs

 

 

 

 

 

 

 

 

 

 

 

(28

)

 

 

 

 

 

(28

)

Recoveries

 

 

28

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

28

 

Provision

 

 

30

 

 

 

80

 

 

 

38

 

 

 

21

 

 

 

16

 

 

 

185

 

Ending Balance

 

$

1,278

 

 

$

4,106

 

 

$

1,727

 

 

$

900

 

 

$

1,359

 

 

$

9,370

 

Ending Balance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for Impairment

 

$

 

 

$

 

 

$

 

 

$

 

 

$

102

 

 

$

102

 

Collectively evaluated for Impairment

 

$

1,278

 

 

$

4,106

 

 

$

1,727

 

 

$

900

 

 

$

1,257

 

 

$

9,268

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the nine months ended September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Balance

 

$

1,019

 

 

$

4,299

 

 

$

1,469

 

 

$

826

 

 

$

1,218

 

 

$

8,831

 

Charge-offs

 

 

 

 

 

(733

)

 

 

 

 

 

(50

)

 

 

 

 

 

(783

)

Recoveries

 

 

58

 

 

 

 

 

 

 

 

 

4

 

 

 

 

 

 

62

 

Provision

 

 

201

 

 

 

540

 

 

 

258

 

 

 

120

 

 

 

141

 

 

 

1,260

 

Ending Balance

 

$

1,278

 

 

$

4,106

 

 

$

1,727

 

 

$

900

 

 

$

1,359

 

 

$

9,370

 

Ending Balance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for Impairment

 

$

 

 

$

 

 

$

 

 

$

 

 

$

102

 

 

$

102

 

Collectively evaluated for Impairment

 

$

1,278

 

 

$

4,106

 

 

$

1,727

 

 

$

900

 

 

$

1,257

 

 

$

9,268

 

 

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.

18


 

The following tables summarize information in regards to the recorded investment in loans receivable by loan class as of September 30, 2020 and December 31, 2019:

 

September 30, 2020

 

Loans Receivable

 

(Dollars in thousands)

 

Ending

Balance

 

 

Ending

Balance:

Individually

Evaluated

for

Impairment

 

 

Ending

Balance:

Collectively

Evaluated

for

Impairment

 

Residential Real Estate

 

$

157,518

 

 

$

299

 

 

$

157,219

 

Commercial Real Estate

 

 

505,201

 

 

 

1,097

 

 

 

504,104

 

Construction and Land Development

 

 

325,516

 

 

 

 

 

 

325,516

 

Commercial & Industrial

 

 

261,959

 

 

 

517

 

 

 

261,442

 

Consumer

 

 

51,505

 

 

 

107

 

 

 

51,398

 

Total

 

$

1,301,699

 

 

$

2,020

 

 

$

1,299,679

 

 

December 31, 2019

 

Loans Receivable

 

(Dollars in thousands)

 

Ending

Balance

 

 

Ending

Balance:

Individually

Evaluated

for

Impairment

 

 

Ending

Balance:

Collectively

Evaluated

for

Impairment

 

Residential Real Estate

 

$

150,848

 

 

$

1,482

 

 

$

149,366

 

Commercial Real Estate

 

 

421,870

 

 

 

 

 

 

421,870

 

Construction and Land Development

 

 

272,620

 

 

 

 

 

 

272,620

 

Commercial & Industrial

 

 

121,225

 

 

 

 

 

 

121,225

 

Consumer

 

 

75,583

 

 

 

 

 

 

75,583

 

Total

 

$

1,042,146

 

 

$

1,482

 

 

$

1,040,664

 

 

The following table summarizes information in regard to impaired loans by loan portfolio class as of September 30, 2020 and December 31, 2019:

 

 

 

September 30, 2020

 

 

December 31, 2019

 

(Dollars in thousands)

 

Recorded

Investment

 

 

Unpaid

Principal

Balance

 

 

Related

Allowance

 

 

Recorded

Investment

 

 

Unpaid

Principal

Balance

 

 

Related

Allowance

 

With no related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single family

 

$

299

 

 

$

299

 

 

$

 

 

$

1,482

 

 

$

1,482

 

 

$

 

Commercial Real Estate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-owner Occupied

 

 

1,097

 

 

 

1,097

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

46

 

 

 

46

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

 

107

 

 

 

107

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,549

 

 

 

1,549

 

 

 

 

 

 

1,482

 

 

 

1,482

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

$

471

 

 

$

471

 

 

$

329

 

 

$

 

 

$

 

 

$

 

Total

 

$

2,020

 

 

$

2,020

 

 

$

329

 

 

$

1,482

 

 

$

1,482

 

 

$

 

 

19


 

The following table presents additional information regarding the impaired loans for the three and nine months ended September 30, 2020:

 

 

 

Three Months Ended September 30,

 

 

 

2020

 

 

2019

 

(Dollars in thousands)

 

Average

Record

Investment

 

 

Interest

Income

Recognized

 

 

Average

Record

Investment

 

 

Interest

Income

Recognized

 

With no related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single family

 

$

301

 

 

$

2

 

 

$

1,491

 

 

$

10

 

Commercial Real Estate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-owner Occupied

 

 

1,097

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

253

 

 

 

1

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

 

115

 

 

 

2

 

 

 

 

 

 

 

Total

 

 

1,766

 

 

 

5

 

 

 

1,491

 

 

 

10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

$

268

 

 

$

8

 

 

$

102

 

 

$

 

Total

 

$

2,034

 

 

$

13

 

 

$

1,593

 

 

$

10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

2020

 

 

2019

 

(Dollars in thousands)

 

Average

Record

Investment

 

 

Interest

Income

Recognized

 

 

Average

Record

Investment

 

 

Interest

Income

Recognized

 

With no related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single family

 

$

305

 

 

$

7

 

 

$

1,499

 

 

$

41

 

Commercial Real Estate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-owner Occupied

 

 

1,099

 

 

 

17

 

 

 

 

 

 

 

Commercial & Industrial

 

 

357

 

 

 

10

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

 

129

 

 

 

6

 

 

 

 

 

 

 

Total

 

 

1,890

 

 

 

40

 

 

 

1,499

 

 

 

41

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

$

167

 

 

$

9

 

 

$

105

 

 

$

4

 

Total

 

$

2,057

 

 

$

49

 

 

$

1,499

 

 

$

45

 

 

If interest on nonaccrual loans had been accrued, such income would have been $71,549 and $0 for the nine months ended September 30, 2020 and 2019.

The following table presents nonaccrual loans by classes of the loan portfolio as of September 30, 2020 and December 31, 2019:

 

(Dollars in thousands)

 

September 30,

2020

 

 

December 31,

2019

 

Residential Real Estate

 

 

 

 

 

 

 

 

Single family

 

$

145

 

 

$

 

Commercial Real Estate

 

 

 

 

 

 

 

 

Non-owner occupied

 

 

1,097

 

 

 

 

Total

 

$

1,242

 

 

$

 

20


 

 

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, on the basis of 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, 2020 and December 31, 2019:

 

 

 

September 30, 2020

 

(Dollars in thousands)

 

Pass

 

 

Watch

 

 

Special

Mention

 

 

Substandard

 

 

Total

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single Family

 

$

138,326

 

 

$

 

 

$

741

 

 

$

663

 

 

$

139,730

 

Multifamily

 

 

16,922

 

 

 

 

 

 

 

 

 

 

 

 

16,922

 

Farmland

 

 

866

 

 

 

 

 

 

 

 

 

 

 

 

866

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

134,012

 

 

 

 

 

 

 

 

 

 

 

 

134,012

 

Non-owner occupied

 

 

370,092

 

 

 

 

 

 

 

 

 

1,097

 

 

 

371,189

 

Construction & Land Development

 

 

324,932

 

 

 

 

 

 

 

 

 

584

 

 

 

325,516

 

Commercial – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

257,951

 

 

 

3,027

 

 

 

141

 

 

 

840

 

 

 

261,959

 

Consumer – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unsecured

 

 

522

 

 

 

 

 

 

 

 

 

 

 

 

522

 

Secured

 

 

50,877

 

 

 

 

 

 

 

 

 

106

 

 

 

50,983

 

Total

 

$

1,294,500

 

 

$

3,027

 

 

$

882

 

 

$

3,290

 

 

$

1,301,699

 

 

 

 

December 31, 2019

 

(Dollars in thousands)

 

Pass

 

 

Watch

 

 

Special

Mention

 

 

Substandard

 

 

Total

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single Family

 

$

143,019

 

 

$

 

 

$

 

 

$

516

 

 

$

143,535

 

Multifamily

 

 

6,512

 

 

 

 

 

 

 

 

 

 

 

 

6,512

 

Farmland

 

 

801

 

 

 

 

 

 

 

 

 

 

 

 

801

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

133,966

 

 

 

 

 

 

 

 

 

150

 

 

 

134,116

 

Non-owner occupied

 

 

287,754

 

 

 

 

 

 

 

 

 

 

 

 

287,754

 

Construction & Land Development

 

 

272,620

 

 

 

 

 

 

 

 

 

 

 

 

272,620

 

Commercial – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

109,106

 

 

 

3,772

 

 

$

5,685

 

 

 

2,662

 

 

 

121,225

 

Consumer – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unsecured

 

 

599

 

 

 

 

 

 

 

 

 

 

 

 

599

 

Secured

 

 

74,984

 

 

 

 

 

 

 

 

 

 

 

 

74,984

 

Total

 

$

1,029,361

 

 

$

3,772

 

 

$

5,685

 

 

$

3,328

 

 

$

1,042,146

 

 

21


 

The following tables present the segments of the loan portfolio summarized by aging categories as of September 30, 2020 and December 31, 2019:

 

 

 

September 30, 2020

 

(Dollars in thousands)

 

30-59

Days Past

Due

 

 

60-89

Days Past

Due

 

 

Greater

than 90

Days

 

 

Total Past

Due

 

 

Current

 

 

Total

Loans

Receivable

 

 

Nonaccrual

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single Family

 

$

365

 

 

$

 

 

$

 

 

$

365

 

 

$

139,365

 

 

$

139,730

 

 

$

145

 

Multifamily

 

 

 

 

 

 

 

 

 

 

 

 

 

 

16,922

 

 

 

16,922

 

 

 

 

Farmland

 

 

 

 

 

 

 

 

 

 

 

 

 

 

866

 

 

 

866

 

 

 

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 

 

 

 

 

 

 

 

 

 

 

 

134,012

 

 

 

134,012

 

 

 

 

Non-owner occupied

 

 

 

 

 

 

 

 

1,097

 

 

 

1,097

 

 

 

370,092

 

 

 

371,189

 

 

 

1,097

 

Construction & Land Development

 

 

 

 

 

584

 

 

 

 

 

 

584

 

 

 

324,932

 

 

 

325,516

 

 

 

 

Commercial – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

261,959

 

 

 

261,959

 

 

 

 

Consumer – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unsecured

 

 

 

 

 

 

 

 

 

 

 

 

 

 

522

 

 

 

522

 

 

 

 

Secured

 

 

18

 

 

 

13

 

 

 

 

 

 

31

 

 

 

50,952

 

 

 

50,983

 

 

 

 

Total

 

$

383

 

 

$

597

 

 

$

1,097

 

 

$

2,077

 

 

$

1,299,622

 

 

$

1,301,699

 

 

$

1,242

 

 

 

 

December 31, 2019

 

(Dollars in thousands)

 

30-59

Days Past

Due

 

 

60-89

Days Past

Due

 

 

Greater

than 90

Days

 

 

Total Past

Due

 

 

Current

 

 

Total

Loans

Receivable

 

 

Nonaccrual

 

Residential Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Single Family

 

$

 

 

$

 

 

$

 

 

$

 

 

$

143,535

 

 

$

143,535

 

 

$

 

Multifamily

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6,512

 

 

 

6,512

 

 

 

 

Farmland

 

 

 

 

 

 

 

 

 

 

 

 

 

 

801

 

 

 

801

 

 

 

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 

 

 

150

 

 

 

 

 

 

150

 

 

 

133,966

 

 

 

134,116

 

 

 

 

Non-owner occupied

 

 

 

 

 

 

 

 

 

 

 

 

 

 

287,754

 

 

 

287,754

 

 

 

 

Construction & Land Development

 

 

 

 

 

 

 

 

 

 

 

 

 

 

272,620

 

 

 

272,620

 

 

 

 

Commercial – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

121,225

 

 

 

121,225

 

 

 

 

Consumer – Non Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unsecured

 

 

 

 

 

 

 

 

 

 

 

 

 

 

599

 

 

 

599

 

 

 

 

Secured

 

 

124

 

 

 

 

 

 

 

 

 

124

 

 

 

74,860

 

 

 

74,984

 

 

 

 

Total

 

$

124

 

 

$

150

 

 

$

 

 

$

274

 

 

$

1,041,872

 

 

$

1,042,146

 

 

$

 

 

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 of time, generally six months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

 

Forbearance not automatically a Troubled Debt Restructuring (TDR)

On March 9, 2020, the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Consumer Financial Protection Bureau, National Credit Union Administration, and Conference of State Bank Supervisors issued a joint statement to financial institutions urging them to work constructively with borrowers and other customers affected by COVID-19.  

 

Since then, the agencies provided additional guidance and the CARES Act was signed into law.  Together, they offer these key takeaways:

 

22


 

Working with Customers

The agencies encourage financial institutions to work prudently and pro-actively with borrowers – consistent with "safe and sound" practices – who are or may be unable to meet their payment obligations because of the effects of COVID-19. The agencies view loan modification programs as positive actions to mitigate adverse effects on borrowers due to COVID-19. The agencies will not criticize institutions for working with borrowers and will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings ("TDRs").

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 suspension applies during the modification.  A modification can be a forbearance agreement, a new repayment plan, interest rate modification, or any other arrangement that defers or delays the payment of principal or interest.  This provision applies only to loans that were current – less than 30 days past due on payments – as of December 31, 2019. 

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, 2020, and December 31, 2019, the Company had TDRs totaling $0 and $1.5 million, respectively. At December 31, 2019, the Company had one TDR which was performing in compliance with the restructured terms and on accrual status. During the nine months ended September 30, 2020, the Bank removed the TDR designation from its only TDR loan after it was modified in accordance with applicable guidance.  

 

The following table details the Company’s TDRs that are on accrual status and non-accrual status at September 30, 2020:

 

 

 

As of September 30, 2020

 

(Dollars in thousands)

 

Number

Of Loans

 

 

Accrual

Status

 

 

Non-

Accrual

Status

 

 

Total TDRs

 

Total

 

 

 

 

$

 

 

$

 

 

$

 

 

The following table details the Company’s TDRs that are on accrual status and non-accrual status at December 31, 2019:

 

 

 

As of December 31, 2019

 

(Dollars in thousands)

 

Number

Of Loans

 

 

Accrual

Status

 

 

Non-

Accrual

Status

 

 

Total TDRs

 

Residential Real Estate

 

 

1

 

 

$

1,482

 

 

$

 

 

$

1,482

 

Total

 

 

1

 

 

$

1,482

 

 

$

 

 

$

1,482

 

 

 

Note 4. Derivatives and Risk Management Activities

The Bank uses derivative financial instruments (or “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 (or “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.

23


 

The following tables summarize key elements of the Banks’s derivative instruments as of September 30, 2020 and December 31, 2019.

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer-related interest rate

contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars in thousands)

 

Notional

Amount

 

 

Positions

 

 

Assets

 

 

Liabilities

 

 

Collateral

Pledges

 

Matched interest rate swap with borrower

 

$

175,807

 

 

 

32

 

 

$

13,967

 

 

 

 

 

$

15,120

 

Matched interest rate swap with counterparty

 

$

175,807

 

 

 

32

 

 

 

 

 

$

13,967

 

 

$

15,120

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer-related interest rate

contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars in thousands)

 

Notional

Amount

 

 

Positions

 

 

Assets

 

 

Liabilities

 

 

Collateral

Pledges

 

Matched interest rate swap with borrower

 

$

71,860

 

 

 

12

 

 

$

4,039

 

 

 

 

 

$

6,400

 

Matched interest rate swap with counterparty

 

$

71,860

 

 

 

12

 

 

 

 

 

$

4,039

 

 

$

6,400

 

 

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, 2020 was $1.9 million and $2.7 million, respectively. Interest rate swap income for the same periods for 2019 were $407,000 and $878,000, respectively.

Note 5. 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, 2020, and December 31, 2019, the Bank’s entire portfolio of available for sale securities are considered to be Level 2 securities.

24


 

Derivative asset (liability) – interest rate swaps on loans

As discussed in “Note 4: 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, 2020 and December 31, 2019:

 

 

 

September 30, 2020

 

(Dollars in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Securities

 

$

 

 

$

75,000

 

 

$

 

 

$

75,000

 

Collateralized Mortgage Backed

 

 

 

 

 

12,643

 

 

 

 

 

 

12,643

 

Subordinated Debt

 

 

 

 

 

3,053

 

 

 

 

 

 

3,053

 

Municipal Securities

 

 

 

 

 

21,370

 

 

 

 

 

 

21,370

 

U.S. Government Agencies

 

 

 

 

 

6,778

 

 

 

 

 

 

6,778

 

Derivative asset – interest rate swap on loans

 

 

 

 

 

13,967

 

 

 

 

 

 

13,967

 

Total

 

$

 

 

$

132,811

 

 

$

 

 

$

132,811

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liability – interest rate swap on loans

 

 

 

 

 

13,967

 

 

 

 

 

 

13,967

 

Total

 

$

 

 

$

13,967

 

 

$

 

 

$

13,967

 

 

 

 

December 31, 2019

 

(Dollars in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Securities

 

$

 

 

$

49,998

 

 

$

 

 

$

49,998

 

Collateralized Mortgage Backed

 

 

 

 

 

17,673

 

 

 

 

 

 

17,673

 

Subordinated Debt

 

 

 

 

 

2,554

 

 

 

 

 

 

2,554

 

Municipal Securities

 

 

 

 

 

14,631

 

 

 

 

 

 

14,631

 

U.S. Government Agencies

 

 

 

 

 

7,935

 

 

 

 

 

 

7,935

 

Derivative asset – interest rate swap on loans

 

 

 

 

 

4,039

 

 

 

 

 

 

4,039

 

Total

 

$

 

 

$

96,830

 

 

$

 

 

$

96,830

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liability – interest rate swap on loans

 

 

 

 

 

4,039

 

 

 

 

 

 

4,039

 

Total

 

$

 

 

$

4,039

 

 

$

 

 

$

4,039

 

 

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. The vast majority 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.

 

25


 

 

 

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, 2020 and December 31, 2019 that were measured at fair value on a nonrecurring basis during the period:

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & Industrial

 

$

 

 

$

 

 

$

142

 

 

$

142

 

Other Real Estate Owned

 

 

 

 

 

 

 

 

1,580

 

 

 

1,580

 

Total

 

$

 

 

$

 

 

$

1,722

 

 

$

1,722

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Real Estate Owned

 

$

 

 

$

 

 

$

1,207

 

 

$

1,207

 

Total

 

$

 

 

$

 

 

$

1,207

 

 

$

1,207

 

The following table summarizes the value of the Bank’s assets as of September 30, 2020 that were measured at fair value on a nonrecurring basis during the period:

 

 

 

Fair Value Measurements at September 30, 2020

(Dollars in thousands)

 

Fair Value

 

 

Valuation Technique(s)

 

Unobservable Inputs

 

Range of

Inputs

Impaired Loans, net

 

$

142

 

 

Appraisals/Discounted Cash Flows

 

Discount to reflect current market

conditions or cash flows and estimated selling costs.

 

3% - 10%

Other Real Estate Owned, net

 

$

1,580

 

 

Appraisals

 

Discount to reflect current market

conditions and estimated selling costs.

 

6% - 10%

Total

 

$

1,722

 

 

 

 

 

 

 

 

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.

26


 

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.

 

September 30, 2020

 

Carrying

 

 

Estimated

 

 

Quoted

Prices in

Active

Markets for

Identical

Assets

 

 

Significant

Other

Observable

Inputs

 

 

Significant

Unobservable

Inputs

 

(Dollars in thousands)

 

Amount

 

 

Fair Value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

102,480

 

 

$

102,480

 

 

$

102,480

 

 

$

 

 

$

 

Restricted equity securities

 

 

4,616

 

 

 

4,616

 

 

 

 

 

 

4,616

 

 

 

 

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale

 

 

118,844

 

 

 

118,844

 

 

 

 

 

 

118,844

 

 

 

 

Held to maturity

 

 

23,114

 

 

 

24,135

 

 

 

 

 

 

24,135

 

 

 

 

Loans, net

 

 

1,279,899

 

 

 

1,314,407

 

 

 

 

 

 

 

 

 

1,314,407

 

Derivative asset – interest rate swap on loans

 

 

13,967

 

 

 

13,967

 

 

 

 

 

 

13,967

 

 

 

 

Bank owned life insurance

 

 

25,157

 

 

 

25,157

 

 

 

 

 

 

25,157

 

 

 

 

Accrued interest receivable

 

 

8,110

 

 

 

8,110

 

 

 

 

 

 

8,110

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

1,417,045

 

 

$

1,430,789

 

 

$

 

 

$

906,616

 

 

$

524,173

 

Derivative liability – interest rate swaps on loans

 

 

13,967

 

 

 

13,967

 

 

 

 

 

 

13,967

 

 

 

 

Accrued interest payable

 

 

871

 

 

 

871

 

 

 

 

 

 

871

 

 

 

 

 

 

December 31, 2019

 

Carrying

 

 

Estimated

 

 

Quoted

Prices in

Active

Markets for

Identical

Assets

 

 

Significant

Other

Observable

Inputs

 

 

Significant

Unobservable

Inputs

 

(Dollars in thousands)

 

Amount

 

 

Fair Value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

53,376

 

 

$

53,376

 

 

$

53,376

 

 

$

 

 

$

 

Restricted equity securities

 

 

6,157

 

 

 

6,157

 

 

 

 

 

 

6,157

 

 

 

 

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale

 

 

92,791

 

 

 

92,791

 

 

 

 

 

 

92,791

 

 

 

 

Held to maturity

 

 

23,914

 

 

 

24,678

 

 

 

 

 

 

24,678

 

 

 

 

Loans, net

 

 

1,030,425

 

 

 

1,048,181

 

 

 

 

 

 

 

 

 

1,048,181

 

Derivative asset – interest rate swap on loans

 

 

4,039

 

 

 

4,039

 

 

 

 

 

 

4,039

 

 

 

 

Bank owned life insurance

 

 

24,562

 

 

 

24,562

 

 

 

 

 

 

24,562

 

 

 

 

Accrued interest receivable

 

 

4,282

 

 

 

4,282

 

 

 

 

 

 

4,282

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

1,071,623

 

 

$

1,079,011

 

 

$

 

 

$

510,766

 

 

$

568,245

 

Advances from the FHLB

 

 

40,000

 

 

 

39,998

 

 

 

 

 

 

39,998

 

 

 

 

Derivative liability – interest rate swaps on loans

 

 

4,039

 

 

 

4,039

 

 

 

 

 

 

4,039

 

 

 

 

Accrued interest payable

 

 

982

 

 

 

982

 

 

 

 

 

 

982

 

 

 

 

 

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, 2020 from December 31, 2019.

27


 

Note 6. Earnings Per Common Share

Basic earnings per common share excludes dilution and is computed by dividing net income available to common stockholders 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 2020 or 2019.

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 stockholders.

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

(Dollars in thousands, except for per share data)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Net income available to common shareholders

 

$

5,172

 

 

$

3,709

 

 

$

8,008

 

 

$

10,387

 

Weighted average number of common shares issued, basic and diluted

 

 

8,272,570

 

 

 

8,251,672

 

 

 

8,274,419

 

 

 

8,248,284

 

Net income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted income per common share

 

$

0.63

 

 

$

0.45

 

 

$

0.97

 

 

$

1.26

 

 

 

Note 7. 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, 2020 and December 31, 2019:

 

 

 

September 30, 2020

 

 

December 31, 2019

 

Unrealized gain on securities

 

$

1,260

 

 

$

609

 

Unrealized loss on securities transferred to HTM

 

 

(61

)

 

 

(81

)

Securities gains included in net income

 

 

 

 

 

5

 

Tax effect

 

 

(247

)

 

 

(110

)

Total accumulated other comprehensive income

 

$

952

 

 

$

423

 

 

Note 8. Leases

Right-of-use assets and lease liabilities are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets. 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.

28


 

Cash paid for amounts included in the measurement of lease liabilities during the nine months ended September 30, 2020 was $276,000. During the nine months ended September 30, 2020 and 2019, the Company recognized lease expense of $442,000 and $240,000, respectively.

 

 

 

As of September 30,

 

(Dollars in thousands)

 

2020

 

Lease liabilities

 

$

6,686

 

Right-of-use assets

 

$

6,291

 

Weighted-average remaining lease term – operating leases

   (in months).

 

 

189.8

 

Weighted-average discount rate – operating leases

 

 

3.12

%

 

 

 

 

 

 

 

For the nine months

ended September 30,

 

(Dollars in thousands)

 

2020

 

Lease Cost

 

 

 

 

Operating lease cost

 

$

442

 

Total lease costs

 

$

442

 

Cash paid for amounts included in measurement of lease

   liabilities

 

$

276

 

 

The Company is the lessor for three operating leases. One lease is extended on a month-to-month basis while two of these leases have arrangements for over twelve months with an option to extend the lease terms. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations. Total rent income on these operating leases is approximately $6,000 per month.

As of September 30, 2020, 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, 2020 is as follows:

 

(Dollars in thousands)

 

 

 

 

2020

 

$

130

 

2021

 

 

529

 

2022

 

 

542

 

2023

 

 

556

 

2024

 

 

571

 

Thereafter

 

 

6,076

 

Total undiscounted cash flows

 

$

8,404

 

Discount

 

 

(1,718

)

Lease liabilities

 

$

6,686

 

 

 

 

 

29


 

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

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, 2019, previously filed with the Securities and Exchange Commission (“SEC”) on March 23, 2020. Results for the three and nine months ended September 30, 2020 are not necessarily indicative of results for the year ending December 31, 2020 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 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;

30


 

 

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 commercial bank holding company. MainStreet Bank is 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. 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 $140 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.

Both the Company and the Bank 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 seven Bank branches; located in Herndon, Fairfax, Fairfax City, 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.

COVID-19 Economic Impact

On Friday, March 13, 2020, President Trump declared a national emergency caused by the coronavirus (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.

31


 

As an essential business, MainStreet Bank is firstly committed to providing a safe work environment. On March 16, 2020, we transitioned nearly all our employees to work from home. We were fully prepared to do so because of our available technology.  

The Bank established a crisis task force compromised of executive officers, senior management and department heads in order to provide streamlined communication across business functions. This designated group began meeting routinely to track and monitor the pandemic’s impact on the key operations of the institution. Executive management also held weekly meetings with the entire Bank staff to communicate new initiatives and share information about how we are responding to the needs of our employees and customers.

Since most of our customers were comfortable using our digital platform, we temporarily closed two of our seven locations and reduced the hours of the remaining locations. We also increased the average wage of our dedicated customer-facing branch staff by 50% during the initial stages of this crisis, as we believed they provided an invaluable customer interaction and were committed to meeting the needs of our customers who had to conduct business in person.

At the forefront of the crisis, we established a forbearance program for commercial customers with a term-debt repayment structure. The forbearances either provide two months deferral of principal and interest payments or converting the loan to three months of interest-only payments. Both solutions were focused on assisting our borrowers in preserving their liquidity.  

In order to maintain the Company’s strong asset quality, the Board and management initiated two payment deferral programs to support borrowers needs during the pandemic:

Phase 1 – Borrowers could opt to defer up to two months of principal and interest payments, and

Phase 2 – Commercial lenders would work with borrowers individually to design and implement a custom solution to achieve a positive outcome for the borrower.

An overwhelming number of borrowers, 77.5% (by dollar amount), did not indicate a need for any support from either phase to continue performing on their loan obligations.    

Phase 1 - Initiated March 24, 2020. At this point little was known about the state of the pandemic with no predictions on its duration or severity.  A total of 195 borrowers participated in this phase, representing 22.5% of the dollar amount of loans outstanding.

Phase 1 was evenly distributed across the portfolio, excluding the hotel loan segment. The Company has 15 operating hotels in its portfolio totaling $92.4 million. The hospitality industry was significantly impacted by the pandemic and 14 hotels that we financed requested to participate in Phase 1.  All loans that requested a Phase 1 deferral have returned to a normal paying status or participated in Phase 2.

Paycheck Protection Program – Initiated April 3, 2020. During Phase 1, the Bank was also participating as a lender in the Paycheck Protection Program (PPP), described below, to provide additional liquidity assistance to our borrowers. The Bank processed over 1,000 PPP loans totalling just over $173 million. Underwriting standards were focused on providing precisely the amount that should qualify for forgiveness by the federal government.

Phase 2 – Initiated May 4, 2020. The Board and management aligned the maximum deferment for Phase 2 with the Federal Reserve’s Main Street Lending Program and set the maximum deferment period at 12 months. The Board and management also established several restrictive covenants for borrowers participating in Phase 2.  

The objective established by Bank Management was for each borrower to attain a greater than 90% probability of a positive outcome. The Bank’s lending teams worked with their borrowers to determine what amount and term of deferment, if any, would be reasonable to achieve that objective.

There were 42 borrowers representing 7.4% of total loans outstanding who would ultimately participate in Phase 2.  While still a concentration, only 60% of the hotels requested additional payment deferrals for Phase 2.  As of September 30, 2020, the loans with remaining deferments are shown below.

32


 

 

Phase 2 Estimated Loan Deferments Remaining

Deferred Amount by Month (000’s)

Loan Type

1

2

3

4

Total

Deferred

Number of

Borrowers

Closed-end 1st Lien

$2,165

 

 

 

$2,165

1

Owner-Occupied Com'l CRE

$441

$1,747

 

$235

$2,423

3

Commercial Real Estate

$4,518

$26,924

$7,040

 

$38,482

8

- Hotels

 

22,600

7,040

 

29,640

5

- Office

993

4,324

 

 

5,317

2

- Other

3,525

 

 

 

3,525

1

Commercial & Industrial

$606

 

$3,000

 

$3,606

3

Other Consumer

$64

 

 

 

$64

1

Total

$7,794

$28,671

$10,040

$235

$46,740

16

 

The Company actively monitors customer performance and will continue to work with customers within the guidelines established by the Board of Directors in the most prudent manner possible to achieve positive outcomes and maintain good asset quality.

Regulatory easing for COVID-19 pandemic

Federal Reserve Bank reserve requirements to zero.

On March 15, 2020, the Federal Reserve reduced reserve requirement ratios to zero percent effective March 26, 2020.  This action eliminated reserve requirements for all depository institutions. Prior to the change, reserve requirement ratios on net transactions accounts differed based on the amount of net transactions accounts at the depository institution.

A certain amount of net transaction accounts, known as the "reserve requirement exemption amount," was subject to a reserve requirement ratio of zero percent.  Net transaction account balances above the reserve requirement exemption amount and up to a specified amount, known as the "low reserve tranche," were subject to a reserve requirement ratio of 3 percent. Net transaction account balances above the low reserve tranche were subject to a reserve requirement ratio of 10 percent. The reserve requirement exemption amount and the low reserve tranche are indexed each year pursuant to formulas specified in the Federal Reserve Act

Community Bank Leverage Ratio reduced to 8%

As required by Section 4012 of the CARES Act, the federal banking agencies temporarily lowered the community bank leverage ratio (the “CBLR”), issuing two interim final rules to set the CLBR at 8% and then gradually re-establish it at 9%.

Under the interim final rules, the CBLR was set at 8% beginning in the second quarter of 2020 through the end of the year. Community banks that have a leverage ratio of 8% or greater and meet certain other criteria may elect to use the CBLR framework. Beginning in 2021, the CBLR will increase to 8.5% for the calendar year. Community banks will have until Jan. 1, 2022, before the leverage ratio requirement to use the CBLR framework will return to 9%.

“The agencies are providing community banking organizations with a clear and gradual transition back to the 9 percent leverage ratio requirement previously established by the agencies,” regulators said in a joint press release. “This transition will allow community banking organizations to focus on supporting lending to creditworthy households and businesses given the recent strains on the U.S. economy caused by the coronavirus.”

Forbearance not automatically a Troubled Debt Restructuring (TDR)

On March 9, 2020, the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Consumer Financial Protection Bureau, National Credit Union Administration, and Conference of State Bank Supervisors issued a joint statement to financial institutions urging them to work constructively with borrowers and other customers affected by COVID-19.  

Since then, the agencies provided additional guidance and the CARES Act was signed into law.  Together, they offer these key takeaways:

Working with Customers

The agencies encourage financial institutions to work prudently and pro-actively with borrowers – consistent with "safe and sound" practices – who are or may be unable to meet their payment obligations because of the effects of COVID-19. The agencies view loan modification programs as positive actions to mitigate adverse effects on borrowers due to COVID-19. The agencies will not criticize institutions for working with borrowers and will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings ("TDRs").

33


 

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 suspension applies during the modification.  A modification can be a forbearance agreement, a new repayment plan, interest rate modification, or any other arrangement that defers or delays the payment of principal or interest.  This provision applies only to loans that were current – less than 30 days past due on payments – as of December 31, 2019. 

The agencies are to defer to the financial institutions to suspend the TDR requirements.  Financial institutions may presume that borrowers current on payments are not experiencing financial difficulties at modification to determine TDR status, and no further TDR analysis is required for each loan modification in the program.  Examiners will exercise judgment in reviewing loan modifications, including TDRs, will not automatically adversely risk rate credits affected by COVID-19, and will not criticize prudent efforts to modify the terms on existing loans to affected customers.

Past Due Reporting and Nonaccrual Status

Regarding loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral. A loan’s payment date is governed by the due date stipulated in the loan documents. If a financial institution agrees to a payment deferral, this may result in no contractual payments being past due, and these loans are not considered past due during the deferral period.  During a short-term deferral or modification, the loans generally should not be reported as nonaccrual.

Paycheck Protection Program Payments

Many financial institutions may have borrowers who apply for a loan under the CARES Act's Paycheck Protection Program (PPP), which allows an eligible borrower to obtain a loan to cover payroll, rent, mortgage interest, and utilities for the covered period. Up to 100% of the loan can be forgiven if the borrower spends the loan proceeds appropriately in accordance with forgiveness guidelines.

Federal Reserve Paycheck Protection Program Lending Facility

On April 9, 2020, the Federal Reserve issued guidance for banks that wish to participate in the Federal Reserve’s Paycheck Protection Program Lending Facility (the “PPPL Facility”). Under the PPPL Facility, the Federal Reserve Banks will extend funding, on a non-recourse basis, to banks participating in the PPP administered by the Small Business Administration (the “SBA”), taking PPP loans originated under the PPP as collateral.

Main Street Lending Program

The Federal Reserve has announced that it is establishing a Main Street Lending Program to support lending to small and medium-sized businesses that were in sound financial condition before the onset of the COVID-19 pandemic. The Program will operate through three facilities: The Main Street New Loan Facility (MSNLF), the Main Street Priority Loan Facility (MSPLF), and the Main Street Expanded Loan Facility (MSELF).

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.

34


 

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, 2020 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K, for the year ended December 31, 2019, other than the items discussed in our Recently Issued Accounting Pronouncements.

Comparison of Statements of Income for the Three Months Ended September 30, 2020 and 2019

General

Net income increased $1.5 million to $5.2 million for the three months ended September 30, 2020 from $3.7 million for the three months ended September 30, 2019. The increase in net income for the three months ended September 30, 2020 was primarily due to an increase in loan swap fee income, which increased $1.4 million over the same period in 2019. Net interest income increased $1.9 million, to $11.9 million for the three months ended September 30, 2020, from $10.0 million for the three months ended September 30, 2019. Net income was affected by increases of $605,000 in salaries and employee benefits and $386,000 in other operating expenses compared to the same period in 2019. Pre-tax pre-provision income was $7.1 million for the quarter ended September 30, 2020. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net income, which is a non-GAAP financial measure, to the most directly comparable financial measures calculated in accordance with U.S. GAAP.

Interest Income

Total interest income increased $485,000, or 3.2%, to $15.6 million for the three months ended September 30, 2020 from $15.1 million for the three months ended September 30, 2019. The increase was primarily the result of an increase in interest and fees on loans of $891,000, but was offset by a decrease in interest on federal funds sold and interest-earning deposits of $400,000 and a decrease in interest on investment securities of $6,000. Total average interest-earning assets increased $324.7 million, to $1.47 billion for the three months ended September 30, 2020 from $1.15 billion for the same period in 2019 primarily as a result of an increase in the average balance of loans of $295.8 million, a $2.3 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 $26.6 million. The average yield on our interest-earning assets decreased 102 basis points to 4.23% for the three months ended September 30, 2020 as compared to 5.25% for the three months ended September 30, 2019 primarily as a result 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 $891,000, to $15.1 million for the three months ended September 30, 2020 from $14.2 million for the same period in 2019. This increase was primarily due to an increase in average loans outstanding of $295.8 million, which increased to $1.29 billion as of September 30, 2020 from $996.8 million as of September 30, 2019. Of the $295.8 million increase in average loans, $172.7 million was attributable to average PPP loans. In addition to the growth in the loan portfolio the Federal Reserve decreased the federal interest rate to 25 basis points in the first quarter of 2020, which decreased yields on the Bank’s asset sensitive balance sheet as compared to the same period in 2019. The average yield on loans decreased 103 basis points, or 18.1%, for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019.

Interest income on federal funds sold and interest-earning deposits decreased by $400,000 to $12,000 for the three months ended September 30, 2020, from $412,000 for the three months ended September 30, 2019. The decrease was primarily due to a significant average yield decrease despite the average balance on these deposits increasing 32.4%. The average yield decreased 197 basis points, to 0.04% for the three months ended September 30, 2020 from 2.01% for the three months ended September 30, 2019. The decrease in average yield was primarily due to the decrease in the federal interest rate to 25 basis points during first quarter of 2020. The average balance of interest-earning deposits and federal funds sold increased $26.6 million to $108.7 million for the three months ended September 30, 2020 from $82.1 million for the three months ended September 30, 2019. The Bank held higher average balances in these accounts during the third quarter of 2020 while determining strategic alternatives to deploy this capital.

35


 

Interest on investment securities decreased by $6,000 to $491,000 for the three months ended September 30, 2020 from $497,000 for the three months ended September 30, 2019, respectively. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals increased in total $43,000, or 14.6%, to $334,000 for the three months ended September 30, 2020, from $291,000 for the three months ended September 30, 2019. Mortgage backed securities decreased by $54,000, or 60.4%, to $35,000 for the three months ended September 30, 2020, from $89,000 for the three months ended September 30, 2019. The average yield on total securities decreased 12 basis points, to 2.67% for the three months ended September 30, 2020, from 2.79% for the same period in 2019. As a decrease in market rates resulted in stagnant yielding investments, investment income decreased accordingly despite the average balance of investment securities increasing by $2.3 million, to $73.5 million for the three months ended September 30, 2020, from $71.2 million for the three months ended September 30, 2019

Interest Expense

Total interest expense decreased $1.4 million, to $3.7 million for the three months ended September 30, 2020 from $5.1 million for the three months ended September 30, 2019, primarily due to a $1.1 million decrease in interest expense on time deposits and a $219,000 decrease in interest-bearing demand deposits.

Interest expense on deposits decreased $1.3 million, to $3.4 million for the three months ended September 30, 2020 from $4.8 million for the three months ended September 30, 2019 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 $117.5 million to $944.3 million during the three months ended September 30, 2020 as compared to $826.7 million for the three months ended September 30, 2019. The increase in the average balance of interest-bearing deposits was primarily a result of a $215.0 million increase in the average balance of money market deposit accounts offset by a $64.5 million decrease in the average balance of time deposits. The large increase in money market deposits was primarily driven by accounts opened and funded in connection with PPP loans. The average cost of deposits was 146 basis points for the three months ended September 30, 2020, compared to 232 basis points for the three months ended September 30, 2019. The average rate paid on money market deposits decreased 124 basis points to 0.59% for the three months ended September 30, 2020 from 1.83% for the three months ended September 30, 2019. The average rate paid on interest-bearing deposits decreased 103 basis points to 0.85% for the three months ended September 30, 2020 from 1.88% for the three months ended September 30, 2019. The average cost of certificates of deposit decreased by 49 basis points to 2.17% for the three months ended September 30, 2020 as compared to 2.66% for the three months ended September 30, 2019. The decrease in the average cost of interest-bearing demand deposits for the three months ended September 30, 2020, in addition to a falling 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, 2019.

Interest expense on advances from the Federal Home Loan Bank decreased $63,000 to $13,000 for the three months ended September 30, 2020, from $76,000 for the three months ended September 30, 2019 as a result of an decrease in the average balance on the Federal Home Loan Bank advances which decreased to $4.5 million for the three months ended September 30, 2020 from $11.5 million for the three months ended September 30, 2019. In addition, the average rate of the Federal Home Loan Bank advances decreased 149 basis points for the three months ended September 30, 2020 compared to the same period in the prior year. The average balance of the Federal Home Loan Bank advances decreased $7.0 million for the three months ended September 30, 2020, primarily due to the repayment of advances.

Net Interest Income

Net interest income increased approximately $1.9 million, or 18.9%, to $11.9 million for the three months ended September 30, 2020 from $10.0 million for the three months ended September 30, 2019 as a result of our net interest-earning assets increasing $214.1 million to $511.1 million for the three months ended September 30, 2020 from $297.0 million for the three months ended September 30, 2019. The interest rate spread decreased by 17 basis points to 2.69% for the three months ended September 30, 2020 from 2.86% for the three months ended September 30, 2019. The net interest margin decreased by 26 basis points from 3.48% for the three months ended September 30, 2019 to 3.22% for the three months ended September 30, 2020. The net interest margin, excluding PPP loans for the three months ended September 30, 2020, was 3.32%, a decrease of 16 basis points from the same period in 2019. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net income which is a non-GAAP financial measure, to the most directly comparable financial measures calculated in accordance with U.S. GAAP.

36


 

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.

 

 

 

For the Three Months Ended September 30,

 

 

 

2020

 

 

2019

 

 

 

Average

Balance

 

 

Interest

Income/

Expense

 

 

Yield/

Cost (5)

 

 

Average

Balance

 

 

Interest

Income/

Expense

 

 

Yield/

Cost (5)

 

 

 

(Dollars in thousands)

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans (1)

 

$

1,292,566

 

 

$

15,083

 

 

 

4.67

%

 

$

996,777

 

 

$

14,192

 

 

 

5.70

%

Investment securities

 

 

73,486

 

 

 

491

 

 

 

2.67

%

 

 

71,182

 

 

 

497

 

 

 

2.79

%

Federal funds and interest-bearing

   deposits

 

 

108,666

 

 

 

12

 

 

 

0.04

%

 

 

82,056

 

 

 

412

 

 

 

2.01

%

Total interest-earning assets

 

 

1,474,718

 

 

$

15,586

 

 

 

4.23

%

 

 

1,150,015

 

 

$

15,101

 

 

 

5.25

%

Non-interest-earning assets

 

 

65,665

 

 

 

 

 

 

 

 

 

 

 

43,524

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,540,383

 

 

 

 

 

 

 

 

 

 

$

1,193,539

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

$

26,469

 

 

$

56

 

 

 

0.85

%

 

$

58,510

 

 

$

275

 

 

 

1.88

%

Money market deposits

 

 

332,750

 

 

 

490

 

 

 

0.59

%

 

 

117,717

 

 

 

539

 

 

 

1.83

%

Savings and NOW deposits

 

 

62,066

 

 

 

55

 

 

 

0.35

%

 

 

62,975

 

 

 

71

 

 

 

0.45

%

Time deposits

 

 

522,995

 

 

 

2,841

 

 

 

2.17

%

 

 

587,537

 

 

 

3,900

 

 

 

2.66

%

Total interest-bearing deposits

 

 

944,280

 

 

 

3,442

 

 

 

1.46

%

 

 

826,739

 

 

 

4,785

 

 

 

2.32

%

Federal funds purchased

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal Home Loan Bank advances

 

 

4,511

 

 

 

13

 

 

 

1.15

%

 

 

11,522

 

 

 

76

 

 

 

2.64

%

Subordinated debt

 

 

14,823

 

 

 

245

 

 

 

6.61

%

 

 

14,795

 

 

 

244

 

 

 

6.60

%

Total interest-bearing liabilities

 

 

963,614

 

 

$

3,700

 

 

 

1.54

%

 

 

853,056

 

 

$

5,105

 

 

 

2.39

%

Non-interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits and other liabilities

 

 

428,726

 

 

 

 

 

 

 

 

 

 

 

209,125

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

1,392,340

 

 

 

 

 

 

 

 

 

 

 

1,062,181

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

148,043

 

 

 

 

 

 

 

 

 

 

 

131,358

 

 

 

 

 

 

 

 

 

Total liabilities and Stockholders’

   equity

 

$

1,540,383

 

 

 

 

 

 

 

 

 

 

$

1,193,539

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

11,886

 

 

 

 

 

 

 

 

 

 

$

9,996

 

 

 

 

 

Interest rate spread (2)

 

 

 

 

 

 

 

 

 

 

2.69

%

 

 

 

 

 

 

 

 

 

 

2.86

%

Net interest-earning assets (3)

 

$

511,104

 

 

 

 

 

 

 

 

 

 

$

296,959

 

 

 

 

 

 

 

 

 

Net interest margin (4)

 

 

 

 

 

 

 

 

 

 

3.22

%

 

 

 

 

 

 

 

 

 

 

3.48

%

Net interest margin, excluding PPP loans

 

 

 

 

 

 

 

 

 

 

3.32

%

 

 

 

 

 

 

 

 

 

 

3.48

%

Average interest-earning assets to

   average interest-bearing liabilities

 

 

153.04

%

 

 

 

 

 

 

 

 

 

 

134.81

%

 

 

 

 

 

 

 

 

 

(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.

37


 

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, 2020 and 2019

 

 

 

Increase (Decrease) Due to

 

 

Total

Increase

 

 

 

Volume

 

 

Rate

 

 

(Decrease)

 

 

 

(In thousands)

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

13,316

 

 

$

(12,425

)

 

$

891

 

Investment securities

 

 

70

 

 

 

(76

)

 

 

(6

)

Federal funds and interest-bearing deposits

 

 

705

 

 

 

(1,105

)

 

 

(400

)

Total interest-earning assets

 

 

14,091

 

 

 

(13,606

)

 

 

485

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

 

(109

)

 

 

(110

)

 

 

(219

)

Money market deposit accounts

 

 

2,094

 

 

 

(2,143

)

 

 

(49

)

Savings and NOW accounts

 

 

(1

)

 

 

(15

)

 

 

(16

)

Time deposits

 

 

(396

)

 

 

(663

)

 

 

(1,059

)

Total deposits

 

 

1,588

 

 

 

(2,931

)

 

 

(1,343

)

Federal Home Loan Bank advances

 

 

(33

)

 

 

(30

)

 

 

(63

)

Subordinated debt

 

 

1

 

 

 

 

 

 

1

 

Total interest-bearing liabilities

 

 

1,556

 

 

 

(2,961

)

 

 

(1,405

)

Change in net interest income

 

$

12,535

 

 

$

(10,645

)

 

$

1,890

 

 

Provision for Loan Losses

Management believes that the provision recorded for the period ended September 30, 2020 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, 2020, management compiled and analysed extensive amounts of information, including additional relief requested and conversations with borrowers, in an attempt 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 in order to isolate and monitor going forward the heightened stresses our borrowers are facing. We will continuously review the loan portfolio in order to determine the depth and breadth of potential loan losses associated with the pandemic. As we obtain additional information and are able 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 on a monthly basis and provisions are made for loan losses as required in order to maintain the allowance.

38


 

Provision for loan losses increased by $450,000 to $635,000 for the three months ended September 30, 2020 from $185,000 for the three months ended September 30, 2019 primarily as a result of additional loan growth and provisions added due to the COVID-19 pandemic. The increase in loan originations, which totaled approximately $46.7 million for the three months ended September 30, 2019 compared to loan originations, of $51.7 million for the three months ended September 30, 2020, did not include any significant PPP loans as the program had nearly expired. Non-performing loans increased $1.2 million from zero at September 30, 2019 to $1.2 million as of September 30, 2020, however, $1.1 million is related to one borrower. During the three months ended September 30, 2020, special mention loans decreased $4.4 million for a balance of $882,000, compared to the same period in 2019. Substandard loans remained unchanged as of September 30, 2020 compared to September 30, 2019. During the three months ended September 30, 2020, there were charge-offs of $35,000, and recoveries of $15,000 were received.

Non-Interest Income

Non-interest income increased $1.4 million, or 99.0%, to $2.9 million for the three months ended September 30, 2020 from $1.4 million for the three months ended September 30, 2019. The increase in non-interest income was primarily due to increases in loan swap fee income of $1.4 million and $95,000 in deposit account service charges for the three months ended September 30, 2020. These increases were offset by decreases in gains on the sale of loans of $270,000. The Company has focused on expanding fee income through loan swaps throughout 2020. In addition, bank owned life insurance income increased $93,000 to $199,000 for the three months ended September 30, 2020 from $106,000 for the three months ended September 30, 2019 primarily as a result of an increased investment in this asset class.

Non-Interest Expense

Non-interest expense increased $1.1 million, or 17.7%, to $7.6 million for the three months ended September 30, 2020 from $6.5 million for the three months ended September 30, 2019 primarily as a result of increases in salary and employee benefits of $605,000 and other operating expenses of $386,000. Salaries and employee benefits expense increased by $605,000 to $4.5 million for the three months ended September 30, 2020 from $3.9 million for the three months ended September 30, 2019 primarily as a result of increasing the salary for our employees who were customer facing during the depth of the pandemic. It was important to support our employees who couldn’t adhere to a work-from-home policy due to the unique nature of their job responsibilities. In addition, we added five employees and the related salary and benefit expenses for these additional employees. Other operating expenses increased $386,000, or 32.1%, to $1.6 million for the three months ended September 30, 2020 from $1.2 million for the three months ended September 30, 2019 due to increases in professional and consulting fees and fees related to investments in technology infrastructure. Franchise taxes increased approximately $35,000 to $342,000 for the three months ended September 30, 2020 from $307,000 for the three months ended September 30, 2019 as a result of the increase in the Company’s capital as of September 30, 2020 compared to the balance sheet as of September 30, 2019. FDIC insurance premiums increased approximately $260,000 to $400,000 for the three months ended September 30, 2020 from $140,000 for the three months ended September 30, 2019.

Income Tax Expense

Income tax expense increased $250,000, or 23.8%, to a tax expense of $1.3 million for the three months ended September 30, 2020 from a tax expense of $1.0 million for the three months ended September 30, 2019. The increase in federal income tax expense for the three months ended September 30, 2020 compared to the same period a year ago was driven by the increase in income before income taxes of $1.7 million, or 36.0%, to income before income tax of $6.5 million as of September 30, 2020 compared to income before income tax of $4.8 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 $60,000 for the three months ended September 30, 2020. For the three months ended September 30, 2020, the Company had an effective federal tax expense rate of 20.1%, compared to effective federal tax expense rate of 22.0% for the three months ended September 30, 2019.

Comparison of Statements of Income for the Nine Months Ended September 30, 2020 and 2019

General

Net income decreased $2.4 million, to $8.0 million for the nine months ended September 30, 2020, from $10.4 million for the nine months ended September 30, 2019. The decrease in net income for the nine months ended September 30, 2020 was primarily due to an increase in provision for loan losses in response to the COVID-19 pandemic. Offsetting the increased provision, the Bank saw an increase in net interest income of $3.7 million, an increase in non-interest income of $1.9 million, of which $1.8 million was provided by loan swap fees, and an increase of $279,000 in bank owned life compared to the same period in 2019. Pre-tax pre-provision income was $16.4 million for the nine months ended September 30, 2020 compared to $14.3 million. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net income which is a non-GAAP financial measure, to the most directly comparable financial measures calculated in accordance with U.S. GAAP.

Interest Income

Total interest income increased $1.8 million, or 4.2%, to $45.6 million for the nine months ended September 30, 2020, from $43.8 million for the nine months ended September 30, 2019. The increase was primarily the result of an increase in interest and fees on loans of $2.7 million, offset by a decrease in interest on investment securities of $180,000 and a decrease on interest on federal funds sold and interest-earning deposits of $716,000. Total average interest-earning assets increased $271.5 million, to $1.4 billion for the nine months ended September 30, 2020, from $1.1 billion for the same period in 2019 primarily as a result of an increase in the average balance of loans of $217.9 million, a $2.4 million

39


 

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 $51.2 million. The average yield on our interest-earning assets decreased 85 basis points to 4.39% for the nine months ended September 30, 2020 as compared to 5.24% for the nine months ended September 30, 2019 primarily as a result of a lower average yield on the loan portfolio.

Interest and fees on loans increased $2.7 million to $43.7 million for the nine months ended September 30, 2020 from $41.0 million for the same period in 2019. This increase was primarily due to an increase in average loans outstanding of $217.9 million, which increased to $1.2 billion as of September 30, 2020 from $970.7 million as of September 30, 2019. During the nine months ended September 30, 2020, the Federal Reserve lowered the federal funds interest rate to approximately 25 basis points, which decreased yields on the Bank’s asset sensitive balance sheet. The average yield on loans decreased 73 basis points, or 13.0% for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019.

Interest income on federal funds sold and interest-earning deposits decreased by $716,000 to $416,000 for the nine months ended September 30, 2020, from $1.1 million for the nine months ended September 30, 2019. The decrease was primarily due to a significant decrease average yield and despite an increase in average balance on these deposits. The average yield decreased 165 basis points, to 0.45% for the nine months ended September 30, 2020 from 2.10% for the nine months ended September 30, 2019. The average balance of interest-earning deposits and federal funds sold increased $51.2 million to $123.2 million for the nine months ended September 30, 2020 from $72.0 million for the nine months ended September 30, 2019.

Interest on investment securities decreased by $180,000 to $1.5 million for the nine months ended September 30, 2020 from $1.7 million for the nine months ended September 30, 2019. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals decreased in total $95,000, or 9.3%, to $925,000 for the nine months ended September 30, 2020, from $1.0 million for the nine months ended September 30, 2019. Mortgage backed securities decreased by $80,000, or 30.0%, to $186,000 for the nine months ended September 30, 2020, from $266,000 for the nine months ended September 30, 2019. The average yield on securities decreased 43 basis points to 2.70% for the nine months ended September 30, 2020 from 3.13% for the same period in 2019, as decreased market rates resulted in lower yielding investments. The average balance of investment securities increased by $2.4 million to $73.5 million for the nine months ended September 30, 2020, from $71.1 million for the nine months ended September 30, 2019.

Interest Expense

Total interest expense decreased $1.9 million to $12.7 million for the nine months ended September 30, 2020 from $14.6 million for the nine months ended September 30, 2019, primarily due to a $594,000 decrease in interest expense on interest-bearing demand deposits and a $726,000 decrease in interest expense on time deposits.

Interest expense on deposits decreased $1.5 million, to $11.9 million for the nine months ended September 30, 2020 from $13.4 million for the nine months ended September 30, 2019 primarily as a result of a decrease in average interest bearing deposit yields despite an increase in average interest bearing balances of $140.6 million to $922.7 million during the nine months ended September 30, 2020 as compared to $782.1 million for the nine months ended September 30, 2019. The increase in the average balance of interest-bearing deposits was primarily as a result of a $160.7 million increase in the average balance of our money market deposit accounts and a $8.4 million increase in the average balance of our time deposits. The large increase in money market deposits was primarily driven by accounts opened and funded in connection with PPP loans. The increase in the average balance of our time deposits was primarily a result of retail growth and brokered deposits obtained through a deposit placement network on a reciprocal basis, such that amounts are under the standard FDIC insurance maximum of $250,000 making the deposits eligible for FDIC insurance. The average cost of deposits was 171 basis points for the nine months ended September 30, 2020 compared to 228 basis points for the nine months ended September 30, 2019. The average rate paid on money market deposits decreased 117 basis points to 0.80% for the nine months ended September 30, 2020 from 1.97% for the nine months ended September 30, 2019. The increase in the average balance of our certificates of deposits of $8.4 million from $535.1 million for the nine months ended September 30, 2019 to $543.5 million for the nine months ended September 30, 2020 was primarily the result of the Company’s retail growth strategies. The average cost of certificates of deposit decreased by 22 basis points to 2.39% for the nine months ended September 30, 2020 as compared to 2.61% for the nine months ended September 30, 2019. The decrease in the average cost of certificates of deposit for the nine months ended September 30, 2020 was the result of decreases in short term market interest rates as compared to the nine months ended September 30, 2019. The decrease in the average balance of our interest-bearing demand deposits of $31.7 million from $57.5 million for the nine months ended September 30, 2019 to $25.8 million for the nine months ended September 30, 2020, 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 $350,000 to $107,000 for the nine months ended September 30, 2020, from $457,000 for the nine months ended September 30, 2019, as a result of an decrease in the average rate on the Federal Home Loan Bank advances which decreased to 1.73% for the nine months ended September 30, 2020 from 2.64% for the nine months ended September 30, 2019. In addition, the average balance of the Federal Home Loan Bank advances decreased $14.8 million to $8.3 million for the nine months ended September 30, 2020 from $23.1 million for the nine months ended September 30, 2019 primarily due to the repayment of advances.

40


 

Net Interest Income

Net interest income increased approximately $3.7 million, or 12.6%, to $32.9 million for the nine months ended September 30, 2020 from $29.2 million for the nine months ended September 30, 2019 as a result of our net interest-earning assets increasing $145.8 million to $439.5 million for the nine months ended September 30, 2020 from $293.7 million for the nine months ended September 30, 2019. Our interest rate spread decreased by 27 basis points to 2.60% for the nine months ended September 30, 2020 from 2.87% for the nine months ended September 30, 2019. Our net interest margin decreased by 33 basis points from 3.50% for the nine months ended September 30, 2019 to 3.17% for the nine months ended September 30, 2020. The net interest margin, excluding PPP loans for the nine months ended September 30, 2020, was 3.21%, a decrease of 29 basis points from the same period in 2019. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net 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.

 

 

 

For the Nine Months Ended September 30,

 

 

 

2020

 

 

2019

 

 

 

Average

Balance

 

 

Interest

Income/

Expense

 

 

Yield/

Cost (5)

 

 

Average

Balance

 

 

Interest

Income/

Expense

 

 

Yield/

Cost (5)

 

 

 

(Dollars in thousands)

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans (1)

 

$

1,188,565

 

 

$

43,702

 

 

 

4.90

%

 

$

970,708

 

 

$

40,985

 

 

 

5.63

%

Investment securities

 

 

73,504

 

 

 

1,488

 

 

 

2.70

%

 

 

71,069

 

 

 

1,668

 

 

 

3.13

%

Federal funds and interest-bearing

   deposits

 

 

123,217

 

 

 

416

 

 

 

0.45

%

 

 

72,011

 

 

 

1,132

 

 

 

2.10

%

Total interest-earning assets

 

 

1,385,286

 

 

$

45,606

 

 

 

4.39

%

 

 

1,113,788

 

 

$

43,785

 

 

 

5.24

%

Non-interest-earning assets

 

 

65,368

 

 

 

 

 

 

 

 

 

 

 

41,883

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,450,654

 

 

 

 

 

 

 

 

 

 

$

1,155,671

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

$

25,847

 

 

$

209

 

 

 

1.08

%

 

$

57,517

 

 

$

803

 

 

 

1.86

%

Money market deposits

 

 

288,836

 

 

 

1,742

 

 

 

0.80

%

 

 

128,122

 

 

 

1,889

 

 

 

1.97

%

Savings and NOW deposits

 

 

64,513

 

 

 

169

 

 

 

0.35

%

 

 

61,418

 

 

 

218

 

 

 

0.47

%

Time deposits

 

 

543,531

 

 

 

9,740

 

 

 

2.39

%

 

 

535,083

 

 

 

10,466

 

 

 

2.61

%

Total interest-bearing deposits

 

 

922,727

 

 

 

11,860

 

 

 

1.71

%

 

 

782,140

 

 

 

13,376

 

 

 

2.28

%

Federal funds purchased

 

 

 

 

 

 

 

 

 

 

 

46

 

 

 

 

 

 

 

Federal Home Loan Bank advances

 

 

8,266

 

 

 

107

 

 

 

1.73

%

 

 

23,114

 

 

 

457

 

 

 

2.64

%

Subordinated debt

 

 

14,816

 

 

 

727

 

 

 

6.54

%

 

 

14,788

 

 

 

723

 

 

 

6.52

%

Total interest-bearing liabilities

 

 

945,809

 

 

$

12,694

 

 

 

1.79

%

 

 

820,088

 

 

$

14,556

 

 

 

3.55

%

Non-interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits and other liabilities

 

 

361,771

 

 

 

 

 

 

 

 

 

 

 

208,328

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

1,307,580

 

 

 

 

 

 

 

 

 

 

 

1,028,416

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

143,074

 

 

 

 

 

 

 

 

 

 

 

127,255

 

 

 

 

 

 

 

 

 

Total liabilities and Stockholders’

   equity

 

$

1,450,654

 

 

 

 

 

 

 

 

 

 

$

1,155,671

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

32,912

 

 

 

 

 

 

 

 

 

 

$

29,229

 

 

 

 

 

Interest rate spread (2)

 

 

 

 

 

 

 

 

 

 

2.60

%

 

 

 

 

 

 

 

 

 

 

2.87

%

Net interest-earning assets (3)

 

$

439,477

 

 

 

 

 

 

 

 

 

 

$

293,700

 

 

 

 

 

 

 

 

 

Net interest margin (4)

 

 

 

 

 

 

 

 

 

 

3.17

%

 

 

 

 

 

 

 

 

 

 

3.50

%

Net interest margin, excluding PPP loans (5)

 

 

 

 

 

 

 

 

 

 

3.21

%

 

 

 

 

 

 

 

 

 

 

3.50

%

Average interest-earning assets to

   average interest-bearing liabilities

 

 

146.47

%

 

 

 

 

 

 

 

 

 

 

135.81

%

 

 

 

 

 

 

 

 

 

(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.

41


 

(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.

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 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 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 Nine Months Ended

 

 

 

September 30, 2020 and 2019

 

 

 

Increase (Decrease) Due to

 

 

Total Increase

 

 

 

Volume

 

 

Rate

 

 

(Decrease)

 

 

 

(In thousands)

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

10,705

 

 

$

(7,988

)

 

$

2,717

 

Investment securities

 

 

86

 

 

 

(266

)

 

 

(180

)

Federal funds and interest-bearing deposits

 

 

789

 

 

 

(1,505

)

 

 

(716

)

Total interest-earning assets

 

 

11,580

 

 

 

(9,759

)

 

 

1,821

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

 

(337

)

 

 

(257

)

 

 

(594

)

Money market deposit accounts

 

 

1,935

 

 

 

(2,082

)

 

 

(147

)

Savings and NOW accounts

 

 

17

 

 

 

(66

)

 

 

(49

)

Time deposits

 

 

256

 

 

 

(982

)

 

 

(726

)

Total deposits

 

 

1,871

 

 

 

(3,387

)

 

 

(1,516

)

Federal Home Loan Bank advances

 

 

(228

)

 

 

(122

)

 

 

(350

)

Subordinated debt

 

 

2

 

 

 

2

 

 

 

4

 

Total interest-bearing liabilities

 

 

1,645

 

 

 

(3,507

)

 

 

(1,862

)

Change in net interest income

 

$

9,935

 

 

$

(6,252

)

 

$

3,683

 

 

Provision for Loan Losses

Provision for loan losses increased by $5.3 million, to $6.6 million for the nine months ended September 30, 2020, from $1.3 million for the nine months ended September 30, 2019 primarily as a direct result of additional provisions added in repsonse to the COVID-19 pandemic. In addition, loan originations increased $201.9 million, from $169.7 million for the nine months ended September 30, 2019 compared to loan originations of $371.6 million, excluding $173.1 in PPP loans, for the nine months ended September 30, 2020. Non-performing loans increased $1.2 million, from $13,000 at September 30, 2019 to $1.2 million as of September 30, 2020, however $1.1 million is related to one borrower. During the nine months ended September 30, 2020, substandard loans remained relatively stable. During the nine months ended September 30, 2020, there were $1.8 million in total charge-offs, and recoveries of $31,000 were received. During the nine months ended September 30, 2019, total charge-offs of $755,000 were recorded and recoveries received totaled $34,000.

Non-Interest Income

Non-interest income increased $1.9 million, or 50.9%, to $5.6 million for the nine months ended September 30, 2020 from $3.7 million for the nine months ended September 30, 2019. The increase in non-interest income was primarily due to an increase in loan fees from loan interest rate swaps of $1.8 million and $279,000 in bank owned life insurance income for the nine months ended September 30, 2020. The Bank has focused on expanding loan rate swap opportunities throughout 2020. In addition, deposit account service fees increased $199,000 to $1.4 million for the nine months ended September 30, 2020 from $1.2 million for the nine months ended September 30, 2019 primarily as a result of an increased customer deposit portfolio. The increase in non-interest income was partially offset by a decrease of $533,000 in gains on sale of loans for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

42


 

Non-Interest Expense

Non-interest expense increased $3.5 million or 18.6% to $22.1 million for the nine months ended September 30, 2020, from $18.7 million for the nine months ended September 30, 2019, primarily as a result of increases in salary and employee benefits of $1.6 million and other operating expenses of $1.2 million. Salaries and employee benefits expense increased by $1.6 million to $13.2 million for the nine months ended September 30, 2020 from $11.6 million for the nine months ended September 30, 2019 primarily as a result of increasing the salaries for our employees who were customer facing during the depth of the pandemic. It was important to support our employees who could not adhere to a work-from-home policy due to the unique nature of their job responsibilities. In addition, we added five employees and the related salary and benefit expenses for these additional employees. Other operating expenses increased $1.2 million, or 35.0%, to $4.6 million for the nine months ended September 30, 2020 from $3.4 million for the nine months ended September 30, 2019 due to increases in professional and consulting fees and fees related to investments in technology infrastructure. FDIC insurance premiums increased approximately $560,000 to $1.1 million for the nine months ended September 30, 2020 from $550,000 for the nine months ended September 30, 2019. Data processing expenses increased approximately $196,000 to $931,000 for the nine months ended September 30, 2020 from $735,000 for the nine months ended September 30, 2019

Income Tax Expense

Income tax expense decreased $819,000, or 31.4%, to $1.8 million for the nine months ended September 30, 2020 from $2.6 million for the nine months ended September 30, 2019. The decrease in federal income tax expense for the nine months ended September 30, 2020 compared to the same period a year ago is driven by the decrease in income before income taxes of $3.2 million, or 31.5%, to $9.8 million for the nine months ended September 30, 2020 compared to $13.0 million for the same period in the prior year. The Company has included assessments in income tax expense for potential state tax liabilities during 2020. For the nine months ended September 30, 2020, the Bank had an effective federal tax rate of 18.3%, compared to effective federal tax rate of 20.1% for the nine months ended September 30, 2019.

Comparison of Statements of Financial Condition at September 30, 2020 and at December 31, 2019

Total Assets

Total assets increased $352.8 million, or 27.6%, to $1.6 billion at September 30, 2020 from $1.3 billion at December 31, 2019. The increase was primarily the result of increases in the loan portfolio of $249.5 million, of which $173.1 million are PPP loans, $62.7 million in cash equivalents, and $9.9 million in the fair value loan interest rate swaps.

Investment Securities

Investment securities increased $25.3.0 million, or 21.6%, from $116.7 million at December 31, 2019 to $142.0 million at September 30, 2020. The decrease was primarily in the available-for-sale portfolio, particularly in U.S treasury securities. At September 30, 2020, our held-to-maturity portion of the securities portfolio, at amortized cost, was $23.1 million, and our available-for-sale portion of the securities portfolio, at fair value, was $118.8 million compared to our held-to-maturity portion of the securities portfolio of $23.9 million and our available-for-sale portion of the securities portfolio of $92.8 million at December 31, 2019.

Net Loans

Net loans increased $249.5 million, or 24.2%, to $1.28 billion at September 30, 2020 from $1.03 billion at December 31, 2019. Residential real estate loans increased $6.7 million, or 4.4%, to $157.5 million at September 30, 2020 from $150.8 million at December 31, 2019. Commercial real estate loans increased by $83.3 million from $421.9 million at December 31, 2019 to $505.2 million at September 30, 2020. Commercial and industrial loans increased by $140.7 million from $121.2 million at December 31, 2019 to $262.0 million at September 30, 2020. Paycheck Protection Program loans comprised of $173.1 million of this portfolio. Commercial and industrial loans, excluding PPP loans, decreased by $32.3 million from December 31, 2019 to September 30, 2020. Construction loans increased $52.9 million to $325.5 million at September 30, 2020 from $272.6 million at December 31, 2019. Consumer loans decreased by $24.1 million from $75.6 million at December 31, 2019 to $51.5 million at September 30, 2020.

43


 

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 Nine Months Ended September 30,

 

 

For the Year Ended December 31,

 

 

 

2020

 

 

2019

 

 

 

(Dollars in thousands)

 

Balance at beginning of year

 

$

9,584

 

 

$

8,831

 

Charge-offs:

 

 

 

 

 

 

 

 

Commercial real estate

 

 

(1

)

 

 

(733

)

Commercial and industrial

 

 

(1,793

)

 

 

(98

)

Consumer

 

 

(35

)

 

 

(98

)

Total charge-offs

 

 

(1,829

)

 

 

(929

)

Recoveries:

 

 

 

 

 

 

 

 

Residential real estate

 

 

 

 

 

58

 

Commercial real estate

 

 

 

 

 

1

 

Commercial and industrial

 

 

23

 

 

 

0

 

Consumer

 

 

8

 

 

 

5

 

Total recoveries

 

 

31

 

 

 

64

 

Net charge-offs

 

 

(1,798

)

 

 

(865

)

Provision for loan losses

 

 

6,560

 

 

 

1,618

 

Balance at end of period

 

$

14,346

 

 

$

9,584

 

Ratios:

 

 

 

 

 

 

 

 

Net charge offs to average loans outstanding

 

 

0.15

%

 

 

0.09

%

Allowance for loan losses to non-performing loans at end of

   period

 

 

11.55

 

 

N/A

 

Allowance for loan losses to gross loans at end of period

 

 

1.10

%

 

 

0.92

%

Allowance for loan losses to gross loans at end of period, excluding PPP loans

 

 

1.27

%

 

 

0.92

%

 

Deposits

Deposits increased $345.4 million, or 32.2%, to $1.41 billion at September 30, 2020 from $1.07 billion at December 31, 2019. Our core deposits increased $411.8 million, or 62.9%, to $1.07 billion at September 30, 2020 from $654.2 million at December 31, 2019. The increase in core deposits primarily was driven by accounts generated in order to service the PPP loans the Bank generated and new deposit growth initiatives. Non-interest bearing demand deposits increased $163.9 million, or 64.9%, to $416.6 million at September 30, 2020 from $252.7 million at December 31, 2019. Money market deposits increased $206.8 million, or 146.4%, to $348.1 million at September 30, 2020 from $141.3 million at December 31, 2019. Offsetting these increases were certificates of deposit which decreased $50.5 million, or 9.0%, to $510.4 million at September 30, 2020 from $560.9 million at December 31, 2019. The decrease in certificates of deposit was primarily the result of decreased brokered deposits as core deposits replaced this source of funding throughout the year.

44


 

Nonperforming Assets

The following table presents information regarding nonperforming assets at the dates indicated:

 

 

 

September 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

 

 

(Dollars in thousands)

 

Non-accrual loans:

 

 

 

 

 

 

 

 

Residential Real Estate

 

$

145

 

 

$

 

Commercial Real Estate

 

 

1,097

 

 

 

 

Total non-accrual loans

 

 

1,242

 

 

 

 

Total non-performing loans

 

 

1,242

 

 

 

 

Other real estate owned

 

 

1,580

 

 

 

1,207

 

Total non-performing assets

 

$

2,822

 

 

$

1,207

 

Ratios:

 

 

 

 

 

 

 

 

Total non-performing loans to gross loans receivable

 

 

0.10

%

 

 

0.00

%

Total non-performing loans to total assets

 

 

0.08

%

 

 

0.00

%

Total non-performing assets to total assets

 

 

0.17

%

 

 

0.09

%

 

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 $382.0 million as of September 30, 2020. The Company has the ability to borrow up to 100% of our PPP outstanding loan balances as of September 30, 2020, through the Paycheck Protection Program Lending Facility, however we were able to fund these loans through our own capital at this time. Additionally, at September 30, 2020, we had the ability to borrow up to $92.0 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, 2020.

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, 2020, cash and cash equivalents totaled $127.6 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $118.8 million at September 30, 2020.

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 $11.7 million and $11.9 million for the nine months ended September 30, 2020 and September 30, 2019, respectively. There were no sales of available-for-sale securities in the nine months ended September 30, 2020 and seven available-for-sale securities sold for a net gain of $5,000 in the nine months ended September 30, 2019. 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 $281.1 million and $112.4 million for the nine months ended September 30, 2020 and September 30, 2019, respectively. Net cash provided by financing activities was $332.1 million and $114.4 million for the nine months ended September 30, 2020 and 2019, respectively, which consisted primarily of increases in interest bearing and non-interest bearing deposits of $181.5 million and $138.1 million offset by net repayments of $40.0 million and $30.0 million from the Federal Home Loan Bank for the nine months ended September 30, 2020 and 2019, respectively.

45


 

We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of September 30, 2020, totaled $269.7 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 past experience that a significant portion of such deposits will remain with us. We have the ability to 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, 2020, MainStreet Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory guidelines.

On September 15, 2020, the Company issued 1,000,000 depositary shares, each representing a 1/40th interest in a share of the Company’s Fixed-to-Floating Rate Series A Noncumulative Perpetual Preferred Stock, par value $1.00 per share, with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share). Dividends will accrue on the depositary shares at a fixed rate equal to 7.50% per annum. On September 25, 2020, the Company completed the sale of an additional 150,000 depositary shares, pursuant to the underwriters’ full exercise of their over-allotment option to purchase additional depositary shares.

Regulatory Capital

Information presented for September 30, 2020 and December 31, 2019, 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 conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer for 2020 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, 2020, the Company and the Bank meet all capital adequacy requirements to which each is subject.

On September 17, 2019, the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce compliance burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of at least 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all applicable requirements will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital.

The CBLR framework will be available for banks to use in their March 31, 2020, Call Report. The Bank is not choosing to opt in to the CBLR at this time. Under the guidance, a community bank has the ability to opt in or opt out, as desired.

46


 

The Bank’s actual capital amounts and ratios are presented in the table (dollars in thousands):

 

 

 

Actual

 

 

Capital Adequacy

Purposes

 

To Be Well Capitalized

Under the Prompt

Corrective Action

Provision

(Dollars in thousands)

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

Amount

 

 

Ratio

As of September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital (to risk-weighted assets)

 

$

171,239

 

 

 

13.39

%

 

$

102,331

 

 

≥ 8.0%

 

$

127,913

 

 

> 10.0%

Common equity tier 1 capital (to risk-weighted assets)

 

$

156,893

 

 

 

12.27

%

 

$

57,561

 

 

≥ 4.5%

 

$

102,331

 

 

> 8.0%

Tier 1 capital (to risk-weighted assets)

 

$

156,893

 

 

 

12.27

%

 

$

76,748

 

 

≥ 6.0%

 

$

102,331

 

 

> 8.0%

Tier 1 capital (to average assets)

 

$

156,857

 

 

 

10.19

%

 

$

61,573

 

 

≥ 4.0%

 

$

76,960

 

 

> 5.0%

As of December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital (to risk-weighted assets)

 

$

157,892

 

 

 

13.50

%

 

$

93,576

 

 

≥ 8.0%

 

$

116,970

 

 

≥ 10.0%

Common equity tier 1 capital (to risk-weighted assets)

 

$

148,308

 

 

 

12.68

%

 

$

52,636

 

 

≥ 4.5%

 

$

93,576

 

 

≥ 8.0%

Tier 1 capital (to risk-weighted assets)

 

$

148,308

 

 

 

12.68

%

 

$

70,182

 

 

≥ 6.0%

 

$

93,576

 

 

≥ 8.0%

Tier 1 capital (to average assets)

 

$

148,308

 

 

 

12.12

%

 

$

48,937

 

 

≥ 4.0%

 

$

61,171

 

 

≥ 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, 2020, we had outstanding loan commitments of $254.0 million and outstanding stand-by letters of credit of $672,000. 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 income.

Management believes that the use of these non-GAAP measures provide 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,

 

 

For the nine months ended September 30,

 

 

 

 

2020

 

 

 

2019

 

 

 

2020

 

 

 

2019

 

Pre-tax pre-provision earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (GAAP)

 

$

5,172

 

 

$

3,709

 

 

$

8,008

 

 

$

10,387

 

Tax expense

 

 

1,299

 

 

 

1,049

 

 

 

1,793

 

 

 

2,612

 

Provision for loan losses

 

 

635

 

 

 

185

 

 

 

6,560

 

 

 

1,260

 

Adjusted net income (non-GAAP)

 

$

7,106

 

 

$

4,943

 

 

$

16,361

 

 

$

14,259

 

 

 

 

For the three months ended September 30,

 

 

For the nine months ended September 30,

 

 

 

 

2020

 

 

 

2019

 

 

 

2020

 

 

 

2019

 

Net interest margin adjusted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (GAAP)

 

$

11,886

 

 

$

9,996

 

 

$

32,912

 

 

$

29,229

 

Less: PPP fees recognized

 

 

644

 

 

 

 

 

 

1,235

 

 

 

 

Less: PPP interest income earned

 

 

432

 

 

 

 

 

 

772

 

 

 

 

Net interest income, excluding PPP income (non-GAAP)

 

 

10,810

 

 

 

9,996

 

 

 

30,905

 

 

 

29,229

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average interest earning assets (GAAP)

 

 

1,474,718

 

 

 

1,150,015

 

 

 

1,385,286

 

 

 

1,113,788

 

Less: average PPP loans

 

 

172,659

 

 

 

 

 

 

102,891

 

 

 

 

Average interest earning assets, excluding PPP (non-GAAP)

 

 

1,302,059

 

 

 

1,150,015

 

 

 

1,282,395

 

 

 

1,113,788

 

Net interest margin, excluding PPP (non-GAAP)

 

 

3.32

%

 

 

3.48

%

 

 

3.21

%

 

 

3.50

%

 

47


 

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

Not required for smaller reporting companies

Item 4 – Controls and Procedures

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, 2020. 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 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. There’s been no significant effect or impact on internal controls over financial reporting with the Company’s transition to a remote/work from home environment.

48


 

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

At September 30, 2020, 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.

Item 1A – Risk Factors

The COVID-19 pandemic and resulting economic conditions have adversely impacted our business and financial results and could have a more material adverse impact on our business, financial condition and results.

The COVID-19 pandemic has created, and could continue to create, significant disruption of the global economy and financial markets. Governments, businesses, and the public are taking actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, “stay at home” orders, cancellation of events and travel, closures of businesses and schools, fiscal stimulus, and legislation intended to provide monetary aid and other relief. While the scope, duration, and full effect of COVID-19 are rapidly evolving and not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a prolonged period, or result in sustained economic stress or recession, many of the factors disclosed in the “Risk Factors” sections in our Annual Report on Form 10-K for the year ended December 31, 2019 and this Quarterly Report on Form 10-Q.

The effects of the COVID-19 pandemic and resulting economic conditions have already adversely impacted our business and financial results as discussed above in “Management’s Discussion and Analysis of Results of Operations and Financial Condition.” and could further adversely impact on our business and results of operations in a number of 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. Concern about the spread of COVID-19 has caused, and is 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. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, 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.

In an effort to support our communities during the pandemic, we are participating in the PPP established by the CARES Act, under which the Small Business Administration (“SBA”) is authorized to temporarily guarantee certain loans to small businesses. Under the 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 SBA determines there is a deficiency in the manner in which 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.

49


 

Operational Risk. 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 have modified our business practices with a portion of our employees working remotely from their homes to minimize interruptions of our operations. Further, 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 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 of time. A significant amount of loan growth during the second quarter was a direct result of PPP loans. This loan growth is likely to end in the near-term.

Litigation Risk. 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.

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.

50


 

As a participating lender in the PPP and the Federal Reserve’s Main Street Lending Program (“MSLP”), the Company and the Bank are subject to additional risks of litigation from the Bank’s clients, the Federal Reserve or other parties regarding the Bank’s originating, processing, or servicing of loans under the PPP or the MSLP, risks that the SBA may not fund some or all PPP loan guaranties, and risks that the Federal Reserve may rescind its purchase of participation interests in MSLP loans.

 

On March 27, 2020, President Trump signed the CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP and also provided authority for the Federal Reserve establishment of the MSLP.  

 

Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Congress has approved additional funding for the PPP and President Trump signed the new legislation on April 24, 2020. 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. In addition, litigation may be costly, regardless of outcome. 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.

 

The Bank also may have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which loans were originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan or the calculation of the maximum PPP loan to which a borrower is entitled, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

 

Under the authority provided in the CARES Act, the Federal Reserve has established the MSLP to support lending to eligible small-and-medium sized businesses. Pursuant to the MSLP, eligible lending institutions are authorized to make loans to eligible borrowers and a special purpose vehicle established by the Federal Reserve Bank of Boston (the “Main Street SPV”) will purchase either a 95% or 85% participation interest in such loans, depending on the eligibility of the borrower and the type of loan.

 

It is possible that the Company or the Bank will be exposed to litigation from clients and non-clients that solicit the Bank for MSLP loans, regarding its process and procedures used to process applications for the MSLP. 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 MSLP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

 

The Bank’s credit risk in connection with loans under the MSLP is generally limited, as the Bank’s retained risk from any such loan will be either 5% or 15%.  However, the Bank also may have greater credit risk on MSLP loans if a determination is made by the Federal Reserve that there is a deficiency in the manner in which MSLP loans were originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive an MSLP loan or the servicing of an MSLP loan in which the Main Street SPV has purchased a participation interest. In the event of a loss resulting from a default on an MSLP loan and a determination by the Federal Reserve that there was a deficiency in the manner in which the MSLP loan was originated, funded, or serviced by the Bank, the Federal Reserve may attempt to rescind the purchase of a participation interest in the loan or file a claim against the Company or the Bank.

Reference is made to “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 23, 2020.


51


 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchase of Equity Securities

The Company did not repurchase common shares during the three months ended September 30, 2020.

On October 22, 2020, the Company announced that the Board of Directors had authorized a new plan to repurchase up to $17.0 million of the Company’s outstanding common stock. The new stock repurchase program replaces the Company’s previous program. For additional information, see the Company’s Current Report on Form 8-K filed on October 22, 2020.

 

52


 

Item 6 – Exhibits

 

  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

 

*

Filed herewith

53


 

SIGNATURES

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 12, 2020

 

By:

 

/s/ Jeff W. Dick

 

 

 

 

Jeff W. Dick

 

 

 

 

Chairman & Chief Executive Officer

 

 

 

 

(Principal Executive Officer)

 

 

 

 

 

Date: November 12, 2020

 

By:

 

/s/ Thomas J. Chmelik

 

 

 

 

Thomas J. Chmelik

 

 

 

 

Senior Executive Vice President and

 

 

 

 

Chief Financial Officer

 

 

 

 

(Principal Financial Officer)

 

54