MainStreet Bancshares(MNSB) - 2020 Q2 - Quarterly Report

PART I – FINANCIAL INFORMATION Item 1 – Consolidated Financial Statements This section presents the unaudited consolidated financial statements, including the balance sheet, income statement, comprehensive income, stockholders' equity, and cash flows, along with detailed notes explaining accounting policies, investment securities, loans, derivatives, fair value measurements, earnings per share, accumulated other comprehensive income, and leases Consolidated Statements of Financial Condition The company's total assets significantly increased to $1.53 billion as of June 30, 2020, from $1.28 billion at December 31, 2019, primarily driven by a substantial rise in net loans and deposits Consolidated Statements of Financial Condition | Metric | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Total Assets | $1,528,867 | $1,277,358 | | Loans, net | $1,259,012 | $1,030,425 | | Total Deposits | $1,342,332 | $1,071,623 | | Total Liabilities | $1,388,697 | $1,140,324 | | Total Stockholders' Equity | $140,170 | $137,034 | Unaudited Consolidated Statements of Income The company reported a net loss of $634,000 for the three months ended June 30, 2020, a significant decline from a net income of $3.43 million in the prior year, primarily due to a substantial increase in the provision for loan losses Unaudited Consolidated Statements of Income (Three Months) | Metric | Three Months Ended June 30, 2020 (in thousands) | Three Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Total Interest Income | $14,904 | $14,867 | | Total Interest Expense | $4,178 | $4,982 | | Net Interest Income | $10,726 | $9,885 | | Provision for Loan Losses | $5,575 | $750 | | Total Non-Interest Income | $1,318 | $1,341 | | Total Non-Interest Expense | $7,360 | $6,177 | | Income (Loss) before income taxes | $(891) | $4,299 | | Income Tax Expense (Benefit) | $(257) | $868 | | Net Income (Loss) | $(634) | $3,431 | | Basic EPS | $(0.08) | $0.42 | | Diluted EPS | $(0.08) | $0.42 | Unaudited Consolidated Statements of Income (Six Months) | Metric | Six Months Ended June 30, 2020 (in thousands) | Six Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Net Income (Loss) | $2,836 | $6,678 | | Basic EPS | $0.34 | $0.81 | | Diluted EPS | $0.34 | $0.81 | Unaudited Consolidated Statements of Comprehensive Income (Loss) Comprehensive income for the three months ended June 30, 2020, was a loss of $508,000, a decrease from a gain of $3.80 million in the prior year, reflecting the net loss partially offset by other comprehensive income from unrealized gains on available-for-sale securities Unaudited Consolidated Statements of Comprehensive Income (Loss) (Three Months) | Metric | Three Months Ended June 30, 2020 (in thousands) | Three Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Net Income (Loss) | $(634) | $3,431 | | Other comprehensive income | $126 | $366 | | Comprehensive Income (Loss) | $(508) | $3,797 | Unaudited Consolidated Statements of Comprehensive Income (Loss) (Six Months) | Metric | Six Months Ended June 30, 2020 (in thousands) | Six Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Net Income (Loss) | $2,836 | $6,678 | | Other comprehensive income | $531 | $581 | | Comprehensive Income (Loss) | $3,367 | $7,259 | Unaudited Consolidated Statements of Stockholders' Equity Total stockholders' equity increased to $140.17 million as of June 30, 2020, from $137.03 million at December 31, 2019, primarily due to net income and other comprehensive income, partially offset by common stock repurchases Unaudited Consolidated Statements of Stockholders' Equity | Metric | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Common Stock | $32,433 | $32,397 | | Capital Surplus | $74,850 | $75,117 | | Retained Earnings | $31,933 | $29,097 | | Accumulated Other Comprehensive Income | $954 | $423 | | Total Stockholders' Equity | $140,170 | $137,034 | - Net income for the six months ended June 30, 2020, contributed $2,836,000 to retained earnings[12] - Common stock repurchases amounted to $990,000 for the six months ended June 30, 2020[12] Unaudited Consolidated Statements of Cash Flows Cash and cash equivalents increased by $11.51 million for the six months ended June 30, 2020, driven by significant cash provided by financing activities (primarily deposits) which offset substantial cash used in investing activities (mainly loan originations) Unaudited Consolidated Statements of Cash Flows | Metric | Six Months Ended June 30, 2020 (in thousands) | Six Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Net cash provided by operating activities | $4,510 | $6,731 | | Net cash used in investing activities | $(232,772) | $(70,990) | | Net cash provided by financing activities | $239,772 | $70,994 | | Increase in Cash and Cash Equivalents | $11,510 | $6,735 | | Cash and Cash Equivalents, end of period | $76,354 | $64,811 | Notes to Unaudited Consolidated Financial Statements This section provides detailed disclosures on the company's organization, accounting policies, and the impact of recent accounting pronouncements, including specific notes on investment securities, loans, derivatives, fair value measurements, earnings per share, accumulated other comprehensive income, and leases Note 1. Organization, Basis of Presentation and Impact of Recently Issued Accounting Pronouncements This note outlines the company's structure as a bank holding company and its subsidiary, MainStreet Bank, detailing its regulatory status as an 'emerging growth company' and 'smaller reporting company'. It also discusses the basis of financial statement presentation and the ongoing assessment of recently issued accounting pronouncements, particularly ASU 2016-13 (CECL) and the temporary relief for COVID-19 related loan modifications - MainStreet Bancshares, Inc. is a bank holding company, and MainStreet Bank is its wholly-owned subsidiary, operating in Fairfax, Virginia, and the Washington, D.C. metropolitan area[16][18] - The company is classified as an 'emerging growth company' and a 'smaller reporting company', allowing for reduced public company reporting requirements[17][69] - The company is currently assessing the impact of ASU 2016-13 (CECL) on its consolidated financial statements, with required application for fiscal years beginning after December 15, 2022[62][63] - Short-term loan modifications made in good faith in response to COVID-19 to current borrowers are not to be considered Troubled Debt Restructurings (TDRs) per interagency guidance and the CARES Act[70][71] Note 2. Investment Securities This note provides a detailed breakdown of the company's investment securities, classifying them as available-for-sale or held-to-maturity, and reports their amortized cost, unrealized gains/losses, and fair values. It confirms no other-than-temporary impairment was recognized Investment Securities | Security Type | June 30, 2020 (Fair Value, in thousands) | December 31, 2019 (Fair Value, in thousands) | |:---|:---|:---| | Investment securities available-for-sale | $91,823 | $92,791 | | Investment securities held-to-maturity | $23,843 (Amortized Cost) | $23,914 (Amortized Cost) | | Total Investment Securities | $115,666 | $116,705 | - No securities were sold from the available-for-sale portfolio for the six months ended June 30, 2020[73] - The Bank does not consider any securities in its available-for-sale or held-to-maturity portfolios to be other-than-temporarily impaired at June 30, 2020, or December 31, 2019[75] Note 3. Loans Receivable This note details the composition of the loan portfolio, highlighting significant growth in commercial and industrial loans due to the Paycheck Protection Program (PPP). It also provides a summary of the allowance for loan losses, which increased substantially due to COVID-19 related provisions, and information on impaired and nonaccrual loans Loan Portfolio Composition | Loan Type | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Residential Real Estate | $171,411 | $150,848 | | Commercial Real Estate | $497,279 | $421,870 | | Construction and Land Development | $283,971 | $272,620 | | Commercial – Non Real-Estate (C&I) | $268,290 | $121,225 | | Consumer – Non Real-Estate | $59,551 | $75,583 | | Total Gross Loans | $1,280,502 | $1,042,146 | | Allowance for Loan Losses | $(13,731) | $(9,584) | | Net Loans | $1,259,012 | $1,030,425 | - Commercial and industrial loans at June 30, 2020, included $171.6 million in Paycheck Protection Program (PPP) loans[77] Allowance for Loan Losses Activity | Metric | Six Months Ended June 30, 2020 (in thousands) | Six Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Beginning Balance (Allowance for Loan Losses) | $9,584 | $8,831 | | Provision for Loan Losses | $5,925 | $1,075 | | Ending Balance (Allowance for Loan Losses) | $13,731 | $9,185 | Nonaccrual Loans | Nonaccrual Loans | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Residential Real Estate | $150 | $0 | | Commercial Real Estate | $1,097 | $0 | | Consumer | $58 | $0 | | Total Nonaccrual Loans | $1,305 | $0 | - The company had no loans classified as Troubled Debt Restructuring (TDR) as of June 30, 2020, down from $1.5 million at December 31, 2019, after removing the designation from its only TDR loan following modification[29][93][94] Note 4. Derivatives and Risk Management Activities This note describes the company's use of derivative financial instruments, specifically interest rate loan swaps, which are entered into with commercial loan customers and simultaneously with dealer counterparties to manage interest rate risk. These back-to-back swaps result in net-zero fair value changes Matched Interest Rate Swaps | Derivative Type | June 30, 2020 (Notional Amount, in thousands) | December 31, 2019 (Notional Amount, in thousands) | |:---|:---|:---| | Matched interest rate swap with borrower | $108,880 | $71,860 | | Matched interest rate swap with counterparty | $108,880 | $71,860 | Interest Rate Swap Fee Income (Three Months) | Metric | Three Months Ended June 30, 2020 (in thousands) | Three Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Interest rate swap fee income | $423 | $181 | Interest Rate Swap Fee Income (Six Months) | Metric | Six Months Ended June 30, 2020 (in thousands) | Six Months Ended June 30, 2019 (in thousands) | |:---|:---|:---| | Interest rate swap fee income | $826 | $471 | Note 5. Fair Value Presentation This note outlines the company's fair value measurement methodologies, categorizing financial instruments into a three-level hierarchy based on observability of inputs. It indicates that available-for-sale securities and derivatives are primarily Level 2, while impaired loans and other real estate owned (OREO) are largely Level 3 due to significant unobservable inputs - Available-for-sale securities and derivative assets/liabilities are classified as Level 2, with valuations based on observable market data[104][105] - Impaired loans and Other Real Estate Owned (OREO) are primarily classified as Level 3, with fair values determined using appraisals and discounted cash flows that may involve significant unobservable inputs or adjustments[107][109][110] Assets Measured at Fair Value on a Nonrecurring Basis | Asset Type | June 30, 2020 (Fair Value, in thousands) | |:---|:---| | Impaired Loans | $62 | | Other Real Estate Owned | $1,175 | | Total Assets measured at fair value on a nonrecurring basis | $1,237 | Note 6. Earnings (Losses) Per Common Share This note presents the basic and diluted earnings per share calculations, reporting a net loss per common share for the three months ended June 30, 2020, and noting the absence of potentially dilutive securities Earnings (Losses) Per Common Share (Three Months) | Metric | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | |:---|:---|:---| | Net Income (Loss) per common share: Basic | $(0.08) | $0.42 | | Net Income (Loss) per common share: Diluted | $(0.08) | $0.42 | Earnings (Losses) Per Common Share (Six Months) | Metric | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | |:---|:---|:---| | Net Income (Loss) per common share: Basic | $0.34 | $0.81 | | Net Income (Loss) per common share: Diluted | $0.34 | $0.81 | - There were no potentially dilutive securities outstanding at June 30, 2020, or December 31, 2019[115][117] Note 7. Accumulated Other Comprehensive Income This note details the cumulative balances of accumulated other comprehensive income, primarily consisting of unrealized gains on securities, net of deferred taxes Accumulated Other Comprehensive Income | Component | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Unrealized gain on securities | $1,268 | $609 | | Unrealized loss on securities transferred to HTM | $(69) | $(81) | | Securities gains included in net income | $0 | $5 | | Tax effect | $(245) | $(110) | | Total accumulated other comprehensive income | $954 | $423 | Note 8. Leases This note provides information on the company's operating lease liabilities and corresponding right-of-use assets, including their weighted-average remaining lease term and discount rate Lease Information | Metric | June 30, 2020 (in thousands) | |:---|:---| | Lease liabilities | $6,764 | | Right-of-use assets | $6,386 | | Weighted-average remaining lease term (in months) | 193.6 | | Weighted-average discount rate | 3.12% | - Cash paid for amounts included in the measurement of lease liabilities during the six months ended June 30, 2020, was $92,000[121] - The company recognized operating lease expense of $147,000 for the six months ended June 30, 2020[121] Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial performance and condition, including an overview of its business, the significant impact of the COVID-19 pandemic, regulatory responses, critical accounting policies, and detailed comparisons of income statements and financial condition for the reported periods. It also covers liquidity, capital resources, off-balance sheet arrangements, and non-GAAP financial measures Forward-Looking Statements This section cautions readers that the report contains forward-looking statements and identifies various factors that could cause actual results to differ materially, including the highly uncertain impact of the COVID-19 pandemic, general economic conditions, competition, interest rate fluctuations, and regulatory changes - The impact of the COVID-19 outbreak and measures taken in response are highly uncertain and difficult to predict, posing a significant risk[127] - Key risk factors include general economic conditions, competition, inflation, interest rate environment, adverse changes in securities markets, and changes in laws or government regulations[127] - Other risks mentioned are cyber threats, fraud, reliance on third parties, deterioration of asset quality, and the effectiveness of internal controls[127] Overview MainStreet Bancshares, Inc., through MainStreet Bank, operates as a community bank serving small to medium-sized businesses, professional practices, and retail customers in the Washington, D.C. metropolitan area, distinguishing itself through responsive, personalized services and advanced banking technology - MainStreet Bank focuses on serving small to medium-sized businesses, professional practices, and retail customers in Northern Virginia and the greater Washington, D.C. metropolitan area[130][132] - The bank emphasizes responsive, personalized services, local decision-making, and advanced banking technologies, including online business banking solutions and mobile apps, to compete with larger institutions[130][132][133] - Products and services include business and consumer checking, savings, certificates of deposit, and a broad array of commercial, real estate, and consumer loans[134] COVID-19 Economic Impact The company responded to the COVID-19 pandemic by transitioning most employees to remote work, implementing two phases of loan forbearance programs for commercial customers, and actively participating in the Paycheck Protection Program (PPP), processing nearly $172 million in loans. These actions led to significant provisions for loan losses to address the pandemic's impact - Nearly all employees transitioned to work from home due to the pandemic, supported by advanced technology[140] - The bank implemented a two-phase loan deferment program for borrowers, with Phase 1 seeing 195 borrowers (22.5% of total loans) participating, including 14 hotels[144][145][146][147] - The bank processed 1,071 Paycheck Protection Program (PPP) loans totaling nearly $172 million[148] - Phase 2 of the loan deferment program is estimated to involve 42 borrowers (7.4% of total loans), with 60% of hotels requesting additional deferrals[152] - A general qualitative factor of $2.76 million was added to the allowance for loan losses calculation during Q2 2020 to address the ongoing impact of the COVID-19 pandemic, in addition to a $1.76 million charge-off for one commercial borrower[153][154] Regulatory easing for COVID-19 pandemic Regulatory bodies introduced measures to ease the burden on financial institutions during the COVID-19 pandemic, including reducing Federal Reserve reserve requirements to zero, temporarily lowering the Community Bank Leverage Ratio (CBLR) to 8%, and providing guidance that short-term, good-faith loan modifications for current borrowers are not automatically considered Troubled Debt Restructurings (TDRs) - The Federal Reserve Board reduced reserve requirement ratios to zero percent, effective March 26, 2020, eliminating reserve requirements for all depository institutions[156] - The Community Bank Leverage Ratio (CBLR) was temporarily lowered to 8% from Q2 2020 through year-end, with a gradual increase to 8.5% in 2021 and 9% by January 1, 2022[158][159] - The CARES Act allows financial institutions to suspend TDR accounting principles for COVID-19 related loan modifications for loans that were current as of December 31, 2019[162][163] - The Federal Reserve established a Paycheck Protection Program Lending Facility (PPPL Facility) to provide non-recourse funding to banks participating in the PPP, taking PPP loans as collateral[167] Critical Accounting Policies The company's critical accounting policies, including those for loan losses, fair value, derivatives, income taxes, and OREO, remain consistent with the prior annual report, with ongoing assessment of new pronouncements and an enterprise-wide initiative to manage the transition away from LIBOR - Critical accounting policies include the allowance for loan losses, fair value of financial instruments, derivative financial instruments, income taxes, and other real estate owned[52][170] - The company has established an enterprise-wide initiative led by senior management to identify, assess, and monitor risks associated with the expected discontinuation of LIBOR and transition to alternative reference rates (ARRs)[171][172] Comparison of Statements of Income for the Three Months Ended June 30, 2020 and 2019 For the three months ended June 30, 2020, the company reported a net loss, primarily driven by a significant increase in the provision for loan losses due to the COVID-19 pandemic, despite an increase in net interest income. Non-interest expense also rose, while non-interest income slightly decreased General Net income decreased by $4.1 million, resulting in a net loss of $634,000 for the three months ended June 30, 2020, compared to a net income of $3.4 million in the prior year, primarily due to a $4.8 million increase in the provision for loan losses General (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Net Income (Loss) | $(634) | $3,431 | | Provision for Loan Losses | $5,575 | $750 | | Net Interest Income | $10,726 | $9,885 | Interest Income Total interest income remained relatively flat, increasing by $37,000, as a $522,000 increase in interest and fees on loans (driven by a $235.0 million increase in average loans, including $135.2 million from PPP loans) was largely offset by decreases in interest from federal funds sold and investment securities due to lower market interest rates Interest Income (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Total Interest Income | $14,904 | $14,867 | | Interest and fees on loans | $14,399 | $13,877 | | Interest on federal funds sold | $9 | $375 | | Interest on investment securities | $496 | $615 | - Average yield on interest-earning assets decreased 107 basis points to 4.22% for Q2 2020 from 5.29% for Q2 2019, primarily due to lower market rates and 1% rate on PPP loans[175] - Average loans outstanding increased by $235.0 million, including $135.2 million attributable to average PPP loans[176] Interest Expense Total interest expense decreased by $804,000 to $4.2 million for the three months ended June 30, 2020, primarily due to lower average interest-bearing deposit yields and a decrease in Federal Home Loan Bank advances, despite an increase in average deposit balances Interest Expense (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Total Interest Expense | $4,178 | $4,982 | | Interest expense on deposits | $3,893 | $4,579 | | Interest on Federal Home Loan Bank advances | $44 | $162 | - The average cost of deposits decreased to 167 basis points for Q2 2020 from 231 basis points for Q2 2019[182] - Average interest-bearing deposit balances increased by $140.4 million to $932.1 million, driven by a $180.0 million increase in money market deposits, largely from PPP loan-related accounts[182] Net Interest Income Net interest income increased by $841,000, or 8.5%, to $10.7 million for the three months ended June 30, 2020, primarily due to a $161.1 million increase in net interest-earning assets, despite a decrease in both the interest rate spread and net interest margin Net Interest Income (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Net Interest Income | $10,726 | $9,885 | | Interest rate spread | 2.47% | 2.89% | | Net interest margin | 3.04% | 3.51% | - Net interest-earning assets increased $161.1 million to $455.7 million for Q2 2020 from $294.6 million for Q2 2019[184] Average Balances, Net Interest Income, Yields Earned and Rates Paid (Three Months) This table provides a detailed breakdown of average interest-earning assets and interest-bearing liabilities, along with their respective interest income/expense, yields, and costs, for the three months ended June 30, 2020 and 2019 Average Balances, Net Interest Income, Yields Earned and Rates Paid (Three Months) | Metric | Q2 2020 (Avg Balance, in thousands) | Q2 2020 (Income/Expense, in thousands) | Q2 2020 (Yield/Cost) | Q2 2019 (Avg Balance, in thousands) | Q2 2019 (Income/Expense, in thousands) | Q2 2019 (Yield/Cost) | |:---|:---|:---|:---|:---|:---|:---| | Loans | $1,213,250 | $14,399 | 4.75% | $978,282 | $13,877 | 5.67% | | Investment securities | $73,186 | $496 | 2.71% | $73,218 | $615 | 3.36% | | Federal funds and interest-bearing deposits | $126,164 | $9 | 0.03% | $73,494 | $375 | 2.04% | | Total interest-earning assets | $1,412,600 | $14,904 | 4.22% | $1,124,994 | $14,867 | 5.29% | | Total interest-bearing liabilities | $956,903 | $4,178 | 1.75% | $830,435 | $4,982 | 2.40% | | Net interest income | | $10,726 | | | $9,885 | | | Interest rate spread | | | 2.47% | | | 2.89% | | Net interest margin | | | 3.04% | | | 3.51% | Rate/Volume Analysis (Three Months) This analysis shows that for the three months ended June 30, 2020, the increase in net interest income was primarily driven by volume growth in interest-earning assets and a decrease in interest-bearing liabilities, which offset the negative impact of declining interest rates Rate/Volume Analysis (Three Months) | Category | Volume Increase (Decrease) (in thousands) | Rate Increase (Decrease) (in thousands) | Total Increase (Decrease) (in thousands) | |:---|:---|:---|:---| | Interest-earning assets | $12,145 | $(12,108) | $37 | | Interest-bearing liabilities | $1,883 | $(2,687) | $(804) | | Change in net interest income | $10,262 | $(9,421) | $841 | Provision for Loan Losses (Three Months) The provision for loan losses increased significantly by $4.8 million to $5.6 million for the three months ended June 30, 2020, primarily due to additional provisions related to the COVID-19 pandemic, including a qualitative factor for heightened stress and a $1.7 million charge-off for one borrower - Provision for loan losses increased by $4.8 million to $5.6 million for Q2 2020 from $750,000 for Q2 2019, primarily due to COVID-19 related provisions[196] - A COVID-19 qualitative factor was incorporated into the allowance for loan losses calculation to monitor heightened stress on borrowers[191] - Charge-offs of $1.7 million, related to one borrower, were recorded during Q2 2020, which was fully reserved[196] Non-Interest Income (Three Months) Non-interest income slightly decreased by $23,000, or 1.7%, to $1.3 million for the three months ended June 30, 2020. This was primarily due to decreases in gains on sale of loans and other fee activity, partially offset by increases in loan swap fee income and bank-owned life insurance income Non-Interest Income (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Total Non-Interest Income | $1,318 | $1,341 | | Loan swap fee income | $423 | $181 | | Bank owned life insurance income | $198 | $106 | | Net gain on sale of loans | $0 | $263 | Non-Interest Expense (Three Months) Non-interest expense increased by $1.2 million, or 19.2%, to $7.4 million for the three months ended June 30, 2020, driven by higher salaries and employee benefits (including increased pay for customer-facing staff during the pandemic) and increased other operating expenses, such as professional fees, technology investments, and FDIC insurance premiums Non-Interest Expense (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Total Non-Interest Expense | $7,360 | $6,177 | | Salaries and employee benefits | $4,263 | $3,847 | | Other operating expenses | $1,713 | $1,150 | | FDIC insurance premiums | $430 | $210 | - Salaries and employee benefits increased due to supporting customer-facing employees during the pandemic and adding one employee[198] Income Tax Expense (Three Months) The company reported an income tax benefit of $257,000 for the three months ended June 30, 2020, a decrease of $1.1 million from a tax expense of $868,000 in the prior year, reflecting the pre-tax loss Income Tax Expense (Three Months) | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | |:---|:---|:---| | Income Tax Expense (Benefit) | $(257) | $868 | | Income (Loss) before income taxes | $(891) | $4,299 | | Effective federal tax rate (benefit) | 28.8% | 20.2% | Comparison of Statements of Income for the Six Months Ended June 30, 2020 and 2019 For the six months ended June 30, 2020, net income decreased significantly due to a substantial increase in the provision for loan losses related to the COVID-19 pandemic. This was partially offset by growth in net interest income and non-interest income, while non-interest expenses also rose General Net income decreased by $3.8 million to $2.8 million for the six months ended June 30, 2020, from $6.7 million in the prior year, primarily due to an increased provision for loan losses in response to the COVID-19 pandemic General (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Net Income | $2,836 | $6,678 | | Provision for Loan Losses | $5,925 | $1,075 | | Net Interest Income | $21,025 | $19,233 | | Non-Interest Income | $2,732 | $2,267 | Interest Income Total interest income increased by $1.3 million, or 4.7%, to $30.0 million for the six months ended June 30, 2020, driven by an $1.8 million increase in interest and fees on loans, despite lower yields on federal funds sold and investment securities due to reduced interest rates Interest Income (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Total Interest Income | $30,020 | $28,684 | | Interest and fees on loans | $28,619 | $26,793 | | Interest on federal funds sold | $404 | $720 | | Interest on investment securities | $997 | $1,171 | - Average yield on interest-earning assets decreased 75 basis points to 4.48% for YTD 2020 from 5.23% for YTD 2019[203] - Average loans outstanding increased by $178.5 million to $1.14 billion for YTD 2020[204] Interest Expense Total interest expense decreased by $456,000 to $9.0 million for the six months ended June 30, 2020, primarily due to lower average interest-bearing deposit yields and reduced Federal Home Loan Bank advances, despite an increase in average interest-bearing deposit balances Interest Expense (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Total Interest Expense | $8,995 | $9,451 | | Interest expense on deposits | $8,419 | $8,591 | | Interest on Federal Home Loan Bank advances | $94 | $380 | - The average cost of deposits decreased to 184 basis points for YTD 2020 from 226 basis points for YTD 2019[208] - Average interest-bearing deposit balances increased by $153.3 million to $912.8 million, driven by a $133.2 million increase in money market deposits (from PPP loans) and a $49.5 million increase in time deposits[208] Net Interest Income Net interest income increased by $1.8 million, or 9.3%, to $21.0 million for the six months ended June 30, 2020, driven by a $108.7 million increase in net interest-earning assets, despite a decrease in both the interest rate spread and net interest margin Net Interest Income (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Net Interest Income | $21,025 | $19,233 | | Interest rate spread | 2.56% | 2.88% | | Net interest margin | 3.14% | 3.50% | - Net interest-earning assets increased $108.7 million to $403.0 million for YTD 2020 from $294.3 million for YTD 2019[210] Average Balances, Net Interest Income, Yields Earned and Rates Paid (Six Months) This table provides a detailed breakdown of average interest-earning assets and interest-bearing liabilities, along with their respective interest income/expense, yields, and costs, for the six months ended June 30, 2020 and 2019 Average Balances, Net Interest Income, Yields Earned and Rates Paid (Six Months) | Metric | YTD 2020 (Avg Balance, in thousands) | YTD 2020 (Income/Expense, in thousands) | YTD 2020 (Yield/Cost) | YTD 2019 (Avg Balance, in thousands) | YTD 2019 (Income/Expense, in thousands) | YTD 2019 (Yield/Cost) | |:---|:---|:---|:---|:---|:---|:---| | Loans | $1,135,995 | $28,619 | 5.04% | $957,457 | $26,793 | 5.60% | | Investment securities | $73,512 | $997 | 2.71% | $70,897 | $1,171 | 3.30% | | Federal funds and interest-bearing deposits | $131,239 | $404 | 0.62% | $69,242 | $720 | 2.08% | | Total interest-earning assets | $1,340,746 | $30,020 | 4.48% | $1,097,596 | $28,684 | 5.23% | | Total interest-bearing liabilities | $937,786 | $8,995 | 1.92% | $803,329 | $9,451 | 2.35% | | Net interest income | | $21,025 | | | $19,233 | | | Interest rate spread | | | 2.56% | | | 2.88% | | Net interest margin | | | 3.14% | | | 3.50% | Rate/Volume Analysis (Six Months) This analysis indicates that for the six months ended June 30, 2020, the increase in net interest income was primarily driven by volume growth in interest-earning assets and a decrease in interest-bearing liabilities, which collectively outweighed the negative impact of declining interest rates Rate/Volume Analysis (Six Months) | Category | Volume Increase (Decrease) (in thousands) | Rate Increase (Decrease) (in thousands) | Total Increase (Decrease) (in thousands) | |:---|:---|:---|:---| | Interest-earning assets | $9,238 | $(7,902) | $1,336 | | Interest-bearing liabilities | $2,411 | $(2,867) | $(456) | | Change in net interest income | $6,827 | $(5,035) | $1,792 | Provision for Loan Losses (Six Months) The provision for loan losses increased significantly by $4.9 million to $5.9 million for the six months ended June 30, 2020, primarily due to additional provisions related to the COVID-19 pandemic. This occurred alongside a decrease in loan originations (excluding PPP) and an increase in non-performing loans - Provision for loan losses increased by $4.9 million to $5.9 million for YTD 2020 from $1.1 million for YTD 2019, primarily due to the COVID-19 pandemic[218] - Non-performing loans increased by $1.3 million to $1.3 million as of June 30, 2020, with $1.1 million related to one borrower[218] - Total charge-offs for YTD 2020 were $1.8 million, with recoveries of $16,000[218] Non-Interest Income (Six Months) Non-interest income increased by $465,000, or 20.5%, to $2.7 million for the six months ended June 30, 2020, primarily driven by higher loan fees from interest rate swaps and bank-owned life insurance income, partially offset by decreased gains on sale of loans Non-Interest Income (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Total Non-Interest Income | $2,732 | $2,267 | | Loan fees from loan interest rate swaps | $826 | $471 | | Bank owned life insurance income | $397 | $211 | | Gains on sale of loans | $0 | $263 | Non-Interest Expense (Six Months) Non-interest expense increased by $2.3 million, or 19.0%, to $14.5 million for the six months ended June 30, 2020, primarily due to increases in salaries and employee benefits (including pandemic support), other operating expenses (professional/consulting fees, technology), and FDIC insurance premiums Non-Interest Expense (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Total Non-Interest Expense | $14,502 | $12,185 | | Salaries and employee benefits | $8,696 | $7,707 | | Other operating expenses | $3,005 | $2,201 | | FDIC insurance premiums | $710 | $410 | - Salaries and employee benefits increased due to increased pay for customer-facing employees during the pandemic and the addition of one employee[221] Income Tax Expense (Six Months) Income tax expense decreased by $1.1 million, or 68.4%, to $494,000 for the six months ended June 30, 2020, reflecting a significant decrease in income before income taxes Income Tax Expense (Six Months) | Metric | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---| | Income Tax Expense | $494 | $1,562 | | Income before income taxes | $3,330 | $8,240 | | Effective federal tax rate | 14.8% | 19.0% | Comparison of Statements of Financial Condition at June 30, 2020 and at December 31, 2019 The company's financial condition at June 30, 2020, showed significant growth in total assets and deposits, primarily driven by PPP loans and core deposit increases. Net loans also expanded, while nonperforming assets saw an increase Total Assets Total assets increased by $251.2 million, or 19.7%, to $1.5 billion at June 30, 2020, from $1.3 billion at December 31, 2019, primarily driven by increases in PPP loans, other gross loans receivable, and loan interest rate swaps - Total assets increased by $251.2 million (19.7%) to $1.5 billion at June 30, 2020[223] - Key drivers of asset growth included $171.6 million in PPP loans, $55.7 million in other gross loans receivable, and $8.9 million in loan interest rate swaps[223] Investment Securities Investment securities decreased slightly by $1.0 million, or 0.9%, to $115.7 million at June 30, 2020, primarily due to a decrease in the available-for-sale portfolio, particularly mortgage-backed securities Investment Securities | Metric | June 30, 2020 (in millions) | December 31, 2019 (in millions) | |:---|:---|:---| | Total Investment Securities | $115.7 | $116.7 | | Held-to-maturity portfolio | $23.8 | $23.9 | | Available-for-sale portfolio | $91.8 | $92.8 | Net Loans Net loans increased substantially by $228.6 million, or 22.2%, to $1.3 billion at June 30, 2020, primarily driven by $171.6 million in PPP loans and increases in commercial real estate and construction loans, while consumer loans decreased - Net loans increased by $228.6 million (22.2%) to $1.3 billion at June 30, 2020[225] - Commercial and industrial loans increased by $147.1 million, including $171.6 million from PPP loans[225] - Commercial real estate loans increased by $75.4 million, and construction loans increased by $11.4 million[225] - Consumer loans decreased by $16.0 million[225] Allowance for Loan Losses The allowance for loan losses increased significantly to $13.73 million at June 30, 2020, from $9.58 million at December 31, 2019, primarily due to a substantial provision for loan losses in response to the COVID-19 pandemic Allowance for Loan Losses | Metric | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Balance at end of period | $13,731 | $9,584 | | Provision for loan losses (YTD) | $5,925 | $1,618 | | Net charge-offs (YTD) | $(1,778) | $(865) | - The allowance for loan losses to gross loans at June 30, 2020, was 1.07%, or 1.24% excluding PPP loans[227] Deposits Total deposits increased substantially by $270.7 million, or 25.3%, to $1.34 billion at June 30, 2020, primarily driven by a significant increase in core deposits, especially non-interest bearing demand and money market deposits, largely due to accounts generated in connection with PPP loans - Total deposits increased by $270.7 million (25.3%) to $1.34 billion at June 30, 2020[228] - Core deposits increased by $285.3 million (43.6%) to $939.5 million, primarily driven by PPP loan-related accounts[228] - Non-interest bearing demand deposits increased by $135.4 million (53.6%), and money market deposits increased by $190.9 million (135.1%)[228] - Certificates of deposit decreased by $23.0 million, or 4.1%, as core deposits replaced this funding[228] Nonperforming Assets Total nonperforming assets increased to $2.48 million at June 30, 2020, from $1.21 million at December 31, 2019, primarily due to an increase in non-accrual loans, particularly in residential and commercial real estate Nonperforming Assets | Metric | June 30, 2020 (in thousands) | December 31, 2019 (in thousands) | |:---|:---|:---| | Total non-accrual loans | $1,305 | $0 | | Other real estate owned | $1,175 | $1,207 | | Total non-performing assets | $2,480 | $1,207 | - Total non-performing assets to total assets increased to 0.16% at June 30, 2020, from 0.09% at December 31, 2019[229] Liquidity and Capital Resources The company maintains a strong liquidity position, primarily funded by deposits and supplemented by FHLB advances, and actively manages its cash flows. MainStreet Bank also exceeds all regulatory capital requirements, being considered 'well capitalized' under Basel III, though it has not opted into the CBLR framework Liquidity Management The company manages its liquidity to meet financial obligations, primarily through deposits, supplemented by FHLB advances and other borrowings. It monitors liquidity daily and maintains sufficient funds, with cash and cash equivalents totaling $76.4 million and available-for-sale securities of $91.8 million at June 30, 2020 - Deposits are the primary source of funds, supplemented by wholesale deposits, FHLB advances, and other short-term borrowings[230] - At June 30, 2020, FHLB advances outstanding were $10.0 million with an unused borrowing capacity of $332.6 million[230] - Cash and cash equivalents totaled $76.4 million, and available-for-sale securities totaled $91.8 million at June 30, 2020[233] Cash Flow Activity | Cash Flow Activity (Six Months Ended June 30) | 2020 (in thousands) | 2019 (in thousands) | |:---|:---|:---| | Net cash provided by operating activities | $4,510 | $6,731 | | Net cash used in investing activities | $(232,772) | $(70,990) | | Net cash provided by financing activities | $239,772 | $70,994 | Capital Management MainStreet Bank adheres to Basel III capital requirements and is considered 'well capitalized' under regulatory guidelines, exceeding all minimum capital ratios as of June 30, 2020. The bank has not opted into the Community Bank Leverage Ratio (CBLR) framework - MainStreet Bank exceeded all regulatory capital requirements and was considered 'well capitalized' under regulatory guidelines as of June 30, 2020[236][240] - The bank has not opted into the Community Bank Leverage Ratio (CBLR) framework at this time[243] Regulatory Capital The table below presents the Bank's actual capital amounts and ratios as of June 30, 2020, demonstrating its strong capital position well above the minimum requirements for capital adequacy and the 'well capitalized' thresholds under the Prompt Corrective Action provisions Regulatory Capital (June 30, 2020) | Capital Ratio (June 30, 2020) | Actual Amount (in thousands) | Actual Ratio | Minimum for Capital Adequacy (Amount, in thousands) | Minimum for Capital Adequacy (Ratio) | Minimum for Well Capitalized (Amount, in thousands) | Minimum for Well Capitalized (Ratio) | |:---|:---|:---|:---|:---|:---|:---| | Total capital (to risk-weighted assets) | $165,236 | 13.26% | $99,690 | ≥ 8.0% | $124,613 | > 10.0% | | Common equity tier 1 capital (to risk-weighted assets) | $151,529 | 12.16% | $56,076 | ≥ 4.5% | $99,690 | > 8.0% | | Tier 1 capital (to risk-weighted assets) | $151,529 | 12.16% | $74,767 | ≥ 6.0% | $99,690 | > 8.0% | | Tier 1 capital (to average assets) | $151,537 | 10.23% | $59,252 | ≥ 4.0% | $74,065 | > 5.0% | Off-Balance Sheet Arrangements and Contractual Obligations The company engages in off-balance sheet financial instruments, primarily commitments to extend credit and standby letters of credit, and anticipates having sufficient funds to meet these future cash requirements - Outstanding loan commitments totaled $264.3 million at June 30, 2020[245] - Outstanding stand-by letters of credit totaled $672,000 at June 30, 2020[245] Use of Certain Non-GAAP Financial Measures Management uses certain non-GAAP financial measures, such as adjusted net income, to supplement the evaluation of the company's operating performance by excluding non-recurring items, enhancing comparability with other periods and institutions Non-GAAP Financial Measures | Metric | Q2 2020 (in thousands) | Q2 2019 (in thousands) | YTD 2020 (in thousands) | YTD 2019 (in thousands) | |:---|:---|:---|:---|:---| | Net income (loss), as reported | $(634) | $3,431 | $2,836 | $6,678 | | Tax expense (benefit) | $(257) | $868 | $494 | $1,562 | | Provision for loan losses | $5,575 | $750 | $5,925 | $1,075 | | Adjusted net income | $4,684 | $5,049 | $9,255 | $9,315 | - Adjusted net income is used to provide meaningful information about operating performance by excluding the effects of items that do not reflect ongoing operations[247] Item 3 – Quantitative and Qualitative Disclosures about Market Risk This section is not required for smaller reporting companies - This disclosure is not required for smaller reporting companies[249] Item 4 – Controls and Procedures Management, including the Chief Executive Officer and Chief Financial Officer, concluded that the company's disclosure controls and procedures were effective as of June 30, 2020, and there were no material changes to internal control over financial reporting despite the transition to a remote work environment - Disclosure controls and procedures were evaluated and deemed effective as of June 30, 2020[249] - No material changes occurred in internal control over financial reporting during the second fiscal quarter of 2020, even with the transition to a remote work environment[250] PART II – OTHER INFORMATION Item 1 – Legal Proceedings The company is not involved in any material legal proceedings beyond routine matters occurring in the ordinary course of business, and no material proceedings are pending or threatened by governmental authorities - The company was not involved in any material pending legal proceedings at June 30, 2020[252] - No material proceedings are pending or known to be threatened or contemplated against the company by governmental authorities[252] Item 1A – Risk Factors This section details various risks, with a primary focus on the adverse impacts of the COVID-19 pandemic on credit quality, business continuity, operations, interest rates, liquidity, and litigation, particularly concerning participation in government-backed loan programs like PPP and MSLP COVID-19 Pandemic Impact The COVID-19 pandemic has caused significant disruption to the global economy and financial markets, adversely impacting the company's business and financial results, with the scope, duration, and full effect remaining highly uncertain - The COVID-19 pandemic has created significant disruption of the global economy and financial markets[253] - The pandemic and related containment efforts have adversely impacted the company's business and financial results, with future effects highly uncertain[254] Credit Risk The COVID-19 pandemic increases credit risk due to potential borrower repayment shortfalls, declining collateral values, and regulatory changes that may limit remediation actions. Participation in the PPP also introduces repayment risk if borrowers fail to qualify for forgiveness or if SBA finds origination/servicing deficiencies - Business shutdowns, unemployment, and economic instability may cause customers to be unable to make scheduled loan payments, leading to delinquencies and credit losses[255] - The value of collateral supporting loans may be negatively affected, and regulatory changes may slow or prevent remediation actions[255] - PPP loans carry repayment risk if borrowers fail to qualify for forgiveness or if the SBA determines deficiencies in origination, funding, or servicing[256] Business Continuity Planning Risk The pandemic introduces risks to business continuity, including reduced demand for financial products and potential declines in loan originations due to economic uncertainty and rapidly changing governmental actions - The COVID-19 pandemic has significantly increased economic and demand uncertainty, potentially leading to reduced demand for banking products and a decline in loan originations[257] Operational Risk Remote work arrangements implemented in response to COVID-19 introduce operational risks, such as limitations on customer service, increased cybersecurity threats, and potential disruptions from reliance on third-party service providers with limited capacities - Current and future restrictions on workforce access to facilities could limit customer service and adversely affect operations[258] - Remote work measures introduce additional operational risks, including increased cybersecurity risk[258] - Reliance on third-party service providers poses risks if their availability and access are limited for prolonged periods[259] Interest Rate Risk Volatility in interest rates caused by COVID-19, including the Federal Reserve's rate cuts, negatively affects net interest income, funding costs, and the fair value of the investment portfolio, potentially leading to higher income volatility - The Federal Reserve lowered its target range for the federal funds rate to 0 to 0.25 percent due to COVID-19 concerns[260] - A prolonged period of volatile market conditions could increase funding costs and negatively affect market risk mitigation strategies[260] - Fluctuations in interest rates will impact income, expenses, and the market value of interest-earning assets and liabilities[260] Liquidity Risk The company's liquidity could be negatively impacted by widespread payment deferrals and other loan relief offered to COVID-19 affected customers. Additionally, the significant loan growth from PPP is expected to end in the near-term - The company's liquidity could be negatively impacted if a significant number of customers apply for or request additional payment deferrals due to COVID-19[261] - The significant loan growth experienced during Q2 2020, largely from PPP loans, is likely to end in the near-term[261] Litigation Risk Participation in the PPP and the Federal Reserve's Main Street Lending Program (MSLP) exposes the company to increased litigation risk from clients, non-clients, and regulatory authorities regarding loan origination, processing, servicing, and potential guaranty denials or rescissions of participation interests - Participation in the PPP exposes the company to litigation risk regarding its application processing procedures and potential SBA denials of loan guaranties due to deficiencies[262][265][266] - Participation in the MSLP also carries litigation risk from clients and non-clients, and the Federal Reserve may rescind participation interests or file claims if deficiencies are found in loan origination or servicing[268][269] - Concerns exist regarding possible employee lawsuits for tort claims related to COVID-19, alleging unsafe workplaces[263] Item 6 – Exhibits This section lists the exhibits filed with the Form 10-Q, including certifications from the Chief Executive Officer and Chief Financial Officer, and XBRL (eXtensible Business Reporting Language) documents - Exhibits include Rule 13a-14(a) Certifications of the Chief Executive Officer and Chief Financial Officer, Section 1350 Certification, and various XBRL Taxonomy documents[272] SIGNATURES SIGNATURES This section contains the official signatures of the registrant's Chairman & Chief Executive Officer and Senior Executive Vice President and Chief Financial Officer, certifying the report on behalf of MainStreet Bancshares, Inc - The report was duly signed on August 12, 2020, by Jeff W. Dick, Chairman & Chief Executive Officer, and Thomas J. Chmelik, Senior Executive Vice President and Chief Financial Officer[274][275]