UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
(Mark One)
| x | QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT |
For the transition period from to
Commission file number 333-86993
MainStreet BankShares, Inc.
(Exact name of small business issuer as specified in its charter)
| Virginia | 54-1956616 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
Suite 30, Patrick Henry Mall 730 East Church Street, Martinsville, Virginia | 24112 | |
| (Address of principal executive offices) | (Zip Code) |
Issuer’s telephone number (276) 632-8054
(Former name, former address and former fiscal year, if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 1,774,853 as of April 30, 2007
Transitional Small Business Disclosure Format: (Check one): Yes ¨ No x
MAINSTREET BANKSHARES, INC.
Form 10-QSB
| Page No. | ||||
Item 1 | 3-16 | |||
Item 2 | 17-25 | |||
Item 3 | 26 | |||
PART II OTHER INFORMATION
Item 6 | 26 | |||
| 27 | ||||
| 28-29 | ||||
2
MAINSTREET BANKSHARES, INC.
| Item 1. | Financial Statements |
The financial statements filed as part of Item 1 of Part I are as follows:
| 1. | Consolidated Balance Sheet as of March 31, 2007 (unaudited). |
| 2. | Consolidated Statements of Income for the quarters ended March 31, 2007 (unaudited) and March 31, 2006 (unaudited). |
| 3. | Consolidated Statements of Cash Flows for the year-to-date periods ended March 31, 2007 (unaudited) and March 31, 2006 (unaudited). |
| 4. | Notes to Consolidated Financial Statements. |
3
MAINSTREET BANKSHARES, INC.
Consolidated Balance Sheet
(Unaudited)
March 31, 2007
ASSETS | ||||
Cash and due from banks | $ | 4,287,568 | ||
Interest bearing deposits in banks | 126,809 | |||
Federal funds sold | 5,197,000 | |||
Securities available for sale, at fair value | 27,244,611 | |||
Restricted equity securities | 1,191,300 | |||
Loans: | ||||
Commercial loans | 93,824,212 | |||
Residential real estate loans | 24,712,361 | |||
Consumer loans | 41,241,907 | |||
Total Gross Loans | 159,778,480 | |||
Unearned deferred fees and costs, net | 133,349 | |||
Loans, net of unearned deferred fees and costs | 159,911,829 | |||
Less: Allowance for loan losses | (1,936,919 | ) | ||
Net Loans | 157,974,910 | |||
Furniture, fixtures and equipment, net | 782,370 | |||
Accrued interest receivable | 940,671 | |||
Bank owned life insurance | 2,510,057 | |||
Other assets | 1,652,342 | |||
TOTAL ASSETS | $ | 201,907,638 | ||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||
Deposits: | ||||
Noninterest bearing demand deposits | $ | 16,655,898 | ||
Interest checking deposits | 8,676,269 | |||
Money market deposits | 15,972,777 | |||
Savings deposits | 12,923,256 | |||
Time deposits $100,000 and over | 48,281,958 | |||
Other time deposits | 67,958,918 | |||
Total Deposits | 170,469,076 | |||
Short-term borrowings | 10,000,000 | |||
Accrued interest payable and other liabilities | 1,569,691 | |||
Total Liabilities | 182,038,767 | |||
Shareholders’ Equity: | ||||
Preferred stock, no par value, authorized 10,000,000 shares; none issued | ||||
Common stock, no par value, authorized 10,000,000 shares; issued and outstanding 1,774,853 shares | 18,681,792 | |||
Retained earnings | 1,182,175 | |||
Accumulated other comprehensive income | 4,904 | |||
Total Shareholders’ Equity | 19,868,871 | |||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 201,907,638 | ||
See accompanying notes to consolidated financial statements.
4
MAINSTREET BANKSHARES, INC.
Consolidated Statements of Income
(Unaudited)
Three Months Ended March 31, 2007 | Three Months Ended March 31, 2006 | |||||
Interest Income: | ||||||
Interest and fees on loans | $ | 3,188,401 | $ | 2,892,021 | ||
Interest on interest-bearing deposits | 2,425 | 3,600 | ||||
Interest on federal funds sold | 278,834 | 40,234 | ||||
Interest on securities available for sale | 125,033 | 22,310 | ||||
Dividends on restricted equity securities | 16,873 | 17,356 | ||||
Total Interest Income | 3,611,566 | 2,975,521 | ||||
Interest Expense: | ||||||
Interest on time deposits $100,000 and over | 627,307 | 322,508 | ||||
Interest on other deposits | 1,139,505 | 675,408 | ||||
Interest on federal funds purchased | — | 2,466 | ||||
Interest on short-term borrowings | 136,000 | 55,587 | ||||
Interest on long-term borrowings | — | 100,641 | ||||
Total Interest Expense | 1,902,812 | 1,156,610 | ||||
Net Interest Income | 1,708,754 | 1,818,911 | ||||
Provision for loan losses | — | 79,044 | ||||
Net Interest Income After Provision for Loan Losses | 1,708,754 | 1,739,867 | ||||
Noninterest Income: | ||||||
Service charges on deposit accounts | 67,355 | 51,231 | ||||
Mortgage brokerage income | 89,956 | 80,211 | ||||
Servicing fee income | 141,036 | 126,250 | ||||
Other fee income and miscellaneous income | 43,815 | 39,234 | ||||
Total Noninterest Income | 342,162 | 296,926 | ||||
Noninterest Expense: | ||||||
Salaries and employee benefits | 630,484 | 541,765 | ||||
Occupancy and equipment expense | 154,855 | 138,184 | ||||
Professional fees | 97,937 | 67,173 | ||||
Advertising and promotion | 28,749 | 22,800 | ||||
Outside processing | 97,940 | 81,333 | ||||
Franchise tax | 49,260 | 40,251 | ||||
Other expenses | 128,917 | 99,766 | ||||
Total Noninterest Expense | 1,188,142 | 991,272 | ||||
Net Income Before Tax | $ | 862,774 | $ | 1,045,521 | ||
Income Tax Expense | 286,905 | 328,148 | ||||
Net Income | $ | 575,869 | $ | 717,373 | ||
Basic Net Income Per Share | $ | .33 | $ | .42 | ||
Diluted Net Income Per Share | $ | .31 | $ | .41 | ||
See accompanying notes to consolidated financial statements.
5
MAINSTREET BANKSHARES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended March 31, 2007 | Three Months Ended March 31, 2006 | |||||||
Cash Flows From Operating Activities | ||||||||
Net income from operations | $ | 575,869 | $ | 717,373 | ||||
Provision for loan losses | — | 79,044 | ||||||
Stock option expense | 5,063 | — | ||||||
Depreciation and amortization | 48,013 | 42,947 | ||||||
Amortization of discounts and premiums, net | (12,302 | ) | (303 | ) | ||||
Increase in accrued interest receivable | (68,461 | ) | (115,882 | ) | ||||
Increase in other assets | (464,031 | ) | (44,206 | ) | ||||
Increase in value of life insurance contracts | (10,057 | ) | — | |||||
Increase in accrued interest payable and other liabilities | 283,844 | 249,874 | ||||||
Net cash provided by operating activities | 357,938 | 928,847 | ||||||
Cash Flows From Investing Activities | ||||||||
(Increase) decrease in interest-bearing deposits in other in other banks | 128,971 | (61,894 | ) | |||||
(Increase) decrease in federal funds sold | 7,687,000 | (5,804,000 | ) | |||||
Purchases of furniture, fixtures, and equipment | (90,426 | ) | (13,095 | ) | ||||
Purchases of securities available for sale | (19,309,916 | ) | (1,998,516 | ) | ||||
Purchases of restricted equity securities | (46,200 | ) | (349,500 | ) | ||||
Proceeds from calls and maturities of securities available for sale | 12,151,634 | 300,000 | ||||||
Loan originations and principal collections, net | (3,422,064 | ) | (8,034,511 | ) | ||||
Purchase of bank owned life insurance | (2,500,000 | ) | — | |||||
Net cash used in investing activities | (5,401,001 | ) | (15,961,516 | ) | ||||
Cash Flows From Financing Activities | ||||||||
Increase in time deposits $100,000 and over | 355,506 | 3,609,853 | ||||||
Increase in other time deposits | 1,751,676 | 5,467,394 | ||||||
Increase in other deposits | 3,541,843 | 1,268,393 | ||||||
Decrease in federal funds purchased | — | (2,025,000 | ) | |||||
Proceeds from short-term borrowings | — | 5,000,000 | ||||||
Issuance of common stock | 99,990 | — | ||||||
Net cash provided by financing activities | 5,749,015 | 13,320,640 | ||||||
Net increase (decrease) in cash | $ | 705,952 | $ | (1,712,029 | ) | |||
Cash and due from banks at beginning of period | 3,581,616 | 4,310,255 | ||||||
Cash and due from banks at end of period | $ | 4,287,568 | $ | 2,598,226 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the period for interest | $ | 1,935,458 | $ | 1,406,311 | ||||
Cash paid during the period for taxes | $ | 77,100 | $ | — | ||||
See accompanying notes to consolidated financial statements.
6
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
Note 1 – Summary of Accounting Policies
| (a) | General |
The accompanying consolidated financial statements of MainStreet BankShares, Inc. are unaudited. However, in the opinion of management, all adjustments necessary for a fair presentation of the financial statements have been included. All adjustments were of a normal recurring nature, except as otherwise disclosed herein. The consolidated financial statements conform to generally accepted accounting principles and general banking industry practices. The information contained in the footnotes included in MainStreet BankShares Inc. 2006 Annual Report on Form 10-KSB should be referred to in connection with the reading of these unaudited interim consolidated financial statements. In certain instances, amounts reported in the 2006 financial statements have been reclassified to conform to the 2007 statement presentation.
MainStreet BankShares, Inc. (the “Corporation”, “MainStreet”, or “BankShares”) incorporated as a Virginia corporation effective January 14, 1999, was a development stage enterprise until July 24, 2000. MainStreet has had two registered stock offerings since its inception raising a total of $14,029,501. The Corporation was primarily organized to serve as a bank holding company. MainStreet also had a private placement offering of its common stock that commenced on September 20, 2004 and terminated January 31, 2005. This offering raised total proceeds of $1,807,101. The additional capital was used principally to aid in maintaining all regulatory capital ratios at the adequately capitalized level. The shares from this private placement offering were registered with The Securities and Exchange Commission (“SEC”) effective December 8, 2006. Currently, MainStreet has two wholly-owned subsidiaries, Franklin Community Bank, National Association (“Franklin Bank”) and MainStreet RealEstate, Inc. (“MainStreet RE”).
Franklin Bank operates as a locally owned and operated commercial bank emphasizing personal customer service and other advantages incident to banking with a locally owned community bank. Franklin Bank’s primary service area is Franklin County, Town of Rocky Mount and surrounding areas. Franklin Bank was organized as a nationally chartered commercial bank and member of the Federal Reserve Bank of Richmond. Franklin Bank opened for business on September 16, 2002.
MainStreet RE was formed as a subsidiary of MainStreet effective February 8, 2007. This subsidiary was formed for the sole purpose of owning the real estate of the Corporation.
On January 13, 2005, MainStreet, Smith River Community Bank, National Association (“Smith River”), and Argentum Capital Management, LLC (“Argentum”) entered into an Agreement pursuant to which MainStreet agreed to sell, and Argentum or its assigns agreed to purchase, all of the outstanding shares of the common stock of Smith River Bank for $6,500,000. The transaction closed on March 23, 2005. As part of the transaction, MainStreet agreed to acquire specified loans from Smith River under certain conditions after the closing. In the event Smith River determines it must charge off one of the specified loans, (after pursuing normal collection efforts), MainStreet will acquire all of Bank’s right, title and interest in the charged off loan. MainStreet’s obligation to purchase such loans will not exceed the principal amount of the loans at the time of purchase plus Smith River’s out of pocket collection expenses. The outstanding principal balance of such loans at March 31, 2007 was $109,284. MainStreet recorded a contingent liability of $250,000 against such loans in 2005. MainStreet has paid Smith River $201,637 to indemnify them for two such loans. The reserve against such loans at March 31, 2007 was $48,579. Also as part of the transaction, Smith River has agreed to outsource certain administrative and related activities to MainStreet for a period of three years following the closing for an annual fee of $505,000 to be
adjusted annually based upon the terms of the original agreement. MainStreet downstreamed $4,000,000 to Franklin Bank immediately following the sale of Smith River.
7
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
MainStreet and Franklin Bank were well-capitalized at March 31, 2007.
The Corporation reports its activities as a single business segment. In determining the appropriateness of segment definition, the Corporation considered components of the business about which financial information is available and will evaluate it regularly relative to resource allocation and performance assessment.
| (b) | Principles of Consolidation |
The consolidated financial statements include the accounts of MainStreet and its wholly-owned subsidiaries, Franklin Bank and MainStreet RE. All significant intercompany accounts and transactions associated with MainStreet’s wholly-owned subsidiaries have been eliminated.
| (c) | Cash Equivalents |
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks.
| (d) | Securities |
BankShares classifies and accounts for its investments in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Securities are classified at purchase date under the specific identification method. Amortization and accretion of premiums and discounts are included in income over the contractual life of the securities. The cost of securities sold is determined on the specific identification method.
| (e) | Loans |
Loans are stated at the unpaid principal balances. Interest on loans is computed by methods which generally result in level rates of return on principal amounts outstanding. It is BankShares’ policy to discontinue the accrual of interest on loans once they become 90 days past due and are not well-collateralized, or earlier when it becomes doubtful that the full principal and interest will be collected. Once a loan is placed on nonaccrual status, any interest that is collected will be recorded on a cash basis. Interest on impaired loans is recognized in the same manner as loans that are not considered impaired; that is interest is generally recognized on the cash basis once the collection of principal and interest is 90 days or more past due.
BankShares collectively reviews for impairment all consumer loans and smaller homogeneous loans. BankShares considers a loan to be impaired when, based upon current information and events, it believes it is probable that BankShares will be unable to collect all amounts due according to the contractual terms of the loan agreement. BankShares’ impaired loans include nonaccrual loans, troubled debt restructurings, and certain other nonperforming loans. For collateral dependent loans, BankShares bases the measurement of these impaired loans on the fair value of the loan’s collateral properties. For all other loans, BankShares uses the measurement of these impaired loans on the more readily determinable of the present value of expected future cash flows discounted at the loan’s effective interest rate or the observable market price. Impairment losses are recognized through an increase in the allowance for loan losses and a corresponding charge to the provision for loan losses. Adjustments to impairment losses due to changes in the fair value of underlying collateral on impaired loans are included in the provision for loan losses.
8
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
| (f) | Loan Fees and Costs |
BankShares adopted Statement of Financial Accounting Standards No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”. Using a method that approximates the interest method, loan origination and commitment fees and certain costs are deferred over the contractual life of the related loan as an adjustment to the net interest margin. A regular review will be conducted on the pricing levels of fees and costs as experience with our lending process increases.
| (g) | Allowance for Loan Losses |
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and are capable of estimation and (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses is maintained at a level, which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk ratings and discusses individually the loans on these reports with the responsible loan officers. Management provides a quarterly analysis of the allowance based on peer analysis, regulatory reserve analysis and an analysis based on the experience in each category of commercial, real estate or consumer loans. With this information, management then again utilizes the tools and analyzes the risk-rated loans, past dues, concentrations of credit, unsecured loans, and the economic trend to further add to the allowance. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. This allowance, then, is designated as a specific reserve. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms.
| (h) | Other Real Estate |
Other real estate is comprised of properties acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. The properties are carried at the fair market value less selling costs, based on appraised value. Loan losses arising from the acquisition of such properties are charged against the allowance for loan losses. Any subsequent write-downs are charged to expenses. While management uses available information to recognize losses on other real estate, additional write-downs may be necessary based on changes in economic conditions.
| (i) | Furniture, Fixtures and Equipment |
Furniture, fixtures and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are charged to expense on a straight-line basis over the estimated useful lives. Maintenance, repairs, and minor improvements are charged to expense as incurred. Significant improvements are capitalized.
9
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
| (j) | Organizational Costs |
The American Institute of CPA’s has issued Statement of Position 98-5, “Reporting on the Costs of Start-Up Activities.” In general, the SOP requires that organizational and similar start-up costs be expensed. Examples of such costs that have been incurred by the Corporation are legal fees, consulting fees, and regulatory application fees. The Corporation adopted the requirements of the SOP from its inception and has accordingly expensed all organizational costs.
| (k) | Stock Options and Warrants |
MainStreet adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (SFAS n. 123 (R)), on January 1, 2006 using the modified-prospective method, which requires the recognition of compensation costs beginning with the effective date based on (a) the requirements of SFAS No. 123 (R) for all share-based awards granted after the effective date and (b) the requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), for all awards granted to employees prior to the effective date of SFAS No. 123 (R) that remain unvested after the effective date. MainStreet recorded compensation cost in the amount of $5,063 and $0 for the quarter ending March 31, 2007 and 2006, respectively. Additional disclosures required by SFAS No. 123 (R) are included in Note 6 to the consolidated financial statements herein.
| (l) | Advertising Costs |
Advertising costs are expensed as incurred.
| (m) | Income Taxes |
The Corporation is subject to federal and state income taxes. The liability (or balance sheet) approach is used in financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed quarterly for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. An income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
| (n) | Net Income Per Share |
Statement of Financial Accounting Standards No. 128, “Accounting for Earnings Per Share” requires dual presentation of basic and diluted earnings per share on the face of the statements of income and requires a reconciliation of the numerators and denominators of the basic and diluted earnings per share calculation. Basic income per share is calculated based on the weighted average number of shares of common stock outstanding during each period. For the quarter ending March 31, 2007 and March 31, 2006, basic income per share and average shares outstanding were $.33 and 1,767,886 and $.42 and 1,730,853, respectively. Diluted income per share is computed using the weighted average number of shares of common stock outstanding during each period adjusted to reflect the dilutive effect of all potential common shares that were outstanding during the period. For the quarter ending March 31, 2007 and 2006 diluted income per share and average shares outstanding were $.31 and 1,874,907 and $.41 and 1,761,773, respectively. At March 31, 2007 and March 31, 2006, there were 83,416 warrants outstanding and exercisable. At March 31, 2007 and March 31, 2006, there were 155,367 and 174,207 options, respectively, that were outstanding. Of these stock options, 141,207 and 174,207 were exercisable at March 31, 2007 and 2006, respectively.
10
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
| (o) | Use of Estimates |
The presentation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral.
The Corporation’s loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Corporation has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on local economic conditions.
While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Corporation to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
Note 2 – Securities
The carrying values, unrealized gains and losses and approximate market values of investment securities at March 31, 2007 are shown in the tables below. The entire investment portfolio is classified as available-for-sale to preserve maximum liquidity for funding needs.
| March 31, 2007 | |||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Losses | Approximate Market Value | ||||||||||
U.S. government agencies | $ | 19,048,267 | $ | — | $ | (22,845 | ) | $ | 19,025,422 | ||||
Mortgage backed securities | 5,577,145 | 54,921 | (15,632 | ) | 5,616,434 | ||||||||
Municipals | 2,611,768 | 18,144 | (27,157 | ) | 2,602,755 | ||||||||
Total securities available for sale | $ | 27,237,180 | $ | 73,065 | $ | (65,634 | ) | $ | 27,244,611 | ||||
11
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
The following table details unrealized losses and related fair values in the Bank’s investment securities portfolio. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2007.
| Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||
U. S. Agencies | $ | 1,750,234 | $ | (4,408 | ) | $ | 2,281,563 | $ | (18,437 | ) | $ | 4,031,797 | $ | (22,845 | ) | ||||||
Mortgage backed securities | 3,470,892 | (15,632 | ) | — | — | 3,470,892 | (15,632 | ) | |||||||||||||
Municipal bonds | 1,579,296 | (27,157 | ) | — | — | 1,579,296 | (27,157 | ) | |||||||||||||
Total temporarily impaired securities | $ | 6,800,422 | $ | (47,197 | ) | $ | 2,281,563 | $ | (18,437 | ) | $ | 9,081,985 | $ | (65,634 | ) | ||||||
Management considers the nature of the investment, the underlying causes of the decline in market value, the severity and duration of the decline in market value and other evidence, on a security by security basis, in determining if the decline in market value is other than temporary. Management believes all unrealized losses presented in the table above to be temporary in nature.
Note 3 – Allowance for Loan Losses
Changes in the allowance for loan losses for the nine months ended March 31, 2007 and 2006 are as follows:
| 2007 | 2006 | ||||||
Balance at beginning of year | $ | 1,942,781 | $ | 1,777,345 | |||
Provision for loan losses | — | 79,044 | |||||
Recoveries | 620 | 4,364 | |||||
Charge-offs | (6,482 | ) | — | ||||
Balance at period end | $ | 1,936,919 | $ | 1,860,753 | |||
Net charge-offs (recoveries) of $(5,862) and $(4,364) for the first three months of 2007 and 2006 equated to .00% and (.01)% respectively, of average loans outstanding net of unearned income and deferred fees. The loan loss reserve at March 31, 2007 was $1,936,919 or 1.21% of loans, net of unearned income and deferred fees. At December 31, 2006, the loan loss reserve was $1,942,781, or 1.24% of loans, net of unearned income and deferred fees. There were no loans past due more than 90 days and still accruing interest at March 31, 2007 and December 31, 2006. Nonaccrual loans were $868,489 and $588,762 at March 31, 2007 and December 31, 2006, respectively. These loans are also considered impaired loans. Lost interest related to impaired loans as of March 31, 2007 and March 31, 2006 was $23,544 and $1,292, respectively.
Overdrafts reclassified to loans at March 31, 2007 and December 31, 2006 were $81,737 and $107,591, respectively.
12
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
Note 4 – Income Per Share
| Three Months Ended March 31, 2007 | ||||||||
Income Numerator | Shares Denominator | Per Share Amount | ||||||
Basic EPS | ||||||||
Net income available to common shareholders | $ | 575,869 | 1,767,886 | $ | .33 | |||
Diluted EPS | ||||||||
Net income available to common shareholders | $ | 575,869 | 1,838,629 | $ | .31 | |||
| Three Months Ended March 31, 2006 | ||||||||
| Income Numerator | Shares Denominator | Per Share Amount | ||||||
Basic EPS | ||||||||
Net income available to common shareholders | $ | 717,373 | 1,730,853 | $ | .42 | |||
Diluted EPS | ||||||||
Net income available to common shareholders | $ | 717,373 | 1,761,773 | $ | .41 | |||
Note 5 – Comprehensive Income
BankShares adopted Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income”. This statement established standards for reporting and presentation of comprehensive income and its components. The following table discloses the reclassifications related to securities available-for-sale that are included in accumulated other comprehensive loss on the balance sheet as of March 31, 2007 and 2006.
| March 31, 2007 | March 31, 2006 | |||||||
Net Income | $ | 575,869 | $ | 717,373 | ||||
Net unrealized holding gains (losses) during the period | (2,283 | ) | (3,621 | ) | ||||
Less reclassification adjustments for gains (losses) included in net income | — | — | ||||||
Income tax benefit (expense) | 776 | 1,231 | ||||||
Change in accumulated other comprehensive loss | (1,507 | ) | (2,390 | ) | ||||
Total Comprehensive Income | $ | 574,362 | $ | 714,983 | ||||
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MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
Note 6 – Stock Options and Warrants
On the opening date of Smith River Bank, July 24, 2000, now retired President and CEO, Mr. McCullar, was granted 33,000 stock options at the then fair market value of $9.09. The stock options became exercisable if Mr. McCullar was employed as President and CEO of MainStreet and Smith River Bank on the first anniversary of the day the bank opened for business (the first 11,000 options) and on each of the next two anniversaries (for each of the next two 11,000 option grants). All such options have vested and were exercised on May 3, 2006. Other options in the amount of 33,000, of which all are vested and exercisable, have been granted at the then fair market value of $9.55 to former employees.
Each organizer/director was granted one warrant for each share of stock that they purchased in the original offering. These warrants were granted on July 24, 2000 and totaled 96,250 warrants. Each warrant entitles the organizer/director to purchase, at anytime within ten years from the date of grant, an additional share at $9.09 per share. The right to exercise the warrants vested for one-third (1/3) of the shares covered by the warrants on each of the first three anniversaries of the date Smith River Bank opened for business, so long as the organizer/director had served continuously as a director of MainStreet or Smith River Bank from its opening until the particular anniversary and had attended a minimum of 75% of the Board of Directors meetings during the period. The warrants are detachable and the shares with which they were originally issued as a unit may be separately transferred. The warrants are generally not transferable except by operation of law. BankShares has the right, upon notice from any regulatory authority, to require immediate exercise or forfeiture of the warrants if the exercise is reasonably necessary in order to inject additional capital into the Bank. Of these warrants, 83,416 are fully vested and 12,834 have been forfeited. None have been exercised.
The shareholders of MainStreet approved the 2004 Key Employee Stock Option Plan, (the “Plan”), at its Annual Meeting on April 15, 2004. The Plan permits the grant of Non-Qualified Stock Options and Incentive Stock Options to persons designated as “Key Employees” of BankShares or its subsidiaries. The Plan was effective by the Board of Directors as of January 21, 2004 and remains in effect, subject to the right of the Board of Directors to terminate the Plan, until January 21, 2009, at which time it terminates except with respect to awards made prior to and outstanding on that date which remain valid in accordance with their terms. Option awards are generally granted with an exercise price equal to the market value of MainStreet’s stock at the date of grant. The options issued in 2006 have a vesting period of 3 years and have a ten year contractual term. The options issued in 2005 vested immediately upon grant and have a ten year contractual term. All share awards provide for accelerated vesting if there is a change in control (as defined in the Plan). The maximum number of shares that may be issued under the Plan may not exceed 150,700. As of March 31, 2007, there were 122,367 options granted under this Plan, respectively.
As of March 31, 2007 the Corporation has reserved 267,116 shares of authorized but unissued shares of common stock related to these option and warrant agreements.
The Black-Scholes module was utilized to calculate the fair-value of the stock options on the date of grant in 2006 using the assumptions of risk-free interest rate; expected life of options; expected volatility of the stock price and expected dividend yield. Expected volatilities are based on the historical volatility of MainStreet’s stock. All options are included in the calculation of compensation cost. The risk-free rate for the period within the contractual life of the option is based upon the ten year Treasury rate at the date of the grant.
MainStreet recorded $5,063 and $0 in equity-based compensation during the quarter ended March 31, 2007 and 2006, respectively.
14
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
Following is a status and summary of changes of options and warrants during the quarter ended March 31, 2007:
| Quarter Ended March 2007 | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||
Outstanding at Beginning of year | 238,783 | $ | 10.97 | |||||||
Granted | — | — | ||||||||
Exercised | — | — | ||||||||
Forfeited | — | — | ||||||||
Outstanding at quarter-end | 238,783 | $ | 10.97 | 6.54 | $ | 1,702,523 | ||||
Exercisable at quarter-end | 224,623 | $ | 10.60 | 6.34 | $ | 1,684,673 | ||||
The total intrinsic value of options exercised during the quarter ended March 31, 2007 and 2006 was $0 and $0, respectively.
As of March 31, 2007, there was $54,734 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 3.0 years. The total fair value of shares vested (using the grant date exercise price) during the quarters ended March 31, 2007 and 2006 was $0 and $0, respectively.
The exercise price of the outstanding stock options and warrants have a range of $9.09-$16.75 and $9.09-$12.09 at March 31, 2007 and 2006, respectively. At March 31, 2007 there were 141,207 options and 83,416 warrants exercisable at a weighted average price of $10.60. At March 31, 2006 there were 174,207 options and 83,416 warrants exercisable at a weighted average price of $10.41.
Note 7 – Financial Instruments With Off-Balance-Sheet Risk
In the normal course of business to meet the financing needs of its customers, BankShares is a party to financial instruments with off-balance-sheet risk. These financial instruments involve commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making commitments as is used for on-balance-sheet risk. At March 31, 2007, outstanding commitments to extend credit were $35,463,122. There are no commitments to extend credit on impaired loans.
Commitments to extend credit are agreements to lend to a customer as long as there is no breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments may expire without ever being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash outlays for the Corporation.
15
MAINSTREET BANKSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
March 31, 2007
Note 8 – Short-term borrowings
Short-term borrowings as of March 31, 2007 consist of a Federal Home Loan Bank of Atlanta advance. The advance in the amount of $10,000,000 is a prime rate based advance. Interest is paid monthly at prime minus 2.81%. The interest rate at March 31, 2007 was 5.44%. Early repayment of the advance is subject to a .25% fee of the advance amount being repaid. The maturity date is May 18, 2007.
Note 9 – Contingencies and Other Matters
The Corporation currently is not involved in any litigation or similar adverse legal or regulatory matters.
16
MAINSTREET BANKSHARES, INC.
March 31, 2007
| Item 2. | Management’s Discussion and Analysis |
Forward-Looking Statements
This report contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements, which are representative only on the date hereof. Readers of this report should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. The Corporation takes no obligation to update any forward-looking statements contained herein. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce margins; (3) general economic conditions, either nationally or regionally, may be less favorable than expected that could result in a deterioration of credit quality or a reduced demand for credit; and (4) legislative or regulatory changes including changes in accounting standards, may adversely affect the business.
General
MainStreet BankShares, Inc. (the “Corporation”, “MainStreet”, or “BankShares”), incorporated as a Virginia corporation effective January 14, 1999, was a development stage enterprise until July 24, 2000. MainStreet has had two registered stock offerings since its inception raising a total of $14,029,501. The Corporation was primarily organized to serve as a bank holding company. MainStreet also had a private placement offering of its common stock that commenced on September 20, 2004 and terminated January 31, 2005. This offering raised total proceeds of $1,807,101. The additional capital was used principally to aid in maintaining all regulatory capital ratios at the adequately capitalized level. The shares from this private placement offering were registered with The Securities and Exchange Commission (“SEC”) effective December 8, 2006. Currently, MainStreet has two wholly-owned subsidiaries, Franklin Community Bank, National Association (“Franklin Bank”) and MainStreet RealEstate, Inc. (“MainStreet RE”).
Franklin Bank was organized as a nationally chartered commercial bank and member of the Federal Reserve Bank of Richmond. Franklin Bank opened for business on September 16, 2002. Franklin Bank operates as a locally owned and operated commercial bank emphasizing personal customer service and other advantages incident to banking with a locally owned community bank. Franklin Bank’s primary service area is Franklin County, Town of Rocky Mount and surrounding areas. Franklin Bank currently has two branches including the main office. Franklin Bank has received approval from the Office of the Comptroller of the Currency (the “OCC”) to open a third banking office in the Union Hall area of Franklin County and Smith Mountain Lake that will be called the Southlake office. It is anticipated that this branch will open in early third quarter. Franklin Bank has applied to the OCC for approval to open another banking facility in the 220 north corridor of Franklin County. If approved, it is anticipated that this branch will open in late second quarter or early third quarter.
MainStreet RE was formed as a subsidiary of MainStreet effective February 8, 2007. This subsidiary was formed for the sole purpose of owning the real estate of the Corporation.
On January 13, 2005, MainStreet, Smith River Community Bank, National Association (“Smith River”), and Argentum Capital Management, LLC (“Argentum”) entered into an Agreement pursuant to which MainStreet agreed to sell, and Argentum, or investors obtained by Argentum for this purpose, agreed to
17
MAINSTREET BANKSHARES, INC.
March 31, 2007
purchase, all of the outstanding shares of the common stock of Smith River for $6,500,000. The transaction closed on March 23, 2005. As part of the transaction, MainStreet has agreed to acquire specified loans from Smith River under certain conditions after the closing. In the event Smith River determines it must charge off one of the specified loans, (after pursuing normal collection efforts),
MainStreet will acquire all of Bank’s right, title, and interest in the charged off loan. MainStreet’s obligation to purchase such loans will not exceed the principal amount of the loans at the time of purchase plus Smith River’s out of pocket collection expenses. The outstanding principal balance of such loans at March 31, 2007 was 109,284. MainStreet recorded a contingent liability of $250,000 against such loans in 2005. MainStreet has paid Smith River $201,637 to indemnify them for two such loans. The reserve against such loans at March 31, 2007 was $48,579. Also as part of the transaction, Smith River has agreed to outsource certain administrative and related activities to MainStreet for a period of three years following the closing for an annual fee of $505,000 to be adjusted annually based upon theterms of the original agreement. MainStreet downstreamed $4,000,000 to Franklin Bank immediately following the sale of Smith River. MainStreet and Franklin Bank were well-capitalized at March 31, 2007.
Critical Accounting Policies
MainStreet’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors, peer comparisons, regulatory factors, concentrations of credit, past dues, and the trend in the economy as factors in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in estimating risk.
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and are capable of estimation and (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or
values that are observable in the secondary market and the loan balance. The allowance for loan losses is maintained at a level, which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk ratings and discusses individually the loans on these reports with the responsible loan officers. Management provides a quarterly analysis of the allowance based on peer analysis, regulatory reserve analysis and an analysis based on the experience in each category of commercial, real estate or consumer loans. With this information management then again utilizes the tools and analyzes the risk-rated loans, past dues, concentrations of credit, unsecured loans, and the economic trend to further add to the allowance. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. This allowance, then, is designated as a specific reserve. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms.
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MAINSTREET BANKSHARES, INC.
March 31, 2007
Overview
Total assets at March 31, 2007 were $201,907,638 as compared to $195,295,354 at December 31, 2006, an increase of $6,612,284, or 3.39%. An increase in deposits has funded this increase in total assets. The largest components of total assets at March 31, 2007 were net loans in the amount of $157,974,910, MainStreet and Franklin Bank were well capitalized at March 31, 2007. The book value of shareholders’ equity at March 31, 2007 was $11.19 per share.
Net income for the three months ending March 31, 2007 and 2006 was $575,869 and $717,373. Basic earnings per share for the three months of 2007 and 2006 were $.33 and $.42, respectively. Diluted earnings per share for the three months of 2007 and 2006 were $.31 and $.41, respectively. Annualized return on average assets at March 31, 2007 was 1.19% and annualized return on average shareholders’ equity was 11.91%.
MainStreet’s net interest margin for the three month period ending March 31, 2007 and 2006 was 3.67% and 4.70%, respectively. This decrease of 103 basis points was primarily caused by an increase in the cost of funds. Compared to March of 2006, net loans have increased $7,480,106 and deposits have increased $35,967,675. These deposit dollars have funded the increase in loans along with the increase in overnight federal funds sold and short-term securities available for sale. These investments do not yield as high an interest rate as loans. Also, competition has caused Franklin Bank to compete and raise interest bearing rates accordingly. The Federal Reserve raised short-term interest rates four times in 2006. The quarter ended with a prime rate of 8.25%. The Corporation is asset sensitive and interest rates on variable rate loans make up a little more than 50% of Franklin’s loan portfolio. These loans repriced faster as interest rates increased than deposits repriced, but deposit rates have clearly caught up. As deposits have matured, they have renewed at higher interest rates. Overall deposit maturity is short because Franklin Bank was organized during a rising interest rate environment. Consumers have tended to invest their deposit dollars in short-ended time deposits and savings instruments. However, the economy in the market area of the Corporation continues to be vibrant with some signs of softening. Competition continues to be strong in the Franklin market and young financial institutions such as Franklin Bank must price new loans competitively. Franklin Bank’s growth is also quite dependent on consumer and real estate based lending and there is concern over the sustainability of the substantial growth that has been occurring in real estate markets generally. Franklin Bank’s future growth may be negatively affected if deterioration in the real estate market occurs. As mentioned earlier, a little more than 50% of Franklin’s loans are variable. As the prime rate changes, these loans generally change immediately. In a rising interest rate environment, this has a positive impact on the net interest margin. In a decreasing interest rate environment, this has a negative impact on the net interest margin. These factors could result in a further compression of MainStreet’s net interest margin should short-term interest rates drop.
Results of Operations
Net interest income is the difference between total interest income and total interest expense. The amount of net interest income is determined by the volume of interest-earning assets, the level of interest rates earned on those assets, and the cost of supporting funds. The difference between rates earned on interest-earning assets and the cost of supporting funds is measured by the net interest margin.
Net interest income was $1,708,754 for the three months ending March 31, 2007 compared to $1,818,911 for the three months ending March 31, 2006, a decrease of $110,157. This decrease was primarily due to an increase in the cost of funds due to volume and interest rates. Loan demand has softened somewhat since last year and the loan to deposit ratio has decreased to 93.81% at March 31, 2007 from 113.27% at March 31, 2006. As mentioned previously, the net interest margin was 3.67% and 4.70%, respectively, for the three months ended March 31, 2007 and 2006. The prime rate, which is the basis for pricing many commercial and consumer loans, follows the short-term interest rate established by the Federal Reserve. The prime rate was increased four times during 2006. It remained at 8.25% at March 31, 2007. Deposit rates have been competitive. Also with shorter maturities on deposits, in the future, deposit rates could continue to increase and could impact the net interest margin negatively.
19
MAINSTREET BANKSHARES, INC.
March 31, 2007
Provision for Loan Losses
A provision for loan losses is charged to earnings for the purpose of establishing an allowance for loan losses that is maintained at a level, which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk ratings and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a quarterly analysis of the allowance based on peer analysis, regulatory reserve analysis and an analysis based on the experience in each category of commercial, real estate or consumer loans. As the allowance is maintained losses are, in turn, charged to this allowance rather than being reported as a direct expense.
A provision for loan losses was recorded in the amounts $0 and $79,044 for the three month period ending March 31, 2007 and 2006, respectively. No expense was recorded in 2007 due to the allowance being at an acceptable level based on management’s analysis. The 2006 expense was attributed primarily to loan growth. The allowance for loan losses was $1,936,919 at March 31, 2007 which equated to 1.21% of loans, net of unearned deferred fees and costs. At December 31, 2006, the allowance was $1,942,781, or 1.24% of loans, net of unearned deferred fees and costs. Net charge-offs (recoveries) of ($5,862) and ($4,364) for the first three months of 2007 and 2006 equated to (.00%) and (.01%) respectively, of average loans outstanding net of unearned income and deferred fees. The amount of charge-offs can fluctuate substantially based on the financial condition of the borrowers, business conditions in the borrower’s market, collateral values and other factors which are not capable of precise projection at any point in time. Nonaccrual loans at March 31, 2007 were $868,489 which represents .54% of loans, net of unearned income. No assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future.
Noninterest Income
Total noninterest income was $342,162 and $296,926 for the three months ending March 31, 2007 and 2006, respectively, an increase of $45,236 or 15.23%. Of total noninterest income service charges on deposit accounts were $67,355 and $51,231 for the above-referenced time periods, respectively, an increase of $16,124 or 31.47%. NSF charges, net of waives and charge-offs, primarily contributed to the increase in service charges. Mortgage brokerage income increased slightly by $9,745 in 2007 compared to 2006. Franklin Bank has partnered with several different organizations in which Franklin Bank originates mortgage loans, which for the most part, then close in the companies’ names. Franklin Bank receives fee income from the transactions. Servicing fee income increased $14,786 for the first three months of 2007 compared to 2006 due to increased fees. These are fees paid to MainStreet for backroom servicing provided to Smith River Bank and their holding company River Bancorp, Inc. and its additional subsidiary, a mortgage corporation. Other miscellaneous income increased slightly in 2007 over the 2006 income by $4,581; however, the 2006 income included $19.5 thousand of gain on sale of other real estate. The 2007 income includes $8.8 thousand of income related to a title company that Franklin Bank has purchased a small percentage.
Noninterest Expense
Total noninterest expense was $1,188,142 and $991,272 for the three month period ending March 31, 2007 and 2006, respectively, an increase of $196,870 or 19.86%. The following chart shows the categories of noninterest expenses for the three month period ending March 31, 2007 and 2006, the dollar change, and the percentage change.
20
MAINSTREET BANKSHARES, INC.
March 31, 2007
Expense | YTD 3/31/07 | YTD 3/31/06 | Dollar Change | Percentage Change | ||||||||
Salaries and employee benefits | $ | 630,484 | $ | 541,765 | $ | 88,719 | 16.38 | % | ||||
Occupancy and equipment | 154,855 | 138,184 | 16,671 | 12.06 | ||||||||
Professional fees | 97,937 | 67,173 | 30,764 | 45.80 | ||||||||
Advertising and promotion | 28,749 | 22,800 | 5,949 | 26.09 | ||||||||
Outside processing | 97,940 | 81,333 | 16,607 | 20.42 | ||||||||
Franchise tax | 49,260 | 40,251 | 9,009 | 22.38 | ||||||||
Other expenses | 128,917 | 99,766 | 29,151 | 29.22 | ||||||||
As can be seen by the chart, the largest component of noninterest expense is salaries and employee benefits which also comprised the largest dollar increase in the year to year comparison. A large part of this increase is due to an upswing in staffing because of the growth of the Corporation which would also cause an increase in benefits. During 2006, an incentive plan, primarily based on performance, was implemented and during 2007 this was expanded to include all full-time employees. With that inclusion and the additional staffing, the increase was approximately $34 thousand. Benefits expense also increased due to the rising costs of health care which is reflected in increased premiums paid. Also, the 2007 expense includes an increase in 401-K costs of approximately $9.6 thousand due to increased participation and an increase in the Corporation’s match. MainStreet matches 100% of the first 3% and 50% of the next 2% of the employee’s deferral. MainStreet’s employees are its most valuable resource and asset. Occupancy and equipment costs are the next largest expense of the Corporation and include rent, utilities, janitorial service, repairs and maintenance, real estate taxes, service maintenance contracts and depreciation expense. Of the $16,671 period over period increase, the largest component was an increase in maintenance contracts due to asset size increase, additional vendors for information technology monitoring, and the implementation of branch capture during the first quarter of 2007. Now capture of item processing items is executed in the branch. This allows for all day banking along with increased efficiencies. Professional fees include fees for audit, legal, and other and increased $30,764 in the first quarter of 2007 versus 2006 primarily due to initiatives for information technology, consulting fees for the retired President and CEO, and the engagement of a transfer agent in late 2006. Consulting costs paid to MainStreet’s former President, after his retirement at April 30, 2006, were paid per his employment agreement. Expenses for information technology initiatives that were planned include penetration testing and network monitoring. Outside processing expense increased $16.6 thousand in 2007 over the 2006 expense for the first quarter due to increased costs associated with MainStreet’s core data processor. Some of these costs are due to new products such as branch capture and bill pay that have been implemented by the Corporation. Other expenses include OCC assessments, FDIC assessments, travel expense, meals and entertainment, subscriptions and dues, seminars and education, and contributions.
Income Taxes
BankShares is subject to both federal and state income taxes. Franklin Bank is not subject to state income taxes. A bank in Virginia is required to pay a franchise tax that is based on the capital of the entity. MainStreet recorded income tax expense on income in the amount of $286,905 and $328,148 for the three month period ending March 31, 2007 and 2006, respectively.
21
MAINSTREET BANKSHARES, INC.
March 31, 2007
BALANCE SHEET
Investment Portfolio
The Corporation’s investment portfolio is used for several purposes as follows:
| 1) | To maintain sufficient liquidity to cover deposit fluctuations and loan demand. |
| 2) | To use securities to fulfill pledging collateral requirements. |
| 3) | To utilize the maturity/repricing mix of portfolio securities to help balance the overall interest rate risk position of the balance sheet. |
| 4) | To make a reasonable return on investments. |
Funds not utilized for capital expenditures or lending are invested in securities of the U.S. Government and its agencies, mortgage-backed securities, municipal bonds, corporate debt securities and certain equity securities. Currently, BankShares has invested in U.S. Agencies, mortgage-backed securities, municipal bonds, Federal Reserve Bank stock and Federal Home Loan Bank stock. BankShares’ policy is not to invest in derivatives or other high-risk instruments. The entire securities portfolio was categorized as available-for-sale at March 31, 2007 and is carried at estimated fair value. Unrealized market valuation gains and losses on securities classified as available-for-sale are recorded as a separate component of shareholders’ equity. Please refer to Note 2 to the Notes to Consolidated Financial Statements for the break down of the securities available for sale portfolio.
Loan Portfolio
BankShares has a credit policy detailing the credit process and collateral in loan originations. Loans to purchase real estate and personal property are generally collateralized by the related property with loan amounts established based on certain percentage limitations of the property’s total stated or appraised value. Credit approval is primarily a function of the credit worthiness of the individual borrower or project based on pertinent financial information, the amount to be financed, and collateral. The loan portfolio was as follows:
| March 31, 2007 | December 31, 2006 | |||||||||||
Commercial | $ | 93,824,212 | 58.72 | % | $ | 91,439,663 | 58.48 | % | ||||
Residential real estate | 24,712,361 | 15.47 | 25,293,941 | 16.18 | ||||||||
Consumer | 41,241,907 | 25.81 | 39,614,458 | 25.34 | ||||||||
Total | $ | 159,778,480 | 100.00 | % | $ | 156,348,062 | 100.00 | % | ||||
Gross loans increased $3,430,418 or 2.19% at March 31, 2007 compared to December 31, 2006. The mix of the type of loans is comparable for the two periods. Although some continued loan growth for Franklin Bank is expected, it is unlikely that the level of loan growth experienced since the Bank opened in September 2002 will continue. The real estate market has softened somewhat. Commercial loans continue to be the primary source of lending.
Although the commercial portfolio is diversified, there are three areas classified as concentrations of credit at March 31, 2007. The areas of concentrations are in loans for real estate with an outstanding balance of $26,395,138.81; loans for construction of buildings with an outstanding balance of $26,683,041.43; and loans for construction of heavy and civil engineering buildings with an outstanding balance of $12,772,679. In addition, we also consider our residential construction as a concentration of credit which totaled $30,887,663 at quarter end.
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MAINSTREET BANKSHARES, INC.
March 31, 2007
Nonaccrual loans and loans past due 90 days or more are considered by MainStreet to be nonperforming loans. MainStreet’s policy is to discontinue the accrual of interest on loans once they become 90 days past due and are not well-collateralized, or earlier when it becomes doubtful that the full principal and interest will be collected. Once a loan is placed on nonaccrual status, any interest that is collected will generally be recorded on a cash basis until the loan is satisfied in full or circumstances have changed to such an extent that the collection of both principal and interest is probable.
There were no loans past due more than 90 days at March 31, 2007 or December 31, 2006 other than loans on nonaccual status. Nonaccrual loans were $868,489 and $588,762 at March 31, 2007 and December 31, 2006, respectively. These loans are also considered impaired loans. Lost interest related to impaired loans as of March 31, 2007 and March 31, 2006 was $23,544 and $1,292, respectively. The nonaccrual loans were .54% and .38% of loans net of unearned at March 31, 2007 and December 31, 2006, respectively.
Deposits
Total deposits at March 31, 2007 and December 31, 2006 were $170,469,076 and $164,820,051, respectively. The deposit mix was as follows:
| March 31, 2007 | December 31, 2006 | |||||||||||
Demand | $ | 16,655,898 | 9.77 | % | $ | 14,257,360 | 8.65 | % | ||||
Interest checking | 8,676,269 | 5.09 | 11,261,198 | 6.83 | ||||||||
Money markets | 15,972,777 | 9.37 | 13,088,848 | 7.94 | ||||||||
Savings | 12,923,256 | 7.58 | 12,078,951 | 7.33 | ||||||||
Time deposits $100,000 and over | 48,281,958 | 28.32 | 47,926,452 | 29.08 | ||||||||
Other time deposits | 67,958,918 | 39.87 | 66,207,242 | 40.17 | ||||||||
Total | $ | 170,469,076 | 100.00 | % | $ | 164,820,051 | 100.00 | % | ||||
Total deposits increased $5,649,025 or 3.43%. The levels and mix of deposits are influenced by such factors as customer service, interest rates paid, service charges, and the convenience of banking locations. Management attempts to identify and implement the pricing and marketing strategies that will help control the overall cost of deposits and to maintain a stable deposit mix. Management has had to price deposits competitively in the market to attract depositors, especially in the last quarter. The overall cost of interest bearing deposits was 4.78% and 3.51%, respectively for the three months ended March 31, 2007 and 2006. This increase in funding costs is reflective of the increase in the short-term federal funds rate throughout 2004, 2005 and 2006. Competition for deposits has intensified and is expected to continue. This could adversely affect the margin by increasing interest expense. As can be seen by the chart, demand deposits, money market accounts, and savings have increased as a percentage of total deposits while interest checking, other time deposits and time deposits $100,000 and over have decreased.
Short-term Borrowings
Short-term borrowings as of March 31, 2007 consist of a Federal Home Loan Bank of Atlanta advance. The advance in the amount of $10,000,000 is a prime rate based advance. Interest is paid monthly at prime minus 2.81%. The interest rate at March 31, 2007 was 5.44%. Early repayment of the advance is subject to a .25% fee of the advance amount being repaid. The maturity date is May 18, 2007.
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MAINSTREET BANKSHARES, INC.
March 31, 2007
Shareholders’ Equity
Total shareholders equity was $19,868,871 and $19,189,456 at March 31, 2007 and December 31, 2006, respectively. Book value per share was $11.19 and $10.88 at March 31, 2007 and December 31, 2006, respectively. The initial stock offering was completed during the third quarter of 2000 with net proceeds of $6,708,162. The secondary offering was completed December 31, 2002, and net proceeds from the sale of common stock were $6,874,941. The private placement offering was terminated on January 31, 2005, and
net proceeds from the total sale of common stock were $1,727,498. Offering expenses were netted against equity in all offerings.
The maintenance of appropriate levels of capital is a priority and is continually monitored. MainStreet and Franklin Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Quantitative measures established by regulations to ensure capital adequacy require MainStreet and Franklin Bank to maintain minimum capital ratios. Failure to meet minimum capital ratios can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the consolidated financial statements. Also, declining capital can impact the ability of Franklin Bank to grow other loan assets. The following are MainStreet’s capital ratios at:
| March 31, 2007 | December 31, 2006 | |||||
Tier I Leverage Ratio (Actual) | 9.84 | % | 9.82 | % | ||
Tier I Leverage Ratio (Quarterly Ave.) | 10.15 | 10.26 | ||||
Tier I Risk-Based Capital Ratio | 11.97 | 11.97 | ||||
Tier II Risk-Based Capital Ratio | 13.14 | 13.18 |
MainStreet downstreamed to Franklin Bank $4,000,000 of the proceeds from the sale of Smith River Bank in March of 2005. Franklin Bank utilized the proceeds to fund loan growth. MainStreet and Franklin Bank are considered well-capitalized under federal and state capital guidelines at March 31, 2007.
Asset Liability Management
Asset liability management functions to maximize profitability within established guidelines for liquidity, capital adequacy, and interest rate risk. It also helps to ensure that there is adequate liquidity to meet loan demand or deposit outflows and interest rate fluctuations. Liquidity is the ability to meet maturing obligations and commitments, withstand deposit fluctuations, fund operations, and provide for loan requests. MainStreet’s material off balance sheet obligations were primarily loan commitments in the amount of $35,463,122 at March 31, 2007. MainStreet has a liquidity contingency plan that provides guidance on the maintenance of appropriate liquidity and what action is required under various liquidity scenarios. MainStreet’s liquidity is provided by cash and due from banks, interest-bearing deposits, federal funds sold, securities available-for-sale, and loan repayments. MainStreet also has overnight borrowing lines available with their correspondent bank, the ability to borrow from the Federal Reserve Bank’s discount window, and the ability to borrow long-term from the Federal Home Loan Bank of Atlanta. MainStreet’s ratio of liquid assets to total liabilities at March 31, 2007 and December 31, 2006 was 16.95% and 17.86%, respectively. Core deposits are the primary foundation for liquidity.
Interest rate sensitivity is measured by the difference, or gap, between interest sensitive earning assets and interest sensitive interest bearing liabilities and the resultant change in net interest income due to market rate fluctuations, and the effect of interest rate movements on the market. Management utilizes these techniques for management of interest rate risk in order to minimize change in net interest income with interest rate changes. MainStreet BankShares, Inc. has partnered with Compass Bank using the Sendero model to help measure interest rate risk. The asset liability management process requires a number of key assumptions. Management determines the most likely outlook for the economy and interest rates measuring the effect on net interest income in a rising and declining 100, 200, and 300 interest rate
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MAINSTREET BANKSHARES, INC.
March 31, 2007
environment. A shock report for these rates along with a ramped approach with each. With the shock, net interest income is modeled assuming that interest rates move the full rate change in the first month. With the ramp, net interest income is modeled assuming rates move one quarter of the full rate change in each quarter. With this approach, management also reviews the economic value of equity which is the net present value of the balance sheet’s cash flows or the residual value of future cash flows ultimately due to shareholders.
The following table demonstrates the percentage change in net interest income from the current level prime rate of 8.25% in a rising and declining 100, 200, and 300 basis point interest rate environment:
Net Interest Income Percentage Change From Level Rates | |||||||||
Rate Shift | Prime Rate | Change From Level Ramp | Change from Level Shock | ||||||
+300 bp | 11.25 | % | 13.00 | % | 30.00 | % | |||
+200 bp | 10.25 | 8.00 | 20.00 | ||||||
+100 bp | 9.25 | 6.00 | 10.00 | ||||||
-100 bp | 7.25 | - 5.00 | - 6.00 | ||||||
-200 bp | 6.25 | -10.00 | -16.00 | ||||||
-300 bp | 5.25 | -13.00 | -24.00 | ||||||
As discussed previously, MainStreet is sensitive to change in the interest rate environment particularly due to the large percentage of variable rate loans. In a rising rate environment, it is anticipated that the impact would be positive on the net interest margin. In a declining rate environment, MainStreet has significant exposure to the net interest margin. Management seeks to lower the impact on the net interest margin. Conscious efforts will be made to originate or renew variable rate loans to a fixed rate status. Also, the possibility of off balance sheet instruments may be utilized to aid this initiative.
In order to preserve capital to facilitate growth and expansion, we do not anticipate paying cash dividends in the foreseeable future. Our Board of Directors will make a determination whether to pay cash dividends on the basis of operating results, financial condition, tax considerations, and other relevant factors. Also, at present, the only source of funds from which we could pay cash dividends would be dividends received from Franklin Bank. Franklin Bank similarly does not anticipate paying cash dividends to BankShares in the near future in order to preserve their capital to facilitate growth and expansion of business and to provide a sufficient capital base for its banking activities. Payment of cash dividends by Franklin Bank is limited by regulatory requirements and limitations. In general, the OCC limits annual dividends to retained profits of the current year plus two prior years, without OCC approval. Regulatory restrictions on Franklin Bank’s ability to pay dividends may adversely impact BankShares’ ability to pay dividends to its shareholders.
The holding company generates revenue through the affiliate fee charged to Franklin Bank and the servicing fee charged to Smith River Bank and its affiliates for its operation and service. These services include accounting, investments, treasury management, compliance (provided to Franklin Bank only), deposit and loan operations, and data processing. BankShares utilizes this affiliate fee and servicing income to meet its obligations. The corporation owns a lot adjacent to Franklin Bank that may be utilized in 2007 for additional parking for the main office. It is anticipated that MainStreet RE will own the Southlake branch office upon completion.
Stock Compensation Plans
BankShares approved the 2004 Key Employee Stock Option Plan at its Annual Meeting of Shareholders, April 15, 2004. This plan permits the granting of Incentive and Non Qualified stock options as determined by BankShares’ Board of Directors. The maximum aggregate number of shares that may be issued under this plan are 150,700. Currently, there are 121,367 stock options that have been granted under this plan. Please refer to footnote #6 for a discussion on stock options and warrants.
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MAINSTREET BANKSHARES, INC.
March 31, 2007
| Item 3. | Controls and Procedures |
MainStreet’s principal executive officer and principal financial officer have reviewed MainStreet’s disclosure controls and procedures (as defined in 204.13a-15(e) and 240.15d-15(e)) as of the end of the period covered by this quarterly report and based on their evaluation believe that MainStreet’s disclosure controls and procedures are effective.
| Item 6. | Exhibits |
See index to exhibits.
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In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: May 2, 2007 | By | /s/ Larry A. Heaton | ||
| Larry A. Heaton | ||||
| President and Chief Executive Officer | ||||
Date: May 2, 2007 | By | /s/ Brenda H. Smith | ||
| Brenda H. Smith | ||||
| Executive Vice President, Chief Financial Officer and Corporate Secretary | ||||
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| Number | Description of Exhibit | |
| 3(i)** | Restated Articles of Incorporation of the Corporation, dated March 6, 2001. | |
| 3(ii) | By-laws of the Corporation, dated August 5, 1999 amended February 20, 2001, amended amended October 16, 2002, amended September 17, 2003, amended July 13, 2005 and amended April 20, 2006 filed on Form 8-K on April 24, 2006 and herein incorporated by reference. | |
| 4.1 | Warrant Plan and Certificates as adopted July 27, 1999 and amended August 26, 1999 and amended December 19, 2000 incorporated by reference to the Corporation’s Quarterly Form 10-QSB for quarter ended September 30, 1999, filed December 20, 1999, and herein incorporated by reference. | |
| 4.2 | Provision in Registrant’s Articles of Incorporation and Bylaws defining the Rights of Holder of the Registrant’s common stock (included in Exhibits 3.1 and 3.2, respectively). | |
| 4.3* | Form of Shares Subscription Agreement. | |
| 4.3.1*** | Form of Shares Subscription Agreement. | |
| 4.4* | Form of Units Subscription Agreement. | |
| 4.5 | 2004 Key Employee Stock option Plan filed March 16, 2005 on Form S-8 and herein incorporated by reference. | |
| 10.1* | Employment Agreement with Retired President and CEO, Cecil R. McCullar, dated as of June 1, 1999. Amendment to employment agreement with President/CEO, Cecil R. McCullar, filed with the Corporation’s Quarterly Form 10-QSB on May 11, 2005 and herein incorporated by reference. | |
| 10.2 | Employment agreement with Executive Vice President , Brenda H. Smith, dated October 1, 2002, filed with the Corporation’s Quarterly Form 10-QSB on November 7, 2002 and herein incorporated by reference. Amendment to employment agreement filed with on Form 8-K on April 24, 2006 and herein incorporated by reference. | |
| 10.3 | Employment Agreement with President and Chief Executive Officer, Larry A. Heaton, entered into December 30, 2005, effective January 1, 2006, filed on Form 8-K, January 4, 2006 and herein incorporated by reference. | |
| 10.4 | Stock Purchase Agreement By and Among Argentum Capital Management, LLC, and Assigns; MainStreet BankShares, Inc., and Smith River Community Bank, N.A. dated 1/13/05 filed on Form 8-K on January 14, 2005, and herein incorporated by reference. | |
| 10.5 | Administrative Services Agreement with Smith River Community Bank, N.A. incorporated by reference to the Corporation’s Form 8-K filed March 28, 2005. | |
| 10.6 | Indemnity Agreement with Smith River Community Bank, N.A. incorporated by reference to the Corporation’s Form 8-K filed March 28, 2005. | |
| 31.1 | Certification of President and Chief Executive Officer Pursuant to Rule 13a-15(e) under the Securities and Exchange Act of 1934. | |
| 31.2 | Certification of Executive Vice President, Chief Financial Officer and Corporate Secretary Pursuant to Rule 13a-15(e) under the Securities and Exchange Act of 1934. | |
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| 32 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). | |
| * | (Incorporated by reference to Registration statement #333-86993 on Form SB-2 filed September 13, 1999.) |
| ** | (Incorporated by reference to the Corporation’s Annual Form 10-KSB filed March 15, 2001.) |
| *** | (Incorporated by reference to Registration Statement # 333-63424 on Form SB-2 filed June 20, 2001.) |
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