Mainstreet Bankshares 10Q 2009 Q1 Quarterly report

Mainstreet Bankshares (MREE) 10-Q2009 Q1 Quarterly report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2009

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

For the transition period from to

Commission file number 333-86993

MainStreet BankShares, Inc.

(Exact name of registrant 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)

Registrant’s telephone number (276) 632-8054

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

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 1,713,375 as of April 30, 2009

MAINSTREET BANKSHARES, INC.

Form 10-Q

Index


		Page No.
PART I FINANCIAL INFORMATION

Item 1	Financial Statements	1-18

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19-32

Item 4	Controls and Procedures	32

	PART II OTHER INFORMATION

Item 4	Submission of Matters to a Vote of Security Holders	32

Item 5	Other Information	32

Item 6	Exhibits	32

	Signatures	33

	Index to Exhibits	34-35

MAINSTREET BANKSHARES, INC.

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

The financial statements filed as part of Item 1 of Part I are as follows:

Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008 (audited).

Consolidated Statements of Income for the quarters and year-to-date periods ended March 31, 2009 (unaudited) and March 31, 2008 (unaudited).

Consolidated Statements of Cash Flows for the year-to-date periods ended March 31, 2009 (unaudited) and March 31, 2008 (unaudited).

Notes to Consolidated Financial Statements.

MAINSTREET BANKSHARES, INC.

Consolidated Balance Sheets


	(Unaudited) March 31, 2009			(Audited) December 31, 2008
ASSETS

Cash and due from banks	$	2,545,473		$	2,767,176
Interest-bearing deposits in banks		187,384			127,853
Federal funds sold		7,293,000			280,000

Total Cash and Cash Equivalents		10,025,857			3,175,029
Securities available for sale, at fair value		21,561,108			21,588,488
Restricted equity securities		1,063,800			1,434,900

Loans:
Total Gross Loans		185,827,813			193,434,697
Unearned deferred fees and costs net		89,731			72,853

Loans, net of unearned deferred fees and costs		185,917,544			193,507,550
Less: Allowance for loan losses		(3,517,509	)		(3,502,029	)

Net Loans		182,400,035			190,005,521
Bank premises and equipment, net		2,087,704			2,141,949
Accrued interest receivable		823,188			855,054
Other assets		2,140,761			2,679,933
Bank owned life insurance		2,747,755			2,720,450


TOTAL ASSETS	$	222,850,208		$	224,601,324


LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:
Noninterest bearing demand deposits	$	17,657,086		$	16,235,463
Interest bearing deposits		163,059,508			155,622,403

Total Deposits		180,716,594			171,857,866

Repurchase agreements		13,500,000			13,500,000
Short-term borrowings		5,367,728			16,711,375
Accrued interest payable and other liabilities		1,433,054			1,164,818

Total Liabilities		201,017,376			203,234,059


Commitments and contingencies		—			—

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 1,713,375 shares at March 31, 2009 and December 31, 2008, respectively		17,810,173			17,799,014
Retained earnings		3,523,962			3,269,480
Accumulated other comprehensive income		498,697			298,771

Total Shareholders’ Equity		21,832,832			21,367,265


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	222,850,208		$	224,601,324

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC.

Consolidated Statements of Income

(Unaudited)


	Three Months Ended March 31, 2009			Three Months Ended March 31, 2008
Interest and Dividend Income:
Interest and fees on loans	$	2,734,714		$	3,182,603
Interest on interest-bearing deposits		75			3,829
Interest on federal funds sold		1,558			33,300
Interest on securities available for sale		279,989			343,217
Dividends on restricted equity securities		5,933			11,123


Total Interest and Dividend Income		3,022,269			3,574,072

Interest Expense:
Interest on time deposits $100,000 and over		473,853			639,670
Interest on other deposits		663,973			1,104,103
Interest on short-term borrowings		13,103			1,441
Interest on repurchase agreements		132,675			133,554


Total Interest Expense		1,283,604			1,878,768


Net Interest Income		1,738,665			1,695,304
Provision for loan losses		126,000			25,900


Net Interest Income After Provision for Loan Losses		1,612,665			1,669,404

Noninterest Income:
Service charges on deposit accounts		70,658			90,035
Mortgage brokerage income		52,369			78,753
Servicing fee income		—			147,868
Income on bank owned life insurance		27,304			28,572
Gain on sale of securities available for sale		—			78
Loss on sale of other real estate owned and repossessions		(79,513	)		934
Other fee income and miscellaneous income		55,013			61,643


Total Noninterest Income		125,831			407,883

Noninterest Expense:
Salaries and employee benefits		695,221			705,866
Occupancy and equipment expense		203,392			203,840
Professional fees		75,657			44,212
Outside processing		111,992			117,634
FDIC Assessment		77,585			29,694
Franchise tax		52,500			52,500
Other expenses		144,620			156,184


Total Noninterest Expense		1,360,967			1,309,930

Net Income Before Tax	$	377,529		$	767,357
Income Tax Expense		123,047			251,132


Net Income	$	254,482		$	516,225

Net Income Per Share Basic	$	.15		$	.30


Net Income Per Share Diluted	$	.15		$	.29

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC.

Consolidated Statements of Cash Flows

(Unaudited)


	Three Months Ended March 31, 2009			Three Months Ended March 31, 2008
Cash Flows From Operating Activities
Net income from operations	$	254,482		$	516,225
Provision for loan losses		126,000			25,900
Depreciation and amortization		68,293			71,149
Amortization of discounts and premiums, net		(5,024	)		(5,857	)
Gain on sale of securities		—			(78	)
(Gain) loss and impairment on other real estate owned and repossessions		79,513			(934	)
Stock option expense		11,159			10,808
Deferred tax benefit		(69,365	)		(17,974	)
Decrease in accrued interest receivable		31,866			88,500
Increase in other assets		(172,978	)		(4,229	)
Increase in value of BOLI		(27,305	)		(28,573	)
Increase in accrued interest payable and other liabilities		268,236			36,651
Tax benefit of warrant exercise		—			15,727

Net cash provided by operating activities		564,877			707,315

Cash Flows From Investing Activities

Purchases of bank premises and equipment		(14,048	)		(18,637	)
Purchases of securities available for sale		(1,162,734	)		(10,486,016	)
Purchases of restricted equity securities		(78,900	)		(18,600	)
Redemptions of restricted equity securities		450,000			—
Calls/maturities/repayments of securities available for sale		1,498,056			4,475,288
Proceeds from sale of securities		—			2,611,113
Proceeds from sale of other real estate owned and repossessions		599,010			23,000
Loan originations and principal collections, net		7,479,486			(3,263,335	)

Net cash provided by (used in) investing activities		8,770,870			(6,677,187	)

Cash Flows From Financing Activities

Increase (decrease) in non-interest bearing deposits		1,421,623			(200,318	)
Increase in interest bearing deposits		7,437,105			4,265,413
Repayment of short-term borrowings		(11,512,000	)		—
Proceeds from short-term borrowings		168,353			241,611
Proceeds from repurchase agreement		—			6,000,000
Dividends paid		—			(85,944	)
Repurchase of common stock		—			(251,000	)
Proceeds from issuance of common stock		—			49,995


Net cash provided by (used in) financing activities		(2,484,919	)		10,019,757


Net increase (decrease) in cash and cash equivalents	$	6,850,828		$	4,049,885
Cash and cash equivalents at beginning of period		3,175,029			4,184,981

Cash and cash equivalents at end of period	$	10,025,857		$	8,234,866


Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	1,237,508		$	1,921,537

Cash paid during the period for taxes	$	—		$	97,122

Unrealized gain on securities available for sale	$	(302,918	)	$	(296,231	)

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

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. 2008 Annual Report on Form 10-K should be referred to in connection with the reading of these unaudited interim consolidated financial statements.

MainStreet BankShares, Inc. (the “Corporation”, “MainStreet”, or “BankShares”) was incorporated in Virginia on January 14, 1999. MainStreet has had two registered stock offerings raising a total of $14,029,501. 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 shares from the private placement offering were subsequently registered with The Securities and Exchange Commission (“SEC”) effective December 8, 2006. The Corporation was primarily organized to serve as a bank holding company. Its first wholly-owned subsidiary was Smith River Community Bank, N.A. (“Smith River Bank”) which was sold on March 23, 2005 for $6.5 million. In 2002, MainStreet organized a second bank subsidiary, Franklin Community Bank, National Association (“Franklin Bank”). On February 8, 2007, MainStreet formed a wholly-owned real estate company, MainStreet RealEstate, Inc. (“MainStreet RE”) for the sole purpose of owning the real estate of the Corporation.

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. It currently has four banking offices including its main office.

When MainStreet sold Smith River Bank the capital was redeployed to Franklin Bank. As part of the transaction, MainStreet agreed to acquire specified loans from Smith River Bank under certain conditions after the closing. In the event Smith River Bank 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 Bank’s out of pocket collection expenses. The outstanding principal balance of such loans at March 31, 2009 and December 31, 2008 totaled $85,989 and $86,514, respectively, and consisted of one loan. Also, as part of the transaction, Smith River Bank 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 that was adjusted annually based upon the terms of the original agreement. The original Servicing Agreement expired on March 22, 2008 at which time MainStreet elected not to renew the Servicing Agreement.

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.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

(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, due from banks, interest-bearing deposits in banks, and federal funds sold.

(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.

Purchased premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are determined to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on settlement date and are determined using 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.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

(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-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management provides a detailed quarterly analysis of the allowance based on our historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions and the economic trend. These are generally grouped by homogeneous loan pools. 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. 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. Other real estate owned totaled $765,800 and $1,158,600 at March 31, 2009 and December 31, 2008, respectively, and is included in other assets on the Corporation’s balance sheet.

(i)	Bank Premises and Equipment

Land is carried at cost. Buildings, 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 ranging from three years to forty years. Maintenance, repairs, and minor improvements are charged to expense as incurred. Significant improvements are capitalized.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

(j)	Stock Options and Warrants

MainStreet adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (SFAS .No. 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 $11,159 and $10,808 for the quarters ending March 31, 2009 and 2008, respectively. Additional disclosures required by SFAS No. 123 (R) are included in Note 8 to the consolidated financial statements herein.

(k)	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. 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.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.

MainStreet is currently being audited by the Internal Revenue Service for tax years ending December 31, 2005 and 2006.

(l)	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. 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. Please refer to Note 6 for detailed information on net income per share for the quarter and year-to-date periods. Please refer to Note 8 for detailed information on stock options and warrants.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

(m)	Comprehensive Income

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

(n)	Advertising costs

The Corporation follows the policy of charging the costs of advertising to expense as incurred.

(o)	Reclassifications

Certain reclassifications have been made to prior period balances to conform to current year presentations.

(p)	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.

(q)	Recent Events

On April 16, 2009, Franklin Bank entered into a formal agreement (“Agreement”) with The Comptroller of the Currency (“OCC”). The Agreement requires Franklin Bank to perform certain actions within designated time frames. The Bank must be in compliance with all of the Articles of the Agreement during the course of the Agreement. The Agreement is intended to demonstrate the Bank’s commitment to review/enhance certain aspects of various policies. The Agreement describes Franklin Bank’s commitment to enhance practices related to credit administration and liquidity. Franklin Bank expects to achieve full compliance and has already initiated steps to do so.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

Within 30 days, Franklin Bank must adopt sublimits for concentrations in acquisition and development loans, speculative lot loans, and speculative single-family housing construction loans and determine if any action is necessary to reduce these concentrations. Franklin Bank has already reviewed and amended these limits. Certain concentrations have been lowered.

Within 60 days, Franklin Bank must establish an effective program for early identification of emerging and potential problem credits to include accurate ratings, accrual status, continued financial analyses, and formal work out plans. Franklin Bank has developed an attestation process monthly for loan officers to include risk rating and accrual status of their loan portfolios. Franklin Bank has a Problem Loan Committee that meets quarterly. Problem loan sheets will be expanded to include a summary of the most recent financial analysis; most recent collateral valuation factoring possible liquidation and timing discount; and enhanced action plans with target dates. Primary and secondary repayment sources will be detailed. Our internal loan review will report to an independent committee of the board and will continue to make quarterly reports with enhanced information including the overall quality of the loan portfolio; the identification, type, rating, and amount of problem loans; the identification and amount of delinquent loans; credit and collateral documentation exceptions; the identification and status of credit-related violations of law; the loan officer who originated each loan reported; concentrations of credit; and loans to executive officers and directors. Also, within 60 days Franklin Bank shall develop a written underwriting program to include reasonable amortization of speculative lot and single family housing construction loans and ensure updated appraisals are documented. Our credit policy has been amended to address the amortization periods. Personnel have been designated to ensure the reporting system has updated appraisals and evaluations. Within 60 days the Bank shall eliminate the basis of criticism of assets criticized by the OCC. Franklin Bank has dedicated an experienced employee to work through problem assets. Within 60 days Franklin Bank shall enhance its asset liability management policy to ensure monitoring of the Bank’s liquidity position which will include more detailed reporting to the Board. These reports have been created. The Agreement also required Franklin Bank to take action to ensure adequate sources of liquidity. Franklin Bank has increased its sources by adding correspondent bank lines; becoming a member of QwickRate (an internet certificate of deposit program); becoming a member of the Certificate of Deposit Account Registry Service (“CDARS”); and partnering with certain institutions to acquire brokered deposits. According to the Agreement, brokered deposits cannot exceed 15% of total deposits. At March 31, 2009, brokered deposits were less than 5%. Franklin Bank will also revise its Contingency Liquidity Plan to include crises relevant to current balance sheet composition. Franklin Bank will also be required to review and enhance the analysis of the allowance for loan losses.

Within 90 days, Franklin Bank must develop and implement a three-year capital plan.

Under the Agreement, a Compliance Committee of three members of the Board of Directors was formed to monitor the progress and make regular reports to the OCC. Failure to comply with the provisions of the Agreement could subject Franklin Bank and its directors to additional enforcement actions. While the Corporation intends to take such actions as may be necessary to enable Franklin Bank to comply with the requirements of the Agreement, there can be no assurance that it will be able to comply fully with the provisions of the Agreement in the time frames required. Such compliance could be costly and affect the operations of the Corporation.

Note 2 – Securities

The carrying values, unrealized gains and losses and approximate market values of investment securities at March 31, 2009 and December 31, 2008 are shown in the following tables. The entire investment portfolio is classified as available-for-sale to preserve maximum liquidity for funding needs.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009


	March 31, 2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Approximate Market Value
U.S. government sponsored agencies	$	2,762,767	$	9,217	$	—	$	2,771,984
Mortgage backed securities		18,042,740		746,384		—		18,789,124

Total securities available for sale	$	20,805,507	$	755,601	$	—	$	21,561,108


	December 31, 2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Approximate Market Value
U. S. government sponsored agencies	$	2,397,461	$	34,497	$	—	$	2,431,958
Mortgage backed securities		18,738,344		418,186		—		19,156,530

Total securities available-for-sale	$	21,135,805	$	452,683	$	—	$	21,588,488

At March 31, 2009 and December 31, 2008, MainStreet had no securities in an unrealized loss position. There were no gains or losses recorded on sales and call of securities available for sale at March 31, 2009.

Federal Reserve Bank stock and Federal Home Loan Bank stock are included in restricted equity securities and totaled $435,100 and $628,700, respectively, at March 31, 2009 and $390,100 and $1,044,800, respectively, at December 31, 2008.

Note 3 – Loans Receivable

The major components of gross loans in the consolidated balance sheets at March 31, 2009 and December 31, 2008 are as follows:


	March 31, 2009		December 31, 2008
Commercial	$	15,215,953	$	18,251,922
Real Estate
Construction and land development		47,034,346		51,200,170
Residential I-4 families		47,304,192		43,707,986
Home Equity lines		15,465,133		16,012,671
Commercial real estate		57,935,742		61,174,895
Consumer		2,872,447		3,087,053

Total Gross Loans	$	185,827,813	$	193,434,697

Overdrafts reclassified to loans at March 31, 2009 and December 31, 2008 were $39,374 and $48,973, respectively.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

Note 4 – Allowance for Loan Losses

Changes in the allowance for loan losses for the three months ended March 31, 2009 and 2008 are as follows:


	2009			2008
Balance at beginning of year	$	3,502,029		$	2,086,592
Provision for loan losses		126,000			25,900
Recoveries		2,595			—
Charge-offs		(113,115	)		(14,020	)

Balance at period end	$	3,517,509		$	2,098,472

Net charge-offs of $110,520 and $14,020 for the first three months of 2009 and 2008, respectively, equated to .23% and .03%, respectively, of average loans outstanding net of unearned income and deferred fees. The loan loss reserve at March 31, 2009 was $3,517,509 or 1.89% of loans, net of unearned income and deferred fees. At December 31, 2008, the loan loss reserve was $3,502,029 or 1.81% of loans, net of unearned income and deferred fees.


	For the Periods Ended
	March 31, 2009		December 31, 2008
Nonaccrual loans and leases	$	7,935,300	$	4,217,698
Foreclosed real estate		765,800		1,158,600
Other foreclosed property		—		—

Total foreclosed property		765,800		1,158,600

Total nonperforming assets	$	8,701,100	$	5,376,298

Loans 90 days or more past due and still accruing	$	445,424	$	464,701

Impaired loans totaled $7,935,300 and $4,217,698 at March 31, 2009 and December 31, 2008, respectively, of which all were on nonaccrual. Lost interest related to these loans at March 31, 2009 and December 31, 2008 was $90,241 and $113,626, respectively. The average balance during the first quarter of 2009 for impaired loans was approximately $5,566,125. The average balance for impaired loans during the year ended 2008 was approximately $1,766,634. Interest income reflected in the March 31, 2009 income statement related to impaired loans was $23,336. Of the $7,935,300 of impaired loans at March 31, 2009, $5,511,239 had specific reserves of $583,926 included in the allowance for loan losses. Of the $4,217,698 of impaired loans at December 31, 2008, $3,859,393 had specific reserves of $499,949 included in the allowance for loan losses.

Note 5 – Borrowings

The Corporation entered into a repurchase agreement with Citigroup Global Markets, Inc. (“CGMI”) in the amount of $7,500,000 on September 18, 2007. The repurchase date is September 18, 2012. The pricing rate was fixed at 4.22% until September 18, 2008. On that date, it could have been called by CBMI and can be called quarterly with two business days prior notice. Interest is payable quarterly. The repurchase agreement is collateralized by agency mortgage backed securities. The interest rate remained at 4.22% at March 31, 2009.

The Corporation entered into a repurchase agreement with Barclays Capital on January 2, 2008 in the amount of $6,000,000. The repurchase date is January 2, 2013. The initial interest rate was fixed at 3.57% until January 2, 2009 at which time the repurchase agreement could have been called. It can be called quarterly with two business days prior notice. Interest is payable quarterly. The repurchase agreement is collateralized by agency mortgage backed securities. The interest rate remained at 3.75%.

The Corporation had borrowed short-term borrowings of $5,000,000 from Federal Home Loan Bank of Atlanta (“FHLB”) at March 31, 2009. The interest rate in effect at March 31, 2009 was .45%. The borrowing is secured by a blanket lien on loans secured by commercial real estate and loans secured by 1-4 family first liens, second liens, and equity lines.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

The Corporation has an internal Corporate Cash Management account for customers to sweep their excess demand deposit accounts on an overnight basis in order to earn interest. This account is not FDIC insured but the Corporation is required to pledge agency funds at 100% towards these balances. The Corporate Cash Management sweep accounts totaled $367,728 at March 31, 2009 and $199,375 at December 31, 2008.

Note 6 – Net Income Per Share

The following table shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential dilutive common stock had no effect on income available to common shareholders.


	Three Months Ended March 31, 2009			Three Months Ended March 31, 2008
	Shares	Per Share Amount		Shares	Per Share Amount
Earnings per share, basic	1,713,375	$	.15	1,723,891	$	.30

Effect of dilutive securities:
Stock options and warrants	—			46,641

Earnings per share, diluted	1,713,375	$	.15	1,770,532	$	.29

Shares not included in the calculation of diluted earnings per share because they were anti-dilutive were 223,824 and 28,311 for the first quarter ending March 31, 2009 and 2008, respectively.

Note 7 – 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 gain (loss) on the balance sheet as of March 31, 2009 and 2008.


	March 31, 2009			March 31, 2008
Net Income	$	254,482		$	516,225

Net unrealized holding gains (losses) during the period		302,918			296,309
Less reclassification adjustments for gains included in net income		—			(51	)
Income tax benefit (expense)		(102,992	)		(100,746	)


Change in accumulated other comprehensive income (loss)		199,926			195,512


Total Comprehensive Income	$	454,408		$	711,737

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

Note 8 – Stock Options and Warrants

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, 55,916 are fully vested, 27,500 have been exercised, and 12,834 have been forfeited.

Options in the amount of 33,000, all of which are vested and exercisable, have been granted at the then fair market value of $9.55 to former employees.

The shareholders of MainStreet approved the 2004 Key Employee Stock Option Plan, (the “Plan”), at its Annual Meeting on April 15, 2004. The Plan permitted 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 approved by the Board of Directors as of January 21, 2004 and terminated on January 21, 2009, except with respect to awards made prior to and outstanding on that date which remain valid in accordance with their terms. Option awards were granted with an exercise price equal to the market value of MainStreet’s stock at the date of grant. The options issued in 2007 and 2006 have a vesting period of three 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 could have been issued under the Plan could not exceed 150,700. As of March 31, 2009, there were 136,527 stock options granted under this Plan of which 822 stock options have been exercised and 797 stock options were forfeited.

As of March 31, 2009 the Corporation has reserved 223,824 shares of authorized but unissued shares of common stock related to these option and warrant agreements.

The Black-Scholes model was utilized to calculate the fair-value of the stock options on the date of grant in 2007 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. Stock options granted in 2006 and forward 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. Expected life was calculated using the simplified method based on the average of the vesting period and contractual life of the options.

MainStreet recorded $11,159 and $10,808 in equity-based compensation cost during the quarters ended March 31, 2009 and 2008, respectively.

MainStreet did not have anyone exercise warrants, or stock options during the quarter ended March 31, 2009. MainStreet received $49,995 in cash from the exercise of warrants and stock options during the first three months of March 31, 2008. MainStreet received a tax benefit in the amount of $15,727 with the filing of its 2008 corporate income tax return.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

Following is a status and summary of changes of options and warrants during the three months ended March 31, 2009:


	Three Month Period Ended March 31, 2009	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at Beginning of year	223,824	$	11.43
Granted	—		—
Exercised	—		—
Forfeited	—		—

Outstanding at March 31, 2009	223,824	$	11.43	5.18	$	—

Exercisable at March 31, 2009	209,928	$	11.15	4.96	$	—

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2009. This amount changes based on changes in the market value of the Corporation’s stock. The total intrinsic value of stock options and warrants exercised during the years ended March 31, 2009 and 2008 was $0 and $46,255, respectively.

As of March 31, 2009 and 2008, there was $56,717 and $102,658, respectively, of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. The original unrecognized compensation cost is expected to be recognized over a remaining weighted-average period of three years.

As of March 31, 2009, stock options and warrants outstanding and exercisable are summarized as follows:


Range of Exercise Prices		Stock Options and Warrants Outstanding And Exercisable	Remaining Contractual Life
$	9.09	55,916	1.35
	9.55	33,000	4.25
	12.09	89,264	6.65
	12.09	18,121	6.75
	16.75	8,907	7.75
	15.00	4,720	8.70

$	9.09 - $ 16.75	209,928

Note 9 – 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.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

At March 31, 2009, outstanding commitments to extend credit including letters of credit were $27,225,017. 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.

Note 10 – Fair Value Measurements

MainStreet adopted SFAS No. 157, “Fair Value Measurements” (SFAS 157), on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. SFAS 157 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

In February of 2008, the FASB issued Staff Position No. 157-2 (FSP 157-2) which delayed the effective date of SFAS 157 for certain nonfinancial assets and nonfinancial liabilities except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP 157-2 deferred the effective date of SFAS 157 for such nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. Those items affected by FSP 157-2 include other real estate owned (OREO). Beginning January 1, 2009, MainStreet has fully complied with SFAS 157.

In October of 2008, the FASB issued Staff Position No. 157-3 (FSP 157-3) to clarify the application of SFAS 157 in a market that is not active and to provide key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 was effective upon issuance, including prior periods for which financials statements were not issued.

SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect MainStreet’s market assumptions. The three levels of the fair value hierarchy under SFAS 157 based on these two types of inputs are as follows:


Level 1	–	Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2	–	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

Level 3	–	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by MainStreet to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2009:


	Balance as of March 31, 2009		Fair Value Measurements at March 31, 2009 Using
Description	Balance as of March 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities	$	21,561,108	$	—	$	21,561,108	$	—

Total assets at fair value	$	21,561,108	$	—	$	21,561,108	$	—

Total liabilities at fair value	$	—	$	—	$	—	$	—

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by MainStreet to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of MainStreet using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned (OREO): Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair market value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the OREO as nonrecurring Level 2. When the appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the OREO as nonrecurring Level 3.

MAINSTREET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2009

The following table summarizes MainStreet’s financial assets that were measured at fair value on a nonrecurring basis during the period.


	Balance as of March 31, 2009		Carrying value at March 31, 2009
Description	Balance as of March 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	4,927,313	$	—	$	4,477,313	$	450,000
Other Real Estate Owned	$	765,800		—	$	248,900	$	516,900

Total assets at fair value	$	5,693,113	$	—	$	4,726,213	$	966,900

Total liabilities at fair value	$	—	$	—	$	—	$	—

Note 11 – Contingencies and Other Matters

The Corporation currently is not involved in any litigation or similar adverse legal or regulatory matters.

MAINSTREET BANKSHARES, INC.

March 31, 2009

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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”) was incorporated as a Virginia corporation on January 14, 1999. MainStreet has had two registered stock offerings raising a total of $14,029,501. MainStreet also had a private placement offering which raised total proceeds of $1,807,101. The shares from this private placement offering were registered with The Securities and Exchange Commission (“SEC”) effective December 8, 2006. The Corporation was primarily organized to serve as a bank holding Company. Its first wholly-owned subsidiary was Smith River Community Bank, N.A. (“Smith River Bank”), located in Martinsville, Virginia, which was sold on March 23, 2005 for $6.5 million. In 2002, MainStreet organized a second bank subsidiary, Franklin Community Bank, N.A. (“Franklin Bank”) to serve the Franklin County area of Virginia. Franklin Bank was organized as a nationally chartered commercial bank and member of the Federal Reserve Bank of Richmond. MainStreet provides a wide variety of banking services through Franklin Bank. 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. It relies on local advertising and the personal contacts of its directors, employees, and shareholders to attract customers and business to the Bank. Franklin Bank has four offices in Rocky Mount and Franklin County. On February 8, 2007, MainStreet formed a wholly-owned real estate company, MainStreet RealEstate, Inc. for the sole purpose of owning the real estate of the Corporation. MainStreet RealEstate, Inc. owns the Union Hall (Southlake) branch of Franklin Bank.

As mentioned previously, MainStreet sold Smith River Bank in 2005. As part of the transaction, MainStreet agreed to acquire specified loans from Smith River Bank under certain conditions after the closing. In the event Smith River Bank 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 Bank’s out of pocket collection expense. The outstanding principal balance of such loans at March 31, 2009 and December 31, 2008 was $85,989 and $86,514, respectively, and consisted of one loan. Also as part of the transaction, Smith River Bank 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 that was adjusted annually based upon the terms of the original agreement. The original Servicing Agreement expired March 22, 2008. MainStreet elected not to renew the Servicing Agreement.

MAINSTREET BANKSHARES, INC.

March 31, 2009

On April 16, 2009, Franklin Bank entered into a formal agreement (“Agreement”) with The Comptroller of the Currency (“OCC”). The Agreement requires Franklin Bank to perform certain actions within designated time frames. The Bank must be in compliance with all of the Articles of the Agreement during the course of it. The Agreement is intended to demonstrate the Bank’s commitment to review/enhance certain aspects of various policies. The Agreement describes Franklin Bank’s commitment to enhance practices related to credit administration and liquidity. Franklin Bank expects to achieve full compliance and has already initiated steps to do so.

Within 60 days, Franklin Bank must establish an effective program for early identification of emerging and potential problem credits to include accurate ratings, accrual status, continued financial analyses, and formal work out plans. Franklin Bank has developed an attestation process monthly for loan officers to include risk rating and accrual status of their loan portfolios. Franklin Bank has a Problem Loan Committee that meets quarterly. Problem loan sheets will be expanded to include a summary of the most recent financial analysis; most recent collateral valuation factoring possible liquidation and timing discount; and enhanced action plans with target dates. Primary and secondary repayment sources will be detailed. Our internal loan review will report to an independent committee of the board and will continue to make quarterly reports with enhanced information including the overall quality of the loan portfolio; the identification, type, rating, and amount of problem loans; the identification and amount of delinquent loans; credit and collateral documentation exceptions; the identification and status of credit-related violations of law; the loan officer who originated each loan reported; concentrations of credit; and loans to executive officers and directors. Also, within 60 days Franklin Bank shall develop a written underwriting program to include reasonable amortization of speculative lot and single family housing construction loans and ensure update appraisals are documented. Our credit policy has been amended to address the amortization periods. Personnel have been designated to ensure the reporting system has updated appraisals and evaluations. Within 60 days the Bank shall eliminate the basis of criticism of assets criticized by the OCC. Franklin Bank has dedicated an experienced employee to work through problem assets. Within 60 days Franklin Bank shall enhance its asset liability management policy to ensure monitoring of the Bank’s liquidity position which will include more detailed reporting to the Board. These reports have been created. The Agreement also required Franklin Bank to take action to ensure adequate sources of liquidity. Franklin Bank has increased its sources by adding correspondent bank lines; becoming a member of QwickRate (an internet certificate of deposit program); becoming a member of the Certificate of Deposit Account Registry Service (“CDARS”); and partnering with certain institutions to acquire brokered deposits. According to the Agreement, brokered deposits cannot exceed 15% of total deposits. At March 31, 2009, brokered deposits were less than 5%. Franklin Bank will also revise its Contingency Liquidity Plan to include crises relevant to current balance sheet composition. Franklin Bank will also be required to review and enhance the analysis of the allowance for loan losses.

Within 90 days, Franklin Bank must develop and implement a three-year capital plan.

MAINSTREET BANKSHARES, INC.

March 31, 2009

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 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-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a detailed quarterly analysis of the allowance based on our historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions, and the economic trend. These are generally grouped by homogeneous loan pools. 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.

Overview

Total assets at March 31, 2009 were $222,850,208 as compared to $224,601,324 at December 31, 2008, a decline of $1,751,116, or .78%. Loans, net of unearned income, decreased $7,590,006, or 3.92% funds primarily re-invested in overnight federal funds sold which had a balance of $7,293,000 at March 31, 2009 compared to $280,000 at December 31, 2008. Deposits increased $8,858,728, or 5.15%. This increase was utilized to pay down short-term borrowings which dropped $11,343,647, or 67.88% from year end. The largest component of total assets at March 31, 2009 was net loans in the amount of $182,400,035, followed by securities available for sale with a balance of $21,561,108. The loan to deposit ratio at March 31, 2009 and December 31, 2008 was 102.88% and 112.60%, respectively. The loan to deposit ratio has dropped somewhat since year-end due to loans being participated to other banking institutions and the increase in deposits since year end. Even so, liquidity is being monitored closely due to the high loan to deposit ratio and continues to be a concern. The increase in deposits in the first quarter of 2009 followed a decline in deposits during the fourth quarter of 2008. During the later part of 2008, deposit pricing became intense as banks were challenged with liquidity issues and were willing to pay increased interest rates to attract depositors. Franklin Bank experienced a reduction in deposits which caused us to bring in brokered deposits for the first time in early 2009. These brokered deposits are less than 5% of total deposits at March 31, 2009. Deposit attrition appears to have stabilized somewhat. Total shareholders’ equity was $21.8 million at March 31, 2009. MainStreet and Franklin Bank were well capitalized at March 31, 2009. The book value of shareholders’ equity at March 31, 2009 was $12.74 per share.

MAINSTREET BANKSHARES, INC.

March 31, 2009

Net income for the first quarter of 2009 was $254,482 compared to $516,225 at March 31, 2008 which equated to basic net income per share of $.15 and $.30, respectively. Diluted net income per share was $.15 and $.29 for the quarters ending March 31, 2009 and 2008, respectively. Annualized return on average assets at March 31, 2009 was .46% and annualized return on average shareholders’ equity was 4.76%. Annualized return on average assets at March 31, 2008 was .97% and annualized return on average shareholders’ equity was 9.77%. The declines in the net income, return on average assets and return on average shareholders equity were due largely to the decline in the net interest margin, the increase in nonaccrual loans as discussed further below, and the write-downs or loss on sale of other real estate properties.

For the three months ending March 31, 2009 and 2008, the net interest margin was 3.24% and 3.34%, respectively, a 10 basis point decline. The yield on interest earning assets for the year-to-date period ending March 31, 2009 was 5.63% compared to 7.03% for the year-to-date period ending March 31, 2008, a decline of 140 basis points. The funding side of the interest margin dropped during this time period also by 130 basis points. As can be noted from the above ratios, the decrease in the net interest margin was primarily caused by a decline in the interest rate environment. Competition for deposits in Franklin Bank’s primary market area has been fierce and deposit rates have remained stubbornly high. Franklin Bank has strived to decrease the funding side of the equation. However, deposits must be maintained for liquidity and deposit rates must be competitive to retain core deposits. With the prime rate at 3.25%, which is the basis for most of our variable rate loans, the interest margin is adversely impacted.

The Federal Reserve began lowering the short term interest rates in 2007 with 100 basis points cuts ending the year at 4.25%. In 2008, the Federal Reserve lowered short term interest rates 400 basis points and ended the year with a range of 0—0.25% which remained the same at March 31, 2009. In correlation, the prime rate is currently 3.25%. Franklin Bank is asset sensitive and interest rates on variable rate loans make up almost 40% of Franklin’s loan portfolio. Loan volume has also decreased during the first quarter of 2009 so there have not been as many opportunities for fee income. Franklin Bank’s growth is also quite dependent on consumer and real estate based lending and there is concern over the sustainability given the current economic environment. Franklin Bank’s future growth and earnings may be negatively affected if real estate markets remain depressed or deteriorate further. The level of nonaccrual loans has also negatively affected interest income with $90,241 in lost interest for the first quarter of this year.

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 for the three months of 2009 was $1,738,665 compared to $1,695,304 for the three months of 2008, an increase of $43,361, or 2.56%. Interest income decreased $551,803 and interest expense decreased $595,164. The largest category of interest income is loans, net of unearned deferred fees and costs. Total loan income decreased; but average volume increased $18,204,066 in comparison to the prior year. The change due to volume added $309,518 to interest income, however, the interest rate reduction lowered interest income by $757,408 along with the nonaccrual loans. The interest expense decreased primarily as a result of the lowering of the short term interest rate by the Federal Reserve. Franklin Bank has been able to lower deposit rates during the first quarter of this year. Average volume on interest bearing deposits increased $1,538,646 which added approximately $16,581 offset by the decline in interest rates on deposits of $622,528.

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

MAINSTREET BANKSHARES, INC.

March 31, 2009

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 homogenous loan pools, identifying impairment, historical losses, credit concentrations, economic conditions, and other risks. 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 of $126,000 and $25,900 was recorded for the three month period ending March 31, 2009 and 2008, respectively. While loan volume has declined, we have prudently continued to add to our loan loss reserve. Nonperforming loans (nonaccrual and over 90 days past due) were $8,380,724 at March 31, 2009 and $4,682,399 at December 31, 2008, an increase of $3,698,325, or 78.98%. The allowance for loan losses was $3,517,509 at March 31, 2009 which equated to 1.89% of loans, net of unearned deferred fees and costs. At December 31, 2008, the allowance was $3,502,029, or 1.81% of loans, net of unearned deferred fees and costs. Net charge-offs of $110,520 and $14,020 for the first three months of 2009 and 2008 equated to ..23% and .03%, 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. The increase in nonperforming loans is primarily due to the deterioration in the real estate market in our area.

Nonaccrual loans at March 31, 2009 were $7,935,300 which represents 4.27% of loans, net of unearned deferred fees and costs. Management considers these loans impaired. A total of $583,926 in specific reserves was included in the balance of the allowance for loan losses as of March 31, 2009 for impaired loans. Nonaccrual loans at December 31, 2008 were $4,217,698, all of which management considers to be impaired. A total of $499,949 in specific reserves was included in the balance of the allowance for loan losses as of December 31, 2008 for these impaired loans. No assurance can be given that continuing adverse economic conditions or other circumstances will not result in increased provisions in the future. Deterioration in the national real estate markets and in our local markets caused by the recent well-publicized credit and liquidity problems at the national and international level has resulted in larger than historical asset quality issues within local communities like ours.

MainStreet’s other real estate owned from foreclosed properties at March 31, 2009 was $765,800 which is included in other assets on the balance sheet.

Noninterest Income

Total noninterest income was $125,831 and $407,883 for the three months ending March 31, 2009 and 2008, respectively, a decline of $282,052, or (69.15)%. The following chart demonstrates the categories of change:


Noninterest Income	YTD 3/31/09			YTD 3/31/08		Dollar Change			Percentage Change
Service charges on deposit accounts	$	70,658		$	90,035	$	(19,377	)	(21.52	)%
Mortgage brokerage income		52,369			78,753		(26,384	)	(33.50	)
Servicing fee income		—			147,868		(147,868	)	(100.00	)
Income on bank owned life insurance		27,304			28,572		(1,268	)	(4.44	)
Gain on sale of securities available for sale		—			78		(78	)	(100.00	)
Loss on sale of other real estate owned and repossessions		(79,513	)		934		(80,447	)	(8,613.17	)
Other fee income & miscellaneous		55,013			61,643		(6,630	)	(10.76	)

MAINSTREET BANKSHARES, INC.

March 31, 2009

As mentioned above, total noninterest income declined $282,052 for the first quarter of 2009 compared to the first quarter of 2008. The largest category of decline was reflected in the servicing fee income which dropped $147,868. The Servicing Agreement with Smith River Bank expired on March 22, 2008, per MainStreet’s election to not renew. The 2008 income included the allowable increase per the Agreement for the period serviced in 2008 along with costs for deconversion of their data from MainStreet’s systems. The loss of revenue from termination of the Servicing Agreement is offset to some degree by a reduction in noninterest expense associated with performance of the Agreement. Mortgage brokerage income reflected a 33.50% drop in 2009 compared to 2008 which is a direct result of the softening of the real estate market. Franklin Bank partners with several organizations in which we originate residential mortgage loans that for the most part close in the companies’ names. Franklin Bank receives the mortgage brokerage commission. Service charges on deposits accounts declined $19,377 in the quarter-to-quarter comparison primarily due to a decrease in NSF fees, net of waives and charge-offs. Franklin Bank experienced a loss on sale of other real estate and repossessions of $79,513 in the first quarter of 2009 compared to a modest gain of $934 in 2008. These also include market write downs of properties once they have been transferred to other real estate when updated information suggests the market value is lower.

Noninterest Expense

Total noninterest expense was $1,360,967 and $1,309,930 for the first three month period ending March 31, 2009 and 2008, respectively, an increase of $51,037 or 3.90%. The following chart shows the categories of noninterest expenses for the three month period ending March 31, 2009 and 2008, the dollar change, and the percentage change:


Expense	YTD 3/31/09		YTD 3/31/08		Dollar Change			Percentage Change
Salaries and employee benefits	$	695,221	$	705,866	$	(10,645	)	(1.51	)%
Occupancy and equipment		203,392		203,840		(448	)	(.22	)
Professional fees		75,657		44,212		31,445		71.12
Outside processing		111,992		117,634		(5,642	)	(4.80	)
FDIC Assessment		77,585		29,694		47,891		161.28
Franchise tax		52,500		52,500		—		—
Other expenses		144,620		156,184		(11,564	)	(7.40	)

MainStreet’s employees are its most valuable resource and asset. Salaries and employee benefits comprise 51.08% and 53.89% of total noninterest expense for the periods ending March 31, 2009 and 2008, respectively. This expense declined $10.6 thousand from first quarter 2008; however, there were variances within the category. Salaries expense increased $11,045 due to the addition of a credit analyst, certain promotions, and annual performance increases. Employee insurance costs increased $3.4 thousand due to increased premiums. Incentive or bonus expense declined in the quarter to quarter comparison $12.1 thousand due to the anticipated net income for 2009. The basis for payout in 2009 has changed to deposit gathering and net income versus budget. Personnel taxes declined $11.4 thousand and 401-K match expense declined $6.1 thousand at March 31, 2009 compared to March 31, 2008 because there was no payout of incentive in January 2009 for 2008 as there was in January 2008 for 2007. The credit for FASB 91 salaries expense decreased $8.9 thousand resulting in an actual increase in the quarter to quarter comparison. This was due to decreased loan volumes. Occupancy and equipment costs are the next largest expenses of the Corporation and include rent, utilities, janitorial service, repairs and maintenance, real estate taxes, service maintenance contracts and depreciation expense. This expense remained stable for the first quarter of 2009 compared to the same quarter in 2008. Professional fees include fees for audit, legal, and other and increased $31,445 or 71.12% in the quarters comparison. Legal expenses actually increased $20.7 thousand; audit expense increased $7.6 thousand; and other professional fees increased $3.2 thousand. Outside processing expense decline slightly at March 31, 2009 compared to March 31, 2008. FDIC Assessment expense increased $47.9 thousand which included an accrual for the one time special assessment. The turmoil in the financial services industry has resulted in the need to increase FDIC insurance premiums and this may

MAINSTREET BANKSHARES, INC.

March 31, 2009

intensify depending on the length and depth of the current recession. This expense is anticipated to increase further during the year based on the new assessment. Other expenses declined $11.6 thousand. These expenses include OCC assessments, travel expense, meals and entertainment, subscriptions and dues, director fees, supplies, telephone, postage, seminars and education, supplies, advertising and promotion, and contributions.

Income Taxes

MainStreet 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. 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. No valuation allowances were deemed necessary at March 31, 2009 and March 31, 2008. 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. MainStreet recorded income tax expense in the amounts of $123,047 and $251,132 for the quarters ending March 31, 2009 and 2008, respectively. MainStreet is currently being audited for the tax years ending 2005 and 2006 by the Internal Revenue Service. Management does not anticipate any material adjustments.

BALANCE SHEET

Investment Portfolio

The Corporation’s investment portfolio is used for several purposes as follows:

To maintain sufficient liquidity to cover deposit fluctuations and loan demand.

To use securities to fulfill pledging collateral requirements.

To utilize the maturity/repricing mix of portfolio securities to help balance the overall interest rate risk position of the balance sheet.

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, Federal Reserve Bank stock and Federal Home Loan Bank stock. The entire securities portfolio was categorized as available for sale at March 31, 2009 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 established 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:

MAINSTREET BANKSHARES, INC.

March 31, 2009


	March 31, 2009				December 31, 2008
Commercial	$	15,215,953	8.19	%	$	18,251,922	9.43	%
Real Estate:
Construction & land development		47,034,346	25.31			51,200,170	26.47
Residential 1-4 families		47,304,192	25.45			43,707,986	22.60
Home equity lines		15,465,133	8.32			16,012,671	8.28
Commercial real estate		57,935,742	31.18			61,174,895	31.62
Loans to individuals		2,872,447	1.55			3,087,053	1.60

Total Gross Loans	$	185,827,813	100.00	%	$	193,434,697	100.00	%

Gross loans decreased $7.6 million or 3.93% at March 31, 2009 compared to December 31, 2008. As can be seen by the chart above, real estate loans represent 90.26% and 88.97% of gross loans at March 31, 2009 and December 31, 2008, respectively. Franklin Bank has a high concentration of real estate related loans. Accordingly, the Bank has taken steps to reduce certain components of this concentration. The Bank participated loans during the first quarter reducing the commercial real estate portfolio. The construction and land development portfolio also declined while loans secured by residential 1-4 families increased from year end. During this economic environment, the credit markets have tightened substantially. These and other factors indicate diminished economic activity and lower loan demand. Moreover, Franklin Bank’s current concentration in real estate related loans reduces the Bank’s participation in these loan markets. Our loan to deposit ratio for March 31, 2009 was 102.88% compared to 112.60% at December 31, 2008. Although reduced somewhat, this is a high degree of leverage and we intend to reduce our current ratio and prudently increase liquidity. We will continue to serve our customers, but in doing so will be governed by the necessity of preserving the institution’s history of safety and soundness during these difficult economic times.

For the most part, MainStreet’s business activity is with customers located in its primary market area. Accordingly, operating results are closely correlated with the economic trends within the region and influenced by the significant industries in the region including pre-built housing, real estate development, agriculture, and resort and leisure services. In addition, the ultimate collectibility of the loan portfolio is susceptible to changes in the market condition of the region. The loan portfolio is diversified, but does have three areas classified as concentrations of credit at March 31, 2009. The areas of concentrations are in loans for real estate including construction with an outstanding balance of $34,492,536; loans for construction of buildings with an outstanding balance of $24,999,868; and loans for construction of heavy and civil engineering buildings with an outstanding balance of $14,633,638. At December 31, 2008, there were three areas classified as concentrations of credit which were loans for real estate to commercial borrowers with an outstanding balance of $35,152,304; loans for construction of buildings with an outstanding balance of $25,911,163; and loans for construction of heavy and civil engineering buildings with an outstanding balance of $17,040,449. The residential 1-4 loan portfolio consists of first liens and junior liens on residential properties. The consumer loan portfolio consists primarily of loans to individuals for home improvements, personal property, automobiles, and other consumer purposes. The Bank monitors these concentrations of credit closely, especially since we are in a softening real estate market.

Impaired loans totaled $7,935,300 at March 31, 2009, all of which were on nonaccrual status. A total of $583,926 in specific reserves was included in the balance of the allowance for loan losses as of March 31, 2009 for impaired 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 $445,424 and $464,701 in loans past due more than 90 days, still accruing interest, at March 31, 2009 and December 31, 2008, respectively. Nonaccrual loans were $7,935,300 and $4,217,698 at March 31, 2009 and December 31, 2008, respectively. Lost interest related to impaired loans as of March 31, 2009, December 31, 2008 and March 31, 2008 was $90,241, $113,626, and $11,514, respectively. The nonaccrual loans were 4.27% and 2.18% of loans, net of unearned income, at March 31, 2009 and

MAINSTREET BANKSHARES, INC.

March 31, 2009

December 31, 2008, respectively. Our nonperforming loans have increased since year end and we continue to monitor our loans closely and strive to identify issues early in order to address them as needed. Overall, the Bank continues to work with troubled borrowers when appropriate and likewise to move quickly to identify and resolve any problem loans.

At March 31, 2009 and December 31, 2008, MainStreet had $765,800 and $1,158,600, respectively, in other real estate, which is property acquired through foreclosure. Other real estate is carried at the lower of cost or fair market value, less selling costs, based on appraised value.

Deposits

Total deposits at March 31, 2009 and December 31, 2008 were $180,716,594 and $171,857,866, respectively, an increase of $8,858,728 or 5.15%. The deposit mix was as follows:


	March 31, 2009				December 31, 2008
Demand	$	17,657,086	9.77	%	$	16,235,463	9.45	%
Interest checking		8,104,783	4.48			7,583,082	4.41
Money markets		19,230,959	10.64			19,793,511	11.52
Savings		10,349,666	5.73			9,980,230	5.81
Time deposits $100,000 and over		56,972,501	31.53			50,804,834	29.56
Other time deposits		68,401,599	37.85			67,460,746	39.25

Total	$	180,716,594	100.00	%	$	171,857,866	100.00	%

As can be seen by the chart, the largest components of deposits are time deposits including those $100,000 and over. The increase from year end to March 31, 2009 has primarily been in these deposits. The other mix of deposits has remained comparably the same from year end. 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. Competition for deposits is fierce from other depository institutions in our market. 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. The overall cost of interest bearing deposits was 2.85% and 4.38%, respectively for the three months ended March 31, 2009 and March 31, 2008. This decline of 153 basis points is due to the decline in the short-term interest rates. These rates declined 200 basis points from March 2008 to March 2009. Franklin Bank experienced attrition in deposits in late 2008 as other banks were challenged by liquidity issues and raised interest rates paid on deposits. This seems to have stabilized somewhat in the first quarter of 2009. Franklin Bank, however, did attract brokered deposits for the first time during the first quarter of 2009. These deposits were $8.9 million at March 31, 2009 which included deposits through the CDARS program.

Competition for deposits remains strong in our market and this situation is expected to continue. This has adversely affected the net interest margin. Deposit rates have been lowered, but because of the competition for deposits and the declining interest rates on loans the net interest margin continues to be compressed and net income suffers as a result.

Short-term Borrowings

The Corporation had short-term borrowings from Federal Home Loan Bank of Atlanta (“FHLB”) of $5,000,000 at March 31, 2009 at the daily rate credit. The interest rate on the advance was .45% at March 31, 2009. As collateral for this borrowing, FHLB holds a blanket lien on loans secured by commercial real estate and loans secured by 1-4 family first liens, second liens, and equity lines. This short-term borrowing was paid down $10,000,000 during the first quarter of 2009.

MAINSTREET BANKSHARES, INC.

March 31, 2009

The Corporation has an internal Corporate Cash Management account for customers into which excess demand deposit accounts are swept on an overnight basis in order to earn interest. This account is not FDIC insured but the Corporation is required to pledge agency funds at 100% towards these balances. The Corporate Cash Management sweep accounts totaled $367,728 at March 31, 2009 and $199,375 at December 31, 2008.

Repurchase Agreements

The Corporation entered into a repurchase agreement with Citigroup Global Markets, Inc. (“CGMI”) in the amount of $7,500,000 on September 18, 2007. The repurchase date is September 18, 2012. The initial interest rate was fixed at 4.22% until September 18, 2008. At that date, it could have been called by CGMI and can be called quarterly by CGMI with two business days prior notice. Interest is payable quarterly. The repurchase agreement is collateralized by agency mortgage backed securities. The interest rate remained at 4.22% at March 31, 2009.

The Corporation entered into a repurchase agreement with Barclays Capital in the amount of $6,000,000 on January 2, 2008. The repurchase date is January 2, 2013. The initial interest rate was fixed at 3.57% until January 2, 2009 at which time the repurchase agreement could have been called by Barclays Capital. It can be called quarterly with two business days prior notice. Interest is payable quarterly. The repurchase agreement is secured by agency mortgage backed securities. The interest rate remained at 3.57% at March 31, 2009.

Shareholders’ Equity

Total shareholders’ equity was $21,832,832 and $21,367,265 at March 31, 2009 and December 31, 2008, respectively. Book value per share was $12.74 and $12.47 at March 31, 2009 and December 31, 2008, respectively.

At a regularly scheduled Board meeting on September 19, 2007, MainStreet approved a plan to repurchase up to 100,000 shares of the Company’s common stock. The open ended plan was effective immediately. Shares were purchased on the open market or through privately negotiated transactions. Price, timing, and the number of shares repurchased were based on various market conditions. By year end 2008, a total of 78,800 shares had been repurchased with total costs of $1,176,170. This initiative was executed to enhance shareholder value and to increase liquidity options available to shareholders. At this time no further repurchases are contemplated to preserve capital in the recessionary economy.

MainStreet’s Board of Directors, at their regularly scheduled board meeting on September 19, 2007 approved a cash dividend of $.05 which was MainStreet’s first cash dividend. Since that date, MainStreet paid a quarterly cash dividend until the fourth quarter of 2008. The Board of Directors has prudently suspended the cash dividend during these economic times of uncertainty.

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, 2009		December 31, 2008
Tier I Leverage Ratio (Actual)	9.59	%	9.39	%
Tier I Leverage Ratio (Quarterly Ave.)	9.51		9.32
Tier I Risk-Based Capital Ratio	11.67		11.04
Tier II Risk-Based Capital Ratio	12.92		12.30

MAINSTREET BANKSHARES, INC.

March 31, 2009

MainStreet and Franklin Bank are considered well-capitalized under federal and state capital guidelines at March 31, 2009.

Liquidity and 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 $27,225,017 at March 31, 2009. 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 banks, the ability to borrow from the Federal Reserve Bank’s discount window, and the ability to borrow long-term and short-term from the Federal Home Loan Bank of Atlanta. MainStreet’s ratio of liquid assets to total liabilities at March 31, 2009 and December 31, 2008 was 6.88% and 1.74%, respectively. Core deposits are the primary foundation for liquidity. Competition in our markets is fierce and customers seek higher interest rates especially during this low interest rate environment. Lines of credit are essential while other funding sources may be utilized. Liquidity remains a concern in this economic environment. Franklin Bank has experienced attrition of deposits as interest rates have increased as most institutions have sought to maintain liquidity as consumers were withdrawing deposits due to concerns over the health of the country’s financial system. In the first quarter of 2009, we developed relationships with several entities allowing for the gathering of brokered deposits. Franklin Bank has accepted brokered deposits in the amount of $8.9 million as of March 31, 2009. We have also become a member of the Certificate of Deposit Account Registry Service (“CDARS”). This allows us to provide our depositors with up to $50 million in FDIC insurance. We receive the deposits and forward them to CDARS and we receive deposits back if wanted. The send and receive transaction is called a reciprocal transaction. We can also bid on deposits in a one-way buy transaction which would allow for new depositors. CDARS deposits are also considered brokered deposits. Franklin Bank has become a member of QwickRate in order to bid for internet certificates of deposit. As of March 31, 2009, we had not bid on any of these internet certificates of deposit.

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 to manage 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 environment. A shock report for these rates along with a ramped approach with each is modeled. 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.

MAINSTREET BANKSHARES, INC.

March 31, 2009

The following table demonstrates the percentage change in net interest income from the level prime rate of 5.00% at March 31, 2009 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	6.25	%	10.00	18.00
+200 bp	5.25		5.00	10.00
+100 bp	4.25		3.00	5.00
-100 bp	2.25		- 2.00	- 3.00
-200 bp	1.25		- 3.00	- 4.00
-300 bp	.25		- 6.00	-10.00

As discussed previously, MainStreet is asset sensitive to changes 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 moderate this impact on the net interest margin.

Inflation

Most of MainStreet’s assets are monetary in nature and therefore are sensitive to interest rate fluctuations. MainStreet does not have significant fixed assets or inventories. Fluctuations in interest rates and actions of the Board of Governors of the Federal Reserve Systems (“FRB”) have a great effect on MainStreet’s profitability. Management continually strives to manage the relationship between interest-sensitive assets and liabilities. MainStreet and Franklin Bank must comply with numerous federal and state laws and regulations. In light of the increasing government involvement in the financial services industry and to address the underlying causes of the recent credit crunch, it is likely that financial institutions like MainStreet and Franklin Bank will have to meet additional legal requirements, all of which add to the Corporation’s cost of doing business. In addition, regulatory concerns over real estate related assets on the balance sheets of financial institutions and liquidity due to deposit fluctuations and other factors are likely to translate into higher regulatory scrutiny of financial institutions. This could impact MainStreet.

Stock Compensation Plans

BankShares approved the 2004 Key Employee Stock Option Plan at its Annual Meeting of Shareholders, April 15, 2004. This plan permitted the granting of Incentive and Non Qualified stock options as determined by BankShares’ Board of Directors to persons designated as “Key Employees” of BankShares and its subsidiaries. The Plan terminated on January 21, 2009. Awards made under the Plan prior to and outstanding on that date remain valid in accordance with their terms.

Recent Accounting Developments

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather, provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. The Corporation adopted SFAS 157 on January 1, 2008. The FASB approved a one-year deferral for the implementation of the Statement for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis.

MainStreet adopted the provisions of SFAS 157 for nonfinancial assets and liabilities as of January 1, 2009 without a material impact on the consolidated financial statements.

MAINSTREET BANKSHARES, INC.

March 31, 2009

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)). The Standard significantly changed the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes principles for how an acquirer recognizes and measures the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisition dates on or after the beginning of an entity’s first year that begins after December 15, 2008. MainStreet does not expect the implementation of SFAS 141(R) to have a material impact on its consolidated financial statements, at this time.

In April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP FAS 141(R)-1 amends and clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. MainStreet does not expect the adoption of FSP FAS 141(R)-1 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. The FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. Earlier adoption is permitted for periods ending after March 15, 2009. MainStreet does not expect the adoption of FSP FAS 157-4 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. In addition, the FSP amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. MainStreet does not expect the adoption of FSP FAS 107-1 and APB 28-1 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” FSP FAS 115-2 and FAS 124-2 amends other-than-temporary impairment guidance for debt securities to make guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. MainStreet does not expect the adoption of FSP FAS 115-2 and FAS 124-2 to have a material impact on its consolidated financial statements.

In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (SAB 111). SAB 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled “Other Than Temporary Impairment of Certain Investments in Debt and Equity

Securities.” SAB 111 maintains the SEC Staff’s previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. MainStreet does not expect the implementation of SAB 111 to have a material impact on its consolidated financial statements.

Item 4.

Controls and Procedures

MainStreet’s principal executive officer and principal financial officer have reviewed MainStreet’s disclosure controls and procedures (as defined in 240.13a-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. There have not been any changes in our internal control over financial reporting that occurred during the period that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

PART II. OTHER INFORMATION

Item 4.

Submission of Matters to a Vote of Security Holders

MainStreet BankShares, Inc. held its tenth annual meeting of shareholders on May 7, 2009 at The Franklin Center in Rocky Mount, Virginia. There was one matter submitted to a vote of security holders, which was the election of three directors.


		For	Against
Joseph F. Clark	(Class B – Term expires 2012)	1,120,202	1,760
C. Laine Dalton	(Class B – Term expires 2012)	1,117,544	4,418
Joel R. Shepherd	(Class B – Term expires 2012)	1,111,017	10,945

The following classes of directors also continued after the meeting:

Class C Directors – Term Expires 2010


William L. Cooper, III		Director
J. Mac Deekens		Director
Danny M. Perdue		Director

Class A Directors – Term Expires 2011


Larry A. Heaton		Director
Michael A. Turner		Director

Item 5.

Other Information

None.

Item 6.

Exhibits

See index to exhibits.

SIGNATURES

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 11, 2009	By	/s/ Larry A. Heaton
		Larry A. Heaton
		President and Chief Executive Officer

Date: May 11, 2009	By	/s/ Brenda H. Smith
		Brenda H. Smith
		Executive Vice President, Chief Financial Officer and Corporate Secretary

Index to Exhibits


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 October 16, 2002; amended September 17, 2003; amended July 13, 2005 and filed on form 10-QSB on August 10, 2005 and herein incorporated by reference; 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 Holders 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 by and between MainStreet, Franklin Bank, and Larry A. Heaton (President and CEO of Franklin Bank) dated December 30, 2005 incorporated by reference to the Corporation’s Form 8-K filed January 4, 2006.

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		Administrative Services Agreement with Smith River Community Bank, N.A. incorporated by reference to the Corporation’s Form 8-K filed March 28, 2005.

10.4#		Supplemental Executive Retirement Agreement by and between Franklin Community Bank, N.A. and Larry A. Heaton incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.5#		Supplemental Executive Retirement Agreement by and between Franklin Community Bank, N.A. and Brenda H. Smith incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.6#		Change in Control Agreement between MainStreet BankShares, Inc. and Lisa J. Correll incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.7#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Carey D. Wrenn incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.8#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Robert W. Shorter incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.9#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Debra B. Scott incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.10#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Linda P. Adams incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.

10.11		Formal agreement by and between The Comptroller of the Currency and Franklin Community Bank, National Association dated April 16, 2009 incorporated by reference to the Corporation’s Form 8-K filed April 20, 2009.

31.1		Certification of President and Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d- 14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Executive Vice President, Chief Financial Officer and Corporate Secretary Pursuant to Rule 13a-14(a) or 15d – 14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

Index to Exhibits (con’t)


*		(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.)
#		Management contract or compensatory plan or agreement required to be filed as an Exhibit to this Form 10-Q.

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Legalese
Litigious
Readability	7th grade Bad

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