MainStreet Bancshares (MNSB) 10-Q 2020 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2020

OR

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

For the transition period from to to

Commission file number: 001-38817

MainStreet Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Virginia	81-2871064
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

10089 Fairfax Boulevard, Fairfax, VA 22030

(Address of Principal Executive Offices and Zip Code)

(703) 481-4567

(Registrant’s Telephone Number, Including Area Code)

Not applicable

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

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ☒  Yes    ☐  No

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

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
Emerging growth company	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	MNSB	The Nasdaq Stock Market LLC

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of May 6, 2020, there were 8,260,231 outstanding shares, par value $4.00 per share, of the issuer’s common stock.

INDEX

PART I – FINANCIAL INFORMATION	3
Item 1 – Consolidated Financial Statements	3
Notes to Consolidated Financial Statements	8
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3 – Quantitative and Qualitative Disclosures about Market Risk	41
Item 4 – Controls and Procedures	41
PART II OTHER INFORMATION	42
Item 1 – Legal Proceedings	42
Item 1A – Risk Factors	42
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3 – Defaults upon Senior Securities	43
Item 4 – Mine Safety Disclosures	43
Item 5 – Other Information	43
Item 6 – Exhibits	44
SIGNATURES	45

2

PART I – FINANCIAL INFORMATION

Item 1 –  Consolidated Financial Statements – Unaudited

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

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

	At March 31, 2020 (unaudited)		At December 31, 2019 (*)
Assets
Cash and due from banks	$	62,098	$	53,376
Federal funds sold		10,677		11,468
Cash and cash equivalents		72,775		64,844
Investment securities available-for-sale, at fair value		102,191		92,791
Investment securities held-to-maturity		23,878		23,914
Restricted securities, at cost		5,041		6,157
Loans, net of allowance for loan losses of $9,898 and $9,584, respectively		1,059,628		1,030,425
Premises and equipment, net		14,666		14,153
Other real estate owned, net		1,207		1,207
Accrued interest and other receivables		4,809		5,420
Bank owned life insurance		24,761		24,562
Other assets		20,786		13,885
Total Assets	$	1,329,742	$	1,277,358
Liabilities and Stockholders’ Equity
Liabilities
Non-interest bearing deposits	$	240,979	$	252,707
Interest bearing demand deposits		16,846		53,707
Savings and NOW deposits		60,454		63,015
Money market deposits		265,443		141,337
Time deposits		559,489		560,857
Total deposits		1,143,211		1,071,623
Federal Home Loan Bank advances		10,000		40,000
Subordinated debt, net		14,812		14,805
Other liabilities		21,424		13,896
Total Liabilities		1,189,447		1,140,324
Stockholders’ Equity
Preferred stock, $1.00 par value, 2,000,000 shares authorized; no shares issued and    outstanding as of March 31, 2020 and December 31, 2019		—		—
Common stock, $4.00 par value, 10,000,000 shares authorized; issued and outstanding    8,260,231 shares (including 155,742 nonvested shares) for March 31, 2020 and    8,260,259 shares (including 160,961 nonvested shares) for December 31, 2019		32,418		32,397
Capital surplus		74,482		75,117
Retained earnings		32,567		29,097
Accumulated other comprehensive income		828		423
Total Stockholders’ Equity		140,295		137,034
Total Liabilities and Stockholders’ Equity	$	1,329,742	$	1,277,358

* Derived from audited consolidated financial statements.

See Notes to the Unaudited Consolidated Financial Statements

3

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Income for the Three months ended March 31, 2020 and 2019 (Dollars in thousands, except per share data)

	For the Three Months Ended March 31,
	2020		2019
Interest Income
Interest and fees on loans	$	14,220	$	12,916
Interest on investments securities		501		556
Interest on federal funds sold		395		345
Total Interest Income		15,116		13,817
Interest Expense
Interest on interest bearing DDA deposits		117		245
Interest on savings and NOW deposits		64		73
Interest on money market deposits		778		763
Interest on time deposits		3,566		2,931
Interest on Federal Home Loan Bank advances and other borrowings		50		219
Interest on subordinated debt		241		238
Total Interest Expense		4,816		4,469
Net interest income		10,300		9,348
Provision for Loan Losses		350		325
Net interest income after provision for loan losses		9,950		9,023
Non-Interest Income
Deposit account service charges		487		370
Bank owned life insurance income		199		105
Loan swap fee income		403		290
Other fee income		325		161
Total Non-Interest Income		1,414		926
Non-Interest Expense
Salaries and employee benefits		4,433		3,860
Furniture and equipment expenses		454		385
Advertising and marketing		256		105
Occupancy expenses		267		213
Outside services		276		227
Administrative expenses		164		167
Other operating expenses		1,293		1,051
Total Non-Interest Expense		7,143		6,008
Income before income taxes		4,221		3,941
Income Tax Expense		751		694
Net Income	$	3,470	$	3,247
Net Income per common share:
Basic	$	0.42	$	0.39
Diluted	$	0.42	$	0.39

See Notes to the Unaudited Consolidated Financial Statements

4

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Comprehensive Income for the Three Months Ended and Three Months Ended March 31, 2020 and 2019 (Dollars in thousands)

	For the Three Months Ended March 31,
	2020		2019
Comprehensive Income, net of taxes
Net Income	$	3,470	$	3,247
Other comprehensive gain, net of tax:
Unrealized gains on available for sale securities arising    during the period (net of tax, $103 and $56, respectively)		400		209
Add: reclassification adjustment for amortization of unrealized    losses on securities transferred from available for sale to held    to maturity (net of tax, $1 and $1, respectively)		5		6
Other comprehensive income		405		215
Comprehensive Income	$	3,875	$	3,462

See Notes to the Unaudited Consolidated Financial Statements

5

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Stockholders’ Equity for the Three months ended March 31, 2020 and 2019 (Dollars in thousands)

									Accumulated Other
	Common			Capital			Retained		Comprehensive
	Stock			Surplus			Earnings		Income		Total
Balance, December 31, 2019	$	32,397		$	75,117		$	29,097	$	423	$	137,034
Vesting of restricted stock		261			(261	)		—		—		—
Stock based compensation expense		—			376			—		—		376
Common stock repurchased		(240	)		(750	)		—		—		(990	)
Net income		—			—			3,470		—		3,470
Other comprehensive income		—			—			—		405		405
Balance, March 31, 2020	$	32,418		$	74,482		$	32,567	$	828	$	140,295

									Accumulated Other
	Common		Capital			Retained			Comprehensive
	Stock		Surplus			Earnings			Loss			Total
Balance, December 31, 2018	$	32,176	$	74,256		$	15,186		$	(367	)	$	121,251
Vesting of restricted stock		211		(211	)		—			—			—
Stock based compensation expense		—		270			—			—			270
Net income		—		—			3,247			—			3,247
Change related to restricted stock awards		—		38			(38	)		—			—
Other comprehensive income		—		—			—			215			215
Balance, March 31, 2019	$	32,387	$	74,353		$	18,395		$	(152	)	$	124,983

See Notes to the Unaudited Consolidated Financial Statements

6

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows (Dollars in thousands)

For the three months ended March 31,	2020			2019
Cash Flows from Operating Activities
Net income	$	3,470		$	3,247
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion, net		419			378
Deferred income tax benefit		(150	)		(94	)
Provision for loan losses		350			325
Stock based compensation expense		376			270
Income from bank owned life insurance		(199	)		(105	)
Subordinated debt amortization expense		7			7
Gain on disposal of premises and equipment		(14	)		(59	)
Amortization of operating lease right-of-use assets		96			56
Change in:
Accrued interest receivable and other receivables		611			(503	)
Other assets		(6,946	)		(4,040	)
Other liabilities		7,528			5,039
Net cash provided by operating activities		5,548			4,521
Cash Flows from Investing Activities
Activity in available-for-sale securities:
Payments		2,284			806
Maturities		50,000			30,000
Purchases		(61,318	)		(43,984	)
Activity in held-to-maturity securities:
Refunded		—			650
Purchases of restricted investment in bank stock		(159	)		(1,113	)
Redemption of restricted investment in bank stock		1,275			1,275
Net increase in loan portfolio		(29,553	)		(26,935	)
Proceeds from sale of premises and equipment		14			69
Purchases of premises and equipment		(758	)		(280	)
Net cash used in investing activities		(38,215	)		(39,512	)
Cash Flows from Financing Activities
Net decrease in non-interest deposits		(11,728	)		(18,005	)
Net increase in interest bearing demand, savings, and time deposits		83,316			64,695
Net decrease in Federal Home Loan Bank advances and other borrowings		(30,000	)		(10,000	)
Repurchases of common stock		(990	)		—
Net cash provided by financing activities		40,598			36,690
Increase in Cash and Cash Equivalents		7,931			1,699
Cash and Cash Equivalents, beginning of period		64,844			58,076
Cash and Cash Equivalents, end of period	$	72,775		$	59,775
Supplementary Disclosure of Cash Flow Information
Cash paid during the period for interest	$	4,653		$	3,929
Cash paid during the period for income taxes	$	—		$	—
Right of use assets obtained in exchange for new operating lease liabilities	$	—		$	2,647

See Notes to the Unaudited Consolidated Financial Statements

7

MAINSTREET BANCSHARES, INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

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

Organization

MainStreet Bancshares Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose principal activity is the ownership and management of MainStreet Bank. The Company is authorized to issue 10,000,000 shares of common stock with a par value of $4.00 per share. Additionally, the Company is authorized to issue 2,000,000 shares of preferred stock at a par value $1.00 per share. There is currently no preferred stock outstanding. The Company is regulated under the Bank Holding Company Act of 1956, as amended (“BHC Act”) and is subject to inspection, examination, and supervision by the Federal Reserve Board.

On April 18, 2019, the Company completed the registration of its common stock with the Securities Exchange Commission through its filing of a General Form for Registration of Securities on Form 10 (“Form 10”), pursuant to Section 12(b) of the Securities Exchange Act of 1934. The Company is considered an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the “JOBS Act,” and as defined in Section 2(a) of the Securities Act of 1933, as amended, or the “Securities Act.” We are also a “smaller reporting company” as defined in Exchange Act Rule 12b-2. As such, we may elect to comply with certain reduced public company reporting requirements in future reports that we file with the Securities and Exchange Commission, or the “SEC.”

We were approved to list shares of our common stock on the Nasdaq Capital Market under our current symbol “MNSB” as of April 22, 2019.

MainStreet Bank is headquartered in Fairfax, Virginia where it also operates a branch. The Bank was incorporated on March 28, 2003 and received its charter from the Bureau of Financial Institutions of the Commonwealth of Virginia (the “Bureau”) on March 16, 2004. The Bank commenced regular operations on May 26, 2004 and is supervised by the Bureau and the Federal Reserve Bank of Richmond. The Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation. The Bank places special emphasis on serving the needs of individuals, and small and medium-sized business and professional concerns in the Washington, D.C. metropolitan area.

In February 2020, the Bank applied to the Office of the Comptroller of the Currency (the “OCC”) in order to convert from a Virginia-chartered bank to a federal charter as a national bank. If the OCC approves the Bank’s application and the charter conversion is completed, the Bank will become subject to regulation, supervision and examination by the OCC rather than by the Bureau and the Federal Reserve. Following the proposed charter conversion, the Bank’s business activities, investments and legal lending limit will be governed by the National Bank Act and the regulations and rulings of the OCC. While the applicable provisions of the National Bank Act and OCC regulations differ in various ways from Virginia law and the regulations of the Federal Reserve, the Bank’s management has determined that any such differences would have no material effect on the operations of the Bank. Furthermore, the branching network of the Bank will remain the same following the proposed charter conversion. The holding company will continue to be regulated and supervised by the Federal Reserve Bank of Richmond.

Basis of Presentation

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) for interim information and with the instructions to the Quarterly Report on Form 10-Q, as applicable to a smaller reporting company. Accordingly, they do not include all the information and footnotes required by US GAAP for complete financial statements.

The financial statements are unaudited; but in the opinion of management include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation thereof. The balances as of December 31, 2019 have been derived from the audited consolidated financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes thereto contained in the Form 10-K filed by the Company with the U.S. Securities and Exchange Commission on March 23, 2020. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020, events through the date of issuance of the financial statements included herein.

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

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

Investment securities – The Bank’s investment securities are classified as either held to maturity, available for sale or trading. At March 31, 2020 and December 31, 2019, the Bank held approximately $23.9 million and $23.9 million, respectively, in securities classified as held to maturity. The Bank held no securities classified as trading. Municipal securities that were originally purchased as available for sale were transferred to held to maturity during 2013. The unrealized loss on the securities transferred to held to maturity is being amortized over the expected life of the securities. At March 31, 2020 and December 31, 2019, the unamortized unrealized loss was $74,517 and $81,076, respectively, before tax, and remains in accumulated other comprehensive income, net of tax.

8

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

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

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Restricted equity securities consist of the Federal Reserve Bank and Federal Home Loan Bank of Atlanta (“FHLB”) stock in the amount of $3.3 million and $1.6 million respectively, as of March 31, 2020, compared to $3.3 million and $2.7 million, respectively, as of December 31, 2019. Restricted equity securities also consisted of $126,800 in Community Bankers Bank stock at March 31, 2020 and December 31, 2019. This restricted stock is recorded at cost because its ownership is restricted and it lacks a market for resale. The Bank is required to maintain Federal Reserve Bank stock at a level of 6% of capital and surplus. The FHLB requires the Bank to maintain stock, at a minimum, in an amount equal to 4.5% of outstanding borrowings and 0.20% of total assets. When evaluating restricted stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Bank does not consider these investments to be impaired at March 31, 2020 or December 31, 2019 and no previous impairment has been recognized.

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

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

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

9

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

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

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

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

• The loan is a non-consumer loan, unless the loan is well secured and recovery is probable.

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

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

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

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

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

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

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

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

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

10

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Earnings per share– Net income per common share has been determined under the provisions of FASB ASC 260, “Earnings Per Share” and has been computed based on the weighted average common shares outstanding during the quarter ended March 31, (8,287,317 for 2020 and 8,242,873 for 2019). Diluted earnings per share reflect additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.

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

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

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

Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from the estimates.

The Company’s critical accounting policies relate to (1) the allowance for loan losses, (2) fair value of financial instruments, (3) derivative financial instruments, (4) income taxes, and (5) other real estate owned. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. In connection with the determination of the allowances for losses on loans and valuation of other real estate owned management obtains independent appraisals for significant properties.

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

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

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

Revenue Recognition

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

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

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

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

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

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

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Impact of Recently Issued Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has formed a Committee to oversee the accounting impact of this ASU. In anticipation of the ASU, the Company is working with a third party to compile data and develop an estimate using historical and qualitative data based on the requirements of ASU 2016-13.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119.  SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.”  It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.”  The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects.  For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years.  Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-12 will have on its consolidated financial statements.

In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years.  Early adoption is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its consolidated financial statements.

In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is monitoring developments into rates that may be acceptable alternatives to LIBOR and working with those we have a relationship with that could be impacted by a change in reference rate from LIBOR. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

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

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

Regulatory easing for coronavirus COVID-19 pandemic

Federal Reserve Bank reserve requirements to zero.

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

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

Community Bank Leverage Ratio reduced to 8%

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

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

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

Forbearance not automatically a Troubled Debt Restructuring (TDR)

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

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

Working with Customers

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

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Troubled Debt Restructuring (TDR)

According to United States generally-accepted accounting principles, restructuring a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider.  The CARES Act states that from March 1, 2020, until the end of the year (unless the President terminates the COVID-19 emergency declaration sooner), financial institutions may elect to suspend the TDR accounting principles for loan modifications related to COVID-19.

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

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

Past Due Reporting and Nonaccrual Status

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

Paycheck Protection Program Payments

Many financial institutions may have borrowers who apply for a loan under the CARES Act's Paycheck Protection Program (PPP), which allows an eligible borrower to obtain a loan to cover payroll, rent, mortgage interest, and utilities for the Covered Period (February 15, 2020 - June 30, 2020).  Up to 100% of the loan can be forgiven if the borrower spends the loan proceeds appropriately.   Financial institutions should know there are several factors that can prohibit a borrower from obtaining a PPP loan (e.g., an owner or related business in bankruptcy).  Financial institutions should also be vigilant that, with any modification or workout, PPP loan proceeds are not used for a prohibited purpose (e.g., principal reduction on a loan).

Federal Reserve Paycheck Protection Program Lending Facility

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

Main Street Lending Program

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

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Note 2. Investment Securities

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

	March 31, 2020
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U.S. Treasury Securities	$	60,000	$	—	$	—		$	60,000
Collateralized Mortgage Backed		15,877		430		(6	)		16,301
Subordinated Debt		2,500		35		(2	)		2,533
Municipal Securities		15,200		826		—			16,026
U.S. Governmental Agencies		7,501		—		(170	)		7,331
Total	$	101,078	$	1,291	$	(178	)	$	102,191

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

	March 31, 2020
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Municipal Securities	$	22,378	$	774	$	—	$	23,152
Subordinated Debt		1,500		—		—		1,500
Total	$	23,878	$	774	$	—	$	24,652

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

	December 31, 2019
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U.S. Treasury Securities	$	49,999	$	—	$	(1	)	$	49,998
Collateralized Mortgage Backed		17,659		82		(68	)		17,673
Subordinated Debt		2,500		55		(1	)		2,554
Municipal Securities		13,888		743		—			14,631
U.S. Governmental Agencies		8,135		—		(200	)		7,935
Total	$	92,181	$	880	$	(270	)	$	92,791

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

	December 31, 2019
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Municipal Securities	$	22,414	$	766	$	(2	)	$	23,178
Subordinated Debt		1,500		—		—			1,500
Total	$	23,914	$	766	$	(2	)	$	24,678

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The scheduled maturities of securities available-for-sale and held-to-maturity at March 31, 2020 were as follows:

	March 31, 2020
	Available-for-Sale				Held-to-Maturity
(Dollars in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	60,012	$	60,012	$	—	$	—
Due from one to five years		—		—		1,510		1,552
Due from after five to ten years		3,514		3,557		8,593		8,882
Due after ten years		37,552		38,622		13,775		14,218
Total	$	101,078	$	102,191	$	23,878	$	24,652

Securities with a fair value of $267,207 and $267,899 at March 31, 2020 and December 31, 2019, respectively, were pledged to secure FHLB advances.

There were no securities sold from the available-for-sale portfolio for the three months ended March 31, 2020 and 2019.

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

	March 31, 2020
	Less than 12 Months					12 Months or Longer					Total
(Dollars in thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Available-for-sale:
Collateralized Mortgage Backed	$	98	$	(6	)	$	2	$	—		$	100	$	(6	)
Subordinated Debt		498		(2	)		—		—			498		(2	)
U.S Governmental Agencies		—		—			7,295		(170	)		7,295		(170	)
Total	$	596	$	(8	)	$	7,297	$	(170	)	$	7,893	$	(178	)

	December 31, 2019
	Less than 12 Months					12 Months or Longer					Total
(Dollars in thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Available-for-sale:
U.S. Treasury Securities	$	49,998	$	(1	)	$	—	$	—		$	49,998	$	(1	)
Collateralized Mortgage Backed		6,223		(67	)		834		(1	)		7,057		(68	)
Subordinated Debt		499		(1	)		—		—			499		(1	)
U.S Government Agencies		—		—			7,857		(200	)		7,857		(200	)
Total	$	56,720	$	(69	)	$	8,691	$	(201	)	$	65,411	$	(270	)
Held-to-maturity:
Municipal Securities	$	537	$	(2	)	$	—	$	—		$	537	$	(2	)
Total	$	537	$	(2	)	$	—	$	—		$	537	$	(2	)

The factors considered in evaluating securities for impairment include whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. These unrealized losses are primarily attributable to current financial market conditions for these types of investments, particularly changes in interest rates, causing bond prices to decline, and are not attributable to credit deterioration.

At March 31, 2020, there were three collateralized mortgage backed securities with fair values totaling $98,000 in an unrealized loss position of less than 12 months and one security with a fair value totaling $2,000 in an unrealized loss position greater than 12 months. At March 31, 2020 nine U.S. government agencies with fair values totaling approximately $7.3 million that were in an unrealized loss position of more than 12 months. At March 31, 2020, there were no held-to-maturity securities in an unrealized loss position. The Bank does not consider any of the securities in the available for sale or held to maturity portfolio to be other-than-temporarily impaired at March 31, 2020 and December 31, 2019.

18

All municipal securities originally purchased as available for sale were transferred to held to maturity during 2013. The unrealized loss on the securities transferred to held to maturity is being amortized over the expected life of the securities. The unamortized, unrealized loss, before tax, at March 31, 2020 and December 31, 2019 was $74,517 and $81,076, respectively.

Note 3. Loans Receivable

Loans receivable were comprised of the following:

(Dollars in thousands)	March 31, 2020			December 31, 2019
Residential Real Estate:
Single family	$	141,457		$	143,535
Multifamily		7,715			6,512
Farmland		796			801
Commercial Real Estate:
Owner-occupied		134,988			134,116
Non-owner occupied		314,798			287,754
Construction and Land Development		285,960			272,620
Commercial – Non Real-Estate:
Commercial & Industrial		118,258			121,225
Consumer – Non Real Estate:
Unsecured		419			599
Secured		67,741			74,984
Total Gross Loans		1,072,132			1,042,146
Less: unearned fees		(2,595	)		(2,118	)
Less: unamortized discount on consumer secured loans		(11	)		(19	)
Less: allowance for loan losses		(9,898	)		(9,584	)
Net Loans	$	1,059,628		$	1,030,425

The unsecured consumer loans above include $419,000 and $599,000 of overdrafts reclassified as loans for the quarters ended March 31, 2020 and December 31, 2019, respectively.

The Bank held no loans for sale at March 31, 2020 and December 31, 2019.

The following tables summarize the activity in the allowance for loan losses by loan class for the three months ended March 31, 2020 and 2019.

19

Allowance for Credit Losses By Portfolio Segment

	Real Estate
For the three months ended March 31, 2020	Residential			Commercial			Construction		Consumer			Commercial			Total
(Dollars in thousands)
Beginning Balance	$	1,030		$	4,254		$	2,180	$	568		$	1,552		$	9,584
Charge-offs		—			(1	)		—		—			(47	)		(48	)
Recoveries		—			—			—		3			9			12
Provision		(29	)		277			108		(46	)		40			350
Ending Balance	$	1,001		$	4,530		$	2,288	$	525		$	1,554		$	9,898
Ending Balance:
Individually evaluated for Impairment	$	—		$	—		$	—	$	—		$	—		$	—
Collectively evaluated for Impairment	$	1,001		$	4,530		$	2,288	$	525		$	1,554		$	9,898
For the three months ended March 31, 2019
Beginning Balance	$	1,019		$	4,299		$	1,469	$	826		$	1,218		$	8,831
Recoveries		30			—			—		3			—			33
Provision		52			139			66		32			36			325
Ending Balance	$	1,101		$	4,438		$	1,535	$	861		$	1,254		$	9,189
Ending Balance:
Individually evaluated for Impairment	$	—		$	733		$	—	$	—		$	—		$	733
Collectively evaluated for Impairment	$	1,101		$	3,705		$	1,535	$	861		$	1,254		$	8,456

The Company maintains a general allowance for loan losses based on evaluating known and inherent risks in the loan portfolio, including management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. The reserve is an estimate based upon factors and trends identified by management at the time the financial statements are prepared.

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

March 31, 2020
Loans Receivable
(Dollars in thousands)	Ending Balance		Ending Balance: Individually Evaluated for Impairment		Ending Balance: Collectively Evaluated for Impairment
Residential Real Estate	$	149,968	$	1,627	$	148,341
Commercial Real Estate		449,786		—		449,786
Construction and Land Development		285,960		—		285,960
Commercial & Industrial		118,258		—		118,258
Consumer		68,160		—		68,160
Total	$	1,072,132	$	1,627	$	1,070,505

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December 31, 2019
Loans Receivable
(Dollars in thousands)	Ending Balance		Ending Balance: Individually Evaluated for Impairment		Ending Balance: Collectively Evaluated for Impairment
Residential Real Estate	$	150,848	$	1,482	$	149,366
Commercial Real Estate		421,870		—		421,870
Construction and Land Development		272,620		—		272,620
Commercial & Industrial		121,225		—		121,225
Consumer		75,583		—		75,583
Total	$	1,042,146	$	1,482	$	1,040,664

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

	March 31, 2020						December 31, 2019
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded
Residential Real Estate:
Single family	$	1,627	$	1,627	$	—	$	1,482	$	1,482	$	—
		1,627		1,627		—		1,482		1,482		—
With an allowance recorded	$	—	$	—	$	—	$	—	$	—	$	—
Total	$	1,627	$	1,627	$	—	$	1,482	$	1,482	$	—

The following table presents additional information regarding the impaired loans for the Three months ended March 31, 2020 and 2019:

	Three Months Ended March 31,
	2020				2019
(Dollars in thousands)	Average Record Investment		Interest Income Recognized		Average Record Investment		Interest Income Recognized
With no related allowance recorded
Residential Real Estate:
Single family	$	1,631	$	15	$	1,506	$	15
		1,631		15		1,506		15
With an allowance recorded
Commercial Real Estate:
Owner occupied	$	—	$	—	$	1,939	$	—
		—		—		1,939		—
Total	$	1,631	$	15	$	3,445	$	15

If interest on nonaccrual loans had been accrued, such income would have been $3,718 and $35,155 for the three months ended March 31, 2020 and 2019

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

(Dollars in thousands)	March 31, 2020		December 31, 2019
Residential Real Estate
Single family	$	150	$	—
Consumer
Secured		58		—
Total	$	208	$	—

Credit quality risk ratings include regulatory classifications of Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Loans classified as Pass have quality metrics to support that the loan will be repaid according to the terms established. Loans classified as Watch have similar characteristics as Pass loans with some emerging signs of financial weaknesses that should be monitored closer. Loans classified as Special Mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of prospects for repayment. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.

The following tables summarize the aggregate Pass and criticized categories of Watch, Special Mention, Substandard and Doubtful within the Company’s internal risk rating system as of March 31, 2020 and December 31, 2019:

	March 31, 2020
(Dollars in thousands)	Pass		Watch		Special Mention		Substandard		Total
Residential Real Estate:
Single Family	$	140,938	$	—	$	—	$	519	$	141,457
Multifamily		7,715		—		—		—		7,715
Farmland		796		—		—		—		796
Commercial Real Estate:
Owner occupied		134,988		—		—		—		134,988
Non-owner occupied		314,798		—		—		—		314,798
Construction & Land Development		285,960		—		—		—		285,960
Commercial – Non Real Estate:
Commercial & Industrial		103,657		6,788		4,979		2,834		118,258
Consumer – Non Real Estate:
Unsecured		419		—		—		—		419
Secured		67,597		—		—		144		67,741
Total	$	1,056,868	$	6,788	$	4,979	$	3,497	$	1,072,132

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	December 31, 2019
(Dollars in thousands)	Pass		Watch		Special Mention		Substandard		Total
Residential Real Estate:
Single Family	$	143,019	$	—	$	—	$	516	$	143,535
Multifamily		6,512		—		—		—		6,512
Farmland		801		—		—		—		801
Commercial Real Estate:
Owner occupied		133,966		—		—		150		134,116
Non-owner occupied		287,754		—		—		—		287,754
Construction & Land Development		272,620		—		—		—		272,620
Commercial – Non Real Estate:
Commercial & Industrial		109,106		3,772	$	5,685		2,662		121,225
Consumer – Non Real Estate:
Unsecured		599		—		—		—		599
Secured		74,984		—		—		—		74,984
Total	$	1,029,361	$	3,772	$	5,685	$	3,328	$	1,042,146

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

	March 31, 2020
(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans Receivable		Nonaccrual
Residential Real Estate:
Single Family	$	—	$	—	$	—	$	—	$	141,307	$	141,457	$	150
Multifamily		—		—		—		—		7,715		7,715		—
Farmland		—		—		—		—		796		796		—
Commercial Real Estate:
Owner occupied		—		—		—		—		134,988		134,988		—
Non-owner occupied		—		—		—		—		314,798		314,798		—
Construction & Land Development		—		—		—		—		285,960		285,960		—
Commercial – Non Real Estate:
Commercial & Industrial		1,750		47		—		1,797		116,461		118,258		—
Consumer – Non Real Estate:
Unsecured		—		—		—		—		419		419		—
Secured		109		—		—		109		67,574		67,741		58
Total	$	1,859	$	47	$	—	$	1,906	$	1,070,018	$	1,072,132	$	208

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	December 31, 2019
(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans Receivable		Nonaccrual
Residential Real Estate:
Single Family	$	—	$	—	$	—	$	—	$	143,535	$	143,535	$	—
Multifamily		—		—		—		—		6,512		6,512		—
Farmland		—		—		—		—		801		801		—
Commercial Real Estate:
Owner occupied		—		150		—		150		133,966		134,116		—
Non-owner occupied		—		—		—		—		287,754		287,754		—
Construction & Land Development		—		—		—		—		272,620		272,620		—
Commercial – Non Real Estate:
Commercial & Industrial		—		—		—		—		121,225		121,225		—
Consumer – Non Real Estate:
Unsecured		—		—		—		—		599		599		—
Secured		124		—		—		124		74,860		74,984		—
Total	$	124	$	150	$	—	$	274	$	1,041,872	$	1,042,146	$	—

The Company may grant a concession or modification for economic or legal reasons related to a borrower’s financial condition that it would not otherwise consider resulting in a modified loan that is then identified as a troubled debt restructuring (“TDR”). The Company may modify loans through rate reductions, extensions of maturity, interest only payments, or payment modifications to better match the timing of cash flows due under the modified terms with the cash flows from the borrowers’ operations. Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses. TDRs are restored to accrual status when the obligation is brought current, has performed in accordance with the modified contractual terms for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

The Company may identify loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions and negative trends may result in a payment default in the near future.

As of March 31, 2020, and December 31, 2019, the Company had TDRs totaling $1.5 million and $1.5 million, respectively. At March 31, 2020 the Company had one TDR which was performing in compliance with the restructured terms and on accrual status. No modifications occurred to TDR loans during the three months ended March 31, 2020. No additional loan commitments were outstanding to this borrower at March 31, 2020 and December 31, 2019. As of March 31, 2020, and December 31, 2019, there was no specific reserve related to this TDR loan.

The following table details the Company’s TDRs that are on accrual status and non-accrual status at March 31, 2020:

	As of March 31, 2020
(Dollars in thousands)	Number Of Loans		Accrual Status		Non- Accrual Status		Total TDRs
Residential Real Estate		1	$	1,477	$	—	$	1,477
Total		1	$	1,477	$	—	$	1,477

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

	As of December 31, 2019
(Dollars in thousands)	Number Of Loans		Accrual Status		Non- Accrual Status		Total TDRs
Residential Real Estate		1	$	1,482	$	—	$	1,482
Total		1	$	1,482	$	—	$	1,482

Note 4. Derivatives and Risk Management Activities

The Bank uses derivative financial instruments (or “derivatives”) primarily to assist customers with their risk management objectives. The Bank classifies these items as free standing derivatives consisting of customer accommodation interest rate loan swaps (or “interest rate loan

24

swaps”). The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Bank receives a floating rate. These back-to-back interest rate loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the consolidated financial statements. Changes in fair value are recorded in other noninterest expense and net to zero because of the identical amounts and terms of the interest rate loan swaps.

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

March 31, 2020
Customer-related interest rate contracts
Dollars in thousands)	Notional Amount		Positions		Assets		Liabilities		Collateral Pledges
Matched interest rate swap with borrower	$	88,150		16	$	11,025		—	$	11,350
Matched interest rate swap with counterparty	$	88,150		16		—	$	11,025	$	11,350

December 31, 2019
Customer-related interest rate contracts
Dollars in thousands)	Notional Amount		Positions		Assets		Liabilities		Collateral Pledges
Matched interest rate swap with borrower	$	71,860		12	$	4,039		—	$	6,400
Matched interest rate swap with counterparty	$	71,860		12		—	$	4,039	$	6,400

The Company is able to recognize fee income upon execution of the interest rate swap contract. Interest rate swap fee income for the three months ended March 31, 2020 and 2019 was $403,000 and $290,000, respectively.

Note 5. Fair Value Presentation

In accordance with FASB ASC 820, “Fair Value Measurements and Disclosure”, the Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is the most representative of fair value under current market conditions.

In accordance with the guidance, a hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The three levels of the fair value hierarchy under FASB ASC 820 based on these two types of inputs are as follows:

Level 1 –Valuation is based on quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.

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

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

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

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Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. As of March 31, 2020, and December 31, 2019, the Bank’s entire portfolio of available for sale securities are considered to be Level 2 securities.

Derivative asset (liability) – interest rate swaps on loans

As discussed in “Note 4: Derivative Financial Instruments”, the Bank recognizes interest rate swaps at fair value on a recurring basis. The Bank has contracted with a third party vendor to provide valuations for these interest rate swaps using standard valuation techniques and therefore classifies such interest rate swaps as Level 2.

The following tables provide the fair value for assets required to be measured and reported at fair value on a recurring basis as of March 31, 2020 and December 31, 2019:

	March 31, 2020
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale:
U.S. Treasury Securities	$	—	$	60,000	$	—	$	60,000
Collateralized Mortgage Backed		—		16,301		—		16,301
Subordinated Debt		—		2,533		—		2,533
Municipal Securities		—		16,026		—		16,026
U.S. Government Agencies		—		7,331		—		7,331
Derivative asset – interest rate swap on loans		—		11,025		—		11,025
Total	$	—	$	113,216	$	—	$	113,216
Liabilities:
Derivative liability – interest rate swap on loans		—		11,025		—		11,025
Total	$	—	$	11,025	$	—	$	11,025

	December 31, 2019
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale:
U.S. Treasury Securities	$	—	$	49,998	$	—	$	49,998
Collateralized Mortgage Backed		—		17,673		—		17,673
Subordinated Debt		—		2,554		—		2,554
Municipal Securities		—		14,631		—		14,631
U.S. Government Agencies		—		7,935		—		7,935
Derivative asset – interest rate swap on loans		—		4,039		—		4,039
Total	$	—	$	96,830	$	—	$	96,830
Liabilities:
Derivative liability – interest rate swap on loans		—		4,039		—		4,039
Total	$	—	$	4,039	$	—	$	4,039

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

26

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

Impaired loans

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

Other real estate owned

Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Bank. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Bank because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Statements of Income.

The following table summarizes the value of the Bank’s assets as of March 31, 2020 and December 31, 2019 that were measured at fair value on a nonrecurring basis during the period:

March 31, 2020
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Other Real Estate Owned	$	—	$	—	$	1,207	$	1,207
Total	$	—	$	—	$	1,207	$	1,207
December 31, 2019
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Other Real Estate Owned	$	—	$	—	$	1,207	$	1,207
Total	$	—	$	—	$	1,207	$	1,207

The following table summarizes the value of the Bank’s assets as of March 31, 2020 that were measured at fair value on a nonrecurring basis during the period:

	Fair Value Measurements at March 31, 2020
(Dollars in thousands)	Fair Value		Valuation Technique(s)	Unobservable Inputs	Range of Inputs
Other Real Estate Owned, net	$	1,207	Appraisals	Discount to reflect current market conditions and estimated selling costs.	6% - 10%
Total	$	1,207

Fair Value of Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. In accordance with ASU 2016-01, the Company uses the exit price notion, rather than the entry price notion, in calculation the fair values of financial instruments not measured at fair value on a recurring basis.

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The following tables reflect the carrying amounts and estimated fair values of the Company’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.

March 31, 2020	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(Dollars in thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
Assets:
Cash and due from banks	$	62,098	$	62,098	$	62,098	$	—	$	—
Restricted equity securities		5,041		5,041		—		5,041		—
Securities:
Available for sale		102,191		102,191		—		102,191		—
Held to maturity		23,878		24,652		—		24,652		—
Loans, net		1,059,628		1,060,192		—		—		1,060,192
Derivative asset – interest rate swap on loans		11,025		11,025		—		11,025		—
Bank owned life insurance		24,761		24,761		—		24,761		—
Accrued interest receivable		4,238		4,238		—		4,238		—
Liabilities:
Deposits	$	1,143,211	$	1,156,659	$	—	$	583,722	$	572,937
Advances from the FHLB		10,000		10,000		—		10,000		—
Derivative liability – interest rate swaps on loans		11,025		11,025		—		11,025		—
Accrued interest payable		1,145		1,145		—		1,145		—

December 31, 2019	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(Dollars in thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
Assets:
Cash and due from banks	$	53,376	$	53,376	$	53,376	$	—	$	—
Restricted equity securities		6,157		6,157		—		6,157		—
Securities:
Available for sale		92,791		92,791		—		92,791		—
Held to maturity		23,914		24,678		—		24,678		—
Loans, net		1,030,425		1,048,181		—		—		1,048,181
Derivative asset – interest rate swap on loans		4,039		4,039		—		4,039		—
Bank owned life insurance		24,562		24,562		—		24,562		—
Accrued interest receivable		4,282		4,282		—		4,282		—
Liabilities:
Deposits	$	1,071,623	$	1,079,011	$	—	$	510,766	$	568,245
Advances from the FHLB		40,000		39,998		—		39,998		—
Derivative liability – interest rate swaps on loans		4,039		4,039		—		4,039		—
Accrued interest payable		982		982		—		982		—

The above information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. There were no changes in methodologies or transfers between levels at March 31, 2020 from December 31, 2019.

Note 6. Earnings Per Common Share

Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock which then shared in the earnings of the Bank. There were no such potentially dilutive securities outstanding in 2020 or 2019.

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The weighted average number of shares used in the calculation of basic and diluted earnings per share includes unvested restricted shares of the Company’s common stock outstanding. Applicable guidance requires that outstanding un-vested share-based payment awards that contain voting rights and rights to non-forfeitable dividends participate in undistributed earnings with common stockholders.

	For the Three Months Ended March 31,
(Dollars in thousands)	2020		2019
Net income	$	3,470	$	3,247
Weighted average number of shares issued,    basic and diluted		8,287,317		8,242,873
Net income per share:
Basic and diluted income per share	$	0.42	$	0.39

Note 7. Accumulated Other Comprehensive Income

The following table presents the cumulative balances of the components of accumulated other comprehensive income, net of deferred taxes, as of March 31, 2020 and December 31, 2019:

	2020			2019
Unrealized gain(loss) on securities	$	1,109		$	609
Unrealized loss on securities transferred to HTM		(75	)		(81	)
Securities gains included in net income		5			5
Tax effect		(211	)		(110	)
Total accumulated other comprehensive gain	$	828		$	423

Note 8. Leases

Right-of-use assets and lease liabilities are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets. Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. The incremental borrowing rate was equal to the rate of borrowing from the FHLB that aligned with the term of the lease contract. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

Cash paid for amounts included in the measurement of lease liabilities during the three months ended March 31, 2020 was $73,000. During three months ended March 31, 2020 and 2019, the Company recognized lease expense of $147,000 and $72,000, respectively.

	As of March 31,
(Dollars in thousands)	2020
Lease liabilities	$	6,798
Right-of-use assets	$	6,490
Weighted-average remaining lease term – operating leases    (in months).		196.0
Weighted-average discount rate – operating leases		3.12	%
	For the three months ended March 31,
(Dollars in thousands)	2020
Lease Cost
Operating lease cost	$	147
Total lease costs	$	147
Cash paid for amounts included in measurement of lease    liabilities	$	73

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

As of March 31, 2020, all of the Company’s lease obligations are classified as operating leases. The Company does not have any finance lease obligations.

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities as of March 31, 2020 is as follows:

(Dollars in thousands)
2020	$	351
2021		529
2022		542
2023		556
2024		571
Thereafter		6,076
Total undiscounted cash flows	$	8,625
Discount		(1,827	)
Lease liabilities	$	6,798

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

The following discussion and analysis is intended as a review of significant factors affecting the Company’s consolidated financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the related notes and the Company’s Annual Report on Form 10-K, which contains audited consolidated financial statements of the Company as of and for the year ended December 31, 2019, previously filed with the Securities and Exchange Commission (“SEC”) on March 23, 2020. Results for the three months ended March 31, 2020 are not necessarily indicative of results for the year ending December 31, 2020 or any future period.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain forward-looking statements and information relating to the Company within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on the beliefs of management as well as assumptions made by and information currently available to management. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe,” “expect,” “anticipate,” “estimate,” and “intend” or future or conditional verbs such as “will,” “should,” “could,” or “may” and similar expressions or the negative thereof. Important factors that could cause actual results to differ materially from those in the forward–looking statements included herein include, but are not limited to:

• general economic conditions, either nationally or in our market area, that are worse than expected; including the future impacts of the novel coronavirus disease (COVID-19) outbreak and measures taken in response for which future developments are highly uncertain and difficult to predict;

• competition among depository and other financial institutions, particularly intensified competition for deposits;

• inflation and an interest rate environment that may reduce our margins or reduce the fair value of financial instruments;

• adverse changes in the securities markets;

• changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory structure and in regulatory fees and capital requirements;

• our ability to enter new markets successfully and capitalize on growth opportunities;

• our ability to successfully integrate acquired entities;

• changes in consumer spending, borrowing and savings habits;

• changes in accounting policies and practices;

• changes in our organization, compensation and benefit plans;

• our ability to attract and retain key employees;

• changes in our financial condition or results of operations that reduce capital;

• changes in the financial condition or future prospects of issuers of securities that we own;

• the concentration of our business in the Northern Virginia as well as the greater Washington, DC metropolitan area and the effect of changes in the economic, political and environmental conditions on this market;

• adequacy of or increases in the allowance for loan losses;

• cyber threats, attacks or events;

• reliance on third parties for key services;

• deterioration of our asset quality, including an increase in loan delinquencies, problem assets and foreclosures;

• future performance of our loan portfolio with respect to recently originated loans;

• additional risks related to new lines of business, products, product enhancements or services;

• results of examination of us by our regulators, including the possibility that our regulators may require us to increase our allowance for loan losses or to write-down assets or take other supervisory action;

• the effectiveness of our internal controls over financial reporting and our ability to remediate any future material weakness in our internal controls over financial reporting;

• liquidity, interest rate and operational risks associated with our business;

• implications of our status as a smaller reporting company and as an emerging growth company; and

• a work stoppage, forced quarantine, or other interruption or the unavailability of key employees.

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Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein. We caution readers not to place undue reliance on forward-looking statements. The Company disclaims any obligation to revise or update any forward-looking statements contained in this Form 10-Q to reflect future events or developments.

Overview

As used herein, The “Company,” “we,” “our,” and “us” refer to MainStreet Bancshares, Inc., and the “Bank” refers to MainStreet Bank.

MainStreet Bancshares, Inc. is a commercial bank holding company. MainStreet Bank is a community bank focused on serving the borrowing, cash management and depository needs of small to medium-sized businesses and professional practices and retail customers. We emphasize providing responsive and personalized services to our clients. Due to the consolidation of financial institutions in our primary market area, we believe there is a significant opportunity for a local bank to provide a full range of financial services. By offering highly professional, personalized banking products and service delivery methods and employing advanced banking technologies, we seek to distinguish ourselves from larger, regional banks operating in our market area and are able to compete effectively with other community banks.

We believe we have a solid franchise that meets the financial needs of our clients and communities by providing an array of personalized products and services delivered by seasoned banking professionals with decisions made at the local level. We believe a significant customer base in our market prefers to do business with a local institution that has a local management team, a local Board of Directors and local founders and that this customer base may not be satisfied with the responsiveness of larger regional banks. By providing quality services, coupled with the opportunities provided by the economies in our market area, we have generated and expect to continue to generate organic growth.

We service Northern Virginia as well as the greater Washington, D.C. metropolitan area. Our goal is to deliver a customized and targeted mix of products and services that meets or exceeds customer expectations. To accomplish this goal, we have deployed a premium operating system that gives customers access to up-to-date banking technology. These systems and our highly skilled staff have allowed us to compete aggressively with larger financial institutions. The combination of sophisticated technology and personal service sets us apart from our competition. We strive to be the leading community bank in our market.

We offer a full range of banking services to individuals, small to medium-sized businesses and professional service organizations through both traditional and electronic delivery. We were the first community bank in the Washington, D.C. metropolitan area to offer a full online business banking solution, including remote check scanners on a business customer’s desktop. We offer mobile banking apps for iPhones, iPads and Android devices that provide for remote deposit of checks. In addition, we were the first bank headquartered in the Commonwealth of Virginia to offer CDARS, the Certificate of Deposit Account Registry Service, an innovative deposit insurance solution that provides Federal Deposit Insurance Corporation (“FDIC”) insurance on deposits up to $140 million. We believe that enhanced electronic delivery systems and technology increase profitability through greater productivity and cost control, and allow us to offer new and better products and services.

Our products and services include: business and consumer checking, premium interest-bearing checking, business account analysis, savings, certificates of deposit and other depository services, as well as a broad array of commercial, real estate and consumer loans. Internet account access is available for all personal and business accounts, internet bill payment services are available on most accounts, and a robust online cash management system is available for business customers.

Both the Company and the Bank are incorporated in and chartered by the Commonwealth of Virginia. The Bank is a member of the Federal Reserve System, and its deposits are insured by the FDIC. The Bank opened for business on May 26, 2004 and is headquartered in Fairfax, Virginia. We currently operate seven Bank branches; located in Herndon, Fairfax, Fairfax City, McLean, Clarendon, Leesburg Virginia, and one in Washington D.C.

The Company’s executive offices are located at 10089 Fairfax Boulevard, Fairfax, Virginia. Our telephone number is (703) 481-4567, and our internet address is www.mstreetbank.com. The information contained on our website shall not be considered part of this Memorandum and the Investor Presentation, and the reference to our website does not constitute incorporation by reference of the information contained on the website.

COVID-19 Economic Impact

On Friday, March 13, 2020, President Trump declared a national emergency caused by the coronavirus (COVID-19) pandemic. The federal and state guidelines issued in connection with this national emergency to curb the spread of the COVID-19 pandemic have caused economic disruption across nearly every industry as well as rampant unemployment.  The Commonwealth of Virginia and the District of Columbia instituted stay at home guidelines with an exception made for essential businesses.  Both jurisdictions consider banking to be an essential business.

As an essential business, MainStreet Bank is firstly committed to providing a safe work environment.  On the following Monday, March 16, 2020 we transitioned nearly all our employees to work from home.  We were fully prepared to do so because of our advanced technology.  We anticipate continuing to work from home until we deem it to be safe to return everyone to work.

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

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

At the forefront of the crisis, we established a forbearance program for commercial customers with a term-debt repayment structure.  The forbearances either provide two months deferral of principal and interest payments or converting the loan to three months of interest-only payments.  Both solutions were focused on assisting our borrowers in preserving their liquidity.  As of April 30, 2020, we have processed loan forbearance requests for 158 borrowers, which represented approximately 37.0% of the dollar value of commercial term-debt structured relationships for the Bank at that date. A similar program was offered to consumer borrowers wherein up to two months of principal and interest payments may be deferred. As of April 30, 2020, less than 4% of these loans had requested a deferral.

On a positive note, regulators were quick to issue guidance allowing us and other financial institutions flexibility to work with borrowers on payment deferral options and other loan modifications without otherwise impairing the loan or requiring reclassification to a troubled debt restructured (“TDR”) status.

As an SBA Preferred lender, the Bank was proactive in establishing an efficient process to service the Small Business Administration (“SBA”) Payment Protection Program (“PPP”). The PPP was designed to fund up to eight weeks of payroll and other defined operating expenses, with the intention of converting the loan proceeds into a grant if appropriate documentation was provided through the lender to the SBA. As of April 30, 2020, the Bank has processed 761 applications for a total of $167.9 million for our customers.  

The federal government has also implemented additional programs to help individuals and small businesses replace lost or lessened income due to the coronavirus pandemic. These benefits include, but are not limited to, additional elevated payments for those filing unemployment, extended eligibility for unemployment benefits, payroll tax credits, individual stimulus payments, and additional health benefits.

The Bank has effective systems to monitor ongoing liquidity needs on a daily basis. In addition, the Bank has access to specialized funding through the Federal Reserve to fund the PPP loans. We do not expect significant changes in our access to funding sources resulting from participation in these programs.

MainStreet Bank’s lenders are experienced in the unique markets we serve, and the Bank has established strict underwriting standards. In adhering to our internal guidelines, we have consistently held a lower than average balance of problem loans, classified loans and loans to be charged-off. We will continuously review the loan portfolio in order to determine the depth and breadth of potential loan losses associated with the pandemic. We will also provision for appropriate potential losses in a timely manner.

Critical Accounting Policies

The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. Critical accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the current period or in future periods.

Following the announcement by the U.K.’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for the London InterBank Offered Rate (LIBOR) after 2021, central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates (IBOR) and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates (ARRs) and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.

To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, the Company has established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs.

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Our critical accounting policies involving significant judgments and assumptions used in the preparation of the consolidated financial statements as of March 31, 2020 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K, for the year ended December 31, 2019, other than the items discussed in our Recently Adopted Accounting Pronouncements.

Comparison of Statements of Income for the Three Months Ended March 31, 2020 and 2019

General

Net income increased $223,000 to $3.5 million for the three months ended March 31, 2020 from $3.2 million for the three months ended March 31, 2019. The increase in net income for the three months ended March 31, 2020 was primarily due to an increase in interest income from the Bank’s loan portfolio, an increase in non-interest income of $488,000, of which $113,000 was provided by loan swap fees, $117,000 provided by an increase in deposit account service charges, and $164,000 provided by an increase in other fee activity. Net income was offset by an increases of $573,000 in salaries and employee benefits and $635,000 in interest expense on time deposits compared to the same period in 2019.

Interest Income

Total interest income increased $1.3 million, or 9.4%, to $15.1 million for the three months ended March 31, 2020 from $13.8 million for the three months ended March 31, 2019. The increase was primarily the result of an increase in interest and fees on loans of $1.3 million, an increase in interest on federal funds sold and interest-earning deposits of $50,000, but was offset by a decrease in interest on investment securities of $55,000. Total average interest-earning assets increased $199.0 million, to $1.27 billion for the three months ended March 31, 2020 from $1.07 billion for the same period in 2019 primarily as a result of an increase in the average balance of loans of $122.3 million, a $5.3 million increase in the average balance of investment securities and an increase in the average balance of federal funds sold and interest-earning deposits with banks of $71.4 million. The average yield on our interest-earning assets decreased 40 basis points to 4.77% for the three months ended March 31, 2020 as compared to 5.17% for the three months ended March 31, 2019 primarily as a result of lower average yields on interest earning assets due to market conditions and the Federal Reserve lowering the federal interest rates to near 0%.

Interest and fees on loans increased $1.3 million, to $14.2 million for the three months ended March 31, 2020 from $12.9 million for the same period in 2019. This increase was primarily due to an increase in average loans outstanding of $122.3 million, which increased to $1.06 billion as of March 31, 2020 from $936.4 million as of March 31, 2019. In addition to the growth in the loan portfolio the Federal Reserve decreased the federal interest rate to 25 basis points in the first quarter of 2020, which decreased yields on the Bank’s asset sensitive balance sheet as compared to the same period in 2019. The average yield on loans decreased 15 basis points, or 2.7%, for the three months ended March 31, 2020 as compared to the three months ended March 31, 2019.

Interest income on federal funds sold and interest-earning deposits increased by $50,000 to $395,000 for the three months ended March 31, 2020, from $345,000 for the three months ended March 31, 2019. The increase was primarily due to an increase in the average balance on these deposits despite a decrease in average yield. The average yield decreased 96 basis points, to 1.16% for the three months ended March 31, 2020 from 2.12% for the three months ended March 31, 2019. The decrease in average yield was primarily due to the decrease in the federal interest rate to 25 basis points during first quarter of 2020. The average balance of interest-earning deposits and federal funds sold increased $71.4 million to $136.3 million for the three months ended March 31, 2020 from $64.9 million for the three months ended March 31, 2019. The Bank held higher average balances in these accounts during the first quarter of 2020 while determining strategic alternatives to deploy this capital.

Interest on investment securities decreased by $55,000 to $501,000 for the three months ended March 31, 2020 from $556,000 for the three months ended March 31, 2019, respectively. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals decreased in total $59,000, or 16.5%, to $298,000 for the three months ended March 31, 2020, from $356,000 for the three months ended March 31, 2019. Mortgage backed securities increased by $12,000, or 17.9%, to $77,000 for the three months ended March 31, 2020, from $66,000 for the three months ended March 31, 2019. The average yield on total securities decreased 53 basis points, to 2.71% for the three months ended March 31, 2020, from 3.24% for the same period in 2019. As a decrease in market rates resulted in stagnant yielding investments, investment income decreased despite an increase in average balances for the comparison period. The average balance of investment securities increased by $5.3 million, to $73.8 million for the three months ended March 31, 2020, from $68.6 million for the three months ended March 31, 2019

Interest Expense

Total interest expense increased $347,000, to $4.8 million for the three months ended March 31, 2020 from $4.5 million for the three months ended March 31, 2019, primarily due to a $635,000 increase in interest expense on time deposits, which was offset by $169,000 decrease in interest expense on borrowings.

Interest expense on deposits increased $513,000, to $4.5 million for the three months ended March 31, 2020 from $4.0 million for the three months ended March 31, 2019 primarily as a result of an increase in average interest bearing deposits of $166.4 million to $893.5 million during the three months ended March 31, 2020 as compared to $727.2 million for the three months ended March 31, 2019. The increase in the average balance of interest-bearing deposits was primarily a result of a $99.1 million increase in the average balance of time deposit accounts and a $86.3 million increase in the average balance of money market deposits. These increases were offset by a $23.1 decrease in interest bearing demand deposits. The increase in the average balance of time deposits was primarily a result of retail growth and brokered deposits obtained

34

through a deposit placement network on a reciprocal basis, such that amounts are under the standard FDIC insurance maximum of $250,000 making the deposits eligible for FDIC insurance. The average cost of deposits was 203 basis points for the three months ended March 31, 2020, compared to 221 basis points for the three months ended March 31, 2019. The average rate paid on money market deposits decreased 77 basis points to 1.35% for the three months ended March 31, 2020 from 2.12% for the three months ended March 31, 2019. The increase in the average balance of our certificates of deposits of $99.1 million, from $468.0 million for the three months ended March 31, 2019 to $567.1 million for the three months ended March 31, 2020 was primarily the result of the Bank’s retail growth strategies. The average cost of certificates of deposit increased by 1 basis point to 2.52% for the three months ended March 31, 2020 as compared to 2.51% for the three months ended March 31, 2019. The increase in the average cost of certificates of deposit for the three months ended March 31, 2020, in spite of a falling rate environment, was the result of increased deposit competition and our continued funding of higher interest brokered deposits as compared to the three months ended March 31, 2019.

Interest expense on advances from the Federal Home Loan Bank decreased $168,000 to $50,000 for the three months ended March 31, 2020, from $218,000 for the three months ended March 31, 2019 as a result of an decrease in the average balance on the Federal Home Loan Bank advances which decreased to $10.3 million for the three months ended March 31, 2020 from $34.1 million for the three months ended March 31, 2019. In addition, the average rate of the Federal Home Loan Bank advances decreased 62 basis points for the three months ended March 31, 2020 compared to the same period in the prior year. The average balance of the Federal Home Loan Bank advances decreased $23.8 million for the three months ended March 31, 2020, primarily due to the repayment of advances.

Net Interest Income

Net interest income increased approximately $952,000, or 10.2%, to $10.3 million for the three months ended March 31, 2020 from $9.3 million for the three months ended March 31, 2019 as a result of our net interest-earning assets increasing $56.5 million to $350.2 million for the three months ended March 31, 2020 from $293.7 million for the three months ended March 31, 2019. The interest rate spread decreased by 20 basis points to 2.67% for the three months ended March 31, 2020 from 2.87% for the three months ended March 31, 2019. The net interest margin decreased by 25 basis points from 3.50% for the three months ended March 31, 2019 to 3.25% for the three months ended March 31, 2020.

Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are based on daily balances.

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	For the Three Months Ended March 31,
	2020								2019
	Average Balance			Interest Income/ Expense		Yield/ Cost (5)			Average Balance			Interest Income/ Expense		Yield/ Cost (5)
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	1,058,738		$	14,220		5.37	%	$	936,401		$	12,916		5.52	%
Investment securities		73,838			501		2.71	%		68,550			556		3.24	%
Federal funds and interest-bearing    deposits		136,314			395		1.16	%		64,944			345		2.12	%
Total interest-earning assets		1,268,890		$	15,116		4.77	%		1,069,895		$	13,817		5.17	%
Non-interest-earning assets		59,363								36,788
Total assets	$	1,328,253							$	1,106,683
Interest-bearing liabilities:
Interest-bearing demand deposits	$	33,558		$	117		1.39	%	$	56,701		$	245		1.73	%
Money market deposits		230,158			778		1.35	%		143,825			763		2.12	%
Savings and NOW deposits		62,699			64		0.41	%		58,616			73		0.50	%
Time deposits		567,112			3,566		2.52	%		468,009			2,931		2.51	%
Total interest-bearing deposits		893,527			4,525		2.03	%		727,151			4,012		2.21	%
Federal funds purchased		—			—		—			139			1		2.88	%
Federal Home Loan Bank advances		10,330			50		1.94	%		34,111			218		2.56	%
Subordinated debt		14,809			241		6.51	%		14,780			238		6.44	%
Total interest-bearing liabilities		918,666		$	4,816		2.10	%		776,181		$	4,469		2.30	%
Non-interest-bearing liabilities:
Demand deposits and other liabilities		270,422								207,180
Total liabilities		1,189,088								983,361
Stockholders’ Equity		139,165								123,322
Total liabilities and Stockholders’    equity	$	1,328,253							$	1,106,683
Net interest income				$	10,300							$	9,348
Interest rate spread (2)							2.67	%							2.87	%
Net interest-earning assets (3)	$	350,224							$	293,714
Net interest margin (4)							3.25	%							3.50	%
Average interest-earning assets to    average interest-bearing liabilities		138.12	%							137.84	%

(1) Includes loans classified as non-accrual

(2) Interest rate spread represents the difference between the average yield on average interest–earning assets and the average cost of average interest-bearing liabilities.

(3) Net interest earning assets represent total average interest–earning assets less total interest–bearing liabilities.

(4) Net interest margin represents net interest income divided by total average interest-earning assets.

(5) Annualized.

Rate/ Volume Analysis

The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior average volume). The volume column shows the effects attributable to changes in volume (changes in average volume multiplied by prior rate). Changes attributable to both volume and rate are allocated between the volume and rate categories. The net column represents the sum of the prior columns.

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For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

	For the Three Months Ended
	March 31, 2020 and 2019
	Increase (Decrease) Due to						Total Increase
	Volume			Rate			(Decrease)
	(In thousands)
Interest-earning assets:
Loans	$	3,405		$	(2,101	)	$	1,304
Investment securities		215			(270	)		(55	)
Federal funds and interest-bearing deposits		918			(868	)		50
Total interest-earning assets		4,538			(3,239	)		1,299
Interest-bearing liabilities:
Interest-bearing demand deposits		(86	)		(42	)		(128	)
Money market deposit accounts		1,389			(1,374	)		15
Savings and NOW accounts		27			(36	)		(9	)
Time deposits		623			12			635
Total deposits		1,953			(1,440	)		513
Federal funds purchased		(1	)		—			(1	)
Federal Home Loan Bank advances		(125	)		(43	)		(168	)
Subordinated debt		—			3			3
Total interest-bearing liabilities		1,827			(1,480	)		347
Change in net interest income	$	2,711		$	(1,759	)	$	952

Provision for Loan Losses

Management believes that the provision recorded for the period ended March 31, 2020 reflects a balance sufficient to provide for each allowance segment, using objective data and information available to us at this time in evaluating our standard analysis of local/national economic data, changes in underwriting quality, portfolio concentrations, experience of lending team, and credit quality. In performing our assessment of the allowance for loan losses as of March 31, 2020, the Board and management considered the level of uncertainty and lack of objective information available, and determined that it would be premature to attempt to make an objective estimate of potential losses caused by the COVID-19 pandemic, and that subjective provision added to the allowance for loan and lease losses as of March 31, 2020 would be driven largely by speculation. We will continuously review the loan portfolio in order to determine the depth and breadth of potential loan losses associated with the pandemic. As we obtain sufficient, verifiable information to more accurately assess the full nature and extent of elevated risk to the Bank’s lending portfolio that may arise from this crisis, additional provision expense during the second quarter and remainder of 2020 may be required. The Board and management agreed to continue to work expeditiously with borrowers to analyse the loan portfolio with a goal of timely identifying, provisioning and reporting potential losses that could occur throughout the course of the pandemic.

The Board and management focused all efforts on pre-emptive measures to help borrowers sustain their liquidity. Forbearance programs have been implemented for commercial term-debt borrowers and for consumer term-debt borrowers. All available officers and other employees participated in this endeavour. Subsequently, many of these officers and other employees assisted with the SBA Paycheck Protection Program (PPP). The PPP focused on providing qualifying small businesses with a loan to fund up to eight weeks of qualifying payroll expenses along with other defined operating expenses. Under the PPP, with appropriate documentation, the United States Treasury will agree to convert the eligible amount of loan funds into a grant with the principal and interest forgiven.

The Board and management’s sole objective was to offer forbearance and implement the federal program and working with eligible borrowers on methods to preserve their liquidity while continuing to meet payroll and operating expenses.  

The provision for loan losses, which is an operating expense, is maintained to ensure that the allowance for loan losses is maintained at levels we consider necessary and appropriate to absorb both probable and reasonably estimated credit losses at a balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available over time or economic conditions change. This evaluation is inherently subjective, as it requires estimates and assumptions that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for loan losses is assessed on a monthly basis and provisions are made for loan losses as required in order to maintain the allowance.

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Provision for loan losses increased by $25,000 to $350,000 for the three months ended March 31, 2020 from $325,000 for the three months ended March 31, 2019 primarily as a result of an increase in loan originations which totaled approximately $26.9 million for the three months ended March 31, 2019 compared to loan originations of $71.1 million for the three months ended March 31, 2020. Non-performing loans decreased $1.8 million, or 90%, from $2.0 million at March 31, 2019 to $208,000 as of March 31, 2020, as a result of one loan removed through foreclosure and two loans placed on nonaccrual were added. During the three months ended March 31, 2020, substandard loans increased $169,000 for a balance of $3.5 million; primarily due to a $150,000 loan being place on nonaccrual during the quarter. Special mention loans decreased $706,000 as of March 31, 2020 primarily due to principal reductions. During the three months ended March 31, 2020, there were $48,000 in charge-offs and recoveries of $12,000 were received.

Non-Interest Income

Non-interest income increased $488,000, or 52.7%, to $1.4 million for the three months ended March 31, 2020 from $926,000 for the three months ended March 31, 2019. The increase in non-interest income was primarily due to increases in loan interest rate swaps of $113,000, $117,000 in deposit account service charges, and $164,000 in other fee activity for the three months ended March 31, 2020. The Bank has focused on expanding these areas throughout 2020. In addition, bank owned life insurance income increased $94,000 to $199,000 for the three months ended March 31, 2020 from $105,000 for the three months ended March 31, 2019 primarily as a result of an increased investment in this asset class.

Non-Interest Expense

Non-interest expense increased $1.1 million, or 18.9%, to $7.1 million for the three months ended March 31, 2020 from $6.0 million for the three months ended March 31, 2019 primarily as a result of increases in salary and employee benefits of $573,000 and other operating expenses of $242,000. Salaries and employee benefits expense increased by $573,000 to $4.4 million for the three months ended March 31, 2020 from $3.9 million for the three months ended March 31, 2019 primarily as a result of adding twelve employees and the related salary and benefit expenses for these additional employees. Other operating expenses increased $242,000, or 23.0%, to $1.3 million for the three months ended March 31, 2020 from $1.1 million for the three months ended March 31, 2019 due to increases in professional and consulting fees and fees related to investments in technology infrastructure. Franchise tax increased approximately $35,000 to $342,000 for the three months ended March 31, 2020 from $307,000 for the three months ended March 31, 2019 as a result of the increase in the Company’s capital as of March 31, 2020 compared to the balance sheet as of March 31, 2019. FDIC insurance premiums increased approximately $90,000 to $280,000 for the three months ended March 31, 2020 from $190,000 for the three months ended March 31, 2019.

Income Tax Expense

Income tax expense increased $57,000, or 8.2%, to $751,000 for the three months ended March 31, 2020 from $694,000 for the three months ended March 31, 2019. The increase in federal income tax expense for the three months ended March 31, 2020 compared to the same period a year ago was driven by the increase in income before income taxes of $280,000, or 7.1%, to $4.2 million as of March 31, 2020 compared to $3.9 million for the same period in the prior year. As a result of a change in tax regulation, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $60,000 for the three months ended March 31, 2020. For the three months ended March 31, 2020, the Company had an effective federal tax rate of 17.8%, compared to effective federal tax rate of 17.6% for the three months ended March 31, 2019.

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

Total Assets

Total assets increased $52.4 million, or 4.1%, to $1.33 billion at March 31, 2020 from $1.28 billion at December 31, 2019. The increase was primarily the result of increases of $30.0 million in gross loans receivable, $9.4 million in available-for-sale securities, and $7.0 million in loan interest rate swaps.

Investment Securities

Investment securities increased $8.2 million, or 6.7%, from $122.9 million at December 31, 2019 to $131.1 million at March 31, 2020. The increase was primarily in the available-for-sale portfolio, particularly in U.S. treasury securities. At March 31, 2020, our held-to-maturity portion of the securities portfolio, at amortized cost, was $23.9 million, and our available-for-sale portion of the securities portfolio, at fair value, was $102.2 million compared to our held-to-maturity portion of the securities portfolio of $23.9 million and our available-for-sale portion of the securities portfolio of $92.8 million at December 31, 2019.

Net Loans

Net loans increased $29.2 million, or 2.8%, to $1.06 billion at March 31, 2020 from $1.03 billion at December 31, 2019. Residential real estate loans decreased $883,000, or 0.6%, to $150.0 million at March 31, 2020 from $150.8 million at December 31, 2019. Commercial real estate loans increased by $27.9 million from $421.9 million at December 31, 2019 to $449.8 million at March 31, 2020. Commercial and industrial loans decreased by $3.0 million from $121.2 million at December 31, 2019 to $118.3 million at March 31, 2020. Construction loans increased $13.3 million to $286.0 million at March 31, 2020 from $272.6 million at December 31, 2019. Consumer loans decreased by $7.4 million from $75.6 million at December 31, 2019 to $68.2 million at March 31, 2020.

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Allowance for Loan Losses

	For the Three Months Ended March 31,
	2020			2019
	(Dollars in thousands)
Balance at beginning of period	$	9,584		$	8,831
Charge-offs:
Commercial Real Estate		(1	)		—
Commercial and Industrial		(47	)		—
Total charge-offs		(48	)		—
Recoveries:
Residential Real Estate		—			30
Commercial and Industrial		9			—
Consumer		3			3
Total recoveries		12			33
Net recoveries (charge-offs)		(36	)		33
Provision for loan losses		350			325
Balance at end of period	$	9,898		$	9,189
Ratios:
Net charge offs to average loans outstanding		0.0	%		0.0	%
Allowance for loan losses to non-performing loans at end of    period		47.59			4.66
Allowance for loan losses to gross loans at end of period		0.93	%		0.96	%

Deposits

Deposits increased $71.6 million, or 6.7%, to $1.14 billion at March 31, 2020 from $1.07 billion at December 31, 2019. Our core deposits increased $131.4 million, or 20.1%, to $785.7 million at March 31, 2020 from $654.2 million at December 31, 2019. Certificates of deposit decreased $1.4 million, or 0.2%, to $559.5 million at March 31, 2020 from $560.9 million at December 31, 2019. The decrease in certificates of deposit was primarily the result of decreased brokered deposits as core deposits replaced this funding over the quarter.

Nonperforming Assets

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

	March 31,			December 31,
	2020			2019
	(Dollars in thousands)
Non-accrual loans:
Residential Real Estate	$	150		$	—
Consumer		58			—
Total non-accrual loans		208			—
Total non-performing loans		208			—
Other real estate owned		1,207			1,207
Total non-performing assets	$	1,415		$	1,207
Ratios:
Total non-performing loans to gross loans receivable		0.02	%		0.00	%
Total non-performing loans to total assets		0.02	%		0.00	%
Total non-performing assets to total assets		0.11	%		0.09	%

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Liquidity and Capital Resources

Liquidity Management. Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Deposits are the primary source of funds for lending and investing activities; however, the Company also utilizes wholesale deposits as a funding source in addition to customer deposits. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, federal funds purchased, and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process. MainStreet Bank had Federal Home Loan Bank advances of $10.0 million outstanding with unused borrowing capacity of $309 million as of March 31, 2020. Additionally, at March 31, 2020, we had the ability to borrow up to $49.0 million from other financial institutions.

The Board of Directors, management and the Asset Liability Committee (ALCO) are responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as of March 31, 2020.

We monitor and adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand; (2) expected deposit flows; (3) yields available on interest-earning deposits and securities; and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short-and intermediate-term securities.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents, which include federal funds sold and interest-earning deposits in other banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2020, cash and cash equivalents totaled $72.8 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $102.2 million at March 31, 2020.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $5.5 million and $4.5 million for the three months ended March 31, 2020 and March 31, 2019, respectively. Net cash used in investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans and proceeds from maturing securities, was $38.2 million and $39.5 million for the three months ended March 31, 2020 and March 31, 2019, respectively. There were no sales of available-for-sale securities in three months ended March 31, 2020 and 2019. Net cash provided by financing activities was $40.6 million and $36.7 million for the three months ended March 31, 2020 and 2019, respectively, which consisted primarily of increases in interest bearing deposits of $83.3 million and $64.7 million offset by net repayments of $30.0 million and $10.0 million from the Federal Home Loan Bank for the three months ended March 31, 2020 and 2019, respectively.

We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of March 31, 2020, totaled $297.5 million of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other deposits, Federal Home Loan Bank advances and commitments from other financial institutions. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Capital Management. MainStreet Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At March 31, 2020, MainStreet Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory guidelines.

Regulatory Capital

Information presented for March 31, 2020 and December 31, 2019, reflects the Basel III capital requirements that became effective January 1, 2015 for the Bank. Under these capital requirements and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk- weightings and other factors.

The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer for 2020 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of March 31, 2020, the Company and the Bank meet all capital adequacy requirements to which it is subject.

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

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

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

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

	Actual					Capital Adequacy Purposes			To Be Well Capitalized Under the Prompt Corrective Action Provision
(Dollars in thousands)	Amount		Ratio			Amount		Ratio	Amount		Ratio
As of March 31, 2020
Total capital (to risk-weighted assets)	$	161,870		13.20	%	$	98,113	≥ 8.0%	$	122,641	> 10.0%
Common equity tier 1 capital (to risk-weighted assets)	$	151,972		12.39	%	$	55,189	≥ 4.5%	$	98,113	> 8.0%
Tier 1 capital (to risk-weighted assets)	$	151,972		12.39	%	$	73,585	≥ 6.0%	$	98,113	> 8.0%
Tier 1 capital (to average assets)	$	151,972		11.45	%	$	53,078	≥ 4.0%	$	66,348	> 5.0%
As of December 31, 2019
Total capital (to risk-weighted assets)	$	157,892		13.50	%	$	93,576	≥ 8.0%	$	116,970	≥ 10.0%
Common equity tier 1 capital (to risk-weighted assets)	$	148,308		12.68	%	$	52,636	≥ 4.5%	$	93,576	≥ 8.0%
Tier 1 capital (to risk-weighted assets)	$	148,308		12.68	%	$	70,182	≥ 6.0%	$	93,576	≥ 8.0%
Tier 1 capital (to average assets)	$	148,308		12.12	%	$	48,937	≥ 4.0%	$	61,171	≥ 5.0%

Off-Balance Sheet Arrangements and Contractual Obligations

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At March 31, 2020, we had outstanding loan commitments of $284.9 million and outstanding stand-by letters of credit of $672,000. We anticipate that we will have sufficient funds available to meet our current lending commitments.

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

Not required for smaller reporting companies

Item 4 – Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of March 31, 2020. Based on their evaluation of the Company’s disclosure controls and procedures, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and regulations are designed and operating in an effective manner.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) occurred during the first fiscal quarter of 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

At March 31, 2020, the Company was not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which involve amounts in the aggregate believed by management to be immaterial to the financial condition and operating results of the Company. In addition, no material proceedings are pending or known to be threatened or contemplated against the Company or its subsidiary by governmental authorities.

Item 1A – Risk Factors

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

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

Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Congress has approved additional funding for the PPP and President Trump signed the new legislation on April 24, 2020. Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of litigation, from both clients and non-clients that solicited the Bank for PPP loans, regarding its process and procedures used to process applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation may be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

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

Under the authority provided in the CARES Act, the Federal Reserve has established the MSLP to support lending to eligible small-and-medium sized businesses. Pursuant to the MSLP, eligible lending institutions are authorized to make loans to eligible borrowers and a special purpose vehicle established by the Federal Reserve Bank of Boston (the “Main Street SPV”) will purchase either a 95% or 85% participation interest in such loans, depending on the eligibility of the borrower and the type of loan. The Federal Reserve has issued guidance regarding the MSLP, but the program has not yet commenced.  

It is possible that the Company or the Bank will be exposed to litigation from clients and non-clients that solicit the Bank for MSLP loans, regarding its process and procedures used to process applications for the MSLP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. Any financial liability, litigation costs or reputational damage caused by MSLP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

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

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

42

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

Issuer Purchases of Equity Securities

The Company’s Board of Directors authorized a share repurchase program for the Company’s common stock (the “Repurchase Program”) in September 2019 for up to $10.0 million of the Company’s outstanding common stock. Repurchases under the Repurchase Program may be made through privately-negotiated transactions, or open-market transactions, including pursuant to a trading plan in accordance with Rule 10b5- and/or Rule 10b-18 under the Exchange Act. During the three months ended March 31, 2020, the Company repurchased 60,000 shares of its common stock for an aggregate cost of $1.0 million. These transactions occurred prior to the economic impact stemming from the COVID-19 crisis at the end first quarter. The Company has no plans to repurchase additional shares at this time.

The following table summarizes repurchases of the Company’s common stock that occurred during the three months ended March 31, 2020.

(Dollars in thousands, except for per share amounts)	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under the Plans or Programs
January 1, 2020 - March 31, 2020		60	$	16.50		60	$	9,000
Total		60	$	16.50		60

Item 3 – Defaults upon Senior Securities

Not Applicable

Item 4 – Mine Safety Disclosures

Not Applicable

Item 5 – Other Information

None

43

Item 6 – Exhibits

31.1	Rule 13a-14(a) Certification of the Chief Executive Officer *
31.2	Rule 13a-14(a) Certification of the Chief Financial Officer *
32.0	Section 1350 Certification *
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Label Linkbase Document
101.PRE	XBRL Taxonomy Presentation Linkbase Document

* Filed herewith

44

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		MAINSTREET BANCHSHARES, INC
		(Registrant)
Date: May 12, 2020	By:	/s/ Jeff W. Dick
		Jeff W. Dick
		Chairman & Chief Executive Officer
		(Principal Executive Officer)
Date: May 12, 2020	By:	/s/ Thomas J. Chmelik
		Thomas J. Chmelik
		Senior Executive Vice President and
		Chief Financial Officer
		(Principal Financial Officer)

45