MAINSTREET BANKSHARES INC - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - MAINSTREET BANKSHARES INC	Financial_Report.xls
EX-31.2 - EXHIBIT 31.2 - MAINSTREET BANKSHARES INC	v385489_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - MAINSTREET BANKSHARES INC	v385489_ex31-1.htm
EX-32 - EXHIBIT 32 - MAINSTREET BANKSHARES INC	v385489_ex32.htm

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

June 30, 2014

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

For the transition period from

Commission file number

333-86993

MainStreet BankShares, Inc.

(Exact name of registrant as specified in its charter)

Virginia		54-1956616
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1075 Spruce Street, Martinsville, Virginia		24112
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number

(276) 632-8054

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

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

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

Large Accelerated filer ¨		Accelerated filer ¨

Non-accelerated filer ¨		Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 1,713,375 as of August 11, 2014

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Form 10-Q

Index

		Page No.

	PART I FINANCIAL INFORMATION

Item 1	Financial Statements	1-33

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33-53

Item 3	Quantitative and Qualitative Disclosures About Market Risk	53

Item 4	Controls and Procedures	54

	PART II OTHER INFORMATION

Item 1	Legal Proceedings	54

Item 1A	Risk Factors	54

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	54

Item 3	Defaults Upon Senior Securities	54

Item 4	Mine Safety Disclosures	54

Item 5	Other Information	54

Item 6	Exhibits	54

	Signatures	55

	Index to Exhibits	56

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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

Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013 (audited).

Consolidated Statements of Operations for the quarters ended June 30, 2014 (unaudited) and June 30, 2013 (unaudited).

Consolidated Statements of Operations for the year-to-date periods ended June 30, 2014 (unaudited) and June 30, 2013 (unaudited).

Consolidated Statements of Comprehensive Income (Loss) for the quarters ended June 30, 2014 (unaudited) and June 30, 2013 (unaudited).

Consolidated Statements of Comprehensive Income (Loss) for the year-to-date periods ended June 30, 2014 (unaudited) and June 30, 2013 (unaudited).

Consolidated Statements of Cash Flows for the year-to-date periods ended June 30, 2014 (unaudited) and June 30, 2013 (unaudited).

Notes to Consolidated Financial Statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	(Unaudited)			(Audited)
	June 30, 2014			December 31, 2013

ASSETS

Cash and due from banks	$	3,804,713		$	2,929,591
Interest-bearing deposits in banks		6,499,067			10,343,469
Federal funds sold		5,329,941			4,691,091
Total Cash and Cash Equivalents		15,633,721			17,964,151
Securities available-for-sale, at fair value		14,111,780			21,832,432
Securities held to maturity, at amortized cost		5,641,208			—
Restricted equity securities		587,200			654,600
Loans held for sale		—			306,250

Loans:
Total Gross Loans		126,528,906			123,637,386
Unearned deferred fees and costs, net		91,985			86,600
Loans, net of unearned deferred fees and costs		126,620,891			123,723,986
Less: Allowance for loan losses		(2,245,086	)		(2,379,145	)
Net Loans		124,375,805			121,344,841
Bank premises and equipment, net		1,485,786			1,509,562
Accrued interest receivable		440,754			462,081
Bank owned life insurance		1,926,688			1,898,736
Other real estate owned, net of valuation allowance		218,340			728,163
Other assets		1,859,728			2,330,201

TOTAL ASSETS	$	166,281,010		$	169,031,017

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:
Non-interest bearing demand deposits	$	26,543,867		$	26,856,990
Interest bearing deposits		112,931,286			115,964,448
Total Deposits		139,475,153			142,821,438

Accrued interest payable and other liabilities		2,005,696			2,222,038
Total Liabilities		141,480,849			145,043,476

Commitments and contingencies		—			—

Shareholders’ Equity:
Preferred stock, no par value, authorized 10,000,000 shares; none issued		—			—
Common stock, no par value, authorized 10,000,000 shares; issued and outstanding 1,713,375 shares at June 30, 2014 and December 31, 2013, respectively		17,866,890			17,866,890
Retained earnings		6,759,696			6,161,960
Accumulated other comprehensive income (loss)		173,575			(41,309	)
Total Shareholders’ Equity		24,800,161			23,987,541

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	166,281,010		$	169,031,017

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

	Three Months			Three Months
	Ended			Ended
	June 30, 2014			June 30, 2013

Interest and Dividend Income:
Interest and fees on loans	$	1,610,480		$	1,717,012
Interest on interest-bearing deposits		2,842			10,971
Interest on federal funds sold		2,465			2,082
Interest on securities:
Taxable		88,287			68,956
Nontaxable		18,148			17,571
Dividends on restricted equity securities		8,474			8,199
Total Interest and Dividend Income		1,730,696			1,824,791

Interest Expense:
Interest on deposits		178,898			278,657
Interest on short-term borrowings		1			1
Total Interest Expense		178,899			278,658

Net Interest Income		1,551,797			1,546,133
Provision for loan losses		13,384			1,064,897

Net Interest Income After Provision for Loan Losses		1,538,413			481,236

Noninterest Income:
Service charges on deposit accounts		64,758			59,217
Mortgage commissions		30,559			77,557
Electronic card fees		47,651			48,168
Investment fee income		56,640			48,754
Income on bank owned life insurance		14,115			9,533
Gain on securities sold/called		—			47,194
Other fee income and miscellaneous income		23,759			45,292
Total Noninterest Income		237,482			335,715

Noninterest Expense:
Salaries and employee benefits		708,692			677,275
Occupancy and equipment expense		184,168			189,243
Professional fees		61,735			59,373
Outside processing		76,435			104,055
FDIC assessment		32,321			50,866
Franchise tax		59,000			54,000
Regulatory examination fees		11,274			26,304
Other real estate and repossessions		(4,779	)		42,761
Other expenses		134,522			136,436
Total Noninterest Expense		1,263,368			1,340,313

Net Income (Loss) Before Tax	$	512,527		$	(523,362	)
Income Tax Expense (Benefit)		163,017			(187,822	)
Net Income (Loss)	$	349,510		$	(335,540	)
Basic Net Income (Loss) Per Common Share	$	.20		$	(.20	)
Diluted Net Income (Loss) Per Common Share	$	.20		$	(.20	)

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

	Six Months			Six Months
	Ended			Ended
	June 30, 2014			June 30, 2013

Interest and Dividend Income:
Interest and fees on loans	$	3,182,075		$	3,487,050
Interest on interest-bearing deposits		6,780			18,111
Interest on federal funds sold		5,086			3,668
Interest on securities available:
Taxable		181,644			146,088
Nontaxable		36,130			34,215
Dividends on restricted equity securities		17,070			16,508
Total Interest and Dividend Income		3,428,785			3,705,640

Interest Expense:
Interest on deposits		383,059			565,266
Interest on short-term borrowings		1			1
Interest on repurchase agreements		—			595
Total Interest Expense		383,060			565,862

Net Interest Income		3,045,725			3,139,778
Provision for loan losses		86,872			1,252,502

Net Interest Income After Provision for Loan Losses		2,958,853			1,887,276

Noninterest Income:
Service charges on deposit accounts		121,838			129,205
Mortgage commissions		54,026			151,543
Electronic card fees		87,557			91,934
Investment fee income		107,987			89,998
Income on bank owned life insurance		27,952			18,972
Gain on securities sold/called		—			47,194
Other fee income and miscellaneous income		48,961			72,748
Total Noninterest Income		448,321			601,594

Noninterest Expense:
Salaries and employee benefits		1,416,856			1,341,604
Occupancy and equipment expense		380,475			379,430
Professional fees		115,544			119,514
Outside processing		161,434			208,848
FDIC assessment		59,868			104,795
Franchise tax		118,250			108,000
Regulatory examination fees		33,823			52,607
Other real estate and repossessions		(1,022	)		104,999
Other expenses		249,947			249,886
Total Noninterest Expense		2,535,175			2,669,683

Net Income (Loss) Before Tax	$	871,999		$	(180,813	)
Income Tax Expense (Benefit)		274,263			(81,130	)
Net Income (Loss)	$	597,736		$	(99,683	)
Basic Net Income (Loss) Per Common Share	$	.35		$	(.06	)
Diluted Net Income (Loss) Per Common Share	$	.35		$	(.06	)

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

	Three Months Ended June 30, 2014			Three Months Ended June 30, 2013

Net Income (Loss)	$	349,510		$	(335,540	)
Other Comprehensive Income (Loss):
Net unrealized holding gains (losses) on securities available for sale during the period		177,667			(484,858	)
Deferred income tax (expense) benefit on unrealized holding losses or gains on securities available for sale		(60,407	)		164,851
Less reclassification adjustments for gains included in net Income (1)		—			(47,194	)
Tax related to realized gain on securities sold (2)		—			16,046
Amortization of held to maturity transfer during period		(67	)		—
Tax effect of amortization of held to maturity transfer during period		23			—
Other Comprehensive Income (Loss)		117,216			(351,155	)
Total Comprehensive Income (Loss)	$	466,726		$	(686,695	)

(1)

Reclassifications for gains on sales of securities available-for-sale are included in the “gain on securities sold/called” line item on the Consolidated Statements of Operations.

(2)

Income taxes related to gains on sales of securities available-for-sale are included in the “income tax expense (benefit)” line item on the Consolidated Statements of Operations.

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

	Six Months Ended June 30, 2014			Six Months Ended June 30, 2013

Net Income (Loss)	$	597,736		$	(99,683	)
Other Comprehensive Income (Loss):
Net unrealized holding gains (losses) on securities available for sale during the period		325,649			(543,358	)
Deferred income tax (expense) benefit on unrealized holding losses or gains on securities available for sale		(110,721	)		184,741
Less reclassification adjustments for gains included in net Income (1)		—			(47,194	)
Tax related to realized gain on securities sold (2)		—			16,046
Amortization of held to maturity transfer during period		(67	)		—
Tax effect of amortization of held to maturity transfer during period		23			—
Other Comprehensive Income (Loss)		214,884			(389,765	)
Total Comprehensive Income (Loss)	$	812,620		$	(489,448	)

(1)

Reclassifications for gains on sales of securities available-for-sale are included in the “gain on securities sold/called” line item on the Consolidated Statements of Operations.

(2)

Income taxes related to gains on sales of securities available-for-sale are included in the “income tax expense (benefit)” line item on the Consolidated Statements of Operations.

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

	Six Months Ended June 30, 2014			Six Months Ended June 30, 2013
Cash Flows From Operating Activities
Net income (loss)	$	597,736		$	(99,683	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		86,872			1,252,502
Depreciation and amortization		74,645			78,008
Amortization of discounts and premiums, net		77,819			98,928
Gain on sale of securities		—			(47,194	)
(Gain) loss and impairment on other real estate owned and repossessions		(9,941	)		61,074
Deferred tax expense		210,268			372,991
Change in loans held for sale		306,250			5,500
Decrease in accrued interest receivable		21,327			99,700
Decrease in other assets		149,507			205,709
Increase in value of bank owned life insurance		(27,952	)		(18,972	)
Change in reserve for unfunded lending commitments		7,393			(3,189	)
Increase in executive retirement plan accrual		71,313			60,360
Payments on executive retirement plan		(140,628	)		(140,628	)
Decrease in accrued interest payable and other liabilities		(154,420	)		(136,559	)
Net cash provided by operating activities		1,270,189			1,788,547

Cash Flows From Investing Activities

Purchases of bank premises and equipment		(50,869	)		(68,073	)
Purchases of securities available for sale		—			(4,220,991	)
Calls/maturities/repayments of securities available for sale		2,327,207			3,137,179
Redemptions of restricted equity securities		67,400			86,400
Proceeds from sale of securities		—			1,086,283
Proceeds from sale of other real estate owned and repossessions		768,780			1,471,387
Loan originations and principal collections, net		(3,366,852	)		5,066,776
Net cash provided by (used in) investing activities		(254,334	)		6,558,961

Cash Flows From Financing Activities

Increase (decrease) in non-interest bearing deposits		(313,123	)		4,830,418
Decrease in interest bearing deposits		(3,033,162	)		(1,464,690	)
Repayment of repurchase agreement		—			(6,000,000	)
Net cash used in financing activities		(3,346,285	)		(2,634,272	)

Net increase (decrease ) in cash and cash equivalents	$	(2,330,430	)	$	5,713,236
Cash and cash equivalents at beginning of period		17,964,151			24,038,353
Cash and cash equivalents at end of period	$	15,633,721		$	29,751,589

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	405,958		$	628,760
Cash paid during the period for interest	$	405,958		$	628,760
Cash paid during the period for taxes	$	64,000		$	—
Unrealized (loss) gain on securities available for sale	$	335,261		$	(590,552	)
Transfer of securities available for sale to held to maturity	$	5,647,033		$	—
Transfers between loans, other real estate & other assets	$	249,016		$	48,750
Amortization of net unrealized loss on securities moved to HTM	$	(67	)	$	—

See accompanying notes to consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Note 1 – Summary of Accounting Policies

(a) General

The accompanying consolidated financial statements of MainStreet BankShares, Inc. are unaudited. However, in the opinion of management, all adjustments necessary for a fair presentation of the financial statements have been included. All adjustments were of a normal recurring nature, except as otherwise disclosed herein. The consolidated financial statements conform to generally accepted accounting principles and general banking industry practices. The information contained in the footnotes included in MainStreet BankShares, Inc.’s 2013 Annual Report on Form 10-K should be referred to in connection with the reading of these unaudited interim consolidated financial statements.

MainStreet BankShares, Inc. (the “Corporation”, “MainStreet”, or “BankShares”) was incorporated in Virginia on January 14, 1999. The Corporation was primarily organized to serve as a bank holding company. Its first wholly-owned subsidiary was located in Martinsville, Virginia and was sold on March 23, 2005. In 2002, MainStreet organized a second bank subsidiary, Franklin Community Bank, National Association (“Franklin Bank”). On February 8, 2007, MainStreet formed a wholly-owned real estate company, MainStreet RealEstate, Inc. (“MainStreet RE”) for the sole purpose of owning the real estate of the Corporation.

Franklin Bank was organized as a nationally chartered commercial bank and member of the Federal Reserve Bank of Richmond. Franklin Bank opened for business on September 16, 2002. Franklin Bank operates as a locally owned and operated commercial bank emphasizing personal customer service and other advantages incident to banking with a locally owned community bank. Franklin Bank’s primary service area is Franklin County, Town of Rocky Mount and surrounding areas. It currently has three banking offices including its main office.

The Corporation reports its activities as a single business segment. In determining the appropriateness of segment definition, the Corporation considered components of the business about which financial information is available and will evaluate it regularly relative to resource allocation and performance assessment.

(b) Our accounting policies and basic principles have not changed since the summary disclosure of these in our Annual Report on Form 10-K. Please refer to the Form 10-K for these policies.

Note 2 – Securities

The amortized costs, unrealized gains and losses and approximate market values of investment securities at June 30, 2014 and December 31, 2013 are shown in the following tables.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

	June 30, 2014
			Gross		Gross
Available for Sale:	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gains		Losses			Market Value
U.S. government sponsored agencies	$	1,489,192	$	423	$	(20,405	)	$	1,469,210
Mortgage backed securities		11,842,092		319,995		(20,232	)		12,141,855
Corporates		496,316		4,399		—			500,715

Total securities available for sale	$	13,827,600	$	324,817	$	(40,637	)	$	14,111,780

	June 30, 2014
			Gross		Gross
Held to Maturity:	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gains		Losses			Market Value
States and political subdivisions	$	5,641,208	$	2,400	$	(21,674	)	$	5,621,934
Total securities held to maturity	$	5,641,208	$	2,400	$	(21,674	)	$	5,621,934

	December 31, 2013
			Gross		Gross
Available for Sale:	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gains		Losses			Market Value
U. S. government sponsored agencies	$	2,688,955	$	555	$	(66,510	)	$	2,623,000
Mortgage backed securities		13,012,376		202,523		(59,744	)		13,155,155
States and political subdivisions		5,686,412		11,784		(140,819	)		5,557,377
Corporates		495,770		2,488		(1,358	)		496,900

Total securities available-for-sale	$	21,883,513	$	217,350	$	(268,431	)	$	21,832,432

All of our mortgage backed securities are either guaranteed by U.S. government agencies or issued by U. S. government sponsored agencies.

The amortized costs and market values of the securities portfolio at June 30, 2014, by contractual maturity, are shown in the following table. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

	Available for Sale				Held to Maturity
	Amortized		Approximate		Amortized		Approximate
	Cost		Market Value		Cost		Market Value
Due in one year or less	$	—	$	—	$	—	$	—
Due after one year but within five years		496,316		500,715		1,851,006		1,844,513
Due after five years but with ten years		3,652,672		3,705,651		3,790,202		3,777,421
Due after ten years		9,678,612		9,905,414		—		—

	$	13,827,600	$	14,111,780	$	5,641,208	$	5,621,934

There were no gross gains or losses recorded on sales and calls of securities available for sale for the quarter-to-date and year-to-date periods ending June 30, 2014. There were gross gains of $47,194 recorded on sales and calls of securities available for sale for the quarter-to-date and year-to-date periods ending June 30, 2013.

During the three months and six months periods ended June 30, 2014, available for sale securities with a market value of $5.6 million were transferred to the held to maturity securities portfolio. The unrealized loss of $(9,612) is now part of the amortized cost of the securities and will be amortized over the life of the securities as an adjustment to the yield.

Following demonstrates the unrealized loss position of securities at June 30, 2014 and December 31, 2013.

	June 30, 2014
Available for Sale:	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
U. S. government sponsored agencies	$	492,655	$	(7,345	)	$	486,940	$	(13,060	)	$	979,595	$	(20,405	)
Mortgage backed securities		—		—			1,885,029		(20,232	)		1,885,029		(20,232	)
Total temporarily impaired securities	$	492,655	$	(7,345	)	$	2,371,969	$	(33,292	)	$	2,864,624	$	(40,637	)

	June 30, 2014
Held to Maturity:	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
States and political subdivisions	$	3,177,000	$	(11,607	)	$	2,153,947	$	(10,067	)	$	5,330,947	$	(21,674	)
Total temporarily impaired securities	$	3,177,000	$	(11,607	)	$	2,153,947	$	(10,067	)	$	5,330,947	$	(21,674	)

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

	December 31, 2013
	Less Than 12 Months					12 Months or More				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
	Value		Losses			Value		Losses		Value		Losses
U. S. government sponsored agencies	$	1,921,845	$	(66,510	)	$	—	$	—	$	1,921,845	$	(66,510	)
Mortgage backed Securities		4,275,948		(59,744	)		—		—		4,275,948		(59,744	)
States and political Subdivisions		3,856,363		(140,819	)		—		—		3,856,363		(140,819	)
Corporates		248,135		(1,358	)		—		—		248,135		(1,358	)
Total temporarily impaired securities	$	10,302,291	$	(268,431	)	$	—	$	—	$	10,302,291	$	(268,431	)

An impairment is considered “other than temporary” if any of the following conditions are met: the Corporation intends to sell the security, it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis, or the Corporation does not expect to recover the security’s entire amortized cost basis (even if the Bank does not intend to sell). At June 30, 2014 and December 31, 2013, there were $8.2 million comprising twenty securities and $10.3 million comprising twenty-three securities, respectively, in securities with unrealized losses based on market prices at the respective dates. Declines in fair value are due to interest rate fluctuations and not due to credit deterioration of the issuers. The Corporation does not have any securities that are considered “other than temporarily impaired” at June 30, 2014 and December 31, 2013.

Federal Reserve Bank stock is included in restricted equity securities and totaled $435,100 at June 30, 2014 and December 31, 2013. The Corporation’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $152,100 and $219,500 at June 30, 2014 and December 31, 2013, respectively, and is also included in restricted equity securities. FHLB stock is generally viewed as a long term investment and as a restricted investment security which is carried at cost, because there is no market for the stock other than the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Note 3 – Loans Receivable

The major components of gross loans in the consolidated balance sheets at June 30, 2014 and December 31, 2013 are as follows:

	June 30, 2014		December 31, 2013
Commercial	$	10,194,933	$	9,426,188
Real Estate:
Construction and land development		15,738,882		16,394,964
Residential 1-4 families:
First liens		34,287,121		33,787,645
Junior liens		7,079,779		6,331,233
Home equity lines		6,746,222		5,764,941
Commercial real estate		51,194,330		50,579,103
Consumer		1,287,639		1,353,312
Total Gross Loans	$	126,528,906	$	123,637,386
Unearned deferred fees and costs, net		91,985		86,600
Recorded Investment	$	126,620,891	$	123,723,986

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Overdrafts reclassified to loans at June 30, 2014 and December 31, 2013 were $8,793 and $6,196, respectively.

Loan Origination/Risk Management: Franklin Bank’s Board of Directors annually approves and reviews policies and procedures to be utilized as tools by account officers for the purpose of making sound and prudent credit decisions. Every loan transaction is closely evaluated from the perspective of profitability realizing that there is no profit in a loan that becomes a loss. Each credit decision is based on merit and no other factors. Account officers carry a heavy burden of accountability in being assigned the responsibility for the development of Franklin Bank’s loan portfolio by meeting the legitimate credit needs of our customers while also exercising prudence and seasoned judgment. A comprehensive reporting system has been developed to provide senior management timely information related to portfolio performance including growth, delinquency, adversely risk rated, and credit concentrations. The portfolio is constantly reviewed based on segments of concern, past due status, extension of credits along with stress testing the portfolio’s collateral values and debt service coverages for a significant portion of loans within defined loan concentrations. Annually, a loan review plan is developed to identify and mitigate potential weakness in the loan portfolio. Scope is determined based upon a risk assessment of various concentrations and loan product types in which higher risk may exist. The developed plan is presented to the Loan Committee of Franklin Bank’s Board of Directors each year for approval. Overall, the goal is to review 33% of the entire loan portfolio annually. Review segments vary from year to year to ensure a complete cycle of all significant loan product types. Results of each review segment are communicated to the Loan Committee of the Board of Directors of Franklin Bank with a response from Franklin Bank’s senior lender or head of retail lending depending on the product type reviewed.

In general all loans exceeding $100,000 are documented by three years of financial reports in conjunction with review and analysis by a credit analyst independent of the lending approval process. Generally all real estate loans are underwritten based on verified income, or cash flow, and margined at 80% or less depending upon the regulatory supervisory limit. All loans are underwritten based upon analysis of all identified primary and secondary repayment sources.

Construction & Land Development: Emphasis is placed on the estimated absorption period of the project based on the intimate knowledge of local demand and geographic concentrations by appraisers and account officers. Projects are monitored by Franklin Bank’s in-house construction inspector to ensure adherence to project specifications and timely completion. Loan to values are manually tracked to ensure conforming collateral coverage is maintained throughout the development phase. Interest carry abilities are determined by analyzing global cash flow and available liquidity. Due to their complex nature, loans for speculative housing and speculative lot requests are underwritten by Franklin Bank’s business lending group. Terms at origination for speculative lot loans are based on collateral margins and on qualifying the borrower to policy requirements based on a ten year amortization period.

Speculative housing loan terms generally are held to eighteen months with allowance made for substantial curtailments.

Commercial Real Estate: Loans are generally underwritten based on verified income or cash flow to ensure a global coverage ratio of at least 1.25. In general, collateral margin is determined based on appraisal or evaluation market value not to exceed 80 percent of appraised market value or cost, whichever is less. All properties receive proper environmental due diligence prior to funding of the credit. Account officers perform and document a market analysis which may include data on competing businesses and projects. When applicable, market analysis data may be obtained from independent sources. Cash flows and collateral margins are appropriately stress tested. Terms generally range from five to fifteen years, however, may be longer based on approval from Franklin Bank’s President and Chief Credit Officer.

Commercial Loans: Loans are generally underwritten based on verified income or cash flow to ensure global debt service coverage ratio of at least 1.25. Terms can range up to seven years based on loan purpose and collateral offered. Based on policy, credit lines have maturities of one year. Generally inventory loans are margined at 50% while equipment loans, depending on age of collateral, range from 90%, if new, to 80%, if used. Receivables are margined at 80% based on the aging of receivables outstanding sixty days or less.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Consumer /Residential 1-4 Families and Equity Lines: Loans are generally underwritten based on a maximum debt to income ratio of 40 percent gross. Incomes are verified for all secured loans exceeding $35,000 and unsecured loans totaling $10,000 or more. Policy requires income verification to be documented for all real estate loans. Collateral margins and terms for non-real estate collateral are determined and made available to retail lenders by Franklin Bank’s Chief Credit Officer. Cash flows for all self employed borrowers are determined by Franklin Bank’s independent credit analyst. Policy defines unsecured loan terms at a maximum of thirty six months while individual unsecured lines are underwritten to maturities of less than one year with the line amount being based on a percentage of available liquidity and net worth. Construction loans for individuals are underwritten to policy based on cost overruns of at least fifteen percent. Debt to income ratios for equity lines are underwritten based on the borrower paying 1.5% of the total available line monthly. All equity lines are reviewed annually and filtered based on updated credit scores, average percentage drawn and delinquency. “Watch” accounts are identified based on filters and then individually reviewed by the responsible account officer.

Note 4 – Allowance for Loan Losses

Changes in the allowance for loan losses for the six months ended June 30, 2014 and 2013 are as follows:

	2014			2013

Balance at beginning of year	$	2,379,145		$	2,602,098
Provision for loan losses		86,872			1,252,502
Recoveries		92,652			35,179
Charge-offs		(313,583	)		(972,785	)
Balance at period end	$	2,245,086		$	2,916,994

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

A breakdown of the allowance by loan segment for the six months ended June 30, 2014 is as follows:

				Real Estate
				Construction			Residential 1-4 Families						Home		Commercial
				and Land			First			Junior			Equity		Real
	Commercial			Development			Liens			Liens			Lines		Estate		Consumer			Unallocated		Total

Beginning Balance	$	151,289		$	353,391		$	601,276		$	100,906		$	100,351	$	1,061,037	$	10,895		$	—	$	2,379,145
Charge-offs		(76,045	)		(63,746	)		(106,435	)		(66,409	)		—		—		(948	)		—		(313,583	)
Recoveries		16,644			30,793			8,029			8,559			16,730		6,388		5,509			—		92,652
Provision		16,227			(19,617	)		(30,084	)		71,945			498		24,829		(6,926	)		30,000		86,872
Ending Balance	$	108,115		$	300,821		$	472,786		$	115,001		$	117,579	$	1,092,254	$	8,530		$	30,000	$	2,245,086

			June 30, 2014 Real Estate
			Construction		Residential 1-4 Families				Home		Commercial
			and Land		First		Junior		Equity		Real
	Commercial		Development		Liens		Liens		Lines		Estate		Consumer		Unallocated		Total

Allowance for loan losses:

Ending Balance:
Individually evaluated for impairment	$	—	$	—	$	—	$	189	$	—	$	331,006	$	—	$	—	$	331,195

Ending Balance:
Collectively evaluated for impairment		108,115		300,821		472,786		114,812		117,579		761,248		8,530		30,000		1,913,891

	$	108,115	$	300,821	$	472,786	$	115,001	$	117,579	$	1,092,254	$	8,530	$	30,000	$	2,245,086

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

			June 30, 2014 Real Estate
			Construction		Residential 1-4 Families				Home		Commercial
			and Land		First		Junior		Equity		Real				Gross
	Commercial		Development		Liens		Liens		Lines		Estate		Consumer		Loans

Recorded investment in loans:

Ending Balance:
Individually evaluated for impairment	$	614,669	$	422,715	$	470,214	$	132,380	$	69,950	$	2,033,393	$	—	$	3,743,321

Ending Balance:
Collectively evaluated for impairment		9,580,264		15,316,167		33,816,907		6,947,399		6,676,272		49,160,937		1,287,639		122,785,585

	$	10,194,933	$	15,738,882	$	34,287,121	$	7,079,779	$	6,746,222	$	51,194,330	$	1,287,639	$	126,528,906

A breakdown of the allowance for loan losses by loan segment for the year ended December 31, 2013 is as follows:

				Real Estate
				Construction			Residential 1-4 Families						Home			Commercial
				and Land			First			Junior			Equity			Real
	Commercial			Development			Liens			Liens			Lines			Estate			Consumer			Unallocated			Total

Beginning Balance	$	108,336		$	767,018		$	701,668		$	134,847		$	88,411		$	740,073		$	11,745		$	50,000		$	2,602,098
Charge-offs		(450,100	)		(592,292	)		(151,295	)		(156,561	)		(9,052	)		(534,150	)		(74,461	)		—			(1,967,911	)
Recoveries		12,278			9,090			7,448			20,497			—			1,429			29,336			—			80,078
Provision		480,775			169,575			43,455			102,123			20,992			853,685			44,275			(50,000	)		1,664,880
Ending Balance	$	151,289		$	353,391		$	601,276		$	100,906		$	100,351		$	1,061,037		$	10,895		$	—		$	2,379,145

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

			December 31, 2013 Real Estate
			Construction		Residential 1-4 Families				Home		Commercial
			and Land		First		Junior		Equity		Real
	Commercial		Development		Liens		Liens		Lines		Estate		Consumer		Unallocated		Total

Allowance for loan losses:

Ending Balance:
Individually evaluated for impairment	$	50,000	$	10	$	101,540	$	—	$	—	$	424,376	$	—	$	—	$	575,926

Ending Balance:
Collectively evaluated for impairment		101,289		353,381		499,736		100,906		100,351		636,661		10,895		—		1,803,219

	$	151,289	$	353,391	$	601,276	$	100,906	$	100,351	$	1,061,037	$	10,895	$	—	$	2,379,145

			December 31, 2013 Real Estate
			Construction		Residential 1-4 Families				Home		Commercial
			and Land		First		Junior		Equity		Real				Gross
	Commercial		Development		Liens		Liens		Lines		Estate		Consumer		Loans

Recorded investment in loans:

Ending Balance:
Individually evaluated for impairment	$	725,863	$	576,552	$	1,130,961	$	182,170	$	71,338	$	3,308,733	$	—	$	5,995,617

Ending Balance:
Collectively evaluated for impairment		8,700,325		15,818,412		32,656,684		6,149,063		5,693,603		47,270,370		1,353,312		117,641,769

	$	9,426,188	$	16,394,964	$	33,787,645	$	6,331,233	$	5,764,941	$	50,579,103	$	1,353,312	$	123,637,386

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

An age analysis of past due loans as of June 30, 2014 is as follows:

													Accruing Loans
	Loans		Loans		Loans 90								90 or More Days		Nonaccrual Loans
	30-59 Days Past Due		60-89 Days Past Due		Or More Days Past Due		Total Past Due Loans		Current Loans		Gross Loans		Past Due (Included in Past Dues)		(Included in Past Dues & Current)
Commercial	$	63,281	$	—	$	—	$	63,281	$	10,131,652	$	10,194,933	$	—	$	—
Real Estate:
Construction and land development		—		75,168		162,710		237,878		15,501,004		15,738,882		—		266,074
Residential 1-4 Families
First Liens		177,088		—		196,275		373,363		33,913,758		34,287,121		—		470,214
Junior Liens		16,499		33,690		189		50,378		7,029,401		7,079,779		—		132,380
Home Equity lines		—		—		—		—		6,746,222		6,746,222		—		69,950
Commercial Real Estate		—		—		—		—		51,194,330		51,194,330		—		2,033,393
Consumer		62		—		—		62		1,287,577		1,287,639		—		—

	$	256,930	$	108,858	$	359,174	$	724,962	$	125,803,944	$	126,528,906	$	—	$	2,972,011

An age analysis of past due loans as of December 31, 2013 is as follows:

													Accruing Loans
													90 or More Days
	Loans 30-59 Days Past Due		Loans 60-89 Days Past Due		Loans 90 Or More Days Past Due		Total Past Due Loans		Current Loans		Gross Loans		Past Due (Included in Past Dues)		Nonaccrual Loans (Included in Past Dues & Current)
Commercial	$	—	$	—	$	—	$	—	$	9,426,188	$	9,426,188	$	—	$	—
Real Estate:
Construction and land development		320,143		—		259,973		580,116		15,814,848		16,394,964		—		576,552
Residential 1-4 Families
First Liens		893,473		33,154		802,830		1,729,457		32,058,188		33,787,645		—		1,125,187
Junior Liens		65,603		—		16,232		81,835		6,249,398		6,331,233		—		152,985
Home Equity lines		—		—		—		—		5,764,941		5,764,941		—		71,338
Commercial Real Estate		416,668		—		—		416,668		50,162,435		50,579,103		—		2,079,556
Consumer		50,244		—		—		50,244		1,303,068		1,353,312		—		—

	$	1,746,131	$	33,154	$	1,079,035	$	2,858,320	$	120,779,066	$	123,637,386	$	—	$	4,005,618

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Impaired loans at June 30, 2014 are as follows:

	Unpaid		Recorded		Recorded
	Contractual		Investment		Investment				Average		Interest
	Principal		with Related		with No Related		Related		Recorded		Income
	Balance		Allowance		Allowance		Allowance		Investment		Recognized
Commercial	$	614,669	$	—	$	614,669	$	—	$	654,747	$	—
Real Estate:
Construction and land development		568,707		—		422,715		—		436,091		4,299
Residential 1-4 Families
First Liens		478,785		—		470,214		—		861,360		6,031
Junior Liens		157,347		189		132,191		189		162,387		—
Home Equity lines		79,002		—		69,950		—		70,721		—
Commercial Real Estate		2,033,393		2,033,393		—		331,006		2,500,840		3,313
Consumer		—		—		—		—		—		—

	$	3,931,903	$	2,033,582	$	1,709,739	$	331,195	$	4,686,146	$	13,643

Impaired loans at December 31, 2013 are as follows:

	Unpaid		Recorded		Recorded
	Contractual		Investment		Investment				Average		Interest
	Principal		with Related		with No Related		Related		Recorded		Income
	Balance		Allowance		Allowance		Allowance		Investment		Recognized
Commercial	$	778,980	$	60,000	$	665,863	$	50,000	$	287,405	$	34,511
Real Estate:
Construction and land development		890,255		162,710		413,842		10		960,164		24,249
Residential 1-4 Families
First Liens		1,154,822		541,539		589,422		101,540		1,460,986		37,253
Junior Liens		190,455		—		182,170		—		216,673		9,361
Home Equity lines		80,390		—		71,338		—		59,495		263
Commercial Real Estate		3,308,733		2,079,556		1,229,177		424,376		2,156,878		46,367
Consumer		—		—		—		—		—		—

	$	6,403,635	$	2,843,805	$	3,151,812	$	575,926	$	5,141,601	$	152,004

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

The Corporation assesses all loan modifications to determine whether they are considered troubled debt restructurings (TDRs). During the six months ending June 30, 2014, the Corporation modified or renewed four loans that were considered to be TDRs, of which two are on nonaccrual. The construction and land development credits were loans restructured to allow the borrowers time to sell their properties. One commercial real estate credit was restructured into a new credit, waiving lost interest. The second commercial real estate loan was the renewal of an existing troubled debt restructuring that is interest only.

	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Construction and land development		2	$	291,063	$	291,063
Commercial Real Estate		2		2,104,152		2,104,152
Total		4	$	2,395,215	$	2,395,215

During the three months ending June 30, 2014, the Corporation modified or renewed one loan that was considered to be a TDR. The construction and land development credit was a loan restructured to allow the borrower time to sell his properties.

	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Construction and land development		1	$	158,282	$	158,282
Total		1	$	158,282	$	158,282

There were no troubled debt restructurings modified during the past twelve months that defaulted during the three month or six month periods ended June 30, 2014. For this purpose, if a note defaults it means at some point it has been greater than 60 days past due or we have received some information that leads us to believe the full collection of the principal and interest is doubtful.

During the three month and six month periods ending June 30, 2013, the Corporation modified one loan that was considered to be a TDR. The Corporation lowered the payment on the loan, which extended the amortization out of policy guidelines, in order to allow the borrower time to attract new tenants. The following table presents information relating to the loan modified as TDR during the three and six months ended June 30, 2013.

	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial Real Estate		1	$	1,898,387	$	1,898,387
Total		1	$	1,898,387	$	1,898,387

There were no troubled debt restructurings modified during the past twelve months that defaulted during the three month and six month period ended June 30, 2013. For this purpose, if a note defaults it means at some point it has been greater than 60 days past due or we have received some information that leads us to believe the full collection of the principal and interest is doubtful.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

At June 30, 2014 and December 31, 2013 the balance in loans under the terms of troubled debt restructurings not included in nonaccrual loans was $771,310 and $1,929,999, respectively. Troubled debt restructurings (not on nonaccrual) decreased from December 31, 2013 to June 30, 2014 because one restructured credit, with terms reflecting current market rates, is no longer being reported as a troubled debt restructuring due to sustained performance of six months and another small credit was paid off. These loans did not have any additional commitments at June 30, 2014 and December 31, 2013, respectively. Loan restructurings generally occur when a modification that would otherwise not be considered is granted to the borrower having financial difficulties. These loans may continue to accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance with the modified terms. The borrowers were complying with the modified terms of their contracts at June 30, 2014 and December 31, 2013, respectively, that were not in nonaccrual status. Troubled debt restructurings are included in the impaired loan disclosures.

The following table describes the interest earned, reflected in income and lost for the six month periods.

	June 30, 2014		June 30, 2013
Interest that would have been earned	$	110,065	$	129,203
Interest reflected in income		13,643		42,261
Lost interest	$	96,422	$	86,942

The Corporation’s internally assigned grades for credit quality are as follows:

Prime (1.00)

Exceptional credits are of the highest quality. These loans are supported by large, well-established borrowers with excellent financial stability and strength, and may be secured by cash or cash equivalents. Where applicable, guarantors have substantial net worth and personal cash flow, and could easily fulfill their obligation should the need arise.

Good (2.00)

Superior credits are supported by well-established borrowers with excellent financial stability and strength. The borrower’s cash flow, liquidity, and equity are more than ample. These credits may be secured by cash or cash equivalents. For loans with personal guarantees, the guarantors are high net worth individuals, and have the resources available to satisfy their obligation if necessary.

Acceptable (3.00)

Loans in this category are supported by borrowers and guarantors that are financially sound. Cash flow, liquidity and equity are sufficient to provide a comfortable margin in the event of short-term economic disturbances. Assets pledged as collateral would provide a dependable secondary source of repayment.

Pass/Watch (4.00)

Credits in this category present the maximum acceptable risk for new facilities. Borrowers generate enough cash for debt service needs, but may not have sufficient resources to weather short-term market fluctuations. Management may lack depth or experience, and industry volatility may be an issue. Where applicable, guarantors have sufficient resources to provide an additional margin of protection.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Special Mention (5.00)

Assets in this category demonstrate signs of potential weakness, which, if uncorrected, could result in default. The borrower’s liquidity or equity may be marginal, trends in cash flow and profitability may point to a weakening financial condition, or the borrower’s industry may be slightly unstable or showing early indications of decline.

Collateral may be illiquid or provide only a relatively small margin. Migration analysis data is performed and updated quarterly on these loans. It is based on loans downgraded originally into this category. Our loss factor is determined based on charge-offs during the quarter divided by the balance of special mention loans at the beginning of the quarter. This is then increased by the qualitative factors which increase the applied loss factor to 3%.

Substandard (6.00)

Loans in this category present an unacceptable credit risk. Borrowers and guarantors may be financially weak, and may lack the sufficient resources to adequately service debt. The abilities of management and industry stability may also be of concern. Collateral may be lacking in quality or liquidity, and offers little additional protection.

Migration analysis data is performed and updated quarterly on these loans. It is based on loans downgraded originally into this category. Our loss factor is determined based on charge-offs during the quarter divided by the balance of substandard loans at the beginning of the quarter. This is then increased by the qualitative factors which increases the applied loss factor to 8%. This does not apply to impaired loans where a specific reserve is determined based on the loss, if any, that is calculated.

Doubtful (7.00)

These loans have an extremely high probability of loss, though the timing and magnitude of the loss may remain unclear. Borrowers and guarantors exhibit major financial shortcomings, and clearly lack the sufficient resources to adequately service debt or honor their commitments. Collateral is lacking in quality or liquidity, and offers little, if any, additional protection.

Loss (8.00)

The probability of collection on these credits is so low that they may be properly classified as uncollectible.

Generally, consumer loans, home equity lines, and residential 1-4 family loans are not risk rated and considered a pass credit unless they are related to a risk rated commercial loan relationship or exhibit criticized asset characteristics.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

			June 30, 2014 Real Estate
			Construction		Residential 1-4 Families				Home		Commercial				Gross Loans by
Internal Risk Rating Grades	Commercial		And Land Development		First Liens		Junior Liens		Equity Lines		Real Estate		Consumer		Internal Risk Rating Grade
Grade:
Pass	$	9,959,470	$	13,979,539	$	33,493,578	$	6,447,283	$	6,671,388	$	45,281,845	$	1,275,388	$	117,108,491
Special Mention		—		892,166		—		14,961		—		2,162,990		2,061		3,072,178
Substandard		235,463		867,177		793,543		617,346		74,834		3,418,489		10,190		6,017,042
Doubtful		—		—		—		189		—		331,006		—		331,195
Loss		—		—		—		—		—		—		—		—

	$	10,194,933	$	15,738,882	$	34,287,121	$	7,079,779	$	6,746,222	$	51,194,330	$	1,287,639	$	126,528,906

			December 31, 2013 Real Estate
			Construction		Residential 1-4 Families				Home		Commercial				Gross Loans by
Internal Risk Rating Grades	Commercial		And Land Development		First Liens		Junior Liens		Equity Lines		Real Estate		Consumer		Internal Risk Rating Grade
Grade:
Pass	$	9,179,636	$	14,308,667	$	32,126,801	$	5,773,125	$	5,693,603	$	47,028,384	$	1,342,215	$	115,452,431
Special Mention		—		907,175		204,731		—		—		711,413		907		1,824,226
Substandard		196,552		1,179,112		1,354,573		558,108		71,338		2,414,930		10,190		5,784,803
Doubtful		50,000		10		101,540		—		—		424,376		—		575,926
Loss		—		—		—		—		—		—		—		—

	$	9,426,188	$	16,394,964	$	33,787,645	$	6,331,233	$	5,764,941	$	50,579,103	$	1,353,312	$	123,637,386

Note 5 – Borrowings

The Corporation has the ability to borrow from Federal Home Loan Bank of Atlanta (“FHLB”). Borrowing capacity is secured by a blanket lien on loans secured by commercial real estate and loans secured by 1-4 family first liens, second liens, and equity lines. The borrowing capacity at June 30, 2014, based upon lendable collateral value, was $33,148,065. There were no FHLB advances outstanding at June 30, 2014 and December 31, 2013.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

There were no overnight federal funds purchased at June 30, 2014 and December 31, 2013. The Corporation has $14,500,000 in overnight federal funds lines with its correspondents.

The Corporation has an internal Corporate Cash Management account for customers to sweep their excess demand deposit accounts on an overnight basis in order to earn interest. This account is not FDIC insured but the Corporation is required to pledge agency funds at 100% towards these balances. There were no Corporate Cash Management sweep accounts at June 30, 2014 and December 31, 2013, respectively.

Note 6 – Repurchase Agreements

The Corporation entered into a repurchase agreement with Barclays Capital on January 2, 2008 in the amount of $6,000,000. The repurchase date was January 2, 2013. The interest rate was fixed at 3.57% until maturity or until it was called. Beginning January 2, 2009 the repurchase agreement became callable and could have been called quarterly with two business days prior notice. Interest was payable quarterly. The repurchase agreement was collateralized by agency mortgage backed securities.

Note 7 – Net Income (Loss) Per Common Share

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

	Three Months Ended				Three Months Ended
	June 30, 2014				June 30, 2013
	Shares		Per Share Amount		Shares		Per Share Amount
Earnings (loss) per common share, basic		1,713,375	$	.20		1,713,375	$	(.20	)
Effect of dilutive securities:
Stock options and warrants		—				—
Earnings (loss) per common share, diluted		1,713,375	$	.20		1,713,375	$	(.20	)

Options and warrants not included in the calculation of diluted earnings per share because they were anti-dilutive were 67,023 and 128,272 for the quarter-to-date periods ending June 30, 2014 and 2013, respectively.

	Six Months Ended				Six Months Ended
	June 30, 2014				June 30, 2013
	Shares		Per Share Amount		Shares		Per Share Amount
Earnings (loss) per common share, basic		1,713,375	$	.35		1,713,375	$	(.06	)
Effect of dilutive securities:
Stock options and warrants		—				—
Earnings (loss) per common share, diluted		1,713,375	$	.35		1,713,375	$	(.06	)

Options and warrants not included in the calculation of diluted earnings per share because they were anti-dilutive were 67,023 and 144,772 for the year-to-date periods ending June 30, 2014 and 2013, respectively.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Note 8 – Stock Options and Warrants

The shareholders of MainStreet approved the 2004 Key Employee Stock Option Plan, (the “Plan”), at its Annual Meeting on April 15, 2004. The Plan permitted the grant of Non-Qualified Stock Options and Incentive Stock Options to persons designated as “Key Employees” of BankShares or its subsidiaries. The Plan was approved by the Board of Directors as of January 21, 2004 and terminated on January 21, 2009, except with respect to awards made prior to and outstanding on that date which remain valid in accordance with their terms. Option awards were granted with an exercise price equal to the market value of MainStreet’s stock at the date of grant. The options issued in 2007 and 2006 had a vesting period of three years and have a ten year contractual term. The options issued in 2005 vested immediately upon grant and have a ten year contractual term. All share awards provided for accelerated vesting if there was a change in control (as defined in the Plan). The maximum number of shares that could have been issued under the Plan could not exceed 150,700. As of June 30, 2014, there were 136,527 stock options granted under this Plan of which 822 have been exercised, 61,249 options have expired, and 7,433 were forfeited. Options in the amount of 33,000 not under the plan expired in June 2013.

As of June 30, 2014 the Corporation has reserved 67,023 shares of authorized but unissued shares of common stock related to the stock option agreements.

Following is a status and summary of changes in stock options during the six months ended June 30, 2014:

					Weighted
			Weighted		Average
	Six Month		Average		Remaining		Aggregate
	Period Ended		Exercise		Contractual		Intrinsic
	June 30, 2014		Price		Term		Value
Outstanding at Beginning of year		67,023	$	12.87
Granted		—		—
Exercised		—		—
Forfeited		—		—
Expired		—		—
Outstanding at June 30, 2014		67,023	$	12.87		1.75	$	—
Exercisable at June 30, 2014		67,023	$	12.87		1.75	$	—

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2014. This amount changes based on changes in the market value of the Corporation’s stock.

As of June 30, 2014, there was no unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan.

As of June 30, 2014, stock options and warrants outstanding and exercisable are summarized as follows:

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

		Stock Options
Range of		and Warrants		Remaining
Exercise		Outstanding		Contractual
Prices		And Exercisable		Life
$	12.09		43,977		1.40
	12.09		9,066		1.50
	15.00		7,464		3.45
	16.75		6,516		2.50
	$12.09 - $16.75		67,023

Note 9 – Financial Instruments With Off-Balance-Sheet Risk

In the normal course of business to meet the financing needs of its customers, BankShares is a party to financial instruments with off-balance-sheet risk. These financial instruments involve commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making commitments as is used for on-balance-sheet risk. At June 30, 2014, and December 31, 2013 outstanding commitments to extend credit including letters of credit were as follows:

	June 30, 2014		December 31, 2013
Commercial	$	4,184,605	$	4,258,081
Real Estate:
Construction and land development		4,595,059		1,691,512
Residential 1-4 families
First liens		383,629		918,377
Junior liens		867,188		359,672
Home Equity lines		7,672,203		7,790,927
Commercial real estate		2,781,201		2,271,121
Consumer		381,895		391,967
Total Outstanding Commitments	$	20,865,780	$	17,681,657

There are no commitments to extend credit on impaired loans except for letters of credit that are outstanding and cannot be withdrawn. Commitments to extend credit are agreements to lend to a customer as long as there is no breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments may expire without ever being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash outlays for the Corporation.

Note 10 – Fair Value Measurements

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

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

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

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

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

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

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). We only utilize third party vendors to provide fair value data for the purposes of recording amounts related to our fair value measurements of our securities available for sale portfolio. We obtain SSAE16 reports from our third party vendor on an annual basis. Our third party vendor also utilizes a reputable pricing company for security market data that utilizes a matrix pricing model. For government sponsored agencies the model gathers information from market sources and integrates relative credit information, observed market movements and sector news. For agency mortgage backed securities the model incorporates the current weighted average maturity and takes into account additional pool level information supplied directly by the agency or government sponsored enterprise. The third party vendor system has controls and edits in place for month-to-month market checks and zero pricing. We make no adjustments to the pricing service data received for our securities available for sale.

The following table presents the balances of financial assets measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013:

			Fair Value Measurements at June 30, 2014 Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Balance as of		Assets		Inputs		Inputs
Description	June 30, 2014		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
U. S. government sponsored agencies	$	1,469,210	$	—	$	1,469,210	$	—
Mortgage backed securities		12,141,855		—		12,141,855		—
Corporates		500,715		—		500,715		—
Total available-for-sale securities	$	14,111,780	$	—	$	14,111,780	$	—

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

			Fair Value Measurements at December 31, 2013 Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Balance as of		Assets		Inputs		Inputs
Description	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
U. S. government sponsored agencies	$	2,623,000	$	—	$	2,623,000	$	—
Mortgage backed securities		13,155,155		—		13,155,155		—
States and political Subdivisions		5,557,377		—		5,557,377		—
Corporates		496,900		—		496,900		—
Total available-for-sale securities	$	21,832,432	$	—	$	21,832,432	$	—

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

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

Loans held for sale: Loans held for sale are recorded at fair value on a nonrecurring basis which is the carrying value. Loans held for sale, generally, are closed and sold within two weeks.

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing recent appraisals conducted by an independent, licensed appraiser outside of MainStreet using observable market data (Level 2). However, if the appraisal of the real estate property is not current, or has been discounted, then the fair value is considered Level 3. It is also considered Level 3 if an evaluation is conducted by Franklin Bank, rather than by a third party. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Operations.

Other Real Estate Owned (OREO): Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair market value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on a recent appraisal conducted by an independent licensed appraisal using observable market data, the Corporation records the OREO as nonrecurring Level 2. When the appraisal of the real estate property is not current, or has been discounted, the Corporation records the OREO as nonrecurring Level 3. It is also considered Level 3 if an evaluation is conducted by Franklin Bank, rather than by a third party. Any fair value adjustments are recorded as other real estate and repossessions expense on the Consolidated Statements of Operations.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

The following table summarizes MainStreet’s assets that were measured at fair value on a nonrecurring basis as of June 30, 2014 and December 31, 2013.

Carrying value at June 30, 2014

Quoted Prices in

Significant

Active Markets

Other

Significant

for Identical

Observable

Unobservable

Balance as of

Assets

Inputs

Description

June 30, 2014

(Level 1)

(Level 2)

(Level 3)

Impaired loans

2,457,728

—

362,829

2,094,899

Other real estate owned

218,340

—

218,340

			Carrying value at December 31, 2013
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Balance as of		Assets		Inputs		Inputs
Description	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
Loans held for sale	$	306,250	$	—	$	306,250	$	—
Impaired loans		3,055,465		—		369,592		2,685,873
Other real estate owned		728,163		—		65,800		662,363

The following table displays quantitative information about Level 3 Fair Value Measurements for June 30, 2014:

	Fair Value		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$	444,926	Internal evaluations	Internal evaluations		13% - 17% (15%)
		1,649,973	Appraisal	Market discount/Timing discount		10% - 16% (16%)
Other real estate owned	$	35,980	Internal evaluations	Internal evaluations and market discount		8% (8%)
	$	182,360	Appraisal	Market discount		24% (24%)

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

(a)

Short-Term Financial Instruments

The carrying value of short-term financial instruments including cash and cash equivalents, federal funds sold and interest-bearing deposits in domestic banks approximate the fair value of these instruments. These financial instruments generally expose the Corporation to limited credit risk and have no stated maturity or have an average maturity of 30-45 days and carry interest rates which approximate market value.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

(b)

Securities Available for Sale

The fair value of investments is estimated based on quoted market prices or dealer quotes.

(c)

Securities Held to Maturity

The fair value of investments is estimated based on quoted market prices or dealer quotes.

(d)

Restricted Equity Securities

The carrying value of restricted equity securities approximates fair value based on the redemption provisions of the applicable entities.

(e)

Loans Held for Sale

The carrying value of these loans approximates the fair value. With applications taken prior to mid-May of this year, we would close some mortgage loans in our name and then sell them to our partners within a short period of days. Beginning in mid-May, Franklin Bank no longer closes mortgage loans in our name for resale.

(f)

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate – commercial, real estate – construction, real estate – mortgage and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan as well as estimates for operating expenses and prepayments. The estimate of maturity is based on management’s assumptions with repayment for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

(g)

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

(h)

Bank Owned Life Insurance

The carrying amount is a reasonable estimate of fair value.

(i)

Deposits

The fair value of demand, interest checking, savings and money market deposits is the amount payable on demand. The fair value of fixed maturity time deposits and certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities and repayment characteristics.

(j)

Commitments to Extend Credit and Standby Letters of Credit

The only amounts recorded for commitments to extend credit and standby letters of credit are the fees arising from these unrecognized financial instruments. The fair value of these commitments has been determined to be immaterial.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

The carrying values and estimated fair values of financial instruments at June 30, 2014 and December 31, 2013 are as follows:

	Fair Value Measurements at June 30, 2014 using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Value		Level 1		Level 2		Level 3		Fair Value
FINANCIAL ASSETS:
Cash and due from banks	$	3,804,713	$	3,804,713	$	—	$	—	$	3,804,713
Interest-bearing deposits in banks		6,499,067		6,499,067		—		—		6,499,067
Federal funds sold		5,329,941		5,329,941		—		—		5,329,941
Securities available-for-sale		14,111,780		—		14,111,780		—		14,111,780
Securities held to maturity		5,641,208		—		5,621,934		—		5,621,934
Restricted equity securities		587,200		—		587,200		—		587,200
Loans, net		124,375,805		—		362,829		124,265,582		124,628,411
Accrued interest receivable		440,754		—		440,754		—		440,754
Bank owned life insurance		1,926,688		—		1,926,688		—		1,926,688

FINANCIAL LIABILITIES:
Deposits:
Non-interest bearing demand deposits	$	26,543,867	$	—	$	26,543,867	$	—	$	26,543,867
Interest bearing deposits		112,931,286		—		113,218,547		—		113,218,547
Accrued interest payable		63,677		—		63,677		—		63,677

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

	Fair Value measurements at December 31, 2013 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Carrying Value		Level 1		Level 2		Level 3		Fair Value

FINANCIAL ASSETS:
Cash and due from banks	$	2,929,591	$	2,929,591	$	—	$	—	$	2,929,591
Interest-bearing deposits in other banks		10,343,469		10,343,469		—		—		10,343,469
Federal funds sold		4,691,091		4,691,091		—		—		4,691,091
Securities available-for-sale		21,832,432		—		21,832,432		—		21,832,432
Restricted equity securities		654,600		—		654,600		—		654,600
Loans held for sale		306,250		—		306,250		—		306,250
Loans, net		121,344,841		—		369,592		120,980,345		121,349,937
Accrued interest receivable		462,081		—		462,081		—		462,081
Bank owned life insurance		1,898,736		—		1,898,736		—		1,898,736

FINANCIAL LIABILITIES:
Deposits:
Non-interest bearing demand deposits	$	26,856,990	$	—	$	26,856,990	$	—	$	26,856,990
Interest bearing deposits		115,964,448		—		116,336,714		—		116,336,714
Accrued interest payable		86,575		—		86,575		—		86,575

Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on-and-off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.

The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Corporation’s overall interest rate risk.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

Note 11 – Contingencies and Other Matters

In the normal course of business, the Corporation may be involved in various legal proceedings. Based on the information presently available, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business or the financial condition or results of operations of the Corporation.

Note 12 – Subsequent Events

In preparing these financial statements, the Corporation has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were filed.

Note 13 – Regulatory

On April 16, 2009, Franklin Bank entered into a formal agreement (“Agreement”) with The Comptroller of the Currency (“OCC”). The Agreement required Franklin Bank to perform certain actions within designated time frames. The Agreement was intended to demonstrate the Bank’s commitment to review/enhance certain aspects of various policies and practices related to credit administration and liquidity. Franklin Bank achieved full compliance with the Agreement. The Agreement was terminated in August 2013.

On June 17, 2009, MainStreet BankShares, Inc. entered into a Memorandum of Understanding (“MOU”) with the Federal Reserve Bank of Richmond (“Federal Reserve”). The MOU required the bank holding company to utilize its financial and managerial resources to assist Franklin Bank in functioning in a safe and sound manner and restricted MainStreet from conducting various activities. On January 26, 2011, we entered into a new MOU with the Federal Reserve which contained the same terms of the previous MOU (which was terminated) but added provisions regarding compliance with certain laws and regulations. This MOU was terminated in September 2013. There are no longer any restrictions or stipulations attributable to the MOU.

Note 14 – Changes in Accumulated Other Comprehensive Income (Loss)

	For the Three Months Ended June 30, 2014
	Net Unrealized Gains		Adjustments			Net Securities Transferred			Accumulated Other
	on Securities		Related to Post			to Held to Maturity from			Comprehensive
	available for sale (1)		Retirement Benefits (2)			Available for Sale			Income

Balance at March 31, 2014	$	63,955	$	(7,596	)	$	—		$	56,359

Other comprehensive income		123,604		—			(6,388	)		117,216

Balance at June 30, 2014	$	187,559	$	(7,596	)	$	(6,388	)	$	173,575

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

June 30, 2014

	For the Three Months Ended June 30, 2013
	Net Unrealized Gains
	(Losses) on Securities			Adjustments Related to		Accumulated Other
	available for sale (1)			Post Retirement Benefits (2)		Comprehensive Income

Balance at March 31, 2013	$	331,330		$	56,617	$	387,947

Other comprehensive loss		(351,155	)		—		(351,155	)

Balance at June 30, 2013	$	(19,825	)	$	56,617	$	36,792

	For the Six Months Ended June 30, 2014
	Net Unrealized Gains			Adjustments			Net Securities Transferred			Accumulated Other
	(Losses) on Securities			Related to Post			to Held to Maturity from			Comprehensive
	available for sale (1)			Retirement Benefits (2)			Available for Sale			Income (Loss)

Balance at December 31, 2013	$	(33,713	)	$	(7,596	)	$	—		$	(41,309	)

Other comprehensive income		221,272			—			(6,388	)		214,884

Balance at June 30, 2014	$	187,559		$	(7,596	)	$	(6,388	)	$	173,575

	For the Six Months Ended June 30, 2013
	Net Unrealized Gains
	(Losses) on Securities			Adjustments Related to		Accumulated Other
	available for sale (1)			Post Retirement Benefits (2)		Comprehensive Income

Balance at December 31, 2012	$	369,940		$	56,617	$	426,557

Other comprehensive loss		(389,765	)		—		(389,765	)

Balance at June 30, 2013	$	(19,825	)	$	56,617	$	36,792

(1) Represents the difference between the fair value and amortized cost of securities available for sale.

(2) Represents changes in the SERP liability due to prior service costs, gains and losses, and amortizations.

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

Forward-Looking Statements

This report contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements, which are representative only on the date hereof. Readers of this report should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed throughout this report. The Corporation takes no obligation to update any forward-looking statements contained herein. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce margins; (3) general economic conditions, either nationally or regionally, may be less favorable than expected that could result in a deterioration of credit quality or a reduced demand for credit; and (4) legislative or regulatory changes including changes in accounting standards, may adversely affect the business.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

General

We use the term “MainStreet” or “Corporation” to refer to MainStreet BankShares, Inc. We use the term “Bank” or “Franklin Bank” to refer to Franklin Community Bank, National Association. We use “we”, “us”, or “our” to refer to the consolidated businesses of the Corporation and its subsidiaries unless the content indicates otherwise. MainStreet was incorporated on January 14, 1999 in the Commonwealth of Virginia and is the bank holding company for Franklin Bank which serves the Franklin County area of Virginia. MainStreet provides a wide variety of banking services through Franklin Bank. Franklin Bank operates as a locally-owned and operated commercial bank emphasizing personal customer service and other advantages incident to banking with a locally owned community bank. It relies on local advertising and the personal contacts of its directors, employees, and shareholders to attract customers and business to the Bank. Franklin Bank has three banking offices in Rocky Mount and Franklin County. MainStreet also has a wholly-owned real estate company, MainStreet RealEstate, Inc. which owns the real estate of the Corporation. MainStreet RealEstate, Inc. owns the Union Hall (Southlake) office of Franklin Bank.

with the Agreement. The Agreement was terminated in August 2013.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability.

Allowance for Loan Losses

We use historical loss factors, peer comparisons, regulatory factors, concentrations of credit, past dues, and the trend in the economy as factors in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in estimating risk. The allowance for loan losses reflects our best estimate of the losses inherent in our loan portfolio. The allowance is based on two basic principles of accounting: (i) losses are accrued when they are probable of occurring and are capable of estimation and (ii) losses are accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses is maintained at a level, which reflects management’s best estimate of probable credit losses inherent in the loan portfolio and is, therefore, believed to be appropriate.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions and other risks inherent in the portfolio. Management reviews the past due reports and risk-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a quarterly analysis of the allowance based on our historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions, and the economic trend. These are generally grouped by homogeneous loan pools. Impaired loans are reviewed individually to determine possible impairment based on one of the three recognized methods which are fair value of collateral, present value of expected cash flows, or observable market price. A specific reserve is allocated for the amount of the impairment. Although management uses available information to recognize losses on loans, the substantial uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, make it possible that a material change in the allowance for loan losses in the near term may be appropriate. However, the amount of the change cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms.

Deferred Tax Assets

The Corporation uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established.

Management considers the determination of this valuation allowance to be a critical accounting policy due to the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income.

These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. A valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, or if we project lower levels of future taxable income. If such a valuation allowance is deemed necessary in the future, it would be established through a charge to income tax expense that would adversely affect our operating results.

Overview

We continue 2014 with a low interest rate environment and sluggish loan demand in our market, which has negatively impacted our net interest margin. Despite these continued challenges, we are pleased to report a decrease in our nonperforming assets and a moderate increase in our loan portfolio as compared to year end 2013. We continue to maintain an aggressive posture in resolving our problem assets. We believe this strategy will strengthen the Corporation’s position and prepare us for future growth.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Total assets at June 30, 2014 were $166.3 million compared to $169.0 million at year-end December 31, 2013, a decline of $2.7 million. Our balance sheet has declined since year-end due to our continued strategy to lower our deposit costs. At June 30, 2014, loans, net of unearned deferred fees and costs, increased $2.9 million from year-end 2013. Our overall strategy for 2014 also includes loan growth in an effort to improve our net interest margin and increase our net income. Despite the continued effort to resolve our problem credits and sluggish loan demand, our loan portfolio experienced an overall increase. Securities available for sale decreased $7.7 million from December 31, 2013 primarily due to calls of securities, pay downs on mortgage backed securities, and the transfer of $5.6 million of municipal bonds into the held to maturity category. Due to the maturity and repayment of all repurchase agreements, we now have additional securities that can be utilized and pledged for other purposes as needed. Deposits decreased $3.3 million since year end 2013. Our higher cost time deposits have declined since year end 2013. Other real estate owned has declined by $.5 million since December 31, 2013. Our continued aggressive approach to rid our balance sheet of nonperforming assets has worked as our balance in other real estate owned has declined to a balance of $218,340. The intentional shrinkage in our balance sheet has had a positive impact on our capital ratios. Total cash and cash equivalents decreased from year-end 2013 by $2.3 million. Liquidity continues to be an important focus for our Corporation during these tumultuous times and our liquid assets were 24.29% of total liabilities at June 30, 2014 which remains strong. We monitor our liquidity daily to ensure we have prudent levels of liquidity while we strive to lower our deposit costs. This strategy also resulted in a lowering of our overall interest bearing deposits. We maintained our core relationships as can be evidenced by the stability in demand deposits, which are our free funds.

We continue to focus on our asset quality due to the elevated level of nonperforming loans, criticized and classified assets, economic uncertainty and unemployment levels. Nonperforming loans decreased $2.3 million from year end 2013 to June 30, 2014. Nonaccrual loans decreased by $1.0 million during the first six months of 2014. Troubled debt restructurings (not on nonaccrual) decreased by $1.2 million during the first six months of 2014. Other impaired loans decreased by $60,000 in the first half of 2014. Our loans rated special mention or worse (excluding troubled debt restructurings and those in nonaccrual status) increased at June 30, 2014 as compared to year end 2013 in the amount of $2.2 million. We transferred $249,016 of loans into other real estate and other repossessed assets during the first six months of 2014. Our other real estate properties have declined to $218,340 at June 30, 2014 compared to $728,163 at December 31, 2013. A substantial amount of our foreclosed properties have been sold as of June 30, 2014. We continue to take an aggressive approach to our other real estate properties to rid our balance sheet of nonperforming assets.

Total shareholders’ equity was $24.8 million at June 30, 2014. MainStreet and Franklin Bank were well capitalized at June 30, 2014 under bank regulatory capital classifications. The book value of shareholders’ equity at June 30, 2014 was $14.47 per share.

Our year-to-date net income at June 30, 2014 was $597,736, or $.35 per common basic share. This net income equated to an annualized return on average assets of 0.73% and an annualized return on average shareholders’ equity of 4.93%. The net loss for the same period in 2013 was $(99,683), or $(.06) per common basic share. This net income equated to an annualized return on average assets and annualized return on average shareholders’ equity of (.11%) and (.82%), respectively. Credit related expenses such as the provision for loan losses, realized losses on sales of other real estate properties, impairment losses on other real estate properties, and loss of interest on nonaccrual loans continue to negatively impact our operating results, although to a lesser extent than the prior year. In addition, the lack of loan volume has negatively impacted loan fee income and interest income. Provision expense, other real estate and repossession expenses, write downs and losses on sales together accounted for $85,850 and $1,357,501 in expense for the six month periods ending June 30, 2014 and June 30, 2013, respectively.

Net income for the second quarter of 2014 was $349,510, or $.20 per common basic share as compared to a net loss in the amount of $(335,540), or $(.20) per common basic share for the second quarter of 2013. Provision expense, other real estate and repossession expenses, write downs and losses on sales together accounted for $8,605 and $1,107,658 for the quarters ended June 30, 2014 and 2013, respectively. Credit related issues continue to have a negative impact on our Corporation’s net income.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Results of Operations

Net interest income is the difference between total interest income and total interest expense. The amount of net interest income is determined by the volume of interest-earning assets, the level of interest rates earned on those assets, and the cost of supporting funds. The difference between rates earned on interest-earning assets and the cost of supporting funds is measured by the net interest margin.

Net interest income for the six month periods ending June 30, 2014 and 2013 was $3,045,725 and $3,139,778, respectively, a modest decrease of $94,053, or 3.00%. Both interest income and interest expense dollars dropped in comparison to last year, primarily due to volume and the lowering of deposit costs. The decline in interest income was also due to lost interest income on continued elevated levels of nonaccrual loans. For the six months ending June 30, 2014 and 2013, the net interest margin was 3.89% and 3.72%, respectively, a 17 basis point increase. The yield on interest earning assets for the year-to-date period ending June 30, 2014 was 4.37% compared to 4.38% for the year-to-date period ending June 30, 2013, a decrease of 1 basis point. However, the funding side of the interest margin also dropped during this time period by a favorable 18 basis points in the year-to-year comparison. The maturity and repayment of our repurchase agreements has had a positive impact on our net interest margin. We engaged a consultant to assist us in the lowering of our deposit costs. We have realized the positive impact of our strategic effort.

The yield on interest earning assets has declined due to the interest rate environment, sluggish loan demand reducing loan fee income, and continued lost interest on nonaccrual loans. Lost interest for the six month periods ending June 30, 2014 and 2013 was $96,422 and $86,942, respectively. Lost interest for the three month periods ending June 30, 2014 and 2013 was $43,247 and $54,118, respectively. Franklin Bank’s growth is also quite dependent on the recovery in consumer and real estate based lending and there is concern over the timing of recoveries in these markets given the current economic environment. Franklin Bank’s future growth and earnings may be negatively affected if real estate and consumer based markets remain depressed or deteriorate further.

The low interest rate environment continues with the Federal Reserve leaving short-term interest rates within a range of 0% - .25%. This low rate environment has been in effect since 2008. In determining how long to maintain the current target range, the Federal Reserve will assess progress towards its objectives of maximum employment and 2% inflation. It is anticipated that it will likely be appropriate to maintain the current target rate for a considerable time after the asset purchase program ends, especially if projected inflation runs below the 2% longer-run goal. It is also anticipated that economic conditions may for some time warrant keeping the target rate below levels the Federal Reserve views as normal in the longer run. Franklin Bank has a portfolio of variable rate loans. A rising interest rate environment generally has a positive impact on the net interest margin because deposits rates are slower to increase. Although low interest rates have been beneficial for our cost of funds, with prime presently at 3.25% which is the interest rate basis for many of our loans, MainStreet’s net interest margin has been adversely affected by the prolonged, recessionary low interest rate environment.

The net interest margin and net interest income have shown improvement with the maturity of our repurchase agreements. The rates on these repurchase agreements were above current market rates. Of these repurchase agreements, $7.5 million matured in September 2012 and $6.0 million matured in early January 2013.

Net interest income for the three month periods ending June 30, 2014 and 2013 was $1,551,797 and $1,546,133, respectively, a modest increase of $5,664, or .37%. This equated to a net interest margin of 3.96% and 3.60% at June 30, 2014 and 2013, respectively.

Provision for Loan Losses

A provision for loan losses is charged to earnings for the purpose of establishing an allowance for loan losses that is maintained at a level which reflects management’s best estimate of probable credit losses inherent in the loan portfolio and is, therefore, believed to be appropriate. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk ratings and discusses individually the loans on these reports with the responsible loan officers. Management provides a detailed quarterly analysis of the allowance based on homogenous loan pools, identifying impairment, historical losses, credit concentrations, economic conditions, and other risks. As the allowance is maintained losses are, in turn, charged to this allowance rather than being reported as a direct expense.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Our methodology for determining the allowance is based on two basic principles of accounting as follows: i) losses are accrued when they are probable of occurring and are capable of estimation and (ii) losses are accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our analysis is based on an individual review of all credits rated Pass/Watch and lower in our risk rating system by account officers in addition to a review of management information system reports on numerous portfolio segments. The analysis of the allowance is solely based on historical and qualitative factors with historical losses adjusted to higher factors for our criticized and classified loans compared to similar banks with comparable real estate concentrations nationally. Our process allows loan groups to be identified and properly categorized. Our impaired loans are individually reviewed to determine possible impairment based on one of three recognized methods which are fair value of collateral, present value of expected cash flows, or observable market price. A specific reserve is then allocated for the amount of the impairment. Impairment is defined as a loan in which we feel it is probable (meaning likely, not virtually certain) that we will be unable to collect all amounts due under the contractual terms of the loan agreement. Possible loss for loans risk rated special mention or lower are then allocated based on a historical loss migration and adjusted for qualitative factors. Remaining loans are pooled based on homogenous loan groups and allocated based on Franklin Bank’s historical net loss experience. These pools are as follows: 1) commercial loans; 2) construction and land development; 3) residential 1-4 family first liens; 4) residential 1-4 family junior liens; 5) home equity lines; 6) commercial real estate; and 7) consumer loans. Historical loss is calculated based on a twelve-quarter average history. Historical net loss data is adjusted and applied to pooled loans based on qualitative factors. We utilize the following qualitative factors: 1) changes in the value of underlying collateral such as loans not conforming to supervisory loan to value limits; 2) national and local economic conditions; 3) changes in portfolio volume and nature such as borrower’s living outside our primary trade area; 4) changes in past dues, nonaccruals; and 5) quality and impact and effects of defined credit concentrations. The methodology has continued to evolve as our company has grown and our loan portfolio has grown and become more diverse.

Provision expense for the first six months of 2014 was $86,872 as compared to $1,252,502 for the first six months of 2013. Our loan portfolio, net of unearned deferred fees and costs, increased $2.9 million or 2.34% from year-end 2013. Gross charge-offs year-to-date 2014 were $313,583 compared to $972,785 year-to-date 2013. We transferred $249,016 from loans to other real estate and other repossessed assets during the year-to-date period ending June 30, 2014. The allowance for loan losses was $2.2 million at June 30, 2014 and $2.4 million at December 31, 2013, a minimal decrease of $.2 million, which is discussed below. The allowance for loan losses was 1.77% and 1.92% of loans net of unearned deferred fees and costs at June 30, 2014 and December 31, 2013, respectively. Our criticized and classified loans that are evaluated by historical loss migration increased $2,178,197 at June 30, 2014 compared to year-end 2013. The loans evaluated collectively by pools increased $2.9 million at June 30, 2014 versus December 31, 2013. Impaired loans evaluated individually were $3.7 million and $6.0 million at June 30, 2014 and December 31, 2013, respectively, with specific reserves of $331,195 and $575,926, respectively. The relatively unchanged balance in the allowance for loan losses from year end 2013 was primarily due to decreased specific reserves on nonaccrual loans and minimal reduced allocations on loan volumes evaluated collectively by pools in the amount of $38,729, all offset by an increase in adversely rated loans. The primary factors contributing to the minimal reduction in loans evaluated collectively by pools are percentages due to historical charge offs and the level of past dues and nonaccruals present in the loan portfolio. There were no changes in the economy or second trade area factors. Despite a decrease in our past dues and nonaccrual loans, the level of adversely rated credits increased primarily due to one credit in the amount of $1.2 million which was reported as a troubled debt restructuring (not on nonaccrual) at year end, but is considered a special mention credit at June 30, 2014. The ratio of the allowance for loan losses to loans, net of unearned fees and costs actually declined due to the increase in the loan portfolio since year end 2013. The allowance for loan losses was not replenished by the full $313,583 of gross charge offs because approximately $90,000 of that total gross charge off amount was provided for in our allowance for loan losses at year-end 2013 as a specific reserve. An unallocated amount of $30,000 was included in the reserve at June 30, 2014, but there was no unallocated amount at December 31, 2013. Net charge-offs of $220,931 and $937,606 for the first six months of 2014 and 2013 equated to .35% and 1.44%, respectively, of average loans outstanding net of unearned income and deferred fees. The amount of charge-offs can fluctuate substantially based on the financial condition of the borrowers, business conditions in the borrower’s market, collateral values and other factors which are not capable of precise projection at any point in time.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Provision expense for the second quarter of 2014 and 2013 was $13,384 and $1,064,897, respectively. The allowance for loan losses was $2.2 million at June 30, 2014 and $2.4 million at March 31, 2014. The allowance for loan losses was 1.77% and 1.86% of loans net of unearned at June 30, 2014 and March 31, 2014, respectively. Our criticized and classified loans that are evaluated by historical loss migration increased $1.4 million at June 30, 2014 compared to prior quarter end. The loans evaluated collectively by pools decreased $.4 million at June 30, 2014 versus March 31, 2014. Impaired loans evaluated individually were $3.7 million and $4.3 million at June 30, 2014 and March 31, 2014, respectively, with specific reserves of $331,195 and $481,885, respectively. The relatively unchanged balance in the allowance for loan losses from the end of the first quarter of 2014 was primarily due to decreased specific reserves on nonaccrual loans and reduced allocations on loan volumes evaluated collectively by pools, all offset by an increase in adversely rated loans. Gross charges offs and recoveries for the second quarter of 2014 were $150,525 and $30,192, respectively. Net charge-offs of $120,333 for the second quarter of 2014 equated to .38%, of quarterly average loans outstanding net of unearned income and deferred fees.

Following is a breakdown of our nonperforming loans by balance sheet type which includes nonaccrual loans, loans past due 90 days and still accruing, troubled debt restructurings (not on nonaccrual), and other impaired loans.

	June 30, 2014		December 31, 2013
Commercial	$	614,669	$	725,863
Real Estate:
Construction and land development		422,715		576,552
Residential 1-4 families:
First liens		470,214		1,130,961
Junior liens		132,380		182,170
Home equity loans		69,950		71,338
Commercial real estate		2,033,393		3,308,733
Consumer		—		—
Total Nonperforming Loans	$	3,743,321	$	5,995,617

Total nonperforming loans decreased in the amount of $2,252,296 or 37.57% at June 30, 2014 as compared to December 31, 2013. Nonaccrual loans (included in the impaired loans above) were $2,972,011 and $4,005,618 at June 30, 2014 and December 31, 2013, respectively, which represented 2.35% and 3.24%, respectively, of loans, net of unearned deferred fees and costs. Management considers these loans impaired along with loans 90 days or more past due and still accruing, troubled debt restructurings (not on nonaccrual), and other impaired loans. Loans once considered impaired are included in the reserve, but if well collateralized, no specific reserve is allocated for them. Please refer to Note 4 to the financial statements for a breakdown of the allowance by category, specific reserves by category, and impaired loans by category. Note 4 also gives information related to which categories of loans and dollar amounts had specific reserves allocated. At June 30, 2014 loans secured by commercial real estate were the largest category of impaired loans at $2.0 million. At December 31, 2013 loans secured by commercial real estate were the largest category of impaired loans at $3.3 million. Commercial loans were the next largest of the impaired loan categories at June 30, 2014 at $.6 million. Residential 1-4 family first liens were the next largest of the impaired loan categories at December 31, 2013 at $1.1 million.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Many of the asset quality issues in our loan portfolio are the result of our borrowers having to sell various real estate properties to repay the loan. In order to sell the properties and repay the loan, there must be buyers in the marketplace to acquire the properties. Our market, mainly real estate, continues to produce few buyers. In addition, borrowers’ incomes have been reduced which increases their debt to income ratio. The overall economy in Franklin County has shown little improvement over the last year. We continue to struggle with high unemployment, a continued slowing of building activity, a slowing of transportation and warehousing, and excessive supply of real estate in the Smith Mountain Lake resort area as discussed below. There is continued economic pressure on consumers and business enterprises and unemployment is at 5.2% (March 2014 data), down from 5.4% at February 28, 2014. Absorption analysis in our market place shows increased turnover rates for various inventories over historical levels. Data obtained also revealed declines in real estate values based on listing prices to selling price. Locally and nationally there has been an overall loss of wealth in real estate and equities. Smith Mountain Lake is a core area for development in Franklin County. It is a resort area and largely follows the national trend rather than the local trend and has been particularly adversely affected as a result. Until unemployment declines and consumer confidence increases, these trends may continue. While we continue to address our asset quality issues and have shown great improvement, no assurance can be given that continuing adverse economic conditions or other circumstances will not result in increased provisions in the future.

Noninterest Income

Total noninterest income was $448,321 and $601,594 for the six months ending June 30, 2014 and 2013, respectively, a decrease of $153,273, or 25.48%. The following chart demonstrates the categories of change:

Noninterest Income	YTD 6/30/14		YTD 6/30/13		Dollar Change			Percentage Change

Service charges on deposit accounts	$	121,838	$	129,205	$	(7,367	)		(5.70	)%
Mortgage commissions		54,026		151,543		(97,517	)		(64.35	)
Electronic card fees		87,557		91,934		(4,377	)		(4.76	)
Investment fee income		107,987		89,998		17,989			19.99
Income on bank owned life insurance		27,952		18,972		8,980			47.33
Gain on securities sold/called		—		47,194		(47,194	)		(100.00	)
Other fee income & miscellaneous		48,961		72,748		(23,787	)		(32.70	)

As noted above, total noninterest income decreased $153,273 for the six months ending June 30, 2014 compared to the six months ending June 30, 2013. Service charges on deposit accounts decreased $7,367 in the year to year comparison. This decrease is primarily due to a decrease in NSF charges, returned deposit item fees, and miscellaneous service charges on accounts, all offset by increases in demand deposit service charges, business account charges, and a decline in demand deposit charge-offs. Mortgage commissions decreased in the year to year comparison by $97,517, or 64.35%. Mortgage volumes have decreased in part by the economic environment and additional regulatory enactments. Franklin Bank partners with several organizations in which we originate residential mortgage loans that are sold to other companies. Franklin Bank receives the mortgage commission. With applications taken prior to mid-May of this year, we would close some mortgage loans in our name and then sell them to our partners within a short period of days. Beginning in mid-May, Franklin Bank no longer closes mortgage loans in our name for resale. Our partners provide the underwriting of the loans.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Electronic card fees experienced a decrease of $4,377 or 4.76% for the six months ended June 30, 2014 as compared to June 30, 2013. Franklin Bank has an investment advisor which partners with Infinex Financial Group to advise and manage investment portfolios for our clients. Franklin Bank receives fee income from this partnership based upon volume. Fee income received on investment income during the first six months of 2014 and 2013 was $107,987 and $89,998, respectively, an increase of $17,989, or 19.99%. Franklin Bank has bank owned life insurance on the life of one of its current executive officers. Prior to the death of Larry Heaton in December 2012, Franklin Bank insured the lives of two executive officers. The balance at June 30, 2014 was $1.9 million. Income on this investment increased $8,980 or 47.33% compared to the prior year due to the purchase of an additional policy in late 2013. There were no gains on securities sold or called during the six months ending June 30, 2014. Other fee income and miscellaneous income experienced a decrease of $23,787, or 32.70%. This decrease is primarily due to a decrease in title fee income and miscellaneous income, all offset by small increases in wire fee charges and checkbook charges. Title fee income decreased by $10,301 in the year to year comparison. Title fee income is generated from a small interest purchased in a title insurance company by Franklin Bank. Franklin Bank elected to present assets and liabilities related to derivatives on its mortgage loans held for sale on a gross basis. Derivatives in a gain position were recorded as other assets and those in a loss position were recorded as other liabilities, with the offset being miscellaneous income and miscellaneous expense, respectively. This quarterly entry caused fluctuations in these accounts. Since Franklin Bank no longer closes its mortgage loans in its name to sell within a short period of days, there is no longer a mortgage loan derivative recorded as of June 30, 2014. A decrease to miscellaneous income was experienced in the amount of $16,358 in the year to year comparison as a result of changes in mortgage derivative assets.

Total noninterest income was $237,482 and $335,715 for the three months ending June 30, 2014 and 2013, respectively, a decrease of $98,233 or 29.26%. The following chart demonstrates the categories of change:

Noninterest Income	QTD 6/30/14		QTD 6/30/13		Dollar Change			Percentage Change
Service charges on deposit accounts	$	64,758	$	59,217	$	5,541			9.36	%
Mortgage commissions		30,559		77,557		(46,998	)		(60.60	)
Electronic card fees		47,651		48,168		(517	)		(1.07	)
Investment fee income		56,640		48,754		7,886			16.18
Income on bank owned life insurance		14,115		9,533		4,582			48.06
Gain on securities sold/called		—		47,194		(47,194	)		(100.00	)
Other fee income & miscellaneous		23,759		45,292		(21,533	)		(47.54	)

Service charges on deposit accounts increased primarily due to an increase in NSF fee income. There were no gains on securities sold/called during the quarter ended June 30, 2014. The same comments concerning noninterest income in the year to year comparison are applicable to the quarterly comparisons of noninterest income for all other categories. Overall noninterest income decreased in four of the categories and increased in three of the categories.

Noninterest Expense

Total noninterest expense was $2,535,175 and $2,669,683 for the six month period ending June 30, 2014 and 2013, respectively, a decrease of $134,508, or 5.04%. Excluding the nonrecurring expenses of other real estate and repossessions, noninterest expense decreased $28,487, or 1.11%. The following chart shows the categories of noninterest expenses for the six month periods ending June 30, 2014 and 2013, the dollar change, and the percentage change:

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Noninterest Expense	YTD 6/30/14			YTD 6/30/13		Dollar Change			Percentage Change
Salaries and employee benefits	$	1,416,856		$	1,341,604	$	75,252			5.61	%
Occupancy and equipment		380,475			379,430		1,045			0.28
Professional fees		115,544			119,514		(3,970	)		(3.32	)
Outside processing		161,434			208,848		(47,414	)		(22.70	)
FDIC Assessment		59,868			104,795		(44,927	)		(42.87	)
Franchise tax		118,250			108,000		10,250			9.49
Regulatory examination fees		33,823			52,607		(18,784	)		(35.71	)
Other real estate and repossessions		(1,022	)		104,999		(106,021	)		(100.97	)
Other expenses		249,947			249,886		61			0.02

MainStreet’s employees continue to be its most valuable resource and asset. Salaries and employee benefits expense comprise the largest category of noninterest expense at 55.89% and 50.25%, respectively, of total noninterest expense for the six month periods ending June 30, 2014 and 2013. Salaries and employee benefits increased $75,252 or 5.61% in the first six months of 2014 as compared to the first six months of 2013. Of this increase, total salaries increased $63,257 and employee benefits increased $11,995. Commissions were only paid to mortgage and investment personnel. Referral fees were also paid to employees for mortgage and investment referrals. The primary contributor to the increase in employee benefits was an increase in supplemental executive retirement plan expense. Occupancy and equipment costs include rent, utilities, janitorial service, repairs and maintenance, real estate taxes, equipment rent, service maintenance contracts and depreciation expense. This category increased a nominal amount of $1,045 or .28% in the year to year comparison. Professional fees include fees for audit, legal, and other professional fees and showed a $3,970 decrease in comparing the six months ended June 30, 2014 to the same period in 2013. Outside processing expenses decreased $47,414 or 22.70% in the year to year comparison primarily due to a decrease in data processing fees. FDIC assessment declined $44,927 or 42.87% due to changes in the factors used in the calculation of the assessment and an overall decline in our asset base. However, the overall premium is still burdensome. The turmoil in the financial services industry resulted in the need to increase prepaid FDIC insurance premiums 3 years ago to sustain the insurance fund. Depending on the length and depth of the recessionary environment, there could be additional increased prepaid assessments depending on the health of the financial services sector. Franchise tax increased by $10,250 in the year to year comparison primarily due to anticipated increases in capital and a reduction of other real estate owned. Regulatory examination fees decreased $18,784 in the first six months of 2014 as compared to the first six months of 2013. With the termination of the formal agreement with the OCC, the surcharge on our regulatory assessment fee is no longer applicable. Other real estate and repossessions are nonrecurring expenses in the category of noninterest expense. The losses, write-downs and expenses associated with our other real estate properties experienced a decrease of $106,021, or 100.97%, compared to the same period in 2013. The Company continues to take an aggressive approach to disposing of its other real estate properties to rid its balance sheet of nonperforming assets. As of June 30, 2014 our other real estate owned balance has declined to $218,340. Other expenses increased nominally in the amount of $61 in the year to year comparison.

Total noninterest expense was $1,263,368 and $1,340,313 for the three month periods ending June 30, 2014 and 2013, respectively, a decrease of $76,945 or 5.74%. Excluding the nonrecurring expenses of other real estate and repossessions, noninterest expense decreased $29,405 or 2.27%. The following chart shows the categories of noninterest expenses for the three month periods ending June 30, 2014 and 2013, the dollar change, and the percentage change:

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Noninterest Expense	QTD 6/30/14			QTD 6/30/13		Dollar Change			Percentage Change
Salaries and employee benefits	$	708,692		$	677,275	$	31,417			4.64	%
Occupancy and equipment		184,168			189,243		(5,075	)		(2.68	)
Professional fees		61,735			59,373		2,362			3.98
Outside processing		76,435			104,055		(27,620	)		(26.54	)
FDIC Assessment		32,321			50,866		(18,545	)		(36.46	)
Franchise tax		59,000			54,000		5,000			9.26
Regulatory examination fees		11,274			26,304		(15,030	)		(57.14	)
Other real estate and repossessions		(4,779	)		42,761		(47,540	)		(111.18	)
Other expenses		134,522			136,436		(1,914	)		(1.40	)

Overall, the same explanations for the year to date comparisons are applicable to the quarterly comparisons of noninterest expense. Noninterest expense increased in three of the categories and decreased in six of the categories.

Income Taxes

MainStreet is subject to both federal and state income taxes. Franklin Bank is not subject to state income taxes. A bank in Virginia is required to pay a franchise tax that is based on the capital of the entity. The liability (or balance sheet) approach is used in financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed quarterly for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. No valuation allowances were deemed necessary at June 30, 2014 and December 31, 2013. 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. MainStreet recorded income tax expense and an income tax benefit in the amounts of $274,263 and $(81,130) for the six month periods ending June 30, 2014 and June 30, 2013, respectively. MainStreet recorded income tax expense and an income tax benefit in the amounts of $163,017 and $(187,822) for the three month periods ending June 30, 2014 and June 30, 2013, respectively.

BALANCE SHEET

Investment Portfolio

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

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

To use securities to fulfill pledging collateral requirements.

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

To make a reasonable return on investments.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Funds not utilized for capital expenditures or lending are invested in securities of the U.S. Government and its agencies, mortgage-backed securities, municipal bonds, corporate debt securities and certain equity securities. Currently, we have invested in U.S. Agencies, mortgage-backed securities, municipal bonds, corporate debt securities, Federal Reserve Bank stock and Federal Home Loan Bank stock. The value of our investment portfolio is susceptible to the impact of monetary and fiscal policies of the United States, particularly whether and how the current debate over fiscal issues are resolved. Our mortgage backed securities are either guaranteed by U.S. government agencies or issued by U.S. government sponsored agencies. Our securities portfolio, with the exception of our municipal bonds, was categorized as available for sale at June 30, 2014 and is carried at estimated fair value. Our municipal securities are now categorized as held to maturity and are carried at amortized cost. The unrealized market valuation gains and losses on securities classified as available for sale and the held to maturity transfer adjustment on our municipal bonds are recorded as separate components of shareholders’ equity. Please refer to Note 2 of the Notes to Consolidated Financial Statements for the breakdown of the securities available for sale and securities held to maturity portfolios.

Loan Portfolio

We have established a credit policy detailing the credit process and collateral in loan originations. Loans to purchase real estate and personal property are generally collateralized by the related property with loan amounts established based on certain percentage limitations of the property’s total stated or appraised value. Credit approval is primarily a function of the credit worthiness of the individual borrower or project based on pertinent financial information, the amount to be financed, and collateral. The loan portfolio was as follows:

	June 30, 2014				December 31, 2013
Commercial	$	10,194,933	8.06	%	$	9,426,188	7.63	%
Real Estate:
Construction & land development		15,738,882	12.44			16,394,964	13.26
Residential 1-4 families:
First liens		34,287,121	27.10			33,787,645	27.33
Junior liens		7,079,779	5.59			6,331,233	5.12
Home equity lines		6,746,222	5.33			5,764,941	4.66
Commercial real estate		51,194,330	40.46			50,579,103	40.91
Consumer		1,287,639	1.02			1,353,312	1.09
Total Gross Loans	$	126,528,906	100.00	%	$	123,637,386	100.00	%

Unearned deferred fees & costs, net		91,985				86,600
Recorded Investment	$	126,620,891			$	123,723,986

Gross loans increased $2,891,520, or 2.34% at June 30, 2014 compared to December 31, 2013. As can be seen by the chart above, Franklin Bank has a high concentration in real estate loans. These loans represented 90.92% and 91.28% of gross loans at June 30, 2014 and December 31, 2013, respectively. Accordingly, the Bank took steps to reduce certain concentrations within the real estate loans, including participating loans in our loan portfolio. The loan committee of the board of directors reviews all new loans and renewals of loans within our target concentrations for approval. During this economic environment, the credit markets have tightened substantially and the real estate market continues to be soft. These and other factors indicate diminished economic activity, higher risk in these loans, and lower loan demand. Moreover, Franklin Bank’s current concentration in real estate related loans reduces the Bank’s ability to participate in these loan categories. Our loan to deposit ratio for June 30, 2014 was 90.78% compared to 86.63% at December 31, 2013, an increase of 4.15%. We lowered our policy loan to deposit ratio, thus increasing liquidity, and have maintained a lower percentage because of lower loan demand. However, the percentage has increased by 4.15% since year end and will be monitored on an ongoing basis. We will continue to serve our customers, but in doing so will be governed by the necessity of preserving the institution’s history of safety and soundness during these difficult economic times.

Our loan portfolio is our primary source of profitability; therefore, our underwriting approach is critical and is designed throughout our policies to have an acceptable level of risk. Cash flow adequacy has always been a necessary condition of creditworthiness. If the debt cannot be serviced by the borrower’s cash flow, there must be an additional secondary source of repayment. As we have discussed, many of our loans are real estate based so they are also secured by the underlying collateral, the value of which has been under stress due to economic conditions. We strive to build relationships with our borrowers, so it is very important to continually understand and assess our borrowers’ financial strength and condition.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Our credit policy requires that new loans originated must have a maximum loan-to-value of 80% while certain loans have lower limits as follows: raw land (65%); improved land (75%); non-obsolete inventory (60% of value); used automobiles (75% of purchase price); and stock (75%). We do not require mortgage insurance; however, loans exceeding supervisory loan to value limits are one of our qualitative factors in the allowance for loan loss methodology.

Our credit policy requires updated appraisals to be obtained on existing loans whereby collateral value is critical to the repayment of the loan and market value may have declined by 15% or more. In regard to development projects a new appraisal should be obtained when the project sale out rate is less than 25% of the original assumptions documented by the existing appraisal in the file. Development loans must be reviewed at least annually or sooner in a declining real estate cycle. Once an appraisal exceeds 18 months it must be updated and reviewed before additional funding may occur. An appraisal in file may not be used for additional funding under any circumstances after 36 months. Loan account officers prepare criticized loan workout sheets for the Problem Loan Committee on all loans risk rated special mention or lower and any loan delinquent 60 days or more. Account officers who indicate a loan is impaired are required to determine collateral value by one of three recognized methods which are 1) fair value of collateral; 2) present value of expected cash flows; or 3) observable market value. The difference in the collateral value minus estimated selling expenses, the present value of expected future cash flows, or the observable market value as compared to the recorded loan balance is allocated as a specific reserve in the loan loss analysis. Any collateral declines dropping loans below supervisory loan to value limits is included in the qualitative factors based on loan pools in the loan loss analysis.

We continue to review and enhance our credit policies based on economic and environmental changes. We have developed a list of critical exceptions that require additional monitoring of loans which contain them. Financials are required for business and retail loans less than $35,000 and annual financials are required on all business term loans exceeding $250,000. Our credit policy requires detailed rent rolls on all commercial income producing properties at origination and renewal. We also require real estate site visits by the originating officer on loans over $250,000. We believe there is great value in looking at the collateral upon which we are taking a lien. We have eliminated interest only periods for speculative lot loans and require amortization at origination. The bank introduced an interest only home equity line product in late 2013. These new lines require a loan to value of 80% or less with debt to income being calculated at 1.5% of the outstanding balance. Loans must be collateralized by a first or second deed of trust on the primary residence of the borrower. Other banks have similarly tightened credit availability, particularly for real estate related loans. Moreover higher standards for consumer real estate loans under the Dodd-Frank Act further restrict the ability to provide residential loans. Generally this has the effect of reducing qualified buyers for real estate and therefore the value of real estate. This in turn can lead to lower appraisals and additional charge offs within our loan portfolio and other real estate properties as well as increased provision which reduce income.

In addition, we hired an experienced in-house credit analyst and purchased software to assist lenders with cash flow and certain ratio analysis. We also purchased software to assist with the credit ratings of loans upon origination, renewal, and the receipt of new financials. Please refer to Notes #3 and #4 to the financial statements for further discussion of underwriting and risk ratings of loans.

Approximately 27% of our loan portfolio consists of variable rate loans. Variable rate commercial loans are stressed 2% above the current rate to communicate the impact of potential rate increases to account officers. Retail loans with variable rate features are underwritten 2% over the current rate. Home equity lines are underwritten at 1.5% of the full committed loan amount for debt to income purposes.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

We monitor our loan portfolio by the loan segments found in Note #3 of the financial statements. In addition, we look at the trends of significant industries within the loan segments. Loan segments are categorized primarily based upon regulatory guidelines, which follows the underlying collateral. For the most part, our business activity is with customers located in our primary market area. Accordingly, operating results are closely correlated with the economic trends within the region and influenced by the significant industries in the region including pre-built housing, real estate development, agriculture, and resort and leisure services. In addition, the ultimate collectability of the loan portfolio is susceptible to changes in the market condition of the region. The real estate market in our area, particularly Smith Mountain Lake, is also affected by the national economy because a substantial portion of our lending is real estate based and dependent on buyers who move into our region.

We continue to monitor portfolio concentrations and have established guide limits based on loss exposure and potential impact to capital. Our defined concentration limits arte within regulatory guidelines. There are two industry concentrations that are broken out in the tables below by our loan segments. MainStreet does not currently consider its loans for construction of heavy and civil engineering buildings to be a concentration of credit because their total does not exceed 25% of total capital as of June 30, 2014.

June 30, 2014
			Loans for
	Loans for		Real Estate
	Construction		Including
	of Buildings		Construction		Total
Commercial	$	272,156	$	182,366	$	454,522
Real Estate
Construction and land development		1,701,443		1,942,138		3,643,581
Residential, 1-4 families
First Liens		3,321,860		8,788,251		12,110,111
Junior Liens		635,355		452,915		1,088,270
Home Equity Lines		9,597		343,178		352,775
Commercial real estate		2,591,600		24,874,239		27,465,839
Consumer		863		10,763		11,626
Total	$	8,532,874	$	36,593,850	$	45,126,724

December 31, 2013
			Loans for
			Construction of		Loans for
	Loans for		Heavy & Civil		Real Estate
	Construction		Engineering		Including
	of Buildings		Buildings		Construction		Total
Commercial	$	296,178	$	687,341	$	221,608	$	1,205,127
Real Estate
Construction and land development		2,366,758		4,138,105		2,014,334		8,519,197
Residential, 1-4 families
First Liens		3,666,276		795,653		8,179,695		12,641,624
Junior Liens		529,732		—		472,819		1,002,551
Home Equity Lines		9,880		34,667		334,442		378,989
Commercial real estate		2,552,156		—		24,556,483		27,108,639
Consumer		2,735		—		13,209		15,944
Total	$	9,423,715	$	5,655,766	$	35,792,590	$	50,872,071

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Overall, our concentrations decreased nominally from year end to the end of the second quarter of 2014, excluding loans for construction of heavy and civil engineering buildings. We continue to monitor them on an ongoing basis in an effort to control their growth.

Disclosed below are concentrations in acquisition and development loans, speculative lot loans, and speculative single-family housing construction. Some of these amounts are also included in the above concentrations as shown below.

June 30, 2014

	Total Concentration		Concentrations Included Above		Net Addition to Concentrations
Acquisition & development	$	491,664	$	44,295	$	447,369
Speculative lot loans		3,295,859		433,372		2,862,487
Speculative single-family housing construction		3,144,681		569,371		2,575,310

December 31, 2013

	Total Concentration		Concentrations Included Above		Net Addition to Concentrations
Acquisition & development	$	455,405	$	—	$	455,405
Speculative lot loans		4,007,894		3,138,066		869,828
Speculative single-family housing construction		1,971,059		1,399,864		571,195

MainStreet also considers its home equity lines of credit and its 1-4 family residential first and junior liens to be a concentration of credit.

Following is a breakdown of our nonperforming loans and assets.

	For the Periods Ended
	June 30, 2014		December 31, 2013
Nonaccrual loans and leases	$	2,972,011	$	4,005,618
Loans past due 90 days or more and still accruing		—		—
Troubled debt restructurings (not on nonaccrual)		771,310		1,929,999
Other impaired loans		—		60,000
Total nonperforming loans		3,743,321		5,995,617
Foreclosed real estate		218,340		728,163
Other foreclosed property		—		—
Total foreclosed property		218,340		728,163
Total nonperforming assets	$	3,961,661	$	6,723,780

Impaired loans totaled $3,743,321 and $5,995,617 at June 30, 2014 and December 31, 2013, respectively. Nonaccrual loans decreased $1,033,607 at June 30, 2014 compared to year end 2013. Troubled debt restructurings (not on nonaccrual) decreased $1,158,689 from year end 2013. There were no loans past due more than 90 days, and still accruing, at June 30, 2014 or December 31, 2013. Other impaired loans decreased by $60,000 from December 31, 2013. We are continuing to work with our troubled borrowers. We move quickly to identify and resolve any problem loans. Please refer to Note #4 to the consolidated financial statements for detailed information of nonaccrual loans, impaired loans, and nonperforming assets. Also, please refer to Provision Expense in this Management’s Discussion and Analysis.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

To ensure timely identification of nonaccrual loans, loan account officers review monthly their individual portfolios along with past due reports to determine the proper accrual status. Account officers also prepare criticized loan workout sheets for all loans risk rated special mention or lower and all loans 60-days or more delinquent are reported to the Franklin Bank’s Problem Loan Committee made up of senior management. The accrual status of these loans is reviewed and approved by the Problem Loan Committee. Account officers must attest to the accrual status and risk rating of all loans in their portfolio on a monthly basis. Attestations are presented to and reviewed by the Problem Loan Committee. The criticized loan worksheets are presented to the Problem Loan Committee quarterly. The Committee meets monthly to review updates on these loans along with the attestation sheets completed by the account officers. The criticized loan worksheets were expanded to include a summary of the most recent financial analysis; most recent collateral valuation factoring possible liquidation and timing discount; and enhanced action plans with target dates. Primary and secondary repayment sources are detailed. A dedicated officer now manages our problem assets, although currently on a less than full-time basis due to decreased volumes. A credit analyst performs required financial analysis on all loans $100,000 and over at origination or renewal and at the receipt of new financial statements. In addition, software was purchased to assist with this process. Software assists the credit analyst and lender in the risk rating of each loan.

We have an internal loan review function that has an annual loan review plan approved by the loan committee and the President. Enhanced reporting includes the overall quality of the loan portfolio; the identification, type, rating, and amount of problem loans; the identification and amount of delinquent loans; credit and collateral documentation exceptions; the identification and status of credit-related violations of law; the loan officer who originated each loan reported; concentrations of credit; and loans to executive officers and directors.

Deposits

Total deposits at June 30, 2014 and December 31, 2013 were $139,475,153 and $142,821,438, respectively, a decrease of $3,346,285, or 2.34%. We continue in 2014 our strategy to lower overall deposit costs, which is discussed in more detail below. The deposit mix was as follows:

	June 30, 2014				December 31, 2013
Demand deposits	$	26,543,867	19.03	%	$	26,856,990	18.80	%
Interest checking deposits		9,290,501	6.66			9,248,249	6.48
Money market deposits		25,891,481	18.57			23,660,000	16.57
Savings deposits		15,947,967	11.43			16,240,448	11.37
Time deposits $100,000 and over		30,285,261	21.71			29,977,151	20.99
Other time deposits		31,516,076	22.60			36,838,600	25.79

Total	$	139,475,153	100.00	%	$	142,821,438	100.00	%

The largest component of deposits continues to be time deposits including those $100,000 and over representing 44.31% of total deposits at June 30, 2014 compared to 46.78% at December 31, 2013. As a percentage of total deposits, the mix continues to change somewhat. The levels and mix of deposits are influenced by such factors as customer service, interest rates paid, service charges, and the convenience of banking locations. Our core deposit relationships remained as can be seen in the table above. Demand deposits, which do not pay interest, are now 19.03% of total deposits as compared to 18.80% at December 31, 2013. However, the dollar amount of our demand deposits has decreased by a nominal amount since year end 2013. An increase in demand deposits would improve the net interest margin and the total yield on interest bearing deposits. Money market deposits and interest checking accounts each increased as a percentage of total deposits along with the dollar amount. Savings deposits increased nominally as a percentage of total deposits, but have decreased in dollar amount since year end 2013. Money market deposits have increased $2,231,481 since year end 2013 and as a percentage of total deposits. Our total deposits have decreased $3.3 million since year end 2013 primarily due to a $5.0 million decline in our time deposits, offset by a total increase in our lower deposit cost accounts in the amount of $1.7 million. This is all part of our strategic efforts to lower our deposit costs while maintaining ample liquidity to fill our needs and for contingency planning. As we lowered interest rates, our time deposits especially declined, although at a slower rate than last year, as they experienced a $5.0 million decrease since year end.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Competition remains strong in our market from other depository institutions. Management attempts to identify and implement the pricing and marketing strategies that will help control the overall cost of deposits and to maintain a stable deposit mix. Our goal has been to strive to gather the whole customer relationship, including deposits and loans, and not just certificates of deposit. We have been successful in lowering our deposit costs and maintaining liquidity. Loan demand has been soft overall, despite our increase in loans since year end, and parallels our deposit strategy. Our strategic plan in 2014 includes continued lowering of our deposit costs to benefit net income, which includes increasing our demand deposits.

The overall cost of interest bearing deposits was .68% and .90%, respectively, for the six months ended June 30, 2014 and June 30, 2013. This decline of 22 basis points is due to the continued monitoring of deposit rates and the rollover of many deposits into lower current market interest rates. We monitor this closely to keep deposit costs low, but to maintain ample liquidity. We are a member of the CDARS programs and of QwickRate.

Borrowings

We have several sources for borrowings generally to assist with liquidity. At June 30, 2014 and December 31, 2013, we had no balances outstanding with the Federal Home Loan Bank of Atlanta (“FHLB”), overnight federal funds purchased, or corporate cash management accounts. The FHLB holds a blanket lien on loans secured by commercial real estate and loans secured by 1-4 family first liens, second liens, and equity lines, which provide a source of liquidity to the Corporation. Loans included in these portfolios at June 30, 2014 and December 31, 2013 were $99,012,164 and $96,223,160, respectively.

The Bank has an internal Corporate Cash Management account for customers into which excess demand deposit accounts are swept on an overnight basis in order to earn interest. This account is not FDIC insured but the Bank is required to pledge agency funds at 100% towards these balances. The Corporate Cash Management sweep accounts totaled $0 at June 30, 2014 and December 31, 2013.

Repurchase Agreements

The Bank entered into a repurchase agreement with Barclays Capital (“Barclays”) on January 2, 2008 in the amount of $6,000,000. The repurchase date was January 2, 2013. The interest rate was fixed at 3.57% until maturity or until it was called. Beginning January 2, 2009 the repurchase agreement became callable and could have been called quarterly with prior notice of two business days. Interest was payable quarterly. The repurchase agreement was collateralized by federal agency and agency mortgage backed securities.

Shareholders’ Equity

Total shareholders’ equity was $24,800,161 and $23,987,541 at June 30, 2014 and December 31, 2013, respectively. Book value per share was $14.47 and $14.00 at June 30, 2014 and December 31, 2013, respectively. The maintenance of appropriate levels of capital is a priority and is continually monitored. MainStreet and Franklin Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Quantitative measures established by regulations to ensure capital adequacy require MainStreet and Franklin Bank to maintain minimum capital ratios. Failure to meet minimum capital ratios can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the consolidated financial statements. Also, declining capital can impact the ability of Franklin Bank to grow other assets. The required level of capital can also be affected by earnings, asset quality, and other issues. While MainStreet and Franklin Bank were considered well-capitalized under established regulatory classifications at June 30, 2014 and December 31, 2013, in the current economic circumstances, capital resources are a focus for the Corporation. Capital adequacy levels are also monitored to support the Bank’s safety and soundness. Should it be necessary or appropriate to obtain additional capital, then the current shareholder base could suffer dilution.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

The following are MainStreet’s capital ratios at:

	June 30, 2014			December 31, 2013
Tier I Leverage Ratio (Actual)		14.36	%		13.62	%
Tier I Leverage Ratio (Quarterly Ave.)		14.45			13.59
Tier I Risk-Based Capital Ratio		19.50			18.98
Tier II Risk-Based Capital Ratio		20.75			20.24

Liquidity and Asset Liability Management

Asset liability management functions to maximize profitability within established guidelines for liquidity, capital adequacy, and interest rate risk. It also helps to ensure that there is adequate liquidity to meet loan demand or deposit outflows and interest rate fluctuations. Liquidity is the ability to meet maturing obligations and commitments, withstand deposit fluctuations, fund operations, and provide for loan requests. In this economic environment liquidity remains a concern. MainStreet’s material off-balance sheet obligations were primarily loan commitments of the Bank in the amount of $20,865,780 at June 30, 2014. We have a liquidity contingency plan that provides guidance on the maintenance of appropriate liquidity and what action is required under various liquidity scenarios. Our liquidity is provided by cash and due from banks, interest-bearing deposits, federal funds sold, securities available for sale, and loan repayments. The Bank has overnight borrowing lines available with their correspondent banks, the ability to borrow from the Federal Reserve Bank’s discount window, and the ability to borrow long-term and short-term from the Federal Home Loan Bank of Atlanta. At June 30, 2014 and December 31, 2013, we had available credit from borrowing in the amounts of $47,648,065 and $43,687,459, respectively. Our ratio of liquid assets to total liabilities at June 30, 2014 and December 31, 2013 was 24.29% and 26.88%, respectively.

Core deposits are the primary foundation for our Corporation’s liquidity. Our core deposit relationships remained as can be seen by the stability of our demand deposits. Competition in our markets is strong and customers seek higher interest rates especially during this low interest rate environment. Lines of credit are essential to our business while other funding sources may be utilized. Due to our strategic efforts to reduce deposit costs, total time deposits and savings deposits have decreased from year end 2013; however, interest checking accounts and money market deposits increased over 2013 levels. Demand deposits decreased nominally in the amount of $313,123 since year end 2013. Total deposits actually decreased $3.3 million from year end 2013. The shrinkage of the balance sheet has had a positive impact on our capital. We monitor the deposits and our liquidity daily to ensure we have ample liquidity. The Bank is a member of the Certificate of Deposit Account Registry Service (“CDARS”). This allows us to provide the Bank’s depositors with up to $50 million in FDIC insurance. In a reciprocal transaction, the Bank receives the deposits and forwards them to CDARS and receives deposits back, if wanted. We can also bid on deposits in a one-way buy transactions which would allow for new depositors. CDARS deposits are also considered brokered deposits. Franklin Bank had accepted brokered deposits, including CDARS deposits, in the amount of $5.1 million as of June 30, 2014. Franklin Bank became a member of QwickRate in order to bid for internet certificates of deposit as another source of liquidity. At June 30, 2014, Franklin Bank had $3.4 million in internet certificates of deposit.

Interest rate sensitivity is measured by the difference, or gap, between interest sensitive earning assets and interest sensitive interest bearing liabilities and the resultant change in net interest income due to market rate fluctuations, and the effect of interest rate movements on the market. Management utilizes these techniques to manage interest rate risk in order to minimize change in net interest income with interest rate changes. MainStreet has partnered with Compass Bank using the Sendero model to help measure interest rate risk. The asset liability management process requires a number of key assumptions. Management determines the most likely outlook for the economy and interest rates measuring the effect on net interest income in a rising and declining 100, 200, 300, and 400 interest rate environment, as applicable. A shock report for these rates along with a ramped approach with each is modeled. With the shock, net interest income is modeled assuming that interest rates move the full rate change in the first month. With the ramp, net interest income is modeled assuming rates move one quarter of the full rate change in each quarter. With this approach, management also reviews the economic value of equity which is the net present value of the balance sheet’s cash flows or the residual value of future cash flows ultimately due to shareholders.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

The following table demonstrates the percentage change in net interest income from the level prime rate of 3.25% at June 30, 2014 in a rising and declining 100, 200, 300, and 400 basis point interest rate environment, as applicable:

Net Interest Income Percentage Change From Level Rates

Rate Shift	Prime Rate			Change From Level Ramp			Change from Level Shock
+400 bp		7.25	%		4.00	%		7.00	%
+300 bp		6.25			3.00			5.00
+200 bp		5.25			2.00			4.00
+100 bp		4.25			1.00			2.00
-100 bp		2.25			-1.00			-1.00
-200 bp		1.25			-1.00			-3.00
-300 bp		.25			-2.00			-5.00

MainStreet is sensitive to change in the interest rate environment particularly due to the level of variable rate loans in our loan portfolio, the short-tern of fixed rate loans, and the assumed repricing of our interest bearing liabilities. Management seeks to lower the impact on the net interest margin. The addition of floors to segments of our variable rate loan portfolio has contributed significantly to management of the interest income component of our net interest margin. Historically, Franklin Bank has been asset sensitive. However, due to the large amount of repricing deposit liabilities in the near term, the Bank has shifted to a liability sensitive position.

Inflation

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

Stock Compensation Plans

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

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

Recent Accounting Developments

In January 2014, the FASB issued ASU 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Corporation is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Corporation does not expect the adoption of ASU 2014-08 to have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers: Topic 606”. This ASU applies to any entity using U.S. GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition”, most industry-specific guidance, and some cost guidance included in Subtopic 605-35, “Revenue Recognition—Construction-Type and Production-Type Contracts”. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To be in alignment with the core principle, an entity must apply a five step process including: identification of the contract(s) with a customer, identification of performance obligations in the contract(s), determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue when (or as) the entity satisfies a performance obligation. Additionally, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer have also been amended to be consistent with the guidance on recognition and measurement. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Corporation is currently assessing the impact that ASU 2014-09 will have on its consolidated financial statements.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures”. This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014; however, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The Corporation is currently assessing the impact that ASU 2014-11 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation – Stock Compensation (Topic 718)”, should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Corporation is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

N/A

Item 4.

Controls and Procedures

MainStreet’s principal executive officer and principal financial officer has reviewed MainStreet’s disclosure controls and procedures (as defined in 240.13a-15(e) and 240.15d-15(e)) as of the end of the period covered by this quarterly report and based on their evaluation believe that MainStreet’s disclosure controls and procedures are effective. There have not been any changes in our internal control over financial reporting that occurred during the period that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

June 30, 2014

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

N/A

Item 1A

Risk Factors

N/A

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

N/A

Item 3.

Defaults Upon Senior Securities

N/A

Item 4

Mine Safety Disclosures

N/A

Item 5.

Other Information

Lisa J. Correll was named as a Director of MainStreet RealEstate, Inc. at MainStreet’s regularly scheduled Board meeting on Wednesday, August 6, 2014.

Item 6.

Exhibits

See index to exhibits.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: August 11, 2014	By	/s/ Brenda H. Smith
		Brenda H. Smith
		President and Chief Executive Officer
		Corporate Secretary

Date: August 11, 2014	By	/s/ Lisa J. Correll
		Lisa J. Correll
		Senior Vice President and Chief Financial Officer

Index to Exhibits

Number		Description of Exhibit
3(i)*		Restated Articles of Incorporation of the Corporation, dated March 6, 2001.
3(ii)		By-laws of the Corporation, dated August 5, 1999 amended February 20, 2001; amended October 16, 2002; amended September 17, 2003; amended July 13, 2005; amended April 20, 2006; and amended October 21, 2009 filed on Form 8-K on October 22, 2009 and herein incorporated by reference.
4.1		Provision in Registrant’s Articles of Incorporation and Bylaws defining the Rights of Holders of the Registrant’s common stock (included in Exhibits 3.1 and 3.2, respectively).
4.2		2004 Key Employee Stock option Plan filed March 16, 2005 on Form S-8 and herein incorporated by reference.
10.2#		Employment Agreement with Executive Vice President , Brenda H. Smith, dated October 1, 2002, filed with the Corporation’s Quarterly Form 10-QSB on November 7, 2002 and herein incorporated by reference. Amendment to employment agreement filed with on Form 8-K on April 24, 2006 and herein incorporated by reference.
10.3		Supplemental Executive Retirement Agreement by and between Franklin Community Bank, N.A. and Larry A. Heaton incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.
10.4#		Supplemental Executive Retirement Agreement by and between Franklin Community Bank, N.A. and Brenda H. Smith incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.
10.5#		Change in Control Agreement between MainStreet BankShares, Inc. and Lisa J. Correll incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.
10.6#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Robert W. Shorter incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.
10.7#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Debra B. Scott incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.
10.8#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Linda P. Adams incorporated by reference to the Corporation’s Form 10-KSB filed March 6, 2008.
10.9		Formal Agreement by and between The Comptroller of the Currency and Franklin Community Bank, National Association dated April 16, 2009 incorporated by reference to the Corporation’s Form 8-K filed April 20, 2009.
10.10#		Change in Control Agreement between MainStreet BankShares, Inc., Franklin Community Bank, N.A. and Todd Hammock incorporated by reference to the Corporation’s Form 10-K filed March 25, 2014.
10.11#		Change in Control Agreement between MainStreet BankShares, Inc. and Sonya B. Smith incorporated by reference to the Corporation’s Form 10-K filed March 25, 2014.
10.12#		Employment Agreement by and between Brenda H. Smith and MainStreet BankShares, Inc. incorporated by reference to the Corporation’s Form 8-K filed April 28, 2014.
31.1		Certification of President and Chief Executive Officer, and Corporate Secretary Pursuant to Rule 13a- 14(a) or 15(d)-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Senior Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) or 15(d)- 14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002.
32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
101		Interactive Data File

(Incorporated by reference to the Corporation’s Annual Form 10-KSB filed March 15, 2001.)

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

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MAINSTREET BANKSHARES INC Reports