Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - MAINSTREET BANKSHARES INCFinancial_Report.xls
EX-32 - EXHIBIT 32 - MAINSTREET BANKSHARES INCv393236_ex32.htm
EX-31.2 - EXHIBIT 31.2 - MAINSTREET BANKSHARES INCv393236_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - MAINSTREET BANKSHARES INCv393236_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended  September 30, 2014

 

 

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

For the transition period from ______________ to ______________ 

 

Commission file number  333-86993

 

MainStreet BankShares, Inc.

 

(Exact name of registrant as specified in its charter)

 

Virginia   54-1956616
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
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 November 13, 2014

 

 
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Form 10-Q

 

Index

 

 

PART I FINANCIAL INFORMATION

 

Page No.

 

Item 1         Financial Statements       1-34
     
Item 2         Management’s Discussion and Analysis of Financial Condition and Results of Operations      34-55
     
Item 3         Quantitative and Qualitative Disclosures About Market Risk         56
     
Item 4         Controls and Procedures         56

 

PART II OTHER INFORMATION
     
Item 1         Legal Proceedings         56
                        
Item 1A      Risk Factors         56
                        
Item 2         Unregistered Sales of Equity Securities and Use of Proceeds         56
                        
Item 3         Defaults Upon Senior Securities         56
                        
Item 4         Mine Safety Disclosures         56
     
Item 5         Other Information         56
     
Item 6         Exhibits         56
     
                   Signatures         57
     
                   Index to Exhibits      58
     

 

 
 

 

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:

 

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

 

2.Consolidated Statements of Income for the quarters ended September 30, 2014 (unaudited) and September 30, 2013 (unaudited).

 

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

 

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

 

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

 

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

 

7.Notes to Consolidated Financial Statements.

 

 
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

   (Unaudited)   (Audited) 
   September 30, 2014   December 31, 2013 
         
ASSETS          
           
Cash and due from banks  $2,844,936   $2,929,591 
Interest-bearing deposits in banks   8,141,483    10,343,469 
Federal funds sold   6,138,330    4,691,091 
Total Cash and Cash Equivalents   17,124,749    17,964,151 
Securities available-for-sale, at fair value    13,400,384    21,832,432 
Securities held to maturity, at amortized cost (fair value $5,645,106)   

5,623,054

    --- 
Restricted equity securities   587,200    654,600 
Loans held for sale   ---    306,250 
           
Loans:          
Total Gross Loans   127,014,331    123,637,386 
Unearned deferred fees and costs, net   120,299    86,600 
Loans, net of unearned deferred fees and costs   127,134,630    123,723,986 
Less:  Allowance for loan losses   (2,204,907)   (2,379,145)
Net Loans   124,929,723    121,344,841 
Bank premises and equipment, net   1,452,224    1,509,562 
Accrued interest receivable   416,813    462,081 
Bank owned life insurance   1,941,032    1,898,736 
Other real estate owned, net of valuation allowance   186,379    728,163 
Other assets   1,689,704    2,330,201 
           
TOTAL ASSETS  $167,351,262   $169,031,017 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
Deposits:          
Non-interest bearing demand deposits  $27,549,542   $26,856,990 
Interest bearing deposits   112,527,565    115,964,448 
Total Deposits   140,077,107    142,821,438 
Accrued interest payable and other liabilities   2,157,384    2,222,038 
Total Liabilities   142,234,491    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 September 30, 2014 and December 31, 2013, respectively   17,866,890    17,866,890 
Retained earnings   7,103,386    6,161,960 
Accumulated other comprehensive income (loss)   146,495    (41,309)
Total Shareholders’ Equity   25,116,771    23,987,541 
           
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $167,351,262   $169,031,017 

 

See accompanying notes to consolidated financial statements.

 

2
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Unaudited)

 

   Three Months   Three Months 
   Ended   Ended 
   September 30, 2014   September 30, 2013 
Interest and Dividend Income:          
Interest and fees on loans  $1,632,397   $1,624,693 
Interest on interest-bearing deposits   4,259    9,981 
Interest on federal funds sold   2,726    2,603 
Interest on securities:          
Taxable   83,112    80,252 
Nontaxable   17,875    18,095 
Dividends on restricted equity securities   7,937    7,911 
Total Interest and Dividend Income   1,748,306    1,743,535 
           
Interest Expense:          
Interest on deposits   163,805    259,546 
Total Interest Expense   163,805    259,546 
           
Net Interest Income   1,584,501    1,483,989 
Provision for (recovery of) loan losses   (13,262)   73,659 
           
Net Interest Income After Provision for (Recovery of)   1,597,763    1,410,330 
Loan Losses          
           
Noninterest Income:          
Service charges on deposit accounts   62,058    59,049 
Mortgage commissions   23,480    57,809 
Electronic card fees   46,335    49,846 
Investment fee income   52,431    36,259 
Income on bank owned life insurance   14,344    9,745 
Other fee income and miscellaneous income   24,290    7,547 
Total Noninterest Income   222,938    220,255 
           
Noninterest Expense:          
Salaries and employee benefits   683,602    724,413 
Occupancy and equipment expense   193,412    194,399 
Professional fees   102,347    50,014 
Outside processing   86,983    99,886 
FDIC assessment   28,840    58,754 
Franchise tax   58,500    54,000 
Regulatory examination fees   16,741    21,662 
Other real estate and repossessions   33,426    21,505 
Other expenses   113,088    126,535 
Total Noninterest Expense   1,316,939    1,351,168 
           
Net Income Before Tax  $503,762   $279,417 
Income Tax Expense   160,072    85,355 
Net Income  $343,690   $194,062 
Basic Net Income Per Common Share  $.20   $.11 
Diluted Net Income Per Common Share  $.20   $.11 

 

See accompanying notes to consolidated financial statements.

 

3
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Unaudited)

 

   Nine Months   Nine Months 
   Ended   Ended 
   September 30, 2014   September 30, 2013 
Interest and Dividend Income:          
Interest and fees on loans  $4,814,472   $5,111,743 
Interest on interest-bearing deposits   11,039    28,092 
Interest on federal funds sold   7,812    6,271 
Interest on securities:          
Taxable   264,756    226,340 
Nontaxable   54,005    52,310 
Dividends on restricted equity securities   25,007    24,419 
Total Interest and Dividend Income   5,177,091    5,449,175 
           
Interest Expense:          
Interest on deposits   546,864    824,812 
Interest on short-term borrowings   1    1 
Interest on repurchase agreements   ---    595 
Total Interest Expense   546,865    825,408 
           
Net Interest Income   4,630,226    4,623,767 
Provision for loan losses   73,610    1,326,161 
           
Net Interest Income After Provision for Loan Losses   4,556,616    3,297,606 
           
Noninterest Income:          
Service charges on deposit accounts   183,896    188,254 
Mortgage commissions   77,506    209,352 
Electronic card fees   133,892    141,780 
Investment fee income   160,418    126,257 
Income on bank owned life insurance   42,296    28,717 
Gain on securities sold/called   ---    47,194 
Other fee income and miscellaneous income   73,251    80,295 
Total Noninterest Income   671,259    821,849 
           
Noninterest Expense:          
Salaries and employee benefits   2,100,458    2,066,017 
Occupancy and equipment expense   573,887    573,829 
Professional fees   217,891    169,528 
Outside processing   248,417    308,734 
FDIC assessment   88,708    163,549 
Franchise tax   176,750    162,000 
Regulatory examination fees   50,564    74,269 
Other real estate and repossessions   32,404    126,504 
Other expenses   363,035    376,421 
Total Noninterest Expense   3,852,114    4,020,851 
           
Net Income Before Tax  $1,375,761   $98,604 
Income Tax Expense   434,335    4,225 
Net Income  $941,426   $94,379 
Basic Net Income Per Common Share  $.55   $.06 
Diluted Net Income Per Common Share  $.55   $.06 

 

See accompanying notes to consolidated financial statements.

 

4
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

  

Three Months

Ended

September 30, 2014

  

Three Months

Ended

September 30, 2013

 
         
Net Income  $343,690   $194,062 
Other Comprehensive Income (Loss):          
Net unrealized holding gains (losses) on securities available for sale during the period   (40,835)   36,757 
Deferred income tax (expense) benefit on unrealized holding losses or gains on securities available for sale  13,884    (12,497)
Amortization of held to maturity transfer during period   (195)   --- 
Tax effect of amortization of held to maturity transfer during period   66    --- 
Other Comprehensive Income (Loss)   (27,080)   24,260 
Total Comprehensive Income  $316,610   $218,322 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

  

Nine Months

Ended

September 30, 2014

  

Nine Months

Ended

September 30, 2013

 
         
         
Net Income  $941,426   $94,379 
Other Comprehensive Income (Loss):          
Net unrealized holding gains (losses) on securities available for sale during the period   284,814    (506,601)
Deferred income tax (expense) benefit on unrealized holding losses or gains on securities available for sale  (96,837)   172,244 
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   (262)   --- 
Tax effect of amortization of held to maturity transfer during period   89    --- 
Other Comprehensive Income (Loss)   187,804    (365,505)
Total Comprehensive Income (Loss)  $1,129,230   $(271,126)

 

 

(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 Income.

 

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

 

 

See accompanying notes to consolidated financial statements.

 

6
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

  

Nine Months

Ended

September 30, 2014

  

Nine Months

Ended

September 30, 2013

 
Cash Flows From Operating Activities          
Net income  $941,426   $94,379 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   73,610    1,326,161 
Depreciation and amortization   108,048    115,594 
Amortization of discounts and premiums, net   115,852    145,479 
Gain on sale of securities   ---    (47,194)
Loss and impairment on other real estate owned and repossessions   22,020    76,453 
Loss on fixed asset disposal   ---    4,215 
Deferred tax expense   275,591    93,297 
Change in loans held for sale   306,250    432,000 
Decrease in accrued interest receivable   45,268    104,728 
Decrease in other assets   268,158    260,026 
Increase in value of bank owned life insurance   (42,296)   (28,717)
Change in reserve for unfunded lending commitments   17,259    (2,436)
Increase in executive retirement plan accrual   106,970    113,980 
Payments on executive retirement plan   (140,628)   (140,628)
Decrease in accrued interest payable and other liabilities   (48,255)   (78,881)
Net cash provided by operating activities   2,049,273    2,468,456 
           
Cash Flows From Investing Activities          
Purchases of bank premises and equipment   (50,710)   (82,262)
Purchases of securities available for sale   ---    (9,505,740)
Calls/maturities/repayments of securities available for sale   2,977,694    4,011,334 
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    1,480,632 
Loan originations and principal collections, net   (3,907,508)   7,915,806 
Net cash provided by (used in) investing activities   (144,344)   4,992,453 
           
Cash Flows From Financing Activities          
Increase in non-interest bearing deposits   692,552    4,810,431 
Decrease in interest bearing deposits   (3,436,883)   (6,981,403)
Repayment of repurchase agreement   ---    (6,000,000)
Net cash used in financing activities   (2,744,331)   (8,170,972)
           
Net decrease in cash and cash equivalents  $(839,402)  $(710,063)
Cash and cash equivalents at beginning of period   17,964,151    24,038,353 
Cash and cash equivalents at end of period  $17,124,749   $23,328,290 
           
Supplemental disclosure of cash flow information:          
Cash paid during the period for interest  $574,833   $900,248 
Cash paid during the period for taxes  $79,000   $250,000 
Unrealized (loss) gain on securities available for sale  $284,814   $(553,795)
Transfer of securities available for sale to held to maturity  $5,647,033   $--- 
Transfers between loans, other real estate & other assets  $249,016   $417,673 
Amortization of net unrealized loss on securities moved to HTM  $(262)  $--- 

 

See accompanying notes to consolidated financial statements.

 

7
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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.

 

On August 24, 2014, MainStreet and American National Bankshares Inc. (“American National”) entered into an Agreement and Plan of Reorganization pursuant to which MainStreet will merge with and into American National. American National will be the surviving corporation in the merger. For further information on the merger and the Special Meeting of Shareholders, please refer to Note 15 of the Notes to Consolidated Financial Statements.

 

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 September 30, 2014 and December 31, 2013 are shown in the following tables.

 

8
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

       September 30, 2014     
       Gross   Gross     
Available for Sale:  Amortized   Unrealized   Unrealized   Approximate 
   Cost   Gains   Losses   Market Value 
U.S. government sponsored agencies  $1,489,611   $1,164   $(15,125)  $1,475,650 
Mortgage backed securities   11,170,834    274,362    (22,015)   11,423,181 
Corporates   496,594    4,959    ---    501,553 
                     
Total securities available for sale  $13,157,039   $280,485   $(37,140)  $13,400,384 

 

 

       September 30, 2014     
       Gross   Gross     
Held to Maturity:  Amortized   Unrealized   Unrealized   Approximate 
   Cost   Gains   Losses   Market Value 
States and political subdivisions  $5,623,054   $22,315   $(263)  $5,645,106 
Total securities held to maturity  $5,623,054   $22,315   $(263)  $5,645,106 

 

 

       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 September 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.

 

9
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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     691,660       710,038       2,964,469       2,976,644  
Due after five years but with ten years     3,568,534       3,612,637       2,658,585       2,668,462  
Due after ten years     8,896,845       9,077,709       ---       ---  
                                 
    $ 13,157,039     $ 13,400,384     $ 5,623,054     $ 5,645,106  

 

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 September 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 September 30, 2013.

 

During the nine month period ended September 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 at transfer of $(9,612) is part of the amortized cost of the securities and is being amortized over the life of the securities as an adjustment to the yield.

 

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

 

       September 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  $---   $---   $984,875   $(15,125)  $984,875   $(15,125)
Mortgage backed securities   ---    ---    1,759,986    (22,015)   1,759,986    (22,015)
Total temporarily impaired securities  $---   $---   $2,744,861   $(37,140)  $2,744,861   $(37,140)

 

 

       September 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  $158,588   $(263)  $---   $---   $158,588   $(263)
Total temporarily impaired securities  $158,588   $(263)  $---   $---   $158,588   $(263)

 

10
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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 September 30, 2014 and December 31, 2013, there were $2.9 million comprising six 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 September 30, 2014 and December 31, 2013.

 

Federal Reserve Bank stock is included in restricted equity securities and totaled $435,100 at September 30, 2014 and December 31, 2013. The Corporation’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $152,100 and $219,500 at September 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 September 30, 2014 and December 31, 2013 are as follows:

 

   September 30, 2014   December 31, 2013 
Commercial  $9,921,459   $9,426,188 
Real Estate:          
Construction and land development   16,315,096    16,394,964 
Residential 1-4 families:          
First liens   34,239,534    33,787,645 
Junior liens   6,956,288    6,331,233 
Home equity lines   6,572,167    5,764,941 
Commercial real estate   51,868,688    50,579,103 
Consumer   1,141,099    1,353,312 
Total Gross Loans  $127,014,331   $123,637,386 
Unearned deferred fees and costs, net   120,299    86,600 
Recorded Investment  $127,134,630   $123,723,986 

 

11
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

Overdrafts reclassified to loans at September 30, 2014 and December 31, 2013 were $8,104 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, it may be longer based on approval from Franklin Bank’s President and Chief Credit Officer.

 

12
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

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.

 

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 nine months ended September 30, 2014 and 2013 are as follows:

 

   2014   2013 
         
Balance at beginning of year  $2,379,145   $2,602,098 
Provision for loan losses    73,610    1,326,161 
Recoveries   114,438    52,977 
Charge-offs   (362,286)   (1,251,460)
Balance at period end  $2,204,907   $2,729,776 

 

13
 

  

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

A breakdown of the allowance by loan segment for the nine months ended September 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)   (73,240)   (112,905)   (66,409)   ---    (32,739)   (948)   ---    (362,286)
Recoveries   22,553    39,665    8,455    12,565    16,730    7,676    6,794    ---    114,438 
Provision   6,408    (28,326)   (40,173)   73,811    (1,231)   42,622    (9,501)   30,000    73,610 
Ending Balance  $104,205   $291,490   $456,653   $120,873   $115,850   $1,078,596   $7,240   $30,000   $2,204,907 

 

Please refer to the Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption “Provision for Loan Losses” for further detail about the allowance for loan losses.

 

       September 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  $---   $3,747   $---   $---   $---   $332,437   $---   $---   $336,184 
                                              
Ending Balance:                                             
Collectively                                             
evaluated for                                             
impairment   104,205    287,743    456,653    120,873    115,850    746,159    7,240    30,000    1,868,723 
                                              
  $104,205   $291,490   $456,653   $120,873   $115,850   $1,078,596   $7,240   $30,000   $2,204,907 

 

14
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

     

September 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  $605,335   $403,111   $244,495   $129,910   $68,850   $2,103,254   $---   $3,554,955 
                                         
Ending Balance:                                        
Collectively                                        
evaluated for                                        
impairment   9,316,124    15,911,985    33,995,039    6,826,378    6,503,317    49,765,434    1,141,099    123,459,376 
                                         
   $9,921,459   $16,315,096   $34,239,534   $6,956,288   $6,572,167   $51,868,688   $1,141,099   $127,014,331 

 

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 

 

15
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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 

 

16
 

  

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

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

 

                           Accruing Loans   Nonaccrual  
                        90 or More Days   Loans 
   Loans   Loans   Loans 90               Past Due   (Included in 
   30-59 Days   60-89 Days   Or More Days   Total Past   Current   Gross   (Included   Past Dues & 
   Past Due   Past Due   Past Due   Due Loans   Loan   Loans   in Past Dues)   Current) 
Commercial  $---   $---   $---   $---   $9,921,459   $9,921,459   $---   $--- 
Real Estate:                                        
Construction and land development   89,429    124,899    124,987    339,315    15,975,781    16,315,096    ---    249,886 
Residential 1-4 Families                                        
First Liens   296,861    ---    ---    296,861    33,942,673    34,239,534    ---    143,631 
Junior Liens   ---    ---    ---    ---    6,956,288    6,956,288    ---    129,910 
Home Equity lines   ---    ---    ---    ---    6,572,167    6,572,167    ---    68,850 
Commercial Real Estate   ---    ---    190,317    190,317    51,678,371    51,868,688    ---    2,103,254 
Consumer   1,777    ---    ---    1,777    1,139,322    1,141,099    ---    --- 
                                         
   $388,067   $124,899   $315,304   $828,270   $126,186,061   $127,014,331   $---   $2,695,531 

 

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

 

                           Accruing Loans   Nonaccrual 
                           90 or More Days   Loans 
   Loans   Loans   Loans 90               Past Due   (Included in 
   30-59 Days   60-89 Days   Or More Days   Total Past   Current   Gross   (Included   Past Dues & 
   Past Due   Past Due   Past Due   Due Loans   Loans   Loans   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 

 

17
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

Impaired loans at September 30, 2014 are as follows:

 

           Recorded             
   Unpaid   Recorded   Investment             
   Contractual   Investment   with No       Average   Interest 
   Principal   with Related   Related   Related   Recorded   Income 
   Balance   Allowance   Allowance   Allowance   Investment   Recognized 
Commercial  $605,335   $---   $605,335   $---   $642,394   $--- 
Real Estate:                              
Construction and land development   466,773    124,899    278,212    3,747    427,846    4,299 
Residential 1-4 Families                              
First Liens   244,495    ---    244,495    ---    707,144    6,031 
Junior Liens   138,195    ---    129,910    ---    154,268    --- 
Home Equity lines   77,902    ---    68,850    ---    70,253    --- 
Commercial Real Estate   2,135,993    1,912,937    190,317    332,437    2,401,443    3,313 
Consumer   ---    ---    ---    ---    ---    --- 
                               
   $3,668,693   $2,037,836   $1,517,119   $336,184   $4,403,348   $13,643 

 

Impaired loans at December 31, 2013 are as follows:

 

           Recorded             
   Unpaid   Recorded   Investment             
   Contractual   Investment   with No       Average   Interest 
   Principal   with Related   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 

 

18
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

The Corporation assesses all loan modifications to determine whether they are considered troubled debt restructurings (TDRs). During the nine months ending September 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 credit was a loan restructured to allow the borrower time to sell their property. The real estate 1-4 family credit was a restructure into a performing credit. It had been a construction and land development credit that had previously been restructured. 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 allowing the borrower time to acquire additional tenants.

 

   Number of
Contracts
   Pre-Modification Outstanding
Recorded Investment
   Post-Modification Outstanding
Recorded Investment
 
Construction and land development   1   $153,225   $153,225 
Real estate 1-4 family   1    100,864    100,864 
Commercial real estate   2    2,036,553    2,137,953 
Total   4   $2,290,642   $2,392,042 

 

During the three months ending September 30, 2014, the Corporation modified or renewed three credits that were considered to be TDRs. The construction and land development credit was a loan restructured to allow the borrower time to sell their property. The real estate 1-4 family credit was a restructure into a performing credit. It had been a construction and land development credit that had previously been restructured. The commercial real estate loan was the renewal of an existing troubled debt restructuring allowing the borrower time to acquire additional tenants.

 

   Number of
Contracts
   Pre-Modification Outstanding
Recorded Investment
   Post-Modification Outstanding
Recorded Investment
 
Construction and land development   1   $153,225   $153,225 
Real estate 1-4 family   1    100,864    100,864 
Commercial real estate   1    1,811,537    1,912,937 
Total   3   $2,065,626   $2,167,026 

 

There were no troubled debt restructurings modified during the past twelve months that defaulted during the three month or nine month periods ended September 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 nine months ending September 30, 2013, the Corporation modified four loans that were considered to be TDRs of which one is on nonaccrual. Both commercial loans were the renewals of credit designated as a TDR. The Corporation lowered the payment on one of the commercial real estate credits, which extended the amortization out of policy guidelines, in order to allow the borrower time to attract new tenants. The second commercial real estate credit was a result of charging off part of the original credit and positioning the credit and borrowers with ability to go forward with a performing credit. There were no additional loans designated as troubled debt restructurings in the third quarter of 2013. The following table presents information relating to the loans modified as TDRs during the nine months ended September 30, 2013.

 

19
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

   Number of
Contracts
   Pre-Modification Outstanding
Recorded Investment
   Post-Modification Outstanding
Recorded Investment
 
Commercial   2   $114,156   $114,156 
Commercial real estate   2    3,541,847    3,147,854 
Total   4   $3,656,003   $3,262,010 

 

One TDR in the amount of $119,616 renewed within the last twelve months ending September 30, 2013, was on nonaccrual and has not performed. The credit was renewed to allow the borrower to sell the property. It was in the construction and land development category.

 

At September 30, 2014 and December 31, 2013 the balance in loans under the terms of troubled debt restructurings not included in nonaccrual loans was $859,424 and $1,929,999, respectively. Troubled debt restructurings (not on nonaccrual) decreased from December 31, 2013 to September 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 September 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 September 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 nine month periods.

 

   September 30, 2014   September 30, 2013 
Interest that would have been  earned  $147,878   $202,646 
Interest reflected in income   13,643    44,442 
Lost interest  $134,235   $158,204 

 

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.

 

20
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

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.

 

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.

 

21
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

       September 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  $9,697,234   $15,096,420   $33,768,822   $6,168,827   $6,497,242   $46,246,445   $1,135,769   $118,610,759 
Special Mention   ---    464,927    ---    46,949    ---    2,146,441    ---    2,658,317 
Substandard   224,225    750,002    470,712    740,512    74,925    3,143,365    5,330    5,409,071 
Doubtful   ---    3,747    ---    ---    ---    332,437    ---    336,184 
Loss   ---    ---    ---    ---    ---    ---    ---    --- 
                                         
   $9,921,459   $16,315,096   $34,239,534   $6,956,288   $6,572,167   $51,868,688   $1,141,099   $127,014,331 

 

 

        

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 September 30, 2014, based upon lendable collateral value limited to 20% of total assets, was $33,110,000. There were no FHLB advances outstanding at September 30, 2014 and December 31, 2013.

 

22
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

There were no overnight federal funds purchased at September 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 September 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 day’s prior notice. Interest was payable quarterly. The repurchase agreement was collateralized by agency mortgage backed securities.

 

Note 7 – Net Income Per Common Share

 

The following tables show the weighted average number of shares used in computing earnings 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 
   September 30, 2014   September 30, 2013 
  

 

Shares

  

Per Share

Amount

  

 

Shares

  

Per Share

Amount

 
Earnings per common share, basic   1,713,375   $.20    1,713,375   $.11 

Effect of dilutive securities:

Stock options and warrants

   70    

 

 

    ---    

 

 

 
Earnings per common share, diluted   1,713,445   $.20    1,713,375   $.11 

 

Options and warrants not included in the calculation of diluted earnings per share because they were anti-dilutive were 13,980 and 128,272 for the quarter-to-date periods ending September 30, 2014 and 2013, respectively.

 

   Nine Months Ended   Nine Months Ended 
   September 30, 2014   September 30, 2013 
  

 

Shares

  

Per Share

Amount

  

 

Shares

  

Per Share

Amount

 
Earnings per common share, basic   1,713,375   $.55    1,713,375   $.06 

Effect of dilutive securities:

Stock options and warrants

   23         ---    

 

 

 
Earnings per common share, diluted   1,713,398   $.55    1,713,375   $.06 

 

Options and warrants not included in the calculation of diluted earnings per share because they were anti-dilutive were 49,342 and 128,272 for the year-to-date periods ending September 30, 2014 and 2013, respectively.

 

23
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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 September 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 September 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 nine months ended September 30, 2014:

 

           Weighted     
       Weighted   Average     
   Nine Month   Average   Remaining   Aggregate 
   Period Ended   Exercise   Contractual   Intrinsic 
   September 30, 2014   Price   Term   Value 
Outstanding at Beginning of year   67,023   $12.87           
Granted   ---    ---           
Exercised   ---    ---           
Forfeited   ---    ---           
Expired   ---    ---           
Outstanding at September 30, 2014   67,023   $12.87    1.50   $93,356 
Exercisable at September 30, 2014   67,023   $12.87    1.50   $93,356 

 

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 September 30, 2014. This amount changes based on changes in the market value of the Corporation’s stock.

 

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

 

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

 

24
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

    Stock Options     
Range of   and Warrants   Remaining 
Exercise   Outstanding   Contractual 
Prices   And Exercisable   Life 
          
$12.09    43,977    1.15 
 12.09    9,066    1.25 
 15.00    7,464    3.20 
 16.75    6,516    2.25 
 $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 September 30, 2014, and December 31, 2013 outstanding commitments to extend credit including letters of credit were as follows:

 

   September 30, 2014   December 31, 2013 
Commercial  $4,720,503   $4,258,081 
Real Estate:          
Construction and land development   3,177,070    1,691,512 
Residential 1-4 families          
First liens   569,119    918,377 
Junior liens   866,242    359,672 
Home Equity lines   8,163,794    7,790,927 
Commercial real estate   2,605,281    2,271,121 
Consumer   352,996    391,967 
Total Outstanding Commitments  $20,455,005   $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:

 

25
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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 September 30, 2014 and December 31, 2013:

 

       Fair Value Measurements at September 30, 2014 Using 
       Quoted Prices         
       in Active   Significant     
       Markets for   Other   Significant 
       Identical   Observable   Unobservable 
   Balance as of   Assets   Inputs   Inputs 
Description  September 30, 2014   (Level 1)   (Level 2)   (Level 3) 
Available-for-sale securities:                    
U. S. government sponsored agencies  $1,475,650   $---   $1,475,650   $--- 
Mortgage backed securities   11,423,181    ---    11,423,181    --- 
Corporates   501,553    ---    501,553    --- 
Total available-for-sale securities  $13,400,384   $---   $13,400,384   $--- 

 

26
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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 Income.

 

Other Real Estate Owned (OREO): Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair market value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on a recent appraisal conducted by an independent licensed appraisor 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 Income.

 

27
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

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

 

       Carrying value at September 30, 2014 
       Quoted Prices in   Significant     
       Active Markets   Other   Significant 
       for Identical   Observable   Unobservable 
   Balance as of   Assets   Inputs   Inputs 
Description  September 30, 2014   (Level 1)   (Level 2)   (Level 3) 
Impaired loans  $2,215,716   $---   $1,649,350   $566,366 
Other real estate owned   186,379    ---    ---    186,379 

 

       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 September 30, 2014:

 

  

Fair

Value

  

Valuation

Technique(s)

 

Unobservable

Input

 

Range (Weighted

Average)

 
Assets                
Impaired loans  $311,469   Internal evaluations  Internal evaluations      6% - 37% (22%) 
    254,897   Appraisal  Market discount/Timing discount    19% - 63% (33%) 
Other real estate owned  $35,979   Internal evaluations  Internal evaluations and
market discount
   

 

9% (9%)

 
   $150,400   Appraisal  Market discount               40% (40%) 

 

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.

 

28
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

(b)Securities Available for Sale

 

The fair value of investments is estimated based upon security market data that utilizes a matrix pricing model. Our third party vendor utilizes a reputable pricing company to gather this security data. We make no adjustments to the pricing service data received for our securities available for sale.

 

(c)Securities Held to Maturity

 

The fair value of investments is estimated based upon security market data that utilizes a matrix pricing model. Our third party vendor utilizes a reputable pricing company to gather this security data. We make no adjustments to the pricing service data received for our securities held to maturity.

 

(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, represented by the cash surrender value, 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.

 

29
 

 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

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

 

       Fair Value Measurements at September 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  $2,844,936   $2,844,936   $---   $---   $2,844,936 
Interest-bearing deposits in banks   8,141,483    8,141,483    ---    ---    8,141,483 
Federal funds sold   6,138,330    6,138,330    ---    ---    6,138,330 
Securities available-for-sale
   13,400,384    ---    13,400,384    ---    13,400,384 
Securities held to maturity   5,623,054    ---    5,645,106    ---    5,645,106 
Restricted equity securities   587,200    ---    587,200    ---    587,200 
Loans, net   124,929,723    ---    1,649,350    123,250,188    124,899,538 
Accrued interest receivable   416,813    ---    416,813    ---    416,813 
Bank owned life insurance   1,941,032    ---    1,941,032    ---    1,941,032 
                          
FINANCIAL LIABILITIES:                         
Deposits:                         
Non-interest bearing demand deposits  $27,549,542   $---   $27,569,542   $---   $27,569,542 
Interest bearing deposits   112,527,565    ---    112,771,365    ---    112,771,365 
Accrued interest payable   58,607    ---    58,607    ---    58,607 

 

30
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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.

 

31
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 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 September 30, 2014 
   Net Unrealized Gains on Securities available for sale (1)   Adjustments Related to Post Retirement Benefits (2)   Net Securities Transferred to Held to Maturity from Available for Sale   Accumulated Other Comprehensive Income 
                 
Balance at June 30, 2014  $187,559   $(7,596)  $(6,388)  $173,575 
                     
Other comprehensive loss   (26,951)   ---    (129)   (27,080)
                     
Balance at September 30, 2014  $160,608   $(7,596)  $(6,517)  $146,495 

 

32
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

September 30, 2014

 

 

       For the Three Months Ended
September 30, 2013
 
   Net Unrealized Gains (Losses) on Securities available for sale (1)   Adjustments Related to Post Retirement Benefits (2)   Accumulated Other Comprehensive Income 
             
Balance at June 30, 2013  $(19,825)  $56,617   $36,792 
                
Other comprehensive income   24,260    ---    24,260 
                
Balance at September 30, 2013  $4,435   $56,617   $61,052 

 

 

       For the Nine Months Ended September 30, 2014 
   Net Unrealized Gains (Losses) on Securities available for sale (1)   Adjustments Related to Post Retirement Benefits (2)   Net Securities Transferred to Held to Maturity from Available for Sale   Accumulated Other Comprehensive Income (Loss) 
                 
Balance at December 31, 2013  $(33,713)  $(7,596)  $---   $(41,309)
                     
Other comprehensive income   194,321    ---    (6,517)   187,804 
                     
Balance at September 30, 2014  $160,608   $(7,596)  $(6,517)  $146,495 

 

 

     For the Nine Months Ended
September 30, 2013
 
   Net Unrealized Gains (Losses) on Securities available for sale (1)   Adjustments Related to Post Retirement Benefits (2)   Accumulated Other Comprehensive Income 
             
Balance at December 31, 2012  $369,940   $56,617   $426,557 
                
Other comprehensive loss   (365,505)   ---    (365,505)
                
Balance at September 30, 2013  $4,435   $56,617   $61,052 

 

 

(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.

 

Note 15 – Merger Related Information

 

On August 24, 2014, MainStreet and American National Bankshares Inc. (“American National”) entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) pursuant to which MainStreet will merge with and into American National (the “Merger”). American National will be the surviving corporation in the merger. The Merger Agreement was approved by the Boards of Directors of both companies. As a result of the merger, the holders of shares of MainStreet common stock will receive $3.46 in cash and 0.482 shares of American National common stock for each share of MainStreet common stock held immediately prior to the effective date of the merger. Each share of American National common stock outstanding immediately prior to the merger will continue to be outstanding after the merger. Each option to purchase shares of MainStreet common stock that is outstanding immediately prior to the effective date of the merger will vest upon the merger and be converted into an option to purchase shares of American National common stock, based on a 0.643 exchange ratio. It is expected that immediately following the merger, Franklin Bank will be merged with and into American National Bank and Trust Company, American National’s wholly-owned bank subsidiary. The merger is expected to be completed in early January 2015.

 

33
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

A Special Meeting of Shareholders will be held on Tuesday, December 9, 2014 to vote upon a proposal to approve the Merger Agreement. The merger cannot be completed unless the holders of more than two-thirds of the outstanding shares of MainStreet common stock vote in favor of approval of the merger agreement at the Special Meeting. Other business to be conducted at the Special Meeting include a shareholder vote to approve, on an advisory basis only, the compensation paid to named executive officers of MainStreet in connection with or as a result of the merger. Lastly, there will be an adjournment proposal to be voted upon at the Special Meeting to allow a future date for the meeting if there are not sufficient votes to approve the merger proposal. This will permit further solicitation of proxies required to approve the merger approval if necessary or appropriate. The record date has been fixed as of the close of business on October 20, 2014 for determining the shareholders of MainStreet entitled to notice of and to vote at the Special Meeting.

 

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

 

Forward-Looking Statements

 

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

 

General

 

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.

 

34
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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.

 

On August 24, 2014, MainStreet and American National Bankshares Inc. (“American National”) entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) pursuant to which MainStreet will merge with and into American National (the “Merger”). American National will be the surviving corporation in the merger. The Merger Agreement was approved by the Boards of Directors of both companies. As a result of the merger, the holders of shares of MainStreet common stock will receive $3.46 in cash and 0.482 shares of American National common stock for each share of MainStreet common stock held immediately prior to the effective date of the merger. Each share of American National common stock outstanding immediately prior to the merger will continue to be outstanding after the merger. Each option to purchase shares of MainStreet common stock that is outstanding immediately prior to the effective date of the merger will vest upon the merger and be converted into an option to purchase shares of American National common stock, based on a 0.643 exchange ratio. It is expected that immediately following the merger, Franklin Bank will be merged with and into American National Bank and Trust Company, American National’s wholly-owned bank subsidiary. The merger is expected to be completed in early January 2015.

 

A Special Meeting of Shareholders will be held on Tuesday, December 9, 2014 to vote upon a proposal to approve the Merger Agreement. The merger cannot be completed unless the holders of more than two-thirds of the outstanding shares of MainStreet common stock vote in favor of approval of the merger agreement at the Special Meeting. Other business to be conducted at the Special Meeting include a shareholder vote to approve, on an advisory basis only, the compensation paid to named executive officers of MainStreet in connection with or as a result of the merger. Lastly, there will be an adjournment proposal to be voted upon at the Special Meeting to allow a future date for the meeting if there are not sufficient votes to approve the merger proposal. This will permit further solicitation of proxies required to approve the merger approval if necessary or appropriate. The record date has been fixed as of the close of business on October 20, 2014 for determining the shareholders of MainStreet entitled to notice of and to vote at the Special Meeting.

 

Please refer to the Agreement and Plan of Reorganization filed on Form 8-K on August 28, 2014 and the Definitive Proxy Statement filed on November 3, 2014 with the Securities and Exchange Commission for further details and information on the Merger Agreement and Special Meeting of Shareholders.

 

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.

 

35
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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.

 

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.

 

36
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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 has strengthened the Corporation’s position.

 

Total assets at September 30, 2014 were $167.4 million compared to $169.0 million at year-end December 31, 2013, a decline of $1.6 million. Our balance sheet has declined since year-end due to our continued strategy to lower our deposit costs. At September 30, 2014, loans, net of unearned deferred fees and costs, increased $3.4 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 $8.4 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 $2.7 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 $186,379. 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 $.8 million. Liquidity continues to be an important focus for our Corporation during these tumultuous times and our liquid assets were 24.64% of total liabilities at September 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 $2.4 million from year end 2013 to September 30, 2014. Nonaccrual loans decreased by $1.3 million during the first nine months of 2014. Troubled debt restructurings (not on nonaccrual) decreased by $1.1 million during the first nine months of 2014. Other impaired loans decreased by $60,000 in the first nine months of 2014. Our loans rated special mention or worse (excluding troubled debt restructurings and those in nonaccrual status) increased at September 30, 2014 as compared to year end 2013 in the amount of $1.4 million. We transferred $249,016 of loans into other real estate and other repossessed assets during the first nine months of 2014. Our other real estate properties have declined to $186,379 at September 30, 2014 compared to $728,163 at December 31, 2013. A substantial amount of our foreclosed properties have been sold as of September 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 $25.1 million at September 30, 2014. MainStreet and Franklin Bank were well capitalized at September 30, 2014 under bank regulatory capital classifications. The book value of shareholders’ equity at September 30, 2014 was $14.66 per share.

 

Our year-to-date net income at September 30, 2014 was $941,426, or $.55 per common basic share. This net income equated to an annualized return on average assets of 0.76% and an annualized return on average shareholders’ equity of 5.11%. The net income for the same period in 2013 was $94,379, 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 0.07% and 0.52%, 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, sluggish 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 $106,014 and $1,452,665 in expense for the nine month periods ending September 30, 2014 and September 30, 2013, respectively.

 

37
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

Net income for the third quarter of 2014 was $343,690, or $.20 per common basic share as compared to net income in the amount of $194,062, or $.11 per common basic share for the third quarter of 2013. Provision expense, other real estate and repossession expenses, write downs and losses on sales together accounted for $20,164 and $95,164 for the quarters ended September 30, 2014 and 2013, respectively. Credit related issues continue to have a negative impact on our Corporation’s net income.

 

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 nine month periods ending September 30, 2014 and 2013 was $4,630,226 and $4,623,767, respectively, a modest increase of $6,459, or .14%. Both interest income and interest expense dollars dropped in comparison to last year, primarily due to volume, loan rates, 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 nine months ending September 30, 2014 and 2013, the net interest margin was 3.91% and 3.64%, respectively, a 27 basis point increase. The yield on interest earning assets for the year-to-date period ending September 30, 2014 was 4.37% compared to 4.28% for the year-to-date period ending September 30, 2013, an increase of 9 basis points. 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 increased despite the interest rate environment, sluggish loan demand reducing loan fee income, and continued lost interest on nonaccrual loans. Lost interest for the nine month periods ending September 30, 2014 and 2013 was $134,235 and $158,204, respectively. Lost interest for the three month periods ending September 30, 2014 and 2013 was $37,813 and $71,262, 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. Franklin Bank’s growth is also dependent on the outcome of its pending merger.

 

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.

 

38
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

Net interest income for the three month periods ending September 30, 2014 and 2013 was $1,584,501 and $1,483,989, respectively, an increase of $100,512, or 6.77%. This equated to a net interest margin of 3.94% and 3.48% at September 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.

 

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 nine months of 2014 was $73,610 as compared to $1,326,161 for the first nine months of 2013. Our loan portfolio, net of unearned deferred fees and costs, increased $3.4 million or 2.76% from year-end 2013. Gross charge-offs year-to-date 2014 were $362,286 compared to $1,251,460 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 September 30, 2014. The allowance for loan losses was $2.2 million at September 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 1.73% and 1.92% of loans net of unearned deferred fees and costs at September 30, 2014 and December 31, 2013, respectively. Our criticized and classified loans that are evaluated by historical loss migration increased $1,441,252 at September 30, 2014 compared to year-end 2013. The loans evaluated collectively by pools increased $4.3 million at September 30, 2014 versus December 31, 2013. Impaired loans evaluated individually were $3.6 million and $6.0 million at September 30, 2014 and December 31, 2013, respectively, with specific reserves of $336,184 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, all offset by an increase in adversely rated loans.

 

39
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

The primary factors contributing to the minimal reduction in loans evaluated collectively by pools are overall reduced percentages due to historical charge offs and the reduced level of past dues and nonaccruals present in the loan portfolio, all offset by an increase in loan volume. There were no changes in the economy, second trade area, or concentration 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 September 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 $362,286 of gross charge offs because approximately $105,000 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 September 30, 2014, but there was no unallocated amount at December 31, 2013. Net charge-offs of $247,848 and $1,198,483 for the first nine months of 2014 and 2013 equated to .26% and 1.24%, 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.

 

Provision expense for the third quarter of 2014 and 2013 was $(13,262) and $73,659, respectively. The allowance for loan losses was $2.2 million at September 30, 2014 and $2.2 million at June 30, 2014. The allowance for loan losses was 1.73% and 1.77% of loans, net of unearned fees and costs at September 30, 2014 and June 30, 2014, respectively. Our criticized and classified loans that are evaluated by historical loss migration decreased $.7 million at September 30, 2014 compared to prior quarter end. The loans evaluated collectively by pools increased $1.4 million at September 30, 2014 versus June 30, 2014. Impaired loans evaluated individually were $3.6 million and $3.7 million at September 30, 2014 and June 30, 2014, respectively, with specific reserves of $336,184 and $331,195, respectively. The allowance for loan losses remained relatively unchanged from the second to third quarter of 2014. Gross charges offs and recoveries for the third quarter of 2014 were $48,703 and $21,786, respectively. Net charge-offs of $26,917 for the third quarter of 2014 equated to .08%, 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.

 

   September 30, 2014   December 31, 2013 
Commercial  $605,335   $725,863 
Real Estate:          
Construction and land development   403,111    576,552 
Residential 1-4 families:          
First liens   244,495    1,130,961 
Junior liens   129,910    182,170 
Home equity loans   68,850    71,338 
Commercial real estate   2,103,254    3,308,733 
Consumer   ---    --- 
Total Nonperforming Loans  $3,554,955   $5,995,617 

 

40
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

Total nonperforming loans decreased in the amount of $2,440,662 or 40.71% at September 30, 2014 as compared to December 31, 2013. Nonaccrual loans (included in the impaired loans above) were $2,695,531 and $4,005,618 at September 30, 2014 and December 31, 2013, respectively, which represented 2.12% 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 September 30, 2014 loans secured by commercial real estate were the largest category of impaired loans at $2.1 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 September 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.

 

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 5.6% (July 2014 data), up from 5.5% at June 30, 2014. Absorption analysis in our market place shows a slight increase in the number of projected 2014 total waterfront real estate sales in the Smith Mountain Lake area; however, the level of properties listed is still elevated. Average turnover rates for waterfront condo and waterfront single family homes are expected to increase in 2014 over 2013 levels, while turnover rates for waterfront lots are expected to decrease in 2014 over 2013 levels. Data obtained also reveal an expected decline in average sales price in 2014 versus 2013 on waterfront condos and waterfront single family homes, while the average sales price of waterfront lots are expected to increase in 2014 versus 2013. 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 $671,259 and $821,849 for the nine months ending September 30, 2014 and 2013, respectively, a decrease of $150,590, or 18.32%. The following chart demonstrates the categories of change:

 

Noninterest Income  YTD 9/30/14   YTD 9/30/13   Dollar Change   Percentage Change 
Service charges on deposit accounts  $183,896   $188,254   $(4,358)   (2.31)%
Mortgage commissions   77,506    209,352    (131,846)   (62.98)
Electronic card fees   133,892    141,780    (7,888)   (5.56)
Investment fee income   160,418    126,257    34,161    27.06 
Income on bank owned life insurance   42,296    28,717    13,579    47.29 
Gain on securities sold/called   ---    47,194    (47,194)   (100.00)
Other fee income & miscellaneous   73,251    80,295    (7,044)   (8.77)

 

41
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

As noted above, total noninterest income decreased $150,590 for the nine months ending September 30, 2014 compared to the nine months ending September 30, 2013. Service charges on deposit accounts decreased $4,358 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 business account charges and a decline in demand deposit charge-offs. Mortgage commissions decreased in the year to year comparison by $131,846, or 62.98%. 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.

 

Electronic card fees experienced a decrease of $7,888 or 5.56% for the nine months ended September 30, 2014 as compared to September 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 nine months of 2014 and 2013 was $160,418 and $126,257, respectively, an increase of $34,161, or 27.06%. 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 September 30, 2014 was $1.9 million. Income on this investment increased $13,579 or 47.29% 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 nine months ending September 30, 2014. Other fee income and miscellaneous income experienced a decrease of $7,044, or 8.77%. This decrease is primarily due to a decrease in title fee income and evaluation fee income, all offset by increases in wire fee charges, checkbook charges, and a reduction in losses taken on fixed asset disposals. 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. Evaluation fee income decreased by $3,429 in the year to year comparison. Losses taken on fixed asset disposals were $0 and $4,215 for the nine months ended September 30, 2014 and 2013, respectively.

 

Total noninterest income was $222,938 and $220,255 for the three months ending September 30, 2014 and 2013, respectively, an increase of $2,683 or 1.22%. The following chart demonstrates the categories of change:

 

Noninterest Income  QTD 9/30/14   QTD 9/30/13   Dollar Change   Percentage Change 
Service charges on deposit accounts  $62,058   $59,049   $3,009    5.10%
Mortgage commissions   23,480    57,809    (34,329)   (59.38)
Electronic card fees   46,335    49,846    (3,511)   (7.04)
Investment fee income   52,431    36,259    16,172    44.60 
Income on bank owned life insurance   14,344    9,745    4,599    47.19 
Other fee income & miscellaneous   24,290    7,547    16,743    221.85 

 

Service charges on deposit accounts increased primarily due to an increase in net NSF fee income and a reduction in demand deposit charge-offs. There were no gains on securities sold/called during the quarter ended September 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. One other factor contributing to the increase in other fee income and miscellaneous income was the quarterly entry of our mortgage derivative in 2013. 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. A decrease to miscellaneous income in the amount of $13,860 was recorded in the third quarter of 2013. Overall noninterest income decreased in two of the categories and increased in four of the categories.

 

42
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

Noninterest Expense

 

Total noninterest expense was $3,852,114 and $4,020,851 for the nine month period ending September 30, 2014 and 2013, respectively, a decrease of $168,737, or 4.20%. Excluding the nonrecurring expenses of other real estate and repossessions, noninterest expense decreased $74,637, or 1.92%. The following chart shows the categories of noninterest expenses for the nine month periods ending September 30, 2014 and 2013, the dollar change, and the percentage change:

 

Noninterest Expense  YTD 9/30/14   YTD 9/30/13   Dollar Change   Percentage  Change 
Salaries and employee benefits  $2,100,458   $2,066,017   $34,441    1.67%
Occupancy and equipment   573,887    573,829    58    0.01 
Professional  fees   217,891    169,528    48,363    28.53 
Outside processing   248,417    308,734    (60,317)   (19.54)
FDIC Assessment   88,708    163,549    (74,841)   (45.76)
Franchise tax   176,750    162,000    14,750    9.10 
Regulatory examination fees   50,564    74,269    (23,705)   (31.92)
Other real estate and repossessions   32,404    126,504    (94,100)   (74.38)
Other expenses   363,035    376,421    (13,386)   (3.56)

 

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 54.53% and 51.38%, respectively, of total noninterest expense for the nine month periods ending September 30, 2014 and 2013. Salaries and employee benefits increased $34,441 or 1.67% in the first nine months of 2014 as compared to the first nine months of 2013. Of this increase, total salaries increased $45,073 and employee benefits decreased $10,632. 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 decrease in employee benefits was a decrease 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 $58 in the year to year comparison. Professional fees include fees for audit, legal, and other professional fees and showed a $48,363 increase in comparing the nine months ended September 30, 2014 to the same period in 2013. Included in legal expense in the first nine months of 2014 is $76.3 thousand in merger related expenses. Outside processing expenses decreased $60,317 or 19.54% in the year to year comparison primarily due to a decrease in data processing fees. FDIC assessment declined $74,841 or 45.76% 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 $14,750 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 $23,705 in the first nine months of 2014 as compared to the first nine 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 $94,100, or 74.38%, 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 September 30, 2014 our other real estate owned balance has declined to $186,379. Other expenses decreased in the amount of $13,386 or 3.56% in the year to year comparison.

 

43
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

Total noninterest expense was $1,316,939 and $1,351,168 for the three month periods ending September 30, 2014 and 2013, respectively, a decrease of $34,229 or 2.53%. Excluding the nonrecurring expenses of other real estate and repossessions, noninterest expense decreased $46,150 or 3.47%. The following chart shows the categories of noninterest expenses for the three month periods ending September 30, 2014 and 2013, the dollar change, and the percentage change:

 

Noninterest Expense  QTD 9/30/14   QTD 9/30/13   Dollar Change   Percentage  Change 
Salaries and employee benefits  $683,602   $724,413   $(40,811)   (5.63)%
Occupancy and equipment   193,412    194,399    (987)   (.51)
Professional  fees   102,347    50,014    52,333    104.64 
Outside processing   86,983    99,886    (12,903)   (12.92)
FDIC Assessment   28,840    58,754    (29,914)   (50.91)
Franchise tax   58,500    54,000    4,500    8.33 
Regulatory examination fees   16,741    21,662    (4,921)   (22.72)
Other real estate and
repossessions
   33,426    21,505    11,921    55.43 
Other expenses   113,088    126,535    (13,447)   (10.63)

 

Overall, the same explanations for the year to date comparisons are applicable to the quarterly comparisons of noninterest expense with the exceptions of other real estate and repossessions and salaries and employee benefits. Other real estate and repossessions expense increased $11,921 in the quarterly comparison due to increased write-downs on one property in the third quarter due to its impending sale in October. Salaries and employee benefits decreased primarily due to employee attrition and decreased expense on the supplemental executive retirement plan.

 

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 September 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 in the amounts of $434,335 and $4,225 for the nine month periods ending September 30, 2014 and September 30, 2013, respectively. MainStreet recorded income tax expense in the amounts of $160,072 and $85,355 for the three month periods ending September 30, 2014 and September 30, 2013, respectively.

 

44
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

BALANCE SHEET

 

Investment Portfolio

 

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

 

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

  · To use securities to fulfill pledging collateral requirements.

  · To utilize the maturity/repricing mix of portfolio securities to help balance the overall interest rate risk position of the balance sheet.
  · To make a reasonable return on investments.

 

Funds not utilized for capital expenditures or lending are invested in securities of the U.S. Government and its agencies, mortgage-backed securities, municipal bonds, corporate debt securities and certain equity securities. Currently, 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 September 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:

 

   September 30, 2014   December 31, 2013 
Commercial  $9,921,459    7.81%  $9,426,188    7.63%
Real Estate:                    
Construction & land development   16,315,096    12.84    16,394,964    13.26 
Residential 1-4 families:                    
First liens   34,239,534    26.96    33,787,645    27.33 
Junior liens   6,956,288    5.48    6,331,233    5.12 
Home equity lines   6,572,167    5.17    5,764,941    4.66 
Commercial real estate   51,868,688    40.84    50,579,103    40.91 
Consumer   1,141,099    .90    1,353,312    1.09 
Total Gross Loans  $127,014,331    100.00%  $123,637,386    100.00%
                     
Unearned deferred fees & costs, net   120,299         86,600      
Recorded Investment  $127,134,630        $123,723,986      

 

Gross loans increased $3,376,945, or 2.73% at September 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

 

45
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

91.29% and 91.28% of gross loans at September 30, 2014 and December 31, 2013, respectively. 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 September 30, 2014 was 90.76% compared to 86.63% at December 31, 2013, an increase of 4.13%. We lowered our policy loan to deposit ratio, thus increasing liquidity, and maintained a lower percentage because of lower loan demand. However, the percentage has increased by 4.13% 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.

 

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.

 

46
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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 30% 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.

 

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 are 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 September 30, 2014.

 

   September 30, 2014     
       Loans for     
   Loans for   Real Estate     
   Construction   Including     
   of Buildings   Construction   Total 
Commercial  $332,244   $258,050   $590,294 
Real Estate               
Construction and land development   1,634,348    2,222,371    3,856,719 
Residential, 1-4 families               
First Liens   3,169,242    8,408,238    11,577,480 
Junior Liens   613,449    460,298    1,073,747 
Home Equity Lines   ---    352,678    352,678 
Commercial real estate   2,526,719    25,017,451    27,544,170 
Consumer   818    10,198    11,016 
Total  $8,276,820   $36,729,284   $45,006,104

 

 

47
 

  

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

   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 

 

Overall, our concentrations decreased by $210,201 from year end to the end of the third 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.

 

   September 30, 2014     
   Total Concentration   Concentrations Included Above   Net Addition to Concentrations 
Acquisition & development  $737,760   $291,000   $446,760 
Speculative lot loans   3,189,775    488,740    2,701,035 
Speculative single-family housing construction   3,617,260    509,040    3,108,220 

 

   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.

 

48
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

Following is a breakdown of our nonperforming loans and assets.

 

   For the Periods Ended 
   September 30, 2014   December 31, 2013 
Nonaccrual loans and leases  $2,695,531   $4,005,618 
Loans past due 90 days or more and still accruing   ---    --- 
Troubled debt restructurings (not on nonaccrual)   859,424    1,929,999 
Other impaired loans   ---    60,000 
Total nonperforming loans   3,554,955    5,995,617 
Foreclosed real estate   186,379    728,163 
Other foreclosed property   ---    --- 
Total foreclosed property   186,379    728,163 
Total nonperforming assets  $3,741,334   $6,723,780 

 

Impaired loans totaled $3,554,955 and $5,995,617 at September 30, 2014 and December 31, 2013, respectively. Nonaccrual loans decreased $1,310,087 at September 30, 2014 compared to year end 2013. Troubled debt restructurings (not on nonaccrual) decreased $1,070,575 from year end 2013. There were no loans past due more than 90 days, and still accruing, at September 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.

 

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 September 30, 2014 and December 31, 2013 were $140,077,107 and $142,821,438, respectively, a decrease of $2,744,331, or 1.92%. We continue in 2014 our strategy to lower overall deposit costs, which is discussed in more detail below. The deposit mix was as follows:

 

49
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

   September 30, 2014   December 31, 2013 
Demand deposits  $27,549,542    19.67%  $26,856,990    18.80%
Interest checking deposits   9,471,232    6.76    9,248,249    6.48 
Money market deposits   27,433,204    19.58    23,660,000    16.57 
Savings deposits   16,693,009    11.92    16,240,448    11.37 
Time deposits $100,000 and over   28,234,350    20.16    29,977,151    20.99 
Other time deposits   30,695,770    21.91    36,838,600    25.79 
                     
Total  $140,077,107    100.00%  $142,821,438    100.00%

 

The largest component of deposits continues to be time deposits including those $100,000 and over representing 42.07% of total deposits at September 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 19.67% of total deposits as compared to 18.80% at December 31, 2013. The dollar amount of our demand deposits has also increased since year end 2013. An increase in demand deposits improves the net interest margin and the total yield on interest bearing deposits. Money market deposits, interest checking accounts, and savings deposits each increased as a percentage of total deposits along with the dollar amount. Money market deposits have increased $3,773,204 since year end 2013 and as a percentage of total deposits. Our total deposits have decreased $2.7 million since year end 2013 primarily due to a $7.9 million decline in our time deposits, offset by a total increase in our lower deposit cost accounts in the amount of $5.2 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 $7.9 million decrease since year end.

 

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 .65% and .88%, respectively, for the nine months ended September 30, 2014 and September 30, 2013. This decline of 23 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 September 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 September 30, 2014 and December 31, 2013 were $99,346,594 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 September 30, 2014 and December 31, 2013.

 

50
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

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 $25,116,771 and $23,987,541 at September 30, 2014 and December 31, 2013, respectively. Book value per share was $14.66 and $14.00 at September 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 September 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.

 

The following are MainStreet’s capital ratios at:

 

   September 30, 2014   December 31, 2013 
Tier I Leverage Ratio (Actual)   14.54%   13.62%
Tier I Leverage Ratio (Quarterly Ave.)   14.58    13.59 
Tier I Risk-Based Capital Ratio   19.82    18.98 
Tier II Risk-Based Capital Ratio   21.08    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 $20,455,005 at September 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 September 30, 2014 and December 31, 2013, we had available credit from borrowing in the amounts of $47,610,000 and $43,687,459, respectively. Our ratio of liquid assets to total liabilities at September 30, 2014 and December 31, 2013 was 24.64% and 26.88%, respectively.

 

51
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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 have decreased from year end 2013; however, interest checking accounts, savings deposits, and money market deposits increased over 2013 levels. Demand deposits increased in the amount of $692,552 since year end 2013. Total deposits actually decreased $2.7 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 $3.9 million as of September 30, 2014. Franklin Bank became a member of QwickRate in order to bid for internet certificates of deposit as another source of liquidity. At September 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 previously partnered with Compass Bank using the Sendero model to help measure interest rate risk. Effective with the third quarter of 2014, MainStreet now partners with Ficast Data to help measure its 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 is modeled. With the shock, net interest income is modeled assuming that interest rates move the full rate change immediately. With this approach, management also reviews the economic value of equity which is the net present value of the balance sheet’s cash flows or the residual value of future cash flows ultimately due to shareholders.

 

The following table demonstrates the percentage change in net interest income from the level prime rate of 3.25% at September 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 Shock 
+400 bp   7.25%   9.02%
+300 bp   6.25    6.57 
+200 bp   5.25    4.14 
+100 bp   4.25    1.88 
-100 bp   2.25    -1.43 
-200 bp   1.25    -4.39 
-300 bp   .25    -6.57 

 

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-term 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.

 

52
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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.

 

Recent Accounting Developments

 

In January 2014, the FASB issued ASU 2014-01, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Corporation is currently assessing the impact that ASU 2014-01 will have on its consolidated financial statements.

 

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.

 

53
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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.

 

In June 2014, the FASB issued ASU 2014-10, “Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation”. The amendments in this ASU remove all incremental financial reporting requirements from U.S. GAAP for development stage entities, including the removal of Topic 915, “Development Stage Entities”, from the FASB Accounting Standards Codification. In addition, this ASU adds an example disclosure and removes an exception provided to development stage entities in Topic 810, “Consolidation”, for determining whether an entity is a variable interest entity. The presentation and disclosure requirements in Topic 915 will no longer be required for the first annual period beginning after December 15, 2014. The revised consolidation standards are effective for annual periods beginning after December 15, 2015. Early adoption is permitted. The Corporation does not expect the adoption of ASU 2014-10 to have a material impact on its consolidated financial statements.

 

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.

 

54
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

 

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.

 

In August 2014, the FASB issued ASU No. 2014-14, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure”. The amendments in this ASU apply to creditors that hold government-guaranteed mortgage loans and is intended to eliminate the diversity in practice related to the classification of these guaranteed loans upon foreclosure. The new guidance stipulates that a mortgage loan be derecognized and a separate other receivable be recognized upon foreclosure if (1) the loan has a government guarantee that is not separable from the loan prior to foreclosure, (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the other receivable should be measured on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. Entities may adopt the amendments on a prospective basis or modified retrospective basis as of the beginning of the annual period of adoption; however, the entity must apply the same method of transition as elected under ASU 2014-04. Early adoption is permitted provided the entity has already adopted ASU 2014-04. The Corporation is currently assessing the impact that ASU 2014-14 will have on its consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. This update is intended to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The Corporation does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.

 

55
 

 

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

 

September 30, 2014

 

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.

 

 

PART II. OTHER INFORMATION

 

Item 1.Legal Proceedings

 

N/A

 

Item 1ARisk 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 4Mine Safety Disclosures

 

N/A

 

Item 5.Other Information

 

N/A

 

Item 6.Exhibits

 

See index to exhibits.

 

56
 

 

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: November 14, 2014 By   /s/ Brenda H. Smith
    Brenda H. Smith
    President and Chief Executive Officer
    Corporate Secretary
     
Date: November 14, 2014 By   /s/ Lisa J. Correll
    Lisa J. Correll
    Senior Vice President and Chief Financial Officer

 

57
 

 

Index to Exhibits

 

Number   Description of Exhibit
     

2.1

 

  Agreement and Plan of Reorganization between American National Bankshares Inc. and MainStreet BankShares, Inc. dated August 24, 2014 incorporated by reference to the Corporation’s 8-K filed August 28, 2014.
     
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.
     
22   Definitive Proxy Statement filed with the Securities and Exchange Commission on November 3, 2014 and herein incorporated by reference.
     
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.

 

58