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MREE > SEC Filings for MREE > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for MAINSTREET BANKSHARES INC

Form 10-Q for MAINSTREET BANKSHARES INC


13-Nov-2012

Quarterly Report


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 its subsidiary bank, Franklin Community Bank, National Association ("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) branch of Franklin Bank.

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 Bank must comply with the Agreement while it is outstanding. The Bank submitted the responses required in the respective time frames described below. The Bank continues to submit periodic reports and take other actions as required by the Agreement to achieve sustained performance.

Within 30 days, Franklin Bank was required to adopt sublimits for concentrations in acquisition and development loans, speculative lot loans, and speculative single-family housing construction loans and determine if any action was necessary to reduce these concentrations. Franklin Bank reviewed and amended these limits and certain concentrations were lowered.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

September 30, 2012

Within 60 days, Franklin Bank was required to do the following:

Franklin Bank was required to establish an effective program for early identification of emerging and potential problem credits to include accurate ratings, accrual status, continued financial analyses, and formal work out plans. Franklin Bank developed an attestation process monthly for loan officers to include risk rating and the accrual status of their loan portfolios. Franklin Bank has a Problem Loan Committee made up of senior management and one Board Loan Committee director that meets monthly. Criticized loan worksheets were enhanced and 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 on the worksheets. Franklin Bank's internal loan review function reports to the loan committee of the board of directors rather than to management. This committee of the board meets quarterly and reporting has been enhanced to include 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 identification of the loan officer who originated each loan reported; concentrations of credit; and loans to executive officers and directors.

Franklin Bank was required to develop a written underwriting program to include reasonable amortization of speculative lot and single family housing construction loans and ensure updated appraisals are documented. Our credit policy was amended to address the amortization periods. Personnel have been designated to ensure the reporting system has updated appraisals and evaluations. All files were reviewed to ensure correct appraisal information. A credit analyst position was created in December 2008. The 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, new software was purchased to assist with this process and to assist the credit analyst and lenders in the risk rating of loans.

Franklin Bank also had to eliminate the basis of criticism of assets criticized by the OCC. Franklin Bank has dedicated an experienced employee to work through problem assets. The other actions described above also assist in achieving compliance with this requirement. Franklin Bank continually strives to lower its problem assets.

Franklin Bank was required to enhance its asset liability management policy to ensure monitoring of its liquidity position which included more detailed reporting to the Board. The Agreement also required Franklin Bank to increase its liquidity immediately and to take action to ensure adequate sources of liquidity. Franklin Bank increased its sources by adding correspondent bank lines; becoming a member of QwickRate (an internet certificate of deposit program); becoming a member of the Certificate of Deposit Account Registry Service ("CDARS"); and partnering with certain institutions to acquire brokered deposits. According to the Agreement, brokered deposits cannot exceed 15% of total deposits. At September 30, 2012 and December 31, 2011, brokered deposits were $5.3 million and $6.9 million, respectively, and were less than 5% of total deposits in both comparisons. Franklin Bank also participated loans during the first half of 2009 which improved our liquidity. Franklin Bank revised its Contingency Liquidity Plan to include crises relevant to current balance sheet composition. New reports created to assist with asset liability and liquidity include a maturity schedule of certificates of deposit; the volatility of demand deposits; loan commitments and letters of credit; borrowing lines and continued availability; an analysis of the impact of decreased cash flow from the loss of income from nonperforming loans and loans sold or participated; rolling sources and uses report; rollover risk analysis; and prioritization of funding sources and uses. Franklin Bank was required to review and enhance the analysis of the allowance for loan losses. The Bank has continued to review and enhance the process.

Within 90 days, Franklin Bank was required to develop and implement a three-year detailed capital plan. The Plan was put in place and is continually updated as appropriate. The plan includes detailed projections for growth and capital requirements; projections for primary sources and secondary sources of capital; and a revised dividend policy. The Agreement prohibits the Bank from paying dividends until compliance with the program and certain other conditions are met.

Under the Agreement, a Compliance Committee of three members of the Franklin Bank's Board of Directors was formed to monitor the progress and make regular reports to the OCC. Failure to comply with the provisions of the Agreement could subject Franklin Bank and its directors to additional enforcement actions. The Compliance Committee of Franklin Bank continues to meet monthly to ensure adherence and compliance with the Agreement.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

September 30, 2012

The Compliance Committee reviews the Agreement by article in detail at each meeting along with the corresponding actions of Franklin Bank within each article. The Committee reports monthly to the full board of directors. While Franklin Bank intends to continue to take such actions as may be necessary to enable it to comply with the requirements of the Agreement, there can be no assurance that it will be able to comply fully with the provisions of the Agreement. Such compliance is costly and affects the operations of Franklin Bank and the Corporation. Franklin Bank has met all of the required time lines for submission of information to the OCC along with regular reporting. Franklin Bank must demonstrate sustained performance under the Agreement.

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. The MOU restricted MainStreet from declaring or paying any dividends without the prior written approval of the Federal Reserve. Under the MOU, MainStreet cannot incur or guarantee any debt or redeem or purchase any shares of its common stock without the prior written consent of the Federal Reserve. Since then, MainStreet has not paid or declared any dividends or incurred or guaranteed any debt. On January 26, 2011, the MOU with the Federal Reserve was replaced with a new MOU which includes the same provisions as the prior MOU and also requires MainStreet to comply with the restrictions on indemnification and severance payments of section 18(k) of the FDI Act (12 U.S.C. 1828(k)) and Part 359 of the Federal Deposit Insurance Corporation's regulations (12 C.F.R. Part 359). Also, the Corporation may not appoint any individual to the board or employ or change the responsibilities of any individual as senior executive officer if the Federal Reserve notifies the Corporation of disapproval within the required time limits. Management believes the holding company is appropriately using its financial and managerial resources to assist Franklin Bank to function in a safe and sound manner.

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. 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 collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions and other risks inherent in the portfolio. Management reviews the past due reports and risk-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a 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, then, 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.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

September 30, 2012

Overview

Total assets at September 30, 2012 were $186.2 million compared to $203.9 million at year-end December 31, 2011, a decline of $17.7 million. Our balance sheet has declined since year-end due to our continued strategy to lower our deposit costs and due to the repayment of our $7.5 million repurchase agreement in September 2012. In addition, the resolution of problem credits and soft loan demand have caused our loans to decline. At September 30, 2012, loans, net of unearned deferred fees and costs, declined $6.5 million from year-end 2011 and $1.9 million from the prior quarter end. Securities available for sale remained stable with year end balances despite purchases of $9.9 million; however, the purchases were offset by pay downs on mortgage backed securities and called securities. Deposits declined $10.7 million. 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 2011 by $9.6 million, primarily due to the purchase of securities, offset by pay downs on mortgage backed securities and called securities, and the repayment of our $7.5 million repurchase agreement. Liquidity continues to be an important focus for our Company during these tumultuous times and our liquid assets were 20.75% of total liabilities at September 30, 2012 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 deposits. We maintained our core relationships as can be evidenced by the increase 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; however, these asset quality levels have improved significantly since year-end 2011 and since the first quarter of 2012. We transferred $2.2 million of loans into other real estate and other repossessed assets during the first nine months of 2012. None the less, our other real estate properties declined to $1.5 million at September 30, 2012 compared to $3.6 million at December 31, 2011. As can be seen by the addition of properties, but overall decline in balance at quarter end, we have sold approximately $4.3 million of properties in other real estate and have approximately $.9 million in additional properties under contract.

Total shareholders' equity was $22.5 million at September 30, 2012. MainStreet and Franklin Bank were well capitalized at September 30, 2012 under bank regulatory capital classifications. The book value of shareholders' equity at September 30, 2012 was $13.15 per share.

Our year-to-date net income at September 30, 2012 was $186,643, or $.11 per basic share. This income equated to an annualized return on average assets of .13% and an annualized return on average shareholders' equity of 1.10%. Net loss for the same period in 2011 was $(254,091), or $(.15) per basic share. This equated to an annualized loss on average assets and annualized loss on average shareholders' equity of (.16%) and (1.53%), respectively. Credit related expenses such as 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. In addition, the lack of loan volume has negatively impacted loan fee income and interest income. Provision expense, other real estate and repossession expenses, write downs and losses on sales together accounted for $1,282,601 and $2,234,350 in expense for the nine month periods ending September 30, 2012 and September 30, 2011, respectively.

Net loss for the third quarter of 2012 was $(32,701), or $(.02) per basic share compared to net income of $74,312, or $.04 per basic share, for the third quarter of 2011. Provision expense and other real estate and repossession expenses, write-downs and losses on sale together were $614,199 for the third quarter of 2012 compared to $537,683 for the third quarter of 2011. Credit related issues continue to have a negative impact on our Company's net income.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

September 30, 2012

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 period ending September 30, 2012 and 2011 was $4,817,382 and $5,244,071, respectively, a decline of $426,689, or 8.14%. Both interest income and interest expense dollars dropped in comparison to last year, primarily due to volume and the lowering of deposit costs. The decline in interest income was also due to an increase in lost interest income on nonaccrual loans. For the nine months ending September 30, 2012 and 2011, the net interest margin was 3.49% and 3.55%, respectively, a 6 basis point decrease. The yield on interest earning assets for the year-to-date period ending September 30, 2012 was 4.53% compared to 4.89% for the year-to-date period ending September 30, 2011, a decline of 36 basis points. However, the funding side of the interest margin also dropped during this time period by a favorable 30 basis points in the year-to-year comparison. We engaged a consultant to assist us in the lowering of our deposit costs. We have realized the positive impact of our strategic effort.

The yield on interest earning assets has declined due to the interest rate environment, lack of loan demand reducing loan fee income, and continued lost interest on nonaccrual loans. Lost interest for the period ending September 30, 2012 and 2011 was $212,715 and $377,314, respectively. Franklin Bank's growth is also quite dependent on the recovery in consumer and real estate based lending and there is concern over the timing of recoveries in these markets given the current economic environment. Franklin Bank's future growth and earnings may be negatively affected if real estate and consumer based markets remain depressed or deteriorate further.

The low interest rate environment continues with the Federal Reserve leaving short-term interest rates within a range of 0% - .25%. This low rate environment has been in effect since 2008. The Federal Reserve has also indicated that interest rates will remain at this level throughout 2015. Franklin Bank has a portfolio of variable rate loans. A rising interest rate environment generally has a positive impact on the net interest margin because deposits rates are slower to increase. Although low interest rates have been beneficial for our cost of funds, with prime presently at 3.25% which is the interest rate basis for many of our loans, MainStreet's net interest margin has been adversely affected by the prolonged, recessionary low interest rate environment.

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

Net interest income for the three month period ending September 30, 2012 and 2011 was $1,622,620 and $1,725,866, respectively, a decline of $103,246, or 5.98%. This equated to a net interest margin of 3.52% and 3.57% at September 30, 2012 and 2011, 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 collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk ratings and discusses individually the loans on these reports with the responsible loan officers. Management provides a detailed quarterly analysis of the allowance based on homogenous loan pools, identifying impairment, historical losses, credit concentrations, economic conditions, and other risks. As the allowance is maintained losses are, in turn, charged to this allowance rather than being reported as a direct expense.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

September 30, 2012

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 three-year average (twelve quarters) 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 2012 and 2011 was $(33,249) and $1,344,113, respectively. Our loan portfolio, net of unearned deferred fees and costs, declined $6.5 million or 4.52% from year-end 2011. Due to the decline in volumes of our adverse rated and impaired loans offset by the increase in collectively evaluated pools, we have not provided any additional dollars this year to our loan loss reserve based on our quarterly detailed allowance calculation as discussed above. Gross charge-offs year-to-date 2012 were $989,260 compared to $1,720,824 year-to-date 2011. We transferred $2.2 million from loans to other real estate and other repossessed assets during the year-to-date period ending September 30, 2012. Based on updated appraisals we received on these properties, along with other loans, we charged off the balance noted above. The allowance for loan losses was $2.4 million at September 30, 2012 and $3.3 million at December 31, 2011, a decline of $.9 million due to charge offs, declining provision expense and some modest recoveries. The allowance for loan losses was 1.76% and 2.29% of loans net of unearned at September 30, 2012 and December 31, 2011, respectively. Our criticized and classified loans that are evaluated by historical loss migration declined $3.8 million at September 30, 2012 compared to year-end 2011. The loans evaluated collectively by pools increased $1.2 million at September 30, 2012 versus December 31, 2011. Impaired loans evaluated individually were $4.9 million and $8.8 million at September 30, 2012 and December 31, 2011, respectively, with specific reserves of $123,000 and $818,572, respectively. The decline in the allowance for loan losses to loans, net of unearned deferred fees, from year end 2011 was primarily because the volumes of our adverse rated loans and our impaired loans declined. The allowance for loan losses was not replenished by $989,260 of gross charge offs because the loans were provided for in our allowance for loan losses at year-end 2011. The unallocated amount increased $11,890 from year-end 2011. Net charge-offs of $830,707 and $1,634,279 for the nine months of 2012 and 2011 equated to .80% and 1.41%, respectively, of average loans outstanding net of unearned income and deferred fees. The amount of charge-offs can fluctuate substantially based on the financial condition of the borrowers, business conditions in the borrower's market, collateral values and other factors which are not capable of precise projection at any point in time.

MAINSTREET BANKSHARES, INC. AND SUBSIDIARIES

September 30, 2012

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