MainStreet Bancshares, Inc.: Form 10-Q for the period ended Sep 30, 2023
Filed with the SEC on Nov 13, 2023 and accepted by EDGAR at Nov 13, 2023, 12:09 ET.
Management's discussion and analysis
As filed, 73,863 characters, with its headings, lists and tables. Extracted from the main document; charts and exhibits are in the original on sec.gov.
The following discussion and analysis is intended as a review of significant factors affecting the Company’s consolidated financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the related notes and the Company’s Annual Report on Form 10-K, which contains audited consolidated financial statements of the Company as of and for the year ended December 31, 2022, previously filed with the SEC on March 23, 2023. Results for the three and nine months ended September 30, 2023 are not necessarily indicative of results for the year ending December 31, 2023 or any future period.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements and information relating to the Company within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on the beliefs of management as well as assumptions made by and information currently available to management. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe,” “expect,” “anticipate,” “estimate,” and “intend” or future or conditional verbs such as “will,” “should,” “could,” or “may” and similar expressions or the negative thereof. Important factors that could cause actual results to differ materially from those in the forward–looking statements included herein include, but are not limited to:
- general economic conditions, either nationally or in our market area, that are worse than expected;
- competition among depository and other financial institutions, particularly intensified competition for deposits;
- inflation and an interest rate environment that may reduce our margins or reduce the fair value of certain of our financial instruments;
- adverse changes in the securities markets;
- changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory structure and in regulatory fees and capital requirements;
- the impact of significant changes in accounting procedures or requirements on our financial condition or results of operations;
- our ability to enter new markets successfully and capitalize on growth opportunities;
- our ability to successfully integrate acquired and newly organized entities;
- changes in consumer spending, borrowing and savings habits;
- changes in accounting policies and practices;
- changes in our organization, compensation and benefit plans;
- our ability to attract and retain key employees;
- changes in our financial condition or results of operations that reduce capital;
- changes in the financial condition or future prospects of issuers of securities that we own;
- the concentration of our business in the Northern Virginia as well as the greater Washington, DC metropolitan area and the effect of changes in the economic, political and environmental conditions on those markets;
- adequacy of or increases in the allowance for credit losses;
- cyber threats, attacks or other data security events;
- fraud or misconduct by internal or external parties;
- reliance on third parties for key services;
- deterioration of our asset quality, including an increase in loan delinquencies, problem assets and foreclosures;
- future performance of our loan portfolio with respect to recently originated loans;
- additional risks related to new lines of business, products, product enhancements or services;
- results of examination of us by our regulators, including the possibility that our regulators may require us to increase our allowance for credit losses or to write-down assets or take other supervisory action;
- the effectiveness of our internal controls over financial reporting and our ability to remediate any future material weakness in our internal controls over financial reporting;
- liquidity, interest rate and operational risks associated with our business;
- implications of our status as a smaller reporting company and as an emerging growth company;
- a work stoppage, forced quarantine, or other interruption or the unavailability of key employees; and
- other risk factors and information included in our Annual Report on Form 10-K for the year ended December 31, 2022 and this Quarterly Report on Form 10-Q.
Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein. We caution readers not to place undue reliance on forward-looking statements. The Company disclaims any obligation to revise or update any forward-looking statements contained in this Form 10-Q to reflect future events or developments.
Overview
As used herein, the “Company,” “we,” “our,” and “us” refer to MainStreet Bancshares, Inc. and its subsidiaries, and the “Bank” refers to MainStreet Bank.
MainStreet Bancshares, Inc.
MainStreet Bancshares, Inc. is a bank holding company that owns 100% of MainStreet Bank and MainStreet Community Capital, LLC.
The Company and its subsidiaries are incorporated in and chartered by the Commonwealth of Virginia. The Company’s executive offices are located at 10089 Fairfax Boulevard, Fairfax, Virginia. Our telephone number is (703) 481-4567, and our internet address is www.mstreetbank.com (http://www.mstreetbank.com). The information contained on our website shall not be considered part of this Quarterly Report on Form 10-Q, and the reference to our website does not constitute incorporation by reference of the information contained on the website.
MainStreet Bank
MainStreet Bank is a community commercial bank incorporated in and chartered by the Commonwealth of Virginia. The Bank is a member of the Federal Reserve Bank of Richmond, and its deposits are insured by the FDIC. The Bank opened for business on May 26, 2004, and is headquartered in Fairfax, Virginia. We currently operate six Bank branches; located in Herndon, Fairfax, McLean, Clarendon, Leesburg in Virginia, and one in Washington D.C.
We emphasize providing responsive and personalized services to our clients. Due to the consolidation of financial institutions in our primary market area, we believe there is a significant opportunity for a local bank to provide a full range of financial services. By offering highly professional, personalized banking products and service delivery methods and employing advanced banking technologies, we seek to distinguish ourselves from larger, regional banks operating in our market area and believe we are able to compete effectively with other community banks.
We believe we have a solid franchise that meets the financial needs of our clients and communities by providing an array of personalized products and services delivered by seasoned banking professionals with decisions made at the local level. We believe a significant customer base in our market prefers to do business with a local institution that has a local management team, a local Board of Directors and local founders and that this customer base may not be satisfied with the responsiveness of larger regional banks. By providing quality services, coupled with the opportunities provided by the economies in our market area, we have generated and expect to continue to generate organic growth.
We service Northern Virginia as well as the greater Washington, D.C. metropolitan area. Our goal is to deliver a customized and targeted mix of products and services that meets or exceeds customer expectations. To accomplish this goal, we have deployed a premium operating system that gives customers access to up-to-date banking technology. These systems and our highly skilled staff have allowed us to compete with larger financial institutions. The combination of sophisticated technology and personal service sets us apart from our competition. We strive to be the leading community bank in our market.
We offer a full range of banking services to individuals, small to medium-sized businesses and professionals through both traditional and electronic delivery. We were the first community bank in the Washington, D.C. metropolitan area to offer a full online business banking solution, including remote check scanners on a business customer’s desktop. We offer mobile banking apps for iPhones, iPads and Android devices that provide for remote deposit of checks. In addition, we were the first bank headquartered in the Commonwealth of Virginia to offer CDARS, the Certificate of Deposit Account Registry Service, an innovative deposit insurance solution that provides FDIC insurance on deposits up to $150 million. We believe that enhanced electronic delivery systems and technology increase profitability through greater productivity and cost control and allow us to offer new and better products and services.
Our products and services include: business and consumer checking, premium interest-bearing checking, business account analysis, savings, certificates of deposit and other depository services, as well as a broad array of commercial, real estate and consumer loans. Internet account access is available for all personal and business accounts, internet bill payment services are available on most accounts, and a robust online cash management system is available for business customers.
Avenu
On October 25, 2021, MainStreet Bancshares, Inc. formally introduced Avenu, a division of MainStreet Bank. Avenu represents the Company’s suite of Banking as a Service (“BaaS”) solutions designed to meet the banking needs of Fintech customers. We believe our approach to providing a proprietary BaaS solution is unique. Our transformational subledger combined with our high-touch compliance training goes beyond the industry standards to ensure that our Fintech partners will prosper. This division of MainStreet Bank currently serves money service businesses, payment processers, and BaaS customers and provides the Bank with valuable low-cost deposits and additional streams of fee income. A major component of the BaaS solution includes a fintech core, which is Software as a Service (SaaS). Our SaaS solution has launched with our first beta client.
MainStreet Community Capital, LLC
In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company, to apply for NMTC allocations from the U.S. Department of Treasury’s Community Development Financial Institutions Fund. To promote development in economically distressed areas, the NMTC program was established under the Community Renewal Tax Relief Act of 2000 to provide tax incentives for capital investment in disadvantaged market areas that have not experienced economic expansion. The program establishes a tax credit for investment in a CDE and ongoing compliance with the program is accomplished through a governing board and an advisory board which maintains accountability to residents and businesses in the aforementioned disadvantaged areas. This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”).
Effects of Inflation
The United States is experiencing elevated inflation. In response, the Federal Open Markets Committee (FOMC) raised the Federal Funds rate 425 basis points throughout 2022 and an additional 100 basis points during the first nine months of 2023. In addition to raising the Federal Funds rate, the Federal Reserve may take other means necessary to fulfill its dual mandate.
The effects of rising inflation and the actions of the Federal Reserve, as well as the economy at large may impact the Bank’s customers, including their willingness and ability to repay their obligations, to invest, to save or to spend. This impact could affect the Bank’s customer's general appetite for banking products and the credit health of the Bank’s customer base. The timing and impact of inflation and rising interest rates on our business and related financial results will depend on future developments, which are highly uncertain and difficult to predict.
Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. Critical accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the current period or in future periods.
Following the announcement by the U.K.’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for the London InterBank Offered Rate (LIBOR) after 2021, the Company has opted to use the published Secured Overnight Funding Rate (SOFR) as a substitute and replacement for any financial instruments that are or would otherwise be tied to the LIBOR index. The Bank has officially transitioned all instruments away from LIBOR.
Our critical accounting policies involving significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2023, have remained unchanged since our Annual Report on Form 10-K for the year ended December 31, 2022 was filed, unless noted herein. As of January 1, 2023, we have adopted the current expected credit loss standard. Any additional changes are discussed in our Recently Issued Accounting Pronouncements.
Comparison of Statements of Income for the Three Months Ended September 30, 2023 and 2022
General
Total revenue increased $9.4 million to $32.7 million for the three months ended September 30, 2023 from $23.3 million for the three months ended September 30, 2022. These increases in total revenue were offset by increases in total expenses. Total expenses increased $10.8 million to $24.5 million for the three months ended September 30, 2023 from $13.7 million for the three months ended September 30, 2022. The increase in revenue for the three months ended September 30, 2023 was primarily due to increases in loan interest income of $9.5 million over the same period in 2022. Income was positively impacted by interest earned on federal funds sold, which earned $204,000 in additional interest for the three months ended September 30, 2023 than the same period in 2022. These increases in income were offset by increases in interest expense of $9.3 million and $1.1 million in salaries and employee benefits for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Net income decreased $1.4 million to $6.3 million for the three months ended September 30, 2023 from $7.7 million for the three months ended September 30, 2022.
Interest Income
Total interest income increased $9.8 million, or 44.6%, to $31.7 million for the three months ended September 30, 2023 from $21.9 million for the three months ended September 30, 2022, on a tax equivalent basis. The increase was primarily the result of an increase in interest and fees on loans of $9.5 million and an increase in interest on federal funds sold of $204,000. Total average interest-earning assets increased $124.6 million, to $1.87 billion for the three months ended September 30, 2023 from $1.74 billion for the same period in 2022 primarily because of an increase of $218.8 million in the average balance of loans and was offset by a decrease of $87.5 million in the average balance of federal funds sold and a $6.7 million decrease in the average balance of investment securities. The average yield on our interest-earning assets increased 175 basis points to 6.76% for the three months ended September 30, 2023 as compared to 5.01% for the three months ended September 30, 2022 primarily because of higher average yields on interest earning assets due to market conditions, and the Federal Reserve increasing the benchmark interest rates by 525 basis points over the course of the previous eighteen months.
Interest and fees on loans increased $9.5 million, to $29.8 million for the three months ended September 30, 2023 from $20.3 million for the same period in 2022. This increase was primarily due to an increase in the average yield on loans and the average loans outstanding increasing $218.8 million, which increased to $1.67 billion for the three months ended September 30, 2023 from $1.45 billion for the three months ended September 30, 2022. The average yield on loans increased 153 basis points, or 27.5%, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. The Federal Reserve increased the federal funds target interest rate by 25 basis points during the quarter so we expect our asset sensitive balance sheet to continue to benefit from the current rate environment.
Interest income on federal funds sold and interest-earning deposits increased by $0.2 million to $1.2 million for the three months ended September 30, 2023, from $1.0 million for the three months ended September 30, 2022. The increase was primarily due to an increase in the average yield on these deposits despite the average balances decreasing over the same time period. The average balance of interest-earning deposits and federal funds sold decreased $87.5 million to $94.8 million for the three months ended September 30, 2023 from $182.3 million for the same period in 2022. The average yield increased to 5.09% for the three months ended September 30, 2023 from 2.20% for the same period in 2022.
Interest on investment securities increased by $90,000 to $798,000 for the three months ended September 30, 2023 from $708,000 for the three months ended September 30, 2022 on a fully tax-equivalent basis. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals increased in total $60,000, or 19.0%, to $377,000 for the three months ended September 30, 2023, from $317,000 for the three months ended September 30, 2022. Interest on mortgage-backed securities decreased by $5,000, or 4.5%, to $108,000 for the three months ended September 30, 2023, from $114,000 for the three months ended September 30, 2022. Subordinated debt interest income increased by $3,000, or 2.0%, to $135,000 for the three months ended September 30, 2023, from $132,000 for the three months ended September 30, 2022. The average yield on taxable securities increased 67 basis points, to 2.70% and the average yield on tax-exempt securities increased 12 basis points, to 3.56% on a tax equivalent basis for the three months ended September 30, 2023, from 2.03% and 3.44%, respectively, for the same period in 2022. Increased market rates resulted in investment income rising despite the average balance of investment securities decreasing by $6.7 million, to $105.3 million for the three months ended September 30, 2023, from $112.0 million for the three months ended September 30, 2022.
Interest Expense
Total interest expense increased $9.3 million, to $13.1 million for the three months ended September 30, 2023 from $3.8 million for the three months ended September 30, 2022, primarily due to a $5.3 million increase in interest expense on time deposits and a $3.7 million increase in interest expense on money market deposits. There were additional increases in interest expense primarily due to the increase in average outstanding balances of advances on FHLB borrowings that were included in the three months ended September 30, 2023 over the three months ended September 30, 2022
Interest expense on deposits increased $9.1 million to $12.1 million for the three months ended September 30, 2023 from $3.0 million for the three months ended September 30, 2022 primarily as a result of an increase in average interest-bearing deposit yields and balances. The increase in average deposit balances was $258.2 million to $1.24 billion during the three months ended September 30, 2023 as compared to $981.6 million for the three months ended September 30, 2022. The increase in the average balance of interest-bearing deposits was primarily a result of a $156.6 million increase in the average balance of money market deposit accounts and by a $124.6 million increase in the average balance of time deposits. The average cost of deposits was 386 basis points for the three months ended September 30, 2023, compared to 121 basis points for the three months ended September 30, 2022. The average rate paid on money market deposits increased 322 basis points to 3.99% for the three months ended September 30, 2023 from 0.77% for the three months ended September 30, 2022. The average rate paid on interest-bearing demand deposits increased 50 basis points to 1.24% for the three months ended September 30, 2023 from 0.74% for the three months ended September 30, 2022 primarily due to market competition and the interest rate environment. The average cost of certificates of deposit increased by 269 basis points to 4.26% for the three months ended September 30, 2023 as compared to 1.57% for the three months ended September 30, 2022. The decrease in the average balance of non interest-bearing demand deposits for the three months ended September 30, 2023, primarily was the result of depositors looking for higher yielding products and market competition.
Net Interest Income
Net interest income increased approximately $0.5 million, or 2.7%, to $18.6 million for the three months ended September 30, 2023 from $18.1 million for the three months ended September 30, 2022 despite our net interest-earning assets decreasing $149.9 million to $537.4 million for the three months ended September 30, 2023 from $687.3 million for the three months ended September 30, 2022. The interest rate spread tightened by 73 basis points to 2.84% for the three months ended September 30, 2023 from 3.57% for the three months ended September 30, 2022, on a tax equivalent basis. The net interest margin compressed by 17 basis points from 4.14% for the three months ended September 30, 2022 to 3.97% for the three months ended September 30, 2023 on a tax equivalent basis. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net interest margin.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are based on daily balances.
(Dollars in thousands)
| Interest-earning assets: | For the Three Months Ended September 30, 2023 Average Balance | Interest Income/ Expense(6) | Yield/ Cost(5)(6) | 2022 Average Balance | Interest Income/ Expense(6) | Yield/ Cost(5)(6) |
|---|---|---|---|---|---|---|
| Loans(1) | $1,665,474 | $29,750 | 7.09% | $1,446,679 | $20,261 | 5.56% |
| Investment securities: | ||||||
| Taxable | 67,513 | 459 | 2.70% | 73,914 | 378 | 2.03% |
| Tax-exempt | 37,812 | 339 | 3.56% | 38,074 | 330 | 3.44% |
| Federal funds and interest-bearing deposits | 94,808 | 1,217 | 5.09% | 182,331 | 1,013 | 2.20% |
| Total interest-earning assets | 1,865,607 | $31,765 | 6.76% | 1,740,998 | $21,982 | 5.01% |
| Non-interest-earning assets | 63,883 | 61,479 | ||||
| Total assets | $1,929,490 | $1,802,477 | ||||
| Interest-bearing liabilities: | ||||||
| Interest-bearing demand deposits | $77,047 | $240 | 1.24% | $93,569 | $175 | 0.74% |
| Savings and NOW deposits | 48,594 | 145 | 1.18% | 55,100 | 43 | 0.31% |
| Money market deposits | 413,710 | 4,156 | 3.99% | 257,091 | 496 | 0.77% |
| Time deposits | 700,405 | 7,526 | 4.26% | 575,832 | 2,275 | 1.57% |
| Total interest-bearing deposits | 1,239,756 | 12,067 | 3.86% | 981,592 | 2,989 | 1.21% |
| Federal funds purchased | 2,501 | 35 | 5.55% | 2 | — | — |
| Federal Home Loan Bank advances | 13,478 | 186 | 5.48% | — | — | — |
| Subordinated debt | 72,504 | 828 | 4.53% | 72,107 | 828 | 4.56% |
| Total interest-bearing liabilities | 1,328,239 | $13,116 | 3.92% | 1,053,701 | $3,817 | 1.44% |
| Non-interest-bearing liabilities: | ||||||
| Demand deposits and other liabilities | 388,004 | 558,337 | ||||
| Total liabilities | 1,716,243 | 1,612,038 | ||||
| Stockholders’ equity | 213,247 | 190,439 | ||||
| Total liabilities and stockholders’ equity | $1,929,490 | $1,802,477 | ||||
| Net interest income | $18,649 | $18,165 | ||||
| Interest rate spread(2) | 2.84% | 3.57% | ||||
| Net interest-earning assets(3) | $537,368 | $687,297 | ||||
| Net interest margin(4) | 3.97% | 4.14% | ||||
| Average interest-earning assets to average interest-bearing liabilities | 140.5% | 165.23% |
(1) Includes loans classified as non-accrual
(2) Interest rate spread represents the difference between the average yield on average interest–earning assets and the average cost of average interest-bearing liabilities.
(3) Net interest earning assets represent total average interest–earning assets less average interest–bearing liabilities.
(4) Net interest margin represents net interest income divided by total average interest-earning assets.
(5) Annualized.
(6) Income and yields for all periods presented are reported on a tax-equivalent basis using the federal statutory tax rate of 21%. Refer to “Use of Certain Non-GAAP Financial Measures.”
Rate/ Volume Analysis
The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior average volume). The volume column shows the effects attributable to changes in volume (changes in average volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, . The Total Increase (Decrease) column represents the sum of the prior columns.
(Dollars in thousands)
| Interest-earning assets: | For the Three Months Ended September 30, 2023 and 2022 Increase (Decrease) Due to Volume | Rate | Total Increase (Decrease) |
|---|---|---|---|
| Loans | $3,365 | $6,124 | $9,489 |
| Investment securities: | |||
| Taxable | (189) | 270 | 81 |
| Tax-exempt | (14) | 23 | 9 |
| Federal funds and interest-bearing deposits | (2,766) | 2,970 | 204 |
| Total interest-earning assets | 396 | 9,387 | 9,783 |
| Interest-bearing liabilities: | |||
| Interest-bearing demand deposits | (180) | 245 | 65 |
| Savings and NOW accounts | (34) | 136 | 102 |
| Money market deposit accounts | 465 | 3,195 | 3,660 |
| Time deposits | 589 | 4,662 | 5,251 |
| Total deposits | 840 | 8,238 | 9,078 |
| Fed funds purchased | 35 | — | 35 |
| Federal Home Loan Bank advances | 186 | — | 186 |
| Subordinated debt | 20 | (20) | — |
| Total interest-bearing liabilities | 1,081 | 8,218 | 9,299 |
| Change in net interest income | $(685) | $1,169 | $484 |
Provision for Credit Losses
Management believes that the provision recorded for the period ended September 30, 2023 reflects a balance sufficient to provide for each allowance segment, using objective data and information available to us at this time in evaluating our standard analysis of local/national economic data, changes in underwriting quality, portfolio concentrations, experience of lending team, credit quality and supportable forecasts. We will continuously review the credit portfolio to determine the depth and breadth of potential credit losses. As we obtain additional information and to more accurately assess the full nature and extent of elevated risk to the credit portfolio that may arise, additional provision expenses may be required.
The provision for credit losses, which is an operating expense, is maintained to ensure that the allowance for credit losses is maintained at levels we consider necessary and appropriate to absorb expected credit losses at a balance sheet date. In determining the level of the allowance for credit losses on loans and off-balance sheet credit exposure, we consider past and current loss experience, evaluations of real estate collateral, current and future economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available over time or economic conditions change. This evaluation is inherently subjective, as it requires estimates and assumptions that are susceptible to significant revision as circumstances change or as more information becomes available. The allowance for credit losses is assessed monthly and provisions are made for credit losses as required in order to maintain the overall allowance.
The provision for credit losses on loans decreased by $98,000 to a recovery for credit losses on loans of $98,000 for the three months ended September 30, 2023 from a provision for credit losses on loans of $0 for the three months ended September 30, 2022. Loan originations, which totaled approximately $83.2 million for the three months ended September 30, 2022 increased $8.8 million to $92.0 million for the three months ended September 30, 2023. Despite loan originations increasing, the Company noted that many lines of credit were paid down during the quarter, which lowered the provision for loan losses for the period ended 2023 compared to 2022. The Company noted that a majority of this provision just shifted and increased the provision for unfunded commitments as of September 30, 2023. The Company did not have any non-performing loans at September 30, 2022 and non-performing loans to gross loans was only 0.02% as of September 30, 2023.
The provision for credit losses on off-balance sheet credit exposure increased by $353,000 for the three months ended September 30, 2023.
During the three months ended September 30, 2023, there was one loan downgraded to special mention for $16.0 million. Substandard and doubtful loans remained consistant as of September 30, 2023 for a collective balance of $10.7 million. Of the substandard loans as of September 30, 2023, 79% are connected to the hospitality industry. These loans were initially impacted by the pandemic and were downgraded out of an abundance of caution while cash flows and occupancy levels have continued to increase to pre-pandemic levels. Management does not believe there will be losses associated with these credits. During the three months ended September 30, 2023, watch list loans, which are considered pass credits, improved by $35.6 million to $56.3 million as of September 30, 2023. As interest rates have risen significantly over the last eighteen months, management believes in taking a proactive approach to risk management in the loan portfolio. While these credits do not represent expected losses, management will take a more active monitoring role to ensure any potential risk is mitigated. During the three months ended September 30, 2023, there was $324,000 in charge-offs incurred for one credit, and recoveries of $1,000 were received.
Non-Interest Income
Non-interest income decreased $385,000, or 28.6%, to $963,000 for the three months ended September 30, 2023 from $1.3 million for the three months ended September 30, 2022. The decrease in non-interest income was primarily due to decreases in fee income earned on originating loan swaps in the three months ended September 30, 2023 compared to the same period in 2022. The Company also recognized a nonrecurring operating loss on a new market tax credit equity investment during the quarter of $87,000. The Company continues to focus on increasing fee income as it strategically benefits our customers.
Non-Interest Expense
Non-interest expense increased $1.5 million, or 15.5%, to $11.4 million for the three months ended September 30, 2023 from $9.9 million for the three months ended September 30, 2022 primarily because of increases in salary and employee benefits of $1.1 million and other various operating expenses of $1.3 million. Salaries and employee benefits expense increased by $1.1 to $6.9 million for the three months ended September 30, 2023 from $5.9 million for the three months ended September 30, 2022 primarily as a result of twenty-eight new employees and the related salary and benefit expenses for these additional employees. Franchise taxes increased approximately $93,000 to $459,000 for the three months ended September 30, 2023 from $366,000 for the three months ended September 30, 2022 because of the make up of the Company’s capital as of September 30, 2023 compared to the balance sheet as of September 30, 2022. Offsetting these increases was a decrease in advertising and marketing expenses decreased $127,000, or 18.0%, to $577,000 for the three months ended September 30, 2023 from $704,000 for the three months ended September 30, 2022 due to timing and new initiatives to further enhance the Company's brand.
Income Tax Expense
Income tax expense decreased $292,000, or 16.2%, to a tax expense of $1.5 million for the three months ended September 30, 2023 from a tax expense of $1.8 million for the three months ended September 30, 2022. The decrease in federal income tax expense for the three months ended September 30, 2023 compared to the same period a year ago was driven by the decrease in income before income taxes of $1.7 million, to income before income tax of $7.9 million for the three months ended September 30, 2023 compared to income before income tax expense of $9.6 million for the same period in the prior year. The Company was able to apply and claim a research and development tax credit of approximately $242,000 for its associated work in developing a software platform in 2022. The Company also invests in projects that have tax credit benefits in order to help reduce it's overall tax liability. As a result of expanding its footprint, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $212,000 for the three months ended September 30, 2023. For the three months ended September 30, 2023, the Company had an effective income tax expense rate of 19.3%, compared to an effective income tax expense rate of 18.9% for the three months ended September 30, 2022.
Comparison of Statements of Income for the Nine Months Ended September 30, 2023 and 2022
General
Total revenue increased $32.0 million to $93.8 million for the nine months ended September 30, 2023 from $61.8 million for the nine months ended September 30, 2022. These increases in total revenue were offset by increases in total expenses. Total expenses increased $29.1 million to $66.1 million for the nine months ended September 30, 2023 from $37.0 million for the nine months ended September 30, 2022. The increase in revenue for the nine months ended September 30, 2023 was primarily due to increases in net interest income of $9.5 million over the same period in 2022. Income was positively impacted by interest earned on federal funds sold, which earned $2.3 million in additional interest for the nine months ended September 30, 2023 than the same period in 2022. These increases in income were offset by increases of $4.1 million in salaries and employee benefits for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Net income increased $2.3 million to $21.4 million for the nine months ended September 30, 2023 from $19.1 million for the nine months ended September 30, 2022.
Interest Income
Total interest income increased $33.0 million, or 56.8%, to $91.0 million for the nine months ended September 30, 2023 from $58.1 million for the nine months ended September 30, 2022 ,on a tax equivalent basis. The increase was primarily the result of an increase in interest and fees on loans of $30.4 million and an increase in interest on federal funds sold of $2.3 million. Total average interest-earning assets increased $192.6 million, to $1.85 billion for the nine months ended September 30, 2023 from $1.65 billion for the same period in 2022 primarily because of an increase of $220.4 million in the average balance of loans and was offset by a decrease of $22.8 million in the average balance of federal funds sold and interest-earning deposits and a $5.1 million decrease in the average balance of investment securities. The average yield on our interest-earning assets increased 190 basis points to 6.61% for the nine months ended September 30, 2023 as compared to 4.71% for the nine months ended September 30, 2022 primarily because of higher average yields on interest earning assets due to market conditions, loans related to PPP lending with a rate of 1% paying off, and the Federal Reserve increasing the benchmark interest rates by 525 basis points over the course of the previous eighteen months.
Interest and fees on loans increased $30.4 million, to $85.3 million for the nine months ended September 30, 2023 from $54.9 million for the same period in 2022. This increase was primarily due to an increase in the average yield on loans and the average loans outstanding increasing $220.4 million, which increased to $1.64 billion for the nine months ended September 30, 2023 from $1.42 billion for the nine months ended September 30, 2022. The average yield on loans increased 178 basis points, or 34.4%, for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022. The Federal Reserve increased the federal funds target interest rate by 100 basis points throughout the first nine months of 2023 and we expect our asset sensitive balance sheet to continue to benefit from the current rate environment.
Interest income on federal funds sold and interest-earning deposits increased by $2.3 million to $3.5 million for the nine months ended September 30, 2023, from $1.2 million for the nine months ended September 30, 2022. The increase was primarily due to an increase in the average yield on these deposits despite the average balances decreasing over the same time period. The average balance of interest-earning deposits and federal funds sold decreased $22.8 million to $99.0 million for the nine months ended September 30, 2023 from $121.8 million for the same period in 2022. The average yield increased to 4.76% for the nine months ended September 30, 2023 from 1.36% for the same period in 2022.
Interest on investment securities increased by $249,000 to $2.4 million for the nine months ended September 30, 2023 from $2.1 million for the nine months ended September 30, 2022 on a fully tax-equivalent basis. Interest on investments in U.S Treasury, U.S. Government Agencies, and U.S Municipals increased in total $161,000, or 16.6%, to $1.1 million for the nine months ended September 30, 2023, from $969,000 for the nine months ended September 30, 2022. Interest on mortgage-backed securities decreased by $13,000, or 4.0%, to $308,000 for the nine months ended September 30, 2023, from $321,000 for the nine months ended September 30, 2022. Subordinated debt interest income increased by $7,000, or 1.8%, to $395,000 for the nine months ended September 30, 2023, from $388,000 for the nine months ended September 30, 2022. The average yield on taxable securities increased 60 basis points, to 2.67% and the average yield on tax-exempt securities increased 8 basis points, to 3.56% on a tax equivalent basis for the nine months ended September 30, 2023, from 2.07% and 3.48%, respectively, for the same period in 2022. Increased market rates resulted in investment income rising despite the average balance of investment securities decreasing by $5.1 million, to $107.1 million for the nine months ended September 30, 2023, from $112.2 million for the nine months ended September 30, 2022.
Interest Expense
Total interest expense increased $23.4 million, to $32.1 million for the nine months ended September 30, 2023 from $8.7 million for the nine months ended September 30, 2022, primarily due to a $13.5 million increase in interest expense on time deposits and a $7.5 million increase in interest expense on money market deposits. There were additional increases in interest expense primarily due to the increase in average outstanding balance of our FHLB advances that were included in the nine months ended September 30, 2023 over the nine months ended September 30, 2022.
Interest expense on deposits increased $21.8 million to $28.3 million for the nine months ended September 30, 2023 from $6.5 million for the nine months ended September 30, 2022 primarily as a result of an increase in average interest-bearing deposit yields and balances. The increase in average interest-bearing deposit balances was $238.0 million to $1.16 billion during the nine months ended September 30, 2023 as compared to $917.8 million for the nine months ended September 30, 2022. The increase in the average balance of interest-bearing deposits was primarily a result of a $75.0 million increase in the average balance of money market deposit accounts and by a $188.1 million increase in the average balance of time deposits. The average cost of deposits was 327 basis points for the nine months ended September 30, 2023, compared to 94 basis points for the nine months ended September 30, 2022. The average rate paid on money market deposits increased 298 basis points to 3.38% for the nine months ended September 30, 2023 from 0.40% for the nine months ended September 30, 2022. The average rate paid on interest-bearing demand deposits increased 90 basis points to 1.43% for the nine months ended September 30, 2023 from 0.53% for the nine months ended September 30, 2022 primarily due to market competition and the interest rate environment. The average cost of time deposits increased by 221 basis points to 3.58% for the nine months ended September 30, 2023 as compared to 1.37% for the nine months ended September 30, 2022. The decrease in the average balance of interest-bearing demand deposits for the nine months ended September 30, 2023, primarily was the result of depositors looking for higher yielding products and market competition.
The average balance of subordinated debt increased $9.6 million for the nine months ended September 30, 2023, due to an additional $43.9 million issued in late March of 2022 and was fully captured in the nine months ended September 30, 2023.
Net Interest Income
Net interest income increased approximately $9.5 million, or 19.8%, to $58.9 million for the nine months ended September 30, 2023 from $49.4 million for the nine months ended September 30, 2022 despite our net interest-earning assets decreasing $68.5 million to $581.0 million for the nine months ended September 30, 2023 from $649.4 million for the nine months ended September 30, 2022. The interest rate spread decreased by 34 basis points to 3.22% for the nine months ended September 30, 2023 from 3.56% for the nine months ended September 30, 2022, on a tax equivalent basis. The net interest margin increased by 27 basis points from 4.01% for the nine months ended September 30, 2022 to 4.28% for the nine months ended September 30, 2023 on a tax equivalent basis. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net interest margin.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are based on daily balances.
(Dollars in thousands)
| Interest-earning assets: | For the Nine Months Ended September 30, 2023 Average Balance | Interest Income/ Expense (6) | Yield/ Cost(5)(6) | 2022 Average Balance | Interest Income/ Expense(6) | Yield/ Cost(5)(6) |
|---|---|---|---|---|---|---|
| Loans(1) | $1,640,460 | $85,336 | 6.95% | $1,420,013 | $54,900 | 5.17% |
| Investment securities: | ||||||
| Taxable | 69,260 | 1,384 | 2.67% | 73,496 | 1,136 | 2.07% |
| Tax-exempt | 37,876 | 1,009 | 3.56% | 38,703 | 1,008 | 3.48% |
| Federal funds and interest-bearing deposits | 99,004 | 3,528 | 4.76% | 121,832 | 1,241 | 1.36% |
| Total interest-earning assets | 1,846,600 | $91,257 | 6.61% | 1,654,044 | $58,285 | 4.71% |
| Non-interest-earning assets | 62,832 | 71,361 | ||||
| Total assets | $1,909,432 | $1,725,405 | ||||
| Interest-bearing liabilities: | ||||||
| Interest-bearing demand deposits | $78,018 | $834 | 1.43% | $86,836 | $345 | 0.53% |
| Savings and NOW deposits | 50,382 | 400 | 1.06% | 66,714 | 122 | 0.24% |
| Money market deposits | 328,037 | 8,285 | 3.38% | 252,992 | 766 | 0.40% |
| Time deposits | 699,377 | 18,747 | 3.58% | 511,242 | 5,236 | 1.37% |
| Total interest-bearing deposits | 1,155,814 | 28,266 | 3.27% | 917,784 | 6,469 | 0.94% |
| Federal funds purchased | 6,878 | 274 | 5.33% | 2 | — | — |
| Federal Home Loan Bank advances | 30,531 | 1,105 | 4.84% | 24,011 | 83 | 0.46% |
| Subordinated debt | 72,405 | 2,460 | 4.54% | 62,807 | 2,108 | 4.49% |
| Total interest-bearing liabilities | 1,265,628 | $32,105 | 3.39% | 1,004,604 | $8,660 | 1.15% |
| Non-interest-bearing liabilities: | ||||||
| Demand deposits and other liabilities | 436,157 | 531,115 | ||||
| Total liabilities | 1,701,785 | 1,535,719 | ||||
| Stockholders’ Equity | 207,647 | 189,686 | ||||
| Total liabilities and stockholders’ equity | $1,909,432 | $1,725,405 | ||||
| Net interest income | $59,152 | $49,625 | ||||
| Interest rate spread(2) | 3.22% | 3.56% | ||||
| Net interest-earning assets(3) | $580,972 | $649,440 | ||||
| Net interest margin(4) | 4.28% | 4.01% | ||||
| Average interest-earning assets to average interest-bearing liabilities | 145.90% | 164.65% |
(1) Includes loans classified as non-accrual
(2) Interest rate spread represents the difference between the average yield on average interest–earning assets and the average cost of average interest-bearing liabilities.
(3) Net interest earning assets represent total average interest–earning assets less average interest–bearing liabilities.
(4) Net interest margin represents net interest income divided by total average interest-earning assets.
(5) Annualized.
(6) Income and yields for all periods presented are reported on a tax-equivalent basis using the federal statutory tax rate of 21%. Refer to “Use of Certain Non-GAAP Financial Measures.”
Rate/ Volume Analysis
The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior average volume). The volume column shows the effects attributable to changes in volume (changes in average volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately. The Total Increase (Decrease) column represents the sum of the prior columns.
(In thousands)
| Interest-earning assets: | For the Nine Months Ended September 30, 2023 and 2022 Increase (Decrease) Due to Volume | Rate | Total Increase (Decrease) |
|---|---|---|---|
| Loans | $9,459 | $20,977 | $30,436 |
| Investment securities: | |||
| Taxable | (105) | 353 | 248 |
| Tax-exempt | (29) | 30 | 1 |
| Federal funds and interest-bearing deposits | (418) | 2,705 | 2,287 |
| Total interest-earning assets | 8,907 | 24,065 | 32,972 |
| Interest-bearing liabilities: | |||
| Interest-bearing demand deposits | (61) | 550 | 489 |
| Savings and NOW accounts | (54) | 332 | 278 |
| Money market deposit accounts | 288 | 7,231 | 7,519 |
| Time deposits | 2,509 | 11,002 | 13,511 |
| Total deposits | 2,682 | 19,115 | 21,797 |
| Federal funds purchased | 274 | — | 274 |
| Federal Home Loan Bank advances | 31 | 1,074 | 1,105 |
| Subordinated debt | 328 | 24 | 352 |
| Total interest-bearing liabilities | 3,315 | 20,213 | 23,528 |
| Change in net interest income | $5,592 | $3,852 | $9,444 |
Provision for Credit Losses
Management believes that the provision recorded for the period ended September 30, 2023 reflects a balance sufficient to provide for each allowance segment, using objective data and information available to us at this time in evaluating our standard analysis of local/national economic data, changes in underwriting quality, portfolio concentrations, experience of lending team, credit quality and supportable forecasts. We will continuously review the credit portfolio to determine the depth and breadth of potential credit losses. As we obtain additional information and to more accurately assess the full nature and extent of elevated risk to the credit portfolio that may arise, additional provision expenses may be required.
The provision for credit losses, which is an operating expense, is maintained to ensure that the allowance for credit losses is maintained at levels we consider necessary and appropriate to absorb expected credit losses at a balance sheet date. In determining the level of the allowance for credit losses on loans and off-balance sheet credit exposure, we consider past and current loss experience, evaluations of real estate collateral, current and future economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available over time or economic conditions change. This evaluation is inherently subjective, as it requires estimates and assumptions that are susceptible to significant revision as circumstances change or as more information becomes available. The allowance for credit losses is assessed monthly and provisions are made for credit losses as required in order to maintain the overall allowance.
The provision for credit losses on loans decreased by $346,000 to a provision for credit losses on loans of $934,000 for the nine months ended September 30, 2023 from a provision for credit losses on loans of $1.3 million for the nine months ended September 30, 2022. Loan originations, which totaled approximately $227.7 million for the nine months ended September 30, 2022 increased $108.0 million to loan originations of $335.7 million for the nine months ended September 30, 2023. The Company did not have any non-performing loans at September 30, 2022 and non-performing loans to gross loans was only 0.02% as of September 30, 2023.
The provision for credit losses on off-balance sheet credit exposure increased by $242,000 for a provision of credit losses on off-balance sheet credit exposure of $1.6 million for the nine months ended September 30, 2023.
During the nine months ended September 30, 2023, there was one loan downgraded to special mention for $16.0 million. Substandard and doubtful loans increased $1.2 million as of September 30, 2023 for a balance of $10.4 million. Of the substandard loans as of September 30, 2023, 79% are connected to the hospitality industry. These loans were initially impacted by the pandemic and were downgraded out of an abundance of caution while cash flows and occupancy levels have continued to increase to pre-pandemic levels. Management does not believe there will be losses associated with these credits. During the nine months ended September 30, 2023, watch list loans, which are considered pass credits, increased $32.7 million. As the rates have risen significantly over the last eighteen months, management believes in taking a proactive approach to risk management in the loan portfolio. While these credits do not represent expected losses, management will take a more active monitoring role to ensure any potential risk is mitigated. During the nine months ended September 30, 2023, there were $331,000 in charge-offs incurred, and recoveries of $14,000 were received.
Non-Interest Income
Non-interest income decreased $996,000, or 26.4%, to $2.8 million for the nine months ended September 30, 2023 from $3.8 million for the nine months ended September 30, 2022. The decrease in non-interest income was primarily due to decreases in mortgage origination and fee income on loan swaps originated in the nine months ended September 30, 2023 compared to the same period in 2022. The Company also recognized operating losses on a new market tax credit equity investments during the year of $176,000. The Company continues to focus on increasing fee income as it strategically benefits our customers.
Non-Interest Expense
Non-interest expense increased $5.6 million, or 19.9%, to $34.0 million for the nine months ended September 30, 2023 from $28.3 million for the nine months ended September 30, 2022 primarily because of increases in salary and employee benefits of $4.1 million and advertising and marketing expenses of $388,000. Salaries and employee benefits expense increased by $4.1 million to $21.1 million for the nine months ended September 30, 2023 from $17.0 million for the nine months ended September 30, 2022 primarily as a result of twenty-eight new employees and the related salary and benefit expenses for these additional employees. Advertising and marketing expenses increased $388,000, or 23.0%, to $2.1 million for the nine months ended September 30, 2023 from $1.7 million for the nine months ended September 30, 2022 due to timing and new initiatives to further enhance the Company's brand. Franchise taxes increased approximately $311,000 to $1.4 million for the nine months ended September 30, 2023 from $1.1 million for the nine months ended September 30, 2022 because of the make up of the Company’s capital as of September 30, 2023 compared to the balance sheet as of September 30, 2022. Offsetting these increases was a decrease in furniture and equipment expenses of $93,000, or 4.4%, to $2.0 million for the nine months ended September 30, 2023 from $2.1 million for the nine months ended September 30, 2022 due to more normalized expense levels for furniture and equipment.
Income Tax Expense
Income tax expense increased $657,000, or 14.7%, to a tax expense of $5.1 million for the nine months ended September 30, 2023 from a tax expense of $4.5 million for the nine months ended September 30, 2022. The increase in federal income tax expense for the nine months ended September 30, 2023 compared to the same period a year ago was driven by the increase in income before income taxes of $3.0 million, to income before income tax of $26.6 million for the nine months ended September 30, 2023 compared to income before income tax expense of $23.6 million for the same period in the prior year. The Company was able to apply and claim a research and development tax credit of approximately $242,000 for its associated work in developing a software platform in 2022. The Company also invests in projects that have tax credit benefits in order to help reduce it's overall tax liability. As a result of expanding its footprint, the Company has included assessments in income tax expense for potential state tax liabilities which totaled $675,000 for the nine months ended September 30, 2023. For the nine months ended September 30, 2023, the Company had an effective income tax expense rate of 19.3%, compared to an effective income tax expense rate of 18.9% for the nine months ended September 30, 2022.
Comparison of Statements of Financial Condition at September 30, 2023 and December 31, 2022
Total Assets
Total assets increased $95.7 million, or 5.0%, to $2.0 billion at September 30, 2023 from $1.93 billion at December 31, 2022. The increase was primarily the result of increases in the loan portfolio of $101.5 million and was offset by a decrease in federal funds sold of $9.4 million as of September 30, 2023.
Investment Securities
Investment securities decreased $9.7 million, or 9.3%, from $104.6 million at December 31, 2022 to $94.9 million at September 30, 2023. The decrease was primarily due to normal paydown of available-for-sale securities, amortization of certain restricted stock securities, and fluctuations in balances of restricted stock held in connection to FHLB advances. At September 30, 2023, our held-to-maturity portion of the securities portfolio, at amortized cost, was $17.6 million, and our available-for-sale portion of the securities portfolio, at fair value, was $56.7 million compared to our held-to-maturity portion of the securities portfolio of $17.6 million and our available-for-sale portion of the securities portfolio of $62.6 million at December 31, 2022.
Net Loans
Net loans increased $101.5 million, or 6.4%, to $1.68 billion at September 30, 2023 from $1.58 billion at December 31, 2022. Residential real estate loans increased $68.5 million, or 17.4%, to $462.9 million at September 30, 2023 from $394.4 million at December 31, 2022. Commercial real estate loans increased by $33.9 million from $700.7 million at December 31, 2022 to $734.6 million at September 30, 2023. Commercial and industrial loans decreased by $23.5 million from $97.4 million at December 31, 2022 to $73.9 million at September 30, 2023. Paycheck Protection Program ("PPP") loans comprised $1.0 million of this portfolio as of September 30, 2023. Construction loans increased $32.9 million to $426.7 million at September 30, 2023 from $393.8 million at December 31, 2022. Consumer loans decreased by $8.7 million from $13.3 million at December 31, 2022 to $4.6 million at September 30, 2023. The $8.7 million decrease in consumer loans is primarily a result of management’s decision to let the indirect lending portfolio amortize off the balance sheet.
Allowance for Credit Losses - Loans
The allowance for credit losses on loans represents an amount that, in our judgment, will be adequate to absorb current and expected losses in the loan portfolio. The provision for credit losses on loans increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The table below summarizes the allowance activity for the periods indicated:
(Dollars in thousands)
| For the Nine Months Ended September 30, 2023 | For the Year Ended December 31, 2022 | |
|---|---|---|
| Balance at beginning of year | $14,114 | $11,697 |
| Impact of adopting ASC 326 | 895 | — |
| Charge-offs: | ||
| Commercial and industrial | (325) | — |
| Consumer | (6) | — |
| Total charge-offs | (331) | — |
| Recoveries: | ||
| Residential real estate | 8 | — |
| Consumer | 6 | 19 |
| Total recoveries | 14 | 19 |
| Net (charge-offs) recoveries | (317) | 19 |
| Provision for credit losses - loans | 934 | 2,398 |
| Balance at end of period | $15,626 | $14,114 |
| Ratios: | ||
| Net (charge-offs) recoveries to average loans outstanding | (0.02)% | 0.00% |
| Non-performing loans to allowance for credit losses on loans at end of period | 2.08% | 0.15% |
| Allowance for credit losses on loans to gross loans at end of period | 0.92% | 0.88% |
Nonperforming Assets
The following table presents information regarding nonperforming assets at the dates indicated:
(Dollars in thousands)
| Loans accruing past 90 days: | September 30, 2023 | December 31, 2022 |
|---|---|---|
| Commercial and industrial | $— | $15 |
| Consumer - secured | — | 6 |
| Total loans accruing past 90 days | — | 21 |
| Non-accrual loans | ||
| Commercial and industrial | 325 | — |
| Total non-accrual loans | 325 | — |
| Total non-performing loans | 325 | 21 |
| Other real estate owned | — | — |
| Total non-performing assets | $325 | $21 |
| Ratios: | ||
| Total non-performing loans to gross loans receivable | 0.02% | 0.00% |
| Total non-performing loans to total assets | 0.02% | 0.00% |
| Total non-performing assets to total assets | 0.02% | 0.00% |
Deposits
Deposits increased $170.3 million, or 11.3% to $1.68 billion at September 30, 2023 from $1.51 billion at December 31, 2022. Our core deposits decreased $20.0 million, or 1.7%, to $1.14 billion at September 30, 2023 from $1.16 billion at December 31, 2022. Non-interest bearing demand deposits decreased $155.8 million, or 28.3%, to $394.9 million at September 30, 2023 from $550.7 million at December 31, 2022. Interest bearing demand deposits decreased $3.7 million, or 4.6%, to $76.4 million at September 30, 2023 from $80.1 million at December 31, 2022. Time deposits increased $95.8 million, or 15.8%, to $704.0 million at September 30, 2023 from $608.1 million at December 31, 2022. Money market demand deposits increased $238.9 million, or 107.3%, to $461.4 million at September 30, 2023 from $222.5 million at December 31, 2022. The increase in money market deposit accounts and time deposits were primarily the result of the higher rate environment, deposit competition, and customers looking for additional interest-bearing options.
Liquidity and Capital Resources
Liquidity Management. Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Deposits are the primary source of funds for lending and investing activities. The Company uses wholesale deposits in addition to customer deposits, as funding sources. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB secured advances, other secured borrowings, federal funds purchased, and other short-term unsecured borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. Additional liquidity can be obtained through the Federal Reserve Bank Term Funding Program and discount window. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process. MainStreet Bank had no federal funds purchased outstanding and an additional secured borrowing capacity of $560.3 million as of September 30, 2023. Additionally, at September 30, 2023, we had the ability to borrow up to $129.0 million from other financial institutions.
The Board of Directors, management, and the Asset Liability Committee (ALCO) are responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as of September 30, 2023.
We monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand; expected deposit flows; yields available on interest-earning deposits and securities; and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short-and intermediate-term securities.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents, which include federal funds sold and interest-earning deposits in other banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2023, cash and cash equivalents totaled $121.2 million. The Company has availability on secured and unsecured lines for an additional $689.3 million. Finally, securities classified as available-for-sale, which provide additional sources of liquidity, totaled $56.7 million at September 30, 2023.
Our cash flows are provided by and used in three primary activities: operating activities, investing activities, and financing activities. Net cash provided by operating activities was $26.3 million and $22.9 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. There were no sales of securities in the nine months ended September 30, 2023 or for nine months ended September 30, 2022. Net cash used in investing activities, which consist primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans and proceeds from maturing securities, was $102.1 million and $186.2 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. Net cash provided by financing activities was $66.4 million and $174.9 for the nine months ended September 30, 2023 and 2022, respectively, which consisted primarily of increases in interest bearing deposits of $326.1 million for the nine months ended September 30, 2023, partially offset by repayments of Federal Home Loan Bank advances of $100.0 million and decreased non-interest bearing deposits of $155.8 million.
We are committed to maintaining a strong liquidity position. We monitor our liquidity position daily. We anticipate that we have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of September 30, 2023, totaled $470.8 million of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other deposits, Federal Home Loan Bank advances and commitments from other financial institutions. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on experience that a significant portion of such deposits will remain with us. We can attract and retain deposits by adjusting the interest rates offered.
Effects of Inflation. In an effort to combat inflation, the Federal Reserve, through the FOMC, increased rates a total of 5.25% during 2022 and through September 30, 2023, which has had a negative effect on the price of existing securities. As a result of rising interest rates, the Company recorded an accumulated other comprehensive loss on securities available for sale of approximately $10.8 million as of September 30, 2023, compared to recording accumulated other comprehensive loss in the amount of $8.5 million as of December 31, 2022. This unrealized loss is counter to total equity growth during 2022 and 2023 that had otherwise strong net earnings. Management does not anticipate the unrealized losses to be other than temporary and they do not reflect credit deterioration within the portfolio.
Capital Management. MainStreet Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2023, MainStreet Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory guidelines.
Regulatory Capital
Information presented for September 30, 2023 and December 31, 2022, reflects the Basel III capital requirements that became effective January 1, 2015 for the Bank. Under these capital requirements and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk- weightings and other factors.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Bank must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer for 2023 and 2022 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2023, the Bank meet all capital adequacy requirements to which each is subject.
The Bank’s actual capital amounts and ratios are presented in the table (dollars in thousands):
(Dollars in thousands)
| As of September 30, 2023 | Actual Amount | Ratio | Capital Adequacy Purposes Amount | Ratio | To Be Well Capitalized Under the Prompt Corrective Action Provision Amount | Ratio |
|---|---|---|---|---|---|---|
| Total capital (to risk-weighted assets) | $307,451 | 16.89% | $145,603 | ≥ 8.0% | $182,004 | > 10.0% |
| Common equity tier 1 capital (to risk-weighted assets) | $290,273 | 15.95% | $81,902 | ≥ 4.5% | $118,303 | > 6.5% |
| Tier 1 capital (to risk-weighted assets) | $290,273 | 15.95% | $109,203 | ≥ 6.0% | $145,603 | > 8.0% |
| Tier 1 capital (to average assets) | $290,273 | 14.97% | $77,560 | ≥ 4.0% | $96,950 | > 5.0% |
| As of December 31, 2022 | ||||||
| Total capital (to risk-weighted assets) | $286,572 | 16.27% | $140,929 | ≥ 8.0% | $176,161 | ≥ 10.0% |
| Common equity tier 1 capital (to risk-weighted assets) | $272,458 | 15.47% | $79,272 | ≥ 4.5% | $114,504 | ≥ 6.5% |
| Tier 1 capital (to risk-weighted assets) | $272,458 | 15.47% | $105,696 | ≥ 6.0% | $140,929 | ≥ 8.0% |
| Tier 1 capital (to average assets) | $272,538 | 15.05% | $72,435 | ≥ 4.0% | $90,544 | ≥ 5.0% |
Off-Balance Sheet Arrangements and Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At September 30, 2023, we had outstanding loan commitments of $361.8 million and $586,000 in outstanding stand-by letters of credit. We anticipate that we will have sufficient funds available to meet our current lending commitments.
Use of Certain Non-GAAP Financial Measures
The accounting and reporting policies of the Company conform to U.S. GAAP and prevailing practices in the banking industry. However, certain non-GAAP measures are used by management to supplement the evaluation of the Company’s performance. These measures include adjusted net interest income and net interest margin.
Management believes that the use of these non-GAAP measures provides meaningful information about operating performance by enhancing comparability with other financial periods and other financial institutions. The non-GAAP measures used by management enhance comparability by excluding the effects of items that do not reflect ongoing operating performance, including non-recurring gains or charges. These non-GAAP financial measures should not be considered an alternative to U.S. GAAP-basis financial statements, and other bank holding companies may define or calculate these or similar measures differently. A reconciliation of the non-GAAP financial measures used by the Company to evaluate and measure the Company’s performance to the most directly comparable U.S. GAAP financial measures is presented below.
(Dollars in thousands, except for per share data)
| Net interest margin, fully-taxable equivalent (FTE) | For the three months ended September 30, 2023 | 2022 | For the nine months ended September 30, 2023 | 2022 |
|---|---|---|---|---|
| Net interest income (GAAP) | $18,578 | $18,096 | $58,940 | $49,413 |
| FTE adjustment on tax-exempt securities | 71 | 69 | 212 | 212 |
| Net interest income (FTE) (non-GAAP) | $18,649 | $18,165 | 59,152 | 49,625 |
| Average interest earning assets | 1,865,607 | 1,740,998 | 1,846,600 | 1,654,044 |
| Net interest margin (GAAP) | 3.95% | 4.12% | 4.27% | 3.99% |
| Net interest margin (FTE) (non-GAAP) | 3.97% | 4.14% | 4.28% | 4.01% |
Market risk
As filed, 3,725 characters, with its headings, lists and tables. Extracted from the main document; charts and exhibits are in the original on sec.gov.
Market Risk Management
The effective management of market risk is essential to achieving the Company’s strategic financial objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in the Company’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value.
Interest Rate Market Risk
The Company’s net interest income and the fair value of its financial instruments are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Committee. The Asset/Liability Committee meets regularly and has responsibility for approving asset/liability management policies, formulating strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company.
We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under different interest rate assumptions. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturity and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on our net interest income.
The table below reflects the results of our Earnings-at-Risk (EaR) stress simulation. The EaR stress simulation is a financial risk management tool that we use to assess our raw exposure to an immediate and sustained change in interest rates up and down 400 basis points. The results focus specifically on the potential impact of each scenario to our net interest income, and help us understand how various risks, such as market fluctuations, economic downturns, or specific events, could affect our ability to generate profits.
Our simulation model uses actual data as of September 30, 2023, and dynamically incorporates Board-approved budget assumptions in order to forecast the impact of stress factors. It is important to note that no other changes are made. The purpose of this simulation is so that management and the Board can make informed decisions that enhance our resilience and long-term viability. In other words, we examine the results of the stress test first to ensure that they are within Board-approved risk tolerance limits and second to determine whether we should make changes to the structure of our earning assets and interest-bearing liabilities.
Finally, as we consider simulation model outputs, we also consider their impact to other risk factors and ultimately to determine whether our capital provides a sufficient cushion to our risk profile.
(Dollars in thousands)
| Basis Point Change in Interest Rates (1) | Net Interest Income Stress Simulation September 30, 2023 Net Interest Income Year 1 Forecast (2) | Year 1 Change From Level |
|---|---|---|
| +400 | $89,054 | 6.47% |
| +300 | $88,483 | 5.78% |
| +200 | $87,157 | 4.20% |
| +100 | $86,028 | 2.85% |
| Level | $83,646 | — |
| -100 | $81,687 | (2.34)% |
| -200 | $80,568 | (3.68)% |
| -300 | $81,795 | (2.21)% |
| -400 | $81,562 | (2.49)% |
(1) Interest rate changes are immediate and sustained for the entire 12-month period
(2) Simulation model assumptions are locked for the entire 12-month period.
Controls and procedures
As filed, 1,316 characters, with its headings, lists and tables. Extracted from the main document; charts and exhibits are in the original on sec.gov.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2023. Based on their evaluation of the Company’s disclosure controls and procedures, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and regulations are designed and operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) occurred during the third fiscal quarter of 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. There has been no significant effect or impact on internal controls over financial reporting as the Company implemented the current expected credit loss accounting standard.
Risk factors
As filed, 2,050 characters, with its headings, lists and tables. Extracted from the main document; charts and exhibits are in the original on sec.gov.
For detailed information about certain risk factors that could materially affect our business, financial condition, results of operations or prospects, see “Risk Factors” in Part I, Item 1A of our 2022 Annual Report on Form 10-K. Set forth below are additional risk factors.
Defaults by or deteriorating asset quality of other financial institutions could adversely affect us.
Financial institutions are often interrelated as a result of trading, clearing, counterparty, or other relationships. For example, we execute transactions with financial institution counterparties. These transactions may expose us to counterparty credit risk that could ultimately result in a loss on default. Such a loss could have an effect on our financial condition. Further, actions taken by governments and/or regulatory bodies in response to financial crises affecting the banking system and financial markets, such as nationalization, conservatorship, receivership, or other intervention could have an adverse effect.
The results of mainstream media and social media contagion and speculation could impact the banking system and have an adverse effect on us.
The results of poorly executed decisions in a financial institution of significant size can negatively impact other financial institutions, despite the quality of leadership and decision making of the other financial institutions or their ability to effectively identify, measure, manage and control risk.
Misinformed or inaccurate reporting regarding an incident or incidents can impact the broader banking industry. Any adverse financial market or economic condition could be reported in a way to exert downward pressure on the price of financial institution securities and could negatively impact credit availability for certain issuers without regard to their underlying financial strength.
This contagion risk can also occur when a perceived lack of trust in the banking system spreads throughout the industry based upon the results of a few poorly managed larger financial institutions.
Figures reported in this filing
Standardized line items from the XBRL in this filing, for the period ended 2023-09-30. Comparative periods it repeats are left out.
| Line item | Period | Value | XBRL concept |
|---|---|---|---|
| Revenue | 3 months2023-07-01 to 2023-09-30 | $514.0k | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 9 months2023-01-01 to 2023-09-30 | $1.6m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Selling, general and administrative | 3 months2023-07-01 to 2023-09-30 | $277.0k | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 9 months2023-01-01 to 2023-09-30 | $703.0k | us-gaap:SellingGeneralAndAdministrativeExpense |
| Interest expense | 3 months2023-07-01 to 2023-09-30 | $13.1m | us-gaap:InterestExpense |
| Interest expense | 9 months2023-01-01 to 2023-09-30 | $32.1m | us-gaap:InterestExpense |
| Income tax | 3 months2023-07-01 to 2023-09-30 | $1.5m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months2023-01-01 to 2023-09-30 | $5.1m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months2023-07-01 to 2023-09-30 | $6.3m | us-gaap:NetIncomeLoss |
| Net income | 9 months2023-01-01 to 2023-09-30 | $21.4m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months2023-07-01 to 2023-09-30 | $0.77 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months2023-01-01 to 2023-09-30 | $2.64 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months2023-07-01 to 2023-09-30 | $0.77 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months2023-01-01 to 2023-09-30 | $2.64 | us-gaap:EarningsPerShareBasic |
| Operating cash flow | 9 months2023-01-01 to 2023-09-30 | $26.3m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months2023-01-01 to 2023-09-30 | $490.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months2023-01-01 to 2023-09-30 | $2.3m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 9 months2023-01-01 to 2023-09-30 | $43.0k | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Total assets | At period end2023-09-30 | $2.02bn | us-gaap:Assets |
| Total liabilities | At period end2023-09-30 | $1.81bn | us-gaap:Liabilities |
| Shareholders' equity | At period end2023-09-30 | $213.7m | us-gaap:StockholdersEquity |
Source: SEC EDGAR, the filing index for accession 0001437749-23-031495. Last ingested by Listed: Oct 27, 2026, 09:36 ET. Listed shows no prices and gives no investment advice.