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Item7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the years ended December 31, 2022 and 2021. The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Company. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.

Forward-Looking Statements

This Annual Report on Form 10-K 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:

• adverse changes in the securities markets;

• our ability to successfully integrate acquired entities;

• changes in consumer spending, borrowing and savings habits;

• changes in accounting policies and practices;

• changes in our organization, compensation and benefit plans;

• our ability to attract and retain key employees;

• adequacy of our allowance for credit losses;

• deterioration of our asset quality;

• cyber threats, attacks or events

• reliance on third parties for key services

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

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-K to reflect future events or developments. The discussion of the critical accounting policies and analysis set forth below is intended to supplement and highlight information contained in the accompanying Consolidated Financial Statements and the selected financial data presented elsewhere in this Form 10-K.

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.

The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry. The Company’s critical accounting policies relate to (1) the allowance for loan losses, (2) fair value of financial instruments, and (3) derivative financial instruments. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.

Allowance for Loan Losses: Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses inherent in the loan portfolio. Management performs periodic and systematic detailed reviews of its loan portfolio to identify trends and to assess the overall collectability of the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.

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

Estimates for the allowance for loan losses are determined by analyzing historical losses, historical migration to charge-off experience, current trends in delinquencies and charge-offs, the results of regulatory examinations and changes in the size, composition and risk assessment of the loan portfolio. Also included in management’s estimate for the allowance for loan losses are considerations with respect to the impact of current economic events. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which the Company conducts business.

While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates. A detailed discussion of the methodology used in determining the allowance for loan losses is included in Note 1, Basis of Presentation, in Notes to Consolidated Financial Statements.

Fair Value of Financial Instruments: A portion of the Company’s assets and liabilities is carried at fair value, with changes in fair value recorded either in earnings or accumulated other comprehensive income (loss). These include investment securities available for sale and interest rate loan swaps on qualifying commercial loans. Periodically, the estimation of fair value also affects investment securities held to maturity when it is determined that an impairment write-down is other than temporary. Fair value determination is also relevant for certain other assets such as other real estate owned, which is recorded at the lower of the recorded balance or fair value, less estimated costs to sell. The determination of fair value also impacts certain other assets that are periodically evaluated for impairment using fair value estimates, including impaired loans.

Fair value is generally based upon quoted market prices, when available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use observable market-based parameters as inputs. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as other unobservable parameters. Any such valuation adjustments are applied consistently over time. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

See Note 20, Fair Value Presentation, in Notes to Consolidated Financial Statements for a detailed discussion of determining fair value, including pricing validation processes.

Derivative Financial Instruments: The Bank recognizes derivative financial instruments at fair value as either other assets or other liabilities in the consolidated balance sheet. The Bank’s derivative financial instruments include interest rate swaps with certain qualifying commercial loan customers and dealer counterparties. Because the interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Bank’s interest rate swaps with loan customers and dealer counterparties are described more fully in Note 19 in the December 31, 2022, Consolidated Financial Statements.

Selected Financial Data

The following table sets forth summarized historical consolidated financial information for each of the periods indicated. This information should be read together with the accompanying consolidated financial statements included in this Form 10-K. The historical information indicated as of and for the years ended December 31, 2022,and 2021 has been derived from the Company's audited consolidated financial statements for the years ended December 31, 2022, and 2021. Historical results set forth below and elsewhere in this Form 10-K are not necessarily indicative of future performance

At December 31,

(In thousands)

Selected Financial Condition Data:

Computer software, net of amortization 9,149 2,493

FHLB advances and other borrowings 100,000 —

For the year ended December 31,

(In thousands)

Selected Operating Data:

Provision for (recovery of) loan losses 2,398 (1,175 )

Net interest income after provision for (recovery of) loan losses 67,611 54,711

Less: Preferred stock dividends 2,156 2,156

Net income available to common shareholders $ 24,518 $ 20,015

Basic and diluted net income per common share $ 3.26 $ 2.65

At or For the Years Ended December 31,

Performance Ratios:

Return on average assets 1.53 % 1.32 %

Interest rate spread 3.66 % 2.94 %

Net interest margin (1) 4.19 % 3.33 %

Non-interest expense to average assets 2.24 % 1.95 %

Per share Data and Shares Outstanding

Earnings per common share (basic and diluted) $ 3.26 $ 2.65

Book value per common share $ 22.98 $ 21.27

Dividends per common share $ 0.25 $ —

Tangible book value per common share $ 21.75 $ 20.94

Market value per common share $ 27.49 $ 24.59

Capital Ratios (Bank)

Common equity tier 1(CET1) capital to risk-weighted assets 15.47 % 15.23 %

Total risk-based capital to risk-weighted assets 16.27 % 16.06 %

Tier 1 capital to risk-weighted assets 15.47 % 15.23 %

Tier 1 capital to average assets 15.05 % 12.90 %

Asset Quality Ratios

Allowance for loan losses as a percentage of total loans 0.88 % 0.86 %

Allowance for loan losses as a percentage of non-performing assets N/A 15.09

Net charge-offs to average outstanding loans during the period 0.00 % 0.00 %

Non-performing loans as a percentage of total loans 0.00 % 0.00 %

Non-performing assets as a percentage of total assets 0.00 % 0.05 %

Other Data:

Common equity / total assets 8.88 % 9.80 %

Total equity / total assets 10.30 % 11.46 %

Average equity to average assets 10.94 % 10.63 %

Number of offices 6 6

Number of full-time equivalent employees 168 138

Analysis of Results of Operations for the Years Ended December 31, 2022 and 2021

Net Income

The following table sets forth the principal components of net income for the periods indicated.

For the Year Ended December 31,

(In thousands)

Net income for the year ended December 31, 2022, was $26.7 million, an increase of $4.5 million, or 20.3% compared to $22.2 million earned during the year ended December 31, 2021. The increase in net income was due to $16.5 million of additional net interest income, primarily driven by increased volume of loans and increase in interest rates. The increase net interest income was offset by an increase in non-interest expenses of $6.2 million primarily in salaries and employee benefits and general operating expenses.

Net Interest Income and Net Interest Margin

Net interest income is the principal component of the Company’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest margin, stated as a percentage, is the yield obtained by dividing the difference between interest income generated on earning assets and the interest expense paid on all funding sources by average earning assets. Fluctuations in interest rates as well as changes in the volume and mix of earning assets and interest-bearing liabilities can impact net interest income and net interest margin.

Net interest income before provision for or recovery of loan losses totaled $70.0 million for the year ended December 31, 2022, compared to $53.5 million for the year ended December 31, 2021. The increase in net interest income was driven by an increase in loan production and increase in interest rates on variable rate credits and loans that repriced during the year ended December 31, 2022.

The net interest margin was 4.19% for the year ended December 31, 2022, compared to 3.35% for the year ended December 31, 2021, on a fully tax equivalent basis. The increase in net interest margin primarily resulted from an increase of income on our interest earning assets that outpaced the increase on average rates of our cost of funds, primarily in interest-bearing deposits, money market deposits and other borrowings. The increase in the federal funds target rate will impact wholesale deposits that will reprice in a higher interest rate environment, which will increase margin pressure on our loan portfolio and other interest earning assets.

The yield for the year ended December 31, 2022 for the loan portfolio was 5.47% compared to 4.79% for the year ended December 31, 2021. The increase primarily reflects the maturity of lower yielding loans and higher yields on new and variable rate loans based on higher interest rates during the year. The Federal Reserve increased its targeted benchmark interest rate 425 - 450 basis points by the year end, which impacted yields obtained on new loans throughout the year.

For the year ended December 31, 2022, the yield on the taxable investment securities portfolio was 2.20% compared to 2.08% for the year ended December 31, 2021. For the year ended December 31, 2022, the yield on the tax-exempt investment securities portfolio was 3.48% compared to 3.42% for the year ended December 31, 2021. The increase in both categories was primarily due to rates on variable securities increasing with the current rate environment and lower yields on investment securities maturing during the period.

The rate paid on interest bearing deposits increased to 1.14% during the year ended December 31, 2022, from 0.90% during the year ended December 31, 2021. This increase was a result of higher rates paid on all outstanding deposits in conjunction with the increasing rate environment throughout the year.

The rate paid on FHLB borrowings for the year ended December 31, 2022 was 1.45% compared to the prior year when the bank did not have any FHLB borrowings outstanding.

The following table sets forth the major components of net interest income and the related yields and rates for the year ended December 31, 2022, compared to the year ended December 31, 2021.

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.

For the Year Ended December 31,

(Dollars in thousands)

Interest-earning assets:

Investment securities

Interest-bearing liabilities:

Federal funds purchased 2 — — — — —

Non-interest-bearing liabilities:

Interest rate spread (2) 3.66 % 2.96 %

Net interest margin (4) 4.19 % 3.35 %

(1) Includes loans classified as non-accrual.

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 volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

For the Twelve Months Ended

Increase (Decrease) Due to Total Increase

Volume Rate (Decrease)

(In thousands)

Interest-earning assets:

Federal funds and interest-bearing deposits (79 ) 2,257 2,178

Interest-bearing liabilities:

Interest-bearing demand deposits $ 73 $ 299 $ 372

Savings and NOW deposits (28 ) 66 38

Federal Home Loan Bank advances 347 — 347

Provision for Loan Losses

We establish a provision for loan losses, which is charged to operations, in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimated at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available or economic conditions change.

This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for loan losses is assessed on a monthly basis and provisions are made for loan losses as required in order to maintain the allowance.

The provision for loan losses increased to a loan loss provision of $2.4 million for the year ended December 31, 2022, compared to the prior year which ended as a recovery of loan loss provision of $1.2 million. The increase is a return to a normal provision for loan losses due to loan growth. The prior year was a direct result of recovering the special COVID-19 pandemic provision that was provisioned for in 2021. Loan originations increased $24.4 million, which totaled $575.6 million for the year ended December 31, 2021 compared to loan originations of $599.9 million for the year ended December 31, 2022. Non-performing loans were $0 at December 31, 2021 and $21,000 at December 31, 2022.

On September 22, 2022, the Company completed the sale of a loan note for a customer that had stopped making payments and declared bankruptcy. The Company incurred a loss of $211,000 on this transaction that was properly accounted for in its Statement of Income as a loss on the sale of a loan. This credit had previously identified weaknesses and deemed to be of substandard quality with an appropriate reserve allocation. We determined that the best course of action was to sell the note at a discount to an interested party. Had the loan sale not occurred, the Company would have recorded a specific allocation to the provision for loan losses and proceeded with an orderly liquidation of collateral.

During the year ended December 31, 2022, substandard loans increased $4.2 million for a balance of $9.5 million. During the year ended December 31, 2022, special mention loans decreased $16.9 million to $0. During the year ended December 31, 2022, watch list loans decreased $45.6 million to $25.0 million. Management does not believe any loss currently exists in these loans. During the year ended December 31, 2022, there were no charge-offs and recoveries of $19,000 were received. During the year ended December 31, 2021, there were $32,000 in charge-offs recorded and recoveries received of $27,000.

Non-Interest Income

Our primary sources of non-interest income are service charges on deposit accounts, such as interchange fees and statement fees, income earned on bank owned life insurance, fees earned from executing interest rate swaps on commercial loans, and gains realized on the sale of the guaranteed portion of Small Business Administration (“SBA”) loans.

The following table presents, for the periods indicated, the major categories of non-interest income:

For the Year Ended December 31,

(In thousands)

Non-interest income

Net gain on called held-to-maturity securities 4 6 -33.33 %

Non-interest income decreased $1.3 million, or 20.9%, to $4.8 million for the year ended December 31, 2022 from $6.1 million for the year ended December 31, 2021. The decrease in non-interest income was primarily due to mortgage originations and other loan fees were down $382,000 and $528,000, respectively for the year ended December 31, 2022. Fees earned on interest rate swaps for commercial loans increased $536,000, or 645.8%, to $619,000 for the year ended December 31, 2022 from $83,000 for the year ended December 31, 2021. This increase was purely related to the volume of interest rate swaps entered into during 2021 compared to 2022. Bank owned life insurance income increased $108,000 for the year ended December 31, 2022, compared to the year ended December 31, 2021, due to the rising rate environment throughout 2022. The deposit service fees largely remained consistent for the year ended December 31, 2022, as compared to the same period in 2021.

Non-Interest Expense

Generally, non-interest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest component of non-interest expense is salaries and employee benefits. Non-interest expense also includes operational expenses, such as occupancy and equipment expenses, professional fees, advertising expenses and other general and administrative expenses, including FDIC assessments, communications, travel, meals, training, supplies and postage. The following table presents, for the periods indicated, the major categories of non-interest expense:

For the Year Ended December 31,

(In thousands)

Non-interest expense

Other real estate expenses, net 38 84 -54.76 %

Non-interest expense increased $6.2 million or 18.8% to $39.1 million for the year ended December 31, 2022 from $32.9 million for the year ended December 31, 2021 primarily as a result of increases in salary and employee benefits of $4.5 million, advertising and marketing expenses of $739,000 and outside services of $681,000. Salaries and employee benefits expense increased by $4.5 million to $23.8 million for the year ended December 31, 2022 from $19.3 million for the year ended December 31, 2021 primarily as a result of increasing our personnel team members by 30 employees. Advertising and marketing increased $739,000, or 47.2%, to $2.3 million for the year ended December 31, 2022 from $1.6 million for the year ended December 31, 2021. Outside service expenses increased $681,000, or 48.9%, to $2.1 million for the year ended December 31, 2022, due to investments in the Company’s payments division and other technological infrastructure. Offsetting these increases, our FDIC insurance decreased approximately $414,000 to $637,000 for the year ended December 31, 2022 from $1.1 million for the year ended December 31, 2021. This decrease was attributed to continued financial strength that resulted in a reduction of FDIC assessments.

Income Tax Expense

Income tax expense increased $929,000, or 16.1%, to $6.7 million for the year ended December 31, 2022 from $5.8 million for the year ended December 31, 2021. The increase in federal income tax expense for the year ended December 31, 2022 compared to the same period a year earlier was driven by the increase in income before income taxes of $5.4 million, or 19.4%, to $33.4 million as of December 31, 2022 compared to $28.0 million for the same period in the prior year. The Company is able to apply and claim a research and development tax credit for its associated work in developing a software platform. In addition, the Company has invested in projects that generate tax credits through the Low Income Housing Tax Credits ("LIHTC") program as well as NMTC projects. As a result of tax regulation, the Company has included assessments in income tax expense for state tax liabilities during 2022. For the year ended December 31, 2022, the Bank had an effective tax rate of 20.1%, compared to effective federal tax rate of 20.7% for the year ended December 31, 2021.

Analysis of Results of Operations for the Year Ended December 31, 2022

Net Income

The following table sets forth the principal components of net income (loss) for the Avenu division of MainStreet Bank for the periods indicated. All amounts set forth are included in the Results of Operations for the Year Ended December 31, 2022 and 2021 for MainStreet Bancshares, Inc. unless indicated otherwise.

For the Year Ended December 31,

(In thousands)

Income Statement

For the year ended December 31, 2022, the Avenu division recorded a net loss of $433,000. As the Company develops the software and ramps up the resources needed to operate a new division, elevated levels of non-interest expenses were anticipated. The Avenu division held $62.9 million in average non-interest bearing deposits which provides tremendous value to the Company, while simultaneously establishing a new division. Avenu is developing a comprehensive hosted BaaS software platform that will provide Fintechs with a subledger integrated within a regulatory compliant framework, easily connectable application programming interfaces ("APIs"), and access to banking payment networks. The goal for the Avenu team is to deploy the platform in 2023.

Comparison of Statements of Financial Condition at December 31, 2022 and at December 31, 2021

Total Assets

Total assets increased $278.3 million, or 16.9%, to $1.9 billion at December 31, 2022 from $1.6 billion at December 31, 2021. The increase was primarily the result of increases of $240.7 million in gross loans receivable, $37.4 million in cash equivalents, and $25.4 million in other assets. These increases were offset by a decrease in availabe-for-sale securities of $37.3 million, attributable to not purchasing treasury securities as part of our income tax strategy.

Investment Securities

We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital and liquidity requirements. Our investment policy is established and reviewed annually by the Board of Directors. We are permitted under federal law to invest in various types of liquid assets, including United States Government obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities, time deposits of federally insured institutions, subordinated debt of other financial institutions, equity securities, certain bankers’ acceptances and federal funds.

Our investment objectives are to maintain high asset quality, to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. The Board of Directors has the overall responsibility for the investment portfolio, including approval of our investment policy. The Board of Directors is also responsible for implementation of the investment policy and monitoring investment performance. The Board of Directors reviews the status of the investment portfolio on a quarterly basis, or more frequently if warranted.

Generally accepted accounting principles require that, at the time of purchase, we designate a security as held to maturity, available-for-sale, or trading, depending on our ability and intent to hold such security. Debt securities available for sale are reported at fair value, while debt securities held to maturity are reported at amortized cost. We do not maintain a trading portfolio. Establishing a trading portfolio would require specific authorization by the Board of Directors.

The total investment securities portfolio, including both investment securities available for sale and investment securities held to maturity, was $80.3 million at December 31, 2022, a decrease of $40.0 million compared with December 31, 2021. At December 31, 2022, the investment securities portfolio includes $62.6 million of investment securities available for sale and $17.6 million of investment securities held to maturity compared to $99.9 million of investment securities available for sale and $20.3 million of investment securities held to maturity at December 31, 2021.

The Company did not sell any securities within the investment portfolio for the year ended December 31, 2022 or 2021.

While all securities are reviewed by the Company for other-than-temporary impairments (“OTTI”), the securities that typically are impacted by credit impairment are non-agency collateralized mortgage obligations and asset-backed securities. Refer to Note 3, in Notes to Consolidated Financial Statements for further details. To date, we have had no OTTI.

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2022, are summarized in the following table. Maturities are based on the final contractual payment date, and do not reflect the effect of scheduled principal repayments, prepayments, or early redemptions that may occur. Adjustable-rate mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust. The Company does invest in both taxable and non-taxable municipal securities. No material changes occurred in the non-taxable security portfolio for the year ended December 31, 2022.

More than One Year More than Five Years More than

One Year or Less through Five Years through Ten Years Ten Years Total

Weighted Weighted Weighted Weighted Weighted

Cost Yield (1) Cost Yield (1) Cost Yield (1) Cost Yield (1) Cost Value Yield (1)

(Dollars in thousands)

Securities available for sale:

Municipal Securities

Securities held to maturity:

Municipal Securities

Loan Portfolio

Our primary source of income is derived from interest earned on loans. Our loan portfolio consists of loans secured by real estate as well as commercial business loans and consumer loans, substantially all of which are secured by corresponding deposits at the Bank. Our loan customers primarily consist of small- to medium-sized businesses, professionals, real estate investors, small residential builders and individuals. Our owner occupied and investment commercial real estate loans, residential construction loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals. Our lending activities are principally directed to our market area consisting of the Washington, D.C. and Northern Virginia metropolitan areas.

Loan Portfolio Maturities and Yields.The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2022. Demand loans, having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. Maturities are based on the final contractual payment date and do not reflect the impact of prepayments and scheduled principal amortization.

Single-Family Multi-Family Farmland Owner Occupied Non-owner Occupied

(In thousands)

Amounts due in:

Amounts due in: (In thousands)

The following table sets forth our fixed and adjustable-rate loans at December 31, 2022, that are contractually due after December 31, 2022.

Fixed Adjustable

Rates Rates Total

(In thousands)

Residential real estate:

Commercial real estate:

Commercial – non-real estate:

Consumer – non-real estate:

The following table shows our loan originations, participations, purchases, sales and repayment activities for the periods indicated.

Years Ended December 31,

(In thousands)

Loans originated:

Real estate loans:

Residential real estate:

Commercial real estate:

Commercial – non-real estate:

Consumer – non-real estate:

Loan principal repayments:

Loans transferred to (from) loans held for sale:

Transfers from loans held for sale — (26,046 )

Loans, net of unearned income, totaled $1.6 billion at December 31, 2022, an increase of $240.7 million from December 31, 2021. The increase in total loans was primarily driven by growth in the overall loan portfolio, with significant increases in multifamily residential real estate, as well as the owner occupied and non-owner occupied commercial real estate portfolio.

Asset Quality

The Company’s asset quality remained strong during the year ended December 31, 2022. Nonperforming assets, which includes nonaccrual loans, accruing loans 90 days past due, accruing troubled debt restructured (“TDR”) loans 90 days past due, and other real estate owned totaled $21,000 at December 31, 2022, and $775,000 million at December 31, 2021.

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

As a percentage of total assets, nonperforming assets were 0.00% at December 31, 2022, compared with 0.05% at December 31, 2021. As of December 31, 2022, the Company had no loans placed on nonaccrual status.

See Note 1, Organization, Basis of Presentation, and Impact of Recently Issued Accounting Pronouncements and Note 5, Allowance for Loan Losses, in Notes to Consolidated Financial Statements for further information on the Company’s credit grade categories, which are derived from standard regulatory rating definitions.

The following table summarizes asset quality information at December 31, 2022, and December 31, 2021.

December 31, December 31,

(Dollars in thousands)

Loans accruing past 90 days:

Commercial and industrial $ 15 $ —

Consumer non real estate - secured 6 —

Total non-performing loans 21 —

Other real estate owned — 775

Total non-performing assets $ 21 $ 775

Ratios:

Total non-performing loans to gross loans receivable 0.00 % 0.00 %

Total non-performing loans to total assets 0.00 % 0.00 %

Total non-performing assets to total assets 0.00 % 0.05 %

There was no interest income that would have been recorded for the years ended December 31, 2022 and 2021 had non-accruing loans been current according to their original terms.

According to United States generally accepted accounting principles, restructuring a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The CARES Act states that from March 1, 2020, until the end of the year (unless the President terminates the COVID-19 emergency declaration sooner), financial institutions may elect to suspend the TDR accounting principles for loan modifications related to COVID-19. The Consolidated Appropriations Act of 2021, enacted in December 2020, extended this relief to the earlier of January 1, 2022, or the first day of a bank’s fiscal year that begins after the national emergency ends.

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

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

As of December 31, 2022, there were no loans not disclosed in the above table, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.

Analysis and Determination of the Allowance for Loan Losses.The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable and estimable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of probable credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loans losses which is charged to expense and reduced by full and partial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is based on various factors, including, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss or loan pools, the fair value of the underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. An integral part of their examination process, the Federal Reserve Board will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses.

The following table sets forth activity in our allowance for loan losses for the periods indicated.

For the Year Ended December 31, For the Year Ended December 31,

(Dollars in thousands)

Charge-offs:

Consumer — (32 )

Total charge-offs — (32 )

Recoveries:

Commercial and industrial — 11

Total recoveries 19 27

Net (charge-offs) recoveries 19 (5 )

Provision for (recovery of) loan losses 2,398 (1,175 )

Ratios:

Net charge offs to average loans outstanding (annualized) 0.00 % 0.00 %

Allowance for loan losses to non-performing loans at end of period 0.15 % N/A

Allowance for loan losses to gross loans at end of period 0.88 % 0.86 %

At December 31, 2022, our allowance for loan losses represented 0.88% of total loans and had only $21,000 in non-performing loans. The allowance for loan losses increased to $14.1 million at December 31, 2022 from $11.7 million at December 31, 2021 as a direct result of normal loan provisions in conjunction with loan growth throughout the year. There were $19,000 in net loan recoveries and $5,000 in net loan charge-offs during the years ended December 31, 2022 and December 31, 2021, respectively.

Allocation of Allowance for Loan Losses.The following table sets forth the allowance for loan losses allocated by loan category and the percent of the allowance in each category to the total allocated allowance at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

At December 31,

Residential Real Estate:

Commercial Real Estate:

Commercial – Non Real Estate:

Consumer – Non Real Estate:

Funding Activities

Deposits are the primary source of funds for lending and investing activities and their cost is the largest category of interest expense. The Company also utilizes brokered deposits as a funding source in addition to customer deposits. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, federal funds purchased, and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process

Deposits

Total deposits increased by $100.9 million from December 31, 2021 to December 31, 2022. Brokered deposits, which are included in the table below, totaled $317.3 million and $245.5 million at December 31, 2022, and December 31, 2021, respectively. The following table presents the Company’s average deposits segregated by major category for the year ended December 31, 2022:

At December 31,

(Dollars in thousands)

Deposit type:

The overall increase in total deposits were primarily driven by an increase in non-interest bearing demand deposits and time deposits largely due to our deposit gather strategies. These increases were partially offset by a decrease in money market deposits. Non-interest bearing deposits increased from December 31, 2022, compared to December 31, 2021 primarily as a result of increased efforts Company wide to replace higher cost of funds with sticky lower cost deposit accounts.

At December 31, 2022, the Company had $486.9 million in total deposits in excess of the FDIC insurance limit of $250,000.

Certificates of deposit in amounts in excess of the FDIC insurance limit of $250,000 totaled approximately $331.3 million. The following table sets forth the maturity of these certificates as of December 31, 2022.

(In thousands)

Maturity period:

Over three through six months 93,817

Over six through twelve months 85,494

Over twelve months through three years 37,984

Over three years —

The following table sets forth all of our time deposits classified by interest rate as of the dates indicated.

At December 31,

(In thousands)

Interest Rate Range:

The following table sets forth by interest rate ranges information concerning the maturities of our certificates of deposit as of December 31, 2022.

Period to Maturity

(Dollars in thousands)

Interest Rate Range:

Borrowed Funds

We may obtain advances from the Federal Home Loan Bank of Richmond upon the security of the common stock we own in that bank and certain of our residential and commercial mortgage loans, provided certain standards related to creditworthiness have been met. These advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. Federal Home Loan Bank advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending.

At December 31, 2022 and 2021, we were permitted to borrow up to an aggregate total of $465.0 million and $414.0 million, respectively, from the Federal Home Loan Bank of Richmond. There were Federal Home Loan Bank borrowings outstanding of $100.0 million and $0 at December 31, 2022, and December 31, 2021, respectively. Additionally, we had credit availability of $104.0 million with correspondent banks for short-term liquidity needs, if necessary. No borrowings were outstanding at December 31, 2022 and 2021, under this facility.

Liquidity and Capital Resources

Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves.

The Company assesses liquidity needs on a daily basis using a sophisticated monitoring system that identifies daily sources and uses for a rolling 30-day period. The Company also assesses liquidity needs under various scenarios of market conditions, asset growth and changes in credit ratings. The assessment includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The assessment provides regular monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity.

The asset portion of the balance sheet provides liquidity primarily through unencumbered debt securities available for sale, loan principal and interest payments, maturities and prepayments of investment securities held to maturity and, to a lesser extent, sales of investment debt securities available for sale. Other short-term investments such as federal funds sold and maturing interest- bearing deposits with other banks, are additional sources of liquidity.

The liability portion of the balance sheet provides liquidity through various customers’ interest-bearing and noninterest-bearing deposit accounts and through FHLB and other borrowings. Brokered deposits, federal funds purchased, and other short-term borrowings are additional sources of liquidity and, basically, represent the Company’s incremental borrowing capacity. These sources of liquidity are used as necessary to fund asset growth and meet short-term liquidity needs.

In addition to the Company’s financial performance and condition, liquidity may be impacted by the Company’s structure as a bank holding company that is a separate legal entity from the Bank. The Company requires cash for various operating needs that could include payment of dividends to its stockholder, the servicing of debt, and the payment of general corporate expenses. The primary source of liquidity for the Company is dividends paid by the Bank. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be paid by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits and other such items. Any future dividends must be set forth in the Company's capital plans before any dividends can be paid.

The Company’s ability to raise funding at competitive prices is affected by the rating agencies’ views of the Company’s credit quality, liquidity, capital and earnings. Management meets with the rating agencies on a routine basis to discuss the current outlook for the Company.

The Board of Director's 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 December 31, 2022.

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

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents, which include federal funds sold and interest-earning deposits in other banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2022, cash and cash equivalents totaled $130.6 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $62.6 million at December 31, 2022.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $33.5 million and $29.1 million for the twelve months ended December 31, 2022, and December 31, 2021, respectively. Net cash used in investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans and proceeds from maturing securities, was $228.7 million and $60.5 million for the twelve months ended December 31, 2022, and December 31, 2021, respectively. There were no sales of available-for-sale debt securities in 2022 or 2021. Net cash provided by financing activities was $232.6 million and used in financing activities was $14.2 million for the twelve months ended December 31, 2022 and 2021, respectively, which consisted primarily of increases in interest bearing deposits and FHLB advances for the twelve months ended December 31, 2022. There were no net repayments from the Federal Home Loan Bank for year ended 2022.

We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of December 31, 2022, totaled $516.9 million of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds in the normal course of business, including other deposits and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered. Management believes that the current sources of liquidity are adequate to meet the Company’s requirements and plans for continued growth.

Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The federal regulatory capital rules apply to all depository institutions as well as to bank holding companies with consolidated assets of $3 billion or more. However, the regulatory capital requirements generally do not apply on a consolidated basis to a bank holding company with total consolidated assets of less than $3 billion unless the holding company: (1) is engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (2) conducts significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; or (3) has a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission. The Federal Reserve may apply the regulatory capital standards at its discretion to any bank holding company, regardless of asset size, if such action is warranted for supervisory purposes.

Because the Company has total consolidated assets of less than $3 billion and does not engage in activities that would trigger application of the federal regulatory capital rules, it is not at present subject to consolidated capital requirements under the such rules.

The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2022 and 2021 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2022, the Company and the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2022 and 2021, the most recent notification from the Federal Reserve Bank of Richmond categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Common Equity Tier 1 risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.

The Bank’s actual regulatory capital amounts and ratios as of December 31, 2022 and 2021 are presented in the table below.

(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio

Non-GAAP Measures

In reporting the results of December 31, 2022, the Company has provided supplemental performance measures on an operating basis. These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be considered in isolation or as a substitute for comparable measures calculated in accordance with GAAP. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company uses the non-GAAP measures discussed herein in its analysis of the Company’s performance.

Net interest margin on a fully tax equivalent (FTE) basis, provides valuable additional insight into the net interest margin and the impact that investments in tax-exempt securities have on our financial metrics. The entire FTE adjustment is attributable to the interest tax effect on tax-exempt securities, using the statutory federal income tax rate of 21%.

The Company believes that tangible common stockholders equity, excluding intangible assets, is a meaningful supplement to GAAP financial measures and useful to investors because it provides an additional measure to calculate the book value of our common shares by removing the value of a subjective portion of our balance sheet.

The following table reconciles these non-GAAP measures from their respective GAAP basis measures for the years ended December 31,

For the year ended December 31,

Net interest margin (FTE)

FTE adjustment on tax-exempt securities 281 282

Net interest margin (GAAP) 4.18 % 3.33 %

Net interest margin (FTE) (non-GAAP) 4.19 % 3.35 %

Stockholders equity, adjusted

Tangible common stockholders equity (non-GAAP) 161,870 159,032

Tangible book value per common share (non-GAAP) $ 21.75 $ 20.94

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

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 sets forth, as of December 31, 2022, the calculation of the estimated changes in our net interest income that would result from changes in market interest rates over one year if we take no action from our current plan.

Basis Point Change in Net Interest Income Year 1 Change

Interest Rates Year 1 Forecast From Level

(Dollars in thousands)

Economic Value of Equity (“EVE”). We analyze the sensitivity of our financial condition to changes in interest rates through our economic value of equity model. This analysis measures the difference between predicted changes in the fair value of our assets and predicted changes in the present value of our liabilities assuming various changes in current interest rates. The table below represents an analysis of our interest rate risk as measured by the estimated changes in our economic value of equity, resulting from an instantaneous and sustained parallel shift in the yield curve at December 31, 2022.

Estimated Increase EVE as a Percentage of Fair

(Decrease) EVE Value of Assets(3)

Basis Point Increase

Change in Estimated EVE (Decrease)

Interest Rates(1) EVE(2) Amount Percent Ratio(4) Basis Points

(Dollars in thousands)

(1) Assumes an immediate uniform change in interest rates at all maturities.

(4) EVE Ratio represents EVE divided by the fair value of assets.

Market Interest Rate Shift

The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power of money over time due to inflation.

The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories that are greatly impacted by inflation. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also affects other expenses that tend to rise during periods of general inflation.

Management believes the most significant potential impact of inflation on financial results is a direct result of the Company’s ability to manage the impact of changes in interest rates. Management attempts to maintain a balanced position between rate-sensitive assets and liabilities in order to minimize the impact of interest rate fluctuations on net interest income. However, this goal can be difficult to completely achieve in times of rapidly changing interest rates and is one of many factors considered in determining the Company’s interest rate positioning. The Company is asset sensitive as of December 31, 2022. Refer to the Net Interest Income Sensitivity table for additional details on the Company’s interest rate sensitivity.

The Bank also uses derivative financial instruments to manage risk to the Bank associated with changing interest rates, and to assist customers with their risk management objectives. The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Bank receives a floating rate thus allowing the Bank another tool to further manage the interest rate risk for certain products. These back-to-back loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the Consolidated Balance Sheet.

We believe that our current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes.

Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors

MainStreet Bancshares, Inc.

Fairfax, Virginia

Opinion on the Financial Statements

We have audited the accompanying consolidated statements of financial condition of MainStreet Bancshares, Inc. and Subsidiary (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ YOUNT, HYDE & BARBOUR, P.C.

We have served as the Company's auditor since 2008.

Winchester, Virginia

March 23, 2023

Item8 – Financial Statements and Supplementary Data

Consolidated Financial Statements

Consolidated Statements of Financial Condition as of December 31, 2022 and December 31, 2021 (Dollars in thousands, except per share data)

Assets

Investment securities available-for-sale, at fair value 62,631 99,913

Investment securities held-to-maturity, at amortized cost 17,642 20,349

Restricted securities, at amortized cost 24,325 15,609

Other real estate owned, net — 775

Accrued interest and other receivables 9,581 7,701

Computer software, net of amortization 9,149 2,493

Liabilities and Stockholders’ Equity

Liabilities

Federal Home Loan Bank advances 100,000 —

Commitments and contingencies (Note 13)

Stockholders’ Equity

Accumulated other comprehensive income (loss) (8,546 ) 197

See Notes to the Consolidated Financial Statements

Consolidated Statements of Income for the Years Ended December 31, 2022 and 2021 (Dollars in thousands, except per share data).

For the Year Ended December 31,

Interest Income

Interest and dividends on investments securities

U.S. government agencies and corporations 37 62

Mortgage-backed securities 438 350

Tax-exempt obligations of states and political subdivisions 1,058 1,060

Taxable obligations of states and political subdivisions 254 207

Interest on federal funds sold 2,312 134

Interest Expense

Interest on interest bearing DDA deposits 601 229

Interest on savings and NOW deposits 203 165

Interest on money market deposits 1,547 772

Interest on Federal Home Loan Bank advances 347 —

Interest on subordinated debt 2,936 1,884

Provision for (recovery of) loan losses 2,398 (1,175 )

Net interest income after provision for (recovery of) loan losses 67,611 54,711

Non-Interest Income

Deposit account service charges 2,420 2,426

Bank owned life insurance income 1,008 900

Loan swap fee income 619 83

Net gain on held-to-maturity securities 4 6

Net gain (loss) on sale of loans (168 ) 847

Non-Interest Expense

Furniture and equipment expenses 2,786 2,468

Administrative expenses 872 685

Other real estate expenses, net 38 84

Net Income available to common shareholders $ 24,518 $ 20,015

Net Income per common share:

See Notes to the Consolidated Financial Statements

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2022 and 2021 (Dollars in thousands)

For the Year Ended December 31,

Comprehensive Income, net of taxes

Other comprehensive loss, net of tax benefit:

Other comprehensive loss (8,743 ) (780 )

See Notes to the Consolidated Financial Statements

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2022 and 2021 (Dollars in thousands).

Accumulated Other

Preferred Common Capital Retained Comprehensive

Stock Stock Surplus Earnings Income (Loss) Total

Vesting of restricted stock — 407 (407 ) — — —

Stock based compensation expense — — 2,519 — — 2,519

Dividends on common stock - ($0.25 per share) — — — (1,882 ) — (1,882 )

Other comprehensive loss — — — — (8,743 ) (8,743 )

Accumulated Other

Preferred Common Capital Retained Comprehensive

Stock Stock Surplus Earnings Income Total

Vesting of restricted stock — 336 (336 ) — — —

Stock based compensation expense — — 1,888 — — 1,888

Other comprehensive loss — — — — (780 ) (780 )

See Notes to the Consolidated Financial Statements

Consolidated Statements of Cash Flows (Dollars in thousands)

Cash Flows from Operating Activities

Depreciation, amortization, and accretion, net 2,083 1,893

Amortization of right-of-use assets 496 472

Deferred income tax (benefit) (894 ) 336

Loss on sale of other real estate owned 4 40

Loss on valuation of other real estate owned 70 22

Provision for (recovery of) loan losses 2,398 (1,175 )

Stock based compensation expense 2,519 1,888

Income from bank owned life insurance (1,008 ) (900 )

Subordinated debt amortization expense 328 223

Gain on disposal of premises and equipment — (57 )

Loss (gain) on loans held for sale 168 (847 )

Gain on called held-to-maturity securities (4 ) (6 )

Change in:

Accrued interest receivable and other receivables (1,861 ) 1,903

Net cash provided by operating activities 33,544 29,124

Cash Flows from Investing Activities

Activity in available-for-sale securities:

Activity in held-to-maturity securities:

Purchases of equity securities (3,916 ) (10,651 )

Purchases of restricted investment in bank stock (9,123 ) (758 )

Redemption of restricted investment in bank stock 4,125 332

Proceeds from sale of other real estate owned 701 343

Proceeds from sale of loans — 31,264

Purchases of bank owned life insurance — (10,000 )

Proceeds from sale of premises and equipment — 79

Purchases of premises and equipment (1,125 ) (1,806 )

Computer software developed (6,656 ) (2,493 )

Net cash used in investing activities (228,736 ) (60,515 )

Cash Flows from Financing Activities

Net increase in Federal Home Loan Bank advances and other borrowings 100,000 —

Repurchase of common stock (6,918 ) —

Cash dividends paid on preferred stock (2,156 ) (2,156 )

Cash dividends paid on common stock (1,882 ) —

Net cash provided by (used in) financing activities 232,593 (14,202 )

Increase (decrease) in Cash and Cash Equivalents 37,401 (45,593 )

Cash and Cash Equivalents, beginning of period 93,199 107,528

Cash and Cash Equivalents, end of period $ 130,600 $ 93,199

Supplementary Disclosure of Cash Flow Information

Cash paid during the period for interest $ 12,639 $ 10,165

Cash paid during the period for income taxes $ 6,381 $ 6,838

Net unrealized loss on securities available-for-sale $ (11,373 ) $ (1,023 )

See Notes to the Consolidated Financial Statements

MAINSTREET BANCSHARES,INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

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

Organization

MainStreet Bancshares Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose principal activity is the ownership and management of MainStreet Bank. On May 18,2016, the stockholders of MainStreet Bank (the “Bank”) approved a Reorganization Agreement and Plan of Share Exchange (“Reorganization”) whereby the Bank would reorganize into a holding company structure. The Plan of Share Exchange called for each outstanding share of Bank common stock to be automatically converted into and exchanged for one share of the Company’s common stock, and the common stockholders of the Bank would become the common stockholders of the Company on the effective date of the Reorganization. On October 12, 2021, the Company filed an election with the Federal Reserve Board to be a financial holding company in order to engage in a broader range of financial activities than are permitted for bank holding companies generally. The Company is authorized to issue 10,000,000 shares of common stock with a par value of $4.00 per share. Additionally, the Company is authorized to issue 2,000,000 shares of preferred stock at a par value $1.00 per share. There are currently 28,750 shares of preferred stock outstanding.

On July 15,2016, the Reorganization became effective, and the Bank became a wholly-owned subsidiary of the Company. The holding company is regulated under the Bank Holding Company Act of 1956, as amended, and is subject to inspection, examination, and supervision by the Federal Reserve Board.

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

We were approved to list shares of our common stock on the Nasdaq Capital Market under our current symbol “MNSB” as of April 22,2019. We were approved to list depositary shares of preferred stock on the Nasdaq Capital Market on the symbol “MNSBP” as of September 16, 2020. Each depositary share represents a 140th interest in a share of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock.

In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company to promote development in economically distressed areas. This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”). In January 2022, the Community Development Financial Institutions Fund (“CDFI”) of the United States Department of the Treasury certified MainStreet Community Capital, LLC as a registered CDE.

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

Basis of Presentation

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) as applicable to a smaller reporting company.

Principles of Consolidation – The consolidated financial statements include accounts of the Company and its wholly-owned subsidiaries, the Bank and MainStreet Community Capital, LLC. All significant intercompany transactions and balances have been eliminated in consolidation.

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

Investment securities – The Bank’s investment debt securities are classified as either held to maturity, available for sale or trading. At December 31, 2022 and December 31, 2021, the Bank held approximately $17.6 million and $20.3 million, respectively, in securities classified as held to maturity. The Bank held no securities classified as trading.

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

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

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

Restricted equity securities consist of the Federal Reserve Bank and Federal Home Loan Bank of Atlanta (“FHLB”) stock in the amount of $4.8 million and $5.1 million respectively, as of December 31, 2022, compared to $4.1 million and $826,000, respectively, as of December 31, 2021. Restricted equity securities also consisted of $126,800 in Community Bankers Bank stock at December 31, 2022 and December 31, 2021. This restricted stock is recorded at cost because its ownership is restricted and it lacks a market for resale. The Bank is required to maintain Federal Reserve Bank stock at a level of 6% of capital and surplus. The FHLB requires the Bank to maintain stock, at a minimum, in an amount equal to 4.5% of outstanding borrowings and 0.20% of total assets. When evaluating restricted stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Bank does not consider these investments to be impaired at December 31, 2022 or December 31, 2021 and no previous impairment has been recognized. Restricted equities include $6.7 million in Low-Income Housing Tax Credits (“LIHTC”) that are carried at amortized cost through the proportional amortization method. Restricted equities also include $6.1 million of nonmarketable securities as of December 31, 2022 that do not qualify for equity method accounting. As of December 31, 2021 restricted equities include $4.9 million in LIHTC and $5.7 million of nonmarketable securities that do not qualify for equity method accounting. These investments are recorded at cost because the ownership is restricted and lacks a market for resale.

Loans held for sale - Loans intended for sale are recorded at the lower aggregate cost or fair value as of the statement of financial condition date. Gains and losses on loan sales are determined by the specific-identification method.

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

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

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

Troubled Debt Restructuring (TDR) occurs when the Bank agrees to modify the original terms of a loan due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. Upon designation as a TDR, the Bank evaluates the borrower’s payment history, past due status and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Bank concludes that the borrower is able to continue making such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on nonaccrual status at the time of the TDR, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. As of December 31, 2022, and December 31, 2021, the Bank had zero loans classified as TDR.

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

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

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

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

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

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

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

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

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

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

Computer softwaredevelopment - The Company capitalizes new product development costs incurred for software to be sold from the point at which technological feasibility has been established through the point at which the product is ready for general availability. Software development costs that are capitalized are evaluated annually for impairment and are assigned an estimated economic life based on the type of product, market characteristics, and maturity of the market for that particular product. These costs are amortized on a straight-line basis. All of this amortization expense is included within components of operating income.

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

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. As of December 31, 2022, and December 31, 2021, there were no such liabilities recorded.

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

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

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

The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Sholes model is used to estimate the fair value of stock options, while the market price of the Bank’s common stock at the date of grant is used for restricted stock awards. No stock options were granted during 2022 and 2021.

Earnings per common share – Net income per common share has been determined under the provisions of FASB ASC 260, “Earnings Per Share” and has been computed based on the weighted average common shares outstanding during the year ended December 31, (7,529,382 for 2022 and 7,559,310 for 2021). Diluted earnings per share reflect additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.

The only potential dilutive stock of the Bank as defined in FASB ASC 260 would be stock options granted to various directors, officers, and employees of the Bank. There were no such options outstanding at December 31, 2022 or December 31, 2021. Restricted stock is included in the computation of basic earnings per share as the holder is entitled to full benefits of a stockholder during the vesting period and is thus considered a participating security.

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

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

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

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

Fair value of financial instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 20. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Derivative Financial Instruments – The Bank recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated statement of financial condition. The Bank’s derivative financial instruments include interest rate swaps with certain qualifying commercial loan customers and dealer counterparties. Because the interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Bank’s interest rate swaps with loan customers and dealer counterparties are described more fully in Note 19.

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

Revenue Recognition

Most revenue associated with the Company’s financial instruments, including interest income and gains/losses on investment securities, derivatives and sales of financial instruments are outside the scope of ASC Topic 606. The Company’s services that fall within the scope of ASC Topic 606 are presented within noninterest income and are recognized as revenue. A description of the primary revenue streams accounted for under ASC Topic 606 follows:

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

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

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

Impact of Recently Issued Accounting Pronouncements

During June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration. The Company adopted ASU 2016-13 as of January 1, 2023 in accordance with the required implementation date and recorded the impact of adoption to retained earnings, net of deferred income taxes, as required by the standard. The adjustment recorded at adoption was not significant to the overall allowance for credit losses or shareholders’ equity as compared to December 31, 2022 and consisted of adjustments to the allowance for credit losses on loans as well as an adjustment to the Company’s reserve for unfunded loan commitments. Subsequent to adoption, the Company will record adjustments to its allowances for credit losses and reserves for unfunded commitments through the provision for credit losses in the consolidated statements of income.

The Company is utilizing a third-party model to tabulate its estimate of current expected credit losses, using a weighted average remaining life methodology. In accordance with ASC 326, the Company has segmented its loan portfolio based on similar risk characteristics which included call report codes and other attributes that significant to the Company. The Company primarily utilizes average remaining portfolio life and Federal Reserve Economic Data for its reasonable and supportable forecasting of current expected credit losses. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider the following qualitative adjustment factors: lending practices, national/local economics, portfolio composition, employee experience, credit quality indicators, underlying collateral, concentrations and other external factors. The Company’s CECL implementation process was overseen by the Allowance for Credit Losses Committee and included an assessment of data availability and gap analysis, data collection, consideration and analysis of multiple loss estimation methodologies, an assessment of relevant qualitative factors and correlation analysis of multiple potential loss drivers and their impact on the Company’s historical loss experience.

In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No.2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No.2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No.2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No.2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has inventoried its exposure to instruments that include a reference to LIBOR and have included amendments to transition to an appropriate comparable rate. The Company has also discontinued using LIBOR as a primary rate reference. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No.33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No.33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No.33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No.33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021-06 to have a material impact on its consolidated financial statements.

Recently Adopted Accounting Developments

ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments: In June 2016, FASB issued ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The new accounting guidance in this ASU replaces the incurred loss model with an expected loss model, which is referred to as the current expected credit loss ("CECL") model. The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost, including loan receivables, and held-to-debt securities. It also applies to off-balance sheet credit exposures not accounted for as loan recievables (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor. The CECL model requires an entity to estimate credit losses over the life of an asset or off-balance sheet exposure. The new accounting guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2022.

Adoption will be applied through a one-time cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. Management adopted the guidance on January 1, 2023 and implemented changes to relevant systems as necessary. The Company currently intends to use a blend of multiple economic forecasts to estimate expected credit losses over a six month reasonable forecast period and then revert, over a one year period, to longer term historical loss experience to arrive at lifetime expected credit losses. The estimated increase in the allowance is primarily due to required increases for commercial real estate, residential, and installment loans to include the requirement to estimate lifetime expected credit losses and the remaining length of time to maturity for these loans. Additionally, management expects an increase in the allowance for credit losses for unfunded commitments.

While adoption of this ASU is expected to increase the allowance for credit losses, it does not change the overall credit risk in the Company's loan, lease and securities portfolios or the ultimate losses therein. The transition adjustment to increase the allowance will result in a decrease to shareholders' equity on January 1, 2023, but will not have an impact on the Bank's regulatory capital. The ultimate impact of the adoption of this ASU on January 1, 2023 was an increase of $2.2 million, comprised of increases of $895,000 in the allowance for credit losses and $1.3 million for the reserve for unfunded commitments. This represents an increase of 2 and 8 basis points, respectively. Calculated credit losses on held-to-maturity debt securities were not material and there was no impact to the available for sale portfolio or other financial instruments.

Note 2. Restrictions on Cash

To comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirements were $0 as of December 31, 2022 and December 31, 2021.

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

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

Note 3. Investment Securities

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

Municipal Securities

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

Municipal Securities

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

Municipal Securities

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

Municipal Securities

The scheduled maturities of securities available-for-sale and held-to-maturity at December 31,2021 were as follows:

Available-for-Sale Held-to-Maturity

(Dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value

Due in one year or less $ — $ — $ 264 $ 262

Securities with a fair value of $3.6 million and $410,492 at December 31, 2022 and December 31, 2021, respectively, were pledged as collateral to secure public funds and loans swaps.

There were no securities sold from the available-for-sale portfolio during the years ended December 31, 2022 and 2021.

The following tables summarize the fair value and unrealized losses at December 31, 2022 and December 31, 2021, aggregated by investment category and length of time that individual securities have been in a continuous loss position:

Less than 12 Months 12 Months or Longer Total

Available-for-sale:

Municipal Securities

Held-to-maturity:

Municipal securities

Less than 12 Months 12 Months or Longer Total

Available-for-sale:

Municipal Securities

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

At December 31, 2022, there were twelve collateralized mortgage backed securities with fair values totaling $2.0 million, twenty-two municipal securities with a fair value of $12.4 million, eight subordinated debt securities with fair values of $3.4 million, and one U.S. government agency securitiy with a fair value of $1.8 million considered temporarily impaired and in an unrealized loss position of less than 12 months. At December 31, 2022, there were seven U.S. government agencies with fair values totaling approximately $1.0 million, thirteen collateralized mortgage backed securities with a fair value totaling $20.2 million, thirteen subordinated debt securities with fair values of $4.7 million and twenty municipal securities with a fair value of $14.3 million that were in an unrealized loss position of more than 12 months. The Bank does not consider any of the securities in the available for sale portfolio to be other-than-temporarily impaired at December 31, 2022 and December 31, 2021. There were no securities sold during 2022 or 2021.

All municipal securities originally purchased as available for sale were transferred to held to maturity during 2013. The unrealized loss on the securities transferred to held to maturity is being amortized over the expected life of the securities. The unamortized, unrealized loss, before tax, at December 31, 2022 and December 31, 2021 was $8,228 and $29,016, respectively.

Note 4. Loans Receivable

Loans receivable were comprised of the following:

Residential Real Estate:

Commercial Real Estate:

Commercial – Non Real-Estate:

Consumer – Non Real Estate:

Less: allowance for loan losses (14,114 ) (11,697 )

The unsecured consumer loans above include $2.0 million and $185,135 of overdrafts reclassified as loans for the years ended December 31, 2022 and December 31, 2021, respectively.

There were no nonaccrual loans as of December 31, 2022 and December 31, 2021.

The following tables present the segments of the loan portfolio summarized by aging categories as of December 31, 2022 and December 31, 2021:

Residential Real Estate:

Commercial Real Estate:

Commercial – Non Real Estate:

Consumer – Non Real Estate:

Residential Real Estate:

Commercial Real Estate:

Commercial – Non Real Estate:

Consumer – Non Real Estate:

No loans were modified under the terms of a TDR during the years ended December 31, 2022 and 2021, and there were no loans modified as TDR’s that subsequently defaulted during the years ended December 31, 2022 and 2021 that were modified as TDR’s within the twelve months prior to default.

MNSB US Equity

MNSB · 10-K · period ended 2022-12-31

Item7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Item 8. Financial Statements and Supplementary Data

MNSB US Equity☆

MNSB · 10-K · period ended 2022-12-31

Item7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Item 8. Financial Statements and Supplementary Data

MNSB US Equity