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Item 7 – 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, 2020 and 2019. The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Corporation. 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 loan 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.

COVID-19 Pandemic

The effects of the COVID-19 pandemic and resulting economic conditions have impacted our business and financial results and could continue to impact our business and results of operations in a number of ways in the future, including without limitation in areas related to credit, collateral, customer demand, operations, interest rate risk, liquidity and litigation, as described in more detail below. The extent to which the Company’s business will continue to be negatively affected by the pandemic will depend on future developments, which are highly uncertain and cannot be reasonably predicted.

Credit Risk. The risk of timely loan repayment and the value of collateral supporting our loans are affected by the strength of our borrowers’ businesses. Concern about the spread of COVID-19 has caused, and is likely to continue to cause, business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is not sufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, our ability to liquidate real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for, or profitability of, our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making business decisions or may delay our taking certain remediation actions. In addition, we have unfunded commitments to extend credit to customers. Increased borrowings under these commitments could adversely impact our liquidity.

In an effort to support our communities during the pandemic, we are participating in the Paycheck Protection Program (“PPP”), a program established by the CARES Act to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic.PPP loans are fully guaranteed by the Small Business Administration (“SBA”) and provide for full forgiveness of the loans during a specified forgiveness period that meet specific guidelines provided by the SBA. The deadline to apply for PPP loans was initially June 30, 2020 and was later extended to August 8, 2020; the Consolidated Appropriations Act of 2021 (the “CAA”), enacted in December 2020, reopened and expanded the PPP. Small businesses and other entities and individuals can apply for PPP loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria.

PPP loans are subject to regulatory requirements that would require forbearance of loan payments for a specified time or that could limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, or if the borrower defaults and the SBA determines there is a deficiency in the manner in which any PPP loans were originated, funded or serviced by the Bank, we would be subject to repayment risk as well as the heightened risk of holding these loans at unfavorable interest rates as compared to loans that we would have otherwise made.

Business Continuity Planning Risk. Our financial condition and results of operations may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various responses of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to severe disruption and volatility in capital markets. Furthermore, many of the governmental actions in response to the pandemic have been directed toward curtailing household and business activity to contain COVID-19. These actions have been rapidly changing. Future effects of COVID-19 on economic activity could negatively affect the future banking products we provide and could result in a decline in loan originations.

Operational Risk. Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to minimize interruptions of our operations. Technology in employees’ homes may be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk.

We rely on many third parties in our business operations. Many of these parties may limit the availability and access of their services. If third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.

Interest Rate Risk. Our net interest income, lending activities, deposits, investment portfolio, cash flows and profitability are and are likely to continue to be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. On March 15, 2020 the Federal Reserve lowered its target range for the federal funds rate to a range from 0 to 0.25 percent, and has since maintained that range, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. A prolonged period of extremely volatile and

unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices will likely cause a loss of future net interest income and a decrease in current fair market values of our investment portfolio and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.

Liquidity. Federal, state and local governments have mandated or encouraged financial institutions to accommodate borrowers and other customers affected by the COVID-19 pandemic. Legal and regulatory responses to concerns about the COVID-19 pandemic could result in additional regulation or restrictions affecting the conduct of our business in the future. In addition to our measures to address the potential effects from negative economic conditions noted above, the Company has instituted a program to help COVID-19 impacted customers. This program includes waiving certain fees and charges and offering payment deferment and other loan relief, as appropriate, for customers impacted by COVID-19. The Company’s liquidity could be negatively impacted if a significant number of customers apply and are approved for the deferral of payments or request additional deferrals. In addition, if these deferrals are not effective in mitigating the effect of COVID-19 on our customers, the negative effects on our business and results of operations may be more substantial and may continue over a longer period of time. A significant amount of loan growth during the second quarter was a direct result of PPP loans. This loan growth is likely to end in the near-term.

Litigation Risk. Although the Company has taken and continues to take precautions to protect the safety and well-being of its employees, no assurance can be given that the steps being taken will be adequate or appropriate. Concerns have been expressed regarding possible employee lawsuits for tort claims related to the COVID-19 pandemic, including class action lawsuits alleging that unsafe workplaces have caused employees to contract COVID-19 or subjected them to the risk of exposure. Possible statutory defenses may mitigate the risk of liability in any such lawsuits; however, the availability of such defenses is uncertain and cannot be predicted at this time.

The PPP has also attracted interest from federal and state enforcement authorities, oversight agencies, regulators and Congressional committees. Offices of state attorneys general and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations that entitle the Bank to rely on borrower certifications, and they may take more aggressive actions against the Bank for alleged violations of the provisions governing the Bank’s participation in the PPP. Federal and state regulators can impose or request that we consent to substantial sanctions, restrictions and requirements if they determine there are violations of laws, rules or regulations or weaknesses or failures with respect to general standards of safety and soundness, which could adversely affect our business, reputation, results of operation and financial condition.

Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of litigation, from both clients and non-clients that solicited the Bank for PPP loans, regarding its process and procedures used to process applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

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, (3) income taxes, and (4) 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 19, Fair Value Presentation, in Notes to Consolidated Financial Statements for a detailed discussion of determining fair value, including pricing validation processes.

Income Taxes: The Company’s income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated taxes due. The calculation of each component of the Company’s income tax provision is complex and requires the use of estimates and judgments in its determination. As part of the Company’s evaluation and implementation of business strategies, consideration is given to the regulations and tax laws that apply to the specific facts and circumstances for any tax positions under evaluation. Management closely monitors tax developments on both the federal and state level in order to evaluate the effect they may have on the Company’s overall tax position and the estimates and judgments used in determining the income tax provision and records adjustments as necessary.

Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expenses. In evaluating the Company’s ability to recover its deferred tax assets within the jurisdiction from which they arise, the Company must consider all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and the results of recent operations. A valuation allowance is recognized for a deferred tax asset if, based on the available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized. See Note 10, Income Taxes, in Notes to Consolidated Financial Statements for additional information.

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 18 in the December 31, 2020, Consolidated Financial Statements.

Other Real Estate Owned:Assets acquired through, or in lieu of, foreclosure are held forsale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure.Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based onupdated appraisals, general market conditions, recent sales of similar properties, length of time theproperties have been held, and our ability and intention with regard to continued ownership of theproperties. The Company may incur additional write-downs of foreclosed assets to fair value lessestimated costs to sell if valuations indicate a further deterioration in market conditions.

Analysis of Results of Operations for the Years Ended December 31, 2020 and 2019

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)

Less: Preferred stock dividends 635 — 100.00 %

Net income available to common shareholders $ 15,082 $ 13,950 8.11 %

Net income for the year ended December 31, 2020, was $15.7 million, an increase of $1.7 million, or 12.67% compared to $14.0 million earned during the year ended December 31, 2019. The increase in net income was due to $6.5 million of additional net interest income, primarily driven by increased volume of loans and decrease in interest rates on interest-bearing deposits. The increase in non-interest expenses was due to a $2.2 million increase in salaries and employee benefits and $2.0 million increase in the provision for loan losses.

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 loan losses totaled $46.0 million for the year ended December 31, 2020, compared to $39.4 million for the year ended December 31, 2019. The increase in net interest income was driven by an increase in loan production and decrease in interest rates on interest-bearing deposits during the year for the year ended December 31, 2020.

The net interest margin was 3.21% for the year ended December 31, 2020, compared to 3.50% for the year ended December 31, 2019. The decrease in net interest margin primarily resulted from a decrease in average rates earned on our loan portfolio and investment in lower yielding securities. In addition, loans associated with the Paycheck Protection Program (“PPP”) carried a below market rate of 1.00%. This decrease was offset by decreasing rates on our cost of funds, primarily in wholesale deposits, money market deposits and other borrowings.

The yield for the year ended December 31, 2020 for the loan portfolio was 4.89% compared to 5.61% for the year ended December 31, 2019. The decrease primarily reflects the maturity of higher yielding loans and lower yields on new loans based on lower interest rates starting in the first half of the year. The Federal Reserve decreased its targeted benchmark interest rate to 0-25 basis points, which impacted yields obtained on new loans.

For the year ended December 31, 2020, the yield on the total investment securities portfolio was 2.63% compared to 3.09% for the year ended December 31, 2019. The decrease of 46 basis points was primarily due to rates on variable securities decreasing with the current rate environment and lower yields on investment securities purchased during the period.

The rate paid on interest bearing deposits decreased to 1.58% during the year ended December31, 2020, from 2.25% during the year ended December31, 2019. This decrease was a result of lower rates paid on all outstanding deposits in conjunction with the decreasing rate environment throughout the year.

The rate paid on FHLB borrowings for the year ended December 31, 2020 was 1.73% compared to 2.59% for the corresponding period in 2019. This decrease was primarily due to falling interest rates for these types of borrowings.

The following table sets forth the major components of net interest income and the related yields and rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.

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:

Interest-bearing liabilities:

Federal funds purchased — — — 37 1 2.70 %

Non-interest-bearing liabilities:

Interest rate spread (2) 2.69 % 2.87 %

Net interest margin (4) 3.21 % 3.50 %

Net interest margin, excluding PPP loans(5) 3.21 % 3.50 %

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 698 (1,670 ) (972 )

Interest-bearing liabilities:

Interest-bearing demand deposits $ (270 ) $ (411 ) $ (681 )

Savings and NOW deposits 19 (87 ) (68 )

Federal funds purchased (1 ) — (1 )

Federal Home Loan Bank advances (300 ) (141 ) (441 )

Subordinated debt 1 (1 ) —

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 $3.6 million for the year ended December 31, 2020 from $1.6 million for the year ended December 31, 2019. The increase is primarily as a direct result of additional provisions added in response to the COVID-19 pandemic. In addition, loan originations increased $178.6 million, which totalled $230.8 million for the year ended December 31, 2019 compared to loan originations of $409.4 million for the year ended December 31, 2020. Loan originations included $173.1 million in PPP loans during the year ended December 31, 2020. Non-performing loans increased $149,000, from $0 at December 31, 2019 to $149,000 as of December 31, 2020. During the year ended December 31, 2020, substandard loans decreased $1.2 million for a balance of $2.1 million. During the year ended December 31, 2020, the watchlist increased $68.1 million, however this increase is attributable to only five relationships all of which are in the hospitality industry. Management does not believe any loss currently exists in these loans but due to the disproportionate impact COVID-19 has had on the hospitality industry, the Bank is managing these credits closely. During the year ended December 31, 2020, there were $1.9 million in charge-offs and recoveries of $1.5 million were received. During the year ended December 31, 2019, there were $929,000 in charge-offs recorded and recoveries received of $865,000.

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 period indicated, the major categories of non-interest income:

For the Year Ended December 31,

(In thousands)

Non-interest income

Net gain on available-for-sale securities — 5 -100.00 %

Non-interest income increased $2.6 million, or 54.1%, to $7.5 million for the year ended December 31, 2020 from $4.9 million for the year ended December 31, 2019. The increase in non-interest income was primarily due to an increase in service fees on our business accounts and fees earned from executing interest rate swaps on commercial loans for the year ended December 31, 2020. The Bank has focused on expanding these areas and expects similar opportunities throughout 2021. Deposit account service fees increased $248,000 to $1.9 million for the year ended December 31, 2020 from $1.7 million for the year ended December 31, 2019 primarily as a result of an increased customer deposit portfolio and fee structure. Bank owned life insurance income increased $281,000 for the year ended December 31, 2020 compared to the year ended December 31, 2019 due to additional policies purchased later in the prior year. Fees earned on interest rate swaps for commercial loans increased $2.5 million, or 255%, to $3.5 million for the year ended December 31, 2020 from $989,000 for the year ended December 31, 2019. This increase was purely related to the volume of interest rate swaps entered into during 2020.

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

Non-interest expense increased $4.9 million or 19.4% to $30.3 million for the year ended December 31, 2020 from $25.4 million for the year ended December 31, 2019 primarily as a result of increases in salary and employee benefits of $2.1 million, FDIC insurance of $649,000 and other operating expenses of $776,000. Salaries and employee benefits expense increased by $2.1 million to $17.9 million for the year ended December 31, 2020 from $15.8 million for the year ended December 31, 2019 primarily as a result of increasing the salaries for our employees who were customer facing during the depth of the pandemic. It was important to support our employees who could not adhere to a work-from-home policy due to the unique nature of their job responsibilities. Other operating expenses increased $345,000, or 22.4%, to $1.9 million for the year ended December 31, 2020 from $1.5 million for the year ended December 31, 2019 due to increases in professional and consulting fees and fees related to investments in technology infrastructure. The Bank also revalued its other real estate owned portfolio which resulted in a writedown of $400,000. FDIC increased approximately $649,000 to $1.3 million for the year ended December 31, 2020 from $680,000 for the year ended December 31, 2019.

Income Tax Expense

Income tax expense increased $489,000, or 14.6%, to $3.8 million for the year ended December 31, 2020 from $3.4 million for the year ended December 31, 2019. The increase in federal income tax expense for the year ended December 31, 2020 compared to the same period a year ago was driven by the increase in income before income taxes of $2.3 million, or 13.0%, to $19.6 million as of December 31, 2020 compared to $17.3 million for the same period in the prior year. As a result of tax regulation, the Company has included assessments in income tax expense for state tax liabilities during 2020. For the year ended December 31, 2020, the Bank had an effective federal tax rate of 19.6%, compared to effective federal tax rate of 19.4% for the year ended December 31, 2019.

Comparison of Statements of Financial Condition at December 31, 2020 and at December 31, 2019

Total Assets

Total assets increased $365.8 million, or 28.6%, to $1.6 billion at December 31, 2020 from $1.3 billion at December 31, 2019. The increase was primarily the result of increases of $257.0 million in gross loans receivable, $53.2 million in available-for-sale securities, and $9.4 million in other assets.

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 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, 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 $169.9 million at December 31, 2020, an increase of $53.2 million compared with December 31, 2019. At December 31, 2020, the investment securities portfolio includes $147.4 million of investment securities available for sale and $22.5 million of investment securities held to maturity compared to $92.8 million of investment securities available for sale and $23.9 million of investment securities held to maturity at December 31, 2019.

During the year ended December 31, 2019, the Company sold seven securities in the available-for-sale investment portfolio. Of these seven, four were sold at a loss of $18,000 and three were sold at a gain of $23,000 for a net gain of $5,000. The Company did not sell any securities within the investment portfolio for the year ended December 31, 2020.

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.

Securities Portfolio Composition. The following table sets forth the amortized cost and estimated fair value of our available for sale and held to maturity securities at the dates indicated.

December 31,

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

Available-for-sale:

Held-to-maturity:

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2020, 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.

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 Cost Yield Cost Yield Cost Yield Cost Value Yield

(Dollars in thousands)

Securities available for sale:

Securities held to maturity:

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.

Average loans represented 85.2% of average interest-earning assets for the year ended December 31, 2020, compared to 87.3% for the year ended December 31, 2019. The following table presents the Company’s loan portfolio by portfolio segment at December 31, 2020 and December 31, 2019.

At December 31,

Amount Percent Amount Percent

(Dollars in thousands)

Residential real estate:

Commercial real estate:

Commercial – non-real estate:

Consumer – non-real estate:

Less: unamortized discount on secured loans (1 ) (19 )

Less: allowance for loan losses (12,877 ) (9,584 )

(1) Includes PPP loan balances of $135.2 million as of December 31, 2020.

The consumer loans above include $241,000 and $599,000 of overdrafts reclassified as loans for the years ended December 31, 2020 and 2019, respectively.

The Bank held $57.0 million loans for sale at December 31, 2020 and $0 at December 31, 2019.

Loan Portfolio Maturities and Yields.The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2020. 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:

Construction and Land Development Commercial and Industrial Consumer Total

Amounts due in: (In thousands)

After fifteen years — — — 31,962

The following table sets forth our fixed and adjustable-rate loans at December 31, 2020 that are contractually due after December 31, 2020.

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 other real estate owned:

Transfers to other real estate owned 362 1,207

Loans transferred to loans held for sale:

Transfers to loans held for sale 57,006 —

Loans, net of unearned income, totaled $1.2 billion at December 31, 2020, an increase of $207.3 million from December 31, 2019. The increase in total loans was primarily driven by growth in the overall loan portfolio, with significant increases in the commercial and industrial segment through the PPP program, as well as the construction portfolio. The Company reclassified approximately $57.0 million of commercial real estate loans to loans held for sale as part of its regulatory risk strategy.

Asset Quality

The Company’s asset quality remained strong during the year ended December 31, 2020. 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 $1.2 million at December 31, 2020 and 2019.

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.

Refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section “COVID 19 Economic Impact ” of this Form 10-K for additional information on loan modifications during the year ended December 31, 2020.

As a percentage of total assets, nonperforming assets were 0.08% at December 31, 2020 compared with 0.09% at December 31, 2019. As of December 31, 2020, the Company had $149,000 in 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, 2020 and December 31, 2019.

December 31, December 31,

(Dollars in thousands)

Non-accrual loans:

Residential real estate

Single family $ 149 $ —

Total non-accrual loans 149 —

Total non-performing loans 149 —

Total non-performing assets $ 1,329 $ 1,207

Accruing TDRs:

Residential real estate $ — $ 1,482

Total accruing TDRs $ — $ 1,482

Ratios:

Total non-performing loans to gross loans receivable 0.01 % 0.00 %

Total non-performing loans to total assets 0.01 % 0.00 %

Total non-performing assets to total assets 0.08 % 0.09 %

Interest income that would have been recorded for the years ended December 31, 2020 and 2019 had non-accruing loans been current according to their original terms amounted to $45 and $0 respectively. We did not recognize any interest income for these loans for the years ended December 31, 2020 and 2019, respectively.

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, 2020, 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.

Delinquent Loans. The following table sets forth our delinquent loans at December 31, 2020 and 2019.

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:

Classified Assets. Federal regulations provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets. Loans not classified as impaired are assigned a higher allowance factor based on an internal migration analysis, which increases with the severity of classification, than pass rated loans. The characteristics of the loan ratings are as follows:

In connection with the filing of our periodic reports with the Federal Reserve Board and in accordance with our classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations.

On the basis of this review of our assets, our classified and special mention assets, at the dates indicated were as follows.

(Dollars in thousands) Pass Watch Special Mention Substandard Doubtful Total

Residential Real Estate:

Commercial Real Estate:

Commercial – Non Real Estate:

Consumer – Non Real Estate:

(Dollars in thousands) Pass Watch Special Mention Substandard Doubtful Total

Residential Real Estate:

Commercial Real Estate:

Commercial – Non Real Estate:

Consumer – Non Real Estate:

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 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)

Balance at beginning of year $ 9,584 $ 8,831

Charge-offs:

Commercial real estate (1 ) (733 )

Commercial industrial (1,792 ) (98 )

Recoveries:

Residential real estate 2 58

Commercial real estate — 1

Commercial and industrial 1,526 5

Consumer 8 —

Ratios:

Net charge offs to average loans outstanding (annualized) 0.03 % 0.09 %

Allowance for loan losses to non-performing loans at end of period 8642.28 % N/A

Allowance for loan losses to gross loans at end of period 1.03 % 0.92 %

At December 31, 2020, our allowance for loan losses represented 1.03 % of total loans and had no non-performing loans. The allowance for loan losses increased to $12.9 million at December 31, 2020 from $9.6 million at December 31, 2019 primarily as a direct result of adding a general qualitative factor to the allowance for loan losses in response to the COVID-19 pandemic, as well as provision expense on newly originated loans. There were $317,000 and $865,000 in net loan charge-offs during the years ended December 31, 2020 and December 31, 2019, 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:

(1) No allowance assigned to PPP loans due to SBA guarantee

Derivative Financial Instruments

The Bank uses derivative financial instruments (“derivatives”) primarily to manage risks to the Bank associated with changing interest rates, and to assist customers with their risk management objectives. The Bank classifies these items as free standing derivatives consisting of customer accommodation loan swaps (“loan swaps”). The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms. 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. 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. Changes in fair value are recorded in other noninterest expense and net to zero because of the identical amounts and terms of the swaps.

The following tables summarize key elements of the Banks’s derivative instruments as of the dates indicated.

Customer-related interest rate contracts

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 $309.7 million from December 31, 2019 to December 31, 2020. Brokered deposits, which are included in the table below, totaled $279.9 million and $236.9 million at December 31, 2020 and December 31, 2019, respectively. The following table presents the Company’s average deposits segregated by major category for the year ended December 31, 2020:

At December 31,

(Dollars in thousands)

Deposit type:

The overall increase in total deposits was primarily driven by an increase in non-interest bearing demand deposits and money market deposits largely due to balances related to the PPP initiative. The increase was partially offset by a decrease in interest bearing demand deposits and time deposits. Certificates and other time deposits decreased from December 31, 2020 compared to December 31, 2019 primarily as a result of decreasing our wholesale deposits.

At December 31, 2020, the aggregate amount of all our certificates of deposit in amounts greater than or equal to $250,000 was approximately $219.0 million. The following table sets forth the maturity of these certificates as of December 31, 2020.

(In thousands)

Maturity period:

Three months or less $ 20,228

Over three through twelve months 55,664

Over twelve months through three years 101,304

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, 2020.

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 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, 2020 and 2019, we were permitted to borrow up to an aggregate total of $407.7 million and $308.4 million, respectively, from the Federal Home Loan Bank of Richmond. There were Federal Home Loan Bank borrowings outstanding of $0 at December 31, 2020 and $40.0 million at December 31, 2019. 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, 2020 and 2019, under this facility.

The following table shows certain information regarding Federal Home Loan Bank advances at or for the dates indicated:

For the Years Ended December 31,

(Dollars in thousands)

Balance at end of period $ — $ 40,000

Average balance during the period $ 6,189 $ 21,162

Weighted average interest rate at end of period — 1.98 %

Weighted average interest rate during the period 1.73 % 2.59 %

On December 30, 2016, the Company completed the issuance of $14.3 million in aggregate principal amount of fixed-to-floating rate subordinated notes in a private placement transaction to various accredited investors. During the first quarter 2017, an additional $700,000 of subordinated notes was issued for a total issuance of $15.0 million. The net proceeds of the offering are intended to support growth and be used for other general business purposes. The notes have a maturity date of December 31, 2026 and have an annual fixed interest rate of 6.25% until December 31, 2021. Thereafter, the notes will have a floating interest rate based on three-month London Interbank Offered Rate (“LIBOR”) rate plus 425 basis points (4.25%) (computed on the basis of a 360-day year of twelve 30-day months) from and including January 1, 2022 to the maturity date or any early redemption date. Interest will be paid semi-annually, in arrears, on July 1 and January 1 of each year during the time that the notes remain outstanding through the fixed interest rate period or earlier redemption date. Interest will be paid quarterly, in arrears, on April 1, July 1, October 1 and January 1 throughout the floating interest rate period or earlier redemption date.

Stockholders’ Equity

Total stockholders’ equity at December 31, 2020 was $167.7 million, an increase of $30.6 million compared to December 31, 2019. Stockholders' equity increased $15.1 million due to net income and $27.3 million due to a preferred stock issuance during the period. These increases were offset by common share repurchases of approximately $13.8 million. In addition, accumulated other comprehensive income increased $554,000, primarily as a result of a increase in the fair value of investment debt securities available for sale.

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 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, 2020.

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, 2020, cash and cash equivalents totaled $107.5 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $147.4 million at December 31, 2020.

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 $16.9 million and $16.7 million for the twelve months ended December 31, 2020 and December 31, 2019, 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 $313.8 million and $161.4 million for the twelve months ended December 31, 2020 and December 31, 2019, respectively. During the twelve months ended December 31, 2019, the Company realized gains on sale of available-for-sale debt securities of $5,000. There were no sales of available-for-sale debt securities in 2020. Net cash provided by financing activities was $339.5 million and $151.5 million for the twelve months ended December 31, 2020 and 2019, respectively, which consisted primarily of increases in interest bearing deposits of $117.8 million and $248.8 million offset by net repayments of $40.0 million from the Federal Home Loan Bank for the twelve months ended December 31, 2020. There were no net repayments from the Federal Home Loan Bank for the same period in 2019.

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, 2020, totaled $272.8 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.

Off Balance Sheet Arrangements

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. The following table presents information about the Company's commitments at December 31, 2020.

Commitments

(In Thousands)

Commitments to extend credit $ 219,414

Standby and commercial letters of credit 1,062

On March 9, 2021, the Bank signed a lease commitment for a new operations center.

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 2020 and 2019 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, 2020, the Company and the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2020 and 2019, 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, 2020 and 2019 are presented in the table below.

(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio

COVID-19 Economic Impact

On Friday, March 13, 2020, President Trump declared a national emergency caused by the coronavirus (COVID-19) pandemic. The federal and state guidelines issued in connection with this national emergency to curb the spread of the COVID-19 pandemic have caused economic disruption across nearly every industry as well as significant unemployment. The Commonwealth of Virginia and the District of Columbia instituted stay at home guidelines with an exception made for essential businesses. Both jurisdictions consider banking to be an essential business.

As an essential business, MainStreet Bank is firstly committed to providing a safe work environment. On March 16, 2020, we transitioned nearly all our employees to work from home. We were fully prepared to do so because of our available technology.

The Bank established a crisis task force compromised of executive officers, senior management and department heads in order to provide streamlined communication across business functions. This designated group began meeting routinely to track and monitor the pandemic’s impact on the key operations of the institution. Executive management also held weekly meetings with the entire Bank staff to communicate new initiatives and share information about how we are responding to the needs of our employees and customers.

Since most of our customers were comfortable using our digital platform, we temporarily closed two of our seven locations and reduced the hours of the remaining locations. We also increased the average wage of our dedicated customer-facing branch staff by 50% during

the initial stages of this crisis, as we believed they provided an invaluable customer interaction and were committed to meeting the needs of our customers who had to conduct business in person.

At the forefront of the crisis, we established a forbearance program for commercial customers with a term-debt repayment structure. The forbearances either provide two months deferral of principal and interest payments or converting the loan to three months of interest-only payments. Both solutions were focused on assisting our borrowers in preserving their liquidity.

In order to maintain the Company’s strong asset quality, the Board and management initiated two payment deferral programs to support borrowers needs during the pandemic:

Phase 1 – Borrowers could opt to defer up to two months of principal and interest payments, and

Phase 2 – Commercial lenders would work with borrowers individually to design and implement a custom solution to achieve a positive outcome for the borrower.

An overwhelming number of borrowers, 77.5% (by dollar amount), did not indicate a need for any support from either phase to continue performing on their loan obligations.

Phase 1 - Initiated March 24, 2020. At this point little was known about the state of the pandemic with no predictions on its duration or severity. A total of 195 borrowers participated in this phase, representing 22.5% of the dollar amount of loans outstanding.

Phase 1 was evenly distributed across the portfolio, excluding the hotel loan segment. The Company has 15 operating hotels in its portfolio totaling $92.4 million. The hospitality industry was significantly impacted by the pandemic and 14 hotels that we financed requested to participate in Phase 1. All loans that requested a Phase 1 deferral have returned to a normal paying status or participated in Phase 2.

Paycheck Protection Program – Initiated April 3, 2020. During Phase 1, the Bank was also participating as a lender in the Paycheck Protection Program (PPP), described below, to provide additional liquidity assistance to our borrowers. The Bank processed over 1,000 PPP loans totalling just over $173 million. Underwriting standards were focused on providing precisely the amount that should qualify for forgiveness by the federal government.

Phase 2 – Initiated May 4, 2020. The Board and management aligned the maximum deferment for Phase 2 with the Federal Reserve’s Main Street Lending Program and set the maximum deferment period at 12 months. The Board and management also established several restrictive covenants for borrowers participating in Phase 2.

The objective established by Bank Management was for each borrower to attain a greater than 90% probability of a positive outcome. The Bank’s lending teams worked with their borrowers to determine what amount and term of deferment, if any, would be reasonable to achieve that objective.

There were 42 borrowers representing 7.4% of total loans outstanding who would ultimately participate in Phase 2. While still a concentration, only 60% of the hotels requested additional payment deferrals for Phase 2. As of December 31, 2020, all previously reported borrowers with payment deferrals are scheduled to be back to making monthly payments.

The Bank is currently participating in the additional round of the Paycheck Protection Program for eligible borrowers.

Regulatory easing for COVID-19 pandemic

Federal Reserve Bank reserve requirements to zero.

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

Community Bank Leverage Ratio reduced to 8%

As required by Section 4012 of the CARES Act, the federal banking agencies temporarily lowered the community bank leverage ratio (the “CBLR”), issuing two interim final rules to set the CLBR at 8% and then gradually re-establish it at 9%.

Under the interim final rules, the CBLR was set at 8% beginning in the second quarter of 2020 through the end of the year. Community banks that have a leverage ratio of 8% or greater and meet certain other criteria may elect to use the CBLR framework. Beginning in 2021, the CBLR will increase to 8.5% for the calendar year. Community banks will have until Jan. 1, 2022, before the leverage ratio requirement to use the CBLR framework will return to 9%.

“The agencies are providing community banking organizations with a clear and gradual transition back to the 9 percent leverage ratio requirement previously established by the agencies,” regulators said in a joint press release. “This transition will allow community banking organizations to focus on supporting lending to creditworthy households and businesses given the recent strains on the U.S. economy caused by the coronavirus.”

Forbearance not automatically a Troubled Debt Restructuring (TDR)

On March 9, 2020, the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Consumer Financial Protection Bureau, National Credit Union Administration, and Conference of State Bank Supervisors issued a joint statement to financial institutions urging them to work constructively with borrowers and other customers affected by COVID-19.

Since then, the agencies provided additional guidance and the CARES Act was signed into law. Together, they offer these key takeaways:

Working with Customers

The agencies encourage financial institutions to work prudently and pro-actively with borrowers – consistent with "safe and sound" practices – who are or may be unable to meet their payment obligations because of the effects of COVID-19. The agencies view loan modification programs as positive actions to mitigate adverse effects on borrowers due to COVID-19. The agencies will not criticize institutions for working with borrowers and will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings ("TDRs").

Troubled Debt Restructuring

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 – less than 30 days past due on payments – as of December 31, 2019.

Past Due Reporting and Nonaccrual Status

Regarding loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral. A loan’s payment date is governed by the due date stipulated in the loan documents. If a financial institution agrees to a payment deferral, this may result in no contractual payments being past due, and these loans are not considered past due during the deferral period. During a short-term deferral or modification, the loans generally should not be reported as nonaccrual.

Federal Reserve Paycheck Protection Program Lending Facility

On April 9, 2020, the Federal Reserve issued guidance for banks that wish to participate in the Federal Reserve’s Paycheck Protection Program Lending Facility (the “PPPL Facility”). Under the PPPL Facility, the Federal Reserve Banks will extend funding, on a non-recourse basis, to banks participating in the PPP administered by the Small Business Administration (the “SBA”), taking PPP loans originated under the PPP as collateral.

Main Street Lending Program

The Federal Reserve has announced that it is establishing a Main Street Lending Program to support lending to small and medium-sized businesses that were in sound financial condition before the onset of the COVID-19 pandemic. The Program will operate through three facilities:

The Main Street New Loan Facility (MSNLF), the Main Street Priority Loan Facility (MSPLF), and the Main Street Expanded Loan Facility (MSELF).

Non-GAAP Measures

In reporting the results of December 31, 2019, 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 excluding PPP loans, which is used in computing net interest margin, provides valuable additional insight into the net interest margin and the impact the Paycheck Protection Program has had on our financial metrics. The entire PPP adjustment is attributable to the interest received on PPP loans, which is lower than normal market rates, and fees recognized on PPP loans that are amortized ratably over the life of the loan.

The Company believes that Allowance for loan losses, excluding PPP to total loans is a meaningful supplement to GAAP financial measures and useful to investors because it measures the reserves placed aside to absorb possible credit losses inherent in the loan portfolio. PPP loans are backed by the full faith of the SBA and as such, we have not set aside reserves for this segment of the loan portfolio.

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,

Paycheck Protection Program adjustment impact

Less: Average PPP loans 116,690 — —

Net interest margin adjustment

Less: PPP fees recognized 2,598 — —

Less: PPP interest income earned 1,167 — —

Less: average PPP loans 116,690 — —

Net interest margin (GAAP) 3.21 % 3.50 % 3.41 %

Net interest margin, excluding PPP (non-GAAP) 3.21 % 3.50 % 3.41 %

Allowance for loan losses, adjusted

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, 2020, 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, 2020.

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, 2020. 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, 2020 and 2019, 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, 2020 and 2019, 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 audit 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, 2021

Item 8 – Financial Statements and Supplementary Data

Consolidated Financial Statements

Consolidated Statements of Financial Condition as of December 31, 2020 and December 31, 2019 (Dollars in thousands, except per share data)

Assets

Investment securities available-for-sale, at fair value 147,414 92,791

Investment securities held-to-maturity 22,520 23,914

Restricted securities, at cost 4,616 6,157

Loans held for sale 57,006 —

Accrued interest and other receivables 9,604 5,420

Liabilities and Stockholders’ Equity

Liabilities

Federal Home Loan Bank advances — 40,000

Commitments and contingencies (Note 12)

Stockholders’ Equity

Accumulated other comprehensive income 977 423

See Notes to the Consolidated Financial Statements

Consolidated Statements of Income for the Years Ended December 31, 2020and 2019 (Dollars in thousands, except per share data).

For the Year Ended December 31,

Interest Income

Interest on investments securities 2,007 2,202

Interest on federal funds sold 431 1,403

Interest Expense

Interest on interest bearing DDA deposits 317 998

Interest on savings and NOW deposits 221 289

Interest on money market deposits 2,162 2,379

Interest on federal fund purchases — 1

Interest on Federal Home Loan Bank advances 107 548

Interest on subordinated debt 966 966

Net interest income after provision for loan losses 42,367 37,818

Non-Interest Income

Deposit account service charges 1,916 1,668

Bank owned life insurance income 779 498

Net gain on available-for-sale securities — 5

Net gain on sale of loans 33 566

Non-Interest Expense

Furniture and equipment expenses 2,128 1,728

Administrative expenses 674 731

Other real estate expenses, net 459 62

Preferred stock dividends 635 —

Net Income per common share:

See Notes to the Consolidated Financial Statements

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2020 and 2019 (Dollars in thousands)

For the Year Ended December 31,

Comprehensive Income, net of taxes

Other comprehensive income, net of tax:

Other comprehensive income 554 790

See Notes to the Consolidated Financial Statements

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2020 and 2019 (Dollars in thousands).

Accumulated Other

Common Capital Retained Comprehensive

Stock Surplus Earnings Income (Loss) Total

Vesting of restricted stock 221 (221 ) — — —

Stock based compensation expense — 1,043 — — 1,043

Other changes related to restricted stock awards — 39 (39 ) — —

Other comprehensive income — — — 790 790

Accumulated Other

Preferred Common Capital Retained Comprehensive

Stock Stock Surplus Earnings Income Total

Vesting of restricted stock — 316 (316 ) — — —

Stock based compensation expense — — 1,529 — — 1,529

Dividends on preferred stock — — — (635 ) — (635 )

Other comprehensive income — — — — 554 554

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 1,746 1,593

Amortization of right-of-use assets 390 236

Deferred income tax benefit (1,752 ) (462 )

Writedown of other real estate owned 432 —

Gain on valuation of other real estate owned (43 ) —

Stock based compensation expense 1,529 1,043

Income from bank owned life insurance (779 ) (498 )

Subordinated debt amortization expense 29 29

Gain on disposal of premises and equipment (36 ) (67 )

Gain on sale of available-for-sale securities — (5 )

Change in:

Accrued interest receivable and other receivables (4,184 ) (250 )

Net cash provided by operating activities 17,016 16,692

Cash Flows from Investing Activities

Activity in available-for-sale securities:

Activity in held-to-maturity securities:

Purchases of restricted investment in bank stock (1,222 ) (5,109 )

Redemption of restricted investment in bank stock 2,763 4,846

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

Proceeds from sale of premises and equipment 53 77

Purchases of premises and equipment (1,282 ) (990 )

Cash Flows from Financing Activities

Net decrease in Federal Home Loan Bank advances and other borrowings (40,000 ) —

Issuance of preferred stock, net 27,263 —

Cash dividends paid on preferred stock (635 ) —

Repurchase of common stock (13,797 ) —

Increase in Cash and Cash Equivalents 42,684 6,768

Cash and Cash Equivalents, beginning of period 64,844 58,076

Cash and Cash Equivalents, end of period $ 107,528 $ 64,844

Supplementary Disclosure of Cash Flow Information

Cash paid during the period for interest $ 16,587 $ 19,498

Cash paid during the period for income taxes $ 4,618 $ 4,159

Transfers from loans to other real estate owned $ 362 $ 1,207

Net unrealized gain on securities available-for-sale $ 678 $ 967

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. 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 is 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 (“BHC Act”) 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 shares of preferred stock on the Nasdaq Capital Market on the symbol “MNSBP” as of September 16, 2020.

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 business and professional concerns 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 subsidiary, the Bank. 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 balance sheet 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, 2020 and December 31, 2019, the Bank held approximately $22.5 million and $23.9 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 $3.3 million and $1.1 million respectively, as of December 31, 2020, compared to $3.3 million and $2.7 million, respectively, as of December 31, 2019. Restricted equity securities also consisted of $126,800 in Community Bankers Bank stock at December 31, 2020 and December 31, 2019. 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, 2020 or December 31, 2019 and no previous impairment has been recognized.

Loans held for sale - Loans intended for sale are recorded at the lower aggregate cost or fair value as of the balance sheet 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 balance sheet. 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, 2020, and December 31, 2019, the Bank had approximately zero and $1.5 million of loans classified as TDR, respectively. At December 31, 2019, TDR loans consisted of one loan.

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 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.

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, 2020, and December 31, 2019, 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 2020 and 2019.

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, (8,131,334 for 2020 and 8,251,302 for 2019). 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, 2020 or December 31, 2019. 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.

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, (3) derivative financial instruments, and (4) income taxes. 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 and valuation of other real estate owned 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 19. 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 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 18.

MNSB US Equity

MNSB · 10-K · period ended 2020-12-31

Item 7 – 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 2020-12-31

Item 7 – 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