MNSB - NASDAQ

Everyone and thank you for joining our Virtual Earnings Webcast. My name is Jeff Dick, and I’m the Chairman and CEO of MainStreet Bancshares Inc. and MainStreet Bank. I'm joined here today with our CFO, Tom Chmelik, our Chief Lending Officer, Tom Floyd, and our Chief Accountant, Alex Vari. We'll open for questions after today's presentation. We have two analysts on the webcast with us today, Chris Marinac from Janney Montgomery Scott and Matt Breese from Stephens Inc. Both analysts will be able to ask their questions and share their comments directly following the presentation. You can submit written questions throughout the presentation using the viewing portal. If we miss your question during the discussion, please reach out after the webcast. You should know that we have not authorized the transcription of today's virtual meeting. Unauthorized transcripts may include errors, omissions, inaccuracies, and we don't encourage their use. We will post the video of this meeting on our website. Unauthorized transcripts also do not include our disclosures regarding forward-looking statements and SEC filings referenced in our slide presentation. On that note, we'd also be remiss, If we didn't point you to our Safe Harbor page, that describes the context of forward-looking statements. We use certain non-GAAP measures, which are identified as such, within our presentation materials. We are a Virginia Community Bank celebrating our 20th year of business. We serve the Washington D.C. Metropolitan area, and we have a great organic growth story using a branch-light strategy. We've always been a tech-forward bank with strong online and mobile banking technology. We trade on the NASDAQ Capital Markets Index. The DC market is a great place to do business. We always talk about the strength of our market because we are in a region that hosts the federal government. But we also have world-class universities, hospital systems, airports, tourism data centers, and at least 16 Fortune 500 companies. As such, we also have low unemployment and a very high median household income for our workforce. We ended the quarter with a closing price of $17.73 and a $135 million market cap. The closing price was 75% tangible book value. At this point I will turn the presentation over to Alex Vari. Alex is our Chief Accountant. He works with Tom Chmelik to ensure the accuracy of all of our books and our records. Alex is going to talk you through our financial performance.

Thank you, Jeff. Slide 6 summarizes our financial performance over the past four quarters. The quarter is down due primarily to increase deposit costs. I'll summarize it in the following five ratios. Our EPS is $0.27 per share. Our efficiency ratio is 78%. Our return on average assets is 0.5%. And our return on average equity is 4.7%. And our NIM is 3.15%. Our net loans increased $51.7 million for the quarter and our total deposits increased $22.6 million. Total assets held relatively steady quarter-on-quarter, as did net charge-offs at [0.08%] (ph). Our liquidity remains strong, with good ratios throughout. We have $517 million available in secured advances through the Federal Home Loan Bank of Atlanta, and an additional $129 million in unsecured lines from six different providers. As you look at Slide 8, you will see that our cumulative cycle loan beta is 54%, up slightly from year end 2023's 47%. Our cumulative cycle deposit beta is 63%. Again, up slightly from year end 2023's funding beta of 56%. Slide 9 provides our monthly net interest margin, which is important because it provides additional support, indicating what should be a nice leveling off of the NIM over the last several months. We have some very exciting opportunities in the pipeline, in addition to Avenue, that will continue to reduce our funding costs over the second half of the year and further improve our net interest margin. Our core deposits continue to increase and now represent 78% of total deposits. Non-interest-bearing demand deposits and low-cost demand deposits encompass 27% of core deposits, and the overall weighted average cost of core deposits is 3.48%. Non-core deposits represent 22% of total deposits, with a weighted average rate of 5.04%. It is important to note that 62% of the non-core deposits are adjustable rate. Included in that 62% is $173 million of the term deposits with a weighted maturity of 39 months that are callable at our discretion. At this point, I'll turn the presentation over to Tom Floyd, our Chief Lending Officer, to discuss our loan portfolio and loan performance.

Thank you, Alex. As we look at the loan portfolio, it is worth remembering that so much of lending is about discipline. We have disciplined underwriting, which starts with an independent team of analysts. The team produces comprehensive credit memos that over the years have been commended by regulators, auditors, and loan review specialists. This is an important first step in controlling and minimizing the riskiness of the loans we underrate. We finished the first half of the year with $1.8 billion in outstanding loans, our legal lending limit was $47 million, and our average loan size was $1.9 million. As we generate new opportunities, we also give strong consideration to the discipline of loan pricing. We are a commodity business. We don't set interest rates. We set a risk spread, which we define in our credit risk policy. A loan pricing isn't just about setting the rate. It is also about setting the duration for the rate. Just as we focused on writing floating rate loans during the low flat interest rate cycle leading up to 2022. We've now shifted the portfolio so that 63% of the loans have fixed rates. And up to 37% of loans with floating rates, 57% have floors, with a weighted average rate of 6.48%. Slide 15 shows that we manage our concentration on investor commercial real estate and construction well. This is our best asset and it continues to perform at a very high level for us. A Federal Reserve Bank of Kansas City publication from April 18, 2024, did a nice job of identifying that banks' commercial real estate risks are uneven. They determined that CRE risks can vary substantially across property types and geographic locations, suggesting that aggregate CRE exposure may be a poor measure of risk. The publication goes on to say that banks' exposure to CRE risk depends on more than just loan concentrations. Other key factors include the stringency of the bank's underwriting, its willingness and ability to monitor existing borrowers, and the capital and loan loss provisions it holds against potential losses. Finally, the authors add, despite a relatively strong economic outlook, investors continue to closely assess the risks that commercial properties pose to banks, particularly those with sizable loan concentrations. Under closer examination, though, CRE risks are diverse and depend strongly on property type, property characteristics, and geographic location. Slide 16 shows the results of our hard work. We charged off 0.08% of gross loans in the second quarter. Only 1.15% of our total gross loans are non-performing. 76% of the non-performing loans are comprised of 2 projects where the principals encountered significant delays which exhausted their liquidity. Each project is fully leveraged at near completion. We're actively working toward near-term resolution for both projects. The remaining 24% of non-performing assets consist of seven relationships that we feel will be favorably resolved. At this point, we estimate the loss exposure in non-performing loans to be less than 10% of the current balance. Just 2.74% of our total gross loans are criticized or classified at this time. We originated $73 million of new loans during the second quarter with a weighted average rate of 8.29% and with good loan to values. Our pure office exposure is down to $13 million. Slide 19 reflects the construction portfolio that's diversified both by type and by location. The construction book has a weighted average interest rate of 8.68%, with good loan to values throughout. It is important to note that 89% of the construction portfolio loans have payment reserves funded by the customers. The remaining 11% of construction loans are to customers with strong liquidity and a good track record performance. Likewise, our non-owner-occupied commercial real estate is also diversified by type and location with a weighted average interest rate of 6.54%, good loan to values, and good occupancy. Our owner-occupied loans also reflect good diversification with a weighted average rate of 6.19% and good loan to values. Slide 22 shows the trend in stress tests over the past five quarters and resulting impact capital. The Q2 stress test for all earning assets reflects a worst case stress loss estimated at $42.5 million. In all quarters, we remained strongly capitalized. The stress test includes loan level testing for all construction and investor commercial real estate. For all other loan categories, we use the balance in each call report category multiplied by our worst ever loss for that call report category. For investments, we use the market price. And finally, for bank and life insurance, we determine the liquidation value. That wraps it up for our loan presentation. I'll turn it over to our CFO, Tom Chmelik now.

Thank you, Tom. During the first half of 2024, we repurchased 41,858 shares of common stock for an average price of $17.50, which was accretive to book value. As Tom Floyd indicated, we are very well capitalized. We also have a good capital stack consisting of a good mix of common, preferred, and subordinated debt. Our accumulated and other complements of income is just 3% of capital. Finally, as we look to the remainder of 2024, we offer the following guidance. The expense-run rate will average 2% per month through the remainder of 2024, which includes the amortization of avenue capitalized expenses. And we project low single digit loan growth for the year. As Jeff said earlier, MainStreet Bank has a strong culture and a focus on building shareholder value. We are in the business of taking risks and our team is well placed to identify, measure, monitor and control those risks. We'll do our best to continue to prove that to you quarter-on-quarter. I'll turn it back to Jeff at this point for an update on Avenue.

Thank you, Tom. I'd like to start this part of the presentation by discussing why we chose the banking as a service path, where we are in the process, and where we go from here. MainStreet Bank has always had a branch-like strategy. But it’s fair to lookout where we are with respect to our peers. It seems most $2 billion banks have between 22 and 25 branches. So we looked at what adding 15 branch locations would do for us. We estimated the fixed cost to be $130,000 per branch or [$1,950,000] (ph) per year. In year one, we estimated the branches would produce $75 million in demand deposits, growing to $300 million in demand deposits in year five. We compared that with building out of banking as a service solution. Assuming annual fixed costs of $1.8 million, We estimated the solution would produce $225 million in demand deposits in year 1, going to $1 billion in year five. We also looked at the current environment for branch deposit gathering, particularly in a metropolitan area like we serve. The reality is, customers bank online. Convenience is key. If convenience means opening another account, they will. As wealth transfers to the next generation, certificates of deposit, as we know them, will become a thing of the past. So when we go back to comparing the two strategies, branching doesn't make sense. If customers don't need or want to go to the bank, building more locations doesn't solve for anything. If you didn't pick up on it, the background image on the last slide was from the site where they filmed the Field of Dreams. If you build it, they will come works well in the movies, but not so much for today's banking customers. The reason I included this comparison is because just a few years back it would have been accepted without question. In reality some banks will continue with the branching strategy. The real comparison I think is in the opportunity and the opportunity cost. According to an article co-authored by Boston Consulting Group and QED Investors, embedded finance will become all-pervasive by 2030. They estimate the small and medium-sized business segment will account for $150 billion, and the consumer segment $120 billion. But since March of 2023, the three prudential regulators have issued consent orders against 12 banks in the banking-as-a-service space. Each consent order is different, but they have similar themes. Banks aren't ensuring proper compliance systems, they aren't completing proper due diligence, they don't have ready access to information, and they're relying upon someone else to do the heavy lifting. The problem is each time another bank receives a consent order, they raise the bar for the rest of us. Regulators and the industry can't help but looking at banking as a service providers with a jaded eye. As a result, we needed to reassess our deployment strategy. I talked through this during our last virtual meeting, but I think it merits a deeper dive. Our intention was to fully launch the first two versions of Avenue in an environment that included manual workarounds. Given the regulatory environment we have now, management and the Board weighed the cost of going forward with a solution that included some manual workarounds. We thought a lot about the downside risk. With 12 banks having set the table with a lack of attention to detail and weak solutions, there would be no upside for regulators to give us credit for manual overrides and future intentions. The downside would be to receive a regulatory action that would divert our attention from our goal. Management and the Board decided that waiting until we had version 1.2, a complete version, was the right thing to do. And in reality, opportunities are still strong, as many of our competitors will be busy for the foreseeable future working through their regulatory burdens. Talk to different people and estimate anywhere from three years to five years to work out of a consent order. When fintechs come to us they won't have to worry about whether we will be there for them. There's not another solution that can do what Avenue can. Avenue is a software-as-a-solution platform that was designed, built, and owned by MainStreet Bank. Through Avenue, we will enable fintechs, social media platforms, and other solution providers with the ability to embed app-based FDIC-insured banking solutions for their customers. All the banking components reside under our control. We host the ledger along with the integrated tools for customer identification, anti-money laundering, bank secrecy, compliance management, complaint management, case management, tokenization, reconciliation, and multi-factor authentication. I've said it before, but we've kept our regulators abreast of our solutions since the very beginning, and we've shared ongoing progress reports along the way. Just last week, the Avenue team spent the morning at the Richmond Fed, providing an update on our solution from every angle. System architecture, compliance, cybersecurity, quality assurance, and accounting. This meeting was at our request. We wanted them to see and hear that Banking- as-a-Service can be deployed the right way. We did tell them that we recently delayed launching our first version until all solutions have been fully integrated. They know that we take this very seriously. At the same time, the entire team is really excited to bring this solution to market and they are working overtime. As we speak, our first client is finalizing their beta testing and will start scaling over the next several weeks. We have another client that will shift from the sandbox into production over the next few weeks. Yet another client that was previously reported as going into the sandbox is soon ready to finally do so. We actually had to put the brakes on them until they moved their solution to a US-based cloud. We met with them a week ago for an update and they indicated that the move has taken place. Once we've confirmed that, they will go back into the sandbox. The team has done a great job of working through all of the priorities that we have to have to ensure that everything will be done as it should be. Then the rest of the fintechs will continue to progress as version 1.2 is fully launched. As we built this process, we've capitalized $17.2 million building it. The build has been efficient and as you know, the cost will be amortized over 10 years. Avenue deposits produced $1.1 million in interest and fees over the first half of the year, which covered half of their overall expenses. This is truly an exciting time as we continue our transformative journey. Overcoming hurdles is what every successful business does, especially when innovating. I was going to say in spite of the delay, but really it's because of the delay and everything that's happened, we still have early mover advantage. Our Avenue solution works. The remaining sprints to get to version 1.2 will be completed in September. And finally, it's also worth noting that we took a fine-tooth comb through each of those 12 consent orders and we've put a list together of the information that we think regulators are looking for. The good news is that we have that information at the ready. All of our upfront due diligence has been well documented. We've written durable contracts for all the services and if we haven't already built the reports in the format that the regulators request will be easily able to do that and produce them for them. So again we'll address the questions that you submitted through the portal after we hear from our analysts. At this point if our technology is working correctly we'll start with Chris Marinac from Janney Montgomery Scott. Chris are you on the phone?

Yes Jeff can you hear me?

Yes.

Alright great thanks for hosting us today. I guess I want to start where you finished with Avenue. If you look at the Avenue situation here does you know does the regulatory actions of the last six weeks to eight weeks suggest that there that there was a problem at MainStreet or that you simply need more time to find the customers to kind of get you because I know there was I think a mission to try to have some additional traction by the third and fourth quarter of this year So just want to understand that better.

Yeah, good question. And like I said, everything counts. And from the very beginning, as you know, we've been set out to build a fully compliant and well-balanced solution. We just decided that, like I said, there is just no credit for being almost right and then implementing something. And From a regulatory standpoint, I was there, I remember, there's no upside. So when they come in, if they see something's missing, the easiest thing they can do is put it in the report. And whether that means you actually end up with anything from just matters requiring attention to an MOU and ultimately to a consent order, we just didn't want to risk that. It's so much easier to wait, in the scheme of things, five years to work yourself out of a consent order versus a few months or a few quarters to get it right and completely launch ready for scaling purposes. It just became sort of a no-brainer for us. And just getting it right, that landed steadfast on our risk management team. And so that's where we are. There's nothing new, nothing that feedback wise from the regulators or anything else it just we want to do this right so that we can stay in the space you know and not have to slow down before we can speed up.

Okay, and is the pipeline bigger than it was before? It would seem that you would have a bigger pipeline and maybe that just hasn't gelled yet because this is all, you know, lasts several weeks, but just curious if the pipeline ultimately is bigger or is should be bigger than what you originally had.

Yeah, again another good question. The Avenue team supplied me with numbers that were slightly more than what we put in the slide deck. I felt very comfortable and confident with the numbers that we put in there. I think there are more opportunities that are waiting in the sidelines. And honestly, I feel like once we launch and people can start to see how robust the solution is that those are going to come easy and quickly.

Okay I'm just looking at the pending decisions and the waiting for licenses those are lower numbers than last quarter so that was kind of a pipeline question yeah for that.

Yeah go ahead.

Look, I have a question about the Main Bank so we can finish, Avenue first.

Well if you want to go ahead with those questions.

Sure. So my question I guess on the Main Bank is do you have a vision for an interest margin bottoming or is it still in a transitional point here? I know it's a little bit uncertain exactly where the cost of funds will go the next two quarters, but I just want to get a sense of kind of margin and maybe some of the puts and takes that where you can kind of control where that goes.

Yeah, yeah, thanks for that question. As you can see in the slide deck, the NIM has kind of leveled off over the last few months. We feel very good about that. That's where we're seeing some nice level of consistency. If you're looking at interest income over the last quarter or so, you're seeing that continue to rise. And as I mentioned earlier, we have a lot of exciting opportunities in the second half of the year to get some low cost deposits in addition to Avenue. And so we feel very optimistic that we're going to be able to lower funding costs and we continue seeing the nice growth in the interest side, which should help to increase the name in the back half of the year.

Gotcha. Okay, great. I'll step back and pass this back to Matt and I may come back afterwards.

That sounds good. Matt, are you with us today? With us today? We'll wait and see if he does connect with us. He might be having sound problems. Do you want to take questions from the folks? Actually, if you don't mind reading.

Can you hear me?

Yesh, go ahead, Matt?

All right. Let's try it this way. I'm sorry about that, just trying to figure out the technology here. I'm sorry if I missed it. When do you plan or what is the updated year end Avenue related deposit goal? I think previously we were targeting $225 million by the end of the year. When do you plan on hitting that level at this point?

So I mean we're still shooting for that because we put it out as earlier guidance and we did feel like the second half of the year was where we were going to be generating most of the Avenue deposit growth this year. That's an aggressive target. We're working on it. We hope to get to at least 100 by the end of the year. We hope to do better than that. But so it's really how effective the fintechs do with their marketing and everything once they are fully launched in order to bring the solutions in. And the first 2 fintechs have taken a little bit longer as I was talking to the members of the team that are involved in helping the fintechs connect through APIs and everything. But they were giving us an update the other day that each one is getting progressively faster and they're still looking at trying to get fintechs who are app ready, completely on the system within 2 months to 3 months. They feel like that's completely doable. So it is a function of again, how well they do and how much they can put through us. But at a minimum, I'm shooting for $100 million. We think it's doable. I'd still like to get to that bigger number.

And Do those 2 fintechs represent the lion's share of the 100 million you're talking about?

Actually, three of them do.

Okay, I appreciate the thoughts on the margin for the rest of the year. I was curious your thoughts on loan growth throughout the rest of the year. I also noticed that the CRE concentration ticked up just a hair, so just wanted to get a sense for overall loan growth expectations and then comfort with that CRE concentration even if it's bouncing up a little bit.

Sure, For loan growth at the end of the year, we're envisioning low single digits. The CRE growth, we don't expect a lot of major shift from the level that it's at now, just depending on the timing of payoffs and new loan originations, funding's on 40 issued commitments. It's going to fluctuate in there, you know, I would say between 7% to 10%, you know, but certainly below our upper limit of [375] (ph) where we have that set, but just some minor movements in there, you know, around that threshold of what we expect.

And then on the credit front, you know, NPA's jumped a bit this quarter. It's a low level, granted, but you know, what happened there? What were the credits that drove that increase, and what are you thinking for loss content if there is any?

On the presentation we spoke to this. So if you look at, and if you want to look at the slide deck on number 17 where you've got the list of non-performing, So the total balance is the $20.7 million, roughly 76% of that is two projects.

Okay, they're both substantially completed. One's a multifamily project, one's a condo project. We're expecting resolutions for both those cases in the very near-term. So that was the main driver in that number. That's the majority of it. The other $5 million give or take of the balance is spread across seven relationships that are smaller and not all lumped into one particular bucket. So we feel like we're in good shape. I had mentioned on the call that we feel the total loss exposure in that whole $20 million bucket is less than 10% of that, less than $2 million. That helps.

Yep, very helpful. Okay, I had two other ones. You know, one, I saw the expense guidance for increases of 2% per quarter. I'm assuming it's on the entirety of the expense base. Is that a good number to use into 2025, as well as build out on Avenue continues?

I think it's probably premature to continue it out that far. We're going to reassess and continue to provide guidance each quarter to the best that we know at that time. So we just wanted to give you the insight for the remainder of the year for now.

Part of that, Matt, is you look at Avenue, it's a function of how successful Avenue is. And as that continues to grow, the success brings in low cost deposits, it brings in fee income. And so if we're adding more features and functionality because we have those successes, then it's possible that we would continue to grow the team to support Avenue. On the other side of it, it would be bringing in those low-cost deposits and the fee income. So I think that's one of the reasons I think Alex's statement is absolutely spot on for right now. You know, that gets us to a point where, you know, you're fully taking on the capitalized bill as we have it today. So that's probably the best way to look at it.

Got it, okay. And then last one for me, and likely the hardest, just given the stock performance this year, the Avenue build out is certainly part of that and the timing of when we'll start to see the inflection point and the deposits, especially considering your benchmark, the KRE and the bank index. At what point does that become an overarching issue? And when do you start to weigh independence if it doesn't start to hit some of your targets?

Yeah, so I think that's an ongoing question that we look at all the time. We like to look at it from the other side as we see the success of Avenue. How is that going to impact the share price and the opportunities that will come with it. And so, again, going back to the -- just for a second, to the branch, we could easily have spent money building branches like a lot of banks have, only to find that, the deposits aren't coming along. Well, you're stuck with that, right? You're stuck with the bricks and mortar. You also have to staff those locations every day. Avenue will be successful. There are several players – several fintechs that are coming into it. It is going to be successful. It is a measure now of how successful will it be. If it's only modestly successful but it's covering all its costs, bringing in good deposits, it's worth keeping. If it's hugely successful, we'll continue to grow, develop, put more architects, programmers in to give it more features and functionality. All of that will help to even build a bigger deposit basis. Given what we see from industry reports, the opportunities are there. Where we are significantly different than everybody else. The people that were playing in that space up until now had middleware providers, and those middleware providers had their own capital costs to be covered. And they were significant, and they started to really charge the banks for the deposits that they were giving them and trying to make these every way possible. We don't have any of that. We have our fixed solution that we're putting out there. We've got pricing that we can always be more competitive than other folks because we've got those costs significantly controlled and we've got the profits built into the company, not to two companies or three companies. So it's a function of just getting it out there, bringing it in. Avenue works, I've had the main system architect, they've stressed tests from a volume of transaction process per minute, per second, all that stuff. It works and it's hearty. So like I said, It's a function of getting it out there. You always have to be aware of what happens with the downside. But just keep this in mind. The book value that we report on our stock is the book value not including Avenue. It's the tangible book value. Avenue at this point is an intangible asset. So on our worst day, the tangible book value is still real. It's there. If you had to do something with that $17.5 million, I don't see it happening. If we did, that's a hit. That changes the profile of the institution, and everything changes from that point. But the fact is, it's a great solution. It's taken longer to bring about because of what's happened in the market, that doesn't mean it's not going to work. That just means when we bring it out, it's going to be that much better and easier to scale because we don't have any of those manual things that we would have had to do otherwise. So I think it's a great question, Matt, but like I said, we're focused on it. From the other side, How do we go forward? When it's successful? What other things do we need to do? How do we determine the stickiness of those deposits that are bringing in? Because every fintech is going to have a different profile. Some deposits will be stickier than others, so some will have to keep in funds, some will have to, we'll be able to maybe lend in the construction book, some, you know, we'll just -- we'll have to maybe go a little, we'll be able to go a little bit longer term, depending upon what it is, the app itself for the fintech is trying to achieve. What you can be rest assured of is we're not going to take those funds that are due tomorrow and put them into 30 year securities. I think you said that was your last question. I don't know if you have a follow on or not, but if not, can we go to Andrew? Can you read the --?

Yeah, the first question is regarding the buyback program that we talked about. Do we continue, will you continue it going forward?

Yes, right now the current buyback program has $3.5 million remaining in it, So we will continue to look at opportunities as they arise for us to buy the blocks or just in the open market.

All right. The next question is we mentioned earlier that we have strategies to improve our core deposits outside of Avenue. Is it possible for us to elaborate on this?

Sure. This is just your traditional banking and relationship banking. So we have a good pipeline with our commercial lending team and our business banking team that are focused on developing relationships in our community. And we have a good pipeline that we're excited about. We're actively trying to work it through. We're treating each opportunity like a nugget of gold and taking it through and trying to get it booked and opened up as soon as possible.

The next question is, do we have an estimate of when we believe Avenue to be net positive to our earnings?