Earnings Call Transcript - MNSB Q2 2025

Jeff Dick, Chairman and CEO

Good afternoon, and thank you for joining our second quarter 2025 earnings webcast. My name is Jeff Dick. I am the Chairman and CEO of MainStreet Bancshares, Inc. and MainStreet Bank. With me today is our Bank Chief Financial Officer, Alex Vari; our Chief Lending Officer, Tom Floyd; and our company Chief Financial Officer, Tom Chmelik. Chris Marinac, Director of Research for Janney Montgomery Scott, will join us at the end of the call today with his questions. If you'd like, you can also submit written questions throughout the presentation using the web portal. We'll address your questions at the end of the presentation. If for some reason, we miss your question during the discussion, please reach out to us after the webcast. I'd like to take a moment to point you to our safe harbor page that describes the context of forward-looking statements that we may make today. Please also know that we may use certain non-GAAP measures, which are identified as such within the presentation materials. The D.C. metropolitan area is much more than a host to just the federal government. With our major universities, tourism, data centers, world-class medical facilities and Fortune 500 companies, it is a great place to do business. We still have low unemployment and good median household incomes. Housing is still undersupplied, and it remains a seller's market. While the market is vibrant and we see good opportunities, we are affected by the actions taken by the federal and D.C. government, and we monitor those actions to assess their impact on our business strategy. You'll see that Slide 4 recaps our growth story, and there's not a whole lot more to say on that slide. The next slide, we are a Virginia community bank serving the Washington, D.C. metropolitan area for over 21 years. We have a great organic growth story using a branch-light strategy. MNSB is a small-cap stock that trades on the NASDAQ Capital Markets Exchange and is listed on the Russell 2000 Index. As of quarter end, we traded at 78% of tangible book value. During today's presentation, you will hear good news about our net interest margin expansion, our solid earnings, and our strong asset quality. And at this point, I'll turn the presentation over to our bank CFO, Alex Vari.

Alex Vari, Bank CFO

Thank you, Jeff. On Slide 7, we summarized our financial performance over the last 5 quarters, with this last quarter illustrating our commitment to be a high achieving community bank. Earnings per share increased to $0.53, our return on average assets to 0.86%, our return on average tangible common equity to 8.84% and our net interest margin to 3.75%. We are very excited to report strong quarterly results. Contributing factors during the quarter included improvements in nonperforming loans while recovering a meaningful amount of accrued interest, continuing to lower our cost of funds and improve our net interest margin. We are seeing good loan opportunities as we look at our third and fourth quarter pipeline. On Slide 8, we recognize it's important to understand expectations for future quarters and want to call out a few onetime nonrecurring transactions during the quarter on both the revenue and expense side. You can see we had nonrecurring revenue of $1.5 million, consisting of a recovery of accrued interest and fees on a previous loan and recognition of some noninterest income gains. Focusing on core community banking, we had nonrecurring expenses of $1.8 million related to personnel downsizing, contract terminations, and realigning certain accruals. Without these nonrecurring adjustments, our EPS would have been $0.56 and our return on average assets would have been 0.91%. Slide 9 highlights our intentional management of our loan-to-deposit ratio to maximize our net interest income, which has increased for the third consecutive quarter. Our liquidity position remains strong with ample funding sources, particularly in our secured credit availability. As of the quarter end, we have liquidity and available credit facilities to match 38% of our deposit portfolio. Moving to Slide 10, you will see continued improvement in our net interest margin. While we are reporting a quarterly net interest margin of 3.75%, our core net interest margin also showed meaningful expansion quarter-over-quarter. Our net interest margin rose primarily as our cost of funds continued to contract. Our total funding costs reduced 20 basis points to 3.29% during the quarter. Looking at where the net interest margin is headed, we believe the margin will hold steady and could see progress as we have $152 million in CDs repricing in the second half of the year and a robust loan pipeline. Slide 11 shows resilience and consistency in our deposit portfolio mix. On Slide 12, you will see our business banking team continues to attract and grow noninterest and low-cost deposits, helping to replace higher cost funding and expand our net interest margin. Core deposits remained consistent with the prior quarter, while noninterest-bearing and low-cost deposits grew by $6 million during the quarter. We also reduced our reliance on noncore deposits by 19%, which was accretive to our net interest margin. Slide 13 lays out our estimated expense run rate for the remainder of the year. We continue to be committed to driving operating expenses down as we focus on core community banking. We were able to achieve our strong quarterly performance at the current operating level. While we are projecting additional expense reductions, we have revised our estimations for the second half of the year that include operating costs of a community bank in a major metropolitan market. Attracting and retaining talented bankers, expanding our customer footprint and the ever-growing regulatory burden across all community banks must face. We believe we are well positioned in the marketplace to build on our strong quarterly performance for the second half of the year. On Slide 14, we typically get questions about stock buybacks. We have an active buyback plan in place with a capacity of just over $3 million to repurchase shares. We will continue to look at opportunities to execute buybacks in line with our strategy. At this point, I'll turn the presentation over to Tom Floyd, our Chief Lending Officer, to discuss our loan portfolio and loan performance.

Tom Floyd, Chief Lending Officer

Thank you, Alex. I'm incredibly proud of the hard work everyone on the team put in during the second quarter, and our consistent strong performance is a testament to that effort. Over the next few minutes, I'm excited to delve into the details and trends about our portfolio composition. I'll also highlight the proactive steps we're taking to actively manage risk. We've experienced positive trends in our workout credits, and I look forward to sharing more specifics on that as well. Our commitment to serving our community remains unwavering, and we are optimistic about what the future holds. Slide 15 provides an overview of our diversified loan portfolio as of the end of the quarter. Our total loans outstanding are $1.8 billion distributed as follows: 30% is nonowner-occupied commercial real estate, 21% is owner-occupied commercial real estate, 18% is construction, 14% is multifamily, 11% is residential real estate and 6% is commercial and industrial. Additionally, it's worth noting that nearly all of our construction portfolio has a suitable interest reserve held at the bank. Slide 16 highlights our commercial real estate concentration over the last 7 quarters. We've always effectively managed our exposure here and finished the quarter at 366% of capital. Our Board sets our limit at 375%. So we've been strategically building our pipeline to maximize our opportunity to grow assets. And based on the pipeline and number of quality opportunities in our market, we're confident we can continue to operate at our comfort threshold. You may be familiar with the asset on Slide 17, as we've discussed it in the last few presentations. Not all stories have a happy ending, but I'm happy to report this one does. We've collected 100% of principal, interest at the default rate, and all fees. This is the outcome we anticipated, and it's excellent to see this resolution come to pass. Slide 18 is a lens into our government contracting portfolio. Before I dive into this slide, I want to assure you that we're in constant contact with our borrowers in this highly dynamic space to ensure we're appropriately supporting our clients and effectively managing risk. Our portfolio has 29 asset-based lines of credit in place where all advances are supported by a borrowing base of billed receivables. These receivables are deposited directly into our bank from our clients' respective customers and the funds are used to automatically curtail their corresponding credit lines. As you can see, these 29 lines have balances of $13 million outstanding with total commitments of $79.2 million, which equates to a 16% utilization rate. Over the average line's lifetime, this is relatively consistent. Our entire government contracting book only has $2.5 million in outstanding term debt. These loans are amortizing rapidly with an average remaining term of 30 months. It's worth noting that the average deposit relationship attributable to this portfolio is $75.5 million over the quarter, which equates to 580% of outstanding and 95% of commitments. The next slide highlights that our loan portfolio is well positioned for stable or falling rates. 70% of our portfolio has rate resets beyond 6 months with the remaining 30% with rate resets within 6 months. Of those loans with a faster reset, 45% have a weighted average floor rate of 6.5%. As we progress in 2025, we anticipate this will help our net interest margin as rates are expected to remain stable or decrease. Slide 20 is a snapshot of our year-to-date production and volume of loans participated to other banks. As you'll see, our originations have resulted in $97 million outstanding in loans year-to-date, and we participated out $13 million over the same period. This is a testament to our lending process, which is relationship-driven and supported by superior credit underwriting, resulting in strong market demand for our organic loan production. Slide 21 shows our trend in average new loan size moving downward, while our legal lending limit has increased. This highlights that in the current environment, we're sticking to smaller-sized opportunities within our market. Slide 22 shows we have a nominal level of classified loans and nonperforming assets. Slide 23 shows the trend in stress tests over the past 8 quarters and the resulting impact to capital. The Q2 stress test for all earning assets reflects a worst-case stress loss estimated at $46.79 million. In all quarters, we remain 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-owned life insurance, we determine the liquidation value. In summary, our team has done an excellent job serving our clients while managing risk over the second quarter of 2025, and we continue to see our efforts with our workout credits pay off, no pun intended. We're passionate about serving our community, and we love seeing it thrive, and we are optimistic about the future. That wraps it up for our loan presentation. Back to you, Jeff.

Jeff Dick, Chairman and CEO

Thanks, Tom. As I indicated at the top of the hour and as you've heard during this brief presentation, we've shared good news about our net interest margin expansion, our solid earnings, and our strong asset quality. We'll address the questions that have been submitted through the portal after we hear from Chris Marinac, Director of Research at Janney Montgomery Scott. Chris?

Christopher Marinac, Director of Research

Jeff, can you hear me okay?

Jeff Dick, Chairman and CEO

I can, yes.

Christopher Marinac, Director of Research

All right. Great. I wanted to ask about sort of loan pipelines and loan growth and kind of what's a sustainable pace, both in the next couple of quarters, as well as you think through your business plan in the next couple of years?

Jeff Dick, Chairman and CEO

Okay. Tom Floyd, do you want to take that?

Tom Floyd, Chief Lending Officer

Sure. Great question, Chris. So in the beginning of the year, we had given guidance for low single-digit loan growth, and we still feel like that's good guidance. We've had a little bit of a retraction in the first quarter, but that we view as normal just based on the timing of payoffs and when we can get the right opportunities closed and booked. We're looking for not just growth for growth's sake, but the right opportunities, and we are very encouraged with what we have in the pipeline. So...

Jeff Dick, Chairman and CEO

Yes. And you'll remember, too, in the first part of the year, first half of the year with the change in administration and the effects of DOGE and other things, we did sort of try to constrain our lending while we waited to see the total impact on the economy that was going to come from that. We think things have settled down now. So we're in a...

Christopher Marinac, Director of Research

So with that pace of growth, I mean, there seems to be limited pressure on funding. So do you see the funding mix continuing to get more favorable and perhaps giving you further relief on the margin?

Alex Vari, Bank CFO

Yes. As I mentioned in the presentation, we're going to have opportunities to reprice some of our funding. Deposits in our market, of course, are challenging, but our business bankers are doing a great job getting out there, growing relationships, and picking up new relationships. And so I think between what we're able to do, repricing CDs and developing new relationships and new deposits, that's going to help us on the funding side here in the back half of the year.

Unknown Executive, Executive

And I think the business bankers focusing on core deposits that they're focusing on the noninterest-bearing is really helping out, and we're seeing some of those things that they're working on right now.

Jeff Dick, Chairman and CEO

And on the sort of the total balance sheet management side, it's funny. There are times where over the years where you could just focus on growing one side over the other. This is the time where we're really looking at growing both sides in a fairly lockstep manner. And as Tom Floyd alluded to earlier, looking a little bit more at what loans are going to help to maximize the earnings power of the company. And then likewise, on the deposit side, do we need to bring in those deposits right now? Can we let some of the other higher cost deposits run off, keep our loan-to-deposit ratio right around 100% and not just growing for growth's sake, but really trying to manage the balance sheet to maximize our earnings power of the company.

Christopher Marinac, Director of Research

Great. And my other question just has to do with asset quality in general. I mean, my impression is that the criticized and classified are moving in a positive direction. I'm just kind of curious what else you see on the horizon, either for new issues that could fester or just general valuation trends as we're now at the midpoint of the year.

Tom Floyd, Chief Lending Officer

Yes, that's a great question. We are satisfied with the credit quality we're observing across the board. We are continuing to monitor the asset prices of underlying real estate. As we've mentioned before, we have very little exposure to office space, but we keep an eye on all asset levels in our market. We are noticing a slight increase in the days on market for residential real estate, but it remains at a level that is not concerning. It is still a seller's market. We will continue to monitor these factors closely. However, at this moment, we are pleased with the trends we are observing. While the future is uncertain, we are happy with the trends related to credit quality.

Christopher Marinac, Director of Research

And then I'll just sneak one more in. Just in general, the government contracting business that you see, whether it's in your bank or just around you in the marketplace, is that stabilizing? Or is the uncertainty that existed earlier this year kind of still in place?

Tom Floyd, Chief Lending Officer

We do believe that it's stabilizing. It's a dynamic marketplace, and there's lots of news coming out constantly. So it's something we have to make sure that we don't get comfortable with or take our eye off the ball. And so the key is just continually to be in communication with our customers to make sure we're appropriately managing risk. But overall, I do think that there is a sense that there's a little more stability than there was a few months ago.

Jeff Dick, Chairman and CEO

Yes, Chris, thank you as well. I would like to add to the government contracting question because it's an important topic. We have changed our borrowing base certificate, and one of our requests to the customers is to confirm that there have been no changes to their contract structures. We obtain this confirmation on at least a monthly basis, and our lenders maintain regular communication with those borrowers as well. Tom, I'm not sure if you have anything to add.

Tom Floyd, Chief Lending Officer

And we're only advancing on billed receivables. We don't advance on unbilled receivables at all.

Jeff Dick, Chairman and CEO

I think for our term debt structure in the government contracting portfolio, Tom indicated that there is about $2.5 million outstanding, which is also very strong. At this point, we'll address a few questions from you on the phone this afternoon.

Unknown Executive, Executive

We've got some good questions in the queue today. First up, can you talk about efforts on growing core deposits since Avenue has been shut down?

Alex Vari, Bank CFO

Yes, as we mentioned earlier, we aim to maintain a high loan-to-deposit ratio to enhance the company's earning potential. Our business bankers are actively working in markets where we previously had limited presence, focusing on building new relationships and increasing deposits. This is evidenced by the growth we experienced in noninterest and low-cost deposits over the last quarter, which highlights their efforts. Additionally, our lending team is committed to engaging with customers and bringing in deposits while we assess deals, ensuring we prioritize this aspect. Tom, do you have anything to add from the lending perspective?

Tom Floyd, Chief Lending Officer

Absolutely. I'd appreciate that. We are at our best when we work as a team with the business banking and lending side, working in concert with expanding existing relationships and identifying the right opportunities. So it's something that we take very seriously in terms of focusing on teamwork and working together to build relationships. So we are very excited, like I said, about the pipeline that we've built and the diversified industries that we have an opportunity to serve and work with so...

Alex Vari, Bank CFO

Yes. And anecdotally, I've heard just the referrals that the lenders are giving the business bankers and vice versa and really collaborating to penetrate more into the market than we have before and kind of to build those have been successful, and I think we're seeing good opportunities on that side.

Unknown Executive, Executive

Will there be any costs associated with closing down Avenu in future quarters?

Jeff Dick, Chairman and CEO

I can address that question. Most of the costs related to staffing and the various systems we are using to operate have already been incurred. Currently, we are in a maintenance phase as we assess any potential future value from the solution. We are making efforts to minimize these maintenance costs, but I don't expect to see anything significant moving forward. Do you agree, Alex?

Alex Vari, Bank CFO

Yes, I agree with that.

Unknown Executive, Executive

How many shares were repurchased in the second quarter?

Alex Vari, Bank CFO

Yes, good question. We didn't see any block trades occur in the second quarter other than when we were admitted to the Russell 2000 and the reconstitution. So there wasn't a lot of opportunity for those.

Unknown Executive, Executive

With regulatory limits on CRE, will the bank's growth be limited?

Tom Floyd, Chief Lending Officer

No. We've always done a good job operating within our Board set policy. And I will say that with the opportunities in our pipeline right now, we have a very wide range of industries that are non-CRE with owner-occupied CRE being a major component, which obviously doesn't count against that ratio. So we are very excited about that. And with low single digit as what we've discussed as our guidance, we see no issue there.

Jeff Dick, Chairman and CEO

And I think the growth in capital, too, as we're going to see in the coming quarters, will obviously augment some of those ratios.

Unknown Executive, Executive

Did you repurchase any shares in the quarter? If not? No.

Jeff Dick, Chairman and CEO

I already asked that one.

Unknown Executive, Executive

Sorry, my apologies. What are your profitability goals for 2026 ROA and ROE?

Alex Vari, Bank CFO

Yes. Yes, great question. I think our quarterly results show that we're well on our way to a 1% ROA. There's always uncertainty with market conditions and what the rate environment is going to look like. But we're seeing good loan opportunities. We're seeing good deposit opportunities. We're trending in a very positive way. And so I think those things are going to put us on that trajectory to be where we want to be.

Unknown Executive, Executive

And I think on the ROE, I mean, if we get close to 1%, that's going to be back into the double-digit numbers where we were historically. What levels of profitability do you need to produce to justify the bank's independence?

Jeff Dick, Chairman and CEO

That's a great question. We believe that a standard of 1% or more is important. Our focus isn't just on justifying the bank's independence, but rather on identifying the right opportunities for us at this time. As we evaluate corporate alternatives, we concentrate on whether we can generate a better income stream independently compared to any opportunities we might be considering, such as a merger or acquisition. Our main driving factor is to continually assess market opportunities and compare them to what we can achieve on our own. There’s no magic number, but if we aren't able to get at least back to the 1% range, it may not make sense for a bank in a major metropolitan area. To refocus, we’ve mentioned in recent quarters that gathering low-cost deposits remains one of our biggest challenges, and the team is doing an excellent job. Our business bankers and lenders are working closely to explore all available opportunities. Interestingly, large banks can sometimes inadvertently help us because they are utilizing AI to manage check deposit funds availability. We've heard customers share stories of large deposits being held for 21 days due to AI decisions, which is frustrating for them. This creates a positive opportunity for us as a community bank that prioritizes relationships. We ensure funds clear more quickly than that. We aim to find these opportunities, and many of our business bankers have come from large banks and excel at maintaining relationships and engaging with the community. I truly appreciate everyone's comments today and look forward to reporting strong quarters ahead. We are on track, but economic uncertainties remain. Thank you for your investment in MainStreet Bank, and we look forward to our future conversations. If you have any questions or comments, don't hesitate to reach out. Thank you.