MainStreet Bancshares, Inc. 10-K

Item 7A. Quantitative and Qualitative Disclosures about Market Risk   Market Risk Management   The effective management of market risk is essential to achieving the Company’s strategic financial objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in the Company’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value.   Interest Rate Market Risk   The Company’s net interest income and the fair value of its financial instruments are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Committee. The Asset/Liability Committee meets regularly and has responsibility for approving asset/liability management policies, formulating strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company.   We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under different interest rate assumptions. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturity and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on our net interest income.   The table below sets forth, as of December 31, 2022, the calculation of the estimated changes in our net interest income that would result from changes in market interest rates over one year if we take no action from our current plan.   Basis Point Change in     Net Interest Income     Year 1 Change   Interest Rates     Year 1 Forecast     From Level   (Dollars in thousands)   +400     $39,336     63.14 % +300     $35,752     48.27 % +200     $31,847     32.08 % +100     $28,271     17.25 % Level     $24,112     —   -100     $19,857     -17.65 % -200     $15,088     -37.43 % -300     $10,798     -55.22 % -400     $6,764     -71.95 %   Economic Value of Equity ( “ EVE ” ). We analyze the sensitivity of our financial condition to changes in interest rates through our economic value of equity model. This analysis measures the difference between predicted changes in the fair value of our assets and predicted changes in the present value of our liabilities assuming various changes in current interest rates. The table below represents an analysis of our interest rate risk as measured by the estimated changes in our economic value of equity, resulting from an instantaneous and sustained parallel shift in the yield curve at December 31, 2022.                 Estimated Increase     EVE as a Percentage of Fair                 (Decrease) EVE     Value of Assets(3)   Basis Point                                     Increase   Change in     Estimated                     EVE     (Decrease)   Interest Rates(1)     EVE(2)     Amount     Percent     Ratio(4)     Basis Points   (Dollars in thousands)   +400     $ 330,364     $ (4,740 )     (1.41 )%     4.87 %     87   +300     $ 337,010     $ 1,906       0.57 %     5.20 %     93   +200     $ 339,397     $ 4,293       1.28 %     4.33 %     77   +100     $ 340,263     $ 5,158       1.54 %     2.97 %     53   Level     $ 335,105     $ —       —       —       —   -100     $ 324,423     $ (10,682 )     (3.19 )%     (4.44 )%     (79 ) -200     $ 308,977     $ (26,127 )     (7.80 )%     (10.16 )%     (182 ) -300     $ 291,949     $ (43,156 )     (12.88 )%     (16.29 )%     (291 ) -400     $ 273,933     $ (61,172 )     (18.25 )%     (22.66 )%     (405 )   (1) Assumes an immediate uniform change in interest rates at all maturities. (2) EVE is the fair value of expected cash flows from assets, less fair value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet contracts. (3) Fair value of assets represents the amount at which an asset could be exchanged between knowledgeable and willing parties in an arms-length transaction. (4) EVE Ratio represents EVE divided by the fair value of assets.   52     Market Interest Rate Shift   The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power of money over time due to inflation.   The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories that are greatly impacted by inflation. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also affects other expenses that tend to rise during periods of general inflation.   Management believes the most significant potential impact of inflation on financial results is a direct result of the Company’s ability to manage the impact of changes in interest rates. Management attempts to maintain a balanced position between rate-sensitive assets and liabilities in order to minimize the impact of interest rate fluctuations on net interest income. However, this goal can be difficult to completely achieve in times of rapidly changing interest rates and is one of many factors considered in determining the Company’s interest rate positioning. The Company is asset sensitive as of December 31, 2022. Refer to the Net Interest Income Sensitivity table for additional details on the Company’s interest rate sensitivity.   The Bank also uses derivative financial instruments to manage risk to the Bank associated with changing interest rates, and to assist customers with their risk management objectives. The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Bank receives a floating rate thus allowing the Bank another tool to further manage the interest rate risk for certain products. These back-to-back loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the Consolidated Balance Sheet.     We believe that our current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes.   53