###### ** **

###### **SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

----

 

###### **FORM10-Q**

 

**QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchanges Act of 1934**

 

##### **For the quarter endedSeptember 30, 2001**

 

**Commission file number000-25128**

 

----

 

**MAINSTREET BANKS, INC.**

(Exactname of registrant as specified in its charter)

 

| **Georgia**                                                    |   | **58-2104977**                        |
|----------------------------------------------------------------|--------|---------------------------------------|
| (State  of Incorporation)                                      |   | (I.R.S.  Employer Identification No.) |
|                                                           |   |                                  |
| **676 Chastain Road, Kennesaw, GA**                            |   | **30144**                             |
| (Address  of principal executive offices)                      |   | (Zip  Code)                           |
|                                                           |   |                                  |
| **770-422-2888**                                               |
| (Registrant’s  telephone number)                          |
|                                                           |   |                                  |
| **First Sterling Banks, Inc.**                                 |
| **P.O. Box 2147, Marietta, GA 30061**                          |
| (Former  name and address)                                     |
|                                                           |
| **None**                                                       |
| Securities  registered under Section 12(b) of the Exchange Act |
|                                                           |
| **Common Stock, no par value**                                 |
| Securities  registered under Section 12(g) of the Exchange Act |

 

----

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes  ý   No  o

##### **APPLICABLE ONLY TOCORPORATE ISSUERS**

 

As of October 29, 2001,registrant had outstanding 15,665,271 shares of common stock.

 

 

**MAIN STREET BANKS,INC.**

**TABLE OF CONTENTS**

 
| **PART I.**  |     | **FINANCIAL INFORMATION**                                                              |
|--------------|----------|----------------------------------------------------------------------------------------|
|         |     |                                                                                   |   |
|         | Item 1.  | Financial Statements                                                                   |
|         |     |                                                                                   | Consolidated Balance Sheets  September 30, 2001 (unaudited) and December 31, 2000 |
|         |     |                                                                                   |
|         |     |                                                                                   | Consolidated  Statements of Income (unaudited) Three Months Ended September 30, 2001 and  2000 and Nine Months Ended September 30, 2001 and 2000 |
|         |     |                                                                                   |
|         |     |                                                                                   | Consolidated  Statements of Comprehensive Income (unaudited) Three Months Ended September  30, 2001 and 2000 and Nine Months Ended September 30, 2001 and 2000 |
|         |     |                                                                                   |
|         |     |                                                                                   | Consolidated  Statements of Cash Flows (unaudited) Nine Months Ended September 30, 2001 and  2000 |
|         |     |                                                                                   |   |
|         |     |                                                                                   | Notes to  Consolidated Financial Statements (unaudited) |
|         |     |                                                                                   |   |
|         | Item  2. | Management's  Discussion and Analysis of Financial Condition and Results of Operations |
|         |     |                                                                                   |   |
|         | Item 3.  | Quantitative and Qualitative  Disclosures about Market Risk (included in Item 2)       |
|         |     |                                                                                   |   |
| **PART II.** |     | **OTHER INFORMATION**                                                                  |   |
|         |     |                                                                                   |   |
|         | Item 6.  | Exhibits and  Reports on Form 8-K                                                      |
|         |     |                                                                                   |   |
|         |     | Signatures                                                                             |   |
|              |          |                                                                                        |  |  |  |  |

 

##### **PART I. – FINANCIALINFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

**MAINSTREET BANKS, INC.**

##### **CONSOLIDATED BALANCESHEETS**

 
|                                                                                                                                                                                |   | **(Unaudited)**    |          |              |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------------|-------------------|--------|
|                                                                                                                                                                                |   | **September  30,** |          | **December  31,** |   |
|                                                                                                                                                                                |   | **2001**           |          | **2000**          |   |
| **Assets**                                                                                                                                                                          |   |               |          |              |   |
| Cash  and due from banks                                                                                                                                                            |   | $                  | 43,135,942    |              | $      | 39,295,553 |   |
| Interest-bearing  deposits in banks                                                                                                                                                 |   | 3,523,752          |          | 1,665,159         |   |
| Federal  funds sold and securities purchased under agreement to resell                                                                                                              |   | 57,608,797         |          | 88,436,897        |   |
| Investment  securities available for sale                                                                                                                                           |   | 136,783,665        |          | 152,962,319       |   |
| Investment  securities held to maturity (fair value of $741,444 and $15,879,777 at  September 30, 2001 and December 31, 2000, respectively)                                         |   | 686,840            |          | 18,538,266        |   |
| Mortgage  loans held for sale                                                                                                                                                       |   | 8,166,253          |          | 2,248,415         |   |
| Loans,  net of unearned income                                                                                                                                                      |   | 798,471,503        |          | 735,963,071       |   |
| Allowance  for loan losses                                                                                                                                                          |   | (11,811,458        | )             | (10,907,424       | )      |
| Loans,  net                                                                                                                                                                         |   | 786,660,045        |          | 725,055,647       |   |
|                                                                                                                                                                                |   |               |          |              |   |
| Premises  and equipment, net                                                                                                                                                        |   | 27,103,138         |          | 27,034,148        |   |
| Other  real estate                                                                                                                                                                  |   | 1,217,069          |          | 2,122,802         |   |
| Accrued  interest receivable                                                                                                                                                        |   | 6,447,176          |          | 7,139,716         |   |
| Goodwill  and other intangible assets                                                                                                                                               |   | 765,784            |          | 945,534           |   |
| Other  assets                                                                                                                                                                       |   | 4,563,510          |          | 5,130,795         |   |
| Total  assets                                                                                                                                                                       |   | $                  | 1,076,661,971 |              | $      | 1,070,575,251 |   |
|                                                                                                                                                                                |   |               |          |              |   |
| **Liabilities and stockholders’ equity**                                                                                                                                       |   |               |          |              |   |
| Liabilities:                                                                                                                                                                        |   |               |          |              |   |
| Deposits:                                                                                                                                                                           |   |               |          |              |   |
| Noninterest-bearing  demand                                                                                                                                                         |   | $                  | 151,554,684   |              | $      | 139,119,905 |   |
| Interest-bearing  demand and money market                                                                                                                                           |   | 252,399,107        |          | 201,483,455       |   |
| Savings                                                                                                                                                                             |   | 42,296,159         |          | 44,727,911        |   |
| Time  deposits of $100,000 or more                                                                                                                                                  |   | 155,397,004        |          | 157,782,734       |   |
| Other  time deposits                                                                                                                                                                |   | 305,316,195        |          | 342,795,505       |   |
| Total  deposits                                                                                                                                                                     |   | 906,963,149        |          | 885,909,510       |   |
|                                                                                                                                                                                |   |               |          |              |   |
| Accrued  interest payable                                                                                                                                                           |   | 5,237,793          |          | 5,652,685         |   |
| Federal  Home Loan Bank advances                                                                                                                                                    |   | 52,121,250         |          | 52,127,500        |   |
| Federal  funds purchased and securities sold under repurchase agreements                                                                                                            |   | 6,226,164          |          | 32,615,659        |   |
| Other  liabilities                                                                                                                                                                  |   | 2,308,559          |          | 495,635           |   |
| Total  liabilities                                                                                                                                                                  |   | 972,856,915        |          | 976,800,989       |   |
|                                                                                                                                                                                |   |               |          |              |   |
| **Shareholders’ equity**                                                                                                                                                       |   |               |          |              |   |
| Common  stock3⁄4no  par value per share; 50,000,000 shares authorized; outstanding, 15,662,271  and 15,515,174 shares at September 30, 2001 and December 31, 2000,  respectively |   | 32,099,307         |          | 31,522,786        |   |
| Retained  earnings                                                                                                                                                                  |   | 69,883,256         |          | 63,347,204        |   |
| Accumulated  other comprehensive gain (loss)                                                                                                                                        |   | 2,856,368          |          | (61,853           | )      |
| Treasury  stock, at cost, 169,082 shares at September 30, 2001 and December 31, 2000,  respectively                                                                                 |   | (1,033,875         | )             | (1,033,875        | )      |
| Total  shareholders’ equity                                                                                                                                                    |   | 103,805,056        |          | 93,774,262        |   |
| Total  liabilities and shareholders’ equity                                                                                                                                    |   | $                  | 1,076,661,971 |              | $      | 1,070,575,251 |   |

* *

*Seeaccompanying notes.*

* *

**MAINSTREET BANKS, INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

 
|                                                                       |   | **Three  Months Ended** |       | **Nine  Months Ended** |   |
|----------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                                       |   | **September  30,**      |       | **September  30,**     |   |
|                                                                       |   | **2001**                |       | **2000**               |   | **2001** |   | **2000** |   |
| Interest Income:                                                           |   |                    |       |                   |   |   |   |   |   |
| Loans,  including fees                                                     |   | $                       | 18,445,983 |                   | $      | 18,936,609 |   | $ | 55,802,733 |   | $ | 54,065,556 |   |
| Interest  on investment securities:                                        |   |                    |       |                   |   |   |   |   |   |
| Taxable                                                                    |   | 1,750,869               |       | 1,869,850              |   | 5,953,890 |   | 5,332,465 |   |
| Non-taxable                                                                |   | 319,240                 |       | 331,398                |   | 956,136 |   | 868,295 |   |
| Federal  funds sold and other short term investments                       |   | 449,847                 |       | 1,099,087              |   | 1,854,021 |   | 1,896,292 |   |
| Interest-bearing  deposits in banks                                        |   | 83,194                  |       | 16,862                 |   | 111,726 |   | 52,906 |   |
| Total  interest income                                                     |   | 21,049,133              |       | 22,253,806             |   | 64,678,506 |   | 62,215,514 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Interest  expense:                                                         |   |                    |       |                   |   |   |   |   |   |
| Interest-bearing  demand and money market                                  |   | 1,044,362               |       | 1,486,617              |   | 3,293,001 |   | 3,839,732 |   |
| Savings                                                                    |   | 191,401                 |       | 285,121                |   | 670,603 |   | 800,628 |   |
| Time  deposits of $100,000 or more                                         |   | 2,181,652               |       | 1,739,489              |   | 7,077,471 |   | 4,678,797 |   |
| Other  time deposits                                                       |   | 4,357,388               |       | 5,615,950              |   | 15,030,188 |   | 14,277,970 |   |
| Federal  funds purchased and securities sold under agreement to repurchase |   | 42,169                  |       | 136,413                |   | 173,726 |   | 388,418 |   |
| Federal  Home Loan Bank advances                                           |   | 484,387                 |       | 879,930                |   | 1,986,220 |   | 2,375,244 |   |
| Other  interest expense                                                    |   | 18,940                  |       | 4,839                  |   | 38,059 |   | 16,213 |   |
| Total  interest expense                                                    |   | 8,320,299               |       | 10,148,359             |   | 28,269,268 |   | 26,377,002 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Net  interest income                                                       |   | 12,728,834              |       | 12,105,447             |   | 36,409,238 |   | 35,838,512 |   |
| Provision for loan losses                                                  |   | 562,000                 |       | 485,000                |   | 1,532,000 |   | 1,569,000 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Net  interest income after provision for loan losses                       |   | 12,166,834              |       | 11,620,447             |   | 34,877,238 |   | 34,269,512 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Noninterest  income:                                                       |   |                    |       |                   |   |   |   |   |   |
| Service  charges on deposit accounts                                       |   | 1,544,847               |       | 1,312,161              |   | 4,320,558 |   | 3,826,308 |   |
| Investment  securities gains (losses)                                      |   | -                       |       | (565                   | )      | 22,191 |   | (516,804 | ) |
| Gain  on sales of premises and equipment                                   |   | 13,066                  |       | 2,253                  |   | 10,224 |   | 30,024 |   |
| Gain  on sales of loans                                                    |   | 90,756                  |       | 1,246                  |   | 407,682 |   | 38,300 |   |
| Other  income                                                              |   | 2,008,008               |       | 1,498,193              |   | 5,356,173 |   | 4,345,643 |   |
| Total  noninterest income                                                  |   | 3,656,677               |       | 2,813,288              |   | 10,116,828 |   | 7,723,471 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Noninterest  expense:                                                      |   |                    |       |                   |   |   |   |   |   |
| Salaries  and other compensation                                           |   | 4,416,260               |       | 4,212,232              |   | 12,300,907 |   | 12,309,713 |   |
| Employee  benefits                                                         |   | 732,680                 |       | 599,468                |   | 2,000,530 |   | 1,875,941 |   |
| Net  occupancy and equipment expense                                       |   | 1,227,894               |       | 1,144,305              |   | 3,629,522 |   | 3,508,165 |   |
| Professional services                                                      |   | 359,297                 |       | 352,114                |   | 1,274,369 |   | 742,450 |   |
| Regulatory  agency assessments                                             |   | 60,824                  |       | 80,868                 |   | 220,904 |   | 240,179 |   |
| Amortization  of intangible assets                                         |   | 59,916                  |       | 109,692                |   | 179,750 |   | 329,075 |   |
| Merger  and one-time expenses                                              |   | -                       |       | -                      |   | 2,510,625 |   | 973,457 |   |
| Other  expense                                                             |   | 2,040,885               |       | 2,109,609              |   | 5,988,073 |   | 6,188,168 |   |
| Total  noninterest expense                                                 |   | 8,897,756               |       | 8,608,288              |   | 28,104,680 |   | 26,167,148 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Income  before income taxes                                                |   | 6,925,755               |       | 5,825,447              |   | 16,889,386 |   | 15,825,835 |   |
| Income  tax expense                                                        |   | 2,392,434               |       | 2,021,907              |   | 5,916,552 |   | 5,845,878 |   |
| Net  income                                                                |   | $                       | 4,533,321  |                   | $      | 3,803,540 |   | $ | 10,972,834 |   | $ | 9,979,957 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Earnings  per share:                                                       |   |                    |       |                   |   |   |   |   |   |
| Basic                                                                      |   | $                       | .29        |                   | $      | .25 |   | $ | .70 |   | $ | .65 |   |
| Diluted                                                                    |   | $                       | .28        |                   | $      | .24 |   | .68 |   | $ | .63 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Dividends  declared per share                                              |   | $                       | .09        |                   | $      | .08 |   | $ | .27 |   | $ | .16 |   |
|                                                                       |   |                    |       |                   |   |   |   |   |   |
| Weighted  average common shares outstanding:                          |   |                    |       |                   |   |   |   |   |   |
| Basic                                                                      |   | 15,648,336              |       | 15,507,140             |   | 15,628,618 |   | 15,471,443 |   |
| Diluted                                                                    |   | 16,178,030              |       | 15,830,747             |   | 16,098,382 |   | 15,792,731 |   |
|                                                                            |        |                         |            |                        |        |  |  |  |  |  |  |  |  |  |

 

*See accompanying notes.*

 

**MAINSTREET BANKS, INC.**

##### **CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME**

**(Unaudited)**

 
|                                                                            |   | **Three Months Ended** |      | **Nine Months Ended** |   |
|---------------------------------------------------------------------------------|--------|------------------------|-----------|-----------------------|--------|
|                                                                            |   | **September  30,**     |      | **September  30,**    |   |
|                                                                            |   | **2001**               |      | **2000**              |   | **2001** |   | **2000** |   |
| **Net income**                                                                  |   | $                      | 4,533,321 |                  | $      | 3,803,540 |   | $ | 10,972,834 |   | $ | 9,979,957 |   |
|                                                                            |   |                   |      |                  |   |   |   |   |   |
| **Other  comprehensive income,****net of tax**                                  |   |                   |      |                  |   |   |   |   |   |
|                                                                            |   |                   |      |                  |   |   |   |   |   |
| Unrealized  gains on securities available for sale                              |   | 1,379,812              |      | 1,026,676             |   | 2,932,867 |   | 1,131,371 |   |
| Less  reclassification adjustment for net (gains) losses included in net income |   | -                      |      | -                     |   | (14,646 | ) | 340,717 |   |
|                                                                            |   |                   |      |                  |   |   |   |   |   |   |   |   |   |
| **Comprehensive income**                                                        |   | $                      | 5,913,133 |                  | $      | 4,830,216 |   | $ | 13,891,055 |   | $ | 11,452,045 |   |

* *

*See accompanying notes.*

* *

**MAINSTREET BANKS, INC.**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

** (Unaudited)**

 
|                                                                               |   | **Nine  Months Ended** |        |
|------------------------------------------------------------------------------------|--------|------------------------|-------------|
|                                                                               |   | **September  30,**     | ** **  |
|                                                                               |   | **2001**               |        | **2000** |   |
| **Operating activities**                                                           |   |                   |        |   |   |
| Net  income                                                                        |   | $                      | 10,972,834  |   | $ | 9,979,957 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                   |        |   |   |
| Provision  for loan losses                                                         |   | 1,532,000              |        | 1,569,000 |   |
| Depreciation  and amortization of premises and equipment                           |   | 1,631,725              |        | 1,501,473 |   |
| Amortization  of intangible assets                                                 |   | 179,750                |        | 329,075 |   |
| Loss  on sales of other real estate                                                |   | 27,661                 |        | 3⁄4 |   |
| Investment  securities (gains) losses                                              |   | (22,191                | )           | 516,804 |   |
| Net  accretion of investment securities                                            |   | (503,793               | )           | (47,759 | ) |
| Net  accretion of loans purchased                                                  |   | (44,655                | )           | (53,508 | ) |
| Gain  on sales of premises and equipment                                           |   | (10,224                | )           | (30,024 | ) |
| Net  increase in mortgage loans held for sale                                      |   | (5,917,838             | )           | (1,556,646 | ) |
| Gains  on sales of mortgage loans                                                  |   | (469,968               | )           | (275,746 | ) |
| Gains  on sales of other loans                                                     |   | (407,682               | )           | (38,300 | ) |
| Deferred  income tax provision                                                     |   | 1,196,345              |        | 1,014,439 |   |
| Deferred  net loan fees                                                            |   | 159,388                |        | (573,658 | ) |
| Vesting  in restricted stock award plan                                            |   | 369,683                |        | 390,286 |   |
| Changes  in operating assets and liabilities:                                      |   |                   |        |   |   |
| (Increase)  decrease in accrued interest receivable                                |   | 692,540                |        | (942,987 | ) |
| Increase (decrease) in accrued interest payable                                    |   | (414,892               | )           | 1,833,284 |   |
| Other                                                                              |   | (143,074               | )           | 5,483,732 |   |
| Net  cash provided by operating activities                                         |   | 8,827,609              |        | 19,099,422 |   |
|                                                                               |   |                   |        |   |   |
| **Investing  activities**                                                          |   |                   |        |   |   |
| Purchases  of investment securities held to maturity                               |   | -                      |        | (3,508,940 | ) |
| Purchases  of investment securities available for sale                             |   | (31,506,988            | )           | (30,570,853 | ) |
| Purchases  of other investments                                                    |   | -                      |        | (1,418,867 | ) |
| Maturities  of investment securities held to maturity                              |   | -                      |        | 1,881,118 |   |
| Maturities  and calls of investment securities available for sale                  |   | 69,583,744             |        | 8,153,173 |   |
| Proceeds  from sales of investment securities available for sale                   |   | 1,104,250              |        | 14,605,975 |   |
| Net  increase in loans funded                                                      |   | (64,145,388            | )           | (67,652,456 | ) |
| Purchases  of premises and equipment                                               |   | (2,283,988             | )           | (492,521 | ) |
| Proceeds  from sales of premises and equipment                                     |   | 407,267                |        | - |   |
| Proceeds  from sales of other real estate                                          |   | 1,863,427              |        | 10,198 |   |
| Improvements to other real estate                                                  |   | (35,776                | )           | - |   |
| Net cash used in investing activities                                              |   | (25,013,452            | )           | (78,993,173 | ) |
|                                                                               |   |                   |        |   |   |
| **Financing  activities**                                                          |   |                   |        |   |   |
| Net  increase in demand and savings accounts                                       |   | 60,918,679             |        | 47,387,130 |   |
| (Decrease)  increase in time deposits                                              |   | (39,865,040            | )           | 79,411,929 |   |
| Decrease  in federal funds purchased                                               |   | (26,389,495            | )           | (10,370,987 | ) |
| Net  (decrease) increase in Federal Home Loan Bank advances                        |   | (6,250                 | )           | 5,988,750 |   |
| Dividends  paid                                                                    |   | (4,109,463             | )           | (2,432,047 | ) |
| Proceeds  from the issuance of common stock                                        |   | 508,294                |        | 301,485 |   |
| Net  cash (used in) provided by financing activities                               |   | (8,943,275             | )           | 120,286,260 |   |
| Net  increase (decrease) in cash and cash equivalents                              |   | (25,129,118            | )           | 60,392,509 |   |
| Cash  and cash equivalents at beginning of period                                  |   | 129,397,609            |        | 76,317,510 |   |
| Cash  and cash equivalents at end of period                                        |   | $                      | 104,268,491 |   | $ | 136,710,019 |   |
| **Supplemental  disclosures of cash flow information**                             |   |                   |        |   |   |
| Cash  paid during the period for:                                                  |   |                   |        |   |   |
| Interest                                                                           |   | $                      | 28,684,159  |   | $ | 24,543,402 |   |
| Income  taxes, net                                                                 |   | 650,000                |        | 3,674,800 |   |
| **Supplemental  disclosures of noncash transactions**                              |   |                   |        |   |   |
| Loans  transferred to real estate acquired through foreclosure                     |   | $                      | 894,257     |   | $ | 390,368 |   |
| Transfer  of investment securities from held to maturity to available for sale     |   | $                      | 17,851,829  |   | $ | - |   |

 

*See accompanying notes.*

 

 

**MAINSTREET BANKS, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**SEPTEMBER30, 2001**

 

**NOTE 1.        BASIS OF PRESENTATION**

 

The accompanyingunaudited consolidated financial statements of Main Street Banks, Inc. (the“Company”) have been prepared in accordance with accounting principlesgenerally accepted in the United States followed within the financial servicesindustry for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and notes required for complete financial statementpresentation. In the opinion of management, all adjustments (consisting solelyof normal recurring adjustments) considered necessary for a fair presentationof the financial position and results of operations for interim periods havebeen included.

 

The results of operations for thenine-month period ended September 30, 2001 are not necessarily indicative ofthe results that may be expected for the year ending December 31, 2001. Thesefinancial statements and related “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” should be read in conjunctionwith the supplemental consolidated financial statements and notes thereto forthe year ended December 31, 2000, included in the Company’s Current Report onForm 8-K dated May 11, 2001.

 

**NOTE 2.**        **BUSINESS COMBINATION**

 

On January 25, 2001, the Companycompleted a business combination with Walton Bank and Trust Company (“Walton”)by exchanging 2.752 shares of its common stock for each share of Waltonoutstanding common stock.  Thecombination was accounted for as a pooling of interests and, accordingly, allprior financial statements have been restated to include the results of Walton.

 

**NOTE 3.**        **CURRENT ACCOUNTING DEVELOPMENTS**

 

The Financial AccountingStandards Board issued Statement No. 138, “Accounting for DerivativeInstruments and Hedging Activities” (“Statement 138”) which amended certainprovisions of Statement No. 133, “Accounting for Derivative Instruments andHedging Activities.” Statement 138 requires all derivatives to be recorded attheir fair value on the statement of financial condition. Accounting for thechanges in fair value of a derivative depends on the intended use of thederivative and the resulting designation. Statement 138 was effective for theCompany on January 1, 2001.  The adoptionof the standard did not result in a material financial impact based on theCompany’s limited use of derivatives.

 

Under the provisions ofStatement 138, a company can elect to make a one-time transfer of investmentsecurities from “held to maturity” to “available for sale” without tainting theheld to maturity category. Upon adoption of Statement 138 on January 1, 2001,the Company transferred $17,851,829 of investment securities to the “availablefor sale” category.

 

In July 2001, the FASBissued Statement No.141, “Business Combinations,” effective for businesscombinations initiated after June 30, 2001, and Statement No.142, “Goodwill andOther Intangible Assets”, effective for fiscal years beginning after December15, 2001.  Under SFAS No.141, use of thepooling-of-interests method is no longer permitted. SFAS No.141 also includesguidance on the initial recognition and measurement of goodwill and otherintangible assets acquired in a business combination that is completed afterJune 30, 2001.  SFAS No.142 no longerpermits the amortization of goodwill and indefinite-lived intangible assets.Instead, these assets must be reviewed annually (or more frequently undercertain conditions) for impairment in accordance with this statement.Intangible assets that do not have indefinite lives will continue to beamortized over their useful lives.  Theadoption of the new standards will not have a material impact on the Company’sfinancial statements.

 

**NOTE 4.**        **EARNINGS PER COMMON SHARE**

 

The computation of diluted earnings pershare is as follows:

 
|                              |   | **Three Months Ended** |      | **Nine Months Ended** |   |
|-----------------------------------|--------|------------------------|-----------|-----------------------|--------|
|                              |   | **September 30,**      |      | **September 30,**     |   |
|                              |   | **2001**               |      | **2000**              |   | **2001** |   | **2000** |   |
| Basic and diluted net  income     |   | $                      | 4,533,321 |                  | $      | 3,803,540 |   | $ | 10,972,834 |   | $ | 9,979,957 |   |
|                              |   |                   |      |                  |   |   |   |   |   |
| Basic weighted average  shares    |   | 15,648,336             |      | 15,507,140            |   | 15,628,618 |   | 15,471,443 |   |
| Effect of Employee  Stock Options |   | 529,694                |      | 323,607               |   | 469,764 |   | 321,288 |   |
| Diluted weighted  average shares  |   | 16,178,030             |      | 15,830,747            |   | 16,098,382 |   | 15,792,731 |   |
|                              |   |                   |      |                  |   |   |   |   |   |
| Diluted earnings per  share       |   | $                      | .28       |                  | $      | .24 |   | $ | .68 |   | $ | .63 |   |

 

**NOTE 5.**        **LOANS**

 

Loans are stated atunpaid principal balances, net of unearned income and deferred loan fees.  Interest is accrued only if deemedcollectible.  The following tablerepresents the composition of the Company’s loan portfolio:

 
|                       |   | **September 30,**            |         | **December 31,** |   |
|----------------------------|--------|------------------------------|--------------|------------------|--------|
|                       |   | **2001**                     |         | **2000**         |   |
|                       |   | ***(Dollars in thousands)*** | *** *** |
|                       |   |                         |         |             |   |
| Commercial                 |   | $                            | 71,296       |             | $      | 97,572 |   |
| Real  estate construction  |   | 170,728                      |         | 150,107          |   |
| Residential  mortgage      |   | 153,146                      |         | 162,706          |   |
| Commercial  real estate    |   | 346,861                      |         | 263,500          |   |
| Consumer                   |   | 58,170                       |         | 63,857           |   |
| Total  loans               |   | 800,201                      |         | 737,742          |   |
| Less:                      |   |                         |         |             |   |
| Net  deferred loan fees    |   | (1,730                       | )            | (1,779           | )      |
| Allowance  for loan losses |   | (11,811                      | )            | (10,907          | )      |
|                       |   |                         |         |             |   |
| Net  loans                 |   | $                            | 786,660      |             | $      | 725,056 |   |

 

### **ITEM2.          MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF                        OPERATIONS**

 

The following ismanagement’s discussion and analysis of certain significant factors, which haveaffected the Company’s financial position at September 30, 2001 as compared toDecember 31, 2000, and operating results for the three-month and nine-monthperiods ended September 30, 2001. These comments should be read in conjunctionwith the Company’s unaudited consolidated financial statements and accompanyingnotes appearing elsewhere herein.

 

**ForwardLooking Statements**

 

This discussion containscertain forward-looking statements including statements relating to present orfuture trends or factors generally affecting the banking industry andspecifically affecting the Company’s operations, markets and products.  Without limiting the foregoing, the words“believes” “anticipates”, “intends”, “expects” or similar expressions areintended to identify forward-looking statements.  These forward-looking statements involve certain risks anduncertainties.  Actual results coulddiffer materially from those projected for many reasons including, withoutlimitation, changing events and trends that have influenced the Company’sassumptions.  These trends and eventsinclude (i) changes in the interest rate environment which may reduce margins,(ii) non-achievement of expected growth (iii) less favorable than anticipatedchanges in national and local business environment and securities markets (iv)adverse changes in the regulatory requirements affecting the Company (v)greater competitive pressures among financial institutions in the Company’smarket and (vi) greater than expected loan losses. Additional information andother factors that could affect future financial results are included in theCompany’s filings with the Securities and Exchange Commission, including theAnnual Report on Form 10-K for 2000 and supplemental financial statements onForm 8-K.

 

**Overview**

 

Total assets haveincreased slightly since December 2000.   Total loans have increased $62.5 million or 8.49% since December2000.  The growth in loans has beenfunded primarily by an increase in deposits of $21.1 million or 2.38% and areduction in Federal funds sold of $30.8 million.  Overnightborrowings have decreased $26.4 million since December 2000.

 

Return on average equity(operating income, excluding one-time charges) for the three months and ninemonths ended September 30, 2001 was 17.8% and 17.7% on average equity of $101.1million and $98.1 million, respectively. This compares to 17.8% and 18.5% on average equity of $85.1 million and$81.7 million respectively, for the same periods in 2000.

 

Return on average assets(operating income, excluding one-time charges) for the three months and ninemonths ended September 30, 2001 was 1.71% and 1.66%, respectively.  This compares to 1.51% and 1.58%,respectively for the same periods in 2000.

 

**Capital**

 

At September 30, 2001, the capital ratiosof the Company and the Bank were adequate based on regulatory minimum capitalrequirements.  The minimum capitalrequirements for banks and bank holding companies require a leverage capital tototal assets ratio of at least 4%, core capital to risk-weighted assets ratioof at least 4% and total capital to risk-weighted assets of 8%.  The following table reflects the Company’s andthe Bank’s compliance with regulatory capital requirements at September 30,2001.

 
|                        |   | **Company** |   | **Bank** |   |
|-----------------------------|--------|-------------|--------|----------|--------|
| Leverage  ratio             |   | 9.51        | %      | 9.40     | %      |
|                        |   |        |   |     |   |
| Risk  based capital ratios: |   |        |   |     |   |
| Tier  1 risk based capital  |   | 11.90       | %      | 11.69    | %      |
| Risk-based  capital         |   | 13.15       | %      | 12.94    | %      |

** **

**Loans and Allowance for LoanLosses**

 

At September30, 2001, loans, net of unearned income, were $798.5million, an increase of $62.5 million or 8.49% over net loans at December 31,2000 of $736.0 million. The growth in the loan portfolio was attributable to aconsistent focus on quality loan production and strong loan markets in thestate and region. Real estate-construction loans increased $20.6 million or13.7% from December 31, 2000. The Company continues to monitor the compositionof the loan portfolio to ensure that the market risk to the balance sheet isnot adversely affected by the impact of changes in the economic environment onany one segment of the portfolio.

 

The Company primarily focuses on the followingloan categories: (1) commercial, (2) real estate construction, (3) real estatemortgage and (4) consumer loans. The Company’s management has strategicallylocated its branches in high growth markets and has taken advantage of a surgein residential and industrial growth in northeastern Georgia.

 

The allowance for loanlosses is a reserve established through charges to earnings in the form of aprovision for loan losses.  Theprovision for loan losses is based on management’s evaluation of the size andcomposition of the loan portfolio, the level of non-performing and past dueloans, historical trends of charged-off loans and recoveries, prevailingeconomic conditions and other factors management deems appropriate. MainStreet’s management has established an allowance for loan losses, which itbelieves, is adequate for anticipated losses in the loan portfolio.  Based on a continuous credit evaluation ofthe loan portfolio, management presents a quarterly review of the allowance forloan losses to Main Street’s board of directors. The review that management hasdeveloped primarily focuses on risk by evaluating the level of loans in certainrisk categories.  These categories havealso been established by management and take the form of loan grades. These loangrades closely mirror regulatory classification guidelines and include passloan categories 1 through 4 and special mention, substandard, doubtful, andloss categories of 5 through 8, respectively. By grading the loan portfolio inthis manner Main Street’s management is able to effectively evaluate theportfolio by risk, which management believes is the most effective way toanalyze the loan portfolio and thus analyze the adequacy of the reserve forloan losses. Management also reviews charge-offs and recoveries on a quarterlybasis to identify trends.

 

Main Street’s riskmanagement processes include a loan review program to evaluate the credit riskin the loan portfolio. The credit review department is independent of the loanfunction and reports to the Senior Vice President of Risk Management.  Through the loan review process, Main Streetmaintains an internally criticized classified loan watch list which, along withthe delinquency report of loans serves as a tool to assist management assessthe overall quality of the loan portfolio and the adequacy of the allowance forloan losses. Loans classified as “substandard” are those loans with clear anddefined weaknesses such as a highly leveraged position, unfavorable financialratios, uncertain financial ratios, uncertain repayment sources, deteriorationin underlying collateral values, or poor financial condition which mayjeopardize recoverability of the debt. Loans classified as “doubtful” are thoseloans that have characteristics similar to substandard loans but have anincreased risk of loss, or at least a portion of the loan may require beingcharged-off. Loans classified as “loss” are those loans that are in the processof being charged-off.

 

For the nine-month period endingSeptember 30, 2001, net charge-offs totaled $627,966 or .11% (annualized) ofaverage loans outstanding for the period, net of unearned income, compared to$294,406 or .06% in net charge-offs for the same period in 2000. The provisionfor loan losses for the nine months ended September 30, 2001 was $1,532,000compared to $1,569,000 for the same period in 2000. The allowance for loanlosses totaled $11,811,458 or 1.48% of total loans, net of unearned income atSeptember 30, 2001, compared to $10,907,424 or 1.48% at December 31, 2000.

 

The following table presents an analysisof the allowance for loan losses for the nine-month period ended September 30,2001 and September 30, 2000 follows:

 
|                                                         |   | **Nine Months Ended** |       |
|--------------------------------------------------------------|--------|-----------------------|------------|
|                                                         |   | **September 30,**     |       |
|                                                         |   | **2001**              |       | **2000** |   |
| Balance  of allowance for loan losses at beginning of period |   | $                     | 10,907,424 |   | $ | 9,743,922 |   |
|                                                         |   |                  |       |   |   |
| Provision  charged to operating expense                      |   | 1,532,000             |       | 1,569,000 |   |
| Charge-offs:                                                 |   |                  |       |   |   |
| Commercial,  financial and agricultural                      |   | 162,047               |       | 183,733 |   |
| Real  estate – construction and land development        |   | 11,107                |       | 10,000 |   |
| Real  estate – mortgage                                 |   | 56,156                |       | 40,612 |   |
| Installment  and other consumer                              |   | 671,502               |       | 350,373 |   |
| Total  charge-offs                                           |   | 900,812               |       | 584,718 |   |
| Recoveries:                                                  |   |                  |       |   |   |
| Commercial,  financial and agricultural                      |   | 100,471               |       | 21,437 |   |
| Real  estate – construction and land development        |   | -                     |       | 15,776 |   |
| Real  estate – mortgage                                 |   | 21,731                |       | 75,897 |   |
| Installment  and other consumer                              |   | 150,644               |       | 177,202 |   |
| Total  recoveries                                            |   | 272,846               |       | 290,312 |   |
| Net  charge-offs                                             |   | 627,966               |       | 294,406 |   |
|                                                         |   |                  |       |   |   |
| Balance  of allowance for loan losses at end of period       |   | $                     | 11,811,458 |   | $ | 11,018,516 |   |

 

**Liquidity and Market RiskSensitivity**

 

Liquidity involves theCompany’s ability to raise funds to support asset growth or reduce assets tomeet deposit withdrawals and other payment obligations, to maintain reserverequirements and otherwise to operate on an ongoing basis. During the pastthree years, the Company’s liquidity needs have primarily been met by growth incore deposits, as previously discussed, together with advances from the FederalHome Loan Bank. Although access to purchased funds from correspondent banks isavailable and has been utilized on occasion to take advantage of investmentopportunities, the Company does not generally rely on these external-fundingsources. The cash and federal funds sold position, supplemented by amortizinginvestment and loan portfolios, have generally created an adequate liquidityposition.

 

The Company’s asset liability and fundsmanagement policy provides management with the necessary guidelines foreffective funds management and a measurement system for monitoring its netinterest rate sensitivity position. Main Street manages its sensitivityposition within established guidelines.

 

Market risk is definedas the risk of loss arising from adverse changes in market interest rates andprices. In order to maintain acceptable net interest income levels, interestrates, liquidity and maturities of the Company’s assets and liabilities need tobe managed.  In a decreasing rateenvironment earnings are typically negatively impacted as the Company’s ratesensitive assets generally reprice faster than its rate sensitive liabilitiesthus an increase in interest rates will typically have a positive impact onearnings.

 

Interest rate risk is managed by the assetliability committee, which is composed of senior officers of Main Street, inaccordance with policies approved by its board of directors. The assetliability committee formulates strategies based on appropriate levels ofinterest rate risk. In determining the appropriate level of interest rate risk,the asset liability committee considers the impact on earnings and capital ofthe current outlook on interest rates, potential changes in interest rates,regional economies, liquidity, business strategies and other factors. The assetliability committee meets regularly to review, among other things, thesensitivity of assets and liabilities to interest rate changes, the book andmarket values of assets and liabilities, unrealized gains and losses, purchaseand sale activities, commitments to originate loans and the maturities ofinvestments and borrowings. Additionally, the asset liability committee reviewsliquidity, cash flow flexibility, maturities of deposits and consumer andcommercial deposit activity. The Company’s management uses two methodologies tomanage interest rate risk: (i) an analysis of relationships betweeninterest-earning assets and interest-bearing liabilities; and (ii) an interestrate shock simulation model. The Company has traditionally managed its businessto reduce its overall exposure to changes in interest rates.

 

Main Street manages its exposure to interestrates by structuring its balance sheet in the ordinary course of business. MainStreet may utilize interest rate swaps, financial options, or financial futurescontracts in order to reduce interest rate risk. In May a $50 million interestrate floor was purchased to protect against further prime rate reductions andlessen the effect such reductions would have on interest income.

 

An interest rate sensitive asset or liability isone that, within a defined time period, either matures or experiences aninterest rate change in line with general market interest rates. The managementof interest rate risk is performed by analyzing the maturity and repricingrelationships between interest-earning assets and interest-bearing liabilitiesat specific points in time (gap) and by analyzing the effects of interest ratechanges on net interest income over specific periods of time by projecting theperformance of the mix of assets and liabilities in varied interest rateenvironments. Interest rate sensitivity reflects the potential effect on netinterest income of a movement in interest rates. A company is considered to beasset sensitive, or having a positive gap, when the amount of itsinterest-earning assets maturing or repricing within a given period exceeds theamount of its interest-bearing liabilities also maturing or repricing withinthat time period. Conversely, a company is considered to be liabilitysensitive, or having a negative gap, when the amount of its interest-bearingliabilities maturing or repricing within a given period exceeds the amount ofits interest-earning assets also maturing or repricing within that time period.During a period of rising interest rates, a negative gap would tend to affectnet interest income adversely, while a positive gap would tend to result in anincrease in net interest income. During a period of falling interest rates, anegative gap would tend to result in an increase in net interest income, whilea positive gap would tend to affect net interest income adversely.

 

## **Results of Operations for the Three Months EndedSeptember 30, 2001 and 2000**

 

Net income for thequarter ended September 30, 2001 was $4.5 million compared to $3.8 million forthe quarter ended September 30, 2000, an increase of $729,781 or 19.19% overthe same period in 2000.  Operatingdiluted earnings per share was $.28 and $.24 for the quarters ending September30, 2001 and September 30, 2000, respectively.

 

Theincrease in operating net income is primarily attributable to an increase innet interest income of $623,387 and an increase in operating non-interestincome of $843,389.  The Company wasable to realize an increase in interest income as average earning assetsincreased $38.9 million or 4.16% over the same period in 2000. The yield onearning assets declined 89 basis points compared to the same period in 2000, asinterest rates have continued to decline in 2001. Interest expense decreased$1.8 million or 18.01% over the same period in 2000.  Average interest bearing liabilities increased $28.0 million or3.67% over the same period in 2000 and the average rate declined 112 basispoints.  The Bank offered several certificateof deposit promotions during 2000, for varying terms, as these certificatesre-price the effective rate on interest bearing liabilities would continue todecline throughout 2001.  The netinterest margin for the quarter ended September 30, 2001 was 5.27% compared to5.23% for the quarter ended September 30, 2000.  Increased service charges and the growth of several fee-basedservices further augmented the increase in earnings.  Mortgage origination fees increased $197,442 or 59.29% over thesame period in 2000.  The decline ininterest rates has resulted in an increased number of first time homebuyers andmany people taking advantage of the opportunity to reduce rates throughrefinancing.  Operating expensesincreased only $289,468 or 3.36% over the quarter ended September 30, 2000.  The Company operates in the highly competitive,dynamic metro-Atlanta market and continues to enjoy excellent growth.  We have experienced a decline in timedeposits as we have priced time deposits to be competitive, but not aggressive,in an effort to protect earnings and our margins.   We introduced a new deposit campaign in the second quarterspecifically targeting demand and money market deposits.  Through the end of September 2001 thecampaign had generated approximately $15 million in new deposits.  Average total deposits for the quarter endedSeptember 30, 2001, have increased $39.1 million or 4.60% over the quarterended September 30, 2000.  Averageinterest bearing demand and money market deposits have increased $35.4 millionor 18.63% over the same period in 2000. Average loans for the quarter ended September 30, 2001, increased $46.4million or 6.37% over the quarter ended September 30, 2000.

 

Theprovision for loan losses was $562,000 for the three months ended September 30,2001 as compared to $485,000 for the same period in 2000.  Average loans, net of unearned income,increased $46.4 million or 6.37% over the quarter ended September 30,2000.  Management closely monitors theloan portfolio and the underwriting of loans and considers the allowance forloan losses to be adequate.

 

Non-performingassets which includes other real estate owned and non accrual loans, totaled$2.3 million or .29% of total loans at September 30, 2001, compared to $2.3million or .32% of total loans at September 30, 2000.

 

## **Results of Operationsfor the Nine Months Ended September 30, 2001 and 2000**

 

Net income for the nine months endedSeptember 30, 2001 was $11.0 million compared to $10.0 million for the ninemonths ended September 30, 2000. Operating net income, which excludes the impact of merger expenses and otherone time items was $13.0 million for the nine months ended September 30, 2001,an increase of $1.7 million or 15.23% over the same period in 2000.  Operating diluted earnings per share was$0.81 and $0.72 for the nine months ended September 30, 2001 and September 30,2000, respectively.  Net interest incomewas $36.4 million for the nine months ended September 30, 2001 and $35.8million for the same period in 2000. Average earning assets for the nine months ended September 30, 2001 were$975.2 million an increase of $87.8 million or 9.9% over same period in 2000,related interest income increased by $2.5 million or 3.96%.  The yield on earning assets has declined 49basis points, compared to the same period in 2000, primarily the result severalreductions in the prime interest rate.  Since December 2000 through September 2001, the prime rate has declinedfrom 9.50% to 6.00%.  Average interestbearing liabilities increased $78.8 million or 11.01%, resulting in an increasein interest expense of $1.9 million or 7.17% over the same period in 2000, theaverage rate increased 16 basis points. The higher rate is a result of several certificate of deposit promotionsoffered in 2000, for varying terms.  Asthese certificates re-price over the next several months we will see a declinein the rate on interest bearing deposits. In the second quarter of 2001, management elected to refinance theFederal Home Loan Bank (“FHLB”) debt and take advantage of the lower interestrates.  Previously FHLB debt was forstaggered terms, at fixed rates.  Theexisting debt was rolled into floating rate overnight advances.  While the prepayment penalty was $534,568,net of tax, we immediately realized a 200 basis point improvement in rate andanticipated the penalty would be recovered in less than ten months.  As rates have continued to decline, throughthe end of September we estimate the savings to be approximately $470,000 andwould expect full recovery of the penalty by year-end.  The net interest margin for the nine monthsended September 30, 2001 was 5.08% compared to 5.48% for the same period in2000.

 

Non-interest income,excluding one-time items, for the nine month period ended September 30, 2001increased $1.9 million or 22.83% over the same period in 2000.  The strong growth in transaction accountscoupled with an increase in the service charge structure has resulted in anincrease in service charges of $494,250 or 12.92% over the same period in2000.  The decline in interest rates hasbeen very favorable for the mortgage division, which has seen a significantincrease in new homebuyers as well as refinancing activity.  Mortgage origination fees have increased$644,222 or 83.00% over the nine month period ended September 30, 2000.  Non-interest expense, excluding one-time itemsincreased $400,364 or 1.59% over the nine-month period ended September 30,2000.

 

The provision for loanlosses declined $37,000 from the same period in 2000.  The allowance for loan losses as a percentage of total loansoutstanding was 1.48% at September 30, 2001 and December 31, 2000.

 

**PART II. – OTHER INFORMATION**

 

### **ITEM6.          EXHIBITS AND REPORTS ON FORM8-K**

 

(a)         Currentreport on Form 8-K

 

The Company filed a Form 8-K on September 21,2001 to reflect a common stock repurchase program for up to 150,000 shares ofthe Company’s 15,641,114 shares outstanding as of June 30, 2001.  The repurchased shares are available for usein connection with the Company’s stock plans and for other corporate purposes.

 

**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 

 
|   |              |   | **MAIN STREET BANKS, INC**             |
|--------|-------------------|--------|----------------------------------------|
|   |              |   |                                   |
|   |              |   |                                   |
|   |              |   |                                   |
| Date:  | November 13, 2001 |   | By:                                    | /s/ Edward C. Milligan |
|   |              |   | Edward C. Milligan,  President and     |
|   |              |   | Chief Executive  Officer               |
|   |              |   |                                   |
|   |              |   |                                   |
|   |              |   |                                   |
| Date:  | November 13, 2001 |   | By:                                    | /s/ Barbara J. Bond |
|   |              |   | Barbara  J. Bond, Secretary, Principal |
|   |              |   | Financial  and Accounting Officer      |