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CFFI > SEC Filings for CFFI > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for C & F FINANCIAL CORP


8-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement Regarding Forward-Looking Statements

This report contains statements concerning the Corporation's expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute "forward-looking statements" as defined by federal securities laws and may include, but are not limited to, statements regarding profitability, liquidity, the Corporation's and each business segment's loan portfolio, allowance for loan losses, trends regarding the provision for loan losses, trends regarding net loan charge-offs and expected future charge-off activity, trends regarding levels of nonperforming assets and troubled debt restructurings and expenses associated with nonperforming assets, provision for indemnification losses, levels of noninterest income and expense, interest rates and yields including continuation of the current low interest rate environment, competitive trends in the Corporation's businesses and markets, the deposit portfolio including trends in deposit maturities and rates, interest rate sensitivity, market risk, regulatory developments, monetary policy implemented by the Federal Reserve including quantitative easing programs, capital requirements, growth strategy and financial and other goals. These statements may address issues that involve estimates and assumptions made by management and risks and uncertainties. Actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in:

interest rates

general business conditions, as well as conditions within the financial markets

general economic conditions, including unemployment levels

the legislative/regulatory climate, including the Dodd-Frank Act and regulations promulgated thereunder, the Consumer Financial Protection Bureau (CFPB) and the regulatory and enforcement activities of the CFPB and rules promulgated under the Basel III framework

monetary and fiscal policies of the U.S. Government, including policies of the Treasury and the Federal Reserve Board

the value of securities held in the Corporation's investment portfolios

the quality or composition of the loan portfolios and the value of the collateral securing those loans

the commercial and residential real estate markets

the inventory level and pricing of used automobiles

the level of net charge-offs on loans and the adequacy of our allowance for loan losses

demand in the secondary residential mortgage loan markets

the level of indemnification losses related to mortgage loans sold

demand for loan products

deposit flows

the strength of the Corporation's counterparties

competition from both banks and non-banks

demand for financial services in the Corporation's market area

the Corporation's expansion and technology initiatives

technology

reliance on third parties for key services

accounting principles, policies and guidelines

These risks are exacerbated by the turbulence over the past several years in the global and United States financial markets. Continued weakness in the global and United States financial markets could further affect the Corporation's performance, both directly by affecting the Corporation's revenues and the value of its assets and liabilities, and indirectly by affecting the Corporation's counterparties and the economy in general. While there are some signs of improvement in the economic environment, there was a prolonged period of volatility and disruption in the markets, and unemployment has risen to, and remains at, high levels. There can be no assurance that these unprecedented developments will not continue to materially and adversely affect our business, financial condition and results of operations, as well as our ability to raise capital for liquidity and business purposes.


Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, and other institutions. As a result, defaults by, or even rumors or questions about defaults by, one or more financial services institutions, or the financial services industry generally, could create another market-wide liquidity crisis similar to that experienced in late 2008 and early 2009 and could lead to losses or defaults by us or by other institutions. There is no assurance that any such losses would not materially adversely affect the Corporation's results of operations.

There can be no assurance that the actions taken by the federal government and regulatory agencies will alleviate the industry or economic factors that may adversely affect the Corporation's business and financial performance. Further, many aspects of the Dodd-Frank Act remain subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall effect on the Corporation's business and financial performance.

These risks and uncertainties, and the risks discussed in more detail in Item 1A, "Risk Factors" of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2012, should be considered in evaluating the forward-looking statements contained herein. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.

The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Corporation. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.

Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectibility of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available.

Allowance for Indemnifications: The allowance for indemnifications is established through charges to earnings in the form of a provision for indemnifications, which is included in other noninterest expenses. A loss is charged against the allowance for indemnifications under certain conditions when a purchaser of a loan (investor) sold by C&F Mortgage incurs a loss due to borrower misrepresentation, fraud, early default, or underwriting error. The allowance represents an amount that, in management's judgment, will be adequate to absorb any losses arising from indemnification requests. Management's judgment in determining the level of the allowance is based on the volume of loans sold, historical experience, current economic conditions and information provided by investors. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

Impairment of Loans: We consider a loan impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We measure impairment on a loan-by-loan basis for commercial, construction and residential loans in excess of $500,000 by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. Troubled debt restructurings (TDRs) are also considered impaired loans, even if the loan balance is less than $500,000. A TDR occurs when we agree to significantly modify the original terms of a loan due to the deterioration in the financial condition of the borrower.


Impairment of Securities: Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value.
Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.

Other Real Estate Owned (OREO): Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of like properties, length of time the properties have been held, and our ability and intention with regard to continued ownership of the properties. The Corporation may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further other-than-temporary deterioration in market conditions.

Goodwill: All of the Corporation's goodwill was recognized in connection with the Bank's acquisition of C&F Finance Company in September 2002. With the adoption of Accounting Standards Update 2011-08, Intangible-Goodwill and Other-Testing Goodwill for Impairment, in 2012, the Corporation is no longer required to perform a test for impairment unless, based on an assessment of qualitative factors related to goodwill, we determine that it is more likely than not that the fair value of C&F Finance Company is less than its carrying amount. If the likelihood of impairment is more than 50 percent, the Corporation must perform a test for impairment and we may be required to record impairment charges. In assessing the recoverability of the Corporation's goodwill, major assumptions used in determining impairment are increases in future income, sales multiples in determining terminal value and the discount rate applied to future cash flows. As part of any impairment test, we will perform a sensitivity analysis by increasing the discount rate, lowering sales multiples and reducing increases in future income.

Retirement Plan: The Bank maintains a non-contributory, defined benefit pension plan for eligible full-time employees as specified by the plan. Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Bank's actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the interest crediting rate, the estimated future return on plan assets and the anticipated rate of future salary increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.

Derivative Financial Instruments: The Corporation recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated balance sheet. The derivative financial instruments have been designated as and qualify as cash flow hedges. The effective portion of the gain or loss on the cash flow hedges is reported as a component of other comprehensive income, net of deferred taxes, and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings.

Accounting for Income Taxes: Determining the Corporation's effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Corporation's tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.

For further information concerning accounting policies, refer to Item 8, "Financial Statements and Supplementary Data," under the heading "Note 1:
Summary of Significant Accounting Policies" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2012.


OVERVIEW

Our primary financial goals are to maximize the Corporation's earnings and to deploy capital in profitable growth initiatives that will enhance long-term shareholder value. We track three primary financial performance measures in order to assess the level of success in achieving these goals: (i) return on average assets (ROA), (ii) return on average common equity (ROE), and
(iii) growth in earnings. In addition to these financial performance measures, we track the performance of the Corporation's three principal business activities: retail banking, mortgage banking, and consumer finance. We also actively manage our capital through growth and dividends, while considering the need to maintain a strong regulatory capital position.

Financial Performance Measures

Net income for the Corporation was $4.0 million for the three months ended March 31, 2013, compared with $3.8 million for the three months ended March 31, 2012. Net income available to common shareholders was $4.0 million, or $1.19 per common share assuming dilution, for the three months ended March 31, 2013, compared with $3.6 million, or $1.11 per common share assuming dilution, for the three months ended March 31, 2012. The difference between reported net income and net income available to common shareholders for 2012 is a result of the Preferred Stock dividends and amortization of the Warrant related to the Corporation's participation in the CPP. The Corporation's earnings for the first quarter of 2013 were attributable to profitability at all three of its principal business segments. The Consumer Finance segment continued to benefit from (1) sustained loan growth and (2) the low funding costs on its variable-rate borrowings. The Mortgage Banking segment benefited from higher gains on loans sold and ancillary loan production fees as a result of higher loan production and correspondingly higher sales volume. The Retail Banking segment benefited from the effects of (1) the continued low interest rate environment on the cost of deposits, (2) lower provisions for loan losses and (3) increased overdraft protection fees.

The Corporation's ROE and ROA were 15.46 percent and 1.64 percent, respectively, on an annualized basis for the three months ended March 31, 2013, compared to 16.73 percent and 1.60 percent for the three months ended March 31, 2012. The decline in ROE during the first quarter of 2013, compared to the first quarter of 2012, was attributable to capital growth resulting from record earnings for 2012, which outpaced the increase in net income for the same periods.

Principal Business Activities. An overview of the financial results for each of the Corporation's principal business segments is presented below. A more detailed discussion is included in "Results of Operations."

Retail Banking: C&F Bank's net income was $696,000 for the first quarter of 2013, compared to net income of $307,000 for the first quarter of 2012. The improvement in quarterly financial results for 2013 resulted from the effects of the continued low interest rate environment on the cost of deposits , lower loan loss provision expense, increased overdraft protection fees and lower foreclosed properties expenses due to the disposition of foreclosed properties. Partially offsetting these positive factors were the negative effects of the following:
(1) a decrease in average loans to nonaffiliates to $393.7 million for the first quarter of 2013 from $400.7 million for the first quarter of 2012 resulting from weak loan demand in the current economic environment and intensified competition for loans in our markets and (2) higher data processing expenses related to expanding the banking services offered to customers and improving operational efficiency.

The Bank's nonperforming assets were $11.7 million at March 31, 2013, compared to $17.7 million at December 31, 2012. Nonperforming assets at March 31, 2013 included $6.4 million in nonaccrual loans and $5.3 million in foreclosed properties, compared to $11.5 million in nonaccrual loans and $6.2 million in foreclosed properties at December 31, 2012. The decrease in nonaccrual loans was primarily the result of the sale of notes totaling $10.9 million relating to one commercial relationship, $5.2 million of which was on nonaccrual status at December 31, 2012. This note sale resulted in a $2.1 million charge-off, which had previously been provided for in the allowance for loan losses. As a result of this charge-off, the Bank's allowance for loan losses as a percentage of average loans declined to 2.84 percent at March 31, 2013 from 3.38 percent at December 31, 2012. Management believes it has provided adequate loan loss reserves for the Retail Banking segment's nonaccrual loans.

Mortgage Banking: C&F Mortgage Corporation's net income was $546,000 for the first quarter of 2013, compared to $418,000 for the first quarter of 2012. The improvement in quarterly financial results for 2013 resulted from higher gains on sales of loans and ancillary loan production fees. Loan sales volume increased to $205.5 million for the first quarter of 2013, compared to $179.6 million for the first quarter of 2012. Loan origination volume increased to $178.2 million in the first quarter of 2013, compared to $173.3 million in the first quarter of 2012. The increase in loan originations is a result of the continued low interest rate environment that has led to increased mortgage borrowing and refinancing activity. During the first quarter of 2013, the amounts of loan originations for refinancings and new and resale home purchases were $82.0 million and $96.2 million, respectively, compared to $79.7 million and $93.6 million, respectively, during the first quarter of 2012. In connection with the higher originations and net income in the first quarter of 2013, the mortgage banking segment incurred higher production-based and income-based expenses. Higher non-production personnel costs have also been incurred in order to manage the increasingly complex regulatory environment in which the mortgage banking segment operates.


Consumer Finance: C&F Finance Company's net income was $3.1 million for the first quarter of 2013, compared to net income of $3.3 million for the first quarter of 2012. Average loans outstanding during the first quarter of 2013 increased $31.8 million, or 12.79 percent, compared to the first quarter of 2012. Additionally, the consumer finance segment continued to benefit from the low funding costs related to its variable-rate borrowings. Offsetting these items were (1) increases in net charge-offs as a result of economic conditions and lower resale prices of repossessed automobiles, which resulted in an $850,000 increase in the provision for loan losses during the first quarter of 2013, (2) a decline in average loan yields in response to loan pricing strategies used by competitors to grow market share in automobile financing and
(3) an increase in personnel expenses incurred to support loan growth and segment expansion into new markets.

Annualized net charge-offs as a percentage of average loans outstanding increased to 3.57 percent for the first quarter of 2013, compared to 2.76 percent for the year ended December 31, 2012. The allowance for loan losses as a percentage of consumer finance loans was 7.97 percent as of March 31, 2013, compared to 7.96 percent as of December 31, 2012. Management believes that the current allowance for loan losses is adequate to absorb probable losses in the Consumer Finance segment's loan portfolio.

Other and Eliminations: The net loss for the first quarter of 2013 for this combined segment was $286,000, compared to a net loss of $209,000 for the first quarter of 2012. Revenue and expense of this combined segment include the results of operations of our investment, insurance and title subsidiaries, interest expense associated with the Corporation's trust preferred capital notes, other general corporate expenses and the effects of intercompany eliminations.

Capital Management. Total shareholders' equity was $104.9 million at March 31, 2013, compared to $102.2 million at December 31, 2012. Capital growth resulted from earnings for the first quarter of 2013, offset in part by dividends declared and a decline in unrealized holding gains on securities available for sale, which are a component of accumulated other comprehensive income. The Corporation declared cash dividends of 29 cents per common share during the first quarter of 2013, which was an 11.5 percent increase over the 26 cents per common share declared for the first quarter of 2012. The dividend payout ratio was a 23.6 percent of net income available to common shareholders for the first quarter of 2013.

RESULTS OF OPERATIONS

The following table presents the average balance sheets, the amounts of interest earned on earning assets, with related yields, and interest expense on interest-bearing liabilities, with related rates, for the three months ended March 31, 2013 and 2012. Loans include loans held for sale. Loans placed on nonaccrual status are included in the balances and are included in the computation of yields, but had no material effect. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid using the federal corporate income tax rate of 34 percent).


TABLE 1: Average Balances, Income and Expense, Yields and Rates

                                                  Three Months Ended March 31,
                                         2013                                       2012
(Dollars in              Average       Income/        Yield/        Average       Income/        Yield/
thousands)               Balance       Expense         Rate         Balance       Expense         Rate
Assets
Securities:
Taxable                 $  32,545     $     140           1.72 %   $  21,365     $      86           1.61 %
Tax-exempt                115,379         1,730           6.00       118,595         1,798           6.06
Total securities          147,924         1,870           5.06       139,960         1,884           5.38
Loans, net                729,444        17,829           9.91       711,451        17,490           9.86
Interest-bearing
deposits in other
banks and Federal
funds sold                 41,032            23           0.23        15,383             8           0.21
Total earning assets      918,400        19,722           8.71       866,794        19,382           8.94
Allowance for loan
losses                    (35,796 )                                  (34,116 )
Total non-earning
assets                     95,617                                     93,045
Total assets            $ 978,221                                  $ 925,723
Liabilities and
Shareholders' Equity
Time and savings
deposits:
Interest-bearing
deposits                $ 133,210     $     126           0.38 %   $ 112,868     $     142           0.50 %
Money market deposit
accounts                  112,640            83           0.30        86,512           100           0.46
Savings accounts           48,563            10           0.08        44,057            11           0.09
Certificates of
deposit, $100 or more     126,444           375           1.20       139,219           640           1.85
Other certificates of
deposit                   159,485           485           1.23       168,516           724           1.72
Total time and
savings deposits          580,342         1,079           0.75       551,172         1,617           1.17
Borrowings                163,985         1,069           2.61       159,017         1,222           3.07
Total
interest-bearing
liabilities               744,327         2,148           1.15       710,189         2,839           1.60
Demand deposits           104,837                                     94,394
Other liabilities          25,415                                     22,627
Total liabilities         874,579                                    827,210
Shareholders' equity      103,642                                     98,513
Total liabilities and
shareholders' equity    $ 978,221                                  $ 925,723
Net interest income                   $  17,574                                  $  16,543
Interest rate spread                                      7.56 %                                     7.34 %
Interest expense to
average earning
. . .
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