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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2020

or

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _________ to _________

Commission File Number 000-23423

C&F FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Virginia

54-1680165

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

3600 La Grange Parkway Toano, VA

23168

(Address of principal executive offices)

(Zip Code)

(804) 843-2360

(Registrant’s telephone number, including area code)

802 Main Street, West Point, VA 23181

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $1.00 par value per share

CFFI

The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes     No   

At August 4, 2020, the latest practicable date for determination, 3,648,586 shares of common stock, $1.00 par value, of the registrant were outstanding.

Table of Contents

TABLE OF CONTENTS

PART I - Financial Information

    

Page

 

Item 1.

Financial Statements

 

3

 

Consolidated Balance Sheets – June 30, 2020 (unaudited) and December 31, 2019

 

3

 

Consolidated Statements of Income (unaudited) – Three and six months ended June 30, 2020 and 2019

 

4

 

Consolidated Statements of Comprehensive Income (unaudited) – Three and six months ended June 30, 2020 and 2019

 

5

 

Consolidated Statements of Equity (unaudited) – Three months ended June 30, 2020 and 2019

 

6

 

Consolidated Statements of Equity (unaudited) – Six months ended June 30, 2020 and 2019

7

Consolidated Statements of Cash Flows (unaudited) – Six months ended June 30, 2020 and 2019

 

8

 

Notes to Consolidated Financial Statements (unaudited)

9

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

37

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

70

 

Item 4.

Controls and Procedures

 

70

 

PART II - Other Information

 

 

Item 1A.

Risk Factors

 

71

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

72

 

Item 6.

Exhibits

 

73

 

Signatures

 

74

 

2

Table of Contents

Part I – FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

C&F FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)

   June 30,    

December 31, 

    

2020

    

2019

  

Assets

(unaudited)

*

Cash and due from banks

$

15,774

$

21,148

Interest-bearing deposits in other banks

 

64,526

 

144,285

Total cash and cash equivalents

 

80,300

 

165,433

Securities—available for sale at fair value, amortized cost of
$241,178 and $187,759, respectively

 

247,133

 

189,733

Loans held for sale, at fair value

 

180,137

 

90,500

Loans, net of allowance for loan losses of $36,094 and $32,873, respectively

 

1,292,896

 

1,082,318

Restricted stock, at cost

 

3,209

 

3,257

Corporate premises and equipment, net

 

39,458

 

35,261

Other real estate owned, net of valuation allowance of $88 and $88, respectively

 

1,103

 

1,103

Accrued interest receivable

 

8,104

 

6,776

Goodwill

 

25,191

 

14,425

Other intangible assets, net

 

2,457

 

912

Bank-owned life insurance

19,862

16,044

Net deferred tax asset

12,425

11,219

Other assets

 

70,929

 

40,451

Total assets

$

1,983,204

$

1,657,432

Liabilities

Deposits

Noninterest-bearing demand deposits

$

464,703

$

296,985

Savings and interest-bearing demand deposits

 

688,545

 

572,209

Time deposits

 

492,541

 

422,056

Total deposits

 

1,645,789

 

1,291,250

Short-term borrowings

 

22,648

 

16,360

Long-term borrowings

 

43,390

 

119,529

Trust preferred capital notes

 

25,298

 

25,281

Accrued interest payable

 

1,210

 

1,291

Other liabilities

 

61,604

 

38,442

Total liabilities

 

1,799,939

 

1,492,153

Commitments and contingent liabilities (Note 11)

 

 

Equity

Common stock ($1.00 par value, 8,000,000 shares authorized, 3,647,447 and 3,438,126 shares issued and outstanding, respectively, includes 137,705 and 142,020 of unvested shares, respectively)

 

3,510

 

3,296

Additional paid-in capital

 

21,055

 

9,503

Retained earnings

 

158,799

 

154,248

Accumulated other comprehensive loss, net

 

(638)

 

(2,249)

Equity attributable to C&F Financial Corporation

182,726

164,798

Noncontrolling interest

539

481

Total equity

 

183,265

 

165,279

Total liabilities and equity

$

1,983,204

$

1,657,432

*     Derived from audited consolidated financial statements.

See notes to consolidated financial statements.

3

Table of Contents

C&F FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except per share amounts)

Three Months Ended June 30, 

Six Months Ended June 30, 

    

2020

    

2019

  

2020

    

2019

Interest income

Interest and fees on loans

$

22,204

$

22,323

$

45,101

$

43,243

Interest on interest-bearing deposits and federal funds sold

 

52

 

582

 

650

 

1,171

Interest and dividends on securities

U.S. government agencies and corporations

 

120

 

101

 

246

 

202

Mortgage-backed securities

543

567

1,063

1,178

Tax-exempt obligations of states and political subdivisions

513

556

1,009

1,139

Taxable obligations of states and political subdivisions

 

108

 

93

 

200

 

186

Other

 

44

 

54

 

93

 

108

Total interest income

 

23,584

 

24,276

 

48,362

 

47,227

Interest expense

Savings and interest-bearing deposits

 

355

 

597

 

941

 

1,199

Time deposits

 

2,131

 

1,624

 

4,430

 

2,930

Borrowings

 

557

 

1,120

 

1,558

 

2,231

Trust preferred capital notes

 

287

 

310

 

576

 

595

Total interest expense

 

3,330

 

3,651

 

7,505

 

6,955

Net interest income

 

20,254

 

20,625

 

40,857

 

40,272

Provision for loan losses

 

3,600

 

1,810

 

6,250

 

4,205

Net interest income after provision for loan losses

 

16,654

 

18,815

 

34,607

 

36,067

Noninterest income

Gains on sales of loans

 

4,605

 

2,955

 

8,281

 

5,091

Mortgage banking fee income

 

1,986

 

1,267

 

3,291

 

2,037

Interchange income

1,141

1,071

2,230

2,029

Service charges on deposit accounts

 

639

 

944

 

1,641

 

1,862

Wealth management services income, net

 

748

 

475

 

1,333

 

924

Other service charges and fees

 

394

 

417

 

769

 

715

Net gains on sales, maturities and calls of available for sale securities

 

3

 

1

 

7

 

5

Other

 

2,312

 

1,072

 

1,024

 

2,642

Total noninterest income

 

11,828

 

8,202

 

18,576

 

15,305

Noninterest expenses

Salaries and employee benefits

 

14,354

 

11,495

 

25,171

 

23,402

Occupancy

 

2,567

 

2,148

 

4,894

 

4,338

Other

 

6,871

 

5,906

 

13,812

 

11,486

Total noninterest expenses

 

23,792

 

19,549

 

43,877

 

39,226

Income before income taxes

 

4,690

 

7,468

 

9,306

 

12,146

Income tax expense

 

947

 

1,626

 

1,924

 

2,533

Net income

3,743

5,842

7,382

9,613

Less net (loss) income attributable to noncontrolling interest

 

(3)

 

(1)

 

58

 

(1)

Net income attributable to C&F Financial Corporation

$

3,746

$

5,843

$

7,324

$

9,614

Net income per share - basic and diluted

$

1.03

$

1.69

$

2.01

$

2.77

See notes to consolidated financial statements.

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C&F FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

Three Months Ended June 30, 

Six Months Ended June 30, 

    

2020

    

2019

    

2020

    

2019

Net income

$

3,743

$

5,842

$

7,382

$

9,613

Other comprehensive income:

Defined benefit plan:

Reclassification of recognized net actuarial losses into net income1

57

52

99

94

Related income tax effects

(12)

(11)

(21)

(20)

Amortization of prior service credit into net income1

(17)

(17)

(34)

(34)

Related income tax effects

3

3

7

7

Defined benefit plan, net of tax

31

27

51

47

Cash flow hedges:

Unrealized holding losses arising during the period

(154)

(102)

(2,128)

(210)

Related income tax effects

39

26

547

54

Amortization of hedging gains into net income2

(3)

(6)

Related income tax effects

1

2

Cash flow hedges, net of tax

(117)

(76)

(1,585)

(156)

Securities available for sale:

Unrealized holding gains arising during the period

1,779

1,547

3,988

3,373

Related income tax effects

(373)

(325)

(837)

(708)

Reclassification of net realized gains into net income3

(3)

(1)

(7)

(5)

Related income tax effects

1

1

Securities available for sale, net of tax

1,403

1,221

3,145

2,661

Other comprehensive income, net of tax

1,317

1,172

1,611

2,552

Comprehensive income

5,060

7,014

8,993

12,165

Less comprehensive (loss) income attributable to noncontrolling interest

(3)

(1)

58

(1)

Comprehensive income attributable to C&F Financial Corporation

$

5,063

$

7,015

$

8,935

$

12,166

1These items are included in the computation of net periodic benefit cost and are included in “Noninterest income – Other” on the Consolidated Statements of Income. See “Note 8: Employee Benefit Plans,” for additional information.
2These items are included in “Interest expense – Trust preferred capital notes” on the Consolidated Statements of Income.
3These items are included in “Net gains on sales, maturities and calls of available for sale securities” on the Consolidated Statements of Income.

See notes to consolidated financial statements.

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C&F FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY

FOR THE THREE MONTHS ENDED JUNE 30, 2020 AND 2019

(Unaudited)

(Dollars in thousands, except per share amounts)

Attributable to C&F Financial Corporation

Accumulated

   

   

Additional

   

   

Other

   

 

Common

Paid - In

Retained

Comprehensive

Noncontrolling

Total

 

Stock

Capital

Earnings

Loss, Net

Interest

Equity

 

Balance March 31, 2020

$

3,509

 

$

20,710

 

$

156,438

 

$

(1,955)

 

$

542

$

179,244

Comprehensive income:

Net income (loss)

 

 

 

3,746

 

 

(3)

 

3,743

Other comprehensive income

 

 

 

 

1,317

 

 

1,317

Share-based compensation

 

 

312

 

 

 

 

312

Common stock issued

 

1

 

33

 

 

 

 

34

Cash dividends declared ($0.38 per share)

(1,385)

(1,385)

Balance June 30, 2020

$

3,510

$

21,055

$

158,799

$

(638)

 

$

539

$

183,265

Attributable to C&F Financial Corporation

Accumulated

   

   

Additional

   

   

Other

   

 

Common

Paid - In

Retained

Comprehensive

Noncontrolling

Total

 

Stock

Capital

Earnings

Loss, Net

Interest

Equity

 

Balance March 31, 2019

$

3,337

 

$

11,362

 

$

143,003

 

$

(3,292)

 

$

490

$

154,900

Comprehensive income:

Net income (loss)

 

 

 

5,843

 

 

(1)

 

5,842

Other comprehensive income

 

 

 

 

1,172

 

 

1,172

Share-based compensation

 

 

310

 

 

 

 

310

Restricted stock vested

 

1

(1)

 

 

 

 

Common stock issued

 

34

 

 

 

 

34

Common stock purchased

(33)

(1,598)

(1,631)

Cash dividends declared ($0.37 per share)

 

 

 

(1,276)

 

 

 

(1,276)

Balance June 30, 2019

$

3,305

$

10,107

$

147,570

$

(2,120)

 

$

489

$

159,351

See notes to consolidated financial statements.

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C&F FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2020 AND 2019

(Unaudited)

(Dollars in thousands, except per share amounts)

Attributable to C&F Financial Corporation

   

   

   

   

Accumulated

   

 

Additional

Other

Common

Paid - In

Retained

Comprehensive

Noncontrolling

Total

 

Stock

Capital

Earnings

Loss, Net

Interest

Equity

 

Balance December 31, 2019

3,296

9,503

154,248

(2,249)

 

481

165,279

Comprehensive income:

Net income

 

 

 

7,324

 

 

58

 

7,382

Other comprehensive income

 

 

 

 

1,611

 

 

1,611

Share-based compensation

 

701

 

 

 

 

701

Restricted stock vested

 

16

(16)

 

 

 

 

Acquisition of Peoples Bankshares, Incorporated

 

210

 

11,402

 

 

 

 

11,612

Common stock issued

 

2

69

 

 

 

71

Common stock purchased

(14)

(604)

(618)

Cash dividends declared ($0.76 per share)

(2,773)

(2,773)

Balance June 30, 2020

$

3,510

$

21,055

$

158,799

$

(638)

 

$

539

$

183,265

Attributable to C&F Financial Corporation

Accumulated

   

   

Additional

   

   

Other

   

 

Common

Paid - In

Retained

Comprehensive

Noncontrolling

Total

 

Stock

Capital

Earnings

Loss, Net

Interest

Equity

 

Balance December 31, 2018

$

3,358

 

$

12,752

 

$

140,520

 

$

(4,672)

 

$

$

151,958

Comprehensive income:

Net income (loss)

 

 

 

9,614

 

 

(1)

 

9,613

Other comprehensive income

 

 

 

 

2,552

 

 

2,552

Issuance of noncontrolling interest

490

490

Share-based compensation

 

 

767

 

 

 

 

767

Restricted stock vested

 

16

(16)

 

 

 

 

Common stock issued

 

1

 

69

 

 

 

 

70

Common stock purchased

(70)

(3,465)

(3,535)

Cash dividends declared ($0.74 per share)

 

 

 

(2,564)

 

 

 

(2,564)

Balance June 30, 2019

$

3,305

$

10,107

$

147,570

$

(2,120)

 

$

489

$

159,351

See notes to consolidated financial statements.

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C&F FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

Six Months Ended June 30, 

    

2020

    

2019

Operating activities:

Net income

$

7,382

$

9,613

Adjustments to reconcile net income to net cash used in operating activities:

Depreciation

 

1,791

 

1,826

Provision for loan losses

 

6,250

 

4,205

Share-based compensation

 

701

 

767

Pension expense

396

324

Accretion of certain acquisition-related discounts, net

 

(1,972)

 

(1,638)

Amortization of intangible assets

166

141

Net realized gains on sales, maturities and calls of securities available for sale

 

(7)

 

(5)

Net realized losses on sale of corporate premises and equipment

509

11

Accretion of discounts and amortization of premiums on securities, net

 

941

 

811

Income from bank-owned life insurance

 

(206)

 

(168)

Proceeds from sales of loans held for sale

 

624,112

 

342,531

Origination of loans held for sale

 

(698,740)

 

(385,581)

Gains on sales of loans held for sale

(8,281)

(5,091)

Other losses, net

305

23

Change in other assets and liabilities:

Accrued interest receivable

 

(898)

 

207

Other assets

 

929

 

1,731

Accrued interest payable

 

(341)

 

356

Other liabilities

 

208

 

2,425

Net cash used in operating activities

 

(66,755)

 

(27,512)

Investing activities:

Acquisition of Peoples Bankshares, Incorporated

19,101

Disposition of assets related to business combination

8,004

Proceeds from sales, maturities and calls of securities available for sale and payments on mortgage-backed securities

 

70,780

 

33,639

Purchases of securities available for sale

 

(107,964)

 

(16,594)

Purchases of time deposits, net

(6,464)

Repayments on loans held for investment by non-bank affiliates

62,462

60,675

Purchases of loans held for investment by non-bank affiliates

(53,013)

(77,356)

Net increase in community banking loans held for investment

(102,276)

(14,717)

Proceeds from sales of other real estate owned

 

281

 

521

Purchases of corporate premises and equipment

 

(3,453)

 

(1,471)

Changes in collateral posted with other financial institutions, net

(9,270)

(2,100)

Other investing activities, net

 

38

 

8

Net cash used in investing activities

 

(121,774)

 

(17,395)

Financing activities:

Net increase (decrease) in demand and savings deposits

 

189,256

 

(21,409)

Net (decrease) increase in time deposits

 

(6,394)

 

49,957

Net increase in short-term borrowings

 

6,288

 

1,927

Repayments of long-term borrowings

(82,553)

Repurchases of common stock

(355)

(3,288)

Cash dividends paid

(2,773)

(2,564)

Other financing activities, net

 

(73)

 

(74)

Net cash provided by financing activities

 

103,396

 

24,549

Net decrease in cash and cash equivalents

 

(85,133)

 

(20,358)

Cash and cash equivalents at beginning of period

 

165,433

 

115,013

Cash and cash equivalents at end of period

$

80,300

$

94,655

Supplemental cash flow disclosures:

Interest paid

$

8,010

$

6,581

Income taxes paid

 

2,130

 

546

Supplemental disclosure of noncash investing and financing activities:

Value of shares withheld at vesting for employee taxes

$

263

$

247

Liabilities assumed to acquire right of use assets at lease commencement

2,778

1,048

Issuance of noncontrolling interest

 

 

490

See notes to consolidated financial statements.

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C&F FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1: Summary of Significant Accounting Policies

Principles of Consolidation: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial reporting and with applicable quarterly reporting regulations of the Securities and Exchange Commission (the SEC). They do not include all of the information and notes required by U.S. GAAP for complete financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the C&F Financial Corporation Annual Report on Form 10-K for the year ended December 31, 2019.

The unaudited consolidated financial statements include the accounts of C&F Financial Corporation (the Corporation) and its direct wholly-owned subsidiary, Citizens and Farmers Bank (the Bank or C&F Bank) and indirect subsidiaries that are wholly-owned or controlled. Subsidiaries that are less than wholly owned are fully consolidated if they are controlled by the Corporation or one of its subsidiaries, and the portion of any subsidiary not owned by the Corporation is reported as noncontrolling interest. All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, the Corporation owns all of the common stock of C&F Financial Statutory Trust I, C&F Financial Statutory Trust II and Central Virginia Bankshares Statutory Trust I, all of which are unconsolidated subsidiaries. The subordinated debt owed to these trusts is reported as liabilities of the Corporation.  The accounting and reporting policies of the Corporation conform to U.S. GAAP and to predominant practices within the banking industry.

Nature of Operations: The Corporation is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Corporation owns all of the stock of its subsidiary, C&F Bank, which is an independent commercial bank chartered under the laws of the Commonwealth of Virginia.

C&F Bank has five wholly-owned subsidiaries: C&F Mortgage Corporation (C&F Mortgage), C&F Finance Company (C&F Finance), C&F Wealth Management Corporation (C&F Wealth Management), C&F Insurance Services, Inc. and CVB Title Services, Inc., all incorporated under the laws of the Commonwealth of Virginia. C&F Mortgage, organized in September 1995, was formed to originate and sell residential mortgages and through its subsidiary, Certified Appraisals LLC, provides ancillary mortgage loan production services for residential appraisals. C&F Mortgage owns a 51 percent interest in C&F Select LLC, which was organized in January 2019 and is also engaged in the business of originating and selling residential mortgages. C&F Finance, acquired in September 2002, is a finance company purchasing automobile, marine and recreational vehicle (RV) loans through indirect lending programs. C&F Wealth Management, organized in April 1995, is a full-service brokerage firm offering a comprehensive range of wealth management services and insurance products through third-party service providers. C&F Insurance Services, Inc., was organized in July 1999, for the primary purpose of owning an equity interest in an independent insurance agency that operates in Virginia and North Carolina. CVB Title Services, Inc. was organized for the primary purpose of owning an equity interest in a full service title and settlement agency. Business segment data is presented in Note 10.

Basis of Presentation: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, impairment of loans and goodwill impairment. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these financial statements, have been made.

The outbreak of the novel coronavirus and the resulting COVID-19 pandemic has caused a significant disruption in economic activity worldwide, including in market areas served by the Corporation. Estimates for the allowance for loan losses at June 30, 2020 include losses related to the pandemic.  The Corporation expects that the pandemic will continue to have an effect on its results of operations, including resulting in additional provision for loan losses in future periods.  

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It is unknown how long these conditions will last and what the ultimate financial impact will be to the Corporation.  Depending on the severity of the economic consequences of the pandemic, the Corporation’s goodwill may become impaired.

Reclassification: Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation.  None of these reclassifications are considered material.

Business Combination: On January 1, 2020, the Corporation completed the acquisition of Peoples Bankshares, Incorporated (Peoples) and its banking subsidiary, Peoples Community Bank for an aggregate purchase price of $22.19 million of cash and stock.  Additional information about the acquisition is presented in Note 2.

Derivative Financial Instruments: The Corporation recognizes derivative financial instruments at fair value as either an other asset or other liability in the Consolidated Balance Sheets. The Corporation’s derivative financial instruments include (1) interest rate swaps that qualify and are designated as cash flow hedges on the Corporation’s trust preferred capital notes, (2) interest rate swaps with certain qualifying commercial loan customers and dealer counterparties and (3) interest rate contracts arising from mortgage banking activities, including interest rate lock commitments (IRLCs) on mortgage loans and related forward sales of mortgage loans and mortgage backed securities. The gain or loss on the Corporation’s cash flow hedges is reported as a component of other comprehensive income, net of deferred income taxes, and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. IRLCs, forward sales contracts and interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, and therefore changes in the fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Corporation’s derivative financial instruments are described more fully in Note 12.

Leases: The Corporation’s leases comprise primarily operating leases of real estate and office equipment in which the Corporation or one of its subsidiaries is the lessee. In the second quarter of 2020, the Corporation entered into a new lease of real estate which is classified as a finance lease. The right of use asset and lease liability were measured at $2.18 million at commencement of the lease. The Corporation’s right of use assets, which are presented in other assets in the Consolidated Balance Sheets, and lease liabilities, which are presented in other liabilities and long-term borrowings in the Consolidated Balance Sheets for operating and finance leases, respectively, are presented in the table below.

    

June 30, 

December 31, 

(Dollars in thousands)

2020

    

2019

Operating leases:

Right of use assets

$

2,491

$

2,785

Lease liabilities

2,597

2,813

Finance leases:

Right of use assets

$

2,172

$

Lease liabilities

 

2,185

 

Income Taxes: The Corporation’s effective tax rate was 20.7 percent and 20.9 percent for the first six months of 2020 and 2019, respectively. The Corporation recognized income tax benefits of $303,000 in the second quarter and first six months of 2020 arising from a change in tax law enacted in response to the COVID-19 pandemic which changed the tax rate applied to certain net operating losses of Peoples. Changes in tax law are recognized in income tax expense in the period in which they are enacted.

Share-Based Compensation: Share-based compensation expense, net of forfeitures, for the three months ended June 30, 2020 and the first six months of 2020 was $312,000 ($217,000 after tax) and $701,000 ($435,000 after tax), respectively, for restricted stock granted during 2015 through 2020. As of June 30, 2020, there was $3.30 million of total unrecognized compensation expense related to unvested restricted stock that will be recognized over the remaining requisite service periods.

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A summary of activity for restricted stock awards during the first six months of 2020 and 2019 is presented below:

2020

 

    

    

Weighted-

 

Average

 

Grant Date

 

Shares

Fair Value

 

Unvested, December 31, 2019

 

142,020

$

48.88

Granted

14,650

 

53.22

Vested

 

(16,230)

 

39.97

Forfeited

 

(2,735)

 

5.89

Unvested, June 30, 2020

 

137,705

50.33

2019

    

    

Weighted-

Average

Grant Date

Shares

Fair Value

Unvested, December 31, 2018

 

139,455

$

45.75

Granted

 

16,100

 

51.73

Vested

 

(16,290)

 

41.08

Forfeited

 

(410)

 

53.28

Unvested, June 30, 2019

 

138,855

46.97

Paycheck Protection Program: Beginning in April 2020, the Corporation originated loans under the Paycheck Protection Program (PPP) of the Small Business Administration (SBA).  PPP loans are fully guaranteed by the SBA, and in some cases borrowers may be eligible to obtain forgiveness of the loans, in which case loans would be repaid by the SBA.  As repayment of the PPP loans is guaranteed by the SBA, the Corporation does not recognize a reserve for PPP loans in its allowance for loan losses.  The Corporation received fees from the SBA of one percent to five percent of the principal amount of each loan originated under the PPP.  Fees received from the SBA are recognized net of direct origination costs in interest income over the life of the related loans.  Recognition of fees related to PPP loans is dependent upon the timing of ultimate repayment or forgiveness.

Recently Adopted Accounting Pronouncements:

On January 1, 2020, the Corporation adopted Accounting Standards Update (ASU) 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” These amendments modified the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. The applicable amendments of ASU 2018-13 were applied prospectively and did not have a material effect on the Corporation’s consolidated financial statements.

Recent Significant Accounting Pronouncements:

In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” as part of its project on financial instruments. Subsequently, this ASU was amended when the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” ASU 2019-05, “Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief,” ASU 2019-10, “Financial Instruments—Credit losses (Topic 326), Derivatives and hedging (Topic 815), and Leases (Topic 842)—Effective dates,” ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” ASU 2020-02, “Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842)” and ASU 2020-03, “Codification Improvements to Financial Instruments” (collectively, ASC 326).  ASC 326 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination.  

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The new standard will be effective for the Corporation beginning on January 1, 2023.  Early adoption of the new standard is permitted.

The amendments of ASC 326, upon adoption, will be applied on a modified retrospective basis, with the cumulative effect of adopting the new standard being recorded as an adjustment to opening retained earnings in the period of adoption. The Corporation has established a working group to prepare for and implement changes related to ASC 326 and has gathered historical loan loss data for purposes of evaluating appropriate portfolio segmentation and modeling methods under the standard.  The Corporation has performed procedures to validate the historical loan loss data to ensure its suitability and reliability for purposes of developing an estimate of expected credit losses under ASC 326. The Corporation has engaged a vendor to assist in modeling expected lifetime losses under ASC 326, and is continuing to develop and refine an approach to estimating the allowance for credit losses. The adoption of ASC 326 will result in significant changes to the Corporation’s consolidated financial statements, which may include changes in the level of the allowance for credit losses that will be considered adequate, a reduction in total equity and regulatory capital of C&F Bank, differences in the timing of recognizing changes to the allowance for credit losses and expanded disclosures about the allowance for credit losses. The Corporation has not yet determined an estimate of the effect of these changes. The adoption of the standard will also result in significant changes in the Corporation’s internal control over financial reporting related to the allowance for credit losses.

In August 2018, the FASB issued ASU 2018-14, “Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans.” These amendments modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Certain disclosure requirements have been deleted while the following disclosure requirements have been added: the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments also clarify the disclosure requirements regarding the projected benefit obligation (PBO) and fair value of plan assets for plans with PBOs in excess of plan assets and the accumulated benefit obligation (ABO) and fair value of plan assets for plans with ABOs in excess of plan assets. The amendments are effective for fiscal years ending after December 15, 2020. Early adoption is permitted.  The Corporation does not expect the adoption of ASU 2018-14 to have a material effect on its consolidated financial statements.

Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Corporation’s financial position, results of operations or cash flows.

NOTE 2:  Business Combination

On January 1, 2020, the Corporation completed its acquisition of Peoples.  Peoples shareholders received 0.5366 shares of the Corporation’s common stock and $27.00 in cash for each share of Peoples common stock, with cash paid in lieu of any fractional shares of the Corporation’s common stock.  In connection with the transaction, the Corporation paid aggregate cash consideration of $10.58 million and issued 209,871 shares of its common stock to the shareholders of Peoples.  

The Corporation accounted for the acquisition using the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method of accounting, the assets acquired and liabilities assumed in the acquisition and the common stock of the Corporation issued as consideration were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is inherently subjective and involves significant judgment regarding the methods and assumptions used to estimate fair value.  During the measurement period, the acquirer shall adjust the amounts recognized at the acquisition date and may recognize additional assets or liabilities to reflect new information obtained from facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date.  Measurement period adjustments are recognized in the reporting period in which they are determined.  The measurement period may not exceed one year from the acquisition date.  

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The following table presents as of January 1, 2020 the total consideration paid by the Corporation in connection with the acquisition of Peoples, the fair values of the assets acquired and liabilities assumed, and the resulting goodwill.

    

Amounts

Recognized as of

(Dollars in thousands)

January 1, 2020

Purchase price:

Cash paid

$

10,579

Common stock issued

 

11,612

Total purchase price

$

22,191

Identifiable assets acquired:

Cash and cash equivalents

$

29,680

Securities available for sale

 

17,169

Loans

 

124,195

Accrued interest receivable

430

Corporate premises and equipment

 

3,105

Other real estate owned

 

281

Core deposit intangible asset

 

1,711

Bank-owned life insurance

3,591

Investment in small business investment company

1,493

Other receivables

5,234

Other assets

 

3,658

Total identifiable assets acquired

 

190,547

Identifiable liabilities assumed:

Demand and savings deposits

 

94,798

Time deposits

77,018

Borrowings

 

4,245

Accrued interest payable

 

260

Salaries, benefits and deferred compensation

2,054

Other liabilities

 

747

Total identifiable liabilities assumed

 

179,122

Net identifiable assets assumed

$

11,425

Goodwill resulting from acquisition

$

10,766

In connection with the acquisition, the Corporation recorded approximately $10.77 million of goodwill and $1.71 million of other intangible assets related to the core deposits of Peoples.  The goodwill arising from the acquisition of Peoples is not deductible for income taxes.  The core deposit intangible asset (CDI) will be amortized over a period of 15 years using a declining balance method.

Loans acquired from Peoples had aggregate outstanding principal of $131.92 million and an estimated fair value of $124.20 million.  The discount between the outstanding principal balance and fair value represents expected credit losses and adjustments for market interest rates.  Under the acquisition method, the allowance for loan losses recorded in the books of Peoples in the amount of $2.87 million was not carried over into the books of the Corporation.  Loans that have evidence of deterioration in credit quality since origination are categorized as purchased credit impaired (PCI).  PCI loans acquired from Peoples included medical student loans with an outstanding principal balance of $4.28 million and a fair value of $635,000 at January 1, 2020, which were purchased by Peoples and the performance of which was previously backed by surety bonds.  The surety bonds were terminated in 2018 when the issuer of the bond was placed into liquidation by its insurance regulator, and replacement surety bond coverage has not been obtained.

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Information about PCI loans acquired from Peoples as of January 1, 2020 is as follows:

(Dollars in thousands)

    

January 1, 2020

 

Contractual principal and interest due

$

20,310

Nonaccretable difference

 

(7,679)

Expected cash flows

 

12,631

Accretable yield

 

(3,372)

Purchase credit impaired loans - estimated fair value

$

9,259

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

Loans:  The acquired loans were recorded at fair value at the acquisition date without carryover of People's allowance for loan losses. The fair value of the loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then discounting those cash flows based on a discount rate that would be required by a market participant. In this regard, the acquired loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type, loan purpose and loan structure. Credit risk characteristics included risk rating groups (pass rated loans and adversely classified loans), updated loan-to-value ratios and lien position, and past loan performance. For valuation purposes, these pools were further disaggregated by maturity and pricing characteristics (e.g., fixed-rate, adjustable-rate, balloon maturities).

Core Deposit Intangible: The fair value of the CDI was determined based on a discounted cash flow analysis using a discount rate based on the estimated cost of equity capital for a market participant. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the cost of alternative funding sources available through the FHLB. The life of the deposit base and projected deposit attrition rates were determined using Peoples’ historical deposit data. The CDI was estimated at $1.71 million or 1.8% of non-maturity deposits.

Deposits:  The fair value adjustment of deposits represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar term certificates of deposit. The resulting estimated fair value adjustment of certificates of deposit ranging in maturity from three months to five years is a $557,000 premium and is being amortized into income over a period of two years.

The following table presents certain unaudited pro forma information as if the acquisition had taken place on January 1, 2019. These results combine the historical results of Peoples and the Corporation for the period prior to the merger.  While certain adjustments were made for estimated effects resulting from the application of the acquisition method, including certain fair value adjustments, this pro forma information is not indicative of what would have occurred had the acquisition actually taken place on January 1, 2019. Pro forma adjustments for the three and six months ended June 30, 2019 include the net impact of accretion of loan discounts related to market interest rates, amortization of premiums on deposits and borrowings, amortization of intangible assets and related income taxes.  Unaudited pro forma net income for the three and six months ended June 30, 2019 include after tax merger related expenses of $28,000 recorded by Peoples, or $(0.01) per share.  Additionally, the Corporation expects to achieve further operational cost savings and other efficiencies as a result of the acquisition which are not reflected in the unaudited pro forma amounts below.

    

Unaudited Pro Forma

    

Unaudited Pro Forma

    

 

Three Months Ended

Six Months Ended

 

(Dollars in thousands, except per share amounts)

June 30, 2019

June 30, 2019

 

Total revenues (net interest income plus nonintererest income)

$

30,808

$

59,463

Net income

$

5,969

$

10,258

Net income per share, basic and diluted

$

1.63

$

2.78

The revenue and earnings amounts specific to Peoples since the acquisition date that are included in the consolidated results for 2020 are not readily determinable.  The disclosures of these amounts are impracticable due to the merging of certain processes and systems at the acquisition date.

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Merger related expenses associated with the acquisition of Peoples were $439,000 ($347,000 after income taxes) for the three months ended June 30, 2020, $1.40 million ($1.13 million after income taxes) for the six months ended June 30, 2020 and $2.10 million ($1.78 million after income taxes) in the aggregate through June 30, 2020.  There were no merger related expenses during the three and six months ended June 30, 2019.  These costs included the integration of systems and operations and legal and consulting expenses, which have been expensed as incurred.  The Corporation believes that any further merger related expenses incurred in future periods will not be significant to the Corporation as a whole.

NOTE 3: Securities

The Corporation’s debt securities, all of which are classified as available for sale, are summarized as follows:

June 30, 2020

 

    

    

Gross

    

Gross

    

 

Amortized

Unrealized

Unrealized

 

(Dollars in thousands)

Cost

Gains

Losses

Fair Value

 

U.S. government agencies and corporations

$

37,068

$

153

$

(16)

$

37,205

Mortgage-backed securities

 

102,749

 

3,500

 

 

106,249

Obligations of states and political subdivisions

 

101,361

 

2,321

 

(3)

 

103,679

$

241,178

$

5,974

$

(19)

$

247,133

December 31, 2019

 

    

    

Gross

    

Gross

    

 

Amortized

Unrealized

Unrealized

 

(Dollars in thousands)

Cost

Gains

Losses

Fair Value

 

U.S. government agencies and corporations

$

21,454

$

3

$

(17)

$

21,440

Mortgage-backed securities

 

85,649

 

979

 

(43)

 

86,585

Obligations of states and political subdivisions

 

80,656

 

1,111

 

(59)

 

81,708

$

187,759

$

2,093

$

(119)

$

189,733

The amortized cost and estimated fair value of securities at June 30, 2020, by the earlier of contractual maturity or expected maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

June 30, 2020

 

    

Amortized

    

 

(Dollars in thousands)

Cost

Fair Value

 

Due in one year or less

$

63,267

$

63,568

Due after one year through five years

 

139,191

 

143,546

Due after five years through ten years

 

36,488

 

37,698

Due after ten years

 

2,232

 

2,321

$

241,178

$

247,133

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The following table presents the gross realized gains and losses on and the proceeds from the sales, maturities and calls of securities. During the six months ended June 30, 2020, $5.99 million in proceeds were related to sales of assets acquired in the acquisition of Peoples. There were no sales of securities during the three and six months ended June 30, 2019.

Three Months Ended June 30, 

Six Months Ended June 30, 

(Dollars in thousands)

    

2020

    

2019

    

2020

2019

Realized gains from sales, maturities and calls of securities:

Gross realized gains

$

3

$

1

$

7

$

5

Gross realized losses

 

 

 

 

Net realized gains

$

3

$

1

$

7

$

5

Proceeds from sales, maturities, calls and paydowns of securities

$

31,717

$

17,982

$

70,780

$

33,639

The Corporation pledges securities primarily to secure public deposits and repurchase agreements. Securities with an aggregate amortized cost of $118.55 million and an aggregate fair value of $122.58 million were pledged at June 30, 2020. Securities with an aggregate amortized cost of $126.22 million and an aggregate fair value of $127.47 million were pledged at December 31, 2019.

Securities in an unrealized loss position at June 30, 2020, by duration of the period of the unrealized loss, are shown below.

Less Than 12 Months

12 Months or More

Total

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(Dollars in thousands)

Value

Loss

Value

Loss

   Value   

Loss

 

U.S. government agencies and corporations

$

14,320

$

16

$

$

$

14,320

$

16

Mortgage-backed securities

 

 

 

 

 

Obligations of states and political subdivisions

 

1,412

 

3

 

 

 

1,412

 

3

Total temporarily impaired securities

$

15,732

$

19

$

$

$

15,732

$

19

There were 11 debt securities totaling $15.73 million of aggregate fair value considered temporarily impaired at June 30, 2020. The primary cause of the temporary impairments in the Corporation’s investments in debt securities was fluctuations in interest rates. The Corporation’s mortgage-backed securities are entirely issued by either U.S. government agencies or U.S. government-sponsored enterprises.  Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the U.S. government, that investors in such mortgage-backed securities will receive timely principal and interest payments.  At June 30, 2020, all of the Corporation’s obligations of states and political subdivisions that were in a net unrealized loss position were rated “A” or better by Standard & Poor's or Moody's Investors Service. The Corporation considers these to meet regulatory credit quality standards, meaning that the securities have low risk of default by the obligor and the full and timely repayment of principal and interest is expected over the expected life of the investment. Because the Corporation intends to hold these investments in debt securities to maturity and it is more-likely-than-not that the Corporation will not be required to sell these investments before a recovery of unrealized losses, the Corporation does not consider these investments to be other-than-temporarily impaired at June 30, 2020 and no other-than-temporary impairment loss has been recognized in net income. 

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Securities in an unrealized loss position at December 31, 2019, by duration of the period of the unrealized loss, are shown below.

Less Than 12 Months

12 Months or More

Total

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(Dollars in thousands)

Value

Loss

Value

Loss

   Value   

Loss

 

U.S. government agencies and corporations

$

6,256

$

11

$

4,094

$

6

$

10,350

$

17

Mortgage-backed securities

4,099

 

7

 

10,166

 

36

 

14,265

 

43

Obligations of states and political subdivisions

 

9,187

 

53

 

1,368

 

6

 

10,555

 

59

Total temporarily impaired securities

$

19,542

$

71

$

15,628

$

48

$

35,170

$

119

The Corporation’s investment in restricted stock totaled $3.21 million at June 30, 2020 and consisted of Federal Home Loan Bank (FHLB) stock.  Restricted stock is generally viewed as a long-term investment, which is carried at cost because there is no market for the stock other than the FHLBs. Therefore, when evaluating restricted stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing any temporary decline in value. The Corporation did not consider its investment in restricted stock to be other-than-temporarily impaired at June 30, 2020 and no impairment has been recognized.

NOTE 4: Loans

Major classifications of loans are summarized as follows:

June 30, 

December 31, 

 

(Dollars in thousands)

    

2020

    

2019

 

Real estate – residential mortgage

$

205,011

$

181,295

Real estate – construction 1

 

72,094

 

54,246

Commercial, financial and agricultural 2

 

682,817

 

500,812

Equity lines

 

52,697

 

52,083

Consumer

 

15,722

 

13,756

Consumer finance

 

300,649

 

312,999

 

1,328,990

 

1,115,191

Less allowance for loan losses

 

(36,094)

 

(32,873)

Loans, net

$

1,292,896

$

1,082,318

1Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
2Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

Consumer loans included $173,000 and $449,000 of demand deposit overdrafts at June 30, 2020 and December 31, 2019, respectively.

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Loans acquired in business combinations are recorded in the Consolidated Balance Sheets at fair value at the acquisition date under the acquisition method of accounting.  The outstanding principal balance and the carrying amount at June 30, 2020 and December 31, 2019 of loans acquired in business combinations were as follows:

June 30, 2020

December 31, 2019

 

Acquired Loans -

  

Acquired Loans -

  

  

Acquired Loans -

  

Acquired Loans -

  

 

Purchased

Purchased

Acquired Loans -

Purchased

Purchased

Acquired Loans -

 

(Dollars in thousands)

Credit Impaired

Performing

Total

Credit Impaired

Performing

Total

 

Outstanding principal balance

$

18,591

$

116,971

$

135,562

$

6,262

$

27,839

$

34,101

Carrying amount

Real estate – residential mortgage

$

1,814

$

22,448

$

24,262

$

107

$

7,035

$

7,142

Real estate – construction

3,762

3,762

Commercial, financial and agricultural1

 

5,452

 

74,254

 

79,706

 

563

 

11,338

 

11,901

Equity lines

 

77

 

11,767

 

11,844

 

35

 

8,046

 

8,081

Consumer

 

488

 

2,317

 

2,805

 

 

3

 

3

Total acquired loans

$

7,831

$

114,548

$

122,379

$

705

$

26,422

$

27,127

1Includes acquired loans classified by the Corporation as commercial real estate lending and commercial business lending.

The following table presents a summary of the change in the accretable yield of loans classified as purchased credit impaired (PCI):

Six Months Ended June 30, 

(Dollars in thousands)

    

2020

 

2019

 

Accretable yield, balance at beginning of period

$

4,721

$

5,987

Additions

 

3,372

 

Accretion

 

(1,687)

 

(1,760)

Reclassification of nonaccretable difference due to improvement in expected cash flows

 

923

 

727

Other changes, net

 

115

 

349

Accretable yield, balance at end of period

$

7,444

$

5,303

Loans on nonaccrual status were as follows:

June 30, 

December 31, 

 

(Dollars in thousands)

    

2020

    

2019

 

Real estate – residential mortgage

$

980

$

1,526

Commercial, financial and agricultural:

Commercial business lending

 

 

11

Equity lines

 

244

 

229

Consumer

 

542

 

118

Consumer finance

 

369

 

611

Total loans on nonaccrual status

$

2,135

$

2,495

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The past due status of loans as of June 30, 2020 was as follows:

  

  

  

  

  

  

  

90+ Days

 

30 - 59 Days

60 - 89 Days

90+ Days

Total

Past Due and

 

(Dollars in thousands)

Past Due

Past Due

Past Due

Past Due

PCI

Current1

Total Loans

Accruing

 

Real estate – residential mortgage

$

537

$

285

$

880

$

1,702

$

1,814

$

201,495

$

205,011

$

291

Real estate – construction:

Construction lending

 

 

 

 

 

56,382

 

56,382

 

Consumer lot lending

 

 

 

 

 

15,712

 

15,712

 

Commercial, financial and agricultural:

Commercial real estate lending

 

232

 

 

 

232

5,452

 

415,999

 

421,683

 

Land acquisition and development lending

 

 

 

 

 

38,121

 

38,121

 

Builder line lending

 

 

 

 

 

22,172

 

22,172

 

Commercial business lending

 

 

 

 

 

200,841

 

200,841

 

Equity lines

 

47

 

 

50

 

97

76

 

52,524

 

52,697

 

Consumer

 

 

57

 

 

57

489

 

15,176

 

15,722

 

Consumer finance

 

5,096

 

705

 

369

 

6,170

 

294,479

 

300,649

 

Total

$

5,912

$

1,047

$

1,299

$

8,258

$

7,831

$

1,312,901

$

1,328,990

$

291

1For the purposes of the table above, “Current” includes loans that are 1-29 days past due.

The table above includes nonaccrual loans that are current of $649,000, 60-89 days past due of $19,000 and 90+ days past due of $1.04 million, as well as nonaccrual loans that are PCI of $427,000.

The past due status of loans as of December 31, 2019 was as follows:

  

  

  

  

  

  

  

90+ Days

 

30 - 59 Days

60 - 89 Days

90+ Days

Total

Past Due and

 

(Dollars in thousands)

Past Due

Past Due

Past Due

Past Due

PCI

Current1

Total Loans

Accruing

 

Real estate – residential mortgage

$

1,428

$

161

$

1,016

$

2,605

$

107

$

178,583

$

181,295

$

Real estate – construction:

Construction lending

 

 

 

 

 

40,943

 

40,943

 

Consumer lot lending

 

 

 

 

 

13,303

 

13,303

 

Commercial, financial and agricultural:

Commercial real estate lending

 

 

 

 

563

 

325,991

 

326,554

 

Land acquisition and development lending

 

 

 

 

 

42,891

 

42,891

 

Builder line lending

 

 

 

 

 

26,373

 

26,373

 

Commercial business lending

 

73

 

18

 

 

91

 

104,903

 

104,994

 

Equity lines

 

229

 

56

 

223

 

508

35

 

51,540

 

52,083

 

109

Consumer

 

20

 

10

 

 

30

 

13,726

 

13,756

 

Consumer finance

 

11,034

 

1,420

 

611

 

13,065

 

299,934

 

312,999

 

Total

$

12,784

$

1,665

$

1,850

$

16,299

$

705

$

1,098,187

$

1,115,191

$

109

1For the purposes of the table above, “Current” includes loans that are 1-29 days past due.

The table above includes nonaccrual loans that are current of $547,000, 30-59 days past due of $197,000, 60-89 days past due of $10,000 and 90+ days past due of $1.74 million.

There were no loan modifications during the three months ended June 30, 2020 classified as a troubled debt restructuring (TDR). There was one loan modification during the six months ended June 30, 2020 that was classified as a TDR.  This TDR was an equity line with a recorded investment of $84,000 at the time of its modification and included modifications of the loan’s payment structure. There was one loan modification during the three and six months ended June 30, 2019 that was classified as a TDR.  This TDR was a consumer loan with a recorded investment of $121,000 at the time of its modification and included a modification of the loan’s interest rate.

All TDRs are considered impaired loans and are individually evaluated in the determination of the allowance for loan losses. A TDR payment default occurs when, within 12 months of the original TDR modification, either a full or partial charge-off occurs or a TDR becomes 90 days or more past due. The specific reserve associated with a TDR is reevaluated

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when a TDR payment default occurs. There were no TDR payment defaults during the three and six months ended June 30, 2020 and 2019.

In response to the effects of the COVID-19 pandemic, including economic disruption and adverse impacts to commercial and consumer borrowers, the Bank has accommodated certain borrowers by granting short-term payment deferrals or periods of interest-only payments of up to six months in each case.  As of June 30, 2020, the Bank had provided short-term payment deferrals on 200 loans with an aggregate balance of $94.91 million. Generally, a short-term payment deferral does not result in a loan modification being classified as a TDR.  Management cannot predict the overall impact of the COVID-19 pandemic on its loan portfolio or the extent of payment deferrals or other modifications that may be granted.

Impaired loans, which included TDRs of $3.79 million, and the related allowance at June 30, 2020 were as follows:

    

    

    

    

 

Recorded

Recorded

 

Investment

Investment

Average

 

Unpaid

in Loans

in Loans

Balance-

Interest

Principal

without

with

Related

Impaired

Income

(Dollars in thousands)

Balance

Specific Reserve

Specific Reserve

Allowance

Loans

Recognized

 

Real estate – residential mortgage

$

2,892

$

1,072

$

1,677

$

69

$

2,875

$

44

Commercial, financial and agricultural:

Commercial real estate lending

 

1,401

 

 

1,401

 

72

 

1,409

 

37

Equity lines

 

121

 

113

 

 

 

120

 

1

Consumer

 

126

 

 

114

 

107

 

115

 

Total

$

4,540

$

1,185

$

3,192

$

248

$

4,519

$

82

Impaired loans, which included TDRs of $4.35 million, and the related allowance at December 31, 2019 were as follows:

    

    

    

    

 

Recorded

Recorded

 

Investment

Investment

Average

 

Unpaid

in Loans

in Loans

Balance-

Interest

Principal

without

with

Related

Impaired

Income

(Dollars in thousands)

Balance

Specific Reserve

Specific Reserve

Allowance

Loans

Recognized

 

Real estate – residential mortgage

$

3,891

$

2,192

$

1,479

$

72

$

3,506

$

155

Commercial, financial and agricultural:

Commercial real estate lending

 

1,459

 

4

 

1,447

 

77

 

1,581

 

82

Equity lines

 

31

 

31

 

 

 

32

 

2

Consumer

 

130

 

 

121

 

118

 

123

 

Total

$

5,511

$

2,227

$

3,047

$

267

$

5,242

$

239

NOTE 5: Allowance for Loan Losses

The following table presents the changes in the allowance for loan losses by major classification during the six months ended June 30, 2020:

  

Real Estate

  

  

Commercial,

  

  

  

  

 

Residential

Real Estate

Financial &

Equity

Consumer

 

(Dollars in thousands)

Mortgage

Construction

Agricultural

  Lines  

Consumer

   Finance   

   Total   

 

Allowance for loan losses:

Balance at December 31, 2019

$

2,080

$

681

$

7,121

$

733

$

465

$

21,793

$

32,873

Provision charged to operations

285

302

1,724

56

33

3,850

6,250

Loans charged off

(4)

(18)

(133)

(5,422)

(5,577)

Recoveries of loans previously charged off

64

2

105

2,377

2,548

Balance at June 30, 2020

$

2,425

$

983

$

8,829

$

789

$

470

$

22,598

$

36,094

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The following table presents the changes in the allowance for loan losses by major classification during the six months ended June 30, 2019:

  

Real Estate

  

  

Commercial,

  

  

  

  

 

Residential

Real Estate

Financial &

Equity

Consumer

 

(Dollars in thousands)

Mortgage

Construction

Agricultural

  Lines  

Consumer

   Finance   

   Total   

 

Allowance for loan losses:

Balance at December 31, 2018

$

2,246

$

727

$

6,688

$

1,106

$

257

$

22,999

$

34,023

Provision (credited) charged to operations

(68)

23

218

(225)

162

4,095

4,205

Loans charged off

(45)

(29)

(162)

(6,966)

(7,202)

Recoveries of loans previously charged off

9

3

115

2,248

2,375

Balance at June 30, 2019

$

2,142

$

750

$

6,880

$

881

$

372

$

22,376

$

33,401

The following table presents, as of June 30, 2020, the balance of the allowance for loan losses and the balance of loans by impairment methodology.

  

Real Estate

  

  

Commercial,

  

  

  

  

 

Residential

Real Estate

Financial &

Equity

Consumer

 

(Dollars in thousands)

Mortgage

Construction

Agricultural

Lines

Consumer

Finance

Total

 

Allowance balance attributable to loans:

Individually evaluated for impairment

$

69

$

$

72

$

$

107

$

$

248

Collectively evaluated for impairment

2,356

983

8,757

789

363

22,598

35,846

Acquired loans - PCI

Total allowance

$

2,425

$

983

$

8,829

$

789

$

470

$

22,598

$

36,094

Loans:

Individually evaluated for impairment

$

2,749

$

$

1,401

$

113

$

114

$

$

4,377

Collectively evaluated for impairment

200,448

72,094

675,964

52,508

15,119

300,649

1,316,782

Acquired loans - PCI

1,814

5,452

76

489

7,831

Total loans

$

205,011

$

72,094

$

682,817

$

52,697

$

15,722

$

300,649

$

1,328,990

The following table presents, as of December 31, 2019, the balance of the allowance for loan losses, the allowance by impairment methodology, total loans and loans by impairment methodology.

  

Real Estate

  

  

Commercial,

  

  

  

  

 

Residential

Real Estate

Financial &

Equity

Consumer

 

(Dollars in thousands)

Mortgage

Construction

Agricultural

Lines

Consumer

Finance

Total

 

Allowance balance attributable to loans:

Individually evaluated for impairment

$

72

$

$

77

$

$

118

$

$

267

Collectively evaluated for impairment

2,008

681

7,044

733

347

21,793

32,606

Acquired loans - PCI

Total allowance

$

2,080

$

681

$

7,121

$

733

$

465

$

21,793

$

32,873

Loans:

Individually evaluated for impairment

$

3,671

$

$

1,451

$

31

$

121

$

$

5,274

Collectively evaluated for impairment

177,517

54,246

498,798

52,017

13,635

312,999

1,109,212

Acquired loans - PCI

107

563

35

705

Total loans

$

181,295

$

54,246

$

500,812

$

52,083

$

13,756

$

312,999

$

1,115,191

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Loans by credit quality indicators as of June 30, 2020 were as follows:

 

   

Special

   

   

Substandard

   

 

(Dollars in thousands)

Pass

 Mention 

Substandard

Nonaccrual

Total1

 

Real estate – residential mortgage

$

201,678

$

1,511

$

842

$

980

$

205,011

Real estate – construction:

Construction lending

 

56,382

 

 

 

 

56,382

Consumer lot lending

 

15,712

 

 

 

 

15,712

Commercial, financial and agricultural:

Commercial real estate lending

 

393,105

 

26,125

 

2,453

 

 

421,683

Land acquisition and development lending

 

30,575

 

7,546

 

 

 

38,121

Builder line lending

 

22,172

 

 

 

 

22,172

Commercial business lending

 

196,755

 

4,086

 

 

 

200,841

Equity lines

 

52,340

 

105

 

8

 

244

 

52,697

Consumer

 

15,119

 

61

 

 

542

 

15,722

$

983,838

$

39,434

$

3,303

$

1,766

$

1,028,341

1At June 30, 2020, the Corporation did not have any loans classified as Doubtful or Loss.

Included in the table above are loans purchased in connection with the acquisition of Peoples of $93.84 million pass rated, $1.77 million special mention, $2.91 million substandard and $427,000 substandard nonaccrual.

Non-

(Dollars in thousands)

   

Performing

   

Performing

   

Total

 

Consumer finance

$

300,280

$

369

$

300,649

Loans by credit quality indicators as of December 31, 2019 were as follows:

  

   

Special

   

   

Substandard

   

 

(Dollars in thousands)

Pass

 Mention 

Substandard

Nonaccrual

Total1

 

Real estate – residential mortgage

$

177,049

$

1,839

$

881

$

1,526

$

181,295

Real estate – construction:

Construction lending

 

40,943

 

 

 

 

40,943

Consumer lot lending

 

13,303

 

 

 

 

13,303

Commercial, financial and agricultural:

Commercial real estate lending

 

323,218

 

3,266

 

70

 

 

326,554

Land acquisition and development lending

 

33,870

 

9,021

 

 

 

42,891

Builder line lending

 

25,995

 

378

 

 

 

26,373

Commercial business lending

 

104,291

 

692

 

 

11

 

104,994

Equity lines

 

51,662

 

181

 

11

 

229

 

52,083

Consumer

 

13,632

 

6

 

 

118

 

13,756

$

783,963

$

15,383

$

962

$

1,884

$

802,192

1At December 31, 2019, the Corporation did not have any loans classified as Doubtful or Loss.

Non-

(Dollars in thousands)

   

Performing

   

Performing

   

Total

 

Consumer finance

$

312,388

$

611

$

312,999

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NOTE 6: Goodwill and Other Intangible Assets

The carrying amount of goodwill was $25.19 million and $14.43 million at June 30, 2020 and December 31, 2019, respectively. The following table presents the changes in goodwill during the six months ended June 30, 2020.  There were no changes in the recorded balance of goodwill during the three and six months ended June 30, 2019.

Community

Consumer

 

(Dollars in thousands)

    

Banking

    

Finance

 

Total

Balance as of January 1, 2020

$

3,702

$

10,723

$

14,425

Acquisition of Peoples Bankshares, Incorporated

10,766

10,766

Balance at June 30, 2020

$

14,468

$

10,723

$

25,191

The Corporation had $2.46 million and $912,000 of other intangible assets as of June 30, 2020 and December 31, 2019, respectively.  Other intangible assets were recognized in connection with the core deposits acquired from Peoples in 2020 and customer relationships acquired by C&F Wealth Management in 2016.  

The following table summarizes the gross carrying amounts and accumulated amortization of other intangible assets:

June 30, 

December 31, 

2020

2019

Gross

Gross

Carrying

Accumulated

Carrying

Accumulated

(Dollars in thousands)

Amount

Amortization

Amount

Amortization

Amortized intangible assets:

Core deposit intangibles

$

1,711

$

(86)

$

$

Other intangibles

 

1,405

(573)

1,405

(493)

Total

$

3,116

$

(659)

$

1,405

$

(493)

Amortization expense was $83,000 and $63,000 for the three months ended June 30, 2020 and 2019, respectively and $166,000 and $141,000 for the six months ended June 30, 2020 and 2019, respectively.

NOTE 7: Equity, Other Comprehensive Income and Earnings Per Share

Equity and Noncontrolling Interest

During the six months ended June 30, 2020, the Corporation repurchased 8,963 shares of its common stock for an aggregate cost of $355,000 under share repurchase programs authorized by its Board of Directors. During the three and six months ended June 30, 2019, the Corporation repurchased 32,779 and 65,186 shares of its common stock, respectively, for an aggregate cost of $1.62 million and $3.29 million under the share repurchase programs.  The Corporation did not repurchase any of its common stock during the three months ended June 30, 2020.  Additionally during the six months ended June 30, 2020 and 2019, the Corporation withheld 5,069 shares and 4,842 shares of its common stock, respectively, from employees to satisfy tax withholding obligations upon vesting of restricted stock.  The Corporation’s current share repurchase program expired on May 31, 2020 and has not been renewed or extended at this time.

In the first quarter of 2019, C&F Select LLC, a subsidiary of C&F Mortgage, issued a 49 percent ownership interest to an unrelated investor. In exchange for this noncontrolling interest in C&F Select LLC, C&F Bank received a note receivable from the investor for $490,000, which is included in loans in the Consolidated Balance Sheets and is secured by cash deposits at C&F Bank.

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Accumulated Other Comprehensive Loss, Net

The following table presents the cumulative balances of the components of accumulated other comprehensive loss, net of deferred taxes of $303,000 and $604,000 as of June 30, 2020 and December 31, 2019, respectively.

June 30, 

December 31, 

 

(Dollars in thousands)

    

2020

    

2019

 

Net unrealized gains on securities

$

4,705

$

1,560

Net unrecognized losses on cash flow hedges

 

(1,654)

 

(69)

Net unrecognized losses on defined benefit plan

 

(3,689)

 

(3,740)

Total accumulated other comprehensive loss, net

$

(638)

$

(2,249)

Earnings Per Share (EPS)

The components of the Corporation’s EPS calculations are as follows:

Three Months Ended June 30, 

 

(Dollars in thousands)

    

2020

    

2019

 

Net income attributable to C&F Financial Corporation

$

3,746

$

5,843

Weighted average shares outstandingbasic and diluted

 

3,647,707

 

3,463,277

Six Months Ended June 30, 

 

(Dollars in thousands)

  

2020

    

2019

 

Net income attributable to C&F Financial Corporation

$

7,324

$

9,614

Weighted average shares outstandingbasic and diluted

 

3,646,161

 

3,473,875

The Corporation has applied the two-class method of computing basic and diluted EPS for each period presented because the Corporation’s unvested restricted shares outstanding contain rights to nonforfeitable dividends equal to dividends on the Corporation’s common stock.  Accordingly, the weighted average number of shares used in the calculation of basic and diluted EPS includes both vested and unvested shares outstanding.

NOTE 8: Employee Benefit Plans

The following table summarizes the components of net periodic benefit cost for the Bank’s non-contributory cash balance pension plan.

Three Months Ended June 30, 

Six Months Ended June 30, 

(Dollars in thousands)

    

2020

    

2019

    

2020

    

2019

    

Components of net periodic benefit cost:

Service cost, included in salaries and employee benefits

$

415

$

316

$

801

$

609

Other components of net periodic benefit cost:

Interest cost

 

140

 

151

 

275

 

304

Expected return on plan assets

 

(371)

 

(319)

 

(745)

 

(649)

Amortization of prior service credit

 

(17)

 

(17)

 

(34)

 

(34)

Amortization of net obligation at transition

 

 

 

 

Recognized net actuarial losses

 

57

 

52

 

99

 

94

Other components of net periodic benefit cost, included in other noninterest income

(191)

(133)

(405)

(285)

Net periodic benefit cost

$

224

$

183

$

396

$

324

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NOTE 9: Fair Value of Assets and Liabilities

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

 

Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt securities traded in an active exchange market, as well as U.S. Treasury securities.

 

Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3—Valuation is determined using model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect the Corporation’s estimates of assumptions that market participants would use in pricing the respective asset or liability. Valuation techniques may include the use of pricing models, discounted cash flow models and similar techniques.

 

U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.  The Corporation has elected to use fair value accounting for its entire portfolio of loans held for sale (LHFS).

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The following describes the valuation techniques and inputs used by the Corporation in determining the fair value of certain assets recorded at fair value on a recurring basis in the financial statements.

 

Securities available for sale. The Corporation primarily values its investment portfolio using Level 2 fair value measurements, but may also use Level 1 or Level 3 measurements if required by the composition of the portfolio. At June 30, 2020 and December 31, 2019, the Corporation’s entire investment securities portfolio was comprised of securities available for sale, which were valued using Level 2 fair value measurements. The Corporation has contracted with third party portfolio accounting service vendors for valuation of its securities portfolio. The vendors’ sources for security valuation are ICE Data Services (ICE) and Thomson Reuters Pricing Service (TRPS).  Each source provides opinions, known as evaluated prices, as to the value of individual securities based on model-based pricing techniques that are partially based on available market data, including prices for similar instruments in active markets and prices for identical assets in markets that are not active. ICE provides evaluated prices for the Corporation’s obligations of states and political subdivisions category of securities.  ICE uses proprietary pricing models and pricing systems, mathematical tools and judgment to determine an evaluated price for a security based upon a hierarchy of market information regarding that security or securities with similar characteristics.  TRPS provides evaluated prices for the Corporation’s U.S. government agencies and corporations and mortgage-backed categories of securities.  Fixed-rate callable securities of the U.S. government agencies and corporations category are individually evaluated on an option adjusted spread basis for callable issues or on a nominal spread basis incorporating the term structure of agency market spreads and the appropriate risk free benchmark curve for non-callable issues.  Pass-through mortgage-backed securities (MBS) in the mortgage-backed category are grouped into aggregate categories defined by issuer program, weighted average coupon, and weighted average maturity.  Each aggregate is benchmarked to relative to-be-announced mortgage-backed securities (TBA securities) or other benchmark prices. TBA securities prices are obtained from market makers and live trading systems. Collateralized mortgage obligations in the mortgage-backed category are individually evaluated based upon a hierarchy of security specific information and market data regarding that security or securities with similar characteristics.  Each evaluation is determined using an option adjusted spread and prepayment model based on volatility-driven, multi-dimensional spread tables. Fixed-rate securities issued by the Small Business Association in the mortgage backed category are individually

25

Table of Contents

evaluated based upon a hierarchy of security specific information and market data regarding that security or securities with similar characteristics.

Investments in small business investment company funds. The Corporation holds an investment in a small business investment company fund, which is recorded at fair value and included in other assets in the Consolidated Balance Sheets.  Changes in fair value are recognized in net income.  At June 30, 2020, the fair value of the Corporation’s investment in small business investment companies, based on net asset value, was $1.43 million.  Investments in small business investment company funds measured at net asset value are not presented in the tables below related to fair value measurements. Changes in fair value of small business investment company funds resulted in the recognition of unrealized losses of $124,000 for the three and six months ended June 30, 2020.

  

Loans held for sale. Fair value of the Corporation’s LHFS is based on observable market prices for similar instruments traded in the secondary mortgage loan markets in which the Corporation conducts business. The Corporation’s portfolio of LHFS is classified as Level 2.

Derivative asset - IRLCs. The Corporation recognizes IRLCs at fair value. Fair value of IRLCs is based on either (i) the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis or (ii) the observable price for individual loans traded in the secondary market for loans that will be delivered on a mandatory basis. All of the Corporation’s IRLCs are classified as Level 2.

Derivative asset/liability – interest rate swaps on loans. The Corporation recognizes interest rate swaps at fair value.  The Corporation has contracted with a third party vendor to provide valuations for these interest rate swaps using standard valuation techniques. All of the Corporation’s interest rate swaps on loans are classified as Level 2.

Derivative asset/liability – cash flow hedges. The Corporation recognizes cash flow hedges at fair value. The fair value of the Corporation’s cash flow hedges is determined using the discounted cash flow method.  All of the Corporation’s cash flow hedges are classified as Level 2.

Derivative asset/liability – forward sales of TBA securities. The Corporation recognizes forward sales of TBA securities at fair value. The fair value of forward sales of TBA securities is based on prices obtained from market makers and live trading systems for TBA securities of similar issuer programs, coupons and maturities. All of the Corporation’s forward sales of TBA securities are classified as Level 2.

26

Table of Contents

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis.

June 30, 2020

 

Fair Value Measurements Using

Assets/Liabilities at

 

(Dollars in thousands)

  

Level 1

    

Level 2

    

Level 3

    

 Fair Value 

 

Assets:

Securities available for sale

U.S. government agencies and corporations

$

$

37,205

$

$

37,205

Mortgage-backed securities

 

 

106,249

 

 

106,249

Obligations of states and political subdivisions

 

 

103,679

 

 

103,679

Total securities available for sale

 

 

247,133

 

 

247,133

Loans held for sale

 

 

180,137

 

 

180,137

Derivatives

IRLC

 

 

3,701

 

 

3,701

Interest rate swaps on loans

9,743

9,743

Total assets

$

$

440,714

$

$

440,714

Liabilities:

Derivatives

Interest rate swaps on loans

$

$

9,743

$

$

9,743

Cash flow hedges

2,273

2,273

Forward sales of TBA securities

93

93

Total liabilities

$

$

12,109

$

$

12,109

December 31, 2019

 

Fair Value Measurements Using

Assets/Liabilities at

 

(Dollars in thousands)

  

Level 1

    

Level 2

    

Level 3

    

 Fair Value 

 

Assets:

Securities available for sale

U.S. government agencies and corporations

$

$

21,440

$

$

21,440

Mortgage-backed securities

 

 

86,585

 

 

86,585

Obligations of states and political subdivisions

 

 

81,708

 

 

81,708

Total securities available for sale

 

 

189,733

 

 

189,733

Loans held for sale

 

 

90,500

 

 

90,500

Derivatives

IRLC

 

 

1,083

 

 

1,083

Interest rate swaps on loans

 

 

2,462

 

 

2,462

Total assets

$

$

283,778

$

$

283,778

Liabilities:

Derivatives

Interest rate swaps on loans

$

$

2,462

$

$

2,462

Cash flow hedges

145

145

Forward sales of TBA securities

25

25

Total liabilities

$

$

2,632

$

$

2,632

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Corporation may be required, from time to time, to measure and recognize certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. The following describes the valuation techniques and inputs used by the Corporation in determining the fair value of certain assets recorded at fair value on a nonrecurring basis in the financial statements.

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Table of Contents

Impaired loans. The Corporation does not record loans held for investment at fair value on a recurring basis. However, there are instances when a loan is considered impaired and an allowance for loan losses is established. The Corporation measures impairment either based on the fair value of the loan using the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent, or using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. The Corporation maintains a valuation allowance to the extent that this measure of the impaired loan is less than the recorded investment in the loan. When an impaired loan is measured at fair value based solely on observable market prices or a current appraisal without further adjustment for unobservable inputs, the Corporation records the impaired loan as a nonrecurring fair value measurement classified as Level 2. However, if based on management’s review, additional discounts to observed market prices or appraisals are required or if observable inputs are not available, the Corporation records the impaired loan as a nonrecurring fair value measurement classified as Level 3.

Impaired loans that are measured based on expected future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest, are not recorded at fair value and are therefore excluded from fair value disclosure requirements.

OREO. Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure. Initial fair value is based upon appraisals the Corporation obtains from independent licensed appraisers. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of similar properties, length of time the properties have been held, and our ability and intent with regard to continued ownership of the properties. The Corporation may incur additional write-downs of foreclosed assets to fair value less estimated costs to sell if valuations indicate a further deterioration in market conditions. As such, the Corporation records OREO as a nonrecurring fair value measurement classified as Level 3.

The following table presents the balances of assets measured at fair value on a nonrecurring basis. At June 30, 2020 there were no impaired loans that were measured at fair value.

June 30, 2020

 

Fair Value Measurements Using

Assets at Fair

 

(Dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Value

 

Other real estate owned, net

$

$

$

268

$

268

Total

$

$

$

268

$

268

    

December 31, 2019

 

Fair Value Measurements Using

Assets at Fair

 

(Dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Value

 

Impaired loans, net

$

$

$

102

$

102

Other real estate owned, net

 

 

 

268

 

268

Total

$

$

$

370

$

370

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The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a nonrecurring basis:

Fair Value Measurements at June 30, 2020

 

(Dollars in thousands)

    

Fair Value

    

Valuation Technique(s)

    

Unobservable Inputs

    

Range (Weighted Average)1

 

Other real estate owned, net

$

268

 

Appraisals

 

Discount to reflect current market conditions and estimated selling costs

 

33%-75% (45%)

Total

$

268

1The weighted average of unobservable inputs is calculated based on the relative asset fair values.

Fair Value of Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation. The Corporation uses the exit price notion in calculating the fair values of financial instruments not measured at fair value on a recurring basis.

The following tables reflect the carrying amounts and estimated fair values of the Corporation’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.

  

Carrying

  

   Fair Value Measurements at June 30, 2020 Using   

  

 Total Fair 

 

(Dollars in thousands)

      Value      

Level 1

Level 2

Level 3

      Value      

 

Financial assets:

Cash and short-term investments

$

80,300

$

80,300

$

$

$

80,300

Securities available for sale

 

247,133

 

247,133

 

247,133

Loans, net

 

1,292,896

 

 

 

1,299,598

 

1,299,598

Loans held for sale

 

180,137

 

 

180,137

 

 

180,137

Derivatives

IRLC

3,701

3,701

3,701

Interest rate swaps on loans

9,743

9,743

9,743

Bank-owned life insurance

19,862

19,862

19,862

Accrued interest receivable

 

8,104

 

8,104

 

 

 

8,104

Financial liabilities:

Demand deposits

1,153,248

1,153,248

1,153,248

Time deposits

 

492,541

 

 

501,932

 

 

501,932

Borrowings

 

91,336

 

 

92,667

 

 

92,667

Derivatives

Cash flow hedges

 

2,273

 

2,273

 

2,273

Interest rate swaps on loans

9,743

9,743

9,743

Forward sales of TBA securities

93

93

93

Accrued interest payable

 

1,210

 

1,210

 

 

 

1,210

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 Carrying 

  

Fair Value Measurements at December 31, 2019 Using

  

 Total Fair 

 

(Dollars in thousands)

      Value      

Level 1

Level 2

Level 3

      Value      

 

Financial assets:

Cash and short-term investments

$

165,433

$

165,433

$

$

$

165,433

Securities available for sale

 

189,733

 

189,733

 

189,733

Loans, net

 

1,082,318

 

 

 

1,082,783

 

1,082,783

Loans held for sale

 

90,500

 

 

90,500

 

 

90,500

Derivatives

IRLC

1,083

1,083

1,083

Interest rate swaps on loans

2,462

2,462

2,462

Bank-owned life insurance

16,044

16,044

16,044

Accrued interest receivable

 

6,776

 

6,776

 

 

 

6,776

Financial liabilities:

Demand deposits

869,194

869,194

869,194

Time deposits

 

422,056

 

 

423,605

 

 

423,605

Borrowings

 

161,170

 

 

154,964

 

 

154,964

Derivatives

Cash flow hedges

 

145

 

145

 

145

Interest rate swaps on loans

2,462

2,462

2,462

Forward sales of TBA securities

25

25

25

Accrued interest payable

 

1,291

 

1,291

 

 

 

1,291

 

NOTE 10: Business Segments

The Corporation operates in a decentralized fashion in three principal business segments: community banking, mortgage banking and consumer finance. Revenues from community banking operations consist primarily of interest earned on loans and investment securities and fees earned on deposit accounts and debit card interchange activity. Previously, the community banking segment was referred to as the retail banking segment. Mortgage banking operating revenues consist principally of gains on sales of loans in the secondary market, mortgage banking fee income related to loan originations, and interest earned on mortgage loans held for sale. Revenues from consumer finance consist primarily of interest earned on purchased retail installment sales contracts.

C&F Wealth Management derives revenues from offering wealth management services and insurance products through third-party service providers.  The Corporation’s revenues and expenses are comprised primarily of interest expense associated with the Corporation’s trust preferred capital notes, general corporate expenses, and changes in the value of the rabbi trust and deferred compensation liability related to its nonqualified deferred compensation plan.  The results of C&F Wealth Management and the Corporation are not significant to the Corporation on a consolidated basis and are included in “Other.”

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Three Months Ended June 30, 2020

 

    

Community

    

Mortgage

    

Consumer

    

    

    

 

(Dollars in thousands)

Banking

Banking

Finance

Other

Eliminations

Consolidated

 

Revenues:

Interest income

$

14,894

$

1,097

$

9,689

$

$

(2,096)

$

23,584

Gains on sales of loans

 

 

4,605

 

 

 

 

4,605

Other noninterest income

 

2,221

 

2,387

 

80

 

2,535

 

 

7,223

Total operating income

 

17,115

 

8,089

 

9,769

 

2,535

 

(2,096)

 

35,412

Expenses:

Provision for loan losses

 

1,400

 

 

2,200

 

 

 

3,600

Interest expense

 

2,718

 

280

 

2,090

 

338

 

(2,096)

 

3,330

Salaries and employee benefits

 

7,640

 

2,272

 

2,134

 

2,308

 

 

14,354

Depreciation and amortization

829

73

45

43

990

Other noninterest expenses

 

5,020

 

2,166

 

1,057

 

205

 

 

8,448

Total operating expenses

 

17,607

 

4,791

 

7,526

 

2,894

 

(2,096)

 

30,722

Income (loss) before income taxes

 

(492)

 

3,298

 

2,243

 

(359)

 

 

4,690

Income tax expense (benefit)

 

(560)

 

977

 

605

 

(75)

 

 

947

Net income (loss)

$

68

$

2,321

$

1,638

$

(284)

$

$

3,743

Total assets

$

1,860,367

$

192,987

$

301,372

$

21,834

$

(393,356)

$

1,983,204

Capital expenditures

$

1,568

$

32

$

305

$

$

$

1,905

Three Months Ended June 30, 2019

 

    

Community

    

Mortgage

    

Consumer

    

    

    

 

(Dollars in thousands)

Banking

Banking

Finance

Other

Eliminations

Consolidated

 

Revenues:

Interest income

$

15,419

$

669

$

10,365

$

2

$

(2,179)

$

24,276

Gains on sales of loans

 

 

2,955

 

 

 

 

2,955

Other noninterest income

 

2,893

 

1,335

 

110

 

909

 

 

5,247

Total operating income

 

18,312

 

4,959

 

10,475

 

911

 

(2,179)

 

32,478

Expenses:

Provision for loan losses

 

110

 

 

1,700

 

 

 

1,810

Interest expense

 

2,493

 

409

 

2,618

 

310

 

(2,179)

 

3,651

Salaries and employee benefits

 

6,873

 

1,611

 

2,069

 

942

 

 

11,495

Depreciation and amortization

758

59

50

(35)

832

Other noninterest expenses

 

4,382

 

1,276

 

1,361

 

203

 

 

7,222

Total operating expenses

 

14,616

 

3,355

 

7,798

 

1,420

 

(2,179)

 

25,010

Income (loss) before income taxes

 

3,696

 

1,604

 

2,677

 

(509)

 

 

7,468

Income tax expense (benefit)

 

625

 

422

 

728

 

(149)

 

 

1,626

Net income (loss)

$

3,071

$

1,182

$

1,949

$

(360)

$

$

5,842

Total assets

$

1,386,332

$

101,554

$

309,705

$

19,696

$

(249,291)

$

1,567,996

Capital expenditures

$

566

$

52

$

32

$

67

$

$

717

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Six Months Ended June 30, 2020

 

    

Community

    

Mortgage

    

Consumer

    

    

    

 

(Dollars in thousands)

Banking

Banking

Finance

Other

Eliminations

Consolidated

 

Revenues:

Interest income

$

30,809

$

1,758

$

19,790

$

$

(3,995)

$

48,362

Gains on sales of loans

 

8,281

 

 

 

 

8,281

Other noninterest income

 

4,853

 

3,998

 

197

 

1,247

 

 

10,295

Total operating income

 

35,662

 

14,037

 

19,987

 

1,247

 

(3,995)

 

66,938

Expenses:

Provision for loan losses

 

2,400

 

3,850

 

6,250

Interest expense

 

5,862

 

585

4,376

677

(3,995)

 

7,505

Salaries and employee benefits

 

15,700

 

4,117

4,377

977

 

25,171

Depreciation and amortization

1,635

145

91

86

1,957

Other noninterest expenses

 

10,020

 

3,817

2,398

514

 

16,749

Total operating expenses

 

35,617

 

8,664

 

15,092

 

2,254

 

(3,995)

 

57,632

Income (loss) before income taxes

 

45

 

5,373

 

4,895

 

(1,007)

 

 

9,306

Income tax expense (benefit)

 

(593)

 

1,509

1,327

(319)

 

 

1,924

Net income (loss)

$

638

$

3,864

$

3,568

$

(688)

$

$

7,382

Total assets

$

1,860,367

$

192,987

$

301,372

$

21,834

$

(393,356)

$

1,983,204

Capital expenditures

$

2,320

$

326

$

807

$

$

$

3,453

Six Months Ended June 30, 2019

 

    

Community

    

Mortgage

    

Consumer

    

    

    

 

(Dollars in thousands)

Banking

Banking

Finance

Other

Eliminations

Consolidated

 

Revenues:

Interest income

$

29,743

$

1,019

$

20,510

$

4

$

(4,049)

$

47,227

Gains on sales of loans

 

 

5,091

 

 

 

 

5,091

Other noninterest income

 

5,331

 

2,173

 

239

 

2,471

 

 

10,214

Total operating income

 

35,074

 

8,283

 

20,749

 

2,475

 

(4,049)

 

62,532

Expenses:

Provision for loan losses

 

110

 

 

4,095

 

 

 

4,205

Interest expense

 

4,668

 

572

 

5,169

 

595

 

(4,049)

 

6,955

Salaries and employee benefits

 

13,851

 

2,758

 

4,254

 

2,539

 

 

23,402

Depreciation and amortization

1,593

121

102

10

1,826

Other noninterest expenses

 

8,450

 

2,458

 

2,684

 

406

 

 

13,998

Total operating expenses

 

28,672

 

5,909

 

16,304

 

3,550

 

(4,049)

 

50,386

Income (loss) before income taxes

 

6,402

 

2,374

 

4,445

 

(1,075)

 

 

12,146

Income tax expense (benefit)

 

1,041

 

625

 

1,211

 

(344)

 

 

2,533

Net income (loss)

$

5,361

$

1,749

$

3,234

$

(731)

$

$

9,613

Total assets

$

1,386,332

$

101,554

$

309,705

$

19,696

$

(249,291)

$

1,567,996

Capital expenditures

$

1,288

$

76

$

40

$

67

$

$

1,471

During the three months ended June 30, 2020, the Corporation recorded merger related expenses of $439,000 ($347,000 after income taxes), in connection with its acquisition of Peoples, all of which was allocated to the community banking segment and recorded as $50,000 of salaries and benefits expense and $389,000 of other noninterest expense.  During the six months ended June 30, 2020, the Corporation recorded merger related expenses of $1.40 million ($1.13 million after income taxes), in connection with its acquisition of Peoples, of which $1.30 million ($1.03 million after income taxes) was allocated to the community banking segment and recorded as $119,000 of salaries and benefits expense, $879,000 of other noninterest expense and a loss on disposal of equipment of $298,000 included in other noninterest income.  The remainder was recorded as other noninterest expense at the holding company.

The community banking segment extends two warehouse lines of credit to the mortgage banking segment, providing a portion of the funds needed to originate mortgage loans. The community banking segment charges the mortgage banking segment interest at the daily FHLB advance rate plus a spread ranging from 50 basis points to 175 basis points. The community banking segment also provides the consumer finance segment with a portion of the funds needed to purchase

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loan contracts by means of variable rate notes that carry interest at one-month LIBOR plus 200 basis points, with a floor of 3.5 percent and fixed rate notes that carry interest at rates ranging from 2.0 percent to 8.0 percent. The community banking segment acquires certain residential real estate loans from the mortgage banking segment at prices similar to those paid by third-party investors. These transactions are eliminated to reach consolidated totals. Certain corporate overhead costs incurred by the community banking segment are not allocated to the mortgage banking, consumer finance and other segments.

 

NOTE 11: Commitments and Contingent Liabilities

The Corporation enters into commitments to extend credit in the normal course of business to meet the financing needs of its customers, including loan commitments and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amounts recorded on the Consolidated Balance Sheets. The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  Collateral is obtained based on management’s credit assessment of the customer.

Loan commitments are agreements to extend credit to a customer provided that there are no violations of the terms of the contract prior to funding. Commitments have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of loan commitments at the Bank was $303.92 million at June 30, 2020 and $256.15 million at December 31, 2019, which does not include IRLCs at the mortgage banking segment, which are discussed in Note 12.

Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The total contract amount of standby letters of credit, whose contract amounts represent credit risk, was $17.18 million at June 30, 2020 and $16.60 million at December 31, 2019.

The mortgage banking segment sells substantially all of the residential mortgage loans it originates to third-party investors. As is customary in the industry, the agreements with these investors require the mortgage banking segment to extend representations and warranties with respect to program compliance, borrower misrepresentation, fraud, and early payment performance. Under the agreements, the investors are entitled to make loss claims and repurchase requests of the mortgage banking segment for loans that contain covered deficiencies. The mortgage banking segment has obtained early payment default recourse waivers for a significant portion of its business. Recourse periods for early payment default for the remaining investors vary from 90 days up to one year. Recourse periods for borrower misrepresentation or fraud, or underwriting error do not have a stated time limit. The mortgage banking segment maintains an allowance for indemnifications that represents management’s estimate of losses that are probable of arising under these recourse provisions. As performance data for loans that have been sold is not made available to the mortgage banking segment by the investors, the evaluation of potential losses is inherently subjective.  A schedule of expected losses on loans with claims or indemnifications is maintained to ensure the reserve is adequate to cover estimated losses. For the three and six months ended June 30, 2020, the Corporation recorded $156,000 and $163,000 of provision for indemnifications, compared to no provision for indemnifications for the three and six months ended June 30, 2019, respectively. The allowance for indemnifications was $2.64 million at June 30, 2020 and $2.48 million at December 31, 2019.

 

NOTE 12: Derivative Financial Instruments

The Corporation uses derivative financial instruments primarily to manage risks to the Corporation associated with changing interest rates, and to assist customers with their risk management objectives. The Corporation designates certain interest rate swaps as hedging instruments in qualifying cash flow hedges.  The changes in fair value of these designated hedging instruments is reported as a component of other comprehensive income.  Derivative contracts that are not designated in a qualifying hedging relationship include customer accommodation loan swaps and contracts related to mortgage banking activities.

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Table of Contents

Cash flow hedges.  The Corporation designates interest rate swaps as cash flow hedges when they are used to manage exposure to variability in cash flows on variable rate borrowings such as the Corporation’s trust preferred capital notes. These interest rate swaps are derivative financial instruments that manage the risk of variability in cash flows by exchanging variable-rate interest payments on a notional amount of the Corporation’s borrowings for fixed-rate interest payments.  Interest rate swaps designated as cash flow hedges are expected to be highly effective in offsetting the effect of changes in interest rates on the amount of variable-rate interest payments, and the Corporation assesses the effectiveness of each hedging relationship quarterly. If the Corporation determines that a cash flow hedge is no longer highly effective, future changes in the fair value of the hedging instrument would be reported in earnings. As of June 30, 2020, the Corporation has designated cash flow hedges to manage its exposure to variability in cash flows on certain variable rate borrowings for periods that end between June 2024 and June 2029.

 

All interest rate swaps were entered into with counterparties that met the Corporation’s credit standards and the agreements contain collateral provisions protecting the at-risk party. The Corporation believes that the credit risk inherent in these derivative contracts is not significant.

Unrealized gains or losses recorded in other comprehensive income related to cash flow hedges are reclassified into earnings in the same period(s) during which the hedged interest payments affect earnings. When a designated hedging instrument is terminated and the hedged interest payments remain probable of occurring, any remaining unrecognized gain or loss in other comprehensive income is reclassified into earnings in the period(s) during which the forecasted interest payments affect earnings.  Amounts reclassified into earnings and interest receivable or payable under designated interest rate swaps are reported in interest expense.  The Corporation does not expect any unrealized losses related to cash flow hedges to be reclassified into earnings in the next twelve months.  

Loan swaps.  The Bank also enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and offsetting terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Corporation receives a floating rate. These back-to-back loan swaps are derivative financial instruments and are reported at fair value in “other assets” and “other liabilities” in the Consolidated Balance Sheets.  Changes in the fair value of loan swaps are recorded in other noninterest expense and sum to zero because of the offsetting terms of swaps with borrowers and swaps with dealer counterparties.

Mortgage banking.  The mortgage banking segment enters into IRLCs with customers to originate loans for which the interest rates are determined (or “locked”) prior to funding. The mortgage banking segment is exposed to interest rate risk through fixed-rate IRLCs and mortgage loans from the time that interest rates are locked until the loans are sold in the secondary market. The mortgage banking segment mitigates this interest rate risk by either (1) entering into forward sales contracts with investors at the time that interest rates are locked for mortgage loans to be delivered on a best efforts basis or (2) entering into forward sales contracts for TBA securities until it can enter into forward sales contracts with investors for mortgage loans to be delivered on a mandatory basis. IRLCs, forward sales of loans and forward sales of TBA securities are derivative financial instruments and are reported at fair value in other assets and other liabilities in the Consolidated Balance Sheets.  Changes in the fair value of mortgage banking derivatives are recorded as a component of gains on sales of loans.

At June 30, 2020, the mortgage banking segment had $232.97 million of IRLCs and $166.01 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using best-efforts forward sales contracts for $398.98 million in mortgage loans.  Also at June 30, 2020, the mortgage banking segment had $14.90 million of IRLCs and $8.84 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using forward sales of $20.75 million of TBA securities and mandatory-delivery forward sales contracts for $1.60 million in mortgage loans.  

At December 31, 2019, the mortgage banking segment had $63.35 million of IRLCs and $65.77 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using best-efforts forward sales contracts for $129.12 million in mortgage loans.  Also at December 31, 2019, the mortgage banking segment had $11.72 million of IRLCs and $21.98 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using forward

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sales of $24.0 million of TBA securities and mandatory-delivery forward sales contracts for $6.73 million in mortgage loans.

The following tables summarize key elements of the Corporation’s derivative instruments other than forward sales of mortgage loans.  The fair values of forward sales of mortgage loans were not material to the consolidated financial statements of the Corporation at June 30, 2020 or December 31, 2019.

June 30, 2020

 

    

Notional

    

    

    

 

(Dollars in thousands)

Amount

Assets

Liabilities

 

Cash flow hedges:

Interest rate swap contracts

$

25,000

$

$

2,273

Not designated as hedges:

 

 

 

Customer-related interest rate swap contracts:

 

 

 

Matched interest rate swaps with borrower

 

85,282

 

9,743

 

Matched interest rate swaps with counterparty

85,282

9,743

Mortgage banking contracts:

IRLCs

247,871

3,701

Forward sales of TBA securities

 

20,750

 

 

93

December 31, 2019

    

Notional

    

    

    

(Dollars in thousands)

Amount

Assets

Liabilities

Cash flow hedges:

Interest rate swap contracts

$

25,000

$

$

145

Not designated as hedges:

 

 

Customer-related interest rate swap contracts:

 

 

 

Matched interest rate swaps with borrower

 

74,266

 

2,454

 

8

Matched interest rate swaps with counterparty

74,266

8

2,454

Mortgage banking contracts:

IRLCs

75,073

1,083

Forward sales of TBA securities

24,000

 

 

25

The Corporation is required to maintain cash collateral with dealer counterparties for derivative instruments in a loss position, subject to certain thresholds and offsets. At June 30, 2020 and at December 31, 2019, $11.79 million and $2.52 million, respectively, of cash collateral was maintained with dealer counterparties and was included in “Other assets” in the Consolidated Balance Sheets.

  

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NOTE 13: Other Noninterest Expenses

The following table presents the significant components in the Consolidated Statements of Income line “Noninterest Expenses-Other.”

Three Months Ended June 30, 

Six Months Ended June 30, 

(Dollars in thousands)

    

2020

    

2019

    

2020

    

2019

    

Data processing fees

$

2,448

$

1,974

$

4,842

$

3,896

Professional fees

738

789

1,718

1,353

Mortgage banking loan processing expenses

780

388

1,264

683

Telecommunication expenses

409

330

781

648

Marketing and advertising expenses

348

435

838

808

Travel and educational expenses

 

100

 

304

544

706

All other noninterest expenses

 

2,048

 

1,686

 

3,825

 

3,392

Total other noninterest expenses

$

6,871

$

5,906

$

13,812

$

11,486

 

The table above includes merger related expenses for the three months ended June 30, 2020 of $308,000, of which $263,000 was included in data processing fees, $22,000 was included in professional fees, and $23,000 was included in all other noninterest expenses and includes merger related expenses for the six months ended June 30, 2020 of $898,000, of which $501,000 was included in data processing fees, $336,000 was included in professional fees, and $61,000 was included in all other noninterest expenses.  There were no merger related expenses during the three and six months ended June 30, 2019.

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

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. In addition to current and historical information, the following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future business, financial condition or results of operations. For a description of certain factors that may have a significant impact on our future business, financial condition or results of operations, see “Forward-Looking Statements” at the end of this discussion and analysis.

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: (1) return on average assets (ROA), (2) return on average equity (ROE), and (3) growth in earnings.  In addition to these financial performance measures, we track the performance of the Corporation’s three principal business segments: community banking, mortgage banking, and consumer finance.  We also actively manage our capital through growth, dividends and share repurchases, while considering the need to maintain a strong capital position.

Financial Performance Measures

Consolidated net income for the Corporation was $3.7 million for the second quarter of 2020, or $1.03 per share, compared with consolidated net income of $5.8 million for the second quarter of 2019, or $1.69 per share.  Consolidated net income for the Corporation was $7.4 million for the first half of 2020, or $2.01 per share, compared with consolidated net income of $9.6 million for the first half of 2019, or $2.77 per share.  The Corporation’s annualized ROE and ROA were 8.41 percent and 0.77 percent, respectively, for the second quarter of 2020, compared to 15.07 percent and 1.51 percent, respectively, for the second quarter of 2019.  The Corporation’s annualized ROE and ROA were 8.34 percent and 0.78 percent, respectively, for the first half of 2020, compared to 12.54 percent and 1.26 percent, respectively, for the first half of 2019.

Consolidated net income for the second quarter and first six months of 2020 was affected by certain items that management does not expect to have an ongoing impact on consolidated net income, including merger related expenses incurred in connection with the Corporation’s acquisition of Peoples Bankshares, Incorporated (Peoples), which was completed on January 1, 2020, impairment charges related to branch consolidation, and a change in income tax law related to the carryback of net operating losses.  Excluding the effects of these items, adjusted net income for the second quarter and first six months of 2020 was $4.0 million, or $1.11 per share and $8.4 million, or $2.30 per share, respectively. Adjusted ROE and adjusted ROA, on an annualized basis were 9.00 percent and 0.82 percent, respectively, for the second quarter of 2020 and 9.53 percent and 0.89 percent, respectively, for the first six months of 2020. There were no adjustments to net income for the three and six months ended June 30, 2019.  Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net income, adjusted earnings per share, adjusted ROE and adjusted ROA, which are non-GAAP financial measures, to the most directly comparable financial measures calculated in accordance with U.S. GAAP.

Consolidated net income and earnings per share decreased 35.9 percent and 39.1 percent, respectively, for the second quarter of 2020, and decreased 23.2 percent and 27.4 percent, respectively, for the first six months of 2020, compared to the same periods in 2019.  Adjusted net income and adjusted earnings per share decreased 31.4 percent and 34.3 percent, respectively, for the second quarter of 2020, and decreased 12.3 percent and 17.0 percent, respectively, for the first six months of 2020, compared to the same periods in 2019.  The decrease in adjusted earnings per share for the second quarter of 2020 compared to the second quarter of 2019 is due primarily to higher provision for loan losses at the community banking and consumer finance segments, lower net interest income and higher operating expenses at the community banking segment and the issuance of 209,871 shares of common stock in connection with the acquisition of Peoples, partially offset by higher mortgage banking segment net income.  The decrease in adjusted earnings per share for the first

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six months of 2020 compared to the first six months of 2019 is due primarily to higher provision for loan losses and higher operating expenses at the community banking segment and the issuance of common stock in connection with the acquisition of Peoples, partially offset by higher net income at the mortgage banking segment and consumer finance segment.

Impact of and Response to the COVID-19 Pandemic

The outbreak of the novel coronavirus and the resulting COVID-19 illness has caused a significant disruption in economic activity worldwide, and has had a significant impact on businesses and consumers in our market areas and on our results of operations, which the Corporation expects to continue.  Many businesses have temporarily closed or reduced their availability since the beginning of the pandemic; and while many people have returned to work, the U.S. unemployment rate was 11.1 percent in June after reaching 14.7 percent in April.  There remains substantial uncertainty about critical factors that may affect the economy and employment, including a rising trend in new cases of COVID-19 in certain parts the U.S., including Virginia; potential re-tightening of policies that have allowed businesses to open; the continuation, duration and extent of government stimulus efforts, including enhanced unemployment benefits and direct payments; and issues related to the availability of childcare and reopening of schools.

The COVID-19 pandemic presents significant risks and uncertainties in our businesses; however, at this time we cannot determine the ultimate impact of this pandemic on the results of operations of the Corporation.  The federal government and state and local governments have responded to this crisis with unprecedented relief efforts and economic stimulus.  We cannot predict the duration or extent of government intervention during and following the pandemic or the effect it will have on the Corporation.  We believe that as a result of the COVID-19 pandemic, our results of operations may be impacted by elevated loan losses, net interest margin compression, falling demand for loans and potential impairments of securities available for sale and goodwill.

Risks to Results of Operations

Elevated loan losses. The COVID-19 pandemic has had a significant impact on businesses and consumers in our market areas.  Many businesses have temporarily closed or faced declines in revenue since the beginning of the pandemic as consumers have been at times instructed to stay at home.  This disruption has caused employers to lay off or reduce compensation of certain employees, and people who have become ill may not receive compensation while they are not able to work, resulting in many households facing reduced income.  Commercial and consumer borrowers affected by the pandemic may not be able to make timely payments on loans, which may lead to an increase in delinquencies or defaults and may ultimately result in increases in net charge-offs and provision for loan losses.  Furthermore, collateral values may decline as a result of decreased economic activity and increased uncertainty during the crisis, which may contribute to an increase in loan losses during and after the pandemic.

In the second quarter and first six months of 2020, the Corporation recorded additional provision for loan losses of approximately $3.5 million and $5.5 million, respectively, as a result of asset quality deterioration that is expected to arise as a result of the COVID-19 pandemic and related economic disruption.  Management continues to monitor changes in economic conditions and asset quality resulting from the COVID-19 pandemic and believes that additional provision for loan losses may be required in future periods.

Net interest margin compression.  Since December 31, 2019, the Federal Reserve Bank’s Federal Open Market Committee has reduced its benchmark interest rate target to near zero by announcing rate cuts of 50 basis points on March 3, 2020 and 100 basis points on March 15, 2020.  Treasury yields for all maturities are also lower since the outbreak of COVID-19.  Lower market interest rates will result in lower average yields on all classes of earning assets.  While we also expect that average costs of deposits and borrowings will decrease, this may occur slowly based on the repricing of time deposits at maturity, and the effect on net interest margin may not offset the effect of lower yields on earning assets.

Falling demand for loans. As businesses and consumers have been affected by the pandemic, new investment and consumer spending may decline, resulting in lower demand for loans.  Our recent performance and strategic planning have depended in part on growth in lending, and we have invested in expanding our commercial lending team.  While loans outstanding at the community banking segment grew during the second quarter of 2020, which included loans originated

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under the Paycheck Protection Program, there can be no assurance that loan growth will continue during or after the pandemic.  Lower demand for loans in our markets as a result of the COVID-19 pandemic, combined with lower interest rates on new loans, may negatively impact interest income from loans.

Impairment of securities and goodwill.  A broad decrease in economic activity as a result of the COVID-19 pandemic is expected to affect tax revenues of states and political subdivisions, and increased uncertainty has resulted in volatility in the market price of investments.  The Corporation holds securities issued by states and political subdivisions that may experience shortfalls in general revenues or an inability to repay obligations when due as a result of the crisis, and there is a risk that these securities may become impaired, which would have a negative impact on the Corporation’s results of operations.  Additionally, depending on the severity of the economic consequences of the COVID-19 pandemic, the Corporation’s goodwill may become impaired, which would have a negative impact on the Corporation’s results of operations.

Our Response to the Crisis

The Corporation has taken steps in various areas of our businesses in response to the changes in circumstances arising from the COVID-19 pandemic.

We have adapted our technology and processes to allow a substantial portion of administrative personnel to work remotely beginning in mid-March 2020.  During the second quarter of 2020, some employees have returned to our offices on a full-time or part-time basis, but many continue to work remotely as we utilize our administrative offices at no more than 50 percent of normal staffing.
We have implemented safe and healthy practices of social distancing and enhanced cleaning to protect our employees and customers as we continue to operate and serve our communities. These practices include closing the lobbies of our Bank branches except for appointments.
Bank customers continue to have access to our products and services through our online and mobile platforms, ATMs and drive-thru facilities, as well as by appointment in our branch lobbies.
We have originated 1,210 loans under the Paycheck Protection Program (PPP) of the Small Business Administration (SBA) as of June 30, 2020, with an aggregate principal amount of $88.9 million.
We are working proactively with borrowers affected by the crisis, including offering short-term loan modifications, such as payment deferrals or interest only periods of up to six months, for borrowers who are temporarily unable to make loan payments.  As of June 30, 2020, we have provided payment deferrals or interest only periods of less than six months on 200 loans with aggregate balances of $94.9 million.

Principal Business Segments

An overview of the financial results for each of the Corporation’s principal segments is presented below. A more detailed discussion is included in the section “Results of Operations.”

Community Banking:  The community banking segment reported net income of $68,000 for the second quarter of 2020, compared to net income of $3.1 million for the second quarter of 2019.  For the first six months of 2020, C&F Bank reported net income of $638,000, compared to $5.4 million for the first six months of 2019.  Prior to the second quarter of 2020, the community banking segment was referred to as the retail banking segment.  There have been no changes to the composition of the community banking segment.

Community banking segment net income included the effects of the following items which management does not expect to have an ongoing impact on segment income: (1) merger related expenses of $439,000 ($347,000 after income taxes) and $1.3 million ($1.0 million after income taxes) for the second quarter and first six months of 2020, respectively; (2) a write-down of assets of $281,000 ($222,000 after income taxes) for the second quarter and first six months of 2020 related to the planned consolidation of C&F Bank’s main office into a nearby branch and donation of real estate to the Town of West Point, VA expected to occur in the fourth quarter of 2020; and (3) income tax benefits of $303,000 in the second quarter and first six months of 2020 arising from a change in tax law enacted in response to the COVID-19 pandemic which changed the tax rate applied to certain net operating losses of Peoples.  The community banking segment expects to

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recover the amount of the asset write-down through cost savings by the end of 2021, with estimated annual cost savings of approximately $220,000.

In addition to the effects of these items that are not expected to have an ongoing impact on segment earnings, community banking segment net income decreased for the second quarter and first six months of 2020 compared to the same periods in 2019 primarily as a result of (1) higher provision for loan losses, as the COVID-19 pandemic continues to have a disruptive economic impact in the markets that C&F Bank serves, even as many businesses have reopened, (2) higher operating expenses, including assuming certain operating costs of Peoples and investing in technology infrastructure to support continued growth; (3) lower yields on loans, securities, and interest-earning deposits with other banks; (4) higher average balances of interest-bearing deposit accounts; and (5) lower service charges on deposit accounts.  These factors were partially offset by higher average loans outstanding, which contributed to higher interest income for the first six months of 2020 compared to the same period in 2019, and higher non-interest income from debit card interchange fees.  The community banking segment completed the integration of the systems and processes of Peoples Community Bank in the second quarter of 2020 and expects that its cost savings following the acquisition of Peoples will be substantially realized by the end of 2020.  

Average loans increased $228.5 million or 29.6 percent for the second quarter of 2020 and $187.7 million or 24.3 percent for the first six months of 2020, compared to the same periods in 2019.  These increases included $102.8 million and $110.7 million for the second quarter and first six months of 2020, respectively, of average balances of  loans acquired in the acquisition of Peoples, and $67.8 million and $33.9 million, respectively, of average balances of loans originated under the PPP. The increase in average loans outstanding for the second quarter and first six months of 2020 compared to the same periods in 2019 excluding the acquisition of Peoples and the PPP was due primarily to growth in the commercial real estate and commercial business lending segments of the loan portfolio.  Average loan yields were lower for the second quarter and first six months of 2020 compared to the same periods in 2019 due to repricing of variable rate loans, lower average yields on new lending, including PPP loans, and lower interest income on purchased credit impaired (PCI) loans.  The recognition of interest income on PCI loans is based on management’s expectation of future payments of principal and interest. Earlier than expected repayments of certain PCI loans resulted in the recognition of additional interest income in the first six months of 2020 and 2019. Interest income recognized on PCI loans was $729,000 and $1.7 million for the second quarter and first six months of 2020, respectively, compared to $1.3 million and $1.8 million for the second quarter and first six months of 2019, respectively.

C&F Bank’s total nonperforming assets were $2.8 million at June 30, 2020, compared to $2.6 million at December 31, 2019. Nonperforming assets at June 30, 2020 included $1.7 million in nonaccrual loans, compared to $1.5 million at December 31, 2019 and included $1.1 million in other real estate owned at both June 30, 2020 and December 31, 2019.  Nonaccrual loans were comprised primarily of residential mortgages and equity lines at June 30, 2020 and December 31, 2019.  The community banking segment recorded provision for loan losses of $1.4 million and $2.4 million in the second quarter and first six months of 2020, respectively, compared to $110,000 for both the second quarter and first six months of 2019, due primarily to the COVID-19 pandemic, and we anticipate that additional increases in the allowance for loan losses may be required in future periods.  

Mortgage Banking:  The mortgage banking segment reported net income of $2.3 million for the second quarter of 2020, compared to net income of $1.2 million for the second quarter of 2019. For the first six months of 2020, C&F Mortgage Corporation reported net income of $3.9 million, compared to net income of $1.7 million for the first six months of 2019.

The increase in net income of the mortgage banking segment for the second quarter and first six months of 2020 compared to the same periods in 2019 was due primarily to higher gains on sales of loans and mortgage banking fee income, resulting from record loan production, and higher fee income for providing mortgage origination functions to third parties, which were partially offset by higher compensation expense related to higher loan volume. Mortgage loan originations for the mortgage banking segment were $448.3 million and $708.6 million for the second quarter and first six months of 2020, respectively, compared to $246.9 million and $385.6 million for the second quarter and first six months of 2019, respectively.  Loan production for the second quarter and first six months of 2020 was the highest reported by the mortgage banking segment for any quarter and for the first six months of any calendar year in the Corporation’s history.  Lower interest rates on mortgage loans have contributed to an increase in volume in the broader mortgage industry in the first six months of 2020 compared to the same period in the prior year.  Mortgage loan originations for the mortgage banking

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segment during the second quarter of 2020 for refinancings and home purchases were $199.6 million and $248.7 million, respectively, compared to $32.1 million and $214.8 million, respectively, during the second quarter of 2019.  Mortgage loan originations for the mortgage banking segment during the first six months of 2020 for refinancings and home purchases were $335.4 million and $373.2 million, respectively, compared to $54.0 million and $331.6 million, respectively, during the first six months of 2019. Gains on sales of loans, which were higher primarily as a result of higher mortgage loan production at the mortgage banking segment, were impacted unfavorably by a higher mix of refinancings, which have lower margins than home purchases, and by expenses related to early repayment of loans sold.

Consumer Finance:  The consumer finance segment reported net income of $1.6 million for the second quarter of 2020, compared to net income of $1.9 million for the second quarter of 2019.  For the first six months of 2020, C&F Finance Company reported net income of $3.6 million, compared to net income of $3.2 million for the first six months of 2019.

 

Favorable factors affecting net income of the consumer finance segment for the second quarter and first six months of 2020 compared to the same periods in 2019 included a decrease in interest expense due to lower average cost of borrowings. Unfavorable factors affecting net income of the consumer finance segment for the second quarter and first six months of 2020 compared to the same periods in 2019 included lower interest income from loans, due primarily to lower average yields, and higher provision for loan losses in the second quarter and first six months of 2020 related to the COVID-19 pandemic and related economic disruption.  The average yield on loans for the second quarter and first six months of 2020 was lower compared to the same periods of 2019 due to continued competition in the non-prime automobile loan business and the consumer finance segment’s pursuing growth in higher quality, lower yielding loans, which include prime marine and recreational vehicle (RV) loans.

The annualized net charge-off ratio for the first six months of 2020 decreased to 1.99 percent from 3.15 percent for the first six months of 2019. The decline reflects a lower number of charge-offs during 2020 due to (1) improvement in loan performance and (2) C&F Finance Company offering a higher number of payment deferrals to borrowers impacted by the pandemic.  Improvement in loan performance has resulted from C&F Finance Company continuing to purchase higher quality loans as well as borrowers benefitting from the government’s stimulus measures in response to the pandemic.  C&F Finance Company offers payment deferrals at times to non-prime automobile borrowers as a management technique to achieve higher ultimate cash collections.  The average amount deferred on a monthly basis during the second quarter and first six months of 2020 were 5.58 percent and 4.05 percent of non-prime automobile loans outstanding, compared to 1.78 percent and 1.91 percent during the same periods in 2019.  At June 30, 2020, total delinquent loans, which does not include loans that have been granted a payment deferral, as a percentage of total loans was 2.05 percent, compared to 4.17 percent at December 31, 2019 and 3.49 percent at June 30, 2019.  The allowance for loan losses was $22.6 million, or 7.52 percent of total loans at June 30, 2020, compared to $21.8 million, or 6.96 percent of total loans at December 31, 2019. The increase in the level of the allowance for loan losses as a percentage of total loans reflects losses that are probable as a result of the economic impacts of the COVID-19 pandemic.  We anticipate that additional increases in the allowance for loan losses may be required in future periods.

Merger Related Expenses.  In the second quarter and first six months of 2020, the Corporation recorded merger related expenses of $439,000 ($347,000 after income taxes) and $1.4 million ($1.1 million after taxes), respectively, in connection with its acquisition of Peoples, of which $439,000 ($347,000 after income taxes) and $1.3 million ($1.0 million after income taxes) was allocated to the community banking segment and the remainder was recorded as a holding company expense in the second quarter and first six months of 2020, respectively. As of June 30, 2020, the Corporation has recorded aggregate merger related expenses of $2.1 million ($1.8 million after income taxes) and expects that any further merger related expenses incurred in future periods will not be significant to the Corporation as a whole.

Capital Management. Total equity was $183.3 million at June 30, 2020, compared to $165.3 million at December 31, 2019. Capital growth resulted primarily from earnings for the first six months of 2020 and the issuance of $11.6 million of common equity in connection with the acquisition of Peoples on January 1, 2020, which was offset in part by share repurchases of $618,000 and cash dividends declared of $0.76 per share during the first six months of 2020. For the second quarter of 2020, the Corporation’s cash dividend equated to a payout ratio of 37.0 percent of second quarter earnings per share. The Corporation cannot predict what impact the COVID-19 pandemic will ultimately have on its earnings and capital levels.  At this time, the Corporation expects to continue paying a regular quarterly dividend.  The Board of Directors of the Corporation continually reviews the amount of cash dividends per share and the resulting

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dividend payout ratio in light of changes in economic conditions (including the impact of COVID-19), current and future capital requirements and expected future earnings.

In May 2019, the Corporation’s Board of Directors authorized a program, effective June 1, 2019, to repurchase up to $5.0 million of the Corporation’s common stock (the Repurchase Program) through May 31, 2020.  The Corporation made no repurchases of its common stock during the three months ended June 30, 2020.  Repurchases under the Corporation’s share repurchase program for the first six months of 2020 were $355,000. The Corporation had made aggregate common stock repurchases of $2.1 million under the Repurchase Program when the program expired on May 31, 2020.  The Repurchase Program has not been renewed or extended at this time. At June 30, 2020, the book value per share of the Corporation’s common stock was $50.10, and tangible book value per share was $42.52, compared to $48.07 and $43.61, respectively, at December 31, 2019.

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 management’s most difficult, subjective or complex judgments affecting the application of these policies, and the greatest 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 probable losses inherent in the loan portfolio. 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 for relevant periods of time, 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. 

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 based on 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 in the loan. All troubled debt restructurings (TDRs) are also considered impaired loans and are evaluated individually. A TDR occurs when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower.  For more information see the section titled “Asset Quality” within Item 2.

Loans Acquired in a Business Combination:  Acquired loans are classified as either (i) purchased credit-impaired (PCI) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition.

PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

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On a quarterly basis, we evaluate our estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for loan losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan or pool(s) of loans. Disposals of loans, which may include sale of loans to third parties, receipt of payments in full or in part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

PCI loans are not classified nonperforming loans by the Corporation at the time they are acquired, regardless of whether they had been classified as nonperforming by the previous holder of such loans, and they will not be classified as nonperforming so long as, at quarterly re-estimation periods, we believe we will fully collect the new carrying value of the pools of loans.

The Corporation accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses may be required for any deterioration in these loans in future periods.

Goodwill: The Corporation's goodwill was recognized in connection with past business combinations and is reported at the community banking segment and the consumer finance segment. The Corporation reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Corporation may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing is required and the goodwill of the reporting unit is not impaired. If the Corporation elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying value to determine whether an impairment exists. In the last evaluation of goodwill at the community banking segment and the consumer finance segment, which was the annual evaluation in the fourth quarter of 2019, the Corporation concluded that no impairment existed based on an assessment of qualitative factors.  As the COVID-19 pandemic and the related economic disruption has caused a recession and resulted in recognition of higher provisions for loan losses and a decrease in net income of the community banking segment and consumer finance segment, management considered the impact of the pandemic on goodwill and determined that a triggering event had not occurred as of June 30, 2020.  Depending on the severity and duration of the economic consequences of the COVID-19 pandemic and their impact on the Corporation, management may determine that goodwill should be evaluated for impairment.

Income Taxes: Determining the Corporation’s effective tax rate requires judgment. The Corporation’s net deferred tax asset is determined annually based on temporary differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. In addition, there may be transactions and calculations for which the ultimate tax outcomes are uncertain and the Corporation’s tax returns are subject to audit by various tax authorities. Although we believe that estimates related to income taxes are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the consolidated financial statements.

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, 2019.

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RESULTS OF OPERATIONS

NET INTEREST INCOME

The following table shows 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 and six months ended June 30, 2020 and 2019.  Loans include loans held for sale. Loans placed on a nonaccrual status are included in the balances and are included in the computation of yields, but had no material effect. Accretion of fair value purchase adjustments related to business combinations are included in the computation of yields on loans and investments and on the costs of deposits and borrowings. The accretion contributed approximately 18 basis points to the yield on loans and 14 basis points to both the yield on interest earning assets and the net interest margin for the second quarter of 2020, compared to approximately 45 basis points to the yield on loans and 36 basis points to both the yield on interest earning assets and the net interest margin for the second quarter of 2019.  The accretion contributed approximately 27 basis points to the yield on loans and 21 basis points to both the yield on interest earning assets and the net interest margin for the first six months of 2020, compared to approximately 31 basis points to the yield on loans and 24 basis points to both the yield on interest earning assets and the net interest margin for the first six months of 2019.  Fees collected on PPP loans are recognized net of direct origination costs over the life of the loans and contributed 10 basis points and 6 basis points to the yield on loans for the second quarter and first six months of 2020, respectively, and contributed 9 and 4 basis points for the second quarter and first six months of 2020, respectively, to both the yield on earning assets and net interest margin.  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 21 percent that was applicable for all periods presented.

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

Three Months Ended June 30, 

   

2020

    

2019

    

Average

    

Income/

    

Yield/

Average

    

Income/

    

Yield/

(Dollars in thousands)

Balance

   

Expense

   

Rate

Balance

   

Expense

   

Rate

Assets

Securities:

Taxable

$

152,185

$

815

 

2.14

%  

$

134,098

$

815

 

2.43

%  

Tax-exempt

 

83,923

 

651

 

3.10

 

74,408

 

704

 

3.78

Total securities

 

236,108

 

1,466

 

2.48

 

208,506

 

1,519

 

2.91

Total loans

 

1,444,899

 

22,235

 

6.19

 

1,138,382

 

22,328

 

7.87

Interest-bearing deposits in other banks

 

100,728

 

52

 

0.21

 

103,153

 

582

 

2.26

Total earning assets

 

1,781,735

 

23,753

 

5.36

 

1,450,041

 

24,429

 

6.76

Allowance for loan losses

 

(34,512)

 

(33,819)

Total non-earning assets

 

208,238

 

129,564

Total assets

$

1,955,461

$

1,545,786

Liabilities and Equity

Interest-bearing deposits:

Interest-bearing demand deposits

$

253,282

111

0.18

$

217,215

307

 

0.57

Money market deposit accounts

 

248,352

 

212

0.34

 

197,395

 

261

0.53

Savings accounts

 

161,153

 

32

0.08

 

120,847

 

29

 

0.10

Certificates of deposit, $100 or more

 

271,504

 

1,254

1.86

 

205,026

 

929

 

1.82

Other certificates of deposit

 

226,270

 

877

1.56

 

183,488

 

695

 

1.52

Interest-bearing deposits

 

1,160,561

 

2,486

 

0.86

 

923,971

 

2,221

 

0.96

Borrowings

 

136,450

 

847

 

2.48

 

159,558

 

1,430

 

3.58

Total interest-bearing liabilities

 

1,297,011

 

3,333

 

1.03

 

1,083,529

 

3,651

 

1.35

Noninterest-bearing demand deposits

 

425,796

 

276,341

Other liabilities

 

54,544

 

30,861

Total liabilities

 

1,777,351

 

1,390,731

Equity

 

178,110

 

155,055

Total liabilities and equity

$

1,955,461

$

1,545,786

Net interest income

$

20,420

$

20,778

Interest rate spread

 

4.33

%  

 

5.41

%  

Interest expense to average earning assets (annualized)

 

0.75

%  

 

1.01

%  

Net interest margin (annualized)

 

4.61

%  

 

5.75

%  

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Table of Contents

Six Months Ended June 30, 

   

2020

    

2019

    

Average

    

Income/

    

Yield/

Average

    

Income/

    

Yield/

(Dollars in thousands)

Balance

   

Expense

   

Rate

Balance

   

Expense

   

Rate

Assets

Securities:

Taxable

$

141,468

$

1,602

2.26

%  

$

136,980

$

1,674

 

2.44

%  

Tax-exempt

 

78,585

 

1,279

 

3.26

 

75,356

 

1,442

 

3.83

Total securities

 

220,053

 

2,881

 

2.62

 

212,336

 

3,116

 

2.93

Total loans

 

1,374,104

 

45,162

 

6.61

 

1,119,116

 

43,254

 

7.79

Interest-bearing deposits in other banks

 

145,098

 

650

 

0.90

 

103,478

 

1,171

 

2.28

Total earning assets

 

1,739,255

 

48,693

 

5.63

 

1,434,930

 

47,541

 

6.68

Allowance for loan losses

 

(33,689)

 

(33,966)

Total non-earning assets

 

195,932

 

128,767

Total assets

$

1,901,498

$

1,529,731

Liabilities and Equity

Interest-bearing deposits:

Interest-bearing demand deposits

$

257,251

341

 

0.27

$

221,122

619

 

0.56

Money market deposit accounts

 

242,966

 

540

 

0.45

 

201,405

 

521

 

0.52

Savings accounts

 

152,921

 

60

 

0.08

 

120,690

 

59

 

0.10

Certificates of deposit, $100 or more

 

260,080

 

2,487

 

1.92

 

193,584

 

1,646

 

1.71

Other certificates of deposit

 

239,667

 

1,943

 

1.63

 

180,089

 

1,284

 

1.44

Total interest-bearing deposits

 

1,152,885

 

5,371

 

0.94

 

916,890

 

4,129

 

0.91

Borrowings

 

150,855

 

2,137

 

2.83

 

159,771

 

2,826

 

3.54

Total interest-bearing liabilities

 

1,303,740

 

7,508

 

1.16

 

1,076,661

 

6,955

 

1.30

Noninterest-bearing demand deposits

 

373,817

 

269,708

Other liabilities

 

46,924

 

30,065

Total liabilities

 

1,724,481

 

1,376,434

Equity

 

177,017

 

153,297

Total liabilities and equity

$

1,901,498

$

1,529,731

Net interest income

$

41,185

$

40,586

Interest rate spread

 

4.47

%  

 

5.38

%  

Interest expense to average earning assets

 

0.87

%  

 

0.97

%  

Net interest margin

 

4.76

%  

 

5.71

%  

Interest income and expense are affected by fluctuations in interest rates, by changes in the volume of earning assets and interest-bearing liabilities, and by the interaction of rate and volume factors. The following table shows the direct causes of the period-to-period changes in the components of net interest income on a taxable-equivalent basis. The Corporation calculates the rate and volume variances using a formula prescribed by the SEC. Rate/volume variances, the third element in the calculation, are not shown separately in the table, but are allocated to the rate and volume variances in proportion to the absolute dollar amounts of each.

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Table of Contents

TABLE 2: Rate-Volume Recap

Three Months Ended June 30, 2020 from 2019

Increase (Decrease)

Total

Due to

Increase

(Dollars in thousands)

    

Rate

    

Volume

    

(Decrease)

Interest income:

Loans

$

(5,346)

$

5,253

$

(93)

Securities:

Taxable

 

(103)

 

103

 

Tax-exempt

 

(136)

 

83

 

(53)

Interest-bearing deposits in other banks

 

(516)

 

(14)

 

(530)

Total interest income

 

(6,101)

 

5,425

 

(676)

Interest expense:

Interest-bearing deposits:

Interest-bearing demand deposits

 

(240)

44

 

(196)

Money market deposit accounts

 

(106)

57

 

(49)

Savings accounts

 

(6)

9

 

3

Certificates of deposit, $100 or more

 

20

305

 

325

Other certificates of deposit

 

18

164

 

182

Total interest-bearing deposits

 

(314)

 

579

 

265

Borrowings

 

(396)

(187)

 

(583)

Total interest expense

 

(710)

 

392

 

(318)

Change in net interest income

$

(5,391)

$

5,033

$

(358)

Six Months Ended June 30, 2020 from 2019

Increase (Decrease)

Total

 

Due to

Increase

 

(Dollars in thousands)

    

Rate

    

Volume

    

(Decrease)

 

Interest income:

Loans

$

(7,127)

$

9,035

$

1,908

Securities:

Taxable

 

(126)

 

54

 

(72)

Tax-exempt

 

(223)

 

60

 

(163)

Interest-bearing deposits in other banks

 

(880)

 

359

 

(521)

Total interest income

 

(8,356)

 

9,508

 

1,152

Interest expense:

Interest-bearing deposits:

Interest-bearing demand deposits

 

(365)

87

 

(278)

Money market deposit accounts

 

(77)

96

 

19

Savings accounts

 

(13)

14

 

1

Certificates of deposit, $100 or more

 

221

620

 

841

Other certificates of deposit

 

188

471

 

659

Total interest-bearing deposits

 

(46)

 

1,288

 

1,242

Borrowings

 

(539)

(150)

 

(689)

Total interest expense

 

(585)

 

1,138

 

553

Change in net interest income

$

(7,771)

$

8,370

$

599

Net interest income, on a taxable-equivalent basis, for the three months ended June 30, 2020 was $20.4 million, compared to $20.8 million for the three months ended June 30, 2019. Net interest income, on a taxable-equivalent basis, for the first six months of 2020 was $41.2 million, compared to $40.6 million for the first half of 2019.  Annualized net interest margin decreased 114 basis points to 4.61 percent for the second quarter of 2020 and decreased 95 basis points to 4.76 percent for the first six months of 2020, relative to the same periods in 2019, due primarily to lower average yields on loans.  The yield on interest-earning assets and cost of interest-bearing liabilities decreased by 140 basis points and 32 basis points, respectively, for the second quarter of 2020 and decreased by 105 basis points and 14 basis points, respectively for the first six months of 2020, compared to the same periods in 2019.  Average earning assets grew by $331.7 million and $304.3 million for the second quarter and first six months of 2020, compared to the same periods in 2019, primarily due to the acquisition of Peoples on January 1, 2020 as well as growth in loans, including PPP loans, and securities, funded by deposit growth.

Average loans, which includes both loans held for investment and loans held for sale, increased $306.5 million to $1.4 billion for the second quarter of 2020, compared to the same period in 2019, and increased $255.0 million to $1.4 billion

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for the first six months of 2020, compared to the same period in 2019. Average loans held for investment at the community banking segment increased $228.5 million, or 29.6 percent, for the second quarter of 2020, and increased $187.7 million, or 24.3 percent for the first six months of 2020 compared to the same periods in 2019.  These increases included $102.8 million and $110.7 million for the second quarter and first six months of 2020, respectively, of average balances of loans acquired in the acquisition of Peoples, and $67.8 million and $33.9 million, respectively, of average balances of loans originated under the PPP. The remaining increase in average loans outstanding at the community banking segment for the second quarter and first six months of 2020 compared to the same periods in 2019 was due primarily to growth in the commercial real estate and commercial business lending segments of the loan portfolio. Average loans held for investment at the consumer finance segment decreased $2.2 million, or 0.7 percent, for the second quarter of 2020, and increased $5.9 million, or 2.0 percent, for the first six months of 2020, compared to the same periods of 2019 as average marine and RV loans increased due to the continued expansion of the consumer finance segment’s purchases of those loan contracts and average automobile loans decreased.  Average loans held for sale at the mortgage banking segment increased $78.8 million, or 134.8 percent, for the second quarter of 2020, and increased $60.3 million, or 140.1 percent, for the first six months of 2020, compared to the same periods in 2019, due to higher loan production.

The overall yield on average loans decreased 168 basis points to 6.19 percent for the second quarter of 2020 and decreased 118 basis points to 6.61 percent for the first six months of 2020, compared to the same periods of 2019 due primarily to lower market interest rates, changes in the composition of the loan portfolio, and loans originated under the PPP, which had lower yields relative to other loans. Average loans at the community banking and mortgage banking segments increased as a percentage of total loans, while average loans at the consumer finance segment, which has higher average yields, decreased as a percentage of total loans. In addition, yields at the consumer finance segment were lower as it has continued to pursue growth in higher quality, lower yielding loans including prime marine and RV loans. Lower interest income on PCI loans at the community banking segment for the second quarter and first half of 2020 as compared to the same periods of 2019 also contributed to the decrease in yield. While yields on loans originated under the PPP were lower than the average yield of other loans at the community banking segment during the second quarter and first six months of 2020, unrecognized net deferred fees of $3.4 million at June 30, 2020 may result in higher yields in future periods as they are recognized over the remaining life of those loans, a portion of which are expected to be repaid by the SBA prior to maturity in accordance with the forgiveness provisions of the PPP.  

Average securities available for sale increased $27.6 million and $7.7 million for the second quarter and first six months of 2020, compared to the same periods in 2019 due primarily to the acquisition of Peoples and higher purchases of securities, partially offset by net declines during 2019 from sales, maturities and calls. The average yield on the securities portfolio on a taxable-equivalent basis decreased 43 and 31 basis points for the second quarter and first six months of 2020, compared to the same periods in 2019, due to purchases of securities in 2020 at lower average yields relative to the average yield of the portfolio as a whole.

Average interest-bearing deposits in other banks, consisting primarily of excess cash reserves maintained at the Federal Reserve Bank, decreased $2.4 million and increased $41.6 million for the second quarter and first six months of 2020, compared to the same periods in 2019. The average yield on interest-bearing deposits in other banks decreased 205 and 138 basis points for the second quarter and first six months of 2020, respectively, compared to the same periods in 2019, due to lower average rates on excess cash reserves, partially offset by an increase in purchased time deposits.  The Federal Reserve Bank decreased the interest rate on excess cash reserve balances from 2.35 percent at June 30, 2019 to 1.55 percent by the end of 2019, and then further decreased the interest rate to 0.10 percent by the end of the second quarter of 2020 in response to the COVID-19 pandemic.

Average money market, savings and interest-bearing demand deposits increased $127.3 million and $109.9 million for the second quarter and first six months of 2020, and average time deposits increased $109.3 million and $126.1 million for the second quarter and first six months of 2020, compared to the same periods in 2019, due primarily to the acquisition of Peoples.  The increases in average money market, savings and interest bearing-demand deposits included $58.0 million for the second quarter of 2020 and $68.5 million for the first six months of 2020, and the increases in average time deposits included $78.0 million for the second quarter of 2020 and $77.9 million for the first six months of 2020, related to the acquisition of Peoples. Deposit growth was also impacted by the effect of PPP loans and direct government payments received by depositors. The average cost of interest-bearing deposits decreased ten and increased three basis points for the second quarter and first six months of 2020, compared to the same periods in 2019, as offered interest rates increased in

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the second half of 2019 and decreased in the first six months of 2020.  Changes in the cost of money market, savings and interest-bearing demand deposits take effect immediately upon a change in rates, but changes in the average cost of time deposits lag changes in pricing based on the repricing of time deposits at maturity.

Average borrowings decreased $23.1 million and $8.9 million for the second quarter and first six months of 2020, compared to the same periods in 2019 due primarily to the repayment of long-term borrowings partially offset by the assumption of $4.0 million of subordinated debt upon the acquisition of Peoples.  Repayment of long-term borrowings included paying off a revolving bank line of credit in the second quarter of 2020 using excess cash. The average cost of borrowings decreased 110 and 71 basis points during the second quarter and first six months of 2020, compared to the same periods in 2019, because of decreases in short-term interest rates, to which variable-rate borrowings at the consumer finance segment are indexed.

The Corporation believes that its net interest margin may be affected in future periods by several factors that are difficult to predict, including (1) changes in interest rates, which may depend on the severity of adverse economic conditions, the timing and extent of any economic recovery, and the extent of government stimulus measures, which are inherently uncertain, (2) possible changes in the composition of earning assets which may result from decreased loan demand as a result of the current economic environment (3) accretion of purchase discounts on loans related to acquisitions, which is included in yields on loans and may fluctuate based on the timing of repayment, (4) the repricing of  higher-rate time deposits and borrowings as they mature to lower rates, which may occur at a slower rate than the repricing of interest bearing assets and (5) the recognition of net deferred fees on PPP loans, which is subject to the timing of repayment or forgiveness.

Noninterest Income

TABLE 3: Noninterest Income

Three Months Ended June 30, 2020

    

Community

    

Mortgage

    

Consumer

    

Other and

    

 

(Dollars in thousands)

Banking

Banking

Finance

Eliminations

Total

Gains on sales of loans

$

$

4,605

$

$

$

4,605

Mortgage banking fee income

1,986

1,986

Interchange income

1,141

1,141

Service charges on deposit accounts

639

 

 

 

639

Wealth management services income, net

1

747

748

Other service charges and fees

394

 

 

 

394

Gain (loss) on disposition of assets, net

(276)

(276)

Net gains on sales, maturities and calls of available for sale securities

3

 

 

 

3

Other income (loss), net

319

 

401

 

80

 

1,788

2,588

Total noninterest income

$

2,221

$

6,992

$

80

$

2,535

$

11,828

Three Months Ended June 30, 2019

 

    

Community

    

Mortgage

    

Consumer

    

Other and

    

 

(Dollars in thousands)

Banking

Banking

Finance

Eliminations

Total

 

Gains on sales of loans

$

$

2,955

$

$

$

2,955

Mortgage banking fee income

1,267

1,267

Interchange income

1,071

1,071

Service charges on deposit accounts

 

944

 

 

 

 

944

Wealth management services income, net

475

475

Other service charges and fees

 

416

 

 

1

 

 

417

Gain (loss) on disposition of assets, net

7

(6)

1

Net gains on sales, maturities and calls of available for sale securities

 

1

 

 

 

 

1

Other income (loss), net

 

454

 

68

 

109

 

440

 

1,071

Total noninterest income

$

2,893

$

4,290

$

110

$

909

$

8,202

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Table of Contents

Six Months Ended June 30, 2020

 

    

Community

    

Mortgage

    

Consumer

    

Other and

    

 

(Dollars in thousands)

Banking

Banking

Finance

Eliminations

Total

 

Gains on sales of loans

$

$

8,281

$

$

$

8,281

Mortgage banking fee income

3,291

3,291

Interchange income

2,230

2,230

Service charges on deposit accounts

 

1,641

 

 

 

 

1,641

Wealth management services income, net

1

1,332

1,333

Other service charges and fees

 

768

 

 

1

 

 

769

Gain (loss) on disposition of assets, net

(574)

65

(509)

Net gains on sales, maturities and calls of available for sale securities

 

7

 

 

 

 

7

Other income (loss), net

 

780

 

642

 

196

 

(85)

 

1,533

Total noninterest income

$

4,853

$

12,279

$

197

$

1,247

$

18,576

Six Months Ended June 30, 2019

    

Community

    

Mortgage

    

Consumer

    

Other and

    

(Dollars in thousands)

Banking

Banking

Finance

Eliminations

Total

Gains on sales of loans

$

$

5,091

$

$

$

5,091

Mortgage banking fee income

2,037

2,037

Interchange income

2,029

2,029

Service charges on deposit accounts

 

1,862

 

 

 

 

1,862

Wealth management services income, net

924

924

Other service charges and fees

 

713

 

 

2

 

 

715

Gain (loss) on disposition of assets, net

4

13

(6)

11

Net gains on sales, maturities and calls of available for sale securities

 

5

 

 

 

 

5

Other income (loss), net

 

718

 

123

 

237

 

1,553

 

2,631

Total noninterest income

$

5,331

$

7,264

$

239

$

2,471

$

15,305

Total noninterest income increased $3.6 million, or 44.2 percent, in the second quarter of 2020, compared to the second quarter of 2019, and increased $3.3 million, or 21.4 percent, in the first six months of 2020, compared to the first six months of 2019.  This increase in noninterest income was due primarily to (1) higher mortgage loan production at the mortgage banking segment, which resulted in an increase in gains on sales of loans, mortgage banking fee income and  fee income for providing mortgage origination functions to third parties (included in other income), as lower mortgage loan interest rates made mortgage products more attractive to consumers and contributed to an increase in volume in the mortgage industry, (2) an increase in wealth management services income and (3) an increase in debit card interchange income at the community banking segment, partially offset by (1) asset write-downs at the community banking segment of $281,000 and $579,000 in the second quarter and first six months of 2020, respectively, (2) lower  service charges on deposit accounts at the community banking segment due to fewer overdraft fees charged and (3) unrealized losses at the community banking segment on investments in small business investment company funds of $124,000 for the second quarter and first six months of 2020.  Asset write-downs at the community banking segment included $298,000 of merger related costs recognized in the first quarter of 2020 upon disposition of assets acquired from Peoples and $281,000 recognized in the second quarter of 2020 related to branch consolidation.  Noninterest income was also affected by an increase of $1.4 million for the second quarter of 2020 and a decrease of $1.6 million for the first six months of 2020, compared to the same periods in 2019, related to unrealized gains and losses in the Corporation’s nonqualified deferred compensation plan, which are included in “Other income (loss), net” in the “Other and Eliminations” column in the tables above.  Unrealized gains and losses on the Corporation’s nonqualified deferred compensation plan are offset by expenses, as discussed below.  Gains on sales of loans, which were higher primarily as a result of higher mortgage loan production at the mortgage banking segment, were impacted unfavorably by a higher mix of refinancings, which have lower margins than home purchases, and by expenses related to early repayment of loans sold.

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Table of Contents

Noninterest Expense

TABLE 4: Noninterest Expense

Three Months Ended June 30, 2020

 

    

Community

    

Mortgage

    

Consumer

    

Other and

    

 

(Dollars in thousands)

Banking

Banking

Finance

Eliminations

Total

 

Salaries and employee benefits

    

$

7,640

    

$

2,272

    

$

2,134

    

$

2,308

    

$

14,354

 

Occupancy expense

 

1,551

 

800

 

161

 

55

 

2,567

Other expenses:

Data processing

1,855

18

294

18

2,185

Professional fees

678

110

77

186

1,051

Mortgage banking loan processing expenses

780

780

Other expenses (income)

 

1,765

 

531

 

570

 

(11)

 

2,855

Total other expenses

 

4,298

 

1,439

 

941

 

193

 

6,871

Total noninterest expense

$

13,489

$

4,511

$

3,236

$

2,556

$

23,792

Three Months Ended June 30, 2019

 

Community

Mortgage

Consumer

Other and

 

(Dollars in thousands)

    

Banking

    

Banking

    

Finance

    

Eliminations

    

Total

 

Salaries and employee benefits

    

$

6,873

    

$

1,611

    

$

2,069

    

$

942

    

$

11,495

 

Occupancy expense

 

1,435

 

537

 

167

 

9

 

2,148

Other expenses:

Data processing

1,599

14

340

22

1,975

Professional fees

580

41

149

19

789

Mortgage banking loan processing expenses

388

388

Other expenses

 

1,526

 

355

 

755

 

118

 

2,754

Total other expenses

 

3,705

 

798

 

1,244

 

159

 

5,906

Total noninterest expense

$

12,013

$

2,946

$

3,480

$

1,110

$

19,549

Six Months Ended June 30, 2020

 

    

Community

    

Mortgage

    

Consumer

    

Other and

    

 

(Dollars in thousands)

Banking

Banking

Finance

Eliminations

Total

 

Salaries and employee benefits

    

$

15,700

    

$

4,117

    

$

4,377

    

$

977

    

$

25,171

 

Occupancy expense

 

3,073

 

1,463

 

325

 

33

 

4,894

Other expenses:

Data processing

4,163

34

608

37

4,842

Professional fees

1,050

182

202

284

1,718

Mortgage banking loan processing expenses

1,264

1,264

Other expenses

 

3,369

1,019

1,354

246

5,988

Total other expenses

 

8,582

 

2,499

 

2,164

 

567

 

13,812

Total noninterest expense

$

27,355

$

8,079

$

6,866

$

1,577

$

43,877

Six Months Ended June 30, 2019

 

Community

Mortgage

Consumer

Other and

 

(Dollars in thousands)

    

Banking

    

Banking

    

Finance

    

Eliminations

    

Total

 

Salaries and employee benefits

    

$

14,545

    

$

3,391

    

$

4,348

    

$

1,118

    

$

23,402

 

Occupancy expense

 

2,921

 

1,016

 

370

 

31

 

4,338

Other expenses:

Data processing

3,183

24

649

40

3,896

Professional fees

905

57

285

106

1,353

Mortgage banking loan processing expenses

683

683

Other expenses

 

2,340

166

1,388

1,660

 

5,554

Total other expenses

 

6,428

 

930

 

2,322

 

1,806

 

11,486

Total noninterest expense

$

23,894

$

5,337

$

7,040

$

2,955

$

39,226

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Total noninterest expenses increased $4.2 million, or 21.7 percent, in the second quarter of 2020, compared to the second quarter of 2019, and increased $4.7 million, or 11.9 percent, in the first six months of 2020, compared to the first six months of 2019.  This increase in noninterest expenses was due primarily to (1) merger related expenses associated with the acquisition of Peoples, (2) the assumption of certain operating costs of Peoples Community Bank at the community banking segment, included primarily in salaries and employee benefits and data processing expenses, (3) increases in salaries and employee benefits expense associated with (a) C&F Bank adding new talent to its commercial lending team in the Richmond and Charlottesville markets at the community banking segment during 2019 and (b) higher mortgage loan production at the mortgage banking segment, resulting in higher commissions and increased personnel, (4) higher data processing expenses associated with investing in technology infrastructure to support continued growth (5) higher expense for loan processing at the mortgage banking segment as a result of higher mortgage loan production and (6) provision for indemnifications at the mortgage banking segment, included in “Other expenses,” of $156,000 and $163,000 for the second quarter and first six months of 2020, compared to zero in 2019.  Noninterest expense was also affected by an increase of $1.4 million for the second quarter of 2020 and a decrease of $1.6 million for the first six months of 2020, compared to the same periods in 2019, in salaries and employee benefits expense related to unrealized gains and losses in the Corporation’s nonqualified deferred compensation plan, which are shown in the “Other and Eliminations” column in the tables above.

Merger related expenses for the second quarter of 2020 were $439,000, of which $50,000 was salaries and employee benefits expense, $263,000 was data processing expense, $81,000 was occupancy expense, $22,000 was professional fees expense and $23,000 was included in other noninterest expenses, and all of which were allocated to the community banking segment.  Merger related expenses for the first six months of 2020 were $1.4 million, including $1.3 million at the community banking segment, of which $501,000 was data processing expense, $236,000 was professional fees expense, $119,000 was salaries and employee benefits expense, $81,000 was occupancy expense, $61,000 was included in all other noninterest expenses, and $298,000 was a loss on disposition of assets and was recorded in noninterest income.  Merger related expenses for the first six months of 2020 also included $100,000 at the holding company, shown in the “Other and Eliminations” column, above, which was professional fees expense.  There were no merger related expenses for the first six months of 2019.

In connection with the consolidation of C&F Bank’s main office in West Point, VA, which is expected to occur in the fourth quarter of 2020, the community banking segment expects to realize annualized cost savings of approximately $220,000 by the second quarter of 2021.

Income Taxes

The Corporation’s consolidated effective income tax rate was 20.7 percent and 20.9 percent for the first six months of 2020 and 2019, respectively. The lower effective income tax rate for the first six months of 2020 compared to the same period in 2019 resulted primarily from income tax benefits of $303,000 arising from a change in income tax law enacted in response to the COVID-19 pandemic which changed the tax rate applied to certain net operating losses of Peoples, partially offset by higher pre-tax income at the mortgage banking and consumer finance segments, which are subject to state income tax, and a limitation on the deductibility of executive compensation.

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ASSET QUALITY

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. Table 5 summarizes the allowance activity for the periods indicated:

TABLE 5: Allowance for Loan Losses

Three Months Ended June 30, 

 

(Dollars in thousands)

    

2020

    

2019

 

Balance, beginning of period

$

33,298

$

33,589

Provision for loan losses:

Community Banking

 

1,400

 

110

Consumer Finance

 

2,200

 

1,700

Total provision for loan losses

 

3,600

 

1,810

Loans charged off:

Real estate—residential mortgage

 

 

(45)

Commercial, financial and agricultural1

 

 

(29)

Consumer

 

(40)

 

(86)

Consumer finance

 

(1,996)

 

(3,076)

Total loans charged off

 

(2,036)

 

(3,236)

Recoveries of loans previously charged off:

Real estate—residential mortgage

 

60

 

4

Commercial, financial and agricultural1

 

1

 

2

Consumer

 

43

 

73

Consumer finance

 

1,128

 

1,159

Total recoveries

 

1,232

 

1,238

Net loans charged off

 

(804)

 

(1,998)

Balance, end of period

$

36,094

$

33,401

Ratio of annualized net (recoveries) charge-offs to average total loans outstanding during period for Community Banking

 

(0.03)

%  

 

0.04

Ratio of annualized net charge-offs to average total loans outstanding during period for Consumer Finance

 

1.15

%  

 

2.52

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Six Months Ended June 30, 

 

(Dollars in thousands)

  

2020

   

2019

   

Balance, beginning of period

$

32,873

$

34,023

Provision for loan losses:

Community Banking

 

2,400

 

110

Consumer Finance

 

3,850

 

4,095

Total provision for loan losses

 

6,250

 

4,205

Loans charged off:

Real estate—residential mortgage

 

(4)

 

(45)

Commercial, financial and agricultural1

 

(18)

 

(29)

Consumer

 

(133)

 

(162)

Consumer finance

 

(5,422)

 

(6,966)

Total loans charged off

 

(5,577)

 

(7,202)

Recoveries of loans previously charged off:

Real estate—residential mortgage

 

64

 

9

Commercial, financial and agricultural1

 

2

 

3

Consumer

 

105

 

115

Consumer finance

 

2,377

 

2,248

Total recoveries

 

2,548

 

2,375

Net loans charged off

 

(3,029)

 

(4,827)

Balance, end of period

$

36,094

$

33,401

Ratio of annualized net (recoveries) charge-offs to average total loans outstanding during period for Community Banking

 

(0.01)

 

0.03

Ratio of annualized net charge-offs to average total loans outstanding during period for Consumer Finance

 

1.99

 

3.15

1

Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

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Table 6 presents the allocation of the allowance for loan losses as of the dates indicated.

TABLE 6: Allocation of Allowance for Loan Losses

 

June 30, 

December 31, 

 

(Dollars in thousands)

    

2020

    

    

2019

 

Allocation of allowance for loan losses:

Real estate—residential mortgage

$

2,425

$

2,080

Real estate—construction 1

 

983

 

681

Commercial, financial and agricultural 2

 

8,828

 

7,121

Equity lines

 

789

 

733

Consumer

 

471

 

465

Consumer finance

 

22,598

 

21,793

Total allowance for loan losses

$

36,094

$

32,873

Ratio of loans to total period-end loans:

Real estate—residential mortgage

 

16

%  

 

16

Real estate—construction 1

 

5

 

5

Commercial, financial and agricultural 2

 

51

 

45

Equity lines

 

4

 

5

Consumer

 

1

 

1

Consumer finance

 

23

 

28

 

100

%  

 

100

1Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
2Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

Loans by credit quality indicators are presented in Table 7 below.  The characteristics of these loan ratings are as follows:

Pass rated loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio.  The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue.  When necessary, acceptable personal guarantors support the loan.

Special mention loans have a specific identified weakness in the borrower’s operations and in the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may be characterized by late payments.  The Corporation’s risk exposure is mitigated by collateral supporting the loan.  The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Corporation’s credit extension.  The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan.  The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Corporation.  There is a distinct possibility that the Corporation will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet the Corporation’s definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Corporation will be unable to collect all amounts due.

Substandard nonaccrual loans have the same characteristics as substandard loans; however, they have a nonaccrual classification because it is probable that the Corporation will not be able to collect all amounts due.

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Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.
Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

TABLE 7: Credit Quality Indicators

 

Loans by credit quality indicators as of June 30, 2020 were as follows:

   

   

Special

   

   

Substandard

   

 

(Dollars in thousands)

Pass

Mention

Substandard

Nonaccrual

Total1

 

Real estate – residential mortgage

$

201,678

$

1,511

$

842

$

980

$

205,011

Real estate – construction 2

 

72,094

 

 

 

 

72,094

Commercial, financial and agricultural 3

 

642,607

 

37,757

 

2,453

 

 

682,817

Equity lines

 

52,340

 

105

 

8

 

244

 

52,697

Consumer

 

15,119

 

61

 

 

542

 

15,722

$

983,838

$

39,434

$

3,303

$

1,766

$

1,028,341

Included in the table above are loans purchased in connection with the acquisition of Peoples of $93.8 million pass rated, $1.8 million special mention, $2.9 million substandard and $427,000 substandard nonaccrual.

Non-

(Dollars in thousands)

   

Performing

   

Performing

   

Total

 

Consumer finance

$

300,280

$

369

$

300,649

1At June 30, 2020, the Corporation did not have any loans classified as Doubtful or Loss.
2Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
3Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

Loans by credit quality indicators as of December 31, 2019 were as follows:

   

   

Special

   

   

Substandard

   

 

(Dollars in thousands)

Pass

Mention

Substandard

Nonaccrual

Total1

 

Real estate – residential mortgage

$

177,049

$

1,839

$

881

$

1,526

$

181,295

Real estate – construction 2

 

54,246

 

 

 

 

54,246

Commercial, financial and agricultural 3

 

487,374

 

13,357

 

70

 

11

 

500,812

Equity lines

 

51,662

 

181

 

11

 

229

 

52,083

Consumer

 

13,632

 

6

 

 

118

 

13,756

$

783,963

$

15,383

$

962

$

1,884

$

802,192

Non-

(Dollars in thousands)

   

Performing

   

Performing

   

Total

 

Consumer finance

$

312,388

$

611

$

312,999

1At December 31, 2019, the Corporation did not have any loans classified as Doubtful or Loss.
2Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
3Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

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The increase in loans rated Special Mention at June 30, 2020 compared to December 31, 2019 is related primarily to two commercial real estate loans which were rated Pass at December 31, 2019.  Each loan was classified as Special Mention at June 30, 2020 partially as a result of effects on the borrowers of the COVID-19 pandemic.

Table 8 summarizes nonperforming assets as of the dates indicated.

TABLE 8: Nonperforming Assets

Community Banking Segment

June 30, 

December 31, 

(Dollars in thousands)

    

2020

    

2019

    

Loans, excluding purchased loans

$

900,774

$

770,423

Purchased performing loans1

114,548

26,422

Purchased credit impaired loans1

7,831

705

Total loans

$

1,023,153

$

797,550

Nonaccrual loans

$

1,734

$

1,512

OREO2

 

1,103

 

1,103

Total nonperforming assets

$

2,837

$

2,615

Accruing loans past due for 90 days or more

$

291

$

109

Troubled debt restructurings (TDRs)3

$

3,790

$

4,353

Allowance for loan losses (ALL)

$

12,898

$

10,482

Nonperforming assets to total loans and OREO

 

0.28

%  

 

0.33

%  

ALL to total loans, excluding purchased credit impaired loans4

 

1.27

 

1.32

ALL to total nonaccrual loans

 

743.83

 

693.25

Annualized net (recoveries) charge-offs to average total loans

(0.01)

0.04

1Acquired loans are tracked in two separate categories – “purchased performing” and “purchased credit impaired.” The remaining discount for the purchased performing loans was $2.4 million at June 30, 2020 and $1.4 million at December 31, 2019. The remaining discount for the purchased credit impaired loans was $10.7 million at June 30, 2020 and $5.6 million at December 31, 2019.  The increase in remaining discount on purchased performing loans and purchased credit impaired loans from December 31, 2019 to June 30, 2020 is due primarily to loans acquired in the acquisition of Peoples.
2OREO includes $835,000 at both June 30, 2020 and December 31, 2019 related to the land and buildings of the Bellgrade branch, which was consolidated into a nearby branch in 2019.
3Nonaccrual loans include nonaccrual TDRs of $459,000 at June 30, 2020 and $254,000 at December 31, 2019.
4The ratio of ALL to total loans, excluding purchased credit impaired loans, includes purchased performing loans and loans originated under the PPP for which no allowance for loan losses is required.  The ratio of ALL to total loans excluding all purchased loans and loans originated under the PPP was 1.59 percent at June 30, 2020 and 1.36 percent at December 31, 2019.

Mortgage Banking Segment

June 30, 

December 31, 

(Dollars in thousands)

    

2020

    

2019

    

Nonaccrual loans

$

32

$

372

Total loans

$

5,188

$

4,642

ALL

$

598

$

598

Nonaccrual loans to total loans

 

0.62

%

8.01

%

ALL to total loans

 

11.53

12.88

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Consumer Finance Segment

June 30, 

December 31, 

(Dollars in thousands)

    

2020

    

2019

    

Nonaccrual loans

$

369

$

611

Accruing loans past due for 90 days or more

$

$

Repossessed assets

$

265

$

410

Total loans

$

300,649

$

312,999

ALL

$

22,598

$

21,793

Nonaccrual consumer finance loans to total consumer finance loans

 

0.12

%  

 

0.20

%  

ALL to total consumer finance loans

 

7.52

 

6.96

Annualized net charge-offs to average total loans

1.99

3.05

Nonperforming assets of the community banking segment totaled $2.8 million at June 30, 2020, compared to $2.6 million at December 31, 2019. Nonperforming assets at June 30, 2020 consisted of $1.1 million in OREO at both June 30, 2020 and December 31, 2019, and consisted of $1.7 million in nonaccrual loans at June 30, 2020, compared to $1.5 million in nonaccrual loans at December 31, 2019.  Nonaccrual loans were comprised primarily of residential mortgages and equity lines at June 30, 2020 and December 31, 2019.  

The allowance for loan losses as a percentage of total loans at the community banking segment, excluding PCI loans, at June 30, 2020 decreased to 1.27 percent, compared to 1.32 percent at December 31, 2019, due to the addition of loans in 2020, including purchased performing loans that were recorded at fair value in the acquisition of Peoples and PPP loans, which require no reserve. The allowance for loan losses as a percentage of total loans excluding all purchased loans and loans originated under the PPP was 1.59 percent at June 30, 2020, compared to 1.36 percent at December 31, 2019.  The community banking segment recorded provision for loan losses of $1.4 million and $2.4 million in the second quarter and first six months of 2020 due primarily to asset quality issues expected to result from the COVID-19 pandemic and related economic disruption and loan growth.  We anticipate that additional increases in the allowance for loan losses may be required in future periods as more information becomes available about the economic impacts of this crisis.  

Nonaccrual loans at the consumer finance segment were $369,000 at June 30, 2020, compared to $611,000 at December 31, 2019. Nonaccrual consumer finance loans remain low relative to the allowance for loan losses and the total consumer finance loan portfolio because the consumer finance segment generally initiates repossession of loan collateral once a loan becomes more than 60 days delinquent.  Repossessed vehicles of the consumer finance segment are classified as other assets and consist only of vehicles the Corporation has the legal right to sell.  Prior to the reclassification from loans to repossessed vehicles, the difference between the carrying amount of each loan and the fair value of each vehicle (i.e. the deficiency) is charged against the allowance for loan losses. At June 30, 2020, repossessed vehicles available for sale totaled $265,000, compared to $410,000 at December 31, 2019.

The consumer finance segment’s allowance for loan losses increased $805,000 to $22.6 million at June 30, 2020 from $21.8 million at December 31, 2019, and its provision for loan losses increased $500,000 for the second quarter of 2020 and decreased $245,000 for the first six months of 2020, compared to the same periods in 2019. Total delinquent loans, which does not include loans that have been granted a payment deferral, as a percentage of total loans decreased to 2.05 percent at June 30, 2020 compared to 4.17 percent at December 31, 2019. The consumer finance segment, at times, offers payment deferrals to non-prime automobile borrowers as a management technique to achieve higher ultimate cash collections on select loan accounts. Payment deferrals may affect the ultimate timing of when an account is charged off. A significant reliance on deferrals as a means of managing collections may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio.  The average amounts deferred on a monthly basis during the second quarter and first six months of 2020 were 5.58 percent and 4.05 percent of non-prime automobile loans outstanding, compared to 1.78 percent and 1.91 percent during the same periods in 2019. Payment deferrals increased for the three and six months ended June 30, 2020 compared to the same periods in 2019 as the COVID-19 pandemic affected the ability of some borrowers to make timely payments.

The annualized net charge-off ratio for the first six months of 2020 decreased to 1.99 percent from 3.15 percent for the first six months of 2019 due to a lower number of charge-offs during the first six months of 2020 as a result of improvement

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in loan performance and the consumer finance segment offering a higher number of payment deferrals to borrowers impacted by the pandemic. Improvement in loan performance has resulted from the consumer finance segment continuing to purchase higher quality loans, including marine and RV loans, as well as borrowers benefitting from the government’s stimulus measures in response to the pandemic. The Corporation can give no assurance as to the continuation of government stimulus measures or the extent to which they will be effective. The allowance for loan losses as a percentage of loans increased to 7.52 percent at June 30, 2020, compared to 6.96 percent at December 31, 2019. The increase in the level of the allowance for loan losses as a percentage of total loans reflects losses that are probable as a result of the economic impacts of the COVID-19 pandemic.  We anticipate that additional increases in the allowance for loan losses may be required in future periods as more information becomes available about the economic impacts of this crisis.

Impaired Loans

We measure impaired loans either based on fair value of the loan using the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent, or using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment in the loan. TDRs occur when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions typically are made for loss mitigation purposes and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs are considered impaired loans.

TABLE 9: Impaired Loans

Impaired loans, which included TDRs of $3.8 million, and the related allowance at June 30, 2020, were as follows:

    

    

    

    

 

Recorded

Recorded

 

Investment

Investment

Average

 

Unpaid

in Loans

in Loans

Balance-

Interest

Principal

without

with

Related

Impaired

Income

(Dollars in thousands)

Balance

Specific Reserve

Specific Reserve

Allowance

Loans

Recognized

 

Real estate – residential mortgage

$

2,892

$

1,072

$

1,677

$

69

$

2,875

$

44

Commercial, financial and agricultural:

Commercial real estate lending

 

1,401

 

 

1,401

 

72

 

1,409

 

37

Equity lines

 

121

 

113

 

 

 

120

 

1

Consumer

 

126

 

 

114

 

107

 

115

 

Total

$

4,540

$

1,185

$

3,192

$

248

$

4,519

$

82

Impaired loans, which included TDRs of $4.4 million, and the related allowance at December 31, 2019, were as follows:

    

    

    

    

 

Recorded

Recorded

 

Investment

Investment

Average

 

Unpaid

in Loans

in Loans

Balance-

Interest

Principal

without

with

Related

Impaired

Income

(Dollars in thousands)

Balance

Specific Reserve

Specific Reserve

Allowance

Loans

Recognized

 

Real estate – residential mortgage

$

3,891

$

2,192

$

1,479

$

72

$

3,506

$

155

Commercial, financial and agricultural:

Commercial real estate lending

 

1,459

 

4

 

1,447

 

77

 

1,581

 

82

Equity lines

 

31

 

31

 

 

 

32

 

2

Consumer

 

130

 

 

121

 

118

 

123

 

Total

$

5,511

$

2,227

$

3,047

$

267

$

5,242

$

239

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TDRs at June 30, 2020 and December 31, 2019 were as follows:

TABLE 10: Troubled Debt Restructurings

June 30, 

December 31,

(Dollars in thousands)

    

2020

    

2019

 

Accruing TDRs

$

3,331

$

4,099

Nonaccrual TDRs1

 

459

 

254

Total TDRs2

$

3,790

$

4,353

1Included in nonaccrual loans in Table 8: Nonperforming Assets.
2Included in impaired loans in Table 9: Impaired Loans.

While TDRs are considered impaired loans, not all TDRs are on nonaccrual status.  If a loan was on nonaccrual status at the time of the TDR modification, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the Corporation’s policy for returning loans to accrual status. If a loan was accruing prior to being modified as a TDR and if management concludes that the borrower is able to make such modified payments, and there are no other factors or circumstances that would cause management to conclude otherwise, the TDR will remain on an accruing status.

The Corporation has accommodated certain borrowers affected by the COVID-19 pandemic by granting short-term payment deferrals or periods of interest-only payments, including, as of June 30, 2020, 200 loans which had an aggregate balance of $94.9 million and were current at the time of modification.  Generally, a short-term payment deferral does not result in a loan modification being classified as a TDR.  Management cannot predict the overall impact of the COVID-19 pandemic on its loan portfolio or the extent of payment deferrals or other modifications that may be granted.  Depending on the severity and duration of the economic disruption caused by the COVID-19 pandemic, the Corporation may experience an increase in delinquencies that may lead to further loan modifications, including loan modifications that may be classified as TDRs.  For further information concerning loan modifications in response to the COVID-19 pandemic, refer to Table 14 below.

FINANCIAL CONDITION

At June 30, 2020, the Corporation had total assets of $2.0 billion, which was an increase of $325.8 million since December 31, 2019. The increase resulted primarily from the acquisition of Peoples on January 1, 2020, which added total assets of $190.6 million, and deposit growth, partially offset by repayment of borrowings.

Loan Portfolio

Table 11 presents information pertaining to the composition of loans held for investment.

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TABLE 11: Summary of Loans Held for Investment

June 30, 2020

December 31, 2019

(Dollars in thousands)

    

Amount

Percent

  

    

Amount

Percent

 

Real estate—residential mortgage

$

205,011

16

$

181,295

16

Real estate—construction 1

 

72,094

 

5

 

54,246

5

Commercial, financial, and agricultural 2

 

682,817

 

51

 

500,812

45

Equity lines

 

52,697

 

4

 

52,083

5

Consumer

 

15,722

 

1

 

13,756

1

Consumer finance

 

300,649

 

23

 

312,999

28

Total loans

 

1,328,990

 

100

 

1,115,191

100

Less allowance for loan losses

 

(36,094)

 

 

(32,873)

Total loans, net

$

1,292,896

 

$

1,082,318

1Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
2Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

Beginning in April 2020, the community banking segment originated loans under the PPP which are guaranteed by the SBA, and in some cases borrowers may be eligible to obtain forgiveness of the loans, in which case loans would be repaid by the SBA.  Aggregate fees from the SBA of $3.8 million, net of direct costs, will be recognized in interest income over the life of the loans. As repayment of the loans is guaranteed by the SBA, the community banking segment does not recognize a reserve for PPP loans in its allowance for loan losses.  Table 12 presents information pertaining to loans originated under the PPP.

TABLE 12: Loans Originated under the Paycheck Protection Program through June 30, 2020

Dollars in thousands

Number of Loans

Amount Advanced

Below $50

804

$

15,837

At least $50 and below $250

334

35,740

At least $250 and below $500

49

16,697

$500 and greater

23

20,612

1,210

$

88,886

In evaluating the allowance for loan losses, the community banking segment considered its exposure to segments of the economy that it believes have been or will be most sensitive to the impacts of the COVID-19 pandemic.  Table 13 presents balances of loans to borrowers in these sensitive industries at June 30, 2020, and the exposure of the community banking segment to those borrowers, which includes available credit.

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TABLE 13: Sensitive Industries and Exposure

June 30, 2020

Dollars in thousands

Balance

Exposure

Health care1

$

78,305

$

81,850

Apartments

77,087

95,860

Commercial real estate - retail2

54,833

60,710

Restaurants

11,715

16,764

Fitness centers and recreation

11,606

11,885

Hospitality

3,398

17,878

$

236,944

$

284,947

________________________

1Includes primarily loans secured by medical office buildings and assisted living facilities.
2Includes loans secured by commercial real estate used or being constructed for use in a retail business, a majority of which are leased to unrelated retail tenants.

During the second quarter of 2020, the community banking segment assisted loan customers who experienced difficulty making payments as a result of the pandemic and related economic disruption by offering payment deferrals.  Loan modifications were offered on balances that comprise 9 percent of the balance of total loans of the community banking segment.  These modifications included periods of interest-only payments and periods of complete payment deferral, which represented 39 percent and 61 percent, respectively, of the total modifications offered, based on loan balance.  Loans that were modified in response to the COVID-19 pandemic, including modifications offered to borrowers in the industries most sensitive to the impacts of the pandemic, are presented in Table 14.

TABLE 14: Loan Modifications in Response to COVID-19

June 30, 2020

Dollars in thousands

Number of Loans

Balance

Health care

37

$

33,178

Apartments

4

9,781

Commercial real estate - retail

15

9,577

Restaurants

5

3,596

Fitness centers and recreation

3

8,478

Hospitality

2

3,398

Loans in COVID-19 sensitive industries

66

68,008

Other commercial

45

20,521

Consumer

89

6,385

Total loans

200

$

94,914

Investment Securities

The investment portfolio plays a primary role in the management of the Corporation’s interest rate sensitivity. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements. The investment portfolio consists of securities available for sale, which may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors. These securities are carried at estimated fair value. At June 30, 2020 and December 31, 2019, all securities in the Corporation’s investment portfolio were classified as available for sale.

The following table sets forth the composition of the Corporation’s securities available for sale in dollar amounts at fair value and as a percentage of the Corporation’s total securities available for sale at the dates indicated.

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TABLE 15: Securities Available for Sale

June 30, 2020

December 31, 2019

 

(Dollars in thousands)

    

Amount

    

Percent

    

Amount

    

Percent

 

U.S. government agencies and corporations

$

37,205

15

%  

$

21,440

11

%

Mortgage-backed securities

 

106,249

43

 

86,585

46

Obligations of states and political subdivisions

 

103,679

42

 

81,708

43

Total available for sale securities at fair value

$

247,133

100

%  

$

189,733

100

%

For more information about the Corporation's securities available for sale, including information about securities in an unrealized loss position at June 30, 2020 and December 31, 2019, see Part I, Item 1, “Financial Statements” under the heading “Note 3: Securities” in this Quarterly Report on Form 10-Q.

Deposits

The Corporation’s predominant source of funds is depository accounts, which are comprised of demand deposits, savings and money market accounts and time deposits. The Corporation’s deposits are principally provided by individuals and businesses located within the communities served.

During the first six months of 2020, deposits increased $354.5 million to $1.65 billion at June 30, 2020, compared to $1.29 billion at December 31, 2019. This increase resulted from the addition of $171.8 million of deposits in connection with the acquisition of Peoples and deposit growth, which included the effect of PPP loans and direct government payments received by depositors.

The Corporation had $4.6 million in brokered money market and time deposits outstanding at June 30, 2020, compared to $2.0 million at December 31, 2019. The source of these brokered deposits is primarily uninvested cash balances held in third-party brokerage sweep accounts. The Corporation uses brokered deposits as a means of diversifying liquidity sources, as opposed to a long-term deposit gathering strategy.

Borrowings

Borrowings decreased to $91.3 million at June 30, 2020 from $161.2 million at December 31, 2019 due primarily to C&F Finance Company amending and repaying its revolving bank line of credit, which had an outstanding balance of $75.0 million at December 31, 2019, and paydowns on FHLB advances, partially offset by fluctuations in repurchase agreements with commercial deposit customers, the assumption of $4.0 million of subordinated debt in connection with the acquisition of Peoples and recording a lease liability in connection with entering into a finance lease in the second quarter of 2020.

Off-Balance Sheet Arrangements

As of June 30, 2020, there have been no material changes to the off-balance sheet arrangements disclosed in Part II, Item 7, "Management's Discussion and Analysis," under the heading "Off-Balance-Sheet Arrangements" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2019.

At June 30, 2020, the mortgage banking segment had $233.0 million of  interest rate lock commitments (IRLCs) and $166.0 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using best-efforts forward sales contracts for $399.0 million in mortgage loans.  Also at June 30, 2020, the mortgage banking segment had $14.9 million of IRLCs and $8.8 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using forward sales of $20.8 million of TBA securities and mandatory-delivery forward sales contracts for $1.6 million in mortgage loans.  

At December 31, 2019, the mortgage banking segment had $63.4 million of IRLCs and $65.8 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using best-efforts forward sales contracts for $129.1 million in mortgage loans.  Also at December 31, 2019, the mortgage banking segment had $11.7 million of IRLCs and $22.0 million of unpaid principal on mortgage loans held for sale for which it managed interest rate risk using forward

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sales of $24.0 million of TBA securities and mandatory-delivery forward sales contracts for $6.7 million in mortgage loans.

The Corporation uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts.

The Corporation has interest rate swaps that qualify and are designated as cash flow hedges. The Corporation’s cash flow hedges effectively modify the Corporation’s exposure to interest rate risk by converting variable rates of interest on $25.0 million of the Corporation’s trust preferred capital notes to fixed rates of interest for periods that end between June 2024 and June 2029. The cash flow hedges’ total notional amount is $25.0 million. At June 30, 2020, the cash flow hedges had a fair value of $2.3 million, which is recorded in other liabilities.  The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings.

The Corporation also enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs.  The Corporation simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms.  The net effect of these interest rate swaps and the related loans is that the customer pays a fixed rate of interest and the Corporation receives a floating rate.  At June 30, 2020, the total notional amount of the interest rate swaps related to these loans was $170.6 million and the interest rate swaps had a net fair value of zero, with $9.7 million recognized in other assets and $9.7 million recognized in other liabilities.  These swaps are not designated as hedging instruments; therefore, changes in fair value are recorded in other noninterest expense.

The Corporation’s contracts with dealer counterparties for interest rate swaps and forward sales of TBA securities require the Corporation to post collateral for derivative instruments in a loss position, subject to certain thresholds and offsets.  At June 30, 2020 and at December 31, 2019, $11.8 million and $2.5 million, respectively, of cash collateral was maintained with dealer counterparties and was included in “Other assets” in the Consolidated Balance Sheets.

Contractual Obligations

As of June 30, 2020, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in Part II, Item 7, “Management's Discussion and Analysis," under the heading “Table 20: Contractual Obligations” in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2019.

Liquidity

The objective of the Corporation’s liquidity management is to ensure the continuous availability of funds to satisfy the credit needs of our customers and the demands of our depositors, creditors and investors. Stable core deposits and a strong capital position are the components of a solid foundation for the Corporation’s liquidity position. Additional sources of liquidity available to the Corporation include cash flows from operations, loan payments and payoffs, deposit growth, maturities, calls and sales of securities, the issuance of brokered certificates of deposit and the capacity to borrow additional funds.

Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks and nonpledged securities available for sale, totaled $204.85 million at June 30, 2020, compared to $227.7 million at December 31, 2019. The Corporation’s funding sources, including capacity, amount outstanding and amount available at June 30, 2020 are presented in Table 16.

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TABLE 16: Funding Sources

June 30, 2020

 

(Dollars in thousands)

  

Capacity

    

Outstanding

    

Available

 

Unsecured federal funds agreements

$

95,000

$

$

95,000

Repurchase lines of credit

 

50,000

 

 

50,000

Borrowings from FHLB

 

204,009

 

37,000

 

167,009

Borrowings from Federal Reserve Bank

 

102,284

 

 

102,284

Revolving bank line of credit

 

50,000

 

 

50,000

Total

$

501,293

$

37,000

$

464,293

We have no reason to believe these arrangements will not be renewed at maturity.  During the six months ending June 30, 2020, the Corporation pledged additional loans as collateral in order to increase available liquidity at the Federal Reserve Bank that had been unpledged as of December 31, 2019.  Additional loans and securities are available that can be pledged as collateral for future borrowings from the Federal Reserve Bank or the FHLB above the current lendable collateral value. Our ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in our markets. Depending on our liquidity levels, our capital position, conditions in the capital markets, our business operations and initiatives, and other factors, we may from time to time consider the issuance of debt, equity or other securities or other possible capital market transactions, the proceeds of which could provide additional liquidity for our operations.

As a result of the Corporation’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Corporation maintains overall liquidity sufficient to satisfy its operational requirements and contractual obligations.

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Capital Resources

The disclosure below presents the Bank’s actual regulatory capital amounts and ratios under currently applicable regulatory capital standards.  Under the small bank holding company policy statement of the Federal Reserve Board, which applies to certain bank holding companies with consolidated total assets of less than $3 billion, the Corporation is not subject to regulatory capital requirements. The table below reflects the Corporation’s consolidated capital as determined under regulations that apply to bank holding companies that are not small bank holding companies and minimum capital requirements that would apply to the Corporation if it were not a small bank holding company.

Minimum To Be

Well Capitalized

Under Prompt

Minimum Capital

Corrective Action

Actual

Requirements

Provisions

(Dollars in thousands)

 

   Amount   

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

  

As of June 30, 2020:

Total Capital (to Risk-Weighted Assets)

Corporation

$

206,490

13.7

%

$

120,408

 

8.0

%

N/A

 

N/A

C&F Bank

 

201,045

13.5

 

118,951

 

8.0

$

148,689

 

10.0

%

Tier 1 Capital (to Risk-Weighted Assets)

Corporation

 

183,463

12.2

 

90,306

 

6.0

 

N/A

 

N/A

C&F Bank

 

182,243

12.3

 

89,213

 

6.0

 

118,951

 

8.0

Common Equity Tier 1 Capital (to Risk-Weighted Assets)

Corporation

158,463

10.5

67,730

4.5

N/A

N/A

C&F Bank

182,243

12.3

66,910

4.5

96,648

6.5

Tier 1 Capital (to Average Assets)

Corporation

 

183,463

9.6

 

76,682

 

4.0

 

N/A

 

N/A

C&F Bank

 

182,243

9.6

 

75,966

 

4.0

 

94,957

 

5.0

As of December 31, 2019:

Total Capital (to Risk-Weighted Assets)

Corporation

$

195,927

14.9

%

$

105,544

 

8.0

%

N/A

 

N/A

C&F Bank

 

181,369

14.0

 

103,307

 

8.0

$

129,134

 

10.0

%

Tier 1 Capital (to Risk-Weighted Assets)

Corporation

 

179,233

13.6

 

79,158

 

6.0

 

N/A

 

N/A

C&F Bank

 

165,021

12.8

 

77,480

 

6.0

 

103,307

 

8.0

Common Equity Tier 1 Capital (to Risk-Weighted Assets)

Corporation

154,233

11.7

59,369

4.5

N/A

N/A

C&F Bank

165,021

12.8

58,110

4.5

83,937

6.5

Tier 1 Capital (to Average Tangible Assets)

Corporation

 

179,233

11.1

 

64,863

 

4.0

 

N/A

 

N/A

C&F Bank

 

165,021

10.3

 

64,201

 

4.0

 

80,251

 

5.0

The regulatory risk-based capital amounts presented above include:  (1) common equity tier 1 capital (CET1) which consists principally of common stock (including surplus) and retained earnings with adjustments for goodwill, intangible assets and deferred tax assets; (2) Tier 1 capital which consists principally of CET1 plus the Corporation’s “grandfathered” trust preferred securities; and (3) Tier 2 capital which consists principally of Tier 1 capital plus a limited amount of the allowance for loan losses.  In addition, the Corporation has made the one-time irrevocable election to continue treating accumulated other comprehensive income (AOCI) under regulatory standards that were in place prior to the Basel III Final Rule in order to eliminate volatility of regulatory capital that can result from fluctuations in AOCI and the inclusion of AOCI in regulatory capital, as would otherwise be required under the Basel III Capital Rule.  For additional information

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about the Basel III Final Rules, see “Item 1. Business” under the heading “Regulation and Supervision” and “Item 8. Financial Statements and Supplementary Data,” under the heading “Note 16: Regulatory Requirements and Restrictions” in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2019.

In addition to the regulatory risk-based capital amounts presented above, the Bank must maintain a capital conservation buffer of additional capital of 2.5 percent of risk-weighted assets as required by the Basel III Final Rule.  At June 30, 2020, the Bank exceeded the total capital conservation buffer and the tier 1 capital conservation buffer by 302 basis points and 376 basis points, respectively.  At December 31, 2019, the Bank exceeded the total capital conservation buffer and the tier 1 capital conservation buffer by 355 and 428 basis points, respectively.  The increase in regulatory capital of C&F Bank during the first six months of 2020 is due primarily to the acquisition of Peoples and current period earnings.

Effects of Inflation and Changing Prices

The Corporation’s financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP).  U.S. GAAP presently requires the Corporation to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Corporation is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Corporation, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

USE OF CERTAIN NON-GAAP FINANCIAL MEASURES

The accounting and reporting policies of the Corporation conform to U.S. GAAP and prevailing practices in the banking industry. However, certain non-GAAP measures are used by management to supplement the evaluation of the Corporation’s performance. These include adjusted net income; adjusted earnings per share; adjusted annualized ROE; and adjusted annualized ROA, all of which are adjusted to exclude the one-time effect of merger related expenses in connection with the acquisition of Peoples, tangible book value per share and the following fully-taxable equivalent (FTE) measures:  interest income on loans-FTE, interest income on securities-FTE, total interest income-FTE and net interest income-FTE.

Management believes that the use of these non-GAAP measures provide meaningful information about operating performance by enhancing comparability with other financial periods and other financial institutions. The non-GAAP measures used by management enhance comparability by excluding the effects of items that do not reflect ongoing operating performance, including non-recurring gains or charges, balances of intangible assets, including goodwill, that vary significantly between institutions and tax benefits that are not consistent across different opportunities for investment. These non-GAAP financial measures should not be considered an alternative to U.S. GAAP-basis financial statements, and other bank holding companies may define or calculate these or similar measures differently. A reconciliation of the non-GAAP financial measures used by the Corporation to evaluate and measure the Corporation’s performance to the most directly comparable U.S. GAAP financial measures is presented below.

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For The

For The

Quarter Ended

Six Months Ended

(Dollars in thousands except for per share data)

6/30/2020

6/30/2019

6/30/2020

6/30/2019

Adjusted Net Income and Earnings Per Share

(unaudited)

(unaudited)

Net income, as reported

$

3,743

$

5,842

$

7,382

$

9,613

Merger related expenses1

347

-

1,132

-

Branch consolidation1

222

-

222

-

Change in tax law

(303)

-

(303)

-

Adjusted net income

$

4,009

$

5,842

$

8,433

$

9,613

Weighted average shares - basic and diluted

3,647,707

3,463,277

3,646,161

3,473,875

Earnings per share - basic and diluted, as reported

$

1.03

$

1.69

$

2.01

$

2.77

Merger related expenses

0.10

-

0.31

-

Branch consolidation

0.06

-

0.06

-

Change in tax law

(0.08)

-

(0.08)

-

Adjusted earnings per share - basic and diluted

$

1.11

$

1.69

$

2.30

$

2.77

Adjusted Return on Average Equity (ROE)

Average total equity, as reported

$

178,110

$

155,055

$

177,017

$

153,297

Annualized ROE, as reported

8.41

%

15.07

%

8.34

%

12.54

%

Adjusted annualized ROE

9.00

%

15.07

%

9.53

%

12.54

%

Adjusted Return on Average Assets (ROA)

Average assets, as reported

$

1,955,461

$

1,545,786

$

1,901,498

$

1,529,731

Annualized ROA, as reported

0.77

%

1.51

%

0.78

%

1.26

%

Adjusted annualized ROA

0.82

%

1.51

%

0.89

%

1.26

%

Fully Taxable Equivalent Net Interest Income2

Interest income on loans

$

22,204

$

22,323

$

45,101

$

43,243

FTE adjustment

31

5

61

11

FTE interest income on loans

$

22,235

$

22,328

$

45,162

$

43,254

Interest income on securities

$

1,328

$

1,371

$

2,611

$

2,813

FTE adjustment

138

148

270

303

FTE interest income on securities

$

1,466

$

1,519

$

2,881

$

3,116

Total interest income

$

23,584

$

24,276

$

48,362

$

47,227

FTE adjustment

169

153

331

314

FTE interest income

$

23,753

$

24,429

$

48,693

$

47,541

Net interest income

$

20,254

$

20,625

$

40,857

$

40,272

FTE adjustment

169

153

331

314

FTE net interest income

$

20,423

$

20,778

$

41,188

$

40,586

          

________________________

1Merger related expenses are net of related income taxes of $92,000 and $264,000 for the three and six months ended June 30, 2020, respectively. Branch consolidation charges are net of related income taxes of $59,000 for both the three and six months ended June 30, 2020.
2Assuming a tax rate of 21%.

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6/30/2020

12/31/2019

Tangible Book Value Per Share

(unaudited)

*

Equity attributable to C&F Financial Corporation

$

182,726

$

164,798

Less goodwill

25,191

14,425

Less other intangible assets

2,457

912

Tangible equity attributable to C&F Financial Corporation

$

155,078

$

149,461

Shares outstanding

3,647,447

3,438,126

Book value per share

$

50.10

$

48.07

Tangible book value per share

$

42.52

$

43.61

________________________

*

Derived from audited consolidated financial statements.

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements, including statements concerning the Corporation’s expectations, plans, objectives or beliefs regarding future financial performance; actions and initiatives taken in response to the COVID-19 pandemic; potential effects of the COVID-19 pandemic, including on asset quality, the allowance for loan losses, provision for loan losses, interest rates and bank customers, expected benefits of branch consolidation, impairment of securities and goodwill, future dividend payments, expected impacts of the Corporation’s acquisition of Peoples, strategic business initiatives and the anticipated effects thereof, including lending under the PPP loan program, competition among financial institutions and the expected effects thereof, margin compression, technology initiatives, asset quality, adequacy of allowances for loan losses and the level of future charge-offs, capital levels, the effect of future market industry trends and interest rate environments and the effects of future interest rate fluctuations. These forward-looking statements are subject to significant risks and uncertainties due to factors that could have a material adverse effect on the operations and future prospects of the Corporation, including, but not limited to, changes in:

 

the ability of the Corporation and the Bank to realize the anticipated benefits of the acquisition of Peoples
expected revenue synergies and cost savings from the acquisition of Peoples that may not be fully realized or realized within the expected time frame
revenues following the acquisition of Peoples that may be lower than expected
customer and employee relationships and business operations as a result of disruptions caused by the acquisition of Peoples
the ability of the Corporation and the Bank to realize the anticipated benefits of the branch consolidation
interest rates, such as changes or volatility in the Federal Funds rate, yields on U.S. Treasury securities or mortgage rates
general business conditions, as well as conditions within the financial markets
general economic conditions, including unemployment levels and slowdowns in economic growth, especially related to further and sustained economic impacts of the COVID-19 pandemic, the severity and duration of the pandemic, including whether there is a “second wave” as a result of loosening of government restrictions, the pace of recovery when the pandemic subsides and the heightened impact it has on many of the risks described  herein
the Corporation’s ability to manage the impact of the COVID-19 pandemic, including the steps the Corporation takes in response to COVID-19
potential claims, damages and fines related to litigation or actions arising from the Corporation’s participation in and administration of programs related to the COVID-19 pandemic (including, among other things, the PPP and other programs established pursuant to the Coronavirus Aid, Relief, and Economic Security, or CARES, Act)
the legislative and regulatory climate, including regulatory initiatives with respect to financial institutions, including the Consumer Financial Protection Bureau (the CFPB) and the regulatory and enforcement activities of the CFPB, the application of the Basel III capital standards to C&F Bank, the effect of the Economic Regulatory Relief and Consumer Protection Act (the Act) and changes in the effect of the Act due to issuance of interpretive regulatory guidance or enactment of corrective or supplemental legislation

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monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of the Treasury and the Federal Reserve Board, and the effect of these policies on interest rates and business in our markets
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, including sales prices of repossessed vehicles
the level of net charge-offs on loans and the adequacy of our allowance for loan losses
deposit flows
demand in the secondary residential mortgage loan markets
the level of indemnification losses related to mortgage loans sold
competition from both banks and non-banks, including competition in the non-prime automobile finance markets
demand for financial services in the Corporation’s market area, including demand for loans
the Corporation's technology initiatives and other strategic initiatives
the Corporation’s branch consolidations
cyber threats, attacks or events
reliance on third parties for key services
expansion of C&F Bank’s product offerings
accounting principles, policies and guidelines, and elections made by the Corporation thereunder.

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, 2019, and in Item 1A. “Risk Factors,” of Part II of this Quarterly Report on Form 10-Q, should be considered in evaluating the forward-looking statements contained herein.

Forward-looking statements generally can be identified by the use of words such as “believe,” “expect,” “anticipate,” “estimate,” “plan,” “may,” “will,” “intend,” “should,” “could,” or similar expressions, are not statements of historical fact, and are based on management’s beliefs, assumptions and expectations regarding future events or performance as of the date of this report, taking into account all information currently available.  Readers should not place undue reliance on any forward-looking statement. There can be no assurance that actual results will not differ materially from historical results or those expressed in or implied by such forward-looking statements, or that the beliefs, assumptions and expectations underlying such forward-looking statements will be proven to be accurate. Forward-looking statements are made as of the date of this report and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances arising after the date on which the statement was made, except as otherwise required by law.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no significant changes from the quantitative and qualitative disclosures about market risk made in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

ITEM 4.CONTROLS AND PROCEDURES

The Corporation’s management, including the Corporation’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures were effective as of June 30, 2020 to ensure that information required to be disclosed by the Corporation in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Corporation’s disclosure

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controls and procedures will detect or uncover every situation involving the failure of persons within the Corporation or its subsidiary to disclose material information required to be set forth in the Corporation’s periodic reports.

The Corporation completed the acquisition of Peoples on January 1, 2020, and completed its consolidation and integration of Peoples’ legacy systems and processes in the second quarter of 2020.  The integration of Peoples’ legacy systems and processes did not have a material effect on our internal control over financial reporting.

As a result of the COVID-19 pandemic, a substantial portion of our administrative personnel began working remotely in March 2020.  In order to facilitate this change, which occurred with little advance notice, the Corporation adapted certain technologies and processes.  While our internal controls were not designed specifically to operate in a remote working environment, we believe that our internal control over financial reporting was not materially affected by this change in processes and continues to be effective in a remote working environment.

There were no changes in the Corporation’s internal control over financial reporting during the three months ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II – OTHER INFORMATION

 

ITEM 1A.RISK FACTORS

The following risk factor should be considered in addition to the risk factors disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

The Corporation’s results of operations and financial condition have been, and will likely continue to be, adversely affected by the COVID-19 pandemic and, depending on future developments, may be materially adversely impacted by the COVID-19 pandemic.

The outbreak of the novel coronavirus and the resulting COVID-19 pandemic, the widespread government response and the impact on consumers and businesses in our market area have caused significant disruption in the United States and international economies and financial markets and have had and will likely continue to have a significant impact on the operations and financial performance of the Corporation.  Governments, businesses and the public have taken unprecedented actions to contain the spread of COVID-19 and to mitigate its effects including quarantines, shelter-in-place orders, state of emergency declarations, travel bans, closures of businesses and schools, fiscal stimulus and legislative initiatives to deliver monetary aid and other relief.  Many of these actions have adversely impacted the economy and forced temporary closures of nonessential business, and as a result the businesses of many of our customers have been adversely impacted, which could materially affect our busines, financial condition and results of operations.

Although the scope, duration and full effects of the pandemic are rapidly evolving and cannot be fully known at this time, consequences of the pandemic and efforts to contain the spread of COVID-19 and mitigate the pandemic’s effects have included and may include further market volatility, lower interest rates, disrupted trade and supply chains, increased unemployment and reduced economic activity.  The National Bureau of Economic Research has determined that the U.S. economy  has entered a recession as a result of the effects of the COVID-19 pandemic.  The period of recovery from the economic recession cannot be predicted and may be protracted.  If these effects continue for a prolonged period of time, the Corporation may experience significant delinquencies and credit losses due to the inability of borrowers to make timely payments on loans, net interest margin compression, lower demand for our products and services, decreased capital, which may affect the Corporation’s ability to originate new loans, disruption of operational processes arising from practices of social distancing and telecommuting and potential impairment of assets, including securities available for sale and goodwill.  The COVID-19 pandemic may also exacerbate many of the risk factors identified in the Corporation’s Annual Report on Form 10-K, including risk related to our credit quality, collateral, capital, liquidity, operations, interest rate risk, strategic risk and technology.

Although banks have generally been permitted to continue operating during the COVID-19 outbreak, the outbreak has caused the Corporation to change its business operations, including updating branch operations to comply with

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governmental recommendations, closing the lobbies of our branches except for appointments, and implementing a work from home model for many administrative employees.  These changes may have adverse impacts on the Corporation’s business due to reduced effectiveness of operations, unavailability of personnel, and increased cybersecurity risks related to use of remote technology. Additionally, our business operations may be disrupted if key personnel or significant portions of our employees are unable to work effectively, including because of illness.  The changes in business operations could also have a detrimental effect on the Corporation’s relationships with its customers and could reduce demand for the Corporation’s products and services.

The extent to which the COVID-19 pandemic impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to the duration, spread, severity and impact of the COVID-19 pandemic, and the actions required to contain and mitigate it, the effects of the pandemic on our customers and vendors, the remedial actions and stimulus measures adopted by local, state and federal governments, the timing and availability of government support for the economy and financial markets including indirect governmental support for various financial assets including mortgage loans, the short- and long-term health impacts of the pandemic, and how quickly and to what extent normal economic and operating conditions can resume. If the severity of the COVID-19 pandemic worsens, additional actions may be taken by federal, state, and local governments to contain COVID-19 or treat its impact, including additional shelter-in-place orders. There can be no assurance that any efforts by the Corporation to address the adverse impacts of the COVID-19 pandemic will be effective.  Even after the COVID-19 pandemic has subsided, we may continue to experience adverse impacts to our business as a result of any economic recession or depression that has occurred or may occur in the future, or as a result of changes in the behavior of customers, businesses and their employees. Furthermore, the financial condition of our customers and vendors may be adversely impacted, which may result in an elevated level of loan losses, a decrease in demand for our products and services, or reduced availability of services provided by third parties on which we rely. Any of these events may, in turn, have a material adverse impact our business, results of operations and financial condition.

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

In May 2019, the Board of Directors authorized a program, effective June 1, 2019, to repurchase up to $5.0 million of the Corporation’s common stock through May 31, 2020.  The Corporation had made aggregate common stock repurchases of $2.1 million under the share repurchase program when the program expired on May 31, 2020.  The share repurchase program has not been renewed or extended at this time.

There were no purchases of the Corporation’s common stock during the three months ended June 30, 2020. 

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ITEM 6.EXHIBITS

2.1

Agreement and Plan of Reorganization dated as of August 13, 2019 by and among C&F Financial Corporation and Peoples Bankshares, Incorporated (incorporated by reference to Appendix A to Pre-Effective Amendment No. 1 to Form S-4 filed October 15, 2019)

3.1

Amended and Restated Articles of Incorporation of C&F Financial Corporation, effective March 7, 1994 (incorporated by reference to Exhibit 3.1 to Form 10-Q filed November 8, 2017)

 

 

3.1.1

Amendment to Articles of Incorporation of C&F Financial Corporation (incorporated by reference to Exhibit 3.1.1 to Form 8-K filed January 14, 2009)

 

 

3.2

Amended and Restated Bylaws of C&F Financial Corporation, as adopted February 23, 2016 (incorporated by reference to Exhibit 3.1 to Form 8-K filed February 29, 2016)

10.19.9

Ninth Amendment to Amended and Restated Loan and Security Agreement by and among Wells Fargo Bank, N.A., various financial institutions and C&F Finance Company dated as of May 8, 2020 (incorporated by reference to Exhibit 10.19.9 to Form 8-K filed May 13, 2020)

31.1

Certification of CEO pursuant to Rule 13a-14(a)

 

 

31.2

Certification of CFO pursuant to Rule 13a-14(a)

 

 

32

Certification of CEO/CFO pursuant to 18 U.S.C. Section 1350

 

 

101

The following financial statements from the Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in Inline XBRL, filed herewith: (i) the Consolidated Balance Sheets (unaudited), (ii) the Consolidated Statements of Income (unaudited), (iii) the Consolidated Statements of Comprehensive Income (unaudited), (iv) the Consolidated Statements of Equity (unaudited), (v) the Consolidated Statements of Cash Flows (unaudited) and (vi) the Notes to Consolidated Financial Statements (unaudited)

104

The cover page from the Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in Inline XBRL (included with Exhibit 101)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

C&F FINANCIAL CORPORATION

(Registrant)

Date:

August 5, 2020

By:

/s/ Thomas F. Cherry

Thomas F. Cherry

President and Chief Executive Officer

(Principal Executive Officer)

Date:

August 5, 2020

/s/ Jason E. Long

Jason E. Long

Senior Vice President, Chief Financial Officer and Secretary

(Principal Financial and Accounting Officer)

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