UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2006
For the transition period from to
Commission file number 000-23423
C&F Financial Corporation
(Exact name of registrant as specified in its charter)
(804) 843-2360
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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. x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exhange Act.
Large accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
At April 30, 2006, the latest practicable date for determination, 3,153,248 shares of common stock, $1.00 par value, of the registrant were outstanding.
TABLE OF CONTENTS
Part I - Financial Information
Item 1.
Financial Statements
Consolidated Balance Sheets - March 31, 2006 and December 31, 2005
Consolidated Statements of Income - Three months ended March 31, 2006 and 2005
Consolidated Statements of Shareholders’ Equity - Three months ended March 31, 2006 and 2005
Consolidated Statements of Cash Flows - Three months ended March 31, 2006 and 2005
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Part II - Other Information
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
Signatures
PART I - FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share amounts)
ASSETS
Cash and due from banks
Interest-bearing deposits in other banks
Total cash and cash equivalents
Securities-available for sale at fair value, amortized cost of $65,154 and $64,021, respectively
Loans held for sale, net
Loans, net
Federal Home Loan Bank stock
Corporate premises and equipment, net of accumulated depreciation
Accrued interest receivable
Goodwill
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing demand deposits
Savings and interest-bearing demand deposits
Time deposits
Total deposits
Short-term borrowings
Long-term borrowings
Trust preferred capital notes
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingent liabilities
Shareholders’ equity
Preferred stock ($1.00 par value, 3,000,000 shares authorized)
Common stock ($1.00 par value, 8,000,000 shares authorized, 3,152,548 and 3,140,868 shares issued and outstanding, respectively)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income, net
Total shareholders’ equity
Total liabilities and shareholders’ equity
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Interest income
Interest and fees on loans
Interest on other money market investments
Interest on securities
U.S. government agencies and corporations
Tax-exempt obligations of states and political subdivisions
Corporate bonds and other
Total interest income
Interest expense
Savings and interest-bearing deposits
Certificates of deposit, $100 or more
Other time deposits
Borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Gains on sales of loans
Service charges on deposit accounts
Other service charges and fees
Gain on calls of available for sale securities
Other income
Total noninterest income
Noninterest expenses
Salaries and employee benefits
Occupancy expenses
Other expenses
Total noninterest expenses
Income before income taxes
Income tax expense
Net income
Per share data
Net income – basic
Net income – assuming dilution
Cash dividends paid and declared
Weighted average number of shares – basic
Weighted average number of shares – assuming dilution
2
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands)
Accumulated
Other
ComprehensiveIncome
December 31, 2005
Comprehensive income
Other comprehensive loss, net of tax Unrealized loss on securities, net of reclassification adjustment
Repurchase of common stock
Stock options exercised
Cash dividends
March 31, 2006
____________
Disclosure of Reclassification Amount:
Unrealized net holding losses arising during period
Less: reclassification adjustment for gains included in net income
Unrealized losses on securities, net of reclassification adjustment
3
December 31, 2004
Other comprehensive loss, net of tax Unrealized loss on securities
March 31, 2005
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation
Amortization of intangible assets
Accretion of discounts and amortization of premiums on investment securities, net
Net realized gain on securities
Proceeds from sale of loans
Origination of loans held for sale
Change in other assets and liabilities:
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Proceeds from maturities and calls of securities available for sale
Purchase of securities available for sale
Net increase in customer loans
Purchase of corporate premises and equipment
Sale of corporate premises and equipment
Purchase of Federal Home Loan Bank stock
Net cash used in investing activities
Cash flows from financing activities:
Net decrease in demand, interest bearing demand and savings deposits
Net increase in time deposits
Net increase in borrowings
Proceeds from exercise of stock options
Net cash provided by financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure
Interest paid
Income taxes paid
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with applicable quarterly reporting regulations of the Securities and Exchange Commission. They do not include all of the information and notes required by accounting principles generally accepted in the United States of America 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, 2005.
In the opinion of C&F Financial Corporation’s management, all adjustments, consisting only of normal recurring accruals, necessary to present fairly the financial position as of March 31, 2006 and the results of operations and cash flows for the three months ended March 31, 2006 and 2005 have been made. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.
The consolidated financial statements include the accounts of C&F Financial Corporation (the “Corporation”) and its subsidiary, Citizens and Farmers Bank (the “Bank”), with all significant intercompany transactions and accounts being eliminated in consolidation.
Share-Based Compensation: Effective January 1, 2006, the Corporation adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, which requires that the Corporation recognize expense related to the fair value of share-based compensation awards in net income.
Prior to January 1, 2006, the Corporation accounted for its three share-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, stock compensation expense was not recognized in net income, as all options granted under these plans had an exercise price equal to the fair market value of the underlying common stock on the date of grant. However, prior financial statements included pro forma disclosures of the effect on net income and earnings per share as if the Corporation had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to share-based compensation.
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The following table presents the pro forma disclosures for the quarter ended March 31, 2005.
(in 000’s, except per share amounts)
Net income, as reported
Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects
Pro forma net income
Earnings per share:
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
The Corporation has elected to follow the modified prospective transition method allowed by SFAS No. 123(R). Under the modified prospective transition method, compensation expense is recognized prospectively for all unvested options outstanding at January 1, 2006 and for all awards modified or granted after that date. On December 20, 2005, the Corporation accelerated the vesting of all unvested stock options outstanding under the Corporation’s three share-based compensation plans. The board of directors accelerated the vesting of these options in order to eliminate the Corporation’s recognition of compensation expense associated with these options under the SFAS No. 123(R) modified prospective transition method. Because there were no unvested options outstanding at January 1, 2006 and no options were granted in the first quarter of 2006, no share-based compensation expense was recognized in the first quarter of 2006.
Stock option plan activity for the quarter ended March 31, 2006 is summarized below:
RemainingContractualLife
(in years)*
Value ofUnexercisedIn-TheMoneyOptions
(in 000’s)
Options outstanding, January 1
Exercised
Options outstanding and exercisable, March 31
The total value of in-the-money options exercised during the first quarter of 2006 was $270,000.
In November 2005, Financial Accounting Standards Board (FASB) Staff Position (FSP) No. FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, was issued. This FSP provides an elective alternative simplified method for calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R). Companies may take up to one year from the effective date of the FSP to evaluate
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the available transition alternatives and make a one-time election as to which method to adopt. The Corporation is currently in the process of evaluating the alternative methods.
Note 2
Diluted net income per share has been calculated on the basis of the weighted average number of shares of common stock and common stock equivalents outstanding for the applicable periods. Potentially-dilutive common stock had no effect on income available to common shareholders.
Note 3
During the first three months of 2006, the Corporation repurchased 1,520 shares of its common stock in open-market transactions at prices from $39.43 to $40.00. There were no stock repurchases in the first three months of 2005.
Note 4
Securities in an unrealized loss position at March 31, 2006, by duration of the period of unrealized loss, are shown below. No impairment has been recognized on any securities in a loss position based on management’s intent and demonstrated ability to hold such securities to scheduled maturity or call dates and management’s evaluation that there is no permanent impairment in the value of these securities.
Fair
Value
Unrealized
Loss
Mortgage-backed securities
Obligations of states and political subdivisions
Subtotal-debt securities
Preferred stock
Total temporarily impaired securities
The primary cause of the temporary impairments in the Corporation’s investment in debt securities was the decline in prices as interest rates have risen. There are 46 securities totaling $17.47 million in the Corporation’s debt securities portfolio considered temporarily impaired at March 31, 2006. Because the Corporation has the ability and intent to hold these investments until a recovery of unrealized losses, which may be maturity, the Corporation does not consider these investments to be other-than-temporarily impaired at March 31, 2006. The primary cause of the temporary impairments in the Corporation’s investment in preferred stock was one holding in an energy company, which suffered a liquidity crisis as a result of damage to electric and gas facilities by Hurricanes Katrina and Rita. Despite the extent of the damage done, the energy company believes the impact will be relatively short term and that it has sufficient liquidity to meet its current obligations and fund its restoration efforts from its parent company’s available cash and existing credit facility. The Corporation has evaluated the prospects of the energy company in relation to the severity and duration of the impairment. Based on that evaluation and the Corporation’s ability and intent to hold this investment for a reasonable period of time sufficient for a forecasted recovery of unrealized losses, the Corporation does not consider this investment to be other-than-temporarily impaired at March 31, 2006.
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Securities in an unrealized loss position at December 31, 2005 are shown below by duration of the period of unrealized loss.
U.S government agencies and corporations
Note 5
The Bank has a noncontributory defined benefit plan for which the components of net periodic benefit cost are as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of net obligation at transition
Amortization of prior service cost
Amortization of net loss
Net periodic benefit cost
In December 2005, the Bank made a $28,000 contribution to the plan. This payment was the maximum tax-deductible contribution for 2005 allowable under the Internal Revenue Code.
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Note 6
The Corporation operates in a decentralized fashion in three principal business segments: Retail Banking, Mortgage Banking and Consumer Finance. Revenues from Retail Banking operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Mortgage Banking operating revenues consist principally of gains on sales of loans in the secondary market, loan origination fee income and interest earned on mortgage loans held for sale. Revenues from Consumer Finance consist primarily of interest earned on automobile loans.
The Corporation’s other subsidiaries include:
The results of these other subsidiaries are not significant to the Corporation as a whole and have been included in “Other.”
Revenues:
Total operating income
Expenses:
Personnel expenses
Total operating expenses
Provision for income taxes
Capital expenditures
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The Retail Banking segment extends a warehouse line of credit to the Mortgage Banking segment, providing the funds needed to originate mortgage loans. The Retail Banking segment charges the Mortgage Banking segment interest at the daily FHLB advance rate plus 50 basis points. The Retail Banking segment also provides the Consumer Finance segment with a portion of the funds needed to originate loans and charges the Consumer Finance segment interest at LIBOR plus 175 basis points. The Retail Banking segment acquires certain lot and permanent loans, second mortgage loans and home equity lines of credit 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 Retail Banking segment are not allocated to the Mortgage Banking, Consumer Finance and Other segments.
Note 7
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets an amendment of FASB Statement 140. SFAS No. 156 amends SFAS No. 140 with respect to separately-recognized servicing assets and liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract and requires all servicing assets and liabilities to be initially measured at fair value, if practicable. SFAS No. 156 also permits entities to subsequently measure servicing assets and liabilities using an amortization method or fair value measurement method. Under the amortization method, servicing assets and liabilities are amortized in proportion to and over the estimated period of servicing. Under the fair value measurement method, servicing assets are measured at fair value at each reporting date and changes in fair value are reported in net income for the period the change occurs. Adoption of SFAS No. 156 is required as of the beginning of fiscal years beginning subsequent to September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements. The Corporation does not anticipate that SFAS No. 156 will have a material effect on its financial statements.
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In November 2005, FSP 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, was issued. The guidance in FSP 115-1 amends SFAS No. 115 and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. FSP 115-1 applies to investments in debt and equity securities and cost-method investments. The application guidance within FSP 115-1 includes items to consider in determining whether an investment is impaired, in evaluating if an impairment is other-than-temporary and recognizing impairment losses equal to the difference between the investment’s cost and its fair value when an impairment is determined. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is required for all reporting periods beginning after December 15, 2005. Adoption of FSP 115 did not have a material effect on the Corporation’s financial statements.
In May 2005, the Financial Accounting Standards Board issued SFAS No. 154,Accounting Changes and Error Corrections – A Replacement of APB Opinion No. 20 and FASB Statement No. 3. The new standard changes the requirements for the accounting for and reporting of a change in accounting principle. Among other changes, SFAS No. 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented using the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (1) a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle and (2) correction of errors in previously issued financial statements should be termed a “restatement.” The new standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Adoption of SFAS No. 154 did not have a material effect on the Corporation’s financial statements.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains statements concerning the Corporation’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management and risks and uncertainties. Actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in:
These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.
The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Corporation. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that required our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.
Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the adequacy of the allowance is based on evaluations of
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the collectibility of loans while taking into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay, overall portfolio quality and 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 measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan (or, as a practical expedient, at the loan’s observable market price) or the fair value of the collateral if the loan is collateral dependent. 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. A valuation allowance is maintained to the extent that the measure of the impaired loan is less than the recorded investment. The loans currently designated as impaired are being valued based on collateral. The reserves that we have established are based on appraisals of the collateral and have been adjusted for items such as selling costs and current conditions. We believe these adjustments are reasonable.
Impairment of Securities: Impairment of investment securities results in a write-down that must be included in net income when a market decline below cost is other-than-temporary. We regularly review each investment security for impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer and our ability and intention with regard to holding the security to maturity.
Goodwill: Goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment using a two-step process that begins with an estimation of the fair value of the reporting unit. In assessing the recoverability of the Corporation’s goodwill, all of which was recognized in connection with the Bank’s acquisition of C&F Finance in September 2002, we must make assumptions in order to determine the fair value of the respective assets. Major assumptions used in determining impairment were increases in future income, sales multiples in determining terminal value and the discount rate applied to future cash flows. As part of the impairment test, we performed a sensitivity analysis by increasing the discount rate, lowering sales multiples and reducing increases in future income. We completed the annual test for impairment during the fourth quarter of 2005 and determined there was no impairment to be recognized in 2005. If the underlying estimates and related assumptions change in the future, we may be required to record impairment charges.
Defined Benefit Pension Plan: The Bank maintains a non-contributory, defined benefit pension plan for eligible full-time employees as specified by the plan. Plan assets, which consist primarily of marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Bank’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions include the discount rate, the estimated future return on plan assets and the anticipated rate of future salary increases. Changes in these assumptions in the future, if any, may impact pension expense as measured in accordance with SFAS No. 87, Employers’ Accounting for Pensions.
Accounting for Income Taxes: Determining the Corporation’s effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Corporation’s tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be
given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.
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For further information concerning accounting policies, refer to Note 1 of the Corporation’s Consolidated Financial Statements in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005.
OVERVIEW
Our primary financial goals are to maximize the Corporation’s earnings and to deploy capital in profitable growth initiatives that will enhance shareholder value. We track three primary performance measures in order to assess the level of success in achieving these goals: (i) return on average assets (ROA), (ii) return on average equity (ROE) and (iii) growth in earnings. In addition to these financial performance measures, we track the performance of the Corporation’s three principal business activities: retail banking, mortgage banking and consumer finance. We also actively manage our capital through: growth, stock repurchases and dividends.
Financial Performance Measures. For the Corporation, net income decreased 3.1 percent to $2.53 million for the first quarter ended March 31, 2006 compared to the first quarter of 2005, whereas, net income per share assuming dilution increased 8.5 percent to $.77 per share. The Corporation’s ROA was 1.51 percent for the first quarter of 2006 compared with 1.72 percent for the first quarter of 2005, and its ROE was 16.65 percent for the first quarter of 2006 compared with 14.70 percent for the first quarter of 2005. First quarter 2006 results were affected by the Corporation’s strategic growth and capital management initiatives. Lower net income and ROA in 2006 were attributable to interest expense on the short-term borrowings and trust preferred capital securities used to fund our 2005 share repurchase and operating expenses associated with growth. However, earnings per share and ROE in 2006 were positively affected by the shares repurchased through our tender offer in July 2005.
Principal Business Activities. An overview of the financial results for each of the Corporation’s principal segments is presented below. A more detailed discussion is included in “Results of Operations.”
Retail Banking: Net income for C&F Bank decreased approximately $96,000 to $1.35 million for the quarter ended March 31, 2006 compared to the quarter ended March 31, 2005. The decline reflects the effect of the Virginia Peninsula branch expansion and the operations center relocation on operating expenses, as well as interest expense on short-term borrowings and trust preferred securities to fund our share repurchase in 2005 and higher operational and administrative personnel costs to support growth. Higher noninterest expenses were offset in part by an increase in net interest income, which resulted from an increase in both the amount of and yield on earning assets, and a reduction in the provision for loan losses due to improved asset quality. The Bank’s net interest margin has benefited in the short term as variable-rate loans have repriced as short-term interest rates have increased while deposits have repriced at a more gradual pace. Future earnings of the Retail Banking segment may be impacted by net interest margin compression if the lag in deposit repricing continues to diminish.
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Mortgage Banking: Net income for C&F Mortgage Corporation decreased $116,000 to approximately $451,000 for the quarter ended March 31, 2006 compared to the quarter ended March 31, 2005. Higher personnel and operating expenses associated with loan production growth and expansion in the number of loan production offices, along with continued profit margin compression resulting from competition, were offset in part by an increase in gains on sales of loans. For the first quarter of 2006, the amount of loan originations at C&F Mortgage resulting from refinancings was $72.86 million compared to $79.16 million for the first quarter of 2005. Loans originated for new and resale home purchases for these two time periods were $141.43 million and $123.80 million, respectively. Future earnings of the Mortgage Banking segment may be negatively affected if the upward trend in interest rates continues and there are fewer new and resale home sales and loan refinancings.
Consumer Finance: Net income for C&F Finance Company increased $84,000 to approximately $701,000 for the quarter ended March 31, 2006 compared to the quarter ended March 31, 2005. The increase in 2006 resulted from a 19.1 percent increase in average loans outstanding, which more than offset the increases in the cost of borrowings attributable to rising interest rates, the provision for loan losses and operating expenses to support growth. Operating results in 2006 are benefiting from the completion of C&F Finance’s conversion to a new loan system, the consolidation and relocation of its operations center to a new location in Richmond, Virginia, and a change in the third-party lender for its secured revolving line of credit with financing terms that provide for a rate reduction from the prior terms and lower administration fees—all of which occurred after the first quarter of 2005. We believe that with these improvements we have established a platform with the capacity to support current operations and future growth, which will enhance long-term earnings. Future earnings at the Consumer Finance segment will be further impacted by economic conditions including, but not limited to, the employment market, interest rate levels and the resale market for used automobiles.
Capital Management. Total assets grew by $9.62 million to $681.58 million during the first quarter of 2006 since December 31, 2005, and by $65.03 million since March 31, 2005. A detailed discussion of the changes in our financial position since December 31, 2005 is included in the section “Financial Condition.” Dividends for the first quarter of 2006 were 27 cents per share, a 12.5 percent increase over 24 cents per share in the first quarter of 2005. The weighted average number of shares outstanding in the first quarter of 2006 was 3,148,640 compared to 3,551,093 in the first quarter of 2005. This decrease resulted from the repurchase of approximately 427,000 shares of the Corporation’s common stock in 2005, which was accretive to earnings per share and ROE. On November 4, 2005, the Corporation’s board of directors approved the repurchase of up to an additional 5 percent of the Corporation’s common stock (approximately 156,783 shares) over the twelve months ending November 3, 2006.
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RESULTS OF OPERATIONS
Net Interest Income
Selected Average Balance Sheet Data and Net Interest Margin
Securities
Loans held for sale
Loans
Total earning assets
Time and savings deposits
Total interest-bearing liabilities
Net interest margin
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 changes from the first quarter of 2005 to the first quarter of 2006 in the components of net interest income on a taxable-equivalent basis. 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 relationship of the absolute dollar amounts of the change in each. Loans include both nonaccrual loans and loans held for sale.
Increase (Decrease)
Due to Changes in
Total
Increase
(Decrease)
Interest income:
Interest expense:
Change in net interest income
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Net interest income, on a taxable-equivalent basis, for the three months ended March 31, 2006 was $9.89 million compared to $9.20 million for the first quarter of 2005. The higher net interest income resulted primarily from a 10.2 percent increase in the average balance of interest-earning assets, which was partially offset by a decrease in net interest margin to 6.49 percent in the first quarter of 2006 from 6.66 percent in the first quarter of 2005. The decrease in the net interest margin was a result of a 102 basis point increase in the rate on interest-bearing liabilities that was offset in part by a 78 basis point increase in the yield on interest-earning assets.
All of the Corporation’s principal business segments experienced loan growth during the first quarter of 2006 compared to the first quarter of 2005. The majority of the growth occurred at the Retail Banking segment with an increase in average loans of $58.48 million and at the Consumer Finance segment with an increase in average loans of $18.04 million. The increase in loans in the Retail Banking segment was mainly attributable to loan production in the Virginia Peninsula market and residential construction loan growth. The increase in loans at the Consumer Finance segment was mainly attributable to overall growth at existing locations. The yield on loans held for investment and loans held for sale increased as a result of a general increase in interest rates since mid-2004.
Average securities available for sale decreased $3.32 million during the first quarter of 2006 compared to the first quarter of 2005 and their average yield decreased only slightly. The decline in the average balance resulted from the utilization of proceeds from maturities and calls to partially fund the increase in loan demand.
Average interest-earning deposits at other banks, primarily the FHLB, decreased $16.96 million during the first quarter of 2006 compared to the first quarter of 2005; however, their average yield increased 221 basis points. The decline in the average balance resulted from the liquidation of these low-yielding deposits to fund the increase in loan demand. The yield increase reflected the increase in short-term interest rates beginning in mid-2004.
Although average interest-bearing deposits increased $38.62 million during the first quarter of 2006 compared to the first quarter of 2005, the increase in interest on deposits was influenced to a greater extent by the increase in deposit rates. The average cost of deposits increased 79 basis points during 2006 due to an increase in short-term interest rates, coupled with the repricing of maturing deposits at higher interest rates.
Average borrowings increased $33.30 million during the first quarter of 2006 compared to the first quarter of 2005. This was a result of an increase in borrowings from a third-party lender to fund the increase in loans at the Consumer Finance segment, a new line of credit from a third-party and the issuance of trust preferred capital securities to fund the Corporation’s repurchase of 427,186 shares of its common stock in the third quarter of 2005. The majority of these borrowings are indexed to short-term interest rates and reprice as short-term interest rates change. Accordingly, the average cost of borrowings increased 133 basis points during the first quarter of 2006.
The net interest margin has benefited in the short term as variable-rate loans have repriced as short-term interest rates have increased. However, we expect net interest margin compression to occur in 2006 as the favorable impact of the deposit repricing lag lessens in the longer term and the cost of borrowings continues to increase.
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Noninterest Income
Total noninterest income increased 4.2 percent to $5.99 million for the first quarter of 2006 from $5.75 million for the first quarter of 2005. This increase was attributable to (1) higher gains on sales of loans at the Mortgage Banking segment resulting from an increase in the volume of loans closed and sold and (2) higher service charges and fees at the Consumer Finance segment resulting from fees generated from loan processing and collection. Noninterest income declined at the Retail Banking segment because of a gain recognized in 2005 upon the sale of land adjacent to an existing branch site, offsetting the increase in service charges on deposit accounts and other service charges and fees resulting from deposit growth since the first quarter of 2005.
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Noninterest Expense
Occupancy expense
Total noninterest expense
Total noninterest expense increased 9.17 percent to $10.63 million for the first quarter of 2006 from $9.74 million for the first quarter of 2005. The Retail Banking segment reported an increase in total noninterest expense that was primarily attributable to higher personnel and operating expenses to support growth and technology enhancements. First quarter earnings of the Retail Banking segment included costs associated with our new retail banking branch in Hampton, Virginia, which opened in the first quarter of 2006, and the Kiln Creek branch, which will open in the second quarter of 2006; the start-up costs for an additional two retail bank branches in the Richmond, Virginia area, which will open in 2006; and costs related to our new operations center, which opened in late 2005. The increase in noninterest expenses for the Mortgage Banking segment reflected higher production-based compensation due to an increase in loan production and operating expenses due to an increase in the number of loan production offices.
Income Taxes
Income tax expense for the three months ended March 31, 2006 amounted to $1.12 million, resulting in an effective tax rate of 30.6 percent, compared to $1.16 million, or 30.7 percent, for the three months ended March 31, 2005.
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ASSET QUALITY
Allowance for Loan Losses
The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The following tables summarize the allowance activity for periods indicated:
Allowance, beginning of period
Loans charged off
Recoveries of loans previously charged off
Net loans charged off
Allowance, end of period
During the first quarter of 2006, there was a slight decline in the allowance for loan losses at the combined Retail Banking and Mortgage Banking segments since December 31, 2005. No provision was made to increase the allowance because we believe that the current level of the allowance for loan losses is adequate to absorb any losses on existing loans that may become uncollectible.
The Consumer Finance segment, consisting solely of C&F Finance, accounted for the majority of the activity in the allowance for loan losses during the first quarter of 2006. The increase in the provision for loan losses occurred as a result of loan growth and higher charge-offs. The increase in charge-offs is partially attributable to fewer loan losses being deducted from dealer bad debt reserves, which are no longer being withheld from dealers.
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Nonperforming Assets
Retail and Mortgage Banking
March 31,
2006
December 31,
2005
Nonperforming assets*
Accruing loans past due for 90 days or more
Allowance for loan losses
Nonperforming assets to total loans**
Allowance for loan losses to total loans**
Allowance for loan losses to nonperforming assets
Consumer Finance
Nonaccrual loans
Nonaccrual consumer finance loans to total consumer finance loans
Allowance for loan losses to total consumer finance loans
Nonperforming assets and accruing loans past due 90 days or more of the combined Retail and Mortgage Banking segments at March 31, 2006 and December 31, 2005 consisted primarily of one commercial relationship. In March 2006, the borrower entered into a contract to sell the real estate collateral for these loans. Based upon the current terms of the contract between the borrower and the purchaser, no losses are expected on this relationship and any recovery of past due interest and expenses will be recognized upon the closing of the sale of the collateral.
Nonaccrual loans of the Consumer Finance segment as a percentage of total consumer finance loans declined 100 basis points since December 31, 2005, while the ratio of the allowance for loan losses to total consumer finance loans increased slightly during the same period. The decline in nonaccrual loans reflected cyclical behavior and C&F Finance’s overall effort to reduce nonperforming assets. The allowance for loan losses ratio at March 31, 2006 continued to approximate the ratio at December 31, 2005.
FINANCIAL CONDITION
At March 31, 2006, the Corporation had total assets of $681.58 million compared to $671.96 million at December 31, 2005. The increase was principally a result of an increase in loans held for sale and loans held for investment, which was offset in part by a decline in interest-bearing deposits in other banks. Growth in loan demand was funded by reducing the amount the Corporation placed in lower-yielding overnight funds and additional borrowings.
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Loan Portfolio
The following table sets forth the composition of the Corporation’s loans held for investment in dollar amounts and as a percentage of the Corporation’s total gross loans held for investment at the dates indicated:
Real estate - mortgage
Real estate - construction
Commercial, financial and agricultural
Equity lines
Consumer
Consumer- C&F Finance
Total loans
Less unearned loan fees
Less allowance for loan losses
Total loans, net
The increase in loans held for investment occurred predominantly in (1) the variable-rate category of commercial loans and (2) the fixed-rate category of consumer loans at C&F Finance. Typically, growth in variable-rate loans will favorably impact net interest margin in a rising rate environment. There was also growth in fixed-rate consumer loans at C&F Finance, which are funded by variable-rate borrowings; therefore, net interest margin at C&F Finance will be negatively impacted in a rising interest rate environment.
Investment Securities
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:
Total debt securities
Total available for sale securities
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Deposits totaled $488.11 million at March 31, 2006 compared to $495.44 million at December 31, 2005. This decrease occurred in interest-bearing demand deposits as a result of increasing competition for lower-costing funds in the rising rate environment.
Borrowings totaled $108.67 million at March 31, 2006 compared to $92.00 million at December 31, 2005. This increase occurred in the Retail Banking and Consumer Finance segments to partially fund loan growth.
Off-Balance Sheet Arrangements
As of March 31, 2006, there have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005.
Contractual Obligations
As of March 31, 2006, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in “Management’s Discussion and Analysis” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005.
Liquidity
Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks and nonpledged securities available-for-sale, at March 31, 2006 totaled $45.55 million. The Corporation’s funding sources consist of an established federal funds line with a regional correspondent bank of $14.00 million that had no outstanding balance as of March 31, 2006, an established line with the FHLB that had $30.00 million outstanding under a total line of $122.07 million as of March 31, 2006, an unsecured revolving line of credit with a third-party lender that had $7.00 million outstanding under a total line of $7.00 million as of March 31, 2006 and a revolving line of credit with a third party bank that had $66.47 million outstanding under a total line of $85.00 million as of March 31, 2006. We have no reason to believe these arrangements will not be renewed at maturity.
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 Corporation’s and the Bank’s actual capital amounts and ratios are presented in the following table.
Minimum To BeWell CapitalizedUnder Prompt
Corrective ActionProvisions
As of March 31, 2006:
Total Capital (to Risk-Weighted Assets)
Corporation
Bank
Tier I Capital (to Risk-Weighted Assets)
Tier I Capital (to Average Assets)
As of December 31, 2005:
The capital ratios presented above for the Corporation include the effect of the Corporation’s repurchase of 427,186 shares of its common stock at $41 per share on July 27, 2005. On July 21, 2005, the Corporation issued $10.00 million of trust preferred securities through a statutory business trust to partially fund the share repurchase. The trust preferred securities are treated as Tier 1 capital for regulatory capital adequacy determination purposes up to 25 percent of Tier 1 capital after their inclusion. Accordingly, the entire $10.00 million of the Corporation’s trust preferred securities is included in Tier 1 capital in the Corporation’s capital ratios presented above.
Effects of Inflation
The effect of changing prices on financial institutions is typically different from other industries as the Corporation’s assets and liabilities are monetary in nature. Interest rates are significantly impacted by inflation, but neither the timing nor the magnitude of the changes is directly related to price level indices. Impacts of inflation on interest rates, loan demand and deposits are reflected in the consolidated financial statements.
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There have been no significant changes from the quantitative and qualitative disclosures made in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005.
The Corporation, under the supervision and with the participation of 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 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 March 31, 2006 to ensure that information required to be disclosed by the Corporation in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and regulations 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 controls and procedures will detect or uncover every situation involving the failure of persons within the Corporation or its subsidiary to disclose material information otherwise required to be set forth in the Corporation’s periodic reports.
Management of the Corporation is also responsible for establishing and maintaining adequate internal control over financial reporting and control of the Corporation’s assets to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. There were no changes in the Corporation’s internal control over financial reporting during the Corporation’s first quarter ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
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PART II - OTHER INFORMATION
There have been no material changes in the risk factors faced by the Corporation from those disclosed in the Corporation’s Annual Report to Shareholders on Form 10-K for the year ended December 31, 2005.
Maximum Numberof Shares that
May Yet BePurchased Underthe Program1
January 1-31, 2006
February 1-28, 2006
March 1-31, 2006
Articles of Incorporation of C&F Financial Corporation (incorporated by reference to Exhibit 3.1 to Form 10-KSB filed March 29, 1996)
Bylaws of C&F Financial Corporation (incorporated by reference to Exhibit 3.2 to Form 10-KSB filed March 29, 1996)
Certification of CEO pursuant to Rule 13a-14(a)
Certification of CFO pursuant to Rule 13a-14(a)
Certification of CEO/CFO pursuant to 18 U.S.C. Section 1350
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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.
Date:
May 5, 2006
/s/ Larry G. Dillon
Larry G. Dillon
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
/s/ Thomas F. Cherry
Thomas F. Cherry
Executive Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)
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