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 March 31, 2014
☐
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.)
802 Main Street West Point, VA
23181
(Address of principal executive offices)
(Zip Code)
(804) 843-2360
(Registrant’s telephone number, including area code)
N/A
(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. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐ (Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
At May 8, 2014, the latest practicable date for determination, 3,404,971 shares of common stock, $1.00 par value, of the registrant were outstanding.
TABLE OF CONTENTS
Page
Part I - Financial Information
Item 1.
Financial Statements
Consolidated Balance Sheets - March 31, 2014 (unaudited) and December 31, 2013
Consolidated Statements of Income (unaudited) - Three months ended March 31, 2014 and 2013
Consolidated Statements of Comprehensive Income (unaudited) - Three months ended March 31, 2014 and 2013
Consolidated Statements of Shareholders' Equity (unaudited) - Three months ended March 31, 2014 and 2013
Consolidated Statements of Cash Flows (unaudited) - Three months ended March 31, 2014 and 2013
Notes to Consolidated Financial Statements (unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
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
ITEM 1.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share amounts)
March 31,
2014
December 31,
2013
(Unaudited)
ASSETS
Cash and due from banks
Interest-bearing deposits in other banks
Federal funds sold
Total cash and cash equivalents
Securities-available for sale at fair value, amortized cost of $208,227 and $217,708, respectively
Loans held for sale, at fair value
Loans, net of allowance for loan losses of $34,908 and $34,852, respectively
Restricted stocks, at cost
Corporate premises and equipment, net
Other real estate owned, net of valuation allowance of zero and $4,135, respectively
Accrued interest receivable
Goodwill
Core deposit intangible, net
Bank-owned life insurance
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
Common stock ($1.00 par value, 8,000,000 shares authorized, 3,404,012 and 3,388,793 shares issued and outstanding, respectively)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss), net
)
Total shareholders’ equity
Total liabilities and shareholders’ equity
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31,
Interest income
Interest and fees on loans
Interest on money market investments and federal funds sold
Interest and dividends 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
Net gains on sales/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 common share data
Net income – basic
Net income – assuming dilution
Weighted average number of shares – basic
Weighted average number of shares – assuming dilution
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other comprehensive income (loss), net:
Changes in defined benefit plan assets and benefit obligations
Changes in net loss arising during the period1
Tax effect
Amortization of prior service cost1
Net of tax amount
Unrealized gain on cash flow hedging instruments
Unrealized holding gain arising during the period
Unrealized holding gains (losses) on securities
Unrealized holding gains (losses) arising during the period
Reclassification adjustment for gains included in net income2
Comprehensive income, net
These items are included in the computation of net periodic benefit cost. See Note 7, Employee Benefit Plan, for additional information.
Gains are included in "Net gains on sales/calls of available for sale securities" on the income statement.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands, except per share amounts)
Common
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated Other
Comprehensive
Income (Loss), Net
Total
Shareholders’
Equity
Balance December 31, 2013
Comprehensive income:
Other comprehensive income, net
Share-based compensation
Restricted stock vested
Common stock issued
Cash dividends paid – common stock ($0.29 per share)
Balance March 31, 2014
Income, Net
Balance December 31, 2012
Other comprehensive (loss), net
Stock options exercised
Balance March 31, 2013
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Provision for indemnifications
Provision for other real estate owned losses
Net accretion of acquisition-related fair value adjustments
Accretion of discounts and amortization of premiums on securities, net
Net realized gains on sales/calls of securities
Net realized gains on sales of other real estate owned
Net realized gain on sale of equipment
Income from bank-owned life insurance
Proceeds from sales of loans held for sale
Origination of loans held for sale
Change in other assets and liabilities:
Net cash provided by operating activities
Investing activities:
Proceeds from maturities, calls and sales of securities available for sale
Purchases of securities available for sale
Redemption of restricted stocks
Net increase in customer loans
Proceeds from sales of other real estate owned
Purchases of corporate premises and equipment, net
Net cash provided by (used in) investing activities
Financing activities:
Net increase in demand, interest-bearing demand and savings deposits
Net decrease in time deposits
Net increase in borrowings
Proceeds from exercise of stock options
Issuance of common stock
Cash dividends
Net cash provided by financing activities
Net increase 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
Supplemental disclosure of noncash investing and financing activities
Unrealized (losses) gains on securities available for sale
Loans transferred to other real estate owned
Pension adjustment
Unrealized gain (loss) on cash flow hedging instrument
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2013.
The unaudited consolidated financial statements include the accounts of C&F Financial Corporation (the Corporation) and its wholly-owned subsidiary, Citizens and Farmers Bank (the Bank or C&F Bank). All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, C&F Financial Corporation owns 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 a liability of the Corporation.
Nature of Operations: C&F Financial 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, Citizens and Farmers Bank, which is an independent commercial bank chartered under the laws of the Commonwealth of Virginia. On October 1, 2013, the Corporation acquired Central Virginia Bankshares, Inc. (CVBK) and its wholly-owned subsidiary, Central Virginia Bank (CVB), which was an independent commercial bank chartered under the laws of the Commonwealth of Virginia. On March 22, 2014, CVBK was merged with and into C&F Financial Corporation and CVB was merged with and into C&F Bank.
The Bank has six wholly-owned subsidiaries: C&F Mortgage Corporation and Subsidiaries (C&F Mortgage), C&F Finance Company (C&F Finance), C&F Title Agency, Inc., C&F Investment Services, Inc., 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 subsidiaries, Hometown Settlement Services LLC and Certified Appraisals LLC, provides ancillary mortgage loan production services, such as loan settlements, title searches and residential appraisals. C&F Finance, acquired on September 1, 2002, is a finance company providing automobile loans through indirect lending programs. C&F Title Agency, Inc., organized in October 1992, primarily sells title insurance to the mortgage loan customers of the Bank and C&F Mortgage. C&F Investment Services, Inc., organized in April 1995, is a full-service brokerage firm offering a comprehensive range of investment services. C&F Insurance Services, Inc., organized in July 1999, owns an equity interest in an insurance agency that sells insurance products to customers of the Bank, C&F Mortgage and other financial institutions that have an equity interest in the agency. CVB Title Services, Inc. was organized for the primary purpose of owning membership interests in two insurance-related limited liability companies. Business segment data is presented in Note 9.
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, the allowance for indemnifications, impairment of loans, impairment of securities, the valuation of other real estate owned, the projected benefit obligation under the defined benefit pension plan, the valuation of deferred taxes, fair value measurements 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.
Reclassification: Certain reclassifications have been made to prior period amounts to conform to the current period presentation. None of these reclassifications are considered material.
Derivative Financial Instruments: The Corporation recognizes derivative financial instruments at fair value as either an other asset or an other liability in the consolidated balance sheet. The Corporation’s derivative financial instruments as of March 31, 2014 and December 31, 2013 consisted of (1) the fair value of interest rate lock commitments (IRLCs) on mortgage loans that will be sold in the secondary market and the related forward commitments to sell mortgage loans and mortgage-backed securities (MBS) and (2) interest rate swaps that qualified as cash flow hedges of a portion of the Corporation's trust preferred capital notes. Adjustments to reflect unrealized gains and losses resulting from changes in fair value of the Corporation's IRLCs and forward sales commitments and realized gains and losses upon ultimate sale of the loans are classified as noninterest income. The Corporation's IRLCs and forward loan sales commitments are described more fully in Note 8 and Note 10. The effective portion of 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 or period(s) during which the hedged transaction affects earnings. The cash flow hedges are described more fully in Note 11.
Share-Based Compensation: Compensation expense for the first quarter of 2014 included expense, net of forfeitures, of $241,000 ($149,000 after tax), for restricted stock granted during 2009 through 2014. As of March 31, 2014, there was $2.90 million of total unrecognized compensation expense related to unvested restricted stock that will be recognized over the remaining requisite service periods.
A summary of activity for restricted stock awards during the first three months of 2014 is presented below:
Shares
Weighted-
Average
Grant Date
Fair Value
Unvested, January 1, 2014
Granted
Vested
Forfeitures
Unvested, March 31, 2014
There was no stock option activity during the three months ended March 31, 2014. Stock options outstanding at March 31, 2014 are summarized below:
Exercise
Price*
Remaining
Contractual
Life
(in years)*
Intrinsic
Value of
Unexercised
In-The
Money
Options
(in 000’s)
Options outstanding and exercisable at March 31, 2014
________________________________
*
Weighted average
Recent Significant Accounting Pronouncements:
In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-01, Investments-Equity Method and Joint Ventures - Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force). The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Corporation is currently assessing the effect that ASU 2014-01 will have on its financial statements.
In January 2014, the FASB issued ASU 2014-04, Receivables - Troubled Debt Restructurings by Creditors - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force). The amendments in this ASU clarify that if or when an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Corporation is currently assessing the effect that ASU 2014-04 will have on its financial statements.
In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements and Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization's operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Corporation does not expect the adoption of ASU 2014-08 to have a material effect on its financial statements.
NOTE 2: Business Combinations
On October 1, 2013, the Corporation completed its acquisition of CVBK, the one-bank holding company for CVB. Pursuant to the Agreement and Plan of Merger dated June 10, 2013, CVBK's shareholders received $0.32 for each share of CVBK common stock they owned, or approximately $846,000 in the aggregate. In addition, the Corporation purchased from the U.S. Treasury for $3.35 million all of CVBK's preferred stock and warrants issued to the U.S Treasury under the Capital Purchase Program, including accrued and unpaid dividends on the preferred stock. CVB has seven retail bank branches located in the Virginia counties of Powhatan, Cumberland, Chesterfield and Henrico.
The Corporation accounted for the acquisition using the acquisition method of accounting in accordance with Accounting Standards Codification (ASC) 805, Business Combinations. Under the acquisition method of accounting, the assets and liabilities of CVBK were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. The fair values are preliminary and subject to refinement for up to one year after the acquisition date as additional information relative to the acquisition date fair values becomes available. The Corporation has not made any such adjustments since the acquisition date. The following table details the total consideration paid by the Corporation on October 1, 2013 in connection with the acquisition of CVBK, the fair values of the assets acquired and liabilities assumed, and the resulting goodwill.
(Dollars in thousands)
As Recorded by CVBK
Fair Value Adjustments
As Recorded by the Corporation
Consideration paid:
CVBK common stock
CVBk preferred stock and warrants
Total consideration paid
Identifiable assets acquired:
Cash and cash equivalents
Securities available for sale, at fair value
Loans, net of allowance and unearned income
Other real estate owned, net
Core deposit intangibles
Total identifiable assets acquired
Identifiable liabilities assumed:
Total identifiable liabilities assumed
Net identifiable assets (liabilities) assumed
Goodwill resulting from acquisition
The following table illustrates the unaudited pro forma revenue and net income of the combined entities had the acquisition taken place on January 1, 2013. The unaudited combined pro forma revenue and net income combines the historical results of CVBK with the Corporation's consolidated statement of income for the three months ended March 31, 2013 and, while certain adjustments were made for the estimated effect of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition actually taken place on January 1, 2013. Expenses related to systems conversions and other integration related expenses were incurred during the first quarter of 2014 in connection with merging CVBK into the Corporation and CVB into C&F Bank. 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 Three Months Ended March 31, 2013
Total revenues, net of interest expense
NOTE 3: Securities
Debt and equity securities, all of which were classified as available for sale, are summarized as follows:
March 31, 2014
Amortized
Cost
Gross
Unrealized
Gains
Losses
Estimated
Mortgage-backed securities
Obligations of states and political subdivisions
December 31, 2013
U.S. Treasury securities
Corporate and other debt securities
The amortized cost and estimated fair value of securities, all of which were classified as available for sale, at March 31, 2014, 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.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Proceeds from the maturities, calls and sales of securities available for sale for the three months ended March 31, 2014 were $16.59 million.
The Corporation pledges securities primarily as collateral for public deposits and repurchase agreements. Securities with an aggregate amortized cost of $79.80 million and an aggregate fair value of $81.65 million were pledged at March 31, 2014. Securities with an aggregate amortized cost of $149.22 million and an aggregate fair value of $149.83 million were pledged at December 31, 2013.
Securities in an unrealized loss position at March 31, 2014, by duration of the period of the unrealized loss, are shown below.
Less Than 12 Months
12 Months or More
Fair
Value
Loss
Mortgage backed securities
Total temporarily impaired securities
There are 109 debt securities with fair values totaling $69.7 million considered temporarily impaired at March 31, 2014. The primary cause of the temporary impairments in the Corporation's investments in debt securities was fluctuations in interest rates. Interest rates fell during the first quarter of 2014, primarily in the middle and long-end of the United States Treasury yield curve, thereby reducing unrealized losses on the Corporation's portfolio of securities of U.S. government agencies and corporations and obligations of states and political subdivisions. Slower than expected domestic economic growth, coupled with the expressed intent of the Federal Open Market Committee chairman to keep monetary policy accommodative, helped to reverse the negative fixed income trends that prevailed throughout 2013. The municipal bond sector, which is included in the Corporation's obligations of states and political subdivisions category of securities, experienced improved performance driven by declining interest rates across most of the yield curve, improved fundamental credit quality and favorable market technical factors, as demand for municipal bonds outpaced supply throughout the quarter. At March 31, 2014, approximately 97 percent of the Corporation's obligations of states and political subdivisions, as measured by market value, were rated “A” or better by Standard & Poor's or Moody's Investors Service. Of those in a net unrealized loss position, approximately 98 percent were rated, as measured by market value, “A” or better at March 31, 2014. For the approximate two percent not rated "A" (or equivalent) or better, as measured by market value at March 31, 2014, the Corporation considers these to meet regulatory credit quality standards, such that the securities have low risk of default by the obligor, and the full and timely repayment of principal and interest is anticipated 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 March 31, 2014 and no other-then-temporary impairment has been recognized.
Securities in an unrealized loss position at December 31, 2013, by duration of the period of the unrealized loss, are shown below.
The Corporation’s investment in restricted stocks includes membership stock in the Federal Home Loan Bank (FHLB) and the Community Bankers Bank at March 31, 2014, and additionally included stock in the Federal Reserve Bank at December 31, 2013. Restricted stocks totaled $3.69 million at March 31, 2014 and $4.34 million at December 31, 2013. These membership stocks are generally viewed as long-term investments and as a restricted investment securities, which are carried at cost, because there is no market for the stock, other than member institutions. Therefore, when evaluating these investments for impairment, their value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Corporation does not consider these investments to be other-than-temporarily impaired at March 31, 2014 and no impairment has been recognized. These stocks are shown as a separate line item on the balance sheet and are not a part of the available for sale securities portfolio.
NOTE 4: Loans
Major classifications of loans are summarized as follows:
March 31,2014
December 31,2013
Real estate – residential mortgage
Real estate – construction 1
Commercial, financial and agricultural 2
Equity lines
Consumer
Consumer finance
Less allowance for loan losses
Loans, net
1
Includes the Corporation's real estate construction lending and consumer real estate lot lending.
2
Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.
Consumer loans included $407,000 and $354,000 of demand deposit overdrafts at March 31, 2014 and December 31, 2013, respectively.
The outstanding principal balance and the carrying amount of loans acquired pursuant to the Corporation's acquisition of CVBK (or acquired loans) that were recorded at fair value at the acquisition date and are included in the consolidated balance sheet at March 31, 2014 and December 31, 2013 were as follows:
Acquired Loans -Purchased Credit Impaired
Acquired Loans -Purchased Performing
Acquired Loans - Total
Outstanding principal balance
Carrying amount
Real estate – construction
Commercial, financial and agricultural
Total acquired loans
Loans on nonaccrual status were as follows:
Commercial, financial and agricultural:
Commercial real estate lending
Land acquisition and development lending
Builder line lending
Commercial business lending
Total loans on nonaccrual status
The past due status of loans as of March 31, 2014 was as follows:
30-59 Days
Past Due
60-89 Days
90+ Days
Total Past
Due
Current 1
Total Loans
Past Due and
Accruing
Real estate – construction:
Construction lending
Consumer lot lending
1 For the purposes of the above table, “Current” includes loans that are 1-29 days past due.
The table above includes the following:
•
nonaccrual loans that are current of $2.76 million, 30-59 days past due of $794,000, 60-89 days past due of $7,000 and 90+ days past due of $2.15 million and
loans purchased in the acquisition of CVBK that are current of $121.97 million, 30-59 days past due of $2.05 million, 60-89 days past due of $59,000 and 90+ days past due of $5.50 million, all of which are accruing.
The past due status of loans as of December 31, 2013 was as follows:
Current1
Land acquisition & development lending
1 For the purposes of the table above, “Current” includes loans that are 1-29 days past due.
nonaccrual loans that are current of $2.15 million, 30-59 days past due of $7,000, 60-89 days past due of $306,000 and 90+ days past due of $3.11 million and
loans purchased in the acquisition of CVBK that are current of $131.86 million, 30-59 days past due of $1.33 million, 60-89 days past due of $818,000 and 90+ days past due of $2.98 million of which $3,000 are 90+ days past due and accruing.
There were no loan modifications that were classified as troubled debt restructurings (TDRs) during the three months ended March 31, 2014. During the three months ended March 31, 2013, there was a modification of one $6,000 commercial real estate loan which was classified as a TDR because an interest rate concession was made.
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. There were no TDR payment defaults during the three months ended March 31, 2014. During the three months ended March 31, 2013, there was one TDR payment default on a $3,000 commercial real estate loan.
Impaired loans, which consisted solely of TDRs, and the related allowance at March 31, 2014 were as follows:
Recorded
Investment in
Loans
Unpaid
Principal
Balance
Related
Allowance
Balance-Impaired
Interest
Income
Recognized
Impaired loans, which included TDR loans of $5.62 million, and the related allowance at December 31, 2013 were as follows:
Purchased credit-impaired (PCI) loans had an unpaid principal balance of $47.41 million and a carrying value of $31.21 million at March 31, 2014. Determining the fair value of purchased credit impaired loans required the Corporation to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of the cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the effect of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carry-over of previously established allowance for loan losses from acquired loans.
The PCI loan portfolio related to the CVBK acquisition was accounted for at fair value on the date of acquisition as follows:
October 1, 2013
Contractual principal and interest due
Nonaccretable difference
Expected cash flows
Accretable yield
Purchase credit impaired loans - estimated fair value
The following table presents a summary of the change in the accretable yield of the PCI loan portfolio for the period from December 31, 2013 to March 31, 2014:
Accretable Yield
Accretable yield, December 31, 2013
Accretion
Reclassification of nonaccretable difference due to improvement in expected cash flows
Changes in expected cash flows 1
Accretable yield, March 31, 2014
Represents changes in cash flows expected to be collected due to the effects of modifications and changes in prepayment assumptions.
NOTE 5: Allowance for Loan Losses
The following table presents the changes in the allowance for loan losses by major classification during the three months ended March 31, 2014.
Real Estate
Residential
Mortgage
Construction
Commercial,
Financial and
Agricultural
Equity Lines
Finance
Allowance for loan losses:
Balance at December 31, 2013
Provision charged to operations
Loans charged off
Recoveries of loans previously charged off
Balance at March 31, 2014
The following table presents the changes in the allowance for loan losses by major classification during the three months ended March 31, 2013.
Balance at December 31, 2012
Balance at March 31, 2013
The following table presents, as of March 31, 2014, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment or PCI loans), the total loans, and loans by impairment methodology (individually evaluated for impairment, collectively evaluated for impairment, or PCI loans).
Ending balance: individually evaluated for impairment
Ending balance: collectively evaluated for impairment
Ending balance: PCI loans
Loans:
The following table presents, as of December 31, 2013, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment, collectively evaluated for impairment or PCI loans), the total loans and loans by impairment methodology (individually evaluated for impairment, collectively evaluated for impairment or PCI loans).
Ending balance
Loans by credit quality indicators as of March 31, 2014 were as follows:
Pass
Special
Mention
Substandard
Nonaccrual
Total1
Included in the table above are loans purchased in connection with the acquisition of CVBK of $108.04 million pass rated, $3.30 million special mention, $17.63 million substandard and $603,000 substandard nonaccrual.
Performing
Non-Performing
1 At March 31, 2014, the Corporation did not have any loans classified as Doubtful or Loss.
Loans by credit quality indicators as of December 31, 2013 were as follows:
Included in the table above are loans purchased in connection with the acquisition of CVBK of $115.27 million pass rated, $3.30 million special mention, $17.77 million substandard and $652,000 substandard nonaccrual.
1 At December 31, 2013, the Corporation did not have any loans classified as Doubtful or Loss.
NOTE 6: Stockholders’ Equity and Earnings Per Common Share
Accumulated Other Comprehensive Income (Loss)
The following table presents the cumulative balances of the components of accumulated other comprehensive income (loss), net of deferred tax of $957,000 and $163,000 as of March 31, 2014 and December 31, 2013, respectively.
Net unrealized gains on securities
Net unrecognized loss on cash flow hedges
Net unrecognized losses on defined benefit plan
Total accumulated other comprehensive income (loss)
Common Shares
During the first three months of 2014, the Corporation repurchased 225 shares of its common stock from employees to satisfy tax withholding obligations arising upon the vesting of restricted shares. There were no stock repurchases during the first three months of 2013.
Earnings Per Common Share
The components of the Corporation’s earnings per common share calculations are as follows:
Weighted average number of common shares used in earnings per common share – basic
Effect of dilutive securities:
Stock option awards and Warrant
Weighted average number of common shares used in earnings per common share – assuming dilution
Potential common shares that may be issued by the Corporation for its stock option awards and Warrant are determined using the treasury stock method. Approximately 116,150 and 69,000 shares issuable upon exercise of options were not included in computing diluted earnings per common share for the three months ended March 31, 2014 and 2013, respectively, because they were anti-dilutive.
NOTE 7: Employee Benefit Plan
The Bank has a non-contributory defined benefit pension plan for which the components of net periodic benefit cost are as follows:
Three Months Ended
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of net loss
Net periodic benefit cost
NOTE 8: 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 and equity 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. During the second quarter of 2013, the Corporation elected to begin using 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 March 31, 2014 and December 31, 2013, the Corporation's entire investment securities portfolio was 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 Standard & Poor's Securities Evaluations Inc. (SPSE), Thomson Reuters Pricing Service (TRPS) and Interactive Data Pricing and Reference Data LLC (IDC). 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. SPSE and IDC provide evaluated prices for the Corporation's obligations of states and political subdivisions category of securities. Both sources use 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 and IDC provide 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. Fixed-rate securities issued by the Small Business Association in the U.S. government agencies and corporations category are individually evaluated based upon a hierarchy of security specific information and market data regarding that security or securities with similar characteristics. Pass-through mortgage-backed securities 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 a relative mortgage-backed to-be-announced (TBA) or other benchmark price. TBA 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.
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.
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.
Forward sales commitments. Forward commitments to sell mortgage loans and TBAs are used to mitigate interest rate risk for residential mortgage loans held for sale and IRLCs. Forward commitments to sell mortgage loans and TBAs are considered derivatives and are recorded at fair value, based on (i) committed sales prices from investors for commitments to sell mortgage loans or (ii) observable market data inputs for commitments to sell TBAs. The Corporation's forward sales commitments are classified as Level 2.
Derivative liability - cash flow hedges. The Corporation’s derivative financial instruments have been designated as and qualify as cash flow hedges. 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.
The following table presents the balances of financial assets measured at fair value on a recurring basis.
Fair Value Measurements Using
Assets at
Level 1
Level 2
Level 3
Assets:
Securities available for sale
Total securities available for sale
Loans held for sale
Interest rate lock commitments included in other assets
Forward sales commitments included in other assets
Total assets measured at fair value on a recurring basis
Liabilities:
Derivative liability - cash flow hedges
Preferred stock
Interest rate lock commitments
Forward sales commitments
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 other financial assets at fair value on a nonrecurring basis in accordance with 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.
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. A loan is considered impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. All TDRs are considered impaired loans. The Corporation measures impairment on a loan-by-loan basis for commercial, construction and residential loans in excess of $500,000 by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Additionally, management reviews current market conditions, borrower history, past experience with similar loans and economic conditions. Based on management's review, additional write-downs to fair value may be incurred. The Corporation maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. When the fair value of an impaired loan is based solely on observable cash flows, market price or a current appraisal, the Corporation records the impaired loan as nonrecurring Level 2. However, if based on management's review, additional write-downs to fair value are required, the Corporation records the impaired loan as nonrecurring Level 3.
The measurement of impaired loans of less than $500,000 is based on each loan's future cash flows discounted at the loan's effective interest rate rather than the market rate of interest, which is not a fair value measurement and is therefore excluded from fair value disclosure requirements.
Other real estate owned (OREO). Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. 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 like properties, length of time the properties have been held, and our ability and intention with regard to continued ownership of the properties. The Corporation may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further other-than-temporary deterioration in market conditions. As such, we record OREO as nonrecurring Level 3.
The following table presents the balances of financial assets measured at fair value on a non-recurring basis.
Assets at Fair
Impaired loans, net
The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a non-recurring basis as of March 31, 2014:
Fair Value Measurements at March 31, 2014
Valuation Technique(s)
Unobservable Inputs
Range of Inputs
$
2,573
Appraisals
Discount for current market conditions and estimated selling costs
10%
701
0%
3,274
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 following describes the valuation techniques used by the Corporation to measure its financial instruments at fair value as of March 31, 2014 and December 31, 2013.
Cash and short-term investments. The nature of these instruments and their relatively short maturities provide for the reporting of fair value equal to the historical cost.
Loans, net. The fair value of performing loans is estimated using a discounted expected future cash flows analysis based on current rates being offered on similar products in the market. An overall valuation adjustment is made for specific credit risks as well as general portfolio risks. Based on the valuation methodologies used in assessing the fair value of loans and the associated valuation allowance, these loans are considered Level 3.
Loan totals, as listed in the table below, include impaired loans. For valuation techniques used in relation to impaired loans, see the Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis section in this Note 8.
Accrued interest receivable. The carrying amount of accrued interest receivable approximates fair value.
Bank-owned life insurance (BOLI). The fair value of BOLI is estimated using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the fair value.
Deposits. The fair value of all demand deposit accounts is the amount payable at the report date. For all other deposits, the fair value is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products in active markets (Level 2).
Borrowings. The fair value of borrowings is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products in active markets (Level 2).
Accrued interest payable. The carrying amount of accrued interest payable approximates fair value.
Letters of credit. The estimated fair value of letters of credit is based on estimated fees the Corporation would pay to have another entity assume its obligation under the outstanding arrangements. These fees are not considered material.
Unused portions of lines of credit. The estimated fair value of unused portions of lines of credit is based on estimated fees the Corporation would pay to have another entity assume its obligation under the outstanding arrangements. These fees are not considered material.
The following tables reflect the carrying amounts and estimated fair values of the Corporation's financial instruments whether or not recognized on the balance sheet at fair value.
Fair Value Measurements at March 31, 2014 Using
Carrying Value
Total Fair Value
Financial assets:
Cash and short-term investments
BOLI
Derivative asset
Financial liabilities:
Demand deposits
Derivative liability
Fair Value Measurements at December 31, 2013 Using
The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to balance minimizing interest rate risk and increasing net interest income in current market conditions. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors interest rates, maturities and repricing dates of assets and liabilities and attempts to manage interest rate risk by adjusting terms of new loans, deposits and borrowings and by investing in securities with terms that mitigate the Corporation’s overall interest rate risk.
NOTE 9: Business Segments
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 retail installment sales contracts.
The Corporation’s "Other" segment includes an investment company that derives revenues from brokerage services, an insurance company that derives revenues from insurance services, and a title company that derives revenues from title insurance services. The results of the other segment are not significant to the Corporation as a whole and have been included in “Other.” Certain expenses of the Corporation are also included in “Other,” and consist primarily of interest expense associated with the Corporation’s trust preferred capital notes and other general corporate expenses.
Three Months Ended March 31, 2014
Retail
Banking
Other
Eliminations
Consolidated
Revenues:
Other noninterest income
Total operating income
Expenses:
Other noninterest expenses
Total operating expenses
Income (loss) before income taxes
Provision for (benefit from) income taxes
Net income (loss)
Capital expenditures
Three Months Ended March 31, 2013
The Retail Banking segment extends a warehouse line of credit to the Mortgage Banking segment, providing a portion of 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 by means of a variable rate line of credit that carries interest at one-month LIBOR plus 200-225 basis points and fixed rate loans that carry interest rates ranging from 3.8 percent to 8.0 percent. The Retail 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 Retail Banking segment are not allocated to the Mortgage Banking, Consumer Finance and Other segments.
NOTE 10: Commitments and Financial Instruments with Off-Balance-Sheet Risk
C&F Mortgage enters into IRLCs with customers and will sell the underlying loans to investors on either a best efforts or a mandatory delivery basis. C&F Mortgage mitigates interest rate risk on IRLCs and loans held for sale by (a) entering into forward loan sales contracts with investors for loans to be delivered on a best efforts basis or (b) entering into forward sales contracts of MBS for loans to be delivered on a mandatory basis. Both the IRLCs with customers and the forward sales contracts are considered derivative financial instruments. At March 31, 2014, the Corporation had derivative financial instruments with a notional value of $4.50 million. The fair value of these derivative instruments at March 31, 2014 was $627,000.
C&F Mortgage sells substantially all of the residential mortgage loans it originates to third-party counterparties. As is customary in the industry, the agreements with these counterparties require C&F Mortgage to extend representations and warranties with respect to program compliance, borrower misrepresentation, fraud, and early payment performance. Under the agreements, the counterparties are entitled to make loss claims and repurchase requests of C&F Mortgage for loans that contain covered deficiencies. C&F Mortgage has obtained early payment default recourse waivers for a significant portion of its business. Recourse periods for early payment default for the remaining counterparties 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. C&F Mortgage maintains an indemnification reserve for potential claims made under these recourse provisions. The following table presents the changes in the allowance for indemnification losses for the periods presented:
Three Months
Ended March 31,
Allowance, beginning of period
Provision for indemnification losses
Payments
Allowance, end of period
NOTE 11: Interest Rate Swaps
The Corporation uses interest rate swaps to manage exposure of a portion of its trust preferred capital notes to interest rate risk. 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’s interest rate swaps qualify as cash flow hedges. The Corporation’s cash flow hedges effectively modify a portion of the Corporation’s exposure to interest rate risk by converting variable rates of interest on $10.00 million of the Corporation’s trust preferred capital notes to fixed rates of interest until September 2015.
The cash flow hedges total notional amount is $10.00 million. At March 31, 2014, the cash flow hedges had a fair value of ($290,000), which is recorded in other liabilities. The cash flow hedges were fully effective at March 31, 2014 and therefore the loss on the cash flow hedges was recognized as a component of other comprehensive income (loss), net of deferred income taxes.
NOTE 12: Other Noninterest Expenses
The following table presents the significant components in the consolidated statements of income line “Noninterest Expenses – Other Expenses.”
FDIC insurance expense
Data processing fees
Amortization of core deposit intangible
Telecommunication expenses
Professional fees
Travel and education expenses
All other noninterest expenses
Total Other Noninterest Expenses
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Statement Regarding Forward-Looking Statements
This report contains statements concerning the Corporation’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws and may include, but are not limited to, statements regarding future profitability and financial performance, liquidity, the Corporation’s and each business segment’s loan portfolio, allowance for loan losses, trends regarding the provision for loan losses, trends regarding net loan charge-offs and expected future charge-off activity, trends regarding levels of nonperforming assets and troubled debt restructurings and expenses associated with nonperforming assets, provision for indemnification losses, levels of noninterest income and expense, interest rates and yields, competitive trends in the Corporation's businesses and markets, the deposit portfolio including trends in deposit maturities and rates, interest rate sensitivity, market risk, regulatory developments, monetary policy implemented by the Federal Reserve including quantitative easing programs, capital requirements, growth strategy including the outcome of the recent business combination and financial and other goals. These statements may address issues that involve estimates and assumptions made by management and risks and uncertainties. Actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in:
interest rates, such as the current volatility in yields on U.S. Treasury bonds and increases in mortgage rates
general business conditions, as well as conditions within the financial markets
general economic conditions, including unemployment levels
the legislative/regulatory climate, including the Dodd-Frank Wall Street Reform and Consumer Protection Act ( the Dodd-Frank Act) and regulations promulgated thereunder, the Consumer Financial Protection Bureau (CFPB) and the regulatory and enforcement activities of the CFPB and rules promulgated under the Basel III framework
monetary and fiscal policies of the U.S. Government, including policies of the Treasury and the Federal Reserve Board, including the effect of these policies on interest rates and business in our markets
the ability to achieve the results expected from the CVB acquisition, including anticipated costs savings, continued relationships with major customers and deposit retention
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
demand in the secondary residential mortgage loan markets
the level of indemnification losses related to mortgage loans sold
demand for loan products
deposit flows
the strength of the Corporation’s counterparties
competition from both banks and non-banks
demand for financial services in the Corporation’s market area
the Corporation's expansion and technology initiatives
reliance on third parties for key services
accounting principles, policies and guidelines and elections by the Corporation thereunder
These risks are exacerbated by the turbulence over the past several years in the global and United States financial markets. Continued weakness in the global and United States financial markets could further affect the Corporation’s performance, both directly by affecting the Corporation’s revenues and the value of its assets and liabilities, and indirectly by affecting the Corporation’s counterparties and the economy in general. While there are some signs of improvement in the economic environment, there was a prolonged period of volatility and disruption in the markets, and unemployment has risen to, and remains at, high levels. There can be no assurance that these unprecedented developments will not continue to materially and adversely affect our business, financial condition and results of operations, as well as our ability to raise capital for liquidity and business purposes.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, and other institutions. As a result, defaults by, or even rumors or questions about defaults by, one or more financial services institutions, or the financial services industry generally, could create another market-wide liquidity crisis similar to that experienced in late 2008 and early 2009 and could lead to losses or defaults by us or by other institutions. There is no assurance that any such losses would not materially adversely affect the Corporation’s results of operations.
There can be no assurance that the actions taken by the federal government and regulatory agencies will alleviate the industry or economic factors that may adversely affect the Corporation’s business and financial performance. Further, many aspects of the Dodd-Frank Act remain subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall effect on the Corporation’s business and financial performance.
These risks and uncertainties, and the risks discussed in more detail in Item 1A, "Risk Factors" of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2013, should be considered in evaluating the forward-looking statements contained herein. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.
The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Corporation. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.
Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectibility of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available.
Allowance for Indemnifications: The allowance for indemnifications is established through charges to earnings in the form of a provision for indemnifications, which is included in other noninterest expenses. A loss is charged against the allowance for indemnifications under certain conditions when a purchaser of a loan (investor) sold by C&F Mortgage incurs a loss due to borrower misrepresentation, fraud, early default, or underwriting error. The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses arising from indemnification requests. Management’s judgment in determining the level of the allowance is based on the volume of loans sold, historical experience, current economic conditions and information provided by investors. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
Impairment of Loans: We consider a loan impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We measure impairment on a loan-by-loan basis for commercial, construction and residential loans in excess of $500,000 by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. Troubled debt restructurings (TDRs) are also considered impaired loans, even if the loan balance is less than $500,000. A TDR occurs when we agree to significantly modify the original terms of a loan due to the deterioration in the financial condition of the borrower.
Loans Acquired in a Business Combination: Loans acquired in a business combination, such as C&F Financial Corporation's acquisition of CVBK, are recorded at estimated fair value on the date of acquisition without the carryover of the related allowance for loan losses. Purchased credit-impaired (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 market value, PCI loans were 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," and is available to absorb future credit losses on those loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows may result in a reversal of the provision for loan losses to the extent of prior charges, or a reversal of the nonaccretable difference with a positive effect on future interest income. Further, 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 such cash flows.
Subsequent to acquisition, we evaluate on a quarterly basis our estimate of cash flows expected to be collected. In the current economic environment, 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 will generally result in an increase in 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. The Corporation's PCI loans currently consist of loans acquired in connection with the acquisition of CVBK. PCI loans that were classified as nonperforming loans by CVBK are no longer 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.
Loans not designated PCI loans as of the acquisition date are designated purchased performing 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 in future periods for any deterioration in these loans subsequent to the acquisition.
Impairment of Securities: Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.
Other Real Estate Owned (OREO): Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of like properties, length of time the properties have been held, and our ability and intention with regard to continued ownership of the properties. The Corporation may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further other-than-temporary deterioration in market conditions.
Goodwill: The Corporation's goodwill was recognized in connection with the Corporation's acquisition of CVBK in October 2013 and C&F Bank's acquisition of C&F Finance Company in September 2002. With the adoption of ASU 2011-08, Intangible-Goodwill and Other-Testing Goodwill for Impairment, in 2012, the Corporation is no longer required to perform a test for impairment unless, based on an assessment of qualitative factors related to goodwill, we determine that it is more likely than not that the fair value of goodwill is less than its carrying amount. If the likelihood of impairment is more than 50 percent, the Corporation must perform a test for impairment and we may be required to record impairment charges. In assessing the recoverability of the Corporation’s goodwill, major assumptions used in determining impairment are increases in future income, sales multiples in determining terminal value and the discount rate applied to future cash flows. If an impairment test is performed, we will prepare a sensitivity analysis by increasing the discount rate, lowering sales multiples and reducing increases in future income.
Retirement Plan: The Bank maintains a non-contributory, defined benefit pension plan for eligible full-time employees as specified by the plan. Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Bank’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the interest crediting rate, the estimated future return on plan assets and the anticipated rate of future salary increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may affect pension assets, liabilities or expense.
Derivative Financial Instruments: The Corporation recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated balance sheet. The Corporation's derivative financial instruments consist of (1) the fair value of IRLCs on mortgage loans that will be held for sale and related forward sale commitments and (2) interest rate swaps that qualify as cash flow hedges of a portion of the Corporation's trust preferred capital notes. Because the IRLCs and forward sale commitments are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of the Corporation's IRLCs and forward sales commitments and realized gains and losses upon ultimate sale of the loans are classified as noninterest income. The effective portion of the gain or loss on the Corporation's cash flow hedges is reported as a component of other comprehensive income, net of deferred taxes, and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings. For more information concerning fair value measurements of these instruments, see Part I, Item 1, "Financial Statements" in this Quarterly Report on Form 10-Q under the heading "Note 8: Fair Value of Assets and Liabilities."
Accounting for Income Taxes: Determining the Corporation’s effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Corporation’s tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.
For further information concerning accounting policies, refer to Item 8, “Financial Statements and Supplementary Data,” under the heading “Note 1: Summary of Significant Accounting Policies" in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2013.
OVERVIEW
Our primary financial goals are to maximize the Corporation’s earnings and to deploy capital in profitable growth initiatives that will enhance long-term shareholder value. We track three primary financial performance measures in order to assess the level of success in achieving these goals: (i) return on average assets (ROA), (ii) return on average common equity (ROE), and (iii) growth in earnings. In addition to these financial performance measures, we track the performance of the Corporation’s three principal business activities: retail banking, mortgage banking, and consumer finance. We also actively manage our capital through growth and dividends, while considering the need to maintain a strong regulatory capital position.
On October 1, 2013, the Corporation acquired all of the outstanding common stock of CVBK. On March 22, 2014, CVBK was merged with and into C&F Financial Corporation and CVB was merged with and into C&F Bank. The Corporation's financial position and results of operations as of and for the three months ended March 31, 2014 and its financial position as of December 31, 2013 include the financial position and results of operations of CVBK and CVB.
For more information on this acquisition, see Part I, Item I, "Financial Statements" in this Quarterly Report on Form 10-Q under the heading "Note 2: Business Combinations."
Financial Performance Measures
Net income for the Corporation was $2.9 million, or $0.83 per common share assuming dilution, for the three months ended March 31, 2014, compared with $4.0 million, or $1.19 per common shares assuming dilution, for the three months ended March 31, 2013. The decline in net income for the first quarter of 2014, compared to the same period of 2013, was attributable to lower earnings at the Mortgage Banking and the Consumer Finance segments, offset in part by an increase in earnings at the Retail Banking segment. At the Mortgage Banking segment, mortgage interest rate increases since May of last year led to significantly reduced refinance activity and slowed residential real estate purchases, which has translated into weaker mortgage loan volume and correspondingly lower income from gains on sales of loans and ancillary mortgage lending fees. Loan production in the Corporation's Mortgage Banking segment was also affected by inclement winter weather conditions, low resale and new housing inventories and loan officer turnover. At the Consumer Finance segment, an elevated level of net charge-offs attributable to the continued difficult economic environment for this segment's customers resulted in a higher provision for loan losses during the first quarter of 2014, compared to the same period of 2013. In addition, the average balance and yield on the Consumer Finance segment's loan portfolio have declined as a result of increased competition and loan pricing strategies that competitors have used to grow market share in auto financing. The Retail Banking segment, which reported an increase in earnings during the first quarter of 2014, compared to the first quarter of 2013, benefited from (1) net accretion resulting from purchase adjustments associated with the acquisition of CVB, (2) the effects of the continued low interest rate environment on the cost of deposits, (3) a decline in the provision for loan losses as a result of continued stability in asset quality and (4) a decline in expenses associated with foreclosed properties as a result of the sale of a majority of these properties since the first quarter of 2013.
The Corporation’s ROE and ROA were 10.01 percent and 0.88 percent, respectively, on an annualized basis for the first quarter of 2014, compared with 15.46 percent and 1.64 percent, respectively, for the first quarter of 2013. Both ROE and ROA for the first quarter of 2014 were unfavorably affected by lower first quarter net income during 2014, compared to the same period of 2013. The decline in ROE was also affected by internal capital growth of 11.7 percent since March 31, 2013 resulting from earnings, and the decline in ROA was also affected by asset growth of 34.8 percent since March 31, 2013 resulting from the acquisition of CVBK on October 1, 2013.
Principal Business Activities. An overview of the financial results for each of the Corporation’s principal business segments is presented below. A more detailed discussion is included in “Results of Operations.”
Retail Banking: The Retail Banking segment reported net income of $985,000 for the first quarter of 2014, compared to net income of $696,000 for the first quarter of 2013. The results for the first quarter of 2014 for the Retail Banking segment were significantly affected by the purchase accounting adjustments resulting from the CVB transaction. These adjustments resulted from marking assets and liabilities to fair market values as of the acquisition date. Accordingly, yields on loans and investments acquired from CVB increased and the cost of certificates of deposits assumed from CVB decreased, the benefits of which were partially offset by the amortization of the core deposit intangible and higher depreciation associated with the write-up of certain buildings acquired from CVB. The net accretion attributable to these adjustments was $830,000 for the first quarter of 2014. The improvement in net income of the retail banking segment for the first quarter of 2014 also resulted from (1) the effects of the continued low interest rate environment on the cost of deposits, (2) stability in loan credit quality resulting in a $400,000 decrease in the loan loss provision and (3) a significant decline in foreclosed properties resulting in lower holding costs and loss provisions. Partially offsetting these positive factors were the negative effects of the following: (1) higher personnel costs associated with increased staff levels throughout the branch network combined with the addition of commercial loan personnel focused on growing the segment’s commercial and small business loan portfolios, (2) one-time transaction expenses associated with the merger of CVB into C&F Bank and (3) depreciation of information technology equipment purchased to upgrade CVB's systems and equipment to conform to C&F Bank’s technology infrastructure.
The Bank’s nonperforming assets were $5.3 million at March 31, 2014, compared to $7.2 million at December 31, 2013. Nonperforming assets at March 31, 2014 included $4.6 million in total nonaccrual loans, compared to $4.4 million at December 31, 2013, and $701,000 in foreclosed properties, compared to $2.8 million at December 31, 2013. Troubled debt restructurings were $5.6 million at March 31, 2014 and at December 31, 2013, of which $2.7 million and $2.6 million at March 31, 2014 and at December 31, 2013, respectively, were included in nonaccrual loans. The decline in foreclosed properties during the first quarter of 2014 resulted from sales of properties that had a total carrying value of $2.2 million at December 31, 2013.
Mortgage Banking: The mortgage banking segment reported net income of $15,000 for the first quarter of 2014, compared to net income of $546,000 for the first quarter of 2013. Net income at the mortgage banking segment was negatively affected by (1) higher mortgage interest rates that caused a 48.7 percent decline in the Mortgage Banking segment's loan origination volume during the first quarter of 2014, compared to the first quarter of 2013, (2) lower net interest income, gains on sales of loans and ancillary loan origination fees resulting from lower loan production and (3) higher non-production based personnel costs associated with expansion into Virginia Beach, Virginia. Partially offsetting these negative factors was a decline in production-based compensation. During the first quarter of 2014, the amount of loan originations for refinancings and new and resale home purchases were $12.8 million and $78.6 million, respectively, compared to $82.0 million and $96.2 million, respectively during the first quarter of 2013. If conditions influencing the mortgage banking environment, such as higher interest rates and low housing inventories, do not improve, C&F Mortgage Corporation may experience a continuation of lower loan demand, particularly for mortgage refinancings, which could negatively affect earnings of the mortgage banking segment in future periods.
Consumer Finance: The consumer finance segment reported net income of $2.1 million for the first quarter of 2014, compared to net income of $3.1 million for the first quarter of 2013. Average loans outstanding during the first quarter of 2014 declined $3.7 million, or 1.3 percent, compared to the first quarter of 2013. This decline in the average consumer finance loan portfolio, coupled with an 84 basis point decline in yield on the portfolio, resulted in a $692,000 decline in net interest income. In addition, there was a $745,000 increase in the provision for loan losses resulting from elevated charge-offs throughout the first quarter of 2014, compared to the first quarter of 2013. The increase in loan charge-offs is a result of the current economic environment and, in particular, unemployment rates among the segment's target customers that remain higher than historical levels. The increase in the provision for loan losses during the first quarter of 2014 and the lack of portfolio growth since December 31, 2013 resulted in an increase in the ratio of the allowance for loan losses to total loans to 8.36 percent at March 31, 2014 from 8.32 percent at December 31, 2013. Management believes that the current allowance for loan losses is adequate to absorb probable losses in the consumer finance loan portfolio. However, if the current economic environment continues to contribute to an elevated level of charge-offs, a higher provision for loan losses may be required in future periods.
Capital Management. Total shareholders' equity was $117.2 million at March 31, 2014, compared to $112.9 million at December 31, 2013. Capital growth resulted from earnings for the first three months of 2014 and an increase in unrealized holding gains on securities available for sale, which are a component of accumulated other comprehensive income. These increases were offset in part by dividends declared of 29 cents per share during the first quarter of 2014, which were paid on April 1, 2014. This dividend equates to a payout ratio of 34.1 percent of first quarter basic earnings per share.
RESULTS OF OPERATIONS
The following table presents the average balance sheets, the amounts of interest earned on earning assets, with related yields, and interest expense on interest-bearing liabilities, with related rates, for the three months ended March 31, 2014 and 2013. Loans include loans held for sale. Loans placed on nonaccrual status are included in the balances and are included in the computation of yields, but had no material effect. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid using the federal corporate income tax rate of 34 percent).
TABLE 1: Average Balances, Income and Expense, Yields and Rates
Income/
Expense
Yield/
Rate
Assets
Securities:
Taxable
%
Tax-exempt
Total securities
Interest-bearing deposits in other banks and federal funds sold
Total earning assets
Allowance for loan losses
Total non-earning assets
Liabilities and Shareholders’ Equity
Time and savings deposits:
Interest-bearing demand deposits
Money market deposit accounts
Savings accounts
Other certificates of deposit
Total time and savings deposits
Total interest-bearing liabilities
Interest rate spread
Interest expense to average earning assets (annualized)
Net interest margin (annualized)
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 presents the direct causes of the period-to-period changes in the components of net interest income on a taxable-equivalent basis. We calculated 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 relationship of the absolute dollar amounts of the change in each. Loans include both nonaccrual loans and loans held for sale.
TABLE 2: Rate-Volume Recap
Three Months Ended March 31, 2014 from 2013
Increase (Decrease)
Due to
Increase
Volume
(Decrease)
Interest income:
Interest expense:
Interest-bearing deposits
Borrowings (including trust preferred capital notes)
Change in net interest income
Net interest income, on a taxable-equivalent basis, for the three months ended March 31, 2014 was $19.7 million, compared to $17.6 million for the three months ended March 31, 2013. The increase in net interest income for the first quarter of 2014, compared to the same period of 2013, was a result of an increase in average earning assets resulting from the acquisition of CVBK on October 1, 2013, offset in part by a decrease in the net interest margin. Net interest margin decreased 122 basis points to 6.53 percent for the first quarter of 2014, relative to the same period in 2013. The decrease in net interest margin during the first quarter of 2014 can be attributed to a decrease in the yield on interest-earning assets offset in part by decreases in the cost of interest-bearing liabilities and an increase in demand deposits that pay no interest. The decrease in yield on interest-earning assets was primarily attributable to a large increase in interest-bearing deposits in other banks and federal funds sold, which category of earning assets provides the lowest yield of all categories of earning assets, and decreases in the yields on the investment and loan portfolios. The decrease in the cost of interest bearing liabilities is a result of the sustained low interest rate environment, the repricing of higher-rate certificates of deposit as they mature to lower rates, and a shift in the mix of deposits from higher cost interest-bearing deposits to lower cost deposits, including non-interest-bearing demand deposits and low-cost interest-bearing demand deposits, money market deposits and savings accounts.
Average loans, which includes both loans held for investment and loans held for sale, increased $114.9 million to $844.3 million for the first quarter of 2014, compared to the same period of 2013. In total, average loans held for investment increased $141.0 million from the first quarter of 2013 to the same period of 2014. Average loans in the Retail Banking segment increased $144.5 million primarily as a result of the acquisition of CVBK on October 1, 2013. This increase was offset in part by a $3.7 million decrease in the Consumer Finance segment's average loan portfolio. which declined as a result of increased competition. The Mortgage Banking segment's average portfolio of loans held for sale decreased $26.2 million during the first quarter of 2014, compared to the first quarter of 2013. The decline in demand for mortgage loans and refinancing activity during the first quarter of 2014 resulted in an $86.8 million, or 49 percent, decrease in loan originations compared to the first quarter of 2013.
The overall yield on average loans decreased 55 basis points to 9.36 percent for the first quarter of 2014, compared to the first quarter of 2013. This decline includes an 84 basis point decline in the average yield on the Consumer Finance segment's loan portfolio as a result of aggressive pricing strategies by competitive lenders that lowered rates on newly-originated loans during the second half of 2013 and the first quarter of 2014. Further contributing to the decline in overall loan yield is the reduction in concentration of the Consumer Finance segment loans, which is the highest yielding component of total loans, as a percentage of total loans held for investment. The Consumer Finance segment loan portfolio comprised 34 percent of average loans held for investment during the first quarter of 2014, compared to 41 percent during the first quarter of 2013. Partially offsetting these factors in the first quarter of 2014 was $1.2 million of accretion related to the fair value adjustments to CVB's loan portfolio, which contributed approximately 55 basis points to the yield on loans and 38 basis points to the yield on interest earnings assets and the net interest margin for the first quarter of 2014.
Average securities available for sale increased $63.8 million for the first quarter of 2014, compared to the same period of 2013. This increase occurred primarily in mortgage-backed securities, which were purchased in connection with the acquisition of CVBK. The average yield on the available-for-sale securities portfolio declined 66 basis points for the first quarter of 2014, compared to the first quarter of 2013. The lower yield on the securities portfolio resulted from a shift in the mix of the securities portfolio from 78 percent concentration in higher-yielding tax-exempt securities for the first quarter of 2013 to 56 percent concentration in tax-exempt securities for the first quarter of 2014.
Average interest-bearing deposits in other banks and Federal funds sold increased $122.4 million for the first quarter of 2014, compared to the same period of 2013, primarily as a result of the acquisition of CVBK, which had excess liquidity on the date of acquisition. The average yield on these overnight funds decreased three basis points during the first quarter of 2014, compared to the first quarter of 2013.
Average interest-bearing time and savings deposits increased $271.0 million for the first quarter of 2014, compared to the same period of 2013, primarily as a result of the acquisition of CVBK. However, the effect on interest expense of the higher volume of interest-bearing deposits was significantly offset by a 22 basis point decline in the average cost of interest-bearing deposits, in particular on time deposits which continued to reprice at lower interest rates upon renewal, or were not renewed, as well as accretion of the fair value purchase adjustment on time deposits assumed in the CVB acquisition.
Average borrowings increased $6.9 million for the first quarter of 2014, compared to the same period of 2013. This increase was primarily due to the assumption of trust preferred capital notes in connection with the acquisition of CVBK, which had an average carrying value of $4.7 million during the first quarter of 2014. In addition, average retail repurchase agreements increased on average by $2.2 million during the first quarter of 2014. The cost of borrowings declined slightly during the first quarter of 2014, compared to the same period of 2013, due to the higher average balance of overnight repurchase agreements and the lower variable rate on $10.0 million of trust preferred capital notes issued by the Corporation in 2007, the benefits of which were partially offset by the higher rate on the trust preferred capital notes assumed in connection with the CVBK acquisition.
It will be challenging to maintain the Retail Banking segment's net interest margin at its current level if funds obtained from loan repayments and from deposit growth cannot be fully used to originate new loans and instead are reinvested in lower-yielding earning assets, and if the reduction in earning asset yields exceeds interest rate declines in interest-bearing liabilities, which are approaching their interest rate floors. The Retail Banking segment's net interest margin will benefit in future periods from the net accretion associated with the fair value adjustments to the loans, securities, deposits and borrowings purchased in the CVBK acquisition. If conditions influencing the mortgage banking environment, such as higher interest rates and low housing inventories, do not improve, the Mortgage Banking segment may experience a continuation of lower loan demand, particularly for refinancings, which could reduce interest income on loans originated for sale, further contributing to a deterioration in net interest margin. The net interest margin at the Consumer Finance segment will be most affected by increasing competition and loan pricing strategies that competitors may use to grow market share in automobile financing. This increased competition may result in lower yields as the Consumer Finance segment responds to competitive pricing pressures and fewer purchases of automobile retail installment sales contracts.
Noninterest Income
TABLE 3: Noninterest Income
Other and
Gains on calls of available for sale securities
Gains on sales of loans*
* Gains on sales of loans at the Mortgage Banking segment have been restated to conform to current year presentation.
Total noninterest income decreased $286,000, or 5.6 percent, in the first quarter of 2014, compared to the same period in 2013. An $834,000 decline in noninterest income occurred at the Mortgage Banking segment where gains on sales of loans and ancillary loan origination fees were negatively affected by higher mortgage interest rates and low housing inventories, which caused a 48.7 percent decline in the Mortgage Banking segment's loan origination volume during the first quarter of 2014, compared to the first quarter of 2013. The decline in noninterest income at the Mortgage Banking segment was partially offset by a $514,000 increase in noninterest income at the Retail Banking segment during the first quarter of 2014, which resulted from the acquisition of CVB on October 1, 2013 and the contribution of CVB's operations to noninterest income generated by the Retail Banking segment.
Noninterest Expense
TABLE 4: Noninterest Expenses
Other expenses:
OREO expenses (income)
Total other expenses
Salaries and employee benefits*
OREO expenses
*Salaries and employee benefits for prior periods at the Mortgage Banking segment have been restated to conform to current year presentation.
Total noninterest expenses increased $3.3 million, or 25.5 percent, in the first quarter of 2014, compared to the same period in 2013. Noninterest expenses increased at the Retail Banking segment primarily as a result of the acquisition of CVB. Further increases resulted primarily from higher personnel costs during the first quarter of 2014 at (1) the Retail Banking segment due to increased staffing in the branch network to support customer service initiatives and the addition of new personnel dedicated to growing C&F Bank's commercial and small business loan portfolio, (2) the Mortgage Banking segment due to higher non-production based compensation associated with the expansion into Virginia Beach, Virginia and with regulatory compliance and (3) at the Consumer Finance segment due to an increase in the number of personnel to support expansion into new markets. These increases were partially offset by a lower provision for indemnification losses in connection with loans sold to investors at the Mortgage Banking segment and lower foreclosed properties expenses at the Retail Banking segment as a result of the sale of a majority of these properties since the first quarter of 2013.
Income Taxes
Income tax expense for the first quarter of 2014 totaled $1.1 million, resulting in an effective tax rate of 28.1 percent, compared to $1.9 million and 31.7 percent for the first quarter of 2013. The decline in the effective tax rate during the first quarter of 2014 compared to the first quarter of 2013 was a result of higher earnings at the Retail Banking segment, which generates tax-exempt income on securities issued by states and political subdivisions and is exempt from state income taxes.
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 the periods indicated:
TABLE 5: Allowance for Loan Losses
Provision for loan losses:
Retail Banking segment
Mortgage Banking segment
Consumer Finance segment
Total provision for loan losses
Loans charged off:
Real estate—residential mortgage
Real estate—construction 1
Total loans charged off
Recoveries of loans previously charged off:
Total recoveries
Net loans charged off
Ratio of annualized net charge-offs to average total loans outstanding during period for Retail Banking
)%
Ratio of annualized net charge-offs to average total loans outstanding during period for Consumer Finance
___________
Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
For the first quarter of 2013, the annualized net charge-off ratio for the Retail Banking segment includes a $2.1 million charge-off for a single commercial lending relationship.
Table 6 discloses the allocation of the allowance for loan losses at March 31, 2014 and December 31, 2013.
TABLE 6: Allocation of Allowance for Loan Losses
Allocation of allowance for loan losses:
Total allowance for loan losses
_____________
Loans by credit quality ratings 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 is 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 our 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.
Doubtful 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 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
Real estate—construction 2
Commercial, financial and agricultural 3
At March 31, 2014, the Corporation did not have any loans classified as Doubtful or Loss.
3
Included in the table above are loans purchased in connection with the acquisition of CVBK of $108.4 million pass rated, $3.30 million special mention, $17.63 million substandard, and $603,000 substandard accrual.
Real estate – construction 2
_________
At December 31, 2013, 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 CVBK of $115.3 million pass rated, $3.3 million special mention, $17.8 million substandard and $652,000 substandard nonaccrual.
The Retail Banking segment's allowance for loan losses as of March 31, 2014 increased $12,000 since December 31, 2013 as a result of net recoveries during the first quarter of 2014. The allowance for loan losses as a percentage of total loans, excluding purchased credit impaired loans, was 2.22 percent at both March 31, 2014 and December 31, 2013, and there was no provision for loan losses during the first quarter of 2014. In addition, there was a $930,000 decline in the Retail Banking segment's substandard loans. We believe that the current level of the allowance for loan losses at the Retail Banking segment is adequate to absorb any losses on existing loans that may become uncollectible. If current economic conditions continue or worsen, a higher level of nonperforming loans may be experienced in future periods, which may then require a higher provision for loan losses.
The Consumer Finance segment's allowance for loan losses increased by $29,000 to $23.12 million at March 31, 2014 and its provision for loan losses increased $745,000 for the three months ended March 31, 2014, compared to the same period of 2013. The increase in the provision for loan losses during the first quarter of 2014 and the lack of portfolio growth since December 31, 2013 resulted in an increase in the ratio of the allowance for loan losses to total loans to 8.36 percent at March 31, 2014 from 8.32 percent at December 31, 2013. The increase in the provision for loan losses resulted from elevated charge-offs throughout the first quarter of 2014 attributable to the current economic environment and, in particular, unemployment rates that remain higher than historical levels. We believe that the current level of the allowance for loan losses at the Consumer Finance segment is adequate to absorb any losses on existing loans that may become uncollectible. However, if unemployment levels remain elevated or increase in the future or if the current economic environment continues to contribute to an increase in the segment's defaults, a higher provision for loan losses may become necessary.
Nonperforming Assets
Table 8 summarizes nonperforming assets at March 31, 2014 and December 31, 2013.
TABLE 8: Nonperforming Assets
Retail Banking Segment
Loans, excluding purchased loans
Purchased performing loans1
Purchased credit impaired loans1
Total loans
Nonaccrual loans2
Purchased performing-nonaccrual loans3
Total nonaccrual loans
Real estate owned4
Total nonperforming assets
Accruing loans past due for 90 days or more
Troubled debt restructurings (TDRs)2
Purchased performing TDRs6
Allowance for loan losses (ALL)
Nonperforming assets to total loans and OREO*
ALL to total loans, excluding purchased credit impaired loans7
ALL to total nonaccrual loans
__________
The loans acquired from CVB are traced in two separate categories - "purchased performing" and "purchased credit impaired." The fair market value adjustments for the purchased performing loans are $1.2 million at March 31, 2014 and $1.3 million at December 31, 2013 for interest and $4.6 million at March 31, 2014 and $5.2 million at December 31, 2013 for credit. The fair market value adjustments for the purchased credit impaired loans are $4.8 million at March 31, 2014 and $5.0 million at December 31, 2013 for interest and $11.4 million at March 31, 2014 and $11.5 million at December 31, 2013 for credit.
Nonaccrual loans include nonaccrual TDRs of $2.7 million at March 31, 2014 and $2.6 million at December 31, 2013.
Purchased performing-nonaccrual loans are presented net of fair market value interest and credit marks totaling $312,000 at March 31, 2014 and $488,000 at December 31, 2013.
4
Real estate owned is recorded at its estimated fair market value less cost to sell.
5
As required by acquisition accounting, purchased credit impaired loans that were considered nonaccrual and TDRs prior to the acquisition lose these designations and are not included in post-acquisition nonperforming assets as presented in Table 8.
6
Purchased performing TDRs are accruing and are presented net of fair market value interest and credit marks totaling $6,000 at March 31, 2014 and $11,000 at December 31, 2013.
7
For the purpose of calculating this ratio, purchased performing loans are included in total loans. Purchased performing loans were marked to fair value on acquisition date; therefore, no allowance for loan losses was recorded for these loans.
Mortgage Banking Segment
Nonaccrual loans
ALL
Nonperforming loans to total loans
ALL to loans
ALL to nonaccrual loans
Consumer Finance Segment
Nonaccrual consumer finance loans to total consumer finance loans
ALL to total consumer finance loans
Total nonperforming assets of the Retail Banking segment totaled $5.3 million at March 31, 2014, compared to $7.2 million at December 31, 2013, a 26.25 percent decline during the first quarter of 2014. The Retail Banking Segment's nonperforming assets at March 31, 2014 included $4.6 million of nonaccrual loans, compared to $4.4 million at December 31, 2013, and $701,000 of OREO, compared to $2.8 million at December 31, 2013. We believe we have provided adequate loan loss reserves based on current appraisals or evaluations of the collateral. In some cases, appraisals have been adjusted to reflect current trends including sales prices, expenses, absorption periods and other current relevant factors. The 74.7 percent decline in OREO properties since December 31, 2013 resulted from sales of properties that had a total carrying value of $2.2 million at December 31, 2013.
Nonaccrual loans at the Consumer Finance segment decreased to $937,000 at March 31, 2014 from $1.2 million at December 31, 2013. As noted above, the ratio of the allowance for loan losses to total consumer finance loans was 8.36 percent as of March 31, 2014, compared with 8.32 percent at December 31, 2013. Nonaccrual consumer finance loans remain relatively low compared 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 is 60 days or more past due but before the loan reaches 90 days or more past due and is evaluated for nonaccrual status.
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 maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. 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 consisted solely of TDRs, and the related allowance at March 31, 2014, were as follows:
Impaired loans, which included $5.6 million of TDRs, and the related allowance at December 31, 2013, were as follows:
Balance- Impaired
TDRs (including purchased performing TDRs) at March 31, 2014 and December 31, 2013 were as follows:
TABLE 10: Troubled Debt Restructurings
Accruing TDRs
Nonaccrual TDRs1
Total TDRs2
_______________________________
Included in nonaccrual loans in Table 8: Nonperforming Assets.
Included 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 the Corporation concludes that the borrower is able to make such modified payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the TDR will remain on an accruing status.
FINANCIAL CONDITION
At March 31, 2014, the Corporation had total assets of $1.34 billion, which was an increase of $27.3 million since December 31, 2013. The increase resulted from a $47.5 million increase in cash and cash equivalents, which was driven by reduced loan funding needs of the Mortgage Banking segment, proceeds from maturities and calls of investment securities and a decline in OREO due to sales during the first quarter of 2014. The decision to deploy excess liquidity in interest-bearing deposits in other banks was influenced by the lack of attractively-priced investment securities available for purchase during the first quarter of 2014 and continued weak loan demand at the Retail Banking segment in the current economic environment.
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.
TABLE 11: Summary of Loans Held for Investment
Amount
Percent
Total loans, net
_____________________________________________________________
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, changes in loan demand, general liquidity needs and other similar factors. These securities are carried at estimated fair value. At March 31, 2014 and December 31, 2013, 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 at fair value and as a percentage of the Corporation’s total securities available for sale at the dates indicated.
TABLE 12: Securities Available for Sale
U.S Treasury securities
Total available for sale securities at fair value
For more information about the Corporation's securities available for sale, including a description of securities in an unrealized loss position at March 31, 2014 and December 31, 2013, see Note 3 to the consolidated financial statements filed with this Quarterly Report on Form 10-Q.
The Corporation’s predominant source of funds is depository accounts, which consist 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 quarter of 2014 deposits increased $18.9 million to $1.03 billion at March 31, 2014, compared to $1.01 billion at December 31, 2013. This increase resulted primarily from a $23.5 million increase in non-interest bearing demand deposits of individuals and corporations, partially offset by a $7.3 million decrease in time deposits.
The Corporation had $2.3 million in brokered money market deposits outstanding at March 31, 2014, compared to $2.4 million at December 31, 2013. The source of these brokered deposits is 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 increased to $173.6 million at March 31, 2014 from $169.8 million at December 31, 2013 as a result of a $3.7 million increase in retail overnight repurchase agreements with commercial depositors, the level of which is a function of the deposit balances maintained by these depositors.
Off-Balance Sheet Arrangements
As of March 31, 2014, 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, 2013.
Contractual Obligations
As of March 31, 2014, 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, 2013.
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 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, 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, federal funds sold and nonpledged securities available for sale, at March 31, 2014 totaled $323.1 million, compared to $216.4 million at December 31, 2013. The increase in liquid assets since December 31, 2013 resulted primarily from the Corporation's election in January 2014 to secure public deposits by the pooled method, rather than the dedicated or opt-out method, which reduced the amount of collateral required to secure public deposits and thus increased the amount of unpledged securities. In addition, liquidity increased as a result of reduced funding needs of the Mortgage Banking segment and growth in the Corporation's non-interest bearing demand deposit accounts. The Corporation’s funding sources for borrowings, including the capacity, amount outstanding and amount available at March 31, 2014 are presented in Table 13.
TABLE 13: Funding Sources
Capacity
Outstanding
Available
Unsecured federal funds agreements
Repurchase agreements
Repurchase lines of credit
Borrowings from the FHLB
Borrowings from Federal Reserve Bank
Revolving line of credit
We have no reason to believe these arrangements will not be renewed at maturity. Additional loans and securities are also available that can be pledged as collateral for future borrowings from the Federal Reserve Bank and 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.
Capital Resources
The Corporation’s and the Bank’s actual regulatory capital amounts and ratios under currently applicable regulatory capital standards are presented in the following table.
TABLE 14: Capital Ratios
Actual
Minimum
Requirements
Minimum To Be Well Capitalized
Under Prompt Corrective Action
Provisions
Ratio
As of March 31, 2014:
Total Capital (to Risk-Weighted Assets)
Corporation
Bank
Tier 1 Capital (to Risk-Weighted Assets)
Tier 1 Capital (to Average Assets)
As of December 31, 2013:
CVB
The Corporation’s Tier 1 Capital and Total Capital presented in Table 14 include $25.0 million of trust preferred securities. Under the changes to the regulatory capital framework that were approved on July 9, 2013 by the federal banking agencies (Basel III Final Rule), the Corporation's trust preferred securities will continue to be included in Tier 1 Capital and Total Capital until they mature, pursuant to a "grandfathering" provision that exempts the Corporation's trust preferred securities from the more stringent regulatory capital treatment contained in the Basel III Final Rule for trust preferred securities. In addition to "grandfathering" certain previously outstanding trust preferred securities for community banks, the Basel III Final Rule introduces a new Common Equity Tier 1 Capital measure, increases the applicable minimum regulatory capital levels and certain prompt corrective action capital levels, and establishes a capital conservation buffer and new risk weights for certain types of assets. The Basel III Final Rule is effective for community banks on January 1, 2015 and has a transition period applicable to certain regulatory capital changes until January 1, 2019.
Effects of Inflation and Changing Prices
The Corporation’s financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). 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.
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, 2013.
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 March 31, 2014 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 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.
Management of the Corporation is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). During the first quarter ended March 31, 2014, the Corporation completed the integration of CVBK and CVB into the Corporation's operations, compliance programs and internal control processes. There were no changes in the Corporation’s internal control over financial reporting during the Corporation’s first quarter ended March 31, 2014 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
Other than as disclosed in this Item 1A, "Risk Factors," there have been no material changes in the risk factors faced by the Corporation from those disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
The following table summarizes repurchases of the Corporation's Common Stock that occurred during the three months ended March 31, 2014.
Total Number of Shares Purchased 1
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2014 - January 31, 2014
February 1, 2014 - February 28, 2014
March 1, 2014 - March 31, 2014
_________________________
1 These shares were withheld from an employee to satisfy tax withholding obligations arising upon the vesting of restricted shares.
ITEM 6.
EXHIBITS
2.1
Agreement and Plan of Merger dated as of June 10, 2013 by and among C&F Financial Corporation, Special Purpose Sub, Inc. and Central Virginia Bankshares, Inc. (incorporated by reference to Exhibit 2.1 to Form 8-K filed June 14, 2013)
3.1
Articles of Incorporation of C&F Financial Corporation (incorporated by reference to Exhibit 3.1 to Form 10-KSB filed March 29, 1996)
3.1.1
Amendment to Articles of Incorporation of C&F Financial Corporation establishing Series A Preferred Stock, effective January 8, 2009 (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 October 16, 2007 (incorporated by reference to Exhibit 3.2 to Form 8-K filed October 22, 2007)
4.2
Warrant to Purchase up to 167,504 shares of Common Stock, dated January 9, 2009 (incorporated by reference to Exhibit 4.2 to Form 8-K filed January 14, 2009)
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.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Presentation Linkbase Document
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.
(Registrant)
Date
May 12, 2014
/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)
55