ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Corporation. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements. In addition to current and historical information, the following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future business, financial condition or results of operations. For a description of certain factors that may have a significant impact on our future business, financial condition or results of operations, see “Cautionary Statement Regarding Forward-Looking Statements” prior to Part I, Item 1. “Business.”
OVERVIEW
Our primary financial goals are to maximize the Corporation’s earnings and to deploy capital in profitable growth initiatives that will enhance long-term shareholder value. We track three primary financial performance measures in order to assess the level of success in achieving these goals: (1) return on average assets (ROA), (2) return on average equity (ROE), and (3) growth in earnings. In addition to these financial performance measures, we track the performance of the Corporation’s three business segments: community banking, mortgage banking, and consumer finance. We also actively manage our capital through growth, dividends and share repurchases, while considering the need to maintain a strong capital position. The following table presents selected financial performance highlights for the periods indicated:
TABLE 1: Financial Performance Highlights
(Dollars in thousands, except for per share data) Year Ended December 31,
Net Income (Loss):
Earnings per share - basic and diluted $ 8.29 $ 7.95 $ 6.06
Adjusted earnings per share - basic and diluted1 $ 7.61 $ 8.20 $ 6.06
Adjusted return on average equity1 13.64 % 15.22 % 12.54 %
Return on average assets 1.27 % 1.34 % 1.14 %
Adjusted return on average assets1 1.16 % 1.38 % 1.14 %
The Corporation uses adjusted net income, which is a non-GAAP measure of financial performance, to provide meaningful information about operating performance by excluding the effects of certain items that management does not expect to have an ongoing impact on consolidated net income. Adjusted net income for 2022, 2021 and 2020 excludes the effects of asset disposal activity related to branch consolidation, a change in accounting policy election related to the fair
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value of certain equity investments, charges related to pension settlement accounting, a gain upon sale of a pool of purchased credit impaired (PCI) loans, charges related to early repayment of borrowings, merger related expenses incurred in connection with the Corporation’s acquisition of Peoples Bankshares, Incorporated (Peoples), and changes in tax law. For further information regarding non-GAAP measures, including the impact of the above items on each year, refer to “Use of Certain Non-GAAP Financial Measures” and the accompanying disclosure below within this Item 7.
Consolidated net income and earnings per share increased less than one percent and 4.3 percent, respectively, for 2022, compared to 2021. Adjusted net income and adjusted earnings per share decreased 10.1 percent and 7.2 percent, respectively, for 2022, compared to 2021. The increase in consolidated net income for 2022 compared to 2021 was due primarily to higher net income of the community banking segment, offset by lower net income at the mortgage banking segment and the consumer finance segment. The increase in earnings per share for 2022 compared to 2021 was due primarily to fewer shares outstanding, primarily as a result of share repurchases, and higher net income.
A discussion of the performance of our business segments is included under the heading “Business Segments” in the “Results of Operations” section of this discussion and analysis.
Key factors affecting comparisons of consolidated net income for the years ended December 31, 2022 and 2021 are as follows. Comparisons are to the prior year unless otherwise stated.
● Average consumer finance segment loans increased 29.0 percent;
● Average deposits increased 8.4 percent;
Discussion of consolidated net income and earnings per share for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Overview” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
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Capital Management and Dividends
Total equity was $196.2 million at December 31, 2022, compared to $211.0 million at December 31, 2021. Under regulatory capital standards, the Corporation’s tier I capital and total capital ratios at December 31, 2022 were 12.8 percent and 15.4 percent, respectively, compared to 13.0 percent and 15.8 percent, respectively, at December 31, 2021.
Total consolidated equity decreased $14.8 million at December 31, 2022 compared to December 31, 2021, due primarily to unrealized losses in the market value of securities available for sale of $35.6 million (net of tax), which are recognized as a component of other comprehensive income (loss), partially offset by net income. The Corporation’s securities available for sale are fixed income debt securities, and their decline in market value during 2022 was a result of increases in market interest rates. The Corporation expects to recover its investments in debt securities through scheduled payments of principal and interest, and unrealized losses are not expected to affect the earnings or regulatory capital of the Corporation or the Bank.
The Corporation’s Board of Directors continued its historical practice of paying dividends in 2022. For the year ended December 31, 2022, the Corporation declared dividends of $1.64 per share. Annual dividends per share increased 3.8 percent over dividends of $1.58 per share declared in 2021. The Board of Directors of the Corporation continually reviews the amount of cash dividends per share and the resulting dividend payout ratio in light of changes in economic conditions, current and future capital levels and requirements and expected future earnings. In making its decision on the payment of dividends on the Corporation’s common stock, the Corporation’s Board of Directors considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and other factors.
In November 2021, the Board of Directors of the Corporation authorized a program, effective December 1, 2021, to repurchase up to $10.0 million of the Corporation’s common stock through November 2022 (the 2021 Repurchase Program). During the year ended December 31, 2022, the Corporation repurchased $4.5 million of its common stock under the 2021 Repurchase Program. At the expiration of the 2021 Repurchase Program, the Corporation had made aggregate common stock repurchases of 89,373 shares for an aggregate cost of $4.6 million under that program.
On November 15, 2022, the Board of Directors of the Corporation authorized a new program, effective December 1, 2022, to repurchase up to $10.0 million of the Corporation’s common stock through December 31, 2023 (the 2022 Repurchase Program). Repurchases under the 2022 Repurchase Program may be made through privately negotiated transactions or open market transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and/or Rule 10b-18 under the Securities Exchange Act of 1934, as amended, and shares repurchased will be returned to the status of authorized and unissued shares of common stock. During the year ended December 31, 2022, the Corporation repurchased 7,963 shares, or $454,000, of its common stock under the 2022 Repurchase Program.
At December 31, 2022, the book value per share of the Corporation’s common stock was $56.27, and tangible book value per share, a non-GAAP measure, was $48.54, compared to $59.32 and $51.66, respectively, at December 31, 2021. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for information about non-GAAP financial measures, including a reconciliation to the most directly comparable financial measures calculated in accordance with U.S. GAAP.
2023 Outlook
Management’s overall outlook for 2023 is cautiously positive as a result of the continued successes of our diversified business strategy and initiatives underway at each of our business segments; however, we will continue to face numerous ongoing challenges in 2023, including rising interest rates, economic uncertainty and inflation, cybersecurity risks and increased competition in our markets. The following additional factors could influence our financial performance in 2023:
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CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require management’s most difficult, subjective or complex judgments affecting the application of these policies, and the greatest likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.
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Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Our judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs for relevant periods of time, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. In evaluating the level of the allowance, we consider a range of possible assumptions and outcomes related to the various factors identified above. Under alternative assumptions that we considered in developing our estimate of an allowance that will be adequate to absorb probable losses inherent in the loan portfolio at December 31, 2022, our estimate of the allowance varied between $37 million and $42 million.
For further information concerning the Corporation’s adoption of ASC 326, effective January 1, 2023, refer to Item 8. “Financial Statements and Supplementary Data” under the heading “Note 1: Summary of Significant Accounting Policies.”
Impairment of Loans: We consider a loan impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We measure impairment on a loan-by-loan basis based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment in the loan. All troubled debt restructurings (TDRs) are also considered impaired loans and are evaluated individually. A TDR occurs when we agree to significantly modify the original terms of a loan by granting a concession due to deterioration in the financial condition of the borrower. For more information see the section titled “Asset Quality” within this Item 7.
Goodwill: The Corporation's goodwill was recognized in connection with past business combinations and is reported at the community banking segment and the consumer finance segment. The Corporation reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Corporation may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing is required and the goodwill of the reporting unit is not impaired. If the Corporation elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying value to determine whether an impairment exists. In the last evaluation of goodwill at the community banking segment and the consumer finance segment, which was the annual evaluation in the fourth quarter of 2022, the Corporation concluded that no impairment existed based on an assessment of qualitative factors.
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.”
RESULTS OF OPERATIONS
NET INTEREST INCOME
The following table shows the average balance sheets, the amounts of interest earned on earning assets, with related yields, and interest expense on interest-bearing liabilities, with related rates, for each of the years ended December 31, 2022, 2021 and 2020. 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
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paid) using the federal corporate income tax rate of 21 percent that was applicable for all periods presented. Average balances of securities available for sale are included at amortized cost. Loans include loans held for sale. Loans placed on a nonaccrual status are included in the balances and are included in the computation of yields, but had no material effect.
Accretion and amortization of fair value purchase adjustments related to business combinations are included in the computation of yields on loans and investments and on the costs of deposits and borrowings. The accretion contributed approximately 15 basis points and 10 basis points to the yields on community banking segment loans and total loans, respectively, and 7 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2022, compared to approximately 26 basis points and 18 basis points to the yields on community banking segment loans and total loans, respectively, and 13 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2021, and approximately 34 basis points and 23 basis points to the yields on community banking segment loans and total loans, respectively, and 18 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2020.
The yield on loans includes, with respect to PPP loans, interest at a note rate of one percent as well as net deferred origination fees that are amortized based on the contractual maturity of the related loan or accelerated into interest income upon repayment of the loan. Accretion of net PPP origination fees contributed approximately 6 basis points and 4 basis points to the yields on community banking segment loans and total loans, respectively, and 3 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2022, compared to approximately 39 basis points and 27 basis points to the yields on community banking segment loans and total loans, respectively, and 20 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2021 and approximately 16 basis points and 11 basis points to the yields on community banking segment loans and total loans, respectively, and 9 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2020.
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TABLE 2: Average Balances, Income and Expense, Yields and Rates
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Assets
Securities:
Loans:
Liabilities and Equity
Interest-bearing deposits:
Borrowings:
Other liabilities 40,854 50,929 51,406
Interest rate spread 4.09 % 4.06 % 4.36 %
Net interest margin 4.27 % 4.26 % 4.65 %
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Interest income and expense are affected by fluctuations in interest rates, by changes in the volume of earning assets and interest-bearing liabilities, and by the interaction of rate and volume factors. The following table shows the direct causes of the year-to-year changes in the components of net interest income on a taxable-equivalent basis. The Corporation calculates the rate and volume variances using a formula prescribed by the SEC. Rate/volume variances, the third element in the calculation, are not shown separately in the table, but are allocated to the rate and volume variances in proportion to the absolute dollar amounts of each.
TABLE 3: Rate-Volume Recap
Increase (Decrease) Total Increase (Decrease) Total
Due to Increase Due to Increase
(Dollars in thousands) Rate Volume (Decrease) Rate Volume (Decrease)
Interest income:
Loans:
Securities:
Interest expense:
Interest-bearing deposits:
Savings accounts (13) 20 7 (20) 24 4
Borrowings:
Repurchase agreements 12 40 52 (27) 40 13
Net interest income, on a taxable-equivalent basis, for 2022 increased to $94.0 million, compared to $85.9 million for 2021, due primarily to higher average balances of earning assets and the effects of rising interest rates during 2022 on asset yields, partially offset by lower interest income on PPP and PCI loans. Average earning assets grew $183.7 million, or 9.1 percent, in 2022 compared to 2021, and net interest margin increased 1 basis point to 4.27 percent in 2022, compared to 4.26 percent in 2021. The yield on interest-earning assets and cost of interest-bearing liabilities decreased by 4 basis points and 7 basis points, respectively, for 2022, compared to 2021.
Average loans, which includes both loans held for investment and loans held for sale, increased $49.3 million to $1.6 billion for the year ended December 31, 2022, compared to 2021. Average loans held for investment at the community banking segment, excluding PPP loans, increased $96.4 million, or 9.9 percent, for 2022, compared to 2021. The increase in average loans outstanding at the community banking segment for 2022 compared to 2021 was due primarily to growth in the commercial real estate and residential mortgage segments of the loan portfolio. Average loans held for investment at the consumer finance segment increased $96.9 million, or 29.0 percent, for 2022, compared to 2021 due to higher average balances of automobile loans and marine and RV loans. Average loans at the mortgage banking segment, which consist primarily of loans held for sale, decreased $87.3 million, or 65.4 percent, for 2022, compared to 2021, due primarily to lower mortgage loan production volume in 2022, compared to 2021.
The community banking segment average loan yield decreased 17 basis points to 4.32 percent for 2022, compared to 2021, due primarily to lower recognition of net origination fees on PPP loans and lower interest income on PCI loans, partially offset by the effects of rising interest rates during 2022. The average loan yield for the community banking segment includes, with respect to PPP loans, interest at a note rate of one percent as well as net deferred origination fees that are amortized based on the contractual maturity of the related loan or accelerated into interest income upon repayment
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of the loan. Net PPP origination fees recognized in 2022 were $679,000, compared to $4.1 million in 2021. As of December 31, 2022, all net PPP origination fees received by C&F Bank had been recognized in income, totaling $6.3 million since the inception of the PPP in the second quarter of 2020. The recognition of interest income on PCI loans, which were acquired in connection with past mergers and acquisitions, is based on management’s expectation of future payments of principal and interest, which are inherently uncertain. Earlier than expected repayments of certain PCI loans resulted in the recognition of additional interest income during the years ended December 31, 2022 and 2021. Interest income recognized on PCI loans was $1.6 million for the year ended December 31, 2022 and $2.5 million for the year ended December 31, 2021. The consumer finance segment average loan yield decreased 146 basis points to 9.84 percent for 2022, compared to 2021, due to the consumer finance segment continuing to pursue loan contracts of higher credit quality and lower average yields. This impact on consumer finance segment yields is slowing as the portfolio turns over and new loans are brought on at higher current interest rates. The mortgage banking segment average loan yield increased 153 basis points to 4.41 percent, as mortgage interest rates increased throughout 2022.
Average securities available for sale increased $154.1 million for 2022, compared to 2021, due primarily to higher purchases of securities issued by the U.S. Treasury, government agencies and corporations and mortgage-backed securities. The average yield on the securities portfolio on a taxable-equivalent basis increased 25 basis points for 2022, compared to 2021, due primarily to rising interest rates during 2022, which allowed for purchases of securities at higher yields.
Average interest-bearing deposits in other banks, consisting primarily of excess cash reserves maintained at the Federal Reserve Bank, decreased $19.7 million during 2022, compared to 2021, due primarily to utilizing cash to fund growth in higher yielding loans and securities. The average yield on interest-bearing deposits in other banks increased 68 basis points for 2022, compared to 2021. The Federal Reserve Bank increased the interest rate on excess cash reserve balances from 0.10 percent at the end of 2020 to 0.15 percent by the end of 2021 and to 4.40 percent by the end of 2022.
Average money market, savings and interest-bearing demand deposits increased $142.1 million for 2022, compared to 2021, and average time deposits decreased $56.3 million for 2022, compared to 2021. Average noninterest-bearing demand deposits increased $67.8 million for 2022, compared to 2021. Higher average deposit balances are due primarily to growth in consumer and business checking and money market deposits and a shift to non-time deposits. The average cost of interest-bearing deposits decreased 4 basis points for 2022, compared to 2021, due primarily to lower rates on time deposits and a shift in composition toward non-time deposits, partially offset by higher rates on interest-bearing demand deposits. Offered rates on interest-bearing deposit accounts have increased in response to changes in market interest rates during the second half of 2022. While changes in rates take effect immediately for interest checking, money market and savings accounts, changes in the average cost of time deposits lag changes in pricing based on the repricing of time deposits at maturity.
Average borrowings increased $8.1 million for 2022, compared to 2021, due primarily to increases in balances of repurchase agreements with commercial deposit customers. The average cost of borrowings decreased 59 basis points during 2022 compared to 2021, due primarily to the termination of a revolving bank line of credit during the fourth quarter of 2021 and growth in repurchase agreements, which have a lower average cost than long-term borrowings.
The Corporation believes that higher interest rates will continue to have a positive effect on yields of cash reserves, variable rate loans, new loan originations and purchases of securities available for sale at the community banking segment. Although the Corporation expects the cost of deposits and borrowings to increase in connection with higher rates, the extent to which higher interest rates affect net interest margin will depend on a number of factors, including (1) the Corporation’s ability to continue to grow loans at the community banking segment and consumer finance segment because of competition for loans, (2) the continued availability of funding through low-cost deposits and the Corporation’s ability to compete for deposits, (3) average yields on consumer finance loans, which may decline, albeit at a slower rate than in recent periods, as a result of the higher credit quality of loan contracts purchased by the consumer finance segment, (4) possible lower accretion of discounts on purchased loans, which is included in yields on loans, and (5) the level of mortgage loan production and loans held for sale at the mortgage banking segment. The Corporation can give no assurance as to the timing or extent of further increases in market interest rates or the impact of rising interest rates or any other factor on the Corporation's net interest margin. Alternatively, if market interest rates begin to decline, the Corporation’s net interest
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margin would be adversely affected as the Corporation generally expects its assets to reprice more quickly than its deposits and borrowings.
Discussion of net interest income for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Net Interest Income” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
NONINTEREST INCOME
TABLE 4: Noninterest Income
Year Ended December 31,
Service charges on deposit accounts 4,306 3,718 3,357
Investment income in other equity interests 3,138 456 72
Wealth management services income, net 2,442 2,761 2,618
Mortgage lender services income 1,667 2,492 2,176
Total noninterest income decreased $20.7 million, or 42.1 percent, for the year ended December 31, 2022, compared to the year ended December 31, 2021. The decrease in noninterest income was due primarily to (1) lower volume of mortgage loan production and mortgage lender services, which resulted in lower gains on sales of loans and mortgage banking fee income, (2) lower margins on sales of mortgage loans and (3) fluctuations in unrealized gains and losses related to the Corporation’s nonqualified deferred compensation plan, included in other income (loss), net, partially offset by (1) an increase in investment income in other equity interests, (2) higher debit card interchange income and service charges on deposit accounts at the community banking segment and (3) an increase in gains on sale of former bank property and equipment of $584,000, included in other income (loss), net.
Investment income in other equity interests for the year ended December 31, 2022 includes $2.7 million of net positive fair value adjustments recognized upon a change in accounting policy election for certain equity investments, primarily consisting of equity interests in an independent insurance agency and a full service title and settlement agency, which is not expected to recur. For further information concerning the Corporation’s change in accounting policy election, refer to Item 8. “Financial Statements and Supplementary Data” under the heading “Note 2:Adoption of New Accounting Standards.”
The Corporation recognized unrealized losses related to its nonqualified deferred compensation plan of $3.3 million for the year ended December 31, 2022, respectively, compared to unrealized gains of $2.2 million for the year ended December 31, 2021. Unrealized gains and losses in the Corporation’s nonqualified deferred compensation plan are offset by changes in deferred compensation, recorded in salaries and employee benefits expense.
Discussion of noninterest income for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Income” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
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NONINTEREST EXPENSE
TABLE 5: Noninterest Expense
Year Ended December 31,
Early debt repayment charges — — 2,197
Other expenses:
Mortgage banking loan processing expenses 1,682 3,128 3,235
Other real estate loss/(gain) and expense, net 2 (379) 213
Other components of net periodic pension cost (1,198) 161 (810)
Provision for indemnifications (858) (104) 881
Total noninterest expense decreased $14.1 million, or 14.7 percent, for the year ended December 31, 2022, compared to the year ended December 31, 2021. The decrease in noninterest expenses was due primarily to (1) lower expenses tied to mortgage loan production volume reported in salaries and employee benefits, mortgage banking loan processing expenses and data processing, (2) decreases in salaries and employee benefits related to deferred compensation, (3) a non-cash charge of $1.3 million recorded in 2021, that was not repeated in 2022, related to pension settlement accounting at the community banking segment, as a result of lump sum distributions under the normal terms of C&F Bank’s cash balance pension plan during the year that exceeded the threshold for settlement accounting and (4) a net reversal of provision for indemnifications of $858,000 during 2022 compared to a net reversal of provision for indemnifications of $104,000 in 2021, partially offset by net losses and expenses on other real estate owned (OREO) in 2022 compared to net gains on OREO sold during 2021 related primarily to the sale of one property.
Changes in deferred compensation liabilities decreased salaries and employee benefits expense by $3.3 million for the year ended December 31, 2022, and increased salaries and employee benefits expense by $2.2 million for the year ended December 31, 2021, and were offset in both years by unrealized losses and gains, respectively, recorded in noninterest income.
Discussion of noninterest expense for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Expense” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
INCOME TAXES
Income tax expense on 2022 earnings was $7.6 million, resulting in an effective tax rate of 20.6 percent, compared with $9.0 million, or 23.5 percent, in 2021. The Corporation’s consolidated effective tax rate for the year ended December 31, 2022 was lower compared to the year ended December 31, 2021 due primarily to (1) lower state income taxes in 2022 as a greater share of income before taxes was earned at C&F Bank, which is not subject to state income tax but rather state franchise tax, which is included in noninterest expense, (2) tax benefits of tax-exempt interest income that was higher as a percentage of pre-tax income in 2022 compared to 2021 and (3) a decrease in nondeductible executive compensation due to incentive based compensation and the timing of deferred compensation arrangements.
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Discussion of income taxes for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Income Taxes” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
BUSINESS SEGMENTS
The Corporation operates in a decentralized manner in three business segments: community banking, mortgage banking and consumer finance. An overview of the financial results for each of the Corporation’s business segments is presented below.
Community Banking: The community banking segment comprises C&F Bank, C&F Wealth Management, C&F Insurance and CVB Title. The following table presents the community banking segment operating results for the periods indicated.
TABLE 6: Community Banking Segment Operating Results
Year Ended December 31,
Provision for loan losses (600) (200) 4,600
Noninterest income:
Gain on sales of loans — — 3,489
Service charges on deposit accounts 4,366 3,740 3,357
Wealth management services income, net 2,442 2,761 2,618
Investment income in other equity interests 3,138 456 72
Noninterest expense:
Other real estate loss/(gain) and expense, net 2 (379) 213
The increase in community banking segment net income for the year ended December 31, 2022 compared to the year ended December 31, 2021 was due primarily to:
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partially offset by:
Adjusted net income for the community banking segment, which excludes the effects of real estate disposal activity related to branch consolidation, a change in accounting policy election and pension settlement charges, was $22.0 million for the year ended December 31, 2022, compared to $15.0 million for the same period in 2021. Adjusted net income for the community banking segment increased $7.0 million for the year ended December 31, 2022, compared to the same period in 2021 due primarily to the items discussed above.
Net interest income for the community banking segment increased $10.3 million for the year ended December 31, 2022, compared to the year ended December 31, 2021. This increase was due primarily to (1) the effects of rising interest rates during 2022 on asset yields, (2) higher average balances of interest earning assets, and (3) lower average costs of deposits, resulting from a shift in composition toward non-time deposits. Comparisons of interest income on loans were significantly impacted by recognition of net PPP origination fees and interest income on PCI loans, which were lower for the year ended December 31, 2022 compared to the year ended December 31, 2021. In addition to the effects of these items, higher interest rates on variable rate loans to subsidiaries contributed to the increase in interest income on loans for the year ended December 31, 2022 compared to the year ended December 31, 2021. Net PPP origination fees recognized in the year ended December 31, 2022 were $679,000, compared to $4.1 million for the year ended December 31, 2021 and $1.6 million for the year ended December 31, 2020. All net PPP origination fees received by C&F Bank had been recognized in income as of December 31, 2022, totaling $6.3 million since the inception of the PPP in the second quarter of 2020. Interest income recognized on PCI loans was $1.6 million for the year ended December 31, 2022 compared to $2.5 million for the year ended December 31, 2021.
The community banking segment recorded a net reversal of provision for loan losses of $600,000 for the year ended December 31, 2022, compared to a net reversal of provision for loan losses of $200,000 for the year ended December 31, 2021, due primarily to the resolution of certain impaired loans and continued strong credit quality of the loan portfolio, which were partially offset by provision related to growth in the loan portfolio. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio.
Discussion of the community banking segment for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Principal Business Segments” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
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Mortgage Banking: The following table presents the mortgage banking operating results for the periods indicated.
TABLE 7: Mortgage Banking Segment Operating Results
Year Ended December 31,
Provision for loan losses 32 (45) 10
Noninterest income:
Mortgage lender services fee income 1,667 2,492 2,176
Noninterest expense:
The decrease in mortgage banking segment net income of $6.5 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 was due primarily to (1) lower volume of mortgage loan originations and mortgage lender services, which resulted in lower gains on sales of loans and mortgage banking fee income, (2) lower margins on sales of mortgage loans and (3) lower interest income due to lower average balances of loans held for sale, partially offset by lower expenses tied to mortgage loan origination volume such as salaries and employee benefits, loan processing and data processing and larger net reversal of provision for indemnification losses included in other expenses.
The following table presents mortgage loan originations and mortgage loans sold for the periods indicated.
TABLE 8: Mortgage Loan Originations
Year Ended December 31,
Mortgage loan originations:
1 Total mortgage loan originations does not include mortgage lender services.
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Following the elevated volume levels in the mortgage industry during 2020 and 2021 that accompanied historically low mortgage interest rates and a highly active residential real estate market, the rapid rise in mortgage interest rates during 2022, combined with higher home prices, has led to a substantial decline in mortgage loan originations. Mortgage loan originations for the mortgage banking segment decreased 52.2 percent for the year ended December 31, 2022, compared to the year ended December 31, 2021. Gains on sales of loans, while driven in part by mortgage loan originations, also includes the effects of changes in locked loan commitments, which reflect the volume of mortgage loan applications that are in process and have not closed. Lock-adjusted originations for the mortgage banking segment decreased by 51.3 percent for the year ended December 31, 2022 compared to the year ended December 31, 2021. Locked loan commitments decreased by $41.1 million in the year ended December 31, 2022 and decreased by $115.2 million in the year ended December 31, 2021. Locked loan commitments were $42.3 million at December 31, 2022, compared to $83.4 million at December 31, 2021 and $198.6 million at December 31, 2020.
The mortgage banking segment recorded a net reversal of provision for indemnification losses of $858,000 for the year ended December 31, 2022 and a net reversal of provision for indemnification losses of $104,000 for the year ended December 31, 2021. The release of indemnification reserves in 2022 was due primarily to improvement in the mortgage banking segment’s assessment of borrower payment performance and other factors affecting expected losses on mortgage loans sold in the secondary market. The mortgage banking segment increased reserves for indemnification losses during 2020 based on widespread forbearance on mortgage loans and economic uncertainty related to the COVID-19 pandemic. To date, the mortgage banking segment has not made any payments for indemnification losses since the onset of the COVID-19 pandemic, and management believes that the indemnification reserve is sufficient to absorb losses related to loans that have been sold in the secondary market.
Discussion of the mortgage banking segment for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Principal Business Segments” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
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Consumer Finance: The following table presents the consumer finance operating results for the periods indicated.
TABLE 9: Consumer Finance Segment Operating Results
Year Ended December 31,
Noninterest expense:
The decrease in consumer finance segment net income was due primarily to margin compression resulting from lower average yields on automobile loans and increased costs on variable rate borrowings from the community banking segment and higher provision for loan losses, partially offset by loan growth. Average yields on loans decreased as a result of the consumer finance segment’s pursuing growth in higher quality, lower yielding loans.
Provision for loan losses increased $2.9 million for the year ended December 31, 2022, as compared to the same period of 2021, as a result of significant loan growth in 2022, partially offset by lower required reserves resulting from strong loan performance. The consumer finance segment experienced a higher number of charge-offs during 2022, compared to 2021, as government stimulus measures in response to the pandemic that benefitted borrowers had a decreased effect in 2022, the wholesale value of used automobiles declined from a recent peak during the COVID-19 pandemic, and challenges in repossessing automobiles increased due to a decline in the number of repossession agencies. Although charge-offs began to rise during 2022, charge-offs in both 2022 and 2021 were lower than historical levels for the consumer finance segment, due to strong loan performance and a strong market for used automobiles, which helped drive higher sales prices on repossessed automobiles and mitigated losses on defaulted auto loans. Despite some weakening during second half of 2022, the consumer finance segment has experienced loan performance since 2020 that has been consistently stronger than periods prior to the onset of the COVID-19 pandemic, resulting in part from the consumer finance segment’s strategic decision to purchase higher quality loans, and in part from the impacts of government stimulus measures. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio. If loan performance deteriorates resulting in elevated delinquencies or net charge-offs, provision for loan losses may increase in future periods.
Discussion of the consumer finance segment for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Principal Business Segments” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 1, 2022, and is incorporated herein by reference.
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ASSET QUALITY
Allowance and Provision for Loan Losses
Allowance for Loan Losses Methodology – Community Banking and Mortgage Banking. We conduct an analysis of the collectability of the loan portfolio on a regular basis. This analysis does not apply to PCI loans, loans carried at fair value, loans held for sale or off-balance sheet credit exposure (e.g., unfunded loan commitments and standby letters of credit). We use this analysis to assess the sufficiency of the allowance for loan losses and to determine the necessary provision for loan losses.
The analysis, at a minimum, considers the following factors:
● Changes in the nature and volume of the portfolio and in the terms of loans;
● Changes in the quality of our loan review system;
● The effect of other external factors, such as competition;
● Significant one-time transactions affecting the allowance for loan losses.
In conjunction with the factors described above, we consider the following risk elements that are inherent in the loan portfolio as part of the analysis:
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The review process generally begins with loan officers or management identifying problem loans to be reviewed on an individual basis for impairment. This review of individual loans is limited to those loans that have indications of probable loss or that may result in significant losses to the Corporation, while all other loans, which may include delinquent loans and loans classified as special mention or substandard, are evaluated as a group, as discussed below. In addition, all TDRs are considered impaired loans and are individually evaluated. We consider a loan impaired when it is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement. A loan is not considered impaired during a period of delay in payment if the ultimate collectability of all amounts due is expected. If a loan is considered impaired, impairment is measured 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. A valuation allowance is established for an impaired loan to the extent that this measure of the impaired loan is less than the recorded investment in the loan. When a loan is determined to be impaired, we follow a consistent process to measure that impairment in our loan portfolio. For collateral dependent loans we obtain an updated appraisal if we do not have a current one on file. Appraisals are performed by independent third party appraisers with relevant industry experience. We may make adjustments to the appraised value based on recent sales of similar properties or general market conditions when appropriate. We also estimate costs to sell collateral in the measurement of impairment if those costs are expected to reduce the cash flows available to repay or otherwise satisfy the loan.
The remaining non-impaired loans are grouped by loan type (e.g., commercial real estate, commercial, residential mortgage, consumer). We assign each loan type an allowance factor based on the historical loss rate for that type of loan and an evaluation of the qualitative factors mentioned above to determine a general allowance. We assign classified loans (i.e., special mention, substandard, doubtful, loss) a higher allowance factor than non-classified loans within a particular loan type based on our concerns regarding collectability. Our allowance factors increase with the severity of classification. Allowance factors used for unclassified loans are based on our analysis of charge-off history for relevant periods of time which can vary depending on economic conditions, and our judgment based on the overall analysis of the lending environment including the general economic conditions. Our analysis of charge-off history also considers economic cycles and the trends during those cycles. We may occasionally determine that certain groups of loans require no allowance for losses based on characteristics of those loans as a group, such as purchased loans that are initially recorded at fair value or loans that are guaranteed by U.S. government agencies. Purchased loans other than PCI loans are evaluated in the manner described above, and an allowance is recorded to the extent that the recorded investment in such loans exceeds their outstanding principal net of the required allowance for loan losses. PPP loans require no allowance based on the explicit guarantee of the SBA. The allowance for loan losses is the aggregate of specific allowances and the general allowance for each portfolio type.
As discussed above we segregate loans meeting the criteria for special mention, substandard, doubtful and loss from non-classified, or pass rated, loans. We review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these loan ratings are as follows:
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Allowance for Loan Losses Methodology - PCI Loans - As previously described, on a quarterly basis we evaluate our estimate of cash flows expected to be collected on PCI loans. These evaluations require the continued assessment of key assumptions and estimates similar to the initial estimate of fair value, such as the effect of collateral value changes, changing loss severities, estimated and experienced prepayment speeds and other relevant factors. Subsequent decreases to the expected cash flows to be collected on a PCI loan will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses. For a more detailed description, see “Critical Accounting Estimates” in this Item 7.
Allowance for Loan Losses Methodology – Consumer Finance. The consumer finance segment’s loans consist of automobile loans and marine and RV loans. These loans carry risks associated with (1) the continued credit-worthiness of borrowers and (2) the value of rapidly-depreciating collateral. These loans do not lend themselves to a classification process because of the short duration of time between default, repossession and charge-off. Therefore, the loan loss allowance review process generally focuses on an analysis of charge-off history for relevant periods of time, which can vary depending on economic conditions. Further consideration is given to the following factors:
● Changes in the volume and severity of past due loans;
● Changes in the value of the underlying collateral;
● The effect of other external factors, such as competition;
● An overall analysis of the lending environment;
● Significant one-time transactions affecting the allowance for loan losses.
Loans are grouped by loan type (e.g., automobile loans and marine and RV loans). We assign each loan type an allowance factor based on the historical loss rate for that type of loan and an evaluation of the qualitative factors mentioned above to determine a general allowance. Loans are further segregated between performing and nonperforming loans. Performing loans are those that have made timely payments in accordance with the terms of the loan agreement and that are not past due 90 days or more. Nonperforming loans are those that do not accrue interest and are greater than 90 days past due.
In accordance with its policies and guidelines and consistent with industry practices, C&F Finance, at times, offers payment deferrals, whereby the borrower is allowed to move up to two payments within a twelve-month rolling period to the end of the loan. A fee will be collected for extensions only in states that permit it. An account for which all delinquent payments are deferred is classified as current at the time the deferment is granted and therefore is not included as a delinquent account. Thereafter, such an account is aged based on the timely payment of future installments in the same
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manner as any other account. We evaluate the results of this deferment strategy based upon the amount of cash installments that are collected on accounts after they have been deferred versus the extent to which the collateral underlying the deferred accounts has depreciated over the same period of time. Based on this evaluation, we believe that payment deferrals granted according to our policies and guidelines are an effective portfolio management technique and result in higher ultimate cash collections. Payment deferrals may affect the ultimate timing of when an account is charged off. Increased use of deferrals may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio and therefore increase the allowance for loan losses and related provision for loan losses.
The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The following table presents the Corporation’s loan loss experience for the periods indicated:
TABLE 10: Allowance for Loan Losses
Real Estate Commercial,
Residential Real Estate Financial & Equity Consumer
Loans charged off — — — — (184) (4,381) (4,565)
For further information regarding the adequacy of our allowance for loan losses, refer to “Nonperforming Assets” and the accompanying disclosure below within this Item 7.
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The allocation of the allowance for loan losses at December 31 for the years indicated and the ratio of corresponding outstanding loan balances to total loans are as follows:
TABLE 11: Allocation of Allowance for Loan Losses
December 31, December 31,
Allocation of allowance for loan losses:
Real estate—residential mortgage $ 2,622 $ 2,660
Real estate—construction 1 788 856
Commercial, financial and agricultural 2 10,431 11,085
Total allowance for loan losses $ 40,518 $ 40,157
Ratio of loans to total period-end loans:
Real estate—residential mortgage 16 % 15 %
Real estate—construction 1 4 4
Commercial, financial and agricultural 2 48 51
Equity lines 2 3
Consumer 1 1
Consumer finance3 29 26
Loans by credit quality indicators as of December 31, 2022 were as follows:
TABLE 12: Credit Quality Indicators
Special Substandard
(Dollars in thousands) Pass Mention Substandard Nonaccrual Total1
Real estate – construction 2 59,675 — — — 59,675
Non-
(Dollars in thousands) Performing Performing Total
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Loans by credit quality indicators as of December 31, 2021 were as follows:
Special Substandard
(Dollars in thousands) Pass Mention Substandard Nonaccrual Total1
Real estate – construction 2 57,495 — — — 57,495
Non-
(Dollars in thousands) Performing Performing Total
The decrease in non-pass rated loans at December 31, 2022 compared to December 31, 2021 were due primarily to the resolution of certain impaired loans.
Nonperforming Assets
A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across our loan portfolio.
Assets acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure, establishing a new cost basis. 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. We may incur additional write-downs of foreclosed assets to fair value less estimated costs to sell if valuations indicate a further deterioration in market conditions. Revenue and expenses from operations and changes in the property valuations are included in net expenses from foreclosed assets and improvements are capitalized.
At the consumer finance segment, the repossession process is generally initiated after a loan becomes more than 60 days delinquent. Borrowers have an opportunity to redeem their repossessed vehicles by paying all outstanding balances, including finance charges and fees. Vehicles that are not redeemed within the prescribed waiting period before C&F Finance has the legal right to sell the repossessed vehicle then become available-for-sale at the end of that period and are reclassified from loans to other assets and are recorded initially at fair value less estimated costs to sell. The difference between the carrying amount of each loan and the fair value of the vehicle (i.e. the deficiency) is charged against the allowance for loan losses. Accounts still in process of collection or for which the Corporation does not have the legal right to sell continue to be classified as loans until such legal authority is obtained. After the vehicles have been sold in third-party auctions, we credit the proceeds from the sale of the vehicles, and any other recoveries, to the carrying value of the repossessed vehicles. C&F Finance pursues collection of deficiencies, as allowed by state law, when it deems such action to be appropriate.
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Table 13 summarizes the Corporation’s credit ratios on a consolidated basis as of December 31, 2022 and 2021.
TABLE 13: Consolidated Credit Ratios
December 31,
Allowance for loan losses (ALL) $ 40,518 $ 40,157
Nonaccrual loans to total loans 0.07 % 0.21 %
ALL to total loans 2.48 % 2.85 %
Table 14 summarizes nonperforming assets by principal business segment as of the dates indicated.
TABLE 14: Nonperforming Assets
Community Banking Segment
December 31,
Loans, excluding purchased loans and PPP loans $ 1,121,124 $ 954,262
Purchased credit impaired loans1 1,455 3,655
Nonaccrual loans $ 115 $ 2,359
OREO $ — $ 835
Nonaccrual loans to total loans 0.01 % 0.23 %
ALL to total loans 1.25 % 1.43 %
ALL to total loans, excluding purchased credit impaired loans4 1.25 % 1.44 %
ALL to total loans, excluding purchased loans and PPP loans 1.29 % 1.55 %
Net charge-offs to average total loans 0.02 % 0.01 %
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Mortgage Banking Segment
December 31,
Nonaccrual loans $ 149 $ 185
Impaired loans $ — $ 150
Nonaccrual loans to total loans 21.07 % 1.97 %
ALL to total loans 5.09 % 6.00 %
ALL to nonaccrual loans 24.16 % 304.32 %
Net charge-offs to average total loans - % - %
Consumer Finance Segment
December 31,
Nonaccrual loans $ 925 $ 380
Repossessed assets $ 352 $ 190
Nonaccrual loans to total loans 0.19 % 0.10 %
ALL to total loans 5.47 % 6.73 %
Net charge-offs (recoveries) to average total loans 0.59 % (0.14) %
Table 15 presents the changes in the OREO balance for 2022 and 2021.
TABLE 15: OREO Changes
Year Ended December 31,
Balance at the beginning of year, gross $ 835 $ 1,114
Additions 423 —
Charge-offs — (54)
Gain on disposition 289 237
Balance at the end of year, gross — 835
Less valuation allowance — —
Balance at the end of year, net $ — $ 835
Nonperforming assets of the community banking segment totaled $115,000 at December 31, 2022, compared to $3.2 million at December 31, 2021. Nonperforming assets included $115,000 in nonaccrual loans at December 31, 2022 compared to $2.4 million at December 31, 2021, and included no other real estate owned at December 31, 2022, compared to $835,000 at December 31, 2021. The decrease in nonaccrual loans at December 31, 2022 as compared to December 31, 2021 was primarily due to the resolution of certain impaired loans during 2022. If interest on loans on nonaccrual at December 31, 2022 had been recognized throughout the year, the community banking segment would have recorded additional gross interest income in 2022 of $19,000.
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The allowance for loan losses as a percentage of total loans at the community banking segment, excluding PCI loans, decreased to 1.25 percent at December 31, 2022, compared to 1.44 percent at December 31, 2021. The allowance for loan losses as a percentage of total loans excluding all purchased loans and loans originated under the PPP was 1.29 percent at December 31, 2022, compared to 1.55 percent at December 31, 2021. The community banking segment recorded a net reversal of provision for loan losses of $600,000 in 2022 as compared to a net reversal of provision for loan losses of $200,000 in 2021. At December 31, 2022, the allowance for loan losses decreased to $14.5 million, compared to $14.8 million at December 31, 2021. Decreases in the allowance for loan losses during 2022 related to the resolution of certain impaired loans and continued strong credit quality of the loan portfolio, which were partially offset by provision related to growth in the loan portfolio. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio.
Nonaccrual loans at the consumer finance segment increased to $925,000 at December 31, 2022 from $380,000 at December 31, 2021. Nonaccrual consumer finance loans remain low relative to the allowance for loan losses and the total consumer finance loan portfolio as the consumer finance segment generally initiates repossession of loan collateral once a loan becomes more than 60 days delinquent. Repossessed vehicles of the consumer finance segment are classified as other assets and consist only of vehicles the Corporation has the legal right to sell. Prior to the reclassification from loans to repossessed vehicles, the difference between the carrying amount of each loan and the fair value of each vehicle (i.e. the deficiency) is charged against the allowance for loan losses. At December 31, 2022, repossessed vehicles at fair value less estimated costs to sell included in other assets totaled $352,000, compared to $190,000 at December 31, 2021. If interest on loans on nonaccrual at December 31, 2022 had been recognized throughout the year, the consumer finance segment would have recorded additional gross interest income in 2022 of $10,000.
The consumer finance segment’s allowance for loan losses increased by $1.2 million to $26.0 million at December 31, 2022 from $24.8 million at December 31, 2021. The allowance for loan losses as a percentage of loans decreased to 5.47 percent at December 31, 2022, compared to 6.73 percent at December 31, 2021 due primarily to a continued composition shift in the portfolio towards loans with higher credit quality at origination and improved economic conditions. Total delinquent loans, which does not include loans that have been granted a payment deferral, as a percentage of total loans increased to 2.78 percent at December 31, 2022 compared to 2.16 percent at December 31, 2021. The consumer finance segment experienced net charge-offs for the year ended December 31, 2022 of 0.59 percent of average total loans, compared to net recoveries for the year ended December 31, 2021 of 0.14 percent of average total loans, as government stimulus measures in response to the pandemic that benefitted borrowers had a decreased effect in 2022, the wholesale value of used automobiles declined from a recent peak during the COVID-19 pandemic, and challenges in repossessing automobiles increased due to a decline in the number of repossession agencies. Although charge-offs began to rise during 2022, charge-offs in both 2022 and 2021 were lower than historical levels for the consumer finance segment, due to strong loan performance and a strong market for used automobiles, which helped drive higher sales prices on repossessed automobiles and mitigated losses on defaulted auto loans. Despite some weakening in 2022, the consumer finance segment has experienced loan performance since 2020 that has been consistently stronger than periods prior to the onset of the COVID-19 pandemic, resulting in part from the consumer finance segment’s strategic decision to purchase higher quality loans, and in part from the impact of government stimulus measures. The consumer finance segment recorded provision for loan losses of $3.7 million for the year ended December 31, 2022 and $820,000 for the year ended December 31, 2021, asa result of significant loan growth in 2022, partially offset by lower required reserves resulting from strong loan performance. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio. If loan performance deteriorates resulting in elevated delinquencies or net charge-offs, provision for loan losses may increase in future periods. In addition, provision for loan losses may be higher in future periods if net charge-offs increase, including due to lower recoveries from sales of used automobiles if prices decline.
As previously described, the consumer finance segment, at times, offers payment deferrals as a management technique to achieve higher ultimate cash collections on select loan accounts. Payment deferrals may affect the ultimate timing of when an account is charged off. A significant reliance on deferrals as a means of managing collections may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio. The average amounts deferred on a monthly basis during 2022 were 1.63 percent of average automobile loans outstanding, compared to 1.24 percent during 2021 and 2.93 percent during 2020. Payment deferrals increased for 2020
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as the COVID-19 pandemic affected the ability of some borrowers to make timely payment but were lower in 2021 and 2022.
The consumer finance segment is an indirect lender that provides automobile financing through lending programs that are designed to serve customers in both the prime and “non-prime” markets, including those who may have limited access to traditional automobile financing due to having experienced prior credit difficulties. The preferred automobile is a later model, low mileage used vehicle because the value of new vehicles typically depreciates rapidly. In addition to automobile financing, marine and RV loan contracts are also purchased on an indirect basis through a referral program administered by a third party. The marine and RV loan contracts are for prime loans averaging less than $50,000 made to individuals with higher credit scores.
The consumer finance segment’s focus has included non-prime borrowers and, therefore, the anticipated rates of delinquencies, defaults, repossessions and losses on the consumer finance loans are higher than those experienced in the general automobile finance industry and could be more dramatically affected by changes in general economic conditions. Changes in economic conditions may also affect consumer demand for used automobiles and values of automobiles securing outstanding loans, due to changes in demand or changes in levels of inventory of used automobiles, which may directly affect the amount of a loss incurred by the consumer finance segment in the event of default. While we manage the higher risk inherent in loans made to non-prime borrowers through the underwriting criteria, portfolio management and collection methods employed by the consumer finance segment, we cannot guarantee that these criteria or methods will afford adequate protection against these risks. Beginning in 2016 with the consumer finance segment’s implementation of a scorecard model for purchasing loan contracts, the credit-worthiness of borrowers at origination has improved for automobile loans purchased and the level of credit losses experienced has decreased. We cannot provide any assurance that the consumer finance segment’s net charge-off ratio will not increase in future periods. However, we believe that the current allowance for loan losses is adequate to absorb probable losses that have been incurred on existing consumer finance segment loans that may become uncollectible. If factors influencing the consumer finance segment result in higher net charge-off ratios in future periods, the consumer finance segment may need to increase the level of its allowance for loan losses through additional provisions for loan losses, which could negatively affect future earnings of the consumer finance segment.
As discussed above, we measure impaired loans either based on fair value of the loan using the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent, or using the present value of expected future cash flows discounted at the loan’s effective interest rate. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment in the loan. TDRs occur when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions typically are made for loss mitigation purposes and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs are considered impaired loans.
Impaired loans, which included TDRs of $823,000, and the related allowance at December 31, 2022, were as follows:
TABLE 16: Impaired Loans
Recorded Recorded
Investment Investment Average
Unpaid in Loans in Loans Balance- Interest
Principal without with Related Impaired Income
Equity lines 26 26 — — 28 2
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Impaired loans, which included TDRs of $3.6 million, and the related allowance at December 31, 2021, were as follows:
Recorded Recorded
Investment Investment Average
Unpaid in Loans in Loans Balance- Interest
Principal without with Related Impaired Income
Commercial, financial and agricultural:
TDRs at December 31, 2022 and 2021 were as follows:
TABLE 17: Troubled Debt Restructurings
December 31, December 31,
Nonaccrual TDRs1 — 115
1 Included in nonaccrual loans in Table 14: Nonperforming Assets.
While TDRs are considered impaired loans, not all TDRs are on nonaccrual status. If a loan was on nonaccrual status at the time of the TDR modification, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the Corporation’s policy for returning loans to accrual status. If a loan was accruing prior to being modified as a TDR and if management concludes that the borrower is able to make such modified payments, and there are no other factors or circumstances that would cause management to conclude otherwise, the TDR will remain on an accruing status.
FINANCIAL CONDITION
SUMMARY
A financial institution’s primary sources of revenue are generated by its earning assets and sales of financial assets, while its major expenses are produced by the funding of those assets with interest-bearing liabilities, provisions for loan losses and compensation to employees. Effective management of these sources and uses of funds is essential in attaining a financial institution’s maximum profitability while maintaining an acceptable level of risk.
At December 31, 2022, the Corporation had total assets of $2.33 billion compared to $2.26 billion at December 31, 2021. The increase was attributable primarily to increases in loans held for investment and available for sale securities, partially offset by a decrease in interest-bearing deposits in other banks and loans held for sale and was funded by growth in money market, savings and demand deposits. The significant components of the Corporation’s Consolidated Balance Sheets are discussed below.
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LOAN PORTFOLIO
General
Through the community banking segment, we engage in a wide range of lending activities, which include the origination, primarily in the community banking segment’s market area, of (1) one-to-four family and multi-family residential mortgage loans, (2) commercial real estate loans, (3) construction loans, (4) land acquisition and development loans, (5) consumer loans and (6) commercial business loans. We engage in automobile and marine and RV lending through the consumer finance segment and in residential mortgage lending through the mortgage banking segment with the majority of the loans originated through the mortgage banking segment sold to third-party investors. At December 31, 2022, the Corporation’s loans held for investment in all categories, net of the allowance for loan losses, totaled $1.60 billion and loans held for sale had a fair value of $14.3 million.
Tables 18 and 19 present information pertaining to the composition of loans held for investment and the maturity/repricing of certain loans held for investment, respectively.
TABLE 18: Summary of Loans Held for Investment
(Dollars in thousands) Amount Percent Amount Percent
Less allowance for loan losses (40,518) (40,157)
The increase in total loans from December 31, 2021 to December 31, 2022 was due primarily to growth in automobile loans and marine and recreational vehicle loans at the consumer finance segment and commercial real estate and residential mortgage lending at the community banking segment, partially offset by repayment of PPP loans.
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TABLE 19: Maturity/Repricing Schedule of Loans Held for Investment
Real Estate Commercial,
Residential Real Estate Financial & Equity Consumer
Variable Rate:
After 15 years — — — — — — —
Fixed Rate:
Beginning in April 2020, the community banking segment originated loans under the PPP which are guaranteed by the SBA. As repayment of PPP loans is guaranteed by the SBA, the community banking segment does not recognize a reserve for PPP loans in its allowance for loan losses. Table 20 presents the outstanding principal of loans originated under the PPP as of December 31, 2022 and 2021.