CFFI · Read the filing

ITEM 1A.RISK FACTORS

Risk Factors Related to the COVID-19 Pandemic

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

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

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

Although banks have generally been permitted to continue operating during the COVID-19 outbreak, the outbreak has caused the Corporation to change its business operations, including updating branch operations to comply with governmental recommendations and increasing work from home options for our employees. These changes may have adverse impacts on the Corporation’s business due to reduced effectiveness of operations, unavailability of personnel, increased cybersecurity risks related to use of remote technology, and increased costs related to these operational changes. Additionally, our business operations may be disrupted if key personnel or significant portions of our employees are unable to work effectively, including because of illness. The changes in business operations could also have a detrimental effect on the Corporation’s relationships with its customers and could reduce demand for the Corporation’s products and services.

Unfavorable economic conditions and elevated unemployment due to the pandemic may make it difficult for the Corporation to maintain deposit levels and loan origination volume. Such unfavorable conditions may cause the value of our investment portfolio and of the collateral securing the Corporation’s loans to decline. The Federal Reserve has lowered the federal funds rate to a range of zero to 0.25 percent in part as a result of the pandemic. A prolonged period of very low interest rates could reduce the Corporation’s net income and have a material adverse effect on the Corporation’s cash flows.

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

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Risk Factors Related to our Lending Activities and Economic Conditions

Our business is subject to various lending and other economic risks that could adversely affect our results of operations and financial condition.

Deterioration in economic conditions could adversely affect our business. Our business is directly affected by general economic and market conditions; broad trends in industry and finance; legislative and regulatory changes; changes in governmental monetary and fiscal policies; and inflation, all of which are beyond our control. A deterioration in economic conditions, in particular a prolonged economic slowdown within our geographic region or a broader disruption in the economy, possibly as a result of a pandemic or other widespread public health emergency, could result in the following consequences, any of which could hurt our business materially: an increase in loan delinquencies; an increase in problem assets and foreclosures; a decline in demand for our products and services; and a deterioration in the value of collateral for loans made by our various business segments.

Adverse changes in economic conditions in our market areas or adverse conditions in an industry on which a local market in which we do business is dependent could adversely affect our results of operations and financial condition.

We provide full service banking and other financial services between Hampton Roads and Charlottesville, and in the Northern Neck region of Virginia. Our loan and deposit activities are directly affected by, and our financial success depends on, economic conditions within these markets, as well as conditions in the industries on which those markets are economically dependent. A deterioration in local economic conditions or in the condition of an industry on which a local market depends, such as the U.S. military and related defense contractors and industries, could adversely affect such factors as unemployment rates, business formations and expansions and housing market conditions. Adverse developments in any of these factors could result in among other things, a decline in loan demand, a reduction in the number of creditworthy borrowers seeking loans, an increase in delinquencies, defaults and foreclosures, an increase in classified and nonaccrual loans, a decrease in the value of loan collateral, and a decline in the financial condition of borrowers and guarantors, any of which could adversely affect our financial condition or business.

Weakness in the secondary residential mortgage loan markets or demand for mortgage loans may adversely affect income from C&F Mortgage.

Our mortgage banking segment provides a significant portion of our noninterest income. We generate gains on sales of mortgage loans primarily from sales of mortgage loans that we originate. Interest rates, housing inventory, housing demand, cash buyers, new mortgage lending regulations and other market conditions have a direct effect on loan originations across the industry. In particular, in a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in noninterest income. In addition, our results of operations are affected by the amount of noninterest expenses (including for personnel and systems infrastructure) associated with mortgage banking activities. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity.

If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.

Making loans is an essential element of our business. The risk of nonpayment is affected by a number of factors, including but not limited to: the duration of the credit; credit risks of a particular customer; changes in economic and industry conditions; and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans may not be repaid. We attempt to maintain an appropriate allowance for loan losses to provide for losses in our loan portfolio. Because any estimate of loan losses is necessarily subjective and the accuracy of any estimate depends on the outcome of future events that are not within our control, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional provision for loan losses will be required, which would have an adverse effect on the Corporation’s net income. Although we believe our allowance for loan losses is adequate to absorb losses that are

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inherent in our loan portfolio, we cannot predict the timing or severity of such losses nor give any assurance that our allowance will be adequate in the future.

The Financial Accounting Standards Board (FASB) has issued a new accounting standard that will be effective for the Corporation for the fiscal year beginning January 1, 2023. This standard, Accounting Standards Codification (ASC) Topic 326, “Financial Instruments—Credit Losses” (ASC 326) will require the Corporation to record an allowance for credit losses that represents expected credit losses over the lifetime of all loans in its portfolio. This represents a change from the current method of providing for an allowance for loan losses that have been incurred. We have not yet determined the impact that ASC 326 will have on our consolidated financial statements and regulatory capital. While the adoption of ASC 326 will not affect ultimate loan performance or cash flows of the Corporation from making loans, the period in which expected credit losses affect net income of the Corporation may not be similar to the recognition of loan losses under current accounting guidance. If recognition of the allowance for credit losses results in a reduction of the regulatory capital of C&F Bank, the initial reduction in regulatory capital will be phased in over three years under regulatory guidance. If the reduction in regulatory capital of C&F Bank is significant, it may adversely impact the future ability of the Corporation to pay dividends to shareholders.

An increase in mortgage loan defaults or prepayments may result in losses related to loans sold by C&F Mortgage.

Deterioration in economic conditions may cause borrowers to default on their mortgages. This may result in potential repurchase or indemnification obligations for C&F Mortgage on residential mortgage loans originated and sold into the secondary market. Such obligations may arise in the event of claims by investors of borrower misrepresentation, fraud, early-payment default, or underwriting error, as investors attempt to minimize their losses. We cannot be assured that a prolonged period of payment defaults and foreclosures will not result in an increase in requests for repurchases or indemnifications. Alternatively, during periods of low or falling interest rates, our customers may find opportunities to refinance shortly after obtaining a mortgage loan from C&F Mortgage, which may result in unexpected prepayments on loans that have been sold into the secondary market. This may result in obligations of C&F Mortgage to return a portion of the sales proceeds from such loans to investors pursuant to the terms of the sale. We attempt to maintain an appropriate reserve for indemnification losses and for prepayment obligations. Although we believe our reserves for indemnification losses and prepayment obligations are adequate, these estimates are inherently subjective and actual indemnification losses and prepayment obligations will depend on future events that are often not within our control. Therefore, we can give no assurance that established reserves will be adequate. Additional provision for indemnification losses or additional obligations arising from prepayments would have an adverse effect on the Corporation’s net income.

Our level of credit risk is higher due to the concentration of our loan portfolio in commercial loans and in consumer finance loans.

At December 31, 2020, 51.8 percent of our loan portfolio consisted of commercial, financial and agricultural loans, which include loans secured by real estate for builder lines, acquisition and development and commercial development, as well as commercial loans secured by personal property. These loans generally carry larger loan balances and involve a greater degree of financial and credit risk than home equity and residential loans. The increased financial and credit risk associated with these types of loans is a result of several factors, including the concentration of principal in a limited number of loans and to borrowers in similar lines of business, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.

At December 31, 2020, 23.1 percent of our loan portfolio consisted of consumer finance loans that provide automobile financing for customers in the non-prime market. During periods of economic slowdown or recession, delinquencies, defaults, repossessions and losses may increase in this portfolio. Significant increases in the inventory of used automobiles during periods of economic recession may also depress the prices at which we may sell repossessed vehicles or delay the timing of these sales. Because we focus on non-prime borrowers, the actual rates of delinquencies, defaults, repossessions and losses on these loans are higher than those experienced in the general automobile finance industry and could be dramatically affected by a general economic downturn. In addition, our servicing costs may increase without a corresponding increase in our finance charge income. While we manage the higher risk inherent in loans made

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to non-prime borrowers through our underwriting criteria for installment sales contracts we purchase and collection methods, we cannot guarantee that these criteria or methods will ultimately provide adequate protection against these risks.

Risk Factors Related to our Industry

We are subject to interest rate risk and fluctuations in interest rates may negatively affect our financial performance.

Our profitability depends in substantial part on our net interest margin, which is the difference between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits and borrowings divided by total interest-earning assets. Changes in interest rates will affect our net interest margin in diverse ways, including the pricing of loans and deposits, the levels of prepayments and asset quality. We are unable to predict actual fluctuations of market interest rates because many factors influencing interest rates, including changes in economic conditions, are beyond our control. We believe that our current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes. In March 2020, the FOMC announced emergency rate cuts for the federal funds rate, which is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight, in response to the outbreak of COVID-19. Since March 2020, the FOMC has kept the federal funds rate near zero, and financial markets expect interest rates to remain historically low for a prolonged period as the economy recovers from the recession caused by the COVID-19 pandemic. Longer-term market interest rates, including yields on U.S. treasury bonds, have also remained low. Therefore, we are expecting continued pressure on our net interest margin due to intense competition for loans and deposits from both local and national financial institutions and the continued effect of lower interest rates on interest income. In addition, the Corporation could experience further net interest margin compression if it is unable to maintain its current level of loans outstanding by continuing to originate new loans or if it experiences a decrease in deposit balances, which would require the Corporation to seek funding from other sources at higher rates of interest.

We rely substantially on deposits obtained from customers in our target markets to provide liquidity and support growth.

Our business strategies are based on access to funding from local customer deposits. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions that affect savings levels and the amount of liquidity in the economy, including government stimulus efforts in response to economic crises. If our deposit levels fall, we could lose a relatively low cost source of funding and our interest expense would likely increase as we obtain alternative funding to replace lost deposits. If local customer deposits are not sufficient to fund our normal operations and growth, we will look to outside sources, such as borrowings from the FHLB, which is a secured funding source. Our ability to access borrowings from the FHLB will be dependent upon whether and the extent to which we can provide collateral to secure FHLB borrowings. We may also look to federal funds purchased and brokered deposits, although the use of brokered deposits may be limited or discouraged by our banking regulators. We may also seek to raise funds through the issuance of shares of our common stock, or other equity or equity-related securities, or debt securities including subordinated notes as additional sources of liquidity. If we are unable to access funding sufficient to support our business operations and growth strategies or are unable to access such funding on attractive terms, we may not be able to implement our business strategies which may negatively affect our financial performance.

Consumers may increasingly decide not to use banks to complete their financial transactions, which could have a material adverse impact on our financial condition and operations.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the loss of deposits as a lower cost source of funds could have a material adverse effect on our financial condition and results of operations.

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Competition from other financial institutions and financial intermediaries may adversely affect our profitability.

We face substantial competition in originating loans and in attracting deposits. Our competition in originating loans and attracting deposits comes principally from other banks, mortgage banking companies, consumer finance companies, savings associations, credit unions, brokerage firms, insurance companies and other institutional lenders and purchasers of loans. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger clients. These institutions may be able to offer the same loan products and services that we offer at more competitive rates and prices. Increased competition could require us to increase the rates we pay on deposits or lower the rates we offer on loans, which could adversely affect our profitability.

Accounting for past business combinations may expose us to intangible asset risk, which could affect our results of operations.

In connection with accounting for prior acquisitions, we recorded assets acquired and liabilities assumed at their fair value, which resulted in the recognition of certain intangible assets, including goodwill. Adverse conditions in our business climate, including a significant decline in future operating cash flows, changes in interest rates that may lead to net interest margin compression, changes in demand for loans or our ability to originate and hold loans, a sustained period of elevated loan losses, a significant decrease in valuations or stock prices of the Corporation or other bank holding companies, or a deviation from our expected growth rate and performance, may significantly affect the fair value of the Corporation’s reporting units and may trigger impairment losses on intangible assets, which could be materially adverse to our results of operations.

Risk Factors Related to our Operations and Technology

Our risk management framework may not be effective in mitigating risk and loss.

We maintain an enterprise risk management program that is designed to identify, quantify, monitor, report and control the risks we face. These risks include, but are not limited to, interest rate, credit, liquidity, operational, reputation, legal, compliance, economic and litigation risk. Although we assess our risk management program on an ongoing basis and make identified improvements to it, we can give no assurance that this approach and risk management framework (including related controls) will effectively mitigate the risks listed above or limit losses that we may incur. If our risk management program has flaws or gaps, or if our risk management controls do not function effectively, our results of operations, financial condition or business may be adversely affected.

We are subject to security and operational risks, including cybersecurity risks and cyber attacks, relating to our use of technology that could damage our reputation and our business.

In the ordinary course of business, the Corporation collects and stores sensitive data, including proprietary business information and personally identifiable information of our customers and employees, in systems and on networks. The secure processing, maintenance and use of this information is critical to operations and the Corporation’s business strategy. The Corporation has invested in information security technologies and continually reviews processes and practices that are designed to protect its networks, computers and data from damage or unauthorized access. Despite these security measures, the Corporation’s computer systems and infrastructure may be vulnerable to attacks by hackers or may be breached due to employee error, malfeasance or other disruptions. Security breaches, including cyber incidents, identity theft and hacking events, have been experienced by several of the world’s largest financial institutions that utilize sophisticated security tools to prevent such breaches, incidents and events. Any security breach that we experience could result in legal claims, regulatory penalties, disruption in operation, remediation expenses, costs associated with customer notification and credit monitoring services, increased insurance premiums, loss of customers and business partners and damage to the Corporation’s reputation. We rely on customary security systems and procedures to provide the security and authentication necessary to effect secure collection, transmission and storage of sensitive data. These systems and

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procedures include but are not limited to (i) regular penetration testing of our network, (ii) regular employee training programs on sound security practices and awareness of security threats, (iii) deployment of tools to monitor our network including intrusion prevention and detection systems, electronic mail spam filters, anti-virus, anti-malware, anti-ransomware, resource logging and patch management, (iv) multifactor authentication for customers using treasury management tools and employees who access our network from outside of our premises, and (v) enforcement of security policies and procedures for the additions and maintenance of user access and rights to resources. However, because the techniques used to obtain unauthorized access, or to disable or degrade systems change frequently and are often not recognized until launched against a target, the Corporation may be unable to anticipate these techniques or to implement adequate protective measures.

While most of our core data processing is conducted internally, certain key applications are outsourced to third party providers. If our third party providers encounter difficulties or if we have difficulty in communicating with such third parties, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations and reputation. Additionally, in recent years banking regulators have focused on the responsibilities of financial institutions to supervise vendors and other third-party service providers. We may have to dedicate significant resources to manage risks and regulatory burdens presented by our relationship with vendors and third-party service providers, including our data processing and cybersecurity service providers.

We rely on other companies to provide key components of our business infrastructure.

Third parties provide key components of our businesses’ operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections, and network access. While we have selected these third-party vendors carefully, we do not control their actions. Any problem caused by these third parties, such as poor performance of services, failure to provide services, disruptions in communication services provided by a vendor, or failure to handle current or higher volumes could adversely affect the Corporation’s ability to deliver products and services to its customers and otherwise conduct its business, and may harm its reputation. Financial or operational difficulties of a third-party vendor could also hurt the Corporation’s operations if those difficulties affect the vendor’s ability to serve the Corporation. Replacing these third-party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to our businesses’ operations.

Our business is technology dependent, and an inability to successfully implement technological improvements may adversely affect our ability to be competitive and our results of operations and financial condition.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products, systems and services, which may require substantial initial investment to be implemented, including the cost of modifying or adapting existing products, systems and services. The Corporation invests in new technology to enhance customer service, and to increase efficiency and reduce operating costs. Our future success will depend in part upon our ability to create synergies in our operations through the use of technology and to facilitate the ability of customers to engage in financial transactions in a manner that enhances the customer experience. We cannot give any assurance that technological improvements will increase operational efficiency or that we will be able to effectively implement new technology-driven products, systems and services or be successful in marketing new products and services to our customers. A failure to maintain or enhance a competitive position with respect to technology, whether because of a failure to anticipate customer expectations, substantially fewer resources to invest in technological improvements than larger competitors, or because our technological developments fail to perform as desired or are not implemented in a timely manner, could result in higher operating costs, decreased customer satisfaction, and lower market share. An inability to effectively implement new technology and realize operational efficiencies could result in the loss of initial investments in such projects and higher operating costs. Either of these outcomes could have a material adverse impact on our financial condition and results of operations.

We rely heavily on our management team and the unexpected loss of key officers may adversely affect our operations.

We believe that our growth and future success will depend in large part on the skills of our executive officers. We also depend upon the experience of the officers of our subsidiaries and on their relationships with the communities they

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serve. The loss of the services of one or more of these officers could disrupt our operations and impair our ability to implement our business strategy, which could adversely affect our business, financial condition and results of operations.

The success of our business strategies depends on our ability to identify and recruit individuals with experience and relationships in our primary markets.

The successful implementation of our business strategy will require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships as well as new financial products and services. The market for qualified management personnel is competitive, which has contributed to salary and employee benefit costs that have risen and are expected to continue to rise, which may have an adverse effect on the Corporation’s net income. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy, and we may not be able to effectively integrate these individuals into our operations. Our inability to identify, recruit and retain talented personnel to manage our operations effectively and in a timely manner could limit our growth, which could materially adversely affect our business.

Risks Related to the Regulation of the Corporation

Compliance with laws, regulations and supervisory guidance, both new and existing, may adversely affect our business, financial condition and results of operations.

We are subject to numerous laws, regulations and supervision from both federal and state agencies. Failure to comply with these laws and regulations could result in financial, structural and operational penalties, including receivership. In addition, establishing systems and processes to achieve compliance with these laws and regulations may increase our costs and/or limit our ability to pursue certain business opportunities.

Laws and regulations, and any interpretations and applications with respect thereto, generally are intended to benefit consumers, borrowers and depositors, but not stockholders. The legislative and regulatory environment is beyond our control, may change rapidly and unpredictably and may negatively influence our revenues, costs, earnings, and capital levels. Our success depends on our ability to maintain compliance with both existing and new laws and regulations.

Future legislation, regulation and government policy, particularly following changes in political leadership and policymakers in the federal government, could affect the banking industry as a whole, including the Corporation’s business and results of operations, in ways that are difficult to predict. In addition, the Corporation’s results of operations could be adversely affected by changes in the way in which existing statutes and regulations are interpreted or applied by courts and government agencies.

The CFPB may increase our regulatory compliance burden and could affect the consumer financial products and services that we offer.

The CFPB significantly influences consumer financial laws, regulation and policy through rulemaking related to enforcement of the Dodd-Frank Act’s prohibitions against unfair, deceptive and abusive consumer finance products or practices, which are directly affecting the business operations of financial institutions offering consumer financial products or services, including the Corporation. This agency’s broad rulemaking authority includes identifying practices or acts that are unfair, deceptive or abusive in connection with any consumer financial transaction, financial product or service. Although the CFPB has jurisdiction over banks with $10 billion or greater in assets, rules, regulations and policies issued by the CFPB may also apply to the Corporation or its subsidiaries by virtue of the adoption of such policies and practices by the Federal Reserve and the FDIC. Further, the CFPB may include its own examiners in regulatory examinations by the Corporation’s primary regulators. The total costs, limitations and restrictions related to the CFPB may produce significant, material effects on our business, financial condition and results of operations.

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Our earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.

The policies of the Federal Reserve affect us significantly. The Federal Reserve regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold. Those policies determine to a significant extent our cost of funds for lending and investing. Changes in those policies are beyond our control and are difficult to predict. Federal Reserve policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve could reduce the demand for a borrower's products and services. This could adversely affect the borrower’s earnings and ability to repay a loan, which could have an adverse effect on our financial condition and results of operations. Alternatively, an expansion of the money supply could make it easier for a borrower to obtain a loan from another financial institution at a lower interest rate, resulting in a payoff of that borrower’s higher rate loan with us, and which could have an adverse effect on our financial condition and results of operations.

General Risk Factors

Our common stock price may be volatile, which could result in losses to our investors.

Our common stock price has been volatile in the past, and several factors could cause the price to fluctuate in the future. These factors include, but are not limited to, actual or anticipated variations in earnings, changes in analysts’ recommendations or projections with regard to our common stock or the markets and businesses in which we operate, operations and stock performance of other companies deemed to be our peers, and reports of trends and concerns and other issues related to the financial services industry. Fluctuations in our common stock price may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.

Future sales of our common stock by shareholders or the perception that those sales could occur may cause our common stock price to decline.

Although our common stock is listed for trading on NASDAQ Global Select Market, the trading volume in our common stock may be lower than that of other larger financial institutions. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the potential for lower relative trading volume in our common stock, significant sales of the common stock in the public market, or the perception that those sales may occur, could cause the trading price of our common stock to decline or to be lower than it otherwise might be in the absence of these sales or perceptions.

Future issuances of our common stock could adversely affect the market price of our common stock and could be dilutive.

We may issue additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, shares of our common stock. Issuances of a substantial number of shares of our common stock, or the expectation that such issuances might occur, including in connection with acquisitions, could materially adversely affect the market price of the shares of our common stock and could be dilutive to shareholders. Any decision we make to issue common stock in the future will depend on market conditions and other factors, and we cannot predict or estimate the amount, timing, or nature of possible future issuances of our common stock. Accordingly, our shareholders bear the risk that future issuances of our securities will reduce the market price of the common stock and dilute their stock holdings in the Corporation.

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The Corporation’s dividends may not be sustained.

Although the Corporation has historically paid cash dividends to holders of its common stock, holders of common stock are not entitled to receive dividends. Financial, regulatory or economic factors may cause the Corporation’s Board of Directors to consider, among other actions, the suspension or reduction of dividends paid on the Corporation’s common stock. Furthermore, the Corporation is a bank holding company that conducts substantially all of its operations through its subsidiaries, including the Bank. As a result, the Corporation relies on dividends from the Bank for substantially all of its revenues. There are various regulatory restrictions on the ability of the Bank to pay dividends or make other payments to the Corporation, and the Corporation’s right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors. If the Bank is unable to pay dividends to the Corporation, the Corporation may not be able to service its outstanding borrowings and other debt, pay its other obligations or pay a cash dividend to the holders of the Corporation’s common stock, and the Corporation’s business, financial condition and results of operations may be materially adversely affected.

ITEM 1B.UNRESOLVED STAFF COMMENTS

The Corporation has no unresolved comments from the SEC staff.

ITEM 2.PROPERTIES

The following describes the location and general character of the principal offices and other materially important physical properties of the Corporation.

The main office of C&F Bank is located in West Point, VA. The operations center of C&F Bank, which includes the offices of the community banking segment’s loan, deposit and administrative functions, is located in Toano, Virginia. Additionally, the community banking segment operates 30 branch offices. The community banking segment also operates four regional commercial lending offices in Virginia, two of which are situated at bank branch locations. Of the 32 locations used as bank branches or commercial lending offices, 26 are owned by the community banking segment, 5 are leased from nonaffiliates and one is located in a loan production office of the mortgage banking segment.

The mortgage banking segment’s main administrative office and a loan production office are located in Midlothian, Virginia, in a building owned by C&F Bank that also houses a branch of C&F Bank. In addition, the mortgage banking segment has 20 loan production offices, of which 3 in Virginia are located in C&F Bank branches and 17 are leased from nonaffiliates, including: 12 in Virginia, 1 in Maryland, 2 in North Carolina, 1 in South Carolina and 1 in West Virginia.

The consumer finance segment’s headquarters and its loan and administrative functions and staff are located in Richmond, Virginia, in offices that are leased. The consumer finance segment expects to relocate its loan and administrative functions and staff into a building that it owns in Richmond, Virginia, upon completion of the building project in 2021.

All of the Corporation’s properties are in good operating condition and are adequate for the Corporation’s present and anticipated future needs.

ITEM 3.LEGAL PROCEEDINGS

The Corporation and its subsidiaries may be involved in certain litigation matters arising in the ordinary course of business. Although the ultimate outcome of these matters cannot be ascertained at this time, and the results of legal proceedings cannot be predicted with certainty, we believe, based on current knowledge, that the resolution of any such matters arising in the ordinary course of business will not have a material adverse effect on the Corporation.

ITEM 4.MINE SAFETY DISCLOSURES

None.

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INFORMATION ABOUT OUR EXECUTIVE OFFICERS

Name (Age)Present Position Business ExperienceDuring Past Five Years

PART II

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Corporation’s common stock is listed for trading on the NASDAQ Global Select Market of the NASDAQ Stock Market under the symbol “CFFI.” As of March 2, 2021, there were approximately 3,000 shareholders of our common stock. As of that date, the closing price of our common stock on the NASDAQ Global Select Stock Market was $42.66.

Payment of dividends is at the discretion of the Corporation’s Board of Directors and is subject to various federal and state regulatory limitations. For further information regarding payment of dividends refer to Item 1. “Business,” under the heading “Limits on Dividends.” In making its decision on the payment of dividends on the Corporation’s common

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stock, the Corporation’s Board of Directors considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and other factors.

Issuer Purchases of Equity Securities

The Corporation’s Board of Directors authorized a program, effective November 17, 2020, to repurchase up to 365,000 shares of the Corporation’s common stock through November 30, 2021 (the Repurchase Program). Repurchases under the 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. As of December 31, 2020, the Corporation has made aggregate common stock repurchases of 7,459 shares for an aggregate cost of $275,000 under the Repurchase Program. The Corporation’s previous share repurchase program expired on May 31, 2020.

The following table summarizes repurchases of the Corporation’s common stock that occurred during the three months ended December 31, 2020.

Maximum Number

(or Approximate

Total Number of Dollar Value) of

Shares Purchased as Shares that May Yet

Part of Publicly Be Purchased

Shares Purchased1 per Share Programs Programs

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ITEM 6.SELECTED FINANCIAL DATA

Five Year Financial Summary

Financial Condition:

Results of Operations:

Share Data:

Significant Ratios:

Asset Quality:

Allowance for loan losses (ALL)

Ratio of ALL to total loans

On January 1, 2020, the Corporation completed the acquisition of Peoples and its banking subsidiary, Peoples Community Bank for an aggregate purchase price of $22.19 million of cash and stock, which added total assets of $190.6 million.

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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 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 principal business segments: community banking, mortgage banking, and consumer finance. We also actively manage our capital through growth, dividends and share repurchases, while considering the need to maintain a strong capital position.

Financial Performance Measures

Consolidated net income for the Corporation was $22.4 million in 2020, or $6.06 per share assuming dilution, compared to $18.9 million in 2019, or $5.47 per share assuming dilution, and $18.0 million in 2018, or $5.15 per share assuming dilution. The Corporation’s ROE and ROA were 12.54 percent and 1.14 percent, respectively, for 2020, compared to 12.02 percent and 1.20 percent, respectively, for 2019 and 12.40 percent and 1.19 percent, respectively, for 2018.

Consolidated net income for 2020 and 2019 were affected by certain items that management does not expect to have an ongoing impact on consolidated net income, including a gain upon sale of a pool of purchased credit impaired (PCI) loans in 2020, charges related to early repayment of borrowings in 2020, merger related expenses incurred in connection with the Corporation’s acquisition of Peoples Bankshares, Incorporated (Peoples) recorded in 2020 and 2019, impairment charges related to branch consolidation in 2020, and provisions of the CARES Act, which provided income tax benefits related to prior tax years. Excluding the effects of these items, adjusted net income for 2020 was $22.4 million, or $6.06 per share, compared to $19.5 million, or $5.66 per share, for 2019 and $18.0 million, or $5.15 per share, for 2018. Adjusted ROE and adjusted ROA were 12.54 percent and 1.14 percent, respectively, for 2020, compared to 12.44 percent and 1.25 percent, respectively, for 2019 and 12.40 percent and 1.19 percent, respectively, for 2018. Refer to “Use of Certain Non-GAAP Financial Measures,” below, for a reconciliation of adjusted net income, adjusted earnings per share, adjusted ROE and adjusted ROA, which are non-GAAP financial measures, to the most directly comparable financial measures calculated in accordance with U.S. GAAP.

Consolidated net income and earnings per share increased 19.0 percent and 10.8 percent, respectively, for 2020, compared to 2019. Adjusted net income and adjusted earnings per share increased 15.0 percent and 7.1 percent, respectively, for 2020, compared to 2019. The increase in adjusted earnings per share for 2020 compared to 2019 is due primarily to higher mortgage banking segment net income, partially offset by higher provision for loan losses at the community banking segment, and the issuance of 209,871 shares of common stock in connection with the acquisition of Peoples.

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Impact of and Response to the COVID-19 Pandemic

The COVID-19 pandemic has caused a significant disruption in economic activity worldwide, and has had a significant impact on businesses and consumers in our market areas and on our results of operations, which the Corporation expects to continue. Many businesses temporarily closed or reduced their availability at the beginning of the pandemic; and while many people have returned to work, the U.S. unemployment rate remained elevated at 6.7 percent in December 2020, after having reached 14.7 percent in April 2020. Additional unemployment issues may be obscured given the government relief programs that have been made available during late 2020 and early 2021 to assist those in need. There remains substantial uncertainty about critical factors that may affect the economy and employment, including the severity and duration of the pandemic; the availability and pace of vaccinations, the pace of economic recovery when the pandemic subsides, potential re-tightening of policies that had previously allowed businesses to open; any further government stimulus efforts, including the nature, timing and extent of such stimulus; and the timing of reopening of schools, many of which are currently being conducted virtually.

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

Risks to Results of Operations

Elevated loan losses. The COVID-19 pandemic has had a significant impact on businesses and consumers in our market areas. Many businesses temporarily or permanently closed or have faced declines in revenue since the beginning of the pandemic as consumers were instructed to stay at home. Even as many businesses have reopened, restrictions remain, including limited gathering sizes. This disruption has caused employers to lay off or reduce compensation of certain employees, and has caused some people not to receive steady incomes because they are not able to work due to illness or having to care for children or family members, resulting in many households facing reduced income. Commercial and consumer borrowers affected by the pandemic may not be able to make timely payments on loans, which may lead to an increase in delinquencies or defaults and may ultimately result in increases in net charge-offs and provision for loan losses. Furthermore, collateral values may decline as a result of decreased economic activity and increased uncertainty during the crisis, which may contribute to an increase in loan losses during and after the pandemic.

In 2020, the Corporation recorded additional provision for loan losses of approximately $8.0 million as a result of asset quality deterioration that is expected to arise as a result of the COVID-19 pandemic and related economic disruption. Management continues to monitor changes in economic conditions and asset quality resulting from the COVID-19 pandemic. If conditions deteriorate further, then additional provision for loan losses may be required in future periods.

Net interest margin compression. Since December 31, 2019, the FOMC has reduced its benchmark interest rate target to near zero by announcing rate cuts of 50 basis points on March 3, 2020 and 100 basis points on March 15, 2020. Treasury yields for all maturities are also lower since the outbreak of the COVID-19 pandemic. Lower market interest rates have resulted in lower average yields on all classes of earning assets. While average costs of deposits and borrowings have also decreased, and we expect the average cost of time deposits to continue to decrease due to the repricing of time deposits at maturity, those factors may not offset the effect on net interest margin of lower yields on earning assets.

Falling demand for loans. As businesses and consumers have been affected by the pandemic, new investment and consumer spending may decline, resulting in lower demand for loans. Our recent performance and strategic planning have depended, in part, on growth in lending at the community banking segment, and we have invested in expanding our commercial lending team. While loans outstanding at the community banking segment grew during 2020 (which included loans originated under the PPP), there can be no assurance that loan growth will continue during or after the pandemic.

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Lower demand for loans in our markets as a result of the COVID-19 pandemic, combined with lower interest rates on new loans, may negatively impact interest income from loans.

Impairment of securities and goodwill. A broad decrease in economic activity as a result of the COVID-19 pandemic is expected to affect tax revenues of states and political subdivisions, the pandemic has required increased health and safety expenditures by states and political subdivisions, and increased uncertainty has resulted in volatility in the market price of investments. The Corporation holds securities issued by states and political subdivisions that may experience shortfalls in general revenues or an inability to repay obligations when due as a result of the crisis. Additionally, the Corporation holds debt securities of corporate issuers whose financial condition may be adversely impacted by the economic impacts of the COVID-19 pandemic. There is a risk that these securities may become impaired, which would have a negative impact on the Corporation’s results of operations. Additionally, depending on the severity and duration of the economic consequences of the COVID-19 pandemic, the Corporation’s goodwill allocated to the community banking segment may become impaired, which would have a negative impact on the Corporation’s results of operations.

2021 Outlook

Management’s overall outlook for 2021 is relatively positive given our diversified business strategy; however, we will be affected by many challenges in 2021, including the COVID-19 pandemic and limited availability and distribution of vaccines, cyber security and fraud prevention, the low interest rate environment and the impacts of the changing social and political landscapes. These uncertainties could potentially lead to a continued economic downturn, fraud losses, further margin compression, asset quality deterioration and regulatory actions. The following additional factors could influence our financial performance in 2021:

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Principal Business Segments

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

Community Banking: The community banking segment reported net income of $5.4 million for the year ended December 31, 2020, compared to net income of $9.9 million for the year ended December 31, 2019. Previously, the community banking segment was referred to as the retail banking segment. There have been no changes to the composition of the community banking segment.

The decrease in community banking segment net income for the year ended December 31, 2020 compared to the year ended December 31, 2019 was due primarily to (1) lower average yields on loans; (2) higher provision for loan losses resulting from the COVID-19 pandemic and related economic disruption; (3) higher operating expenses, including the effects of (a) assuming certain operating costs of Peoples, which was acquired by the Corporation on January 1, 2020, including costs that have been eliminated following the integration of its operations into the Bank’s, (b) opening two new financial centers in the third quarter of 2020 and (c) investing in technology infrastructure to support continued growth; (4) early debt repayment charges of $2.2 million incurred in connection with the payoff of borrowings of $44.5 million; (5) lower interest income on excess cash reserves; (6) higher merger related expenses in connection with the acquisition of Peoples; (7) higher interest expense on deposits as a result of higher average deposit balances; and (8) a $281,000 write-down of assets in connection with the consolidation of the Bank’s former main office in West Point, VA into a nearby branch office and the donation of the building to the Town of West Point; partially offset by (1) a gain of $3.5 million on the sale of a pool of PCI loans; (2) higher average loans outstanding, which contributed to higher interest income on loans; (3) higher interchange income; and (4) income tax benefits of $326,000 related to prior tax years of Peoples as a result of favorable net operating loss carryback treatment under the CARES Act.

Average loans increased $216.5 million, or 27.8 percent, for the year ended December 31, 2020, compared to the year ended December 31, 2019. These increases included $99.1 million for the year ended December 31, 2020 of average balances of loans acquired in the acquisition of Peoples, and $59.7 million of average balances of loans originated under the PPP. In addition to increases resulting from the acquisition of Peoples and the PPP, the increase in average loans outstanding for the year ended December 31, 2020 compared to the year ended December 31, 2019 resulted from growth in the commercial real estate and commercial business lending segments of the loan portfolio. Average loan yields were lower for 2020 compared to 2019 due to repricing of variable rate loans and lower average yields on new lending, including PPP loans. The recognition of interest income on PCI loans is based on management’s expectation of future payments of principal and interest, which is inherently uncertain. Earlier than expected repayments of certain PCI loans resulted in the recognition of additional interest income during 2020 and 2019. Interest income recognized on PCI loans was $3.0 million and $3.4 million for the years ended December 31, 2020 and 2019, respectively.

C&F Bank’s total nonperforming assets were $3.9 million at December 31, 2020, compared to $2.6 million at December 31, 2019. Nonperforming assets at December 31, 2020 included $3.0 million in nonaccrual loans, compared to $1.5 million at December 31, 2019 and included $907,000 in other real estate owned, compared to $1.1 million at December 31, 2019. The increase in nonaccrual loans compared to December 31, 2019 is due primarily to the downgrading of one commercial relationship in the fourth quarter of 2020, partially offset by payoffs. Nonaccrual loans were comprised primarily of one commercial relationship at December 31, 2020 and were comprised primarily of residential mortgages and equity lines at December 31, 2019. The community banking segment recorded provision for loan losses of $4.6 million for the year ended December 31, 2020, compared to $360,000, for the year ended December 31, 2019. During the year ended December 31, 2020, the allowance for loan losses increased primarily as a result of reserves based on qualitative adjustments related to the COVID-19 pandemic and due to loan growth. As of December 31, 2020, compared to December

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31, 2019, there have not been significant changes in the overall credit quality of the loan portfolio, although management believes the effects of PPP loans, payment deferrals and government stimulus may be delaying signs of credit deterioration. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio. However, if there is further deterioration in economic conditions, additional provision may be required in future periods.

Mortgage Banking: The mortgage banking segment reported net income of $10.7 million for the year ended December 31, 2020, compared to net income of $3.8 million for the year ended December 31, 2019.

The increase in net income of the mortgage banking segment for the year ended December 31, 2020 compared to the year ended December 31, 2019 was due primarily to higher gains on sales of loans and mortgage banking fee income, resulting from higher margins and record loan production, higher mortgage lender services income for providing mortgage origination functions to third parties, and higher net interest income due to higher balances of loans held for sale. Partially offsetting these factors were higher expenses tied to loan production, including compensation expense, loan processing expense and data processing expense. Mortgage loan originations for the mortgage banking segment were $1.8 billion and $944.1 million for the years ended December 31, 2020 and 2019, respectively. Loan production for the year ended December 31, 2020 was the highest reported by the mortgage banking segment for any calendar year in the Corporation’s history. Lower interest rates on mortgage loans have contributed to an increase in volume in the broader mortgage industry in the year ended December 31, 2020 compared to the same period in the prior year. Mortgage loan originations for the mortgage banking segment during the year ended December 31, 2020 for refinancings and home purchases were $917.5 million and $854.5 million, respectively, compared to $224.9 million and $719.2 million, respectively, during the year ended December 31, 2019.

Consumer Finance:The consumer finance segment reported net income of $7.6 million for the year ended December 31, 2020, compared to net income of $6.9 million for the year ended December 31, 2019.

The increase in net income of the consumer finance segment for the year ended December 31, 2020 compared to the year ended December 31, 2019 was due primarily to lower provision for loan losses as a result of lower net charge-offs and a decrease in interest expense due to lower average cost of borrowings, partially offset by lower interest income due to lower average yields on loans. The average yield on loans for the year ended December 31, 2020 was lower compared to the year ended December 31, 2019 due to continued competition in the non-prime automobile loan business, including the effect of a lower interest rate environment, and the consumer finance segment’s pursuing growth in higher quality, lower yielding loans, which include prime marine and recreational vehicle (RV) loans.

The net charge-off ratio for 2020 decreased to 1.54 percent from 3.05 percent for 2019. The decline reflects a lower number of charge-offs during 2020, due to improvement in loan performance, and lower losses per loan charged off as a result of a strong used car market. Improvement in loan performance has resulted from C&F Finance Company continuing to purchase higher quality loans as well as borrowers benefitting from the government’s stimulus measures in response to the COVID-19 pandemic during 2020. C&F Finance Company offers payment deferrals at times to non-prime automobile borrowers as a management technique to achieve higher ultimate cash collections. C&F Finance Company offered a higher number of payment deferrals during the first and second quarters of 2020 to borrowers impacted by the COVID-19 pandemic, and as of December 31, 2020, most borrowers who received a deferral had resumed making payments and were current. The average amount deferred on a monthly basis during the fourth quarter of 2020 and the year ended December 31, 2020 was 1.56 percent and 2.93 percent of non-prime automobile loans outstanding, compared to 1.87 percent and 1.90 percent during the same periods in 2019. At December 31, 2020, total delinquent loans, which does not include loans that have been granted a payment deferral, as a percentage of total loans was 3.08 percent, compared to 2.48 percent at September 30, 2020 and 4.17 percent at December 31, 2019. The allowance for loan losses was $23.5 million, or 7.53 percent of total loans at December 31, 2020, compared to $21.8 million, or 6.96 percent of total loans at December 31, 2019. The increase in the level of the allowance for loan losses as a percentage of total loans is a result of reserves based on qualitative adjustments to reflect losses that management believes are probable as a result of the economic impacts of the COVID-19 pandemic. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio. However, if there is further deterioration in economic conditions, additional provision may be required in future periods.

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Other:The remaining components included in the consolidated results of operations of the Corporation are comprised primarily of net losses associated with holding company expenses of the Corporation, partially offset by the net income of C&F Wealth Management. These components reported aggregate net losses of $1.4 million and $1.7 million for the years ended December 31, 2020 and 2019, respectively. The lower net loss during 2020, compared to 2019, was primarily due to higher net wealth management services income and lower merger related expenses recorded at the holding company during 2020.

Acquisition of Peoples Bankshares, Incorporated: On January 1, 2020, the Corporation completed the acquisition of Peoples and its banking subsidiary, Peoples Community Bank for an aggregate purchase price of $22.2 million of cash and stock. For the year ended December 31, 2020, the Corporation recorded merger related expenses of $1.4 million ($1.1 million after income taxes), of which $1.3 million (1.0 million after income taxes) was allocated to the community banking segment and $100,000 ($100,000 after income taxes) was recorded as a holding company expense. For the year ended December 31, 2019, the Corporation recorded merger related expenses of $709,000 ($653,000 after income taxes), of which $236,000 ($196,000 after income taxes) was allocated to the community banking segment and the remainder was recorded as a holding company expense. In the aggregate, in connection with the acquisition of Peoples, the Corporation recorded merger related expenses of $2.1 million ($1.8 million after income taxes).

Capital Management and Dividends

Total equity was $194.5 million at December 31, 2020, compared to $165.3 million at December 31, 2019. Capital growth resulted primarily from earnings for the year ended December 31, 2020 and the issuance of $11.6 million of common equity in connection with the acquisition of Peoples on January 1, 2020, which was partially offset by cash dividends during 2020. On September 29, 2020, the Corporation completed the issuance of $20.0 million in aggregate principal amount of subordinated notes due in 2030, which are included in Tier 2 capital of the Corporation for regulatory purposes. The subordinated notes will initially bear interest at a fixed rate of 4.875% for five years and at the three month SOFR plus 475.5 basis points thereafter. The Corporation assumed $4.0 million in outstanding principal of subordinated notes in connection with the acquisition of Peoples, which are also included in Tier 2 capital of the Corporation for regulatory purposes.

The Corporation’s Board of Directors continued its historical practice of paying dividends in 2020. For the year ended December 31, 2020, the Corporation declared dividends of $1.52 per share. Annual dividends per share increased 2.0 percent over dividends of $1.49 per share declared in 2019. 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.

On November 17, 2020, the Board of Directors of the Corporation authorized a program, effective November 17, 2020, to repurchase up to 365,000 shares of the Corporation’s common stock (the Repurchase Program) through November 30, 2021. Repurchases under the 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. The Corporation’s previous share repurchase program expired on May 31, 2020 and the Corporation had made aggregate common stock repurchases of $2.1 million under the previous repurchase program. As of December 31, 2020, the Corporation has made aggregate common stock repurchases of 7,459 shares for an aggregate cost of $275,000 under the Repurchase Program. At December 31, 2020, the book value per share of the Corporation’s common stock was $52.80, and tangible book value per share was $45.32, compared to $48.07 and $43.61, respectively, at December 31, 2019.

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CRITICAL ACCOUNTING POLICIES

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

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

Impairment of Loans: We consider a loan impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We measure impairment on a loan-by-loan basis based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment in the loan. All troubled debt restructurings (TDRs) are also considered impaired loans and are evaluated individually. A TDR occurs when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. For more information see the section titled “Asset Quality” within Item 7.

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

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

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

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

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the pools of loans.

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

Goodwill: The Corporation's goodwill was recognized in connection with past business combinations and is reported at the community banking segment and the consumer finance segment. The Corporation reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Corporation may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing is required and the goodwill of the reporting unit is not impaired. If the Corporation elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying value to determine whether an impairment exists.

In the fourth quarter of 2020, the Corporation elected to bypass the qualitative assessment and performed a test of goodwill for impairment at the community banking segment and the consumer finance segment by measuring the fair value of each reporting unit at the testing date and comparing to their respective carrying values. Management concluded that no impairment existed as of December 31, 2020 and that the fair value of the consumer finance segment substantially exceeded its carrying value. The fair value of the community banking segment exceeded its carrying value by $8.8 million or approximately 6 percent. Management measured the fair value of the community banking segment based on correlated indications of value using an income approach (discounted cash flows) and market approach (capitalized forward earnings, capitalized tangible book value and observed transaction multiples of tangible book value). The measurement of fair value was dependent upon management’s expectation of future earnings of the community banking segment, which have been impacted by the COVID-19 pandemic and related economic disruption, as well as management’s understanding and expectations regarding pricing of bank mergers and acquisitions during and after the pandemic. The impacts on the earnings of the community banking segment of the pandemic include recognition of higher provisions for loan losses and a decrease in net interest margin. Management’s estimate of the fair value of the community banking segment may be negatively impacted if adverse effects of the pandemic on loan losses and net interest margin are greater than management expects them to be in future periods.

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

For further information concerning accounting policies, refer to Item 8. “Financial Statements and Supplementary Data” under the heading “Note 1: Summary of Significant Accounting Policies.”

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,

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2020, 2019 and 2018. 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 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, compared to approximately 44 basis points and 29 basis points to the yields on community banking segment loans and total loans, respectively, and 23 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2019, and approximately 41 basis points and 28 basis points to the yields on community banking segment loans and total loans, respectively, and 21 basis points to both the yield on interest earning assets and the net interest margin for the year ended December 31, 2018. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid) using the federal corporate income tax rate of 21 percent that was applicable for all periods presented.

TABLE 1: 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:

Other liabilities 51,406 33,364 27,678

Interest rate spread 4.36 % 5.18 % 5.55 %

Net interest margin 4.65 % 5.52 % 5.80 %

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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 2: 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 (29) 30 1 — 7 7

Net interest income, on a taxable-equivalent basis, for 2020 increased to $84.2 million, compared to $81.1 million for 2019, primarily as a result of the growth in average earning assets, partially offset by lower net interest margin. Average earning assets grew $341.2 million, or 23.2 percent, in 2020 compared to 2019, and net interest margin decreased 87 basis points to 4.65 percent in 2020, compared to 5.52 percent in 2019. The net interest margin decline for 2020 as compared to 2019 was due primarily to lower average yields on loans and other earning assets, partially offset by (1) using lower-yielding excess cash to fund growth in loans and securities and repay borrowings and (2) growth in low cost deposits, including noninterest-bearing demand deposits. The yield on interest-earning assets and cost of interest-bearing liabilities decreased by 112 basis points and 30 basis points, respectively, for 2020, compared to 2019. Average earning assets grew by $341.2 million for 2020, compared to 2019, primarily due to growth in loans (including PPP loans) and securities funded by deposit growth as well as the acquisition of Peoples on January 1, 2020.

Average loans, which includes both loans held for investment and loans held for sale, increased $320.1 million to $1.5 billion for the year ended December 31, 2020, compared to 2019. Average loans held for investment at the community banking segment increased $216.5 million, or 27.8 percent, for 2020, compared to 2019. This increase included during 2020 $99.1 million of average balances of loans acquired in the acquisition of Peoples, and $59.7 million of average balances of loans originated under the PPP. The remaining increase in average loans outstanding at the community banking segment for 2020 compared to 2019 was due primarily to growth in the commercial real estate and commercial business lending segments of the loan portfolio. Average loans held for investment at the consumer finance segment increased $850,000, or 0.2 percent, for 2020, compared to 2019 as average marine and RV loans increased due to the continued expansion of the consumer finance segment’s purchases of those loan contracts, which was partially offset by a decrease in average automobile loans due to continuing competition for loan contracts. Average loans held at the mortgage banking segment, which consist primarily of loans held for sale, increased $102.7 million, or 150.4 percent, for 2020, compared to 2019, as a result of higher loan production and a longer average holding period between origination and the time that loans

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were sold in the secondary market, which were due in part to higher mortgage industry volume during a time of historically low interest rates.

The overall yield on loans decreased 140 basis points to 6.18 percent for 2020, compared to 2019, due to changes in the composition of the loan portfolio and lower average yields at each operating segment. The community banking segment average loan yield decreased 83 basis points to 4.75 percent for 2020, compared to 2019, due primarily to lower market interest rates and lower interest income on PCI loans. 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 fees that were amortized based on the contractual maturity of the related loan or accelerated into interest income upon repayment of the loan. Net PPP loan fees recognized in 2020 were $1.6 million, and there were unrecognized net deferred PPP fees at December 31, 2020 of $2.2 million, which are expected to be recognized primarily in 2021. The consumer finance segment average loan yield decreased 83 basis points to 12.65 percent for 2020, compared to 2019, due to continued competition in the non-prime automobile loan business, including the effect of a lower interest rate environment, and the consumer finance segment continuing to pursue growth in higher quality, lower yielding loans, which includes prime marine and RV loans. The mortgage banking segment average loan yield decreased 105 basis points to 2.90 percent due to lower market interest rates for mortgage loans.

Average securities available for sale increased $38.8 million for 2020, compared to 2019, due primarily to higher purchases of securities and the acquisition of Peoples. The average yield on the securities portfolio on a taxable-equivalent basis decreased 52 basis points for 2020, compared to 2019, due to purchases of securities in 2020 at lower average yields relative to the average yield of the portfolio as a whole and increased calls of securities that were issued during periods of higher market interest rates.

Average interest-bearing deposits in other banks, consisting primarily of excess cash reserves maintained at the Federal Reserve Bank, decreased $17.7 million during 2020, compared to 2019, as the Corporation utilized excess cash to fund growth in loans and securities and repay borrowings. The average yield on these overnight funds decreased 120 basis points for 2020, compared to 2019, due to lower average rates on excess cash reserves, partially offset by an increase in purchased time deposits, which had higher yields during 2020. The Federal Reserve Bank decreased the interest rate on excess cash reserve balances from 1.55 percent at the end of 2019 to 0.10 percent by the end of 2020 in response to the COVID-19 pandemic.

Average money market, savings and interest-bearing demand deposits increased $145.7 million for 2020, compared to 2019, and average time deposits increased $97.8 million for 2020, compared to 2019. The increase in average money market, savings and interest bearing-demand deposits included $58.7 million for 2020, and the increase in average time deposits included $76.8 million for 2020 related to the acquisition of Peoples. Average noninterest-bearing demand deposits increased $148.3 million for 2020, compared to 2019, including $42.9 million related to the acquisition of Peoples. Higher average deposit balances are due primarily to deposit growth during 2020 and the acquisition of Peoples. Deposit growth was also impacted by the effect of PPP loans and direct government payments received by depositors. The average cost of interest-bearing deposits decreased 16 basis points for 2020, compared to 2019, due primarily to lower rates on money market, savings and interest-bearing demand deposits, which take effect immediately upon a change in offered rates. Offered rates on time deposits were also lower during 2020, compared to 2019. Changes in the average cost of time deposits lag changes in pricing based on the repricing of time deposits at maturity.

Average borrowings decreased $31.0 million for 2020, compared to 2019, due primarily to the repayment of long-term borrowings in 2020, partially offset by the issuance of $20.0 million of subordinated notes by the Corporation, subordinated notes that were assumed during the acquisition of Peoples and new finance leases. Repayment of long-term borrowings included paying off a revolving bank line of credit balance of $75.0 million and paying off aggregate convertible FHLB advances of $44.5 million using excess cash. The average cost of borrowings decreased 51 basis points during 2020 compared to 2019, due primarily to the payoff of the revolving bank line of credit and lower short-term interest rates. Aggregate repayments in December 2020 of convertible FHLB advances of $37.0 million are expected to result in annualized interest cost savings of $783,000, and such savings are expected to benefit net interest margin in 2021, compared to 2020.

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

Discussion of net interest income for the year ended December 31, 2018 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, 2019, which was filed with the SEC on March 3, 2020.

NONINTEREST INCOME

TABLE 3: Noninterest Income

Year Ended December 31, 2020

Community Mortgage Consumer Other and

(Dollars in thousands) Banking Banking Finance Eliminations Total

Mortgage banking fee income — 7,743 — (30) 7,713

Interchange income 4,768 — — — 4,768

Service charges on deposit accounts 3,357 — — — 3,357

Wealth management services income, net 1 — — 2,617 2,618

Mortgage lender services income — 2,176 — — 2,176

Other service charges and fees 1,549 — 2 — 1,551

Year Ended December 31, 2019

Community Mortgage Consumer Other and

(Dollars in thousands) Banking Banking Finance Eliminations Total

Gains on sales of loans $ — $ 10,603 $ — $ — $ 10,603

Mortgage banking fee income — 4,700 — — 4,700

Interchange income 4,203 — — — 4,203

Service charges on deposit accounts 3,923 — — — 3,923

Wealth management services income, net — — — 2,029 2,029

Mortgage lender services income — 390 — — 390

Other service charges and fees 1,492 — 4 — 1,496

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Year Ended December 31, 2018

Community Mortgage Consumer Other and

(Dollars in thousands) Banking Banking Finance Eliminations Total

Gains on sales of loans $ — $ 7,841 $ — $ — $ 7,841

Mortgage banking fee income — 3,686 — — 3,686

Interchange income 3,882 — — — 3,882

Service charges on deposit accounts 4,213 — — — 4,213

Wealth management services income, net — — — 1,860 1,860

Mortgage lender services income — 329 — — 329

Other service charges and fees 1,379 — 7 — 1,386

Net gains on calls of available for sale securities 10 — — — 10

Total noninterest income increased $23.4 million, or 73.1 percent, for the year ended December 31, 2020, compared to the year ended December 31, 2019. The increase in noninterest income was due primarily to (1) an increase in gains on sales of loans and mortgage banking fee income, which consists of fees related to loan originations, at the mortgage banking segment as a result of higher margins and record loan production, (2) an increase in gains on sales of loans at the community banking segment related to the sale of a pool of PCI loans in 2020, (3) an increase in mortgage lender services income at the mortgage banking segment for providing mortgage origination functions to third parties, as a result of the Lender Solutions division of C&F Mortgage adding new customers and higher mortgage industry volume, (4) an increase in wealth management services income, and (5) an increase in debit card interchange income at the community banking segment. These increases were partially offset by decreased service charges on deposit accounts at the community banking segment resulting from fewer overdraft fees charged and asset write-downs at the community banking segment of $579,000 in 2020. Asset write-downs, included in “Other income (loss), net,” at the community banking segment included $298,000 of merger related costs recognized in connection with disposition of assets acquired from Peoples and $281,000 related to branch consolidation.

Discussion of noninterest income for the year ended December 31, 2018 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, 2019, which was filed with the SEC on March 3, 2020.

NONINTEREST EXPENSE

TABLE 4: Noninterest Expense

Year Ended December 31, 2020

Community Mortgage Consumer Other and

(Dollars in thousands) Banking Banking Finance Eliminations Total

Early debt repayment charges 2,197 — — — 2,197

Other expenses:

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Year Ended December 31, 2019

Community Mortgage Consumer Other and

(Dollars in thousands) Banking Banking Finance Eliminations Total

Other expenses:

Year Ended December 31, 2018

Community Mortgage Consumer Other and

(Dollars in thousands) Banking Banking Finance Eliminations Total

Other expenses:

Total noninterest expense increased $18.6 million, or 23.3 percent, for the year ended December 31, 2020, compared to the year ended December 31, 2019. The increase in noninterest expenses was due primarily to (1) higher mortgage loan production volume at the mortgage banking segment, resulting in higher expenses related to production volume, included in salaries and employee benefits, data processing and mortgage banking loan processing expenses (2) higher operating expenses at the community banking segment, including the effects of (a) assuming certain salaries and employee benefits expense and data processing expense of Peoples, including some costs that have since been eliminated following the integration of its operations into the Bank’s, (b) occupancy expense related to opening two new financial centers in 2020 and (c) investing in technology infrastructure to support continued growth, (3) early debt repayment charges incurred in connection with the aggregate payoff of $44.5 million of convertible FHLB advances in 2020, (4) provision for indemnifications at the mortgage banking segment, included in “Other expenses,” of $881,000 for 2020 compared to no provision for indemnifications in 2019, (5) higher merger related expenses in connection with the acquisition of Peoples, and (6) higher expense associated with the FDIC insurance assessment at the community banking segment, included in “Other expenses,” as credits available to banks with less than $10 billion in consolidated assets were used to offset assessment expense for portions of 2019 and 2020 and were fully utilized by the end of the first quarter of 2020.

Merger related expenses for the year ended December 31, 2020 included $1.3 million at the community banking segment, of which $501,000 was data processing expense, $236,000 was professional fees expense, $119,000 was salaries and employee benefits expense, $81,000 was occupancy expense, and $61,000 was included in all other noninterest expenses, while $298,000 was a loss on disposition of assets and was recorded in noninterest income. Merger related expenses for the year ended December 31, 2020 also included $100,000 of professional fees expense recorded as a holding company expense and shown in the “Other and Eliminations” column in the tables above. Merger related expenses for the year ended December 31, 2019 included $236,000 at the community banking segment, of which $173,000 was professional fees expense, $50,000 was data processing expense and $13,000 was included in all other noninterest expenses, and $473,000 at the Corporation, of which $441,000 was professional fees expense and $32,000 was included in all other noninterest expenses.

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As of December 31, 2020, the community banking segment has realized substantially all of the cost savings associated with the integration of Peoples. Additionally, C&F Bank expects to realize annualized cost savings of approximately $220,000 in connection with the consolidation of its main office in West Point, VA by the end of the second quarter of 2021.

Discussion of noninterest expense for the year ended December 31, 2018 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, 2019, which was filed with the SEC on March 3, 2020.

INCOME TAXES

Income tax expense on 2020 earnings was $6.8 million, resulting in an effective tax rate of 23.3 percent, compared with $5.1 million, or 21.2 percent, in 2019 and $4.5 million, or 20.1 percent, in 2018. The higher effective income tax rate for 2020 compared to 2019 resulted primarily from higher state income taxes, as a greater share of income before taxes was earned at the mortgage banking segment, which is subject to state income tax, and a limitation on the deductibility of certain executive compensation, partially offset by income tax benefits of $326,000 in 2020 arising from a change in income tax law included in the provisions of the CARES Act, which provided income tax benefits in the current year related to prior tax years of Peoples.

Discussion of income taxes for the year ended December 31, 2018 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, 2019, which was filed with the SEC on March 3, 2020.

ASSET QUALITY

Allowance and Provision for Loan Losses

Allowance for Loan Losses Methodology – Community Banking and Mortgage Banking. We conduct an analysis of the collectibility 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.

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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:

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 collectibility 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 collectibility. 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

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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:

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 Policies” in this Item 7.

Allowance for Loan Losses Methodology – Consumer Finance. The consumer finance segment’s loans consist of non-prime automobile loans and prime 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

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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., non-prime automobile loans and prime 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 to non-prime automobile borrowers, 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 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 average amounts deferred on a monthly basis, as a percentage of average non-prime automobile loans outstanding, during the fourth quarter of 2020 and the year ended December 31, 2020 was 1.56 percent and 2.93 percent, respectively, compared to 1.87 percent and 1.90 percent in the fourth quarter of 2019 and the year ended December 31, 2019, respectively, and 2.53 percent and 2.30 percent in the fourth quarter of 2018 and the year ended December 31, 2018, respectively. Payment deferrals increased for 2020 as the COVID-19 pandemic affected the ability of some borrowers to make timely payments.

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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 5: Allowance for Loan Losses

Year Ended December 31,

Provision for loan losses:

Mortgage Banking 10 — — — —

Loans charged off:

Real estate—residential mortgage (62) (46) (42) (179) (82)

C & F Financial Corp CFFI US Equity

CFFI · 10-K · period ended 2020-12-31

ITEM 1A.RISK FACTORS

ITEM 1B.UNRESOLVED STAFF COMMENTS

ITEM 2.PROPERTIES

ITEM 3.LEGAL PROCEEDINGS

ITEM 4.MINE SAFETY DISCLOSURES

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6.SELECTED FINANCIAL DATA

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

C & F Financial Corp CFFI US Equity☆

CFFI · 10-K · period ended 2020-12-31

ITEM 1A.RISK FACTORS

ITEM 1B.UNRESOLVED STAFF COMMENTS

ITEM 2.PROPERTIES

ITEM 3.LEGAL PROCEEDINGS

ITEM 4.MINE SAFETY DISCLOSURES

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6.SELECTED FINANCIAL DATA

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

C & F Financial Corp CFFI US Equity