CFFI · Read the filing

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)

Commercial, financial and agricultural1 (18) (29) (409) (349) (87)

Equity lines — (138) — (42) (57)

Recoveries of loans previously charged off:

Real estate—residential mortgage 88 26 57 118 163

Commercial, financial and agricultural1 4 4 59 21 206

Equity lines 1 — — 2 —

For further information regarding the adequacy of our allowance for loan losses, refer to “Nonperforming Assets” within this Item 7.

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The allocation of the allowance for loan losses at December 31 for the years indicated and the ratio of corresponding outstanding loan balances to total loans are as follows:

TABLE 6: Allocation of Allowance for Loan Losses

December 31,

Allocation of allowance for loan losses:

Ratio of loans to total period-end loans:

Real estate—residential mortgage 16 % 16 % 17 % 19 % 19 %

Real estate—construction 1 4 5 5 4 6

Commercial, financial and agricultural 2 52 45 43 43 39

Equity lines 4 5 5 5 5

Consumer 1 1 2 1 1

Loans by credit quality indicators as of December 31, 2020 were as follows:

TABLE 7A: Credit Quality Indicators

Special Substandard

(Dollars in thousands) Pass Mention Substandard Nonaccrual Total1

Real estate – construction 2 62,147 — — — 62,147

Included in the table above are loans purchased in connection with the acquisition of Peoples of $53.0 million pass rated, $695,000 special mention and $3.0 million substandard.

Non-

(Dollars in thousands) Performing Performing Total

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

TABLE 7B: Credit Quality Indicators

Special Substandard

(Dollars in thousands) Pass Mention Substandard Nonaccrual Total1

Real estate – construction 2 54,246 — — — 54,246

Non-

(Dollars in thousands) Performing Performing Total

The increase in loans rated Special Mention and Substandard at December 31, 2020 compared to December 31, 2019 is related primarily to three commercial relationships which were rated Pass at December 31, 2019, as well as loans that were acquired from Peoples, partially offset by one commercial relationship that was classified as Special Mention at December 31, 2019 and rated Pass at December 31, 2020. Of the three loan relationships that were rated Pass at December 31, 2019 and were subsequently downgraded, one was classified as Special Mention, one was classified as Substandard and one was classified as Substandard Nonaccrual at December 31, 2020 partially as a result of effects on these borrowers of the COVID-19 pandemic.

The allowance for loan losses as a percentage of total loans at the community banking segment, excluding PCI loans, increased to 1.46 percent at December 31, 2020, compared to 1.32 percent at December 31, 2019. The allowance for loan losses as a percentage of total loans excluding all purchased loans and loans originated under the PPP was 1.74 percent at December 31, 2020, compared to 1.36 percent at December 31, 2019. The community banking segment recorded provision for loan losses of $4.6 million in 2020, primarily to add to reserves based on qualitative adjustments as a result of the COVID-19 pandemic and due to loan growth, compared to provision for loan losses of $360,000 for 2019. As of December 31, 2020, there have not been significant changes in the overall credit quality of the loan portfolio compared to December 31, 2019, 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.

The consumer finance segment’s allowance for loan losses increased by $1.7 million to $23.5 million at December 31, 2020 from $21.8 million at December 31, 2019, and its provision for loan losses decreased $1.7 million for the year ended December 31, 2020, as compared to 2019. Total delinquent loans, which does not include loans that have been granted a payment deferral, as a percentage of total loans decreased to 3.08 percent at December 31, 2020 compared to 4.17 percent at December 31, 2019. The consumer finance segment’s net charge-off ratio for 2020 decreased to 1.54 percent from 3.05 percent for 2019 due to a lower number of charge-offs during 2020, as a result of 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 the consumer finance segment continuing to purchase higher quality loans, including marine and RV loans, as well as borrowers benefitting from the government’s stimulus measures in response to the pandemic. The Corporation can give no assurance as to the continuation of government stimulus measures or the extent to which they will result in supporting borrowers’ ability to continue making their contractual loan payments. The allowance for loan losses as a percentage of loans increased to 7.53 percent at December 31, 2020,

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compared to 6.96 percent at December 31, 2019. The increase in the level of the allowance for loan losses as a percentage of total loans reflects losses that are probable as a result of the economic impacts of the COVID-19 pandemic. 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.

As previously described, the consumer finance segment, at times, offers payment deferrals to non-prime automobile borrowers as a management technique to achieve higher ultimate cash collections on select loan accounts. Payment deferrals may affect the ultimate timing of when an account is charged off. A significant reliance on deferrals as a means of managing collections may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio. Monthly payment deferrals, as a percentage of non-prime automobile loans outstanding, rose to as high as 8.25 percent during the second quarter of 2020 and returned to normal levels by the end of 2020; the average amount deferred on a monthly basis during the fourth quarter of 2020 as a percentage of non-prime automobile loans was 1.56 percent. The average amounts deferred on a monthly basis during 2020 were 2.93 percent of non-prime automobile loans outstanding, compared to 1.90 percent during 2019 and 2.30 percent during 2018. Payment deferrals increased for 2020 compared to 2019 as the COVID-19 pandemic affected the ability of some borrowers to make timely payments.

Because C&F Finance primarily focuses on non-prime borrowers, the anticipated rates of delinquencies, defaults, repossessions and losses on the consumer finance loans are higher than those experienced in the general automobile finance industry and could be more dramatically affected by changes in general economic conditions. Changes in economic conditions may also affect consumer demand for used automobiles and values of automobiles securing outstanding loans, due to changes in demand or changes in levels of inventory of used automobiles, which may directly affect the amount of a loss incurred by C&F Finance in the event of default. While we manage the higher risk inherent in loans made to non-prime borrowers through the underwriting criteria, portfolio management and collection methods employed by C&F Finance, we cannot guarantee that these criteria or methods will afford adequate protection against these risks. Beginning in 2016 with C&F Finance’s implementation of a scorecard model for purchasing loan contracts, the credit worthiness of borrowers at origination has improved for automobile loans purchased by C&F Finance and the level of credit losses experienced has decreased. We cannot provide any assurance that C&F Finance’s net charge-off ratio will not increase in future periods. However, we believe that the current allowance for loan losses is adequate to absorb probable losses that have been incurred on existing consumer finance segment loans that may become uncollectible. If factors influencing the consumer finance segment result in higher net charge-off ratios in future periods, the consumer finance segment may need to increase the level of its allowance for loan losses through additional provisions for loan losses, which could negatively affect future earnings of the consumer finance segment.

Nonperforming Assets

A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across our loan portfolio.

Assets acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of like properties, length of time the properties have been held, and our ability and intention with regard to continued ownership of the properties. We may incur additional write-downs of foreclosed assets to fair value less estimated costs to sell if valuations indicate a further deterioration in market conditions. Revenue and expenses from operations and changes in the property valuations are included in net expenses from foreclosed assets and improvements are capitalized.

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At the consumer finance segment, the repossession process is generally initiated after a loan becomes more than 60 days delinquent. Borrowers have an opportunity to redeem their repossessed vehicles by paying all outstanding balances, including finance charges and fees. Vehicles that are not redeemed within the prescribed waiting period before C&F Finance has the legal right to sell the repossessed vehicle then become available-for-sale at the end of that period and are reclassified from loans to other assets and are recorded initially at fair value less estimated costs to sell. The difference between the carrying amount of each loan and the fair value of the vehicle (i.e. the deficiency) is charged against the allowance for loan losses. Accounts still in process of collection or for which the Corporation does not have the legal right to sell continue to be classified as loans until such legal authority is obtained. After the vehicles have been sold in third-party auctions, we credit the proceeds from the sale of the vehicles, and any other recoveries, to the carrying value of the repossessed vehicles. C&F Finance pursues collection of deficiencies, as allowed by state law, when it deems such action to be appropriate.

Table 8 summarizes nonperforming assets at December 31 of each of the past five years.

TABLE 8: Nonperforming Assets

Community Banking Segment

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Mortgage Banking Segment

Consumer Finance Segment

Accruing loans past due for 90 days or more $ — $ — $ — $ — $ —

Allowance for loan losses to total loans 7.53 6.96 7.77 8.34 8.33

Table 9 presents the changes in the OREO balance for 2020 and 2019.

TABLE 9: OREO Changes

Year Ended December 31,

Balance at the beginning of year, gross $ 1,191 $ 303

Charge-offs (57) —

Sales proceeds (364) (521)

Gain on disposition — 8

Balance at the end of year, gross 1,114 1,191

Less valuation allowance (207) (88)

Balance at the end of year, net $ 907 $ 1,103

Nonperforming assets of the community banking segment totaled $3.9 million at December 31, 2020, compared to $2.6 million at December 31, 2019. Nonperforming assets included $3.0 million in nonaccrual loans at December 31, 2020 compared to $1.5 million at December 31, 2019, and included $907,000 in other real estate owned at December 31, 2020, compared to $1.1 million at December 31, 2019. The increase in nonaccrual loans at December 31, 2020 compared to December 31, 2019 was due primarily to the downgrading of one commercial relationship in 2020, partially offset by payoffs. Nonaccrual loans were comprised primarily of commercial business loans at December 31, 2020 and residential mortgages and equity lines at December 31, 2019. If interest on loans on nonaccrual at December 31, 2020 had been recognized throughout the year, the community banking segment would have recorded additional gross interest income in 2020 of $30,000.

Nonaccrual loans at the consumer finance segment decreased to $402,000 at December 31, 2020 from $611,000 at December 31, 2019. As noted above, the allowance for loan losses at the consumer finance segment increased from $21.8 million at December 31, 2019 to $23.5 million at December 31, 2020, and the ratio of the allowance for loan losses to total consumer finance loans was 7.53 percent as of December 31, 2020, compared to 6.96 percent at December 31, 2019. Nonaccrual consumer finance loans remain low relative to the allowance for loan losses and the total consumer finance loan portfolio because the consumer finance segment generally initiates repossession of loan collateral once a loan

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becomes more than 60 days delinquent. Repossessed vehicles of the consumer finance segment are classified as other assets and consist only of vehicles the Corporation has the legal right to sell. Prior to the reclassification from loans to repossessed vehicles, the difference between the carrying amount of each loan and the fair value of each vehicle (i.e. the deficiency) is charged against the allowance for loan losses. At December 31, 2020, repossessed vehicles at fair value less estimated costs to sell included in other assets totaled $291,000, compared to $410,000 at December 31, 2019. If interest on loans on nonaccrual at December 31, 2020 had been recognized throughout the year, the consumer finance segment would have recorded additional gross interest income in 2020 of $4,000.

As discussed above, we measure impaired loans either based on fair value of the loan using the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent, or using the present value of expected future cash flows discounted at the loan’s effective interest rate. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment in the loan. TDRs occur when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions typically are made for loss mitigation purposes and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs are considered impaired loans.

Impaired loans, which included TDRs of $3.6 million, and the related allowance at December 31, 2020, were as follows:

TABLE 10A: Impaired Loans

Recorded Recorded

Investment Investment Average

Unpaid in Loans in Loans Balance- Interest

Principal without with Related Impaired Income

Commercial, financial and agricultural:

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

TABLE 10B: Impaired Loans

Recorded Recorded

Investment Investment Average

Unpaid in Loans in Loans Balance- Interest

Principal without with Related Impaired Income

Commercial, financial and agricultural:

Equity lines 31 31 — — 32 2

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

TABLE 11: Troubled Debt Restructurings

December 31, December 31,

1 Included in nonaccrual loans in Table 8: Nonperforming Assets.

2 Included in impaired loans in Tables 10A and 10B: Impaired Loans.

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

The Corporation has accommodated certain borrowers affected by the COVID-19 pandemic by granting short-term payment deferrals or periods of interest-only payments on loans with aggregate balances of $104.7 million during the year ended December 31, 2020. Generally, a short-term payment deferral does not result in a loan modification being classified as a TDR. As of December 31, 2020, there were $30.7 million of loans whose modification periods had not ended or had been extended. Of these loans, $30.2 million were not required to be evaluated as TDRs as a result of the CARES Act; however, management believes that these loans have been risk rated appropriately. Management cannot predict the overall impact of the COVID-19 pandemic on its loan portfolio or the extent of payment deferrals or other modifications that may be granted. Depending on the severity and duration of the economic disruption caused by the COVID-19 pandemic, the Corporation may experience an increase in delinquencies that may lead to further loan modifications, including loan modifications that may be classified as TDRs.

FINANCIAL CONDITION

SUMMARY

A financial institution’s primary sources of revenue are generated by its earning assets and sales of financial assets, while its major expenses are produced by the funding of those assets with interest-bearing liabilities, provisions for loan losses and compensation to employees. Effective management of these sources and uses of funds is essential in attaining a financial institution’s maximum profitability while maintaining an acceptable level of risk.

At December 31, 2020, the Corporation had total assets of $2.09 billion compared to $1.66 billion at December 31, 2019. The increase resulted primarily from increases in loans and securities and the acquisition of Peoples on January 1, 2020, which added total assets of $190.5 million, funded primarily by deposit growth. The significant components of the Corporation’s Consolidated Balance Sheets are discussed below.

LOAN PORTFOLIO

General

Through the community banking segment, we engage in a wide range of lending activities, which include the origination, primarily in the community banking segment’s market area, of (1) one-to-four family and multi-family residential mortgage loans, (2) commercial real estate loans, (3) construction loans, (4) land acquisition and development

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loans, (5) consumer loans and (6) commercial business loans. We engage in non-prime automobile, and marine and RV lending through the consumer finance segment and in residential mortgage lending through the mortgage banking segment with substantially all of the loans originated through the mortgage banking segment sold to third-party investors. At December 31, 2020, the Corporation’s loans held for investment in all categories, net of the allowance for loan losses, totaled $1.31 billion and loans held for sale had a fair value of $214.3 million.

Tables 12 and 13 present information pertaining to the composition of loans held for investment and the maturity/repricing of certain loans held for investment.

TABLE 12: Summary of Loans Held for Investment

December 31,

TABLE 13: Maturity/Repricing Schedule of Loans Held for Investment

Commercial,

Financial, Real Estate

(Dollars in thousands) and Agricultural Construction

Variable Rate:

After 5 years 497 —

Fixed Rate:

Beginning in April 2020, the community banking segment originated loans under the PPP which are guaranteed by the SBA, and in some cases borrowers may be eligible to obtain forgiveness of the loans, in which case loans would be repaid by the SBA. Aggregate fees from the SBA of $3.7 million, net of direct costs, will be recognized in interest income over the life of the loans, of which $2.2 million remains unrecognized as of December 31, 2020. As repayment of the loans is guaranteed by the SBA, the community banking segment does not recognize a reserve for PPP loans in its allowance for loan losses. Table 14 presents the outstanding principal of loans originated under the PPP at December 31, 2020, which are recorded in the Consolidated Balance Sheet net of unrecognized net deferred fees of $2.2 million.

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TABLE 14: Paycheck Protection Loans as of December 31, 2020

(Dollars in thousands) Number of Loans Outstanding

In evaluating the allowance for loan losses, the community banking segment considered its exposure to segments of the economy that it believes have been or will be most sensitive to the impacts of the COVID-19 pandemic. Table 15 presents balances of loans to borrowers in these sensitive industries at December 31, 2020, excluding PPP loans, and the exposure of the community banking segment to those borrowers, which includes available credit.

TABLE 15: Sensitive Industries and Exposure

(Dollars in thousands) Balance Exposure

Fitness centers and recreation 11,487 12,206

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The increase in total loans from December 31, 2019 to December 31, 2020 was primarily due to commercial loan growth at the community banking segment resulting from loans acquired in the acquisition of Peoples, loans originated under the PPP, and growth in the commercial real estate and commercial business lending segments of the portfolio.

Total loans at December 31, 2020 and 2019 included loans purchased in connection with the Corporation’s acquisitions. These loans were recorded at estimated fair value on the date of acquisition without the carryover of the related allowance for loan losses. The following tables present the outstanding principal balance and the carrying amount of purchased loans that are included in the Corporation’s Consolidated Balance Sheets at December 31, 2020 and 2019.

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TABLE 16: PCI and Purchased Performing Loans

Purchased

Credit Purchased

(Dollars in thousands) Impaired Performing Total

Carrying amount

Real estate – construction — 1,077 1,077

Purchased

Credit Purchased

(Dollars in thousands) Impaired Performing Total

Carrying amount

Real estate – residential mortgage $ 107 $ 7,035 $ 7,142

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

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CFFI · 10-K · period ended 2020-12-31

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

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