C&F Financial Corporation — Q2 2014 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2014. C&F operates retail banking, mortgage banking and consumer finance businesses. Results include Central Virginia Bank (CVB), acquired in October 2013 and merged into C&F Bank in March 2014; comparisons with 2013 therefore reflect a larger company as well as changes in operating performance.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net interest income | $19.6 million | $17.1 million | $38.6 million | $34.1 million |
| Provision for loan losses | $3.3 million | $3.1 million | $6.8 million | $6.3 million |
| Noninterest income | $5.3 million | $7.0 million | $10.1 million | $12.1 million |
| Noninterest expenses | $16.3 million | $14.5 million | $32.6 million | $27.6 million |
| Net income | $3.7 million | $4.2 million | $6.6 million | $8.2 million |
| Diluted earnings per share | $1.09 | $1.22 | $1.91 | $2.41 |
- Net income fell about 10% in Q2 and 19% in the first half year over year. Net interest income increased, but lower mortgage income, higher expenses and weaker consumer finance results more than offset that growth.
- Net interest margin, on a taxable-equivalent basis, was 6.58% in Q2 and 6.56% for the first half, down from 7.67% and 7.71%, respectively. Reported net interest income above is from the income statement; MD&A presents taxable-equivalent net interest income of $20.2 million for Q2 and $39.8 million for the first half.
- Annualized return on average assets and return on average equity were 1.13% and 12.74% in Q2, versus 1.69% and 15.65% a year earlier. First-half figures were 1.00% and 11.37%, versus 1.66% and 15.55%.
- Segment net income for Q2 was $1.4 million in retail banking, $224,000 in mortgage banking and $2.3 million in consumer finance; the respective prior-year amounts were $499,000, $986,000 and $3.3 million. First-half segment income was $2.4 million, $239,000 and $4.4 million, compared with $1.2 million, $1.5 million and $6.4 million.
Financial position, cash flow and capital
- Total assets were $1.347 billion at June 30, 2014, up $35.2 million from year-end 2013. Gross loans were $826.4 million, net loans $791.2 million, and available-for-sale securities $217.3 million.
- Cash and cash equivalents were $182.4 million, compared with $148.1 million at December 31. First-half cash flow was $10.3 million provided by operations, $3.6 million used in investing and $27.5 million provided by financing, yielding a $34.2 million increase in cash.
- Deposits were $1.040 billion, up $31.5 million since year-end; noninterest-bearing demand deposits rose $29.3 million, while time deposits declined $20.1 million. Total borrowings, including trust preferred capital notes, were approximately $169.6 million. Shareholders’ equity was $119.2 million.
- Management reported liquid assets of $291.7 million, including nonpledged securities, and $264.4 million of available borrowing capacity. It stated that liquidity was sufficient for operating needs and contractual obligations.
- Bank regulatory capital ratios were 15.1% total capital to risk-weighted assets, 13.8% Tier 1 risk-based capital and 9.3% Tier 1 leverage; each exceeded the disclosed well-capitalized thresholds.
- First-half dividends were $0.59 per share. C&F paid $2.3 million to repurchase and cancel its Treasury warrant, completing its exit from TARP. A separate $5 million common-stock repurchase authorization was approved; no shares were repurchased under it in Q2.
Material changes, outlook and risks
- Mortgage banking: Higher mortgage rates, reduced refinancing, soft purchase activity, low housing inventories, winter weather and loan officer turnover weighed on production. Originations fell 40.5% in Q2 and 44.3% in the first half year over year; loan-sale gains declined to $1.6 million and $2.8 million, respectively. Management warned that weak demand could continue to pressure segment earnings.
- Consumer finance: Competitive pricing reduced average loan yields and balances, while elevated charge-offs increased provisions. The segment’s annualized net charge-off ratio was 3.85% in Q2 and 4.42% for the first half, versus 3.09% and 3.33% a year earlier. Management considered reserves adequate but said sustained economic weakness or unemployment could require higher provisions.
- Retail banking and acquisition: CVB acquisition accounting contributed net accretion of $554,000 after tax in Q2 and $1.1 million after tax in the first half. Retail earnings also benefited from lower deposit costs, improved credit quality and reduced foreclosed-property costs. Added staffing, branch operations, system conversion and integration expenses offset some benefits. Management expects further cost savings and efficiencies, but did not quantify them.
- Nonperforming assets in retail banking declined to $5.3 million from $7.2 million at year-end, mainly because OREO fell to $817,000 from $2.8 million. Total reported nonaccrual loans were $5.3 million; the allowance for loan losses was $35.3 million. Consumer finance’s allowance equaled 8.34% of its loans, slightly above 8.32% at year-end.
- Unrealized losses on temporarily impaired securities improved: $1.4 million at June 30 versus $3.9 million at year-end. The company reported no other-than-temporary impairment, citing intent and ability to hold the securities through recovery.
- Mortgage loan sales carry representation-and-warranty and repurchase exposure. The indemnification reserve was $2.1 million at June 30. Mortgage derivatives had $104.3 million notional value and $950,000 fair value. A $10 million interest-rate swap hedged part of trust preferred notes through September 2015.
- Management identified risks from interest-rate and economic changes, mortgage demand and housing conditions, consumer credit quality and used-car values, competition, deposit flows, regulatory changes including Basel III, and realizing CVB acquisition benefits. No specific earnings or other numerical guidance was provided. Management said market-risk disclosures and off-balance-sheet arrangements had no significant or material changes, respectively, from the prior annual report.
Important facts for investors to verify
- Whether mortgage origination volumes and gains recover, and how persistent the consumer finance charge-off and provision trends prove to be.
- How much of reported retail earnings depends on acquisition-related fair-value accretion, and whether CVB integration delivers the anticipated savings without further material costs.
- Whether the allowance remains adequate if unemployment, defaults or collateral values worsen, particularly in consumer finance and commercial lending.
- How excess cash is deployed and whether deposit growth or asset-yield pressure further reduces net interest margin.
- The effect of securities valuation movements, interest-rate sensitivity and upcoming Basel III requirements on earnings and capital.
- The size and development of mortgage repurchase or indemnification claims relative to the $2.1 million reserve, and the status of the authorized but unused $5 million share repurchase program.