C & F FINANCIAL CORP quarterly report, Q2 FY2018

C&F Financial Corporation — Q2 2018 Form 10-Q

Business context and reporting period. Unaudited results for the quarter and six months ended June 30, 2018, compared with the corresponding 2017 periods. C&F operates retail banking, mortgage banking and consumer finance businesses.

Financial performance and condition

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Total operating revenue	$29.9m	$29.8m	$59.1m	$58.1m
Net interest income	$20.0m	$20.1m	$40.2m	$39.8m
Provision for loan losses	$2.0m	$3.1m	$5.3m	$7.5m
Net income	$5.1m	$4.1m	$9.0m	$6.9m
Diluted EPS	$1.45	$1.19	$2.56	$1.97

Q2 annualized return on average assets was 1.34% and return on average equity was 14.16%, up from 1.14% and 11.63%, respectively. First-half figures were 1.19% and 12.62%, versus 0.95% and 9.76%.
Net interest margin fell to 5.69% in Q2 from 6.06% and to 5.77% for the first half from 6.08%. Management cited lower asset yields and higher funding costs; growth in average earning assets partly offset the margin pressure.
Noninterest income was $7.2m in Q2, down from $7.4m; first-half income was essentially unchanged at $13.7m. Noninterest expense rose 1.9% in Q2 to $18.8m and 2.6% for the first half to $37.3m.
Effective tax rates declined to 21.6% for Q2 and 20.3% for the first half, from 30.9% and 28.7%, largely reflecting the federal corporate tax rate reduction.
At June 30, total assets were $1.536bn, loans net of allowance $996.4m, deposits $1.193bn and shareholders’ equity $146.5m. Total assets rose $26.6m from year-end 2017; deposits grew $22.0m.
Cash and cash equivalents were $135.7m, up from $119.4m at year-end. Six-month operating cash flow was $15.5m, investing cash outflow $17.0m, and financing cash inflow $17.8m.
Borrowings totaled $166.1m: $18.8m short-term, $122.0m long-term and $25.2m trust preferred capital notes. Reported available funding capacity was $272.0m. Management said liquidity was sufficient for operating needs and obligations.
Total regulatory capital ratios at June 30 were 14.9% for both the Corporation and Bank; common equity Tier 1 was 11.6% and 13.6%, respectively. Both exceeded applicable capital conservation buffer requirements.

Material changes and asset quality

Net income increased 22% in Q2 and 30% for the first half year over year. Lower loan-loss provisions and lower taxes supported earnings; revenue was broadly flat.
Loans held for investment were $1.032bn, up modestly from $1.028bn at year-end. Construction loans increased to $67.6m from $44.8m, while commercial, financial and agricultural loans declined to $414.6m from $437.9m.
Allowance for loan losses was $35.4m, versus $35.7m at year-end. Retail Banking nonperforming assets declined to $3.0m from $5.4m, primarily after a partial repayment of a commercial relationship. Retail allowance coverage of loans excluding purchased credit-impaired loans remained 1.48%.
Consumer Finance’s first-half annualized net charge-off ratio improved to 3.85% from 5.34%; delinquent loans declined to 4.18% of segment loans from 5.17% at year-end. Its allowance was $24.0m, or 8.11% of loans, versus $24.4m, or 8.34%.
Available-for-sale securities had a $3.661m gross unrealized loss at June 30, versus $1.356m at year-end. The company attributed impairments mainly to interest-rate movements and reported no other-than-temporary impairment.
Accumulated other comprehensive loss widened to $4.2m from $1.9m, principally reflecting unrealized securities losses. Dividends declared were $0.68 per share in the first half. The $5.0m share repurchase authorization was renewed through May 31, 2019; no program repurchases had been made.

Outlook, commentary and risks

No specific earnings or revenue guidance was provided. Management said maintaining the current net interest margin may be challenging, citing potential further rate increases, deposit repricing, competition in non-prime auto lending, and growth in lower-yielding boat and RV loans.
The company began expanding consumer-finance indirect lending to prime boat and RV loans in Q1 2018. Management expects lower credit losses on these loans, but acknowledged that their lower yields may compress margins.
Retail Banking earnings benefited from loan growth and lower provisions; spending increased for technology, digital products, compliance, marketing and market expansion. Mortgage Banking benefited from cost efficiencies but faced lower Q2 mortgage production and gains on loan sales.
Key disclosed risks include changes in interest rates and economic conditions, loan and collateral quality, real-estate markets, non-prime auto competition and vehicle values, deposit flows, mortgage secondary-market demand, mortgage repurchase/indemnification claims, regulation, cybersecurity and third-party service dependencies.
Mortgage loan-sale agreements include representations and warranties; some recourse periods for fraud, misrepresentation or underwriting errors have no stated time limit. The indemnification reserve was $2.541m at June 30.
Off-balance-sheet commitments included $234.4m of loan commitments and $16.3m of standby letters of credit. Many commitments may expire undrawn.
Adoption of revenue-recognition guidance did not change accounting for in-scope revenue streams. The company had not yet estimated the financial effects of the forthcoming lease and expected-credit-loss standards.

Important facts for investors to verify

Whether net interest margin stabilizes as rates, deposit costs and consumer-finance funding costs change.
Whether improved charge-offs and delinquencies persist, particularly in consumer finance, and whether the allowance remains adequate.
Performance, yields and credit quality of the newer prime boat and RV loan portfolio, as well as the ongoing competitive environment in non-prime auto lending.
Trends in commercial real-estate and construction exposures, criticized loans, nonaccrual loans and mortgage indemnification claims.
Liquidity and capital capacity after dividends, any future share repurchases, and changes in available borrowing sources.