C & F FINANCIAL CORP (CFFI) FY 2021 MD&A

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

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The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Corporation. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.  In addition to current and historical information, the following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future business, financial condition or results of operations. For a description of certain factors that may have a significant impact on our future business, financial condition or results of operations, see “Cautionary Statement Regarding Forward-Looking Statements” prior to Part I, Item 1. “Business.”

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OVERVIEW

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Our primary financial goals are to maximize the Corporation’s earnings and to deploy capital in profitable growth initiatives that will enhance long-term shareholder value. We track three primary financial performance measures in order to assess the level of success in achieving these goals: (1) return on average assets (ROA), (2) return on average equity (ROE), and (3) growth in earnings.  In addition to these financial performance measures, we track the performance of the Corporation’s three business segments: community banking, mortgage banking, and consumer finance.  We also actively manage our capital through growth, dividends and share repurchases, while considering the need to maintain a strong capital position.

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The following table presents selected financial performance highlights for the periods indicated:

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TABLE 1: Financial Performance Highlights

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Consolidated net income for the Corporation was $29.1 million in 2021, or $7.95 per share assuming dilution, compared to $22.4 million in 2020, or $6.06 per share assuming dilution, and $18.9 million in 2019, or $5.47 per share assuming dilution.  The Corporation’s ROE and ROA were 14.77 percent and 1.34 percent, respectively, for 2021,

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compared to 12.54 percent and 1.14 percent, respectively, for 2020 and 12.02 percent and 1.20 percent, respectively, for 2019.

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The Corporation uses adjusted net income, which is a non-GAAP measure of financial performance, to provide meaningful information about operating performance by excluding the effects of certain items that management does not expect to have an ongoing impact on consolidated net income. Adjusted net income for 2021, 2020 and 2019 excludes the effects of  charges related to pension settlement accounting, a gain upon sale of a pool of purchased credit impaired (PCI) loans, charges related to early repayment of borrowings, merger related expenses incurred in connection with the Corporation’s acquisition of Peoples Bankshares, Incorporated (Peoples), branch consolidation activity, and changes in tax law.  Excluding the effects of these items, adjusted net income for 2021 was $30.0 million, or $8.20 per share, compared to $22.4 million, or $6.06 per share, for 2020 and $19.5 million, or $5.66 per share, for 2019.  Adjusted ROE and adjusted ROA were 15.22 percent and 1.38 percent, respectively, for 2021, compared to 12.54 percent and 1.14 percent, respectively, for 2020 and 12.44 percent and 1.25 percent, respectively, for 2019.

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Consolidated net income and earnings per share increased 29.9 percent and 31.2 percent, respectively, for 2021, compared to 2020.  Adjusted net income and adjusted earnings per share increased 33.8 percent and 35.3 percent, respectively, for 2021, compared to 2020.  The increase in consolidated net income and adjusted net income for 2021 compared to 2020 is due primarily to higher net income of the community banking segment and consumer finance segment, partially offset by lower net income at the mortgage banking segment.  The increase in earnings per share and adjusted earnings per share for 2021 compared to 2020 is due primarily to higher net income and fewer shares outstanding, primarily as a result of share repurchases.

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A discussion of the performance of our business segments is included under the heading “Business Segments” in the “Results of Operations” section of this discussion and analysis.

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Key factors affecting comparisons of consolidated net income for the years ended December 31, 2021 and 2020 are as follows.  Comparisons are to the prior year unless otherwise stated.

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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 was 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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Capital Management and Dividends

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Total equity was $211.0 million at December 31, 2021, compared to $194.5 million at December 31, 2020.  Capital growth resulted primarily from earnings for the year ended December 31, 2021, which was partially offset by share repurchases and cash dividends during 2021.  Under regulatory capital standards, the Corporation’s tier I capital and total capital ratios at December 31, 2021 were 13.0 percent and 15.8 percent, respectively, compared to 12.5 percent and 15.2 percent, respectively, at December 31, 2020.

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The Corporation’s Board of Directors continued its historical practice of paying dividends in 2021. For the year ended December 31, 2021, the Corporation declared dividends of $1.58 per share. Annual dividends per share increased 3.9 percent over dividends of $1.52 per share declared in 2020.  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.

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In November 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 through November 30, 2021 (the 2020 Repurchase Program).  During the year ended December 31, 2021, the Corporation repurchased $7.2 million of its common stock under the 2020 Repurchase Program.  At the expiration of the 2020 Repurchase Program, the Corporation had made aggregate common stock repurchases of 151,538 shares for an aggregate cost of $7.5 million under that program.

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On November 16, 2021, the Board of Directors of the Corporation authorized a new program, effective December 1, 2021, to repurchase up to $10.0 million of the Corporation’s common stock through November 30, 2022 (the 2021 Repurchase Program). Repurchases under the 2021 Repurchase Program may be made through privately negotiated transactions or open market transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and/or Rule 10b-18 under the Securities Exchange Act of 1934, as amended, and shares repurchased will be returned to the status of authorized and unissued shares of common stock. During the year ended December 31, 2021, the Corporation repurchased 1,106 shares, or $56,000, of its common stock under the 2021 Repurchase Program.

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At December 31, 2021, the book value per share of the Corporation’s common stock was $59.32, and tangible book value per share, a non-GAAP measure, was $51.66, compared to $52.80 and $45.32, respectively, at December 31, 2020.  Refer to “Use of Certain Non-GAAP Financial Measures,” below, for information about non-GAAP financial measures, including a reconciliation to the most directly comparable financial measures calculated in accordance with U.S. GAAP.

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Acquisition of Peoples Bankshares, Incorporated

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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

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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).  There were no merger related expenses in the year ended December 31, 2021.

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2022 Outlook

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Management’s overall outlook for 2022 is positive as a result of the continued successes of our diversified business strategy and initiatives underway at each of our business segments; however, we will continue to face numerous ongoing challenges in 2022, including the COVID-19 pandemic, economic uncertainty and inflation, cyber security risks and increased competition in our markets due to increased adoption of digital platforms and the impact of data-driven commerce. The following additional factors could influence our financial performance in 2022:

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CRITICAL ACCOUNTING ESTIMATES

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

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Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Our judgment in determining the level of the allowance is based on evaluations of the 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.  In evaluating the level of the allowance, we consider a range of possible assumptions and outcomes related to the various factors identified above. Under alternative assumptions that we considered in developing our estimate of an allowance that will be adequate to absorb probable losses inherent in the loan portfolio at December 31, 2021, our estimate of the allowance varied between $36 million and $41 million.

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

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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.

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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.

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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.

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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 the pools of loans.

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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

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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.

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Goodwill: The Corporation's goodwill was recognized in connection with past business combinations and is reported at the community banking segment and the consumer finance segment. The Corporation reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Corporation may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing is required and the goodwill of the reporting unit is not impaired. If the Corporation elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying value to determine whether an impairment exists. In the last evaluation of goodwill at the community banking segment and the consumer finance segment, which was the annual evaluation in the fourth quarter of 2021, the Corporation concluded that no impairment existed based on an assessment of qualitative factors.

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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.

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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.”

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RESULTS OF OPERATIONS

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NET INTEREST INCOME

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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, 2021, 2020 and 2019. 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 26 basis points and 18 basis points to the yields on community banking segment loans and total loans, respectively, and 13 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2021, compared to 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, and 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.  The yield on loans includes, with respect to PPP loans, interest at a note rate of one percent as well as net deferred origination fees that are amortized based on the contractual maturity of the related loan or accelerated into interest income upon repayment of the loan.  Accretion of net PPP origination fees contributed approximately 39 basis points and 27 basis points to the yields on community banking segment loans and total loans, respectively, and 20 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2021, compared to approximately 16 basis points and 11 basis points to the yields on community banking segment loans and total loans, respectively, and 9 basis points to both the yield on interest earning assets and net interest margin for the year ended December 31, 2020.  Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans

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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.

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TABLE 2: Average Balances, Income and Expense, Yields and Rates

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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.

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TABLE 3: Rate-Volume Recap

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Net interest income, on a taxable-equivalent basis, for 2021 increased to $85.9 million, compared to $84.2 million for 2020, primarily as a result of lower cost of deposits, higher accretion of net PPP origination fees and using deposit growth to fund higher average balances of loans and securities and repayment of borrowings, partially offset by lower yields on interest earning assets. The yield on interest-earning assets and cost of interest-bearing liabilities decreased by 72 basis points and 42 basis points, respectively, for 2021, compared to 2020.  Average earning assets grew $207.2 million, or 11.5 percent, in 2021 compared to 2020, and net interest margin decreased 39 basis points to 4.26 percent in 2021, compared to 4.65 percent in 2020. The net interest margin decline for 2021 as compared to 2020 was due primarily to (1) lower average yields on loans and other earning assets and (2) growth in lower yielding securities and cash reserves outpacing loan growth, partially offset by (1) lower average cost of deposits (including growth in noninterest-bearing deposits) and (2) using lower cost deposits to fund growth in loans and securities and repay borrowings.

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Average loans, which includes both loans held for investment and loans held for sale, increased $30.6 million to $1.51 billion for the year ended December 31, 2021, compared to 2020. Average loans held for investment at the community banking segment increased $41.6 million, or 4.2 percent, for 2021, compared to 2020.  Average loans held for investment at the community banking segment included $60.5 million  and $59.7 million of average balances of loans originated under the PPP for 2021 and 2020, respectively.  The remaining increase in average loans outstanding at the community banking segment for 2021 compared to 2020 was due primarily to growth in the commercial real estate segment of the loan portfolio. Average loans held for investment at the consumer finance segment increased $26.6 million, or 8.6 percent, for 2021, compared to 2020 due to higher average balances of marine and RV loans, due to the continued expansion of the consumer finance segment’s purchases of those loan contracts, and higher average balances of non-prime automobile loans, due to higher loan originations resulting from greater demand for used automobiles and higher loan amounts.  Average loans at the mortgage banking segment, which consist primarily of loans held for sale, decreased $37.6 million, or 22.0 percent, for 2021, compared to 2020, as a result of lower mortgage loan production volume and reducing the average holding period for loans held for sale, in 2021, compared to 2020, due to lower volume and increased capacity for the processing and sale of loans.

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The overall yield on loans decreased 32 basis points to 5.86 percent for 2021, compared to 2020, due primarily to lower average yields at the consumer finance and community banking segments, partially offset by changes in the

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composition of the loan portfolio, as growth in higher-yielding loans at the consumer finance segment outpaced growth in lower-yielding loans at the community banking segment. The community banking segment average loan yield decreased 26 basis points to 4.49 percent for 2021, compared to 2020, due primarily to lower market interest rates, especially on commercial real estate loans, and lower interest income on PCI loans, partially offset by higher accretion of net PPP origination fees.  The average loan yield for the community banking segment includes, with respect to PPP loans, interest at a note rate of one percent as well as net deferred origination fees that are amortized based on the contractual maturity of the related loan or accelerated into interest income upon repayment of the loan.  Net PPP origination fees recognized in 2021 were $4.1 million, compared to $1.6 million in 2020, and there were unrecognized net deferred PPP origination fees at December 31, 2021 of $679,000, which are expected to be recognized in 2022. The recognition of interest income on PCI loans, which were acquired in connection with past mergers and acquisitions, is based on management’s expectation of future payments of principal and interest, which are inherently uncertain. Earlier than expected repayments of certain PCI loans resulted in the recognition of additional interest income during the years ended December 31, 2021 and 2020. Interest income recognized on PCI loans was $2.5 million for the year ended December 31, 2021 and $3.0 million for the year ended December 31, 2020. The consumer finance segment average loan yield decreased 135 basis points to 11.30 percent for 2021, compared to 2020, due to purchases of loan contracts at lower yields than the portfolio average yield, partially as a result of lower interest rates for non-prime automobile loans and the consumer finance segment continuing to pursue loan contracts of higher credit quality, including prime marine and RV loans. The mortgage banking segment average loan yield decreased 2 basis points to 2.88 percent, as mortgage interest rates decreased throughout 2020 (although mortgage interest rates also began to rise in 2021).

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Average securities available for sale increased $96.5 million for 2021, compared to 2020, due primarily to higher purchases of securities.  The average yield on the securities portfolio on a taxable-equivalent basis decreased 66 basis points for 2021, compared to 2020, due to purchases of securities in 2020 and 2021 at lower average yields relative to the average yield of the portfolio as a whole, increased calls of securities that were issued during periods of higher market interest rates and accelerated amortization of premiums on mortgage-backed securities as a result of increased prepayment activity.

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Average interest-bearing deposits in other banks, consisting primarily of excess cash reserves maintained at the Federal Reserve Bank, increased $80.1 million during 2021, compared to 2020, due primarily to excess liquidity resulting from deposit growth and decreases in loans held for sale. The average yield on these overnight funds decreased 62 basis points for 2021, compared to 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, and increased the interest rate to 0.15 percent by the end of 2021.

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Average money market, savings and interest-bearing demand deposits increased $145.8 million for 2021, compared to 2020, and average time deposits decreased $41.4 million for 2021, compared to 2020. Average noninterest-bearing demand deposits increased $125.0 million for 2021, compared to 2020.  Higher average deposit balances are due primarily to growth in consumer and business deposits primarily as a result of new accounts and liquidity from government stimulus programs. The average cost of interest-bearing deposits decreased 40 basis points for 2021, compared to 2020, due primarily to lower rates on time deposits and a shift in composition toward non-time deposits. Offered rates on interest-bearing deposit accounts were reduced in response to changes in market interest rates beginning in March 2020.  While changes in rates take effect immediately for interest checking, money market and savings accounts, changes in the average cost of time deposits lag changes in pricing based on the repricing of time deposits at maturity.  Rates on outstanding time deposits continued to decrease during 2021 as accounts at higher rates matured.

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Average borrowings decreased $46.2 million for 2021, compared to 2020, 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 and increases in balances of repurchase agreements with commercial deposit customers.  The average cost of borrowings increased 61 basis points during 2021 compared to 2020, due primarily to the higher cost of the subordinated notes relative to the borrowings that were repaid.

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The Corporation believes that it may be challenging to maintain net interest margin at its current level based on the effects of (1) continued pressure on loan yields at the community banking segment and consumer finance segment related

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to the current environment of low interest rates and competition for loans, (2) the temporary effect on loan yields of recognition of net PPP origination fees, (3) possible changes in the composition of earning assets which may result from decreased loan demand as a result of the current economic environment (4) lower accretion of purchase discounts on loans related to acquisitions, which is included in yields on loans and (5) lower mortgage loan production and therefore lower average loans held for sale at the mortgage banking segment.  However, if market interest rates rise to a meaningful degree in 2022, as some financial markets predict, the Corporation may benefit from higher yields on certain interest earning assets, which would be expected to outpace any increases in the cost of interest bearing liabilities.

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Discussion of net interest income for the year ended December 31, 2019 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, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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NONINTEREST INCOME

TABLE 4: Noninterest Income

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Total noninterest income decreased $5.4 million, or 10.0 percent, for the year ended December 31, 2021, compared to the year ended December 31, 2020.  The decrease in noninterest income was due primarily to decreases in gains on sales of loans and mortgage banking fee income, partially offset by (1) increased debit card interchange income and service charges on deposit accounts at the community banking segment, (2) increased mortgage lender services income primarily as a result of new customers at the mortgage banking segment (3) a decrease in asset write-downs, included in other income, net, at the community banking segment and (4) higher income recognized in connection with investments in small business investment company funds, included in other income, net, at the community banking segment. Gains on sales of loans decreased as a result of lower mortgage loan production at the mortgage banking segment, which was partially offset by higher margins on loans sold, and the sale of a pool of PCI loans in 2020, which resulted in a gain of $3.5 million at the community banking segment. Asset write-downs at the community banking segment in 2020 included $298,000 of merger related costs recognized in connection with disposition of assets acquired from Peoples and $281,000 related to branch consolidation.

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Discussion of noninterest income for the year ended December 31, 2019 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, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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NONINTEREST EXPENSE

TABLE 5: Noninterest Expense

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Total noninterest expense decreased $2.0 million, or 2.0 percent, for the year ended December 31, 2021, compared to the year ended December 31, 2020. The decrease in noninterest expenses was due primarily to (1) early debt repayment charges at the community banking segment in 2020 incurred in connection with the voluntary early repayment of FHLB advances, (2) merger related expenses in 2020, and (3) provision for indemnifications at the mortgage banking segment, included in “Other expenses,” of $881,000 for 2020 compared to reversal of provision for indemnifications of $104,000 in 2021, partially offset by (1) a non-cash charge of $1.3 million related to pension settlement accounting at the community banking segment in 2021, as a result of lump sum distributions under the normal terms of C&F Bank’s cash balance pension plan during the year that exceeded the threshold for settlement accounting and (2) higher salaries and employee benefits expense, primarily at the mortgage banking segment.

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There were no merger related expenses for the year ended December 31, 2021.  Merger related expenses for the year ended December 31, 2020 included $1.4 million, of which $501,000 was data processing expense, $336,000 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, 2019 included $709,000, of which $614,000 was professional fees expense, $50,000 was data processing expense and $45,000 was included in all other noninterest expenses.

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Discussion of noninterest expense for the year ended December 31, 2019 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, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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INCOME TAXES

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Income tax expense on 2021 earnings was $9.0 million, resulting in an effective tax rate of 23.5 percent, compared with $6.8 million, or 23.3 percent, in 2020 and $5.1 million, or 21.2 percent, in 2019.  The Corporation recognized income tax benefits of $326,000 in 2020 arising from a change in tax law enacted in response to the COVID-19 pandemic which changed the tax rate applied to certain net operating losses related to prior tax years of Peoples. The effects of changes in tax law are recognized in income tax expense in the period in which the changes are enacted. The Corporation’s consolidated effective tax rate was also affected by tax benefits of tax-exempt interest income that was lower as a percentage of pre-tax income in 2021 compared to 2020 and an increase in nondeductible executive compensation due to incentive based compensation and the timing of deferred compensation arrangements, partially offset by lower state

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income taxes in 2021, as a greater share of income before taxes was earned at C&F Bank, which is not subject to state income tax, and income tax benefits recorded in 2021 related to branch consolidation activities of $107,000.

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Discussion of income taxes for the year ended December 31, 2019 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, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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BUSINESS SEGMENTS

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The Corporation operates in a decentralized manner in three business segments: community banking, mortgage banking and consumer finance.  An overview of the financial results for each of the Corporation’s business segments is presented below.

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Community Banking:  Beginning with the first quarter of 2021, the community banking segment comprises C&F Bank and C&F Wealth Management.  Prior to the first quarter of 2021, the segment comprised only C&F Bank, and prior periods have been restated to conform to the current period presentation.  The following table presents the community banking segment operating results for the periods indicated.

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TABLE 6: Community Banking Segment Operating Results

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The community banking segment reported net income of $14.1 million and $6.1 million for the years ended December 31, 2021 and 2020, respectively. The increase in community banking segment net income for the year ended December 31, 2021 compared to the year ended December 31, 2020 was due primarily to:

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partially offset by:

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Adjusted net income for the community banking segment, which excludes the effects of the sale of PCI loans, early repayment charges, pension settlement charges, merger related expenses, branch consolidation activity and certain one-time tax benefits, was $15.0 million for the year ended December 31, 2021, compared to $6.1 million for the year ended December 31, 2020. Adjusted net income for the community banking segment increased $8.9 million for the year ended December 31, 2021 compared to the year ended December 31, 2020 due primarily to the items discussed above.

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Net interest income for the community banking segment increased $5.2 million for the year ended December 31, 2021, compared to the year ended December 31, 2020. This increase was due primarily to (1) higher average balances of interest earning assets, (2) lower average costs of deposits, resulting from lower rates and a shift in composition toward non-time deposits, and (3) lower interest expense on borrowings, due to lower borrowings outstanding, partially offset by lower yields on loans, securities and excess cash. Comparisons of interest income on loans were significantly impacted by recognition of net PPP origination fees, which was higher for the year ended December 31, 2021 than in the year ended December 31, 2020, and interest income on PCI loans, which was lower for the year ended December 31, 2021 compared to the year ended December 31, 2020. In addition to the effects of these items, higher average advances to fund loans at subsidiaries and loan growth contributed to the increases in interest income on loans for the year ended December 31, 2021 compared to the year ended December 31, 2020, partially offset by lower average yields on other loans, especially commercial real estate loans, as a result of changes in interest rates. Higher average advances to subsidiaries resulted primarily from the repayment of a third-party bank line of credit at the consumer finance segment in the second quarter of 2020 that was previously used to fund consumer finance loans. Net PPP origination fees recognized in the year ended December 31, 2021 were $4.1 million, compared to $1.6 million for the year ended December 31, 2020.  Deferred net PPP origination fees that remained unrecognized at December 31, 2021 were $679,000, which are expected to be recognized in 2022.  Interest income recognized on PCI loans was $2.5 million for the year ended December 31, 2021 and $3.0 million for the year ended December 31, 2020.

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Provision for loan losses for the community banking segment decreased $4.8 million for the year ended December 31, 2021 compared to the year ended December 31, 2020, due primarily to qualitative adjustments to reserves due to the COVID-19 pandemic that were recognized in 2020 and a portion of which was released in 2021, as credit deterioration has not yet been experienced to the extent previously anticipated, and improvement in asset quality during 2021, including impaired loans, which were partially offset by provision related to growth in the loan portfolio in 2021.  As of December 31, 2021, we have not experienced significant declines in the overall credit quality of the loan portfolio during the COVID-19 pandemic.  Management believes that PPP loans and other forms of government stimulus may have delayed and partially mitigated credit deterioration during 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 are further challenges to the economic recovery, including a resurgence in COVID-19 cases that leads to economic disruption, additional provision for loan losses may be required in future periods.

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There were no merger related expenses in the year ended December 31, 2021.  Merger related expenses at the community banking segment of $1.3 million ($1.0 million after income taxes) were recorded in the year ended December

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31, 2020, 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, $61,000 was included in all other noninterest expenses, and $298,000 was a loss on disposition of assets and was recorded in other noninterest income. Cost savings related to the integration of Peoples were realized primarily in salaries and employee benefits expense.

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C&F Bank amended its cash balance pension plan and closed the plan to new entrants hired after December 31, 2021. The amendment is expected to result in lower expense related to the cash balance pension plan as the number of active participants decreases over time. Separately, the community banking segment recorded a non-cash pension settlement charge of $1.3 million ($995,000 after income taxes) in connection with certain lump sum benefit payments during the year ended December 31, 2021.

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Branch consolidation activity resulted in income tax benefits recognized during the year ended December 31, 2021 of $107,000 and pre-tax charges of $281,000 ($222,000 after income taxes) recorded in other noninterest income during the year ended December 31, 2020.  Income tax benefits of $326,000 were recognized during the year ended December 31, 2020 related to a change in tax law enacted in response to the COVID-19 pandemic which changed the tax rate applied to certain net operating losses related to prior tax years of Peoples.

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Discussion of the community banking segment for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Principal Business Segments” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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Mortgage Banking:  The following table presents the mortgage banking operating results for the periods indicated.

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TABLE 7: Mortgage Banking Segment Operating Results

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The mortgage banking segment reported net income of $7.7 million and $10.7 million for the years ended December 31,  2021 and 2020, respectively. The decrease in mortgage banking segment net income of $3.0 million for the

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year ended December 31, 2021 compared to the year ended December 31, 2020 was due primarily to (1) lower mortgage loan production volume, which resulted in lower gains on sales of loans and mortgage banking fee income as well as lower expenses related to mortgage loan production, (2) lower interest income due to lower average balances of loans held for sale and (3) higher salaries and benefits expense, primarily as a result of the addition of operations staff during 2020 in response to record origination volume, partially offset by (1) higher average margins on loans originated for resale, (2) lower provision for indemnification losses included in other expenses and (3) higher fee income from mortgage lender services as a result of serving a growing number of third-party lenders.

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Discussion of the mortgage banking segment for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Principal Business Segments” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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The following table presents mortgage loan originations and mortgage loans sold for the periods indicated.

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TABLE 8: Mortgage Loan Originations & Mortgage Loans Sold

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Mortgage loan originations for the mortgage banking segment decreased 17.7 percent for the year ended December 31, 2021, compared to the year ended December 31, 2020, while remaining substantially above mortgage loan origination levels experienced prior to the record levels of 2020. We believe sustained historically low interest rates on mortgage loans and higher demand in the housing market have contributed to continued higher volume in the broader mortgage industry during the years ended December 31, 2021 and 2020. Production of the mortgage banking segment began to moderate beginning in the second quarter of 2021, and appears to have normalized as of December 31, 2021. Refinancings, which increased as a share of mortgage loan originations during 2020 compared to historical levels, declined for the year ended December 31, 2021 compared to the year ended December 31, 2020, and purchase volume for the year ended December 31, 2021 has grown compared to the years ended December 31, 2020 and 2019, which contributed to higher average margins on sales of loans for the year ended December 31, 2021 compared to the year ended December 31, 2020. Gains on sales of loans, while driven in part by mortgage loan originations, also includes the effects of changes in locked loan commitments, which reflect the volume of mortgage loan applications that are in process and have not closed.  Locked loan commitments decreased by $115.2 million in the year ended December 31, 2021 and grew by $123.6 million in the year ended December 31, 2020.  Locked loan commitments were $83.4 million at December 31, 2021, compared to $198.6 million at December 31, 2020 and $75.1 million at December 31, 2019. Mortgage lender services fee income is derived from providing mortgage origination functions to third-party mortgage lenders. Mortgage lender services volume increased for the year ended December 31, 2021 compared to the years ended December 31, 2020 and 2019 as a result of business with new customers as well as higher volume with existing customers.

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Consumer Finance:  The following table presents the consumer finance operating results for the periods indicated.

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TABLE 9: Consumer Finance Segment Operating Results

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The consumer finance segment reported net income of $10.0 million and $7.6 million for the years ended December 31, 2021 and 2020, respectively.  The increase in consumer finance segment net income was due primarily to lower provision for loan losses, partially offset by lower net interest income. Interest income decreased $1.1 million for the year ended December 31, 2021 compared to the year ended December 31, 2020 due primarily to lower average yields on loans, partially offset by higher average balances of prime marine and RV loans and non-prime auto loans.  Average yields decreased as a result of purchases of loan contracts at lower yields than the portfolio average yield, partially due to lower interest rates for non-prime auto loans and the consumer finance segment continuing to pursue loan contracts of higher credit quality, including prime marine and RV loans.  Provision for loan losses decreased $5.7 million for the year ended December 31, 2021, as compared to the same period of 2020 as a result of reserves recognized in 2020 related to the COVID-19 pandemic, a portion of which were released in 2021, and lower charge-offs, partially offset by loan growth in 2021. Charge-offs at the consumer finance segment have continued to decrease as a result of continued improvement in the credit quality of purchased loan contracts, borrowers benefitting from the effects of government stimulus programs in 2021 and 2020, and a strong used car market, which results in lower charge-offs upon sale of repossessed autos. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio.  However, if there are further challenges to the economic recovery, including a resurgence in COVID-19 cases that results in economic disruption, additional provision for loan losses may be required in future periods.  In addition, provision for loan losses may be higher in future periods if net charge-offs increase, including due to lower recoveries from sales of used automobiles if prices decline.

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Discussion of the consumer finance segment for the year ended December 31, 2019 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Principal Business Segments” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 3, 2021, and is incorporated herein by reference.

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ASSET QUALITY

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Allowance and Provision for Loan Losses

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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.

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The analysis, at a minimum, considers the following factors:

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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:

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The review process generally begins with loan officers or management identifying problem loans to be reviewed on an individual basis for impairment. This review of individual loans is limited to those loans that have indications of probable loss or that may result in significant losses to the Corporation, while all other loans, which may include delinquent loans and loans classified as special mention or substandard, are evaluated as a group, as discussed below. In addition, all TDRs are considered impaired loans and are individually evaluated.  We consider a loan impaired when it is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement.  A loan is not considered impaired during a period of delay in payment if the ultimate 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.

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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 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.

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As discussed above we segregate loans meeting the criteria for special mention, substandard, doubtful and loss from non-classified, or pass rated, loans. We review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these loan ratings are as follows:

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Allowance for Loan Losses Methodology - PCI Loans - As previously described, on a quarterly basis we evaluate our estimate of cash flows expected to be collected on PCI loans. These evaluations require the continued assessment of key assumptions and estimates similar to the initial estimate of fair value, such as the effect of collateral value changes, changing loss severities, estimated and experienced prepayment speeds and other relevant factors. Subsequent decreases to the expected cash flows to be collected on a PCI loan will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses. For a more detailed description, see “Critical Accounting Estimates” in this Item 7.

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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 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:

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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.

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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

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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.

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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:

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TABLE 10: Allowance for Loan Losses

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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:

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TABLE 11: Allocation of Allowance for Loan Losses

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Loans by credit quality indicators as of December 31, 2021 were as follows:

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TABLE 12: Credit Quality Indicators

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

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The decreases in special mention and substandard loans rated at December 31, 2021 compared to December 31, 2020 were due primarily to repayments.

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The allowance for loan losses as a percentage of total loans at the community banking segment, excluding PCI loans, decreased to 1.44 percent at December 31, 2021, compared to 1.46 percent at December 31, 2020. The allowance for loan losses as a percentage of total loans excluding all purchased loans and loans originated under the PPP was 1.55 percent at December 31, 2021, compared to 1.74 percent at December 31, 2020.  The community banking segment recorded a net reversal of provision for loan losses of $200,000 in 2021, as a partial release of qualitative adjustments to reserves related to the COVID-19 pandemic, and improvement in asset quality were partially offset by additional reserves related to the growth in the loan portfolio. The community banking segment recorded provision for loan losses of $4.6 million for 2020 due primarily to qualitative adjustments to reserves established as a result of the COVID-19 pandemic and growth in the loan portfolio.  As of December 31, 2021, there have not been significant declines in the overall credit quality of the loan portfolio during the COVID-19 pandemic, although management believes the effects of PPP loans and other forms of government stimulus may have delayed and partially mitigated credit deterioration during 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 are further challenges to the economic recovery, including a resurgence in COVID-19 cases that leads to economic disruption, additional provision for loan losses may be required in future periods.

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The consumer finance segment’s allowance for loan losses increased by $1.3 million to $24.8 million at December 31, 2021 from $23.5 million at December 31, 2020. The allowance for loan losses as a percentage of loans decreased to 6.73 percent at December 31, 2021, compared to 7.53 percent at December 31, 2020. The decrease in the level of the allowance for loan losses as a percentage of total loans is primarily a result of improving credit quality of the portfolio, which has resulted in lower net charge-offs, and lower reserves based on qualitative adjustments related to the COVID-19 pandemic.  Total delinquent loans, which does not include loans that have been granted a payment deferral, as a percentage of total loans decreased to 2.16 percent at December 31, 2021 compared to 3.08 percent at December 31, 2020. The consumer finance segment experienced net recoveries for the year ended December 31, 2021 of 0.14 percent of average total loans, compared to net charge-offs of 1.54 percent for 2020, due to a lower number of charge-offs during 2021 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. Additionally, borrowers benefitted during 2021 and 2020 from the government’s stimulus measures in response to the COVID-19 pandemic. As of December 31, 2021, these stimulus programs have generally ended, and the Corporation can give no assurance that loan performance or net charge-offs will continue at the

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levels experienced in 2021 and 2020. The consumer finance segment recorded provision for loan losses of $820,000 for the year ended December 31, 2021, as provision related to growth in the loan portfolio was partially offset by a partial release of qualitative adjustments to reserves related to the COVID-19 pandemic, as credit deterioration has not yet been experienced to the extent previously anticipated, improvement in credit quality and lower net charge-offs. The consumer finance segment recorded provision for loan losses of $6.5 million for the year ended December 31, 2020, due primarily to qualitative adjustments to reserves established as a result of the COVID-19 pandemic, partially offset by improvement in credit quality. Management believes that the level of the allowance for loan losses is sufficient to absorb losses inherent in the portfolio.  However, if there are further challenges to the economic recovery, including a resurgence in COVID-19 cases that results in economic disruption, additional provision for loan losses may be required in future periods.  In addition, provision for loan losses may be higher in future periods if net charge-offs increase, including due to lower recoveries from sales of used automobiles if prices decline.

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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.  The average amounts deferred on a monthly basis during 2021 were 1.24 percent of non-prime automobile loans outstanding, compared to 2.93 percent during 2020 and 1.90 percent during 2019. Payment deferrals increased for 2020 compared to 2019 as the COVID-19 pandemic affected the ability of some borrowers to make timely payments, but were lower in 2021.

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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.

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Nonperforming Assets

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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.

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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

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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.

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Table 13 summarizes the Corporation’s credit ratios on a consolidated basis as of December 31, 2021 and 2020.

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TABLE 13: Consolidated Credit Ratios

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Table 14 summarizes nonperforming assets by principal business segment at December 31 of each of the past two years.

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TABLE 14: Nonperforming Assets

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Community Banking Segment

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Mortgage Banking Segment

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Consumer Finance Segment

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Table 15 presents the changes in the OREO balance for 2021 and 2020.

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TABLE 15: OREO Changes

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Nonperforming assets of the community banking segment totaled $3.2 million at December 31, 2021, compared to $3.9 million at December 31, 2020. Nonperforming assets included $2.4 million in nonaccrual loans at December 31, 2021

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compared to $3.0 million at December 31, 2020, and included $835,000 in other real estate owned at December 31, 2021, compared to $907,000 at December 31, 2020. Nonaccrual loans were comprised primarily of one commercial relationship at December 31, 2021 and 2020.  OREO at December 31, 2021 and 2020 was primarily comprised of a property previously used by the Bank as a branch, which was consolidated into a nearby branch in 2019.  The property was subsequently sold in January 2022.  If interest on loans on nonaccrual at December 31, 2021 had been recognized throughout the year, the community banking segment would have recorded additional gross interest income in 2021 of $214,000.

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Nonaccrual loans at the consumer finance segment decreased to $380,000 at December 31, 2021 from $402,000 at December 31, 2020. As noted above, the allowance for loan losses at the consumer finance segment increased from $23.5 million at December 31, 2020 to $24.8 million at December 31, 2021, and the ratio of the allowance for loan losses to total consumer finance loans was 6.73 percent as of December 31, 2021, compared to 7.53 percent at December 31, 2020. 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 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, 2021, repossessed vehicles at fair value less estimated costs to sell included in other assets totaled $190,000, compared to $291,000 at December 31, 2020.  If interest on loans on nonaccrual at December 31, 2021 had been recognized throughout the year, the consumer finance segment would have recorded additional gross interest income in 2021 of $4,000.

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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.

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Impaired loans, which included TDRs of $2.7 million, and the related allowance at December 31, 2021, were as follows:

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TABLE 16: Impaired Loans

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

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TDRs at December 31, 2021 and 2020 were as follows:

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TABLE 17: Troubled Debt Restructurings

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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.

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The Corporation has accommodated certain borrowers affected by the COVID-19 pandemic by granting short-term payment deferrals or periods of interest-only payments.  Generally, a short-term payment deferral does not result in a loan modification being classified as a TDR. Furthermore, certain modifications are not required to be evaluated for classification as a TDR under statutory and regulatory relief related to the COVID-19 pandemic. There were no modifications offered during the year ended December 31, 2021 which were not evaluated for classification as a TDR. The Corporation has granted loan modifications related to COVID-19 on aggregate balances of $103.6 million since the beginning of the pandemic. At December 31, 2021, loans whose modification periods had not ended had aggregate balances of $7.2 million and all such loans are performing in accordance with their modified terms, which includes payments of interest. Management monitors the credit risk related to these loans and has adjusted risk ratings as applicable as of December 31, 2021. Management cannot predict whether or for how long these borrowers may require further modifications of their loan terms beyond the existing deferral arrangement.

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FINANCIAL CONDITION

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SUMMARY

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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.

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At December 31, 2021, the Corporation had total assets of $2.26 billion compared to $2.09 billion at December 31, 2020. The increase was attributable primarily to increases in cash reserves, available for sale securities and loans held for investment, partially offset by a decrease in loans held for sale and was funded by growth in demand and savings deposits and short-term borrowings. The significant components of the Corporation’s Consolidated Balance Sheets are discussed below.

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LOAN PORTFOLIO

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General

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Through the community banking segment, we engage in a wide range of lending activities, which include the origination, primarily in the community banking segment’s market area, of (1) one-to-four family and multi-family residential mortgage loans, (2) commercial real estate loans, (3) construction loans, (4) land acquisition and development loans, (5) consumer loans and (6) commercial business loans. We engage in 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, 2021, the Corporation’s loans held for investment in all categories, net of the allowance for loan losses, totaled $1.37 billion and loans held for sale had a fair value of $82.3 million.

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Tables 18 and 19 present information pertaining to the composition of loans held for investment and the maturity/repricing of certain loans held for investment.

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TABLE 18: Summary of Loans Held for Investment

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The increase in total loans from December 31, 2020 to December 31, 2021 was due primarily to commercial loan growth at the community banking segment and growth in the consumer finance segment.

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TABLE 19: Maturity/Repricing Schedule of Loans Held for Investment

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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.  Net PPP origination fees recognized in the year ended December 31, 2021 was $4.1 million compared to $1.5 million in the year ended December 31, 2020. Since the second quarter of 2020, the community banking segment has recognized $5.6 million of net fees under the PPP, and deferred net PPP origination fees that remained unrecognized at December 31, 2021 was $679,000, which are expected to be recognized in 2022. As repayment of PPP loans is guaranteed by the SBA, the community banking segment does not recognize a reserve for PPP loans in its allowance for loan losses.  Table 20 presents the outstanding principal of loans originated under the PPP as of December 31, 2021 and 2020.

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TABLE 20: Paycheck Protection Program Loans

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Total loans at December 31, 2021 and 2020 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, 2021 and 2020.

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TABLE 21: PCI and Purchased Performing Loans

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For a description of the Corporation’s accounting for purchased performing and PCI loans, see “Critical Accounting Estimates” in this Item 7.

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Credit Policy

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The Corporation’s credit policy establishes minimum requirements and provides for appropriate limitations on overall concentration of credit within the Corporation. The policy provides guidance in general credit policies, underwriting policies and risk management, credit approval, and administrative and problem asset management policies. The overall goal of the Corporation’s credit policy is to ensure that loan growth is accompanied by acceptable asset quality with uniform and consistently applied approval, administration, and documentation practices and standards.

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Residential Mortgage Lending – Held for Sale

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The mortgage banking segment’s guidelines for underwriting conventional conforming loans comply with the underwriting criteria established by Fannie Mae, Freddie Mac and/or the applicable third party investor. The guidelines for non-conforming conventional loans are based on the requirements of private investors and information provided by third-party investors. The guidelines used by C&F Mortgage to originate FHA-insured, USDA-guaranteed and VA-guaranteed loans comply with the criteria established by HUD, the USDA, the VA and/or the applicable third party investor. The conventional loans that C&F Mortgage originates that have loan-to-value ratios greater than 80 percent at origination are generally insured by private mortgage insurance.

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Residential Mortgage Lending – Held for Investment

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The community banking segment originates residential mortgage loans secured by first and second liens on properties located in its primary market areas in eastern and central Virginia. The Bank offers various types of residential first mortgage loans in addition to traditional long-term, fixed-rate loans. The majority of such loans include 10, 15 and 30 year amortizing mortgage loans with fixed rates of interest. Second mortgage loans are offered with fixed and adjustable rates. Second mortgage loans are granted for a fixed period of time, usually between 5 and 15 years.

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Loans associated with residential mortgage lending are included in the real estate—residential mortgage category in Table 18: Summary of Loans Held for Investment.