UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011March 31, 2012
 
o
¨		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to
 
Commission File Number:Number 000-23423
 
C&F Financial Corporation
(Exact name of registrant as specified in its charter)
 
Virginia 54-1680165
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
   
802 Main Street West Point, VA 23181
(Address of principal executive offices) (Zip Code)
 
(804) 843-2360
(Registrant’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes     o¨  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    o¨  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filero¨Accelerated filero¨
    
Non-accelerated filer
o¨  (Do not check if a smaller reporting company)
Smaller reporting companyx
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No
 
At November 7, 2011,May 4, 2012, the latest practicable date for determination, 3,138,8053,205,431 shares of common stock, $1.00 par value, of the registrant were outstanding.

 
 
 
 
TABLE OF CONTENTS
 
 Page
Part I - Financial Information 
   
Item 1.
Financial Statements
 
   
 
Consolidated Balance Sheets – September 30, 2011- March 31, 2012 (unaudited) and December 31, 20102011
2
   
 
Consolidated Statements of Income (unaudited) –- Three and nine months ended September 30,March 31, 2012 and 2011 and 2010
3
Consolidated Statements of Comprehensive Income (unaudited) – Three months ended March 31, 2012 and 2011
4
   
 
Consolidated Statements of Shareholders’ Equity (unaudited) - NineThree months ended September 30,March 31, 2012 and 2011 and 2010
        45
   
 
Consolidated Statements of Cash Flows (unaudited) - NineThree months ended September 30,March 31, 2012 and 2011 and 2010
        56
   
 
Notes to Consolidated Financial Statements (unaudited)
        67
   
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 2426
   
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 4442
   
Item 4.
Controls and Procedures
 4442
  
Part II - Other Information 
   
Item 1A.
Risk Factors
 4443
   
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 4443
   
Item 6.
Exhibits
 4543
  
Signatures
 4644
 
 
 
 
PART I - FINANCIAL INFORMATION
 
ITEM  1.
FINANCIAL STATEMENTS
 
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share amounts)
 
 
September 30,
2011
  
December 31,
2010
  
March 31,
2012
  
December 31,
2011
 
 (Unaudited)     (Unaudited)    
ASSETS            
            
Cash and due from banks $4,775  $7,150  $6,310  $5,787 
Interest-bearing deposits in other banks  18,058   2,530   20,116   5,720 
Federal funds sold  801   -- 
Total cash and cash equivalents  23,634   9,680   26,426   11,507 
Securities-available for sale at fair value, amortized cost of $135,114 and $129,505, respectively  141,793   130,275 
Securities-available for sale at fair value, amortized cost of $136,605 and $137,575, respectively  143,868   144,646 
Loans held for sale, net  36,377   67,153   63,756   70,062 
Loans, net of allowance for loan losses of $32,590 and $28,840, respectively  622,921   606,744 
Loans, net of allowance for loan losses of $34,757 and $33,677, respectively  626,069   616,984 
Federal Home Loan Bank stock, at cost  3,798   3,887   3,767   3,767 
Corporate premises and equipment, net  28,768   28,743   28,184   28,462 
Other real estate owned, net of valuation allowance of $3,822 and $3,979, respectively  6,442   10,674 
Other real estate owned, net of valuation allowance of $3,986 and $3,927, respectively  5,209   6,059 
Accrued interest receivable  5,150   5,073   5,224   5,242 
Goodwill  10,724   10,724   10,724   10,724 
Other assets  29,292   31,184   32,244   30,671 
Total assets $908,899  $904,137  $945,471  $928,124 
                
LIABILITIES AND SHAREHOLDERS’ EQUITY                
                
Deposits                
Noninterest-bearing demand deposits $98,127  $87,263  $105,542  $95,556 
Savings and interest-bearing demand deposits  226,995   228,185   244,846   242,917 
Time deposits  312,244   309,686   310,166   307,943 
Total deposits  637,366   625,134   660,554   646,416 
Short-term borrowings  5,253   10,618   4,797   7,544 
Long-term borrowings  133,551   132,902   132,988   132,987 
Trust preferred capital notes  20,620   20,620   20,620   20,620 
Accrued interest payable  1,120   1,160   1,107   1,111 
Other liabilities  17,717   20,926   25,936   23,356 
Total liabilities  815,627   811,360   846,002   832,034 
                
Commitments and contingent liabilities        
Commitments and contingencies  —   — 
                
Shareholders’ equity                
Preferred stock ($1.00 par value, 3,000,000 shares authorized, 10,000 and 20,000 shares issued and outstanding, respectively)  10   20 
Common stock ($1.00 par value, 8,000,000 shares authorized, 3,133,327 and 3,118,066 shares issued and outstanding, respectively)  3,047   3,032 
Preferred stock ($1.00 par value, 3,000,000 shares authorized, 10,000 shares issued and outstanding)  10   10 
Common stock ($1.00 par value, 8,000,000 shares authorized, 3,199,314 and 3,178,510 shares issued and outstanding, respectively)  3,105   3,091 
Additional paid-in capital  12,814   22,112   13,866   13,438 
Retained earnings  73,724   67,542   78,969   76,167 
Accumulated other comprehensive income, net  3,677   71   3,519   3,384 
Total shareholders’ equity  93,272   92,777   99,469   96,090 
Total liabilities and shareholders’ equity $908,899  $904,137  $945,471  $928,124 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
2
 
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except for share and per share amounts)

 
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  Three Months Ended March 31, 
 2011  2010  2011  2010  2012  2011 
Interest income                  
Interest and fees on loans $17,611  $16,530  $51,000  $48,014  $17,476  $16,346 
Interest on money market investments  7   9   38   37   8   15 
Interest and dividends on securities                        
U.S. government agencies and corporations  50   63   156   230   57   51 
Tax-exempt obligations of states and political subdivisions  1,222   1,105   3,641   3,307   1,187   1,194 
Corporate bonds and other  28   29   84   102   28   26 
Total interest income  18,918   17,736   54,919   51,690   18,756   17,632 
                        
Interest expense                        
Savings and interest-bearing deposits  247   277   853   822   253   332 
Certificates of deposit, $100 or more  677   782   2,013   2,445 
Certificates of deposit, $100 thousand or more  640   673 
Other time deposits  785   972   2,454   3,014   724   850 
Borrowings  975   1,047   2,907   2,996   973   966 
Trust preferred capital notes  247   256   736   751   249   243 
Total interest expense  2,931   3,334   8,963   10,028   2,839   3,064 
                        
Net interest income  15,987   14,402   45,956   41,662   15,917   14,568 
Provision for loan losses  4,075   3,719   10,285   10,219   2,725   2,820 
                        
Net interest income after provision for loan losses  11,912   10,683   35,671   31,443   13,192   11,748 
                        
Noninterest income                        
Gains on sales of loans  4,282   4,865   11,778   13,292   4,103   3,800 
Service charges on deposit accounts  915   957   2,609   2,563   801   848 
Other service charges and fees  1,370   1,343   3,776   3,592   1,368   1,092 
Net gains (losses) on calls and sales of available for sale securities  1   (11)  1   65 
Net gains on calls and sales of available for sale securities  —   — 
Other income  572   670   1,550   1,388   1,111   717 
Total noninterest income  7,140   7,824   19,714   20,900   7,383   6,457 
                        
Noninterest expenses                        
Salaries and employee benefits  7,965   8,811   24,887   25,474   9,742   8,492 
Occupancy expenses  1,644   1,518   4,781   4,305   1,721   1,526 
Other expenses  4,314   4,475   11,932   14,823   3,594   3,931 
Total noninterest expenses  13,923   14,804   41,600   44,602   15,057   13,949 
                        
Income before income taxes  5,129   3,703   13,785   7,741   5,518   4,256 
Income tax expense  1,616   1,117   4,220   2,008   1,738   1,287 
                        
Net income  3,513   2,586   9,565   5,733   3,780   2,969 
Effective dividends on preferred stock  458   288   1,037   861   146   289 
Net income available to common shareholders $3,055  $2,298  $8,528  $4,872  $3,634  $2,680 
                        
Per common share data                        
Net income – basic $0.97  $0.74  $2.72  $1.58  $1.14  $0.86 
Net income – assuming dilution $0.96  $0.74  $2.69  $1.57  $1.11  $0.85 
Cash dividends declared $0.25  $0.25  $0.75  $0.75  $0.26  $0.25 
Weighted average number of shares – basic  3,141,926   3,089,211   3,132,332   3,082,384   3,190,518   3,123,868 
Weighted average number of shares – assuming dilution  3,174,369   3,096,990   3,166,930   3,099,442   3,264,975   3,167,160 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
3
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITYCOMPREHENSIVE INCOME
(Unaudited)
(In thousands, except per share amounts)thousands)
 
  
Preferred
Stock
  
Common
Stock
  
Additional
Paid-In
Capital
  
Retained
Earnings
  
Accumulated  Other
Comprehensive
Income
  
Total
Shareholders’
Equity
 
Balance December 31, 2010 $20  $3,032  $22,112  $67,542  $71  $92,777 
Comprehensive income:                        
Net income  —   —   —   9,565   —   9,565 
Other comprehensive income, net                        
Changes in defined benefit plan assets and benefit obligations, net  —   —   —   —   11     
Unrealized loss on cash flow hedging instruments, net  —   —   —   —   (245)    
Unrealized holding gains on securities, net of reclassification adjustment  —   —   —   —   3,840     
                         
Other comprehensive income, net  —   —   —   —   3,606   3,606 
                         
Comprehensive income  —   —   —   —   —   13,171 
Share-based compensation  —   —   251   —   —   251 
Stock options exercised  —   8   134   —   —   142 
Restricted stock vested  —   5   (5)  —   —   — 
Preferred stock redemption  (10)  —   (9,990)  —   —   (10,000)
Accretion of preferred stock discount  —   —   311   (311)  —   — 
Common stock issued  —   2   1   —   —   3 
Cash dividends paid – common stock ($0.75 per share)  —   —   —   (2,347)  —   (2,347)
Cash dividends paid – preferred stock (5% per annum)  —   —   —   (725)  —   (725)
Balance September 30, 2011 $10  $3,047  $12,814  $73,724  $3,677  $93,272 
                         
  
Preferred
Stock
  
Common
Stock
  
Additional
Paid-In
Capital
  
Retained
Earnings
  
Accumulated  Other
Comprehensive
Income
  
Total
Shareholders’
Equity
 
Balance December 31, 2009 $20  $3,009  $21,210  $63,669  $968  $88,876 
Comprehensive income:                        
Net income  —   —   —   5,733   —   5,733 
Other comprehensive income, net                        
Changes in defined benefit plan assets and benefit obligations, net  —   —   —   —   (12)    
Unrealized loss on cash flow hedging instruments, net  —   —   —   —   (264)    
Unrealized holding gains on securities, net of reclassification adjustment  —   —   —   —   2,347     
                         
Other comprehensive income, net  —   —   —   —   2,071   2,071 
                         
Comprehensive income  —   —   —   —   —   7,804 
Share-based compensation  —   —   265   —   —   265 
Stock options exercised  —   9   136   —   —   145 
Accretion of preferred stock discount  —   —   98   (98)  —   — 
Cash dividends paid – common stock ($0.75 per share)  —   —   —   (2,313)  —   (2,313)
Cash dividends paid – preferred stock (5% per annum)  —   —   —   (750)  —   (750)
Balance September 30, 2010 $20  $3,018  $21,709  $66,241  $3,039  $94,027 
  Three Months Ended March 31, 
  2012  2011 
       
Net income $3,780  $2,969 
Other comprehensive income, net        
Changes in defined benefit plan assets and benefit obligations, net  7   4 
Unrealized gain on cash flow hedging instruments, net  3   54 
Unrealized holding gains on securities, net of reclassification adjustment  125   555 
Comprehensive income, net $3,915  $3,582 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
4
 
CONSOLIDATED STATEMENTS OF CASH FLOWSSHAREHOLDERS’ EQUITY
(Unaudited)
(In thousands)thousands, except per share amounts)

  Nine Months Ended September 30, 
  2011  2010 
Operating activities:      
Net income $9,565  $5,733 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:        
Depreciation  1,553   1,407 
Provision for loan losses  10,285   10,219 
Provision for indemnifications  552   3,515 
Provision for other real estate owned losses  711   1,695 
Share-based compensation  251   265 
Accretion of discounts and amortization of premiums on securities, net  581   425 
Net realized gains on securities sold and called  (1)  (65)
Net realized gains on sales of other real estate owned  (87)  (6)
Gains on sales of corporate premises and equipment  (18)  -- 
Proceeds from sales of loans  458,486   496,517 
Origination of loans held for sale  (427,710)  (545,176)
Change in other assets and liabilities:        
Accrued interest receivable  (77)  397 
Other assets  (232)  (1,048)
Accrued interest payable  (40)  (289)
Other liabilities  (4,143)  1,193 
Net cash provided by (used in) operating activities  49,676   (25,218)
         
Investing activities:        
Proceeds from maturities, calls and sales of securities available for sale  21,768   22,882 
Purchases of securities available for sale  (27,958)  (30,979)
Decrease in Federal Home Loan Bank stock  89   -- 
Net increase in customer loans  (30,501)  (6,802)
Other real estate owned improvements  --   (219)
Proceeds from sales of other real estate owned  7,851   3,203 
Purchases of corporate premises and equipment, net  (1,560)  (1,504)
Net cash used in investing activities  (30,311)  (13,419)
         
Financing activities:        
Net increase in demand, interest-bearing demand and savings deposits  9,674   13,991 
Net increase in time deposits  2,558   872 
Net decrease in borrowings  (4,716)  (1,487)
Proceeds from exercise of stock options  142   145 
Proceeds from issuance of common stock  3   -- 
Redemption of preferred stock  (10,000)  -- 
Cash dividends  (3,072)  (3,063)
Net cash (used in) provided by financing activities  (5,411)  10,458 
         
Net increase (decrease) in cash and cash equivalents  13,954   (28,179)
Cash and cash equivalents at beginning of period  9,680   38,061 
Cash and cash equivalents at end of period $23,634  $9,882 
         
         
Supplemental disclosure        
Interest paid $9,003  $10,317 
Income taxes paid  5,658   4,032 
Supplemental disclosure of noncash investing and financing activities        
Unrealized gains on securities available for sale $5,908  $3,610 
Loans transferred to other real estate owned  4,039   3,444 
Pension adjustment  16   (19)
Unrealized loss on cash flow hedging instrument  (398)  (425)
  
Preferred
Stock
  
Common
Stock
  
Additional
Paid-In
Capital
  
Retained
Earnings
  
Accumulated 
Other
Comprehensive
Income, Net
  
Total
Shareholders’
Equity
 
Balance December 31, 2011 $10  $3,091  $13,438  $76,167  $3,384  $96,090 
Comprehensive income:                        
Net income  —   —   —   3,780   —   3,780 
Other comprehensive income, net  —   —   —   —   135   135 
Comprehensive income  —   —   —   —   —   3,915 
Stock options exercised  —   12   247   —   —   259 
Share-based compensation  —   —   120   —   —   120 
Accretion of preferred stock discount  —   —   21   (21)  —   — 
Common stock issued  —   2   40   —   —   42 
Cash dividends paid – common stock ($0.26 per share)  —   —   —   (832)  —   (832)
Cash dividends paid – preferred stock (5% per annum)  —   —   —   (125)  —   (125)
Balance March 31, 2012 $10  $3,105  $13,866  $78,969  $3,519  $99,469 
                         
  
Preferred
Stock
  
Common
Stock
  
Additional
Paid-In
Capital
  
Retained
Earnings
  
Accumulated 
Other
Comprehensive
Income, Net
  
Total
Shareholders’
Equity
 
Balance December 31, 2010 $20  $3,032  $22,112  $67,542  $71  $92,777 
Comprehensive income:                        
Net income  —   —   —   2,969   —   2,969 
Other comprehensive income, net  —   —   —   —   613   613 
Comprehensive income  —   —   —   —   —   3,582 
Share-based compensation  —   —   107   —   —   107 
Accretion of preferred stock discount  —   —   39   (39)  —   — 
Cash dividends paid – common stock ($0.25 per share)  —   —   —   (781)  —   (781)
Cash dividends paid – preferred stock (5% per annum)  —   —   —   (250)  —   (250)
Balance March 31, 2011 $20  $3,032  $22,258  $69,441  $684  $95,435 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
5
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
  Three Months Ended March 31, 
  2012  2011 
Operating activities:      
Net income $3,780  $2,969 
Adjustments to reconcile net income to net cash provided by operating activities:        
Depreciation  560   515 
Provision for loan losses  2,725   2,820 
Provision for indemnifications  125   231 
Provision for other real estate owned losses  200   161 
Share-based compensation  120   107 
Accretion of discounts and amortization of premiums on securities, net  191   199 
Net realized gain on securities  —   — 
Realized loss on sales of other real estate owned  13   9 
Sales of loans held for sale  179,602   163,066 
Origination of loans held for sale  (173,296)  (124,077)
Change in other assets and liabilities:        
Accrued interest receivable  18   (17)
Other assets  (1,645)  (1,111)
Accrued interest payable  (4)  9 
Other liabilities  2,470   94 
Net cash provided by operating activities  14,859   44,975 
         
Investing activities:        
Proceeds from maturities, calls and sales of securities available for sale  7,802   6,825 
Purchases of securities available for sale  (7,023)  (11,725)
Net increase in customer loans  (11,912)  (6,953)
Other real estate owned improvements  (205)  — 
Proceeds from sales of other real estate owned  944   3,516 
Purchases of corporate premises and equipment, net  (282)  (536)
Net cash used in investing activities  (10,676)  (8,873)
         
Financing activities:        
Net increase in demand, interest-bearing demand and savings deposits  11,915   6,702 
Net increase (decrease) in time deposits  2,223   (1,828)
Net decrease in borrowings  (2,746)  (5,296)
Proceeds from exercise of stock options  259   — 
Issuance of common stock  42   — 
Cash dividends  (957)  (1,031)
Net cash provided by (used in) financing activities  10,736   (1,453)
         
Net increase in cash and cash equivalents  14,919   34,649 
Cash and cash equivalents at beginning of period  11,507   9,680 
Cash and cash equivalents at end of period $26,426  $44,329 
         
Supplemental disclosure        
Interest paid $2,843  $3,055 
Income taxes paid  228   384 
Supplemental disclosure of noncash investing and financing activities        
Unrealized gains on securities available for sale  192   854 
Loans transferred to other real estate owned  102   2,976 
Pension adjustment  9   5 
Unrealized gain on cash flow hedging instrument  5   89 
The accompanying notes are an integral part of the consolidated financial statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)
 
NOTE 1: Summary of Significant Accounting Policies
 
Principles of Consolidation: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial reporting and with applicable quarterly reporting regulations of the Securities and Exchange Commission (the SEC). They do not include all of the information and notes required by U.S. GAAP for complete financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the C&F Financial Corporation Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
The unaudited consolidated financial statements include the accounts of C&F Financial Corporation (the Corporation) and its wholly-owned subsidiary, Citizens and Farmers Bank (the Bank or C&F Bank). All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, C&F Financial Corporation owns C&F Financial Statutory Trust I and C&F Financial Statutory Trust II, which are unconsolidated subsidiaries. The subordinated debt owed to these trusts is reported as a liability of the Corporation.
 
Nature of Operations: The Corporation is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Corporation owns all of the stock of its subsidiary, C&F Bank, which is an independent commercial bank chartered under the laws of the Commonwealth of Virginia. The Bank and its subsidiaries offer a wide range of banking and related financial services to both individuals and businesses.
 
The Bank has five wholly-owned subsidiaries: C&F Mortgage Corporation and Subsidiaries (C&F Mortgage), C&F Finance Company (C&F Finance), C&F Title Agency, Inc., C&F Investment Services, Inc. and C&F Insurance Services, Inc., all incorporated under the laws of the Commonwealth of Virginia. C&F Mortgage, organized in September 1995, was formed to originate and sell residential mortgages and through its subsidiaries, Hometown Settlement Services LLC and Certified Appraisals LLC, provides ancillary mortgage loan production services, such as loan settlements, title searches and residential appraisals. C&F Finance, acquired on September 1, 2002, is a regional finance company providing automobile loans. C&F Title Agency, Inc., organized in October 1992, primarily sells title insurance to the mortgage loan customers of the Bank and C&F Mortgage. C&F Investment Services, Inc., organized in April 1995, is a full-service brokerage firm offering a comprehensive range of investment services. C&F Insurance Services, Inc., organized in July 1999, owns an equity interest in an insurance agency that sells insurance products to customers of the Bank, C&F Mortgage and other financial institutions that have an equity interest in the agency. Business segment data is presented in Note 9.8.
 
Basis of Presentation: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the allowance for indemnifications, impairment of loans, impairment of securities, the valuation of other real estate owned, the projected benefit obligation under the defined benefit pension plan, the valuation of deferred taxes, the valuation of derivative financial instruments and goodwill impairment. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these financial statements, have been made. Certain reclassifications have been made to prior period amounts to conform to the current period presentation.
 
Derivative Financial Instruments: The Corporation recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated balance sheets. The derivative financial instruments have been designated as and qualify as cash flow hedges. The effective portion of the gain or loss on cash flow hedges is reported as a component of other comprehensive income, net of deferred income taxes, and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.
 
Share-Based Compensation: Compensation expense for the thirdfirst quarter and first nine months of 20112012 included net expense of $119,000$120,000 ($74,000 after tax benefit) and $251,000 ($156,000 after tax benefit), respectively,tax) for restricted stock granted since 2006.2007. As of September 30, 2011,March 31, 2012, there was $958,000$1.37 million of total unrecognized compensation expense related to unvested restricted stock that will be recognized over the remaining requisite service periods.
 
 
67
 
Stock option activity during the nine months ended September 30, 2011first quarter of 2012 and stock options outstanding as of September 30, 2011March 31, 2012 are summarized below:
 
  Shares  
Exercise
Price*
  
Remaining
Contractual
Life
(in years)*
  
Intrinsic
Value of
Unexercised
In-The
Money
Options
(in 000’s)
 
Options outstanding at January 1, 2011  390,617  $34.95   3.7    
Exercised  (8,500)  16.75        
Expired  (2,000)  16.75        
Cancelled  (11,850)  37.86        
Options outstanding and exercisable at September 30, 2011  368,267  $35.37   3.0  $144 
  Shares  
Exercise
Price*
  
Remaining
Contractual
Life
(in years)*
  
Intrinsic
Value of
Unexercised
In-The
Money
Options
(in 000’s)
 
Options outstanding at January 1, 2012  325,067  $36.68   3.0    
Exercised  11,500   22.53        
Options outstanding and exercisable at March 31, 2012  313,567  $37.20   2.8  $261 
 
*Weighted average
 
A summary of activity for restricted stock awards during the first nine monthsquarter of 20112012 is presented below:
 
  Shares  
Weighted-
Average
Grant Date
Fair Value
 
Unvested, January 1, 2011  86,025  $25.89 
Granted  13,950  $22.46 
Vested  (6,450) $26.49 
Cancelled  (7,350) $26.85 
Unvested, September 30, 2011  86,175  $25.21 
  Shares  
Weighted-
Average
Grant Date
Fair Value
 
Unvested, January 1, 2012  87,125  $22.59 
Granted  7,750  $28.45 
Vested  (900) $22.75 
Unvested, March 31, 2012  93,975  $23.07 
 
Recent Significant Accounting Pronouncements:
 
In July 2010,April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (ASU 2010-20). The new disclosure guidance significantly expands the existing disclosure requirements and is intended to lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures, are required for periods beginning after December 15, 2010. The adoption of ASU 2010-20 did not have a material effect on the Corporation’s consolidated financial statements.  The required disclosures have been included in the Corporation’s consolidated financial statements.
In April 2011, the FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this ASU are intended to provide guidance to allow a creditor to determine whether a restructuring is a troubled debt restructuring (TDR) by clarifying the guidance on a creditor’s evaluation of whether it has granted a concession or not and whether a debtor is experiencing financial difficulties or not. The amendments in this ASU are effective for periods beginning after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. Upon adoption, the disclosure requirements promulgated in ASU 2010-20 related to TDRs will become effective. The adoption of ASU 2011-02 did not have a material effect on the Corporation’s consolidated financial statements.
In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing – Reconsideration of Effective Control for Repurchase Agreements.  The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion.  The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modificationmodifications of existing transactions that occur on or after the effective date.  Early adoption was not permitted. The adoption of the new guidance isdid not expected to have a material effect on the Corporation’s consolidated financial statements.
7
 
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  This ASU is the result of joint efforts by the FASB and the International Accounting Standards Board to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements.  The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards.  The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application.  Early application was not permitted.  The adoption ofCorporation has included the amendments is not expected to have a material effect on the Corporation’srequired disclosures in its consolidated financial statements.
 
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income – Presentation of Comprehensive Income.  The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share.  The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted.  The amendments do not require transition disclosures. The adoption ofCorporation has included the amendments is not expected to have a material effect on the Corporation’srequired disclosures in its consolidated financial statements.
8
 
In September 2011, the FASB issued ASU 2011-08, Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.  The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued.  The adoption of the amendments isnew guidance did not expected to have a material effect on the Corporation’s consolidated financial statements.
 
In December 2011, the FASB issued ASU 2011-12, Comprehensive Income - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05. The SEC issued Final Rule No. 33-9002, Interactive Dataamendments are being made to Improve Financial Reporting.  The rule requires companiesallow the FASB time to submitredeliberate whether to present on the face of the financial statements in extensible business reporting language (i.e., XBRL) format with their SEC filingsthe effects of reclassifications out of accumulated other comprehensive income on a phased-in schedule.  Based on this schedule, the Corporationcomponents of net income and other comprehensive income for all periods presented. While the FASB is requiredconsidering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to provide interactive data reports startingreport reclassifications out of accumulated other comprehensive income consistent with the quarterlypresentation requirements in effect before ASU 2011-05.  All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for the period ending June 30,fiscal years, and interim periods within those years, beginning after December 15, 2011. The rule had no effect onCorporation has included the Corporation’srequired disclosures in its consolidated financial statements.  The interactive data reports have been included in this quarterly report as Exhibit 101.
 
NOTE 2: Securities
 
Debt and equity securities, all of which were classified as available for sale, are summarized as follows:
 
  September 30, 2011 
(Dollars in thousands) 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Estimated
Fair Value
 
U.S. government agencies and corporations $11,007  $55  $(6) $11,056 
Mortgage-backed securities  2,397   102   —   2,499 
Obligations of states and political subdivisions  121,683   6,529   (74)  128,138 
Preferred stock  27   73   —   100 
  $135,114  $6,759  $(80) $141,793 
    
  December 31, 2010 
(Dollars in thousands) 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Estimated
Fair Value
 
U.S. government agencies and corporations $13,629  $57  $(30) $13,656 
Mortgage-backed securities  2,229   78   (7)  2,300 
Obligations of states and political subdivisions  113,620   1,694   (1,026)  114,288 
Preferred stock  27   7   (3)  31 
  $129,505  $1,836  $(1,066) $130,275 
8
  March 31, 2012 
(Dollars in thousands) 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Estimated
Fair Value
 
U.S. government agencies and corporations $13,906  $28  $(8) $13,926 
Mortgage-backed securities  2,895   82   —   2,977 
Obligations of states and political subdivisions  119,777   7,197   (75)  126,899 
Preferred stock  27   39   —   66 
  $136,605  $7,346  $(83) $143,868 
    
  December 31, 2011 
(Dollars in thousands) 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Estimated
Fair Value
 
U.S. government agencies and corporations $15,248  $39  $(4) $15,283 
Mortgage-backed securities  2,135   81   —   2,216 
Obligations of states and political subdivisions  120,165   6,998   (84)  127,079 
Preferred stock  27   41   —   68 
  $137,575  $7,159  $(88) $144,646 
 
The amortized cost and estimated fair value of securities, all of which were classified as available for sale, at September 30, 2011,March 31, 2012, by the earlier of contractual maturity or expected maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
 
 September 30, 2011  March 31, 2012 
(Dollars in thousands) 
Amortized
Cost
  
Estimated
Fair Value
  
Amortized
Cost
  
Estimated
Fair Value
 
Due in one year or less $28,327  $28,563  $28,727  $28,883 
Due after one year through five years  30,314   31,269   34,406   35,738 
Due after five years through ten years  49,312   52,741   47,462   50,949 
Due after ten years  27,134   29,120   25,983   28,232 
Preferred stock  27   100   27   66 
 $135,114  $141,793  $136,605  $143,868 
9
 
Proceeds from the maturities, calls and sales of securities available for sale for the ninethree months ended September 30, 2011March 31, 2012 were $21.77$7.80 million.
 
The Corporation pledges securities primarily as collateral for public deposits and repurchase agreements. Securities with an aggregate amortized cost of $92.47$99.92 million and an aggregate fair value of $97.20$105.81 million were pledged at September 30, 2011.March 31, 2012. Securities with an aggregate amortized cost of $93.56$106.97 million and an aggregate fair value of $94.28$112.66 million were pledged at December 31, 2010.2011.
 
Securities in an unrealized loss position at September 30, 2011,March 31, 2012, by duration of the period of the unrealized loss, are shown below.

 Less Than 12 Months  12 Months or More  Total  Less Than 12 Months  12 Months or More  Total 
(Dollars in thousands) 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
U.S. government agencies and corporations $2,754  $6  $—  $—  $2,754  $6  $3,415  $8  $—  $—  $3,415  $8 
Obligations of states and political subdivisions  1,668   28   501   46   2,169   74   2,233   29   969   46   3,202   75 
Total temporarily impaired securities $4,422  $34  $501  $46  $4,923  $80  $5,648  $37  $969  $46  $6,617  $83 
 
There are 1424 debt securities with fair values totaling $4.92$6.62 million considered temporarily impaired at September 30, 2011.March 31, 2012. The primary cause of the temporary impairments in the Corporation’s investments in debt securities was fluctuations in interest rates.  During the third quarter of 2011, the municipal bond sector, which is included in the Corporation’s obligations of states and political subdivisions category of securities, experienced rising securities prices given overall lower interest rates and increased investor demand driven by relatively-improved fiscal conditions of state and local governments and the continued limited supply of new municipal bond issuances.  The drop in supply was due to Congress not reauthorizing the Build America Bond program to continue after 2010 and reluctance on the part of municipalities to incur more debt service given challenging economic conditions.  The vast majority of the Corporation’s municipal bond portfolio is made upconsists of securities where the issuing municipalities have unlimited taxing authority to support their debt servicing obligations. At September 30, 2011,March 31, 2012, approximately 95 percent96% of the Corporation’s obligations of states and political subdivisions, as measured by market value, were rated “A” or better by Standard & Poor’s or Moody’s Investors Service. Of those in a net unrealized loss position, approximately 74 percent92% were rated “A” or better as measured by market value, at September 30, 2011.March 31, 2012. Because the Corporation intends to hold these investments in debt securities to maturity and it is more likely than not that the Corporation will not be required to sell these investments before a recovery of unrealized losses, the Corporation does not consider these investments to be other-than-temporarily impaired at September 30, 2011March 31, 2012 and no other-than-temporary impairment has been recognized.

9
 
Securities in an unrealized loss position at December 31, 2010,2011, by duration of the period of the unrealized loss, are shown below.
 
 Less Than 12 Months  12 Months or More  Total  Less Than 12 Months  12 Months or More  Total 
(Dollars in thousands) 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
U.S. government agencies and corporations $4,345  $30  $—  $—  $4,345  $30  $2,064  $4  $—  $—  $2,064  $4 
Mortgage-backed securities  590   7   —   —   590   7 
Obligations of states and political subdivisions  38,585   925   1,178   101   39,763   1,026   3,305   35   1,328   49   4,633   84 
Subtotal-debt securities  43,520   962   1,178   101   44,698   1,063 
Preferred stock  8   3   —   —   8   3 
Total temporarily impaired securities $43,528  $965  $1,178  $101  $44,706  $1,066  $5,369  $39  $1,328  $49  $6,697  $88 
 
The Corporation’s investment in Federal Home Loan Bank (FHLB) stock totaled $3.80$3.77 million at September 30, 2011March 31, 2012 and $3.89 million at December 31, 2010.2011. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Corporation does not consider this investment to be other-than-temporarily impaired at September 30, 2011March 31, 2012 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.
 
10
NOTE 3: Loans
 
Major classifications of loans are summarized as follows:
 
(Dollars in thousands) 
September 30,
2011
  
December 31,
2010
  
March 31,
2012
  
December 31,
2011
 
Real estate – residential mortgage $146,617  $146,073  $146,867  $147,135 
Real estate – construction 1
  7,122   12,095 
Commercial, financial and agricultural 2
  215,964   219,226 
Real estate – construction  4,461   5,737 
Commercial, financial and agricultural 1
  218,472   212,235 
Equity lines  32,576   32,187   33,335   33,192 
Consumer  5,487   5,250   5,422   6,057 
Consumer finance  247,745   220,753   252,269   246,305 
  655,511   635,584   660,826   650,661 
Less allowance for loan losses  (32,590)  (28,840)  (34,757)  (33,677)
Loans, net $622,921  $606,744  $626,069  $616,984 
 
1
Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
2
Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.
 
Consumer loans included $207,000$181,000 and $378,000$299,000 of demand deposit overdrafts at September 30, 2011March 31, 2012 and December 31, 2010,2011, respectively.
10
 
Loans on nonaccrual status were as follows:

(Dollars in thousands) 
September 30,
2011
  
December 31,
2010
 
Real estate – residential mortgage $1,489  $189 
Real estate – construction:        
Construction lending  —   — 
Consumer lot lending  —   — 
Commercial, financial and agricultural:        
Commercial real estate lending  4,500   5,760 
Land acquisition and development lending  —   — 
Builder line lending  2,303   67 
Commercial business lending  99   1,448 
Equity lines  129   266 
Consumer  —   35 
Consumer finance  595   151 
Total loans on nonaccrual status $9,115  $7,916 
The past due status of loans as of September 30, 2011 was as follows:

(Dollars in thousands) 
30-59 Days
Past Due
  
60-89 Days
Past Due
  
90+ Days Past
Due
  
Total Past
Due
  Current  Total Loans  
90+ Days
Past Due and
Accruing
 
Real estate – residential mortgage $1,246  $166  $848  $2,260  $144,357  $146,617  $— 
Real estate – construction:                            
Construction lending  —   —   —   —   5,440   5,440   — 
Consumer lot lending  —   —   —   —   1,682   1,682   — 
Commercial, financial and agricultural:                            
Commercial real estate lending  5,770   542   1,175   7,487   108,785   116,272   — 
Land acquisition and development lending  —   —   —   —   32,932   32,932   — 
Builder line lending  —   18   —   18   18,597   18,615   — 
Commercial business lending  154   139   —   293   47,852   48,145   — 
Equity lines  108   195   —   303   32,273   32,576   — 
Consumer  46   15   2   63   5,424   5,487   2 
Consumer finance  4,930   913   595   6,438   241,307   247,745   — 
Total $12,254  $1,988  $2,620  $16,862  $638,649  $655,511  $2 

For the purposes of the above table, “Current” includes loans that are 1-29 days past due.
The past due status of loans as of December 31, 2010 was as follows:
(Dollars in thousands) 
30-59 Days
Past Due
  
60-89 Days
Past Due
  
90+ Days Past
Due
  
Total Past
Due
  Current  Total Loans  
90+ Days
Past Due and
Accruing
  
March 31,
2012
  
December 31,
2011
 
Real estate – residential mortgage $1,605  $826  $751  $3,182  $142,891  $146,073  $676  $2,934  $2,440 
Real estate – construction:                                    
Construction lending  —   —   —   —   10,744   10,744   —   —   — 
Consumer lot lending  —   —   —   —   1,351   1,351   —   —   — 
Commercial, financial and agricultural:                                    
Commercial real estate lending  59   —   2,840   2,899   108,418   111,317   186   5,515   5,093 
Land acquisition and development lending  —   —   —   —   34,314   34,314   —   2,821   — 
Builder line lending  —   1,450   195   1,645   23,171   24,816   128   2,024   2,303 
Commercial business lending  9   —   1,383   1,392   47,387   48,779   —   746   673 
Equity lines  223   115   35   373   31,814   32,187   35   10   123 
Consumer  1   11   38   50  ��5,200   5,250   5   —   — 
Consumer finance  4,913   829   151   5,893   214,860   220,753   —   375   381 
Total $6,810  $3,231  $5,393  $15,434  $620,150  $635,584  $1,030 
Total loans on nonaccrual status $14,425  $11,013 
 
 
11

The past due status of loans as of March 31, 2012 was as follows:
(Dollars in thousands)
 
 
30-59 Days
Past Due
  
60-89 Days
Past Due
  
90+ Days Past
Due
  
Total Past
Due
  Current  Total Loans  
90+ Days
Past Due and
Accruing
 
Real estate – residential mortgage $1,124  $373  $2,181  $3,678  $143,189  $146,867  $— 
Real estate – construction:                            
Construction lending  —   —   —   —   3,084   3,084   — 
Consumer lot lending  —   —   —   —   1,377   1,377   — 
Commercial, financial and agricultural:                            
Commercial real estate lending  711   491   —   1,202   125,957   127,159   — 
Land acquisition and development lending  2,821   —   —   2,821   31,226   34,047   — 
Builder line lending  160   —   —   160   18,518   18,678   — 
Commercial business lending  214   24   166   404   38,184   38,588   — 
Equity lines  328   —   —   328   33,007   33,335   — 
Consumer  78   —   —   78   5,344   5,422   2 
Consumer finance  2,950   728   375   4,053   248,216   252,269   — 
Total $8,386  $1,616  $2,722  $12,724  $648,102  $660,826  $2 

The past due status of loans as of December 31, 2011 was as follows:
(Dollars in thousands) 
30-59 Days
Past Due
  
60-89 Days
Past Due
  
90+ Days Past
Due
  
Total Past
Due
  Current  Total Loans  
90+ Days
Past Due and
Accruing
 
Real estate – residential mortgage $1,270  $1,445  $533  $3,248  $143,887  $147,135  $65 
Real estate – construction:                            
Construction lending  —   —   —   —   5,084   5,084   — 
Consumer lot lending  —   —   —   —   653   653   — 
Commercial, financial and agricultural:                            
Commercial real estate lending  986   1,311   —   2,297   114,475   116,772   — 
Land acquisition and development lending  —   —   —   —   32,645   32,645   — 
Builder line lending  —   —   —   —   17,637   17,637   — 
Commercial business lending  480   —   —   480   44,701   45,181   — 
Equity lines  69   90   33   192   33,000   33,192   — 
Consumer  13   —   —   13   6,044   6,057   3 
Consumer finance  5,327   1,041   381   6,749   239,556   246,305   — 
Total $8,145  $3,887  $947  $12,979  $637,682  $650,661  $68 
 
For the purposes of the past due tables above, table, “Current” includes loans that are 1-29 days past due.
 
12
Impaired loans, which included TDRstroubled debt restructurings (TDRs) of $15.53$16.71 million, and the related allowance at September 30, 2011, as well as average impaired loans and interest income recognized for the first nine months of 2011,March 31, 2012 were as follows:
 
(Dollars in thousands) 
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance-Impaired
Loans
  
Interest
Income
Recognized
  
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance Impaired
Loans
  
Interest
Income
Recognized
 
Real estate – residential mortgage $3,048  $3,050  $618  $3,041  $103  $3,351  $3,572  $636  $3,431  $32 
Real estate – construction:                                        
Construction lending  —   —   —   —   —   —   —   —   —   — 
Consumer lot lending  —   —   —   —   —   —   —   —   —   — 
Commercial, financial and agricultural:                                        
Commercial real estate lending  4,591   5,021   920   4,156   57   5,792   5,916   1,588   5,815   39 
Land acquisition and development lending  5,678   6,014   600   5,851   282   8,310   8,634   1,782   6,450   88 
Builder line lending  2,285   2,285   300   2,110   —   2,007   2,007   384   2,101   — 
Commercial business lending  99   100   22   416   4   641   644   129   646   3 
Equity lines  —   —   —   49   —   —   —   —   —   — 
Consumer  324   324   49   331   11   432   432   65   432   4 
Total $16,025  $16,794  $2,509  $15,954  $457  $20,533  $21,205  $4,584  $18,875  $166 
 
As a result of adopting the amendments in ASU 2011-02, the Corporation reassessed all loan modifications that occurred on or after January 1, 2011 to determine whether they should be considered TDRs.  There were no additional TDRs identified in connection with this reassessment.
Loan modifications classified as TDRs during the three months and nine months ended September 30, 2011 were as follows:

(Dollars in thousands) 
Three Months
Ended
September 30,2011
  
Nine Months
Ended
September 30, 2011
 
Real estate – residential mortgage – interest reduction $86  $629 
Real estate – residential mortgage – interest rate concession  285   306 
Commercial, financial and agricultural:        
Commercial real estate lending – interest reduction  —   176 
Commercial real estate lending – interest rate concession  3,559   3,922 
Builder line lending – interest rate concession  —   2,285 
Commercial business lending – interest rate concession  99   99 
Total $4,029  $7,417 
TDR additions during the first nine months of 2011 included two commercial relationships totaling $5.35 million for which modified repayment schedules were negotiated.  While these relationships were also in nonaccrual status at September 30, 2011, the borrowers are servicing the loans in accordance with the modified terms.  The Corporation has no obligation to fund additional advances on its impaired loans.
 
TDR payment defaultsImpaired loans, which include TDRs of $17.09 million, and the related allowance at December 31, 2011 were as follows:
(Dollars in thousands) 
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance Impaired
Loans
  
Interest
Income
Recognized
 
Real estate – residential mortgage $3,482  $3,698  $657  $3,723  $137 
Real estate – construction:                    
Construction lending  —   —   —   —   — 
Consumer lot lending  —   —   —   —   — 
Commercial, financial and agricultural:                    
Commercial real estate lending  5,861   5,957   1,464   6,195   102 
Land acquisition and development lending  5,490   5,814   1,331   6,116   372 
Builder line lending  2,285   2,285   318   2,397   — 
Commercial business lending  652   654   161   663   6 
Equity lines  —   —   —   —   — 
Consumer  324   324   49   324   14 
Total $18,094  $18,732  $3,980  $19,418  $631 
Loan modifications that were classified as TDRs during the three months and nine months ended September 30,March 31, 2012 and 2011 were as follows:

 Three Months Ended March 31, 
(Dollars in thousands) 
Three Months
Ended
September 30,2011
  
Nine Months
Ended
September 30, 2011
  2012  2011 
Real estate – residential mortgage $—  $176 
Consumer  —   5 
Real estate – residential mortgage – interest rate concession $—  $122 
Commercial, financial and agricultural:        
Commercial business lending – interest rate concession  —   86 
Consumer – interest reduction  108   — 
Total $—  $181  $108  $208 
13

TDR payment defaults during three months ended March 31, 2012 and 2011 were as follows:

  Three Months Ended March 31, 
(Dollars in thousands) 2012  2011 
Real estate – residential mortgage $—  $84 
Consumer  —   4 
Total $—  $88 
 
For purposes of this disclosure, a TDR payment default occurs when, within 12 months of the original TDR modification, either a full or partial charge-off occurs or a TDR becomes 90 days or more past due or a charge-off occurs prior to 90 days past due.

12
 
Impaired loans, which included TDRs of $9.77 million, and the related allowance at December 31, 2010 were as follows:
(Dollars in thousands) 
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance-Impaired
Loans
  
Interest
Income
Recognized
 
Real estate – residential mortgage $3,110  $3,110  $466  $2,689  $137 
Real estate – construction:                    
Construction lending  —   —   —   —   — 
Consumer lot lending  —   —   —   —   — 
Commercial, financial and agricultural:                    
Commercial real estate lending  5,760   6,816   1,263   3,582   30 
Land acquisition and development lending  5,919   5,919   400   1,038   30 
Builder line lending  —   —   —   1,014   — 
Commercial business lending  1,142   1,267   404   613   — 
Equity lines  148   150   49   149   4 
Consumer  338   338   51   333   14 
Total $16,417  $17,600  $2,633  $9,418  $215 
NOTE 4: Allowance for Loan Losses
 
ChangesThe following table presents the changes in the allowance for loan losses were as follows:by major classification during the three months ended March 31, 2012.

(Dollars in thousands) 
Real Estate
Residential
Mortgage
  
Real Estate
Construction
  
Commercial,
Financial and
Agricultural
  Equity Lines  Consumer  
Consumer
Finance
  Total 
Allowance for loan losses:                     
Balance at December 31, 2011 $2,379  $480  $10,040  $912  $319  $19,547  $33,677 
Provision charged to operations  386   (13)  335   126   (9)  1,900   2,725 
Loans charged off  (122)  —   —   (121)  (90)  (2,200)  (2,533)
Recoveries of loans previously charged off  10   —   35   —   49   794   888 
Balance at March 31, 2012 $2,653  $467  $10,410  $917  $269  $20,041  $34,757 

The following table presents the changes in the allowance for loan losses by major classification during the three months ended March 31, 2011

(Dollars in thousands) 
Real Estate
Residential
Mortgage
  
Real Estate
Construction
  
Commercial,
Financial and
Agricultural
  Equity Lines  Consumer  
Consumer
Finance
  Total 
Allowance for loan losses:                     
Balance December 31, 2010 $1,442  $581  $8,688  $380  $307  $17,442  $28,840 
Provision charged to operations  377   139   486   24   44   1,750   2,820 
Loans charged off  (145)  —   (1,581)  (9)  (70)  (1,689)  (3,494)
Recoveries of loans previously charged off  11   —   17   —   22   549   599 
Balance March 31, 2011 $1,685  $720  $7,610  $395  $303  $18,052  $28,765 
 
  Three Months Ended September 30,  Nine Months Ended September 30, 
(Dollars in thousands) 2011  2010  2011  2010 
Balance at the beginning of period $30,211  $25,154  $28,840  $24,027 
Provision charged to operations  4,075   3,719   10,285   10,219 
Loans charged off  (2,551)  (2,699)  (8,655)  (9,124)
Recoveries of loans previously charged off  855   561   2,120   1,613 
Balance at the end of period $32,590  $26,735  $32,590  $26,735 

14
The following table presents, as of March 31, 2012, the total allowance for loan losses the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), total loans, and loans by impairment methodology (individually evaluated for the nine months ended September 30,impairment or collectively evaluated for impairment).
(Dollars in thousands) 
Real Estate
Residential
Mortgage
  
Real Estate
Construction
  
Commercial,
Financial and
Agricultural
  Equity Lines  Consumer  
Consumer
Finance
  Total 
Allowance for loan losses:                     
Balance at March 31, 2012 $2,653  $467  $10,410  $917  $269  $20,041  $34,757 
                             
Ending balance: individually evaluated for impairment $636  $—  $3,883  $—  $65  $—  $4,584 
                             
Ending balance: collectively evaluated for impairment $2,017  $467  $6,527  $917  $204  $20,041  $30,173 
��                            
Loans:                            
Balance March 31, 2012 $146,867  $4,461  $218,472  $33,335  $5,422  $252,269  $660,826 
                             
Ending balance: individually evaluated for impairment $3,351  $—  $16,750  $—  $432  $—  $20,533 
                             
Ending balance: collectively evaluated for impairment $143,516  $4,461  $201,722  $33,335  $4,990  $252,269  $640,293 
The following table presents, as of December 31, 2011, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans, and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).
 
(Dollars in thousands) 
Real Estate
Residential
Mortgage
  
Real Estate
Construction
  
Commercial,
Financial and
Agricultural
  Equity Lines  Consumer  
Consumer
Finance
  Total  
Real Estate
Residential
Mortgage
  
Real Estate
Construction
  
Commercial,
Financial and
Agricultural
  Equity Lines  Consumer  
Consumer
Finance
  Total 
Allowance for loan losses:                                          
Balance at beginning of period $1,442  $581  $8,688  $380  $307  $17,442  $28,840 
Provision charged to operations  1,446   153   2,508   539   139   5,500   10,285 
Loans charged off  (648)  —   (2,541)  (9)  (247)  (5,210)  (8,655)
Recoveries of loans previously charged off  90   —   149   —   71   1,810   2,120 
Balance at end of period $2,330  $734  $8,804  $910  $270  $19,542  $32,590 
Balance at December 31, 2011 $2,379  $480  $10,040  $912  $319  $19,547  $33,677 
                            
Ending balance: individually evaluated for impairment $618  $—  $1,842  $—  $49  $—  $2,509  $657  $—  $3,274  $—  $49  $—  $3,980 
                            
Ending balance: collectively evaluated for impairment $1,712  $734  $6,962  $910  $221  $19,542  $30,081  $1,722  $480  $6,766  $912  $270  $19,547  $29,697 
                            
Loans:                                                        
Ending balance $146,617  $7,122  $215,964  $32,576  $5,487  $247,745  $655,511 
Balance at December 31, 2011 $147,135  $5,737  $212,235  $33,192  $6,057  $246,305  $650,661 
                            
Ending balance: individually evaluated for impairment $3,048  $—  $12,653  $—  $324  $—  $16,025  $3,482  $—  $14,288  $—  $324  $—  $18,094 
                            
Ending balance: collectively evaluated for impairment $143,569  $7,122  $203,311  $32,576  $5,163  $247,745  $639,486  $143,653  $5,737  $197,947  $33,192  $5,733  $246,305  $632,567 
 
 
1315

Loans by credit quality indicators as of March 31, 2012 were as follows:
(Dollars in thousands)
 
 Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
 
Real estate – residential mortgage $139,794  $1,419  $2,721  $2,933  $146,867 
Real estate – construction:                    
Construction lending  213   —   2,871   —   3,084 
Consumer lot lending  1,377   —   —   —   1,377 
Commercial, financial and agricultural:                    
Commercial real estate lending  107,385   5,359   8,900   5,515   127,159 
Land acquisition and development lending  15,035   9,923   6,268   2,821   34,047 
Builder line lending  13,756   1,446   1,452   2,024   18,678 
Commercial business lending  35,073   1,870   899   746   38,588 
Equity lines  32,194   295   836   10   33,335 
Consumer  4,543   —   879   —   5,422 
  $349,370  $20,312  $24,826  $14,049  $408,557 
(Dollars in thousands) Performing  Non-Performing  Total 
Consumer finance $251,894  $375  $252,269 
1At March 31, 2012, the Corporation did not have any loans classified as Doubtful or Loss.
Loans by credit quality indicators as of December 31, 2011 were as follows:
(Dollars in thousands) Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
 
Real estate – residential mortgage $140,304  $1,261  $3,130  $2,440  $147,135 
Real estate – construction:                    
Construction lending  2,214   —   2,870   —   5,084 
Consumer lot lending  653   —   —   —   653 
Commercial, financial and agricultural:                    
Commercial real estate lending  96,773   5,413   9,493   5,093   116,772 
Land acquisition and development lending  13,605   9,939   9,101   —   32,645 
Builder line lending  12,480   1,434   1,420   2,303   17,637 
Commercial business lending  41,590   2,001   917   673   45,181 
Equity lines  31,935   298   836   123   33,192 
Consumer  5,271   10   776   —   6,057 
  $344,825  $20,356  $28,543  $10,632  $404,356 
(Dollars in thousands) Performing  Non-Performing  Total 
Consumer finance $245,924  $381  $246,305 
1At December 31, 2011, the Corporation did not have any loans classified as Doubtful or Loss.
16
 
The following table presents, as of December 31, 2010, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

(Dollars in thousands) 
Real Estate
Residential
Mortgage
  
Real Estate
Construction
  
Commercial,
Financial and
Agricultural
  Equity Lines  Consumer  
Consumer
Finance
  Total 
Allowance for loan losses:                     
Balance at end of period $1,442  $581  $8,688  $380  $307  $17,442  $28,840 
Ending balance: individually evaluated for impairment $466  $—  $2,067  $49  $51  $—  $2,633 
Ending balance: collectively evaluated for impairment $976  $581  $6,621  $331  $256  $17,442  $26,207 
Loans:                            
Ending balance $146,073  $12,095  $219,226  $32,187  $5,250  $220,753  $635,584 
Ending balance: individually evaluated for impairment $3,110  $—  $12,821  $148  $338  $—  $16,417 
Ending balance: collectively evaluated for impairment $142,963  $12,095  $206,405  $32,039  $4,912  $220,753  $619,167 
Loans by credit quality indicators as of September 30, 2011 were as follows:
(Dollars in thousands) Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
 
Real estate – residential mortgage $140,943  $862  $3,323  $1,489  $146,617 
Real estate – construction:                    
Construction lending  2,215   354   2,871   —   5,440 
Consumer lot lending  1,682   —   —   —   1,682 
Commercial, financial and agricultural:                    
Commercial real estate lending  94,651   5,988   11,133   4,500   116,272 
Land acquisition and development lending  13,513   10,107   9,312   —   32,932 
Builder line lending  11,979   3,304   1,029   2,303   18,615 
Commercial business lending  43,034   3,733   1,279   99   48,145 
Equity lines  31,383   285   779   129   32,576 
Consumer  4,691   11   785   —   5,487 
  $344,091  $24,644  $30,511  $8,520  $407,766 
(Dollars in thousands) Performing  Non-Performing  Total 
Consumer finance $247,150  $595  $247,745 
1 At September 30, 2011, the Corporation did not have any loans classified as Doubtful or Loss.

14
Loans by credit quality indicators as of December 31, 2010 were as follows:
(Dollars in thousands) Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
 
Real estate – residential mortgage $140,651  $1,344  $3,889  $189  $146,073 
Real estate – construction:                    
Construction lending  6,017   —   4,727   —   10,744 
Consumer lot lending  1,351   —   —   —   1,351 
Commercial, financial and agricultural:                    
Commercial real estate lending  93,235   12,002   320   5,760   111,317 
Land acquisition and development lending  21,642   3,394   9,278   —   34,314 
Builder line lending  13,827   6,112   4,810   67   24,816 
Commercial business lending  42,865   4,166   300   1,448   48,779 
Equity lines  31,562   263   96   266   32,187 
Consumer  4,804   11   400   35   5,250 
  $355,954  $27,292  $23,820  $7,765  $414,831 
(Dollars in thousands) Performing  Non-Performing  Total 
Consumer finance $220,602  $151  $220,753 
1 At December 31, 2010, the Corporation did not have any loans classified as Doubtful or Loss.
NOTE 5: Stockholders’ EquityOther Comprehensive Income and Earnings Per Common Share
 
Other Comprehensive Income
 
The following table presents the cumulative balances of the components of other comprehensive income, net of deferred tax assets of $1.95$1.86 million and $1.61 million$365,000 as of September 30,March 31, 2012 and 2011, and 2010, respectively.
 
(Dollars in thousands) September 30,  March 31, 
 2011  2010  2012  2011 
Net unrealized gains on securities $4,341  $3,514  $4,721  $1,055 
Net unrecognized loss on cash flow hedges  (336)  (264)  (311)  (36)
Net unrecognized losses on defined benefit pension plan  (328)  (211)  (891)  (335)
Total cumulative other comprehensive income $3,677  $3,039  $3,519  $684 
The following tables present the changes in accumulated other comprehensive income, by category, net of tax.
(Dollars in thousands) 
Unrealized
Loss on Cash
Flow Hedging
Instruments
  
Unrealized
Holding Gains
on Securities
  
Defined
Benefit
Pension Plan
Assets and
Benefit
Obligations
  Total 
Balance December 31, 2011 $(314) $4,596  $(898) $3,384 
Net change for the first quarter of 2012  3   125   7   135 
Balance at March 31, 2012 $(311) $4,721  $(891) $3,519 

(Dollars in thousands) 
Unrealized
Loss on Cash
Flow Hedging
Instruments
  
Unrealized
Holding Gains
on Securities
  
Defined
Benefit
Pension Plan
Assets and
Benefit
Obligations
  Total 
Balance December 31, 2010 $(90) $500  $(339) $71 
Net change for the first quarter of 2011  54   555   4   613 
Balance at March 31, 2011 $(36) $1,055  $(335) $684 
The following tables present the change in each component of other comprehensive income on a pre-tax and after-tax basis for the three months ended March 31, 2012 and 2011.
(Dollars in thousands) Three Months Ended March 31, 2012 
  Pre-Tax  
Tax Expense
(Benefit)
  Net-of-Tax 
Defined benefit pension plan:         
Net loss $26  $8  $18 
Amortization of prior service costs  (17)  (6)  (11)
Defined benefit pension plan assets and benefit obligations, net  9   2   7 
Unrealized gain on cash flow hedging instruments  5   2   3 
Unrealized holding gains on securities  193   68   125 
Total increase in other comprehensive income $207  $72  $135 

17


(Dollars in thousands) Three Months Ended March 31, 2011 
  Pre-Tax  
Tax Expense
(Benefit)
  Net-of-Tax 
Defined benefit pension plan:         
Net loss $16  $5  $11 
Amortization of prior service costs  (9)  (3)  (6)
Amortization of net obligation at transition  (1)  --   (1)
Defined benefit pension plan assets and benefit obligations, net  6   2   4 
Unrealized gain on cash flow hedging instruments  83   29   54 
Unrealized holding gains on securities  854   299   555 
Total increase in other comprehensive income $943  $330  $613 
 
The Corporation had no net gains of less than $1,000 from securities reclassified from other comprehensive income to earnings for the ninethree months ended September 30,March 31, 2012 and 2011. The Corporation reclassified net gains of $43,000 from other comprehensive income to earnings for the nine months ended September 30, 2010.
 
On July 27, 2011, the Corporation redeemed $10.00 million, or 50 percent, of the $20.00 million of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the preferred stock) issued to the United States Department of the Treasury in January 2009 under the Capital Purchase Program (CPP).  The Corporation paid $10.10 million to redeem the preferred stock, consisting of $10.00 million in liquidation value and $100,000 of accrued and unpaid dividends associated with the preferred stock.  The funds for this redemption were provided by existing financial resources of the Corporation, and because no new capital was issued, there was no dilution to the Corporation’s common shareholders resulting from this redemption.  The Corporation accelerated the accretion of the corresponding portion of the preferred stock discount, thereby reducing net income available to common shareholders by approximately $213,000 in the third quarter of 2011.  As a result of this redemption, preferred stock dividends will be reduced annually by $500,000.

15
NOTE 6: Earnings Per Common Share
 
The components of the Corporation’s earnings per common share calculations are as follows:
 

(Dollars in thousands) Three Months Ended September 30,  Three Months Ended March 31, 
 2011  2010  2012  2011 
Net income $3,513  $2,586  $3,780  $2,969 
Accumulated dividends on Series A Preferred Stock  (225)  (250)  (125)  (250)
Accretion of Series A Preferred Stock discount  (233)  (38)  (21)  (39)
Net income available to common shareholders $3,055  $2,298  $3,634  $2,680 
Weighted average number of common shares used in earnings per common share – basic  3,141,926   3,089,211 
Weighted average number of common shares used in earnings per common share—basic  3,190,518   3,123,868 
Effect of dilutive securities:                
Stock option awards and Warrant  32,443   7,779   74,457   43,292 
Weighted average number of common shares used in earnings per common share – assuming dilution  3,174,369   3,096,990 
        
      
(Dollars in thousands) Nine Months Ended September 30, 
  2011   2010 
Net income $9,565  $5,733 
Accumulated dividends on Series A Preferred Stock  (725)  (750)
Accretion of Series A Preferred Stock discount  (312)  (111)
Net income available to common shareholders $8,528  $4,872 
Weighted average number of common shares used in earnings per common share – basic  3,132,332   3,082,384 
Effect of dilutive securities:        
Stock option awards and Warrant  34,598   17,058 
Weighted average number of common shares used in earnings per common share – assuming dilution  3,166,930   3,099,442 
Weighted average number of common shares used in earnings per common share—assuming dilution  3,264,975   3,167,160 
 
Potential common shares that may be issued by the Corporation for its stock option awards and the warrant to purchase common shares issued in connection with the Corporation’s participation in the CPPWarrant (defined below) are determined using the treasury stock method. Approximately 343,000277,000 and 380,000303,000 shares issuable upon exercise of options were not included in computing diluted earnings per common share for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively, and 333,000 and 363,000 shares issuable upon exercise of options were not included in computing diluted earnings per common share for the nine months ended September 30, 2011 and 2010, respectively, because they were anti-dilutive.

In January 2009 the Corporation issued to the United States Department of the Treasury (Treasury) under the Capital Purchase Program (CPP) $20.00 million of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the Preferred Stock) and a warrant to purchase 167,504 shares of the Corporation’s common stock (the Warrant). On July 27, 2011 the Corporation redeemed $10.00 million of the Preferred Stock, and on April 12, 2012 the Corporation redeemed the remaining $10.00 million of the Preferred Stock.  More information on the April 2012 redemption is presented in Note 12 to the Corporation’s unaudited financial statements.
18
NOTE 7:6: Employee Benefit Plans
 
The Bank has a non-contributory defined benefit plan for which the components of net periodic benefit cost are as follows:
 
(Dollars in thousands) 
Three Months Ended
September 30,
  
Three Months Ended
March 31,
 
 2011  2010  2012  2011 
Service cost $153  $133  $159  $153 
Interest cost  109   99   99   109 
Expected return on plan assets  (145)  (124)  (158)  (145)
Amortization of net obligation at transition  (1)  (1)  --   (1)
Amortization of prior service cost  (17)  (17)  (17)  (17)
Amortization of net loss  16   12   26   16 
Net periodic benefit cost $115  $102  $109  $115 
 
16

(Dollars in thousands) 
Nine Months Ended
September 30,
 
  2011  2010 
Service cost $459  $399 
Interest cost  327   297 
Expected return on plan assets  (435)  (371)
Amortization of net obligation at transition  (3)  (4)
Amortization of prior service cost  (51)  (51)
Amortization of net loss  48   36 
Net periodic benefit cost $345  $306 
The Bank made a $1.5 million contribution to this plan in the second quarter of 2011.
NOTE 8:7: Fair Value of Assets and Liabilities
 
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:
 
Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt and equity securities traded in an active exchange market, as well as U.S. Treasury securities.
●Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt and equity securities traded in an active exchange market, as well as U.S. Treasury securities.
 
Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Valuations of other real estate owned are based upon appraisals by independent, licensed appraisers, general market conditions and recent sales of like properties.
●Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Valuations of other real estate owned are based upon appraisals by independent, licensed appraisers, general market conditions and recent sales of like properties.
 
Level 3—Valuation is determined using model-based techniques with significant assumptions not observable in the market.
●Level 3—Valuation is determined using model-based techniques with significant assumptions not observable in the market.
 
U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Corporation has not made any fair value option elections as of September 30, 2011.March 31, 2012.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
The following tables present the balances of financial assets measured at fair value on a recurring basis.
 
(Dollars in thousands) September 30, 2011 
Fair Value Measurements Using  
Assets at Fair
Value
 
 March 31, 2012 
 Fair Value Measurements Using  
Assets at Fair
Value
 
(Dollars in thousands) Level 1  Level 2  Level 3  
Assets at Fair
Value
  Level 1  Level 2  Level 3 
  
U.S. government agencies and corporations  —  $11,056   —  $11,056  $—  $13,926  $—  $13,926 
Mortgage-backed securities  —   2,499   —   2,499   —   2,977   —   2,977 
Obligations of states and political subdivisions  —   128,138   —   128,138   —   126,899   —   126,899 
Preferred stock  —   100   —   100   —   66   —   66 
Total securities available for sale  —  $141,793   —  $141,793  $—  $143,868  $—  $143,868 
                
Liabilities:                                
Derivative payable  —  $546   —  $546  $—  $509  $—  $509 
Total liabilities  —  $546   —  $546 

 
 
1719

 December 31, 2010  December 31, 2011 
(Dollars in thousands) Fair Value Measurements Using  
Assets at Fair
Value
  Fair Value Measurements Using  
Assets at Fair
Value
 
Level 1  Level 2  Level 3  Level 1  Level 2  Level 3 
Assets:                        
Securities available for sale                        
U.S. government agencies and corporations  —  $13,656   —  $13,656  $—  $15,283  $—  $15,283 
Mortgage-backed securities  —   2,300   —   2,300   —   2,216   —   2,216 
Obligations of states and political subdivisions  —   114,288   —   114,288   —   127,079   —   127,079 
Preferred stock  —   31   —   31   —   68   —   68 
Total securities available for sale  —  $130,275   —  $130,275  $—  $144,646  $—  $144,646 
                
Liabilities:                                
Derivative payable  —  $148   —  $148  $—  $515  $—  $515 
Total liabilities  —  $148   —  $148 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
 
The Corporation is also required to measure and recognize certain other financial assets at fair value on a nonrecurring basis in the consolidated balance sheets. For assets measured at fair value on a nonrecurring basis and still held on the consolidated balance sheets, the following table provides the fair value measures by level of valuation assumptions used. Fair value adjustments for other real estate owned (OREO) are recorded in other noninterest expense and fair value adjustments for impaired loans are recorded in the provision for loan losses, in the consolidated statements of income.
 
 September 30, 2011  March 31, 2012 
 Fair Value Measurements Using  
Assets at  Fair
Value
  Fair Value Measurements Using  
Assets at Fair
Value
 
(Dollars in thousands) Level 1  Level 2  Level 3  Level 1  Level 2  Level 3 
Impaired loans, net  —  $13,516   —  $13,516  $—  $15,949  $—  $15,949 
OREO, net  —   6,442   —   6,442   —   5,209   —   5,209 
Total  —  $19,958   —  $19,958 
                
      
 December 31, 2010  December 31, 2011 
 Fair Value Measurements Using  
Assets at  Fair
Value
  Fair Value Measurements Using  
Assets at Fair
Value
 
(Dollars in thousands) Level 1  Level 2  Level 3  Level 1  Level 2  Level 3 
Impaired loans, net  —  $13,784   —  $13,784  $—  $14,114  $—  $14,114 
OREO, net  —   10,674   —   10,674   —   6,059   —   6,059 
Total  —  $24,458   —  $24,458 
20
 
Fair Value of Financial Instruments
 
The following reflectscarrying values and estimated fair values of the fair value ofCorporation’s financial instruments, whether or not recognized on the consolidated balance sheets at fair value.value, as of March 31, 2012 are as follows:
 
 September 30, 2011  December 31, 2010    Fair Value Measurements at March 31, 2012 Using 
 
Carrying
Amount
  
Estimated
Fair Value
  
Carrying
Amount
  
Estimated
Fair  Value
     
Quoted
Prices in
Active
Markets
for
Identical
Assets
  
Significant
Other
Observable
Inputs
  
Significant
Unobservable
Inputs
    
(Dollars in thousands) Carrying Value  Level 1  Level 2  Level 3  Balance 
Financial assets:                           
Cash and short-term investments $23,634  $23,634  $9,680  $9,680  $26,426  $26,426  $--  $—  $26,426 
Securities  141,793   141,793   130,275   130,275   143,868   —   143,868   —   143,868 
Loans, net  622,921   626,035   606,744   607,264   626,069   —   632,778   —   632,778 
Loans held for sale, net  36,377   37,768   67,153   67,314   63,756   —   65,314   —   65,314 
Accrued interest receivable  5,150   5,150   5,073   5,073   5,224   —   5,224   —   5,224 
                    
Financial liabilities:                                    
Demand deposits  325,122   325,122   315,448   315,448  $350,388  $—  $350,388  $—  $350,388 
Time deposits  312,244   316,770   309,686   315,009   310,166   —   314,134   —   314,134 
Borrowings  159,424   156,258   164,140   160,398   158,405   —   154,601   —   154,601 
Derivative payable  546   546   148   148   509   —   509   —   509 
Accrued interest payable  1,120   1,120   1,160   1,160   1,107   —   1,107   —   1,107 
The carrying values and estimated fair values of the Corporation’s financial instruments, whether or not recognized on the consolidated balance sheets at fair value, as of December 31, 2011 are as follows:
  2011 
  Carrying  Estimated 
(Dollars in thousands) Amount  Fair Value 
Financial assets:      
Cash and short-term investments $11,507  $11,507 
Securities  144,646   144,646 
Loans, net  616,984   624,219 
Loans held for sale, net  70,062   72,859 
Accrued interest receivable  5,242   5,242 
Financial liabilities:        
Demand deposits  338,473   338,473 
Time deposits  307,943   312,095 
Borrowings  161,151   157,863 
Derivative payable  515   515 
Accrued interest payable  1,111   1,111 
 
 
1821
 
T
The following describes the valuation techniques used by the Corporation to measure financial assets and financial liabilities at fair value as of September 30, 2011March 31, 2012 and December 31, 2010.2011.
 
Cash and short-term investments. The nature of these instruments and their relatively short maturities provide for the reporting of fair value equal to the historical cost.
 
Securities Availableavailable for Sale.sale. Securities available for sale are recorded at fair value on a recurring basis.
 
Loans, net. The estimated fair value of the loan portfolio is based on present values using discount rates equal to the market rates currently charged on similar products.
 
Certain loans are accounted for under ASC Topic 310 - Receivables, including impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. A significant portion of the collateral securing the Corporation’s impaired loans is real estate. The fair value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Corporation using observable market data, which in some cases may be adjusted to reflect current trends, including sales prices, expenses, absorption periods and other current relevant factors (Level 2). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements, if not considered significant, using observable market data (Level 2). At September 30, 2011March 31, 2012 and December 31, 2010,2011, the Corporation’s impaired loans were valued at $13.52$15.95 million and $13.78$14.11 million, respectively.
 
Loans Held for Sale. Loans held for sale are required to be measured at the lower of cost or fair value. These loans currently consist of residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is generally not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Corporation records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the three or nine months ended September 30, 2011.March 31, 2012.
 
Accrued interest receivable. The carrying amount of accrued interest receivable approximates fair value.
 
Deposits. The fair value of all demand deposit accounts is the amount payable at the report date. For all other deposits, the fair value is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.
 
Borrowings. The fair value of borrowings is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.
 
Derivative payable. The fair value of derivatives is determined using the discounted cash flow method.
 
Accrued interest payable. The carrying amount of accrued interest payable approximates fair value.
 
Letters of credit. The estimated fair value of letters of credit is based on estimated fees the Corporation would pay to have another entity assume its obligation under the outstanding arrangements. These fees are not considered material.
 
Unused portions of lines of credit. The estimated fair value of unused portions of lines of credit is based on estimated fees the Corporation would pay to have another entity assume its obligation under the outstanding arrangements. These fees are not considered material.
 
The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to balance minimizing interest rate risk and increasing net interest income in current market conditions. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors interest rates, maturities and repricing dates of assets and liabilities and attempts to manage interest rate risk by adjusting terms of new loans, deposits and borrowings and by investing in securities with terms that mitigate the Corporation’s overall interest rate risk.

19
NOTE 9:8: Business Segments
 
The Corporation operates in a decentralized fashion in three principal business segments: Retail Banking, Mortgage Banking and Consumer Finance. Revenues from Retail Banking operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Mortgage Banking operating revenues consist principally of gains on sales of loans in the secondary market, loan origination fee income and interest earned on mortgage loans held for sale. Revenues from Consumer Finance consist primarily of interest earned on automobile retail installment sales contracts.
 
22
The Corporation’s otherOther segment includes an investment company that derives revenues from brokerage services, an insurance company that derives revenues from insurance services, and a title company that derives revenues from title insurance services. The results of the other segment are not significant to the Corporation as a whole and have been included in “Other.” CertainRevenue and expenses of the Corporation are also included in “Other,” and consist primarily of dividends received on the Corporation’s investment in equity securities, interest expense associated with the Corporation’s trust preferred capital notes and other general corporate expenses.
 
(Dollars in thousands) Three Months Ended September 30, 2011 
 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  Other  Eliminations  Consolidated 
Revenues:                  
Interest income $8,270  $398  $11,391  $—  $(1,141) $18,918 
Gains on sales of loans  —   4,282   —   —   —   4,282 
Other noninterest income  1,538   748   188   384   —   2,858 
Total operating income  9,808   5,428   11,579   384   (1,141)  26,058 
                         
Expenses:                        
Interest expense  2,248   58   1,508   257   (1,140)  2,931 
Provision for loan losses  2,000   200   1,875   —   —   4,075 
Salaries and employee benefits  3,486   2,595   1,657   227   —   7,965 
Other noninterest expenses  3,075   1,779   1,013   91   —   5,958 
Total operating expenses  10,809   4,632   6,053   575   (1,140)  20,929 
Income (loss) before income taxes  (1,001)  796   5,526   (191)  (1)  5,129 
Provision for (benefit from) income taxes  (784)  319   2,155   (73)  (1)  1,616 
Net income (loss) $(217) $477  $3,371  $(118) $—  $3,513 
Total assets $749,484  $46,540  $250,423  $2,798  $(140,346) $908,899 
Capital expenditures $288  $12  $101  $—  $—  $401 
20
  Three Months Ended September 30, 2010 
(Dollars in thousands) 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  Other  Eliminations  Consolidated 
Revenues:                  
Interest income $8,474  $602  $9,610  $43  $(993) $17,736 
Gains on sales of loans  —   4,865   —   —   —   4,865 
Other noninterest income  1,523   1,074   143   219   —   2,959 
Total operating income  9,997   6,541   9,753   262   (993)  25,560 
                         
Expenses:                        
Interest expense  2,586   103   1,385   264   (1,004)  3,334 
Provision for loan losses  1,450   19   2,250   —   —   3,719 
Salaries and employee benefits  3,730   3,462   1,467   152   —   8,811 
Other noninterest expenses  3,334   1,863   704   92   —   5,993 
Total operating expenses  11,100   5,447   5,806   508   (1,004)  21,857 
Income (loss) before income taxes  (1,103)  1,094   3,947   (246)  11   3,703 
Provision for (benefit from) income taxes  (770)  438   1,539   (94)  4   1,117 
Net income (loss) $(333) $656  $2,408  $(152) $7  $2,586 
Total assets $766,872  $89,116  $217,426  $2,692  $(164,293) $911,813 
Capital expenditures $352  $40  $34  $—  $—  $426 
  Nine Months Ended September 30, 2011 
(Dollars in thousands) 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  Other  Eliminations  Consolidated 
Revenues:                  
Interest income $24,474  $1,185  $32,477  $—  $(3,217) $54,919 
Gains on sales of loans  —   11,778   —   —   —   11,778 
Other noninterest income  4,440   2,030   519   947   —   7,936 
Total operating income  28,914   14,993   32,996   947   (3,217)  74,633 
                         
Expenses:                        
Interest expense  6,925   170   4,323   763   (3,218)  8,963 
Provision for loan losses  4,550   235   5,500   —   —   10,285 
Salaries and employee benefits  10,972   8,318   4,986   611   —   24,887 
Other noninterest expenses  9,215   4,526   2,644   328   —   16,713 
Total operating expenses  31,662   13,249   17,453   1,702   (3,218)  60,848 
Income (loss) before income taxes  (2,748)  1,744   15,543   (755)  1   13,785 
Provision for (benefit from) income taxes  (2,253)  698   6,062   (287)  —   4,220 
Net income (loss) $(495) $1,046  $9,481  $(468) $1  $9,565 
Total assets $749,484  $46,540  $250,423  $2,798  $(140,346) $908,899 
Capital expenditures $774  $81  $724  $3  $—  $1,582 
21
 Nine Months Ended September 30, 2010  Three Months Ended March 31, 2012 
(Dollars in thousands) 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  Other  Eliminations  Consolidated  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  Other  Eliminations  Consolidated 
Revenues:                                    
Interest income $25,493  $1,462  $27,350  $145  $(2,760) $51,690  $8,066  $574  $11,340  $—  $(1,224) $18,756 
Gains on sales of loans  —   13,295   —   —   (3)  13,292   —   4,103   —   —   —   4,103 
Other noninterest income  4,215   2,164   436   793   —   7,608   1,566   1,115   260   337   2   3,280 
Total operating income  29,708   16,921   27,786   938   (2,763)  72,590   9,632   5,792   11,600   337   (1,222)  26,139 
                                                
Expenses:                                                
Interest expense  7,943   219   3,883   775   (2,792)  10,028   2,158   106   1,550   249   (1,224)  2,839 
Provision for loan losses  4,050   19   6,150   —   —   10,219   750   75   1,900   —   —   2,725 
Salaries and employee benefits  10,922   9,634   4,414   503   1   25,474   4,006   3,582   1,876   278   —   9,742 
Other noninterest expenses  9,514   7,255   2,031   328   —   19,128   2,909   1,332   923   151   —   5,315 
Total operating expenses  32,429   17,127   16,478   1,606   (2,791)  64,849   9,823   5,095   6,249   678   (1,224)  20,621 
                        
Income (loss) before income taxes  (2,721)  (206)  11,308   (668)  28   7,741   (191)  697   5,351   (341)  2   5,518 
Provision for (benefit from) income taxes  (2,075)  (82)  4,410   (255)  10   2,008   (498)  279   2,087   (130)  —   1,738 
Net income (loss) $(646) $(124) $6,898  $(413) $18  $5,733  $307  $418  $3,264  $(211) $2  $3,780 
Total assets $766,872  $89,116  $217,426  $2,692  $(164,293) $911,813  $786,829  $75,864  $254,913  $3,077  $(175,212) $945,471 
Capital expenditures $1,071  $313  $120  $—  $—  $1,504  $173  $51  $58  $—  $—  $282 
   
(Dollars in thousands) Three Months Ended March 31, 2011 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  Other  Eliminations  Consolidated 
Revenues:                        
Interest income $8,030  $401  $10,209  $—  $(1,008) $17,632 
Gains on sales of loans  —   3,800   —   —   —   3,800 
Other noninterest income  1,474   739   182   262   —   2,657 
Total operating income  9,504   4,940   10,391   262   (1,008)  24,089 
                        
Expenses:                        
Interest expense  2,387   62   1,373   252   (1,010)  3,064 
Provision for loan losses  1,050   20   1,750   —   —   2,820 
Salaries and employee benefits  3,900   2,745   1,655   192   —   8,492 
Other noninterest expenses  2,996   1,551   761   149   —   5,457 
Total operating expenses  10,333   4,378   5,539   593   (1,010)  19,833 
                        
Income (loss) before income taxes  (829)  562   4,852   (331)  2   4,256 
Provision for (benefit from) income taxes  (705)  225   1,892   (126)  1   1,287 
Net income (loss) $(124) $337  $2,960  $(205) $1  $2,969 
Total assets $756,904  $39,404  $232,359  $2,761  $(124,427) $907,001 
Capital expenditures $249  $77  $208  $2  $—  $536 
 
The Retail Banking segment extends a warehouse line of credit to the Mortgage Banking segment, providing a portion of the funds needed to originate mortgage loans. The Retail Banking segment charges the Mortgage Banking segment interest at the daily FHLB advance rate plus 50 basis points. The Retail Banking segment also provides the Consumer Finance segment with a portion of the funds needed to originate loans by means of a variable rate line of credit that carries interest at one-month LIBOR plus 200 basis points and fixed rate loans that carry interest rates ranging from 5.4 percent to 8.0 percent. The Retail Banking segment acquires certain residential real estate loans from the Mortgage Banking segment at prices similar to those paid by third-party investors. These transactions are eliminated to reach consolidated totals. Certain corporate overhead costs incurred by the Retail Banking segment are not allocated to the Mortgage Banking, Consumer Finance and Other segments.
 
23
NOTE 10:9: Commitments and Financial Instruments with Off-Balance-Sheet Risk
 
C&F Mortgage sells substantially all of the residential mortgage loans it originates to third-party investors, some of whom may require the repurchase of loans in the event of loss due to borrower misrepresentation, fraud or early default. Mortgage loans and their related servicing rights are sold under agreements that define certain eligibility criteria for the mortgage loans. Recourse periods for early payment default vary from 90 days up to one year. Recourse periods for borrower misrepresentation or fraud, or underwriting error do not have a stated time limit. C&F Mortgage maintains an indemnification reserve for potential claims made under these recourse provisions. During the second quarter of 2010, C&F Mortgage reached an agreement with its largest third-party investor that resolved all known and unknown indemnification obligations for loans sold to this investor prior to 2010. Risks also arise from the possible inability of counterparties to meet the terms of their contracts. C&F Mortgage has procedures in place to evaluate the credit risk of investors and does not expect any counterparty to fail to meet its obligations. The following table presents the changes in the allowance for indemnification losses for the periods presented:
 
  
Three Months Ended
September 30,
 
(Dollars in thousands) 2011  2010 
Allowance, beginning of period $1,536  $5,328 
Provision for indemnification losses  146   338 
Payments  66   4,605 
Allowance, end of period $1,616  $1,061 
         
  
Nine Months Ended
September 30,
(Dollars in thousands) 2011  2010
Allowance, beginning of period $1,291  $2,538 
Provision for indemnification losses  552   3,515 
Payments  227   4,992 
Allowance, end of period $1,616  $1,061 
22
In April 2011, the Bank reached an agreement to settle a lawsuit seeking the return of tax credits transferred to the Bank by a customer for payment of principal, interest and operating reserves related to an existing loan and the extension of an additional loan in the period prior to the customer entering bankruptcy. The settlement agreement called for the Bank to return certain unused tax credits and make a one-time cash payment. As a result, during the first quarter of 2011, the Corporation increased the provision for loan losses by $300,000 resulting from the charge-off of previously recognized principal payments. This is in addition to an accrual of other expenses of $200,000 recorded during 2010. The Corporation will not accrue any additional expenses related to the settlement subsequent to the first quarter of 2011.

As previously disclosed, the FDIC referred to the Department of Justice an alleged violation of the Equal Credit Opportunity Act and the Fair Housing Act in connection with certain lending practices of C&F Mortgage, a wholly-owned subsidiary of C&F Bank.  On September 30, 2011, C&F Mortgage entered into a settlement with the Department of Justice pursuant to a consent order with respect to certain mortgage company practices.  While there has been no factual finding or adjudication with respect to any matter of the alleged violation, C&F Mortgage and the Department of Justice have mutually decided to reach a settlement to avoid the burden of litigation and the associated distractions.  As part of the consent order, C&F Mortgage agreed to implement certain policies, procedures and monitoring of its lending practices and to provide a $140,000 settlement fund for borrowers who may have been affected.  The Corporation’s board of directors and management strongly disagree with the alleged violations and deny that it violated any fair lending law or regulation or engaged in any wrongdoing.  However, prior to the settlement, C&F Mortgage had already taken steps to strengthen its internal processes to address the issues raised by the Department of Justice.  C&F Mortgage does not tolerate discrimination in its lending practices and will continue to be committed to fair lending.  The results of this settlement, which is pending court approval, are not expected to have a material adverse impact on the Corporation’s results of operations or financial condition.
  
Three Months Ended
March 31,
 
(Dollars in thousands) 2012  2011 
Allowance, beginning of period $1,702  $1,291 
Provision for indemnification losses  125   231 
Payments  —   — 
Allowance, end of period $1,827  $1,522 
 
NOTE 11:10: Derivatives
 
The Corporation uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts. The Corporation’s interest rate swaps qualify as cash flow hedges. The Corporation’s cash flow hedges effectively modify a portion of the Corporation’s exposure to interest rate risk by converting variable rates of interest on $10.00 million of the Corporation’s trust preferred capital notes to fixed rates of interest until September 2015.
 
The cash flow hedges’hedges total notional amount is $10.00 million. At September 30, 2011,March 31, 2012, the cash flow hedges had a fair value of $(546,000)($509,000), which is recorded in other liabilities. The cash flow hedges were fully effective at September 30, 2011March 31, 2012 and therefore the loss on the cash flow hedges was recognized as a component of other comprehensive income (loss), net of deferred income taxes.
 
NOTE 12:11: Other Noninterest Expenses
 
The following table presents the significant components in the consolidated statements of income line “Noninterest Expenses – Other Expenses.”
 

 
Three Months
Ended September 30,
  
Nine Months Ended
September 30,
  
Three Months Ended
March 31,
 
(Dollars in thousands) 2011  2010  2011  2010  2012  2011 
Provision for indemnification losses $146  $337  $552  $3,515 
Professional fees $456  $553 
Data processing fees  496   551 
Loan and OREO expenses  458   953   1,645   2,670   349   470 
Data processing fees  533   455   1,664   1,317 
Telecommunication expenses  277   324   824   828   284   263 
FDIC expenses  85   247   581   735   159   248 
Professional fees  451   481   1,479   1,248 
All other noninterest expenses  2,364   1,678   5,187   4,510   1,850   1,615 
Total Other Noninterest Expenses $4,314  $4,475  $11,932  $14,823 
Total other noninterest expenses $3,594  $3,931 
 
 
2324
NOTE 12: Subsequent Event
On April 11, 2012, the Corporation redeemed the remaining 10,000 shares of its Preferred Stock issued to Treasury in January 2009 under the CPP.  The redemption consisted of $10.0 million in liquidation value and an additional $78,000 of accrued and unpaid dividends associated with the Preferred Stock.  As a result of this redemption, the Corporation will pay no future dividends on the Preferred Stock.  Further, in connection with this redemption, the Corporation will accelerate the accretion of the remaining preferred stock discount during the second quarter of 2012, which will reduce net income available to common shareholders by approximately $151,000 in the second quarter of 2012, but will eliminate any future accretion.
25
 
ITEM 2.
MANAGEMENT’SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
This report contains statements concerning the Corporation’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws and may include, but are not limited to, statements regarding profitability, liquidity, the Corporation’s and each business segment’s loan portfolio, allowance for loan losses, trends regarding the provision for loan losses, trends regarding net loan charge-offs, trends regarding levels of nonperforming assets and TDRstroubled debt restructurings and expenses associated with nonperforming assets, provision for indemnification losses and the effect of the Corporation’s settlement agreement with regard to indemnification obligations, levels of noninterest income and expense, interest rates and yields, the deposit portfolio, including trends in deposit maturities and rates, and deposit portfolio mix, interest rate sensitivity, market risk, regulatory developments, capital requirements, growth strategy and financial and other goals. These statements may address issues that involve estimates and assumptions made by management and risks and uncertainties. Actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in:
 
interest rates
●interest rates
 
general business conditions, as well as conditions within the financial markets
●
general business conditions, as well as conditions within the financial markets
 
general economic conditions, including unemployment levels
●
general economic conditions, including unemployment levels
 
the legislative/regulatory climate, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and regulations promulgated thereunder and the effect of restrictions imposed on us as a participant in the CPP
●
the legislative/regulatory climate, including the Dodd-Frank Act and regulations promulgated thereunder and the Consumer Financial Protection Bureau (CFPB) and the regulatory and enforcement activities of the CFPB
 
monetary and fiscal policies of the U.S. Government, including policies of the Treasury and the Federal Reserve Board
●
monetary and fiscal policies of the U.S. Government, including policies of the Treasury and the Federal Reserve Board
 
the value of securities held in the Corporation’s investment portfolios
●
the value of securities held in the Corporation’s investment portfolios
 
the quality or composition of the loan portfolios and the value of the collateral securing those loans
●
the quality or composition of the loan portfolios and the value of the collateral securing those loans
 
the inventory level and pricing of used automobiles
●
the inventory level and pricing of used automobiles
 
the level of net charge-offs on loans and the adequacy of our allowance for loan losses
●
the level of net charge-offs on loans and the adequacy of our allowance for loan losses
 
the level of indemnification losses related to mortgage loans sold
●
the level of indemnification losses related to mortgage loans sold
 
demand for loan products
●
demand for loan products
 
deposit flows
●
deposit flows
 
the strength of the Corporation’s counterparties
●
the strength of the Corporation’s counterparties
 
competition from both banks and non-banks
●
competition from both banks and non-banks
 
demand for financial services in the Corporation’s market area
●
demand for financial services in the Corporation’s market area
 
technology
●
technology
 
reliance on third parties for key services
●
reliance on third parties for key services
 
the commercial and residential real estate markets
●
the commercial and residential real estate markets
 
demand in the secondary residential mortgage loan markets
●
demand in the secondary residential mortgage loan markets
 
the Corporation’s expansion and technology initiatives
●
the Corporation’s expansion and technology initiatives
 
accounting principles, policies and guidelines
●
accounting principles, policies and guidelines
 
Any forward-looking statements should be considered in context with the various disclosures made by us about our businesses in our public filings with the Securities and Exchange Commission, including without limitation the risks identified above and those more specifically described in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
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.
 
CRITICAL ACCOUNTING POLICIES
 
The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.
 
 
Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectabilitycollectibility of loans while taking into consideration such factors as trends in delinquencies and charge-offs, 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.

Allowance for Indemnifications: The allowance for indemnifications is established through charges to earnings in the form of a provision for indemnifications, which is included in other noninterest expenses. A loss is charged against the allowance for indemnifications under certain conditions when a purchaser of a loan (investor) sold by C&F Mortgage incurs a loss due to borrower misrepresentation, fraud, or early default, or underwriting error. The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses arising from indemnification requests. Management’s judgment in determining the level of the allowance is based on the volume of loans sold, current economic conditions and information provided by investors. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
 
Impairment of Loans: We consider a loan impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We measure impairment on a loan by loanloan-by-loan basis for commercial, construction and residential loans in excess of $500,000 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. 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. TDRsTroubled debt restructurings (TDRs) are also considered impaired loans, even if the loan balance is less than $500,000. A TDR occurs when we agree to significantly modify the original terms of a loan due to the deterioration in the financial condition of the borrower.
 
Impairment of Securities: Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.
 
Other Real Estate Owned (OREO): Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of the loan balance or the fair value less 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. The Corporation may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further other-than-temporary deterioration in market conditions.
 
Goodwill: Goodwill is no longer subject to at least an annual assessment for impairment by applying a fair value based test.amortization over its estimated useful life. In assessing the recoverability of the Corporation’s goodwill, all of which was recognized in connection with the Bank’s acquisition of C&F Finance Company in September 2002, we must make assumptions in order to determine the fair value of the respective assets. Major assumptions used in determining impairmentif goodwill is impaired were increases in future income, sales multiples in determining terminal value and the discount rate applied to future cash flows. As part of the impairment test, we performperformed a sensitivity analysis by increasing the discount rate, lowering sales multiples and reducing increases in future income. We completed the annual test for impairment during the fourth quarter of 20102011 and determined there was no impairment to be recognized in 2010.2011. With the adoption of Accounting Standards Update 2011-08, Intangible-Goodwill and Other-Testing Goodwill for Impairment, in 2012, the Corporation will no longer be required to complete a test for impairment unless, based on an assessment of qualitative factors related to goodwill, we determine that it is more likely than not that the fair value of C&F Finance Company is less than its carrying amount. If the underlying estimateslikelihood of impairment is more than 50 percent, the Corporation will perform a test for impairment and related assumptions change in the future, we may be required to record impairment charges.
 
Retirement Plan: The Bank maintains a non-contributory, defined benefit pension plan for eligible full-time employees as specified by the plan. Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Bank’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the interest crediting rate, the estimated future return on plan assets and the anticipated rate of future salary increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.
 
25
Derivative Financial Instruments: The Corporation recognizes derivative financial instruments at fair value as either an other asset or an other liability in the consolidated balance sheets.  The derivative financial instruments have been designated as and qualify as cash flow hedges.  The effective portion of the gain or loss on the cash flow hedges is reported as a component of other comprehensive income, net of deferred taxes, and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.
 
Accounting for Income Taxes: Determining the Corporation’s effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Corporation’s tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.
 
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” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
OVERVIEW
 
Our primary financial goals are to maximize the Corporation’s earnings and to deploy capital in profitable growth initiatives that will enhance long-term shareholder value. We track three primary financial performance measures in order to assess the level of success in achieving these goals: (i) return on average assets (ROA), (ii) return on average common equity (ROE), and (iii) growth in earnings. In addition to these financial performance measures, we track the performance of the Corporation’s three principal business activities: retail banking, mortgage banking, and consumer finance. We also actively manage our capital through growth and dividends, while considering the need to maintain a strong regulatory capital position.
 
Financial Performance Measures
 
Net income for the Corporation was $3.5$3.8 million for the three months ended September 30, 2011,March 31, 2012, compared with $2.6$3.0 million for the three months ended September 30, 2010.  Net income for the Corporation was $9.6 million for the first nine months of 2011, compared with $5.7 million for the first nine months of 2010.March 31, 2011. Net income available to common shareholders was $3.1$3.6 million, or $0.96$1.11 per common share assuming dilution for the three months ended September 30, 2011,March 31, 2012, compared with $2.3$2.7 million, or $0.74$0.85 per common share assuming dilution for the three months ended September 30, 2010.  Net income available to common shareholders was $8.5 million, or $2.69 per common share assuming dilution for the first nine months of 2011, compared to $4.9 million, or $1.57 per common share assuming dilution for the first nine months of 2010.March 31, 2011. The difference between reported net income and net income available to common shareholders is a result of the Series A Preferred Stock dividends and amortization of the Warrant related to the Corporation’s participation in the CPP. The financial results for the thirdCorporation’s first quarter and first nine monthsearnings were primarily a result of 2011 were affected by (1) the strong earnings in the Consumer Finance segment, which continues to benefit from substantialsustained loan growth low net charge-offs and the current low interest rate environment, (2) modest profitability in thefunding costs on its variable-rate borrowings. The Mortgage Banking segment which has benefited from higher gains on loans sold, lower provisions for indemnification losses, and lower production-basedlegal and income-based compensation during 2011, with an offsetting volume-based declineconsulting expenses incurred as a result of the resolution of the fair lending investigation as discussed in gainsthe Corporation’s Annual Report on sales of loans, and (3) a slight net loss inForm 10-K for the year ended December 31, 2011. The Retail Banking segment which has incurred a decline in loans to non-affiliates due to weakbenefited from the effects of the continued low interest rate environment on the costs of deposits, lower provision for loan demand in the current economic environmentlosses, and increased competition for the limited loan demand that exists, continuing elevated loan loss provisions, higher personnel costslower expenses associated with FDIC deposit insurance and higher expenses for technology investments.foreclosed properties.
 
The Corporation’s ROE and ROA were 15.8616.73 percent and 1.421.60 percent, respectively, on an annualized basis for the third quarter of 2011,three months ended March 31, 2012, compared to 12.6514.51 percent and 1.021.19 percent respectively, for the third quarter of 2010.  For the first ninethree months of 2011, on an annualized basis, the Corporation’s ROE and ROA were 14.92 percent and 1.28 percent, respectively, compared to 9.19 percent and 0.73 percent, respectively, for the first nine months of 2010.ended March 31, 2011. The increase in these ratios during 20112012 was primarily due to the performanceearnings improvement of each of the Consumer Finance segment, whileCorporation’s significant business segments.  In addition, the Retail Banking and Mortgage Banking segments continueeffect of dividends on the Corporation’s Preferred Stock on net income available to be negatively affectedcommon shareholders was lessened for the first quarter of 2012 by the challenging economic environment and issues facing the financial services industrypartial redemption of Preferred Stock in general.July 2011.
 
Principal Business Activities. An overview of the financial results for each of the Corporation’s principal business segments is presented below. A more detailed discussion is included in “Results of Operations.”
 
Retail Banking:C&F Bank reported a net lossincome of $217,000$307,000 for the thirdfirst quarter of 2011,2012, compared to a net loss of $333,000 for the third quarter of 2010.  For the first nine months of 2011, C&F Bank reported a net loss of $495,000, compared to a net loss of $646,000$124,000 for the first nine monthsquarter of 2010.
Factors affecting2011. The improvement in quarterly financial results for 2012 resulted from higher activity-based interchange income, the effects of the continued low interest rate environment on the costs of deposits, a lower provision for loan losses, forlower expenses associated with holding costs of foreclosed properties, and lower FDIC deposit insurance premiums resulting from the three months andFDIC's revised assessment base.  Partially offsetting these positive factors were the nine months ended September 30, 2011 werenegative effects of the following (1) decreasesa decrease in average loans to non-affiliatesnonaffiliates to $400.7 million for the first quarter of 2012 from $408.7 million for the first quarter of 2011 resulting from weak demand in the current economic environment loan charge-offs and transfer ofintensified competition for loans to foreclosed properties,in our markets and (2) increases in loan loss provisions, (3) higher personnel costs principally attributable to the increasing complexity of routine compliance, regulatory and asset quality issues, and (4) higher occupancy expenses associated with depreciation and maintenance of technology investments related to expanding the banking productsservices we offeroff to our customers and to improving our operational efficiency.  Partially offsetting these negative factors were an increase in activity-based interchange income, a decline in FDIC insurance premiums,efficiency and a decline in write-downs associated with foreclosed properties.security.
 
 
C&F Bank’s average non-affiliate loan portfolio has declined to $406.0 million for the third quarter of 2011 from $423.4 million for the third quarter of 2010.  For the first nine months of 2011, the average non-affiliate loan portfolio has declined to $406.6 million from $434.7 million for the first nine months of 2010.  In the coming months, it will be challenging to maintain the Retail Banking segment’s net interest margin at its current level if funds obtained from loan repayments and from deposit growth cannot be fully used to originate new loans and instead are reinvested in lower-yielding earning assets, and if the reduction in earning asset yields exceeds the interest rate decline in interest-bearing liabilities.
The Bank’s nonperforming assets were $14.9$18.6 million at September 30, 2011,March 31, 2012, compared to $18.1$16.1 million at December 31, 2010.2011. Nonperforming assets at September 30, 2011March 31, 2012 included $8.4$13.4 million in nonaccrual loans and $5.2 million in foreclosed properties. TDRs were $16.7 million at March 31, 2012, of which $8.6 million were included in nonaccrual loans, compared to $7.8$17.1 million of TDRs at December 31, 2010, and $6.42011, of which $8.4 million were included in foreclosed properties, compared to $10.3 million at December 31, 2010.  TDRs were $15.5 million at September 30, 2011, compared to $9.8 million at December 31, 2010.  Nonaccrualnonaccrual loans.  The increase in nonaccrual loans which include $6.8 million and $402,000 of TDRs at September 30, 2011 and December 31, 2010, respectively, primarily consist of loans for residential real estateresulted from one commercial relationship secured by undeveloped residential properties and commercial loans secured by non-residential properties.  Specific reserves of $1.4 million have been established for nonaccrual loans as of September 30, 2011.property.  Management believes it has provided adequate loan loss reserves for all of the Retail Banking segment’s loans.nonaccrual loans based on the current estimated fair values of the collateral. Foreclosed properties at September 30, 2011March 31, 2012 consist of both residential and non-residential propertiesproperties. These properties have been written down to their estimated fair values less selling costs. The decline in foreclosed properties since December 31, 20102011 resulted from sales of foreclosedthese properties as the Corporation focused effortscontinued its focus on improving asset quality.quality and reducing foreclosed asset balances.
 
Mortgage Banking: C&F Mortgage Corporation reported net income of $477,000 for the third quarter of 2011, compared to net income of $656,000 for the third quarter of 2010.  For the first nine months of 2011, C&F Mortgage reported net income of $1.0 million, compared to a net loss of $124,000$418,000 for the first nine monthsquarter of 2010.
The decline in net income2012, compared to $337,000 for the thirdfirst quarter of 2011, as compared to the third quarter of 2010, was primarily attributable to lower2011.  The improvement in quarterly financial results for 2012 resulted from higher gains on sales of loans which were $4.3 million for the third quarter of 2011, compared to $4.9 million for the third quarter of 2010.and ancillary loan production fees.  Loan origination volume decreased forincreased to $173.3 million in the thirdfirst quarter of 2011 when compared to the same period in 2010.  This decline was offset in part by lower production-based compensation, which is also related to lower mortgage loan originations in 2011.  The improvement in net income for the nine months ended September 30, 2011,2012, a 39.7 percent increase as compared to the same period in 2010, was primarily attributable to a decrease of $3.0$124.1 million in the provision for indemnification losses.first quarter of 2011.  The increase in loan originations is a result of the continued low interest rate environment that has led to increased mortgage borrowing and refinancing activity.  During the secondfirst quarter of 2010, C&F Mortgage entered into an agreement with one of its largest investors that resolved all known and unknown indemnification obligations for loans sold to that investor prior to 2010.  With this agreement in place, there has been a reduction in indemnification expense in 2011.
Loan origination volume decreased for the third quarter of 2011 to $154.6 million, compared to $201.8 million for the third quarter of 2010.  Similarly, loan origination volume for the first nine months of 2011 decreased to $427.7 million from $545.2 million for the first nine months of 2010.  For the third quarter of 2011,2012, the amount of loan originations for refinancings and new and resale home purchases were $37.1$79.7 million and $117.5$93.6 million, respectively, compared to $92.8$37.2 million and $109.0$86.9 million, respectively, forduring the thirdfirst quarter of 2010.  For the first nine months of 2011, the amount of2011.  Higher loan originations for refinancings and home purchases were $97.2production resulted in a correspondingly higher sales volume, which increased to $179.6 million and $330.5 million, respectively, compared to $163.6 million and $381.6 million, respectively, for the first nine monthsquarter of 2010.  The decline in origination volumes is a result of fluctuations in mortgage rates, a continued overall weakness in the housing market due2012, compared to the challenging economic conditions and the expiration of the homebuyer tax credits that boosted loan demand during the first half of 2010.  These declines in loan originations in 2011 resulted in lower gains on sales of loans, which were $4.3 million and $11.8$163.1 million for the threefirst quarter of 2011.  In connection with the higher sales volume in the first quarter of 2012, the mortgage banking segments incurred higher production and nine months ended September 30, 2011, respectively, compared to $4.9 million and $13.3 million for the three and nine months ended September 30, 2010, respectively.income based compensation expense.
 
In addition toOther items affecting quarterly earnings of the mortgage banking segment were (1) a $147,000 decline in gains on saleslegal and consulting expenses incurred in connection with the resolution of loans, the Mortgage Banking segment’s earningspreviously disclosed fair lending investigation, (2) a $106,000 decline in the provision for the first nine months of 2011 include increases of $377,000 inindemnification losses, and (3) higher non-production salaries expensepersonnel costs in order to manage the increasingly complex regulatory environment and $104,000 in professional fees due to increased legal and compliance costs.  Partially offsetting these revenue declines was lower production-based and income-based compensation forwhich the comparable periods in 2011 and 2010.mortgage banking segment operates.
 
Consumer Finance: C&F Finance Company reported net income of $3.4 million for the third quarter of 2011, compared to net income of $2.4 million for the third quarter of 2010.  For the first nine months of 2011, C&F Finance reported net income of $9.5 million, compared to net income of $6.9$3.3 million for the first nine monthsquarter of 2010.
2012, compared to $3.0 million for the first quarter of 2011.  The earnings increasesimprovement in 2011quarterly financial results for 2012 resulted from the effects of (1) increasesa 10.7 percent increase in average loans outstanding of 17.3 percent and 16.9 percent for the three and nine months ended September 30, 2011, respectively, compared to the same periods in 2010, (2) the sustained low cost of the Consumer Financeconsumer finance segment’s variable-rate borrowings and (3) decreases of $375,000 and $650,000borrowings.  These items were partially offset by (1) a $150,000 increase in the provision for loan losses for the threeresulting from loan growth and nine months ended September 30, 2011, respectively.  The reduction in the provision for loan losses during 2011 was attributable to lowerhigher net charge-offs, which resulted from prudent underwriting criteria, effective collection processes and higher recovery rates on the sale of repossessed vehicles.  These items were partially offset by an(2) a $221,000 increase in compensationpersonnel costs of $190,000 and $572,000 for the three months and nine months ended September 30, 2011, respectively, which was a result ofresulting from an increase in the number of personnel to manage the growth in loans outstanding, as well as higher variable compensation resulting from increased profitability,support loan growth, and portfolio performance.
technology to support growth.  The allowance for loan losses as a percentage of consumer finance loans remained approximatelyat March 31, 2012 was 7.94 percent, which was the same 7.89 percent, at September 30, 2011, compared to 7.90 percentlevel at December 31, 2010.2011.  Management believes that the current allowance for loan losses is adequate to absorb probable losses in the Consumer Finance segment’s loan portfolio.
 
Other and Eliminations: The net lossesloss for the three and nine months ended September 30, 2011March 31, 2012 for this combined segment were $118,000 and $468,000, respectively,was $209,000, compared to a net lossesloss of $145,000 and $395,000$204,000 for the three and nine months ended September 30, 2010, respectively.March 31, 2011. Revenue and expense of this combined segment include the results of operations of our investment, insurance and title subsidiaries, interest expense associated with the Corporation’s trust preferred capital notes, other general corporate expenses and the effects of intercompany eliminations.
 
Capital Management. Total shareholders’ equity was $93.3$99.5 million at September 30, 2011,March 31, 2012, compared to $92.8$96.1 million at December 31, 2010.  Capital growth from2011 for an increase of $3.4 million primarily attributable to first quarter earnings in 2012.  The Corporation paid a quarterly cash dividend of 26 cents per common share during the first nine monthsquarter of 20112012, which was mostly offset by the redemptiona 22.8 percent payout ratio of 50 percent of the preferred shares issued under the CPP, as described below.net income available to common shareholders.
 
The capital and liquidity positions ofOn April 11, 2012, the Corporation remain strong.  Capital has continued to grow during 2011 and exceeds current regulatory capital standards for being well-capitalized.  Whileredeemed the Corporation continues to participateremaining 10,000 shares of its Preferred Stock issued Treasury in the CPP, on July 27, 2011, it completed the redemption of $10.00 million, or 50 percent, of the $20.00 million of preferred shares issuedJanuary 2009 under the CPP.  The funds forredemption consisted of $10.0 million in liquidation value and $78,000 of accrued and unpaid dividends associated with the Preferred Stock.  As a result of this redemption, were provided by existing financial resources of the Corporation will pay no future dividends on the Preferred Stock.  to the Corporation funded this redemption without raising additional capital because of its strong capital position and financial performance.  The redemption results in no dilution to common shareholders because no new capital was issued, there was no dilution toissued.  In connection with this redemption, the Corporation’s common shareholders as a result of the redemption.  The Corporation acceleratedwill accelerate the accretion of a portion of itsthe remaining preferred stock discount, which reducedwill reduce net income available to common shareholders by approximately $213,000$151,000 in the thirdsecond quarter of 2011.  As a result of this redemption, preferred stock dividends2012, but will be reduced annually by $500,000.  We will continue to assess our on-goingeliminate any future accretion.
In connection with the Corporation’s participation in the CPP, the Corporation also issued to Treasury in January 2009 a Warrant to purchase 167,504 shares of the Corporation’s common stock.  The Corporation intends to negotiate with Treasury the repurchase of the Warrant.  This repurchase is not expected to have any effect on the Corporation’s earnings or earnings per share for the second quarter of 2012 but may result in a reduction in capital, and the size of any reduction will be based upon the economic and regulatory environment and our capital levels.
We also manage capital through dividends to the Corporation’s shareholders.  The Corporation’s board of directors continued its policy of paying dividends in 2011.  The dividend payout ratios for the three and nine months ended September 30, 2011 were 25.5 percent and 27.6 percent, respectively, of net income available to common shareholders.  The board of directors continues to evaluate our dividend payout in light of changes in economic conditions, our capital levels and our expected future levels of earnings.  However, in connection with the Corporation’s continued participation in the CPP there are limitations on the Corporation’s ability to pay quarterly cash dividends in excess of $0.31 per share or to repurchase its common stock prior to the earlier of January 9, 2012 or the date on which Treasury no longer holds any of the Series A Preferred Stock.negotiated purchase price.
 
 
RESULTS OF OPERATIONS
 
The following table presents 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 the three and nine months ended September 30, 2011March 31, 2012 and 2010.2011. Loans include loans held for sale. Loans placed on nonaccrual status are included in the balances and are included in the computation of yields, but had no material effect. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid using the federal corporate income tax rate of 34 percent).
 
TABLE 1: Average Balances, Income and Expense, Yields and Rates
 
  Three Months Ended September 30, 
  2011  2010 
(Dollars in thousands) 
Average
Balance
  
Income/
Expense
  
Yield/
Rate
  
Average
Balance
  
Income/
Expense
  
Yield/
Rate
 
Assets                  
Securities:                  
Taxable $18,842  $78   1.63% $21,827  $90   1.65%
Tax-exempt  120,482   1,852   6.26   104,777   1,676   6.40 
Total securities  139,324   1,930   5.54   126,604   1,766   5.58 
Loans, net  689,193   17,611   10.14   688,981   16,545   9.61 
Interest-bearing deposits in other banks and Federal funds sold  12,486   7   0.20   11,932   9   0.30 
Total earning assets  841,003   19,548   9.23   827,517   18,320   8.86 
Allowance for loan losses  (31,012)          (24,941)        
Total non-earning assets  94,830           99,818         
Total assets $904,821          $902,394         
                         
Liabilities and Shareholders’ Equity                        
Time and savings deposits:                        
Interest-bearing deposits $105,518   109   0.41  $95,618   134   0.56 
Money market deposit accounts  81,556   126   0.62   64,425   133   0.83 
Savings accounts  41,986   12   0.11   42,113   10   0.09 
Certificates of deposit, $100 or more  137,695   677   1.95   144,612   782   2.16 
Other certificates of deposit  169,057   785   1.84   177,739   972   2.19 
Total time and savings deposits  535,812   1,709   1.27   524,507   2,031   1.55 
Borrowings  159,743   1,222   3.06   169,092   1,303   3.08 
Total interest-bearing liabilities  695,555   2,931   1.68   693,599   3,334   1.92 
Demand deposits  95,691           91,627         
Other liabilities  19,580           24,506         
Total liabilities  810,826           809,732         
Shareholders’ equity  93,995           92,662         
Total liabilities and shareholders’ equity $904,821          $902,394         
Net interest income     $16,617          $14,986     
Interest rate spread          7.55%          6.94%
Interest expense to average earning assets (annualized)          1.39%          1.61%
Net interest margin (annualized)          7.84%          7.24%
 Nine Months Ended September 30,  Three Months Ended March 31, 
 2011  2010  2012  2011 
(Dollars in thousands) 
Average
Balance
  
Income/
Expense
  
Yield/
Rate
  
Average
Balance
  
Income/
Expense
  
Yield/
Rate
  
Average
Balance
  
Income/
Expense
  
Yield/
Rate
  
Average
Balance
  
Income/
Expense
  
Yield/
Rate
 
Assets                                    
Securities:                                    
Taxable $19,819  $240   1.61% $20,764  $310   1.99% $21,365  $86   1.61% $20,727  $77   1.49%
Tax-exempt  118,262   5,517   6.26   103,587   5,040   6.49   118,595   1,798   6.06   115,159   1,809   6.28 
Total securities  138,081   5,757   5.56   124,351   5,350   5.74   139,960   1,884   5.38   135,886   1,886   5.55 
Loans, net  677,154   51,029   10.07   678,464   48,061   9.45   711,451   17,490   9.86   669,122   16,361   9.78 
Interest-bearing deposits in other banks and Federal funds sold  21,295   38   0.23   14,082   37   0.35 
Interest-bearing deposits in other banks and Fed funds sold  15,383   8   0.21   29,116   15   0.21 
Total earning assets  836,530   56,824   9.07   816,897   53,448   8.72   866,794   19,382   8.94   834,124   18,262   8.76 
Allowance for loan losses  (29,815)          (25,398)          (34,116)          (29,215)        
Total non-earning assets  95,832           94,667           93,045           94,986         
Total assets $902,547          $886,166          $925,723          $899,895         
                                                
Liabilities and Shareholders’ Equity                                                
Time and savings deposits:                                                
Interest-bearing deposits $110,118   430   0.52  $90,036   362   0.54  $112,868  $142   0.50% $115,721  $192   0.66%
Money market deposit accounts  76,159   391   0.69   62,332   429   0.92   86,512   100   0.46   71,288   130   0.73 
Savings accounts  42,070   32   0.10   41,638   31   0.10   44,057   10   0.09   41,808   10   0.10 
Certificates of deposit, $100 or more  134,290   2,013   2.01   145,704   2,445   2.24   139,219   641   1.85   133,635   673   2.01 
Other certificates of deposit  172,868   2,454   1.90   178,724   3,014   2.25   168,516   724   1.72   175,979   850   1.93 
Total time and savings deposits  535,505   5,320   1.33   518,434   6,281   1.62   551,172   1,617   1.17   538,431   1,855   1.38 
Borrowings  159,720   3,643   3.04   168,294   3,747   2.97   159,017   1,222   3.07   160,088   1,209   3.02 
Total interest-bearing liabilities  695,225   8,963   1.72   686,728   10,028   1.95   710,189   2,839   1.60   698,519   3,064   1.75 
                        
Demand deposits  92,409           88,961           94,394           87,235         
Other liabilities  19,778           19,834           22,627           20,285         
Total liabilities  807,412           795,523           827,210           806,039         
Shareholders’ equity  95,135           90,643           98,513           93,856         
Total liabilities and shareholders’ equity $902,547          $886,166          $925,723          $899,895         
Net interest income     $47,861          $43,420          $16,543          $15,198     
                        
Interest rate spread          7.35%          6.77%          7.34%          7.01%
Interest expense to average earning assets (annualized)          1.43%          1.64%          1.31%          1.47%
Net interest margin (annualized)          7.64%          7.09%          7.63%          7.29%
 
 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 presents the direct causes of the period-to-period changes in the components of net interest income on a taxable-equivalent basis. We calculated the rate and volume variances using a formula prescribed by the SEC.Securities and Exchange Commission (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 relationship of the absolute dollar amounts of the change in each. Loans include both nonaccrual loans and loans held for sale.
 
 
TABLE 2: Rate-Volume Recap
 
  
Three Months Ended September 30,
2011 from 2010
 
  
Increase (Decrease)
Due to
  
Total
Increase
 
(Dollars in thousands) Rate  Volume  (Decrease) 
Interest income:         
Loans $738  $328  $1,066 
Securities:            
Taxable  (1)  (11)  (12)
Tax-exempt  (41)  217   176 
Interest-bearing deposits in other banks and Federal funds sold  (3)  1   (2)
Total interest income  693   535   1,228 
             
Interest expense:            
Time and savings deposits:            
Interest-bearing deposits  (38)  13   (25)
Money market deposit accounts  (32)  25   (7)
Savings accounts  2   —   2 
Certificates of deposit, $100 or more  (71)  (34)  (105)
Other certificates of deposit  (145)  (42)  (187)
Total time and savings deposits  (284)  (38)  (322)
Borrowings (including Trust preferred capital notes)  (16)  (65)  (81)
Total interest expense  (300)  (103)  (403)
Change in net interest income $993  $638  $1,631 

  
Nine Months Ended September 30,
2011 from 2010
 
  
Increase (Decrease)
Due to
  
Total
Increase
(Decrease)
 
(Dollars in thousands) Rate  Volume 
Interest income:         
Loans $2,789  $179  $2,968 
Securities:            
Taxable  (56)  (14)  (70)
Tax-exempt  (189)  666   477 
Interest-bearing deposits in other banks and Federal funds sold  —   1   1 
Total interest income  2,544   832   3,376 
             
Interest expense:            
Time and savings deposits:            
Interest-bearing deposits  (8)  76   68 
Money market deposit accounts  (121)  83   (38)
Savings accounts  —   1   1 
Certificates of deposit, $100 or more  (250)  (182)  (432)
Other certificates of deposit  (465)  (95)  (560)
Total time and savings deposits  (844)  (117)  (961)
Borrowings (including Trust preferred capital notes)  84   (188)  (104)
Total interest expense  (760)  (305)  (1,065)
Change in net interest income $3,304  $1,137  $4,441 
31
  
March 31,
2012 from 2011
 
  
Increase (Decrease)
Due to
  
Total
Increase
(Decrease)
 
(Dollars in thousands) Rate  Volume 
Interest income:         
Loans $129  $1,000  $1,129 
Securities:            
Taxable  7   2   9 
Tax-exempt  (237)  226   (11)
Interest-bearing deposits in other banks and Fed funds sold  —   (7)  (7)
Total interest income  (101)  1,221   1,120 
             
Interest expense:            
Time and savings deposits:            
Interest-bearing deposits  (45)  (5)  (50)
Money market deposit accounts  (159)  129   (30)
Savings accounts  (3)  3   — 
Certificates of deposit, $100 thousand or more  (169)  137   (32)
Other certificates of deposit  (90)  (36)  (126)
Total time and savings deposits  (466)  228   (238)
Borrowings  57   (44)  13 
Total interest expense  (409)  184   (225)
Change in net interest income $308  $1,037  $1,345 
 
Net interest income, on a taxable-equivalent basis, for the three months ended September 30, 2011 was $16.6 million, compared to $15.0 million for the three months ended September 30, 2010.  Net interest income, on a taxable-equivalent basis, for the first nine months of 2011 was $47.9 million, compared to $43.4$16.5 million for the first nine monthsquarter of 2010.2012, compared to $15.2 million for the first quarter of 2011. The higher net interest income forduring the thirdfirst quarter of 2011,2012, as compared to the third quartersame period of 2010,2011, resulted from a 6034 basis point increase in net interest margin to 7.847.63 percent, coupled with a 1.63.9 percent increase in average earning assets. The higher net interest income for the first nine months of 2011, as compared to the first nine months of 2010, resulted from a 55 basis point increase in net interest margin to 7.64 percent, coupled with a 2.4 percent increase in average earning assets.  The increases in net interest margin for the three and nine months ended September 30, 2011, compared to the same periods in 2010, werewas principally a result of an increase in the yield on loans and a decrease in the rates paid on timesavings and savingstime deposits, partially offset by a lower yield on municipal securities.  The increasesincrease in the yield on loans werewas primarily a result of a change in the mix of loans whereby the effect of the increase in higher yielding average loans at the Consumer Finance segment and the decline in lower yielding average loans at the Retail Banking andsegment more than offset the increase in lower-yielding average loans held for sale at the Mortgage Banking segments declined and higher yielding loans at the Consumer Finance segment increased.segment. The decreasesdecrease in rates paid on time and savings deposits werewas primarily a result of a reduction in interest rates paid on money market deposit accounts resulting from the sustained low interest rate environment, and the repricing of higher rate certificates of deposit as they matured to lower rates. In addition, the mix in interest-bearing deposits has shifted to shorter-term interest-bearing and money market deposit accounts. The decline in the yield on securities resulted from purchases of municipal securities with lower yields in the current low interest rate environment. While theThe average interest rate paid on borrowings forincreased 5 basis points during the first nine monthsquarter of 2011 increased 7 basis points,2012, as compared to the same period in 2010, the average interest rate paid on borrowings for the third quarter of 2011, was almost level with the rate paid in the third quarter of 2010.  These changes occurred asdue to the effects of changes in the mix of borrowings to less dependence on lower-cost short-term borrowings, which occurred as a result of deposit growth, and the effects of a 25 basis point increase in the rate on our variable-rate revolving line of credit, which began in July 2010, had been absorbed in the average interest rate paid on borrowings during the third quarter of 2010.growth.
 
Average loans, which includes both loans held for investment and loans held for sale, increased slightly to $689.2 million for the quarter ended September 30, 2011 from $689.0 million for the third quarter of 2010.  However, average loans decreased to $677.2$711.5 million for the first nine monthsquarter of 20112012 from $678.5$669.1 million for the first nine monthsquarter of 2010.2011. A portion of the decreasesincrease occurred in the Mortgage Banking segment’s portfolio of loans held for sale, the average balance of which declined $18.5increased $26.4 million induring the thirdfirst quarter of 2011 and $7.3 million in the first nine months of 2011, when compared to the same periods in 2010.  These declines are2012. This increase is indicative of the lowerhigher loan production due to the continued overall weakness in the housing marketlow interest rate environment that has led to increased mortgage borrowing and the expiration of the homebuyer tax credits that boosted loan demand during the first half of 2010.refinancing activity. In total, average loans to non-affiliates held for investment had a minimal decrease inincreased $16.0 million during the first quarter of 2012 compared to the first quarter of 2011. However, the Retail Banking and Mortgage Banking segments’ portfolio of average loans held for investment decreased $17.6$8.0 million induring the thirdfirst quarter of 2011 and $28.1 million in the first nine months of 2011, when compared to the same periods in 2010.2012. Loan production at the Retail Banking segment has been negatively affected by weak demand for new loans in the current economic environment and during the first nine months of 2011 loan originations were not keeping pace with payments on existingintensified competition for loans charge-offs and transfers to foreclosed properties.in our markets. The declines in average loans at the Retail Banking segment have been substantially offset by increasesgrowth in the Consumer Finance segment’s average loan portfolio, which increased $36.3 million in$24.0 during the thirdfirst quarter of 2011 and $34.1 million in the first nine months of 2011, when compared to the same periods in 2010.  These increases2012. This increase resulted from robust demand in existing and new markets.
 
The overall yield on average loans increased 538 basis points to 10.149.86 percent infor the thirdfor the first quarter of 2011 and 62 basis points to 10.07 percent in the first nine months of 2011,2012, when compared to the same periodsperiod in 2010,2011, principally as a result of the continuing shift in the mixloan portfolio to increased levels of the portfolio fromhigher-yielding Consumer Finance loans as a percentage of total loans, and lower yielding loans held in ourlevels of lower-yielding Retail Banking and Mortgage Banking segments to higher yielding loans in our Consumer Finance segment.as a percentage of total loans.
 
Average securities available for sale increased $12.7$4.1 million induring the thirdfirst quarter of 2011 and $13.7 million in the first nine months of 2011,2012, when compared to the same periodsperiod in 2010.2011. The increase in securities available for sale occurred predominantly in the Retail Banking segment’s municipal bond portfolio in conjunction with the strategy to increase the investment portfolio as a percentage of total assets. This strategy is based on the investment portfolio’s role in managing interest rate sensitivity, providing liquidity and serving as an additional source of interest income. The funding for this strategy has come from the growth in deposits, coupled with reduced loan demand in the Retail Banking segment. The lower yieldsyield on the available-for-sale securities portfolio induring the thirdfirst quarter and first nine months of 2011,2012, compared to the same periodsperiod in 2010,2011, resulted from the calls and maturities of higher-yielding securities and purchases of lower-yielding securities in the current low interest rate environment, as well as purchases of shorter-term securities with lower yields during 2011.throughout 2011 and continuing into the first quarter of 2012.
 
Average interest-bearing deposits in other banks and Federal funds sold increased $554,000 and $7.2decreased $13.7 million during the thirdfirst quarter and first nine months of 2011, respectively,2012, compared to the same periodsperiod in 2010,2011, as a result of deploying excess liquidity provided by growth in the Corporation’s deposit portfolio coupled with reducedto partially fund loan demand at the RetailMortgage Banking and Mortgage BankingConsumer Finance segments. The average yieldsyield on these overnight funds of 2021 basis points during the first quarters of 2012 and 23 basis points for the three and nine months ended September 30, 2011 respectively, are an indicationis a result of the continuing low interest rate environment.
 
Average interest-bearing time and savings deposits increased $11.3$12.7 million induring the thirdfirst quarter of 2011 and $17.1 million in the first nine months of 2011,2012, compared to the same periodsperiod in 2010,2011, mainly due to higher deposit balances from municipal customers.  In addition, the mix in interest-bearing deposits has shifteda shift to shorter-term interest-bearing demand and money market deposit accounts, from longer-term certificates of deposits, which allows depositors greater flexibility for funds management and investing decisions.decisions in this low interest rate environment. The average cost of deposits declined 2821 basis points infor the thirdfirst quarter of 2011 and 29 basis points in the first nine months of 2011,2012, compared to the same periodsperiod in 20102011, because time deposits that matured throughout 20102011 and into 20112012 repriced at lower interest rates or were not renewed, interest rates paid on interest-bearing demand and money market deposit accounts decreased as a result of the sustained low interest rate environment, and the balances of shorter-term interest-bearingsavings and money market deposits, which pay a lower interest rate, have increased.
 
Average borrowings decreased $9.3$1.1 million induring the thirdfirst quarter of 2011 and $8.6 million in the first nine months of 2011,2012, compared to the same periodsperiod in 2010.  These decreases were2011.  This decrease was attributable to reduced funding needs as the growth in average earning assets has primarily been met through the growth in average deposits. The average cost of borrowings decreased 2increased 5 basis points in the third quarter and increased 7 basis points infor the first nine monthsquarter of 2011, respectively,2012, compared to the same periodsperiod in 2010,2011, as a result of a change in the composition of borrowings, which has occurred as lower-cost short-term variable-rate borrowings have been repaid with excess liquidity provided by lower loan demand and deposit growth.  In addition, a 25 basis point increase
It will be challenging to maintain the Retail Banking segment’s net interest margin at its current level if funds obtained from loan repayments and from deposit growth cannot be fully used to originate new loans and instead are reinvested in lower-yielding earning assets, and if the reduction in earning asset yields exceeds interest rate declines in interest-bearing liabilities. With the expectation that short-term interest rates will not change significantly during 2012 and the current low rate environment will be relatively unchanged, the net interest margin at the Consumer Finance segment’s variable-rate revolving line of credit, which became effective in July 2010, contributedsegment will be most affected by competition from institutions re-entering the automobile financing market and loan pricing strategies that these competitors may use to the increase in the average cost of borrowings for the nine months ended September 30, 2011.grow market share.
 
 Noninterest Income
 
TABLE 3: Noninterest Income
 
(Dollars in thousands) Three Months Ended September 30, 2011 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Gains on sales of loans $—  $4,282  $—  $—  $4,282 
Service charges on deposit accounts  915   —   —   —   915 
Other service charges and fees  582   747   3   38   1,370 
Net gains on calls of available for sale securities  1   —   —   —   1 
Other income  40   1   185   346   572 
Total noninterest income $1,538  $5,030  $188  $384  $7,140 

(Dollars in thousands) Three Months Ended September 30, 2010 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Gains on sales of loans $—  $4,865  $—  $—  $4,865 
Service charges on deposit accounts  957   —   —   —   957 
Other service charges and fees  527   758   2   56   1,343 
Net gains (losses) on sales and calls of available for sale securities  4   —   —   (15)  (11) 
Other income  35   316   141   178   670 
Total noninterest income $1,523  $5,939  $143  $219  $7,824 

(Dollars in thousands) Nine Months Ended September 30, 2011 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Gains on sales of loans $—  $11,778  $—  $—  $11,778 
Service charges on deposit accounts  2,609   —   —   —   2,609 
Other service charges and fees  1,677   1,975   7   117   3,776 
Net gains on calls of available for sale securities  1   —   —   —   1 
Other income  153   55   512   830   1,550 
Total noninterest income $4,440  $13,808  $519  $947  $19,714 

(Dollars in thousands) Nine Months Ended September 30, 2010  Three Months Ended March 31, 2012 
 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  
Total
 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Gains on sales of loans $—  $13,295  $—  $(3) $13,292  $—  $4,103  $—  $—  $4,103 
Service charges on deposit accounts  2,563   —   —   —   2,563   801   —   —   —   801 
Other service charges and fees  1,438   2,002   6   146   3,592   569   760   4   35   1,368 
Net gains on sales and calls of available for sale securities  53   —   —   12   65 
Gains on calls of available for sale securities  —   —   —   —   — 
Other income  161   162   430   635   1,388   196   355   256   304   1,111 
Total noninterest income $4,215  $15,459  $436  $790  $20,900  $1,566  $5,218  $260  $339  $7,383 
   
(Dollars in thousands) Three Months Ended March 31, 2011 
 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Gains on sales of loans $—  $3,800  $—  $—  $3,800 
Service charges on deposit accounts  848   —   —   —   848 
Other service charges and fees  519   529   2   42   1,092 
Gains on calls of available for sale securities  —   —   —   —   — 
Other income  107   210   180   220   717 
Total noninterest income $1,474  $4,539  $182  $262  $6,457 
 
 
Total noninterest income decreased $684,000,increased $926,000, or 8.714.3 percent, infor the thirdfirst quarter of 2011 and $1.2 million, or 5.7 percent in the first nine months of 2011,2012, compared to the same periodsperiod in 2010.  These decreases primarily2011. This increase resulted from lowerhigher gains on sales of loans and ancillary loan production fees at the Mortgage Banking segment due to the declineincrease in loan production, which were partially offset byoriginations and sales, coupled with increases in other income from higher service charges andactivity-based debit card interchange fees at the Retail Banking segment, duehigher investment services fees at C&F Investment Services, and favorable changes in the fair market value of deferred compensation plan assets in the Retail Banking, Mortgage Banking and Consumer Finance segments. Partially offsetting these increases was a decline in the Retail Banking segment’s service charges on deposit accounts, which resulted from lower overdraft fees during the first quarter of 2012. In future periods the Retail Banking segment may not be able to anfurther increase or sustain recent increases in activity-based bankdebit card interchange income.  Management anticipatesfees as a result of potential legislative or regulatory actions that the Corporation’s noninterest income, in particular gains on sales of loans held for sale generated by the Mortgage Banking segment, will be negatively affected as long as the housing market and demand for mortgage loans remain suppressed by challenging economic conditions.could affect interchange fee pricing.
 
Noninterest Expense
 
TABLE 4: Noninterest Expenses
 
(Dollars in thousands) Three Months Ended September 30, 2011 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Salaries and employee benefits $3,486  $2,595  $1,657  $227  $7,965 
Occupancy expenses  966   474   198   6   1,644 
Other expenses:                    
OREO expenses and write-downs  335   —   —   —   335 
Provision for indemnification losses  —   146   —   —   146 
Other expenses  1,774   1,159   815   85   3,833 
Total other expenses  2,109   1,305   815   85   4,314 
Total noninterest expenses $6,561  $4,374  $2,670  $318  $13,923 
    
(Dollars in thousands) Three Months Ended September 30, 2010 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Salaries and employee benefits $3,729  $3,463  $1,467  $152  $8,811 
Occupancy expenses  848   555   103   12   1,518 
Other expenses:                    
OREO expenses and write-downs  788   35   —   —   823 
Provision for indemnification losses  —   337   —   —   337 
Other expenses  1,699   935   601   80   3,315 
Total other expenses  2,487   1,307   601   80   4,475 
Total noninterest expenses $7,064  $5,325  $2,171  $244  $14,804 

(Dollars in thousands) Nine Months Ended September 30, 2011 
  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Salaries and employee benefits $10,972  $8,318  $4,986  $611  $24,887 
Occupancy expenses  2,874   1,421   467   19   4,781 
Other expenses:                    
OREO expenses and write-downs  1,111   11   —   —   1,122 
Provision for indemnification losses  —   552   —   —   552 
Other expenses  5,230   2,542   2,177   309   10,258 
Total other expenses  6,341   3,105   2,177   309   11,932 
Total noninterest expenses $20,187  $12,844  $7,630  $939  $41,600 
(Dollars in thousands) Three Months Ended March 31, 2012 
 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Salaries and employee benefits $4,006  $3,582  $1,876  $278  $9,742 
Occupancy expenses  1,032   476   205   8   1,721 
Other expenses:                    
OREO expenses  142   —   —   —   142 
Provision for indemnification losses  —   125   —   —   125 
Other expenses  1,735   731   718   143   3,327 
Total other expenses  1,877   856   718   143   3,594 
Total noninterest expenses $6,915  $4,914  $2,799  $429  $15,057 
      
(Dollars in thousands) Nine Months Ended September 30, 2010  Three Months Ended March 31, 2011 
 
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total  
Retail
Banking
  
Mortgage
Banking
  
Consumer
Finance
  
Other and
Eliminations
  Total 
Salaries and employee benefits $10,922  $9,634  $4,414  $504  $25,474  $3,900  $2,745  $1,655  $192  $8,492 
Occupancy expenses  2,506   1,470   306   23   4,305   929   486   105   6   1,526 
Other expenses:                                        
OREO expenses and write-downs  2,298   47   —   —   2,345 
OREO expenses  357   —   —   —   357 
Provision for indemnification losses  —   3,515   —   —   3,515   —   231   —   —   231 
Other expenses  4,710   2,223   1,725   305   8,963   1,710   834   656   143   3,343 
Total other expenses  7,008   5,785   1,725   305   14,823   2,067   1,065   656   143   3,931 
Total noninterest expenses $20,436  $16,889  $6,445  $832  $44,602  $6,896  $4,296  $2,416  $341  $13,949 
 
Total noninterest expenses decreased $881,000,increased $1.1 million, or 6.07.9 percent, infor the thirdfirst quarter of 2011 and $3.0 million, or 6.7 percent in the first nine months of 2011,2012, compared to the same periodsperiod in 2010.  These decreases2011. This increase resulted primarily from higher personnel costs at the Mortgage Banking segment from the $191,000 and the $3.0 million declines in the provision for indemnification losses, as previously described, for the three and nine months ended September 30, 2011, respectively, as compared to the same periods in 2010.  In addition, personnel expenses at the Mortgage Banking segment have declined $868,000 and $1.3 million in the third quarter and first nine months of 2011, respectively, compared to the same periods in 2010, as a result of lower production-based and income based compensation.  Further expense reductions occurred at the Retail Banking segment as (1) OREO expenses declined $453,000 and $1.2 million in the third quarter and first nine months of 2011, respectively, compared to the same periods in 2010 and (2) FDIC deposit insurance premiums declined $162,000 and $154,000 in the third quarter and first nine months of 2011, respectively, compared to the same periods in 2010.  These expense reductions were offset in part by (1) higher non-production salary expense at the Mortgage Banking segment due to higher production and income based compensation, which resulted from the increase in loan production and sales during the first quarter of 2012, as well as higher non-production compensation in order to manage the increasingly complex regulatory compliance environment in which the mortgage banking segment operates and (2) higher personnel expenses at the Consumer Finance segment resulting fromdue to an increase in the number of personnel to managesupport loan growth.  In addition, there were increases in occupancy expense during the growthfirst quarter of 2012 as compared to the same period of 2011 at (1) the Retail Banking segment due to depreciation and maintenance of technology related to expanding the banking services we offer to customers and improving operational efficiency and security and (2) the Consumer Finance segment due to the relocation in loans outstandingApril 2011 to a larger leased headquarter building and higher variable compensation resulting from increased profitability,depreciation and maintenance of technology to support growth.  These increases were partially offset by lower (1) FDIC insurance premiums and loan growth and portfolio performance.OREO expenses at the Retail Banking segment and (2) provision for indemnifications and legal fees at the Mortgage Banking segment.
 
Income Taxes
 
Income tax expenseApplicable income taxes on earnings for the thirdfirst quarter of 20112012 totaled $1.6$1.7 million, resulting in an effective tax rate of 31.5 percent, compared to $1.1$1.3 million, andor 30.2 percent, for the thirdfirst quarter of 2010.  Income tax expense for the first nine months of 2011 totaled $4.2 million, resulting in an effective tax rate of 30.6 percent, compared to $2.0 million and 25.9 percent for the first nine months of 2010.2011. The increasesincrease in the effective tax ratesrate during 2011 werethe first quarter of 2012 was a result of higher pre-tax earnings at the non-bank business segments, which are not exempt from state income taxes, partially offset by the increase in income from the Retail Banking segment’s tax-exempt municipal bond portfolio.taxes.
 
 
ASSET QUALITY
 
Allowance for Loan Losses
 
The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The following tables summarize the allowance activity for the periods indicated:
 
TABLE 5: Allowance for Loan Losses
 
 Three Months Ended September 30,  Three Months Ended March 31, 
(Dollars in thousands) 2011  2010  2012  2011 
Allowance, beginning of period $30,211  $25,154  $33,677  $28,840 
Provision for loan losses:                
Retail Banking segment  2,000   1,450   750   1,050 
Mortgage Banking segment  200   19   75   20 
Consumer Finance segment  1,875   2,250   1,900   1,750 
Total provision for loan losses  4,075   3,719   2,725   2,820 
Loans charged off:                
Real estate—residential mortgage  365   71   122   145 
Real estate—construction  —   330   —   — 
Commercial, financial and agricultural  11   2 
Commercial, financial and agricultural 1
  —   1,581 
Equity lines  —   —   121   9 
Consumer  80   140   90   70 
Consumer finance  2,095   2,156   2,200   1,689 
Total loans charged off  2,551   2,699   2,533   3,494 
Recoveries of loans previously charged off:                
Real estate—residential mortgage  76   6   10   11 
Real estate—construction  —   —   —   — 
Commercial, financial and agricultural  128   2 
Commercial, financial and agricultural 1
  35   17 
Equity lines  —   —   —   — 
Consumer  30   21   49   22 
Consumer finance  621   532   794   549 
Total recoveries  855   561   888   599 
Net loans charged off  1,696   2,138   1,645   2,895 
Allowance, end of period $32,590  $26,735  $34,757  $28,765 
Ratio of annualized net charge-offs to average total loans outstanding during period for Retail Banking and Mortgage Banking  0.45%  0.51%  0.24%  1.71%
Ratio of annualized net charge-offs to average total loans outstanding during period for Consumer Finance  2.01%  3.04%  2.26%  2.03%
 
  Nine Months Ended September 30, 
(Dollars in thousands) 2011  2010 
Allowance, beginning of period $28,840  $24,027 
Provision for loan losses:        
Retail Banking segment  4,550   4,050 
Mortgage Banking segment  235   19 
Consumer Finance segment  5,500   6,150 
Total provision for loan losses  10,285   10,219 
Loans charged off:        
Real estate—residential mortgage  648   851 
Real estate—construction  —   1,145 
Commercial, financial and agricultural  2,541   1,250 
Equity lines  9   — 
Consumer  247   205 
Consumer finance  5,210   5,673 
Total loans charged off  8,655   9,124 
Recoveries of loans previously charged off:        
Real estate—residential mortgage  90   45 
Real estate—construction  —   — 
Commercial, financial and agricultural  149   13 
Equity lines  —   — 
Consumer  71   60 
Consumer finance  1,810   1,495 
Total recoveries  2,120   1,613 
Net loans charged off  6,535   7,511 
Allowance, end of period $32,590  $26,735 
Ratio of annualized net charge-offs to average total loans outstanding during period for Retail Banking and Mortgage Banking  1.02%  1.02%
Ratio of annualized net charge-offs to average total loans outstanding during period for Consumer Finance  1.92%  2.77%
 
Table 6 discloses the allocation of the allowance for loan losses at September 30, 2011March 31, 2012 and December 31, 2010.2011.

TABLE 6: Allocation of Allowance for Loan Losses
 
(Dollars in thousands) 
September 30,
2011
  
December 31,
2010
  
March 31,
2012
  
December 31,
2011
 
Allocation of allowance for loan losses:            
Real estate—residential mortgage $2,330  $1,442  $2,653  $2,379 
Real estate—construction 1
  734   581 
Commercial, financial and agricultural 2
  8,804   8,688 
Real estate—construction  467   480 
Commercial, financial and agricultural 1
  10,410   10,040 
Equity lines  910   380   917   912 
Consumer  270   307   269   319 
Consumer finance  19,542   17,442   20,041   19,547 
Balance $32,590  $28,840  $34,757  $33,677 
1Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
2
Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.

Loans by credit quality ratings are presented in Table 7 below.  The characteristics of these loan ratings are as follows:
●Pass rated loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio.  The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue.  When necessary, acceptable personal guarantors support the loan.
●
Special mention loans have a specifically identified weakness in the borrower’s operations and in the borrower’s ability to generate positive cash flow on a sustained basis.  The borrower’s recent payment history is characterized by late payments.  The Corporation’s risk exposure is mitigated by collateral supporting the loan.  The collateral is considered to be well-margined, well maintained, accessible and readily marketable.
●
Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Corporation’s credit extension.  The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan.  The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Corporation.  There is a distinct possibility that the Corporation will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Corporation will be unable to collect all amounts due.
●
Substandard nonaccrual loans have the same characteristics as substandard loans; however, they have a nonaccrual classification because it is probable that the Corporation will not be able to collect all amounts due.
●
Doubtful loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.
●
Loss loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.
 
TABLE 7: Credit Quality Indicators
 
Loans by credit quality indicators as of September 30, 2011March 31, 2012 were as follows:
 
(Dollars in thousands) Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
  Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
 
Real estate—residential mortgage $140,943  $862  $3,323  $1,489  $146,617  $139,794  $1,419  $2,721  $2,933  $146,867 
Real estate—construction 2
  3,897   354   2,871   —   7,122 
Commercial, financial and agricultural 3
  163,177   23,132   22,753   6,902   215,964 
Real estate—construction  1,590   —   2,871   —   4,461 
Commercial, financial and agricultural 2
  171,249   18,598   17,519   11,106   218,472 
Equity lines  31,383   285   779   129   32,576   32,194   295   836   10   33,335 
Consumer  4,691   11   785   —   5,487   4,543   —   879   —   5,422 
 $344,091  $24,644  $30,511  $8,520  $407,766  $349,370  $20,312  $24,826  $14,049  $408,557 
 
(Dollars in thousands) Performing  Nonperforming  Total  Performing  Non-performing  Total 
Consumer finance $247,150  $595  $247,745  $251,894  $375  $252,269 

1
At September 30, 2011,March 31, 2012, the Corporation did not have any loans classified as Doubtful or Loss.
2
Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
3
Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.
 
Loans by credit quality indicators as of December 31, 20102011 were as follows:
 
(Dollars in thousands) Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
  Pass  
Special
Mention
  Substandard  
Substandard
Nonaccrual
  
Total1
 
Real estate—residential mortgage $140,651  $1,344  $3,889  $189  $146,073  $140,304  $1,261  $3,130  $2,440  $147,135 
Real estate—construction 2
  7,368   —   4,727   —   12,095 
Commercial, financial and agricultural 3
  171,569   25,674   14,708   7,275   219,226 
Real estate—construction  2,867   —   2,870   —   5,737 
Commercial, financial and agricultural 2
  164,448   18,787   20,931   8,069   212,235 
Equity lines  31,562   263   96   266   32,187   31,935   298   836   123   33,192 
Consumer  4,804   11   400   35   5,250   5,271   10   776   —   6,057 
 $355,954  $27,292  $23,820  $7,765  $414,831  $344,825  $20,356  $28,543  $10,632  $404,356 
 
(Dollars in thousands) Performing  Nonperforming  Total  Performing  Non-performing  Total 
Consumer finance $220,602  $151  $220,753  $245,924  $381  $246,305 

1
At December 31, 2010,2011, the Corporation did not have any loans classified as Doubtful or Loss.
2
Includes the Corporation’s real estate construction lending and consumer real estate lot lending.
3
Includes the Corporation’s commercial real estate lending, land acquisition and development lending, builder line lending and commercial business lending.
 
The combined Retail Banking and Mortgage Banking segments’ allowance for loan losses increased $1.7 million$586,000 since December 31, 2010,2011, and the provision for loan losses at these combined segments increased $731,000 and $716,000 indecreased $245,000 during the thirdfirst quarter of 2011 and the first nine months of 2011, respectively,2012, compared to the same periodsperiod in 2010.2011. The allowance for loan losses to total loans for these combined segments increased to 3.203.60 percent at September 30, 2011,March 31, 2012, compared to 2.753.49 percent at December 31, 2010.2011. The increase in this ratio since 20102011 year end was attributable toa function of lower net charge-offs during the higher provision forfirst quarter of 2012 and loan losses, coupled with declining charge-offsgrowth in the third quartercommercial, financial and agricultural loans segment of 2011.the Retail Banking segment’s loan portfolio, and the increase in substandard nonaccrual loans. Substandard nonaccrual loans increased to $30.5$14.0 million at September 30, 2011March 31, 2012 from $23.8$10.6 million at December 31, 2010.2011.  This increase was concentrated in the commercial sector of the Retail Banking segment’s loan portfolio to which we have allocated the largest portion of the Retail Banking segment’s loan loss allowance.  The equity lines sector also experienced an increase inallowance, and was attributable to one commercial relationship secured by undeveloped residential property, which had been classified as substandard loans sinceat December 31, 2010,2011 and was placed on substandard nonaccrual status during the allocationfirst quarter of the allowance for equity line losses increased $530,000.2012.  The allocation of the allowance for real estate-residential mortgage loans increased $888,000$274,000 since December 31, 2011 because second mortgage loans, which are included in this loan category, have experienced an increase in substandard loans. Throughout 2011, we have been updatingWe continue to update credit scores, collateral values and loan-to-value ratios on the Retail Banking segment’s second mortgage loans and equity lines in order to better anticipate default risks within these portfolios. We believe that the current level of the allowance for loan losses at the combined Retail Banking and Mortgage Banking segments is adequate to absorb any losses on existing loans that may become uncollectible. If current economic conditions continue or worsen, a higher level of nonperforming loans may be experienced in future periods, which may then require a higher provision for loan losses.
 
 
The Consumer Finance segment’s allowance for loan losses increased to $19.5$20.0 million at September 30, 2011March 31, 2012 from $17.4$19.5 million at December 31, 2010,2011, and its provision for loan losses decreased $375,000 and $650,000increased $150,000 during the thirdfirst quarter and first nine months of 2011, respectively,2012, compared to the same periodsperiod in 2010.2011. The increase in the allowance for loan losses was primarily due to theloan growth in the loan portfolio.Consumer Finance segment. The allowance for loan losses to totalas a percentage of loans of 7.89at March 31, 2012 was 7.94 percent, at September 30, 2011 remained essentiallywhich was the same as the 7.90 percent at December 31, 2010.2011. The decreaseincrease in the provision for loan losses during the first nine monthsquarter of 2011 as compared to the same period in 20102012 was primarily attributable to lowerslightly higher net charge-offs, the level of which was favorably affected by prudent underwriting criteria for new loans, effective collection processes, and a higher recovery rate on sales of repossessed vehicles fueled by robust used car demand.still at relatively acceptable levels. We believe that the current level of the allowance for loan losses at the Consumer Finance segment is adequate to absorb any losses on existing loans that may become uncollectible. However, if unemployment levels remain elevated or increase in the future, or if consumer demand for automobiles falls and results in declining values of automobiles securing outstanding loans, a higher provision for loan losses may become necessary.
 
Nonperforming Assets
 
Table 8 summarizes nonperforming assets at September 30, 2011March 31, 2012 and December 31, 2010.2011.
 
TABLE 8: Nonperforming Assets
 
Retail Banking and Mortgage Banking Segments
 
(Dollars in thousands) 
September 30,
2011
  
December 31,
2010
  
March 31,
2012
  
December 31,
2011
 
Nonaccrual loans* - Retail Banking $8,416  $7,765 
Nonaccrual loans - Retail Banking $13,428  $10,011 
Nonaccrual loans - Mortgage Banking  104   —   621   621 
OREO** - Retail Banking  6,442   10,295 
OREO** - Mortgage Banking  —   379 
OREO* - Retail Banking  5,209   6,059 
OREO* - Mortgage Banking  —   — 
Total nonperforming assets $14,962  $18,439  $19,258  $16,691 
Accruing loans past due for 90 days or more $2  $1,030  $2  $68 
Troubled debt restructurings $15,527  $9,769  $16,712  $17,094 
Total loans $407,767  $414,831  $408,557  $404,356 
Allowance for loan losses $13,048  $11,398  $14,716  $14,130 
Nonperforming assets to total loans and OREO  3.61%  4.33%
Nonperforming assets to total loans and OREO*  4.65%  4.07%
Allowance for loan losses to total loans  3.20   2.75   3.60   3.49 
Allowance for loan losses to nonaccrual loans  153.15   146.79   104.75   132.90 
*Nonaccrual loans include nonaccrual TDRs of $6.8 million at September 30, 2011 and $402,000 at December 31, 2010.
**OREO is recorded at its estimated fair value less cost to sell.
 
 Consumer Finance Segment
 
(Dollars in thousands) 
September 30,
2011
  
December 31,
2010
  
March 31,
2012
  
December 31,
2011
 
Nonaccrual loans $595  $151  $375  $381 
Accruing loans past due for 90 days or more $—  $—  $—  $— 
Total loans $247,745  $220,753  $252,269  $246,305 
Allowance for loan losses $19,542  $17,442  $20,041  $19,547 
Nonaccrual consumer finance loans to total consumer finance loans  0.24%  0.07%  0.15%  0.15%
Allowance for loan losses to total consumer finance loans  7.89   7.90   7.94   7.94 
 
Nonperforming assets of the combined Retail Banking segmentand Mortgage Banking segments totaled $14.9$19.3 million at September 30, 2011,March 31, 2012, compared to $18.1$16.7 million at December 31, 2010.2011. Nonperforming assets at March 31, 2012 included $13.4 million of nonaccrual loans at the Retail Banking segment, at September 30, 2011 included $8.4 million of nonaccrual loans, compared to $7.8$10.0 million at December 31, 2010,2011, and $6.4$5.2 million of foreclosed, or OREO, properties, compared to $10.3$6.1 million at December 31, 2010.2011. Nonaccrual loans primarily consist of loans for residential real estate secured by residential properties and commercial loans secured by non-residential properties. The increase in nonaccrual loans since December 31, 2011 primarily resulted from one commercial relationship secured by undeveloped residential property. Specific reserves of $1.4$2.9 million have been established for the Retail Banking segment’s nonaccrual loans. We believe we have provided adequate loan loss reserves based on current appraisals or evaluations of the collateral. In some cases, appraisals have been adjusted to reflect current trends including sales prices, expenses, absorption periods and other current relevant factors. OREO properties at September 30, 2011March 31, 2012 primarily consisted of residential and non-residential properties associated with commercial relationships. These properties have been written down to their estimated fair values less cost to sell. The decline in OREO properties since December 31, 20102011 resulted from $7.4 million in sales induring the first nine monthsquarter of 20112012 as the Corporation focused efforts on disposing of OREO property.
 
 
Accruing loans past due for 90 days or more at the combined Retail Banking and Mortgage Banking segments decreased to $2,000 at September 30, 2011, compared to $1.0 million at December 31, 2010.  The decrease was primarily due to loans being moved to a nonaccrual status, being charged-off or transferred to OREO.
Nonaccrual loans at the Consumer Finance segment increaseddecreased to $595,000$375,000 at September 30, 2011March 31, 2012 from $151,000$381,000 at December 31, 2010.2011. As noted above, the allowance for loan losses at the Consumer Finance segment increased from $19.5 million at December 31, 2011 to $20.0 million at March 31, 2012, and the ratio of the allowance for loan losses to total consumer finance loans remained at 7.94 percent as of March 31, 2012 and December 31, 2011. Nonaccrual consumer finance loans remain relatively low compared to the allowance for loan losses and total consumer finance loan portfolio because the Consumer Finance segment frequentlygenerally initiates repossession of loan collateral once a loan is 60 days or more past due but before the loan reaches 90 days or more past due and is evaluated for nonaccrual status.
 
We measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. 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.
TABLE 9: Impaired Loans
 
Impaired loans, which include TDRs of $15.5$16.7 million, and the related allowance at September 30, 2011, as well as average impaired loans and interest income recognized for the first nine months of 2011,March 31, 2012, were as follows:
 
(Dollars in thousands) 
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance-Impaired
Loans
  
Interest
Income
Recognized
  
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance Impaired
Loans
  
Interest
Income
Recognized
 
Real estate – residential mortgage $3,048  $3,050  $618  $3,041  $103  $3,351  $3,572  $636  $3,431  $32 
Commercial, financial and agricultural:                                        
Commercial real estate lending  4,591   5,021   920   4,156   57   5,792   5,916   1,588   5,815   39 
Land acquisition and development lending  5,678   6,014   600   5,851   282   8,310   8,634   1,782   6,450   88 
Builder line lending  2,285   2,285   300   2,110   —   2,007   2,007   384   2,101   — 
Commercial business lending  99   1007   22   416   4   641   644   129   646   3 
Equity lines  —   —   —   49   — 
Consumer  324   324   49   331   11   432   432   65   432   4 
Total $16,025  $16,794  $2,509  $15,954  $457  $20,533  $21,205  $4,584  $18,875  $166 
 
Impaired loans, which include TDRs of $9.8$17.1 million, and the related allowance at December 31, 2010,2011, were as follows:
 
(Dollars in thousands) 
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance-Impaired
Loans
  
Interest
Income
Recognized
  
Recorded
Investment in
Loans
  
Unpaid
Principal
Balance
  
Related
Allowance
  
Average
Balance Impaired
Loans
  
Interest
Income
Recognized
 
Real estate – residential mortgage $3,110  $3,110  $466  $2,689  $137  $3,482  $3,698  $657  $3,723  $137 
Commercial, financial and agricultural:                                        
Commercial real estate lending  5,760   6,816   1,263   3,582   30   5,861   5,957   1,464   6,195   102 
Land acquisition and development lending  5,919   5,919   400   1,038   30   5,490   5,814   1,331   6,116   372 
Builder line lending  —   —   —   1,014   —   2,285   2,285   318   2,397   — 
Commercial business lending  1,142   1,267   404   613   —   652   654   161   663   6 
Equity lines  148   150   49   149   4   —   —   —   —   — 
Consumer  338   338   51   333   14   324   324   49   324   14 
Total $16,417  $17,600  $2,633  $9,418  $215  $18,094  $18,732  $3,980  $19,418  $631 

The balance of impaired loans was $16.0$20.5 million, including $15.5$16.7 million of TDRs at September 30, 2011,March 31, 2012, for which there were specific valuation allowances of $2.5$4.6 million. At December 31, 2010,2011, the balance of impaired loans was $16.4$18.1 million, including $9.8$17.1 million of TDRs, for which there were specific valuation allowances of $2.6$4.0 million.  The increase in troubled debt restructurings was primarily due to two commercial loan relationships totaling $5.5 million for which modified repayment schedules were negotiated.  While these relationships were also in nonaccrual status at September 30, 2011, the borrowers are servicing the loans in accordance with the modified terms. The Corporation has no obligation to fund additional advances on its impaired loans. While TDRs are consideredThe increase in impaired loans we believe that TDRfrom December 31, 2011 to March 31, 2012 was primarily due to one commercial relationship secured by undeveloped residential property, which was transferred to substandard nonaccrual status in the first quarter of 2012.

TDRs remain relatively unchanged at March 31, 2012 from December 31, 2011. As the Retail Banking segment’s loan portfolio remains under credit quality pressure, the Corporation may use loan modifications can beas a responsible approach to managing asset quality when working with borrowers who are experiencing financial difficulties.difficulty, which may result in TDRs.
 
TDRs at September 30, 2011March 31, 2012 and December 31, 20102011 were as follows:
 
TABLE 10: Troubled Debt Restructurings
 
(Dollars in thousands) 
September 30,
2011
  
December 31,
2010
  
March 31,
2012
  
December 31,
2011
 
Accruing TDRs $8,748  $9,367  $8,137  $8,653 
Nonaccrual TDRs1
  6,779   402   8,575   8,441 
Total TDRs2
 $15,527  $9,769  $16,712  $17,094 
1
Included in nonaccrual loans in Table 8: Nonperforming Assets.
2
Included in impaired loans in Table 9: Impaired Loans.

While TDRs are considered impaired loans, not all TDRs are on nonaccrual status.  If a loan was on nonaccrual status at the time of the TDR modification, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the Corporation’s policy for returning loans to accrual status.  If a loan was accruing prior to being modified as a TDR and if the Corporation concludes that the borrower is able to make such modified payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the TDR will remain on an accruing status.
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 the Corporation concludes that the borrower is able to make such modified payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the TDR will remain on an accruing status.
 
FINANCIAL CONDITION
 
At September 30, 2011,March 31, 2012, the Corporation had total assets of $908.9$945.5 million compared to $904.1$928.1 million at December 31, 2010.2011. The increase was principally a result of growth in the portfolio of securities available for sale, loan growth at the Retail Banking and Consumer Finance segmentsegments and an increase in cash and cash equivalents, which were substantially offset in part by reductionsa reduction in loans held for sale at the Mortgage Banking segment, in loans held for investment at the Retail Banking segment and in OREO.segment.
 
Loan Portfolio
 
The following table sets forth the composition of the Corporation’s loans held for investment in dollar amounts and as a percentage of the Corporation’s total gross loans held for investment at the dates indicated.
 
TABLE 11: Summary of Loans Held for Investment
 
 September 30, 2011  December 31, 2010  March 31, 2012  December 31, 2011 
(Dollars in thousands) Amount  Percent  Amount  Percent  Amount  Percent  Amount  Percent 
Real estate – residential mortgage $146,617   22% $146,073   23% $146,867   22% $147,135   22%
Real estate – construction  7,122   1   12,095   2   4,461   1   5,737   1 
Commercial, financial and agricultural 1
  215,964   33   219,226   34   218,472   33   212,235   33 
Equity lines  32,576   5   32,187   5   33,335   5   33,192   5 
Consumer  5,487   1   5,250   1   5,422   1   6,057   1 
Consumer finance  247,745   38   220,753   35   252,269   38   246,305   38 
Total loans  655,511   100%  635,584   100%  660,826   100%  650,661   100%
Less allowance for loan losses  (32,590)      (28,840)      (34,757)      (33,677)    
Total loans, net $622,921      $606,744      $626,069      $616,984     
1
Includes loans secured by real estate for builder lines, acquisition and development and commercial development, as well as commercial loans secured by personal property.
 
41
The increase in total loans held for investment occurred in the commercial, financial and agricultural segment as a result of growth in commercial real estate loans and in the consumer finance category as a result of robustincreased demand for automobiles partially offset by decreases in commercial, financial and agricultural loans due to reduced demand and foreclosures as a result of the continuing challenging economic environment, and by decreases in real estate construction loans.increased market penetration.
 
Investment Securities
 
The investment portfolio isplays a primary componentrole in the management of the Corporation’s interest rate sensitivity. In addition, the portfolio serves as a source of liquidity and is used as needed to satisfymeet collateral requirements primarily for public funds deposits.requirements. The investment portfolio consists solely of securities available for sale, which may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors. These securities are carried at estimated fair value. At March 31, 2012 and December 31, 2011, all securities in the Corporation’s investment portfolio were classified as available for sale.
 
The following table sets forth the composition of the Corporation’s securities available for sale at fair value and as a percentage of the Corporation’s total securities available for sale at the dates indicated.
 
TABLE 12: Securities Available for Sale
 
 September 30, 2011  December 31, 2010  March 31, 2012  December 31, 2011 
(Dollars in thousands) Amount  Percent  Amount  Percent  Amount  Percent  Amount  Percent 
U.S. government agencies and corporations $11,056   8% $13,656   10% $13,926   10% $15,283   10%
Mortgage-backed securities  2,499   2   2,300   2   2,977   2   2,216   2 
Obligations of states and political subdivisions  128,138   90   114,288   88   126,899   88   127,079   88 
Total debt securities  141,693   100   130,244   100   143,802   100   144,578   100 
Preferred stock  100   *   31   *   66   *   68   * 
Total available for sale securities at fair value $141,793   100% $130,275   100% $143,868   100% $144,646   100%
 
*Less than one percent.
 
Deposits
 
The Corporation’s predominant source of funds is depository accounts, which consist of demand deposits, savings and money market accounts, and time deposits. The Corporation’s deposits are principally provided by individuals businesses and municipalitiesbusinesses located within the communities served.
Deposits totaled $637.4$660.6 million at September 30, 2011,March 31, 2012, compared to $625.1$646.4 million at December 31, 2010.  Since2011. The increase from December 31, 2010, the Corporation’s time deposits have increased by $2.5 million and non-interest bearing2011 occurred primarily in noninterest-bearing demand deposits, havewhich increased $9.7$10.0 million shifting the deposit mixof 10.5 percent from December 31, 2011 to shorter duration, lower-cost deposits.March 31, 2012, primarily due to higher account balances for both personal and business depositors. The Corporation had no brokered certificates of deposit outstanding at September 30, 2011March 31, 2012 or December 31, 2010.
2011.
 
Borrowings
 
Borrowings totaled $159.4$158.4 million at September 30, 2011,March 31, 2012, compared to $164.1$161.2 million at December 31, 20102011 as the Corporation used excess liquidity resulting from reduced loan demandfunding needs at the Mortgage Banking segment and deposit growth at the Retail Banking segment to reduce short-term borrowings.
 
Off-Balance Sheet Arrangements
 
As of September 30, 2011,March 31, 2012, there have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
Contractual Obligations
 
As of September 30, 2011,March 31, 2012, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in “Management’s Discussion and Analysis” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
Liquidity
 
The objective of the Corporation’s liquidity management is to ensure the continuous availability of funds to satisfy the credit needs of our customers and the demands of our depositors, creditors and investors. Stable core deposits and a strong capital position are the foundation for the Corporation’s liquidity position. Additional sources of liquidity available to the Corporation include cash flows from operations, loan payments and payoffs, deposit growth, sales of securities, the issuance of brokered certificates of deposit and the capacity to borrow additional funds.
 
42
Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks, federal funds sold and nonpledged securities available for sale, at September 30, 2011March 31, 2012 totaled $68.2$64.5 million, compared to $45.7$49.2 million at December 31, 20102011 as the Corporation had higher interest-bearing deposits at other banks and a higher amount of nonpledged securities available for sale at September 30, 2011,March 31, 2012 compared to December 31, 2010.2011. The Corporation’s funding sources, including the capacity, amount outstanding and amount available at September 30, 2011March 31, 2012 are presented in Table 13: Funding Sources.
 
TABLE 13: Funding Sources
 
 September 30, 2011  March 31, 2012 
(Dollars in thousands) Capacity  Outstanding  Available  Capacity  Outstanding  Available 
Federal funds purchased $59,000  $—  $59,000  $59,000  $—  $59,000 
Repurchase agreements  5,000   5,000   —   5,000   5,000   — 
Borrowings from FHLB  109,012   52,500   56,512   111,708   52,500   59,208 
Borrowings from Federal Reserve Bank  62,366   —   62,366   59,024   —   59,024 
Revolving line of credit  120,000   76,051   43,949   120,000   75,488   44,512 
Total $355,378  $133,551  $221,827  $354,732  $132,988  $221,744 
 
We have no reason to believe these arrangements will not be renewed at maturity. Additional loans and securities are also available that can be pledged as collateral for future borrowings from the Federal Reserve Bank or the FHLB above the current lendable collateral value.
 
As a result of the Corporation’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Corporation maintains overall liquidity sufficient to satisfy its operational requirements and contractual obligations.
 
Capital Resources
 
The Corporation’s and the Bank’s actual capital amounts and ratios are presented in the following table.
 
TABLE 14: Capital Ratios
 
 Actual  
Minimum
Capital
Requirements
  
Minimum To Be
Well Capitalized
Under Prompt
Corrective Action
Provisions
  Actual  
Minimum
Capital
Requirements
  
Minimum To Be
Well Capitalized
Under Prompt
Corrective Action
Provisions
 
(Dollars in thousands) Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio 
As of September 30, 2011:                  
As of March 31, 2012:                  
Total Capital (to Risk-Weighted Assets)                                    
Corporation $109,823   16.2% $54,260   8.0%  N/A   N/A  $116,751   16.8% $55,643   8.0%  N/A   N/A 
Bank  107,945   16.0   54,017   8.0  $67,521   10.0%  114,598   16.5   55,443   8.0  $69,304   10.0%
Tier 1 Capital (to Risk-Weighted Assets)                                                
Corporation  101,047   14.9   27,130   4.0   N/A   N/A   107,735   15.5   27,822   4.0   N/A   N/A 
Bank  99,207   14.7   27,008   4.0   40,513   6.0   105,613   15.2   27,722   4.0   41,582   6.0 
Tier 1 Capital (to Average Assets)                                                
Corporation  101,047   11.3   35,851   4.0   N/A   N/A   107,735   11.7   36,700   4.0   N/A   N/A 
Bank  99,207   11.1   35,746   4.0   44,683   5.0   105,613   11.5   36,596   4.0   45,745   5.0 
                                                
As of December 31, 2010:                        
As of December 31, 2011:                        
Total Capital (to Risk-Weighted Assets)                                                
Corporation $112,947   16.5% $54,647   8.0%  N/A   N/A  $113,427   16.4% $55,205   8.0%  N/A   N/A 
Bank  110,685   16.3   54,434   8.0  $68,042   10.0%  111,029   16.2   54,999   8.0  $68,749   10.0%
Tier 1 Capital (to Risk-Weighted Assets)                                                
Corporation  104,158   15.3   27,324   4.0   N/A   N/A   104,492   15.1   27,603   4.0   N/A   N/A 
Bank  101,929   15.0   27,217   4.0   40,825   6.0   102,126   14.9   27,500   4.0   41,249   6.0 
Tier 1 Capital (to Average Assets)                                                
Corporation  104,158   11.6   35,843   4.0   N/A   N/A   104,492   11.5   36,362   4.0   N/A   N/A 
Bank  101,929   11.4   35,838   4.0   44,798   5.0   102,126   11.3   36,252   4.0   45,315   5.0 
 
On July 27, 2011,April 11, 2012, the Corporation redeemed $10.0 million, or 50 percent,the remaining 10,000 shares of the $20.0 million of the preferred stockits Preferred Stock issued to the United States Department of the Treasury in January 2009 under the CPP.  ThisThe redemption has been reflectedconsisted of $10.0 million in liquidation value and $78,000 of accrued and unpaid dividends associated with the Preferred Stock.  As a result of this redemption, the Corporation will pay no future dividends on the Preferred Stock.  Further, in connection with this redemption, the Corporation will accelerate the accretion of the remaining preferred stock discount, which will reduce net income available to common shareholders by approximately $151,000 in the Corporation’s capital ratios assecond quarter of September 30, 2011.  Information regarding the Corporation’s redemption of the preferred stock is presented in Note 5 to the Unaudited Consolidated Financial Statements.2012, but will eliminate any future accretion.
 
 
4341
In connection with the Corporation’s participation in the CPP, the Corporation also issued to Treasury in January 2009 a Warrant to purchase 167,504 shares of the Corporation’s common stock.  The Corporation intends to negotiate with Treasury the repurchase of the Warrant.  This repurchase is not expected to have any effect on the Corporation’s earnings or earnings per share for the second quarter of 2012, but will result in a reduction in capital, and the size of any such reduction will be based upon the negotiated purchase price.
 
Effects of Inflation and Changing Prices
 
The Corporation’s financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States (GAAP)(“GAAP”). GAAP presently requires the Corporation to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Corporation is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Corporation, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
There have been no significant changes from the quantitative and qualitative disclosures made in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
ITEM  4.
CONTROLS AND PROCEDURES
 
The Corporation’s management, including the Corporation’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)“Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures were effective as of September 30, 2011March 31, 2012 to ensure that information required to be disclosed by the Corporation in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Corporation’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Corporation or its subsidiary to disclose material information required to be set forth in the Corporation’s periodic reports.
 
Management of the Corporation is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). There were no changes in the Corporation’s internal control over financial reporting during the Corporation’s third quarter ended September 30, 2011March 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
 
42
PART II - OTHER INFORMATION
 
ITEM  1A.
RISK FACTORS FACTORS
 
There have been no material changes in the risk factors faced by the Corporation from those disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.2011.
 
ITEM  2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
The Corporation has not purchased any of its Common Stock during 2011.2012.
 
In connection with the Corporation’s sale to the Treasury of its Series A Preferred Stock and Warrant under the CPP, there are limitations on the Corporation’s ability to purchase Common Stock prior to the earlier of January 9, 2012 or the date on which Treasury no longer holds any of the preferred stock. Prior to such time, the Corporation generally may not purchase any Common Stock without the consent of the Treasury.
44
ITEM  6.
EXHIBITS
 
3.1Articles of Incorporation of C&F Financial Corporation (incorporated by reference to Exhibit 3.1 to Form 10-KSB filed March 29, 1996)
  
3.1.1Amendment to Articles of Incorporation of C&F Financial Corporation establishing Series A Preferred Stock, effective January 8, 2009 (incorporated by reference to Exhibit 3.1.1 to Form 8-K filed January 14, 2009)
  
3.2Amended and Restated Bylaws of C&F Financial Corporation, as adopted October 16, 2007 (incorporated by reference to Exhibit 3.2 to Form 8-K filed October 22, 2007)
  
4.1Certificate of Designations for 20,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated by reference to Exhibit 3.1.1 to Form 8-K filed January 14, 2009)
  
4.2Warrant to Purchase up to 167,504 shares of Common Stock, dated January 9, 2009 (incorporated by reference to Exhibit 4.2 to Form 8-K filed January 14, 2009)
  
*10.11.1
10.3.1		Form of Notice of Amendment to Amended and Restated Change in Control Agreement dated March 1, 2012 between C&F Financial Corporation Incentive Stock Option Agreementand Thomas F. Cherry (incorporated by reference to Exhibit 10.3.1 to Form 10-K filed March 5, 2012)
  
  10.2710.14.1Amendment to Amended and Restated Change in Control Agreement dated March 1, 2012 between C&F Financial Corporation and Bryan McKernon (incorporated by reference to Exhibit 10.14.1 to Form 10-K filed March 5, 2012)
10.28Letter Agreement, dated July 27, 2011,April 11, 2012, between C&F Financial Corporation and the United States Department of the Treasury (incorporated by reference to Exhibit 10.2710.28 to Form 8-K filed July 28, 2011)April 12, 2012)
  
31.1
Certification of CEO pursuant to Rule 13a-14(a)
  
31.2
Certification of CFO pursuant to Rule 13a-14(a)
  
32
Certification of CEO/CFO pursuant to 18 U.S.C. Section 1350
101.INSXBRL Instance Document
  
101.SCHXBRL Taxonomy Extension Schema Document
  
101.CALXBRL Taxonomy Extension Calculation Linkbase Document
  
101.DEFXBRL Taxonomy Extension Definition Linkbase Document
  
101.LABXBRL Taxonomy Extension Label Linkbase Document
  
101.PREXBRL Taxonomy Presentation Linkbase Document
*Indicates management contract
 
 
4543
*
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
   C&F FINANCIAL CORPORATION
    (Registrant)
     
DateNovemberMay 8, 2011            2012  /s/ Larry G. Dillon
    Larry G. Dillon
    
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
     
DateNovemberMay 8, 2011            2012  /s/ Thomas F. Cherry
    Thomas F. Cherry
    
Executive Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)
 
 
4644