More annual reports from C&F Financial Corporation:
2023 ReportC & F FINANCIAL CORP FORM 10-K (Annual Report) Filed 3/23/1998 For Period Ending 12/31/1997 Address EIGHTH & MAIN STREETS P O BOX 391 WEST POINT, Virginia 23181 Telephone 804-843-2360 CIK Industry Sector 0000913341 Regional Banks Financial Fiscal Year 12/31 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) ( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 or ( ) 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 000-23423 C&F FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Virginia 54-1680165 ---------------------------------------- ----------------------------------- State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification No.) Eighth and Main Streets, West Point, VA 23181 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (804) 843-2360 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock $1.00 Par (Title of class) 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 ( ) No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) The aggregate market value of the Common Stock held by non-affiliates of the Registrant was approximately $62,201,958 as of March 17, 1998. The number of shares outstanding of the registrant's common stock, $1.00 par value was 1,925,625 at March 17, 1998. DOCUMENTS INCORPORATED BY REFERENCE Location in Form 10-K Incorporated Document --------------------- --------------------- PART II Item 5 - Market for Registrants Common The Company's 1997 Annual Report to Shareholders for Equity and Related Stockholder Matters fiscal years ended December 31, 1997, Investor Information, page 45. Item 6 - Selected Financial Data The Company's 1997 Annual Report to Shareholders for fiscal years ended December 31, 1997, Five Year Financial Summary, page 13. Item 7 - Management's Discussion and The Company's 1997 Annual Report to Shareholders Analysis of Financial Conditions for the fiscal years ended December 31, 1997, and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations, pages 13 through 24. Item 8 - Financial Statements and The Company's 1997 Annual Report to Shareholders Supplementary Data for fiscal years ended December 31, 1997, Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Independent Auditors' Report, pages 25 through 44. Item 9 - Changes in and Disagreements The Company's September 30, 1997 Form 10Q, Other With Accountants on Accounting Information, page 11, and exhibit 16. and Financial Disclosure PART III Item 10 - Directors and Executive The Company's 1998 Proxy Statement, Officers of the Registrant Election of Directors, pages 2 through 4. Item 11 - Executive Compensation The Company's 1998 Proxy Statement, Executive Compensation, pages 5 through 6. Item 12 - Security Ownership of Certain The Company's 1998 Proxy Statement, Principal Holders Beneficial Owners and Management of Capital Stock, page 2. Item 13 - Certain Relationships and The Company's 1998 Proxy Statement, Interest of Related Transactions Management in Certain Transactions, page 5. TABLE OF CONTENTS PART 1 ITEM 1. BUSINESS..................................................................................page 1 ITEM 2. PROPERTIES................................................................................page 2 ITEM 3. LEGAL PROCEEDINGS.........................................................................page 3 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........................................................page 3 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.........................................................page 4 ITEM 6. SELECTED FINANCIAL DATA...................................................................page 4 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION............................................page 4 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................page 4 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...............................................page 7 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..................................................page 7 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................................................page 8 ITEM 11. EXECUTIVE COMPENSATION....................................................................page 8 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...................................................................page 9 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................................................page 9 PART IV ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K.........................................................page 10 Item 1. BUSINESS General PART I C&F Financial Corporation (the "Company") is a bank holding company which was incorporated under the laws of the Commonwealth of Virginia in March, 1994. The Company owns all of the stock of its sole subsidiary, Citizens and Farmers Bank (the "Bank"), which is an independent commercial bank chartered under the laws of the Commonwealth of Virginia. The Bank has a total of nine branches. The Bank has its main office at Eighth and Main Streets, West Point, Virginia, and has branch offices in the locations of Norge, Middlesex, Providence Forge, Quinton, Tappahannock, Varina, Williamsburg and West Point (2 branches). The Bank was originally opened for business under the name Farmers and Mechanics Bank on January 22, 1927. The local community served by the Bank is defined as those portions of King William County, King and Queen County, Hanover County and Henrico County which are east of Route 360; Essex, Middlesex, New Kent, Charles City, and James City Counties; that portion of York County which is directly north of James City County; and that portion of Gloucester County surrounded by Routes 14 and 17. The Company, through its subsidiaries, offers a wide range of banking services available to both individuals and small businesses. These services include various types of checking and savings deposit accounts, and the making of business, real estate, development, mortgage, home equity, automobile and other installment, demand and term loans. Also, the Bank offers ATMs at all locations, credit card services, trust services, travelers' checks, money orders, safe deposit rentals, collections, notary public, wire services and other customary bank services to its customers. The Bank has three wholly-owned subsidiaries, C & F Title Agency, Inc., C&F Investment Services, Inc., and C&F Mortgage Corporation, all incorporated under the laws of the Commonwealth of Virginia. C&F Title Agency, Inc. sells title insurance to the mortgage loan customers of the Company. C&F Investment Services, Inc., organized April, 1995, is a full-service brokerage firm offering a comprehensive range of investment options including stocks, bonds, annuities and mutual funds. C&F Mortgage Corporation, organized in September, 1995, originates and sells residential mortgages. C&F Mortgage Corporation provides mortgage services through six locations in Virginia and two in Maryland. The Virginia offices are in Richmond (two locations), Williamsburg, Newport News, Charlottesville, and Chester. The Maryland offices are in Crofton and Bel Aire. As of December 31, 1997, a total of 220 persons were employed by the Company, of whom 17 were part-time. The Company considers relations with its employees to be excellent. 1 Competition The Bank is subject to competition from various financial institutions and other companies or firms that offer financial services. The Bank's principal competition in its market area consists of all the major statewide banks. The Bank also competes for deposits with savings and loan associations, credit unions and money-market funds. In making loans, the Bank competes with consumer finance companies, credit unions, leasing companies and other lenders. C&F Mortgage Corporation competes for mortgage loans in its market areas with other mortgage companies, commercial banks and other financial institutions. C&F Investment Services competes with other investment companies, brokerage firms, and insurance companies to provide these services. C&F Title Agency competes with other title companies owned by lawyers and other financial institutions. Regulation and Supervision The Company is subject to regulation by the Federal Reserve Bank under the Bank Holding Company Act of 1956. The Company is also under the jurisdiction of the Securities and Exchange Commission and certain state securities commissions with respect to matters relating to the offer and sale of its securities. In addition, the Bank is subject to regulation and examination by the State Corporation Commission and the Federal Deposit Insurance Corporation. ITEM 2. PROPERTIES The following describes the location and general character of the principal offices and other materially important physical properties of the Company and its subsidiary. The Company owns the headquarters located at Eighth and Main Streets in the business district of West Point, Virginia. The building, originally constructed in 1923, has three floors totaling 15,000 square feet. This building houses the Citizens and Farmers Bank Main Office branch, C&F Investment Services, Inc. offices, and office space for the Company's administrative personnel. The Company also owns a building located at Seventh and Main Streets in West Point, Virginia. The building provides space for Citizens and Farmers Bank operations functions and staff. The building was originally constructed prior to 1935 and remodeled by the Company in 1991. The two-story building has 20,000 square feet. Citizens and Farmers Bank owns eight other branch locations in Virginia. Also, the Bank owns several lots in West Point, Virginia and one other lot in New Kent County, Virginia. C&F Mortgage Corporation has eight leased offices, six in Virginia and two in Maryland. Rental expense for these locations totaled $244,000 for the year ended December 31, 1997. All of the Company's properties are in good operating condition and are adequate for the Company's present and anticipated future needs. 2 ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders of the Company through a solicitation of proxies or otherwise. 3 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information contained on pages 43 and 45 of the 1997 Annual Report to Shareholders, which is attached hereto as Exhibit 13, under the captions, "Note 18: Quarterly Condensed Statements of Income - Unaudited" and "Investor Information" is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information contained on page 13 of the 1997 Annual Report to Shareholders, which is attached hereto as Exhibit 13, under the caption, "Five Year Financial Summary" is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The information contained on pages 13 through 24 of the 1997 Annual Report to Shareholders, which is attached hereto as Exhibit 13, under the caption, "Management's Discussion and Analysis of Financial Condition and Results of Operation", is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As the holding company for a commercial bank, the Company's primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Bank's assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. Since the majority of the Company's interest-earning assets and all of the Company's interest-bearing liabilities are held by the Bank, virtually all of the Company's interest rate risk exposure lies at the Bank level. Therefore, all significant interest rate risk management procedures are performed by management of the Bank. Based upon the nature of the Bank's operations, the Bank is not subject to foreign currency exchange or commodity price risk. The Bank's loan portfolio is concentrated primarily in the counties of King William, King and Queen, Hanover, Henrico, Essex, Middlesex, New Kent, Charles City, York and James City and is therefore subject to risks associated with the local economy. As of December 31, 1997, the Company does not own any trading assets. As of December 31, 1997, the Company does not have any hedging transactions in place such as interest rate swaps and caps. The Bank's interest rate management strategy is designed to stabilize net interest income and preserve capital. The Bank manages interest rate risk through the use of a simulation model which measures the sensitivity of future net interest income and the net portfolio value to changes in interest rates. In addition, the Bank monitors interest rate sensitivity through analysis, measuring the terms to maturity or next repricing date of interest-earning assets and interest-bearing liabilities. The matching of the maturities of assets and liabilities may be analyzed by examining the extent to which assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap". An asset or liability is said to be "interest rate sensitive" within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity "gap" is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the 5 amount of interest-bearing liabilities anticipated, based upon certain assumptions, to mature or reprice within that time period. A gap is considered negative when the amount of interest rate sensitive liabilities maturing or repricing within a specific time period exceeds the amount of interest rate sensitive assets maturing or repricing within that same time period. During a period of rising interest rates, a negative gap would tend to result in a decrease in net interest income while a positive gap would tend to result in an increase in net interest income. In a declining interest rate environment, an institution with a negative gap would generally be expected, absent the effect of other factors, to experience a greater decrease in the cost of its liabilities relative to the yield of its assets and thus an increase in the institution's net interest income, whereas an institution with a positive gap would be expected to experience the opposite results. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates as of December 31, 1997 based on the information and assumptions set forth in the notes. The Company believes that the assumptions utilized are reasonable. The expected maturity date values for loans were calculated by adjusting the instruments contractual maturity date for expectations of prepayments, as set forth in the notes. Similarly, expected maturity date values for interest-bearing core deposits were calculated based upon estimates of the period over which the deposits would be outstanding as set forth in the notes. From a risk management perspective, however, the Company utilizes both maturity and repricing dates, as opposed to solely using expected maturity dates. 5 Principal Amount Maturing in: Fair Value There- Dec. 31, (Dollars in thousands) 1998 1999 2000 2001 2002 after Total 1997 -------------------------------------------------------------------------------------------------------------------------- Earning assets: Fixed rate loans(1)(2) $ 16,002 $ 9,777 $ 7,598 $ 6,265 $ 5,142 $ 18,185 $ 62,969 $ 62,780 Average interest rate 9.01% 8.67% 8.32% 8.06% 7.91% 7.82% 8.35% Variable rate loans(1)(2) $ 31,035 $ 8,338 $ 5,846 $ 5,291 $ 4,747 $ 39,738 $ 94,995 $ 95,208 Average interest rate 9.45% 8.91% 8.64% 8.62% 8.60% 8.62% 8.91% Loans held for sale(3) $ 24,525 - - - - - $ 24,525 $ 24,853 Average interest rate 6.28% - - - - - 6.28% Taxable securities(4) $ 5,800 $ 2,997 $ 1,000 $ 999 - $ 25,558 $ 36,354 $ 36,510 Average interest rate 8.08% 6.70% 6.40% 8.00% - 6.73% 6.97% Tax-exempt securities(5) $ 500 $ 1,170 $ 950 $ 1,040 $ 1,378 $ 35,094 $ 40,132 $ 42,031 Average interest rate 6.38% 6.56% 6.80% 6.67% 5.82% 5.77% 5.85% Other interest-bearing assets $ 1,027 - - - - - $ 1,027 $ 1,027 Average interest rate 5.23% - - - - - 5.23% Interest-bearing liabilities: Money market, savings and interest-bearing transaction accounts(6) $ 57,063 $ 9,511 $ 9,511 $ 9,510 $ 9,510 - $ 95,105 $ 95,199 Average interest rate 3.00% 3.01% 2.98% 2.95% 2.92% - 2.99% Certificates of deposit $ 76,767 $ 16,552 $ 5,689 $ 432 $ 1,326 $ 347 $ 101,113 $ 101,275 Average interest rate 5.09% 5.46% 6.08% 5.37% 5.81% 3.55% 5.21% Borrowings $ 9,336 - - - - - $ 9,336 $ 9,336 Average interest rate 5.16% - - - - - 5.16% --------------------------------------------------------------------------------------------------------------------------- (1) Net of undisbursed loan proceeds and does not include net deferred loan fees or the allowance for loan losses. (2) For single-family residential loans, assumes annual prepayment rate of 12%. No prepayment assumptions were used for all other loans. (3) Does not include net deferred loan fees. (4) Includes the Company's investment in Federal Home Loan Bank stock. (5) Average interest rates are the average of stated coupon rates and have not been adjusted for taxes. (6) For money market, savings and interest-bearing transaction accounts, assumes an annual decay rate of 60% for 1998 and 10% for each of the years 1999 through 2002. 6 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information contained on pages 25 through 44 of the 1997 Annual Report to Shareholders, which is attached hereto as Exhibit 13, under the captions, "Consolidated Financial Statements", "Notes to Consolidated Financial Statements", and "Independent Auditors' Report", is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The information in Item 5, Other Information, page 11, and exhibit 16 to Form 10Q filed November 12, 1997, of C&F Financial Corporation is incorporated herein by reference. 7 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT PART III The information required by Item 10 with respect to the Directors of the Registrant is contained on pages 2 through 4 of the 1998 Proxy Statement, which is attached hereto as Exhibit 99, under the caption, "Election of Directors", is incorporated herein by reference. The information in the following table pertains to the executive officers of the Company. Executive Officers of C&F Financial Corporation Name (Age) Business Experience Number of Shares Beneficially Present Position During Past Five Years Owned as of March 18, 1998 ---------------------- ------------------------------------- --------------------------------- Larry G. Dillon (45) President of the Bank since 1989; 20,601 (1) Chairman, President and Senior Vice President of the Bank Chief Executive Officer prior to 1989 Gari B. Sullivan (60) Senior Vice President of the Bank since 1990; 4,505 (1) Secretary Vice President of the Bank from 1989 to 1990; President of the Middlesex Region of First Virginia Bank prior to 1989 Brad E. Schwartz (35) Promoted to Senior Vice President of the Bank 5,436 (1) Treasurer in December 1997. Vice President of the Bank from 1991 to December 1997; Administrative Officer of the Bank from 1989 to 1991; Senior Financial Institutions Examiner with the Bureau of Financial Institutions of the Virginia State Corporation Commission prior to 1989 Thomas F. Cherry (29) Vice President of the Bank since December 1996. 283 (1) Chief Accounting Officer Manager with Price Waterhouse, LLP in Norfolk, VA prior to December 1996. (1) Includes exercisable options of 6,734, 3,034, 5,034, and 233 shares presently held by Messrs. Dillon, Sullivan, Schwartz, and Cherry, respectively. ITEM 11. EXECUTIVE COMPENSATION The information contained on pages 5 through 6 of the 1998 Proxy Statement, which is attached hereto as Exhibit 99, under the caption, "Executive Compensation", is incorporated herein by reference. 8 ITEM 12. SECURITY OWNERSHIP ON CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information contained on page 2 of the 1998 Proxy Statement, which is attached hereto as Exhibit 99, under the caption, "Principal Holders of Capital Stock", is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained on page 5 of the 1998 Proxy Statement, which is attached hereto as Exhibit 99, under the caption, "Interest of Management In Certain Transactions", is incorporated herein by reference. 9 ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K 14 (a) Exhibits PART IV Exhibit No. 3: Articles of Incorporation and Bylaws Articles of Incorporation and Bylaws of C&F Financial Corporation filed as Exhibit Nos. 3.1 and 3.2, respectively, to Form 10KSB filed March 29, 1996, of C&F Financial Corporation is incorporated herein by reference. Exhibit No. 10: Material Contracts Exhibit No. 13: C&F Financial Corporation 1997 Annual Report to Shareholders Exhibit No. 21: Subsidiaries of the Registrant Citizens and Farmers Bank, incorporated in the Commonwealth of Virginia (100% owned) Exhibit No. 23: Consents of experts and counsel 23.1 Consent of Yount, Hyde & Barbour, P.C. 23.2 Consent of Deloitte & Touche LLP Exhibit No. 27: Financial Data Schedule Exhibit No. 99: Additional Exhibits 99.1 C&F Financial Corporation 1998 Annual Meeting Proxy Statement 99.2 Independent Auditors Report of Deloitte & Touche LLP for 1996 and 1995 14 (b) Reports on Form 8-K filed in the fourth quarter of 1997: The Company filed Form 8-K dated November 25, 1997 in the last quarter of the fiscal year ended December 31, 1997. The filing was in order to generate an Exchange Act file number for the Company's use in making an application to the National Association of Securities Dealers Automated Quotation System. 14 (c) Exhibits to this Form 10-K are either filed as part of this Report or are incorporated herein by reference. 14 (d) Financial Statements Excluded from Annual Report to Shareholders pursuant to Rule 14a3(b). Not applicable. 10 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, C&F Financial Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized: C&F FINANCIAL CORPORATION /s/ Larry G. Dillon /s/ Thomas F. Cherry -------------------------------------------- -------------------------------------- Larry G. Dillon Thomas F. Cherry Chairman, President and Chief Executive Officer Chief Accounting Officer Date: March 20, 1998 Date: March 20, 1998 -------------------------------------------- -------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: /s/ W.T. Robinson Date: March 20, 1998 -------------------------------------------- -------------------------------------- W. T. Robinson, Director /s/ J. P. Causey Jr. Date: March 20, 1998 -------------------------------------------- -------------------------------------- J. P. Causey Jr., Director /s/ James H. Hudson, III Date: March 20, 1998 -------------------------------------------- -------------------------------------- James H. Hudson, III, Director /s/ Larry G. Dillon Date: March 20, 1998 -------------------------------------------- -------------------------------------- Larry G. Dillon, Director -------------------------------------------- -------------------------------------- William E. O'Connell, Jr., Director -------------------------------------------- -------------------------------------- Sture G. Olsson, Director EXHIBIT 10 CHANGE IN CONTROL AGREEMENT THIS AGREEMENT is entered into as of the 16th day of December, 1997 by and between C&F FINANCIAL CORPORATION, a Virginia corporation (the "Company"), and LARRY G. DILLON (the "Executive"). RECITALS I. The Executive currently serves as Chief Executive Officer of the Company, and is a key member of management of the Company and its affiliates, and his services and knowledge are valuable to the Company and its affiliates. II. The Board (as defined below) has determined that it is in the best interests of the Company and its shareholders to assure that the Company and its affiliates will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a Change in Control (as defined below) of the Company. The Board believes it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened Change in Control and to encourage the Executive's full attention and dedication to the Company and its affiliates currently and in the event of any threatened or pending Change in Control. Therefore, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement. NOW, THEREFORE, it is hereby agreed as follows: 1. CERTAIN DEFINITIONS. (a) "Agreement Effective Date" means December 16, 1997. (b) The "Agreement Term" means the period commencing on the Agreement Effective Date and ending on the earlier of (i) the Agreement Regular Termination Date or (ii) the date this Agreement terminates pursuant to Section 7. The "Agreement Regular Termination Date" means the third anniversary of the Agreement Effective Date, provided, however, that commencing on the first anniversary of the Agreement Effective Date, and on each subsequent anniversary (such date and each subsequent anniversary shall be hereinafter referred to as the "Renewal Date"), unless this Agreement is previously terminated, the Agreement Regular Termination Date shall be automatically extended for three years from the latest Renewal Date, unless at least one month prior to the latest Renewal Date the Company shall give notice to the Executive in accordance with Section 10(c) of this Agreement that the Agreement Regular Termination Date shall not be so extended. (c) "Board" means the Board of Directors of the Company. (d) "Cause" means: (i) the willful and continued failure of the Executive to substantially perform his duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Board, pursuant to a vote of a majority of the "Outside Directors" (as defined below), which specifically identifies the manner in which the Outside Directors of the Board believe that the Executive has not substantially performed his duties, or (ii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company. For purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered "willful" unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. The cessation of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than two-thirds of the members of the Board who are not and have never been employed by the Company or its subsidiaries (the "Outside Directors") at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive in accordance with Section 10(c) of this Agreement and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive has engaged in the conduct described in paragraph (i) or (ii) above, and specifying the particulars thereof in detail. (e) The "Change in Control Date" means the first date during the Agreement Term on which a Change in Control (as defined in Section 2) occurs. Anything in this Agreement to the contrary notwithstanding, if a Change in Control occurs and if the Executive's employment with the Company is terminated prior to the date on which the Change in Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment either (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change in Control or (ii) otherwise arose in connection with or anticipation of a Change in Control, then for all purposes of this Agreement the "Change in Control Date" shall mean the date immediately prior to the date of such termination of employment. (f) "Company" means C&F Financial Corporation, a Virginia corporation. (g) "Coverage Period" means the period of time beginning with the Change in Control Date and ending on the earliest to occur of (i) the Executive's death and (ii) the sixty-first day after the second anniversary of the Change in Control Date. (h) "Disability" means the absence of the Executive from his duties with the Company on a full-time basis for six months as a result of incapacity to serve as the Chief Executive Officer of the Company, including substantially all duties normally considered a part thereof, due to mental or physical illness or injury which is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to the Executive or the Executive's legal representative. If the Company determines in good faith that the Disability of the Executive has occurred, it may give to the Executive written notice in accordance with Section 10(c) of this Agreement of its intention to terminate the Executive's employment. In such event, the Executive's employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the "Disability Effective Date"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of his duties. (i) "Good Reason" means any good faith determination made by the Executive (which determination shall be conclusive) that any of the following has occurred: (i) the occurrence, on or after the Agreement Effective Date and during the Coverage Period, of any of the following: (A) the assignment to the Executive of any duties inconsistent in any material adverse respect with the Executive's position (including status, offices, titles and reporting requirements), authority, duties or responsibilities immediately prior to the Change in Control, or any other action by the Company which results in a diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive in accordance with Section 10(c) of this Agreement; (B) a reduction by the Company in the Executive's rate of annual base salary, benefits (including, without limitation, incentive or bonus pay arrangements, stock plan benefit arrangements, and retirement and welfare plan coverage) and perquisites as in effect immediately prior to the Change in Control or as the same may be increased from time to time thereafter, other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive in accordance with Section 10(c) of this Agreement; (C) the Company's requiring the Executive to be based at any office or location more than 35 miles from the facility where the Executive is located at the time of the Change in Control or the Company's requiring the Executive to travel on Company business to a substantially greater extent than required immediately prior to the Change in Control Date (but determined without regard to travel necessitated by reason of any anticipated Change in Control); (D) any purported termination by the Company of the Executive's employment otherwise than as expressly permitted by this Agreement; (E) any failure by the Company to comply with and satisfy Section 9(c) of this Agreement by obtaining satisfactory agreement from any successor to assume and perform this Agreement; or (F) so long as no Cause for Executive's termination by the Company exists (or would exist assuming the Board made a determination of Cause), a voluntary cessation by the Executive of his employment for any reason during any Window Period. (ii) any event or condition described in paragraph (i) of this Section 1(i) which occurs on or after the Agreement Effective Date, but prior to a Change in Control, but was at the request of a third party who effectuates the Change in Control, notwithstanding that it occurred prior to the Change in Control, but such event or condition shall not be considered to actually have occurred until the Change in Control Date. (j) "Covered Termination" means a termination of Executive's employment during the Coverage Period (i) by the Company for any reason other than Cause or the Executive's Disability or death, or (ii) by the Executive for Good Reason. (k) "Noncovered Termination" means a cessation of Executive's employment which is not a Covered Termination. (l) "Window Period" means any of (i) the 60-day period commencing on the Change in Control Date, (ii) the 60-day period commencing on the first anniversary of the Change in Control Date, and (iii) the 60-day period commencing on the second anniversary of the Change in Control Date. 2. CHANGE IN CONTROL. "Change in Control" means the occurrence, during the Agreement Term, of either an "Acquisition of Controlling Ownership" (as defined in Section 2(a) below), a "Change in the Incumbent Board" (as defined in Section 2(b) below), a "Business Combination" (as defined in Section 2(c) below), or a "Liquidation or Dissolution" (as defined in Section 2(d) below). (a) "Acquisition of Controlling Ownership" means the acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (x) the then outstanding shares of common stock of the Company (the "Outstanding Common Stock") or (y) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Voting Securities"). Notwithstanding the foregoing, for purposes of this Section 2(a), the following acquisitions shall not constitute a Change in Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, or (iv) any acquisition by any corporation pursuant to a transaction which complies with paragraphs (i), (ii) and (iii) of) of this Section 2(c). (b) "Change in the Incumbent Board" means that individuals who, as of November 30, 1997, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board. For this purpose, any individual who becomes a director subsequent to November 30, 1997 whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be thereupon considered a member of the Incumbent Board (with his predecessor thereafter ceasing to be a member), but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board. (c) "Business Combination" means the consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination") unless all of the following occur: (i) all or substantially all of the individuals and entities who were the beneficial owners respectively, of the Outstanding Common Stock and Outstanding Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 60% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries, in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Common Stock and Outstanding Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination, or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination, and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination. (d) "Liquidation or Dissolution" means the approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. 3. OBLIGATIONS OF THE EXECUTIVE TO REMAIN EMPLOYED. The Executive agrees that in the event any person or group attempts a Change in Control, he shall not voluntarily leave the employ of the Company without Good Reason (i) until such attempted Change in Control terminates or (ii) if a Change in Control shall occur, until the Change in Control Date. For purposes of the foregoing clause (i), Good Reason shall be determined as if a Change in Control had occurred when such attempted Change in Control became known to the Board. 4. OBLIGATIONS UPON THE EXECUTIVE'S TERMINATION. (a) Notice of Termination. Any termination of the Executive's employment by the Company or by the Executive, other than by reason of death, shall be communicated by Notice of Termination to the other party hereto given. For purposes hereof: (i) "Notice of Termination" means a written notice given in accordance with Section 10(c) of this Agreement which (A) states whether such termination is for Cause, Good Reason or Disability, (B) indicates the specific termination provision in this Agreement relied upon, if any, (C) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated, and (D) if the Date of Termination is other than the date of receipt of such notice, specifies the termination date. The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason, Cause or Disability shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder. (ii) "Date of Termination" means (A) if the Executive's employment is terminated by reason of Disability, the Disability Effective Date, (B) if the Executive's employment is terminated by the Company for any reason other than Disability, the date of the Executive's receipt of the Notice of Termination or any later date specified therein, as the case may be, and (C) if the Executive's employment is terminated by the Executive for any reason, the date of the Company's receipt of the Notice of Termination or any later date specified therein, as the case may be. (b) Obligations of the Company in a Covered Termination. If the Executive's employment shall cease by reason of a Covered Termination, then the following shall be paid or provided (the payments and benefits described in (i), (ii) and (iii) below may hereinafter sometimes be referred to as the "Change in Control Benefit" or "Change in Control Benefits"): (i) the Company shall pay or cause to be paid in cash to the Executive in twelve (12) consecutive quarterly installments, with interest at the applicable federal rate (as defined in Section 1274(d) of the Internal Revenue Code of 1986, as amended (the "Code")) determined at the Change in Control Date on the unpaid balance paid at the same time on each installment payment other than the first payment, with the first of such installments being paid not later than 30 days after the Date of Termination, (or if the Executive requests and the Company agrees in a lump sum within 30 days after the Date of Termination) and with the aggregate payments (excluding interest) totaling an amount equal to the product of (A) two and one-half and (B) the sum of the Executive's (1) highest aggregate annual base salary from the Company and its affiliated companies in effect at any time during the 24 month period ending on the Change in Control Date and (2) highest aggregate annual bonuses (including any deferrals thereof) from the Company and its affiliated companies payable for the Company's three fiscal years immediately preceding the fiscal year which includes the Change in Control Date; (ii) for three years after the Executive's Date of Termination, or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Company shall continue or cause to be continued benefits to the Executive and/or the Executive's family at least equal to those under the Welfare Benefit Plans. If the Executive becomes reemployed with another employer and is eligible to receive medical or other welfare benefits under another employer-provided plan, the medical and other welfare benefits described herein shall be secondary to those provided under such other plan during such applicable period of eligibility. For purposes of determining eligibility (but not the time of commencement of benefits) of the Executive for any retiree benefits pursuant to such plans, practices, programs and policies, the Executive shall be considered to have remained employed until three years after the Date of Termination and to have retired on the last day of such period. For purposes hereof, the term "Welfare Benefit Plan" means the welfare benefit plans, practices, policies and programs provided by the Company and its affiliates (including, without limitation, any medical, prescription, dental, vision, disability, life, accidental death and travel accident insurance plans and split dollar insurance programs) to the extent applicable generally to other peer executives of the Company and its affiliates, but in no event shall such plans, practices, policies and programs provide the Executive with benefits which are less favorable, in the aggregate, than the most favorable of such plans, practices, policies and programs in effect for the Executive at any time during the one year period immediately preceding the Change in Control Date or, if more favorable to the Executive, those provided generally at any time after the Change in Control Date to other peer executives of the Company and its affiliated companies; (iii) if the Executive so requests in writing within one year after the Date of Termination, the Company shall purchase the residence which the Executive was using as his primary residence at the Change in Control Date, or such later date to which the Company consents in writing in its sole discretion, for an amount equal to its appraised fair market value at the time of purchase, where the appraisal is performed by an appraiser who is mutually agreeable to the Executive and the Company or otherwise is selected by the Executive from a list of not less than five appraisers selected by the Company and not doing any substantial business with the Company; and (iv) to the extent not theretofore paid or provided, the Company shall timely pay or cause to be paid or provide or cause to be provided to the Executive any other amounts or benefits required to be paid or provided or which the Executive is eligible to receive under any compensation arrangement, plan, program, policy or practice or contract or agreement of the Company and its affiliated companies (such other amounts and benefits shall be hereinafter referred to as the "Other Benefits"). (c) Obligations of the Company in a Noncovered Termination. If the Executive's employment shall cease by reason of a Noncovered Termination, this Agreement shall terminate without further obligations to the Executive other than the obligation timely to pay or cause to be paid or provide or cause to be provided to the Executive his Other Benefits. 5. FULL SETTLEMENT. (a) No Offset or Mitigation. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and such amounts shall not be reduced whether or not the Executive obtains other employment. (b) Executive's Expenses in Dispute Resolution. The Company agrees to pay, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur as a result of a contest (in which the Executive substantially prevails) by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), plus in each case interest on any delayed payment at the lower of (i) the Crestar Bank Prime Rate or (ii) the applicable Federal mid-term rate provided for in Section 1274(d), compounded semi-annually, of the Code. (c) Payment prior to Dispute Resolution. If there shall be any dispute between the Company and the Executive in the event of any termination of Executive's employment, then, unless and until there is a final, nonappealable judgment by a court of competent jurisdiction declaring that such termination was a Noncovered Termination, that the determination by the Executive of the existence of Good Reason was not made in good faith, or that the Company is not otherwise obligated to pay any amount or provide any benefit to the Executive and his dependents or other beneficiaries, as the case may be, under Section 4(b), the Company shall pay all amounts, and provide all benefits, to the Executive and his dependents or other beneficiaries, as the case may be, that the Company would be required to pay or provide pursuant to Section 4(b) as though such termination were not a Noncovered Termination. Notwithstanding the foregoing, the Company shall not be required to pay any disputed amounts pursuant to this Section 5(c) except upon receipt of an adequate bond, letter of credit or undertaking by or on behalf of the Executive to repay all such amounts to which the Executive is ultimately adjudged by such court not to be entitled. 6. PAYMENT LIMITATIONS. (a) Excise Tax Payment Limitation. Notwithstanding anything contained in this Agreement or any other agreement or plan to the contrary, the payments and benefits provided to, or for the benefit of, the Executive under this Agreement or under any other plan or agreement which became payable or are taken into account as a result of the Change in Control (the "Payments") shall be reduced (but not below zero) to the extent necessary so that no payment to be made, or benefit to be provided, to the Executive or for his benefit under this Agreement or any other plan or agreement shall be subject to the imposition of an excise tax under Section 4999 of the Code (such reduced amount is hereinafter referred to as the "Limited Payment Amount"). Unless the Executive and the Company shall otherwise agree, the Company shall reduce or eliminate the Payments to the Executive by first reducing or eliminating those payments or benefits which are not payable in cash and then by reducing or eliminating cash payments, in each case in reverse order beginning with payments or benefits which are to be paid the farthest in time from the Determination (as hereinafter defined). Any notice given by the Executive pursuant to the preceding sentence shall take precedence over the provisions of any other plan, arrangement or agreement governing Executive's rights and entitlements to any benefits or compensation. (b) Excise Tax Payment Limitation Determinations. All determinations required to be made under this Section 6 shall be made by the Company's public accounting firm (the "Accounting Firm"). The Accounting Firm shall provide its calculations, together with detailed supporting documentation, both to the Company and the Executive within fifteen days after the receipt of notice from the Company that there has been a Payment (or at such earlier times as is requested by the Company) and, with respect to any Limited Payment Amount, a reasonable opinion to the Executive that he is not required to report any excise tax on his federal income tax return with respect to the Limited Payment Amount (collectively, the "Determination"). In the event that the Accounting Firm is serving as an accountant or auditor for the individual, entity or group effecting the Change in Control, the Executive shall appoint another nationally recognized public accounting firm to make the determination required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees, costs and expenses (including, but not limited to, the costs of retaining experts) of the Accounting Firm shall be borne by the Company. The Determination by the Accounting Firm shall be binding upon the Company and the Executive (except as provided in Section 6(c) below). (c) Excise Tax Excess Payments Considered a Loan. If it is established pursuant to a final determination of a court or an Internal Revenue Service (the "IRS") proceeding which has been finally and conclusively resolved, that Payments have been made to, or provided for the benefit of, the Executive by the Company, which are in excess of the limitations provided in Section 6(a) (hereinafter referred to as an "Excess Payment"), such Excess Payment shall be deemed for all purposes to be a loan to the Executive made on the date the Executive received the Excess Payment and the Executive shall repay the Excess Payment to the Company on demand, together with interest on the Excess Payment at the applicable federal rate (as defined in Section 1274(d) of the Code) from the date of Executive's receipt of such Excess Payment until the date of such repayment. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the Determination, it is possible that Payments which will not have been made by the Company should have been made (an "Underpayment"), consistent with the calculations required to be made under this Section 6. In the event that it is determined (i) by the Accounting Firm, the Company (which shall include the position taken by the Company, or together with its consolidated group, on its federal income tax return) or the IRS or (ii) pursuant to a determination by a court, that an Underpayment has occurred, the Company shall pay an amount equal to such Underpayment to the Executive within ten days of such determination together with interest on such amount at the applicable federal rate from the date such amount would have been paid to the Executive until the date of payment. (d) Banking Payment Limitation. Notwithstanding anything contained in this Agreement or any other agreement or plan to the contrary, the payments and benefits provided to, or for the benefit of, the Executive under this Agreement or under any other plan or agreement shall be reduced (but not below zero) to the extent necessary so that no payment to be made, or benefit to be provided, to the Executive or for his benefit under this Agreement or any other plan or agreement shall be in violation of the golden parachute and indemnification payment limitations and prohibitions of 12 CFR Section 359. 7. TERMINATION OF AGREEMENT. This Agreement shall be effective as of the Agreement Effective Date and shall normally continue until the later of the Agreement Regular Termination Date or, if a Change in Control has occurred, until the end of the Coverage Period. Notwithstanding the foregoing, this Agreement shall terminate in any event upon the Executive's cessation of employment in a Noncovered Termination. 8. CONFIDENTIAL INFORMATION. (a) No Disclosure by Executive. The Executive shall hold in a fiduciary capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. (b) Remedies for Breach. It is recognized that damages in the event of breach of Section 8(a) above by the Executive would be difficult, if not impossible, to ascertain, and it is therefore specifically agreed that the Company, in addition to and without limiting any other remedy or right it may have, shall have the right to an injunction or other equitable relief in any court of competent jurisdiction, enjoining any such breach. The existence of this right shall not preclude the Company from pursuing any other rights and remedies at law or in equity which it may have. (c) Breach Not Basis to Withhold Payment. In no event shall an asserted violation of the provisions of this Section 8 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement. 9. BENEFIT AND SUCCESSORS. (a) Executive's Benefit. This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die and any amount remains payable hereunder after his death, any such amount, unless otherwise agreed by the Company or provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee or other designee of such payment or, if there is no such designee, the Executive's estate. (b) Company's Benefit. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. (c) Assumption by Successor to Company. The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. 10. MISCELLANEOUS. (a) Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Virginia, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. (b) Amendment. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. (c) Notices. All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to the Executive: Larry G. Dillon If to the Company: C&F Financial Corporation James Hudson, III, Esquire Counsel Hudson and Bondurant, P.C. 826 Main Street, P. O. Box 231 West Point, VA 23181 or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. (d) Severability. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (e) Tax Withholding. The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. (f) Waiver. The Executive's or the Company's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. (g) Executive's Employment. The Executive and the Company acknowledge that, except as may otherwise be provided under any other written agreement between the Executive and the Company, the employment of the Executive by the Company is "at will" and, subject to paragraph (ii) of Section 1(i) hereof deeming a termination to have occurred on or after the occurrence of a Change in Control Date, the Executive's employment and/or this Agreement may be terminated by either the Executive or the Company at any time prior to the Change in Control Date, in which case the Executive shall have no further rights under this Agreement. (h) Nonexclusivity of Rights. Except as expressly provided in Section 6, nothing in this Agreement shall prevent or limit the Executive's continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify, nor shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or subsequent to the Executive's termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement. (i) Statutory References. Any reference in this Agreement to a specific statutory provision shall include that provision and any comparable provision or provisions of future legislation amending, modifying, supplementing or superseding the referenced provision. (j) Nonassignability. This Agreement is personal to the Executive, and without the prior written consent of the Company, no right, benefit or interest hereunder shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, except by will or the laws of descent and distribution, and any attempt thereat shall be void; and no right, benefit or interest hereunder shall, prior to receipt of payment, be in any manner liable for or subject to the recipient's debts, contracts, liabilities, engagements or torts. (k) Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be considered an original and all of which together shall constitute one agreement. (l) Employment with Affiliates. Employment with the Company for purposes of this Agreement shall include employment with any corporation or other entity in which the Company has a direct or indirect ownership interest of 50% or more of the total combined voting power of the then outstanding securities of such corporation or other entity entitled to vote generally in the election of directors or which has a direct or indirect ownership interest of 50% or more of the total combined voting power of the then outstanding securities of the Company entitled to vote generally in the election of directors. IN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written. /s/ Larry G. Dillon ---------------------------------- LARRY G. DILLON, Executive C&F FINANCIAL CORPORATION By /s/ J.P. Causey Jr. --------------------------------- Name: ------------------------------- Its Chairman Compensation Committee -------------------------------- FIVE YEAR FINANCIAL SUMMARY ------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------------------------------------------------ Selected Year-End Balances: Total assets $278,105,969 $256,671,312 $238,995,329 $189,672,758 $181,803,801 Total capital 31,800,533 32,214,509 31,818,296 28,809,166 26,724,571 Total loans (net) 154,744,620 136,732,017 110,012,320 102,649,919 101,687,193 Total deposits 231,513,152 216,422,556 204,001,334 158,811,959 153,751,531 ------------------------------------------------------------------------------------------------------------------------ Summary of Operations: Interest income 19,763,048 18,332,998 15,686,897 13,649,428 13,631,633 Interest expense 8,002,301 7,667,619 6,526,880 4,861,516 4,693,360 ------------------------------------------------------------------------------------------------------------------------ Net interest income 11,760,747 10,665,379 9,160,017 8,787,912 8,938,273 Provision for loan losses 330,000 30,000 -- 7,831 500,000 ------------------------------------------------------------------------------------------------------------------------ Net interest income after provision for loan losses 11,430,747 10,635,379 9,160,017 8,780,081 8,438,273 Other income 6,657,608 4,678,915 1,233,267 996,654 805,208 Operating expenses 11,537,565 10,294,220 6,126,722 4,867,502 4,776,934 ------------------------------------------------------------------------------------------------------------------------ Income before taxes 6,550,790 5,020,074 4,266,562 4,909,233 4,466,547 Income tax expense 1,613,963 958,900 890,630 1,170,839 1,020,335 ------------------------------------------------------------------------------------------------------------------------ Net income $ 4,936,827 $ 4,061,174 $ 3,375,932 $ 3,738,394 $ 3,446,212 ------------------------------------------------------------------------------------------------------------------------ Per share(1) Earnings per common share -- assuming dilution $2.50 $1.84 $1.51 $1.67 $1.55 Dividends .70 .61 .59 .55 .49 ------------------------------------------------------------------------------------------------------------------------ Weighted average number of shares -- assuming dilution 1,976,378 2,213,000 2,236,478 2,233,953 2,231,540 ------------------------------------------------------------------------------------------------------------------------ (1) Per share data has been restated to reflect the two-for-one stock split in March, 1994. SIGNIFICANT RATIOS ---------------------------------------------------------------------------------------------- 1997 1996 1995 ---------------------------------------------------------------------------------------------- Return on average assets 1.90% 1.65% 1.60% Return on average equity 16.08 12.66 11.08 Dividend payout ratio 27.75 33.62 38.97 Average equity to average assets 11.81 13.06 14.44 ---------------------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of C&F Financial Corporation and subsidiary (the "Corporation"). This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to the Consolidated Financial Statements. Overview Net income totaled $4.9 million in 1997, an increase of 21.6% over 1996. In 1996, net income totaled $4.1 million, a 20.3% increase over 1995. Earnings per share were $2.50, $1.84, and $1.51 in 1997, 1996, and 1995, respectively. The increase in earnings per share was a result of higher net income and the repurchase of 119,803 shares of the Corporation's Common Stock in October of 1996 and 204,683 shares of the Corporation's Common Stock on April 4, 1997. Profitability as measured by the Corporation's return on average equity (ROE) was 16.08% in 1997, up from 12.66% in 1996, and 11.08% in 1995. Another key indicator of performance, the return on average assets (ROA) for 1997 was 1.90%, compared to 1.65% and 1.60% for 1996 and 1995, respectively. 13 TABLE 1: AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES The following table shows the average balance sheets for each of the years ended December 31, 1997, 1996 and 1995. In addition, the amounts of interest earned on earning assets, with related yields and interest on interest-bearing liabilities, together with the rates, are shown. Loans include loans held for sale. Also, loans placed on a non-accrual status are included in the balances and were included in the computation of yields, upon which they had an immaterial effect. Interest on tax-exempt securities is on a taxable equivalent basis, which was computed using the federal corporate income tax rate of 34% for all three years. ------------------------------------------------------------------------------------------------------------- 1997 1996 1995 ----------------------- ------------------------ ------------------------ Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ (Dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate ------------------------------------------------------------------------------------------------------------- Assets Securities: Taxable $ 37,309 $ 2,737 7.34% $ 49,102 $ 3,595 7.32% $ 54,858 $ 3,940 7.18% Tax-exempt 39,554 3,388 8.57 41,015 3,629 8.85 28,967 2,658 9.18 ------------------------------------------------------------------------------------------------------------- Total securities 76,863 6,125 7.97 90,117 7,224 8.02 83,825 6,598 7.87 Loans, net 165,168 14,656 8.87 136,089 12,139 8.92 107,422 9,640 8.97 Interest-bearing deposits in other banks 1,251 68 5.44 3,178 172 5.41 3,660 214 5.85 Federal funds sold -- -- -- -- -- -- 2,423 139 5.74 ------------------------------------------------------------------------------------------------------------- Total earning assets 243,282 $20,849 8.57% 229,384 $19,535 8.52% 197,330 $16,591 8.41% Reserve for loan losses (2,032) (1,915) (1,912) Total non-earning assets 18,708 18,384 15,419 ------------------------------------------------------------------------------------------------------------- Total assets $259,958 $245,853 $210,837 ------------------------------------------------------------------------------------------------------------- Liabilities and Shareholders' Equity Time and savings deposits: Interest-bearing deposits $ 34,594 $ 890 2.57% $ 33,256 $ 891 2.68% $ 31,369 $ 902 2.88% Money market deposits 23,416 767 3.28 20,468 671 3.28 18,946 639 3.37 Savings accounts 33,037 1,058 3.20 31,550 986 3.13 28,266 898 3.18 Certificates of deposit, $100M or more 14,137 466 3.30 13,774 488 3.54 10,227 392 3.83 Other certificates of deposit 82,655 4,493 5.44 80,412 4,418 5.49 67,391 3,668 5.44 ------------------------------------------------------------------------------------------------------------- Total time and savings deposits 187,839 7,674 4.09 179,460 7,454 4.15 156,199 6,499 4.16 ------------------------------------------------------------------------------------------------------------- Borrowings 6,441 328 5.09 4,505 214 4.75 848 28 3.30 ------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 194,280 8,002 4.12 183,965 7,668 4.17 157,047 6,527 4.16 ------------------------------------------------------------------------------------------------------------- Demand deposits 31,449 26,741 20,749 Other liabilities 3,533 3,046 2,586 ------------------------------------------------------------------------------------------------------------- Total liabilities 229,262 213,752 180,382 Shareholders' equity 30,696 32,101 30,455 ------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $259,958 $245,853 $210,837 ------------------------------------------------------------------------------------------------------------- Net interest income $12,847 $11,867 $10,064 ------------------------------------------------------------------------------------------------------------- Interest rate spread 4.45 4.35 4.25 ------------------------------------------------------------------------------------------------------------- Interest expense to average earning assets 3.29 3.34 3.31 ------------------------------------------------------------------------------------------------------------- Net interest margin 5.28% 5.17% 5.10% ------------------------------------------------------------------------------------------------------------- 14 Results of Operations Net Interest Income During 1997, net interest income, on a tax equivalent basis, increased 8% to $12.8 million from $11.9 million in 1996. Interest income was up $1.3 million and interest expense was up $334,000. The increase in interest income was primarily due to a 21.4% increase in average outstanding loans. This was partially offset, however, by a 14.7% decline in securities. This decline is due to both securities being called as well as to management's strategic decision to invest more funds into higher yielding loans. For 1997, the average yield on earning assets increased slightly to 8.57% from 8.52% in 1996. The average balance of interest bearing liabilities increased 5.6% while the rate paid on these liabilities decreased to 4.12% from 4.17% in 1996. The Corporation's net interest margin increased to 5.28% in 1997 from 5.17% in 1996. This increase was a result of an increase in the Corporation's interest rate spread to 4.45% for 1997 from 4.35% in 1996. The increase in the interest rate spread was mainly attributed to the increase in higher yielding loans offset by the decrease in lower yielding securities. Also, the cost of interest bearing liabilities decreased slightly to 4.12% in 1997 from 4.17% in 1996. Net interest income in 1996, on a tax equivalent basis, increased 16.8% to $11.9 million from $10.1 million in 1995. This was a result of a $2.9 million increase in interest income which exceeded a $1.1 million increase in interest expense. This was largely due to an approximate 16% increase in average earning assets and an increase in the yield on average earning assets to 8.52% in 1996 from 8.41% in 1995. The rate paid on interest-bearing liabilities increased slightly in 1996 to 4.17% from 4.16% in 1995. The increase in average earning assets was funded by the approximate 15% growth in deposits during 1996. The increase in the yield on average earning assets was a result of the investment of the majority of the deposit growth in higher yielding loans rather than lower yielding securities. The Corporation's net interest margin increased slightly in 1996 to 5.17% from 5.10% in 1995. This was a result of a slight increase in the interest rate spread of .10%. The increase in the interest rate spread is a result of management's efforts to invest available funds into higher yielding loans rather than securities and to manage the cost of deposits. TABLE 2: RATE-VOLUME RECAP Interest income and expense are affected by fluctuations in interest rates, by changes in the volumes of earning assets and interest-bearing liabilities and by the interaction of rate and volume factors. The following analysis shows the direct causes of the year-to-year changes in the components of net interest earnings on a taxable equivalent basis. The rate and volume variances are calculated by a formula prescribed by the Securities and Exchange Commission. Rate/volume variances, the third element in the calculation, are not shown separately, 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 non- accrual loans and loans held for sale. 15 ---------------------------------------------------------------------------------------------------------- 1997 from 1996 1996 from 1995 ---------------------------------------------------------------------------------------------------------- Increase (Decrease) Increase (Decrease) ------------------- Total ------------------- Total Due to Increase Due to Increase (Dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease) ---------------------------------------------------------------------------------------------------------- Interest income: Loans $2,581 $ (64) $ 2,517 $2,557 $ (58) $2,499 Investment securities: Taxable (865) 7 (858) (420) 75 (345) Tax-exempt (127) (114) (241) 1,069 (98) 971 ---------------------------------------------------------------------------------------------------------- Total investment securities (992) (107) (1,099) 649 (23) 626 ---------------------------------------------------------------------------------------------------------- Federal funds sold -- -- -- (69) (70) (139) Interest-bearing deposits in other banks (105) 1 (104) (27) (15) (42) ---------------------------------------------------------------------------------------------------------- Total interest income 1,484 (170) 1,314 3,110 (166) 2,944 ---------------------------------------------------------------------------------------------------------- Interest expense: Time and savings deposits: Interest-bearing deposits 35 (36) (1) 53 (64) (11) Money market deposit accounts 97 (1) 96 50 (18) 32 Savings accounts 47 25 72 102 (14) 88 Certificates of deposit, $100M or more 13 (35) (22) 128 (32) 96 Other certificates of deposit 122 (47) 75 715 35 750 ---------------------------------------------------------------------------------------------------------- Total time and savings deposits 314 (94) 220 1048 (93) 955 Other borrowings 98 16 114 169 17 186 ---------------------------------------------------------------------------------------------------------- Total interest expense 412 (78) 334 1,217 (76) 1,141 ---------------------------------------------------------------------------------------------------------- Change in net interest income $1,072 $ (92) $ 980 $1,893 $ (90) $1,803 ---------------------------------------------------------------------------------------------------------- Interest Sensitivity An important element of earnings performance and the maintenance of sufficient liquidity is proper management of the interest sensitivity position ("GAP") of the Bank. The interest sensitivity GAP is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. This GAP can be managed by repricing assets and liabilities, which can be affected by replacing an asset or liability at maturity or by adjusting the interest rate during the life of the asset or liability. Matching the amounts of assets and liabilities maturing in the same interval helps to reduce interest rate risk and to minimize the impact on net interest income in periods of rising or falling rates. The Corporation's Asset Liability Committee (the "ALM Committee") reviews financial data and sets asset-liability management goals and objectives. The ALM Committee uses computer simulations to measure the effect of various interest rate scenarios on net interest income. This modeling reflects interest rate changes and the related impact on net income over specified time horizons. The Corporation's interest rate sensitivity at December 31, 1997 reflects that it is positioned more favorably for a lower interest rate environment. At December 31, 1997, the net interest earning assets and interest-bearing liabilities repricing in a one-year period as a percent of earning assets was a cumulative net liability sensitivity of 20.02%. In other words, based on the December 31, 1997 balance sheet, the amount of liabilities repricing in 1998 in excess of the amount of assets repricing in 1998, will be $51,545 million, or 20.02% of all earning assets. TABLE 3: INTEREST SENSITIVITY ANALYSIS The interest sensitivity position is indicated by the volume of rate sensitive assets less rate sensitive liabilities. This difference is generally referred to as the interest sensitivity gap. The nature of the gap indicates how future interest rate changes may affect net interest income. The table below shows the Corporation's interest sensitivity position at December 31, 1997. Loans placed on a non-accrual status are not included in the balances. Repricing dates may differ from maturity dates for certain assets due to prepayment assumptions. 16 ------------------------------------------------------------------------------------------------------------ Interest Sensitive Periods Within 91-365 1-5 Over (Dollars in thousands) 90 Days Days Years 5 Years Total ------------------------------------------------------------------------------------------------------------ December 31, 1997 Earning assets: Loans, net of unearned income $ 74,204 $ 9,741 $ 48,745 $ 48,270 $ 180,960 Securities 3,252 3,398 9,185 59,590 75,425 Federal funds sold and other short-term investments 1,027 -- -- -- 1,027 ------------------------------------------------------------------------------------------------------------ Total earning assets 78,483 13,139 57,930 107,860 257,412 ------------------------------------------------------------------------------------------------------------ Interest-bearing liabilities: Interest-bearing transaction accounts 7,664 15,328 15,327 -- 38,319 Savings accounts 6,658 13,316 13,315 -- 33,289 Money market deposit accounts 4,699 9,399 9,399 -- 23,497 Certificates of deposit, $100M or more 3,650 8,804 2,988 -- 15,442 Other certificates of deposit 18,895 45,418 21,358 -- 85,671 Borrowings 9,336 -- -- -- 9,336 ------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 50,902 92,265 62,387 -- 205,554 ------------------------------------------------------------------------------------------------------------ Period gap 27,581 (79,126) (4,457) 107,860 -- Cumulative gap $ 27,581 $(51,545) $(56,002) $ 51,858 -- Ratio of cumulative gap to total earning assets 10.71% (20.02)% (21.76)% 20.15% -- ------------------------------------------------------------------------------------------------------------ Non-Interest Income 1997 vs. 1996 Non-interest income increased by $2.0 million or 42.3% over 1996. The majority of increase was attributed to an approximate $1.4 million increase in gain on the sale of loans resulting from an increase in loan production at C&F Mortgage Corporation (the "Mortgage Corporation"). Loan closings totaled $286 million in 1997 compared to $174 million in 1996, and $2 million in 1995. Other service charges and fees increased $322,000, or 48.4% over 1996 due to increased activity at both Citizens and Farmers Bank (the "Bank") and the Mortgage Corporation. At the Mortgage Corporation, the increase is directly correlated to the increase in loan closings, while at the Bank the increase was attributed to, among other things, fees associated with the Bank's "check" and credit card programs as well as letter of credit fees. Other income increased by $258,000, or 75%, over 1996 primarily the result of improvements at all three of the Bank's subsidiaries. At the Mortgage Corporation, the increase was again directly related to loan production; during 1997, C&F Investment Services, Inc. saw an increase in income as a result of stronger demand for their services both from current customers as well as many new ones. In January 1997, the Bank and Mortgage Corporation joined together to form the Corporation's own title agency using its subsidiary, C&F Title Agency, Inc. (the "Title Agency"). Prior to this, the Title Agency owned a small portion of a jointly owned agency; however, that partial ownership interest was sold and a wholly owned agency was formed. With the amount of loan production at both the Bank and the Mortgage Corporation, owning our own title agency made sense from an income standpoint and a service one. The first full year of operations for the Title Agency has proven this decision to be a good one. 1996 vs. 1995 Non-interest income increased by $3.4 million, or 279.4% over 1995. Gain on the sale of loans increased by $2.7 million or 100% over 1995. The Mortgage Corporation started business in December of 1995. As such, 1996 was the first full year of operations. Loan closings at the Mortgage Corporation totaled $174 million in 1996 compared to $2 million in 1995. Service charges on deposit accounts increased $146,000, or 17.5% over 1995 due largely to an increase in overdraft fee income, the result of overall deposit growth. Other service charges and fees increased $433,000, or 186.1%, over 1995. This increase can be attributed to fees charged in connection with the origination of loans at the Mortgage Corporation which increased by $356,000 during 1996. Other income increased by $179,000, or 109.0%, over 1995. This increase, among other things, was a result of an increase in title insurance fees and in fees generated by C&F Investment Services, Inc. 17 Non-Interest Expense 1997 vs. 1996 Non-interest expense increased $1.2 million, or 12.1%, over 1996. $358,000 of this increase resulted from increased salaries and employee benefits costs. The majority of this increase can be attributed to general pay increases along with the addition of new employees. Other expenses increased by $912,000. At the Mortgage Corporation, other expenses increased by $493,000 which was a result of increased loan closings during 1997. At the Bank, other expenses increased by approximately $245,000. This increase was a result of, among other things, increased employee training costs, costs associated with the Bank's "check" and credit card programs and costs associated with technology. During the year, the Bank upgraded the majority of the personal computers used by its employees and also incurred costs associated with the year 2000 issue. Other expenses also increased as a result of general corporate expenses. During 1997, the Corporation incurred expenses associated with listing on the Nasdaq National Market System and other expenses relating to increasing the awareness of the Corporation's stock. The Bank utilizes and is dependent upon data processing systems and software to conduct its business. The data processing systems include various software packages licensed to the Bank by outside vendors and a mainframe processing system which are run on in-house computer networks. In 1997, the Bank initiated a review and assessment of all hardware and software to confirm that it will function properly in the year 2000. The Bank's mainframe software vendor and the majority of the other vendors which have been contacted have indicated that their hardware and/or software will be Year 2000 compliant. Testing will be performed for compliance. While there may be some additional expenses incurred during the next two years, Year 2000 compliance is not expected to have a material effect on the Corporation's consolidated financial statements. 1996 vs. 1995 Non-interest expense increased $4.2 million or 68.0%, in 1996 over 1995. $2.7 million of this increase resulted from salaries and employee benefits with $2.1 million of this increase related to the Mortgage Corporation. As previously mentioned, 1996 was the first full year of operations for the Mortgage Corporation. Another $300,000 of this increase is a result of the new branches opened and acquired during 1995. The Corporation opened one new branch and acquired two branches during 1995. 1996 was also the first full year of operation for these branches. The remaining increase is attributed to general pay increases and continued growth of the Corporation. Occupancy expense increased $741,000, or 69.9%, over 1995. Occupancy expenses at the Mortgage Corporation increased $454,000. The majority of the remainder of the increase is attributable to increases in depreciation expense and expenses associated with computer hardware and software maintenance contracts. As previously mentioned, two branches were acquired and one new branch was opened during 1995. 1996 was the first full year of depreciation associated with these branches. In addition, the Bank purchased a new mainframe computer and installed five new ATMs during 1996. This attributed to both higher depreciation and maintenance costs. Goodwill amortization increased $221,000, or 359.3%, over 1995. This was a result of a full year's amortization of the goodwill associated with the two branches acquired in 1995 and the additional amortization of goodwill associated with the deposits purchased during 1996. Bank stock tax decreased $163,000, or 44.3%, over 1995. The bank stock tax for 1996 is more in line with the 1994 expense. In 1995, the bank stock tax increased due to a re-calculation of the previous three years' state returns which resulted in taxes being due. FDIC premiums decreased $183,000, or 98.9%, over 1995 as a result of premium rate reductions. Other expenses increased $812,000, or 66.6%, over 1995. $591,000 of this increase is attributed to the Mortgage Corporation. The remaining increase can be attributed to an increase in marketing expense and overall growth of the Corporation. The Corporation engaged in a major advertising campaign during 1996 in an effort to attract new customers in its current trade areas. 18 Income Taxes Applicable income taxes on 1997 earnings amounted to $1,614,000, resulting in an effective tax rate of 24.6% compared to $959,000, or 19.0%, in 1996, and $891,000, or 20.9%, in 1995. The increase in the effective tax rate is a result of the increase in earnings subject to a 34% tax rate versus earnings subject to no taxes such as certain loans to municipalities or investments in obligations of state and political subdivisions. TABLE 4: ALLOWANCE FOR LOAN LOSSES ------------------------------------------------------------------------------------------------------------- Year Ended December 31, (Dollars in thousands) 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------------------------------------- Reserve, beginning of period $ 1,927 $ 1,914 $ 1,895 $ 1,895 $ 1,441 Provision for loan losses 330 30 -- 8 500 Loans charged off: Real estate - mortgage 12 -- -- 18 5 Real estate - construction -- -- -- -- -- Commercial, financial and agricultural 3 4 4 7 14 Consumer 12 25 4 1 33 ------------------------------------------------------------------------------------------------------------- Total loans charged off 27 29 8 26 52 Recoveries of loans previously charged off: Real estate - mortgage -- 1 19 -- -- Real estate - construction -- -- -- -- -- Commercial, financial and agricultural -- 11 -- 8 Consumer 4 -- 8 10 6 ------------------------------------------------------------------------------------------------------------- Total recoveries 4 12 27 18 6 Net loans charged off 23 17 (19) 8 46 ------------------------------------------------------------------------------------------------------------- Balance, end of period $ 2,234 $ 1,927 $ 1,914 $ 1,895 $ 1,895 ------------------------------------------------------------------------------------------------------------- Ratio of net charge-offs to average total loans outstanding during period .01% .01% .01% .01% .05% ------------------------------------------------------------------------------------------------------------- TABLE 5: ALLOCATION OF ALLOWANCE FOR POSSIBLE LOAN LOSSES The allowance for loan losses is a general allowance applicable to all loan categories; however, management has allocated the allowance to provide an indication of the relative risk characteristics of the loan portfolio. The allocation is an estimate and should not be interpreted as an indication that charge-offs in 1998 will occur in these amounts, or that the allocation indicates future trends. The allocation of the allowance at December 31 for the years indicated and the ratio of related outstanding loan balances to total loans are as follows: ------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------------------------------------- Allocation of allowance for possible loan losses, end of year: ------------------------------------------------------------------------------------------------------------- Real estate - mortgage $ 692 $ 873 $ 786 $ 751 $ 698 Real estate - construction 89 69 34 26 51 Commercial, financial and agricultural 926 733 352 260 236 Equity lines 71 62 60 62 65 Consumer 167 160 93 69 51 Unallocated 289 30 589 727 794 ------------------------------------------------------------------------------------------------------------- Balance, December 31 $ 2,234 $ 1,927 $ 1,914 $ 1,895 $ 1,895 ------------------------------------------------------------------------------------------------------------- Ratio of loans to total year-end loans: Real estate - mortgage 57% 62% 70% 71% 68% Real estate - construction 3 2 2 1 3 Commercial, financial and agricultural 31 26 19 19 20 Equity lines 4 5 5 6 6 Consumer 5 5 4 3 3 ------------------------------------------------------------------------------------------------------------- 100% 100% 100% 100% 100% ------------------------------------------------------------------------------------------------------------- 19 Asset Quality-Allowance/Provision For Loan Losses The allowance is to provide for potential losses inherent in the loan portfolio. Among other factors, management considers the Corporation's historical loss experience, the size and composition of the loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits, and current and anticipated economic conditions. There are additional risks of future loan losses which cannot be precisely quantified or attributed to particular loans or classes of loans. Since those risks include general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The allowance is also subject to regulatory examinations and determination as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies. In 1997, the Corporation had $330,000 in provision expense compared to $30,000 in provision expense in 1996 and no provision expense in 1995. The increase in provision is a result of management's recognition of risks associated with the reduction in residential real estate loans and increasing the volume of commercial and commercial real estate loans. Loans charged off during 1997 amounted to $27,000 compared to $29,000 in 1996 and $8,000 in 1995. Recoveries amounted to $4,000, $12,000, and $27,000 in 1997, 1996, and 1995, respectively. The ratio of net charge-offs to average outstanding loans was .01% in 1997, 1996, and 1995. Management feels that the reserve is adequate to absorb any losses on existing loans which may become uncollectible. Table 4 presents the Corporation's loan loss and recovery experience for the past five years. Non-Performing Assets Total non-performing assets, which consist of the Corporation's non-accrual loans and real estate owned was $941,000 at December 31, 1997, an increase of $416,000 from December 31, 1996. The increase over 1996 was a result of a $444,000 loan which was foreclosed on by the Mortgage Corporation. The property which collateralizes the loan is for sale and no significant loss is expected. The Corporation places a loan on non-accrual status when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of both principal and interest is doubtful. Corporate policy is to place loans on non-accrual status if principal or interest is past due for 90 days or more unless the debt is both well secured and in the process of being collected. For 1997, $37,000 in gross interest income would have been recorded if non-accrual loans had been current throughout the period outstanding. For the period ended December 31, 1997, interest income received on non-accrual loans was $14,000. Table 6 summarizes non-performing loans for the past five years. TABLE 6: NON-PERFORMING ASSET ACTIVITY ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------------------------------------ Non-accrual loans $ 497 $ 525 $ 907 $1,331 $1,567 Real estate owned 444 -- -- -- -- ------------------------------------------------------------------------------------------------------------ Total non-performing assets 941 525 907 1,331 1,567 ------------------------------------------------------------------------------------------------------------ Principal and/or interest past due for 90 days or more $ 768 $ 260 $ 180 $ 412 $1,096 ------------------------------------------------------------------------------------------------------------ Non-performing loans to total loans .31% .38% .81% 1.27% 1.55% Allowance for loan losses to total loans 1.42 1.39 1.71 1.81 1.88 Allowance for loan losses to non-performing loans 449.30 367.05 211.03 142.37 120.93 Non-performing assets to total assets .34% .20% .38% .70% .86% ------------------------------------------------------------------------------------------------------------ 20 Financial Condition Summary A financial institution's primary sources of revenue are generated by its earning assets, while its major expenses are produced by the funding of those assets with interest-bearing liabilities. Effective management of these sources and uses of funds is essential in attaining a financial institution's maximum profitability while maintaining a minimum amount of risk. At the end of 1997, the Corporation had total assets of $278 million, up 8.4% over the previous year-end. In 1996, there was an increase of 7.4% in total assets over year-end 1995. Asset growth in 1997 and 1996 is attributed to increases in loans held for sale which resulted from increased loan closings at the Mortgage Corporation and the overall expansion and growth of the Corporation. TABLE 7: SUMMARY OF TOTAL LOANS ------------------------------------------------------------------------------------------------------------- Year Ended December 31, (Dollars in thousands) 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------------------------------------- Real estate - mortgage $ 88,973 $ 86,324 $ 77,924 $ 74,221 $ 69,009 Real estate - construction 4,454 3,415 1,681 1,308 2,554 Commercial, financial and agricultural1 48,737 36,385 21,719 19,379 20,072 Equity lines 7,131 6,180 5,954 6,223 6,496 Consumer 7,683 6,360 4,657 3,457 2,891 ------------------------------------------------------------------------------------------------------------- Total loans 156,978 138,664 111,935 104,588 101,022 Less unearned discount -- (5) (9) (43) (96) Less allowance for possible loan losses (2,233) (1,927) (1,914) (1,895) (1,895) ------------------------------------------------------------------------------------------------------------- Total loans, net $ 154,745 $136,732 $ 110,012 $ 102,650 $ 99,031 ------------------------------------------------------------------------------------------------------------- (1) $37.9 million of commercial, financial and agricultural loans are secured by real estate. TABLE 8: MATURITY/REPRICING SCHEDULE OF LOANS -------------------------------------------------------------------------------------------------------- December 31, 1997 Commercial, financial Real estate Dollars in thousands and agricultural construction -------------------------------------------------------------------------------------------------------- Variable Rate: Within 1 year $ 25,953 $ -- 1 to 5 years 10,762 -- After 5 years -- -- Fixed Rate: Within 1 year 2,065 4,454 1 to 5 years 4,331 -- After 5 years 5,626 -- -------------------------------------------------------------------------------------------------------- Loan Portfolio At December 31, 1997, loans, net of unearned income and reserve for loan losses, totaled $154.7 million, an increase of 13.2% over the 1996 total of $136.7 million. Net loans increased 24.3% and 7.2% in 1996 and 1995, respectively. The Corporation's lending activities are its principal source of income. All loans are attributable to domestic operations. Residential real estate loans, both construction and permanent, represent the major portion of the Corporation's loan portfolio although commercial loans continue to increase as a percentage of total loans. Tables 7 and 8 present information pertaining to the composition of loans including unearned income and the maturity/repricing of loans. 21 TABLE 9: MATURITY OF INVESTMENT SECURITIES ------------------------------------------------------------------------------------------------------------ Year Ended December 31, 1997 1996 1995 --------------- ---------------- --------------- Weighted Weighted Weighted Book Average Book Average Book Average (Dollars in thousands) Value Yield Value Yield Value Yield ------------------------------------------------------------------------------------------------------------ U.S. Government agencies and corporations: Maturing within 1 year $ 5,500 8.06% $ 2,000 7.20% $ 500 7.10% Maturing after 1 year, but within 5 years 1,998 7.43 10,585 7.64 20,459 7.32 Maturing after 5 years, but within 10 years 12,498 6.75 23,472 7.09 29,379 7.21 Maturing after 10 years 11,998 7.30 4,000 8.00 3,000 8.00 ------------------------------------------------------------------------------------------------------------ Total U.S. Government agencies and corporations 31,994 7.22 40,057 7.33 53,338 7.29 ------------------------------------------------------------------------------------------------------------ U.S. Treasuries: Maturing within 1 year -- -- -- -- 4,998 6.86 Maturing after 1 year, but within 5 years 2,998 6.63 2,997 6.63 1,996 5.94 Maturing after 5 years, but within 10 years -- -- -- -- 999 8.02 ------------------------------------------------------------------------------------------------------------ Total U.S. Treasuries 2,998 6.63 2,997 6.63 7,993 6.45 ------------------------------------------------------------------------------------------------------------ State and municipals(1): Maturing within 1 year 850 10.11 1,525 9.80% 1,508 10.62 Maturing after 1 year, but within 5 years 4,188 9.85 5,544 10.08 6,061 10.08 Maturing after 5 years, but within 10 years 10,666 8.74 9,040 8.76 9,193 9.56 Maturing after 10 years 20,425 8.11 21,680 8.15 17,539 8.25 ------------------------------------------------------------------------------------------------------------ Total state and municipals 36,129 8.55 37,789 8.65 34,301 9.06 ------------------------------------------------------------------------------------------------------------ Other securities: Maturing within 1 year 300 8.62 -- -- 500 4.78 Maturing after 1 year, but within 5 years -- -- 300 8.62 300 8.62 ------------------------------------------------------------------------------------------------------------ Total other securities 300 8.62 300 8.62 800 6.22 ------------------------------------------------------------------------------------------------------------ Total investment securities(2): Maturing within 1 year 6,650 8.37 3,525 8.32 7,506 7.62 Maturing after 1 year, but within 5 years 9,184 8.29 19,426 8.20 28,816 7.80 Maturing after 5 years, but within 10 years 23,164 7.63 32,512 7.55 39,571 7.74 Maturing after 10 years 32,423 7.81 25,680 8.13 20,539 8.21 ------------------------------------------------------------------------------------------------------------ Total investment securities $71,421 7.87% $ 81,143 7.92% $ 96,432 7.81% ------------------------------------------------------------------------------------------------------------ (1) Yields on tax exempt securities have been computed on a tax-equivalent basis. (2) Total investment securities excludes preferred stock at $4,004,000 and $4,531,000 amortized cost at December 31, 1997 and 1996, respectively, or $4,296,000 and $4,607,000 estimated fair value at December 31, 1997 and 1996, respectively. Investment Securities The investment securities portfolio plays a primary role in the management of interest rate sensitivity of the Corporation and generates substantial interest income. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements. The securities portfolio consists of two components, investment securities held to maturity and securities available for sale. Securities are classified as investment securities based on management's intent and the Corporation's ability, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost. Securities which may be sold in response to changes in market interest rates, changes in the securities' prepayment risk, increases in loan demand, general liquidity needs, and other similar factors are classified as available for sale and are carried at estimated fair value. At year-end 1997, total investment securities were $75.4 million, down 12.0% from $85.7 million at year-end 1996. Securities of U.S. Government agencies and corporations represent 42.4% of the total securities portfolio, obligations of state and political subdivisions were 47.9%, U.S. Treasury securities were 4.0%, preferred stocks were 5.3%, and the remainder, consisting of investment-grade corporate bonds, totaled .4% at December 31, 1997. The decline in the securities portfolio is due to both maturities of securities and securities with higher yields being called because of the falling interest rate environment during 1997. It is management's intention to invest the majority of the proceeds from the maturities and calls of securities into loans; however, when excess funds are available, new securities will be purchased. Table 9 presents information pertaining to the composition of the investment securities portfolio. 22 TABLE 10: AVERAGE DEPOSITS AND RATES PAID ------------------------------------------------------------------------------------------------------------ Year Ended December 31, 1997 1996 1995 ---------------- ----------------- ---------------- Average Average Average Average Average Average (Dollars in thousands) Balance Rate Balance Rate Balance Rate ------------------------------------------------------------------------------------------------------------ Non-interest bearing demand deposits $ 31,449 $ 26,741 $ 20,749 Interest-bearing transaction accounts 34,594 2.57% 33,256 2.68% 31,369 2.88% Money market deposit accounts 23,416 3.28 20,468 3.28 18,946 3.37 Savings accounts 33,037 3.20 31,550 3.13 28,266 3.18 Certificates of deposit $100,000 or more 14,137 3.30 13,774 3.54 10,227 3.83 Other certificates of deposit 82,655 5.44 80,412 5.49 67,391 5.44 Total interest-bearing deposits 187,839 4.09% 179,460 4.15% 156,199 4.16% ------------------------------------------------------------------------------------------------------------ Total deposits $ 219,288 $ 206,201 $ 176,948 ------------------------------------------------------------------------------------------------------------ TABLE 11: MATURITIES OF CERTIFICATES OF DEPOSIT WITH BALANCES $100,000 OR MORE ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) December 31, 1997 ------------------------------------------------------------------------------------------------------------ 3 months or less $ 3,650 3-6 months 2,126 6-12 months 6,678 Over 12 months 2,988 ------------------------------------------------------------------------------------------------------------ Total $ 15,442 ------------------------------------------------------------------------------------------------------------ Deposits The Corporation's predominate source of funds is depository accounts. The Corporation's deposit base is comprised of demand deposits, savings and money market accounts, and time deposits. The Corporation's deposits are provided by individuals and businesses located within the communities served. Total deposits increased $15.1 million, or 7.0%, in 1997 over 1996. In 1997, the growth by deposit category was a 14.5% increase in non- interest-bearing deposits, a 3.6% increase in savings and interest-bearing demand deposits, and a 7.8% increase in time deposits. In 1996, total deposits increased $12.4 million, or 6.1% over 1995. Deposit growth in 1997 was attributed to growth at existing branch locations. Deposit growth in 1996 was attributed to the acquisition of $7.8 million in deposits from a Crestar Branch. Table 10 presents the average deposit balances and average rates paid for the years 1997, 1996, and 1995. Table 11 details maturities of certificates of deposit with balances of $100,000 and over at December 31, 1997. Liquidity Liquidity represents an institution's ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash and due from banks, interest-bearing deposits with banks, federal funds sold, and investments and loans maturing within one year. 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 depositors' requirements and to meet customers' credit needs. At December 31, 1997, cash, securities classified as available for sale, and federal funds sold were 15.0% of total earning assets, compared to 11.3% at December 31, 1996. Additional sources of liquidity available to the Corporation include its subsidiary Bank's capacity to borrow funds through an established line of credit with a regional correspondent bank and the Federal Home Loan Bank. 23 Capital Resources The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the Corporation's capital is reviewed by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses. On April 4, 1997, the Corporation repurchased 204,683 shares of its common stock. In addition, the Corporation repurchased a total of 119,803 shares of its common stock during 1996. These repurchases were made to reduce capital as it was high relative to the Corporation's asset size. The Corporation's capital position continues to exceed regulatory requirements. The primary indicators relied on by bank regulators in measuring the capital position are the Tier I capital, total risk-based capital, and leverage ratios. Tier I capital consists of common and qualifying preferred shareholders' equity less goodwill. Total capital consists of Tier I capital, qualifying subordinated debt, and a portion of the allowance for loan losses. Risk-based capital ratios are calculated with reference to risk-weighted assets. The Corporation's Tier I capital ratio was 14.1% at December 31, 1997, compared to 20.8% at December 31, 1996. The total capital ratio was 15.2% at December 31, 1997, compared to 22.1% at December 31, 1996. These ratios are in excess of the mandated minimum requirement of 4% and 8%, respectively. Shareholders' equity was $31.8 million at year-end 1997 compared to $32.2 million at year-end 1996. The leverage ratio consists of Tier I capital divided by average assets. At December 31, 1997, the Corporation's leverage ratio was 11.4%, compared to 12.2% at December 31, 1996. Each of these exceeds the required minimum leverage ratio of 3%. The dividend payout ratio was 27.8%, 33.6%, and 39.0%, in 1997, 1996, and 1995, respectively. During 1997, the Corporation paid dividends of $0.70 per share, up 14.8% from $0.61 per share paid in 1996. The Corporation is not aware of any current recommendations by any regulatory authorities which, if they were implemented, would have a material effect on the Corporation's liquidity, capital resources, or results of operations. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards (FAS) 130, "Reporting Comprehensive Income" and FAS 131, "Disclosures about Segments of an Enterprise and Related Information." FAS 130 mandates that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. FAS 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments. It also requires that a public business enterprise report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. Both statements are effective for fiscal years beginning after December 15, 1997. Adoption of these statements will not impact the Corporation's consolidated financial position, results of operations or cash flow, and any effect will be limited to the form and content of its disclosures. Effects Of Inflation The effect of changing prices on financial institutions is typically different from other industries as the Corporation's assets and liabilities are monetary in nature. Interest rates are significantly impacted by inflation, but neither the timing nor the magnitude of the changes are directly related to price level indices. The consolidated financial statements reflect the impacts of inflation on interest rates, loan demands, and deposits. Safe Harbor Statement Under The Private Securities Litigation Reform Act of 1995 The statements contained in this annual report that are not historical facts may be forward looking statements. The forward looking statements are subject to certain risks and uncertainties which could cause actual results to differ materially from historical results or those anticipated. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of their dates. 24 CONSOLIDATED BALANCE SHEETS ------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 ------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 7,843,788 $ 8,254,573 Interest-bearing deposits in other banks 1,027,023 544,755 ------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 8,870,811 8,799,328 Investment securities - available for sale at fair value, amortized cost of $29,497,833 and $19,021,635, respectively 29,793,498 18,918,211 Investment securities - held to maturity at amortized cost, fair value of $47,685,859 and $67,687,235, respectively 45,926,549 66,651,211 Loans held for sale, net 24,479,103 12,284,022 Loans, net 154,744,620 136,732,017 Federal Home Loan Bank stock 1,061,800 856,800 Corporate premises and equipment, net of accumulated depreciation 6,581,568 6,011,694 Accrued interest receivable 2,195,959 2,270,156 Other assets 4,452,061 4,147,873 ------------------------------------------------------------------------------------------------------------- Total assets $278,105,969 $256,671,312 ------------------------------------------------------------------------------------------------------------- Liabilities Deposits Non-interest-bearing demand deposits $ 35,295,210 $ 30,828,663 Savings and interest-bearing demand deposits 95,105,425 91,828,621 Time deposits 101,112,517 93,765,272 ------------------------------------------------------------------------------------------------------------- Total deposits 231,513,152 216,422,556 Borrowings 9,335,687 5,055,275 Accrued interest payable 592,300 541,445 Other liabilities 4,864,297 2,437,527 ------------------------------------------------------------------------------------------------------------- Total liabilities 246,305,436 224,456,803 ------------------------------------------------------------------------------------------------------------- Commitments and contingent liabilities Shareholders' Equity Preferred stock ($1.00 par value, 3,000,000 shares authorized) -- -- Common stock ($1.00 par value, 8,000,000 shares authorized, 1,916,190 and 2,113,041 shares issued and outstanding at December 31, 1997 and 1996, respectively) 1,916,190 2,113,041 Additional paid-in capital 117,692 -- Retained earnings 29,236,260 29,795,739 Net unrealized gain on securities available for sale, net of tax of $273,232 and $157,497, respectively 530,391 305,729 ------------------------------------------------------------------------------------------------------------- Total shareholders' equity 31,800,533 32,214,509 ------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $278,105,969 $256,671,312 ------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements. 25 CONSOLIDATED STATEMENTS OF INCOME ------------------------------------------------------------------------------------------------------------ Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------ Interest income Interest and fees on loans $14,656,120 $12,138,668 $ 9,639,988 Interest on money market investments Federal funds sold -- 678 139,609 Other money market investments 68,399 171, 077 213,647 Interest on investment securities U.S. Treasury securities 198,883 340,449 551,310 U.S. Government agencies and corporations 2,422,390 3,164,782 3,198,130 Tax-exempt obligations of states and political subdivisions 2,041,372 2,111,006 1,754,041 Corporate bonds and other 375,884 406,338 190,172 ------------------------------------------------------------------------------------------------------------ Total interest income 19,763,048 18,332,998 15,686,897 Interest expense Savings and interest-bearing deposits 2,715,785 2,548,155 2,439,260 Certificates of deposit, $100,000 or more 465,701 487,543 391,600 Other time deposits 4,492,910 4,417,701 3,667,512 Short-term borrowings and other 327,905 214,220 28,508 ------------------------------------------------------------------------------------------------------------ Total interest expense 8,002,301 7,667,619 6,526,880 ------------------------------------------------------------------------------------------------------------ Net interest income 11,760,747 10,665,379 9,160,017 Provision for loan losses 330,000 30,000 -- ------------------------------------------------------------------------------------------------------------ Net interest income after provision for loan losses 11,430,747 10,635,379 9,160,017 Other operating income Gain on sale of loans 4,056,340 2,687,629 -- Service charges on deposit accounts 1,012,410 982,752 836,585 Other service charges and fees 987,232 665,390 232,536 Other income 601,626 343,144 164,146 ------------------------------------------------------------------------------------------------------------ Total other operating income 6,657,608 4,678,915 1,233,267 Other operating expenses Salaries and employee benefits 6,332,026 5,973,650 3,233,652 Occupancy expenses 1,798,561 1,800,904 1,060,068 Goodwill amortization 275,160 281,982 61,390 Bank stock tax 186,747 204,457 367,272 Other expenses 2,945,071 2,033,227 1,404,340 ------------------------------------------------------------------------------------------------------------ Total other operating expenses 11,537,565 10,294,220 6,126,722 ------------------------------------------------------------------------------------------------------------ Income before income taxes 6,550,790 5,020,074 4,266,562 Income tax expense 1,613,963 958,900 890,630 ------------------------------------------------------------------------------------------------------------ Net Income $ 4,936,827 $ 4,061,174 $ 3,375,932 ------------------------------------------------------------------------------------------------------------ Earnings per common share $ 2.51 $ 1.84 $ 1.52 ------------------------------------------------------------------------------------------------------------ Earnings per common share - assuming dilution 2.50 1.84 1.51 ------------------------------------------------------------------------------------------------------------ See notes to consolidated financial statements. 26 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ------------------------------------------------------------------------------------------------------------- Net Unrealized Additional Gain (Loss) Common Paid-In Retained on Securities Stock Capital Earnings Available for Sale Total ------------------------------------------------------------------------------------------------------------- Balance January 1, 1995 $ 2,228,394 $ 1,275,452 $ 25,744,763 $ (439,443) $28,809,166 Stock options exercised 2,350 15,045 -- -- 17,395 Net income -- -- 3,375,932 -- 3,375,932 Cash dividends ($.59 per share) -- -- (1,315,525) -- (1,315,525) Change in unrealized gains and losses on securities available for sale -- -- -- 931,328 931,328 ------------------------------------------------------------------------------------------------------------- Balance December 31, 1995 2,230,744 1,290,497 27,805,170 491,885 31,818,296 Repurchase of common stock (119,803) (1,301,282) (705,418) -- (2,126,503) Stock options exercised 2,100 10,785 -- -- 12,885 Net income -- -- 4,061,174 -- 4,061,174 Cash dividends ($.61 per share) -- -- (1,365,187) -- (1,365,187) Change in unrealized gains and losses on securities available for sale -- -- -- (186,156) (186,156) ------------------------------------------------------------------------------------------------------------- Balance December 31, 1996 2,113,041 -- 29,795,739 305,729 32,214,509 Repurchase of common stock (204,683) -- (4,126,518) -- (4,331,201) Stock options exercised 7,832 117,692 -- -- 125,524 Net income -- -- 4,936,827 -- 4,936,827 Cash dividends ($.70 per share) -- -- (1,369,788) -- (1,369,788) Change in unrealized gains and losses on securities available for sale -- -- -- 224,662 224,662 ------------------------------------------------------------------------------------------------------------- Balance December 31, 1997 $ 1,916,190 $ 117,692 $ 29,236,260 $ 530,391 $31,800,533 ------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements. 27 CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------- Operating Activities: Net income $ 4,936,827 $ 4,061,174 $ 3,375,932 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation 878,433 860,290 593,573 Amortization of goodwill 275,160 281,982 61,390 Deferred income taxes (320,929) (23,885) 76,647 Provision for loan losses 330,000 30,000 -- Accretion of discounts and amortization of premiums on investment securities, net (104,715) (92,029) (172,492) Net realized loss (gain) on securities 7,180 9,427 (21,885) Gain on sale of corporate premises and equipment -- (17,973) -- Loss on sale of other real estate owned -- -- 3,407 Origination of loans held for sale (286,419,034) (173,881,464) (1,885,028) Sale of loans 274,223,953 163,482,470 -- Change in other assets and liabilities: Accrued interest receivable 74,197 169,150 (565,718) Other assets (373,662) (177,931) (307,030) Accrued interest payable 50,855 (28,684) 242,895 Other liabilities 2,426,770 1,031,957 1,035,870 ------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by operating activities (4,014,965) (4,295,516) 2,437,561 ------------------------------------------------------------------------------------------------------------- Investing Activities: Proceeds from maturities of investments held to maturity 25,632,350 16,355,272 12,976,250 Proceeds from sales and maturities of investments available for sale 8,576,713 9,831,237 3,500,000 Purchase of investment securities held to maturity (4,867,024) (6,097,835) (7,013,711) Purchase of investments available for sale (19,055,224) (5,219,270) (37,322,896) Purchase of FHLB stock (205,000) (51,400) (32,500) Net increase in customer loans (18,342,603) (26,749,697) (7,362,401) Purchase of corporate premises and equipment (1,618,414) (960,713) (2,435,968) Proceeds from the sale of corporate premises and equipment 170,107 27,310 -- Proceeds from sale of other real estate -- -- 55,834 ------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (9,709,095) (12,865,096) (37,635,392) ------------------------------------------------------------------------------------------------------------- Financing Activities: Net increase (decrease) in demand, interest-bearing demand and savings deposits 7,743,351 1,619,262 (6,911,114) Net increase in time deposits 7,347,245 2,964,659 30,636,645 Assumption of deposit liabilities in branch acquisition, net of premium paid -- 7,406,802 19,368,958 Net increase in other borrowings 4,280,412 3,855,275 -- Repurchase of common stock (4,331,201) (2,126,503) -- Proceeds from exercise of stock options 125,524 12,885 17,072 Cash dividends (1,369,788) (1,365,187) (1,315,525) ------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 13,795,543 12,367,193 41,796,036 ------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 71,483 (4,793,419) 6,598,205 Cash and cash equivalents at beginning of year 8,799,328 13,592,747 6,994,542 ------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 8,870,811 $ 8,799,328 $ 13,592,747 ------------------------------------------------------------------------------------------------------------- Supplemental disclosure Interest paid $ 7,951,446 $ 7,696,303 $ 6,283,986 Income taxes paid 1,699,427 903,611 960,007 ------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements. 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: Summary Of Significant Accounting Policies The accounting and reporting policies of C&F Financial Corporation (the "Corporation") and subsidiary conform to generally accepted accounting principles and to predominant practices within the banking industry. Nature of Operations: C&F Financial Corporation is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Corporation owns all of the stock of its sole subsidiary, Citizens and Farmers Bank (the "Bank"), which is an independent commercial bank chartered under the laws of the Commonwealth of Virginia. The Bank offers a wide range of banking services available to both individuals and small businesses. The Bank has three wholly-owned subsidiaries, C&F Title Agency, Inc., C&F Investment Services, Inc., and C&F Mortgage Corporation, all incorporated under the laws of the Commonwealth of Virginia. C&F Title Agency, Inc., organized in 1992, sells title insurance to the mortgage loan customers of the Bank and C&F Mortgage Corporation. C&F Investment Services, Inc., organized in April 1995, is a full-service brokerage firm offering a comprehensive range of investment services. C&F Mortgage Corporation, organized in September 1995, was formed to originate and sell residential mortgages. Principles of Consolidation: The accompanying consolidated financial statements include the accounts of C&F Financial Corporation and its wholly-owned subsidiary, Citizens and Farmers Bank. All material intercompany accounts and transactions have been eliminated in consolidation. Estimates: The preparation of financial statements in conformity with generally accepted accounting principles 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. Investment Securities: Investments in debt and equity securities with readily determinable fair values are classified as either held to maturity, available for sale, or trading, based on management's intent. Available for sale securities are carried at estimated fair value with the corresponding unrealized gains and losses included in shareholders' equity on an after-tax basis. Securities classified as held to maturity are carried at amortized cost. The Corporation does not have any securities classified as trading securities. Gains or losses are recognized only upon realization at the time of sale using the cost of the specific security sold. In December 1995, in accordance with a permissible, one-time reclassification of securities, the Corporation reassessed its liquidity needs and transferred securities with an amortized cost of $8,985,320 from held to maturity to available for sale at fair value resulting in a net unrealized gain of $902. Securities with an amortized cost of $33,163,438 were also transferred from available for sale to held to maturity at fair value, resulting in a net unrealized gain of $626,324. This effect has been reflected as a component of shareholders' equity of $335,252 and $374,313, net of deferred taxes of $172,706 and $192,828 at December 31, 1997 and 1996, respectively. The unrealized gain will be amortized over the life of each specific investment using the level-yield method. Federal Home Loan Bank Stock: Federal Home Loan Bank stock is stated at cost. No ready market exists for this stock, and it has no quoted market value. For presentation purposes, such stock is assumed to have market value which is equal to cost. In addition, such stock is not considered a debt or equity security in accordance with SFAS 115. Loans: Loans are stated at face value, net of unearned discount and the allowance for loan losses. Unearned discount on certain installment loans is recognized as income over the terms of the loans by a method which approximates the effective interest method. Interest on other loans is credited to operations based on the principal amount outstanding. Loans are generally placed on non-accrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based upon an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans which 29 are carried on non-accrual status, interest is recognized on the cash basis. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan's yield using the level-yield method. The Corporation is amortizing these amounts over the contractual life of the related loans. In 1995, the Bank adopted Statement of Financial Accounting Standard No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"), as amended by SFAS 118. These pronouncements require that an impaired loan be measured 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. The Corporation considers 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. A loan is not considered impaired during a period of delay in payment if the ultimate collectibility of all amounts due is expected. A valuation allowance is maintained to the extent that the measure of the impaired loan is less than the recorded investment. Consistent with the Corporation's method for non-accrual loans, interest receipts for impaired loans are recognized on the cash basis. Loans Held for Sale: Loans held for sale are carried at the lower of cost or market, determined in the aggregate. Market value considers commitment agreements with investors and prevailing market prices. Substantially all loans originated by the mortgage banking operations are held for sale to outside investors. Reserve for Loan Losses: The reserve for loan losses is established through a provision for loan losses charged to expense. The reserve represents an amount which, in management's judgment, will be adequate to absorb any losses on existing loans which may become uncollectible. Management's judgment in determining the adequacy of the reserve is based on evaluations of the collectibility of loans while taking into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions which may affect a borrower's ability to repay, overall portfolio quality, and review of specific potential losses. Loans are charged against the reserve for loan losses when management believes that the collectibility of the principal is unlikely. Actual future losses may differ from estimates as a result of unforeseen events. Other Real Estate Owned: Foreclosed assets held for sale are carried at the lower of (a) fair value minus estimated costs to sell or (b) cost at the time of foreclosure. Such determination is made on an individual asset basis. If the fair value of the asset minus the estimated costs to sell the asset is less than the cost of the asset, the deficiency is recognized as a valuation allowance. If the fair value of the asset minus the estimated costs to sell the asset subsequently increases and the fair value of the asset minus the estimated costs to sell the asset is more than its carrying amount, the valuation allowance is reduced, but not below zero. Increases or decreases in the valuation allowance are charged or credited to income. Recovery of the carrying value of such real estate is dependent to a great extent on economic, operating, and other conditions that may be beyond the Corporation's control. Corporate Premises and Equipment: Corporate premises and equipment are stated at cost less accumulated depreciation computed using straight-line and accelerated methods over the estimated useful lives of the assets. Estimated useful lives range from 10 to 40 years for buildings and from 3 to 10 years for equipment, furniture, and fixtures. Maintenance and repairs are charged to expense as incurred and major improvements are capitalized. Upon sale or retirement of depreciable properties, the cost and related accumulated depreciation are netted against proceeds and any resulting gain or loss is reflected in income. Income Taxes: The Corporation uses an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. 30 Earnings Per Share: In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share." Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented and, where appropriate, restated to conform to the Statement No. 128 requirements. Shareholders' Equity: On April 4, 1997, the Corporation repurchased 204,683 shares of its common stock at a price of $21.00 per share. During 1996 the Corporation repurchased a total of 119,803 shares of its common stock from three shareholders in three independently negotiated transactions at a price of $17.75 per share. Statement of Cash Flows: For the purpose of the statement of cash flows, the Corporation considers cash equivalents to include amounts due from banks, federal funds sold, and money market investments purchased with a maturity of three months or less. Generally, federal funds are purchased and sold for one-day periods. 31 Note 2: Investment Securities Debt and equity securities are summarized as follows: ------------------------------------------------------------------------------------------------------------- December 31, 1997 Gross Gross Estimated Amortized Unrealized Unrealized Fair Available for Sale Cost Gains Losses Value ------------------------------------------------------------------------------------------------------------- U.S. Treasury securities $ 1,998,449 $ 7,177 $ -- $ 2,005,626 U.S. Government agencies and corporations 23,495,722 27,715 (31,234) 23,492,203 Corporate bonds Preferred stock 4,003,662 292,007 -- 4,295,669 ------------------------------------------------------------------------------------------------------------- $29,497,833 $ 326,899 $ (31,234) $29,793,498 ------------------------------------------------------------------------------------------------------------- Held to Maturity ------------------------------------------------------------------------------------------------------------- U.S. Treasury securities $ 999,543 $ 68,270 $ -- $ 1,067,813 U.S. Government agencies and corporations 8,498,250 82,321 -- 8,580,571 Obligations of states and political subdivisions 36,128,774 1,617,875 (11,304) 37,735,345 Corporate bonds 299,982 2,148 -- 302,130 ------------------------------------------------------------------------------------------------------------- $45,926,549 $1,770,614 $ (11,304) $47,685,859 ------------------------------------------------------------------------------------------------------------- Available for Sale December 31, 1996 ------------------------------------------------------------------------------------------------------------- U.S. Treasury securities $1,997,202 $ 1,861 $ (938) $ 1,998,125 U.S. Government agencies and corporations 12,494,290 (181,264) 12,313,026 Preferred stock 4,530,143 106,435 (29,518) 4,607,060 ------------------------------------------------------------------------------------------------------------- $19,021,635 $ 108,296 $(211,720) $18,918,211 ------------------------------------------------------------------------------------------------------------- Held to Maturity ------------------------------------------------------------------------------------------------------------- U.S. Treasury securities $ 999,407 $ 69,031 $ -- $ 1,068,438 U.S. Government agencies and corporations 27,562,617 242,749 (73,427) 27,731,939 Obligations of states and political subdivisions 37,789,268 954,449 (165,976) 38,577,741 Corporate bonds 299,919 9,198 -- 309,117 ------------------------------------------------------------------------------------------------------------- $66,651,211 $1,275,427 $(239,403) $67,687,235 ------------------------------------------------------------------------------------------------------------- The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual 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. ------------------------------------------------------------------------------------------------------------- December 31, 1997 Amortized Estimated Available for Sale Cost Fair Value ------------------------------------------------------------------------------------------------------------- Due in one year or less $ -- $ -- Due after one year through five years 1,998,449 2,005,626 Due after five years through ten years 11,497,881 11,482,532 Due after ten years 11,997,841 12,009,671 ------------------------------------------------------------------------------------------------------------- 25,494,171 25,497,829 ------------------------------------------------------------------------------------------------------------- Preferred Stock 4,003,662 4,295,669 ------------------------------------------------------------------------------------------------------------- $29,497,833 $29,793,498 ------------------------------------------------------------------------------------------------------------- Held to Maturity ------------------------------------------------------------------------------------------------------------- Due in one year or less $ 6,649,638 $ 6,703,188 Due after one year through five years 7,186,282 7,483,611 Due after five years through ten years 11,665,657 12,191,779 Due after ten years 20,424,972 21,307,281 ------------------------------------------------------------------------------------------------------------- $45,926,549 $47,685,859 ------------------------------------------------------------------------------------------------------------- 32 Proceeds from maturities and the redemption of call provisions of investment securities held to maturity in 1997 were $25,632,350. There were no realized gains or losses. Proceeds from maturities and the redemption of call provisions of investment securities available for sale were $8,576,713, resulting in gross realized losses of $30,480 and realized gains of $23,300. The amortized cost and approximate market value of securities pledged to secure public deposits amounted to $22,175,000 and $22,736,000, respectively, at December 31, 1997. Proceeds from maturities and the redemption of call provisions of investment securities held to maturity in 1996 were $16,355,272, resulting in gross realized gains of $8,936. There were no gross realized losses. Proceeds from sales and maturities of investment securities available for sale were $9,831,237, resulting in gross realized losses of $18,363. There were no gross realized gains. Proceeds from maturities and the redemption of call provisions of investment securities held to maturity in 1995 were $12,976,250, resulting in gross realized gains of $21,885. There were no gross realized losses. Proceeds from sales and maturities of investment securities available for sale were $3,500,000. There were no gross realized gains or losses. Note 3: Loans Major classifications of loans are summarized as follows: ------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 ------------------------------------------------------------------------------------------------------------- Real estate - mortgage $ 89,927,391 $ 87,297,654 Real estate - construction 4,471,803 3,431,934 Commercial, financial and agricultural 48,751,540 36,389,560 Equity lines 7,130,910 6,179,907 Consumer 7,683,157 6,360,390 ------------------------------------------------------------------------------------------------------------- 157,964,801 139,659,445 Less unearned discount (338) (4,696) ------------------------------------------------------------------------------------------------------------- 157,964,463 139,654,749 Less unearned loan fees (986,484) (995,957) ------------------------------------------------------------------------------------------------------------- 156,977,979 138,658,792 Less reserve for loan losses (2,233,359) (1,926,775) ------------------------------------------------------------------------------------------------------------- $ 154,744,620 $136,732,017 ------------------------------------------------------------------------------------------------------------- Loans on non-accrual status were $497,260 and $525,110 at December 31, 1997 and 1996, respectively. If interest income had been recognized on non-performing loans at their stated rates during fiscal years 1997, 1996, and 1995, interest income would have increased by approximately $37,000, $56,000, and $359,000, respectively. The balance of impaired loans at December 31, 1997 and 1996 was $497,260 and $525,110, respectively, with no specific valuation allowance associated with these loans. Note 4: Reserve For Loan losses Changes in the reserve for loan losses were as follows: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------- Balance at the beginning of year $1,926,775 $1,914,195 $1,895,340 Provision charged to operations 330,000 30,000 -- Loans charged off (27,430) (29,658) (8,201) Recoveries of loans previously charged off 4,014 12,238 27,056 ------------------------------------------------------------------------------------------------------------- Balance at the end of year $2,233,359 $1,926,775 $1,914,195 ------------------------------------------------------------------------------------------------------------- 33 Note 5: Corporate Premises And Equipment Major classifications of corporate premises and equipment are summarized as follows: ------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 ------------------------------------------------------------------------------------------------------------- Land $ 1,213,073 $ 1,138,956 Buildings 4,974,919 4,415,659 Equipment, furniture, and fixtures 6,481,373 5,666,442 ------------------------------------------------------------------------------------------------------------- 12,669,365 11,221,057 Less accumulated depreciation (6,087,797) (5,209,363) ------------------------------------------------------------------------------------------------------------- $ 6,581,568 $ 6,011,694 ------------------------------------------------------------------------------------------------------------- Note 6: Time Deposits Time deposits are summarized as follows: ------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 ------------------------------------------------------------------------------------------------------------- Certificates of deposit, $100,000 or more $ 15,441,597 $ 14,513,548 Other time deposits 85,670,920 79,251,724 ------------------------------------------------------------------------------------------------------------- $ 101,112,517 $ 93,765,272 ------------------------------------------------------------------------------------------------------------- Remaining maturities on certificates are as follows: --------------------------------------------------------------------------------- Year Ending December 31, --------------------------------------------------------------------------------- 1998 $ 76,766,915 1999 16,552,196 2000 5,688,583 2001 432,288 2002 1,672,535 --------------------------------------------------------------------------------- $ 101,112,517 --------------------------------------------------------------------------------- Note 7: Earnings Per Share The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. ------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------- Weighted average number of common shares used in earnings per common share 1,965,144 2,208,549 2,227,223 Effect of dilutive securities: Stock options 11,234 4,451 9,255 ------------------------------------------------------------------------------------------------------------- Weighted average number of common shares used in earnings per common share - assuming dilution 1,976,378 2,213,000 2,236,478 ------------------------------------------------------------------------------------------------------------- Options on approximately 10,000, 22,800, and 1,600 shares were not included in computing earnings per common share -assuming dilution for the years ended December 31, 1997, 1996, and 1995, respectively, because their effects were antidilutive. 34 Note 8: Income Taxes Principal components of income tax expense as reflected in the statements of income are as follows: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------- Current taxes $ 1,934,892 $ 982,785 $ 813,983 Deferred taxes (320,929) (23,885) 76,647 ------------------------------------------------------------------------------------------------------------- $ 1,613,963 $ 958,900 $ 890,630 ------------------------------------------------------------------------------------------------------------- The income tax provision is less than would be obtained by application of the statutory Federal corporate tax rate to pre-tax accounting income as a result of the following items: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, Percent Percent Percent of of of Pre-tax Pre-tax Pre-tax 1997 Income 1996 Income 1995 Income ------------------------------------------------------------------------------------------------------------- Income tax computed at Federal statutory rates $2,227,269 34.0% $1,706,825 34.0% $1,450,631 34.0% Tax effect of exclusion of interest income on obligations of states and political subdivisions (714,061) (10.9) (712,075) (14.2) (601,178) (14.1) Reduction of interest expense incurred to carry tax-exempt assets 77,067 1.2 32,862 .6 61,693 1.5 State income taxes, net of federal tax benefit 22,054 .3 -- -- -- -- Tax effect of dividends received deduction on preferred stock (66,614) (1.0) (75,460) (1.5) -- -- Other 68,248 1.0 6,748 .1 (20,516) (0.5) ------------------------------------------------------------------------------------------------------------- $1,613,963 24.6% $ 958,900 19.0% $ 890,630 20.9% ------------------------------------------------------------------------------------------------------------- Amounts of deferred tax expense (benefit) attributable to individual temporary differences are: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------- Provision for loan loss $(108,557) $(14,374) $ (2,662) Depreciation (23,492) (11,019) (36,285) Pension expense (31,708) 5,549 (12,765) Deferred revenue on real estate loans 23,727 31,137 32,914 Interest on non-accrual loans (74,710) 631 73,660 Amortization of intangible assets (36,094) (35,734) 6,958 Other (70,095) (75) 14,827 ------------------------------------------------------------------------------------------------------------- $(320,929) $(23,885) $ 76,647 ------------------------------------------------------------------------------------------------------------- Other assets include deferred income taxes of $705,579 and $500,385 at December 31, 1997 and 1996, respectively. Other liabilities include current taxes payable of $312,846 and $74,330 at December 31, 1997 and 1996, respectively. Income tax returns subsequent to 1996 are subject to examination by taxing authorities. 35 The tax effects of each type of significant item that gave rise to deferred taxes are: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 ------------------------------------------------------------------------------------------------------------- Deferred tax asset Deferred loan fees $ 71,180 $ 94,907 Allowance for loan losses 613,371 504,814 Interest on non-accrual loans 138,568 63,858 Accrued pension 128,855 97,147 Intangible asset 68,990 32,896 Other 112,039 41,944 ------------------------------------------------------------------------------------------------------------- Deferred tax asset 1,133,003 835,566 ------------------------------------------------------------------------------------------------------------- Deferred tax liability Net unrealized gain on securities available for sale (273,232) (157,497) Depreciation (154,192) (177,684) ------------------------------------------------------------------------------------------------------------- Deferred tax liability (427,424) (335,181) ------------------------------------------------------------------------------------------------------------- Net deferred tax asset $ 705,579 $ 500,385 ------------------------------------------------------------------------------------------------------------- Note 9: Employee Benefit Plans The Bank has a non-contributory, defined benefit pension plan for full-time employees over 21 years of age. Benefits are generally based upon years of service and average compensation for the five highest-paid consecutive years of service. The net periodic pension cost consists of the following components: service cost (benefits earned during the year), interest costs on the projected benefit obligation, actual return on plan assets and the amount resulting from the amortization and deferral of certain items over 25 years. The Bank funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act. The assumed interest rates used in computing benefits, expected return, and salary increases were 7.5%, 9.0%, and 5.0%, respectively, in 1997, and 7.5%, 9.0%, and 6.0% in 1996, respectively, and 8.5%, 9.0%, and 6.0% in 1995, respectively. The Bank maintains a Defined Contribution "Profit-Sharing" Plan sponsored by the Virginia Bankers Association. The plan was amended effective January 1, 1997 to include a 401(k) savings provision which authorizes a maximum voluntary salary deferral of up to 15% of compensation (with a partial company match), subject to statutory limitations. The profit-sharing arrangement provides for an annual discretionary contribution to the account of each eligible employee based in part on the Bank's profitability for a given year, and on each participant's yearly earnings. All full-time employees with at least six months of service are eligible to participate. Contributions and earnings may be invested in various investment vehicles offered through the Virginia Bankers Association. Contributions and earnings are tax-deferred. An employee is 40% vested after four years of service, 60% after five years, 80% after six years, and fully vested after seven years. The amounts charged to expense under this plan were $244,617, $226,938 and $170,607 in 1997, 1996, and 1995, respectively. The Mortgage Corporation maintains a Defined Contribution 401(k) savings plan (the "Plan") which authorizes a maximum voluntary salary deferral of up to 15% of compensation, subject to statutory limitations. All full-time employees who have attained the age of 18 and have at least one year of service are eligible to participate. The Mortgage Corporation reserves the right to set matching amounts each year. An employee is vested 25% after two years of service, 50% after three years of service, 75% after four years of service, and fully vested after five years. The amount charged to expense under the Plan was $50,000 for 1997. There was no matching contribution in 1996 or 1995. The Bank adopted a Management Incentive Bonus Plan (the "Bonus") effective January 1, 1987. The Bonus is offered to selected members of management. The Bonus is derived from a pool of funds determined by the Bank's total performance relative to (1) prescribed growth rates of assets and deposits, (2) return on average assets, and (3) absolute level of net income. Attainment, in whole or in part, of these goals dictates the amount set aside in the pool of funds. Evaluation of attainment and approval of the pool amount are performed by the Board. Payment 36 of the Bonus is based on individual performance and is paid in cash. Expense is accrued in the fiscal year of the specified bonus performance. Expenses under this plan were $136,700, $83,500, and $66,800 in 1997, 1996, and 1995, respectively. Additional Bonuses totaling $35,205, $37,278, and $44,218 were granted to employees not covered by the Management Incentive Bonus Plan in 1997, 1996, and 1995, respectively. The following table sets forth the defined benefit plan's funded status and amounts recognized in the Consolidated Balance Sheet as of December 31, 1997 and 1996, computed as of October 1, 1997 and 1996: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 ------------------------------------------------------------------------------------------------------------- Accumulated benefit obligation (includes vested benefits of $754,801 and $563,913, respectively) $ 798,249 $ 612,070 ------------------------------------------------------------------------------------------------------------- Projected benefit obligation for service rendered to date (1,314,383) (1,014,681) Plan assets at fair value 1,361,274 1,042,093 ------------------------------------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation (funded status) 46,891 27,412 Unrecognized net gain (396,657) (368,148) Unrecognized net obligation at October 1, 1987, being amortized over 25 years (75,786) (81,199) Unrecognized prior service cost 46,567 49,671 ------------------------------------------------------------------------------------------------------------- Accrued pension cost included in other liabilities $ (378,985) $ (372,264) ------------------------------------------------------------------------------------------------------------- Net pension cost for 1997, 1996, and 1995 includes the following components: ------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------- Service cost - benefits earned during the year $125,797 $ 99,057 $ 77,343 Interest cost on projected benefit obligation 75,968 72,880 55,912 Actual return on plan assets (93,629) (87,149) (78,899) Net amortization and deferral (14,878) (15,802) (16,813) ------------------------------------------------------------------------------------------------------------- Net pension costs for the year $ 93,258 $ 68,986 $ 37,543 ------------------------------------------------------------------------------------------------------------- Note 10: Deferred Compensation Plan Effective December 1, 1989, the President retired from his position; he remains a member of the Board of Directors. In lieu of participation in the Corporation's pension plan, the retired President has received a deferred compensation contract to provide retirement benefits. The contract provides that one half of his highest annual compensation will be paid for life or for a minimum of ten years. An annuity contract payable to the Corporation has been purchased to fund this obligation. The retired President began receiving payouts on the annuity contract on March 1, 1990. The remaining balances of the annuity contract and the deferred compensation liability are recorded in other assets and other liabilities, respectively. Note 11: Related Party Transactions Loans to directors and officers totaled $1,506,000 and $1,760,000 at December 31, 1997 and 1996, respectively. New advances to directors and officers totaled $524,000 and repayments totaled $778,000 in the year ended December 31, 1997. Note 12: Stock Options Under the incentive stock option plan ("the Plan"), options to purchase common stock are granted to certain key employees of the Corporation. Options are issued to employees at a price equal to the fair market value of common stock at the date granted. One-third of the options granted become exercisable commencing one year after the grant date with an additional one-third becoming exercisable after each of the following two years. In 1983, the shareholders authorized 50,000 shares of common stock for issuance under the Plan. An additional 100,000 shares were authorized for the Plan in 1994. All options expire ten years from the grant date. 37 The Corporation applies APB Opinion 25 and related Interpretations in accounting for the Plan. Accordingly, no compensation cost has been recognized for its Plan. Had compensation cost for the Plan been determined based on the fair value at the grant dates of options consistent with FASB Statement 123, the Corporation's net income and earnings per share would not have been materially different from those amounts shown on the statements of income for the years ended December 31, 1997, 1996, and 1995. The fair value of each option granted during the years ended December 31, 1997, 1996, and 1995, was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for 1997, 1996, and 1995, respectively; risk-free rate of 5.6, 6.2, and 6.2 percent and volatility of 20, 15, and 15 percent. The dividend yield and expected lives used in the pricing model was 3 percent and 8 years, respectively, for 1997, 1996, and 1995. Transactions under the Plan for the periods indicated were as follows: ----------------------------------------------------------------------------------------------------------- 1997 1996 1995 ---------------- ----------------- ---------------- Exercise Exercise Exercise Shares Price* Shares Price* Shares Price* ----------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 74,050 $ 18.37 62,400 $ 17.89 50,700 $ 16.65 Granted 16,850 25.00 14,250 18.75 14,050 20.59 Exercised (7,832) 15.06 (2,100) 6.14 (2,350) 7.26 Cancelled (600) 18.25 (500) 20.50 -- -- ----------------------------------------------------------------------------------------------------------- Outstanding at end of year 82,468 $ 19.88 74,050 $ 18.37 62,400 $ 17.89 ----------------------------------------------------------------------------------------------------------- *Weighted average Options exercisable at year end 52,690 47,683 40,183 Weighted-average fair value of options granted during the year $ 5.88 $ 4.20 $ 4.61 ----------------------------------------------------------------------------------------------------------- The following table summarizes information about stock options outstanding at December 31, 1997: ------------------------------------------------------------------------------------------------------------- Options Outstanding Options Exercisable ------------------------------------------- ---------------------------- Number Number Range of Outstanding Remaining Exercisable Exercise at December 31, Contractual Exercise at December 31, Exercise Prices 1997 Life Price* 1997 Price* ------------------------------------------------------------------------------------------------------------- $15.50 to 16.75 6,500 1.6 years $ 16.29 6,500 $ 16.29 $17.50 to 25.00 75,968 7.26 years 20.19 46,190 18.95 ------------------------------------------------------------------------------------------------------------- $15.50 to 25.00 82,468 6.82 years $ 19.88 52,690 $ 18.62 ------------------------------------------------------------------------------------------------------------- *Weighted average Note 13: Regulatory Requirements And Restrictions The Corporation and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of the Corporation's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation's and the Bank's capital amounts and classification are subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined) less goodwill. For both the Corporation and the Bank, Tier I capital consists of shareholders' equity excluding any net 38 unrealized gain (loss) on securities available for sale less goodwill and total capital consists of Tier I capital and a portion of the allowance for loan losses. Risk weighted assets for the Corporation and the Bank were $207,698,000 and $203,065,000, respectively, at December 31, 1997 and $142,688,000 and $137,977,000, respectively, at December 31, 1996. Management believes, as of December 31, 1997, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 1997, the most recent notification from the Federal Reserve Bank and the FDIC categorized the Corporation and the Bank, respectively, as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Corporation and the Bank must maintain total risk based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Corporation's and the Bank's actual capital amounts and ratios are presented in the table. ------------------------------------------------------------------------------------------------------------ To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------- ------------------ ---------------------- Amount Ratio Amount Ratio Amount Ratio ------------------------------------------------------------------------------------------------------------ As of December 31, 1997: Total Capital (to Risk Weighted Assets) Corporation $ 31,586,661 15.2% $ 16,615,840 >8.0% N/A - Bank 26,915,847 13.3 16,245,200 >8.0 $ 20,306,500 >10.0% - - Tier I Capital (to Risk Weighted Assets) Corporation 29,353,302 14.1 8,307,920 >4.0 N/A - Bank 24,681,488 12.2 8,122,600 >4.0 12,183,900 > 6.0 - - Tier I Capital (to Average Assets) Corporation 29,353,302 11.4 7,741,230 >3.0 N/A - Bank $ 24,681,488 9.7% $ 7,600,740 >3.0% $ 12,667,900 > 5.0% - - As of December 31, 1996: Total Capital (to Risk Weighted Assets) Corporation $ 31,501,780 22.1% $ 11,415,040 >8.0% N/A - Bank 26,805,373 19.4 11,038,160 >8.0 $ 13,797,700 >10.0% - - Corporation 29,716,780 20.8 5,707,520 >4.0 N/A - Bank 25,078,373 18.2 5,519,000 >4.0 8,278,620 > 6.0 - - Corporation 29,716,780 12.2 7,309,830 >3.0 N/A - Bank $ 25,078,373 10.5% $ 7,184,399 >3.0% $ 11,973,999 > 5.0% - - ------------------------------------------------------------------------------------------------------------ Note 14: Commitments And Financial Instruments With Off-Balance-Sheet Risk The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commitments to sell loans, and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Collateral is obtained based on management's credit assessment of the customer. 39 Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The total contract amount of standby letters of credit, whose contract amounts represent credit risk, was $3,211,000 and $2,980,000 at December 31, 1997 and 1996, respectively. Loan commitments are agreements to extend credit to a customer provided that there are no violations of the terms of the contract prior to funding. Commitments have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The total amount of loan commitments was $23,110,000 and $19,883,000 at December 31, 1997 and 1996, respectively. Commitments to sell loans are designed to eliminate the Mortgage Corporation's exposure to fluctuations in interest rates in connection with loans held for sale. The Mortgage Corporation sells all of the residential mortgage loans it originates to third party investors, some of whom require the repurchase of loans in the event of early default or faulty documentation. Mortgage loans and their related servicing rights are sold under agreements that define certain eligibility criteria for the mortgage loan. Recourse periods vary from 90 days up to one year and conditions for repurchase vary with the investor. Mortgages subject to recourse are collateralized by single family residences, have loan-to- value ratios of 80% or less, or have private mortgage insurance, or are insured or guaranteed by an agency of the United States government. At December 31, 1997, the Mortgage Corporation had locked rate commitments to originate mortgage loans amounting to approximately $21,670,000. The Mortgage Corporation has entered into mandatory commitments, on a best-effort basis, to sell loans of approximately $46,195,000. Risks arise from the possible inability of counterparties to meet the terms of their purchase contracts. The Mortgage Corporation does not expect any counterparty to fail to meet its obligations. As of December 31, 1997, the Corporation had $3,295,000 in deposits in financial institutions in excess of amounts insured by the Federal Deposits Insurance Corporation (FDIC). The Mortgage Corporation is committed under noncancelable operating leases for certain office locations. Rent expense associated with these operating leases was $244,000 and $191,000 for the years ending December 31, 1997 and 1996, respectively. Future minimum lease payments under these leases are as follows: Year Ending December 31, ---------------------------------------------------------------------------- 1998 $ 272,032 1999 132,963 2000 22,629 ---------------------------------------------------------------------------- $ 427,624 ---------------------------------------------------------------------------- Note 15: Disclosures Concerning The Fair Market Value Of Financial Instruments The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS 107, "Disclosures About Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Corporation using available market information and appropriate valuation methodologies. Loan commitments are conditional and subject to market pricing and, therefore, do not reflect a gain or loss on market value. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on estimated costs to terminate them or otherwise settle the obligations with the counterparties at the reporting date. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Corporation could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. 40 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. Investment securities. The fair value of investment securities is based on quoted market prices. Loans. The estimate of the fair value of the loan portfolio is estimated based on present values using applicable spreads to the U.S. Treasury curve. Deposits. The fair value of all demand 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. Loans held for sale. The fair value of loans held for sale is estimated based on commitments into which individual loans will be delivered. ------------------------------------------------------------------------------------------------------------ December 31, 1997 1996 --------------------------- ------------------------- Carrying Estimated Carrying Estimated (Dollars in thousands) Amount Fair Value Amount Fair Value ------------------------------------------------------------------------------------------------------------ Financial assets: Cash and short-term investments $ 8,871 $ 8,871 $ 8,799 $ 8,799 Investment securities 75,720 77,479 85,569 86,605 Net loans 154,745 154,769 136,732 140,611 Loans held for sale, net 24,479 24,807 12,284 12,515 Financial liabilities: Demand deposits 130,401 130,494 122,657 123,414 Time deposits 101,113 101,275 93,765 92,974 Short-term borrowings 9,336 9,336 5,055 5,054 Off-balance sheet items: Letters of credit -- 3,211 -- 2,980 Unused portions of lines of credit -- 23,110 -- 19,883 ------------------------------------------------------------------------------------------------------------ Note 16: Branch Acquisition On February 23, 1996, the Corporation acquired approximately $7.8 million of the deposits of a Crestar Bank branch office located in West Point, Virginia. The premium paid for these deposits is being amortized on a straight-line basis over the expected period of benefit. In 1995, the Corporation purchased two branches in Middlesex and Tappahannock, Virginia, and the related deposits from First Union National Bank. The Corporation received $19,368,958 in cash, $698,144 in premises and equipment, plus other assets in exchange for the assumption of $22,375,850 in deposit liabilities. The excess of cost over fair market value of net assets acquired is classified as an intangible asset that is included in other assets on the balance sheet. This intangible asset is being amortized on a straight-line basis over the expected period of benefit. 41 Note 17: Parent Company Condensed Financial Information Financial information for the Parent Company as of and for the years ended December 31, 1997 and 1996, is as follows: ----------------------------------------------------------------------------------------------------------------------- December 31, Balance Sheet 1997 1996 ----------------------------------------------------------------------------------------------------------------------- Assets Cash $ 112,456 $ 14,976 Investment securities available for sale 4,295,669 4,607,059 Other assets 613,874 119,700 Investments in subsidiary 26,935,994 27,525,661 ----------------------------------------------------------------------------------------------------------------------- Total assets $ 31,957,993 $32,267,396 ----------------------------------------------------------------------------------------------------------------------- Liabilities and Shareholders' Equity Other liabilities $ 157,460 $ 52,887 Shareholders' equity 31,800,533 32,214,509 ----------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 31,957,993 $32,267,396 ----------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- Years Ended December 31, Statement of Income 1997 1996 1995 ----------------------------------------------------------------------------------------------------------------------- Interest income on investment securities $ 295,477 $ 319,001 $ 60,362 Interest income on loans 21,573 -- -- Dividends received from bank subsidiary 5,420,044 3,591,698 5,379,225 Distributions in excess of equity in net income of subsidiary (672,045) -- (2,063,442) Equity in undistributed net income of subsidiary -- 195,640 -- Other expenses (128,222) (45,165) (213) ----------------------------------------------------------------------------------------------------------------------- Net income $ 4,936,827 $ 4,061,174 $ 3,375,932 ----------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- Years Ended December 31, Statement of Cash Flows 1997 1996 1995 ----------------------------------------------------------------------------------------------------------------------- Operating activities: Net income $ 4,936,827 $ 4,061,174 $ 3,375,932 Adjustments to reconcile net income to net cash provided by operating activities: Distributions in excess of equity in net income of subsidiary 672,045 -- 2,063,442 Equity in undistributed earnings of subsidiary -- (195,640) -- (Decrease) increase in other assets (494,174) 314,912 (22,637) Increase (decrease) in other liabilities 31,767 (294,040) 22,637 ----------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 5,146,465 3,886,406 5,439,374 ----------------------------------------------------------------------------------------------------------------------- Investing activities: Sale of investments 2,083,893 282,500 -- Purchase of investments (1,557,413) (739,536) (4,086,950) ----------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 526,480 (457,036) (4,086,950) ----------------------------------------------------------------------------------------------------------------------- Financing activities: Repurchase of common stock (4,331,201) (2,126,503) -- Dividends paid (1,369,788) (1,365,187) (1,315,525) Proceeds from the issuance of stock 125,524 12,885 17,072 ----------------------------------------------------------------------------------------------------------------------- Net cash used in financing activities (5,575,465) (3,478,805) (1,298,453) ----------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 97,480 (49,435) 53,971 Cash at beginning of year 14,976 64,411 10,440 ----------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 112,456 $ 14,976 $ 64,411 ----------------------------------------------------------------------------------------------------------------------- 42 Note 18: Quarterly Condensed Statements Of Income - Unaudited ------------------------------------------------------------------------------------------------------------- 1997 Quarter Ended In thousands (except per share) March 31 June 30 September 30 December 31 ------------------------------------------------------------------------------------------------------------- Total interest income $ 4,750 $ 4,844 $ 5,013 $ 5,156 Net interest income after provision for loan losses 2,842 2,784 2,888 2,917 Other income 1,145 1,420 1,979 2,114 Other expenses 2,504 2,636 3,049 3,349 Income before income taxes 1,483 1,568 1,818 1,682 Net income 1,174 1,223 1,334 1,206 Earnings per common share - assuming dilution $ .55 $ .63 $ .69 $ .63 Dividends per common share .16 .18 .18 .18 ------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- 1996 Quarter Ended In thousands (except per share) March 31 June 30 September 30 December 31 ------------------------------------------------------------------------------------------------------------- Total interest income $ 4,375 $ 4,541 $ 4,645 $ 4,772 Net interest income after provision for loan losses 2,481 2,609 2,714 2,831 Other income 733 1,324 1,317 1,305 Other expenses 2,347 2,542 2,673 2,732 Income before income taxes 867 1,391 1,358 1,404 Net income 729 1,136 1,069 1,127 Earnings per common share - assuming dilution $ .33 $ .51 $ .48 $ .52 Dividends per common share .15 .15 .15 .16 ------------------------------------------------------------------------------------------------------------- 43 INDEPENDENT AUDITOR'S REPORT [YHB Logo] The Board of Directors and Shareholders C&F Financial Corporation We have audited the accompanying consolidated balance sheets of C&F Financial Corporation and subsidiary as of December 31, 1997, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of C&F Financial Corporation and subsidiary for the years December 31, 1996 and 1995 were audited by other auditors whose report, dated January 17, 1997, expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements referred to above present fairly, in all material respects, the financial position of C&F Financial Corporation and subsidiary at December 31, 1997, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ Yount, Hyde & Barbour, P.C. _______________________________ January 15, 1998 Winchester, Virginia 44 INVESTOR INFORMATION Annual Meeting of Shareholders The annual meeting of shareholders of C&F Financial Corporation will be held at 3:30pm on Tuesday, April 21, 1998 at the van den Boogaard Center, 3510 King William Avenue, West Point, Virginia. All shareholders are cordially invited to attend. Stock Price Information Effective January 22, 1998, the Corporation's common stock is traded on the over-the-counter market and is listed for quotation on the Nasdaq Stock Market National Market System under the symbol "CFFI." Prior to this date the Corporation's Common Stock appeared on the Nasdaq Bulletin Board Listing. As of February 9, 1998 there were approximately 1,057 shareholders of record. Following are the high and low closing prices in 1997 and 1996. The 1997 information was obtained from the Nasdaq Bulletin Board Listing. The 1996 information was obtained from internal shareholder records kept by C&F Financial Corporation as the Corporation acted as its own transfer agent during this period. Over-the- counter market quotations reflected inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions. ------------------------------------------------------------------------------------------------------------- 1997 1996 ------------------------------------------------------------------------------------------------------------- Quarter High Low High Low ------------------------------------------------------------------------------------------------------------- First $ 21.25 $ 17.50 $ 20.50 $ 18.75 Second 21.50 20.00 19.75 18.75 Third 22.50 20.75 19.00 18.50 Fourth 26.50 21.00 20.00 18.00 ------------------------------------------------------------------------------------------------------------- Stock Transfer Agent American Stock Transfer & Trust Company serves as transfer agent for the Corporation. You may write them at 40 Wall Street, New York, NY 10005 or telephone them toll-free at 1-800-937-5449. Annual Report on Form 10-K and Additional Information A copy of Form 10-K as filed with the Securities and Exchange Commission is available without charge to stockholders upon written request. Requests for this or other financial information about C&F Financial Corporation should be directed to: Tom Cherry Vice President and Chief Accounting Officer C&F Financial Corporation P.O. Box 391 West Point, VA 23181 45 DIRECTORS AND ADVISORS C&F Financial Corporation / Citizens And Farmers Bank J. P. CAUSEY JR.*+ Senior Vice President, Secretary & General Counsel Chesapeake Corporation LARRY G. DILLON*+ Chairman, President & CEO C&F Financial Corporation Citizens and Farmers Bank P. L. HARRELL+ President Old Dominion Grain, Inc. JAMES H. HUDSON III*+ Attorney-at-Law Hudson & Bondurant, P.C. JOSHUA H. LAWSON+ President Thrift Insurance Corporation WILLIAM E. O'CONNELL JR.*+ Professor of Business The College of William and Mary STURE G. OLSSON*+ Retired Chairman of the Board Chesapeake Corporation PAUL C. ROBINSON+ Owner & President Francisco, Robinson & Associates, Realtors W. T. ROBINSON*+ Past Chairman of the Board C&F Financial Corporation Citizens and Farmers Bank THOMAS B. WHITMORE JR.+ Retired President Whitmore Chevrolet, Oldsmobile, Pontiac Co., Inc. * C&F Financial Corporation Board Member + Citizens and Farmers Bank Board Member C&F Mortgage Corporation J. P. CAUSEY JR. Senior Vice President, Secretary & General Counsel Chesapeake Corporation LARRY G. DILLON Chairman of the Board JAMES H. HUDSON III Attorney-at-Law Hudson & Bondurant, P.C. BRYAN E. MCKERNON President & Chief Executive Officer C&F Mortgage Corporation WILLIAM E. O'CONNELL JR. Professor of Business The College of William and Mary C&F Investment Services. Inc. LARRY G. DILLON President ERIC F. NOST Vice President BRAD E. SCHWARTZ Treasurer GARI B. SULLIVAN Senior Vice President & Secretary Independent Public Accountants Yount, Hyde & Barbour, P.C. Winchester, VA Corporate Counsel Hudson & Bondurant, P.C. West Point, VA Varina Advisory Board ROBERT A. CANFIELD Attorney-at-Law Canfield, Moore, Shapiro, Sease & Baer SUSAN R. FERGUSON REGGIE H. NELSON IV Partner Colonial Acres Farm ROBERT F. NELSON Professional Engineer Engineering Design Associates PHIL T. RUTLEDGE Retired Deputy County Manager County of Henrico SANDRA W. SEELMANN Real Estate Broker/Owner Varina & Seelmann Realty 46 OFFICERS AND LOCATIONS Citizens And Farmers Bank ADMINISTRATIVE OFFICE 802 Main Street West Point, Virginia 23181 (804) 843-2360 Larry G. Dillon * Chairman of the Board & Chief Executive Officer Brad E. Schwartz * Senior Vice President Gari B. Sullivan * Senior Vice President & Secretary Howard P. Wilkinson Senior Vice President & Chief Lending Officer Leslie A. Campbell Vice President Thomas F. Cherry * Vice President & Chief Accounting Officer Sandra S. Fryer Vice President Deborah R. Nichols Vice President, Branch Administration Julia L. Gresham Assistant Vice President William B. Littreal Assistant Vice President Susan B. Milby Assistant Vice President WEST POINT - MAIN OFFICE 802 Main Street West Point, Virginia 23181 (804) 843-2360 LONGHILL ROAD Sandra C. St.Clair Assistant Vice President & Branch Manager 4780 Longhill Road Williamsburg, Virginia 23188 (757) 565-0593 MIDDLESEX N. Susan Gordon Branch Manager Route 33 at Route 641 Saluda, Virginia 23149 (804) 758-3641 NORGE Alec J. Nuttall Assistant Vice President & Branch Manager 7534 Richmond Road Norge, Virginia 23127 (757) 564-8114 PROVIDENCE FORGE James D. W. King Vice President & Branch Manager 3501 N. Courthouse Road Providence Forge, Virginia 23140 (804) 966-2264 QUINTON Mary T. "Joy" Whitley Assistant Vice President & Branch Manager 2580 New Kent Highway Quinton, Virginia 23141 (804) 932-4383 TAPPAHANNOCK Douglas M. "Judge" Smith Assistant Vice President & Branch Manager 1649 Tappahannock Boulevard Tappahannock, Virginia 22560 (804) 443-2265 VARINA Tracy E. Pendleton Assistant Vice President & Branch Manager W. Kendall Lipscomb Assistant Vice President Route 5 at Strath Road Richmond, Virginia 23231 (804) 795-7000 WEST POINT - 14TH STREET Karen T. Richardson Assistant Vice President & Branch Manager 415 Fourteenth Street West Point, Virginia 23181 (804) 843-2708 LOAN PRODUCTION OFFICE Terrence C. Gates Vice President, Real Estate Construction 300 Arboretum Place, Suite 245 Richmond, Virginia 23236 (804) 330-8300 * Officers of C&F Financial Corporation C&F Mortgage Corporation ADMINISTRATIVE OFFICE 300 Arboretum Place, Suite 245 Richmond, Virginia 23236 (804) 330-8300 Bryan E. McKernon President & Chief Executive Officer Mark A. Fox Executive Vice President & Chief Financial Officer Theresa M. Dougherty Vice President & Senior Underwriter Donna G. Jarratt Vice President & Project Manager ANNAPOLIS, MARYLAND Larry Roussil Vice President & Branch Manager 2191 Defense Highway, Suite 200 Crofton, Maryland 21114 (410) 721-6770 BELAIR, MARYLAND David A. Lehnerd Vice President & Branch Manager 2105 Laurel Bush Road, Suite 201 Belair, Maryland 21015 (410) 569-0479 CHARLOTTESVILLE Philip N. Mahone Vice President & Branch Manager William E. Hamrick Vice President & Branch Manager 114 Whitewood Road, Suite 2 Charlottesville, Virginia 22901 (804) 974-1450 CHESTER Stephen L. Fuller Vice President & Branch Manager 4517 West Hundred Road Chester, Virginia 23831 (804) 748-2900 NEWPORT NEWS Linda H. Gaskins Vice President & Branch Manager 703 Thimble Shoals Boulevard, Suite C4 Newport News, Virginia 23606 (757) 873-8200 RICHMOND Thomas A. Gill Vice President & Branch Manager Donald R. Jordan Vice President & Richmond Production Manager 300 Arboretum Place, Suite 245 Richmond, Virginia 23236 (804) 330-8300 RICHMOND WEST Page C. Yonce Vice President & Branch Manager 7231 Forest Avenue, Suite 202 Richmond, Virginia 23226 (804) 673-3453 WILLIAMSBURG Irving E. "Ed" Jenkins Vice President & Branch Manager 3279-A Lake Powell Road Williamsburg, Virginia 23185 (757) 259-1200 C&F Investment Services, Inc. Eric F. Nost Vice President & Manager 417 Fourteenth Street West Point, Virginia 23181 (804) 843-4584 (800) 853-3863 Douglas L. Hartz Assistant Vice President 2580 New Kent Highway Quinton, Virginia 23141 (804) 932-4383 INDEPENDENT AUDITORS' CONSENT EXHIBIT 23.1 We consent to the incorporation by reference in Registration Statement No. 33-88624 of C&F Financial Corporation on Form S-8 of our report dated January 15,1998, incorporated by reference in this Annual Report on Form 10-KSB of C&F Financial Corporation for the year ended December 31, 1997. /s/ YOUNT, HYDE & BARBOUR, P.C. Winchester, Virginia March 20, 1998 INDEPENDENT AUDITORS' CONSENT EXHIBIT 23.2 We consent to the incorporation by reference in Registration Statement No. 33-88624 of C&F Financial Corporation on Form S-8 of our report dated January 17, 1997, incorporated by reference in this Annual Report on Form 10-K of C&F Financial Corporation for the year ended December 31, 1997. /s/DELOITTE & TOUCHE LLP Richmond, Virginia March 20, 1998 ARTICLE 9 MULTIPLIER: 1,000 PERIOD TYPE FISCAL YEAR END PERIOD END CASH INT BEARING DEPOSITS FED FUNDS SOLD TRADING ASSETS INVESTMENTS HELD FOR SALE INVESTMENTS CARRYING INVESTMENTS MARKET LOANS ALLOWANCE TOTAL ASSETS DEPOSITS SHORT TERM LIABILITIES OTHER LONG TERM PREFERRED MANDATORY PREFERRED COMMON OTHER SE TOTAL LIABILITIES AND EQUITY INTEREST LOAN INTEREST INVEST INTEREST OTHER INTEREST TOTAL INTEREST DEPOSIT INTEREST EXPENSE INTEREST INCOME NET LOAN LOSSES SECURITIES GAINS EXPENSE OTHER INCOME PRETAX INCOME PRE EXTRAORDINARY EXTRAORDINARY CHANGES NET INCOME EPS PRIMARY EPS DILUTED YIELD ACTUAL LOANS NON LOANS PAST LOANS TROUBLED LOANS PROBLEM ALLOWANCE OPEN CHARGE OFFS RECOVERIES ALLOWANCE CLOSE ALLOWANCE DOMESTIC ALLOWANCE FOREIGN ALLOWANCE UNALLOCATED YEAR DEC 31 1997 DEC 31 1997 7,844 1,027 0 0 29,793 45,927 47,686 156,978 2,233 278,106 231,513 9,336 4,864 0 0 0 1,916 0 278,106 14,656 5,107 0 19,763 7,674 8,002 11,761 330,000 (7) 11,531 6,551 6,551 0 0 4,937 2.50 2.50 8.57 497 768 0 0 1,927 27 4 2,233 2,233 0 0 [LOGO] C&F Financial Corporation Eighth and Main Streets P.O. Box 391 West Point, Virginia 23181 Dear Fellow Shareholders: You are cordially invited to attend the 1998 Annual Meeting of Shareholders of C&F Financial Corporation, the holding company for Citizens and Farmers Bank. The meeting will be held on Tuesday, April 21, 1998, at 3:30 p.m. at the van den Boogaard Center, 3510 King William Avenue, West Point, Virginia. The accompanying Notice and Proxy Statement describe the matters to be presented at the meeting. Enclosed is our Annual Report to Shareholders that will be reviewed at the Annual Meeting. Please complete, sign, date and return the enclosed proxy card as soon as possible. Whether or not you will be able to attend the Annual Meeting, it is important that your shares be represented and your vote recorded. The proxy may be revoked at any time before it is voted at the Annual Meeting. We appreciate your continuing loyalty and support of Citizens and Farmers Bank and C&F Financial Corporation. Sincerely, /s/ Larry G. Dillon Larry G. Dillon President & Chief Executive Officer West Point, Virginia March 12, 1998 (This page intentionally left blank) C&F FINANCIAL CORPORATION Eighth and Main Streets P. O. Box 391 West Point, Virginia 23181 NOTICE OF 1998 ANNUAL MEETING OF SHAREHOLDERS TO BE HELD APRIL 21, 1998 The 1998 Annual Meeting of Shareholders of C&F Financial Corporation (the "Company") will be held at the van den Boogaard Center, 3510 King William Avenue, West Point, Virginia, on Tuesday, April 21, 1998, at 3:30 p.m. for the following purposes: 1. To elect one Class I director to serve until the 2000 Annual Meeting of Shareholders and two Class II directors to the Board of Directors of the Company to serve until the 2001 Annual Meeting of Shareholders, as described in the Proxy Statement accompanying this notice. 2. To ratify the Board of Directors' appointment of Yount, Hyde & Barbour, P.C., as the Company's independent public accountants for 1998. 3. To transact such other business as may properly come before the meeting or any adjournment thereof. Shareholders of record at the close of business on February 20, 1998, are entitled to notice of and to vote at the Annual Meeting or any adjournment thereof. By Order of the Board of Directors /s/ Gari B. Sullivan Gari B. Sullivan Secretary March 12, 1998 IMPORTANT NOTICE Please complete, sign, date and return the enclosed proxy card in the accompanying postage paid envelope so that your shares will be represented at the meeting. Shareholders attending the meeting may personally vote on all matters which are considered, in which event the signed proxies are revoked. (This page intentionally left blank) C&F FINANCIAL CORPORATION Eighth and Main Streets P. O. Box 391 West Point, Virginia 23181 PROXY STATEMENT 1998 ANNUAL MEETING OF SHAREHOLDERS April 21, 1998 GENERAL The following information is furnished in connection with the solicitation by and on behalf of the Board of Directors of the enclosed proxy to be used at the 1998 Annual Meeting of Shareholders (the "Annual Meeting") of C&F Financial Corporation (the "Company") to be held Tuesday, April 21, 1998, at 3:30 p.m. at the van den Boogaard Center, 3510 King William Avenue, West Point, Virginia. The approximate mailing date of this Proxy Statement and accompanying proxy is March 12, 1998. Revocation and Voting of Proxies Execution of a proxy will not affect a shareholder's right to attend the Annual Meeting and to vote in person. Any shareholder who has executed and returned a proxy may revoke it by attending the Annual Meeting and requesting to vote in person. A shareholder may also revoke his proxy at any time before it is exercised by filing a written notice with the Company or by submitting a proxy bearing a later date. Proxies will extend to, and will be voted at, any properly adjourned session of the Annual Meeting. If a shareholder specifies how the proxy is to be voted with respect to any proposals for which a choice is provided, the proxy will be voted in accordance with such specifications. If a shareholder fails to specify with respect to such proposals, the proxy will be voted FOR proposals 1 and 2, as set forth in the accompanying notice and further described herein. Voting Rights of Shareholders Only those shareholders of record at the close of business on February 20, 1998, are entitled to notice of and to vote at the Annual Meeting, or any adjournments thereof. The number of shares of common stock of the Company outstanding and entitled to vote at the Annual Meeting is 1,924,755. The Company has no other class of stock outstanding. A majority of the votes entitled to be cast, represented in person or by proxy, will constitute a quorum for the transaction of business. Each share of Company common stock entitles the record holder thereof to one vote upon each matter to be voted upon at the Annual Meeting. With regard to the election of directors, votes may be cast in favor or withheld. If a quorum is present, the nominees receiving a plurality of the votes cast at the Annual Meeting will be elected directors; therefore, votes withheld will have no effect. The ratification of Yount, Hyde & Barbour, P.C., as the Company's independent public accountants requires the affirmative vote of a majority of the shares cast on the matter. Thus, although abstentions and broker non-votes (shares held by customers which may not be voted on certain matters because the broker has not received specific instructions from the customer) are counted for purposes of determining the presence or absence of a quorum for the transaction of business, they are generally not counted for purposes of determining whether such proposals have been approved and therefore have no effect. Solicitation of Proxies The cost of solicitation of proxies will be borne by the Company. Solicitations will be made only by the use of the mails, except that officers and regular employees of the Company and Citizens and Farmers Bank (the "Bank") may make solicitations of proxies by telephone, telegram, special letter, or by special call, acting without compensation other than regular compensation. It is contemplated that brokerage houses and other nominees, custodians, and fiduciaries will be requested to forward the proxy soliciting material to the beneficial owners of the stock held of record by such persons, and the Company will reimburse them for their charges and expenses in this connection. Principal Holders of Capital Stock The following table shows the share ownership as of February 20, 1998, of the shareholders known to the Company to be the beneficial owners of more than 5% of the Company's common stock, par value $1.00 per share, which are 0the only voting securities outstanding. Amount and Nature Name and Address of Beneficial Percent of Beneficial Owner Ownership(1) of Class ------------------- ------------ -------- Sture G. Olsson 142,824(2) 7.4% P. O. Box 311 West Point, VA 23181 W. T. Robinson 106,258(2) 5.5% P. O. Box 391 West Point, VA 23181 (1) For purposes of this table, beneficial ownership has been determined in accordance with the provision of Rule 13d-3 of the Securities Exchange Act of 1934 under which, in general, a person is deemed to be the beneficial owner of a security if he or she has or shares the power to vote or direct the voting of the security or the power to dispose of or direct the disposition of the security, or if he has the right to acquire beneficial ownership of the security within sixty days. (2) Includes shares held by affiliated corporations, close relatives, and children, and shares held jointly with spouses or as custodians or trustees for children, as follows: Mr. Olsson, 134,536 shares (held in a trust of which Crestar Bank and Mr. Olsson are co-trustees); Mr. Robinson, 53,129 shares owned by spouse. As of February 20, 1998, the directors and officers of the Company and its subsidiary bank beneficially owned as a group 345,738 shares (or approximately 17.8%) of Company common stock (including shares for which they hold presently exercisable stock options). PROPOSAL ONE ELECTION OF DIRECTORS The Company's Board is divided into three classes (I, II, and III) of directors. The term of office for Class II directors will expire at the Annual Meeting. One person named below, who currently serves as a director of the Company, will be nominated to serve as a Class I director and two persons named below, each of whom currently serves as a director of the Company, will be nominated to serve as Class II directors. If elected, the Class I nominee will serve until the 2000 Annual Meeting of Shareholders and the Class II nominees will serve until the 2001 Annual Meeting of Shareholders. The persons named in the proxy will vote for the election of the nominees named below unless authority is withheld. The Company's Board believes that the nominees will be available and able to serve as directors, but if any of these persons should not be available or able to serve, the proxies may exercise discretionary authority to vote for a substitute proposed by the Company's Board. Certain information concerning the nominees for election at the Annual Meeting as Class I and Class II directors is set forth below, as well as certain information about the other Class I director and Class III directors, who will continue in office until the 2000 and 1999 Annual Meeting of Shareholders, respectively. Number of Shares Principal Beneficially Owned Served as Occupation During as of February 20, 1998 Name (Age) Since(1) Past Five Years (Percent of Class)(2) ---------- -------- --------------- --------------------- Class I Directors (Serving Until the 2000 Annual Meeting) Larry G. Dillon (44) 1989 Chairman, President and 20,601(3) Chief Executive Officer of the (1.1%) Company and the Bank James H. Hudson, III (49) 1997 (4) Attorney-at-Law 920 (Nominee) Hudson & Bondurant, P.C. * Class II Directors (Nominees) (Serving Until the 2001 Annual Meeting) Sture G. Olsson (77) 1952 Retired; previously Chairman of 142,824(5) the Board, Chesapeake Corporation (7.4%) W. T. Robinson (85) 1948 Retired; previously Chairman of 106,258(5) the Board of the Company and the Bank (5.5%) Class III Directors (Serving Until the 1999 Annual Meeting) J. P. Causey Jr. (54) 1984 Senior Vice President, Secretary & 17,244 General Counsel of Chesapeake * Corporation William E. O'Connell, Jr. (60) 1994 Chessie Professor of Business, 1,000 The College of William and Mary * All Directors and Executive 345,738 Officers as a group (13 persons) (17.8%) * Represents less than 1% of the total outstanding shares of the Company's common stock. (1) Refers to the year in which the director was first elected to the Board of Directors of the Bank. (2) See footnote 1 of table above "Principal Holders of Capital Stock" for description of how beneficial ownership has been determined for purposes of this table. (3) Includes 6,734 shares as to which Mr. Dillon holds presently exercisable options. A description of such options is set forth below in greater detail in "Employee Benefit Plans - Incentive Stock Option Plan". (4) Pursuant to the Bylaws of the Company and the Bank, Mr. Hudson was elected to the respective Boards as a Director of the Company and the Bank on July 15, 1997, to fill the vacancy created by the resignation of D. N. Sutton, Jr. on that date. (5) Includes shares held by affiliated corporations, close relatives, children, and shares held jointly with spouses or as custodians or trustees for children, as follows: Messrs. Olsson and W. T. Robinson, see discussion above under "Principal Holders of Capital Stock." The Board of Directors of the Bank consists of the six members of the Company's Board listed above as well as P. L. Harrell, Joshua H. Lawson, Paul C. Robinson, and Thomas B. Whitmore, Jr. The Board of Directors is not aware of any family relationship between any director or person nominated by the Company to become director; nor is the Board of Directors aware of any involvement in legal proceedings which are material to any impairment of the ability or integrity of any director or person nominated to become a director. Unless authority for the nominees is withheld, the shares represented by the enclosed proxy card, if executed and returned, will be voted FOR the election of the nominees proposed by the Board of Directors. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE DIRECTOR NOMINATED TO SERVE AS A CLASS I DIRECTOR AND THE DIRECTORS NOMINATED TO SERVE AS CLASS II DIRECTORS. Board Committees and Attendance During 1997, there were 10 meetings of the Board of Directors of the Company and 15 meetings of the Board of Directors of the Bank. With the exception of Mr. Olsson, each director attended at least 75% of all meetings of the boards and committees on which he served. The Board of Directors of the Company has a Capital Plan Committee and the Board of Directors of the Bank has Executive, Compensation, and Audit Committees. Members of the Capital Plan Committee are Messrs. Causey, Dillon, Hudson, O'Connell, and W. T. Robinson. The Capital Plan Committee reviews capital related matters and submits proposals or recommendations to the Board of Directors. The Capital Plan Committee met three times during 1997. Members of the Executive Committee are Messrs. Causey, Dillon, Hudson, O'Connell, Olsson, and W. T. Robinson. The Executive Committee reviews various matters and submits proposals or recommendations to the Board of Directors. The Executive Committee did not meet during 1997. Members of the Compensation Committee are Messrs. Causey, Harrell, Hudson, and Whitmore. The Compensation Committee recommends the level of compensation of each officer of the Bank, the granting of stock options and other employee remuneration plans to the Board of Directors. The Compensation Committee met three times during 1997. Members of the Audit Committee are Messrs. Causey, Lawson, and P. Robinson. The Audit Committee reviews and approves various audit functions including the year-end audit performed by the Company's independent public accountants. The Audit Committee met three times during 1997. The Board has no separate nominating committee. The entire Board reviews, on an as-needed basis, the qualifications of candidates for membership to the Board. Directors' Fees Each of the directors of the Company is also a director of the Bank. Effective January 1, 1997, non-employee members of the Board of Directors of the Bank receive an annual retainer of $2,500, payable quarterly, with a base meeting fee of $300 per day for Company or Bank meetings and a fee of $100 for each secondary meeting of the Company, Bank or any committees thereof held on the same day as a meeting for which the base meeting fee is paid. Interest of Management in Certain Transactions As of December 31, 1997, the total maximum extensions of credit (including used and unused lines of credit) to policy-making officers, directors, principal shareholders and their associates amounted to $2,790,251, or 8.8%, of total capital. The maximum aggregate amount of such indebtedness during 1997 was $2,151,434, or 6.8%, of total year-end capital. These loans were made in the ordinary course of the Bank's business, on the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with others, and do not involve more than the normal risks of collectibility or present other unfavorable features. The Bank expects to have in the future similar banking transactions with officers, directors, principal shareholders and their associates. The firm of Thrift Insurance Corporation serves as the local agent for the Fidelity and Deposit Company of Maryland. Mr. Lawson, a director of the Bank, is the majority owner of Thrift Insurance Corporation. The Bank maintains its various insurance policies including its blanket bond coverage, directors and officers liability coverage, and building and equipment coverage through Fidelity and Deposit Company of Maryland. All premiums are negotiated directly with representatives of Fidelity and Deposit Company of Maryland. During 1997, the Bank paid premiums totaling $39,399 to Thrift Insurance Corporation, as agent, for the insurance coverage maintained by the Bank. During 1997 the Company and the Bank and its subsidiaries utilized the legal services of the law firm of Hudson and Bondurant P.C., of which James H. Hudson, III is a partner. The amount of fees paid to Hudson and Bondurant, P.C. did not exceed 5% of the firm's gross revenue. Executive Compensation Summary of Cash and Certain Other Compensations. The following table shows the cash compensation paid to Mr. Dillon, President and Chief Executive Officer of the Company, during 1997, 1996, and 1995. During 1997, no other executive officer of the Company received compensation in excess of $100,000. SUMMARY COMPENSATION TABLE Long-Term Annual Compensation Compensation ------------------- ------------ All Name and Other Annual Other Principal Position Year Salary Bonus(1) Compensation(2) Options(3) Compensation(4) ------------------ ---- ------ -------- --------------- ---------- --------------- Larry G. Dillon 1997 $120,000 $40,000 - 1,600 $19,118 President/Chief 1996 102,500 20,000 - 1,600 17,126 Executive Officer 1995 92,500 15,000 - 1,500 16,322 (1) All bonuses were paid under the Management Incentive Bonus Plan, which is described below in "Employee Benefit Plans". (2) The amount of compensation in the form of perquisites or other personal benefits properly categorized in this column according to the disclosure rules adopted by the Commission did not exceed the lesser of either $50,000, or 10% of the total annual salary and bonus reported in each of the three years reported for Mr. Dillon, and therefore, is not required to be reported. (3) 1997 options were granted at an exercise price of $25.00 per share; 1996 options were granted at an exercise price of $18.75 per share; 1995 options were granted at an exercise price of $20.50 per share. (4) $6,966, $11,711, and $10,908, were paid under the Bank's Profit-Sharing Plan for 1997, 1996, and 1995, respectively, and $5,383, $5,415, and $5,414, were paid under the Bank's Split-Dollar Insurance Program for 1997, 1996, and 1995, respectively, which are described below under "Employee Benefit Plans". $6,769 was paid under the Bank's 401(k) Plan for 1997, which is described below in "Employee Benefit Plans". Stock Options and SAR. The following table shows all grants of options to Mr. Dillon in 1997: Option/SAR Grants in Last Fiscal Year Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation Individual Grants for Option Term ----------------- --------------- % of Total Options Granted Exercise or Options to Employees in Base Price Expiration 5% 10% Name Granted (#)(1) Fiscal Year ($/Sh) Date ($) ($) ---- -------------- ----------- ------ ---- --- --- Larry G. Dillon 1,600 9.8% 25.00 12/16/07 25,156 63,750 (1) Vesting is as follows: One-third by December 16, 1998; two-thirds by December 16, 1999; and 100% by December 16, 2000. Option/SAR Exercises and Holdings. The following table shows stock options exercised by Mr. Dillon in 1997: Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Options/SAR Values Value of Unexercised Number of Unexercised In-the-Money Options at Options at Shares December 31, 1997 (#) December 31, 1997 ($) Acquired on Value Exercisable/ Exercisable/ Name Exercise (#) Realized ($) Unexercisable Unexercisable ---- ------------ ------------ ------------- ------------- Larry G. Dillon 2,800 38,500 8,734/ 70,571/ 3,166 12,078 Change in Control Arrangements The Company has entered into a "change in control agreement" with Mr. Dillon. The agreement provides certain payments to and benefits for Mr. Dillon in the event of a termination of his employment by the Company without "cause," or by Mr. Dillon for "good reason," during the period beginning on the occurrence of a "change in control" (as defined) of the Company and ending sixty-one days after the second anniversary of the change in control date. In such event, Mr. Dillon would be entitled (i) to receive in 12 consecutive quarterly installments, or in a lump sum, two and one-half times the sum of his highest aggregate annual base salary during the 24 month period preceding the change in control date and his highest aggregate annual bonus for the three fiscal years preceding the change in control date; (ii) for a period of three years following termination, to receive continuing health insurance, life insurance, split dollar insurance and similar benefits under the Company's welfare benefit plans and to have the three year period credited as service towards completion of any service requirement for retiree coverage under the Company's welfare benefit plans; and (iii) if Mr. Dillon requests within one year after his termination, to have the Company acquire his residence for its appraised fair market value. During the term of the agreement following a change in control, Mr. Dillon may voluntarily terminate his employment and become entitled to these payment and benefits under certain circumstances. These circumstances include, but are not limited to, a material adverse change in his position, authority or responsibilities or a reduction in his rate of annual base salary, benefits (including incentives, bonuses, stock compensation, and retirement and welfare plan coverage) or other perquisites as in effect immediately prior to the change in control date. Payments and benefits provided under the agreement will be reduced, if and to the extent necessary, so that Mr. Dillon will not be subject to a federal excise tax on, and the Company will not be denied an income tax deduction on account of having made excess parachute payments. Employee Benefit Plans Management Incentive Bonus Plan. The Bank adopted a Management Incentive Bonus Plan (the "Bonus Plan") effective January 1, 1987. The Bonus Plan is offered to selected members of management. The bonus is derived from a pool of funds determined by the Bank's total performance relative to (1) prescribed growth rates of assets and deposits, (2) return on average assets, and (3) absolute level of net income. Attainment, in whole or in part, of these goals dictates the amount set aside in the pool of funds. Evaluation of attainment and approval of the pool amount is done by the Board of Directors of the Bank. Payment of the bonus is based on individual performance and paid in cash as a percentage of the respective individual's base salary. Expense is accrued in the year of the specified bonus performance. Other than the Bonus Plan (above), the Incentive Stock Option Plan (detailed below), and the Split-Dollar Insurance Program (detailed below), there are no personal benefits provided to principal officers and directors which are not provided to all other full-time employees. Profit-Sharing/401(k) Plan. The Bank maintains a Defined Contribution "Profit-Sharing" Plan sponsored by the Virginia Bankers Association. The plan was amended effective January 1, 1997, to include a 401(k) savings provision, which authorizes a maximum voluntary salary deferral of up to 15% of compensation (with a partial company match), subject to statutory limitations. The profit-sharing arrangement provides for an annual discretionary contribution to the account of each eligible employee based in part on the Bank's profitability for a given year, and on each participant's yearly earnings. All full-time employees with at least six months of service are eligible to participate. Contributions and earnings may be invested in various investment vehicles offered through the Virginia Bankers Association. Contributions and earnings are tax-deferred. An employee is 40% vested after four years of service, 60% after five years, 80% after six years, and fully vested after seven years. Retirement Plan. The Bank has a Non-Contributory Defined Benefit Retirement Plan (the "Retirement Plan") covering substantially all employees who have reached the age of 21 and have been fully employed for at least one year. The Retirement Plan provides participants with retirement benefits related to salary and years of credited service. Employees become vested after five plan years of service, and the normal retirement date is the plan anniversary date nearest the employee's 65th birthday. The Retirement Plan does not cover directors who are not active officers. The amount expensed for the Retirement Plan during the year ended December 31, 1997, was $93,258. The following table shows the estimated annual retirement benefits payable to employees in the average annual salary and years of service classifications set forth below assuming retirement at the normal retirement age of 65. Consecutive Five-Year Years of Credited Service Average Salary 15 20 25 30 35 -------------------------- ----------- ----------- ----------- ----------- --------- $ 25,000 $ 4,688 $ 6,250 $ 7,813 $ 8,750 $ 9,688 40,000 8,693 11,590 14,488 16,385 18,283 55,000 13,193 17,590 21,988 25,010 28,033 75,000 19,193 25,590 31,988 36,510 41,033 100,000 26,693 35,590 44,488 50,885 57,283 125,000 34,193 45,590 56,988 65,260 73,533 150,000 41,693 55,590 69,488 79,635 89,783 Benefits under the Retirement Plan are based on a straight life annuity assuming full benefit at age 65, no offsets, and covered compensation of $29,400 for a person age 65 in 1997. Compensation is currently limited to $160,000 by Internal Revenue Code. The estimated annual benefit payable under the Retirement Plan upon retirement is $73,680 for Mr. Dillon, credited with 40 years of service. Benefits are estimated on the basis that he will continue to receive, until age 65, covered salary in the same amount paid in 1997. Split-Dollar Insurance Plan. In addition to a group life insurance plan that is available to all full-time employees, the Bank offers a Split-Dollar Insurance Program to selected members of management. The insurance benefit under this program is equal to five times an officer's annual salary in effect at the time the officer is enrolled in the program. While the Bank advances a portion of the annual premium expense, each participant is obligated to reimburse, without interest, the aggregate amount advanced on his behalf during his participation in the program. Citizens and Farmers Bank recovers its cost from each participant at retirement or from the proceeds of the policy if the participant dies before reaching retirement age. Incentive Stock Option Plan. The Company adopted the 1994 Incentive Stock Plan (the "Incentive Plan") effective May 1, 1994. The Incentive Plan makes available up to 100,000 shares of common stock for awards to key employees of the Company and its subsidiaries in the form of stock options, stock appreciation rights, and restricted stock (collectively, "Awards"). The purpose of the Incentive Plan is to promote the success of the Company and its subsidiaries by providing incentives to key employees that will promote the identification of their personal interests with the long-term financial success of the Company and with growth in shareholder value. The Incentive Plan is designed to provide flexibility to the Company in its ability to motivate, attract, and retain the services of key employees upon whose judgment, interest, and special effort the successful conduct of its operation is largely dependent. Under the terms of the Incentive Plan, the Compensation Committee of the Board of Directors of the Bank (the "Committee") administers the plan. The Committee will have the power to determine the key employees to whom Awards shall be made. Each Award under the Incentive Plan will be made pursuant to a written agreement between the Company and the recipient of the Award (the "Agreement"). In administering the Incentive Plan, the Committee will have the authority to determine the terms and conditions upon which Awards may be made and exercised, to determine terms and provisions of each Agreement, to construe and interpret the Incentive Plan and the Agreements, to establish, amend, or waive rules or regulations for the Incentive Plan's administration, to accelerate the exercisability of any Award, the end of any performance period, or termination of any period of restriction, and to make all other determinations and take all other actions necessary or advisable for the administration of the Incentive Plan. The Board may terminate, amend, or modify the Incentive Plan from time to time in any respect without shareholder approval, unless the particular amendment or modification requires shareholder approval under the Internal Revenue Code of 1986, as amended (the "Code"), the rules and regulations under Section 16 of the Securities Exchange Act of 1934 or pursuant to any other applicable laws, rules, or regulations. Compensation Committee Report on Executive Compensation. The Compensation Committee (the "Committee"), which is composed of non-employee Directors of the Company and the Bank listed below, recommends to the Board of Directors of the Bank (the "Board") the annual salary levels and any bonuses to be paid to the Bank's executive officers. The Committee also makes recommendations to the Board regarding the issuance of stock options and all other compensation related matters. Currently, the individuals serving as Chief Executive Officer and executive officers of the Company also serve in the same capacities, respectively, for the Bank. These officers are presently compensated for services rendered by them to the Bank, but not for services rendered by them to the Company. The primary objective of the Bank's executive compensation program is to attract and retain highly skilled and motivated executive officers who will manage the Bank in a manner to promote its growth and profitability and advance the interest of the Company's stockholders. As such, the compensation program is designed to provide levels of compensation which are reflective of both the individual's and the organization's performance in achieving the organization's goals and objectives, both financial and non-financial, and in helping to build value for the Company's stockholders. Based on its evaluation of these factors, the Committee believes that the executive officers are dedicated to achieving significant improvements in long-term financial performance and that the compensation plans the Committee has implemented and administered have contributed to achieving this management focus. The principal elements of the Bank's compensation program include base annual salary, short-term incentive compensation under the Bank's Management Incentive Bonus Plan, and long-term incentive through the grants of stock options under the 1994 Incentive Stock Plan. In considering compensation for the Chief Executive Officer and the other executive officers, the Committee relied on compensation surveys and an evaluation of the officers' level of responsibility and performance. In 1997, the Committee used the following compensation surveys to assist in developing its recommendation on compensation: the SNL Executive Compensation Review; the Sheshunoff Bank Executive and Director Compensation Survey; and the Virginia Bankers Association's Salary Survey of Virginia Banks. The Committee believes that these are relevant and appropriate indicators of compensation paid by the Bank's competitors. The Committee received an evaluation by the Chief Executive Officer of the performance of the executive officers (other than the Chief Executive Officer) during 1997. The Committee evaluated the performance of the Chief Executive Officer based on the financial performance of the Company and the Bank, achievements in implementing the Bank's long-term strategy, and the personal observations of the Chief Executive Officer's performance by the members of the Committee. No particular weight was given to any particular aspects of the performance of the Chief Executive Officer, but his performance in 1997 was evaluated as outstanding, with the Company and the Bank achieving record earnings and significant progress being made on the Bank's long-term strategy. Based on the salary surveys and the performance evaluations, the Committee generally set base annual salaries for the Chief Executive Officer and the other executive officers in the median range of salaries contained in the various surveys for comparable positions. Adjustments to base annual salary for 1998 ranged from a base salary increase of 3.6% to 16.7% for the Bank's executive officers, with the Chief Executive Officer receiving a 16.7% increase. The Committee also reviewed each executive officer's performance and responsibility to assess the payment of short-term incentive compensation. The Committee uses the compensation surveys and takes into consideration the performance of the Bank relative to its peer group, taking into consideration profit growth, asset growth, return on equity, and return on assets. No particular weight is given to each of these elements. For 1997, the Committee recommended the payment of cash bonuses to all the executive officers ranging from 14% to 33% of base salary, with the Chief Executive Officer receiving a cash bonus of 33% of base salary. The cash bonuses were given based upon the role of such officers in the growth and profitability of the Bank in 1997. Each year, the Committee also considers the desirability of granting long-term incentive awards under the Company's 1994 Incentive Stock Option Plan. The Committee believes that grants of options focus the Bank's senior management on building profitability and shareholder value. The Committee notes in particular its view that stock option grants afford a desirable long-term compensation method because they closely ally the interests of management with shareholder value. In fixing the grants of stock options with the senior management group, other than the Chief Executive Officer, the Committee reviewed with the Chief Executive Officer recommended individual awards, taking into account the respective scope of accountability and contributions of each member of the senior management group. The award to the Chief Executive Officer was fixed separately and was based, among other things, on a review of competitive compensation data from selected peer companies and information on his total compensation as well as the Committee's perception of his past and expected future contributions to the Company's achievement of its long-term goals. Compensation Committee J. P. Causey Jr. - Chairman P. Loy Harrell James H. Hudson, III Thomas B. Whitmore, Jr. Compensation Committee Interlocks and Insider Participation During 1997 and up to the present time, there were transactions between the Company's banking subsidiary and certain members of the Compensation Committee, or their associates, all consisting of extensions of credit by the Bank in the ordinary course of business. Each transaction was made on substantially the same terms, including interest rates, collateral and repayment terms, as those prevailing at the time for comparable transactions with the general public. In the opinion of management, none of the transactions involve more than the normal risk of collectibility or present other unfavorable features. None of the members of the Compensation Committee has served as an officer or employee of the Company or any of its affiliates. No director may serve as a member of the Committee if he is eligible to participate in the Incentive Plan or was at any time within one year prior to his appointment to the Committee eligible to participate in the Incentive Plan. Performance Graph The following graph compares the yearly cumulative total shareholder return on the Company's common stock with (1) the yearly cumulative total shareholder return on stocks included in the NASDAQ stock index and (2) the yearly cumulative total shareholder return on stocks included in the Independent Bank Index prepared by the Carson Medlin Company. The Independent Bank Index is the compilation of the total return to shareholders over the past 5 years of a group of twenty-three independent community banks located in the southeastern states of Florida, Georgia, North Carolina, South Carolina, Tennessee, and Virginia. There can be no assurance that the Company's stock performance will continue into the future with the same or similar trends depicted in the graph below. COMPARISON OF FIVE YEAR CUMULATIVE RETURN [GRAPH] C&F FINANCIAL CORPORATION Five Year Performance Index 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- C&F FINANCIAL CORPORATION 100 101 122 126 119 170 INDEPENDENT BANK INDEX 100 125 153 208 248 358 NAXDAQ INDEX 100 115 112 159 195 240 Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act requires directors, executive officers and 10% beneficial owners of the Company's common stock to file reports concerning their ownership of common stock. The Company believes that its officers and directors complied with all filing requirements under Section 16(a) of the Securities Exchange Act of 1934 during 1997. PROPOSAL TWO RATIFICATION OF APPOINTMENT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors, subject to ratification by the shareholders, has appointed Yount, Hyde & Barbour, P.C. as independent public accountants for the current fiscal year ending December 31, 1998. A representative of Yount, Hyde & Barbour, P.C. will be present at the Annual Meeting and will be given the opportunity to make a statement and respond to appropriate questions from the shareholders. Unless marked to the contrary, the shares represented by the enclosed proxy card, if executed and returned, will be voted FOR the ratification of the appointment of Yount, Hyde & Barbour, P.C. as the independent public accountants of the Company. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" RATIFICATION OF THE APPOINTMENT OF YOUNT, HYDE & BARBOUR, P.C. AS INDEPENDENT PUBLIC ACCOUNTANTS. OTHER BUSINESS As of the date of this Proxy Statement, management of the Company has no knowledge of any matters to be presented for consideration at the Annual Meeting other than those referred to above. If any other matters properly come before the Annual Meeting, the persons named in the accompanying proxy intend to vote such proxy, to the extent entitled, in accordance with their best judgment. SHAREHOLDER PROPOSALS FOR 1999 ANNUAL MEETING Proposals of shareholders intended to be presented at the 1999 Annual Meeting must be received by the Company no later than November 20, 1998. Under applicable law, the Board of Directors need not include an otherwise appropriate shareholder proposal (including any shareholder nominations for director candidates) in its proxy statement or form of proxy for that meeting unless the proposal is received by the Company's Secretary, at the Company's principal office in West Point, Virginia, on or before the date set forth above. By Order of the Board of Directors /s/ Gari B. Sullivan Gari B. Sullivan Secretary West Point, Virginia March 12, 1998 A copy of the Company's Annual Report on Form 10-K Report (including, exhibits) as filed with the Securities and Exchange Commission for the year ended December 31, 1997, will be furnished without charge to shareholders upon written request directed to the Company's Secretary as set forth on the first page of this Proxy Statement. EXHIBIT 99.2 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders C&F Financial Corporation We have audited the accompanying consolidated balance sheets of C&F Financial Corporation and subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of C&F Financial Corporation and subsidiary as of December 31, 1996 and 1995, the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles. End of Filing /s/ DELOITTE & TOUCHE LLP Richmond, Virginia January 17, 1997 © 2005 | EDGAR Online, Inc.
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