Exhibit 13.1

 

Annual Report to Security Holders For the Fiscal Year ended December 31, 2014

 

 

 

 

 

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Dear Shareholders:

2014 was truly a transformational year for Central Federal Corporation and CFBank. These are some of the highlights which I am enthused to share with you.

Due to our having a presence in multiple metro markets, we were able to increase net loan balances by 24% during 2014.  This allowed CFBank to attain critical size to allow us to reach profitability during the second quarter of 2014.  As we continue to add quality loans and earning assets, we expect that the additional earning asset growth will continue to be reflected in our net interest income. 

Net interest income, which is the primary driver of earnings, increased by 61.9% during 2014.  Fourth quarter net interest income was $2.5 million, reflecting an increase of 63.9% over the same quarter of 2013.

Our loan pipelines remain solid entering 2015.  Our Cleveland loan production office, which opened in January of 2014, has been well received.  We have established full service banking relationships with a number of business owners and entrepreneurs whose businesses are located in Northeast Ohio. We believe that our relationship business model with its value-added approach, coupled with delivery through senior level and experienced bankers, has proven successful.

Following the removal of the regulatory Cease and Desist Orders during the first half of 2014, CFBank implemented a number of initiatives that have resulted in successfully growing our core deposit base.  Additionally, we have reduced our reliance on non-core funding, which was one of our key objectives.  This positive trend of core deposit growth is continuing into 2015 and remains important to us as a funding source for loans.

With our entrance into the Cleveland market, CFBank now has a presence in three large metro markets in Ohio (Central Ohio, Northeast Ohio and Akron/Canton) to go along with our two community banking offices located in Columbiana County.  Our footprint and access to business relationships from multiple larger metro markets positions us uniquely among our peers.

We successfully completed a private placement of our Series B Preferred Stock in July of 2014 for an aggregate offering price of $12.0 million.  This capital raise further strengthened our capital position and allows for our continued growth and expansion.  We have already successfully deployed much of this capital into loans, which is reflected in our increased earnings and interest income.  At this point, we believe that we have sufficient capital, when coupled with earnings, to meet our needs and strategic growth objectives for the foreseeable future.

During 2014, we have achieved continued improvement in our credit metrics.  Nonperforming loans were reduced by 73.0% compared to year end 2013.  Our ratio of ALLL to nonperforming loans was 408.0% at year ended December 31, 2014, compared to 99.9% at December 31, 2013.  Nonperforming loans at December 31, 2014 were 0.59% of total loans compared to 2.70% at December 31, 2013.  CFBank currently has only one REO property. 

We reduced our classified assets by 13.1% during 2014.  Further reduction of classified assets remains a key objective for 2015.  The vast majority of remaining classified assets are legacy loans which are amortizing and paying as agreed.  Nonetheless, in spite of our good results in reducing both criticized and classified assets to date, classified asset levels remain higher than we are comfortable with. As a result, management and the Board of Directors is continuing its concerted efforts and focus to further reduce our classified assets.

We have invested substantially in strengthening our infrastructure.  We have increased staffing in both our credit department and loan operations areas, which includes adding experienced and seasoned management personnel.  Also, we are implementing new software to support our commercial credit, loan underwriting and risk management functions. Additional investments to further strengthen these areas of credit risk management and the operations infrastructure will be continuing in 2015 and beyond.

Our residential mortgage volumes showed solid increases over the prior year. Also, we have expanded our product offerings including construction/perm and physician loan programs.  Additionally, we are pleased with our cross-sell results in the residential mortgage lending area of home equity lines of credit (HELOC’s) and depository relationships.

Again, we feel strongly that 2014 was a turning point for us at Central Federal Corporation and CFBank.  We achieved profitability, made considerable improvements in credit quality, expanded our footprint, added several significant new business relationships, completed a successful capital raise, and improved operating results in the majority of our key areas of measurement.

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We enter 2015 excited about the prospects for continuing our positive trajectories and results.  We worked extremely hard to achieve these positive results and I am extremely proud of our team and their commitment to our success.  We are grateful to you, our shareholders, for your support and to our clients for entrusting us with their business.

Our team remains committed to our objective of becoming a top performing niche bank in all key categories of measurement.  Although work remains to be done, I believe that we have accomplished much and achieved several major milestones during 2014.

Onward and upward!

 

 

/s/ Timothy T. O’Dell

Timothy T. O’Dell

Chief Executive Officer

 

 

/s/ Robert E. Hoeweler

Robert E. Hoeweler

Chairman of the Board

 

 

 

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SELECTED FINANCIAL AND OTHER DATA

The information in the following tables should be read in conjunction with our Consolidated Financial Statements, the related Notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this report.

 

 

 

 

 

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FORWARD LOOKING STATEMENTS

Statements in this annual report and in other communications by the Company that are not statements of historical fact are forward-looking statements which are made in good faith by us. Forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per common share, capital structure and other financial items; (2) plans and objectives of the management or Boards of Directors of Central Federal Corporation (the “Holding Company”) or CFBank; (3) statements regarding future events, actions or economic performance; and (4) statements of assumptions underlying such statements.  Words such as "estimate," "strategy," "may," "believe," "anticipate," "expect," "predict," "will," "intend," "plan," "targeted," and the negative of these terms, or similar expressions, are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements.  Various risks and uncertainties may cause actual results to differ materially from those indicated by our forward-looking statements.  The following, among other factors, could cause such differences:

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Forward-looking statements are not guarantees of performance or results.  A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement.  The Holding Company, including its subsidiaries (together referred to as the “Company”) believes it has chosen these assumptions or bases in good faith and that they are reasonable.  We caution you, however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material.  The forward-looking statements included in this report speak only as of the date of the report.  We undertake no obligation to publicly release revisions to any forward-looking statements to reflect events or circumstances after the date of such statements, except to the extent required by law.

 

Our filings with the Securities and Exchange Commission (the “SEC”), detail other risks, all of which are difficult to predict and many of which are beyond our control.

 

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Business Overview

The Holding Company is a savings and loan holding company incorporated in Delaware in 1998.  Substantially all of our business is conducted through our principal subsidiary, CFBank, a federally chartered savings association formed in Ohio in 1892.

CFBank is a community-oriented financial institution offering a variety of financial services to meet the needs of the communities we serve.  Our business model emphasizes personalized service, clients’ access to decision makers, solution-driven lending and quick execution, efficient use of technology and the convenience of online internet banking, mobile banking, remote deposit and corporate cash management.  We attract retail and business deposits from the general public and use the deposits, together with borrowings and other funds, primarily to originate commercial and commercial real estate loans, single-family and multi-family residential mortgage loans and home equity lines of credit.  The majority of our customers are small businesses, small business owners and consumers.

Our principal market area for loans and deposits includes the following Ohio counties: Summit County through our office in Fairlawn, Ohio; Franklin County through our office in Worthington, Ohio; Columbiana County through our offices in Calcutta and Wellsville, Ohio; and Cuyahoga County, through our loan production office in Woodmere, Ohio.  We originate commercial and residential real estate loans and business loans primarily throughout Ohio. Most of our deposits and loans come from our market area.  Because of CFBank’s concentration of business activities in Ohio, the Company’s financial condition and results of operations depend upon economic conditions in Ohio.

General

Our net income is dependent primarily on net interest income, which is the difference between the interest income earned on loans and securities and our cost of funds, consisting of interest paid on deposits and borrowed funds.  Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, the level of nonperforming assets and deposit flows.

Net income is also affected by, among other things, provisions for loan losses, loan fee income, service charges, gains on loan sales, operating expenses, income and other various taxes.  Operating expenses principally consist of employee compensation and benefits, occupancy, FDIC insurance premiums and other general and administrative expenses.  In general, results of operations are significantly affected by general economic and competitive conditions, changes in market interest rates and real estate values, government policies and actions of regulatory authorities.  Our regulators have extensive discretion in their supervisory and enforcement activities, including the authority to impose restrictions on our operations, to classify our assets and to determine the level of our allowance for loan losses.  Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our business, financial condition, results of operations and/or cash flows.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  The Dodd-Frank Act included numerous provisions designed to strengthen the financial industry, enhance consumer protection, expand disclosures and provide for transparency.  Some of these provisions included changes to FDIC insurance coverage, which included a permanent increase in the coverage to $250,000 per depositor. Additional provisions created a Bureau of Consumer Financial Protection, which is authorized to write rules on all consumer financial products. Still other provisions created a Financial Stability Oversight Council, which is not only empowered to determine the entities that are systemically significant and therefore require more stringent regulations, but which is also charged with reviewing, and, when appropriate, submitting comments to the SEC and Financial Accounting Standards Board (FASB) with respect to existing or proposed accounting principles, standards or procedures. The aforementioned are only a few of the numerous provisions included in the Dodd-Frank Act. The overall impact of the entire Dodd-Frank Act will not be known until full implementation is completed, but the possibility of significant additional compliance costs exists, and the Dodd-Frank Act consequently may have a material adverse impact on our operations.

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Cease and Desist Orders

On May 25, 2011, the Holding Company and CFBank each consented to the issuance of an Order to Cease and Desist (the “Holding Company Order” and the “CFBank Order”, respectively, and collectively, the “Orders”) by the Office of Thrift Supervision (the “OTS”), the primary regulator of the Holding Company and CFBank at the time the Orders were issued.  In July 2011, in accordance with the Dodd-Frank Act, the FRB replaced the OTS as the primary regulator of the Holding Company and the OCC replaced the OTS as the primary regulator of CFBank.  See Note 2 to the consolidated financial statements included in this annual report for additional information regarding the Orders.

Effective as of January 23, 2014, the OCC released and terminated the CFBank Order based upon the improved capital position of CFBank, among other factors.  Notwithstanding the release of the CFBank Order, CFBank is required to continue to maintain a minimum Tier 1 Leverage Capital Ratio of 8% and a Total Risk-based Capital to Risk-Weighted Assets ratio of 12%.  In addition, in connection with the release and termination of the CFBank Order, CFBank has made certain commitments to the OCC to continue to adhere to certain prudent practices, including, without limitation, maintaining a written program to continue to improve CFBank’s credit underwriting and administrative process; take actions to protect its interest in criticized assets as identified by CFBank, the OCC examiners or its external loan review process and implement its written program to effectively identify, monitor, control and continue to reduce the level of credit risk to CFBank; review and monitor progress against such plan with the Board of Directors and continue CFBank’s aggressive workout efforts and individualized workout plans on all criticized assets greater than $250,000.  See Note 2 to the consolidated financial statements included in this annual report for additional information regarding the Orders.

On May 15, 2014, the FRB announced the termination of the Holding Company Order, effective as of May 9, 2014.  Notwithstanding the termination of the Holding Company Order, the Holding Company is required to continue to adhere to certain requirements and restrictions based on commitments made to the FRB in connection with the termination of the Holding Company Order.  These commitments require the Holding Company, among other things, to continue to implement certain actions in accordance with the capital plan previously submitted to the FRB; not declare or pay dividends on its stock, purchase or redeem its stock, or accept dividends or other capital distributions from CFBank without the prior written approval of the FRB; not incur, increase or guarantee any debt without the prior written consent of the FRB; and provide prior written notice to the FRB with respect to certain changes in directors and senior executive officers.  See Note 2 to the consolidated financial statements included in this Annual Report for additional information regarding the Orders.

The significant directives contained in the Orders and the commitments made by CFBank and the Holding Company in connection with the release and termination of the Orders  have provided challenges for the operation of our business and our ability to effectively compete in our markets. In addition, the Orders and our ongoing commitments to the regulators have required that we obtain approval from our regulators for any deviations from our business plan, which has limited our flexibility to make changes to the scope of our business activities.  We have also incurred significant additional regulatory compliance expense in connection with the Orders and our regulatory commitments, and it is possible that regulatory compliance expenses could continue to have a material adverse impact on us in the future.

Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies.  Currently, CFBank cannot declare or pay dividends or make any other capital distributions without receiving prior written regulatory approval.  Future dividend payments by CFBank to the Holding Company would be based on future earnings and regulatory approval.  The payment of dividends from CFBank to the Holding Company is not likely to be approved by regulators until CFBank is able to generate consistent earnings.  As a result of the current level of problem assets and the continuing slow economy, it is unlikely CFBank will be able to pay dividends to the Holding Company until such issues are resolved. The Holding Company has adequate operating capital for the foreseeable future. The Holding Company had $3.0 million in cash and cash equivalents at December 31, 2014.  The regulators have further required the Holding Company to develop a business plan, separate from CFBank, that enables it to significantly reduce its dependence on CFBank for dividends through alternative funding mechanisms.

Management’s discussion and analysis represents a review of our consolidated financial condition and results of operations for the periods presented.  This review should be read in conjunction with our consolidated financial statements and related notes.

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Financial Condition

General.    Assets totaled $315.6 million at December 31, 2014 and increased $59.8 million, or 23.4%, from $255.7 million at December 31, 2013.  The increase was primarily due to a $50.7 increase in net loan balances and a $9.0 million increase in cash and cash equivalents, partially offset by a $1.5 million decrease in interest-bearing deposits in other financial institutions.

Cash and cash equivalents.  Cash and cash equivalents totaled $28.2 million at December 31, 2014, and increased $9.0 million, or 47.2%, from $19.2 million at December 31, 2013.  The increase in cash and cash equivalents was a result of management’s efforts to increase deposit activity in order to fund anticipated loan growth. 

Securities. Securities available for sale totaled $10.4 million at December 31, 2014, and increased $773,000, or 8.0%, compared to $9.7 million at December 31, 2013.  The increase was due to $5.0 million in security purchases, which was offset by scheduled payments and maturities.

Loans.    Net loans totaled $257.8 million at December 31, 2014, and increased $50.7 million, or 24.5%, from $207.1 million at December 31, 2013. The increase was primarily due to a $19.3 million increase in single-family loan balances, a $12.3 million increase in construction loan balances, a $9.1 million increase in commercial loan balances and a $7.7 million increase in commercial real estate loan balances.  A renewed lending focus was a key driver in growing earning assets.

On December 11, 2012, CFBank entered into a Mortgage Purchase Program with Northpointe Bank (Northpointe), a Michigan banking corporation.  Through a participation agreement, CFBank agreed to purchase from Northpointe an 80% interest in fully underwritten and pre-sold mortgage loans originated by various prescreened mortgage brokers located throughout the U.S. The participation agreement provides for CFBank to purchase interests in individually (MERS registered) loans from Northpointe and hold them until funded by the end investor.  This process on average takes approximately 14 days.  Given the short term nature of each of these individual loans, common credit risks such as past due, impairment and trouble debt restructure (TDR), nonperforming, and nonaccrual classification are substantially reduced.  Accordingly, due to the low credit risk associated with these loans, there are no reserves allocated to these loans. Northpointe maintains a 20% ownership interest in each loan it participates.  Interest income earned on these loans is based on a contractual interest rate, during the time the loans are outstanding, as opposed to being recorded as a gain on sale of loans.  Effective December 18, 2014, the participation agreement was amended and CFBank agreed to increase the level of interest in loans it purchases from Northpointe from 80% to 95% of the aforementioned loans, and therefore, Northpointe now maintains a 5% ownership in each loans it participates.  During the twelve months ended December 31, 2014 and December 31, 2013, loan origination activity totaled $271.4 and $469.4 million, respectively, and payoffs for the same period totaled $259.2 and $482.0 million, respectively.  At December 31, 2014 and December 31, 2013, CFBank held $25.0 million and $12.7 million, respectively, of such loans which are included in single-family residential loan totals.    

Allowance for loan losses (ALLL).  The allowance for loan losses totaled $6.3 million at December 31, 2014, and increased  $587,000, or 10.2%, from $5.7 million at December 31, 2013.    The increase in the ALLL is due to a combination of factors including a 24.5% increase in overall loan balances and a $313,000 increase in net recoveries during the twelve months ended December 31, 2014. The provision for growth was partially offset by continuous improvement in credit quality and a 73.0% decrease in nonperforming loans.    The ratio of the ALLL to total loans was 2.39% at December 31, 2014, compared to 2.69% at December 31, 2013; the decline is primarily attributable to an increase in the loan portfolio combined with improving asset quality.  In addition, the ratio of the ALLL to nonperforming loans improved to 408.0% at December 31, 2014, compared to 99.9% at December 31, 2013. 

The ALLL is a valuation allowance for probable incurred credit losses.  The ALLL methodology is designed as part of a thorough process that incorporates management’s current judgments about the credit quality of the loan portfolio into a determination of the ALLL in accordance with generally accepted accounting principles and supervisory guidance.  Management analyzes the adequacy of the ALLL quarterly through reviews of the loan portfolio, including the nature and volume of the loan portfolio and segments of the portfolio; industry and loan concentrations; historical loss experience; delinquency statistics and the level of nonperforming loans; specific problem loans; the ability of borrowers to meet loan terms; an evaluation of collateral securing loans and the market for various types of collateral; various collection strategies; current economic conditions, trends and outlook; and other factors that warrant recognition in providing for an adequate ALLL.  Based on the variables involved and the significant judgments management must make about outcomes that are uncertain, the determination of the ALLL is considered to be a critical accounting policy. See the section titled “Critical Accounting Policies” for additional discussion.

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The ALLL consists of specific and general components.  The specific component relates to loans that are individually classified as impaired.  A loan is impaired when, based on current information and events, it is probable that CFBank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans of all classes within the commercial, commercial real estate and multi-family residential loan segments, regardless of size, and loans of all other classes over $250,000, are individually evaluated for impairment when they are 90 days past due, or earlier than 90 days past due if information regarding the payment capacity of the borrower indicates that payment in full according to the loan terms is doubtful.  If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral, less costs to sell, if repayment is expected solely from the collateral.  Large groups of smaller balance loans, such as consumer and single-family residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.  Loans within any class for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (TDRs) and are classified as impaired.  See Notes 1 and 4 to our consolidated financial statements included in this annual report for additional information regarding the ALLL.

Individually impaired loans totaled $6.3 million at December 31, 2014, and decreased $2.6 million, or 29.7%, from $8.9 million at December 31, 2013.  The decrease was primarily due to loan repayments.  The amount of the ALLL specifically allocated to individually impaired loans totaled $64,000 at December 31, 2014 and $1.1 million at December 31, 2013.  The decrease in the ALLL specifically allocated to impaired loans was primarily due to loan repayments and two nonaccrual loans where conditions significantly improved and the loans were evaluated and met the criteria for return to accrual status; as such, the specific reserves were no longer needed.

The specific reserve on impaired loans is based on management’s estimate of the present value of estimated future cash flows using the loan’s effective rate or the fair value of collateral, if repayment is expected solely from the collateral.  On at least a quarterly basis, management reviews each impaired loan to determine whether it should have a specific reserve or partial charge-off. Management relies on appraisals or internal evaluations to help make this determination.  Determination of whether to use an updated appraisal or internal evaluation is based on factors including, but not limited to, the age of the loan and the most recent appraisal, condition of the property and whether we expect the collateral to go through the foreclosure or liquidation process.  Management considers the need for a downward adjustment to the valuation based on current market conditions and on management’s analysis, judgment and experience. The amount ultimately charged-off for these loans may be different from the specific reserve, as the ultimate liquidation of the collateral and/or projected cash flows may be different from management’s estimates. 

Nonperforming loans, which are nonaccrual loans and loans 90 days past due but still accruing interest, decreased $4.2 million, or 73.0%, and totaled $1.5 million at December 31, 2014, compared to $5.7 million at December 31, 2013.  The decrease in nonperforming loans was primarily due to the aforementioned loans that either paid off or were returned to accrual status and continued loan repayments on nonperforming loans.   The ratio of nonperforming loans to total loans was 0.59% at December 31, 2014, compared to 2.70% at December 31, 2013.    

The following table presents information regarding the number and balance of nonperforming loans at December 31, 2014 and December 31, 2013. 

 

 

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Nonaccrual loans include some loans that were modified and identified as TDRs and the loans are not performing.  TDRs included in nonaccrual loans totaled $422,000 at December 31, 2014 and $2.6 million at December 31, 2013.    The decrease in TDRs included in nonaccrual loans was primarily due to the aforementioned loans that were returned to accrual status and continued pay-downs on nonperforming loans.

Nonaccrual loans at December 31, 2014 and December 31, 2013 do not include $5.3 million and $3.5 million, respectively, of TDRs where customers have established a sustained period of repayment performance, generally six months, the loans are current according to their modified terms and repayment of the remaining contractual payments is expected.  These loans are included in total impaired loans. 

See Notes 1 and 4 to our consolidated financial statements included in this annual report for additional information regarding impaired loans and nonperforming loans.

The general reserve component covers non-impaired loans of all classes and is based on historical loss experience adjusted for current factors.  The historical loss experience is determined by loan class and is based on the actual loss history experienced by the Company over a three-year period.  The general component is calculated based on CFBank’s loan balances and actual historical three-year historical loss rates.  For loans with little or no actual loss experience, industry estimates are used based on loan segment. This actual loss experience is supplemented with other economic and judgmental factors based on the risks present for each loan class.  These economic and judgmental factors include consideration of the following:  levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

During the fourth quarter of 2013, after running parallel calculations and analyzing results for the last two quarters, the Bank revised its ALLL methodology for the general reserve.  Previously, the base methodology relied more heavily on industry data and loss given default rates and probability of default.  Based on the fact that the Bank has been tracking historical loss rates for a significant time, the new methodology uses a historical three-year loss rate as its base methodology.  Similar to before, the base methodology may be supplemented with economic and judgmental factors.  Based on the change in methodology which considered portfolio migration, three-year loss rates and revised economic and judgmental factors, a $250,000 reduction to the allowance for loan loss was recorded.  The impact on prior quarters was not considered material. 

Management’s loan review process is an integral part of identifying problem loans and determining the ALLL. We maintain an internal credit rating system and loan review procedures specifically developed as the primary credit quality indicator to monitor credit risk for commercial, commercial real estate and multi-family residential real estate loans.  We analyze these loans individually and categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.  Credit reviews for these loan types are performed at least annually, and more often for loans with higher credit risk.  Loan officers maintain close contact with borrowers between reviews.  Adjustments to loan risk ratings are based on the reviews and at any time information is received that may affect risk ratings.  Additionally, an independent third party review of commercial, commercial real estate and multi-family residential loans is performed at least annually.  Management uses the results of these reviews to help determine the effectiveness of the existing policies and procedures and to provide an independent assessment of our internal loan risk rating system.

We have incorporated the regulatory asset classifications as a part of our credit monitoring and internal loan risk rating system.  In accordance with regulations, problem loans are classified as special mention, substandard, doubtful or loss, and the classifications are subject to review by the regulators.  Assets designated as special mention are considered criticized assets.  Assets designated as substandard, doubtful or loss are considered classified assets. See Note 4 to our consolidated financial statements included in this annual report for additional information regarding descriptions of the regulatory asset classifications.

The levels of criticized and classified loans decreased during the twelve months ended December 31, 2014 due to management’s on-going efforts to improve credit quality and continued payments by customers.  Loans designated as special mention decreased $583,000, or 19.9%, and totaled $2.4 million at December 31, 2014, compared to $2.9 million at December 31, 2013.  Loans classified as substandard decreased $1.9 million, or 13.1%, and totaled $12.9 million at December 31, 2014, compared to $14.9 million at

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December 31, 2013.  No loans were classified as doubtful at December 31, 2014 and December 31, 2013.  See Note 4 to our consolidated financial statements included in this annual report for additional information regarding risk classification of loans. 

In addition to credit monitoring through our internal loan risk rating system, we also monitor past due information for all loan segments.  Loans that are not rated under our internal credit rating system include groups of homogenous loans, such as single-family residential real estate loans and consumer loans. The primary credit indicator for these groups of homogenous loans is past due information. 

Total past due loans decreased $1.4 million, or 54.2%, and totaled $1.2 million at December 31, 2014, compared to $2.5 million at December 31, 2013.  Past due loans totaled 0.4% of the loan portfolio at December 31, 2014, compared to 1.2% at December 31, 2013.  The decrease in past due loan balances was primarily due to decreases in the commercial real estate non-owner and land loan segments. See Note 4 to our consolidated financial statements for additional information regarding loan delinquencies.

All lending activity involves risk of loss.  Certain types of loans, such as option adjustable-rate mortgage (ARM) products, junior lien mortgages, high loan-to-value ratio mortgages, interest only loans, subprime loans and loans with initial teaser rates, can have a greater risk of non-collection than other loans.  CFBank has not engaged in subprime lending, used option ARM products or made loans with initial teaser rates. 

Unsecured commercial loans may present a higher risk of non-collection than secured commercial loans.  Unsecured commercial loans totaled $3.9 million, or 8.4% of the commercial loan portfolio, at December 31, 2014 and $3.7 million, or 10.0% of the commercial loan portfolio, at December 31, 2013. The unsecured loans are primarily lines of credit to small businesses in CFBank’s market area and are guaranteed by the small business owners.  At December 31, 2014 and December 31, 2013, none of the unsecured loans were 30 days or more delinquent.

Loans that contain interest only payments may present a higher risk than those loans with an amortizing payment that includes periodic principal reductions. Interest only loans are primarily commercial lines of credit secured by business assets and inventory, and consumer home equity lines of credit secured by the borrower’s primary residence. Due to the fluctuations in business assets and inventory of our commercial borrowers, CFBank has increased risk due to a potential decline in collateral values without a corresponding decrease in the outstanding principal.  Interest only commercial lines of credit totaled $17.9 million, or 38.4% of the commercial loan portfolio, at December 31, 2014 compared to $12.9 million, or 34.4%, at December 31, 2013.  Given the recessionary effects of the economy in the past several years, the collateral that secures the home equity lines of credit may have experienced a deterioration in value since the loan was originated, increasing the risk to CFBank. Interest only home equity lines of credit totaled $14.9 million, or 85.2% of total home equity lines of credit, at December 31, 2014 compared to $12.1 million, or 81.0%, at December 31, 2013.

We believe the ALLL is adequate to absorb probable incurred credit losses in the loan portfolio as of December 31, 2014; however, future additions to the allowance may be necessary based on factors including, but not limited to, further deterioration in client business performance, continued or deepening recessionary economic conditions, declines in borrowers’ cash flows and market conditions which result in lower real estate values.  Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the ALLL.  Such agencies may require additional provisions for loan losses based on judgments and estimates that differ from those used by management, or on information available at the time of their review.  Management continues to diligently monitor credit quality in the existing portfolio and analyze potential loan opportunities carefully in order to manage credit risk.  An increase in loan losses could occur if economic conditions and factors which affect credit quality, real estate values and general business conditions worsen or do not improve. 

Foreclosed assets.  Foreclosed assets totaled $1.6 million at December 31, 2014 and remained constant compared to $1.6 million at December 31, 2013.  Foreclosed assets at December 31, 2014 and December 31, 2013 consisted of one multi-family property in Mansfield, Ohio.  The level of foreclosed assets and charges to foreclosed assets expense may increase in the future as we increase our workout efforts related to foreclosed assets, nonperforming loans and other loans with credit issues.

Premises and equipment.  Premises and equipment, net, totaled $3.8 million at December 31, 2014, and increased $228,000, or 6.4%, from $3.5 million at December 31, 2013.  The increase is partially attributed to opening the loan production office in Woodmere, Ohio in January 2014.  See Note 8 – Premises and Equipment to our consolidated financial statements included in this annual report for additional information.

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Deposits.    Deposits totaled $258.3 million at December 31, 2014, an increase of $50.0 million, or 24.0%, from $208.3 million at December 31, 2013.    The increase is primarily attributed to a $19.5 million increase in money market account balances, a $18.1 million increase in certificate of deposit account balances, a $9.4 million increase in noninterest checking account balances and a $2.1 million increase in savings account balances.  Also, the majority of the deposit increase is a result of management’s focused sales and marketing efforts to grow core deposits to fund loan growth.

Noninterest bearing checking account balances totaled $37.0 million at December 31, 2014 and increased $9.4 million, or 33.9%, from $27.6 million at December 31, 2013. The majority of this increase is attributable to our focused sales efforts to grow core deposits and expanding our relationship opportunities with our customers.

Certificate of deposit account balances totaled $137.2 million at December 31, 2014 and increased $18.1 million, or 15.2%, from $119.0 million at December 31, 2013.  The increase was due to a $13.3 million increase in retail deposit accounts and a $4.8 million increase in brokered certificate of deposits.

CFBank is a participant in the Certificate of Deposit Account Registry Service® (CDARS) program, a network of banks that allows us to provide our customers with FDIC insurance coverage on certificate of deposit account balances up to $50 million.  CDARS balances are considered brokered deposits by regulation.  Brokered deposits, including CDARS balances, totaled $29.3 million at December 31, 2014, and increased $8.3 million, or 39.8%, from $21.0 million at December 31, 2013.  The increase in brokered is primarily due a $4.2 million increase in CDARS balances, a $3.5 million in other brokered funds and a $600,000 increase in brokered certificate of deposits.  These funds were used to augment our funding sources to fund loan growth or increases in our mortgage purchase program at various times.  See the section titled “Liquidity and Capital Resources” for additional information regarding regulatory restrictions on brokered deposits.

While the CFBank Order was in place from May 2011 until January 2014, CFBank was prohibited from accepting or renewing brokered deposits, including CDARS balances.  CFBank received limited waivers from the prohibition on renewal of reciprocal CDARS deposits from the FDIC, and the restrictions were subsequently lifted upon the termination of the CFBank Order in January 2014.  Customer balances in the CDARS program totaled $10.2 million at December 31, 2014 and increased $4.3 million, or 72.6%, from $5.9 million at December 31, 2013.    

FHLB advances.    FHLB advances totaled $14.5 million at December 31, 2014 and increased $4.5 million, or 45.0%, from $10.0 million at December 31, 2013.  At December 31, 2013, CFBank was limited to borrowing term maturities not exceeding 365 days due to restrictions imposed by the FHLB due to the existence of the CFBank Order. With the termination of the CFBank Order effective January 23, 2014, the FHLB notified the Bank that the restriction on borrowings terms had been lifted, effective January 24, 2014.  See the section titled “Liquidity and Capital Resources”  for additional information regarding limitations on FHLB advances.

Subordinated debentures.  Subordinated debentures totaled $5.2 million at both December 31, 2014 and December 31, 2013.  These debentures were issued in 2003 in exchange for the proceeds of a $5.0 million trust preferred securities offering issued by a trust formed by the Holding Company.  The terms of the subordinated debentures allow for the Holding Company to defer interest payments for a period not to exceed five years.  The Holding Company’s Board of Directors elected to defer interest payments beginning with the quarterly interest payment due on December 30, 2010 in order to preserve cash at the Holding Company prior to completion of the stock offering. Cumulative deferred interest payments through September 30, 2012 totaling $348,000 were paid current in December 2012 with the approval of the FRB.  Subsequently, the Company deferred interest payments, and accrued deferred interest payments totaled $210,000 as of December 31, 2013.  In June 2014, the Company paid all deferred and current interest payments in the amount of $293,000.  During the quarters ended September 30, 2014 and December 31, 2014, with prior non-objection from the FRB, the Company paid current all of the interest.  Pursuant to the Holding Company’s current commitments to the FRB, the Holding Company may not, directly or indirectly, incur, issue, renew, rollover, or pay interest or principal on any debt (including the subordinated debentures) or commit to do so, increase any current lines of credit, or guarantee the debt of any entity, without prior written notice to and written non-objection from the FRB.  As a result, the Company’s ability to continue to pay current interest on the subordinated debentures is conditioned upon receipt of the non-objection of the FRB on a quarterly basis.

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Secured borrowings:  During the course of 2013, CFBank entered into certain loan participations that, according to the structure of the transactions, did not qualify for sales accounting treatment and were therefore accounted for as secured borrowings.  At December 31, 2013, there were five loan participation agreements classified as secured borrowings totaling approximately $6.5 million.  The bank retains an ownership interest in these loans and provides customary servicing to the third-parties which are typically other community banks. During the first quarter of 2014, management amended its loan participation agreements to remove the language that disqualified the loan participations from sales accounting treatment and entered into amended loan participation agreements with the participating institutions with respect to the aforementioned loans.  At December 31, 2014, there were no secured borrowings transactions. 

Stockholders’ equity:  Stockholders’ equity totaled $34.5 million at December 31, 2014, an increase of $11.6 million, or 50.9%, from $22.9 million at December 31, 2013.  The increase in total stockholders’ equity was primarily attributed to the Company’s completion during 2014 of  the sale of 480,000 shares of its newly designated 6.25% Non-Cumulative Convertible Perpetual Preferred Stock, Series B, with a liquidation preference of $25.00 per share (“Series B Preferred Stock”), for an aggregate offering price of $12,000,000.  The Series B Preferred Stock was sold by the Company with the assistance of McDonald Partners, LLC, as placement agent, on a best efforts basis.   After payment of approximately $482,000 in placement fees to McDonald Partners, LLC and approximately $149,000 of other offering expenses, the Company’s net proceeds from its sale of the 480,000 shares of Series B Preferred Stock were approximately $11,369,000.  See Note 17 to the consolidated financial statements included in this annual report for additional information.

Management continues to proactively monitor capital levels and ratios in its on-going capital planning process and to ensure compliance with its regulatory requirements and commitments.  CFBank has leveraged its capital to support balance sheet growth and drive increased net interest income.  Management remains focused on growing capital though improving results from operations; however, should the need arise, CFBank has additional sources of capital and alternatives it could utilize to remain in compliance with the increased capital requirements to which CFBank is subject. 

Currently, the Holding Company has excess cash to cover its expenses for the foreseeable future, and could inject capital into CFBank if necessary for CFBank to remain in compliance with its required capital ratios.  Also, CFBank has the flexibility to manage its balance sheet size as a result of the short duration of the assets as discussed with the Northpointe mortgage program, as well as to deploy those assets into higher earning assets to improve net interest income as the opportunity presents itself.

 

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Comparison of Results of Operations for 2014 and 2013

General.    Net income for the twelve months ended December 31, 2014 totaled $479,000 and increased $1.4 million compared to a net loss of $918,000 for the twelve months ended December 31, 2013, primarily due to a $3.3 million increase in net interest income and a $218,000 decrease in provision expense, offset by a $401,000 decrease in noninterest income and a $1.8 million increase in noninterest expenses.  The 2013 results include a $1.1 million gain on sale of fixed assets related to the sale of the Company’s corporate office building.

Net income attributable to common stockholders totaled $58,000, or ($0.00) per diluted common share, for the year ended December 31, 2014, compared to a  net loss attributable to common stockholders of $918,000, or ($0.06) per diluted common share, for the year ended December 31, 2013.    The dividend on the Series B preferred stock decreased the net income attributable to the common stockholders by $421,000 for 2014.  There was no preferred stock outstanding during 2013.

Net interest income.    Net interest income is a significant component of net income, and consists of the difference between interest income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities.  Net interest income is primarily affected by the volumes, interest rates and composition of interest-earning assets and interest-bearing liabilities.  The tables below titled “Average Balances, Interest Rates and Yields” and “Rate/Volume Analysis of Net Interest Income” provide important information on factors impacting net interest income and should be read in conjunction with this discussion of net interest income.

Net interest income totaled $8.7 million for the year ended December 31, 2014 and increased $3.3 million, or 61.9%, compared to $5.4 million for the year ended December 31, 2013. The increase in net interest income was primarily due to a $3.1 million, or 41.5%, increase in interest income, coupled with a $224,000, or 10.6%, decrease in interest expense.  The increase in interest income was primarily attributed to a $49.8 million, or 23.3%, increase in average interest-earnings assets outstanding, a 52 bps increase in average yield on interest earning assets and improved asset mix.   The decrease in interest expense was attributed to a 27 bps reduction in the average cost of funds on interest bearing liabilities, and improved mix from noninterest bearing deposits.  As a result, net interest margin of 3.31% for the year ended 2014 improved 79 bps over the net interest margin of 2.52% for the year ended 2013. 

Interest income totaled $10.6 million and increased $3.1 million, or 41.5%, for the twelve months ended December 31, 2014, compared to $7.5 million for the twelve months ended December 31, 2013. The increase in interest income was primarily due to a $71.1 million, or 43.6%, increase in average loan and loan held for sale balances from $163.1 million at December 31, 2013, to $234.2 million at December 31, 2014, and a 52 bps improvement in the average yield on interest earning assets.  Additionally, an improved earning assets mix resulted from a $17.1 million, or 47.8%, decrease other earning assets earning 35bps that were redeployed into higher yielding loans.

Interest expense totaled $1.9 million and decreased $224,000, or 10.6%, for the year ended December 31, 2014, compared to $2.1 million for the year ended December 31, 2013.  The decrease in interest expense is primarily due to a 27 bps reduction in the average cost of funds on interest bearing liabilities and improved mix from noninterest bearing deposits, which offset a $32.0 million, or 16.9%, increase in average interest bearing liabilities.   The average cost of funds decreased 149 bps on the average balances on FHLB advances, due to maturities and advances being re-priced in the current lower rate environment, which offset a 31.5% increase in average balances.  Also, the average cost of funds decreased 16 bps on average deposit balances, primarily due to maturities of higher cost brokered CD’s, and CD’s in general re-pricing in the current lower rate environment, which offset a 15.7% increase in average deposit balances.  In addition, noninterest bearing deposit balances increased $11.3 million, or 45.7%, due to increased sales focus on customer relationships, which improved the overall funding mix.

Provision for loan losses.  The provision for loan losses totaled $278,000 for the twelve months ended December 31, 2014 and decreased $218,000, or 44.0%, compared to $496,000 for the twelve months ended December 31, 2013.  The decrease in the provision for loan losses for the year ended December 31, 2014 was primarily due to improved credit quality and a decrease in special mention and substandard loans, which more than offset the provision for growth in the portfolio for new loans generated in 2014.  Net recoveries increased $313,000 due to the fact that there were $309,000 in net recoveries for the year ended December 31, 2014 compared to the net charge-offs of $4,000, for the year ended December 31, 2013.  The improvement in net recoveries was related to a large commercial real estate loan that paid off during 2014.

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The following table presents information regarding net charge-offs for 2014 and 2013.

 

See the section titled “Financial Condition – Allowance for loan losses” for additional information.

Noninterest income.    Noninterest income for the year ended December 31, 2014 totaled $1.5 million, and decreased $401,000, or 21.2%, compared to $1.9 million for the year ended December 31, 2013.  The decrease is primarily due to a  gain realized on the sale of the Company’s corporate office building and certain furniture and fixtures of approximately $1.1 million in 2013, partially offset by a $448,000 increase in gains recognized on the sale of residential mortgages, a $206,000 increase in other noninterest income and a $59,000 increase in service charges on deposit accounts in 2014.    

The increase in net gains on sales of loans is due to increased sales activities associated with the Company’s ramp up and expansion of the mortgage business.  The $206,000 increase in other noninterest income was primarily due to a $33,000 increase in merchant services income and a $125,000 increase in revenue resulting from the Company’s joint ventures, as discussed in Note 22 to our consolidated financial statements.  The increase in service charges on deposits is due to an increase in account levels and pricing changes.

Noninterest expense.  Noninterest expense for the year ended 2014 totaled $9.5 million and increased $1.8 million, or 22.8%, compared to the $7.7 million recognized in 2013.  The overall increase in operating expenses is primarily attributed to a $596,000 increase in salaries and employee benefits, a $283,000 increase in foreclosed asset expense, a $265,000 increase in data processing, a $245,000 increase in occupancy and equipment, a $219,000 increase in professional fees and a $97,000 in director fees.

Salaries and benefit expenses increased primarily due to the full year effect of the investment in mortgage personnel as this business line was ramped up in the latter part of 2013, coupled with an increase in personnel in the credit administration and treasury management areas.  Foreclosed asset expense increased related to maintenance and light rehabilitation incurred to increase occupancy levels, along with increased operating costs.  The increase in data processing expenses is driven by expanded IT services associated with the Company’s growth and expansion, along with investments in our infrastructure.  The increase in occupancy and equipment expenses related to rent expense, leasehold improvements and associated utilities is primarily due to our growth and expansion, and the opening of our loan production office in Woodmere, Ohio.  Professional fees increased due to increased legal and workout fees and increased consulting fees associated with project work related to the expansion of the mortgage division and credit area.

Income taxes.    The Company recorded a deferred tax valuation allowance which reduced the deferred tax asset to zero beginning in 2009 and continuing through the year ended December 31, 2014.  As such, there was no income tax benefit recorded for the year ended December 31, 2014.  

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Comparison of Results of Operations for 2013 and 2012

General.  Net loss attributable to common stockholders totaled $918,000, or ($0.06) per diluted common share, for the year ended December 31, 2013, compared to net earnings attributable to common stockholders of $866,000, or $0.14 per diluted common share, for the year ended December 31, 2012.  For the twelve months ended December, 2012, the discount on the redemption of the TARP obligation increased net earnings attributable to common stockholders by $5.0 million, while the preferred stock dividends and accretion of discount on the preferred stock increased the net loss attributable to the common stockholders by $328,000.  Due to the redemption of the TARP obligation on September 26, 2012, there was no impact in 2013 related to the preferred stock dividends and accretion of discount on the net loss attributable to the common stockholders. The net loss of $918,000 for the year ended December 31, 2013, compared to the net loss of $3.8 million for the year ended December 31, 2012 (excluding the impact of the TARP redemption), improved $2.8 million due primarily to a $752,000 increase in net interest income, a $633,000 decrease in provision expense, a $575,000 decrease in noninterest expense, and a $888,000 increase in noninterest income.

The improved net interest income in 2013 was mainly attributed to the increase in overall outstanding loan balances, while the reduced provisioning expense was due to the improved credit quality of the loan portfolio through the reduction of problem loans. Additionally, declines in operating expenses from 2012 was primarily attributed to lower costs associated with foreclosed assets, reduced FDIC insurance premiums and reduced director fees.

The discount on redemption of the TARP obligations in 2012 increased earnings available to common stockholders by $5.0 million, which resulted in $0.14 earnings per diluted common share despite the net loss for the year ended December 31, 2012.

Net interest income.    Net interest income is a significant component of net income, and consists of the difference between interest income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities.  Net interest income is primarily affected by the volumes, interest rates and composition of interest-earning assets and interest-bearing liabilities.  The tables titled “Average Balances, Interest Rates and Yields” and “Rate/Volume Analysis of Net Interest Income” provide important information on factors impacting net interest income and should be read in conjunction with this discussion of net interest income.

Net interest income totaled $5.4 million for the year ended December 31, 2013 and increased $752,000, or 16.2%, compared to $4.6 million for the year ended December 31, 2012. The increase in net interest income was primarily due to a $232,000, or 3.2%, increase in interest income, coupled with a $520,000, or 19.7%, decrease in interest expense.  The increase in interest income was primarily attributed to a $4.9 million, or 2.4%, increase in average interest-earnings assets outstanding, and improved mix, which was partially offset by a decline in yields. The decrease in interest expense was attributed to a 25 bps reduction in the average cost of funds on interest bearing liabilities, and improved mix from noninterest bearing deposits.  As a result, net interest margin of 2.52% for the year ended 2013 improved 30 bps over the net interest margin of 2.22% for the year ended 2012. 

Interest expense totaled $2.1 million and decreased $520,000, or 19.7%, for the year ended December 31, 2013, compared to $2.6 million for the year ended December 31, 2012.  The decrease in interest expense resulted primarily from lower overall deposit costs due to a 25 bps decrease in average rates, as a result of deposit pricing and CD’s re-pricing in today’s lower rate environment, coupled with a decrease in higher cost brokered CD’s. In addition, CFBank's overall deposit mix improved due to an increase in average noninterest-bearing deposit liabilities, consisting primarily of commercial demand deposit accounts and other noninterest deposits, of $4.6 million, or 26.7%, as a result of CFBank's sales efforts and increase in customer relationships.

Provision for loan losses.  The provision for loan losses totaled $496,000 for the twelve months ended December 31, 2013 and decreased $633,000, or 56.1%, compared to $1.1 million for the twelve months ended December 31, 2012.  The decrease in the provision for loan losses for the year ended December 31, 2013 was primarily due to improved credit quality, a decrease in special mention and substandard loans, and a decrease in net charge-offs, which more than offset the provision for growth in the portfolio for new loans generated in 2013.  Net charge-offs decreased $2.0 million due to the fact that there were net charge-offs of $4,000 for the year ended December 31, 2013, compared to net charge-offs totaling $2.0 million for the year ended December 31, 2012. The decrease in net charge-offs during the twelve months ended December 31, 2013 was primarily related to commercial and multi-family real estate loans.

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The following table presents information regarding net charge-offs for 2013 and 2012.

 

See the section titled “Financial Condition – Allowance for loan losses” for additional information.

Noninterest income.  Noninterest income for the year ended December 31, 2013 totaled $1.9 million, and increased $888,000, or 88.4%, compared to $1.0 million for the year ended December 31, 2012.  The increase is due to gain realized on the sale of the Company’s corporate office building and certain furniture and fixtures of approximately $1.1 million.  This was partially offset by lower gains recognized on the sale of residential mortgages due to increased interest rate levels that slowed the residential mortgage market in 2013, and the fact that there were no net gains on the sale of securities for the year ended 2013, compared to $143,000 in 2012. Service charges on deposits increased approximately $108,000, or 44.1%, over 2012, due to an increase in account level and pricing changes. Other noninterest income increased approximately $127,000, or 56.8%, over 2012, as a result of investments in joint ventures the Holding Company made in 2013, as discussed in Note 22 to our consolidated financial statements.

Noninterest expense.  Noninterest expense for the year ended 2013 was $7.7 million, which represented a decline of $575,000, or 6.9%, compared to the $8.3 million recognized in 2012.  The overall decline in operating expenses is primarily attributed to a $607,000 reduction in costs associated with managing foreclosed properties and a $263,000 reduction in FDIC insurance premiums based on a lower assessment rate. These declines were partially offset by a $138,000 increase in professional fees associated with workout efforts, audit related and other consulting fees, and an increase in data processing fees related to certain services that were outsourced.

Income taxes.  The Company recorded a deferred tax valuation allowance which reduced the deferred tax asset to zero beginning in 2009 and continuing through the year ended December 31, 2013.  As such, there was no income tax benefit recorded for the year ended December 31, 2013.

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Average Balances, Interest Rates and Yields.  The following table presents, for the periods indicated, the total dollar amount of fully taxable equivalent interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates. Average balances are computed using month-end balances.

 

 

 

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Rate/Volume Analysis of Net Interest Income.  The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities.  It distinguishes between the increase and decrease related to changes in balances and/or changes in interest rates.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by the prior rate) and (ii) changes in rate (i.e., changes in rate multiplied by prior volume).  For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

 

 

 

Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss from adverse changes in market prices and interest rates. We have not engaged in and, accordingly, have no risk related to trading accounts, commodities or foreign exchange.  Our hedging policy allows hedging activities, such as interest-rate swaps, up to a notional amount of 10% of total assets and a value at risk of 10% of core capital.  Disclosures about our hedging activities are set forth in Note 20 to our consolidated financial statements.  The Company’s market risk arises primarily from interest rate risk inherent in our lending, investing, deposit gathering and borrowing activities.  The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance-sheet transactions are aggregated and the resulting net positions are identified. Disclosures about fair value are set forth in Note 6 to our consolidated financial statements. 

Management actively monitors and manages interest rate risk.  The primary objective in managing interest rate risk is to limit, within established guidelines, the adverse impact of changes in interest rates on our net interest income and capital. We measure the effect of interest rate changes on CFBank’s economic value of equity (EVE), which is the difference between the estimated market value of its assets and liabilities under different interest rate scenarios.  The change in the EVE ratio is a long-term measure of what might happen to the market value of financial assets and liabilities over time if interest rates changed instantaneously and CFBank did not change existing strategies.  At December 31, 2014, CFBank’s EVE ratios, using interest rate shocks ranging from a 400 bp rise in rates to a 200 bps decline in rates are shown in the following table.  All values are within the acceptable range established by CFBank’s Board of Directors.

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In evaluating CFBank’s exposure to interest rate risk, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered.  For example, the table indicates results based on changes in the level of interest rates, but not changes in the shape of the yield curve. CFBank also has exposure to changes in the shape of the yield curve.  Although certain assets and liabilities may have similar maturities or periods to which they reprice, they may react in different degrees to changes in market interest rates.  The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  In the event of a change in interest rates, prepayments and early withdrawal levels would likely deviate significantly from those assumed in calculating the table.  The ability of many borrowers to service their debt may decrease when interest rates rise.  As a result, the actual effect of changing interest rates may differ materially from that presented in the foregoing table.

Changes in levels of market interest rates could materially and adversely affect our net interest income, loan volume, asset quality, value of loans held for sale and cash flows, as well as the market value of our securities portfolio and overall profitability.

We continue to originate the majority of fixed-rate single-family residential real estate loans for sale rather than retain long-term, low fixed-rate loans in portfolio.  Residential mortgage loan origination volumes are affected by market interest rates on loans.  Rising interest rates generally are associated with a lower volume of loan originations, while falling interest rates are usually associated with higher loan originations.  Our ability to generate gains on sales of mortgage loans is significantly dependent on the level of originations. Changes in interest rates, prepayment speeds and other factors may also cause the value of our loans held for sale to change.

We originate commercial, commercial real estate and multi-family residential real estate mortgage loans for our portfolio, which, in many cases, have adjustable interest rates.  Many of these loans have interest-rate floors, which protect income to CFBank should rates continue to fall.  While adjustable-rate loans better offset the adverse effects of an increase in interest rates as compared to fixed-rate loans, the increased payments required of adjustable-rate loan borrowers upon an interest rate adjustment in a rising interest rate environment could cause an increase in delinquencies and defaults.  The marketability of the underlying property also may be adversely affected in a rising interest rate environment. 

Cash flows are affected by changes in market interest rates.  Generally, in rising interest rate environments, loan prepayment rates are likely to decline, and in falling interest rate environments, loan prepayment rates are likely to increase.

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Liquidity and Capital Resources

In general terms, liquidity is a measurement of an enterprise’s ability to meet cash needs.  The primary objective in liquidity management is to maintain the ability to meet loan commitments and to repay deposits and other liabilities in accordance with their terms without an adverse impact on current or future earnings.  Principal sources of funds are deposits; amortization and prepayments of loans; maturities, sales and principal receipts of securities available for sale; borrowings; and operations.  While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.

CFBank is required by regulation to maintain sufficient liquidity to ensure its safe and sound operation. Thus, adequate liquidity may vary depending on CFBank’s overall asset/liability structure, market conditions, the activities of competitors, the requirements of our own deposit and loan customers and regulatory considerations.  Management believes that the Holding Company’s and CFBank’s liquidity is sufficient to meet its daily operating needs and fulfill its strategic planning.

Liquidity management is both a daily and long-term responsibility of management.  We adjust our investments in liquid assets, primarily cash, short-term investments and other assets that are widely traded in the secondary market, based on our ongoing assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities and the objective of our asset/liability management program.  In addition to liquid assets, we have other sources of liquidity available including, but not limited to, access to advances from the FHLB and borrowings from the FRB and our commercial bank line of credit. 

The following table summarizes CFBank’s cash available from liquid assets and borrowing capacity at December 31, 2014 and 2013.

 

 

Cash, unpledged securities and deposits in other financial institutions increased $5.6 million, or 24.5%, to $28.3 million at December 31, 2014 compared to $22.7 million at December 31, 2013.  The increase was a result of management’s efforts to increase deposit activity in order to fund anticipated loan growth of CFBank.

CFBank’s additional borrowing capacity with the FHLB decreased $826,000, or 8.8%, to $8.6 million at December 31, 2014 compared to $9.4 million at December 31, 2013.  The decrease is primarily due to additional FHLB advances that CFBank added in 2014, partially offset by increased borrowing capacity as a result of additional collateral pledged due to the increase in loans.  As of December 31, 2013, due to regulatory considerations, CFBank was only eligible for future advances with a maximum maturity of 365 days.  On January 24, 2014, CFBank was notified by the FHLB that the restriction on the term of future advances had been lifted as a result of the CFBank Order being terminated effective January 23, 2014.

CFBank’s additional borrowing capacity at the FRB increased $3.5 million, or 13.8%, to $28.6 million at December 31, 2014 from $25.1 million at December 31, 2013.  In addition, CFBank is once again eligible to participate in the FRB’s primary credit program, providing CFBank access to short-term funds at any time, for any reason, based on the collateral pledged.

CFBank’s borrowing capacity with both the FHLB and FRB may be negatively impacted by changes such as, but not limited to, further tightening of credit policies by the FHLB or FRB, deterioration in the credit performance of CFBank’s loan portfolio or CFBank’s financial performance, or a decrease in the balance of pledged collateral.

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CFBank had a $1.0 million unused line of credit with one commercial bank at December 31, 2014, and 2013. 

Deposits are obtained predominantly from the areas in which CFBank’s offices are located. We rely primarily on a willingness to pay market-competitive interest rates to attract and retain retail deposits. Accordingly, rates offered by competing financial institutions may affect our ability to attract and retain deposits.  As a result of the CFBank Order, we were prohibited from offering above-market interest rates and were subject to market rates published by the FDIC when offering deposits to the general public. However, these limitations are no longer applicable to CFBank as a result of the termination of the CFBank Order in January of 2014.  See Note 2 – Regulatory Considerations for further discussion.

As a result of the CFBank Order, we were prohibited from accepting or renewing brokered deposits without FDIC approval, although we had the ability to seek wholesale deposits that are not considered brokered deposits.  At December 31, 2013, CFBank had $21.0 million in brokered deposits with maturity dates from January 2014 through August 2016. In addition, the prohibition on brokered deposits limited CFBank’s ability to participate in the CDARS program and impacted our liquidity management. Although CFBank customers participate in the CDARS program, CDARS deposits are considered brokered deposits by regulation.  As a result of the termination of the CFBank Order effective January 23, 2014, the restrictions on brokered deposits no longer apply and, therefore, we will have greater access to more diversified funding sources.  See Note 2 – Regulatory Order Considerations for further discussion.

CFBank relies on competitive interest rates, customer service, and relationships with customers to retain deposits. To promote and stabilize liquidity in the banking and financial services sector, the FDIC, pursuant to the provisions of the Dodd-Frank Act as previously discussed, permanently increased deposit insurance coverage from $100,000 to $250,000 per depositor. 

The Holding Company, as a savings and loan holding company, has more limited sources of liquidity than CFBank. In general, in addition to its existing liquid assets, sources of liquidity include funds raised in the securities markets through debt or equity offerings, dividends received from its subsidiaries or the sale of assets.  Pursuant to commitments made in connection with the termination of the Holding Company Order, the Holding Company is not permitted to declare or pay dividends on its stock, purchase or redeem its stock, or accept dividends or other capital distributions from CFBank without the prior written approval of the FRB.    In addition, the Holding Company may not incur, increase or guarantee any debt without the prior written consent of the FRB.   The Holding Company is not restricted, however, from raising funds in the securities markets through equity offerings.

The Holding Company had adequate funds at December 31, 2014 to meet its current and anticipated operating needs at this time. The Holding Company’s current cash requirements include operating expenses and interest on subordinated debentures.  The Company may elect to pay dividends on its preferred stock, if and when declared by the Board of Directors, subject to obtaining prior written regulatory “non-objection” from the FRB.    

Annual debt service on the subordinated debentures is currently approximately $170,000.  The subordinated debentures have a variable rate of interest, reset quarterly, equal to the three-month LIBOR plus 2.85%.  The total rate in effect was 3.11% at December 31, 2014.  An increase in the three-month LIBOR would increase the debt service requirement of the subordinated debentures. 

Banking regulations limit the amount of dividends that can be paid to the Holding Company by CFBank without prior regulatory approval. Generally, financial institutions may pay dividends without prior approval as long as the dividend does not exceed the total of the current calendar year-to-date earnings plus any earnings from the previous two years not already paid out in dividends, and as long as the financial institution remains well capitalized after the dividend payment. As of December 31, 2014, CFBank could not pay any dividends to the Holding Company without receiving the prior written approval of the OCC.  Future dividend payments by CFBank to the Holding Company would be based on future earnings and subject to regulatory approval. However, the payment of dividends from CFBank to the Holding Company is not likely to be approved by the OCC until CFBank is able to generate consistent earnings.

The ability of the Holding Company to pay dividends on its common stock and Series B Preferred Stock is generally dependent upon the receipt of dividends and other distributions from CFBank.  The Holding Company is a legal entity that is separate and distinct from CFBank, which has no obligation to make any dividends or other funds available for the payment of dividends by the Holding Company.  The Holding Company also is subject to various legal and regulatory policies and requirements impacting the Holding Company’s ability to pay dividends on its stock, and pursuant to the commitments made to the FRB in connection with the termination of the Holding Company Order, the Holding Company may not declare or pay dividends on its stock without the prior written non-objection of the FRB.  In addition, the Holding Company’s ability to pay dividends on its stock is conditioned upon the payment, on a current basis, of quarterly interest payments on the subordinated debentures underlying the Company’s trust preferred securities, which also requires the written non-objection of the FRB.  Finally, so long as the Company’s Series B Preferred Stock remains

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outstanding, the Holding Company will be prohibited from paying dividends on (other than dividends payable solely for the then-current dividend period in shares) the Company’s common stock, , unless full dividends on the Series B Preferred Stock have been paid or set aside for payment.

Federal income tax laws provided additional deductions, totaling $2,250, for thrift bad debt reserves established before 1988. Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total $765 at year-end 2014. However, if CFBank were wholly or partially liquidated or otherwise ceases to be a bank, or if tax laws were to change, this amount would have to be recaptured and a tax liability recorded. Additionally, any distributions in excess of CFBank’s current or accumulated earnings and profits would reduce amounts allocated to its bad debt reserve and create a tax liability for CFBank. The amount of additional taxable income created by such a distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if CFBank makes a distribution that reduces the amount allocated to its bad debt reserve, then approximately one and one-half times the amount used would be includible in gross income for federal income tax purposes, assuming a 34% corporate income tax rate. CFBank does not intend to make distributions that would result in a recapture of any portion of its bad debt reserve.

A portion of the proceeds from the common stock offering completed in 2012 as well as a portion of the proceeds from the preferred stock offering completed in 2014 has been retained by the Holding Company for general corporate purposes.   The Holding Company had $3.0 million in cash and cash equivalents at December 31, 2014.

Impact of Inflation

The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which presently require us to measure financial position and results of operations primarily in terms of historical dollars.  Changes in the relative value of money due to inflation are generally not considered.  In our opinion, changes in interest rates affect our financial condition to a far greater degree than changes in the inflation rate.  While interest rates are generally influenced by changes in the inflation rate, they do not move concurrently.  Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as changes in monetary and fiscal policy.  A financial institution’s ability to be relatively unaffected by changes in interest rates is a good indicator of its ability to perform in a volatile economic environment.  In an effort to protect performance from the effects of interest rate volatility, we review interest rate risk frequently and take steps to minimize detrimental effects on profitability.

Critical Accounting Policies

We follow financial accounting and reporting policies that are in accordance with U.S. generally accepted accounting principles and conform to general practices within the banking industry.  These policies are presented in Note 1 to our consolidated financial statements.  Some of these accounting policies are considered to be critical accounting policies, which are those policies that are both most important to the portrayal of the Company’s financial condition and results of operations, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.  Application of assumptions different than those used by management could result in material changes in our financial condition or results of operations.  These policies, current assumptions and estimates utilized, and the related disclosure of this process, are determined by management and routinely reviewed with the Audit Committee of the Board of Directors.  We believe that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements were appropriate given the factual circumstances at the time.

We have identified accounting policies that are critical accounting policies, and an understanding of these policies is necessary to understand our financial statements.  The following discussion details the critical accounting policies and the nature of the estimates made by management.

Determination of the allowance for loan losses.    The ALLL represents management’s estimate of probable incurred credit losses in the loan portfolio at each balance sheet date. The allowance consists of general and specific components.  The general component covers loans not classified as impaired and is based on historical loss experience, adjusted for current factors. Current factors considered include, but are not limited to, management’s oversight of the portfolio, including lending policies and procedures; nature, level and trend of the portfolio, including past due and nonperforming loans, loan concentrations, loan terms and other characteristics; current economic conditions and outlook; collateral values; and other items.  The specific component of the ALLL relates to loans that are individually classified as impaired. Loans exceeding policy thresholds are regularly reviewed to identify impairment. A loan is impaired when, based on current information and events, it is probable that CFBank will be unable to collect all amounts due

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according to the contractual terms of the loan agreement.  Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.  Determining whether a loan is impaired and whether there is an impairment loss requires judgment and estimates, and the eventual outcomes may differ from estimates made by management.  The determination of whether a loan is impaired includes: review of historical data; judgments regarding the ability of the borrower to meet the terms of the loan; an evaluation of the collateral securing the loan and estimation of its value, net of selling expenses, if applicable; various collection strategies; and other factors relevant to the loan or loans.  Impairment is measured based on the fair value of collateral, less costs to sell, if the loan is collateral dependent, or alternatively, the present value of expected future cash flows discounted at the loan’s effective rate, if the loan is not collateral dependent. When the selected measure is less than the recorded investment in the loan, an impairment loss is recorded. As a result, determining the appropriate level for the ALLL involves not only evaluating the current financial situation of individual borrowers or groups of borrowers, but also current predictions about future events that could change before an actual loss is determined.  Based on the variables involved and the fact that management must make judgments about outcomes that are inherently uncertain, the determination of the ALLL is considered to be a critical accounting policy. Additional information regarding this policy is included in the previous section titled “Financial Condition - Allowance for loan losses” and in Notes 1, 4 and 6 to our consolidated financial statements.

Valuation of the deferred tax asset.

The Company maintained a valuation allowance against the net deferred tax assets at December 31, 2014 and December 31, 2013, based on its estimate of future reversal and utilization. When determining the amount of deferred tax assets that are more-likely-than-not to be realized, and therefore recorded as a benefit, the Company conducts a regular assessment of all available information. This information includes, but is not limited to, taxable income in prior periods, projected future income and projected future reversals of deferred tax items. Based on these criteria, the Company determined that it was necessary to maintain a full valuation allowance against the entire net deferred tax asset.

In 2012, a recapitalization program through the sale of $22.5 million in common stock improved the capital levels of CFBank and provided working capital for the Holding Company. The result of the change in stock ownership associated with the stock offering, within the guidelines of Section 382 of the Internal Revenue Code of 1986, was that the Company incurred an ownership change. At year-end 2014, the Company had net operating loss carryforwards of $26,732, which expire at various dates from 2024 to 2033, and has alternative minimum tax credit   carryforwards of $75, which do not expire. As a result of the ownership change, the Company's ability to utilize carryforwards that arose before the stock offering closed is limited to $163 per year. Due to this limitation, management determined it is more likely than not that $20,520 of net operating loss carryforwards will expire unutilized. As required by accounting standards, the Company reduced the carrying value of deferred tax assets, and the corresponding valuation allowance, by the $6,977 tax effect of this lost realizability.

Federal income tax laws provided additional deductions, totaling $2,250, for thrift bad debt reserves established before 1988.  Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total $765 at year-end 2014.  However, if CFBank were wholly or partially liquidated or otherwise ceases to be a bank, or if tax laws were to change, this amount would have to be recaptured and a tax liability recorded.   Additionally, any distributions in excess of CFBank’s current or accumulated earnings and profits would reduce amounts allocated to its bad debt reserve and create a tax liability for CFBank. The amount of additional taxable income created by such a distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if CFBank makes a distribution that reduces the amount allocated to its bad debt reserve, then approximately one and one-half times the amount used would be includible in gross income for federal income tax purposes, assuming a 34% corporate income tax rate. CFBank does not intend to make distributions that would result in a recapture of any portion of its bad debt reserve.

At December 31, 2014 and December 31, 2013, the Company had no unrecognized tax benefits recorded.  The Company does not expect the amount of unrecognized tax benefits to significantly change within the next twelve months.  The Company is subject to U.S. federal income tax and is no longer subject to federal examination for years prior to 2011.    Additional information is included in Notes 1 and 14 to our consolidated financial statements.

Fair value of financial instruments.  Another critical accounting policy relates to fair value of financial instruments, which are estimated using relevant market information and other assumptions.  Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items.  Changes in assumptions or in market conditions could significantly affect the estimates.  Additional information is included in Notes 1 and 6 to our consolidated financial statements.

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Market Prices and Dividends Declared

The common stock of Central Federal Corporation trades on the Nasdaq® Capital Market under the symbol “CFBK.”  As of December 31, 2014, there were 15,823,710 shares of common stock outstanding.

The following table shows the quarterly reported high and low sales prices of our common stock during 2014 and 2013.  There were no dividends declared on our common stock during 2014 or 2013.

 

 

 

 

The Holding Company is subject to various legal and regulatory policies and requirements impacting the Holding Company’s ability to pay dividends on its stock. Pursuant to the commitments made to the FRB in connection with the termination of the Holding Company Order, the Holding Company may not declare or pay dividends on its stock without the prior written non-objection of the FRB.  In addition, the Holding Company’s ability to pay dividends on its common stock is conditioned upon certain payments on the subordinated debentures underlying the Holding Company’s trust preferred securities and dividends on the Company’s Series B Preferred Stock.  Additional information is contained in the section titled “Financial Condition - Stockholders’ equity” and in Notes 2 and 17 to our consolidated financial statements.

 

 

 

 

 

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