Summary of CENTRAL FEDERAL CORP

MANAGEMENT'S DISCUSSION AND ANALYSIS
The following analysis discusses changes in financial condition and results of operations during the periods included in the Consolidated Financial Statements which are part of this filing.
Forward-Looking Statements
Statements contained in this Form 10-Q which are not statements of historical fact are forward-looking statements. 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 Company or its management or Board of Directors;
(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. Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those predicted by the forward-looking statements because of various factors and possible events, including: (i) changes in political, economic or other factors such as inflation rates, recessionary or expansive trends, and taxes;
(ii) competitive pressures; (iii) fluctuations in interest rates; (iv) the level of defaults and prepayments on loans made by CFBank; (v) unanticipated litigation, claims or assessments; (vi) fluctuations in the cost of obtaining funds to make loans; and (vii) regulatory changes. Further information on these and other risk factors is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008, all of which are difficult to predict and many of which are beyond our control. Forward-looking statements speak only as of the date on which they are made and we undertake no obligation to publicly release revisions to any forward-looking statements to reflect events or circumstances after the date of such statements, unless required by law. Business Overview
Central Federal Corporation is a unitary savings and loan holding company incorporated in Delaware in 1998. Our primary business is the operation of 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 remote deposit, telephone banking, corporate cash management and online internet banking. We attract 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 consumers and small businesses. 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 the 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 and deposit flows. Net income is also affected by, among other things, loan fee income, provisions for loan losses, service charges, gains on loan sales, operating expenses, and franchise and income taxes. Operating expenses principally consist of employee compensation and benefits, occupancy, and other general and administrative expenses. In general, results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies, and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may also materially impact our performance.
As a result of the current economic recession, which has included failures of financial institutions, investments in banks and other companies by the United States government, and government-sponsored economic stimulus packages, one area of public and political focus is how and the extent to which financial institutions are regulated by the government. The current regulatory environment may result in new or revised regulations that could have a material adverse impact on our performance.

Table of Contents

CENTRAL FEDERAL CORPORATION PART 1. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS The capital, credit and financial markets have experienced significant volatility and disruption for more than a year. These conditions have had significant adverse effects on our national and local economies, including declining real estate values; a widespread tightening in the availability of credit; illiquidity in certain securities markets; increasing loan delinquencies, foreclosures, personal and business bankruptcies and unemployment rates; declining consumer confidence and spending; significant write-downs of asset values by financial institutions and government-sponsored agencies; and a reduction of manufacturing and service business activity and international trade. These conditions have also adversely affected the stock market generally, and have contributed to significant declines in the trading prices of financial institution stocks. We do not expect these difficult market conditions to improve in the short term, and a continuation or worsening of these conditions could increase their adverse effects. Adverse effects of these conditions could include increases in loan delinquencies and charge-offs; increases in our loan loss reserves based on general economic factors; increases to our specific loan loss reserves due to the impact of these conditions on specific borrowers or the collateral for their loans; declines in the value of our securities portfolio; increases in our cost of funds due to continued aggressive deposit pricing by local and national competitors with liquidity needs; attrition of our core deposits due to this aggressive deposit pricing and/or consumer concerns about the safety of their deposits; increases in regulatory and compliance costs; and declines in the trading price of our common stock.
In October 2008, the U.S. Congress enacted the Emergency Economic Stabilization Act of 2008 in response to the impact of the volatility and disruption in the credit and capital markets on the financial sector. The U.S. Treasury Department and federal banking regulators are implementing a number of programs under this legislation that are intended to address these conditions and the asset quality, capital and liquidity issues they have caused for certain financial institutions and to improve the general availability of credit for consumers and businesses. Additionally, in February 2009, the U.S. Congress enacted the American Recovery and Reinvestment Act of 2009 in an effort to save and create jobs, stimulate the U.S. economy and promote long-term growth and stability. There can be no assurance that these acts or the programs that are implemented under them will achieve their intended purposes. If they fail to achieve some or all of those purposes it could result in a continuation or worsening of current economic and market conditions, which could adversely affect our performance and/or the trading price of our common stock.
Other than discussed above and noted in the following narrative, we are not aware of any market or institutional trends, other events, or uncertainties that are expected to have a material effect on liquidity, capital resources or operations. We are not aware of any current recommendations by regulators which would have a material effect if implemented, except as described above. Management's discussion and analysis represents a review of our consolidated financial condition and results of operations. This review should be read in conjunction with our consolidated financial statements and related notes. Financial Condition
General. Assets totaled $289.3 million at March 31, 2009, and increased $11.5 million, or 4.1%, from $277.8 million at December 31, 2008. The increase in assets was due to the growth in cash and short term investments and an increase in commercial and commercial real estate loan balances.
Cash and cash equivalents. Cash and cash equivalents totaled $12.3 million at March 31, 2009 and increased $8.1 million compared to $4.2 million at December 31, 2008. The increase was due to growth in cash and short-term investments due to the $7.2 million of proceeds received through the U.S. Treasury Department's Capital Purchase Program (CPP), which was part of the government's Troubled Asset Relief Program, being held in short-term, liquid investments pending approval from regulators to contribute these proceeds as additional capital to CFBank.

Table of Contents

CENTRAL FEDERAL CORPORATION PART 1. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS Securities. Securities available for sale totaled $22.5 million at March 31, 2009, a decrease of $1.0 million, or 4.3%, compared to $23.5 million at December 31, 2008 due to scheduled maturities and repayments on mortgage-backed securities during the period.
Loans. Net loans totaled $236.2 million at March 31, 2009 and increased $2.3 million, or 1.0%, from $233.9 million at December 31, 2008. The increase was due to a $6.1 million increase in commercial and commercial real estate loans, partially offset by a decrease in single-family and multi-family residential real estate loan balances and home equity lines of credit due to repayments.
Deposits. Deposits totaled $220.4 million at March 31, 2009 and increased $12.7 million, or 6.1%, from $207.6 million at December 31, 2008. Certificate of deposit accounts increased $6.7 million, money market accounts increased $5.3 million, traditional savings account balances increased $553,000, and noninterest bearing checking account balances increased $551,000, while interest bearing checking account balances decreased $364,000 during the three months ended March 31, 2009. The increase in certificate of deposit accounts was primarily due to CFBank's participation in the Certificate of Deposit Account Registry Service® (CDARS) which allows the Bank to provide customers full FDIC insurance on certificate of deposit balances up to $50 million. Customer balances in the CDARS program increased $4.3 million during the three months ended March 31, 2009.
CFBank is a participant in the FDIC's Transaction Account Guarantee Program (TAGP). Under that program, through December 31, 2009, all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under the TAGP is in addition to, and separate from, the coverage available under the FDIC's general deposit insurance rules. Federal Home Loan Bank advances. FHLB advances totaled $28.2 million at March 31, 2009 and decreased $850,000, or 2.9%, compared to $29.1 million at December 31, 2008. FHLB advances were repaid with funds from the increase in deposits.
Shareholders' equity. Shareholders' equity totaled $32.9 million at March 31, 2009 and decreased $153,000, or 0.5%, compared to $33.1 million at December 31, 2008. The decrease in equity was primarily due to the current period net loss of $246,000 and the preferred stock dividends and accretion of unearned discount totaling $101,000, partially offset by a $175,000 increase in the market value of securities. The Company continues to assess whether it will continue to participate, or whether it will seek to repurchase the securities issued to the Treasury Department under the Capital Purchase Program.
Comparison of the Results of Operations for the Three Months Ended March 31, 2009 and 2008
General. Net loss totaled $246,000, or $.08 per diluted common share for the quarter ended March 31, 2009, compared to net income of $124,000, or $.03 per diluted common share, for the quarter ended March 31, 2008. Operations for the three months ended March 31, 2009 were negatively impacted by an increase in the provision for loan losses in response to the effect of current economic conditions and trends on loan portfolio performance.
Net interest income. Net interest income increased $16,000, or 0.8%, and totaled $2.0 million for both the first quarter of 2009 and 2008. Average interest-earning assets increased $12.5 million in the first quarter of 2009 compared to the first quarter of 2008, and included $7.2 million in proceeds received through the U.S. Treasury Department's CPP as previously discussed. The average yield on interest-earning assets decreased to 5.53% in the first quarter of 2009, compared to 6.77% in the first quarter of 2008, due to a decline in market interest rates and investment of the CPP funds in short-term investments. The decline in the average yield on interest-earning assets resulted in a 14.4% decrease in interest income. The average cost of interest-bearing liabilities also decreased, to 2.82% in the first quarter of 2009, from 3.96% in the first quarter of 2008, due to a decline in market interest rates. The decrease in the average cost of interest-bearing liabilities resulted in a 27.9% decrease in interest expense. Net interest margin decreased to 3.05% in the first quarter of 2009, compared to 3.18% in the first quarter of 2008.

Table of Contents

CENTRAL FEDERAL CORPORATION PART 1. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS Interest income. Interest income decreased $629,000, or 14.4%, to $3.7 million in the first quarter of 2009, compared to $4.4 million in the first quarter of 2008. The decrease in interest income was largely due to a decrease in income on loans and securities. Interest income on loans declined $580,000, or 14.6%, to $3.4 million in the first quarter of 2009, from $4.0 million in the first quarter of 2008. The decrease in income on loans was due to a decline in the average yield on loans, partially offset by an increase in the average balance of loans. The average yield on loans decreased 124 basis points (bp) to 5.74% in the first quarter of 2009, from 6.98% in the first quarter of 2008. The decline in yield on loans was due to the origination of new loans at lower market interest rates and lower reset rates on existing adjustable rate loans. The average balance of loans outstanding increased $8.9 million, or 3.9%, to $236.9 million in the first quarter of 2009, from $228.0 million in the first quarter of 2008. Interest income on securities decreased $58,000, or 16.3%, to $297,000 for the first quarter of 2009, from $355,000 in the first quarter of 2008. The decrease in income on securities was due to a decline in the average balance of securities, partially offset by an increase in the average yield. The average balance of securities decreased $5.0 million, or 17.9%, to $23.0 million in the first quarter of 2009, from $28.0 million in the first quarter of 2008. The decrease in the average balance of securities was due to sales, maturities and repayments on mortgage-backed securities in excess of purchases compared to the average balances reported in the year ago quarter. The average yield on securities increased 15 bp to 5.35% in the first quarter of 2009, from 5.20% in the first quarter of 2008.
Interest expense. Interest expense decreased $645,000, or 27.9%, to $1.7 million for the first quarter of 2009, compared to $2.3 million in the first quarter of 2008. The decrease resulted from reduced pricing on deposit accounts and lower borrowing costs. Interest expense on deposits decreased $416,000, or 23.4%, to $1.4 million in the first quarter of 2009, from $1.8 million in the first quarter of 2008. The decrease in expense on deposits was due to a decline in the average cost of deposits, partially offset by an increase in average deposit balances. The average cost of deposits decreased 130 bp to 2.68% in the first quarter of 2009, from 3.98% in the first quarter of 2008, due to lower market interest rates in the current year quarter. Average deposit balances increased $24.5 million, or 13.8%, to $202.8 million in the first quarter of 2009, from $178.3 million in the first quarter of 2008. The increase in average deposit balances was predominantly due to growth in certificate of deposit account balances. Interest expense on FHLB advances and other debt, including subordinated debentures, decreased $229,000 to $311,000 in the first quarter of 2009, from $540,000 in the first quarter of 2008. The decrease in expense on FHLB advances and other debt, including subordinated debentures, was due to both a decline in the average cost of these funds as well as a decrease in the average balances. The average cost of borrowings declined 22 bp to 3.67% in the first quarter of 2009, from 3.89% in the first quarter of 2008. The decrease in borrowing cost was the result of lower market interest rates in the current year quarter. Average balances on FHLB advances and other debt, including subordinated debentures, decreased $21.6 million, or 38.9%, to $33.9 million in the first quarter of 2009, from $55.5 million in the first quarter of 2008. The decrease in the average balances was primarily due to repayment of FHLB advances with funds from the growth in deposits, and the cash flows from the securities portfolio.
Provision for loan losses. Provisions for loan losses are provided based on management's estimate of probable incurred credit losses in the loan portfolio and the resultant allowance for loan losses required. Management's estimate is based on a review 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 and trends; and other factors. Based on this review, the provision totaled $550,000 for the quarter ended March 31, 2009, compared to $224,000 for the quarter ended March 31, 2008. The increase in the first quarter of 2009 was primarily due to an increase in nonperforming loans. The ratio of the allowance for loan losses to total loans totaled 1.47% at March 31, 2009, compared to 1.32% at December 31, 2008.
Nonperforming loans, which are nonaccrual loans and loans 90 days past due still accruing interest, increased $2.6 million and totaled $5.0 million, or 2.08% of total loans, at March 31, 2009, compared to $2.4 million, or 1.02% of total loans, at December 31, 2008.

Table of Contents

CENTRAL FEDERAL CORPORATION PART 1. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS The increase in nonperforming loans included $800,000 in commercial loans, $1.3 million in commercial real estate loans, and $500,000 in home equity lines of credit. The amount of the allowance for loan losses specifically allocated to nonperforming loans totaled $1.0 million at March 31, 2009 compared to $514,000 at December 31, 2008. The company has not experienced any charge-offs related to commercial, commercial real estate or multi-family mortgage loans since implementing its current commercial banking strategy in 2003.
Net charge-offs totaled $141,000, or 0.24% of average loans on an annualized basis, during the first quarter in 2009, compared to net charge-offs of $179,000, or 0.32% of average loans on an annualized basis, in first quarter of 2008. Net charge-offs for both periods related to home equity lines of credit. We believe the allowance for loan losses is adequate to absorb probable incurred credit losses in the loan portfolio as of March 31, 2009; however, future additions to the allowance may be necessary based on factors such as deterioration in client business performance, slowing economic conditions, and declines in cash flows and market conditions which result in lower real estate values. 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 continue to worsen. Noninterest income. Noninterest income increased $95,000, or 49.7%, and totaled $286,000 for the quarter ended March 31, 2009, compared to $191,000 for the quarter ended March 31, 2008. This increase was primarily due to a $116,000 increase in net gains on sales of loans, partially offset by a decline in net gain on sales of securities. The increased gains on the sale of loans was a result of increased mortgage originations from $6.1 million in the first quarter of 2008, to $12.0 million in first quarter of 2009, and a positive change in our internal pricing policies. The increase in mortgage production is a result of management's decision during 2008 to increase our staff of professional mortgage loan originators, who have been successful in increasing this business despite the current depressed condition of the housing market. The decline in net gain on sales of securities was due to a $23,000 gain recognized on the redemption of VISA, Inc. shares during the quarter ended March 31, 2008, and no sales of securities in the current year quarter.
Noninterest expense. Noninterest expense for the quarter ended March 31, 2009 increased $334,000, or 18.1%, and totaled $2.2 million for the quarter ended March 31, 2009, compared to $1.8 million for the quarter ended March 31, 2008. Expenses in the current year quarter increased due to higher occupancy and equipment expenses, professional fees and FDIC premiums, partially offset by a decline in depreciation. Occupancy and equipment expenses increased $39,000 in the first quarter of 2009 due to operating costs associated with the Worthington office and additional office space for the expanded mortgage loan operations. Professional fees increased $267,000 in the first quarter of 2009 due to legal and accounting fees related to the investigation of certain deposit accounts associated with a third party payment processor, which are no longer active, and other legal fees related primarily to nonperforming loans and regulatory filings. FDIC premiums increased $59,000 due to higher assessment rates in the current year quarter to restore the reserve ratio of the Deposit Insurance Fund, as more fully described below, and use of the one-time FDIC credit issued to CFBank as a result of the Federal Deposit Insurance Reform Act of 2005, which reduced premiums in the prior year quarter. Depreciation expense decreased $56,000 in the first quarter of 2009 due to certain assets becoming fully depreciated in the prior year.
The ratio of noninterest expense to average assets was 3.04% for the first quarter of 2009, compared to 2.68% in the first quarter of 2008. The efficiency ratio was 92.92% for the quarter ended March 31, 2009, compared to 83.45% for quarter ended March 31, 2008. The increase in both ratios was a result of the increase in noninterest expense.
As an FDIC-insured institution, CFBank is required to pay deposit insurance premiums to the FDIC. Because the FDIC's deposit insurance fund fell below prescribed levels in 2008, the FDIC has announced increased premiums for all insured depository institutions, including CFBank, in order to begin recapitalizing the fund. Insurance assessments range from 0.12% to 0.50% of total deposits for the first calendar quarter 2009 assessment. Effective April 1, 2009, insurance assessments will range from 0.07% to 0.78%, depending on an institution's risk classification and other factors. These changes will result in increased deposit insurance expense for CFBank in 2009.

Table of Contents

CENTRAL FEDERAL CORPORATION PART 1. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS In addition, under a proposed rule, the FDIC indicated its plans to impose a 20 bp emergency assessment on insured depository institutions to be paid on September 30, 2009, based on deposits at June 30, 2009. FDIC representatives subsequently indicated the amount of this special assessment could decrease if certain events transpire. The proposed rule would also authorize the FDIC to impose an additional emergency assessment of up to 10 bp after June 30, 2009, if necessary to maintain public confidence in federal deposit insurance. Based on the level of CFBank's deposits at March 31, 2009, the 20 bp emergency assessment, if adopted as proposed, would result in a charge of approximately $441,000.
Income taxes. Income taxes decreased $179,000, from a $41,000 expense for the quarter ended March 31, 2008 to a benefit of $138,000 for the quarter ended March 31, 2009 due to the net loss reported in the current year quarter. 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 audited consolidated financial statements in our 2008 Annual Report to Shareholders incorporated by reference into our 2008 Annual Report on Form 10-K. Some of these accounting policies are considered to be critical accounting policies, which are those policies that 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 position or results of operations. We believe that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time.
We have identified accounting polices that are critical accounting policies, and an understanding of these is necessary to understand our financial statements. One critical accounting policy relates to determining the adequacy of the allowance for loan losses. The Allowance for Loan Losses Policy provides a thorough, disciplined and consistently applied process that incorporates management's current judgments about the credit quality of the loan portfolio into determination of the allowance for loan losses in accordance with generally accepted accounting principles and supervisory guidance. Management estimates the required allowance balance using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Management believes that an adequate allowance for loan losses has been established. Additional information regarding this policy is included in the previous section captioned "Provision for Loan Losses" and in Notes 1 and 3 to the consolidated financial statements in our 2008 Annual Report to Shareholders incorporated by reference into our 2008 Annual Report on Form 10-K.
Another critical accounting policy relates to valuation of the deferred tax asset for net operating losses. Net operating losses totaling $2.9 million will expire at various dates ranging from 2024 to 2028. No valuation allowance has been recorded against the deferred tax asset for net operating losses because . . .