City Holding Company — Q2 2018 Form 10-Q
Business and period: Unaudited results for the quarter and six months ended June 30, 2018, compared primarily with the same 2017 periods. City Holding is a West Virginia financial holding company operating through City National Bank, with community banking as its sole reportable segment.
Financial performance
- Profit: Q2 net income was $21.0 million, up from $14.7 million; diluted EPS was $1.35 versus $0.94. First-half net income was $38.6 million versus $30.7 million; diluted EPS was $2.48 versus $1.98.
- Net interest income and margin: Q2 net interest income was $33.6 million, up 7.4%; first-half net interest income was $66.2 million, up 7.3%. Tax-equivalent net interest margin increased to 3.56% in Q2 from 3.46%, and to 3.54% for the first half from 3.46%. Management attributed improvement mainly to higher loan yields and balances, partly offset by higher deposit and borrowing costs.
- Other income and expenses: Q2 noninterest income increased 4.7% to $15.6 million and expenses rose 2.9% to $24.9 million. First-half noninterest income fell to $30.1 million from $33.4 million, principally because 2017 included $4.3 million of investment gains; excluding those gains, first-half noninterest income rose 3.1%. First-half expenses increased 2.3% to $49.9 million, mainly reflecting salary adjustments.
- Taxes: The effective tax rate was about 20.3% in Q2 and 20.2% for the first half, versus 31.7% and 32.0% in the comparable 2017 periods. The filing cites the lower federal corporate tax rate effective in 2018; the 2017 fourth-quarter deferred-tax remeasurement charge was $7.1 million.
- Loans and credit: Gross loans were $3.16 billion at June 30, up $28.1 million, or 0.9%, from year-end 2017. The allowance for loan losses was $16.9 million, or 0.53% of loans, versus $18.8 million, or 0.60%, at year-end. The company recorded a first-half loan-loss recovery of $1.9 million versus a $1.2 million provision in 2017. Q2 results included a $1.3 million recovery tied to liquidation of Kentucky Fuels repossessed assets and a further $1.7 million reserve release; excluding these items, management said Q2 would have included a $0.9 million provision.
- Cash flow and liquidity: First-half operating cash flow was $35.6 million, investing cash flow was negative $56.5 million, and financing cash flow was positive $203.9 million. Cash and cash equivalents rose to $265.5 million from $82.5 million at year-end, as the company increased short-term borrowings to support future investment purchases and liquidity. Deposits were $3.42 billion, short-term borrowings $378.0 million, and long-term debt $16.5 million. Management described liquidity as strong and reported $1.5 billion of additional borrowing capacity at the bank.
- Capital and shareholder returns: Shareholders’ equity was $503.8 million. At June 30, City Holding’s CET1, total capital, and Tier 1 leverage ratios were 15.5%, 16.6%, and 11.1%; City National’s were 13.2%, 13.9%, and 9.2%. Both were described as well capitalized. First-half dividends declared were $0.92 per share; the company repurchased about 214,000 shares for $14.7 million.
Material changes and items to monitor
- Net income and EPS improved, supported by higher net interest income, lower taxes, and loan-loss recoveries. The recovery and reserve release described above are notable and may not recur.
- Nonperforming loans were $13.2 million, or 0.53% of loans, compared with $10.6 million and 0.45% at year-end 2017. Nonperforming assets were $16.9 million. Management attributed the increase primarily to two residential real estate credits and did not anticipate losses on them. Past-due loans declined to $8.2 million from $11.0 million at year-end.
- Available-for-sale securities had $19.1 million of gross unrealized losses at June 30. First-half other comprehensive loss was $10.7 million after tax, largely reflecting securities fair-value declines. Management considered the debt-security losses temporary and reported no investment impairment losses in the first half.
- Subsequent to quarter-end, the company agreed to acquire Poage Bankshares and Farmers Deposit Bancorp. The transactions were expected to close in Q4 2018, subject to approvals and other conditions, and are independent of one another. Estimated pretax merger expenses are $18 million for Poage and $6 million for Farmers Deposit; estimated core deposit intangibles are $4 million and $1.5 million, respectively.
- The company expects to contribute $1.6 million to complete termination of a defined-benefit pension plan in late 2018. It reported ordinary-course legal actions and said outcomes could affect results, without providing a clear estimate of exposure.
Outlook, risks, and contingencies
The filing provides no specific earnings or revenue guidance. Management said future loan-loss provisions will depend on loan growth and mix, credit quality, loss trends, and recoveries. Interest-rate risk is material: the company’s modeled 12-month net income sensitivity was positive 6.5% for an immediate 400-basis-point increase and negative 13.2% for a 100-basis-point decrease. Management cautioned that these estimates depend on assumptions about deposit repricing, customer behavior, competition, prepayments, and new business.
Other disclosed risks include deterioration in credit quality, competition, expense management, employee retention, economic and regulatory changes, and the ability to grow loans and deposits. Off-balance-sheet credit commitments include home equity lines, commercial real estate and other commitments, and letters of credit; management did not anticipate material losses. The company reported no material changes to the risk factors in its 2017 Form 10-K.
Important facts for investors to verify
- How much of earnings growth depends on the Kentucky Fuels recovery and reserve releases, and whether credit costs normalize.
- Whether nonperforming loans and assets stabilize, particularly the two residential real estate credits and commercial loan exposures.
- The drivers of deposit and wholesale funding costs, loan yields, and net interest margin as rates change.
- Merger approvals, closing timetable, integration execution, and actual acquisition costs and cost savings compared with estimates.
- Liquidity and capital levels after planned investment purchases, share repurchases, dividends, and acquisitions.
- Potential effects of securities valuation changes and the upcoming adoption of the expected-credit-loss accounting standard.