City Holding Company — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unaudited consolidated results. Dollar amounts below are in millions unless otherwise noted.
Business context and reporting period
City Holding is a West Virginia bank holding company. On May 31, 2012, it acquired Virginia Savings Bancorp (VSB), adding five branches and expanding into Virginia. The acquisition contributed approximately $72.0 million of loans and $120 million of deposits at closing; reported period-end balances and results therefore include VSB only from the acquisition date.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net interest income | $23.8 | $22.5 | $47.4 | $45.3 |
| Net interest margin, reported | 3.91% | 3.78% | 3.94% | 3.86% |
| Provision for loan losses | $1.7 | $1.3 | $3.6 | $2.4 |
| Noninterest income | $13.8 | $16.5 | $26.9 | $29.2 |
| Noninterest expense | $24.8 | $22.9 | $44.3 | $42.8 |
| Net income | $7.4 | $9.8 | $17.4 | $19.4 |
| Diluted EPS | $0.50 | $0.64 | $1.17 | $1.26 |
For Q2, return on average assets was 1.06% and return on average equity was 9.2%; for the six-month period, the respective returns were 1.26% and 10.9%. Management stated that excluding VSB acquisition and integration expenses, net income would have been $10.0 million for Q2 and $20.2 million for the first six months, with six-month ROA of 1.46% and ROE of 12.7%.
At June 30, total assets were $2.893 billion, gross loans $2.066 billion, deposits $2.395 billion, and shareholders’ equity $320.6 million. Compared with December 31, 2011, assets rose 4.2%, loans 4.7%, and deposits 7.8%; acquisition activity contributed materially to growth. Cash and cash equivalents were $134.0 million.
Six-month operating cash flow was $23.2 million; investing activities used $3.3 million and financing activities used $32.3 million, producing a $12.4 million decrease in cash and cash equivalents. Long-term debt was $16.5 million, consisting of junior subordinated debentures due 2038. Period-end short-term borrowings included $123.1 million of customer repurchase agreements; no federal funds were purchased, versus $75.0 million at year-end.
Regulatory capital ratios remained above well-capitalized thresholds: City Holding total risk-based capital 13.4%, Tier 1 risk-based 12.5%, and Tier 1 leverage 9.7%; City National Bank ratios were 12.4%, 11.5%, and 9.0%, respectively.
Material changes versus comparable periods
- Q2 net income fell 24.6% year over year; six-month net income declined 10.3%. The filing attributes much of the pressure to VSB-related acquisition and integration expense of $4.2 million for the first half, including $4.0 million in Q2.
- Net interest income and margin improved as deposit costs declined. The average rate paid on interest-bearing deposits fell to 0.71% in Q2 from 1.20% a year earlier; management also cited a 0.3 million contribution to Q2 net interest income from VSB.
- Noninterest income declined year over year, partly reflecting lower securities-sale gains: $0.8 million of gross gains in the first half of 2012 versus $3.1 million in the first half of 2011. 2012 also included $0.3 million of credit-related securities impairment.
- Six-month net charge-offs increased to $3.6 million from $1.7 million. Nonperforming loans were $21.9 million, down from $22.1 million at year-end, while nonperforming assets rose to $30.6 million from $30.1 million. The nonperforming-asset ratio improved to 1.47% from 1.52%.
Outlook, risks, contingencies and unusual items
- No specific earnings or financial guidance was provided. Management said future loan-loss provisions depend on loan growth and mix, credit quality, loss experience, recoveries, and economic conditions.
- Management described liquidity as strong. Deposits funded 82.8% of assets, and the bank reported capacity to borrow an additional $1 billion from the FHLB and other institutions. Available-for-sale securities totaled $376.9 million.
- Interest-rate simulations estimated that an immediate, sustained 400-basis-point increase would raise 12-month net income by 22.2% and economic value of equity by 19.6%. These are model estimates dependent on assumptions, not forecasts or guarantees.
- VSB purchase consideration was approximately $12.4 million. Preliminary purchase accounting included $8.0 million of goodwill and a $1.2 million core deposit intangible. On August 2, 2012, the company agreed to acquire Community Financial Corporation for an expected $25.3 million; closing was anticipated in Q1 2013, subject to approvals and customary conditions.
- The Casto overdraft-fee class action settlement was approved. The bank agreed to pay eligible class members $3.366 million and forgive $3.5 million in former-customer account balances. The company said it had accrued the probable loss and funded the settlement account in Q1 2012; it expected the case to close by year-end.
- Investment risks include pooled trust preferred securities with $7.1 million book value and $3.3 million estimated fair value; further collateral deterioration could result in additional impairment. The filing also cites credit, interest-rate, economic, regulatory, competition, funding-growth, and legal risks.
- Other unusual expense included a $0.6 million write-down on a foreclosed property in Q2; the filing states its estimated value was reduced to approximately half of original cost. The company reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether VSB integration costs, acquired credit exposures, and purchase-accounting estimates develop as management expects, and whether the pending Community acquisition closes on schedule and at the expected terms.
- Credit trends behind higher year-to-date net charge-offs, particularly commercial real estate and home equity losses, and the adequacy of the $19.5 million loan-loss allowance.
- Valuation, cash-flow assumptions, and potential further impairment of pooled trust preferred securities and other investment holdings.
- Whether core earnings and margins remain resilient as interest rates, deposit costs, and noninterest income change; reported results include significant acquisition costs and comparison-period securities gains.
- Completion and financial impact of the Casto settlement, and the company’s capacity to sustain dividends and repurchases while funding acquisitions and maintaining capital.