City Holding Company — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. City Holding is a community banking holding company operating through City National Bank of West Virginia, with 87 offices across West Virginia, Virginia, Kentucky and southeastern Ohio. Figures below are in U.S. dollars; financial amounts are in millions unless indicated.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $35.6 | $32.0 | $101.8 | $93.7 |
| Net income | $20.7 | $13.9 | $59.3 | $44.6 |
| Diluted EPS | $1.33 | $0.89 | $3.82 | $2.86 |
| Net interest margin, tax-equivalent | 3.54% | 3.45% | 3.52% | 3.46% |
- Q3 net income rose about 49% year over year; nine-month net income rose about 33%. Q3 income before taxes was $26.3 million, with tax expense of $5.6 million. The effective tax rate was 21.3% for Q3 and 20.6% for the nine-month period.
- For the nine months, return on average assets was 1.86%, return on average equity 15.6%, and return on average tangible common equity 18.5%. The declared dividend was $0.53 per share in Q3 and $1.45 year to date.
- At September 30, total assets were $4.42 billion; deposits $3.44 billion; gross loans $3.15 billion; and shareholders’ equity $512.0 million. Total assets increased $288.5 million from year-end 2017. Gross loans increased 0.6% and deposits increased 3.9%.
- Cash and cash equivalents were $305.9 million, up $223.4 million from year-end. Short-term borrowings were $390.1 million, including $170.0 million in federal funds purchased; long-term debt was $16.5 million. Management said it used short-term borrowings to strengthen on-balance-sheet liquidity. The bank reported capacity to borrow a further $1.5 billion under existing facilities.
- Nine-month cash flows: $56.3 million provided by operations, $63.3 million used in investing, and $230.4 million provided by financing. Financing included $137.9 million of increased short-term borrowings and $122.6 million of increased interest-bearing deposits; the company paid $21.4 million in dividends and repurchased $15.2 million of stock.
- Regulatory capital ratios at September 30 included CET1 of 15.9% at the holding company and 14.0% at the bank; management stated both were well capitalized.
Changes versus comparable periods
- Net interest income and margin improved year over year, supported by higher commercial and residential loan yields, loan prepayment fees, and greater average investment balances. Higher deposit and short-term borrowing costs partly offset the gains.
- The company recorded a $1.9 million loan-loss recovery for the first nine months of 2018, versus a $2.6 million provision in 2017. The allowance fell to $16.3 million from $18.8 million at year-end; annualized net charge-offs were 0.03% of average loans versus 0.12% in the prior-year period.
- Noninterest income for nine months was $45.9 million, down from $48.0 million as reported, primarily because 2017 included $4.3 million of investment gains. Excluding those gains, noninterest income increased $2.1 million. Noninterest expense rose 2.5% to $74.9 million, mainly reflecting salary adjustments.
- Accumulated other comprehensive loss widened to $23.3 million from $5.6 million at year-end, principally reflecting lower fair values of available-for-sale securities. The company reported $24.2 million of gross unrealized losses on those securities and said it considered the declines temporary, with no impairment loss recorded.
Outlook, commentary, risks and unusual items
- City Holding announced agreements to acquire Poage Bankshares/Town Square Bank and Farmers Deposit Bancorp/Farmers Deposit Bank. Both transactions were expected to close in Q4 2018, subject to customary closing conditions; approvals and shareholder votes had been obtained. Estimated pretax merger expenses are $18 million and $6 million, respectively, and estimated core deposit intangibles are $4 million and $1.5 million. The acquisitions are not contingent on one another.
- The company authorized repayment of its $16.5 million junior subordinated debentures, with the trust securities scheduled for redemption on December 17, 2018, subject to regulatory approvals. Management estimated annual interest expense savings of about $1.0 million and expected the company to remain well capitalized.
- Management described liquidity as strong, cited a conservative liquidity posture, and expected available holding-company cash plus bank dividends to meet the parent’s needs for the next 12 months. It anticipated annualized common dividends of approximately $32.8 million.
- Management’s interest-rate model estimated that an immediate, sustained 300-basis-point increase would raise net income 4.6% over 12 months, while a 200-basis-point decrease would reduce it 20.7%. These are scenario estimates dependent on assumptions about deposit repricing, customer behavior and other factors, not earnings guidance.
- Credit items to monitor include nonperforming assets of $15.7 million, or 0.50% of loans and OREO, versus 0.45% at year-end. Management attributed the increase mainly to two residential real estate credits and did not anticipate losses on them. It also reported no expected losses from Hurricane Florence-related exposures in affected areas.
- A notable contributor to the loan-loss recovery was liquidation of repossessed assets tied to Kentucky Fuels Corporation; the bank recovered $1.3 million. The remaining contractual balance was $1.3 million, with no recorded book balance.
- Other risks include interest-rate sensitivity, credit deterioration, competitive and economic conditions, regulatory changes, and successful integration and realization of expected benefits from the acquisitions. The filing reports ordinary-course legal proceedings but provides no clear quantified exposure. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification checklist
- Confirm the closing status, final consideration, integration progress and realized costs or synergies for both proposed acquisitions.
- Track deposit pricing and funding costs, the level and use of short-term borrowings, and the effect of the planned debt redemption on capital and interest expense.
- Review loan delinquency, nonperforming asset and charge-off trends, allowance adequacy, and the Kentucky Fuels recovery and related reserve effects.
- Monitor available-for-sale securities valuations and accumulated other comprehensive loss as interest rates and credit spreads change.
- Compare actual tax expense, earnings and net interest margin with the reported 2018 results; the filing does not provide formal earnings guidance.
- Assess the assumptions behind interest-rate sensitivity estimates and any developments in legal proceedings or contingent exposures.