City Holding Company — Q3 2020 Form 10-Q
Business context and reporting period. City Holding is a community-banking holding company operating through City National Bank, with 94 offices in West Virginia, Kentucky, Virginia and southeastern Ohio. This unaudited filing covers the quarter and nine months ended September 30, 2020; balance-sheet comparisons are to December 31, 2019. COVID-19 and the resulting low-rate environment materially influenced results and customer activity.
Financial performance and condition
- Q3 earnings: Net income was $20.1 million, down from $22.4 million a year earlier; diluted EPS was $1.25 versus $1.36. Pretax income was $25.2 million versus $28.6 million.
- Nine-month earnings: Net income was $67.4 million versus $66.7 million; diluted EPS was $4.15 versus $4.04. Results included a $17.8 million pretax gain from selling Visa shares, without which reported year-to-date earnings comparisons would be weaker.
- Interest income and margins: Q3 net interest income was $38.0 million versus $40.5 million; tax-equivalent net interest margin fell to 3.02% from 3.59%. For nine months, net interest income was $116.5 million versus $121.5 million and tax-equivalent margin was 3.22% versus 3.64%. Lower loan and investment yields outweighed reduced funding costs.
- Other revenue and costs: Q3 noninterest income was $17.0 million versus $16.7 million, while noninterest expense was $28.7 million versus $28.4 million. For nine months, reported noninterest income rose to $65.0 million from $50.4 million, largely due to the Visa gain; excluding the Visa gain and investment-security effects, it declined. Nine-month noninterest expense fell to $86.6 million from $88.6 million.
- Credit costs: Q3 provision for credit losses was $1.0 million versus $0.3 million. The nine-month provision was $10.2 million, compared with a $1.2 million recovery in 2019. The allowance was $24.9 million, or 0.68% of gross loans, at September 30, versus $11.6 million, or 0.32%, at year-end; the increase reflects CECL adoption and COVID-related assumptions.
- Balance sheet: Total assets were $5.51 billion, up from $5.02 billion at year-end. Gross loans were $3.66 billion, up 1.3%; excluding about $90 million of PPP loans, loans declined about 1.1%. Deposits rose $344 million to $4.42 billion. Cash and equivalents increased to $252.7 million from $140.1 million, and investment securities rose to $1.18 billion from $887.6 million.
- Cash flow and funding: For nine months, operating activities generated $80.2 million, investing activities used $317.1 million and financing activities generated $349.5 million. Financing inflows included higher deposits and short-term borrowings. At quarter-end, short-term repurchase borrowings were $279.9 million; long-term debt was zero. The bank reported $2.1 billion of available borrowing capacity.
- Capital and shareholder returns: The company reported regulatory capital ratios of 15.9% CET1 and 16.5% total capital; the bank reported 14.5% and 15.0%, respectively. Management stated both were well capitalized. The company repurchased 491,998 shares for $31.6 million during the nine months and declared $1.71 per share in dividends.
Material changes versus comparable periods
- Q3 net income and EPS declined year over year, as reduced loan yields and lower net interest income more than offset lower deposit funding costs and modestly higher noninterest income.
- Nine-month net income and EPS increased modestly, but the $17.8 million Visa-share gain was a significant nonrecurring contributor. Reported return metrics declined: nine-month ROA was 1.68% versus 1.81%, and ROE was 12.9% versus 14.1%.
- CECL adoption on January 1, 2020 increased the allowance by $5.8 million and reduced retained earnings by $2.3 million. Management also reclassified held-to-maturity securities as available-for-sale.
- Deposit inflows, including customer stimulus and PPP-related funds and reduced spending, substantially increased cash and securities. Management attributed weak underlying loan demand to the pandemic environment.
Outlook, management commentary and risks
- No specific earnings or revenue guidance was provided. Management said it continued to monitor the evolving pandemic and may adjust its response; nine-month results were not necessarily indicative of full-year results.
- Management cited COVID-related uncertainty around economic conditions, borrower creditworthiness, collateral values, customer demand, funding, operations and interest-rate exposure. The company’s credit-loss estimate is sensitive to forecast unemployment and other assumptions; management considered the allowance adequate at quarter-end.
- Commercial loan deferrals totaled about $455 million during the first nine months; $180 million remained deferred at September 30, including $160 million in hotel and lodging loans. Of approximately $135 million in mortgage deferrals, $15 million remained deferred. These balances and subsequent payment performance warrant attention.
- The company had funded about $90 million of SBA-approved PPP loans to more than 1,500 customers and expected about $3.0 million of net processing fees over the loans’ terms. Risks include incomplete forgiveness, borrower inability to repay, SBA payment delays, fraud and unfavorable loan economics.
- Interest-rate risk is material: the company reported that its modeled net income was positively correlated with rising rates, but emphasized that results depend on assumptions about deposit repricing, competition, prepayments and new business. The filing does not provide a firm forecast.
- Unfunded credit commitments and letters of credit are disclosed; management did not anticipate material losses from them. The company is also involved in ordinary-course legal actions and cannot assure they will have no material effect. The filing identifies no other material change to previously disclosed risk factors beyond pandemic and PPP risks.
Important facts for investors to verify
- Whether hotel and other commercial borrowers still under deferral resume payments, and whether credit downgrades, nonperforming loans or charge-offs increase.
- Whether the $24.9 million allowance adequately reflects updated economic forecasts and portfolio risks, particularly in commercial real estate and hotels.
- How quickly deposit growth normalizes, the cost and stability of deposits, and the effect of accumulated liquidity on future net interest margin.
- PPP loan forgiveness, SBA reimbursement timing and realization of the expected processing fees.
- Underlying earnings excluding the Visa gain, as well as the continuing effects of lower rates, reduced service charges, share repurchases and dividends.
- Quarter-end nonperforming loans were $13.6 million and nonperforming assets were $15.7 million; monitor subsequent asset-quality trends and collateral values.