City Holding Company — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. Unaudited consolidated results; balance-sheet comparisons are to December 31, 2010. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net income | $9.8 | $10.7 | $19.4 | $20.0 |
| Diluted EPS | $0.64 | $0.68 | $1.26 | $1.26 |
| Net interest income, reported | $22.5 | $24.7 | $45.3 | $48.2 |
| Provision for loan losses | $1.3 | $1.8 | $2.4 | $2.9 |
| Non-interest income | $16.5 | $13.3 | $29.2 | $25.4 |
| Non-interest expense | $22.9 | $20.0 | $42.8 | $40.5 |
- Q2 net income fell about 8% year over year; first-half net income fell about 3%, while first-half diluted EPS was unchanged.
- Tax-equivalent net interest margin declined to 3.78% in Q2 from 4.22%, and to 3.86% for the first half from 4.18%. Management attributed lower net interest income primarily to reduced income from interest-rate floors and previously securitized loans, as well as lower asset yields.
- Q2 included $3.1 million of gains on securities sales; no credit-related investment impairment was recorded in the first half, versus $1.9 million in the first half of 2010.
- Operating cash flow was $25.4 million in the first half, compared with $27.6 million. Investing activities used $43.3 million; financing activities provided $52.3 million. Cash and cash equivalents increased $34.5 million to $100.8 million.
Balance sheet, liquidity and capital
- Total assets were $2.714 billion, up 2.9% from year-end. Gross loans rose 1.7% to $1.897 billion; commercial real estate loans increased $32.2 million, while commercial and industrial loans declined $13.5 million.
- Deposits increased $63.2 million to $2.235 billion. Short-term borrowings were $127.2 million and long-term debt was $16.5 million; shareholders’ equity was $310.4 million.
- Management described liquidity as strong. City National had capacity to borrow an additional $473 million under existing facilities; 94.9% of the securities portfolio was available-for-sale. First-half cash dividends paid were $10.5 million and treasury-stock purchases were $15.1 million.
- At June 30, City Holding’s total risk-based, Tier 1 risk-based and Tier 1 leverage ratios were 14.4%, 13.4% and 10.1%, respectively. City National’s corresponding ratios were 13.1%, 12.1% and 9.1%; both were above stated “well-capitalized” thresholds.
Credit quality, notable changes and risks
- Nonperforming assets rose to $31.4 million from $21.0 million at year-end; the nonperforming-assets ratio increased to 1.65% from 1.12%. Nonaccrual loans increased to $23.2 million from $10.8 million, primarily due to a deteriorating commercial relationship of approximately $9.7 million.
- The allowance for loan losses was $18.9 million, up from $18.2 million; first-half net charge-offs were $1.7 million. Management considered the allowance adequate, but noted that future provisions depend on loan quality, portfolio mix, loss experience and recoveries.
- The company recorded a $3.0 million litigation reserve in Q2. Two putative class actions allege improper overdraft-fee practices; claimed damages have not been determined and could be material. One case remained without a court ruling on the company’s motion to dismiss.
- Management anticipated approximately $1.5 million in loan recoveries in Q3 or Q4 2011 from a borrower’s life-insurance policy. This was an expectation, not a reported recovery during the quarter.
- Management provided no specific earnings or revenue guidance. It warned of sensitivity to interest rates, economic conditions, credit deterioration, investment valuations, competition, regulation including Dodd-Frank, and its ability to grow loans and deposits or control expenses. A modeled immediate +400-basis-point rate shock estimated a 17.5% increase in net income over 12 months; management cautioned that model assumptions may not reflect actual outcomes.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Progression and collateral support of the large commercial relationship driving higher nonaccrual loans and nonperforming assets; adequacy of the allowance and subsequent loan recoveries.
- Exposure and valuation assumptions for pooled trust-preferred securities: five pooled securities had $7.8 million book value and $4.6 million estimated fair value; management recognized no first-half credit-related impairment but acknowledged further deterioration could cause future charges.
- Outcome and potential financial impact of the overdraft-fee class actions and the sufficiency of the $3.0 million litigation reserve.
- Whether net interest margin pressure, lower service-charge income, and higher legal and professional costs persist; the filing’s Q2 expense figures differ between the financial statements ($22.9 million) and MD&A narrative (which cites $22.2 million), so the reported value should be checked against the original filing.
- Execution of the new one-million-share repurchase authorization approved July 27, 2011, and the effect of ongoing repurchases and dividends on capital and liquidity.