City Holding Earnings 2018-12-31
CHCO 10K Annual Report
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2018
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Transition Period From ____________To_____________.
Commission File Number 0-11733
CITY HOLDING COMPANY
(Exact name of registrant as specified in its charter)
West Virginia | 55-0619957 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
25 Gatewater Road | |
Charleston, West Virginia | 25313 |
(Address of principal executive offices) | (Zip Code) |
(304) 769-1100
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class: | Name of Each Exchange on Which Registered: |
Common Stock, $2.50 par value | NASDAQ Global Select Market |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:
Yes | [X] | No | [ ] |
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act:
Yes | [ ] | No | [ X ] |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes | [X] | No | [ ] |
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes | [X] | No | [ ] |
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] | Accelerated filer [ ] |
Non-accelerated filer [ ] | Smaller reporting company [ ] |
Emerging growth company [ ] | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes | [ ] | No | [X] |
As of June 30, 2018, the last business day of the registrant’s most recently completed second quarter, the aggregate market value of the shares of common stock held by non-affiliates, based upon the closing price per share of the registrant’s common stock as reported on the Nasdaq Global Select Market, was approximately $1.1 billion. (Registrant has assumed that all of its executive officers and directors are affiliates. Such assumption shall not be deemed to be conclusive for any other purpose.)
As of March 7, 2019, there were 16,530,297 shares of the Company’s common stock, $2.50 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement for the 2019 annual shareholders’ meeting to be held on April 17, 2019 are incorporated by reference into Part III, Items 10, 11, 12, 13, and 14.
FORM 10-K INDEX
PART I | Pages | |
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
Part III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Part IV | ||
Item 15. | ||
Item 16. | ||
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements that are included pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements express only management's beliefs regarding future results or events and are subject to inherent uncertainty, risks, and changes in circumstances, many of which are outside of management's control. Examples of forward-looking statements include, but are not limited to, information regarding our business plan and strategies, projected future financial performance, the determination of our allowance for loan losses, the carrying value of certain assets, and statements regarding our risk exposure. Words such as "anticipate," "expect," "may," "will," "should," "likely," "estimate," "intend" and other similar words and expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Uncertainty, risks, changes in circumstances and other factors could cause the Company's actual results to differ materially from those projected in the forward-looking statements. Factors that could cause actual results to differ from those discussed in such forward-looking statements include, but are not limited to those set forth in the Company’s Annual Report on Form 10-K under “Risk Factors” and the following: (1) general economic conditions, especially in the communities and markets in which we conduct our business; (2) credit risk, including risk that negative credit quality trends may lead to a deterioration of asset quality, risk that our allowance for loan losses may not be sufficient to absorb actual losses in our loan portfolio, and risk from concentrations within our loan portfolio; (3) changes in the real estate market, including the value of collateral securing portions of our loan portfolio; (4) changes in the interest rate environment; (5) operational risk, including cybersecurity risk and risk of fraud, data processing system failures, and network breaches; (6) changes in technology and increased competition, including competition from non-bank financial institutions; (7) changes in consumer preferences, spending and borrowing habits, demand for our products and services, and customers' performance and creditworthiness; (8) difficulty growing loan and deposit balances; (9) our ability to effectively execute our business plan, including with respect to future acquisitions, integration of acquired companies, and liquidity needs; (10) changes in regulations, laws, taxes, government policies, monetary policies and accounting policies affecting bank holding companies and their subsidiaries; (11) deterioration in the financial condition of the U.S. banking system may impact the valuations of investments the Company has made in the securities of other financial institutions; (12) regulatory enforcement actions and adverse legal actions; (13) difficulty attracting and retaining key employees; (14) the expected cost savings and any revenue synergies from the merger of City Holding Company, City National Bank of West Virginia, Poage Bankshares, Inc., Town Square Bank, Farmers Deposit Bancorp, Inc. and Farmers Deposit Bank may not be fully realized within the expected time frames; (15) the disruption from the merger of City Holding Company, City National Bank of West Virginia, Poage Bankshares, Inc., Town Square Bank, Farmers Deposit Bancorp, Inc. and Farmers Deposit Bank may make it more difficult to maintain relationships with clients, associates, or suppliers; and (16) other economic, competitive, technological, operational, governmental, regulatory, and market factors affecting our operations. Forward-looking statements made herein reflect management's expectations as of the date such statements are made. Such information is provided to assist stockholders and potential investors in understanding current and anticipated financial operations of the Company and is included pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances that arise after the date such statements are made.
PART I
Item 1.Business
City Holding Company (the "Company" or "City Holding" or the "Parent Company") is a financial holding company headquartered in Charleston, West Virginia. The Company conducts its principal activities through its wholly-owned subsidiary, City National Bank of West Virginia (“City National”). City National provides banking, trust and investment management and other financial solutions through its network of 100 bank branches and 891 full-time equivalent associates located in West Virginia, Virginia, Kentucky and southeastern Ohio. The Company’s business activities are currently limited to one reportable business segment, which is community banking.
In July 2018, the Company announced that it had concurrently executed two separate definitive agreements to acquire Poage Bankshares, Inc., of Ashland, Kentucky and its principal banking subsidiary, Town Square Bank (collectively, "Poage") and Farmers Deposit Bancorp, Inc., of Cynthiana, Kentucky and its principal banking subsidiary, Farmers Deposit Bank (collectively, "Farmers Deposit"). The acquisitions were finalized in December 2018. Poage operated nine branches across northeastern Kentucky, along with a loan production office in Cincinnati, Ohio. Farmers Deposit operated three branches around the Lexington, Kentucky region. As a result of overlapping service areas, the Company plans to merge three of the Poage branches into existing City branches and two existing City branches into former Poage branches.
In September 2018, the Company opened a new branch office in Morgantown, West Virginia. In December 2018, the Company opened a new branch office in the Columbus suburb of Worthington, Ohio.
Rendition of the Company's Worthington branch.
In January 2019, the Company announced the signing of a definitive agreement to sell its Virginia Beach, Virginia, branch to Select Bancorp, Inc., the holding company for Select Bank & Trust Company. The transaction is expected to close during the second quarter of 2019.
After the Poage-City branch mergers and the Virginia Beach branch divestiture, the Company expects to have 94 bank branches in its network.
During 2018, the Company received the highest ranking in customer satisfaction in the north central region in J.D. Power's 2018 U.S. Retail Banking Satisfaction Study.
The principal products produced and services rendered by City National include:
• | Commercial Banking - City National offers a full range of commercial banking services to corporations and other business customers. Loans are provided for a variety of business purposes, including financing for commercial and industrial projects, income producing commercial real estate, owner-occupied real estate and construction and land development. City National also provides deposit services for commercial customers, including treasury management, lockbox and other cash management services. City National provides merchant credit card services through an agreement with a third party vendor. |
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• | Consumer Banking - City National provides banking services to consumers, including checking, savings and money market accounts as well as certificates of deposit and individual retirement accounts. In addition, City National provides consumers with installment and real estate loans and lines of credit. City National also offers credit cards through an agreement with a third party vendor. |
• | Mortgage Banking - City National provides mortgage banking services, including fixed and adjustable-rate mortgages, construction financing, production of conventional and government insured mortgages, secondary marketing and mortgage servicing. |
• | Wealth Management and Trust Services - City National offers specialized services and expertise in the areas of wealth management, trust, investment and custodial services for commercial and individual customers. These services include the administration of personal trusts and estates, as well as the management of investment accounts for individuals, employee benefit plans and charitable foundations. City National also provides corporate trust and institutional custody, financial and estate planning and retirement plan services. |
City National’s customer base is diverse and no single depositor could have a material adverse effect on liquidity, capital, or other elements of financial performance. Although no portion of City National’s loan portfolio is concentrated within a single industry or group of related industries in excess of City National's internally designated limit, residential mortgage loans have historically comprised a significant portion of its loan portfolio. At December 31, 2018, approximately 50% of the Company’s loan portfolio was categorized as residential mortgage and home equity loans. However, due to the fractured nature of residential mortgage lending, there is no concentration of credits that would be considered materially detrimental to the Company’s financial position or operating results.
The Company’s business is not seasonal and has no significant foreign sources or applications of funds. There are no anticipated material capital expenditures, or any expected material effects on earnings or the Company’s competitive position as a result of compliance with federal, state and local provisions enacted or adopted relating to environmental protection.
City National’s loan portfolio is comprised of commercial and industrial, commercial real estate, residential real estate, home equity, consumer loans and demand deposit account ("DDA") overdrafts.
City National's commercial and industrial loan portfolio consists of loans to corporate and other legal entity borrowers, primarily small to mid-size industrial and commercial companies. Commercial and industrial loans typically involve a higher level of risk than other loan types, including industry specific risks such as the pertinent economy, new technology, labor rates and cyclicality, as well as customer specific factors, such as cash flow, financial structure, operating controls and asset quality. Collateral securing these loans includes equipment, machinery, inventory, receivables and vehicles. As of December 31, 2018, City National reported $286 million of loans classified as “Commercial and Industrial.”
Commercial real estate loans consist of commercial mortgages, which generally are secured by nonresidential and multi-family residential properties, including hotel/motel and apartment lending. Commercial real estate loans are provided to many of the same customers and carry similar industry and customer specific risks as the commercial and industrial loans, but have different collateral risks. As of December 31, 2018, City National reported $1.43 billion of loans classified as “Commercial Real Estate.”
City National diversifies risk within the commercial and industrial and commercial real estate portfolios by closely monitoring industry concentrations (against internally established risk-based capital thresholds) and portfolios to ensure that it does not exceed established lending guidelines. Diversification is intended to limit the risk of loss from any single unexpected economic event or trend. Underwriting standards require a comprehensive credit analysis and independent evaluation of all larger balance commercial loans by the loan committee prior to approval.
City National categorizes commercial loans by industry according to the North American Industry Classification System ("NAICS") to monitor its portfolio for possible concentrations in one or more industries. Management monitors industry concentrations against internally established risk-based capital thresholds. As of December 31, 2018, City National was within its internally designated concentration limits. Further, with the exception of loans to borrowers within the "Lessors of Nonresidential Buildings", no other NAICS industry classification exceeded 10% of total loans at December 31, 2018. Loans to "Lessors of Nonresidential Buildings" were 12% of total loans at December 31, 2018. Management also monitors non-owner occupied commercial real estate as a percent of risk-based capital (based upon regulatory guidance). At December 31, 2018, the Company had $1.3 billion of commercial loans classified as non-owner occupied, which was within its designated concentration threshold.
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Residential real estate loans represent loans to consumers that are secured by a first priority lien on residential real property. Residential real estate loans include loans for the purchase or refinance of consumers' residences and first-priority home equity loans allow consumers to borrow against the equity in their home. These loans primarily consist of single family three- and five-year adjustable rate mortgages with terms that amortize up to 30 years. City National also offers fixed-rate residential real estate loans that are sold in the secondary market; once sold these loans are not included on the Company's balance sheet and City National does not retain the servicing rights to these loans. Residential purchase real estate loans are generally underwritten to comply with Fannie Mae guidelines, while first priority lien home equity loans are underwritten with typically less documentation, lower loan-to-value ratios and shorter maturities. As of December 31, 2018, City National reported $1.66 billion of loans classified as “Residential Real Estate.”
City National's home equity loans represent loans to consumers that are secured by a second (or junior) priority lien on residential real property. Home equity loans allow consumers to borrow against the equity in their home without paying off an existing first priority lien. These loans include home equity lines of credit ("HELOC") and amortized home equity loans that require monthly installment payments. Second priority lien home equity loans are underwritten with less documentation than first priority lien residential real estate loans but typically have similar loan-to-value ratios and other terms as first priority lien residential real estate loans. The amount of credit extended under these loans is directly related to the value of the real estate securing the loan at the time the loan is made. As of December 31, 2018, City National reported $153 million of loans classified as “Home Equity.”
All mortgage loans, whether fixed rate or adjustable rate, are originated in accordance with acceptable industry standards and comply with regulatory requirements. Fixed rate mortgage loans are processed and underwritten in accordance with Fannie Mae and Freddie Mac guidelines, while adjustable rate mortgage loans are underwritten in accordance with City National's internal loan policy.
Consumer loans may be secured by automobiles, boats, recreational vehicles, certificates of deposit and other personal property or they may be unsecured. The Company manages the risk associated with consumer loans by monitoring factors such as portfolio size and growth, internal lending policies, and pertinent economic conditions. City National's underwriting standards for consumer loans are continually evaluated and modified based upon these factors. As of December 31, 2018, City National reported $51 million of loans classified as “Consumer.”
DDA overdraft balances reflect demand deposit accounts that have been overdrawn by deposit customers and have been reclassified as loans. As of December 31, 2018, City National reported $6 million of loans classified as “DDA Overdrafts.”
City National’s loan underwriting guidelines and standards are updated periodically with suggested revisions presented to City Holding Company's Board of Directors for approval. The purpose of the underwriting guidelines and standards is to grant loans on a sound and collectible basis; to invest available funds in a safe and profitable manner; to serve the legitimate credit needs of the communities in City National's primary market area; and to ensure that all loan applicants receive fair and equal treatment throughout the lending process. The underwriting guidelines and standards are intended to: (i) minimize loan losses by carefully investigating the credit history and creditworthiness of each applicant; (ii) verify the source of repayment and the ability of the applicant to repay; (iii) adequately collateralize those loans in which collateral is deemed to be required; (iv) exercise appropriate care in the documentation of the application, review, approval, and origination processes; and (v) administer a comprehensive loan collection program. The underwriting guidelines are adhered to by the loan officer assigned to the loan application and subject to his or her experience, background and personal judgment.
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Market Area
City National operates a network of 100 bank branches primarily along the I-64 corridor from Lexington, Kentucky through Lexington, Virginia and along the I-81 corridor through the Shenandoah Valley from Lexington, Virginia to Martinsburg, West Virginia. City National's branch network includes 58 branches in West Virginia, 24 branches in Kentucky,14 branches in Virginia and 4 branches in Ohio. City National provides credit, deposit and investment advisory products and services to a broad geographical area that includes many rural and small community markets in addition to larger cities including Charleston (WV), Huntington (WV), Martinsburg (WV), Ashland (KY), Lexington (KY), Winchester (VA) and Staunton (VA). In addition to its branch network, City National's delivery channels include automated-teller-machines ("ATMs"), interactive-teller machines ("ITMs"), mobile banking, debit cards, interactive voice response systems, and Internet technology.
City National also provides commercial products and services to customers that are outside of its branches' geographical footprint, such as the Charlotte, North Carolina and Pittsburgh, Pennsylvania markets. These loans are diversified across a broad base of industry types, including multi-family housing properties, properties leased to government agencies, nursing homes, grocery and retail stores, and other commercial and industrial loans. At December 31, 2018, the outstanding balance of commercial loans to markets outside of the geographical footprint of the bank's branches was approximately $286 million, or 17% of City National's outstanding commercial loan balances.
City National has approximately 12% of the deposit market share in the counties of West Virginia where its bank branches are located. In Kentucky, City National has approximately 3% of the deposit market share in the counties where its bank branches are located. In Virginia, City National has approximately 9% of the deposit market share in the counties along the I-81 corridor where its bank branches are located. In Ohio, City National has approximately 18% of the deposit market share in Lawrence County where its bank branches are located (excluding the recently opened branch in Worthington, Ohio).
According to the most recent U.S. Census Bureau estimates (2017), in the West Virginia counties where City National's bank branches are located, the population was approximately 1.0 million and has decreased 0.2% since 2010. The population in the counties that City National serves in Kentucky increased 4.3% since 2010. The population in the counties City National serves in Virginia along the I-81 corridor have increased 5.4% since 2010, which is more comparable to the national average increase of approximately 5.5%, and in Lawrence County, Ohio, where City National has three bank branches located in Ohio, the population has decreased 3.5% since 2010.
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Competition
As noted previously, the Company’s principal markets are located in West Virginia and contiguous markets in the surrounding states of Kentucky, Virginia and Ohio. The majority of the Company’s bank branches are located in the areas of Charleston (WV), Huntington (WV), Beckley (WV), Lewisburg (WV), Martinsburg (WV), Lexington (KY), and along the I-81 corridor in Virginia where there is a significant presence of other financial service providers. Within its markets, the Company competes with national, regional, and local community banks for deposits, credit and trust and investment management customers. In addition to traditional banking organizations, the Company competes with credit unions, finance companies, financial technology companies, mutual funds, insurance companies, and other financial service providers, many of which are able to provide specialty financial products and services to targeted customer groups. As further discussed below, changes in laws and regulations enacted in recent years have increased the competitive environment the Company and its subsidiaries face to retain and attract customers.
Regulation and Supervision
Overview: The Company, as a registered financial holding company, and City National, as an insured depository institution, operate in a highly regulated environment and are regularly examined by federal regulators. The following description briefly discusses certain provisions of federal and state laws and regulations to which the Company and City National are subject and the potential impact of such provisions. These federal and state laws and regulations are designed to reduce potential loss exposure to the depositors of depository institutions and to the Federal Deposit Insurance Corporation’s insurance fund; they are not intended to protect the Company’s shareholders. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in state legislatures, and before the various bank regulatory agencies. The likelihood and timing of any changes and the impact such changes might have on the Company are impossible to determine with any certainty. A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations and earnings of the Company. To the extent that the following information describes statutory or regulatory provisions, it is qualified entirely by reference to the particular statute and/or regulation.
As a financial holding company, the Company is regulated under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve Board. The BHCA provides generally for “umbrella” regulation of bank holding companies such as the Company by the Federal Reserve Board, and for functional regulation of banking activities by bank regulators, securities activities by securities regulators, and insurance activities by insurance regulators. The Company is also under the jurisdiction of the Securities and Exchange Commission ("SEC") and is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. The Company is listed on the Nasdaq Global Select Market ("NASDAQ") under the trading symbol “CHCO” and is subject to the rules of the NASDAQ for listed companies.
City National is organized as a national banking association under the National Bank Act of 1863, as amended (the "National Bank Act"). It is subject to regulation and examination by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”). The OCC's supervision and regulation of banks is primarily intended to protect the interests of depositors of the banks. The National Bank Act generally requires each national bank to maintain reserves against deposits, restricts the nature and amount of loans that the bank may make and the interest the bank may charge on such loans, and restricts investments and other activities of the bank.
Bank Holding Company Activities: In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks and certain other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. Under the BHCA, bank holding companies that qualify and elect to be financial holding companies may engage in any activity, or acquire and retain the equity of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the OCC) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as determined solely by the Federal Reserve Board). Activities that are financial in nature include, among other things, securities underwriting and dealing, insurance underwriting and making merchant banking investments.
The Company has elected and qualifies as a financial holding company. In order for the Company to maintain its financial holding company status, both the Company and City National must be categorized as "well-capitalized" and "well-managed" under applicable regulatory guidelines. If the Company or City National fails to meet these requirements, the Federal Reserve Board may impose corrective capital requirements or place limitations on the Company's ability to conduct the broader activities permissible for financial holding companies. The Federal Reserve Board also has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal
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Reserve Board has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
The BHCA, the Bank Merger Act, and other federal and state laws and regulations regulate mergers and acquisitions of commercial banks and bank holding companies. The prior approval of the Federal Reserve Board is typically required for City Holding Company to acquire more than 5% of the voting shares of a commercial bank or bank holding company. Mergers and acquisitions by the Company of national banks, state-chartered banks, federal and state savings associations, and certain other types of entities require prior approval from various regulators. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transaction, the capital position of the combined institution, and the applicant's previous adherence to various banking regulations, including the Community Reinvestment Act of 1977 and anti-money laundering requirements.
Federal Reserve Board policy and federal law require that bank holding companies must serve as a source of financial strength to their subsidiary banks. The Company is expected to commit resources to City National, even at times when the Company may not be inclined to do so. For example, if bank regulatory agencies determine that City National's capital levels are impaired, the Company may be required to restore City National's capital levels with a special assessment.
Banking Operations: The Bank Secrecy Act of 1970 ("BSA") and the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (“Patriot Act”) require financial institutions to develop programs to help prevent them from being used for money laundering, terrorist or other illegal activities. The rules under the BSA and the Patriot Act include the following: (a) require financial institutions to keep records and report on transactions or accounts at issue; (b) require financial institutions to obtain and retain information related to the beneficial ownership of any account opened or maintained by foreign persons; (c) require financial institutions to identify each customer who is permitted to use a payable-through or correspondent account and obtain certain information from each customer permitted to use the account; and (d) prohibit or impose conditions on the opening or maintaining of correspondent or payable-through accounts. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
The Company and its subsidiary bank and other subsidiaries are "affiliates" within the meaning of the Federal Reserve Act. The Federal Reserve Act imposes limitations on a bank with respect to extensions of credit to, investments in, and certain other transactions with, its parent bank holding company and the holding company’s other subsidiaries. Loans and extensions of credit from the bank to its affiliates are also subject to various collateral requirements. Further, City National's authority to extend credit to the Company's directors, executive officers and principal shareholders, including their immediate family members, corporations and other entities that they control, is subject to the restrictions and additional requirements of the Federal Reserve Act and Regulation O promulgated thereafter. These statutes and regulations impose specific limits on the amount of loans City National may make to directors and other insiders, and specify approval procedures that must be followed in making loans that exceed certain amounts.
The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. In order for a financial holding company to commence any new activity permitted by the BHCA, or to acquire any company engaged in any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. Banking regulators also take into account CRA ratings when considering approval of a proposed merger or acquisition transaction. Depository institutions are typically examined for CRA compliance every three years, although the frequency is at the OCC's discretion. City National received a "satisfactory" rating on its most recent CRA examination in 2018.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in July 2010 and implemented far-reaching changes across the financial regulatory landscape, including provisions that impact the Company's operations and regulation of the Company in the following ways, among others:
• | Centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which has rule making authority for a wide range of consumer protection laws that apply to all banks and has broad powers to supervise and enforce consumer protection laws; |
• | Require the OCC to seek to make its capital requirements for national banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction; |
• | Require financial holding companies, such as the Company, to be well-capitalized and well-managed; |
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• | Provide for an increase in the minimum reserve ratio for the FDIC deposit insurance fund from 1.15% to 1.35% and changes in the basis for determining FDIC premiums from deposits to assets; |
• | Repeal the federal prohibitions on the payment of interest on demand deposits; |
• | Amend the Electronic Fund Transfer Act ("EFTA"); |
• | Enhance the requirements for certain transactions with affiliates under the Federal Reserve Act; |
• | Strengthen the existing limits on a depository institution’s credit exposure to one borrower; |
• | Strengthen loan restrictions to insiders; and |
• | Increase the authority of the Federal Reserve Board to examine the Company and its non-bank subsidiaries. |
The Volcker Rule was adopted under the Dodd-Frank Act and prohibit certain entities, including the Company and its affiliates, from owning, sponsoring, or having certain relationships with hedge funds and private equity funds and engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments.
Since the enactment of the Dodd-Frank Act, the Consumer Financial Protection Bureau (the "CFPB") has issued several regulations governing mainly consumer mortgage lending. These regulations include the ability to repay and qualified mortgage rule, which imposes additional requirements on banks designed to ensure borrowers' ability to repay their mortgage loans, a rule on escrow accounts for higher priced mortgage loans, a rule expanding the scope of the high-cost mortgage provision in the Truth in Lending Act, rules related to mortgage servicing, and an interagency rule on appraisals for higher-priced mortgage loans. The CFPB has also promulgated rules under the Equal Credit Opportunity Act, the Truth in Lending Act, and the Real Estate Settlement Procedures Act, all of which impact the Company's loan origination and servicing operations. The CFPB also has broad authority to supervise unfair, deceptive or abusive acts or practices related to banking.
The Company is also subject to the Gramm-Leach Bliley Act of 1999, which governs the distribution and protection of information about its customers, the Equal Credit Opportunity Act, which ensures fair and nondiscriminatory lending practicies, the Truth in Lending Act and Truth in Savings Act, which makes it easier for customers to compare products and services offered by financial institutions, the Home Mortgage Disclosure Act, which imposes additional disclosure requirements on the Company related to information about its mortgage lending, and other federal and state laws and regulations.
The Economic Growth, Regulatory Relief, and Consumer Protection Act (the "Regulatory Relief Act") was signed into law on May 24, 2018. The Regulatory Relief Act scales back certain aspects of the Dodd-Frank Act and provides other regulatory relief for financial institutions. Certain provisions affecting the Company include:
• | Simplifying regulatory capital requirements by providing that banks with less than $10 billion in total consolidated assets that meet a to-be-developed community bank leverage ratio of tangible equity to average consolidated assets between eight and ten percent will be deemed to be in compliance with risk-based capital and leverage requirements. |
• | Reducing reporting requirements on call reports for the first and third quarters of a reporting year for banks with less than $5 billion in total consolidated assets; |
• | Changing how federal financial institution regulators classify certain municipal securities assets under the liquidity coverage ratio rule; |
• | Exempting certain reciprocal deposits from treatment as brokered deposits under the FDIC's brokered deposits rule; |
• | Exempting banks with less than $10 billion in total consolidated assets from certain provisions under the Volcker Rule; and |
• | Authorizing new banking procedures to better facilitate online transactions. |
The Company is still assessing the impact that the Regulatory Relief Act will have on its financial condition and results of operations. In addition, regulatory agencies still need to issue several final rules and regulations required under the Regulatory Relief Act. The Company cannot be certain of the substance of the final rules and regulations or how they will impact the Company’s financial condition and results of operations.
Capital Adequacy: Federal banking regulations set forth capital adequacy guidelines, which are used by regulatory authorities to assess the adequacy of capital in examining and supervising a bank holding company and its insured depository institutions.
In July 2013, the Federal Reserve published the final rules that established a new comprehensive capital framework for banking organizations, commonly referred to as Basel III. These final rules substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions. The final rule became effective January 1, 2015 for smaller, non-complex banking organizations with full implementation by January 1, 2019.
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On January 1, 2019, the Basel III Capital Rules will require City Holding and City National to maintain minimum CET 1, Tier 1 and Total Capital ratios, along with a capital conservation buffer that will become fully phased in on that date, effectively resulting in new minimum capital ratios (which are shown in the table below). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to City Holding Company or City National Bank.
The Company’s regulatory capital ratios for both City Holding and City National are illustrated in the following tables (dollars in thousands):
December 31, 2018 | Actual | Minimum Required - Basel III Phase-In Schedule | Minimum Required - Basel III Fully Phased-In (*) | Required to be Considered Well Capitalized | |||||||||||||||||||||||
Capital Amount | Ratio | Capital Amount | Ratio | Capital Amount | Ratio | Capital Amount | Ratio | ||||||||||||||||||||
CET 1 Capital | |||||||||||||||||||||||||||
City Holding Company | $ | 492,526 | 15.1 | % | $ | 208,294 | 6.375 | % | $ | 228,715 | 7.0 | % | $ | 212,378 | 6.5 | % | |||||||||||
City National Bank | 423,099 | 13.1 | % | 206,676 | 6.375 | % | 226,938 | 7.0 | % | 210,728 | 6.5 | % | |||||||||||||||
Tier 1 Capital | |||||||||||||||||||||||||||
City Holding Company | 496,526 | 15.2 | % | 257,304 | 7.875 | % | 277,725 | 8.5 | % | 261,389 | 8.0 | % | |||||||||||||||
City National Bank | 423,099 | 13.1 | % | 255,306 | 7.875 | % | 275,568 | 8.5 | % | 259,358 | 8.0 | % | |||||||||||||||
Total Capital | |||||||||||||||||||||||||||
City Holding Company | 512,801 | 15.7 | % | 322,651 | 9.875 | % | 343,072 | 10.5 | % | 326,736 | 10.0 | % | |||||||||||||||
City National Bank | 439,374 | 13.6 | % | 320,145 | 9.875 | % | 340,408 | 10.5 | % | 324,198 | 10.0 | % | |||||||||||||||
Tier 1 Leverage Ratio | |||||||||||||||||||||||||||
City Holding Company | 496,526 | 11.4 | % | 174,833 | 4.000 | % | 174,833 | 4.0 | % | 218,542 | 5.0 | % | |||||||||||||||
City National Bank | 423,099 | 9.8 | % | 172,594 | 4.000 | % | 172,594 | 4.0 | % | 215,742 | 5.0 | % | |||||||||||||||
(*) Represents the minimum required capital levels as of January 1, 2019 when Basel III Capital Rules have been fully phased in. | |||||||||||||||||||||||||||
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December 31, 2017 | Actual | Minimum Required - Basel III Phase-In Schedule | Minimum Required - Basel III Fully Phased-In (*) | Required to be Considered Well Capitalized | |||||||||||||||||||||||
Capital Amount | Ratio | Capital Amount | Ratio | Capital Amount | Ratio | Capital Amount | Ratio | ||||||||||||||||||||
CET 1 Capital | |||||||||||||||||||||||||||
City Holding Company | $ | 430,154 | 15.1 | % | $ | 163,441 | 5.75 | % | $ | 198,972 | 7.0 | % | $ | 184,760 | 6.5 | % | |||||||||||
City National Bank | 338,105 | 12.0 | % | 162,164 | 5.75 | % | 197,418 | 7.0 | % | 183,316 | 6.5 | % | |||||||||||||||
Tier 1 Capital | |||||||||||||||||||||||||||
City Holding Company | 446,154 | 15.7 | % | 206,078 | 7.25 | % | 241,609 | 8.5 | % | 227,397 | 8.0 | % | |||||||||||||||
City National Bank | 338,105 | 12.0 | % | 204,468 | 7.25 | % | 239,721 | 8.5 | % | 225,620 | 8.0 | % | |||||||||||||||
Total Capital | |||||||||||||||||||||||||||
City Holding Company | 465,292 | 16.4 | % | 262,927 | 9.25 | % | 298,458 | 10.5 | % | 284,246 | 10.0 | % | |||||||||||||||
City National Bank | 357,243 | 12.7 | % | 260,873 | 9.25 | % | 296,126 | 10.5 | % | 282,025 | 10.0 | % | |||||||||||||||
Tier 1 Leverage Ratio | |||||||||||||||||||||||||||
City Holding Company | 446,154 | 11.0 | % | 161,834 | 4.00 | % | 161,834 | 4.0 | % | 202,293 | 5.0 | % | |||||||||||||||
City National Bank | 338,105 | 8.5 | % | 159,625 | 4.00 | % | 159,625 | 4.0 | % | 199,531 | 5.0 | % | |||||||||||||||
(*) Represents the minimum required capital levels as of January 1, 2019 when Basel III Capital Rules have been fully phased in. | |||||||||||||||||||||||||||
Management believes that, as of December 31, 2018, City Holding and City National would meet all capital adequacy requirements under Basel III on a fully phased-in basis as if such requirements had been in effect. As discussed above, the Regulatory Relief Act will likely result in changes to the minimum required capital ratios applicable to the Company once final rules are implemented.
Additionally, federal banking laws require regulatory authorities to take “prompt corrective action” with respect to depository institutions that do not satisfy minimum capital requirements. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as such terms are defined under federal banking agency regulations. Depository institutions that do not meet minimum capital requirements will face constraints on payment of dividends, equity repurchases and compensation based on the amount of shortfall. A depository institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market, may be subject to asset growth limitations, and may be required to submit capital restoration plans.
Incentive Compensation: The Company is subject to regulatory rules and guidance regarding employee incentive compensation policies intended to ensure that incentive-based compensation does not undermine the safety and soundness of the institution by encouraging excess risk-taking. The Company's incentive compensation arrangements must provide employees with incentives that appropriately balance risk and reward and do not encourage imprudent risk, be compatible with effective controls and risk managements, and be supported by strong corporate governance, including active and effective oversight by the Company's board of directors.
Dividends and Other Payments: The Company is a legal entity separate and distinct from City National. Dividends from City National are essentially the sole source of cash for the Company. The right of the Company, and the shareholders of the Company, to participate in any distribution of the assets or earnings of City National, through the payment of dividends or otherwise, is subject to the prior claims of creditors of City National, except to the extent that claims of the Company in its capacity as a creditor may be recognized. Moreover, there are various legal limitations applicable to the payment of dividends by City National to the Company as well as the payment of dividends by the Company to its shareholders.
City National is subject to various statutory restrictions on its ability to pay dividends to the Company. Specifically, the approval of the OCC is required prior to the payment of dividends by City National in excess of its earnings retained in the current year plus retained net profits for the preceding two years. At December 31, 2018, City National could pay dividends up to $88.8 million without prior regulatory permission. No dividends were paid in 2018 that required regulatory approval. The payment of dividends by the Company and City National may also be limited by other factors, such as requirements to maintain adequate capital above regulatory guidelines. The OCC also has the authority to prohibit any bank under its jurisdiction from engaging in an unsafe or unsound practice in conducting its business. Depending upon the financial condition of City National,
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the payment of dividends could be deemed to constitute such an unsafe or unsound practice. The Federal Reserve Board and the OCC have indicated their view that it generally would be an unsafe and unsound practice to pay dividends except out of current operating earnings. The Federal Reserve Board has stated that, as a matter of prudent banking, a bank or bank holding company should not maintain its existing rate of cash dividends on common stock unless (1) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. Moreover, the Federal Reserve Board has indicated that bank holding companies should serve as a source of managerial and financial strength to their subsidiary banks. Accordingly, the Federal Reserve Board has stated that a bank holding company should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of its bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the bank holding company’s ability to serve as a source of financial strength.
Under federal law, City National may not, subject to certain limited exceptions, make loans or extensions of credit to, or invest in the securities of, or take securities of the Company as collateral for loans to any borrower. City National is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.
Governmental Policies
The Federal Reserve Board regulates money and credit and interest rates in the United States in order to influence general economic conditions. These policies have a significant influence on overall economic growth, demand and distribution of bank loans, investments and deposits, interest rates charged on loans or paid for time and savings deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of banks and bank holding companies in the past and are expected to continue to do so in the future.
In view of changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve Board, it is difficult to predict the impact of possible future changes in interest rates, deposit levels, and loan demand, or their effect on the Company's business and earnings or on the financial condition of the Company's various customers.
Deposit Insurance
Substantially all of the deposits of City National are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. Deposit insurance assessments are based on average total assets minus average tangible equity. In October 2010, the FDIC adopted a new DIF restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. In March 2016, the FDIC adopted a final rule permanently increasing the reserve ratio for the DIF to 1.35% of total insured deposits.
The Company's FDIC insurance expense for the past three years is shown in the table below (in thousands). The FDIC insurance expense includes deposit assessments and Financing Corporation ("FICO") assessments related to outstanding FICO bonds.
For the year ended December 31, | |||||||||
2018 | 2017 | 2016 | |||||||
FDIC insurance expense | $ | 1,251 | $ | 1,348 | $ | 1,622 | |||
On January 24, 2019, the Company was notified by the FDIC that it was eligible for small bank assessment credits. On September 30, 2018, the DIF reserve ratio reached 1.36%. Because the reserve ratio exceeded 1.35%, two deposit assessment changes occurred under the FDIC regulations: (i) surcharges on large banks (total consolidated assets of $10 billion or more) ended and (ii) small banks (total consolidated assets of less than $10 billion) were awarded assessment credits for the portion of their assessments that contributed to the growth in the reserve ratio from 1.15% to 1.35%, to be applied when the reserve ratio is at least 1.38%. The credit will be applied automatically each quarter that the reserve ratio is at least 1.38%, up to the full amount of the bank's credit or assessment, whichever is less.
Under the Federal Deposit Insurance Act, as amended (“FDIA") the FDIC may terminate deposit insurance upon finding that an institution has engaged in unsafe or unsound practices, is in unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
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Cybersecurity
Federal regulators issued two statements regarding cybersecurity: (i) a statement indicating that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institutions and (ii) a statement indicating the expectation of a financial institution's management to maintain a sufficient business continuity planning process to ensure rapid recovery, resumption and maintenance of the financial institution's operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to: (a) enable recovery of data and business operations, (b) address rebuilding network capabilities, and (c) restore data if the financial institution or any of its critical service providers fall victim to this type of cyber-attack. If the Company does not comply with this regulatory guidance, it could be subject to various regulatory sanctions, as well as financial penalties.
In October 2016, the federal banking agencies issued an advance notice of proposed rulemaking on enhanced cybersecurity risk management and resilience standards that would apply to large and interconnected banking organizations and to services provided by third parties to these firms. These enhanced standards would apply only to banks and bank holding companies with total consolidated assets of $50 billion or more; however, it is unclear as to whether any such standards would be applied, and in what form, in the future to smaller banks and bank holding companies.
Future Legislation
Various other legislative and regulatory initiatives, including proposals to overhaul the banking regulatory system and to limit the investments that a depository institution may make with insured funds, are from time to time introduced in Congress and state legislatures, as well as regulatory agencies. Such legislation may change banking statutes and the operating environment of the Company and its subsidiaries in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance in the financial services industry generally. The Company cannot determine the ultimate effect that such potential legislation, if enacted, would have upon its financial condition or operations.
Executive Officers of the Registrant
At December 31, 2018, the executive officers of the Company were as follows:
Name | Age | Positions Held with Registrant |
Charles R. Hageboeck, Ph.D. | 56 | President and Chief Executive Officer, City Holding Company and City National Bank, since February 1, 2005. |
Craig G. Stilwell | 63 | Executive Vice President of Retail Banking, City Holding Company and City National Bank, since February 2005. |
John A. DeRito | 68 | Executive Vice President of Commercial Banking, City Holding Company and City National Bank, since June 2004. |
David L. Bumgarner | 53 | Senior Vice President and Chief Financial Officer, City Holding Company and City National Bank, since February 2005. |
Jeffrey D. Legge | 54 | Senior Vice President, Chief Administration Officer and Chief Information Officer, City Holding Company and City National Bank, since December 2005. |
Employees
The Company had 891 full-time equivalent employees at December 31, 2018.
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Available Information
The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy any document the Company files at the SEC Public Reference Room at 100 F Street, N. E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The Company's SEC filings are also available to the public at the SEC's website at www.sec.gov.
The Company’s Internet website address is www.bankatcity.com. The Company makes available free of charge through its website its annual report, quarterly reports, current reports and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the Securities and Exchange Commission. The information on the Company’s website is not, and shall not be deemed to be, a part of this report or incorporated into any other filing with the Securities and Exchange Commission. Copies of the Company’s annual report will be made available, free of charge, upon written request.
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Item 1A.Risk Factors
An investment in the Company’s common stock is subject to risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. You should carefully consider the risks described below, as well as the other information included or incorporated by reference in this Annual Report on Form 10-K, before making an investment in the Company’s common stock. If any of the following risks occur, the Company’s financial condition and results of operations could be materially and adversely affected, and you could lose all or part of your investment. In this section, the term "Company" includes City National unless the circumstances dictate otherwise.
Economic Conditions in the Company's Market Areas Could Negatively Impact the Company's Business and Financial Condition
The Company’s business is concentrated in West Virginia, Kentucky, Virginia and southeastern Ohio. As a result, the Company’s results of operation, cash flows and financial condition are affected by local and regional economic conditions. A downturn in the economies within the Company’s market areas, or in any one of them, could negatively impact the Company’s results of operation and financial condition. Some examples of economic deterioration include declines in economic growth, declines in consumer and business confidence, increases in inflation, increases in the cost of capital and credit, and limitations in the availability of credit. The Company’s financial performance generally, and the ability of its customers to pay interest on and repay principal of outstanding loans to City National, is highly dependent on the strength of the economic and business environment in the market areas where the Company operates and in the United States as a whole. Additionally, the value of collateral securing loans made and held by City National is impacted by the strength of the economy. Deteriorating economic conditions in the Company’s market areas could cause declines in the overall quality of the loan portfolio requiring charge-off of a greater percentage of loans and/or an increase in the allowance for loan losses, which could negatively impact the Company’s results of operations and financial condition.
While the economic and business environments in West Virginia, Kentucky, Virginia and southeastern Ohio have shown improvement since the recession of 2007 to 2009, there can be no assurance that such improvement will continue or that the economies in the Company’s market areas, or the United States as a whole, will not slip into another recession. A lack of continued economic improvement or economic recession could adversely affect the Company’s results of operation and financial condition. An economic slowdown could have the following consequences:
• | Loan delinquencies may increase; |
• | Problem assets and foreclosures may increase; |
• | Demand for City National's products and services may decline; and |
• | Collateral (including real estate) that secures loans made by City National may decline in value, in turn reducing customers’ borrowing power and making existing loans less secure. |
The oil, natural gas and coal industries, and businesses ancillary thereto, play an important role in the economies of West Virginia, Kentucky, Virginia and southeastern Ohio. The volatility in oil and gas prices since 2014 has negatively impacted oil and gas and other businesses in the Company’s market areas. Additionally, the coal industry continues to be in decline as a result of increased environmental and safety regulatory burden, increased competition from alternative energy sources and a decline in demand for coal. The Company has limited exposure (less than $10 million at December 31, 2018) to coal industry specific loans. Prolonged low oil and gas prices, and continued decline in the coal industry, could result in downward pressure on businesses in the Company’s market area which could negatively affect City National’s customers (both individuals and businesses). As a result, the Company’s operating results and financial condition could be negatively impacted.
The Value of Real Estate Collateral May Fluctuate Significantly Resulting in an Under-Collateralized Loan Portfolio
The market value of real estate, particularly real estate held for investment, can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. If the value of the real estate serving as collateral for the Company's loan portfolio were to decline materially, a significant part of the Company's loan portfolio could become under-collateralized. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then, in the event of foreclosure, we may not be able to realize the amount of collateral that we anticipated at the time of originating the loan. This could have a material adverse effect on the Company's provision for loan losses and the Company's operating results and financial condition.
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The Value of the Company’s Common Stock Fluctuates
The market for the Company’s common stock may experience significant price and volume fluctuations in response to a number of factors including actual or anticipated quarterly variations in operating results, changes in expectations of future financial performance, changes in estimates by securities analysts, governmental regulatory action, banking industry reform measures, customer relationship developments and other factors, many of which will be beyond the Company’s control.
Furthermore, the stock market in general, and the market for financial institutions in particular, have experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of the Company’s common stock, regardless of actual operating performance.
The Trading Volume in the Company’s Common Stock Is Less Than That of Other Larger Financial Services Companies
Although the Company’s common stock is listed for trading on the Nasdaq Global Select Market, the trading volume in its common stock is less than that of other financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Company’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Company has no control. Given the lower trading volume of the Company’s common stock, significant sales of the Company’s common stock, or the expectation of these sales, could cause the Company’s stock price to fall.
Future Sales of Shares of the Company’s Common Stock Could Negatively Affect its Market Price
Future sales of substantial amounts of the Company’s common stock, or the perception that such sales could occur, could adversely affect the market price of the Company’s common stock in the open market. We make no prediction as to the effect, if any, that future sales of shares, or the availability of shares for future sale, will have on the market price of the Company’s common stock.
Shares of the Company’s Common Stock Are Not FDIC Insured
Neither the FDIC nor any other governmental agency insures the shares of the Company’s common stock. Therefore, the value of your common stock of the Company will be based on their market value and may decline.
The Company’s Ability to Pay Dividends Is Limited
Although the Board of Directors has declared cash dividends in the past, the Company's current ability to pay dividends is largely dependent upon the receipt of dividends from City National. Federal laws impose restrictions on the ability of City National to pay dividends. Holders of shares of the Company’s common stock are entitled to dividends if, and when, they are declared by the Company’s Board of Directors out of funds legally available for that purpose. Additional restrictions are placed upon the Company by the policies of federal regulators, including the Federal Reserve Board’s November 14, 1985 policy statement, which provides that bank holding companies should pay dividends only out of the past year’s net income, and then only if their prospective rate of earnings retention appears consistent with their capital needs, asset quality, and overall financial condition. In general, future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including the Company’s and City National’s future earnings, capital requirements, regulatory constraints and financial condition. There can be no assurance that the Company will continue to pay dividends to its shareholders in the future.
The Company and City National Are Extensively Regulated
The Company operates in a highly regulated environment and is subject to supervision and regulation by a number of governmental regulatory agencies, including the Federal Reserve Board, the OCC and the FDIC. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters including but not limited to (i) ownership and control of the Company's equity, (ii) acquisition of other companies and businesses, (iii) permissible activities, (iv) maintenance of adequate capital levels and (v) other operational aspects. Compliance with banking regulations is costly and restricts certain of our activities, including the payment of dividends, mergers and acquisitions, investments, loan amounts and concentrations, interest rates, opening and closing branch locations, and other activities. The bank regulatory agencies also possess broad authority to prevent or remedy unsafe or unsound practices or violations of law. These agencies have significant discretion in their ability to enforce penalties and further limit the Company's activities if the Company fails to comply with applicable regulations.
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The Dodd-Frank Act instituted major changes to the bank and financial institutions regulatory regimes, and additional changes continue to be proposed and implemented by various regulatory agencies. Other changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to reduced revenues, additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. The burden and expenses associated with regulatory compliance have been increasing and may continue to increase. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company's business, financial condition and results of operations.
Proposals to change the laws and regulations governing financial institutions are frequently raised in Congress and before bank regulatory authorities. Changes in applicable laws or regulations could materially affect the Company’s business, and the likelihood of any major changes in the future and their effects are impossible to determine. Moreover, it is impossible to predict the ultimate form any proposed legislation might take or how it might affect the Company.
The Company Is Subject to Lending Risk
There are inherent risks associated with the Company’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Company operates. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Company is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Company to regulatory enforcement action that could result in restrictions of the Company's activities or the assessment of significant civil money penalties against the Company.
A substantial portion of the Company's loan portfolio is comprised of residential and commercial real estate loans. The Company's concentration of real estate loans may subject the Company to additional risk, such as market fluctuations in market value of collateral, environmental liability associated with hazardous or toxic substances found on, in or around the collateral, and difficulty monitoring income-producing property serving as a source of repayment and collateral. Any of these or other risks relating to real estate loans could adversely affect the collection by the Company of the outstanding loan balances.
The Company Is Subject to Interest Rate Risk
Changes in monetary policy, including changes in interest rates, could influence not only the interest income the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company’s ability to originate loans and obtain deposits, (ii) the fair value of the Company’s financial assets and liabilities, and (iii) the average duration of the Company’s mortgage-backed securities portfolio. The Company’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore it's earnings and net profit, could be adversely affected. Earnings also could be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies, including the use of derivatives as hedging instruments, to reduce the potential effects of changes in interest rates on the Company’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations. See the section in Item 7A. Quantitative and Qualitative Disclosures About Market Risk located elsewhere in this report for further discussion related to the Company’s management of interest rate risk.
The Company May be Adversely Affected by the Soundness of Third Parties, Including Other Financial Institutions
The Company's business is highly dependent on third party vendors, especially with respect to information technology and telecommunication systems, payment processing system, and mobile and online banking systems. Our operations rely heavily on the secure processing, storage, transmission, and monitoring of information and transactions, and many of these services are outsourced to third party vendors. The failure of these systems or the inability of a third party vendor to continue providing these services on a reliable basis could adversely affect our operations. In addition, the failure of third parties to
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comply with applicable laws and regulations, or fraud or misconduct on the part of any of these third parties, could disrupt our operations and adversely affect our reputation. It may be difficult for us to replace some of our critical third party vendors, particularly vendors providing our core banking, debit card services and information services, in a timely manner and on terms that are favorable or acceptable to us. Any of these events could increase our expenses and have a material adverse effect on our business, financial condition, and results of operations.
Financial services institutions are interrelated with one another as a result of trading, clearing, counterparty, and other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Company. Any such losses could have a material adverse effect on the Company’s business, financial condition and results of operations. Further, as a result of financial entities and technology systems becoming more interdependent and complex, a cybersecurity incident, information breach or loss, or technology failure that comprises the systems or data of one financial entity could have a material impact on counterparties or other market participants, including the Company.
The Company Depends on the Accuracy and Completeness of Information About Our Customers and Counterparties
The Company relies on information provided to us by or on behalf of customers and other third parties, including financial statements, credit reports, and other financial information, in deciding whether to extend credit or enter into other transactions and in evaluating and monitoring our loan portfolio. The Company also relies on representations from our customers, counterparties, and other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate, incomplete, fraudulent or misleading financial or business information could result in loan losses, reputational damage, or other effects that could have a material adverse effect on our financial condition and results of operation.
The Company’s Allowance for Loan Losses May Not be Sufficient
The Company maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense that represents management’s best estimate of probable losses in the existing loan portfolio. The allowance, in the judgment of management, is necessary to provide for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Company to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the Company’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, the Company will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on the Company’s financial condition and results of operations.
Management evaluates the adequacy of the allowance for loan losses at least quarterly, which includes testing certain individual loans as well as collective pools of loans for impairment. This evaluation includes an assessment of actual loss experience within each category of the portfolio; individual commercial and commercial real estate loans that exhibit credit weakness; current economic events, including employment statistics, trends in bankruptcy filings, and other pertinent factors; industry or geographic concentrations; and regulatory guidance. See the section captioned “Allowance and Provision for Loan Losses” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for loan losses.
Customers May Default on the Repayment of Loans
City National’s customers may default on the repayment of loans, which may negatively impact the Company’s earnings due to loss of principal and interest income. Increased operating expenses may result from management's allocation of time and resources to the collection and work-out of the loan. Collection efforts may or may not be successful causing the Company to write off the loan or repossess the collateral securing the loan, which may or may not exceed the balance of the loan.
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Due to Increased Competition, the Company May Not be Able To Attract and Retain Banking Customers
The Company faces substantial and intense competition in all areas of its operation, including interest rates and other terms for loans and deposits and the range and quality of services provided. Competition comes from a variety of different competitors, many of which have competitive advantages over the Company. The Company faces competition from:
• | local, regional and national banks; |
• | savings and loans associations; |
• | Internet banks; |
• | credit unions; |
• | mutual funds; |
• | mortgage banking firms; |
• | finance companies; |
• | financial technology ("fin-tech") companies; |
• | brokerage firms; |
• | investment advisory and wealth management firms; |
• | investment banking firms; and |
• | other entities. |
In particular, many of City National’s competitors are larger banks and financial institutions whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, the Company’s competitors may have products and services not offered by the Company, which may cause current and potential customers to choose those institutions over the Company. The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes and the continued consolidation within the banking industry. Consumer preferences and expectations continue to evolve, and technology and regulatory changes have lowered barriers to entry and made it possible for banks to expand their geographic reach by providing services over the internet and for non-banks to offer products and services typically provided by banks. Many of our non-bank competitors have fewer regulatory constraints and expenses associated with regulatory compliance and may have lower cost structures, such as credit unions that are not subject to federal income tax.
The Company’s ability to compete successfully depends on a number of factors, including our ability to develop, maintain, and build long-term customer relationships; our ability to expand our market area and range of services and products offered; our ability to keep up-to-date with technological advancements, both with respect to new and existing products and with respect to cybersecurity; customer satisfaction with our products and services; and general industry and economic trends. Failure to perform successfully in any of these areas could significantly weaken our competitive position. If the Company is unable to attract new and retain current customers, loan and deposit growth could decrease, causing the Company’s results of operations and financial condition to be negatively impacted.
The Company Faces Technology Change and the Emergence of Nonbank Alternatives to the Financial System
Consumers may decide not to use banks to complete their financial transactions or invest or deposit their funds. Technology and other changes, including the emergence of fin-tech companies are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can pay bills and transfer funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
The banking and financial services industry continually undergoes technological change, with frequent introductions of new technology-driven products and services. The Company’s future success depends on its ability to addresses the needs and preferences of its customers by using technology to provide products and services that enhance customer convenience and that create additional efficiencies in the Company’s operations. Many of the Company’s competitors have greater resources to invest in technological improvements, and the Company may not be able to implement new technology-driven products and services as quickly and effectively as its competitors. In addition, the necessary process of updating technology can itself lead to disruptions in the availability or function of systems. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on the Company’s business and results of operations.
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The Value of the Company's Investments Could Decline
The Company holds available-for-sale investment securities, which are carried at fair value. The determination of fair value for certain of these securities requires significant judgment of the Company’s management. Therefore, the market price the Company receives for its investment securities could be less than the carrying value for such securities. Further, the value of the Company’s investment portfolio could decline for numerous reasons, many of which are outside the Company’s control, including general market conditions, volatility in the securities market, and inflation rates or expectations of inflation. A portion of the Company’s investment portfolio consists of municipal securities. The value of these securities is subject to additional factors, including the financial condition of the government issuer and general demand for municipal securities.
The Company May Be Required to Write Down Goodwill and Other Intangible Assets, Causing Its Financial Condition and Results to Be Negatively Affected
When the Company acquires a business, a portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The excess of the purchase price over the fair value of the net identifiable tangible and intangible assets acquired determines the amount of the purchase price that is allocated to goodwill acquired. At December 31, 2018, the Company’s goodwill and other identifiable intangible assets were approximately $123 million. Under current accounting standards, if the Company determines goodwill or intangible assets are impaired, it would be required to write down the value of these assets. The Company conducts an annual review to determine whether goodwill and other identifiable intangible assets are impaired. The Company recently completed such an impairment analysis and concluded that no impairment charge was necessary for the year ended December 31, 2018. The Company cannot provide assurance whether it will be required to take an impairment charge in the future. Any impairment charge would have a negative effect on its shareholders’ equity and financial results and may cause a decline in the Company's stock price.
The Company May Be Required to Repurchase Mortgage Loans or Indemnify Mortgage Loan Purchasers
The Company sells some of the fixed rate residential mortgage loans it originates to mortgage loan purchasers in the secondary market. Purchasers of residential mortgage loans, such as government sponsored entities, often require sellers of residential mortgage loans to either repurchase loans previously sold or reimburse purchasers for losses related to loans previously sold under certain circumstances, such as failure to comply with the purchaser’s purchase criteria, breach of a representation or warranty related to the loan or its origination, or borrower fraud. There is no assurance that a purchaser of the Company’s residential mortgage loans will not demand repurchase or indemnification for losses, which could increase the Company’s expenses in defending such claims and negatively affect the Company’s financial condition and results of operation.
The Company May Require Additional Capital in the Future, But That Capital May Not Be Available or May Be Dilutive
The Company faces liquidity risk, which is the possibility that the Company may not be able to meet its obligations as they come due, both to creditors and customers, or capitalize on growth opportunities because of a lack of liquidity. Lack of liquidity can be caused by an inability to liquidate assets or obtain adequate financing on a timely basis, at a reasonable cost and on other reasonable terms, and within acceptable risk tolerances. The Company is also required by its regulators to maintain specified levels of capital to maintain its operations. The Company’s business needs and future growth, including future acquisitions or organic growth into new markets and business lines, may require it to raise additional capital.
One of the Company’s main sources for liquidity is customer deposits. Increased competition and the availability of alternative products may reduce the Company’s ability to attract and retain core deposits. If customers move money out of bank deposits into other investments, we could lose a relatively low cost source of funds. A reduction in the Company’s credit rating may also increase its funding costs.
The Company’s ability to raise additional capital, whether in the form of debt or equity, is dependent on several factors, including the condition of capital markets, investment demand, and the Company’s financial performance. We cannot assure that we will be able to raise additional capital in the future on terms that are favorable or acceptable to us, or at all.
The issuance of debt may increase our capital costs and reduce our liquidity. The issuance of equity securities, including common stock or one or more series of preferred stock, of the Company may reduce the value of our common stock and have a dilutive effect on holders of our common stock. The Company may issue debt or equity securities that are senior in priority to our common stock as to distributions and liquidation, which could negatively affect the value of our common stock.
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Acquisition and Other Growth Opportunities May Present Challenges
Any future acquisitions may result in unforeseen difficulties, which could require significant time and attention from the Company’s management that would otherwise be directed at developing its existing business, and expenses. In addition, the Company could discover undisclosed liabilities resulting from any acquisitions for which it may become responsible. Further, the benefits that the Company anticipates from these acquisitions may not develop. We may experience difficulty integrating businesses acquired through mergers and acquisitions and may fail to realize the expected revenue increases, cost savings, increases in market presence, and other projected benefits from acquisition activity. Acquisitions utilizing the Company’s common stock as consideration may dilute the value of the Company’s common stock, which dilution may not be recouped or recovered for a significant amount of time after the acquisition, if ever.
Any merger or acquisition opportunity that we decide to pursue will ultimately be subject to regulatory approval and other closing conditions. We may expend significant time and resources pursing potential acquisitions that are never consummated due to lack of regulatory approval or other issues. Competition for acquisition candidates in the banking industry is intense. We may expend significant time and resources evaluating acquisition candidates and conducting due diligence that does not lead to an acquisition opportunity.
The Company may implement new lines of business, enter new market areas, or offer new products and services from time to time. There can be substantial risks and uncertainties associated with these efforts, especially where markets are not fully developed. The Company may invest significant time and resources in developing and marketing new lines of business, but the benefits that the Company anticipates from these activities may not develop as expected. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences may impact the Company’s ability to successfully implement organic growth strategies. Failure to successfully manage these risks could have a material adverse effect on the Company’s financial condition and results of operations.
System Failure, Cybersecurity Breaches, Fraud and Employee Misconduct Could Subject the Company to Increased Operating Costs, as Well as Litigation and Other Potential Losses
The computer systems and network infrastructure that the Company uses could be vulnerable to unforeseen hardware and cybersecurity issues, including “hacking” and “identity theft.” The Company’s operations are dependent upon its ability to protect its computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in the Company’s operations could have an adverse effect on its financial condition and results of operations. In addition, the Company’s operations are dependent upon its ability to protect the computer systems and network infrastructure utilized by the Company, including our mobile and Internet banking activities, against damage from physical break-ins, cybersecurity breaches, acts of vandalism, computer viruses, theft of information, misplaced or lost data, programming and/or human errors, and other disruptive problems. The Company is further exposed to the risk that its third-party service provides may be unable to fulfill their contractual obligations with respect to managing the Company’s information and systems. Any cybersecurity breach or other disruptions, whether by the Company or our third-party vendors, would jeopardize the security of information stored in and transmitted through the Company’s computer systems and network infrastructure, which may result in significant liability to the Company, damage its reputation and inhibit current and potential customers from its using Internet banking services.
Despite efforts to ensure the integrity of our systems, we will not be able to anticipate all security breaches of these types, nor will we be able to implement guaranteed preventive measures against such security breaches. Persistent attackers may succeed in penetrating defenses given enough resources, time and motive. The techniques used by cyber criminals change frequently, may not be recognized until launched, and can originate from a wide variety of sources, including outside groups such as external service providers, organized crime affiliates, terrorist organizations or hostile foreign governments. These risks may increase in the future as we continue to increase our mobile payment and other Internet-based product offerings and expand our internal usage of web-based products and applications.
A successful attack to our system security or the system security of one of our critical third-party vendors could cause us serious negative consequences, including significant disruption of operations, misappropriation of confidential information, and damage to our computers or systems or those of our customers and counterparties. A successful security breach could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on the Company.
Criminals are committing fraud at an increasing rate and are using more sophisticated techniques. The Company faces risk of fraudulent activity in many forms, including online payment transfer fraud, debit card fraud, check fraud, mechanical devices attached to ATM machines, phishing attacks to obtain personal information, and impersonation of clients through the
19
use of falsified or stolen credentials. The Company may suffer losses as a result of fraudulent activity committed against it, its customers, and other counterparties.
The Company could be adversely affected if one of its employees causes a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates the Company’s operations or systems. Misconduct by employees could include fraudulent, improper or unauthorized activities on behalf of customers or improper use of confidential information. Employee errors or misconduct could subject the Company to regulatory enforcement action, legal action, reputational damage, and other losses.
The Company's Risk Management Practices May Prove to be Inadequate or Not Fully Effective
The Company's risk management framework seeks to mitigate risk and appropriately balance risk and return. The Company has established policies and procedures intended to identify, monitor and manage the types of risk which it is subject to, including credit risk, market risk, liquidity risk, operational risk and reputational risk. Although the Company has devoted significant resources to develop its risk management policies and procedures and expects to continue to do so in the future, these policies and procedures, as well as its risk management techniques, may not be fully effective. In addition, as regulations and markets in which the Company operates continue to evolve, its risk management framework may not always keep sufficient pace with those changes. If the Company's risk management framework does not effectively identify or mitigate its risks, the Company could suffer unexpected losses and could be materially adversely affected. Management of the Company's risks in some cases depends upon the use of analytical and/or forecasting models. If the models the Company uses to mitigate these risks are inadequate, it may incur increased losses. In addition, there may be risks that exist, or that develop in the future, that the Company has not appropriately anticipated, identified or mitigated.
The Company’s Controls and Procedures May Fail or Be Circumvented
Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition. Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, no matter how well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.
Significant Legal Actions Could Result in Substantial Liabilities
From time to time, the Company is subject to claims related to its operations. These claims and legal actions, including supervisory actions by its regulators, could involve large monetary claims and cause the Company to incur significant defense expenses. As a result, the Company may be exposed to substantial liabilities, which could negatively affect its shareholders’ equity and financial results.
The Company Faces Reputational Risk
The Company faces threats to its reputation from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver expected standards of service or quality, regulatory compliance deficiencies, and questionable or fraudulent activities of the Company’s employees and customers. Negative publicity may arise regarding the Company’s business, employees, or customers, with or without merit, and could result in the loss of customers, investors and employees, costly litigation, a decline in revenue, and increased regulatory oversight.
Changes in Tax Law and Accounting Standards Could Materially Affect the Company's Operations
Changes in tax laws, or changes in the interpretation of existing tax laws, could materially adversely affect the Company’s operations. Similarly, new accounting standards, changes to existing accounting standards, and changes to the methods of preparing financial statements could impact the Company’s reported financial condition and results of operations. These factors are outside the Company’s control and it is impossible to predict changes that may occur and the effect of such changes.
The Tax Cuts and Jobs Act went into effect on January 1, 2018 and significantly impacted the federal income taxation of the Company and its customers. While there are benefits to the Company from the new law, including a reduction of its federal income tax rate, there are also adverse consequences, including an elimination of certain deductible expenses. There is also substantial uncertainty regarding the consequences of the new law on the Company and its customer base.
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The Company Relies Heavily on Its Management Team, and the Unexpected Loss of Key Management May Adversely Affect Its Operations
The Company's success to date has been strongly influenced by its ability to attract and to retain senior management personnel experienced in banking in the markets it serves. Competition for key personnel is intense. The Company's ability to retain executive officers and the current management teams will continue to be important to the successful implementation of its strategies. The Company has employment agreements with these key employees in the event of a change of control, as well as confidentiality, non-solicitation and non-competition agreements related to its stock options. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on the Company's business and financial results.
Severe Weather, Natural Disasters, Acts of War or Terrorism, and Other External Events Could Significantly Impact the Company's Business
Severe weather, natural disasters, health emergencies, acts of war or terrorism, and other adverse external events, especially those that directly affect the Company’s market areas, could have a significant impact on the Company’s ability to conduct business. These events could adversely affect the ability of borrowers to repay outstanding loans, decrease the value of collateral securing loans, cause significant property and infrastructure damage, and affect the stability of the Company’s deposit base. The Company may experience decreased revenue, increased charge-offs, and other expenses.
Item 1B.Unresolved Staff Comments
None.
Item 2.Properties
City National owns the Company’s executive office, located at 25 Gatewater Road, Charleston, West Virginia. This facility has approximately 60,000 square feet and houses the Company's executive and administrative personnel.
City National owns eighty bank branch locations and leases twenty bank branch locations, pursuant to operating leases. All of the properties are suitable and adequate for their current operations. City National also operates two loan production offices leased in Charlotte, North Carolina and Cincinnati, Ohio.
The Company also owns parcels of real estate for potential future branch development.
Item 3.Legal Proceedings
The Company is engaged in various legal actions that it deems to be in the ordinary course of business. As these legal actions are resolved, the Company could realize positive and/or negative impact to its financial performance in the period in which these legal actions are ultimately decided. There can be no assurance that current actions will have immaterial results, either positive or negative, or that no material actions may be presented in the future.
Item 4.Mine Safety Disclosures
None.
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PART II
Item 5.Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Common Stock Market and Dividends
The Company’s common stock trades on the NASDAQ Global Select Market under the symbol "CHCO". This table sets forth the cash dividends declared per share and information regarding the closing market prices per share of the Company’s common stock for the periods indicated. The price ranges are based on transactions as reported on the NASDAQ Global Select Market. At March 7, 2019, there were 2,757 shareholders of record.
Cash Dividends Per Share | Market Value | ||||||||
Low | High | ||||||||
2018 | |||||||||
Fourth Quarter | $ | 0.53 | $ | 66.36 | $ | 77.94 | |||
Third Quarter | 0.53 | 75.54 | 82.79 | ||||||
Second Quarter | 0.46 | 67.95 | 78.44 | ||||||
First Quarter | 0.46 | 65.03 | 72.87 | ||||||
2017 | |||||||||
Fourth Quarter | $ | 0.46 | $ | 65.50 | $ | 73.98 | |||
Third Quarter | 0.44 | 59.94 | 71.91 | ||||||
Second Quarter | 0.44 | 61.34 | 72.78 | ||||||
First Quarter | 0.44 | 60.86 | 67.93 | ||||||
The Company generally pays dividends on a quarterly basis. As noted in the section captioned "Dividends and Other Payments" included in Item 1. Business, the section captioned "Liquidity" included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note Nineteen of Notes to Consolidated Financial Statements, the Company’s ability to pay dividends to its shareholders is dependent upon the ability of City National to pay dividends to the Company. At December 31, 2018, City National could pay $88.8 million in dividends without prior regulatory permission.
Stock Repurchase Plan
The following table sets forth information regarding the Company's common stock repurchases transacted during the fourth quarter of 2018:
Total | Maximum | ||||||||
Number of | Number of | ||||||||
Shares Purchased | Shares that May | ||||||||
as Part of Publicly | Yet Be Purchased | ||||||||
Total Number of | Average Price | Announced Plans | Under the Plans | ||||||
Period | Shares Purchased | Paid per Share | or Programs (a) | or Programs | |||||
October 1 to October 31, 2018 | 57,664 | $ | 72.51 | 57,664 | 123,257 | ||||
November 1 to November 30, 2018 | 11,500 | $ | 74.78 | 11,500 | 111,757 | ||||
December 1 to December 31, 2018 | — | — | — | 111,757 | |||||
(a) On September 24, 2014, the Company announced that the Board of Directors had authorized the Company to buy back up to 1,000,000 shares of its common stock, in open market transactions, at prices that are accretive to continuing shareholders. This plan was rescinded as part of the stock repurchase plan that was approved in February 2019.
(b) On February 27, 2019, the Company announced that the Board of Directors had authorized the Company to buy back up to 1,000,000 shares of its common stock (approximately 6% of the outstanding shares), in open market transactions, at prices that are accretive to continuing shareholders. No timetable was placed on the duration of this share repurchase program.
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At-The-Market Common Stock Offering
On December 19, 2016, the Company announced that it had filed a prospectus supplement to its existing shelf registration statement on Form S-3 for the sale of its common stock having an aggregate value of up to $55 million through an "at-the-market" equity offering program. Through the year ended December 31, 2018, the Company has sold approximately 548,000 common shares at a weighted average price of $64.82, net of broker fees. The Company has sold no shares since the first quarter of 2017. To date, the Company has received $36 million in gross proceeds. Under the program, the Company has the ability to receive an additional $19 million in gross proceeds from the sale of common shares.
Stock-Based Compensation Plan
Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2018, segregated between stock-based compensation plans approved by shareholders and stock-based compensation plans not approved by shareholders, is presented in the table below. Additional information regarding stock-based compensation plans is presented in Note Fifteen, Employee Benefit Plans, of Notes to Consolidated Financial Statements.
Plan Category | Number of Shares to be Issued Upon Exercise of Outstanding Awards (a) | Weighted-average exercise price of outstanding awards (b) | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) | ||||
Plans approved by shareholders | 57,972 | $ | 51.15 | 532,552 | |||
Plans not approved by shareholders | — | — | — | ||||
Total | 57,972 | $ | 51.15 | 532,552 | |||
Stock Performance
The following graph sets forth the cumulative total shareholder return (assuming reinvestment of dividends) to the Company’s shareholders during the five-year period ended December 31, 2018, as well as an overall stock market index (The Nasdaq Stock Market Index) and the Company’s Peer Group ("Peer Group"). The Peer Group consists of twenty-one banking institutions that (i) are over $2 billion but less than $8.5 billion in assets, (ii) have a return on average assets and a return on average equity performance ratios greater than 0%, (iii) derive at least fifteen percent of their total revenues from non-interest income, (iv) have a loan portfolio comprised of less than eighty-five percent commercial loans, (v) have more than thirty branches, and (vi) are headquartered in Illinois, Indiana, Kentucky, Maryland, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia and New York (excluding New York City), excluding: companies in top 5 metro areas (MSAs), thrifts and thinly traded companies. The trading symbols for such financial institutions include: AROW, BUSE, CTBI, FBK, FBNC, FCBC, FCF, FISI, FMBH, GABC, PEBO, PRK, RBCAA, SASR, SRCE, STBA, SYBT, THFF, TMP, UCFC and UVSP. The stock performance shown on the graph below is not necessarily indicative of future price performance.
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2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |
City Holding Company | $100.00 | $104.11 | $105.76 | $162.50 | $166.46 | $171.22 |
NASDAQ Composite | $100.00 | $114.75 | $122.74 | $133.62 | $173.22 | $168.30 |
Peer Group | $100.00 | $107.90 | $114.03 | $172.90 | $174.07 | $155.24 |
This graph shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, unless the Company specifically incorporates this report by reference. It will not be otherwise filed under such Acts.
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Item 6.Selected Financial Data
Table One
Five-Year Financial Summary
(in thousands, except per share data)
2018(1) | 2017 | 2016 | 2015(2) | 2014 | |||||||||||
Summary of Operations | |||||||||||||||
Total interest income | $ | 163,901 | $ | 142,930 | $ | 132,152 | $ | 127,074 | $ | 129,566 | |||||
Total interest expense | 25,692 | 16,805 | 13,207 | 11,830 | 11,960 | ||||||||||
Net interest income | 138,209 | 126,125 | 118,945 | 115,244 | 117,606 | ||||||||||
(Recovery of) provision for loan losses | (2,310 | ) | 3,006 | 4,395 | 6,988 | 4,054 | |||||||||
Total non-interest income | 60,564 | 63,607 | 58,825 | 67,206 | 58,722 | ||||||||||
Total non-interest expenses | 113,066 | 95,981 | 96,164 | 92,951 | 95,041 | ||||||||||
Income before income taxes | 88,017 | 90,745 | 77,211 | 82,511 | 77,233 | ||||||||||
Income tax expense | 18,015 | 36,435 | 25,083 | 28,414 | 24,271 | ||||||||||
Net income available to common shareholders | 70,002 | 54,310 | 52,128 | 54,097 | 52,962 | ||||||||||
Per Share Data | |||||||||||||||
Net income basic | $ | 4.50 | $ | 3.49 | $ | 3.46 | $ | 3.54 | $ | 3.40 | |||||
Net income diluted | 4.49 | 3.48 | 3.45 | 3.53 | 3.38 | ||||||||||
Cash dividends declared | 1.98 | 1.78 | 1.72 | 1.68 | 1.60 | ||||||||||
Book value per share | 36.29 | 32.17 | 29.25 | 27.62 | 25.79 | ||||||||||
Selected Average Balances | |||||||||||||||
Total loans | $ | 3,168,827 | $ | 3,082,448 | $ | 2,920,837 | $ | 2,691,304 | $ | 2,593,597 | |||||
Securities | 650,697 | 582,124 | 495,206 | 383,685 | 365,904 | ||||||||||
Interest-earning assets | 3,942,285 | 3,691,714 | 3,426,158 | 3,084,722 | 2,968,706 | ||||||||||
Deposits | 3,460,306 | 3,298,385 | 3,166,817 | 2,947,543 | 2,824,985 | ||||||||||
Long-term debt | 16,053 | 16,495 | 16,495 | 16,495 | 16,495 | ||||||||||
Total shareholders’ equity | 514,083 | 492,668 | 431,031 | 415,051 | 395,940 | ||||||||||
Total assets | 4,303,364 | 4,079,674 | 3,835,081 | 3,564,730 | 3,404,818 | ||||||||||
Selected Year-End Balances | |||||||||||||||
Net loans | $ | 3,571,642 | $ | 3,108,574 | $ | 3,026,496 | $ | 2,843,283 | $ | 2,631,916 | |||||
Securities | 812,891 | 628,985 | 539,604 | 471,318 | 354,686 | ||||||||||
Interest-earning assets | 4,468,474 | 3,784,453 | 3,611.706 | 3,345,136 | 3,016,477 | ||||||||||
Deposits | 3,975,559 | 3,315,634 | 3,231,653 | 3,083,975 | 2,872,787 | ||||||||||
Long-term debt | 4,053 | 16,495 | 16,495 | 16,495 | 16,495 | ||||||||||
Total shareholders’ equity | 600,764 | 502,507 | 442,438 | 419,272 | 390,853 | ||||||||||
Total assets | 4,899,012 | 4,132,281 | 3,984,403 | 3,714,059 | 3,461,633 | ||||||||||
Performance Ratios | |||||||||||||||
Return on average assets | 1.63 | % | 1.33 | % | 1.36 | % | 1.52 | % | 1.56 | % | |||||
Return on average equity | 13.6 | 11.0 | 12.1 | 13.0 | 13.4 | ||||||||||
Return on average tangible common equity | 16.2 | 13.1 | 14.8 | 15.8 | 16.5 | ||||||||||
Net interest margin | 3.52 | 3.46 | 3.50 | 3.76 | 3.98 | ||||||||||
Efficiency ratio | 50.0 | 51.5 | 54.8 | 53.7 | 53.7 | ||||||||||
Dividend payout ratio | 44.0 | 51.0 | 49.7 | 47.5 | 47.1 | ||||||||||
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Asset Quality | ||||||||||||||||
Net charge-offs to average loans | 0.02 | % | 0.13 | % | 0.13 | % | 0.29 | % | 0.18 | % | ||||||
(Recovery of) provision for loan losses to average loans | (0.07 | ) | 0.10 | 0.15 | 0.26 | 0.16 | ||||||||||
Allowance for loan losses to nonperforming loans | 107.82 | 178.39 | 140.10 | 110.37 | 127.62 | |||||||||||
Allowance for loan losses to total loans | 0.45 | 0.60 | 0.65 | 0.67 | 0.76 | |||||||||||
Consolidated Capital Ratios | ||||||||||||||||
CET 1 Capital | 15.1 | % | 15.1 | % | 13.3 | % | 13.7 | % | * | |||||||
Tier 1 Capital | 15.2 | 15.7 | 13.9 | 14.3 | 13.4 | |||||||||||
Total Capital | 15.7 | 16.4 | 14.7 | 15.1 | 14.2 | |||||||||||
Tier 1 Leverage | 11.4 | 11.0 | 10.2 | 10.2 | 9.9 | |||||||||||
Average equity to average assets | 12.0 | 12.1 | 11.2 | 11.6 | 11.6 | |||||||||||
Tangible equity to tangible assets (end of period) | 10.0 | 10.5 | 9.3 | 9.3 | 9.3 | |||||||||||
Full-time equivalent employees | 891 | 839 | 847 | 853 | 889 | |||||||||||
*Basel III CET 1 ratio requirements were effective beginning January 1, 2015 and were not required for prior periods. | ||||||||||||||||
(1) - In December 2018, the Company acquired Poage Bankshares, Inc. and its principal banking subsidiary, Town Square Bank (collectively, "Poage") and Farmers Deposit Bancorp, Inc. and its principal banking subsidiary, Farmers Deposit Bank (collectively, "Farmers Deposit"). | ||||||||||||||||
(2) - In January 2015, the Company sold its insurance operations, CityInsurance. In November 2015, the Company acquired three branches in Lexington, Kentucky from American Founder's Bank. | ||||||||||||||||
26
Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations
Statistical Information
The information noted below is provided pursuant to Guide 3 -- Statistical Disclosure by Bank Holding Companies.
Description of Information | Page Reference | |||
1. | Distribution of Assets, Liabilities and Stockholders' | |||
Equity; Interest Rates and Interest Differential | ||||
a. | Average Balance Sheets | |||
b. | Analysis of Net Interest Earnings | |||
c. | Rate Volume Analysis of Changes in Interest Income and Expense | |||
2. | Investment Portfolio | |||
a. | Book Value of Investments | |||
b. | Maturity Schedule of Investments | |||
c. | Securities of Issuers Exceeding 10% of Stockholders’ Equity | |||
3. | Loan Portfolio | |||
a. | Types of Loans | |||
b. | Maturities and Sensitivity to Changes in Interest Rates | |||
c. | Risk Elements | |||
d. | Other Interest Bearing Assets | None | ||
4. | Summary of Loan Loss Experience | |||
5. | Deposits | |||
a. | Breakdown of Deposits by Categories, Average Balance and Average Rate Paid | |||
b. | Maturity Schedule of Time Certificates of Deposit and Other Time Deposits of $100,000 or More | |||
6. | Return on Equity and Assets | |||
7. | Short-term Borrowings | |||
27
CITY HOLDING COMPANY
City Holding Company (the “Company”), a West Virginia corporation headquartered in Charleston, West Virginia, is a registered financial holding company under the Bank Holding Company Act and conducts its principal activities through its wholly owned subsidiary, City National Bank of West Virginia ("City National"). City National is a retail and consumer-oriented community bank with 100 bank branches in West Virginia (58), Kentucky (24), Virginia (14) and Ohio (4). City National provides credit, deposit, and trust and investment management services to its customers in a broad geographical area that includes many rural and small community markets in addition to larger cities including Charleston (WV), Huntington (WV), Martinsburg (WV), Ashland (KY), Lexington (KY), Winchester (VA) and Staunton (VA). In the Company's key markets, the Company's primary subsidiary, City National, generally ranks in the top three relative to deposit market share and the top two relative to branch share (Charleston/Huntington MSA, Beckley/Lewisburg counties, Staunton MSA and Winchester, VA/WV Eastern Panhandle counties). In addition to its branch network, City National's delivery channels include automated-teller-machines ("ATMs"), interactive-teller-machines ("ITMs"), mobile banking, debit cards, interactive voice response systems, and Internet technology. The Company’s business activities are currently limited to one reportable business segment, which is community banking.
In July 2018, the Company announced that it had concurrently executed two separate definitive agreements to acquire Poage Bankshares, Inc., of Ashland, Kentucky and its principal banking subsidiary, Town Square Bank (collectively, "Poage") and Farmers Deposit Bancorp, Inc., of Cynthiana, Kentucky and its principal banking subsidiary, Farmers Deposit Bank (collectively, "Farmers Deposit"). The acquisitions were finalized in December 2018. Poage operated nine branches across northeastern Kentucky, along with a loan production office in Cincinnati, Ohio. Farmers Deposit operated three branches around the Lexington, Kentucky region. As a result of overlapping service areas, the Company plans to merge three of the Poage branches into existing City branches and two existing City branches into former Poage branches.
In January 2019, the Company announced the signing of a definitive agreement to sell its Virginia Beach, Virginia, branch to Select Bancorp, Inc., the holding company for Select Bank & Trust Company. The transaction is expected to close during the second quarter of 2019.
After the Poage-City branch mergers and the Virginia Beach branch divestiture, the Company expects to have 94 bank branches in its network.
CRITICAL ACCOUNTING POLICIES
The accounting policies of the Company conform to U.S. generally accepted accounting principles and require management to make estimates and develop assumptions that affect the amounts reported in the financial statements and related footnotes. These estimates and assumptions are based on information available to management as of the date of the financial statements. Actual results could differ significantly from management’s estimates. As this information changes, management’s estimates and assumptions used to prepare the Company’s financial statements and related disclosures may also change. The most significant accounting policies followed by the Company are presented in Note One of the Notes to Consolidated Financial Statements included herein. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified: (i) the determination of the allowance for loan losses and (ii) income taxes to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new information becomes available.
The Allowance and Provision for Loan Losses section of this Annual Report on Form 10-K provides management’s analysis of the Company’s allowance for loan losses and related provision. The allowance for loan losses is maintained at a level that represents management’s best estimate of probable losses in the loan portfolio. Management’s determination of the appropriateness of the allowance for loan losses is based upon an evaluation of individual credits in the loan portfolio, historical loan loss experience, current economic conditions, and other relevant factors. This determination is inherently subjective, as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses related to loans considered to be impaired is generally evaluated based on the discounted cash flows using the impaired loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. The allowance not specifically allocated to individual credits is generally determined by analyzing potential exposure and other qualitative factors that could negatively impact the overall credit risk of the loan portfolio. Loans not individually evaluated for impairment are grouped by pools with similar risk characteristics and the related historical loss rates are adjusted to reflect current inherent risk factors, such as unemployment, overall economic conditions, concentrations of credit, loan growth, classified and impaired loan trends, staffing, adherence to lending policies, and loss trends.
28
The Income Taxes section of this Annual Report on Form 10-K provides management’s analysis of the Company’s income taxes. The Company is subject to federal and state income taxes in the jurisdictions in which it conducts business. In computing the provision for income taxes, management must make judgments regarding interpretation of laws in those jurisdictions. Because the application of tax laws and regulations for many types of transactions is susceptible to varying interpretations, amounts reported in the financial statements could be changed at a later date upon final determinations by taxing authorities. On a quarterly basis, the Company estimates its annual effective tax rate for the year and uses that rate to provide for income taxes on a year-to-date basis. The Company's unrecognized tax benefits could change over the next twelve months as a result of various factors. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and various state taxing authorities for the years ended December 31, 2015 through 2017.
FINANCIAL SUMMARY
The Company’s financial performance over the previous three years is summarized in the following table:
2018 | 2017 | 2016 | |||||||
Net income available to common shareholders (in thousands) | $ | 70,002 | $ | 54,310 | $ | 52,128 | |||
Earnings per common share, basic | $ | 4.50 | $ | 3.49 | $ | 3.46 | |||
Earnings per common share, diluted | $ | 4.49 | $ | 3.48 | $ | 3.45 | |||
ROA* | 1.63 | % | 1.33 | % | 1.36 | % | |||
ROE* | 13.6 | % | 11.0 | % | 12.1 | % | |||
ROATCE* | 16.2 | % | 13.1 | % | 14.8 | % | |||
*ROA (Return on Average Assets) is a measure of the effectiveness of asset utilization. ROE (Return on Average Equity) is a measure of the return on shareholders’ investment. ROATCE (Return on Average Tangible Common Equity) is a measure of the return on shareholders’ equity less intangible assets.
BALANCE SHEET ANALYSIS
Selected balance sheet fluctuations are summarized in the following table (in millions):
December 31, | |||||||||||
2018 | 2017 | $ Change | % Change | ||||||||
Cash and cash equivalents | $ | 123.0 | $ | 82.5 | $ | 40.5 | 49.1 | % | |||
Investment securities | 812.9 | 629.0 | 183.9 | 29.2 | |||||||
Gross loans | 3,587.6 | 3,127.4 | 460.2 | 14.7 | |||||||
Goodwill and other intangible assets, net | 122.8 | 78.6 | 44.2 | 56.2 | |||||||
Total deposits | 3,975.6 | 3,315.6 | 660.0 | 19.9 | |||||||
Long-term debt | 4.1 | 16.5 | (12.4 | ) | (75.2 | ) | |||||
Shareholders' equity | 600.8 | 502.5 | 98.3 | 19.6 | |||||||
Cash and cash equivalents increased $41 million, from $83 million at December 31, 2017 to $123 million at December 31, 2018, as the Company elected to improve its on-balance sheet liquidity during 2018.
Investment securities increased $184 million, from $629 million at December 31, 2017, to $813 million at December 31, 2018. The acquisitions of Poage and Farmers Deposit contributed approximately $119 million to this increase. In addition, in conjunction with its interest rate risk management strategy, the Company elected to grow investment balances to enhance net interest income.
Gross loans increased $460 million, from $3.13 billion at December 31, 2017 to $3.59 billion at December 31, 2018. The acquisitions of Poage and Farmers Deposit contributed approximately $362 million to this increase. Excluding the impact of the two acquisitions, commercial loans increased $57 million and residential real estate loans increased $33 million from December 31, 2017 to December 31, 2018.
29
Goodwill and other intangible assets, net increased $44 million, from $79 million at December 31, 2017 to $123 million at December 31, 2018. The acquisitions of Poage and Farmers Deposit contributed approximately $33 million in goodwill and $11 million in core deposit intangibles in 2018.
Total deposits increased $660 million, from $3.32 billion at December 31, 2017 to $3.98 billion at December 31, 2018. The acquisitions of Poage and Farmers Deposit contributed approximately $472 million to this increase. Excluding the impact of the two acquisitions, the Company grew time deposits ($90 million), interest-bearing demand deposits ($46 million), noninterest-bearing deposits ($32 million) and savings deposits ($20 million).
Long-term debt decreased $12.4 million as the Company repaid its $16.5 million of Junior Subordinated Deferrable Interest Debentures issued by the Company and held by City Holding Company Trust III at a price of 100% of principal. As part of its Poage acquisition, the Company assumed Poage's subordinated debentures of $4.1 million.
Shareholders' equity increased $98 million from December 31, 2017 to December 31, 2018, as the Company issued approximately $83 million of common shares in conjunction with the Poage acquisition. The issuance of these shares, along with net income of $70 million, were partially offset by cash dividends declared of $31 million and common share repurchases of $20 million.
30
TABLE TWO
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(In thousands)
2018 | 2017 | 2016 | ||||||||||||||||||||||||
Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | ||||||||||||||||||
Assets | ||||||||||||||||||||||||||
Loan portfolio(1): | ||||||||||||||||||||||||||
Residential real estate(2),(3) | $ | 1,629,950 | $ | 69,765 | 4.28 | % | $ | 1,598,579 | $ | 63,649 | 3.98 | % | $ | 1,565,079 | $ | 60,736 | 3.88 | % | ||||||||
Commercial, financial, and agriculture(3),(4) | 1,501,667 | 68,981 | 4.59 | 1,450,144 | 58,243 | 4.02 | 1,318,094 | 52,812 | 4.01 | |||||||||||||||||
Installment loans to individuals(3),(5) | 37,210 | 2,349 | 6.31 | 33,725 | 2,514 | 7.45 | 37,664 | 2,917 | 7.75 | |||||||||||||||||
Previously securitized loans(6) | — | 960 | — | — | 1,346 | — | — | 1,673 | — | |||||||||||||||||
Total loans | 3,168,827 | 142,055 | 4.48 | 3,082,448 | 125,752 | 4.08 | 2,920,837 | 118,138 | 4.04 | |||||||||||||||||
Securities: | ||||||||||||||||||||||||||
Taxable | 559,125 | 17,337 | 3.10 | 492,783 | 14,387 | 2.92 | 444,110 | 12,392 | 2.79 | |||||||||||||||||
Tax-exempt(7) | 91,572 | 3,598 | 3.93 | 89,341 | 4,163 | 4.66 | 51,096 | 2,494 | 4.88 | |||||||||||||||||
Total securities | 650,697 | 20,935 | 3.22 | 582,124 | 18,550 | 3.19 | 495,206 | 14,886 | 3.01 | |||||||||||||||||
Deposits in depository institutions | 122,761 | 1,666 | 1.36 | 27,142 | 85 | 0.31 | 10,115 | — | — | |||||||||||||||||
Total interest-earning assets | 3,942,285 | 164,656 | 4.18 | 3,691,714 | 144,387 | 3.91 | 3,426,158 | 133,024 | 3.88 | |||||||||||||||||
Cash and due from banks | 47,562 | 85,473 | 95,295 | |||||||||||||||||||||||
Bank premises and equipment | 73,196 | 73,540 | 76,056 | |||||||||||||||||||||||
Goodwill and intangible assets | 82,117 | 78,881 | 79,456 | |||||||||||||||||||||||
Other assets | 176,110 | 170,312 | 178,069 | |||||||||||||||||||||||
Less: allowance for loan losses | (17,906 | ) | (20,246 | ) | (19,953 | ) | ||||||||||||||||||||
Total assets | $ | 4,303,364 | $ | 4,079,674 | $ | 3,835,081 | ||||||||||||||||||||
Liabilities | ||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 792,765 | 2,114 | 0.27 | % | $ | 705,412 | 643 | 0.09 | % | $ | 685,399 | 615 | 0.09 | % | |||||||||||
Savings deposits | 820,474 | 2,133 | 0.26 | 832,512 | 1,311 | 0.16 | 772,296 | 975 | 0.13 | |||||||||||||||||
Time deposits(3) | 1,142,629 | 17,150 | 1.50 | 1,067,181 | 12,872 | 1.21 | 1,029,172 | 10,462 | 1.02 | |||||||||||||||||
Short-term borrowings | 265,157 | 3,415 | 1.29 | 230,529 | 1,214 | 0.53 | 176,065 | 472 | 0.27 | |||||||||||||||||
Long-term debt | 16,053 | 880 | 5.48 | 16,495 | 765 | 4.64 | 16,495 | 683 | 4.14 | |||||||||||||||||
Total interest-bearing liabilities | 3,037,078 | 25,692 | 0.85 | 2,852,129 | 16,805 | 0.59 | 2,679,427 | 13,207 | 0.49 | |||||||||||||||||
Noninterest-bearing demand deposits | 704,438 | 693,280 | 679,950 | |||||||||||||||||||||||
Other liabilities | 47,765 | 41,597 | 44,673 | |||||||||||||||||||||||
Total shareholders’ equity | 514,083 | 492,668 | 431,031 | |||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 4,303,364 | $ | 4,079,674 | $ | 3,835,081 | ||||||||||||||||||||
Net interest income | $ | 138,964 | $ | 127,582 | $ | 119,817 | ||||||||||||||||||||
Net yield on earning assets | 3.52 | % | 3.46 | % | 3.50 | % | ||||||||||||||||||||
1. | For purposes of this table, non-accruing loans have been included in average balances and the following loan fees (in thousands) have been included in interest income. |
2018 | 2017 | 2016 | |||||||
Loan fees | $ | 1,856 | $ | 558 | $ | 1,048 | |||
2.Includes the Company's residential real estate and home equity loan categories.
31
3. | Included in the above table are the following amounts (in thousands) for the accretion of the fair value adjustments related to the Company's recent acquisitions: |
2018 | 2017 | 2016 | |||||||
Residential real estate | $ | 407 | $ | 530 | $ | 698 | |||
Commercial, financial, and agriculture | 994 | 1,345 | 1,505 | ||||||
Installment loans to individuals | 19 | 44 | 112 | ||||||
Time deposits | — | 16 | 592 | ||||||
Total | $ | 1,420 | $ | 1,935 | $ | 2,907 | |||
4.Includes the Company’s commercial and industrial and commercial real estate loan categories.
5.Includes the Company’s consumer and DDA overdrafts loan categories.
6.Effective January 1, 2012, the carrying value of the Company's previously securitized loans was reduced to $0.
7. | Computed on a fully federal tax-equivalent basis assuming a tax rate of approximately 21% for the year ended December 31, 2018 and 35% for the years ended December 31, 2017 and 2016. |
NET INTEREST INCOME
2018 vs. 2017
The Company's net interest income increased from $126.1 million for the year ended December 31, 2017 to $138.2 million for the year ended December 31, 2018. The Company’s tax equivalent net interest income increased $11.4 million or 8.9%, from $127.6 million in 2017 to $139.0 million in 2018. Exclusive of the impact of the acquisitions of Poage and Farmers Deposit, increased yields on commercial and residential real estate loans increased net interest income $7.8 million and $4.8 million, respectively, while higher average balances on commercial loans ($40.0 million) and residential real estate loans ($20.4 million) increased interest income by $1.6 million and $0.8 million, respectively, as compared to the year ended December 31, 2017. In addition, higher average investment balances ($68.6 million) increased investment income by $2.0 million, while interest income from deposits in depository institutions also increased $1.6 million as the Company elected to improve its on-balance sheet liquidity during the year ended December 31, 2018. These increases were partially offset by increased interest expense on interest bearing liabilities ($7.7 million), primarily due to an increase in the cost of funds. The Company’s reported net interest margin increased from 3.46% for the year ended December 31, 2017 to 3.52% for the year ended December 31, 2018. Excluding the favorable impact of the accretion from the fair value adjustments, the net interest margin would have been 3.49% for the year ended December 31, 2018 and 3.40% for the year ended December 31, 2017.
Excluding the impact of the Poage and Farmers Deposit acquisitions, average interest-earning assets increased $219 million from 2017 to 2018, due to increases in deposits with depository institutions ($96 million), investment securities ($61 million), commercial, financial, and agriculture loans ($40 million) and residential real estate loans ($20 million). Average interest-bearing liabilities increased $159 million from 2017 as increases in interest bearing deposits ($82 million), time deposits ($64 million) and short-term borrowings ($34 million) were partially offset by a decrease in savings deposits ($20 million).
2017 vs. 2016
The Company's net interest income increased from $118.9 million for the year ended December 31, 2016 to $126.1 million for the year ended December 31, 2017. The Company’s tax equivalent net interest income increased $7.8 million, or 6.5%, from $119.8 million in 2016 to $127.6 million in 2017. This increase was due primarily to higher average balances on commercial loans ($132.0 million) which increased interest income by $5.1 million, and residential real estate loans ($33.5 million) which increased interest income by $1.3 million as compared to the year ended December 31, 2016. Increased interest yields on residential real estate loans also increased net interest income by $1.8 million compared to the year ended December 31, 2016. In addition, higher average investment balances ($86.9 million) increased investment income by $3.2 million. These increases were partially offset by increased interest expense on interest bearing deposits ($3.0 million), primarily due to an increase in the cost of funds, and lower accretion from fair value adjustments ($1.0 million). The Company's reported net interest margin decreased from 3.50% for the year ended December 31, 2016 to 3.46% for the year ended December 31, 2017. Excluding the favorable impact of the accretion from fair value adjustments, the net interest margin would have been 3.40% for the year ended December 31, 2017 and 3.41% for the year ended December 31, 2016.
Average interest-earning assets increased $266 million from 2016 to 2017, due to increases in commercial, financial,
and agriculture loans ($132 million), investment securities ($87 million) and residential real estate loans ($34 million). Average
32
interest-bearing liabilities increased $173 million from 2016 due to increases in savings deposits ($60 million), short-term borrowings ($54 million), time deposits ($38 million) and interest-bearing demand deposits ($20 million).
TABLE THREE
RATE/VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
(In thousands)
2018 vs. 2017 Increase (Decrease) Due to Change In: | 2017 vs. 2016 Increase (Decrease) Due to Change In: | |||||||||||||||||
Volume | Rate | Net | Volume | Rate | Net | |||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loan portfolio | ||||||||||||||||||
Residential real estate | $ | 1,249 | $ | 4,867 | $ | 6,116 | $ | 1,300 | $ | 1,613 | $ | 2,913 | ||||||
Commercial, financial, and agriculture | 2,078 | 8,421 | 10,499 | 5,291 | 140 | 5,431 | ||||||||||||
Installment loans to individuals | 235 | (161 | ) | 74 | (305 | ) | (98 | ) | (403 | ) | ||||||||
Previously securitized loans | — | (386 | ) | (386 | ) | — | (327 | ) | (327 | ) | ||||||||
Total loans | 3,562 | 12,741 | 16,303 | 6,286 | 1,328 | 7,614 | ||||||||||||
Securities: | ||||||||||||||||||
Taxable | 1,937 | 1,013 | 2,950 | 1,358 | 637 | 1,995 | ||||||||||||
Tax-exempt(1) | 104 | (669 | ) | (565 | ) | 1,867 | (198 | ) | 1,669 | |||||||||
Total securities | 2,041 | 344 | 2,385 | 3,225 | 439 | 3,664 | ||||||||||||
Deposits in depository institutions | 299 | 1,282 | 1,581 | — | 85 | 85 | ||||||||||||
Total interest-earning assets | $ | 5,902 | $ | 14,367 | $ | 20,269 | $ | 9,511 | $ | 1,852 | $ | 11,363 | ||||||
Interest-bearing liabilities: | ||||||||||||||||||
Interest-bearing demand deposits | $ | 80 | $ | 1,391 | $ | 1,471 | $ | 18 | $ | 10 | $ | 28 | ||||||
Savings deposits | (19 | ) | 841 | 822 | 76 | 260 | 336 | |||||||||||
Time deposits | 910 | 3,367 | 4,277 | 386 | 2,024 | 2,410 | ||||||||||||
Short-term borrowings | 182 | 2,019 | 2,201 | 146 | 596 | 742 | ||||||||||||
Long-term debt | (20 | ) | 135 | 115 | — | 82 | 82 | |||||||||||
Total interest-bearing liabilities | 1,133 | 7,753 | 8,886 | 626 | 2,972 | 3,598 | ||||||||||||
Net Interest Income | $ | 4,769 | $ | 6,614 | $ | 11,383 | $ | 8,885 | $ | (1,120 | ) | $ | 7,765 | |||||
1. | Fully federal taxable equivalent using a tax rate of approximately 21% for 2018 and 35% for 2017 and 2016. |
33
Non-GAAP Financial Measures
Management of the Company uses measures in its analysis of the Company's performance other than those in accordance with generally accepted accounting principals in the United States of America ("GAAP"). These measures are useful when evaluating the underlying performance of the Company's operations. The Company's management believes that these non-GAAP measures enhance comparability of results with prior periods and demonstrate the effects of significant gains and charges in the current period. The Company's management believes that investors may use these non-GAAP financial measures to evaluate the Company's financial performance without the impact of those items that may obscure trends in the Company's performance. These disclosures should not be viewed as a substitute for financial measures determined in accordance with GAAP, nor are they comparable to non-GAAP financial measures that may be presented by other companies.
TABLE FOUR
NON-GAAP FINANCIAL MEASURES
(In thousands)
2018 | 2017 | 2016 | |||||||
Net interest income ("GAAP") | $ | 138,209 | $ | 126,125 | $ | 118,945 | |||
Taxable equivalent adjustment | 756 | 1,457 | 872 | ||||||
Net interest income, fully taxable equivalent | $ | 138,965 | $ | 127,582 | $ | 119,817 | |||
Average total interest earning assets | $ | 3,942,285 | $ | 3,691,714 | $ | 3,426,158 | |||
Net interest margin | 3.52 | % | 3.46 | % | 3.50 | % | |||
Accretion related to fair value adjustments | (0.03 | ) | (0.06 | ) | (0.09 | ) | |||
Net interest margin (excluding accretion) | 3.49 | % | 3.40 | % | 3.41 | % | |||
Equity to assets ("GAAP") | 12.30 | % | 12.16 | % | 11.10 | % | |||
Effect of goodwill and other intangibles, net | (2.29 | ) | (1.70 | ) | (1.80 | ) | |||
Tangible common equity to tangible assets | 10.01 | % | 10.46 | % | 9.30 | % | |||
Return on tangible equity ("GAAP") | 16.2 | % | 13.1 | % | 14.8 | % | |||
Impact of effect tax rate decrease on deferred taxes | — | 1.6 | — | ||||||
Impact of merger related expenses | 2.4 | — | — | ||||||
Return on tangible equity, excluding the above items | 18.6 | % | 14.7 | % | 14.8 | % | |||
Return on assets ("GAAP") | 1.63 | % | 1.33 | % | 1.36 | % | |||
Impact of effect tax rate decrease on deferred taxes | — | 0.17 | — | ||||||
Impact of merger related expenses | 0.24 | — | — | ||||||
Return on assets, excluding the above items | 1.87 | % | 1.50 | % | 1.36 | % | |||
Effective tax rate ("GAAP") | 20.5 | % | 40.2 | % | 32.5 | % | |||
Impact of FIN 48 reserve adjustments | 0.4 | 0.4 | 0.7 | ||||||
Impact of effect tax rate decrease on deferred taxes | (0.2 | ) | (7.9 | ) | — | ||||
Effective tax rate, excluding the above items | 20.7 | % | 32.7 | % | 33.2 | % | |||
34
NON-INTEREST INCOME AND NON-INTEREST EXPENSE
2018 vs. 2017
Selected income statement fluctuations are summarized in the following table (dollars in millions):
For the year ended December 31, | |||||||||||
2018 | 2017 | $ Change | % Change | ||||||||
Net investment security (losses) gains | $ | (0.1 | ) | $ | 4.5 | $ | (4.6 | ) | (102.0 | )% | |
Non-interest income, excluding net investment securities (losses) gains | 60.7 | 59.1 | 1.6 | 2.7 | |||||||
Merger related expenses | 13.3 | — | 13.3 | 100.0 | |||||||
Non-interest expense, excluding merger related expenses | 99.8 | 96.0 | 3.8 | 4.0 | |||||||
During 2017, the Company realized investment gains of $4.5 million that represented partial recoveries of impairment charges previously recognized on pools of trust preferred securities. During 2018, the Company recognized $0.1 million of unrealized investment losses related to its equity and perpetual preferred securities. As a result of the adoption of ASU No. 2016-02, effective January 1, 2018, unrealized gains and losses on equity and equity-like securities are now required to be recognized in the Company's Consolidated Statements of Income.
Exclusive of these gains and losses, non-interest income increased from $59.1 million for the year ended December 31, 2017 to $60.7 million for the year ended December 31, 2018. This increase was primarily attributable to an increase of $1.2 million, or 7.3%, in bankcard revenues and an increase of $1.1 million, or 4.0%, in service charges. These increases were partially offset by a decrease of $1.1 million in bank owned life insurance revenues due to lower death benefit proceeds received during 2018 as compared to 2017.
During 2018, the Company recognized $13.3 million of merger related expenses associated with the completed acquisitions of Poage and Farmers Deposit. Excluding these expenses, non-interest expenses increased from $96.0 million for 2017 to $99.8 million for 2018. This increase was primarily due to an increase in salaries and employee benefits of $3.3 million that was largely attributable to annual salary adjustments, including an adjustment to wages for approximately 50% of the Company's employees late in the first quarter of 2018 to make salaries more competitive in the current employment environment. Additionally, the Company experienced increases in bankcard expenses of $0.6 million and other expenses of $0.5 million.
2017 vs. 2016
Selected income statement fluctuations are summarized in the following table (dollars in millions):
For the year ended December 31, | |||||||||||
2017 | 2016 | $ Change | % Change | ||||||||
Net investment security gains | $ | 4.5 | $ | 3.5 | $ | 1.0 | 28.6 | % | |||
Non-interest income, excluding net investment securities gains | 59.1 | 55.3 | 3.8 | 6.9 | |||||||
Non-interest expense | 96.0 | 96.2 | (0.2 | ) | (0.2 | ) | |||||
During the years ended December 31, 2017 and 2016, the Company realized investment gains of $4.5 million and $3.5 million, respectively, from the sale of pools of trust preferred securities, which represented a partial recovery of impairment charges previously recognized.
Exclusive of these gains, non-interest income increased $3.8 million to $59.1 million for the year ended December 31, 2017, as compared to $55.3 million for the year ended December 31, 2016. This is primarily due to increases in service charges of $1.9 million, or 7.0%, bank owned life insurance of $0.9 million, or 26.6% (primarily due to death benefit proceeds), trust revenues of $0.7 million, or 12.5%, and bankcard revenues of $0.6 million, or 3.7%.
Non-interest expenses decreased $0.2 million from $96.2 million for the year ended December 31, 2016 to $96.0 million for the year ended December 31, 2017. This is primarily due to decreases in occupancy related expenses of $0.6 million, or 5.6%, bankcard expenses of $0.5 million, or 12.0%, FDIC insurance of $0.3 million and repossessed asset losses, net of expenses of $0.2 million. These decreases were partially offset by increases in equipment and software related expenses of $0.5 million,
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or 7.2%, advertising of $0.3 million, or 11.8%, salaries and employee benefits of $0.2 million and telecommunication expenses of $0.2 million, or 9.7%.
INCOME TAXES
Selected information regarding the Company's income taxes is presented in the table below (dollars in millions):
For the year ended December 31, | |||||||||
2018 | 2017 | 2016 | |||||||
Income tax expense | $ | ||||||||