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CHCO > SEC Filings for CHCO > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for CITY HOLDING CO


8-May-2013

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

The accounting policies of the Company conform with 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 to the audited financial statements included in the Company's 2012 Annual Report to Shareholders. The information included in this Quarterly Report on Form 10-Q, including the Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Management's Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with the financial statements and notes thereto included in the 2012 Annual Report of the Company. 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 the determination of the allowance for loan losses, income taxes and other-than-termporary impairment on investment securities, 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.
Pages 41 - 44 of this Quarterly Report on Form 10-Q provide 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 adequacy 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 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 amount of unrecognized tax benefits could change over the next twelve months as a result of various factors. However, management cannot currently estimate the range of possible change. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2009 through 2012. The Company and its subsidiaries state income tax returns are open to audit under the statute of limitations for the years ended December 31, 2009 through 2012.


Table of Contents
On a quarterly basis, the Company performs a review of investment securities to determine if any unrealized losses are other-than-temporarily impaired. Management considers the following, amongst other things, in its determination of the nature of the unrealized losses, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition, capital strength, and near-term (12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment;
(iv) adverse conditions specifically related to the security, an industry, or a geographic area; or (v) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The Company continues to actively monitor the market value of these investments along with the financial strength of the issuers behind these securities, as well as its entire investment portfolio. Based on the market information available, the Company believes that the recent declines in market value are temporary and that the Company does not have the intent to sell any of the securities classified as available for sale and believes it is more likely than not that the Company will not have to sell any such securities before recovery of costs. The Company cannot guarantee that such securities will recover and if additional information becomes available in the future to suggest that the losses are other than temporary, the Company may need to record impairment charges in future periods. No impairment charges were recognized during the quarter ended March 31, 2013 as a result of this review. The Company continues to actively monitor the market values of these investments along with the financial strength of the issuers behind these securities, as well as our entire investment portfolio. Financial Summary
Three Months Ended March 31, 2013 vs. 2012 The Company reported consolidated net income of $8.0 million, or $0.51 per diluted common share, for the three months ended March 31, 2013, compared to $10.0 million, or $0.67 per diluted common share, for the three months ended March 31, 2012. Return on average assets ("ROA") was 0.96% and return on average equity ("ROE") was 9.0% for the three months ended March 31, 2013 compared to 1.47% and 12.7%, respectively, for the same period in 2012.
The Company's net interest income for the first quarter of 2013 increased $6.0 million compared to the first quarter of 2012 (see Net Interest Income). The Company recorded a provision for loan losses of $1.7 million for the first quarter of 2013 compared to $2.0 million for the first three months of 2012. (see Allowance and Provision for Loan Losses). As further discussed under the caption Non-Interest Income and Expense, non-interest income increased $1.2 million from the first quarter ended March 31, 2012, to the first quarter ended March 31, 2013. Non-interest expenses for the first quarter ended March 31, 2013 increased $9.9 million from the first quarter ended March 31, 2012. Net Interest Income
Three Months Ended March 31, 2013 vs. 2012 The Company's tax equivalent net interest income increased $6.0 million, or 25.3%, from $23.7 million for the first quarter of 2012 to $29.7 million for the first quarter of 2013. This increase is primarily due to the acquisitions of Virginia Savings Bancorp, Inc. ("VSB") and Community Financial Corporation ("Community Bank"), and an increase in the accretion related to these acquisitions. The Company's reported net interest margin increased from 3.98% for the quarter ended March 31, 2012 to 4.18% for the quarter ended March 31, 2013. Excluding the favorable impact of the accretion from the fair value adjustments ($2.2 million), the net interest margin for the three months ended March 31, 2013 would have been 3.87%.
The following table presents the actual and estimated future accretion related to the fair value adjustments on net interest income as a result of the Company's acquisitions. The amounts in the table below require management to make significant assumptions based on estimated future default, prepayment and discount rates. Actual performance could be significantly different from that assumed, which could result in the actual results being materially different than those estimated below.

                                     VSB                                Community
                         Loan          Certificates of         Loan          Certificates of
      Year Ended:      Accretion           Deposit           Accretion           Deposit            Total

          1Q 2013     $       985     $             178     $       858     $             160     $   2,181
   Remainder 2013           1,318                   364           2,800                   480         4,962
             2014           1,001                   537           3,043                   294         4,875
             2015             790                   518           1,750                   160         3,218
       Thereafter           1,252                   497           6,791                    46         8,586


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Table One
Average Balance Sheets and Net Interest Income
(In thousands)

                                                                                 Three Months Ended March 31,
                                                            2013                                                                     2012
                                Average                                             Yield/                     Average                                     Yield/
                                Balance                  Interest                    Rate                      Balance                  Interest            Rate
Assets
Loan portfolio(1):
  Residential real
estate(2)                   $     1,277,557             $   13,720                           4.36 %         $    1,067,911           $        11,827           4.45 %
  Commercial,
financial, and
agriculture(3)                    1,121,916                 14,192                           5.13                  862,886                     9,584           4.47
  Installment loans
to individuals(4),(5)                65,863                  1,377                           8.48                   41,681                       770           7.43
  Previously
securitized loans(6)                      *                    650                              *                        *                       887              *
   Total loans                    2,465,336                 29,939                           4.93                1,972,478                    23,068           4.70
Securities:
  Taxable                           350,128                  2,750                           3.19                  351,811                     3,964           4.53
  Tax-exempt(7)                      32,991                    498                           6.12                   41,117                       595           5.82
   Total securities                 383,119                  3,248                           3.44                  392,928                     4,559           4.67
Deposits in
depository
institutions                          9,033                      -                              -                    7,587                         -              -
Federal funds sold                   29,932                     13                           0.18                   27,462                        11           0.16
   Total
interest-earning
assets                            2,887,420                 33,200                           4.66                2,400,455                    27,638           4.63
Cash and due from
banks                               112,002                                                                         75,484
Bank premises and
equipment                            80,958                                                                         64,746
Other assets                        259,335                                                                        216,379
  Less: allowance for
loan losses                         (19,472 )                                                                      (19,726 )
Total assets                $     3,320,243                                  $                              $    2,737,338                               $

Liabilities
Interest-bearing
demand deposits             $       603,300             $      178                           0.12 %         $      523,761                       178           0.14 %
  Savings deposits                  584,048                    213                           0.15                  448,435                       188           0.17
  Time deposits(8)                1,106,982                  2,836                           1.04                  889,110                     3,302           1.49
  Short-term
borrowings                          111,870                     71                           0.26                  113,946                        73           0.26
  Long-term debt                     16,495                    157                           3.86                   16,495                       167           4.07
   Total
interest-bearing
liabilities                       2,422,695                  3,455                           0.58                1,991,747                     3,908           0.79
Noninterest-bearing
demand deposits                     498,404                                                                        392,902
Other liabilities                    42,615                                                                         36,436
Stockholders' equity                356,529                                                                        316,253
Total liabilities and
stockholders' equity        $     3,320,243                                                                 $    2,737,338
Net interest income                                     $   29,745                                                                   $        23,730
Net yield on earning
assets                                                                                       4.18 %                                                            3.98 %

(1) For purposes of this table, non-accruing loans have been included in average balances and loan fees, which are immaterial, have been included in interest income.
(2) - For the three months ended March 31, 2013, interest income on residential real estate loans includes $0.3 million and $0.2 million of accretion related to the fair value market adjustments due to the acquisition of Virginia Savings and Community Financial, respectively.
(3) - For the three months ended March 31, 2013, interest income on commercial, financial, and agriculture loans includes $0.6 million and $0.5 million of accretion related to the fair value market adjustments due to the acquisition of Virginia Savings and Community Financial, respectively.
(4) - For the three months ended March 31, 2013, interest income on installment loans to individuals includes $0.1 million and $0.1 million of accretion related to the fair value market adjustments due to the acquisition of Virginia Savings and Community Financial, respectively.
(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 35%.
(8) - For the three months ended March 31, 2013, interest expense on time deposits includes $0.2 million and $0.2 million in accretion of the fair market value adjustments related to the acquisition of Virginia Savings and Community Financial, respectively.


Table of Contents

Table Two
Rate/Volume Analysis of Changes in Interest Income and Interest Expense
(In thousands)

                                                    Three Months Ended March 31,
                                                            2013 vs. 2012
                                                         Increase (Decrease)
                                                          Due to Change In:
                                                 Volume           Rate         Net
     Interest-earning assets:
     Loan portfolio
       Residential real estate                  $   2,303       $   (410 )   $  1,893
       Commercial, financial, and agriculture       2,853          1,755        4,608
       Installment loans to individuals               443            164          607
       Previously securitized loans                     -           (237 )       (237 )
        Total loans                                 5,599          1,272        6,871
     Securities:
       Taxable                                        (19 )       (1,195 )     (1,214 )
       Tax-exempt(1)                                 (117 )           20          (97 )
        Total securities                             (136 )       (1,175 )     (1,311 )
     Federal funds sold                                 1              1            2
     Total interest-earning assets              $   5,464       $     98     $  5,562

     Interest-bearing liabilities:
     Interest-bearing demand deposits           $      27       $    (27 )   $      -
       Savings deposits                                56            (31 )         25
       Time deposits                                  802         (1,268 )       (466 )
       Short-term borrowings                           (1 )           (1 )         (2 )
       Long-term debt                                   -            (10 )        (10 )
        Total interest-bearing liabilities      $     884       $ (1,337 )   $   (453 )
     Net Interest Income                        $   4,580       $  1,435     $  6,015

(1) Fully federal taxable equivalent using a tax rate of approximately 35%.


Table of Contents
Loans

The composition of the Company's loan portfolio as of the dates indicated
follows:

Table Three
Loan Portfolio
(In thousands)
                                     March 31,       December 31,       March 31,
                                       2013              2012             2012

       Residential real estate      $ 1,149,411     $    1,031,435     $   939,611
       Home equity - junior liens       138,333            143,110         139,764
       Commercial and industrial        149,677            108,739         108,707
       Commercial real estate         1,001,453            821,970         745,586
       Consumer                          55,274             36,564          35,448
       DDA overdrafts                     2,875              4,551           2,848
       Total loans                  $ 2,497,023     $    2,146,369     $ 1,971,964

Loan balances increased $350.7 million from December 31, 2012 to March 31, 2013, with the acquisition of Community Bank contributing $370.9 million. Excluding the Community Bank acquisition, loans have decreased $20.2 million from December 31, 2012. Residential real estate loans increased $118.0 million, or 11.4%, from $1.03 billion at December 31, 2012 to $1.15 billion at March 31, 2013, with the acquisition of Community Bank contributing $116.3 million. Residential real estate loans primarily consist of: (i) single-family 1, 3, 5 and 10 year adjustable rate mortgages with terms that amortize the loans over periods from 15-30 years and (ii) home equity loans secured by first liens. The Company's mortgage products do not include sub-prime, interest only, or option adjustable rate mortgage products. The Company's home equity loans are underwritten differently than 1-4 family residential mortgages with typically less documentation but lower loan-to-value ratios. Home equity loans consist of lines of credit, short-term fixed amortizing loans and non-purchase adjustable rate loans. At March 31, 2013, $16.9 million of the residential real estate loans were for properties under construction.
Exclusive of the acquisition of Community Bank (which contributed $0.2 million), junior lien home equity loans decreased $5.0 million during the first three months of 2013. Junior lien home equity loans consist of lines of credit, short-term fixed amortizing loans, and non-purchase adjustable rate loans with second lien positions.
Exclusive of the acquisition of Community Bank (which contributed $184.6 million), commercial real estate loans decreased $5.1 million, or 0.7%, from $822.0 million at December 31, 2012 to $816.9 million at March 31, 2013. At March 31, 2013, $26.2 million of the commercial real estate loans were for commercial properties under construction. Additionally, commercial and industrial loans ("C&I") decreased $4.8 million, excluding the acquisition of Community Bank (which contributed $45.7 million), to $104.0 million at March 31, 2013.
Exclusive of the acquisition of Community Bank (which contributed $24.1 million), consumer loans decreased $5.4 million during the first three months of 2013. The consumer loan portfolio primarily consists of new and used automobile loans, personal loans secured by cash and cash equivalents, unsecured revolving credit products, and other similar types of credit facilities. The Company strategically decided to reduce consumer loans due to the acquisition of an indirect portfolio of auto loans associated with Community Bank. These loans have higher loss percentages compared to the Company's historical consumer portfolio. In addition, the Company has opted to allow certain other high risk loans to exit the portfolio.


Table of Contents
Allowance and Provision for Loan Losses
Management systematically monitors the loan portfolio and the adequacy of the allowance for loan losses ("ALLL") on a quarterly basis to provide for probable losses inherent in the portfolio. Management assesses the risk in each loan type based on historical trends, the general economic environment of its local markets, individual loan performance, and other relevant factors. Individual credits are selected throughout the year for detailed loan reviews, which are utilized by management to assess the risk in the portfolio and the adequacy of the allowance. Due to the nature of commercial lending, evaluation of the adequacy of the allowance as it relates to these loan types is often based more upon specific credit review, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for general economic conditions and other inherent risk factors. Conversely, due to the homogeneous nature of the real estate and installment portfolios, the portions of the allowance allocated to those portfolios are primarily based on prior loss history of each portfolio, adjusted for general economic conditions and other inherent risk factors.
In evaluating the adequacy of the allowance for loan losses, management considers both quantitative and qualitative factors. Quantitative factors include actual repayment characteristics and loan performance, cash flow analyses, and estimated fair values of underlying collateral. Qualitative factors generally include overall trends within the portfolio, composition of the portfolio, changes in pricing or underwriting, seasoning of the portfolio, and general economic conditions.
The allowance not specifically allocated to individual credits is generally determined by analyzing potential exposure and other qualitative factors that could negatively impact the adequacy of the allowance. 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.
Determination of the allowance for loan losses is subjective in nature and requires management to periodically reassess the validity of its assumptions. Differences between actual losses and estimated losses are assessed such that management can timely modify its evaluation model to ensure that adequate provision has been made for risk in the total loan portfolio.
As a result of the Company's quarterly analysis of the adequacy of the ALLL, the Company recorded a provision for loan losses of $1.7 million in the first three months of 2013 and $2.0 million in the first three months of 2012. Changes in the amount of the provision and related allowance are based on the Company's detailed systematic methodology and are directionally consistent with changes in the composition and quality of the Company's loan portfolio. The Company believes its methodology for determining its ALLL adequately provides for probable losses inherent in the loan portfolio and produces a provision and allowance for loan losses that is directionally consistent with changes in asset quality and loss experience.
The Company had net charge-offs of $0.8 million and $2.7 million for the first three months of 2013 and 2012, respectively. Net charge-offs in the first three months of 2013 consisted primarily of net charge-offs on residential real estate loans of $0.5 million, commercial real estate loans of $0.2 million, and home equity loans of $0.1 million.
The Company's ratio of non-performing assets to total loans and other real estate owned decreased from 1.28% at December 31, 2012 to 1.13% at March 31, 2013. The Company's ratio of non-performing assets to total loans and other real estate owned is less than 30% of the 4.21% non-performing asset ratio reported by the Company's peer group (bank holding companies with total assets between $1 and $5 billion), as of the most recently reported quarter ended December 31, 2012.
The ALLL at March 31, 2013 was $19.7 million compared to $18.8 million at December 31, 2012. Below is a summary of the changes in the components of the ALLL from December 31, 2012 to March 31, 2013.
The allowance allocated to the commercial real estate loan portfolio increased $0.4 million, or 3.5%, from $10.4 million at December 31, 2012 to $10.8 million at March 31, 2013. This increase was primarily due to a $0.8 million provision related to one specific borrower, partially offset by a decrease in the commercial real estate loan portfolio.
The allowance related to the commercial and industrial loan portfolio remained flat at $0.5 million at March 31, 2013.
The allowance allocated to the residential real estate portfolio increased $0.6 million from $5.2 million at December 31, 2012 to $5.8 million at March 31, 2013. This increase was due to an increase in the residential real estate loan portfolio as well as a slight increase in the historical loss factor related to this loan portfolio.


Table of Contents
The allowance allocated to the home equity loan portfolio decreased $0.1 million from $1.7 million at December 31, 2012 to $1.6 million at March 31, 2013. The allowance allocated to the consumer loan portfolio remained flat at $0.1 million at March 31, 2013.
The allowance allocated to overdraft deposit accounts decreased from $0.9 million at December 31, 2012 to $0.8 million at March 31, 2013.
Based on the Company's analysis of the adequacy of the allowance for loan losses . . .
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