UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED June 30, 2000 ------------- 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 0-1173 CITY HOLDING COMPANY (Exact name of registrant as specified in its charter) West Virginia 55-0619957 ------------- ---------- (State or other jurisdiction of (IRS Employer Identification Number) incorporation or organization) 25 Gatewater Road Charleston, West Virginia, 25313 (Address of principal executive officers) (304) 769-1100 (Registrant's telephone number, including area code) Not applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Sections 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 [_] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by the court. Yes [_] No [_] APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common stock, $2.50 Par Value - 16,887,934 shares as of August 10, 2000. 1
FORWARD-LOOKING STATEMENTS All statements other than statements of historical fact included in this Form 10-Q Quarterly Report, including statements in Management's Discussion and Analysis of Financial Condition and Result of Operations are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. Such information involves risks and uncertainties that could result in the Company's actual results differing from those projected in the forward-looking information. Important factors that could cause actual results to differ materially from those discussed in such forward-looking statements include: (1) the Company's plans for divesting unprofitable businesses may not have the positive effect on financial results that is anticipated; (2) the formal agreement with the Comptroller of the Currency may have effects on the Company's business that are not currently anticipated, including effects on operating results; (3) the planned relocation of the origination operations may not have the long-term positive impact on the Company's operating results currently anticipated; (4) other plans initiated by the Company to improve its long-term profitability may not be completed timely or may not have the anticipated impact on the Company's operating results; (5) current earnings from the Company's subsidiaries may not be sufficient to fund the cash needs of the Parent Company, including the payment of stockholders' dividends; (6) as critical dates approach during 2000, the Company's technology systems may experience Year 2000-related disruptions; (7) regulatory rulings affecting, among other things, the Company's and its banking subsidiaries' regulatory capital may change, resulting in the need for increased capital levels with a resulting adverse effect on expected earnings and dividend capability; (8) changes in the interest rate environment may have results on the Company's operating results materially different from those anticipated by the Company's market risk management functions; (9) changes in general economic conditions and increased competition could adversely affect the Company's operating results; and (10) changes in other regulations and government policies affecting bank holding companies and their subsidiaries, including changes in monetary policies, could negatively impact the Company's operating results. 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 are 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. 2
Index City Holding Company and Subsidiaries Part I. Financial Information Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets - June 30, 2000 and December 31, 1999 Consolidated Statements of Income - Six months ended June 30, 2000 and 1999 and Three months ended June 30, 2000 and 1999 Consolidated Statements of Changes in Stockholders' Equity - Six months ended June 30, 2000 and 1999 Consolidated Statements of Cash Flows - Six months ended June 30, 2000 and 1999 Notes to Consolidated Financial Statements - June 30, 2000 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk Part II. Other Information Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Signature 3
PART I, ITEM 1 - FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS CITY HOLDING COMPANY AND SUBSIDIARIES (in thousands) <TABLE> <CAPTION> June 30 December 31 2000 1999 --------------------------------- (Unaudited) <S> <C> <C> Assets Cash and due from banks $ 91,322 $ 120,122 Federal funds sold 2,658 1,990 --------------------------------- Cash and Cash Equivalents 93,980 122,112 Securities available for sale, at fair value 364,408 381,112 Loans: Gross loans 2,006,469 1,886,114 Allowance for loan losses (27,873) (27,113) --------------------------------- Net Loans 1,978,596 1,859,001 Loans held for sale 91,821 118,025 Retained interests 76,951 76,963 Premises and equipment 61,970 66,119 Accrued interest receivable 18,136 18,149 Other assets 159,054 151,009 --------------------------------- Total Assets $2,844,916 $2,792,490 ================================= Liabilities Deposits: Noninterest-bearing $ 273,336 $ 246,555 Interest-bearing 1,847,592 1,709,215 --------------------------------- Total Deposits 2,120,928 1,955,770 Short-term borrowings 335,612 386,719 Long-term debt 50,000 116,000 Corporation-obligated mandatorily redeemable capital securities of subsidiary trusts holding solely subordinated debentures of City Holding Company 87,500 87,500 Other liabilities 52,901 47,959 --------------------------------- Total Liabilities 2,646,941 2,593,948 Stockholders' Equity Preferred stock, par value $25 per share: authorized - 500,000 shares: none issued Common stock, par value $2.50 per share: 50,000,000 shares authorized; 16,892,913 and 16,879,815 shares issued and outstanding at June 30, 2000 and December 31, 1999, including 4,979 and 9,646 shares, respectively, in treasury 42,232 42,199 Capital surplus 59,174 59,164 Retained earnings 112,540 112,951 Cost of common stock in treasury (136) (285) Accumulated other comprehensive loss (15,835) (15,487) --------------------------------- Total Stockholders' Equity 197,975 198,542 --------------------------------- Total Liabilities and Stockholders' Equity $2,844,916 $2,792,490 ================================= </TABLE> See notes to consolidated financial statements. 4
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) CITY HOLDING COMPANY AND SUBSIDIARIES (in thousands, except earnings per share data) <TABLE> <CAPTION> Six Months Ended June 30 2000 1999 ---------------------------- <S> <C> <C> Interest Income Interest and fees on loans $ 90,500 $84,804 Interest on investment securities: Taxable 8,505 8,530 Tax-exempt 2,359 2,551 Other interest income 199 2,783 ---------------------------- Total Interest Income 101,563 98,668 Interest Expense Interest on deposits 38,240 36,370 Interest on short-term borrowings 9,636 4,549 Interest on long-term debt 3,193 2,999 Interest on trust preferred securities 4,008 3,996 ---------------------------- Total Interest Expense 55,077 47,914 ---------------------------- Net Interest Income 46,486 50,754 Provision for loan losses 4,170 4,643 ---------------------------- Net Interest Income After Provision for Loan Losses 42,316 46,111 Other Income Investment securities gains 2 48 Service charges 5,095 4,507 Mortgage loan servicing fees 9,755 11,302 Net origination fees on junior-lien mortgages 1,621 4,031 Gain on sale of loans 993 5,208 Other income 8,171 17,034 ---------------------------- Total Other Income 25,637 42,130 Other Expenses Salaries and employee benefits 27,129 28,991 Occupancy, excluding depreciation 3,781 6,651 Depreciation 6,031 5,619 Advertising 2,643 9,353 Other expenses 22,098 18,140 ---------------------------- Total Other Expenses 61,682 68,754 ---------------------------- Income Before Income Taxes 6,271 19,487 Income Taxes 1,957 7,248 ---------------------------- Net Income $ 4,314 $12,239 ============================ Basic earnings per common share $ 0.26 $ 0.73 ============================ Diluted earnings per common share $ 0.26 $ 0.73 ============================ Average common shares outstanding: Basic 16,877 16,820 ============================ Diluted 16,877 16,820 ============================ </TABLE> See notes to consolidated financial statements. 5
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) CITY HOLDING COMPANY AND SUBSIDIARIES (in thousands, except earnings per share data) <TABLE> <CAPTION> Three Months Ended June 30 2000 1999 -------------------------------- <S> <C> <C> Interest Income Interest and fees on loans $ 46,750 $ 41,096 Interest on investment securities: Taxable 4,225 4,256 Tax-exempt 1,171 1,263 Other interest income 100 1,458 -------------------------------- Total Interest Income 52,246 48,073 Interest Expense Interest on deposits 20,219 17,773 Interest on short-term borrowings 4,969 2,591 Interest on long-term debt 1,604 1,356 Interest on trust preferred securities 2,004 1,998 -------------------------------- Total Interest Expense 28,796 23,718 -------------------------------- Net Interest Income 23,450 24,355 Provision for loan losses 2,085 2,229 -------------------------------- Net Interest Income After Provision for Loan Losses 21,365 22,126 Other Income Investment securities gains 2 6 Service charges 2,691 2,322 Mortgage loan servicing fees 4,901 5,617 Net origination fees on junior-lien mortgages 719 3,838 (Loss) gain on sale of loans (35) 4,483 Other income 3,711 11,445 -------------------------------- Total Other Income 11,989 27,711 Other Expenses Salaries and employee benefits 14,708 13,779 Occupancy, excluding depreciation 1,934 3,307 Depreciation 3,013 2,991 Advertising 1,032 8,233 Other expenses 12,221 9,825 -------------------------------- Total Other Expenses 32,908 38,135 -------------------------------- Income Before Income Taxes 446 11,702 Income Taxes 151 4,708 -------------------------------- Net Income $ 295 $ 6,994 ================================ Basic earnings per common share $ 0.02 $ 0.42 ================================ Diluted earnings per common share $ 0.02 $ 0.42 ================================ Average common shares outstanding: Basic 16,878 16,820 ================================ Diluted 16,878 16,820 ================================ </TABLE> See notes to consolidated financial statements. 6
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY CITY HOLDING COMPANY AND SUBSIDIARIES SIX MONTHS ENDED JUNE 30, 2000 AND 1999 (in thousands) <TABLE> <CAPTION> Common Capital Retained Treasury Stock Surplus Earnings Stock -------------------------------------------------------- <S> <C> <C> <C> <C> Balances at December 31, 1999 $ 42,199 $ 59,164 $ 112,951 $ (285) Comprehensive income: Net income 4,314 Other comprehensive income: Unrealized loss on securities of $349, net of reclassification adjustment for gains included in net income of $1 Total comprehensive income Cash dividends declared ($.28/share) (4,725) Issuance of contingently-issuable shares of common stock 33 10 149 -------------------------------------------------------- Balances at June 30, 2000 $ 42,232 $ 59,174 $ 112,540 $ (136) ======================================================== <CAPTION> Common Capital Retained Treasury Stock Surplus Earnings Stock -------------------------------------------------------- <S> <C> <C> <C> <C> Balances at December 31, 1998 $ 42,051 $ 58,365 $ 120,209 $ (274) Comprehensive income: Net income 12,239 Other comprehensive income: Unrealized gain on securities of $584, net of reclassification adjustment for losses included in net income of $4 Total comprehensive income Cash dividends declared ($.40/share) (6,725) Exercise of 22,908 stock options 82 337 5 Purchase of 11,999 shares of treasury stock (398) Issuance of contingently-issuable shares of common stock (17) 132 ------------------------------------------------------------ Balances at June 30, 1999 $ 42,133 $ 58,685 $ 125,723 $ (535) ============================================================ <CAPTION> Accumulated Other Total Comprehensive Stockholders' Loss Equity ------------------------------------- <S> <C> <C> Balances at December 31, 1999 (15,487) $ 198,542 Comprehensive income: Net income 4,314 Other comprehensive income: Unrealized loss on securities of $349, net of reclassification adjustment for gains included in net income of $1 (348) (348) --------------- Total comprehensive income 3,966 Cash dividends declared ($.28/share) (4,725) Issuance of contingently-issuable shares of common stock 192 ------------------------------------- Balances at June 30, 2000 (15,835) $ 197,975 ===================================== <CAPTION> Accumulated Other Total Comprehensive Stockholders' Loss Equity ------------------------------------- <S> <C> <C> Balances at December 31, 1998 $ (292) $ 220,059 Comprehensive income: Net income 12,239 Other comprehensive income: Unrealized gain on securities of $584, net of reclassification adjustment for losses included in net income of $4 (9,342) (9,342) --------------- Total comprehensive income 2,897 Cash dividends declared ($.40/share) (6,725) Exercise of 22,908 stock options 424 Purchase of 11,999 shares of treasury stock (398) Issuance of contingently-issuable shares of common stock 115 ------------------------------------- Balances at June 30, 1999 $ (9,634) $ 216,372 ===================================== </TABLE> See notes to consolidated financial statements. 7
CONSOLIDATED STATEMENTS OF CASH FLOWS CITY HOLDING COMPANY AND SUBSIDIARIES (in thousands) <TABLE> <CAPTION> Six Months Ended June 30 2000 1999 ----------------------------------------- <S> <C> <C> Operating Activities Net income $ 4,314 $ 12,239 Adjustments to reconcile net income to net cash provided by operating activities: Net amortization 3,155 2,564 Provision for depreciation 6,031 5,619 Provision for loan losses 4,170 4,643 Loans originated for sale (160,961) (215,001) Purchases of loans held for sale (16,065) (129,887) Proceeds from loans sold 204,223 490,465 Realized gains on loans sold (993) (5,208) Realized investment securities gains (2) (48) Decrease (increase) in retained interests 12 (25,660) Decrease (increase) in accrued interest receivable 13 (1,513) Increase in other assets (13,210) (35,313) Increase in other liabilities 4,942 7,078 ----------------------------------------- Net Cash Provided by Operating Activities 35,629 109,978 Investing Activities Proceeds from maturities and calls of securities held to maturity - 27 Proceeds from sales of securities available for sale 32,492 13,377 Proceeds from maturities and calls of securities available for sale 17,652 54,517 Purchases of securities available for sale (31,584) (59,664) Net increase in loans (123,765) (76,306) Net cash paid in branch sales - (52,094) Realized gain on branch sales - (8,681) Purchases of premises and equipment (1,882) (4,260) ----------------------------------------- Net Cash Used in Investing Activities (107,087) (133,084) Financing Activities Net increase (decrease) in noninterest-bearing deposits 26,781 (25,929) Net increase in interest-bearing deposits 138,377 7,469 Net (decrease) increase in short-term borrowings (67,107) 32,939 Proceeds from long-term debt - 8,000 Repayment of long-term debt (50,000) (10,247) Purchases of treasury stock - (398) Exercise of stock options - 424 Cash dividends paid (4,725) (6,725) ----------------------------------------- Net Cash Provided by Financing Activities 43,326 5,533 ----------------------------------------- Decrease in Cash and Cash Equivalents (28,132) (17,573) Cash and Cash Equivalents at beginning of period 122,112 119,777 ----------------------------------------- Cash and Cash Equivalents at end of period $ 93,980 $ 102,204 ========================================= </TABLE> See notes to consolidated financial statements. 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) June 30, 2000 NOTE A - BASIS OF PRESENTATION The accompanying consolidated financial statements, which are unaudited, include all the accounts of City Holding Company ("the Parent Company") and its wholly-owned subsidiaries (collectively, "the Company"). All material intercompany transactions have been eliminated. The consolidated financial statements include all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations and financial condition for each of the periods presented. Such adjustments are of a normal recurring nature. The results of operations for the six months ended June 30, 2000, are not necessarily indicative of the results of operations that can be expected for the year ending December 31, 2000. The Company's accounting and reporting policies conform with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Such policies require management to make estimates and develop assumptions that affect the amounts reported in the consolidated financial statements and related footnotes. Actual results could differ from management's estimates. Certain amounts in the unaudited consolidated financial statements have been reclassified. Such reclassifications had no impact on net income or stockholders' equity in any period presented. For further information, refer to the consolidated financial statements and footnotes thereto incorporated by reference in the City Holding Company Annual Report on Form 10-K for the year ended December 31, 1999. NOTE B - SECURITIZATIONS and RETAINED INTERESTS During the first six months of 1999, the Company sold $261.51 million of junior lien mortgage loans in one securitization transaction. Cash proceeds from the securitization totaled $238.16 million and the Company recognized a pre-tax gain of approximately $3.88 million. Subsequent to the May 1999 securitization, the Company terminated its loan securitization program. As of June 30, 2000 and 1999, the Company reported retained interests in its securitizations of approximately $76.95 million and $91.37 million, respectively. The value of the retained interests is determined using cash flow modeling techniques that incorporate key assumptions related to default, prepayment, and discount rates. To date, negative fair value adjustments approximating $21.57 million, pre-tax, have been recorded. Such fair value declines, deemed to be temporary, have been recorded through the Other Comprehensive Income section within Stockholders' Equity. Adjustments to the estimated fair value of retained interests are primarily the result of the actual performance of the underlying collateral pools 9
and changes in the expected future performance of those loans. Additionally, the actual performance of the underlying collateral loans has resulted in the delay in the expected timing of the receipt of future cash flows by the Company as a result of increased overcollateralization requirements. Key assumptions used in estimating the fair value of the Company's retained interests as of June 30, 2000 and 1999 were as follows: June 30 2000 1999 ----------------------------- Prepayment speed (CPR) 15-21% 17-21% Weighted average cumulative defaults 13.77% 10.79% Weighted average discount rate 14.00% 12.87% At June 30, 2000, the sensitivity of the current estimated fair value of retained interests to immediate ten percent and twenty percent changes in assumptions were as follows: Book value at June 30, 2000 $ 76,951 Prepayment curve: Impact on fair value of 10% increase in the prepayment curve (775) Impact on fair value of 20% increase in the prepayment curve 457 Default curve: Impact on fair value of 10% increase in the default curve (11,798) Impact on fair value of 20% increase in the default curve (17,405) Discount rate: Impact on fair value of 10% increase in the discount rate (8,112) Impact on fair value of 20% increase in the discount rate (13,548) These sensitivity analyses are hypothetical. As these figures indicate, any change in estimated fair value based on a ten percent variation in assumptions cannot be extrapolated because the relationship of the change in assumption to the change in fair value is not linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interests is calculated independent from any change in another assumption; in reality, changes in one factor may result in changes in another, which may magnify or counteract the sensitivities. NOTE C - SHORT-TERM BORROWINGS Effective June 21, 2000, the Parent Company's Term Loan agreement was amended to provide for revised terms and conditions, including modifying the maturity date of the Term Loan from October 1, 2009, to March 31, 2001. As a result, the $16.00 million outstanding under the Term Loan as of June 30, 2000, is included in Short-term borrowings in the Consolidated Balance Sheets. The loan agreement requires a $1.60 million principal payment on October 1, 2000, with the remaining unpaid principal balance due at maturity. The Term Loan has a variable rate (7.5625% at June 30, 2000) with 10
interest payments due quarterly. Additionally, $12.13 million outstanding pursuant to the terms of the Parent Company's $15.00 million Line of Credit with an unrelated party is included in Short-term borrowings. The Line of Credit has a variable rate (7.5625% at June 30, 2000) with interest payments due quarterly and principal due at maturity, March 31, 2001. Both the Term Loan and the Line of Credit contain certain restrictive provisions applicable to the Parent Company and its lead bank, City National Bank of West Virginia. Such provisions include requirements for City Holding Company to maintain specified tangible capital levels, loan loss reserve coverages, and net worth requirements. Additionally, City National must maintain its designation of "well-capitalized" as determined by its primary regulatory authorities. Short term borrowings also include advances from the Federal Home Loan Bank (FHLB) and securities sold under agreement to repurchase. The underlying securities included in repurchase agreements remain under the Company's control during the effective period of the agreements. NOTE D - LONG TERM DEBT The Company, through its banking subsidiaries, maintains long-term financing from the Federal Home Loan Bank ("FHLB") as follows: Amount Available Amount Outstanding Interest Rate Maturity Date - ----------------------------------------------------------------------------- (in thousands) $10,000 $10,000 5.60% July 2002 5,000 5,000 5.48 February 2008 10,000 10,000 4.86 October 2008 25,000 25,000 5.52 October 2009 ------------------- $50,000 =================== In addition to the financing discussed above, the Company's subsidiaries have $98.76 million of available borrowings from the FHLB as of June 30, 2000. NOTE E - TRUST PREFERRED SECURITIES On October 27, 1998, City Holding Capital Trust II (Capital Trust II), a special-purpose statutory trust subsidiary of the Company sold via public offering $57.5 million of 9.125% trust preferred capital securities (the Capital Securities II) and issued $1.8 million of common securities to the Company. Distributions on the Capital Securities II are payable quarterly and each Capital Security II has a stated liquidation value of $25. To fund Capital Trust II, the Company sold to Capital Trust II $59.3 million in 9.125% Junior Subordinated Debentures (the Debentures II) with a stated maturity date of October 31, 2028. The sole assets of Capital Trust II are the Debentures II. Cash distributions on the Capital Securities II in Capital Trust II are made to the extent interest on the Debentures II is received by Capital Trust II. The Company, through 11
various agreements, has irrevocably and unconditionally guaranteed all of Capital Trust II's obligations under the Capital Securities II regarding payment of distributions and payment on liquidation or redemption of the Capital Securities II, but only to the extent of funds held by Capital Trust II. The Capital Securities II are subject to mandatory redemption (i) in whole, but not in part, at the Stated Maturity upon repayment of the Debentures II, (ii) prior to October 31, 2003, in whole, but not in part, contemporaneously with the optional redemption at any time by the Company of the Debentures II at any time within 90 days following an event of certain changes or amendments to regulatory requirements or federal income tax rules and (iii) in whole or in part, at any time on or after October 31, 2003, contemporaneously with the optional redemption by the Company of the Debentures II at a redemption price equal to the aggregate liquidation amount of the Capital Securities II, plus accumulated but unpaid distributions thereon. After deducting expenses incurred in the issuance, the Company received proceeds of $55.34 million from the Capital Securities II offering. On March 31, 1998, City Holding Capital Trust (the Trust), a special- purpose statutory trust subsidiary of the Company, issued $30 million in 9.15% trust preferred capital securities (the Capital Securities) to certain qualified institutional investors and $928,000 of common securities (the Common Securities) to the Company. Distributions on the Capital Securities are payable semi-annually, and each Capital Security has a stated liquidation amount of $1,000. To fund the Trust, the Company sold to the Trust $30.9 million in 9.15% Junior Subordinated Debentures (the Debentures) with a stated maturity date of April 1, 2028. The sole assets of the Trust are the Debentures. Cash distributions on the Capital Securities are made to the extent interest on the Debentures is received by the Trust. The Company, through various agreements, has irrevocably and unconditionally guaranteed all of the Trust's obligations under the Capital Securities regarding payment of distributions and payment on liquidation or redemption of the Capital Securities, but only to the extent of funds held by the Trust. In the event of certain changes or amendments to regulatory requirements or federal income tax rules, the Capital Securities are redeemable in whole at par or, if greater, a make-whole amount. Otherwise, the Capital Securities are generally redeemable in whole or in part on or after April 1, 2008, at a declining redemption price ranging from 104.58% to 100% of the liquidation amount. On or after April 1, 2018, the Capital Securities may be redeemed at 100% of the liquidation amount. After deducting expenses incurred in the issuance, the Company received proceeds of $29.2 million from the Capital Securities offering. The obligations outstanding under Capital Trust II and the Capital Trust are classified as "Corporation-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely junior subordinated debentures of City Holding Company" in the liabilities section of the consolidated balance sheets. Distributions on the Capital Securities and 12
Capital Securities II are recorded in the consolidated statements of income as interest expense. The Company's interest payments on the Debentures and the Debentures II are fully tax deductible. NOTE F - COMMITMENTS AND CONTINGENT LIABILITIES In the normal course of business, certain financial products are offered by the Company to accommodate the financial needs of its customers. Loan commitments (lines of credit) represent the principal off-balance sheet financial product offered by the Company. At June 30, 2000, commitments outstanding to extend credit totaled approximately $285.96 million. To a much lesser extent, the Company offers standby letters of credit, which require payments to be made on behalf of customers when certain specified future events occur. Amounts outstanding pursuant to such standby letters of credit were $35.94 million as of June 30, 2000. Substantially all standby letters of credit have historically expired unfunded. Both of the above arrangements have credit risks essentially the same as that involved in extending loans to customers and are subject to the Company's standard credit policies. Collateral is obtained based on management's credit assessment of the customer. Management does not anticipate any material losses as a result of these commitments. NOTE G - NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The provisions of this statement require that derivative instruments be carried at fair value on the balance sheet and allows hedge accounting when specific criteria are met. The provisions of this statement, as amended, become effective for quarterly and annual reporting beginning January 1, 2001. The impact of adopting the provisions of this statement on the Company's financial position or results of operations subsequent to the effective date is not currently estimable and will depend on the financial position of the Company and the nature and purpose of the derivative instruments in use by management at that time. NOTE H - SEGMENT INFORMATION The Company operates the following business segments: community banking, mortgage banking, and other financial services. These business segments are primarily identified by the products or services offered and the channels through which the product or service is offered. The community banking operations consists of various community banks that offer customers traditional banking products and services through various delivery channels. The mortgage banking operations include the origination, acquisition, servicing, and sale of mortgage loans. The other financial services business segment consists of nontraditional services offered to customers, such as investment advisory, insurance, and internet 13
technology products. Another defined business segment of the Company is corporate support, which includes the parent company and other support needs. To more effectively evaluate and manage the operating performance of each of the Company's business lines, effective April 1, 1999 internal warehouse funding was established for each division within the mortgage-banking and other financial services segments. Prior to April 1, 1999, the community-banking segment provided necessary funding to the divisions within the mortgage-banking and other financial services segments with no associated interest charged to those divisions. Beginning April 1, 1999, any division that has obtained financing from the community-banking segment is charged a cost of funds, at market interest rates, on the amount of funds borrowed from the community- banking segment. Management has determined that the internal warehouse funding policy provides a "fully-costed" assessment of the operating performance of each division and that instituting such policy provides a more accurate analysis of the performance of each division and business segment. Financial information presented in the following tables has been presented reflecting the actual internal policy in place during each respective period. 14
The accounting policies for each of the business segments are the same as those of the Company. Services provided to the banking segments by the divisions within the other financial services segment are eliminated in consolidation. Selected segment information is included in the following tables: <TABLE> <CAPTION> Other Community Mortgage Financial General (in thousands) Banking Banking Services Corporate Eliminations Consolidated ---------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> For the six months ended June 30, 2000 Net interest income (expense) $ 52,741 $ (5,108) $ (136) $(1,011) $ - $ 46,486 Provision for loan losses 4,170 - - - - 4,170 ---------------------------------------------------------------------------- Net interest income after provision for loan losses 48,571 (5,108) (136) (1,011) - 42,316 Other income 9,213 12,304 7,238 1,145 (4,263) 25,637 Other expenses 38,708 14,611 7,559 5,067 (4,263) 61,682 ---------------------------------------------------------------------------- Income before income taxes 19,076 (7,415) (457) (4,933) - 6,271 Income tax expense (benefit) 6,612 (2,947) (141) (1,568) - 1,957 ---------------------------------------------------------------------------- Net Income (loss) $ 12,464 $ (4,468) $ (316) $(3,365) $ - $ 4,314 ============================================================================ Average assets $2,766,776 $182,513 $13,306 $10,286 $(185,637) $2,787,244 ============================================================================ For the six months ended June 30, 1999 Net interest income (expense) $ 52,049 $ (487) $ (200) $ (608) $ - $ 50,754 Provision for loan losses 4,643 - - - - 4,643 ---------------------------------------------------------------------------- Net interest income after provision for loan losses 47,406 (487) (200) (608) - 46,111 Other income 18,582 20,291 6,942 2 (3,687) 42,130 Other expenses 40,516 20,250 8,265 3,410 (3,687) 68,754 ---------------------------------------------------------------------------- Income before income taxes 24,472 (446) (1,523) (4,016) - 19,487 Income tax expense (benefit) 9,450 (141) (493) (1,568) - 7,248 ---------------------------------------------------------------------------- Net Income (loss) $ 16,022 $ (305) $(1,030) $(2,448) $ - $ 12,239 ============================================================================ Average assets $2,394,206 $359,464 $12,464 $14,914 $ (86,618) $2,694,430 ============================================================================ </TABLE> 15
<TABLE> <CAPTION> Other Community Mortgage Financial General (in thousands) Banking Banking Services Corporate Eliminations Consolidated ---------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> For the three months ended June 30, 2000 Net interest income (expense) $ 26,303 $ (2,264) $ (64) $ (525) $ - $ 23,450 Provision for loan losses 2,085 - - - - 2,085 ---------------------------------------------------------------------------- Net interest income after provision for loan losses 24,218 (2,264) (64) (525) - 21,365 Other income 4,607 5,326 3,848 1,140 (2,932) 11,989 Other expenses 21,264 7,147 4,110 3,319 (2,932) 32,908 ---------------------------------------------------------------------------- Income before income taxes 7,561 (4,085) (326) (2,704) - 446 Income tax expense (benefit) 2,705 (2,420) (102) (33) - 151 ---------------------------------------------------------------------------- Net Income (loss) $ 4,856 $ (1,665) $ (224) $(2,671) $ - $ 295 ============================================================================ Average assets $2,783,799 $203,091 $12,908 $ 8,532 $(183,602) $2,824,728 ============================================================================ For the three months ended June 30, 1999 Net interest income (expense) $ 27,562 $ (2,727) $ (213) $ (267) $ - $ 24,355 Provision for loan losses 2,229 - - - - 2,229 ---------------------------------------------------------------------------- Net interest income after provision - for loan losses 25,333 (2,727) (213) (267) 22,126 Other income 12,493 13,620 2,379 (55) (726) 27,711 Other expenses 21,181 13,093 3,708 879 (726) 38,135 ---------------------------------------------------------------------------- Income before income taxes 16,645 (2,200) (1,542) (1,201) - 11,702 Income tax expense (benefit) 6,545 (838) (520) (479) - 4,708 ---------------------------------------------------------------------------- Net Income (loss) $ 10,100 $ (1,362) $(1,022) $ (722) $ - $ 6,994 ============================================================================ Average assets $2,539,171 $328,474 $13,924 $20,836 $(191,277) $2,711,128 ============================================================================ </TABLE> NOTE I - SUBSEQUENT EVENT On July 12, 2000, the Company announced that its principal bank subsidiary, City National Bank of West Virginia, had entered into a formal agreement with the Comptroller of the Currency. The agreement requires City National to adopt a three-year comprehensive strategic plan, improve its loan portfolio management, and develop and adhere to a written plan for liquidity, asset and liability management policy. City National also must incorporate liquidity planning in its financial management process, implement a satisfactory program to manage interest rates, and ensure full compliance of its securitization program with recent OCC regulations. Additionally, City National must develop a plan to dispose of loans held for sale that are held in excess of 90 days, develop a three-year capital plan, strengthen internal controls and its audit committee, and establish a program to maintain an adequate allowance for loan and lease losses. Additionally, as a consequence of entering into this agreement, City National must adhere to certain FDIC restrictions regarding the issuance of brokered deposits. City National is also required to maintain its current capital ratios and to establish a committee of its Board of Directors to oversee its compliance with the agreement. 16
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL SUMMARY Six Months Ended June 30, 2000 vs. 1999 Consolidated net income for the six months ended June 30, 2000 was $4.31 million or $0.26 per diluted common share, compared to $12.24 million or $0.73 per diluted common share for the six months ended June 30, 1999. Return on average assets ("ROA") was 0.31% and return on average equity ("ROE") was 4.33% for the six months ended June 30, 2000. ROA and ROE were 0.91% and 11.08%, respectively, for the same period in 1999. The $7.93 million, or 64.75%, decline in net income for the first six months of 2000 was primarily due to an $18.04 million, or 42.82%, decline in non-interest income and non-recurring expenses recorded in the second quarter of 2000. As more fully discussed under the caption Other Income and Expenses, the Company recognized an $8.68 million pre-tax gain on the sale of six branch locations during the first six months of 1999. Additionally, income generated by the mortgage banking segment (primarily loan sale gains, loan origination fees, and loan servicing fees) declined from $20.54 million during the first half of 1999 to $12.37 million during the same period of 2000. Non-recurring expenses of $2.32 million, after taxes, were recorded during the second quarter of 2000, including $1.55 million attributable to expenses incurred by the Company associated with the termination and non-competition agreements signed with former officers of the Company and $767,000 associated with the downsizing of the Company's Specialty Finance operations in California. As further discussed under Net Interest Income, the Company's net interest income declined $4.27 million, or 8.41%, from $50.75 million during the first six months of 1999 to $46.49 million during the same period of 2000. Partially offsetting the declines in net interest income and non-interest income, non-interest expense declined $7.07 million, or 10.29%, from 1999 to 2000, primarily as a result of decreased advertising costs (see Other Income and Expenses). Three Months Ended June 30, 2000 vs. 1999 Consolidated net income for the three months ended June 30, 2000 was $295,000 or $0.02 per diluted common share, compared to $6.99 million or $0.42 per diluted common share for the three months ended June 30, 1999. ROA was 0.04% and ROE was 0.59% for the three months ended June 30, 2000. ROA and ROE were 1.03% and 12.68%, respectively, for the same period in 1999. The $6.70 million, or 95.78%, decline in net income was primarily due to declines in non-interest income of $15.72 million, or 56.74% from 1999 to 2000, and non-recurring charges against income recorded during the quarter ended June 30, 2000. During the second quarter of 1999, the Company recorded an $8.68 million pre-tax gain on the sale of six branch 17
locations. Additionally, income from mortgage banking activities declined $8.35 million, or 59.93%, from $13.94 million during the second quarter of 1999 to $5.59 million during the second quarter of 2000. Partially offsetting the decline in non-interest income, non-interest expense declined $5.23 million, or 13.71%, from $38.14 million for the quarter ended June 30, 1999 to $32.91 million for the quarter ended June 30, 2000. This decline was primarily due to a $7.20 million decline in advertising costs. As previously discussed, the Company recorded non-recurring expenses of approximately $2.32 million, after taxes, during the second quarter of 2000. Of this total, $1.55 million was attributable to expenses incurred by the Company associated with the termination and non-competition agreements signed with former officers of the Company and $767,000 associated with the downsizing of its Specialty Finance operations in California. NET INTEREST INCOME Six Months Ended June 30, 2000 vs. 1999 Primarily as a result of significant declines in interest income within the mortgage banking segment and higher overall funding costs, net interest income (tax equivalent basis) declined $4.37 million, or 8.39%, for the first six months of 2000, as compared to the first six months of 1999. Although interest income earned on the Company's core loan portfolio increased $9.60 million, or 12.93%, during the first six months of 2000, as compared to the same period of 1999, interest earned on the Company's loans held for sale portfolio declined $3.91 million, or 37.07%, during the same period. The decline in interest earned on the loans held for sale portfolio was due primarily to a $108.79 million decline in the average balance of loans held for sale, reflecting the Company's reduced participation in the Specialty Finance sector. Additionally, management has suspended the accrual of interest income on the Company's retained interests due to the actual performance of the underlying collateral loans and revised forecasts associated with the expected timing of the receipt of cash flows by the Company. As a result, interest income derived from retained interests declined $2.59 million, or 96.75%, from $2.67 million for the first half of 1999, to $87,000 for the same period of 2000. Interest income recognized during 2000 represents interest earned, and cash received, resulting from funds invested during the interim period between the receipt of cash from borrowers and the subsequent payment of cash to noteholders. Total funding costs increased $7.16 million, or 14.95%, from $47.91 million for the first six months of 1999, to $55.08 million for the first six months of 2000. This increase was primarily due to a $5.09 million, or 111.83%, increase in interest expense incurred on the Company's short-term borrowings during the first half of 2000, as compared to 1999. A $109.36 million increase in the average balance of short-term borrowings, coupled with a 172 basis point increase in the 18
average cost of short-term borrowings resulted in this increased interest expense. General economic conditions throughout the country have resulted in a series of interest rate increases over the last several months by the Federal Reserve. Such increases have resulted in an increased funding cost incurred by the Company. Additionally, the Company has experienced significant loan growth and moderate declines in the average balance of its deposit balances since March 1999, resulting in an increased reliance on short-term funding. During 1999, the Company sold certain branch facilities, including approximately $121.48 million of deposits, as required by regulatory authorities for approval of the Company's merger of Horizon Bancorp. The decline in the average balance of the Company's deposits is primarily due to the aforementioned branch sales. See Market Risk Management, herein, for a further discussion of the Company's liquidity position. Three Months Ended June 30, 2000 vs. 1999 Net interest income (tax equivalent basis) declined $955,000, or 3.81%, from $25.04 million for the second quarter of 1999, to $24.08 million for the second quarter of 2000. Growth within the Company's core loan portfolio resulted in a $6.24 million increase in interest income. This increase, however, was largely offset by a decline in interest earned on retained interests and higher overall funding costs. As noted above, management has suspended the accrual of interest income on the Company's retained interests. As a result, interest income derived from retained interests declined $1.38 million, or 96.78%, from $1.43 million for the second quarter of 1999, to $46,000 for the second quarter of 2000. Total funding costs increased $5.08 million, or 21.41%, from $23.72 million for the second quarter of 1999, to $28.80 million for the same period of 2000. This increase was due to a $2.45 million, or 13.76%, increase in interest expense associated with the Company's deposit balances and a $2.38 million, or 91.78%, increase in interest expense associated with short-term borrowings from the second quarter of 1999 to 2000. As noted above, recent increases in interest rates by the Federal Reserve have resulted in a significant increase in the Company's funding costs. Additionally, and as more fully discussed under the caption Market Risk Management, to fund core loan growth and compensate for declines in core deposit balances, the Company has increased its reliance on the issuance of brokered certificates of deposit. Generally, brokered certificates of deposit represent a higher cost of funding than core deposits obtained through the Company's branch market areas. Increases in the volume of brokered certificates of deposit issued by the Company have added to the Company's overall higher funding costs. 19
AVERAGE BALANCE SHEETS and NET INTEREST INCOME (in thousands) <TABLE> <CAPTION> Six months ended June 30, 2000 1999 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ----------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Assets Loan portfolio (1) $1,941,559 $ 83,868 8.64% $1,743,106 $ 74,265 8.52% Loans held for sale 117,903 6,632 11.25 226,694 10,539 9.30 Securities: Taxable 266,878 8,505 6.37 284,458 8,530 6.00 Tax-exempt (2) 96,569 3,629 7.52 104,308 3,925 7.53 ----------------------------------------------------------------------------- Total securities 363,447 12,134 6.68 388,766 12,455 6.41 Retained interest in securitized loans 76,957 87 0.23 72,413 2,673 7.38 Federal funds sold 3,274 112 6.84 5,948 110 3.70 ----------------------------------------------------------------------------- Total earning assets 2,503,140 $102,833 8.22% 2,436,927 $100,042 8.21% Cash and due from banks 75,316 94,094 Bank premises and equipment 64,687 69,522 Other assets 171,435 112,115 Less: allowance for possible loan losses (27,334) (18,228) ----------------------------------------------------------------------------- Total assets $2,787,244 $2,694,430 ============================================================================= Liabilities Demand deposits $ 415,805 $ 6,273 3.02% $ 364,251 $ 5,511 3.03% Savings deposits 326,159 5,473 3.36 336,150 5,011 2.98 Time deposits 1,021,472 26,494 5.19 1,025,388 25,848 5.04 Short-term borrowings 329,091 9,636 5.86 219,727 4,549 4.14 Long-term debt 105,443 3,193 6.06 104,076 2,999 5.76 Trust preferred securities 87,500 4,008 9.16 87,500 3,996 9.13 ----------------------------------------------------------------------------- Total interest-bearing liabilities 2,285,470 55,077 4.82 2,137,092 47,914 4.48 Demand deposits 244,173 287,017 Other liabilities 58,250 49,303 Stockholders' equity 199,351 221,018 ----------------------------------------------------------------------------- Total liabilities and stockholders' equity $2,787,244 $2,694,430 ============================================================================= Net interest income $ 47,756 $ 52,128 ============================================================================= Net yield on earning assets 3.82% 4.28% ============================================================================= </TABLE> (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) Computed on a fully federal tax-equivalent basis assuming a tax rate of approximately 35%. 20
RATE VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE (in thousands) <TABLE> <CAPTION> Six months ended June 30, 2000 vs. 1999 Increase (Decrease) Due to Change In: Volume Rate Net --------------------------------------------- <S> <C> <C> <C> Interest-earning assets: Loan portfolio $ 8,560 $ 1,043 $ 9,603 Loans held for sale (8,875) 4,968 (3,907) Securities: Taxable (1,075) 1,050 (25) Tax-exempt (1) (291) (5) (296) --------------------------------------------- Total securities 1,366 1,045 (321) Retained interest in securitized loans 473 (3,059) (2,586) Federal funds sold (129) 131 2 --------------------------------------------- Total interest-earning assets $(1,337) $ 4,128 $ 2,791 ============================================= Interest-bearing liabilities: Demand deposits $ 809 $ (47) $ 762 Savings deposits (393) 855 462 Time deposits (273) 919 646 Short-term borrowings 2,776 2,311 5,087 Long-term debt 40 154 194 Trust preferred securities - 12 12 --------------------------------------------- Total interest-bearing liabilities $ 2,959 $ 4,204 $ 7,163 ============================================= Net Interest Income $(4,296) $ (76) $(4,372) ============================================= </TABLE> (1) Fully federal taxable equivalent using a tax rate of 35%. The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. 21
AVERAGE BALANCE SHEETS and NET INTEREST INCOME (in thousands) <TABLE> <CAPTION> Three months ended June 30, 2000 1999 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ----------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Assets Loan portfolio (1) $1,976,355 $43,359 8.78% $1,747,574 $37,120 8.50% Loans held for sale 119,792 3,391 11.32 193,629 3,976 8.21 Securities: Taxable 264,357 4,225 6.39 283,751 4,256 6.00 Tax-exempt (2) 97,776 1,801 7.37 104,049 1,943 7.47 ----------------------------------------------------------------------------------- Total securities 362,133 6,026 6.66 387,800 6,199 6.39 Retained interest in securitized loans 76,956 46 0.24 78,518 1,429 7.28 Federal funds sold 2,912 54 7.42 3,546 29 3.27 ----------------------------------------------------------------------------------- Total earning assets 2,538,148 $52,876 8.33% 2,411,067 $48,753 8.09% Cash and due from banks 76,031 118,874 Bank premises and equipment 63,934 68,502 Other assets 174,140 131,312 Less: allowance for possible loan losses (27,526) (18,627) ----------------------------------------------------------------------------------- Total assets $2,824,727 $2,711,128 =================================================================================== Liabilities Demand deposits $ 411,490 $ 3,109 3.02% $ 382,007 $ 2,958 3.10% Savings deposits 322,956 2,717 3.37 330,425 2,461 2.98 Time deposits 1,075,291 14,393 5.35 1,005,116 12,354 4.92 Short-term borrowings 326,875 4,969 6.08 248,049 2,591 4.18 Long-term debt 94,852 1,604 6.76 103,307 1,356 5.25 Trust preferred securities 87,500 2,004 9.16 87,500 1,998 9.13 ----------------------------------------------------------------------------------- Total interest-bearing liabilities 2,318,964 28,796 4.97 2,156,404 23,718 4.40 Demand deposits 247,609 280,326 Other liabilities 58,356 53,698 Stockholders' equity 199,798 220,700 ----------------------------------------------------------------------------------- Total liabilities and stockholders' equity $2,824,727 $2,711,128 =================================================================================== Net interest income $24,080 $25,035 =================================================================================== Net yield on earning assets 3.79% 4.15% =================================================================================== </TABLE> (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) Computed on a fully federal tax-equivalent basis assuming a tax rate of approximately 35%. 22
RATE VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE (in thousands) <TABLE> <CAPTION> Three months ended June 30, 2000 vs. 1999 Increase (Decrease) Due to Change In: Volume Rate Net -------------------------------------------- <S> <C> <C> <C> Interest-earning assets: Loan portfolio $ 4,987 $ 1,252 $ 6,239 Loans held for sale (6,336) 5,751 (585) Securities: Taxable (1,155) 1,124 (31) Tax-exempt (1) (116) (26) (142) -------------------------------------------- Total securities (1,271) 1,098 (173) Retained interest in securitized loans (28) (1,355) (1,383) Federal funds sold (33) 58 25 -------------------------------------------- Total interest-earning assets $(2,681) $ 6,804 $ 4,123 ============================================ Interest-bearing liabilities: Demand deposits $ 552 $ (401) $ 151 Savings deposits (341) 597 256 Time deposits 896 1,143 2,039 Short-term borrowings 977 1,401 2,378 Long-term debt (637) 885 248 Trust preferred securities - 6 6 -------------------------------------------- Total interest-bearing liabilities $ 1,447 $ 3,631 $ 5,078 ============================================ Net Interest Income $(4,128) $ 3,173 $ (955) ============================================ </TABLE> (1) Fully federal taxable equivalent using a tax rate of 35%. The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. 23
LOAN PORTFOLIO The composition of the Company's loan portfolio as of June 30, 2000 and December 31, 1999, is presented in the following table: June 30, 2000 December 31, 1999 ----------------------------------- Commercial, financial and agricultural $ 575,817 $ 589,116 Real estate-mortgage 981,685 949,830 Installment loans to individuals 448,967 347,168 ----------------------------------- Total loans $2,006,469 $1,886,114 =================================== Allowance and Provision for Loan Losses Management systematically monitors the loan portfolio and the adequacy of the allowance for loan losses on a monthly basis to provide for losses in the portfolio. Through the Company's internal loan review department, 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 detail 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 historical charge-off percentages and general economic conditions. 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 charge-off history and general economic conditions, with less emphasis placed on specifically reviewing individual credits, unless circumstances suggest that specific reviews are necessary. In these categories, specific loan reviews would be conducted on higher balance and higher risk loans. In evaluating the adequacy of the allowance, 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. Reserves not specifically allocated to individual credits are generally determined by analyzing potential exposure and other qualitative factors that could negatively impact the adequacy of the allowance. Determination of such reserves is subjective in nature and requires management to periodically reassess the validity of its assumptions. Differences between net charge-offs 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. At June 30, 2000, the allowance for loan losses was $27.87 million or 1.39% of total period-end loans compared to $27.11 million or 1.44% as of December 31, 1999. For further information regarding the 24
Company's allowance for loan losses, refer to the consolidated financial statements and footnotes thereto included in the City Holding Company annual report on Form 10-K for the year ended December 31, 1999. As of June 30, 2000, management is of the opinion that the consolidated allowance for loan losses is adequate to provide for losses on existing loans within the portfolio. The provision for loan losses for the first six months of 2000 was $4.17 million, compared to $4.64 million for the first half of 1999. This represents a $473,000, or 10.19%, decline in the provision for loan losses in 2000, as compared to 1999. While year-to-date net charge-offs remained relatively unchanged ($3.46 million in 1999, as compared to $3.41 million in 2000), non- performing loans have declined $4.88 million, or 25.35%, from $19.23 million at June 30, 1999, to $14.36 million at June 30, 2000. The decline in non-performing loans from period-to-period resulted in the slightly lower loan loss provision through June 30, 2000. <TABLE> <CAPTION> Six months ended Year ended June 30, December 31, Allowance for Loan Losses 2000 1999 ------------------------------------- <S> <C> <C> Balance at beginning of year $27,113 $ 17,610 Charge-offs: Commercial, financial and agricultural (507) (3,925) Real estate-mortgage (499) (1,142) Installment loans to individuals (3,656) (7,185) ------------------------------------- Totals (4,662) (12,252) Recoveries: Commercial, financial and agricultural 213 81 Real estate-mortgage 124 301 Installment loans to individuals 915 1,349 ------------------------------------- Totals 1,252 1,731 ------------------------------------- Net charge-offs (3,410) (10,521) Provision for loan losses 4,170 19,286 Balance of acquired institution - 738 ------------------------------------- Balance at end of period $27,873 $ 27,113 ===================================== As a Percent of Average Total Loans: Net charge-offs 0.35% 0.59% Provision for loan losses 0.43 1.08 As a Percent of Non-performing Loans: Allowance for loan losses 194.16% 168.55% </TABLE> 25
<TABLE> <CAPTION> June 30, 2000 December 31, 2000 ----------------------------------------------- <S> <C> <C> Summary of Non-performing Assets Non-accrual loans $11,995 $ 8,844 Accruing loans past due 90 days or more 1,673 5,126 Restructured loans 688 879 ----------------------------------------------- Total non-performing loans 14,356 14,849 Other real estate owned 5,265 2,626 ----------------------------------------------- Total non-performing assets $19,621 $17,475 =============================================== </TABLE> LOANS HELD FOR SALE Loans held for sale represent mortgage loans the Company has either purchased or originated with the intent to sell and includes traditional fixed- rate and junior lien mortgage loans. Certain traditional fixed-rate mortgages are originated by the Company, with the intent to sell, servicing released, in the secondary market. This product line enables the Company to provide conventional, fixed-rate mortgage products to its customers, but minimize the interest-rate risk associated with fixed-rate loans. At June 30, 2000, conventional mortgage loans represented $32.41 million or 35.30% of the reported balance of loans held for sale. Following a series of actions taken during 1999 to restructure and downsize its California Specialty Finance loan origination operations, the Company effectively closed these locations during the second quarter of 2000 and transferred the remaining platform to its Reston, Virginia loan production offices. Such actions also included terminating the Company's loan securitization program. As a result of these actions, the Company has significantly reduced the volume of origination and acquisition of junior lien mortgage loans since the first quarter of 1999. Reflecting this reduced volume, the average balance of loans held for sale declined from $226.69 million for the first six months of 1999 to $117.90 million for the first six months of 2000. Through formal underwriting guidelines and quality control procedures, the Company has implemented policies and procedures to mitigate the risks associated with the junior lien mortgage product, including concentration risk, credit risk, and interest rate risk. Such policies and procedures addressed lending issues related to the creditworthiness of the borrower, credit scores, debt-to-income ratios, borrower credit histories, and other pertinent factors. Due to the nature of the junior lien mortgage loan, less emphasis is placed on the value of the underlying collateral, although property appraisals may be required for certain loans. 26
During the first six months of 2000, the Company originated $160.96 million and purchased $16.07 million in loans held for sale and sold $204.22 million during the same period. This compares to originations of $215.00 million, purchases of $129.89 million and sales of $490.47 million during the first six months of 1999. LOAN SECURITIZATIONS From December 1997 through May 1999, the Company completed six securitizations of junior lien mortgage loans. Subsequent to the May 1999 securitization, the Company terminated its securitization program. The securitization program was initiated by the Company as a means to mitigate the risk of originating and acquiring this loan product and to continue the growth of the Company's loan servicing portfolio. Each of the securitized pools is serviced by the Company's mortgage loan servicing division. By securitizing originated and purchased junior lien mortgage loans, the Company effectively removed these loans from its balance sheet by creating an investment security or securities, supported by the cash flows generated by these loans, and selling the resulting investment security or securities to independent third parties. As part of this process, the Company provided credit enhancement, in the form of overcollateralization, with respect to the investment security created. As a result, the Company maintains a certain level of credit, prepayment and interest rate risk related to these loans. The risk maintained by the Company, however, is less than that which would be maintained had the Company held these loans on its balance sheet until the loans matured. In return for this risk exposure, the Company expects to receive future income from each securitization that is determined as a function of the "excess spread" derived from the securitized loans. The "excess spread", generally, is calculated as the difference between (A) the interest at the stated rate paid by borrowers and (B) the sum of pass-through interest paid to third-party investors and various fees, including trustee, insurance, servicing, and other similar costs. The "excess spread" represents income to be recognized by the Company over the life of the securitized loan pool. As of June 30, 2000 and 1999, the Company reported retained interests in these securitized loan pools of approximately $76.95 million and $91.37 million, respectively, including accrued interest. Assumptions used to estimate the retained interest at June 30, 2000, include weighted average cumulative defaults approximating 13.77%, prepayment rates of 15-21% CPR, and a weighted- average discount rate of 14.00%. Management monitors the actual default and prepayment rates of each securitized pool on a monthly basis, in addition to the outstanding pool balance, to ensure the rates used to estimate the retained interest are still reasonable. Quarterly, management re-forecasts expected cash flows for each securitization, updating significant assumptions as necessary. To date, negative fair value adjustments approximating $21.57 million, pre-tax, have been recorded. Such fair value declines, deemed to be temporary, have been recorded through the 27
Other Comprehensive Income section with Stockholders' Equity. Adjustments to the estimated fair value of the retained interests are the result of both actual performance of the underlying collateral pools and revised expected timing of the receipt of cash flows by the Company. Although a fair value reduction has been recorded, re-forecasted cash flows as of June 30, 2000 project undiscounted cash flows to be received by the Company are 2.26 times the total retained interest values, before fair value adjustments. LOAN SERVICING At June 30, 2000 and 1999, the Company maintained a servicing portfolio of $1.64 billion and $1.93 billion, respectively. Of the total servicing portfolio, $1.55 billion and $1.81 billion represented loans serviced for others at June 30, 2000 and 1999, respectively. Loans serviced for others are not included in the Consolidated Balance Sheets of the Company. The Company has recorded mortgage loan servicing rights of $8.35 million and $11.22 million at June 30, 2000 and 1999, respectively, associated with the right to service mortgage loans for others. Included in Other Assets in the Consolidated Balance Sheets, the recorded value of mortgage servicing rights is assessed quarterly to determine if the value of those rights has become impaired during the period. In doing so, management estimates the present value of future net cash flows to be derived from its servicing activities. Factors included in the impairment analysis include anticipated servicing income, costs associated with servicing the portfolio, discount rates, and loan prepayment and default rates. As of June 30, 2000, management has determined, based on this analysis, that the recorded value of its servicing rights is fairly stated and there is no impairment in that value. OTHER INCOME AND EXPENSES Six Months Ended June 30, 2000 vs. 1999 Total Other Income declined $16.49 million, or 39.15%, from $42.13 million during the first six months of 1999, to $25.64 million during the same period of 2000. Due to the sale of six branch locations during the second quarter of 1999, a pre-tax gain of approximately $8.68 million was recorded and included in Other Income. Additionally, with the downsizing of the Company's California Specialty Finance loan origination operations throughout 1999 and into 2000, loan volume was significantly reduced. Corresponding to the reduced loan volume, net origination fee income declined $2.41 million, or 59.79%, from $4.03 million during the first six months of 1999, to $1.62 million in 2000. Similarly, the decline in the loan servicing portfolio resulted in a $1.55 million, or 13.69%, decline in loan servicing fees from 1999 to 2000. With reduced loan volume and the termination of the Company's loan securitization program after May 1999, gains recognized from loan 28
sales declined $4.22 million, or 80.93%, from $5.21 million during the first six months of 1999, to $993,000 during the same period of 2000. Total Other Expenses declined $7.07 million, or 10.29%, from $68.75 million during the first six months of 1999, to $61.68 million in 2000. This decline was primarily due to a $6.71 million, or 71.74%, decline in advertising expenses. The decline in advertising costs was largely due to the contraction of the Company's Specialty Finance operations. With the downsizing of those operations, the Company significantly reduced the volume of its nationwide direct mail solicitation of potential borrowers. Occupancy expense declined $2.87 million, or 43.15%, from $6.65 million during the first six months of 1999 to $3.78 million in 2000. This decline was primarily due to the reduced number of branch locations of City National and the contraction of the Company's Specialty Finance operations. Excluding non-recurring 2000 charges associated with the termination and non-competition agreements signed with certain former officers of the Company and charges for severance-related expenses, salaries and employee benefits expense declined $4.37 million, or 15.07%, from $28.99 million in 1999 to $24.62 million in 2000. The decline in compensation costs corresponds to a 8.76% decline in the number of full-time equivalents (FTEs) employed by the Company during these periods. As of June 30, 2000, the Company employed 1,438 FTEs, as compared to 1,576 FTEs as of June 30, 1999. These declines reflect the impact of the Company's downsizing of its California Specialty Finance operations and the reorganization within its community banking segment. Other expenses increased $3.96 million, or 21.82%, from $18.14 million during the first six months of 1999, to $22.10 million in 2000. This increase was primarily attributable to the expenses associated with the Reston, Virginia loan production office, which was opened in the fourth quarter of 2000. Three Months Ended June 30, 2000 vs. 1999 Total Other Income decreased $15.72 million, or 56.74%, from $27.71 million during the second quarter of 1999, to $11.99 million in 2000. As noted above, an $8.68 million gain resulting from the sale of six branch locations was recorded during the second quarter of 1999. Additionally, income derived from mortgage banking activities declined from $13.94 million during the second quarter of 1999 to $5.59 million in 2000. In addition to the impact of downsizing the Specialty Finance operations, the Company recognized a pre-tax loss of $716,000 on the sale of two pools of junior lien mortgage loans with a total book value of $27.12 million during the second quarter of 2000. The loss on the sale of these loan pools offset the gains recognized from recurring loan sale activity and is included in the $35,000 net loss on sale of loans reported for the three months ended June 30, 2000. 29
Total Other Expenses declined $5.23 million, or 13.71%, from $38.14 million during the second quarter of 1999 to $32.91 million in 2000. This decline was primarily due to a $7.20 million, or 87.47%, decline in advertising costs as discussed above. Occupancy expense declined $1.37 million, or 41.52%, from $3.31 million in 1999 to $1.93 million in 2000 due to restructuring within the mortgage banking and community banking segments, as previously discussed. Excluding non-recurring charges, compensation costs declined $1.58 million, or 11.45%, from $13.78 million during the second quarter of 1999 to $12.20 million in 2000. Other expenses increased $2.40 million, or 24.39%, from $9.83 million in 1999, to $12.22 million in 2000, primarily due to the Reston, Virginia loan production office. MARKET RISK MANAGEMENT Market risk is the risk of loss due to adverse changes in current and future cash flows, fair values, earnings or capital due to adverse movements in interest rates and other market factors, including foreign exchange rates and commodity prices. Because the Company has no significant foreign exchange activities and holds no commodities, interest rate risk represents the primary risk factor affecting the Company's balance sheet. The Company seeks to reduce interest rate risk through asset and liability management, where the goal is to optimize the balance between earnings and interest rate risk. The Company's asset and liability management function is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to such risks. Liquidity management is a significant factor in monitoring and managing the Company's exposure to market risk. The Company manages its liquidity position to provide necessary funding for asset growth and to ensure that the funding needs of its customers can be satisfied promptly. Growth within the Company's loan portfolio coupled with declines in deposit balances since March 1999 has resulted in the Company's need for increased short-term funding. Increased reliance on short-term funding facilities has increased the Company's exposure to interest rate risk and has resulted in an overall increase in funding costs. Such changes have had an adverse affect on the Company's net interest margin and overall profitability during the first six months of 2000. In recent months, the Company has instituted procedures to slow loan growth and to attract new deposit balances in an effort to reduce its reliance on external funding sources. Additionally, during the first six months of 2000, the Company issued an additional $162.17 million in brokered certificates of deposit through agreements maintained with various investment banking firms. As of June 30, 2000, the outstanding balance of brokered certificates of deposit approximated $174.62 million, compared to $28.04 million at December 31, 1999. As of June 30, 2000, the weighted average maturity of brokered certificates of deposit was less than one year and the weighted average interest rate to be paid by the Company 30
approximated 6.41%. Through additional issues sold subsequent to June 30, 2000, the outstanding balance of brokered certificates of deposit has increased to $212.31 million as of July 31, 2000. The additional issues have similar terms as those previously disclosed. Effective June 21, 2000, the Parent Company's Term Loan agreement was amended to provide for revised terms and conditions, including modifying the maturity date of the Term Loan from October 1, 2009, to March 31, 2001. As a result, the $16.00 million outstanding under the Term Loan as of June 30, 2000, is included in Short-term borrowings in the Consolidated Balance Sheets. The loan agreement requires a $1.60 million principal payment on October 1, 2000, with the remaining unpaid principal balance due at maturity. CAPITAL RESOURCES Stockholders' equity declined approximately $567,000, or 0.29%, from $198.54 million at December 31, 1999, to $197.98 million at June 30, 2000. During the first six months of 2000, the Company reported net income of $4.31 million and paid dividends to its shareholders of $4.73 million, thus reducing stockholders' equity by $411,000 during the period. Additionally, declines in the fair market value of the Company's securities available-for-sale portfolio resulted in an additional $348,000 decline in stockholders' equity during the period. Regulatory guidelines require the Company to maintain a minimum total capital to risk-adjusted assets ratio of 8 percent (Total capital ratio), with at least one-half of capital consisting of tangible common stockholders' equity (Tier I capital ratio) and a minimum Tier I leverage ratio of 4 percent (Leverage ratio). At June 30, 2000, the Company's total capital to risk-adjusted assets ratio was 10.99%, its Tier I capital ratio was 9.29%, and its leverage ratio was 8.65%. Similarly, the Company's banking subsidiaries are also required to maintain minimum capital levels as set forth by various regulatory agencies. Under capital adequacy guidelines, the banking subsidiaries are required to maintain minimum total capital, Tier I capital, and leverage ratios of 8.00%, 4.00%, and 4.00%, respectively. To be classified as "well capitalized," the banking subsidiaries must maintain total capital, Tier I capital, and leverage ratios of 10.00%, 6.00%, and 5.00%, respectively. As of June 30, 2000, the Company's lead bank, City National, reported total capital, Tier I capital, and leverage ratios of 11.88%, 10.82%, and 10.20%, respectively. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK The information called for by this item is provided under the caption "Market Risk Management" under Item 2--Management Discussion and Analysis of Financial Condition and Results of Operations. 31
PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is party to various legal actions that are incidental to its business. While the outcome of legal actions cannot be predicted with certainty, the Company believes that the outcome of any of these proceedings, or all of them combined, will not have a material adverse effect on its consolidated financial position, results of operations, or cash flows. See Note I - "Subsequent Events" for a description of City National Bank of West Virginia's formal agreement with the Comptroller of the Currency. Item 2. Changes in Securities On June 6, 2000, the Company issued 13,098 shares of its common stock to one of the previous owners of MarCom, Inc. pursuant to a Supplemental Purchase Agreement entered into on April 15, 1998, between City National Bank of West Virginia, a subsidiary of the Company, and the previous owners of MarCom, Inc. The Company's common stock issued in this transaction was not registered under the Securities Act of 1933, in reliance on Section 4(2) of such Act, as a transaction not involving any public offering. Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders: The Company held its Annual Meeting of Shareholders on July 17, 2000 at which time shareholders were to consider two proposals, as follows: 1. Election of six Class One (I) directors to serve for a term of three years. 2. Ratification of the Board of Directors' appointment of Ernst & Young LLP as independent auditors of the Company for 2000. The vote tabulation for each matter was as follows: 1. Election of Directors to the Board of Directors: Director Votes For Votes Withheld Abstentions - ------------------------------------------------------------------------------- Mark H Schaul 10,050,049 945,636 - David W. Hambrick 10,228,149 767,536 - Frank S. Harkins, Jr. 10,121,741 873,944 - Albert M. Tieche, Jr. 10,161,741 833,801 - Thomas E. Lilly 10,228,487 767,198 - James E. Songer, II 10,175,235 820,450 - 32
2. Ratification of the Board of Directors' appointment of Ernst & Young LLP as independent auditors of the Company for 2000: Votes For Votes Against Abstentions ----------------------------------------------------- 10,278,025 643,828 73,832 Item 5. Other Information None Item 6 Exhibits and Reports on Form 8-K: Exhibits Exhibit 11 - Computation of Earnings per Share Exhibit 27 - Financial Data Schedule for the six months ended June 30, 2000 Reports on Form 8-K On May 17, 2000, the Company filed a Current Report on Form 8-K, attaching a news release issued on May 15, 2000, announcing its second quarter 2000 dividend of eight cents per share. The announced dividend represented a decrease of 60% from 1999 cash dividends on an annualized basis. On June 15, 2000, the Company filed a Current Report on Form 8-K, attaching a news release issued on June 14, 2000, announcing the appointment of Robert A. Henson as Acting Chief Executive Officer of the Company. SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CITY HOLDING COMPANY Date: August 14, 2000 By: /s/ Michael D. Dean ---------------------------------- Michael D. Dean Senior Vice President - Finance, Chief Accounting Officer and Duly Authorized Officer 33