-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GyeGNo8N2zWOCFALdV8ROXLWWeuYVYhe9SsPyursqr79KaIlmZKmTszV8iRDLoVP xO7mNlmK9o0M5FRmHRBQZA== 0000916641-98-000234.txt : 19980317 0000916641-98-000234.hdr.sgml : 19980317 ACCESSION NUMBER: 0000916641-98-000234 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980316 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CITY HOLDING CO CENTRAL INDEX KEY: 0000726854 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 550619957 STATE OF INCORPORATION: WV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-11733 FILM NUMBER: 98566655 BUSINESS ADDRESS: STREET 1: 3601 MACCORKLE AVE SE CITY: CHARLESTON STATE: WV ZIP: 25304 BUSINESS PHONE: 3049256611 MAIL ADDRESS: STREET 1: 3601 MACCORKLE AVE SE CITY: CHARLESTON STATE: WV ZIP: 25301 10-K 1 CITY HOLDING 10-K EDGAR SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended Commission File Number December 31, 1997 0-11733 CITY HOLDING COMPANY (Exact name of registrant as specified in its charter) West Virginia 55-0619957 (State of other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 25 Gatewater Road Cross Lanes, West Virginia 25313 (Address of principal offices) Registrant's telephone number, including area code: (304) 769-1100 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $2.50 Par Value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. [x] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K. [x] The aggregate market value of the voting stock held by nonaffiliates of the registrant based on the closing price as of March 10, 1998 (Registrant has assumed that all of its executive officers and directors are affiliates. Such assumption shall not be deemed to be conclusive for any other purpose.): Aggregate Market Value -- $274,206,048 - -------------------------------------- The number of shares outstanding of the issuer's common stock as of March 10, 1998: Common Stock, $2.50 Par Value -- 6,456,906 shares - ------------------------------------------------- The total number of pages are 76 . Exhibit Index is located on page 17 . ----- ----- DOCUMENTS INCORPORATED BY REFERENCE Documents Part of Form 10-K into which Document is incorporated ------------------- Portions of the Annual Part I,Item 1; Part Report to Shareholders II, Items 5, 6, 7, of City Holding Company and 8; Part III, Item for the year ended 13; Part IV, Item 14. December 31, 1997. -------- Portions of City Holding Part III, Items 10, Company's Proxy statement 11, 12 and 13. for the 1998 Annual Meeting of Shareholders. -------- FORM 10-K INDEX PART I Page Item 1. Business 4 Item 2. Properties 11 Item 3. Legal Proceedings 11 Item 4. Submission of Matters to a Vote of Security Holders 11 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters 12 Item 6. Selected Financial Data 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 8. Financial Statements and Supplementary Data 12 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 12 PART III Item 10. Directors and Executive Officers of Registrant 12 Item 11. Executive Compensation 12 Item 12. Security Ownership of Certain Beneficial Owners and Management 12 Item 13. Certain Relationships and Related Transactions 13 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 13, 14 Signatures 15 Exhibit Index 17 PART I Item 1 Business (a) History City Holding Company (the Company), a West Virginia corporation headquartered in Cross Lanes, West Virginia, a suburb of Charleston, commenced operations in November 1983. The Company currently owns The City National Bank of Charleston (a wholly-owned subsidiary) (City National) and its banking divisions, The Peoples National Bank, First State Bank & Trust, The Bank of Ripley, Home National Bank of Sutton, Blue Ridge Bank, Peoples State Bank, The First National Bank of Hinton (Hinton), Merchants National Bank, and The Old National Bank of Huntington. City National and its banking divisions (collectively, the Bank) are retail and consumer-oriented community banks that emphasize personal service and currently operate 43 banking offices in 15 counties throughout the state of West Virginia. Prior to December 1997, these banking divisions of City National operated as separate affiliates. In December 1997, all banking affiliates' charters were combined into one, City National. However, as these banks became divisions of City National, they retained their historical names, management and Boards of Directors consistent with the Company's historical acquisition policy. The Company believes that retaining community loyalty is a prudent business practice and is beneficial in seeking future strategic acquisition opportunities for small to medium size banks, financial service companies and other entities. The most recent bank acquisition by the Company was the acquisition of The Old National Bank of Huntington (Old National) in January 1997, a $49 million bank located in Huntington, West Virginia. In addition, the Company intends to acquire Del Amo Savings Bank, FSB, a $115 million federally chartered savings bank in Torrance, California. This acquisition has been approved by the shareholders of Del Amo, but remains subject to regulatory approval. The Del Amo acquisition is expected to be consummated by the end of the first quarter of 1998. In addition to its banking divisions, as part of its strategy to diversify and expand into new areas of the financial services area, City National also operates seven non-banking divisions, City Mortgage Services, First Allegiance Financial Corporation (First Allegiance), City Credit Services, RMI, Ltd. (RMI), Jarrett-Aim Communications, Inc. (Jarrett-Aim), City Capital Markets Corporation, and CNB East Retail. City Mortgage Services, a mortgage loan servicing division headquartered in Cross Lanes, West Virginia, was formed to facilitate the Company's growth of its mortgage servicing portfolio. On December 31, 1996, the Company acquired certain assets and assumed certain liabilities of Prime Financial Corporation, a mortgage loan servicing company located in Costa Mesa, California, which increased the Company's mortgage loan servicing portfolio by approximately $600 million. This West Coast operation was absorbed into City Mortgage Services. In December 1997, this division was transferred from the Company to City National. In October 1997, City National acquired First Allegiance and created City Credit Services, both headquartered in Irvine, California, which are originators of junior lien mortgages for sale to independent third parties. On December 5, 1997, City National acquired RMI, an insurance agency located in Winfield, West Virginia. RMI offers a full range of insurance products and services, including employee benefit programs, key person programs, benefits consulting services, property and casualty insurance, retirement plans and deferred compensation plans, to select corporate associations and individual clients. In January 1998, City National completed its acquisition of Jarrett-Aim located in Charleston, West Virginia. Jarrett-Aim will print all of the Bank's forms, manage its warehouse and distribution functions as well as provide marketing and direct mail service. City Capital Markets Corporation, a wholly owned subsidiary of City National, was formed in December 1997 as a limited purpose finance company to effect the securitization of various types of mortgage loans and financial assets. CNB East Retail was created during the fourth quarter of 1997 as a separate retail loan origination division of City National. CNB East Retail is the east coast complement to the west coast retail originators, First Allegiance and City Credit Services, previously discussed. The creation of CNB East Retail gives the Company three separate retail origination platforms from which its products and services can be marketed. The Company, in addition to City National and its divisions, owns City Financial Corporation, a full service securities brokerage and investment advisory company, headquartered in Charleston, West Virginia with its office located in City National's main location. (b) Business The banking divisions are engaged in the business of banking in West Virginia by receiving and paying deposits; by negotiating promissory notes, drafts, bills of exchange and other evidence of debt; by buying and selling exchange; by loaning money secured by personal or real property, or both; by dealing in securities and stocks without recourse solely upon order, and for the account of customers, except for purchases of investment securities for its account under limitations and restrictions imposed by regulations of the Comptroller of the Currency; by providing trust services; by supplying credit card services as a licensee of Visa and MasterCard; by providing safe deposit box facilities and miscellaneous other services rendered by a full service bank. No material portion of the banking divisions' deposits are derived from a single person or a few persons, the loss of any one or more of which could have a material adverse effect on liquidity, capital, or other elements of financial performance. No material portion of the banking divisions' loans are concentrated within a single industry or group of related industries. The Company is a bank holding company. Consequently, it is generally dependent upon the Subsidiaries for cash necessary to pay expenses, dividends to its stockholders, and to meet debt service requirements. The Company's business is not seasonal and has no foreign sources or applications of funds. There are no anticipated material capital expenditures, or any expected material effects on earnings or the Company's competitive position as a result of compliance with federal, state and local provisions enacted or adopted relating to environmental protection. (c) Regulation and Supervision Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulators. The following description briefly discusses certain provisions of federal and state laws and certain regulations and the potential impact of such provisions to which the Company and its banking divisions are subject. These federal and state laws and regulations have been enacted for the protection of depositors in national and state banks and not for the protection of shareholders of bank holding companies. Bank Holding Companies As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHCA"), the Company is subject to regulation by the Federal Reserve Board. The Federal Reserve Board has jurisdiction under the BHCA to approve any bank or nonbank acquisition, merger or consolidation proposed by a bank holding company. The BHCA generally limits the activities of a bank holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity which is so closely related to banking or to managing or controlling banks as to be a proper incident thereto. Prior to June 1, 1997, federal law prohibited bank holding companies from any one state to acquire banks and bank holding companies located in any other state. Subsequent to this date, the law allows interstate bank mergers, subject to earlier "opt-in" or "opt-out" action by individual states. West Virginia adopted early "opt-in" legislation that allows interstate bank mergers. These laws also permit interstate branch acquisitions and de novo branching in West Virginia by out-of-state banks if reciprocal treatment is accorded West Virginia banks in the state of the acquiror. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance fund in the event the depository institution becomes in danger of default or in default. For example, under a policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise. In addition, the "cross-guarantee" provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the Bank Insurance Fund (BIF) as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the BIF. The FDIC's claim for reimbursement is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution. The Federal Deposit Insurance Act (FDIA) also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision would give depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of any of the banking divisions. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to approve the ownership of shares by a bank holding company in any company the activities of which the Federal Reserve Board has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. The Federal Reserve Board has by regulation determined that certain activities are closely related to banking within the meaning of the BHCA. These activities include: operating a mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing investment and financial advice; and acting as an insurance agent for certain types of credit-related insurance. The Company is registered under the bank holding company laws of West Virginia. Accordingly, the Company and its banking divisions are subject to further regulation and supervision by the WV Division of Banking. Capital Requirements The Federal Reserve Board and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Under the risk-based capital requirements of these federal bank regulatory agencies, the Company and City National are required to maintain a minimum ratio of total capital to risk-weighted assets of at least 10% in order to remain categorized as well capitalized. At least half of the total capital is required to be "Tier 1 capital", which consists principally of common and certain qualifying preferred shareholders' equity, less certain intangibles and other adjustments. The remainder "Tier 2 capital" consists of a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments) and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company as of December 31, 1997 were 9.2% and 10.00%, respectively, meeting the minimums required. In addition, each of the federal regulatory agencies has established a minimum leverage capital ratio (Tier 1 capital to average tangible assets). These guidelines provide for a minimum ratio of 4% for banks and bank holding companies that meet certain specified criteria, including that they have the highest regulatory examination rating and are not contemplating significant growth or expansion. All other institutions are expected to maintain a leverage ratio of at least 100 to 200 basis points above the minimum. The Tier 1 capital leverage ratio of the Company as of December 31, 1997, was 6.5%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multi-family mortgages. Rules have been promulgated with respect to concentration of credit risk and the risks of non-traditional activities, and also as to the risk of loss on multi-family mortgages. A proposed rule with respect to interest rate risk is still under consideration. The proposal would allow institutions to use internal risk models to measure interest rate risk (if the models are acceptable to examiners) and would require additional capital of institutions identified as having excess interest rate risk. The Company does not expect any of these rules, either individually or in the aggregate, to have a material impact on its capital requirements. Limits on Dividends and Other Payments The Company is a legal entity separate and distinct from its Subsidiaries. Most of the Company's revenues result from the dividends paid to the Company by those Subsidiaries. The right of the Company, and shareholders of the Company, to participate in any distribution of the assets or earnings of any Subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of such Subsidiary, except to the extent that claims of the Company in its capacity as a creditor may be recognized. Moreover, there are various legal limitations applicable to the payment of dividends to the Company as well as the payment of dividends by the Company to its shareholders. Under federal law, the Company's Subsidiaries may not, subject to certain limited expectations, make loans or extensions of credit to, or investment in the securities of, or take securities of the Company as collateral for loans to any borrower. The Company's Subsidiaries are also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions. City National is subject to various statutory restrictions on its ability to pay dividends to the Company. Under applicable regulations, at December 31, 1997, City National could have paid aggregate dividends to the Company of $25.7 million without obtaining prior approval of the Office of the Comptroller of the Currency (the OCC). The payment of dividends by the Company and the banking divisions may also be limited by other factors, such as requirements to maintain adequate capital above regulatory guidelines. The OCC, which supervises City National, has the authority to prohibit any bank under their jurisdiction from engaging in an unsafe and unsound practice in conducting its business. The payment of dividends, depending upon the financial condition of the subsidiary in question, could be deemed to constitute such an unsafe or unsound practice. The Federal Reserve Board and the OCC have indicated their view that it generally would be an unsafe and unsound practice to pay dividends except out of current operating earnings. The Federal Reserve Board has stated that, as a matter of prudent banking, a bank or bank holding company should not maintain its existing rate of cash dividends on common stock unless (1) the organization's net income available to common shareholders over the past year has been sufficient to fund fully the dividends and (2) the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality, and overall financial condition. Moreover, the Federal Reserve Board has indicated that bank holding companies should serve as a source of managerial and financial strength to their subsidiary banks. Accordingly, the Federal Reserve Board has stated that a bank holding company should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the bank holding company's ability to serve as a source of strength. The ability of the Company's subsidiaries to pay dividends in the future is, and is expected to continue to be, influenced by regulatory policies and by capital guidelines. The OCC has broad discretion in developing and applying policies and guidelines, in monitoring compliance with existing policies and guidelines, and in determining whether to modify such policies and guidelines. FDICIA In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) became effective. FDICIA substantially revised the depository institution regulatory and funding provisions of the Federal Deposit Insurance Act and revised several other federal banking statutes. Banks City National and its banking divisions are subject to supervision and regulation by the OCC, the Federal Reserve Board and the FDIC. The various laws and regulations administered by the regulatory agencies affect corporate practices, such as payment of dividends, incurring debt and acquisition of financial institutions and other companies, and affect business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. Governmental Policies The operations of the Company and its banking divisions are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the Federal Reserve Board regulates money and credit and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The Federal Reserve Board has adopted regulations establishing relevant capital measures and relevant capital levels for banks. The relevant capital measures are the total risk-adjusted capital ratio, Tier I risk-adjusted capital ratio and the leverage ratio. Under the regulations, a bank is considered (i) well capitalized if it has a total capital ratio of ten percent or greater, a Tier 1 capital ratio of six percent or greater and a leverage ratio of five percent or greater and is not subject to any order or written directive by such regulator to meet and maintain a specific capital level for any capital measure, (ii) adequately capitalized if it has a total capital ratio of eight percent or greater, a Tier I capital ratio of four percent or greater and a leverage ratio of four percent or greater (three percent in certain circumstances) and is not well capitalized, (iii) undercapitalized if it has a total capital ratio of less than eight percent, a Tier 1 capital ratio of less than four percent or a leverage ratio of less than four percent (three percent in certain circumstances), (iv) significantly undercapitalized if it has a total capital ratio of less than six percent, a Tier 1 capital ratio of less than three percent or a leverage ratio of less than three percent, and (v) critically undercapitalized if its tangible equity is equal to or less than two percent of average quarterly tangible assets. As of December 31, 1997, City National had capital levels that qualify it as being well capitalized under such regulations. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve Board. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. In order to obtain acceptance of a capital restoration plan, a depository institution's holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution's assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. Furthermore, in the event of a bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator. Under FDICIA, a depository institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market. In addition, pass-through insurance coverage may not be available for certain employee benefit accounts. Various other legislation, including proposals to overhaul the banking regulatory system and to limit the investments that a depository institution may make with insured funds are from time to time introduced in Congress. The Company cannot determine the ultimate effect that such potential legislation, if enacted, would have upon its financial condition or operations. Other Safety and Soundness Regulations The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized" or "critically undercapitalized", as such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies. (d) Employees As of December 31, 1997, City Holding Company and Subsidiaries employed 1,136 associates. Employee relations within the Subsidiaries are considered to be satisfactory. (e) Statistical Information The information noted below is provided pursuant to Guide 3 -- Statistical Disclosure by Bank Holding Companies. Page references are to the Annual Report to Shareholders for the year ended December 31, 1997 and such pages are incorporated herein by reference. Page Description of Information Reference - -------------------------- --------- 1. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential a. Average Balance Sheets 8 b. Analysis of Net Interest Earnings 9 c. Rate Volume Analysis of Changes in Interest Income and Expense 9 2. Investment Portfolio a. Book Value of Investments 18 b. Maturity Schedule of Investments 18 c. Securities of Issuers Exceeding 10% of Stockholders' Equity 18 3. Loan Portfolio a. Types of Loans 19 b. Maturities and Sensitivity to Changes in Interest Rates 20 c. Risk Elements 25 d. Other Interest Bearing Assets N/A 4. Summary of Loan Loss Experience 25, 26 5. Deposits a. Breakdown of Deposits by Categories, Average Balance and Average Rate Paid 8 b. Maturity Schedule of Time Certificates of Deposit and Other Time Deposits of $100,000 or More 26 6. Return on Equity and Assets 1 Item 2 Properties City Holding Company and its subsidiaries own the facilities maintained as the Company's headquarters and generally own all of the facilities maintained as operating facilities by the subsidiaries. Those facilities not owned by the Company are maintained under long term lease agreements. The properties owned or leased by the Company consist generally of the main corporate office, the main banking office, forty-two (42) branch locations in West Virginia, four loan production offices in California, two loan production offices in West Virginia and one non-banking office in West Virginia. All of the properties are suitable and adequate for their current operations and are generally being fully utilized. Item 3 Legal Proceedings There are various legal proceedings pending to which City Holding Company and/or its subsidiaries are parties. These proceedings are incidental to the business of City Holding Company and its subsidiaries and, after reviewing the matters and consulting with counsel, management is of the opinion that the ultimate resolution of such matters will not materially affect the consolidated financial statements. Item 4 Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. PART II Item 5 Market for Registrant's Common Stock and Related Stockholder Matters Page 2 of the Annual Report to Shareholders of City Holding Company for the year ended December 31, 1997, included in this report as Exhibit 13, is incorporated herein by reference. During the fourth quarter of 1997, the Company issued 346,606 shares of its common stock pursuant to two acquisition transactions. The shares were issued in private transactions pursuant to the exemption from registration provided under Section 4.(2) of the Securities Act of 1933. Item 6 Selected Financial Data Selected Financial Data on page 1 of the Annual Report to Shareholders of City Holding Company for the year ended December 31, 1997, included in this report as Exhibit 13, is incorporated herein by reference. Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 3 through 27 of the Annual Report to Shareholders of City Holding Company for the year ended December 31, 1997, included in this report as Exhibit 13, is incorporated herein by reference. Item 8 Financial Statements and Supplementary Data The report of independent auditors and consolidated financial statements, included on pages 28 through 52 of the Annual Report to Shareholders of City Holding Company for the year ended December 31, 1997, included in this report as Exhibit 13, are incorporated herein by reference. Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure None PART III Item 10 Directors and Executive Officers of Registrant The information required by Item 10 of FORM 10-K appears in the Company's 1998 Proxy Statement to be filed within 120 days of fiscal year end under the captions "ELECTION OF DIRECTORS" and "EXECUTIVE OFFICERS". Item 11 Executive Compensation The information required by Item 11 of FORM 10-K appears in the Company's 1998 Proxy Statement under the caption "EXECUTIVE COMPENSATION". Item 12 Security Ownership of Certain Beneficial Owners and Management The information required by Item 12 of FORM 10-K appears in the Company's 1998 Proxy Statement under the caption "OWNERSHIP OF EQUITY SECURITIES". Item 13 Certain Relationships and Related Transactions The information required by Item 13 of FORM 10-K appears in the Company's 1998 Proxy Statement under the caption "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" and in NOTE FIFTEEN of Notes to Consolidated Financial Statements appearing at page 28 of the Company's Annual Report to Shareholders for the year ended December 31, 1997, included in this report as Exhibit 13, and incorporated herein by reference. PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Financial Statements Filed; Financial Statement Schedules The following consolidated financial statements of City Holding Company and subsidiaries, included in the Company's Annual Report to Shareholders for the year ended December 31, 1997, are incorporated by reference in Item 8: Exhibit 13 Page Number Report of Independent Auditors 28 Consolidated Balance Sheets - December 31, 1997 and 1996 29 Consolidated Statements of Income - years ended December 31, 1997, 1996, and 1995 30 Consolidated Statements of Changes in Stockholders' Equity - years ended December 31, 1997, 1996, and 1995 31 Consolidated Statements of Cash Flows - years ended December 31, 1997, 1996, and 1995 32 Notes to Consolidated Financial Statements - December 31, 1997 33 - 52 Financial Schedules I and II under Article 9 of Regulation S-X are not applicable. (b) Reports on Form 8-K The Company filed Form 8-K on October 10, 1997, reporting the acquisition of First Allegiance Financial Corporation. (c) Exhibits The exhibits listed in the Exhibit Index on pages 17 through 19 of this FORM 10-K are filed herewith or incorporated by reference from previous filings. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities 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 -------------------------- (Registrant) /s/_________________________ Steven J. Day, President/Director (Principal Executive Officer) /s/_________________________ Robert A. Henson, Chief Financial Officer (Principal Financial Officer) POWER OF ATTORNEY Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on February 23, 1998. Each of the directors and/or officers of City Holding Company whose signature appears below hereby appoints Steven J. Day and Robert A. Henson and each of them severally, as his attorney-in-fact to sign in his name and behalf, in any and all capacities stated below and to file with the Commission, any and all amendments to this report on Form 10-K, making such changes in this report on Form 10-K as appropriate, and generally to do all such things in their behalf in their capacities as officers and directors to enable City Holding Company to comply with the provisions of the Securities Exchange Act of 1934, and all requirements of the Securities and Exchange Commission. /s/__________________________ /s/__________________________ Samuel M. Bowling, C. Scott Briers, Director Director /s/__________________________ /s/__________________________ Dr. D. K. Cales, Steven J. Day, Director Director/President /s/__________________________ /s/___________________________ Robert D. Fisher, Jack E. Fruth, Director Director /s/__________________________ /s/__________________________ Jay Goldman, Carlin K. Harmon, Director Director/Executive Vice President /s/__________________________ /s/__________________________ C. Dallas Kayser, Dale Nibert, Director Director /s/__________________________ /s/___________________________ Otis L. O'Connor, Bob F. Richmond, Director Director /s/__________________________ /s/___________________________ Mark H. Schaul, Van R. Thorn, Director Director /s/__________________________ /s/___________________________ George F. Davis, Hugh R. Clonch, Director/Executive Vice President Director /s/__________________________ /s/___________________________ William M. Frazier, Leon K. Oxley, Director Director /s/__________________________ David E. Haden, Director EXHIBIT INDEX The following exhibits are filed herewith or are incorporated herein by reference. Prior Filing Exhibit Reference or Page Number Description Number Herein - ------- ----------- ----------------- 3(a) Articles of Incorporation of I City Holding Company 3(b) Articles of Amendment to the II Articles of Incorporation of City Holding Company, dated March 6, 1984 3(c) Articles of Amendment to the III Articles of Incorporation of City Holding Company, dated March 4, 1986 3(d) Articles of Amendment to the IV Articles of Incorporation of City Holding Company, dated September 29, 1987 3(e) Articles of Amendment to the Articles of Incorporation of City Holding Company, dated May 6, 1991 V 3(f) Articles of Amendment to the Articles of Incorporation of City Holding Company, dated May 7, 1991 V 3(g) By-laws of City Holding Company I 3(h) Amendment to the By-laws of III City Holding Company, dated February 14, 1985 3(i) Amendment to the By-laws of III City Holding Company, dated March 4, 1986 3(j) Amendment to the By-laws of III City Holding Company, dated May 1, 1986 3(k) Amendment to the By-laws of III City Holding Company, dated February 5, 1987 3(l) Amendment to the By-laws of VI City Holding Company, dated November 3, 1988 3(m) Articles of Amendment to the Articles of Incorporation of City Holding Company, dated August 1, 1994 VIII 4 Amendment and Restated Rights Agreement, dated as of May 7, 1991, between the Company and Sovran Bank, N.A. (predecessor to Nations Bank, N.A.), as Rights Agent VII 10 Agreement dated June 5, 1986, by III and between Steven J. Day and City Holding Company 11 Statement Re: Computation of Per Share Earnings 20 13 City Holding Company Annual Report to Shareholders for Year Ended December 31, 1997 21 22 Subsidiaries of City Holding Company 72 23 Consent of Ernst & Young LLP 73 24 Power of Attorney (included on the signature page hereof) 15 27 Financial Data Schedule for the year ending December 31, 1997 74 - -------------------- I Attached to, and incorporated by reference from Amendment No. 1 to City Holding Company's Registration Statement on Form S-4, Registration No. 2-86250, filed November 4, 1983, with the Securities and Exchange Commission. II Attached to, and incorporated by reference from City Holding Company's Form 8-K Report dated March 7, 1984, and filed with the Securities and Exchange Commission on March 22, 1984. III Attached to, and incorporated by reference from City Holding Company's Form 10-K Annual Report dated December 31, 1986, and filed March 31, 1987, with the Securities and Exchange Commission. IV Attached to and incorporated by reference from City Holding Company's Registration Statement on Form S-4, Registration No. 33-23295, filed with the Securities and Exchange Commission on August 3, 1988. Attached to, and incorporated by reference from City Holding Company's Form 10-K Annual Report dated December 31, 1991, and filed March 17, 1992, with the Securities and Exchange Commission. V Attached to, and incorporated by reference from City Holding Company's Form 10-K Annual Report dated December 31, 1991, and filed March 17, 1992, with the Securities and Exchange Commission. VI Attached to, and incorporated by reference from City Holding Company's Form 10-K Annual Report dated December 31, 1988, and filed March 30, 1989, with the Securities and Exchange Commission. VII Attached to, and incorporated by reference from City Holding Company's Form 8-K Current Report dated May 7, 1991, and filed May 14, 1991, with the Securities and Exchange Commission. VIII Attached to, and incorporated by reference from City Holding Company's Form 10-Q Quarterly Report dated September 30, 1994 and filed November 14, 1994, with the Securities and Exchange Commission. EX-11 2 EXHIBIT 11 EXHIBIT 11 COMPUTATION OF EARNINGS PER SHARE The Company adopted the provisions of Statement of Financial Accounting Standards No. 128, Earnings per Share, effective December 31, 1997. Statement No. 128 requires the restatement of all prior-period earnings per share amounts to conform to the 1997 presentation. The effect of applying the provisions of Statement No. 128 to periods prior to 1997 did not have a material impact on previously reported amounts. For further discussion of earnings per share and the impact of Statement No. 128, see the notes to the consolidated financial statements.
1997 1996 1995 ----------- ------------- ------------ Numerator: Net Income $ 12,464,000 $ 10,130,000 $ 8,718,000 ========== ============= ============ Denominator: Denominator for basic earnings per share -- Weighted average shares outstanding 6,146,528 5,586,006 5,642,186 Effect of dilutive securities: Employee stock options 15,916 1,397 - Contingent stock-acquisition 3,500 - - ----------- ------------- ------------ Dilutive potential common shares 19,416 1,397 0 ----------- ------------- ------------ Denominator for diluted earnings per share - Weighted average shares and assumed conversions 6,165,944 5,587,403 5,642,186 ========== ============= ============ Basic earnings per share $ 2.03 $ 1.81 $ 1.55 ========== ============= ============ Diluted earnings per share $ 2.02 $ 1.81 $ 1.55 ========== ============= ============
SELECTED FINANCIAL DATA TABLE ONE FINANCIAL SUMMARY (in thousands, except per share data)
FIVE YEAR SUMMARY 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- SUMMARY OF OPERATIONS Total interest income $ 96,796 $ 86,069 $ 75,125 $ 62,762 $ 55,301 Total interest expense 44,691 39,064 33,580 25,168 22,425 Net interest income 52,105 47,005 41,545 37,594 32,876 Provision for loan losses 1,662 1,678 1,104 1,040 1,434 Total other income 26,716 11,123 6,346 5,249 3,862 Total other expenses 57,670 40,982 33,887 30,116 24,292 Income before income taxes 19,489 15,468 12,900 11,687 11,012 Net income 12,464 10,130 8,718 8,141 7,645 PER SHARE DATA Net income (basic) (1) $ 2.03 $ 1.81 $ 1.55 $ 1.44 $ 1.35 Net income (diluted) (1) 2.02 1.81 1.55 1.44 1.35 Cash dividends declared (2) .73 .63 .56 .49 .46 Book value per share 16.56 14.21 13.09 11.66 11.56 AVERAGE BALANCE SHEET SUMMARY Total loans $ 757,803 $ 665,641 $ 608,551 $504,795 $413,645 Securities 179,590 166,667 221,743 264,976 262,742 Deposits 892,865 812,655 771,303 736,115 639,480 Long-term debt 46,129 24,666 8,204 6,252 4,387 Stockholders' equity 92,317 76,130 69,463 67,652 63,511 Total assets 1,213,261 1,079,540 957,048 864,690 739,804 AT YEAR END Net loans $ 772,689 $ 690,701 $ 650,195 $547,809 $462,424 Securities 162,912 163,922 194,368 239,882 283,833 Deposits 938,498 828,670 797,415 746,805 709,958 Long-term debt 68,400 34,250 20,000 6,875 5,875 Stockholders' equity 106,255 79,373 73,139 66,299 65,605 Total assets 1,266,143 1,048,810 1,040,969 895,785 816,225 SELECTED RATIOS Return on average assets 1.03% .94% .91% .94% 1.03% Return on average equity 13.50 13.31 12.55 12.03 12.04 Average equity to average assets 7.61 7.05 7.26 7.82 8.58 Dividend payout ratio (2) 35.96 34.81 36.47 33.91 34.36
(1) All earnings per share amounts for all periods have been presented to conform to Statement of Financial Accounting Statement No. 128, Earnings Per Share. (2) Cash dividends and the related payout ratio are based on historical results of the Company and do not include cash dividends of acquired companies prior to the dates of consummation. The Company's Common Stock is included on the Nasdaq National Market under the symbol CHCO. The table below sets forth the cash dividends paid per share and information regarding the market prices per share of the Company's Common Stock for the period indicated. The price ranges are based on transactions as reported on the Nasdaq National Market. At December 31, 1997, there were 2,198 stockholders of record. See NOTE TWELVE of the audited Consolidated Financial Statements for a discussion of restrictions on bank dividends. TWO YEAR SUMMARY OF COMMON STOCK PRICES AND DIVIDENDS MARKET PRICE RANGE* Cash Dividends Per Share* Low High 1997 Fourth Quarter $ .19 $ 39.875 $ 42.375 Third Quarter .18 32.250 43.250 Second Quarter .18 30.000 34.500 First Quarter .18 25.750 34.750 1996 Fourth Quarter $ .170 $ 21.000 $ 26.250 Third Quarter .155 19.773 22.955 Second Quarter .155 20.000 23.409 First Quarter .155 20.909 24.091 - ----------------------------------------------------------------------- *All per share data have been restated to reflect a 10% stock dividend effective November, 1996. Cash dividends represent amounts declared by the Company and do not include cash dividends of acquired companies prior to the dates of acquisition. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CITY HOLDING COMPANY City Holding Company (the Company), a West Virginia corporation headquartered in Cross Lanes, West Virginia, a suburb of Charleston, commenced operations in November 1983. The Company currently owns The City National Bank of Charleston (a wholly-owned subsidiary) (City National) and its banking divisions, The Peoples National Bank, First State Bank & Trust, The Bank of Ripley, Home National Bank of Sutton, Blue Ridge Bank, Peoples State Bank, The First National Bank of Hinton (Hinton), Merchants National Bank, and The Old National Bank of Huntington. City National and its banking divisions (collectively, the Bank) are retail and consumer-oriented community banks that emphasize personal service and currently operate 43 banking offices in 15 counties throughout the state of West Virginia. Prior to December 1997, these banking divisions of City National operated as separate affiliates. In December 1997, all banking affiliates' charters were combined into one, City National. However, as these banks became divisions of City National, they retained their historical names, management and Boards of Directors consistent with the Company's historical acquisition policy. The Company believes that retaining community loyalty is a prudent business practice and is beneficial in seeking future strategic acquisition opportunities for small to medium size banks, financial service companies and other entities. The most recent bank acquisition by the Company was the acquisition of The Old National Bank of Huntington (Old National) in January 1997, a $49 million bank located in Huntington, West Virginia. In addition, the Company intends to acquire Del Amo Savings Bank, FSB, a $115 million federally chartered savings bank in Torrance, California. This acquisition has been approved by the shareholders of Del Amo, but remains subject to regulatory approval. The Del Amo acquisition is expected to be consummated by the end of the first quarter of 1998. In addition to its banking divisions, as part of its strategy to diversify and expand into new areas of the financial services area, City National operates seven non-banking divisions, City Mortgage Services, First Allegiance Financial Corporation (First Allegiance), City Credit Services, RMI, Ltd. (RMI), Jarrett-Aim Communications, Inc. (Jarrett-Aim), City Capital Markets Corporation, and CNB East Retail. City Mortgage Services, a mortgage loan servicing division headquartered in Cross Lanes, West Virginia, was formed to facilitate the Company's growth of its mortgage servicing portfolio. On December 31, 1996, the Company acquired certain assets and assumed certain liabilities of Prime Financial Corporation, a mortgage loan servicing company located in Costa Mesa, California, which increased the Company's mortgage loan servicing portfolio by approximately $600 million. This West Coast operation was absorbed into City Mortgage Services. In December 1997, this division was transferred from the Company to City National. In October 1997, City National acquired First Allegiance and created City Credit Services, both headquartered in Irvine, California, which are originators of junior lien mortgages for sale to independent third parties. On December 5, 1997, City National acquired RMI, an insurance agency located in Winfield, West Virginia. RMI offers a full range of insurance products and services, including employee benefit programs, key person programs, benefits consulting services, property and casualty insurance, retirement plans and deferred compensation plans, to select corporate associations and individual clients. In January 1998, City National completed its acquisition of Jarrett-Aim located in Charleston, West Virginia. Jarrett-Aim will print all of the Bank's forms, manage its warehouse and distribution functions as well as provide marketing and direct mail service. City Capital Markets Corporation, a wholly owned subsidiary of City National, was formed in December 1997 as a limited purpose finance company to effect the securitization of various types of mortgage loans and financial assets. CNB East Retail was created during the fourth quarter of 1997 as a separate retail loan origination division of City National. CNB East Retail is the east coast complement to the west coast retail originators, First Allegiance and City Credit Services, previously discussed. The creation of CNB East Retail gives the Company three separate retail origination platforms from which its products and services can be marketed. The Company, in addition to City National and its divisions, owns City Financial Corporation, a full service securities brokerage and investment advisory company, headquartered in Charleston, West Virginia with its office located in City National's main location. HIGHLIGHTS AND SUMMARY Return on average assets (ROA), a measure of the effectiveness of asset utilization, was 1.03% in 1997. Return on average equity (ROE), which measures the return on stockholders' investment, was 13.50% in 1997. The Company's ROA and ROE were .94% and 13.31%, respectively, in 1996. Basic and diluted earnings per share for 1997 were $2.03 and $2.02, respectively, which represents an increase of approximately 12.2% and 11.6% from the $1.81 (both basic and diluted) per share in 1996. The main reason for the increase in earnings per share is increased net interest income and other income. Increases in net interest income are primarily attributable to the increased volume in the Company's loan portfolio and the increased yield in the Company's loans held for sale portfolio. The increase in other income is a result of the Company's emphasis on diversifying its revenue sources through an expanded line of financial services, primarily mortgage banking activities (see OTHER INCOME AND EXPENSES for further discussion). The Company reported total assets of $1.266 billion at December 31, 1997 and achieved $12.5 million in net income for the year then ended. Total assets increased 20.7% over the 1996 total of $1.049 billion. Net income was up significantly over the $10.1 million and $8.7 million reported for 1996 and 1995, respectively. INCOME STATEMENT INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES Average interest-earning assets increased $115.4 million from 1996 to 1997 and $110.0 million from 1995 to 1996. A significant part of the increase in 1997 is attributable to real estate and commercial loan volume generated by the Company's banking divisions. Most of the growth has been in response to the Company's service-oriented philosophy and its active involvement in the local communities it serves. The Company believes its decentralized management style appeals to retail consumers and small businesses. These lending arrangements are in furtherance of the Company's mission of being a high quality service provider and retaining strong ties to the local communities in which its banking divisions operate. In 1997, the Company's banking divisions had an aggregate increase in average loans of approximately $92.2 million or 13.85%. The 1997 and 1996 increases in average interest earning assets are also attributable to greater average volumes in the whole loan purchasing program and in the origination of debt consolidation loans and other junior lien mortgages to be sold or securitized. At December 31, 1997, these loans had a weighted average coupon of 13.14% and a weighted average maturity of approximately 201 months. The Company earned approximately $15.1 million and $12.6 million of gross interest income during 1997 and 1996, on average balances of program loans of approximately $146.2 million and $136.4 million, respectively. These loans are being funded through short-term borrowings which consist primarily of advances from the Federal Home Loan Bank of Pittsburgh (see LOANS HELD FOR SALE for further discussion). Average investment securities increased $12.9 million from $167 million in 1996 to $180 million in 1997. This increase is primarily attributable to the acquisition of Old National. The overall yield on investments has decreased 9 basis points from 1996 as a result of reinvestment of matured securities at slightly lower rates. Average investment securities decreased $55.1 million from $222 million in 1995 to $167 million in 1996. In 1997, the Company's banking divisions had an aggregate increase in average interest-bearing deposits of approximately $70.6 million or 10.15%. Most of the internal growth in deposits has been in response to the Company's customer service and expansion of banking offices. The 1997 average interest-bearing deposit balances include the acquisition of Old National and the deposits of four new West Virginia banking office locations. Average short-term borrowings increased $3.7 million from 1996 to 1997 and $55.8 million from 1995 to 1996. The average rate paid by the Company for short-term borrowings increased 13 basis points in 1997 and decreased 47 basis points in 1996 due to general movements in market interest rates. For further details see NOTE NINE to the audited Consolidated Financial Statements. Average long-term debt includes $27.8 million in obligations of the Parent Company and $18.3 million in FHLB obligations of City National. For further details with respect to long-term debt, see NOTE ELEVEN of the audited Consolidated Financial Statements. TABLE TWO EARNING ASSETS AND INTEREST-BEARING LIABILITIES (in thousands)
1997 1996 1995 Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate EARNING ASSETS: Loans (1) Commercial and industrial $ 246,172 $ 21,674 8.80% $ 213,687 $ 19,631 9.19% $188,122 $ 18,014 9.58% Real estate 365,459 31,739 8.68 317,204 27,455 8.66 283,752 24,149 8.51 Consumer obligations 146,172 14,584 9.98 134,750 13,408 9.95 136,677 13,270 9.71 -------------------------------------------------------------------------------------------------- Total loans 757,803 67,997 8.97 665,641 60,494 9.09 608,551 55,433 9.11 Loans held for sale 180,543 17,847 9.89 171,308 15,394 8.99 62,408 5,691 9.12 Securities Taxable 144,833 9,005 6.22 130,600 8,139 6.23 181,140 11,612 6.41 Tax-exempt (2) 34,757 2,888 8.31 36,067 3,048 8.45 40,603 3,485 8.58 -------------------------------------------------------------------------------------------------- Total securities 179,590 11,893 6.62 166,667 11,187 6.71 221,743 15,097 6.81 Federal funds sold 1,687 70 4.15 564 30 5.32 1,473 89 6.04 -------------------------------------------------------------------------------------------------- Total earning assets 1,119,623 97,807 8.74 1,004,180 87,105 8.67 894,175 76,310 8.53 Cash and due from banks 38,041 31,057 25,392 Bank premises and equipment 31,856 27,357 22,178 Other assets 31,665 23,675 21,761 Less: allowance for possible loan losses (7,924) (6,729) (6,458) ----------------------------------------------------- --------- --------------- ---------- ------- Total assets $1,213,261 $1,079,540 $957,048 ----------------------------------------------------- --------- --------------- ---------- ------- INTEREST-BEARING LIABILITIES: Demand deposits $ 128,781 $ 3,972 3.08% $ 101,013 $ 3,028 3.00% $106,590 $ 3,059 2.87% Savings deposits 221,460 6,799 3.07 228,286 7,017 3.07 227,217 6,990 3.08 Time deposits 416,331 22,346 5.37 366,650 19,193 5.23 335,011 17,100 5.10 Short-term borrowings 158,428 8,546 5.39 154,759 8,138 5.26 98,973 5,675 5.73 Long-term debt 46,129 3,028 6.56 24,666 1,688 6.84 8,204 756 9.22 --------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 971,129 44,691 4.60 875,374 39,064 4.46 775,995 33,580 4.33 Demand deposits 126,293 116,706 102,485 Other liabilities 23,522 11,330 9,105 Stockholders' equity 92,317 76,130 69,463 --------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $1,213,261 $1,079,540 $957,048 --------------------------------------------------------------------------------------------------- Net interest income $ 53,116 $ 48,041 $ 42,730 --------------------------------------------------------------------------------------------------- Net yield on earning assets 4.74% 4.78% s 4.78% ---------------------------------------------------------------------------------------------------
(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% in 1997 and 34% in 1996 and 1995. NET INTEREST INCOME Net interest income, on a fully federal tax-equivalent basis, increased $5.1 million during 1997. The average yield on earning assets increased from 8.67% in 1996 to 8.74% in 1997, and the average cost of interest-bearing liabilities increased from 4.46% to 4.60% over this same period. This had a minimal effect on the net yield on earning assets, which decreased four basis points from 4.78% in 1996 to 4.74% in 1997. The $82,000 increase in net interest income due to the change in rate, as shown in Table Three, which follows, was coupled with a $5.0 million increase in net interest income due to the change in volume. The major component of this favorable change in volume was additional loans outstanding as more fully discussed in the INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES section. Net interest income, on a fully federal tax-equivalent basis, increased $5.3 million in 1996. The $5.6 million increase caused by changes in volume was offset by a $301,000 decrease in net interest income due to rate. TABLE THREE RATE/VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE (in thousands)
1997 VS. 1996 1996 VS. 1995 Increase (Decrease) Increase (Decrease) Due to Change In: Due to Change In: Volume Rate Net Volume Rate Net ------ ---- --- ------ ---- --- INTEREST INCOME FROM: Loans Commercial and industrial $2,887 $ (844) $ 2,043 $ 2,371 $(754) $ 1,617 Real estate 4,190 94 4,284 2,889 417 3,306 Consumer obligations 1,140 36 1,176 (189) 327 138 ----------------------------------------------- -------------- ---------------- -------------- Total loans 8,217 (714) 7,503 5,071 (10) 5,061 Loans held for sale 859 1,594 2,453 9,787 (84) 9,703 Securities Taxable 885 (19) 866 (3,158) (315) (3,473) Tax-exempt (1) (109) (51) (160) (384) (53) (437) --------------- --------------- --------------- -------------- ---------------- -------------- Total securities 776 (70) 706 (3,542) (368) (3,910) Federal funds sold 48 (8) 40 (49) (10) (59) --------------- --------------- --------------- -------------- ---------------- -------------- Total interest-earning assets $9,900 $ 802 $10,702 $11,267 $(472) $10,795 --------------- --------------- --------------- -------------- ---------------- -------------- INTEREST EXPENSE ON: Demand deposits $ 854 $ 90 $ 944 $ (164) $ 133 $ (31) Savings deposits (210) (8) (218) 33 (6) 27 Time deposits 2,656 497 3,153 1,647 446 2,093 Short-term borrowings 195 213 408 2,968 (505) 2,463 Long-term debt 1,412 (72) 1,340 1,171 (239) 932 --------------- --------------- --------------- -------------- ---------------- ------------- Total interest-bearing liabilities $4,907 $ 720 $ 5,627 $ 5,655 $(171) $ 5,484 --------------- --------------- --------------- -------------- ---------------- -------------- NET INTEREST INCOME $4,993 $ 82 $ 5,075 $ 5,612 $(301) $ 5,311 ----------------------------------------------------------------------------------------------
(1) Fully federal taxable equivalent using a tax rate of approximately 35% in 1997 and 34% in 1996 and 1995. 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. OTHER INCOME AND EXPENSES Total other income increased $15.6 million, or 140%, during 1997 due primarily to the Company's expanded line of financial services. During 1997, the Company continued its pursuit of new products, services and business lines that generate additional fee-based income, reducing the Company's reliance on interest-based revenues. Over the past three years, the Company has begun offering new products to its existing customers and attracting new customers by expanding its focus from traditional banking operations to include trust, brokerage, mortgage banking, insurance and other related services. During 1996, the Company made a significant investment in loan servicing operations by purchasing certain assets (including servicing) and assuming certain Title I home improvement liabilities of Prime Financial Corporation, a large existing FHA loan servicer. At December 31, 1997, the Company serviced approximately $1.253 billion of these and similar loans, generating $11.9 million of gross servicing fee income during the year (compared to a $912 million portfolio serviced at December 31, 1996, which generated $3.0 million of income in 1996). The Company recognized $1.8 million in net origination fees on junior lien mortgages in 1997. In addition, gains on loans sold to third parties were $4.4 million in 1997 as compared to $1.3 million in 1996. In 1996, the Company increased its volume of secondary-market mortgage loan originations and thereby its sales of secondary market loans, which resulted in an increase in fee income, including servicing released premiums and loan sale premiums, from $982,000 in 1995 to $1,777,000 (includes $1.3 million gain on loans sold to third parties) in 1996. This, coupled with the income earned from loan servicing activities, resulted in other income related to mortgage banking activities of $4,735,000 in 1996 compared to $1,332,000 in 1995. Also during 1996, the Company realized a one-time gain approximating $437,000 on the termination of the defined benefit plan of First Merchants Bancorp, Inc., which was acquired by the Company in 1995. Revenues generated by the Company's loan servicing operation are dependent on a variety of factors, including the continued market for Title I, high LTV and other junior lien mortgages loans and an interest rate environment conducive to the general terms of these types of loans. Although management believes that the servicing operations will continue to have a positive impact on the Company, fee income could be reduced if a substantial number of serviced loans are prepaid by the borrowers more quickly than expected or if substantially more loans default than currently anticipated. However, management has recently begun to market its loan servicing capabilities to non-mortgage lenders. Total other expenses increased $16.7 million, or 40.7%, during 1997 due primarily to $8.3 million increase in personnel and occupancy expenses incurred by the Company due to the overall growth. The additional increase of $8.4 million is primarily attributable to a $3.5 million increase in advertising expense due to the solicitation of junior lien mortgage customers and an additional $2.6 million in other expenses due to the Company's expansion. Other expenses also include the cost of projects underway to ensure that the Company's computer systems possess accurate date recognition and data processing functions to avoid any problems associated with the "Year 2000 Issue." The Company has made an assessment of its compliance with the Year 2000 Issue and expects to complete its Year 2000 conversion projects by the end of 1998. The Company expects to begin testing in the second quarter of 1998 and to complete all required testing during 1999. These costs, which are expensed as incurred, have been immaterial to date. Based on currently available information, the remaining costs to address the Year 2000 Issue are not expected to have a material impact on the Company's earnings in the future. The costs of completing the Company's Year 2000 projects, and the date on which the Company believes it will complete all modifications are based on management's best estimate. These estimates were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other significant factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Such material differences may involve a myriad of factors, including, but not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant programming code, and similar uncertainties. During 1996, total other expenses increased $7.1 million, or 20.9%, due primarily to an $1.6 million in expenses incurred by City Mortgage Services, which includes $967,000 in personnel costs and $72,000 in expenses related to equipment. No expenses for this new division were included in the 1995 results. In addition, the Company had an increase of approximately $3.7 million in non-interest expenses associated with growth, consisting of a $2.2 million increase in personnel costs and a $970,000 increase in expenses related to equipment. The additional increase of $2.6 million was attributable to higher personnel costs throughout the organization due to the Company's overall growth during 1996. INCOME TAXES Income tax expense was $7,025,000 in 1997, resulting in an effective tax rate of 36.05% for the year. Such rates were 34.51% and 32.42% in 1996 and 1995, respectively. The effective tax rate from 1996 to 1997 increased due to a decrease in tax-exempt interest income and a higher statutory rate (35% compared to 34% in the previous years). The effective tax rate from 1995 to 1996 increased due primarily to a decrease in tax-exempt interest income. At December 31, 1997, gross deferred tax assets were approximately $5.1 million. Such assets are primarily attributable to the allowance for loan losses ($3 million), loans held for sale ($832,000), acquired net operating loss (NOL) carryforwards ($741,000), and certain nonqualified deferred compensation arrangements sponsored by City National ($374,000). Pursuant to management's evaluation for the quarter ended December 31, 1997, no valuation allowance has been allocated to the deferred tax assets. The quarterly evaluation process employed by management is based upon the expected reversal period of the assets, in consideration of taxes paid by the Company in the carryback years, expected reversals of existing taxable temporary differences, and historical trends in taxable income. Those assets for which realization is expected to be dependent on future events are subjected to further evaluation. Management's analysis has shown that realization of certain deferred tax assets, principally the acquired NOL, will be dependent on future events. After considering such factors as the magnitude of the asset relative to historical levels of financial reporting income and taxable income, the period over which future taxable income would have to be earned to realize the asset, and budgeted future results of operations, management has concluded that it is more likely than not that all deferred tax assets existing at December 31, 1997, will be realized. At present, management does not expect that implementation of tax planning strategies will be necessary to ensure realization. The need for a valuation allowance will continue to be addressed by management each quarter and any changes in the valuation allowance will be reported contemporaneously therewith in the Company's quarterly results of operations. BALANCE SHEET INTEREST RATE SENSITIVITY AND LIQUIDITY Interest Rate Sensitivity: The Company manages its liquidity position to reduce interest rate risk, which is the susceptibility of assets and liabilities to declines in value as a result of changes in general market interest rates. The Company seeks to reduce the risk through asset and liability management, where the goal is to optimize the balance between earnings and interest rate risk. The Company measures interest rate risk through interest sensitivity gap analysis as illustrated in Table Four. At December 31, 1997, the one year period shows a negative gap (liability sensitive) of $373 million. This analysis is a "static gap" presentation and movements in deposit rates offered by the Bank lag behind movements in the prime rate. Such time lags affect the repricing frequency of many items on the Company's balance sheet. Accordingly, the sensitivity of deposits to changes in market rates may differ significantly from the related contractual terms. Table Four is first presented without adjustment for expected repricing behavior. Then, as presented in the "management adjustment" line, these balances have been notionally distributed over the first three periods to reflect those portions of such accounts that are expected to reprice fully with market rates over the respective periods. The distribution of the balances over the repricing periods represents an aggregation of such allocations by each of the banking divisions, and is based upon historical experience with their individual markets and customers. Management expects to continue the same pricing methodology in response to market rate changes; however, management adjustments may change as customer preferences, competitive market conditions, liquidity, and loan growth change. Also presented in the management adjustment line are loan prepayment assumptions, which may differ from the related contractual terms of the loans. These balances have been distributed over the four periods to reflect those loans that are expected to be repaid in full prior to their maturity date. After management adjustments, Table Four shows a negative gap in the one-year period of $141 million. A negative gap position is advantageous when interest rates are falling because interest-bearing liabilities are being repriced at lower rates and in greater volume, which has a positive effect on net interest income. However, when interest rates are rising, this position produces the converse effect. Consequently, the Company has experienced a slight decline in its net interest margin during the past two years and is somewhat vulnerable to a rapid rise in interest rates in 1998. These declines in net interest margin did not translate into declines in net interest income because of increases in the volume of interest-earning assets. TABLE FOUR INTEREST RATE SENSITIVITY GAPS (in thousands)
1 TO 3 MO. 3 TO 12 MO. 1 TO 5 YRS. OVER 5 YRS. TOTAL ---------------- ---------------- --------------- ---------------- ------------- ASSETS Gross loans $ 168,259 $ 103,139 $411,013 $101,547 $ 783,958 Loans held for sale 134,990 0 0 0 134,990 Securities 16,618 20,718 97,495 28,081 162,912 Federal funds sold 40,028 0 0 0 40,028 ---------------- ---------------- --------------- ----------------- ------------- Total interest-earning assets 359,895 123,857 508,508 129,628 1,121,888 LIABILITIES Savings and NOW accounts 358,182 0 0 0 358,182 All other interest-bearing deposits 110,475 189,076 143,824 99 443,474 Short-term borrowings 130,191 0 0 0 130,191 Long-term debt 68,400 0 0 0 68,400 ---------------- ---------------- --------------- ----------------- ------------- Total interest-bearing liabilities 667,248 189,076 143,824 99 1,000,247 ---------------- ---------------- --------------- ----------------- ------------- Interest sensitivity gap $(307,353) $ (65,219) $ 364,684 $129,529 $ 121,641 ---------------- ---------------- --------------- ----------------- ------------- Cumulative sensitivity gap $(307,353) $(372,572) $ (7,888) $121,641 ---------------- ---------------- --------------- ----------------- ------------- Management adjustments $ 299,828 $ (68,246) $(212,058) $(19,524) ---------------- ---------------- --------------- ----------------- ------------- Cumulative management adjusted gap $ (7,525) $(140,990) $ 11,636 $121,641 ---------------- ---------------- --------------- ----------------- -------------
The table above includes various assumptions and estimates by management as to maturity and repricing patterns. Future interest margins will be impacted by balances and rates which are subject to change periodically throughout the year. In addition to the interest rate sensitivity gap analysis, the Company performs an earnings sensitivity analysis to identify the impact of changes in interest rates on its net interest income. Since the simulated gap analysis incorporates management assumptions as noted in the previous gap analysis discussion, actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors. The Company's policy objective is to avoid negative fluctuations in net interest income of 10% within a 12-month period. As of December 31, 1997, the Company had the following estimated earnings sensitivity profile: Immediate Change in Rates ------------------------- Pretax Earnings Changes +200 bp -200bp $ (431,000) $ 431,000 Based on the results of the simulation model as of December 31, 1997, the Company would expect a decrease in net interest income of $216,000 and an increase in net interest income of $216,000 if interest rates gradually increase or decrease, respectively, from current rates by 100 basis points over a 12-month period. Liquidity: As further discussed under "Investments", during the second quarter of 1997, management reclassified its entire held-to-maturity securities portfolio to the available-for-sale classification. This action was taken to provide management with additional liquidity alternatives and more flexibility in managing its interest rate risk. Additionally, during 1997 and continuing into 1998, the Company has sought additional sources of liquidity. These additional sources were necessitated by management's desire to reduce the reliance upon the Federal Home Loan Bank in funding the Company's loans held for sale. In the fourth quarter of 1997, a New York investment banking house committed to issue up to $100 million of the Company's certificates of deposit. The activation of this commitment is solely at the discretion of the Company. The certificates of deposit could be issued in maturities up to five years at a rate equal to a comparable treasury maturity plus a market based spread. At December 31, 1997, $2 million of the certificates of deposit had been sold under this commitment at an average rate and term of approximately 5.70% and two years. In addition, the Company is currently negotiating with a large regional bank to enter into a committed $100 million warehouse line to fund loan purchases and originations. The Company is satisified with its liquidity position and its plans for diversifying the Company's funding sources and there are no known trends, demands, commitments or uncertainties that have resulted or are reasonably likely to result in material changes in liquidity. The Company also seeks to maintain adequate liquidity in order to generate sufficient cash flows to fund operations on a timely basis. The Company manages its liquidity position to provide for asset growth and to ensure that the funding needs of depositors and borrowers can be met promptly. The Company does not have a high concentration of volatile funds, and all such funds are invested in assets of comparable maturity to mitigate liquidity concerns. At December 31, 1997, the Company had $33,400,000 in long-term debt outstanding against a $35,000,000 revolving loan agreement. These funds were used to provide subsidiaries with additional capital, to fund certain acquisitions in 1995 and 1996, and to provide funding for expansion of the Company's data processing operations and mortgage servicing divisions. Total debt service for the Company in 1998 will approximate $2.6 million at current interest rates. In addition to the revolving loan agreement, the Company had $35 million of long-term financing outstanding with the Federal Home Loan Bank at December 31, 1997. Other than long-term debt, the cash needs of the Company consist of routine payroll and benefit expenses of Company personnel, expenses for certain professional services, debt service on affiliate advances, and dividends to shareholders. The Company has approximately $25.7 million available for transfer from City National as of January 1, 1998. City National's earnings in 1998 through the date of dividend declaration are also available for transfer upstream. Such bank dividends are the Company's primary source of cash. During 1998, the Company expects to retire or term-out its long-term debt and also strengthen its regulatory capital position through any of several different avenues. For more specific information regarding restrictions on subsidiary dividends, see NOTE TWELVE to the audited Consolidated Financial Statements. The Company's cash and cash equivalents, represented by cash, due from banks and federal funds sold, are a product of its operating, investing and financing activities. These activities are set forth in the Company's Consolidated Statements of Cash Flows included elsewhere herein. Cash was used from operating activities in 1997 due to cash outlays for loans originated for sale and purchases of loans held for sale. Net cash was used in investing activities for each year presented which is indicative of the Company's net increases in loan volume and purchases of securities available for sale. Cash was provided by financing activities during 1997, as a result of net increases in deposits and short-term borrowings. Cash and cash equivalents increased due to cash provided by operating activities, principally in the form of proceeds from loans sold during 1996. INVESTMENTS The Company's investment portfolio is presented below in Table 5. In June 1997, the Company reclassified its entire held-to-maturity securities portfolio to the available-for-sale classification. The securities transferred consisted of investment securities with approximate amortized cost and market value of $46,520,000 and $46,781,000, respectively. This action was taken by the Company to provide management more flexibility in managing the Company's liquidity and interest rate risk. The Company had $4.1 million in structured notes as of December 31, 1997. All structured notes are federal agency securities that are classified as available for sale. They have a weighted average coupon of 3.65% and a weighted average maturity of less than two years. Approximately 94% of these securities were obtained through the Company's acquisitions and management has no plans to purchase any additional structured notes in the future. The impact of holding these securities on the results of operations was immaterial for the period ending December 31, 1997. TABLE FIVE INVESTMENT PORTFOLIO (in thousands)
BOOK VALUES AS OF December 31 1997 1996 1995 ----------------------- ----------------------- ----------------------- U.S. Treasury and other U.S. government corporations and agencies $ 116,712 $ 106,875 $ 132,007 States and political subdivisions 35,436 36,290 40,635 Other 10,764 20,757 21,726 ----------------------- ----------------------- ----------------------- Total $ 162,912 $ 163,922 $ 194,368 ----------------------- ----------------------- -----------------------
At December 31, 1997, there were no securities of any non-governmental issuers whose aggregate carrying or market value exceeded 10% of stockholders' equity.
MATURING Within After One But After Five but After One Year Within Five Years Within Ten Years Ten Years Amount Yield Amount Yield Amount Yield Amount Yield U.S. Treasury and other U.S. government corporations and agencies $27,223 5.64% $77,043 6.48% $11,607 6.73% $ 839 6.78% States and political subdivisions 3,351 8.27 17,444 8.25 12,928 8.44 1,713 9.14 Other 6,762 6.35 3,008 8.41 0.00 994 6.37 ------------------------------------------------------------------------------------------- Total $37,336 6.00% $97,495 6.86% $24,535 7.63% $3,546 7.81% -------------------------------------------------------------------------------------------
Weighted average yields on tax-exempt obligations of states and political subdivisions have been computed on a fully federal tax-equivalent basis using a tax rate of approximately 35%. LOAN PORTFOLIO The composition of the Company's loan portfolio is presented in the following table: TABLE SIX (in thousands)
DECEMBER 31 1997 1996 1995 1994 1993 ---------------- ---------------- ---------------- ----------------- --------------- Commercial, financial and agricultural $232,602 $224,267 $214,304 $164,366 $149,112 Real estate-mortgage 400,401 338,385 304,848 258,910 205,745 Installment loans to individuals 154,713 142,123 145,734 140,695 124,490 ---------------- ---------------- ---------------- ----------------- ---------------- Total loans $787,716 $704,775 $664,886 $563,971 $479,347 ---------------- ---------------- ---------------- ----------------- ----------------
The Company continues to grant portfolio loans to customers generally within the market areas of City National and its divisions' portfolio. Loan volume has continued to increase in recent years as a result of the Company's more active solicitation of commercial loan business as well as general volume increases applicable to the traditional borrowing segment from which the Company has generated loans in the past. The Company has successfully attracted more commercial customers, while continuing to obtain noncommercial, lower risk collateral such as residential properties. The Company's collateral position with respect to real estate loans has typically been less volatile than its peers, particularly banks located outside of its region where dramatic escalations in real estate values took place in certain prior years. The Company had $28.4 million and $26.0 million outstanding in real estate construction loans at December 31, 1997 and 1996, respectively, the majority of which related to one-to-four family residential properties. Real estate construction loans were not material in all other periods presented. The following table shows the maturity of loans outstanding as of December 31, 1997.
MATURING ----------------------------------------------------------------------------------- After One Within But Within After One Year Five Years Five Years Total ---------------------- ---------------------- ---------------------- -------------- Commercial, financial and agricultural $ 70,169 $102,538 $ 59,895 $232,602 Real estate-mortgage 79,758 96,204 224,439 400,401 Installment loans to individuals 24,378 116,097 14,238 154,713 ---------------------- ---------------------- ---------------------- -------------- Total loans $174,305 $314,839 $298,572 $787,716 ---------------------- ---------------------- ---------------------- -------------- Loans maturing after one year with: Fixed interest rates $366,513 Variable interest rates 246,898 ---------------------- Total $613,411 ----------------------
LOANS HELD FOR SALE Loans held for sale represent mortgage loans the Company has either purchased or originated with the intent to sell or securitize and are carried at the lower of aggregate cost or market. With the acquisition of First Allegiance and the creation of City Credit Services in the fourth quarter of 1997, the Company began to originate high loan-to-value (LTV) debt consolidation loans and other junior lien mortgage loans on a nationwide level. Currently, these divisions are conducting business in 30 states across the country. These loans are expected to either be securitized by the Company or sold within 90-180 days to independent third parties. In addition to the origination of junior lien mortgages, the Company participates in a whole loan purchasing program. Under the program, the Company generally purchases HUD Title I home improvement and high LTV loans secured by junior lien mortgages. The purchased loans typically have balances of $25,000 to $40,000 and are usually sold within 30 to 90 days. The Title I loans are partially insured by the Federal Housing Administration. Although the purchased loans are originated nationwide, the two states that experienced the most volume of originations during 1997 were California and Texas. Although the loans usually are located outside the Company's primary market areas, management believes that these loans pose no greater risk than similar "in-market" loans because of the Company's review of the loans, the credit support associated with the loans, the short duration of the Company's investment and the other terms of the program. In addition, the loans are generally serviced by the Company's mortgage servicing division. Effective November 1996, the Company restructured its participation in the program so that it would receive the full coupon rate on loans purchased during the period the loans are held for sale. Previously, the Company had received a fixed rate of 9% on outstanding balances. The Company's continued origination and purchasing of loans to be sold or securitized is expected to continue to have a positive impact on the Company's operating results. However, this return is not achieved without a degree of risk of loss to the Company. Such risks include credit risk related to the quality of the underlying loan and the borrower's financial capability to repay the loan, market risk related to the continued attractiveness of the loan product to both borrowers and end-investors, and interest rate risk related to potential changes in interest rates and the resulting repricing of both financial assets and liabilities. The Company seeks to manage this risk by continuously improving policies and procedures designed to reduce the risk of loss to a level commensurate with the return being earned on the Company's investment in this program. During 1997, the Company originated $97 million and purchased $798 million in loans held for sale and sold $851 million during the same period. This compares to originations of $118 million, purchases of $1.03 billion, and sales of $1.2 billion during 1996. LOAN SECURITIZATIONS One of the methods utilized by management to mitigate the risk of loss related to the origination and acquisition of junior lien mortgage loans is the securitization of these loans. By securitizing originated and purchased junior lien mortgage loans, the Company effectively removes these loans from its balance sheet by creating an investment security, 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 provides credit enhancement, in the form of overcollateralization, with respect to the investment security created. As a result, the Company does maintain a certain level of credit risk 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 receives on-going 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. LOAN SERVICING Mortgage loans serviced for others are not included in the accompanying balance sheets. They consist primarily of Title I loans and debt consolidation loans secured by second lien mortgages. The unpaid principal balances of mortgage loans serviced for others was $1.253 billion and $912 million at December 31, 1997 and December 31, 1996, respectively. The unpaid principal balances of intercompany mortgage loans serviced was $63.3 million at December 31, 1997. LOAN LOSS ANALYSIS During 1997, the Company charged-off $1,899,000 of loans that were doubtful as to collection and had recoveries of $419,000. The resulting net charge-offs of $1,480,000 represent an increase of $517,000 or 53.7% from that reported in 1996. Net charge-offs decreased approximately 5%, or $52,000 in 1996 versus 1995. Net charge-offs as a percent of average total loans was .20% at December 31, 1997. This represents an increase of 42.9% or 6 basis points from December 31, 1997 to 1996. The Company's asset quality continues to compare favorably with that of peer banks. The provision for possible loan losses charged to operations each year is dependent upon many factors, including loan growth, historical charge-off experience, size and composition of the loan portfolio, delinquencies and general economic trends. The provision of $1,662,000 in 1997 represents .22% of average loans as compared to a provision of $1,678,000, or .25%, in 1996 and a provision of $1,104,000, or .18% in 1995. As further discussed below, management believes that the consolidated allowance for loan losses is adequate to provide for any potential losses on loans currently reported in the consolidated balance sheets. The allowance for loan losses was $7,673,000 or .98% of loans, as of December 31, 1997, compared to $7,281,000 or 1.04% of loans in 1996. As detailed in Table Nine, as of December 31, 1997, the allowance for loan losses is allocated 25% to commercial, financial and agricultural loans, 56% to real estate-mortgage loans and 19% to installment loans to individuals. These amounts reflect management's assessment of the risk in each specific portfolio in relation to the total. These percentages compare to 27%, 54% and 19%, respectively, as of December 31, 1996. The portion of the allowance related to commercial credits is based primarily upon specific credit review with minor weighting being given to past charge-off history. Conversely, due to the homogenous nature of the portfolios and consistency in underwriting standards, the portions of the allowance allocated to the real estate-mortgages and installment loans to individuals are based primarily upon prior charge-off history with minor weighting being given to specific credit reviews. Management has, however, increased the portion of the allowance allocated to real estate mortgages above the trend in net charge-off history for that portfolio. This increase is primarily due to management's concern that rapid increases in real estate lending within the Company over the past several years have led to a portfolio that may not be seasoned enough for past net charge-offs to represent current risk. In addition, the Company's adjustable rate mortgages have grown from $139.4 million at December 31, 1996 to $195.0 million at December 31, 1997, an increase of 40%. In management's opinion, the consolidated allowance for loan losses is adequate to provide for any potential losses on existing loans. See NOTE FIVE to the audited Consolidated Financial Statements for a discussion of concentrations of credit risks. Non-performing loans, consisting of non-accrual, past-due and restructured credits, increased approximately $1,304,000 in 1997. While the general economy remains soft in certain of the banking divisions' market areas, management does not anticipate material loan losses since loan to collateral ratios remain favorable. At December 31, 1997, loans aggregating $331,000 are considered by management to represent possible future credit problems. These loans are generally contractually current, but information is available to management which indicates that serious doubt may exist as to the ability of such borrowers to comply with the present loan repayment terms. The ratio of the allowance for loan losses to non-performing loans, including potential problem loans, was 129% at December 31, 1997, as compared to 149% and 151% at December 31, 1996 and 1995. Tables Seven, Eight and Nine detail loan performance and analyze the allowance for loan losses. TABLE SEVEN ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES (in thousands)
DECEMBER 31 1997 1996 1995 1994 1993 ------------------- ----------------- ------------------- ------------------ ------------- Balance at beginning of year Charge-offs: $ 7,281 $ 6,566 $ 6,477 $ 6,209 $ 5,730 Commercial, financial and agricultural (199) (193) (174) (327) (693) Real estate-mortgage (130) (262) (278) (160) (258) Installment loans to individuals (1,570) (920) (879) (693) (664) ------------------- ----------------- ------------------- ------------------ ------------- Totals (1,899) (1,375) (1,331) (1,180) (1,615) ------------------- ----------------- ------------------- ------------------ ------------- Recoveries: Commercial, financial and agricultural 6 19 56 111 58 Real estate-mortgage 86 166 22 11 220 Installment loans to individuals 327 227 238 286 217 ------------------- ----------------- ------------------- ------------------ ------------- Totals 419 412 316 408 495 ------------------- ----------------- ------------------- ------------------ ------------- Net charge-offs (1,480) (963) (1,015) (772) (1,120) Provision for possible loan losses 1,662 1,678 1,104 1,040 1,434 Balance of acquired institution 210 165 ------------------- ----------------- ------------------- ------------------ ------------- Balance at end of year $ 7,673 $ 7,281 $ 6,566 $ 6,477 $ 6,209 ------------------- ----------------- ------------------- ------------------ ------------- AS A PERCENT OF AVERAGE TOTAL LOANS Net charge-offs .20% .14% .17% .15% .27% Provision for possible loan losses .22 .25 .18 .21 .35 AS A PERCENT OF NONPERFORMING AND POTENTIAL PROBLEM LOANS Allowance for loan losses 129.02% 149.26% 150.84% 134.24% 129.68%
TABLE EIGHT NONACCRUAL, PAST-DUE AND RESTRUCTURED LOANS (in thousands)
DECEMBER 31 1997 1996 1995 1994 1993 ----------------- ------------------ ------------------ ----------------- ----------------- Nonaccrual loans $ 3,758 $ 1,734 $ 2,525 $ 2,614 $ 1,559 Accruing loans past due 90 days or more 1,858 2,674 1,421 1,420 708 Restructured loans 331 235 141 262 1,078 ----------------- ------------------ ------------------ ----------------- ----------------- $ 5,947 $ 4,643 $ 4,087 $ 4,296 $ 3,345 ----------------- ------------------ ------------------ ----------------- -----------------
During 1997, the Company recognized approximately $126,000 of interest income received in cash on nonaccrual and restructured loans. Approximately $403,000 of interest income would have been recognized during the year if such loans had been current in accordance with their original terms. There were no commitments to provide additional funds on nonaccrual, restructured, or other potential problem loans at December 31, 1997. Interest on loans is accrued and credited to operations based upon the principal amount outstanding. The accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest unless the loan is well collateralized and in the process of collection. When interest accruals are discontinued, interest credited to income in the current year that is unpaid and deemed uncollectible is charged to operations. Prior year interest accruals that are unpaid and deemed uncollectible are charged to the allowance for loan losses, provided that such amounts were specifically reserved. TABLE NINE ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (in thousands)
DECEMBER 31 1997 1996 1995 1994 1993 --------------------- --------------------- -------------------- --------------------- -------------------- Percent Percent Percent Percent Percent Of Loans Of Loans Of Loans Of Loans Of Loans In Each In Each In Each In Each In Each Category Category Category Category Category To Total To Total To Total To Total To Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ---------- ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- --------- Commercial, financial and agricultural $1,922 29% $1,939 32% $2,053 32% $1,919 29% $2,100 31% Real estate-mortgage 4,312 51 3,964 48 3,125 46 2,848 46 2,325 43 Installment loans to individuals 1,439 20 1,378 20 1,388 22 1,710 25 1,784 26 ---------- ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- --------- $7,673 100% $7,281 100% $6,566 100% $6,477 100% $6,209 100% ---------- ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------
The portion of the allowance for loan losses that is not specifically allocated to individual credits has been apportioned among the separate loan portfolios based on the risk of each portfolio. CERTIFICATES OF DEPOSIT Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 1997, are summarized as follows: TABLE TEN (in thousands) Amounts Percentage ---------------- ------------------ Three months or less $ 17,456 22% Over three months through six months 11,887 16 Over six months through twelve months 19,526 26 Over twelve months 27,609 36 ---------------- ------------------ Total $ 76,478 100% ---------------- ------------------ CAPITAL RESOURCES As a bank holding company, the Company is subject to regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956. At December 31, 1997, the Federal Reserve Board's minimum ratio of qualified total capital to risk-weighted assets is 8 percent. At least half of the total capital is required to be comprised of Tier I capital, or the Company's common stockholders' equity less intangibles. The remainder ("Tier 2 capital") may consist of certain other prescribed instruments and a limited amount of loan loss reserves. In addition, the Federal Reserve Board has established minimum leverage ratio (Tier 1 capital to quarterly average tangible assets) guidelines for bank holding companies. These guidelines provide for a minimum ratio of 4 percent for bank holding companies that meet certain specified criteria such as maintaining the highest regulatory rating. All other bank holding companies are required to maintain a leverage ratio of 4 percent plus an additional cushion of at least 100 to 200 basis points. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The following table presents comparative capital ratios and related dollar amounts of capital for the Company: DOLLARS IN THOUSANDS 1997 1996 ----------------- ------------------ CAPITAL COMPONENTS Tier 1 risk-based $ 82,842 $ 72,157 Total risk-based 90,515 79,439 CAPITAL RATIOS Tier 1 risk-based 9.16% 10.20% Total risk-based 10.00 11.23 Leverage 6.49 6.58 REGULATORY MINIMUM Tier 1 risk-based (dollar/ratio) $36,191/4.00% $28,290/4.00% Total risk-based (dollar/ratio) 72,381/8.00% 56,579/8.00 Leverage (dollar/ratio) 51,094/4.00% 43,872/4.00 The strong capital position of the Company is indicative of management's emphasis on asset quality and a history of retained net income. The ratios enable the Company to continually pursue acquisitions and other growth opportunities. Improvements in operating results and a consistent dividend program, coupled with an effective management of credit risk, have been, and will be, the key elements in maintaining the Company's present capital position. The Company does not anticipate any material capital expenditures in 1998. Earnings from bank operations are expected to remain adequate to fund payment of stockholders' dividends and internal growth. In management's opinion, City National has the capability to upstream sufficient dividends to meet the cash requirements of the Company. INFLATION Since the assets and liabilities of the Bank is primarily monetary in nature (payable in fixed, determinable amounts), the performance of banks is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. While the effect of inflation on banks is normally not as significant as its influence on those businesses which have large investments in plant and inventories, it does have an effect. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above-average growth in assets, loans and deposits. Also, general increases in the price of goods and services will result in increased operating expenses. FORWARD LOOKING STATEMENTS Information contained in this 1997 Annual Report includes forward-looking financial information relating to the Company's operations based on estimates and assumptions made by management. Such forward-looking information involves risks and uncertainties including those associated with the interest rate and general economic environments, federal and state banking regulations, competition, and other risks. The forward-looking financial information is provided to assist investors and Company shareholders in understanding anticipated future financial operations of the Company and are included pursuant to the safe harbor provisions of the Private Litigation Reform Act of 1995. The actual results achieved may differ materially from those projected in the forward-looking information. Further, the Company disclaims any intent or obligation to update this forward-looking information. Report Of Independent Auditors Board of Directors and Stockholders City Holding Company We have audited the accompanying consolidated balance sheets of City Holding Company and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of City Holding Company and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Charleston, West Virginia January 30, 1998 CONSOLIDATED BALANCE SHEETS CITY HOLDING COMPANY AND SUBSIDIARIES
December 31 1997 1996 -------------------------------- (in thousands) ASSETS Cash and due from banks $ 47,207 $ 47,351 Federal funds sold 40,028 413 -------------------------------- CASH AND CASH EQUIVALENTS 87,235 47,764 Securities available for sale, at fair value 162,912 122,944 Investment securities (approximate market value at December 31, 1996- $41,826,000) 40,978 Loans: Gross loans 787,716 704,775 Unearned income (7,354) (6,793) Allowance for possible loan losses (7,673) (7,281) -------------------------------- NET LOANS 772,689 690,701 Loans held for sale 134,990 92,472 Bank premises and equipment 36,635 30,025 Accrued interest receivable 8,677 7,510 Other assets 63,005 16,416 -------------------------------- TOTAL ASSETS $ 1,266,143 $ 1,048,810 -------------------------------- LIABILITIES Deposits: Noninterest-bearing $ 136,842 $ 118,976 Interest-bearing 801,656 709,694 -------------------------------- TOTAL DEPOSITS 938,498 828,670 Short-term borrowings 130,191 90,298 Long-term debt 68,400 34,250 Other liabilities 22,799 16,219 -------------------------------- TOTAL LIABILITIES 1,159,888 969,437 STOCKHOLDERS' EQUITY Preferred stock, par value $25 per share: authorized - 500,000 shares: none issued Common stock, par value $2.50 per share: authorized - 20,000,000 shares; issued and outstanding: 1997 - 6,427,309 shares; 1996 - 5,598,912 shares including 11,130 and 11,341 shares in treasury at December 3l, 1997 and 1996 16,067 13,998 Capital surplus 48,769 35,426 Retained earnings 40,374 30,246 Net unrealized gain on securities, net of deferred income taxes 1,355 3 -------------------------------- 106,565 79,673 Cost of common stock in treasury (310) (300) -------------------------------- TOTAL STOCKHOLDERS' EQUITY 106,255 79,373 -------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,266,143 $ 1,048,810 --------------------------------
See notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME CITY HOLDING COMPANY AND SUBSIDIARIES
Year Ended December 31 1997 1996 1995 --------------------------------------------------- (in thousands, except per share data) lNTEREST INCOME Interest and fees on loans $ 85,844 $ 75,888 $ 61,124 Interest on investment securities: Taxable 9,005 8,139 11,612 Tax-exempt 1,877 2,012 2,300 Other interest income 70 30 89 --------------------------------------------------- TOTAL INTEREST INCOME 96,796 86,069 75,125 INTEREST EXPENSE Interest on deposits 33,117 29,238 27,149 Interest on short-term borrowings 8,546 8,138 5,675 Interest on long-term debt 3,028 1,688 756 --------------------------------------------------- TOTAL INTEREST EXPENSE 44,691 39,064 33,580 --------------------------------------------------- NET INTEREST INCOME 52,105 47,005 41,545 PROVISION FOR POSSIBLE LOAN LOSSES 1,662 1,678 1,104 --------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 50,443 45,327 40,441 OTHER INCOME Investment securities gains 26 87 2 Service charges 4,307 3,700 3,347 Mortgage loan servicing fees 11,933 2,958 350 Gain on sale of loans 4,392 1,260 581 Other income 6,058 3,118 2,066 --------------------------------------------------- TOTAL OTHER INCOME 26,716 11,123 6,346 OTHER EXPENSES Salaries and employee benefits 28,747 21,593 17,815 Occupancy, excluding depreciation 3,914 2,736 2,555 Depreciation 4,837 3,466 2,534 Other expenses 20,172 13,187 10,983 --------------------------------------------------- TOTAL OTHER EXPENSES 57,670 40,982 33,887 --------------------------------------------------- INCOME BEFORE INCOME TAXES 19,489 15,468 12,900 INCOME TAXES 7,025 5,338 4,182 --------------------------------------------------- NET INCOME $ 12,464 $ 10,130 $ 8,718 --------------------------------------------------- Basic earnings per common share $ 2.03 $ 1.81 $ 1.55 --------------------------------------------------- Diluted earnings per common share $ 2.02 $ 1.81 $ 1.55 --------------------------------------------------- Average common shares outstanding: Basic 6,146,528 5,586,006 5,642,186 --------------------------------------------------- Diluted 6,165,944 5,587,403 5,642,186 ---------------------------------------------------
See notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY CITY HOLDING COMPANY AND SUBSIDIARIES
Unrealized Common Gain/(Loss) Total Stock Capital Retained on Treasury Stockholders' (Par Value) Surplus Earnings Securities Stock Equity ---------------------------------------------------------------------------- (in thousands) Balances at January 1, 1995 $11,753 $18,366 $39,075 $(2,863) $ (32) $ 66,299 Net income 8,718 8,718 Cash dividends declared--$.56 a share (2,852) (2,852) Cash dividends of acquired (150) (150) subsidiary Change in unrealized gain/(loss) 3,258 3,258 net of income taxes of $2,154,000 Purchase of 86,665 shares of (2,286) (2,286) treasury stock Sale of 6,486 shares of treasury (20) 172 152 stock Retirement of 69,739 shares of (174) (1,612) 1,786 common stock held in treasury Issuance of 10% stock dividend 1,151 9,208 (10,359) ---------------------------------------------------------------------------- Balances at December 31, 1995 12,730 25,942 34,432 395 (360) 73,139 Net income 10,130 10,130 Cash dividends declared--$.63 a share (3,540) (3,540) Change in unrealized gain/(loss) (392) (392) net of income taxes of $(261,000) Sale of 2,299 shares of treasury (2) 60 58 stock Redempton of fractional shares (22) (22) Issuance of 10% stock dividend 1,268 9,508 (10,776) ---------------------------------------------------------------------------- Balances at December 31, 1996 13,998 35,426 30,246 3 (300) 79,373 Net income 12,464 12,464 Cash dividends declared--$.73 a share (4,486) (4,486) Change in unrealized gain/(loss) 1,333 1,333 net of income taxes of $818,000 Exercise of 2,627 stock options 7 58 65 Sale of 2,511 shares of treasury 13 67 80 stock Purchase of 2,300 shares of (77) (77) treasury stock Common stock issued in acquisitions 860 12,974 13,834 Issuance of stock for Old National 1,202 298 2,150 19 3,669 ---------------------------------------------------------------------------- Balances at December 31, 1997 $16,067 $48,769 $40,374 $ 1,355 $ (310) $106,255 ----------------------------------------------------------------------------
See notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS CITY HOLDING COMPANY AND SUBSIDIARIES
Year Ended December 31 1997 1996 1995 --------------------------------------------------- (in thousands) OPERATING ACTIVITIES Net income $ 12,464 $ 10,130 $ 8,718 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Net amortization 1,470 943 1,003 Provision for depreciation 4,837 3,466 2,534 Provision for possible loan losses 1,662 1,678 1,104 Deferred income tax benefit (713) (582) (439) Loans originated for sale (97,465) (118,287) (74,242) Purchases of loans held for sale (797,537) (1,029,098) (639,331) Proceeds from loans sold 850,742 1,178,395 622,159 Realized gains on loans sold (4,392) (1,260) (581) Realized investment securities gains (26) (87) (2) (Increase) decrease in accrued interest receivable (877) 521 (1,128) Increase in other assets (31,890) (2,356) (1,027) Increase (decrease) in other liabilities 6,341 7,113 (73) --------------------------------------------------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (55,384) 50,576 (81,305) INVESTING ACTIVITIES Proceeds from maturities and calls of investment securities 3,085 134,539 40,084 Purchases of investment securities (124,979) (3,238) Proceeds from sales of securities available for sale 38,246 33,865 55,185 Proceeds from maturities and calls of securities available for 52,947 47,275 11,331 sale Purchases of securities available for sale (79,111) (60,938) (52,617) Net increase in loans (53,522) (42,184) (103,490) Net cash acquired in acquisitions 9,126 Purchases of premises and equipment (10,303) (9,840) (5,055) --------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (39,532) (22,262) (57,800) FINANCING ACTIVITIES Net increase in noninterest-bearing deposits 3,154 1,984 22,624 Net increase in interest-bearing deposits 62,049 29,271 27,986 Net increase (decrease) in short-term borrowings 39,452 (51,011) 74,682 Proceeds from long-term debt 34,150 14,250 17,525 Repayment of long-term debt (4,400) Purchases of treasury stock (77) (2,286) Proceeds from sales of treasury stock 80 58 152 Redemption of dissenter and fractional shares (22) Exercise of stock options 65 Cash dividends paid (4,486) (3,540) (3,002) --------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 134,387 (9,010) 133,281 --------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 39,471 19,304 (5,824) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 47,764 28,460 34,284 --------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 87,235 $ 47,764 $ 28,460 ---------------------------------------------------
See notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CITY HOLDING COMPANY AND SUBSIDIARIES DECEMBER 31, 1997 NOTE ONE SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES Summary of Significant Accounting and Reporting Policies: The accounting and reporting policies of City Holding Company and its subsidiaries (the Company) conform with 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. Actual results could differ from management's estimates. The following is a summary of the more significant policies. Principles of Consolidation: The consolidated financial statements include the accounts of City Holding Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Description of Principal Markets and Services: The Company is a bank holding company headquartered in Cross Lanes, West Virginia. In December 1997, the Company restructured its banking subsidiaries into one banking charter, The City National Bank of Charleston (City National Bank). City National Bank and its banking divisions are retail and consumer oriented community banks with offices throughout West Virginia. The nonbanking subsidiaries of the Company are comprised of a full service securities brokerage and investment advisory company located in Charleston and an inactive mortgage banking company. In December 1997, the mortgage loan servicing division of the Parent Company was transferred to City National Bank. With the acquisition discussed in Note Three, the mortgage servicing division has loan servicing facilities located in West Virginia and California. Cash and Due from Banks: The Company considers cash and due from banks and federal funds sold as cash and cash equivalents. The carrying amounts reported in the December 31, 1997 and 1996, consolidated balance sheets for cash and cash equivalents approximate those assets' fair values. Securities: Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold debt securities to maturity, they are classified as investment securities and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts. Debt securities for which the Company does not have the intent or ability to hold to maturity are classified as available for sale along with the Company's investment in equity securities. Securities available for sale are carried at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. Securities classified as available for sale include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk, and other factors. The specific identification method is used to determine the cost basis of securities sold. Loans: Interest income on loans is accrued and credited to operations based upon the principal amount outstanding, using methods which generally result in level rates of return. The accrual of interest income generally is discontinued when a loan becomes 90 days past due as to principal or interest. When interest accruals are discontinued, unpaid interest recognized in income in the current year is reversed, and interest accrued in prior years is charged to the allowance for loan losses. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral exceeds the principal balance and related accrued interest, and the loan is in process of collection. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Loans Held for Sale: Loans held for sale represent mortgage loans the Company has either purchased or originated with the intent to sell or securitize in the secondary market and are carried at the lower of aggregate cost or estimated fair value. Mortgage Servicing Rights: On January 1, 1997, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. Statement No. 125 superseded FASB Statement No. 122, Accounting for Mortgage Servicing Rights, however, the basic accounting principles of Statement No. 122 related to the servicing of financial assets are included in Statement No. 125. Statement No. 125 requires the Company to recognize the financial and servicing assets it controls and the liabilities it has incurred and to derecognize financial assets when control has been surrendered in accordance with the criteria provided in the Statement. The effect of adopting Statement No. 125 did not have a material impact on the Company's financial statements. The value of mortgage servicing rights, regardless of how obtained, are capitalized and amortized in proportion to and over the period of estimated net servicing revenues. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. To determine fair value, the Company estimates the present value of future cash flows incorporating various assumptions including servicing income, cost of servicing, discount rates, prepayment speeds, and default rates. For purposes of measuring impairment, the mortgage servicing rights are stratified based upon predominant risk characteristics of the underlying loans. Retained Interest: The Company retains a financial interest in its securitized loan sales. This retained interest is generally comprised of two components: excess spread receivable and overcollateralization. Excess spread receivable represents the present value of the excess cash flows generated by the securitized loans. The excess cash flows generally represent the difference between interest at the stated rate paid by borrowers and the sum of (A) pass-through interest paid to third-party investors and (B) on-going securitization expenses, including servicing, insurance, and trustee costs. The Company determines the present value of the excess cash flows at the time each securitization closes, based on valuation assumptions, including default rates, prepayment rates, and discount rates. Additionally, the Company provides credit enhancement with respect to the security issued, in the form of overcollateralization. The initial overcollateralization will generally be required to increase to a pre-determined amount, at which time the excess cash flows discussed above will be released, monthly, to the Company. The initial overcollateralization amount will reach the required overcollateralization level through the application of monthly excess cash to accelerate payment of the note(s). Generally, the required overcollateralization amount will decrease or increase, subject to pre-established requirements based on the performance of the collateral loans. The Company determines the present value of cash flows to be received by the Company related to the overcollateralization feature at the time each securitization closes, based on the same assumptions previously discussed for the excess spread component. The retained interest is accounted for similar to an available-for-sale security, and as such, the recorded value is adjusted, quarterly, to its estimated fair value with the related increase or decrease in fair value recorded as a separate component of stockholders' equity, net of tax. If the decrease in fair value is determined to be permanent, the impairment is charged to operations. Because the retained interest is uncertificated, the Company has included the recorded value of the retained interest in Other Assets in the consolidated balance sheet. Allowance for Loan Losses: The provision for possible loan losses included in the consolidated statements of income is based upon management's evaluation of individual credits in the loan portfolio, historical loan loss experience, current and expected future economic conditions, and other relevant factors. These provisions, less net charge-offs, comprise the allowance for loan losses. In management's judgment, the allowance for loan losses is maintained at a level adequate to provide for probable losses on existing loans. This evaluation 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 are 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. Bank Premises and Equipment: Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method over the estimated useful lives of the assets. Generally, estimated useful lives of bank premises and furniture, fixtures, and equipment do not exceed 30 and 7 years, respectively. Intangibles: Intangible assets are comprised of goodwill and core deposits and are included in other assets in the consolidated balance sheets. Goodwill is being amortized on a straight-line basis over a 10 to 15 year period and core deposits are being amortized using accelerated methods over 10 year estimated useful lives. The carrying amount of goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as indicated based on the estimated undiscounted cash flows of the entity acquired over the remaining amortization period, the carrying amount of the goodwill is reduced by the estimated shortfall of cash flows discounted over the remaining amortization period. Income Taxes: The consolidated provision for income taxes is based upon reported income and expense. Deferred income taxes (included in other assets) are provided for temporary differences between financial reporting and tax bases of assets and liabilities. The Company files a consolidated income tax return. The respective subsidiaries generally provide for income taxes on a separate return basis and remit amounts determined to be currently payable to the Parent Company. Stock-Based Compensation: In accordance with FASB Statement No. 123, Accounting for Stock-Based Compensation, the Company has elected to follow Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its employee stock options. Because the exercise price of the Company's employee stock options granted equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Basic and Diluted Earnings per Common Share: The Company adopted the provisions of FASB Statement No. 128, Earnings per Share, effective December 31, 1997. Under Statement No. 128, basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding, while diluted earnings per share is computed by dividing net income by the weighted-average number of shares outstanding increased by the number of shares of common stock which would be issued assuming the exercise of stock options and other immaterial common stock equivalents. The incremental shares related to the options were 15,916 and 1,397 in 1997 and 1996 and other common stock equivalents were 3,500 in 1997. The impact of this change was not significant and all per share amounts for all periods have been presented to conform to Statement No. 128 requirements. New Accounting Pronouncements: The effective date of certain provisions of FASB Statement No. 125 related to repurchase agreements, dollar-roll, and securities lending transactions was deferred until January 1, 1998. The adoption of these provisions is not expected to have a significant impact on the financial position or results of operations of the Company. During 1997, the FASB issued several new statements which will also become effective in 1998. These pronouncements include Statement No. 129, Disclosure of Information about Capital Structure; Statement No. 130, Reporting Comprehensive Income; and Statement No. 131, Disclosures about Segments of an Enterprise and Related Information. The Company is in the process of fully evaluating these new pronouncements and will adopt them in 1998 in accordance with the requirements. Such adoption is not expected to have a significant impact on the financial position or results of operations of the Company. Statements of Cash Flows: Cash paid for interest, including long-term debt, was $44,342,000, $39,008,000, and $32,755,000 in 1997, 1996, and 1995, respectively. Cash paid for income taxes was $7,663,000, $5,399,000 and $4,055,000 in 1997, 1996, and 1995, respectively. Reclassifications: Certain amounts in the 1996 and 1995 financial statements have been reclassified to conform to the 1997 presentation. Such reclassifications had no impact on net income or stockholders' equity. NOTE TWO RESTRICTIONS ON CASH AND DUE FROM BANKS City National Bank is required to maintain an average reserve balance with the Federal Reserve Bank. The average amount of the balance for the year ended December 31, 1997, was approximately $12,660,000. Included in cash and due from banks at December 31, 1997, is $6,189,000 of cash restricted for mortgage banking activities. NOTE THREE ACQUISITIONS On November 21, 1997, the Company signed a definitive agreement to acquire Del Amo Savings Bank, FSB (Del Amo). Del Amo is a federally chartered savings bank, headquartered in Torrance, California, with total assets and total deposits of approximately $115 million and $101 million, respectively, at December 31, 1997. Under the terms of the agreement, the Company will acquire all of the outstanding shares of Del Amo common stock in exchange for approximately 254,000 shares of the Company's common stock, valued at approximately $10.7 million. The transaction will be accounted for under the purchase method of accounting. In January 1998 and December 1997, City National Bank, a wholly-owned subsidiary of the Company, acquired Jarrett-Aim Communications, Inc. and RMI, Ltd. (RMI), respectively. Jarrett-Aim is a printer and direct mail corporation and RMI is an insurance agency designed to market insurance products and services to select corporate and individual clients. These transactions were accounted for under the purchase method of accounting. Accordingly, the results of operations attributable to the RMI acquisition have been included in the consolidated totals from the date of its acquisition. The assets of Jarrett-Aim and RMI represent less than 1% of total assets of the Company. On October 9, 1997, City National Bank acquired First Allegiance Financial Corporation (First Allegiance), a mortgage loan origination company headquartered in Irvine, California. The acquisition involved an initial purchase price of approximately $15 million, which was comprised of 300,000 shares of the Company's common stock valued at approximately $12 million (286,000 issued at the acquisition date and the remaining 14,000 to be issued over a three year period), and cash in exchange for substantially all of the assets and liabilities of First Allegiance, which approximated $7.5 million and $6.8 million, respectively, at September 30, 1997. Additional consideration was contingent upon the First Allegiance division satisfying certain pre-established loan production levels subsequent to the acquisition. As a result of certain loan production levels achieved in the fourth quarter of 1997, the Company paid $3.8 million of additional consideration in January 1998. This transaction was accounted for under the purchase method of accounting. Accordingly, the results of operations attributable to the acquisition have been included in the consolidated totals from the date of acquisition. On January 24, 1997, the Company consummated its acquisition of the Old National Bank of Huntington (Old National). Under the terms of the agreement, the Company acquired all the outstanding shares of Old National common stock for 480,917 shares of the Company's common stock valued at approximately $10.1 million. Old National's total assets at December 31, 1996, were approximately $49 million or 4.7% of the Company's consolidated assets. This transaction was accounted for under the pooling of interests method of accounting. However, due to the immateriality of the transaction, prior period financial statements have not been restated and the results of operations attributable to the acquisition have been included in the consolidated totals from the date of acquisition. On December 31, 1996, the Company acquired certain assets and assumed certain liabilities of Prime Financial Corporation, a mortgage loan servicing company located in Costa Mesa, California. This transaction, accounted for under the purchase method of accounting, increased the Company's mortgage loan servicing portfolio by approximately $600 million. As a result of a servicing arrangement entered into by the Company, the loan servicing income and expenses of the acquiree have been included in the Company's financial statements since November 1996. Pro forma results of operations of the 1997 and 1996 purchase acquisitions as though each had been combined with the Company at the beginning of the periods presented do not differ materially from the results presented herein. Intangible assets arising from purchase business combinations consist primarily of goodwill and core deposits which have an aggregate unamortized balance at December 31, 1997 and 1996, of $21,812,000 and $5,781,000, respectively. Amortization of goodwill and core deposits approximated $1,074,000, $619,000, and $623,000 during the years ended December 31, 1997, 1996, and 1995, respectively. NOTE FOUR INVESTMENTS In June 1997, the Company reclassified its entire held-to-maturity securities portfolio to the available-for-sale classification. The securities transferred consisted of investment securities with approximate amortized cost and market value of $46.5 million and $46.8 million, respectively. This transfer was made by the Company to provide management more flexibility in managing the Company's liquidity and interest rate risk. In November 1995, the Financial Accounting Standards Board (FASB) staff issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities. In accordance with provisions in that Special Report, the Company chose to reclassify securities from held to maturity to available for sale. At the date of transfer, the amortized cost of those securities was $69,389,000 and the unrealized gain on those securities was $242,000, which was included in stockholders' equity. Included in the Company's investment portfolio are structured notes with an estimated fair value of $4.1 million and $7.3 million at December 31, 1997 and 1996, respectively. Such investments are used by management to enhance yields, diversify the investment portfolio, and manage the Company's exposure to interest rate fluctuations. These securities consist of federal agency securities with an average maturity of less than two years. Management periodically performs sensitivity analyses to determine the Company's exposure to fluctuation in interest rates of 3% and has determined that the structured notes meet regulatory price sensitivity guidelines. The aggregate carrying and approximate market values of securities follow. Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Available-for-Sale Securities Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------------------- (in thousands) December 31, 1997 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 107,156 $ 455 $ 315 $ 107,296 Obligations of states and political subdivisions 34,195 1,244 3 35,436 Mortgage-backed securities 9,200 249 33 9,416 Other debt securities 3,203 275 3,478 ------------------------------------------------------------- TOTAL DEBT SECURITIES 153,754 2,223 351 155,626 Equity securities 7,095 281 90 7,286 ------------------------------------------------------------- $ 160,849 $ 2,504 $ 441 $ 162,912 -------------------------------------------------------------
Available-for-Sale Securities Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------------------- (in thousands) December 31, 1996 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 79,311 $ 198 $ 588 $ 78,921 Obligations of states and political subdivisions 11,033 246 4 11,275 Mortgage-backed securities 12,347 282 92 12,537 Other debt securities 3,332 130 3,462 ------------------------------------------------------------- TOTAL DEBT SECURITIES 106,023 856 684 106,195 Equity securities 16,918 244 413 16,749 ------------------------------------------------------------- $ 122,941 $ 1,100 $ 1,097 $ 122,944 -------------------------------------------------------------
Held-to-Maturity Securities Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------------------- (in thousands) December 31, 1996 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 14,974 $ 54 $ 133 $ 14,895 Obligations of states and political subdivisions 25,015 973 31 25,957 Mortgage-backed securities 443 15 428 Other debt securities 546 546 ------------------------------------------------------------- $ 40,978 $ 1,027 $ 179 $ 41,826 -------------------------------------------------------------
The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Estimated Fair Cost Value ---------------------------------- (in thousands) Available-for-sale Due in one year or less $ 28,243 $ 28,216 Due after one year through five years 90,604 91,542 Due after five years through ten years 24,071 24,727 Due after ten years 1,636 1,725 ---------------------------------- 144,554 146,210 Mortgage-backed securities 9,200 9,416 ---------------------------------- $ 153,754 $ 155,626 ----------------------------------
Gross gains of $389,000, $89,000, and $103,000, and gross losses of $363,000, $2,000, and $101,000, were realized on sales and calls of securities during 1997, 1996, and 1995, respectively. The book value of securities pledged to secure public deposits and for other purposes as required or permitted by law approximated $107,147,000 and $112,849,000 at December 31, 1997 and 1996, respectively. NOTE FIVE LOANS The loan portfolio is summarized as follows:
December 31 1997 1996 ---------------------------------- (in thousands) Commercial, financial and agricultural $ 232,602 $ 224,267 Residential real estate 400,401 338,385 Installment loans to individuals 154,713 142,123 ---------------------------------- $ 787,716 $ 704,775 ----------------------------------
The Company grants loans to customers generally within the market areas of City National Bank and its banking divisions. There is no significant concentration of credit risk by industry or by related borrowers. There are no foreign loans outstanding and highly leveraged loan transactions are insignificant. The Company originates or purchases FHA Title I home improvement loans, high loan-to-value loans, and other types of second lien mortgages to be sold or securitized. At December 31, 1997 and 1996, these loans held for sale were approximately $114 million and $38 million, respectively. The Company also originates and sells fixed rate mortgage loans on a servicing released basis. At December 31, 1997 and 1996, these loans held for sale were approximately $21 million and $54 million, respectively. On December 31, 1997, the Company sold approximately $35 million of second lien mortgage loans held for sale through an asset-backed securitization transaction. As a result, the Company recorded a retained interest of approximately $4.4 million. NOTE SIX LOAN SERVICING Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others was $1.253 billion and $912 million at December 31, 1997 and 1996, respectively. The unpaid principal balances of intercompany loans serviced was $63,254,000 and $28,290,000 at December 31, 1997 and 1996, respectively. Mortgage loan servicing rights of $2,462,000 and $1,019,000 at December 31, 1997 and 1996, respectively, are included in other assets in the accompanying balance sheets. The fair value of mortgage loan servicing rights at December 31, 1997 and 1996, was not materially different from the recorded value and since the fair value exceeds the recorded value, no valuation allowance is necessary. Amortization of mortgage loan servicing rights approximated $383,000, $225,000, and $128,000 during the years ended December 31, 1997, 1996, and 1995, respectively. NOTE SEVEN ALLOWANCE FOR LOAN LOSSES A summary of changes in the allowance for possible loan losses follows:
1997 1996 1995 -------------------------------------------- (in thousands) Balance at beginning of year $ 7,281 $ 6,566 $ 6,477 Provision for possible loan losses 1,662 1,678 1,104 Charge-offs (1,899) (1,375) (1,331) Recoveries 419 412 316 Balance of acquired institution 210 -------------------------------------------- BALANCE AT END OF YEAR $ 7,673 $ 7,281 $ 6,566 --------------------------------------------
The recorded investment in loans that were considered impaired was $5,947,000 and $4,643,000 at December 31, 1997 and 1996, respectively. Included in these amounts are $1,529,000 and $1,891,000, respectively, of impaired loans for which the related allowance for loan losses is $366,000 and $408,000, respectively. The average recorded investments in impaired loans during the years ended December 31, 1997, 1996 and 1995, were approximately $5,041,000, $4,528,000, and $3,423,000. During the years ended December 31, 1997, 1996, and 1995, $403,000, $332,000, and $328,000, respectively, was recognized as interest income on impaired loans and $126,000, $219,000, and $258,000, respectively, was recognized as interest income using a cash basis method of accounting. NOTE EIGHT BANK PREMISES AND EQUIPMENT A summary of bank premises and equipment follows: December 31 1997 1996 ------------------------- (in thousands) Bank premises $ 31,635 $ 28,141 Furniture, fixtures, and equipment 27,992 19,856 ------------------------- 59,627 47,997 Less allowance for depreciation 22,992 17,972 ------------------------- $ 36,635 $ 30,025 ------------------------- NOTE NINE SHORT-TERM BORROWINGS Short-term borrowings consist primarily of advances from the Federal Home Loan Bank of Pittsburgh (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. A summary of the Company's short-term borrowings is set forth below: (in thousands) 1997: Average amount outstanding during the year $ 158,428 Maximum amount outstanding at any month end 281,504 Weighted average interest rate: During the year 5.39% End of the year 5.56% 1996: Average amount outstanding during the year $ 154,759 Maximum amount outstanding at any month end 207,790 Weighted average interest rate: During the year 5.26% End of the year 5.01% 1995: Average amount outstanding during the year $ 98,973 Maximum amount outstanding at any month end 190,862 Weighted average interest rate: During the year 5.73% End of the year 5.51% NOTE TEN SCHEDULED MATURITIES OF TIME CERTIFICATES OF DEPOSITS OF $100,000 OR MORE Scheduled maturities of time certificates of deposits of $100,000 or more outstanding at December 31, 1997, are summarized as follows: (in thousands) Within one year $ 48,869 Over one through two years 19,227 Over two through three years 6,212 Over three through four years 825 Over four through five years 1,345 ----------------- TOTAL $ 76,478 ----------------- NOTE ELEVEN LONG-TERM DEBT AND UNUSED LINES OF CREDIT Long-term debt includes an obligation of the Parent Company consisting of a $35,000,000 revolving credit loan facility with an unrelated party. At December 31, 1997, $33,400,000 was outstanding. The loan has a variable rate (7.8438% at December 31, 1997) with interest payments due quarterly and principal due at maturity in December 1998. Management intends to refinance the loan according to provisions provided in the agreement. The loan agreement contains certain restrictive provisions applicable to the Parent Company including limitations on additional long-term debt. The Parent Company has pledged the common stock of City National Bank as collateral for the revolving credit loan. City National Bank maintains long-term financing from the FHLB in the form of Long-Term LIBOR Floaters as follows: December 31, 1997 ----------------------------------- Amount Amount Available Outstanding Interest Rate Maturity Date ----------------------------------------------------------------------------- $10,000,000 $10,000,000 5.60% July 2002 25,000,000 25,000,000 5.61 September 2002 The Company has purchased, through its banking divisions, 50,100 shares of FHLB stock at par value. Such purchases entitle the Company to dividends declared by the FHLB and provide an additional source of short-term and long-term funding, in the form of collateralized advances. Additionally, at December 31, 1997, City National Bank has been issued one year flexline commitments of $15.5 million, at prevailing interest rates, from the FHLB with maturities ranging from January to April 1998. Such commitments are subject to satisfying the Capital Stock Requirement provisions, as defined, in the agreement with the FHLB. As of December 31, 1997, there were no amounts outstanding pursuant to the agreements. Financing obtained from the FHLB, including the LIBOR Floaters, is based in part on the amount of qualifying collateral available, specifically U.S. Treasury and agency securities, mortgage-backed securities, and residential real estate loans. At December 31, 1997, collateral pledged to the FHLB included approximately $5 million in FHLB capital stock. NOTE TWELVE RESTRICTIONS ON SUBSIDIARY DIVIDENDS Certain restrictions exist regarding the ability of the subsidiary bank to transfer funds to the Parent Company in the form of cash dividends. The approval of the bank's applicable primary regulator is required prior to the payment of dividends by a subsidiary bank in excess of its earnings retained in the current year plus retained net profits for the preceding two years. During 1998, the subsidiary bank can, without prior regulatory approval, declare dividends of approximately $25,678,000 to the Parent Company, plus retained net profits for the interim period through the date of declaration. NOTE THIRTEEN INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows:
December 31 1997 1996 ---------------------------- (in thousands) Deferred tax assets: Allowance for loan losses $ 2,966 $ 2,827 Loans held for sale 832 Acquired net operating loss carryforward 741 741 Deferred compensation payable 374 391 Other 198 279 ---------------------------- TOTAL DEFERRED TAX ASSETS 5,111 4,238 Deferred tax liabilities: Federal income tax allowance for loan losses 148 148 Premises and equipment 1,121 886 Core deposit intangible 358 458 Loans 187 159 Securities available for sale 820 2 Other 403 406 ---------------------------- TOTAL DEFERRED TAX LIABILITIES 3,037 2,059 ---------------------------- NET DEFERRED TAX ASSETS $ 2,074 $ 2,179 ----------------------------
Significant components of the provision for income taxes are as follows:
1997 1996 1995 -------------------------------------------- (in thousands) Federal: Current $ 6,578 $ 5,046 $ 3,930 Deferred (713) (582) (439) -------------------------------------------- 5,865 4,464 3,491 State 1,160 874 691 -------------------------------------------- TOTAL $ 7,025 $ 5,338 $ 4,182 --------------------------------------------
Current income tax expense attributable to investment securities transactions approximated $10,000, $35,000, and $1,000 in 1997, 1996, and 1995, respectively. As of December 31, 1997, the Company has approximately $1.6 million and $1.8 million, respectively, of federal and state net operating loss carryforwards which expire in 2006. A reconciliation between income taxes as reported and the amount computed by applying the statutory federal income tax rate to income before income taxes follows:
1997 1996 1995 -------------------------------------------- (in thousands) Computed federal taxes and statutory rate $ 6,626 $ 5,414 $ 4,515 State income taxes, net of federal tax benefit 709 502 335 Tax effects of: Nontaxable interest income (621) (685) (805) Other items, net 311 107 137 -------------------------------------------- $ 7,025 $ 5,338 $ 4,182 --------------------------------------------
NOTE FOURTEEN EMPLOYEE BENEFIT PLANS The Company's 1993 Stock Incentive Plan has authorized the grant of options to key employees for up to 300,000 shares of the Company's common stock adjusted for changes in the capital structure of the Company since the adoption of the plan. As of December 31, 1997, 399,300 options are authorized for grant, of which 77,011 have been awarded to date. The options granted have five year terms and vest and become fully exercisable at the end of up to four years of continued employment. Proforma information regarding net income and earnings per share is required by Statement No. 123; however, such information has not been presented herein because the effect of applying Statement 123's fair value method to the Company's stock-based awards results in net income and earnings per share that are not materially different from the amounts reported. A summary of the Company's stock option activity and related information for the years ended December 31 is presented below:
1997 1996 ---------------------------------------------------------- Weighted- Weighted- Average Average Exercise Exercise Options Price Options Price ---------------------------------------------------------- Outstanding at beginning of year 40,511 $ 24.50 Granted 36,500 32.53 40,511 $ 24.50 Exercised (2,627) 24.50 -------------- -------------- Outstanding at end of year 74,384 $ 26.89 40,511 $ 24.50 -------------- -------------- Exercisable at end of year 52,025 $ 27.63 22,994 $ 24.50 Weighted-average fair value of options $ 7.55 $ 5.19 granted during the year
Exercise prices for options outstanding at December 31, 1997, ranged from $24.50 to $40. The weighted-average remaining contractual life of those options at December 31, 1997, was four years. The City Holding Company Profit Sharing and 401(k) Plan (the Plan) is a deferred compensation plan under section 401(k) of the Internal Revenue Code. All employees who complete one year of service are eligible to participate in the Plan. Participants may contribute from 1% to 15% of pre-tax earnings to their respective accounts. These contributions may be invested in any of six investment options selected by the employee, one of which is City Holding Company common stock. The Company matches 50% of the first 6% of compensation deferred by the participant with City Holding Company common stock. Although the profit sharing features of this plan remain intact, future profit contributions, if any, are expected to be made to the employee stock ownership plan discussed below. The City Holding Company Employees' Stock Ownership Plan (ESOP), covering all employees who have completed one year of service and have attained the age of 21, was created January 1, 1996 and includes both Money Purchase and Stock Bonus plan features. Annually, the Company will contribute to the Money Purchase account an amount equal to 9% of eligible compensation. Contributions to the Stock Bonus account are discretionary, as determined by the Company's Board of Directors. The Company's total expense associated with the Plan and the ESOP (collectively, the benefit plans) approximated $2,455,000, $2,126,000, and $1,400,000 in 1997, 1996, and 1995, respectively. The total number of shares of the Company's common stock held by the benefit plans is 274,557. Other than the benefit plans, the Company offers no postretirement benefits. NOTE FIFTEEN TRANSACTIONS WITH DIRECTORS AND OFFICERS Subsidiaries of the Company have granted loans to the officers and directors of the Company and its subsidiaries, and to their associates. The loans were made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unrelated persons and did not involve more than normal risk of collectibility. The aggregate amount of loans outstanding as of December 31, 1997 and 1996, attributable directly and indirectly to these parties, was approximately $34,333,000 and $34,167,000, respectively. During 1997, $16,086,000 of new loans were made and repayments totaled $15,920,000. NOTE SIXTEEN OTHER INCOME AND EXPENSES The following items of other income and other expense exceeded one percent of total revenue for the respective years:
1997 1996 1995 -------------------------------------------- (in thousands) Other income: Secondary market mortgage loan origination fees $ 2,458 $ 517 $ 400 Other expenses: Insurance, including FDIC premiums 319 700 1,139 Advertising 4,402 914 889 Bank supplies 1,429 1,618 1,236 Telecommunications 1,695 1,082 740
NOTE SEVENTEEN 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 December 31, 1997 and 1996, commitments outstanding to extend credit totaled approximately $98,138,000 and $64,379,000, respectively. 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 $2,498,000 and $2,937,000 as of December 31, 1997 and 1996, respectively. Historically, substantially all standby letters of credit have 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 EIGHTEEN PREFERRED STOCK AND SHAREHOLDER RIGHTS PLAN The Company's Board of Directors has the authority to issue preferred stock, and to fix the designation, preferences, rights, dividends and all other attributes of such preferred stock, without any vote or action by the shareholders. As of December 31, 1997, there are no such shares outstanding, nor are any expected to be issued, except as might occur pursuant to the Stock Rights Plan discussed below. The Company's Stock Rights Plan provides that each share of common stock carries with it one right. The rights would be exercisable only if a person or group, as defined, acquired 10% or more of the Company's common stock, or announces a tender offer for such stock. Under conditions described in the Stock Rights Plan, holders of rights could acquire shares of preferred stock or additional shares of the Company's common stock, or in the event of a 50% or more change-in-control, shares of common stock of the acquiror. The value of shares acquired under the plan would equal twice the exercise price. NOTE NINETEEN REGULATORY MATTERS The Company, including its banking subsidiaries, is subject to various regulatory capital requirements administered by the various banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, action by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its banking subsidiaries must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. The Company's and its banking subsidiary's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and its banking subsidiary to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined). Management believes, as of December 31, 1997, that the Company and its banking subsidiary met all capital adequacy requirements to which they were subject. As of December 31, 1997, the most recent notifications from banking regulatory agencies categorized the Company and its banking subsidiary as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Company and its banking subsidiary must maintain minimum total risk-based, Tier 1 risk-based, and Tier I leverage ratios set forth in the table below. There are no conditions or events since notifications that management believes have changed the institutions' categories. The Company's and its banking subsidiary's actual capital amounts and ratios are presented in the following table.
Well 1997 1996 Capitalized Minimum Amount Ratio Amount Ratio Ratio Ratio --------------------------------------------------------------------------- (in thousands) Total Capital (to Risk Weighted Assets): Consolidated $ 90,515 10.0% $ 79,439 11.2% 10% 8% City National Bank 109,693 12.3 93,223 13.3 10 8 Tier I Capital (to Risk Weighted Assets): Consolidated 82,842 9.2 72,157 10.2 6 4 City National Bank 102,020 11.5 85,943 12.2 6 4 Tier I Capital (to Average Assets): Consolidated 82,842 6.5 72,157 6.6 5 4 City National Bank 102,020 7.7 85,943 7.9 5 4
NOTE TWENTY FAIR VALUES OF FINANCIAL INSTRUMENTS FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. FASB No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following table represents the estimates of fair value of financial instruments
Fair Value of Financial Instruments 1997 1996 ------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------------------------------------------------------------------- (in thousands) Assets: Cash and due from banks $ 87,235 $ 87,235 $ 47,764 $ 47,764 Securities 162,912 162,912 163,922 164,770 Net loans 772,689 772,240 690,701 693,832 Loans held for sale 134,990 134,990 92,472 92,472 Liabilities: Demand deposits 484,936 484,936 440,917 440,917 Time deposits 453,562 464,969 387,753 387,808 Short-term borrowings 130,191 130,191 90,298 90,298 Long-term debt 68,400 68,901 34,250 34,245
The following methods and assumptions were used in estimating fair value amounts for financial instruments: The fair values for the loan portfolio are estimated using discounted cash flow analyses at interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying values of accrued interest approximate fair value. The fair values of demand deposits (i.e. interest and noninterest-bearing checking, regular savings, and other types of money market demand accounts) are, by definition, equal to their carrying amounts. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected monthly maturities of time deposits. Securities sold under agreements to repurchase represent borrowings with original maturities of less than 90 days. The carrying amount of advances from the FHLB and borrowings under repurchase agreements approximate their fair values. The fair values of long-term borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. The fair values of commitments are estimated based on fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the counterparties' credit standing. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The fair values approximated the carrying values of these commitments and letters of credit as of December 31, 1997 and 1996. NOTE TWENTY-ONE CITY HOLDING COMPANY (PARENT COMPANY ONLY) FINANCIAL INFORMATION
CONDENSED BALANCE SHEETS December 31 1997 1996 ---------------------------------- (in thousands) ASSETS Cash $ 163 $ 4,243 Securities available for sale 1,140 1,392 Investment in subsidiaries 127,029 93,041 Fixed assets 6,729 6,584 Other assets 7,263 5,079 ---------------------------------- TOTAL ASSETS $ 142,324 $ 110,339 ---------------------------------- LIABILITIES Long-term debt $ 33,400 $ 24,250 Advances from affiliates 934 934 Other liabilities 1,735 5,782 ---------------------------------- TOTAL LIABILITIES 36,069 30,966 STOCKHOLDERS' EQUITY 106,255 79,373 ---------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 142,324 $ 110,339 ----------------------------------
Advances from affiliates, which eliminate for purposes of the Company's consolidated financial statements, represent amounts borrowed from banking subsidiaries to fund the purchase of certain bank premises and to meet other cash needs of the Parent. Such debt is collateralized by the securities and fixed assets of the Parent Company. Interest is due quarterly at prime with principal due at maturity in 1998. CONDENSED STATEMENTS OF INCOME
Year Ended December 31 1997 1996 1995 ----------------------------------------------- (in thousands) INCOME Dividends from bank subsidiary $ 3,430 $ 4,180 $ 13,465 Mortgage loan servicing fees 1,147 Administrative fees 3,357 2,828 Other income 925 1,017 640 ----------------------------------------------- 7,712 9,172 14,105 EXPENSES Interest expense 2,215 1,477 1,144 Other expenses 10,898 9,302 4,206 ----------------------------------------------- 13,113 10,779 5,350 ----------------------------------------------- INCOME BEFORE INCOME TAX BENEFIT AND (EXCESS DIVIDENDS) EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES (5,401) (1,607) 8,755 Income tax benefit (3,235) (2,261) (2,127) ----------------------------------------------- INCOME BEFORE (EXCESS DIVIDENDS) EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES (2,166) 654 10,882 EQUITY IN UNDISTRIBUTED NET INCOME (EXCESS DIVIDENDS) OF SUBSIDIARIES 14,630 9,476 (2,164) ----------------------------------------------- NET INCOME $ 12,464 $ 10,130 $ 8,718 -----------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31 1997 1996 1995 ----------------------------------------------- (in thousands) OPERATING ACTIVITIES Net income $ 12,464 $ 10,130 $ 8,718 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Provision for depreciation 1,579 1,077 272 Increase in other assets (2,165) (2,842) (882) (Decrease) increase in other liabilities (346) 3,807 (300) (Equity in undistributed net income) excess dividends of (14,630) (9,476) 2,164 subsidiaries Realized investment securities gain (308) Other (10) ----------------------------------------------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (3,406) 2,686 9,972 INVESTING ACTIVITIES Proceeds from maturities of investment securities 375 836 Proceeds from sales of securities 496 43 Purchases of investment securities (363) (107) (160) Net change in loans 1,644 (71) Cash invested in subsidiaries (4,495) (625) (6,082) Purchases of premises and equipment (3,063) (4,655) (1,533) ----------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (5,406) (5,415) (6,939) FINANCING ACTIVITIES Proceeds from long-term debt 9,150 9,250 12,525 Principal repayments on long-term debt (4,400) Repayments to bank subsidiary, net (4,873) Cash dividends paid (4,486) (3,540) (3,002) Purchases of treasury stock (77) (2,286) Proceeds from sales of treasury stock 80 58 152 Exercise of stock options 65 Redemption of dissenter and fractional shares (22) ----------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 4,732 5,746 (1,884) ----------------------------------------------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (4,080) 3,017 1,149 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,243 1,226 77 ----------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 163 $ 4,243 $ 1,226 -----------------------------------------------
NOTE TWENTY-TWO SUMMARIZED QUARTERLY FINANCIAL INFORMATION (UNAUDITED) A summary of selected quarterly financial information for 1997 and 1996 follows:
First Second Third Fourth Quarter Quarter Quarter Quarter ------------------------------------------------------ (in thousands, except common share data) 1997 Interest income $ 21,365 $ 24,687 $ 24,823 $ 25,921 Interest expense 9,558 11,024 11,502 12,607 Net interest income 11,807 13,663 13,321 13,314 Provision for possible loan losses 388 440 393 441 Investment securities gains (losses) 28 (17) 4 11 Net income 2,829 3,175 3,485 2,975 Basic earnings per common share 0.47 0.52 0.57 0.47 Diluted earnings per common share 0.47 0.52 0.57 0.46 Average common shares outstanding: Basic 6,068 6,069 6,071 6,375 Diluted 6,079 6,080 6,089 6,402 1996 Interest income $ 21,093 $ 21,503 $ 21,485 $ 21,988 Interest expense 9,683 9,435 9,923 10,023 Net interest income 11,410 12,068 11,562 11,965 Provision for possible loan losses 271 290 382 735 Investment securities gains 61 2 5 19 Net income 2,461 2,566 2,543 2,560 Basic earnings per common share 0.44 0.46 0.45 0.46 Diluted earnings per common share 0.44 0.46 0.45 0.46 Average common shares outstanding: Basic 5,586 5,586 5,586 5,586 Diluted 5,586 5,586 5,586 5,587
Certain amounts previously reported during 1997 have been reclassified to conform to the financial statement presentation. These reclassifications had no impact on net income or stockholders' equity. The 1996 and first three quarters of 1997 earnings per share amounts have been restated to comply with Statement No. 128. EX-22 3 EXHIBIT 22 EXHIBIT 22 SUBSIDIARIES OF THE REGISTRANT As of December 31, 1997, City Holding Company had one banking and three non-banking subsidiaries. The City National Bank of Charleston, Charleston, West Virginia, is a national banking association conducting business in West Virginia and 100% owned by City Holding Company. Hinton Financial Corporation, a single bank holding company, is located in Hinton, West Virginia, and wholly owned by City Holding Company. City Mortgage Corporation, Pittsburgh, Pennsylvania, is an inactive mortgage banking company business in Pennsylvania, and City Financial Corporation, Charleston, West Virginia, is a full service securities brokerage and investment advisory company conducting business in West Virginia. Both are 100% owned by City Holding Company. CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of City Holding Company of our report dated January 30, 1998, included in the 1997 Annual Report to Shareholders of City Holding Company. We also consent to the incorporation by reference in the Registration Statements (Form S-3, Number 33-38391, Form S-8, Number 33-38269, and Form S-8, Number 33-62738) pertaining to the Dividend Reinvestment and Stock Purchase Plan, the Profit-Sharing and 401(k) Plan, and the 1993 Stock Incentive Plan, respectively, of City Holding Company and in the related Prospectuses of our report dated January 30, 1998, with respect to the consolidated financial statements of City Holding Company incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1997. /s/ Ernst & Young LLP Charleston, West Virginia March 11, 1998 EX-27 4 FINANCIAL DATA SCHEDULE
9 This Schedule contains Summary Financial Information extracted from registrants Audited Financial Statements for the Year Ended December 31, 1997, and is qualified in its entirety by reference to such Financial Statements. 1,000 YEAR DEC-31-1997 DEC-31-1997 47,207 0 40,028 0 162,912 0 0 780,362 7,673 1,266,143 938,498 130,191 22,799 68,400 0 0 16,067 90,188 1,266,143 85,844 10,882 70 96,796 33,117 44,691 52,105 1,662 26 57,670 19,489 12,464 0 0 12,464 2.03 2.02 4.74 3,758 1,858 331 0 7,281 1,899 419 7,673 0 0 0
-----END PRIVACY-ENHANCED MESSAGE-----