EX-13 2 exhibit1312-31x14.htm EXHIBIT 13 Exhibit 13 12-31-14
Selected Financial Data                                     Exhibit 13
Table One
Five-Year Financial Summary
(in thousands, except per share data)
 
2014
2013
2012
2011
2010
Summary of Operations
 
 
 
 
 
Total interest income
$
129,566

$
138,539

$
112,212

$
112,888

$
121,916

Total interest expense
11,960

13,301

14,450

20,758

27,628

Net interest income
117,606

125,238

97,762

92,130

94,288

Provision for loan losses
4,054

6,848

6,375

4,600

7,093

Total other income
58,722

58,006

55,257

54,860

48,939

Total other expenses
95,041

102,906

87,401

81,141

78,721

Income before income taxes
77,233

73,490

59,243

61,249

57,413

Income tax expense
24,271

25,275

20,298

20,571

18,453

Net income available to common  shareholders
52,962

48,215

38,945

40,678

38,960

 
 
 
 
 
 
Per Share Data
 
 
 
 
 
Net income basic
$
3.40

$
3.07

$
2.63

$
2.68

$
2.48

Net income diluted
3.38

3.04

2.61

2.67

2.47

Cash dividends declared
1.60

1.48

1.40

1.37

1.36

Book value per share
25.79

24.61

22.47

21.05

20.31

 
 
 
 
 
 
Selected Average Balances
 
 
 
 
 
Total loans
$
2,593,597

$
2,523,755

$
2,041,876

$
1,899,388

$
1,820,588

Securities
365,904

360,860

409,431

454,513

507,915

Interest-earning assets
2,968,706

2,905,783

2,489,072

2,391,484

2,348,258

Deposits
2,824,985

2,821,573

2,338,891

2,221,414

2,190,324

Long-term debt
16,495

16,495

16,495

16,495

16,876

Shareholders’ equity
395,940

373,102

325,073

316,161

316,030

Total assets
3,404,818

3,378,351

2,837,234

2,701,720

2,654,497

 
 
 
 
 
 
Selected Year-End Balances
 
 
 
 
 
Net loans
$
2,631,916

$
2,585,622

$
2,127,560

$
1,953,694

$
1,846,776

Securities
354,686

370,120

402,039

396,175

453,585

Interest-earning assets
3,016,477

2,986,194

2,574,684

2,374,804

2,334,921

Deposits
2,872,787

2,785,133

2,409,316

2,221,268

2,171,375

Long-term debt
16,495

16,495

16,495

16,495

16,495

Shareholders’ equity
390,853

387,623

333,274

311,134

314,861

Total assets
3,461,633

3,368,238

2,917,466

2,777,109

2,637,295

 
 
 
 
 
 
Performance Ratios
 
 
 
 
 
Return on average assets
1.56
%
1.43
%
1.37
%
1.51
%
1.47
%
Return on average equity
13.38

12.92

11.98

12.87

12.33

Return on average tangible common equity
16.49

16.20

14.74

15.66

15.02

Net interest margin
3.98

4.33

3.96

3.89

4.06

Efficiency ratio
53.72

55.82

57.16

55.87

52.93

Dividend payout ratio
47.06

48.21

53.23

51.12

54.84

 
 
 
 
 
 
Asset Quality
 
 
 
 
 
Net charge-offs to average loans
0.17
%
0.20
%
0.34
%
0.18
%
0.41
%
Provision for loan losses to average loans
0.16

0.27

0.31

0.24

0.39


1

Allowance for loan losses to nonperforming loans
128.10

90.25

96.59

87.76

156.39

Allowance for loan losses to total loans
0.76

0.79

0.88

0.98

0.98

 
 
 
 
 
 
Consolidated Capital Ratios
 
 
 
 
 
Total
14.19
%
13.84
%
13.85
%
14.07
%
14.81
%
Tier I Risk-based
13.36

13.00

12.97

13.12

13.88

Tier I Leverage
9.89

9.80

9.82

10.18

10.54

Average equity to average assets
11.63

11.04

11.46

11.70

11.91

Tangible equity to tangible assets (end of period)
9.35

9.49

9.40

9.37

10.01

 
 
 
 
 
 
Full-time equivalent employees
889

923

843

795

805



2

TWO-YEAR SUMMARY OF
COMMON STOCK PRICES AND DIVIDENDS

 
Cash Dividends
Per Share
 
Market
Low
 
High
2014
 
 
 
 
 
Fourth Quarter
$
0.40

 
$
41.88

 
$
46.95

Third Quarter
0.40

 
41.20

 
46.44

Second Quarter
0.40

 
41.74

 
46.43

First Quarter
0.40

 
42.15

 
46.69

 
 
 
 
 
 
2013
 
 
 
 
 
Fourth Quarter
$
0.37

 
$
41.87

 
$
49.21

Third Quarter
0.37

 
40.04

 
46.13

Second Quarter
0.37

 
36.87

 
40.43

First Quarter
0.37

 
36.07

 
40.05


*As more fully discussed under the caption Liquidity in Management’s Discussion and Analysis and in Note Nineteen of the Notes to Consolidated Financial Statements, the Company’s ability to pay dividends to its shareholders is dependent upon the ability of City National to pay dividends to City Holding (“Parent Company”).
 
The Company’s common stock trades on the NASDAQ Global Select Market under the symbol CHCO. The above table sets forth the cash dividends paid per share and information regarding the market prices per share of the Company’s common stock for the periods indicated. The price ranges are based on transactions as reported on the NASDAQ stock market. At February 25, 2015, there were 2,847 shareholders of record.


3

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
CITY HOLDING COMPANY
 
City Holding Company (the “Company”), a West Virginia corporation headquartered in Charleston, West Virginia, is a registered financial holding company under the Bank Holding Company Act and conducts its principal activities through its wholly owned subsidiary, City National Bank of West Virginia ("City National"). City National is a retail and consumer-oriented community bank with 82 banking offices in West Virginia (57), Virginia (14), Kentucky (8) and Ohio (3). City National provides credit, deposit, and trust and investment management services to its customers. In addition to its branch network, City National's delivery channels include ATMs, mobile banking, debit cards, interactive voice response systems, and Internet technology. The Company’s business activities are currently limited to one reportable business segment, which is community banking. City National has approximately 11% of the deposit market share in the counties of West Virginia it serves. In the Company’s key markets, the Company’s primary subsidiary, City National, generally ranks in the top three relative to deposit market share and the top two relative to branch share.

On January 10, 2013, the Company acquired Community Financial Corporation and its wholly owned subsidiary, Community Bank (collectively, "Community"). As a result of this acquisition, the Company acquired eight branches along the I-81 corridor in western Virginia and two branches in Virginia Beach, Virginia. On September 5, 2013, the Company announced the closure of the Lake James branch, which was a branch acquired as a result of this acquisition. On May 31, 2012, the Company acquired Virginia Savings Bancorp, Inc. and its wholly owned subsidiary, Virginia Savings Bank (collectively, "Virginia Savings"). As a result of this acquisition, the Company acquired five branches which expanded its footprint into Virginia.
 
CRITICAL ACCOUNTING POLICIES
 
The accounting policies of the Company conform to U.S. generally accepted accounting principles and require management to make estimates and develop assumptions that affect the amounts reported in the financial statements and related footnotes. These estimates and assumptions are based on information available to management as of the date of the financial statements. Actual results could differ significantly from management’s estimates. As this information changes, management’s estimates and assumptions used to prepare the Company’s financial statements and related disclosures may also change. The most significant accounting policies followed by the Company are presented in Note One of the Notes to Consolidated Financial Statements included herein. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, income taxes, other-than-temporary impairment on investment securities and purchased credit-impaired loans to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new information becomes available.

The Allowance and Provision for Loan Losses section of this Annual Report to Shareholders provides management’s analysis of the Company’s allowance for loan losses and related provision. The allowance for loan losses is maintained at a level that represents management’s best estimate of probable losses in the loan portfolio. Management’s determination of the appropriateness of the allowance for loan losses is based upon an evaluation of individual credits in the loan portfolio, historical loan loss experience, current economic conditions, and other relevant factors. This determination is inherently subjective, as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses related to loans considered to be impaired is generally evaluated based on the discounted cash flows using the impaired loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. 

The Income Taxes section of this Annual Report to Shareholders provides management’s analysis of the Company’s income taxes.  The Company is subject to federal and state income taxes in the jurisdictions in which it conducts business.  In computing the provision for income taxes, management must make judgments regarding interpretation of laws in those jurisdictions.  Because the application of tax laws and regulations for many types of transactions is susceptible to varying interpretations, amounts reported in the financial statements could be changed at a later date upon final determinations by taxing authorities.  On a quarterly basis, the Company estimates its annual effective tax rate for the year and uses that rate to provide for income taxes on a year-to-date basis.  The amount of unrecognized tax benefits could change over the next twelve months as a result of various factors.   

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended December 31, 2011 through 2013. 


4

On a quarterly basis, the Company performs a review of investment securities to determine if any unrealized losses are other-than-temporarily impaired.  Management considers the following, amongst other things, in its determination of the nature of the unrealized losses, (i) the length of time and the extent to which the fair value has been less than cost; (ii) the financial condition, capital strength, and near–term (12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment; (iv) adverse conditions specifically related to the security, an industry, or a geographic area; or (v) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  The Company continues to actively monitor the fair values of its investments along with the financial strength of the issuers behind these securities, as well as its entire investment portfolio.  Based on the market information available, the Company believes that (i) the declines in fair value are temporary, driven by fluctuations in the interest rate environment and not due to the creditworthiness of the issuers, (ii) the Company does not have the intent to sell any of the securities classified as available for sale, and (iii) it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.  The Company cannot guarantee that such securities will recover and if additional information becomes available in the future to suggest that the losses are other-than-temporary, the Company may need to record additional impairment charges in future periods.

The Company values purchased credit-impaired loans at fair value in accordance with ASC Topic 310-30. In determining the estimated fair value, management considers several factors, such as estimated future credit losses, estimated prepayments, remaining lives of the acquired loans and the estimated value of the underlying collateral in determining the present value of the cash flows expected to be received. For these loans, the expected cash flows that exceed the fair value of the loan represent the accretable yield, which is recognized as interest income on a level-yield basis over the expected cash flow periods of the loans. The non-accretable difference represents the difference between the contractually required principal and interest payments and the cash flows expected to be collected based upon management's estimation. Subsequent decreases in the expected cash flows will require the Company to evaluate the need for additions to the Company's allowance for loan losses. Subsequent increases in the expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges with a corresponding adjustment to the accretable yield, which will result in the recognition of additional interest income over the remaining lives of the loans.

 
FAIR VALUE MEASUREMENTS
 
The Company determines the fair value of its financial instruments based on the fair value hierarchy established in ASC Topic 820, whereby the fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. ASC Topic 820 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The hierarchy classification is based on whether the inputs in the methodology for determining fair value are observable or unobservable. Observable inputs reflect market-based information obtained from independent sources (Level 1 or Level 2), while unobservable inputs reflect management’s estimate of market data (Level 3). Assets and liabilities that are actively traded and have quoted prices or observable market data require a minimal amount of subjectivity concerning fair value. Management’s judgment is necessary to estimate fair value when quoted prices or observable market data are not available.

            At December 31, 2014, approximately 8% of total assets, or $264 million, consisted of financial instruments recorded at fair value. Of this total, approximately 99% or $262 million of these financial instruments used valuation methodologies involving observable market data, collectively Level 1 and Level 2 measurements, to determine fair value. Approximately 1% or $2 million of these financial instruments were valued using unobservable market information or Level 3 measurements. The financial instruments valued using unobservable market information were pooled trust preferred investment securities classified as available-for-sale. At December 31, 2014, approximately $10 million of derivative liabilities were recorded at fair value using methodologies involving observable market data. The Company does not believe that any changes in the unobservable inputs used to value the financial instruments mentioned above would have a material impact on the Company’s results of operations, liquidity, or capital resources. See Note Twenty of the Notes to Consolidated Financial Statements for additional information regarding ASC Topic 820 and its impact on the Company’s financial statements.









5

FINANCIAL SUMMARY
 
The Company’s financial performance over the previous three years is summarized in the following table:
 
2014
2013
2012
 
 
 
 
Net income (in thousands)
$
52,962

$
48,215

$
38,945

Earnings per share, basic
$
3.40

$
3.07

$
2.63

Earnings per share, diluted
$
3.38

$
3.04

$
2.61

ROA*
1.56
%
1.43
%
1.37
%
ROE*
13.38
%
12.92
%
11.98
%
ROATCE*
16.49
%
16.20
%
14.74
%

*ROA (Return on Average Assets) is a measure of the effectiveness of asset utilization. ROE (Return on Average Equity) is a measure of the return on shareholders’ investment. ROATCE (Return on Average Tangible Common Equity) is a measure of the return on shareholders’ equity less intangible assets.

The Company's net income increased $4.7 million from 2013 due primarily to decreases of $2.8 million in the provision for loan losses, a decrease in non-interest expenses of $7.9 million due to the recognition of $5.5 million of acquisition and integration expenses associated with the completed acquisition of Community Financial Corporation in 2013 and a decrease of $2.4 million in other expenses (see Non-interest Income and Expense for more analysis of those fluctuations), and income tax expense (see Income Taxes).

            The Company’s tax equivalent net interest income decreased $7.7 million, or 6.1%, from $125.9 million in 2013 to $118.2 million in 2014.  This decrease is due to an expected decrease in accretion from the fair value adjustments related to the acquisitions of Virginia Savings and Community. The Company’s reported net interest margin decreased from 4.33% for the year ended December 31, 2013 to 3.98% for the year ended December 31, 2014 (see Net Interest Income).  The Company’s provision for loan losses decreased $2.8 million from $6.8 million in 2013 to $4.1 million in 2014 (see Allowance and Provision for Loan Losses).
 
BALANCE SHEET ANALYSIS
 
Selected balance sheet fluctuations are summarized in the following table (in millions):
 
December 31,
 
 
 
2014
2013
$ Change
% Change
 
 
 
 
 
Gross loans
$
2,652.1

$
2,606.2

$
45.9

1.8
 %
Investment securities
354.7

370.1

(15.4
)
(4.2
)
Premises and equipment, net
78.0

82.5

(4.5
)
(5.5
)
Goodwill and other intangible assets, net
74.2

75.1

(0.9
)
(1.2
)
 
 
 
 
 
Total deposits
2,872.8

2,785.1

87.7

3.1

Short-term borrowings
134.9

137.8

(2.9
)
(2.1
)
Long-term debt
16.5

16.5

—

—

Total shareholders' equity
390.9

387.6

3.3

0.9


Gross loans increased $46 million, or 1.8%, from December 31, 2013 to $2.65 billion at December 31, 2014, primarily due to an increase in residential real estate loans of $90 million (7.5%) that were partially offset by net decreases in commercial real estate loans of $20 million (1.9%), commercial and industrial ("C&I") loans of $16 million (10.6%) and consumer loans of$7 million (14.4%) (see Loans).

Investment securities decreased $15 million, or 4.2%, from $370 million at December 31, 2013, to $355 million at December 31, 2014.



Premises and equipment, net decreased $5 million, or 5.5%, from $83 million at December 31, 2013 to $78 million at December 31, 2014, primarily due to routine depreciation.

Goodwill and other intangible assets decreased $1 million as a result of amortization on the Company's core deposit intangible assets.

Total deposits increased $88 million, or 3.1%, from $2.79 billion at December 31, 2013 to $2.87 billion at December 31, 2014.

Short-term borrowings decreased $3 million, or 2.1%, from December 31, 2013 to December 31, 2014. All of the Company's short-term borrowings are customer repurchase agreements.

Long-term debt balances remained flat at $16.5 million. 

Shareholders' equity increased $3.3 million from December 31, 2013 to December 31, 2014 (see Capital Resources).
 

7

TABLE TWO
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(In thousands)
 
 
2014
 
2013
 
2012
 
Average Balance
Interest
Yield/
Rate
 
Average Balance
Interest
Yield/
Rate
 
Average Balance
Interest
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Loan portfolio(1):
 
 
 
 
 
 
 
 
 
 
 
Residential real estate(2),(3)
$
1,385,798

55,744

4.02
%
 
$
1,304,741

55,165

4.23
%
 
$
1,114,653

49,000

4.40
%
Commercial, financial, and agriculture(3),(4)
1,154,338

54,197

4.70

 
1,154,637

62,679

5.43

 
880,502

40,815

4.64

Installment loans to individuals(3),(5)
53,461

4,530

8.47

 
64,377

6,219

9.66

 
46,721

3,311

7.09

Previously securitized loans(6)
—

2,187

—

 
—

2,531

—

 
—

3,306

—

     Total loans
2,593,597

116,658

4.50

 
2,523,755

126,594

5.02

 
2,041,876

96,432

4.72

Securities:
 
 
 
 
 
 
 
 
 
 
 
   Taxable
337,440

11,766

3.49

 
330,225

10,697

3.24

 
371,092

14,285

3.85

   Tax-exempt(7)
28,464

1,757

6.17

 
30,635

1,885

6.15

 
38,339

2,218

5.79

     Total securities
365,904

13,523

3.70

 
360,860

12,582

3.49

 
409,431

16,503

4.03

Deposits in depository institutions
9,205

—

—

 
8,116

—

—

 
7,258

—

—

Federal funds sold
—

—

—

 
13,052

22

0.17

 
30,507

53

0.17

     Total interest-earning assets
2,968,706

130,181

4.39

 
2,905,783

139,198

4.79

 
2,489,072

112,988

4.54

Cash and due from banks
130,183

 
 
 
154,983

 
 
 
74,193

 
 
Bank premises and equipment
80,459

 
 
 
82,168

 
 
 
69,772

 
 
Other assets
246,618

 
 
 
255,544

 
 
 
223,783

 
 
   Less: allowance for loan losses
(21,148
)
 
 
 
(20,127
)
 
 
 
(19,586
)
 
 
Total assets
$
3,404,818

 
 
 
$
3,378,351

 
 
 
$
2,837,234

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
614,489

615

0.10
%
 
$
603,844

712

0.12
%
 
$
534,211

697

0.13
%
   Savings deposits
632,510

784

0.12

 
599,574

864

0.14

 
479,760

759

0.16

   Time deposits(3)
1,046,925

9,613

0.92

 
1,103,945

10,782

0.98

 
909,951

12,021

1.32

   Short-term borrowings
133,769

342

0.26

 
127,679

325

0.25

 
121,780

312

0.26

   Long-term debt
16,495

606

3.67

 
16,495

618

3.75

 
16,495

661

4.01

     Total interest-bearing liabilities
2,444,188

11,960

0.49

 
2,451,537

13,301

0.54

 
2,062,197

14,450

0.70

Noninterest-bearing demand deposits
531,061

 
 
 
514,210

 
 
 
414,969

 
 
Other liabilities
33,629

 
 
 
39,502

 
 
 
34,995

 
 
Stockholders’ equity
395,940

 
 
 
373,102

 
 
 
325,073

 
 
Total liabilities and stockholders’ equity
$
3,404,818

 
 
 
$
3,378,351

 
 
 
$
2,837,234

 
 
Net interest income
 
118,221

 
 
 
125,897

 
 
 
98,538

 
Net yield on earning assets
 
 
3.98
%
 
 
 
4.33
%
 
 
 
3.96
%
 
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.Includes the Company's residential real estate and home equity-junior lien loan categories.
3.Included in the above table are the following amounts (in thousands) for the accretion of the fair value adjustments related to the acquisitions of Virginia Saving and Community:


8

 
2014
 
2013
 
2012
 
Virginia Savings
Community
Total
 
Virginia Savings
Community
Total
 
Virginia Savings
Community
Total
Residential real estate
$
427

457

884

 
$
970

805

1,775

 
$
718

—

718

Commercial, financial, and agriculture
504

3,900

4,404

 
2,397

7,861

10,258

 
1,622

—

1,622

Installment loans to individuals
154

561

715

 
145

1,241

1,386

 
75

—

75

Time deposits
535

250

785

 
542

682

1,224

 
179

—

179

     Total
1,620

5,168

6,788

 
4,054

10,589

14,643

 
2,594

—

2,594


4.Includes the Company’s commercial and industrial and commercial real estate loan categories.
5.Includes the Company’s consumer and DDA overdrafts loan categories.
6.Effective January 1, 2012, the carrying value of the Company's previously securitized loans was reduced to $0.
7.Computed on a fully federal tax-equivalent basis assuming a tax rate of approximately 35%.


NET INTEREST INCOME
2014 vs. 2013

The Company’s tax equivalent net interest income decreased $7.7 million, or 6.1%, from $125.9 million in 2013 to $118.2 million in 2014. This decrease is due primarily to an expected decrease in accretion from the fair value adjustments related to the acquisitions of Virginia Savings Bank and Community Bank ($6.8 million for the year ended December 31, 2014 and $14.6 million for the year ended December 31, 2013). The Company’s reported net interest margin decreased from 4.33% for the year ended December 31, 2013 to 3.98% for the year ended December 31, 2014. Excluding the favorable impact of the accretion from the fair value adjustments, the net interest margin would have been 3.75% for the year ended December 31, 2014 and 3.83% for the year ended December 31, 2013. The decrease was primarily caused by loan yields compressing from 4.48% for the year ended December 31, 2013 to 4.27% for the year ended December 31, 2014.

Average interest-earning assets increased $63 million from 2013 to 2014, as increases attributable to residential real estate ($81 million), investment securities ($5 million) and deposits with depository institutions ($1 million) were partially offset by decreases in installment loans to individuals ($11 million), and federal funds sold ($13 million).   Average interest-bearing liabilities decreased $7 million from 2013 due to a decrease in time deposits ($57 million), that was partially offset by increases in savings deposits ($33 million), interest-bearing demand deposits ($11 million) and short-term borrowings ($6 million).

The following table presents the actual and forecasted accretion related to the fair value adjustments on net interest income recorded as a result of the Community and Virginia Savings acquisitions (in thousands).  The amounts in the table below require management to make significant assumptions based on estimated future default, prepayment and discount rates.  Actual performance could be significantly different from that assumed, which could result in the actual results being materially different than those estimated below.

 
Virginia Savings
Community
 
 
Year Ended
Loan
Accretion
Certificates of Deposit
Loan
Accretion
Certificates of Deposit
Total
 
 
 
 
 
 
Actual
 
 
 
 
 
2012
$
2,415

$
179

$
—

$
—

$
2,594

2013
3,512

542

9,907

682

14,643

2014
1,085

536

4,918

249

6,788

 
 
 
 
 
 
Forecasted
 
 
 
 
 
2015
458

518

2,239

160

3,375

2016
271

497

1,373

48

2,189

2017
156

—

995

—

1,151

 




9

2013 vs. 2012
 
The Company’s tax equivalent net interest income increased $27.4 million, or 27.8%, from $98.5 million in 2012 to $125.9 million in 2013. This increase is due primarily to loan growth from the acquisition of Community as of January 9, 2013 and accretion of the fair value adjustments related to the acquisitions of Community and Virginia Savings. In addition, the average rate paid on interest bearing deposits decreased from 0.70% during 2012 to 0.54% during 2013, which was largely attributable to the average rate paid on time deposits declining from 1.32% during 2012 to 0.98% during 2013.

The Company’s reported net interest margin increased from 3.96% for the year ended December 31, 2012 to 4.33% for the year ended December 31, 2013. Excluding the positive impact of accretion relating to the Company's acquisitions, the net interest margin decreased slightly from 3.85% in 2012 and 3.83% for the year ended December 31, 2013.

Excluding the impact of the Community acquisition, average interest-earning assets increased $85 million from 2012 to 2013, as increases attributable to residential real estate ($85 million) and commercial loans ($67 million) were partially offset by a decrease in investment securities ($49 million) and federal funds sold ($17 million). Excluding the impact of the Community acquisition, average interest-bearing liabilities increased $90 million from 2012 due to increases in savings deposits ($47 million), interest-bearing demand deposits ($23 million) and time deposits ($15 million).

TABLE THREE
RATE/VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
(In thousands)
 
2014 vs. 2013
Increase (Decrease)
Due to Change In:
2013 vs. 2012
Increase (Decrease)
Due to Change In:
 
Volume
Rate
Net
Volume
Rate
Net
Interest-earning assets:
 
 
 
 
 
 
Loan portfolio
 
 
 
 
 
 
   Residential real estate
$
3,427

$
(2,848
)
$
579

$
8,356

$
(2,191
)
$
6,165

   Commercial, financial, and agriculture
(16
)
(8,466
)
(8,482
)
12,707

9,157

21,864

   Installment loans to individuals
(1,055
)
(634
)
(1,689
)
1,251

1,657

2,908

   Previously securitized loans
—

(344
)
(344
)
—

(775
)
(775
)
     Total loans
2,356

(12,292
)
(9,936
)
22,314

7,848

30,162

Securities:
 
 
 
 
 
 
   Taxable
234

835

1,069

(1,573
)
(2,015
)
(3,588
)
   Tax-exempt(1)
(134
)
6

(128
)
(446
)
113

(333
)
     Total securities
100

841

941

(2,019
)
(1,902
)
(3,921
)
Federal funds sold
(22
)
—

(22
)
(30
)
(1
)
(31
)
Total interest-earning assets
$
2,434

$
(11,451
)
$
(9,017
)
$
20,265

$
5,945

$
26,210

 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits
$
13

$
(110
)
$
(97
)
$
91

$
(76
)
$
15

   Savings deposits
48

(128
)
(80
)
190

(85
)
105

   Time deposits
(557
)
(612
)
(1,169
)
2,563

(3,802
)
(1,239
)
   Short-term borrowings
16

1

17

15

(2
)
13

   Long-term debt
—

(12
)
(12
)
—

(43
)
(43
)
     Total interest-bearing liabilities
$
(480
)
$
(861
)
$
(1,341
)
$
2,859

$
(4,008
)
$
(1,149
)
Net Interest Income
$
2,914

$
(10,590
)
$
(7,676
)
$
17,406

$
9,953

$
27,359


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





10

NON-INTEREST INCOME AND NON-INTEREST EXPENSE
2014 vs. 2013

Selected income statement fluctuations are summarized in the following table (in millions):

 
For the year ended December 31,
 
 
 
2014
2013
$ Change
% Change
Net investment security gains
$
1.2

$
0.8

$
0.4

50.0
 %
Non-interest income, excluding net investment securities gains
57.6

57.2

$
0.4

0.7

Non-interest expense
95.0

102.9

$
(7.9
)
(7.7
)

During the year ended December 31, 2014, the Company realized investment gains of $1.2 million from the sale of certain equity positions related to community banks and bank holding companies.

Exclusive of net investment securities gains, non-interest income increased $0.4 million to $57.6 million for the year ended December 31, 2014 as compared to $57.2 million for the year ended December 31, 2013.  Bankcard revenues increased $1.5 million, or 11.4%, to $15.1 million and trust and investment management fee income increased $0.6 million, or 15.8%, to $4.6 million. These increases were partially offset by lower service charges on deposit accounts of $1.0 million, or 3.7%, and other income of $0.7 million, primarily due to lower demand for fixed rate mortgage products.

During 2013, the Company recognized $5.5 million of acquisition and integration expenses associated with the completed acquisition of Community. Excluding these expenses, non-interest expenses decreased $2.4 million from $97.4 million for the year ended December 31, 2013 to $95.0 million for the year ended December 31, 2014. This decrease was largely attributable to a decline in other expense of $2.4 million due to a decrease in non-income based taxes as a result of the recognition of previously unrecognized tax position resulting from the close of the statute of limitations for previous tax years that was discrete to 2014. In addition, legal and professional fees also decreased $1.0 million from 2013 primarily due to lower legal settlements. Partially offsetting these decreases were increases in advertising expense ($0.6 million) and bankcard expense ($0.5 million).
 
2013 vs. 2012

Selected income statement fluctuations are summarized in the following table (in millions):
 
For the year ended December 31,
 
 
 
2013
2012
$ Change
% Change
Net investment security gains
$
0.8

$
1.0

$
(0.2
)
(20.0
)%
Non-interest income, excluding net investment securities gains
57.2

54.3

2.9

5.3

Non-interest expense
102.9

87.4

15.5

17.7


During the year ended December 31, 2013, the Company realized investment gains of $0.8 million associated with the calls of trust preferred securities and from the sale of certain equity positions related to community banks and bank holding companies.

Exclusive of net investment securities gains and losses, non-interest income increased $2.9 million to $57.2 million for the year ended December 31, 2013 as compared to $54.3 million for the year ended December 31, 2012. Service charges increased $1.2 million, or 4.5%, to $27.6 million and bankcard revenues increased $1.1 million, or 9.0%, to $13.5 million for the year ended December 31, 2013. These increases were primarily due to the acquisition of Community.

During 2013, the Company recognized $5.5 million of acquisition and integration expenses associated with the completed acquisition of Community. In comparison, during 2012, the Company recorded $4.7 million of acquisition and integration expenses associated with the completed acquisition of Virginia Savings and the impending acquisition of Community. Excluding these expenses, non-interest expenses increased $14.7 million from $82.7 million for the year ended December 31, 2012 to $97.4 million for the year ended December 31, 2013. Salaries and employee benefits increased $7.9 million due primarily to additional employees associated with the acquisition of Community. Normal annual salary increases, increased pension costs and increased incentive compensation accruals also contributed to the increase in salaries and

11

employee benefits. In addition, other expenses increased $2.0 million, occupancy and equipment expenses increased $1.7 million and depreciation expense increased $1.2 million. These increases were primarily attributable to the acquisition of Community and were in line with the Company's expectations. These increases were partially offset by a decrease in repossessed asset losses as a result of losses recognized in 2012.
 
INCOME TAXES
 
The Company recorded income tax expense of $24.3 million, $25.3 million and $20.3 million in 2014, 2013 and 2012, respectively. The Company’s effective tax rates for 2014, 2013 and 2012 were 31.4%, 34.4% and 34.3%, respectively. A reconciliation of the effective tax rate to the statutory rate is included in Note Fourteen of the Notes to Consolidated Financial Statements. During the year ended December 31, 2014, the Company reduced income tax expense by $1.8 million due to the recognition of previously unrecognized tax positions resulting from the close of the statute of limitations for previous tax years. Exclusive of this discrete item recognized in the year ended December 31, 2014, the Company's tax rate from operations was 33.8%. The Company anticipates that it will release $0.9 million from its unrecognized tax positions over the next 12 months.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company’s net deferred tax assets decreased from $42.2 million at December 31, 2013 to $36.8 million at December 31, 2014. The components of the Company’s net deferred tax assets are disclosed in Note Fourteen of the Notes to Consolidated Financial Statements. Realization of the most significant net deferred tax assets is primarily dependent on future events taking place that will reverse the current deferred tax assets. For example, realization of the deferred tax asset attributable to other-than-temporary impairment losses on securities, which have already been recognized in the Company’s financial statements, would be realized if the impaired securities were deemed to be “worthless” by the Internal Revenue Service ("IRS") or if the securities were sold and recognized for tax purposes.  The deferred tax asset and/or liability associated with unrealized securities losses is the tax impact of the unrealized gains and/or losses on the Company’s available for sale security portfolio.  At December 31, 2014 the Company had a deferred tax liability of $0.7 million and at December 31, 2013 the Company had a deferred tax asset of $1.2 million associated with unrealized securities losses and gains.  The impact of the Company’s unrealized gains and/or losses is noted in the Company’s Consolidated Statements of Changes in Shareholders’ Equity as an adjustment to Accumulated Other Comprehensive Income (Loss). The deferred tax liability at December 31, 2014 would be realized if the unrealized gains and/or losses on the Company’s securities were realized from sales or maturities of the related securities.  At December 31, 2014 and 2013, the Company had a deferred tax asset of $8.4 million and $9.5 million, respectively, associated with other-than-temporarily impaired securities.  The deferred tax asset at December 31, 2014 would be realized if the Company’s other-than-temporarily impaired securities were sold, or were deemed by the IRS to be “worthless.”  The deferred tax asset associated with the allowance for loan losses decreased slightly from $7.6 million at December 31, 2013 to $7.4 million at December 31, 2014. The deferred tax asset associated with the allowance for loan losses is expected to be realized as additional loan charge-offs, which have already been provided for within the Company’s financial statements, are recognized for tax purposes.  The deferred tax asset associated with the Company’s previously securitized loans is expected to be realized as the Company recognizes income for financial statement purposes from these loans in future periods. The deferred tax asset associated with these loans decreased from $5.2 million at December 31, 2013 to $4.7 million at December 31, 2014.  The deferred tax asset associated with the Company's intangible assets decreased to $4.9 million at December 31, 2014. The Company believes that it is more likely than not that each of the net deferred tax assets will be realized and that no valuation allowance is necessary as of December 31, 2014 or 2013.
 
RISK MANAGEMENT

Market risk is the risk of loss due to adverse changes in current and future cash flows, fair values, earnings or capital due to adverse movements in interest rates and other factors, including foreign exchange rates, underlying credit risk and commodity prices. Because the Company has no significant foreign exchange activities and holds no commodities, interest rate risk represents the primary risk factor affecting the Company’s balance sheet and net interest margin. Significant changes in interest rates by the Federal Reserve could result in similar changes in LIBOR interest rates, prime rates, and other benchmark interest rates that could affect the estimated fair value of the Company’s investment securities portfolio, interest paid on the Company’s short-term and long-term borrowings, interest earned on the Company’s loan portfolio and interest paid on its deposit accounts.

 The Company’s Asset and Liability Committee (“ALCO”) has been delegated the responsibility of managing the Company’s interest-sensitive balance sheet accounts to maximize earnings while managing interest rate risk. ALCO, comprised of various members of executive and senior management, is also responsible for establishing policies to monitor and limit the Company’s exposure to interest rate risk and to manage the Company’s liquidity position. ALCO satisfies its responsibilities

12

through quarterly meetings during which product pricing issues, liquidity measures, and interest sensitivity positions are monitored.

In order to measure and manage its interest rate risk, the Company uses an asset/liability management and simulation software model to periodically update the interest sensitivity position of the Company’s balance sheet. The model is also used to perform analyses that measure the impact on net interest income and capital as a result of various changes in the interest rate environment. Such analyses quantify the effects of various interest rate scenarios on projected net interest income.

The Company’s policy objective is to avoid negative fluctuations in net income or the economic value of equity of more than 15% within a 12-month period, assuming an immediate parallel increase or decrease of 400 basis points. The Company measures the long-term risk associated with sustained increases and decreases in rates through analysis of the impact to changes in rates on the economic value of equity.  Due to the current Federal Funds target rate of 25 basis points, the Company has chosen not to reflect a decrease of 25 basis points from current rates in its analysis.

The following table summarizes the sensitivity of the Company’s net income to various interest rate scenarios. The results of the sensitivity analyses presented below differ from the results used internally by ALCO in that, in the analyses below, interest rates are assumed to have an immediate and sustained parallel shock. The Company recognizes that rates are volatile, but rarely move with immediate and parallel effects. Internally, the Company considers a variety of interest rate scenarios that are deemed to be possible while considering the level of risk it is willing to assume in “worst-case” scenarios such as shown by the following:
Immediate Basis Point Change in Interest Rates
Implied Federal Funds Rate Associated with Change in Interest Rates
Estimated Increase (Decrease) in Net Income Over 12 Months
Estimated Increase (Decrease) in Economic Value of Equity
December 31, 2014
 
 
 
+400
4.25
%
+2.8
%
-4.1
 %
+300
3.25

+4.9

+1.8

+200
2.25

+5.0

+4.9

+100
1.25

+1.9

+2.9

 
 
 
 
December 31, 2013
 
 
 
+400
4.25
%
+3.3
%
-6.4
 %
+300
3.25

+4.3

-2.0

+200
2.25

+3.3

+0.6

+100
1.25

+0.6

+0.4


These estimates are highly dependent upon assumptions made by management, including, but not limited to, assumptions regarding the manner in which interest-bearing demand deposit and savings deposit accounts reprice in different interest rate scenarios, changes in the composition of deposit balances, pricing behavior of competitors, prepayments of loans and deposits under alternative rate environments, and new business volumes and pricing. As a result, there can be no assurance that the estimates above will be achieved in the event that interest rates increase during 2015 and beyond.  The estimates above do not necessarily imply that the Company will experience increases in net income if market interest rates rise.  The table above indicates how the Company’s net income and the economic value of equity behave relative to an increase or decrease in rates compared to what would otherwise occur if rates remain stable.

Based upon the estimates above, the Company believes that its net income is positively correlated with increasing rates as compared to the level of net income the Company would expect if interest rates remain flat.
 
LIQUIDITY

The Company evaluates the adequacy of liquidity at both the Parent Company level and at the banking subsidiary level. At the Parent Company level, the principal source of cash is dividends from its banking subsidiary, City National. Dividends paid by City National to the Parent Company are subject to certain legal and regulatory limitations. Generally, any dividends in amounts that exceed the earnings retained by City National in the current year plus retained net profits for the preceding two years must be approved by regulatory authorities. At December 31, 2014, City National could pay dividends up to $12.0 million without prior regulatory permission.

During 2014, the Parent Company used cash obtained from the dividends received primarily to: (1) pay common dividends to shareholders and (2) remit interest payments on the Company’s junior subordinated debentures and (3) fund

13

repurchases of the Company's common shares.  Additional information concerning sources and uses of cash by the Parent Company is reflected in Note Twenty One of the Notes to Consolidated Financial Statements.

Over the next 12 months, the Parent Company has an obligation to remit interest payments approximating $0.6 million on the junior subordinated debentures held by City Holding Capital Trust III. Additionally, the Parent Company anticipates continuing the payment of dividends, which are expected to approximate $24.2 million on an annualized basis for 2015 based on common shareholders of record at December 31, 2014 and a dividend rate of $1.60 for 2015.  However, interest payments on the debentures can be deferred for up to five years under certain circumstances and dividends to shareholders can, if necessary, be suspended.  In addition to these anticipated cash needs, the Parent Company has operating expenses and other contractual obligations, which are estimated to require $1.1 million of additional cash over the next 12 months. As of December 31, 2014, the Parent Company reported a cash balance of $12.5 million and management believes that the Parent Company’s available cash balance, together with cash dividends from City National will be adequate to satisfy its funding and cash needs over the next twelve months.

Excluding the interest and dividend payments discussed above, the Parent Company has no significant commitments or obligations in years after 2015 other than the repayment of its $16.5 million obligation under the debentures held by City Holding Capital Trust III. However, this obligation does not mature until June 2038, or earlier at the option of the Parent Company. It is expected that the Parent Company will be able to obtain the necessary cash, either through dividends obtained from City National or the issuance of other debt, to fully repay the debentures at their maturity.

City National manages its liquidity position in an effort to effectively and economically satisfy the funding needs of its customers and to accommodate the scheduled repayment of borrowings. Funds are available to City National from a number of sources, including depository relationships, sales and maturities within the investment securities portfolio, and borrowings from the FHLB and other financial institutions. As of December 31, 2014, City National’s assets are significantly funded by deposits and capital. Additionally, City National maintains borrowing facilities with the FHLB and other financial institutions that are accessed as necessary to fund operations and to provide contingency funding mechanisms. As of December 31, 2014, City National has the capacity to borrow an additional $1.5 billion from the FHLB and other financial institutions under existing borrowing facilities. City National maintains a contingency funding plan, incorporating these borrowing facilities, to address liquidity needs in the event of an institution-specific or systemic financial industry crisis. Also, although it has no current intention to do so, City National could liquidate its unpledged securities, if necessary, to provide an additional funding source.  City National also segregates certain mortgage loans, mortgage-backed securities, and other investment securities in a separate subsidiary so that it can separately monitor the asset quality of these primarily mortgage-related assets, which could be used to raise cash through securitization transactions or obtain additional equity or debt financing if necessary.

 The Company manages its asset and liability mix to balance its desire to maximize net interest income against its desire to minimize risks associated with capitalization, interest rate volatility, and liquidity. With respect to liquidity, the Company has chosen a conservative posture and believes that its liquidity position is strong. As illustrated in the Consolidated Statements of Cash Flows, the Company generated $53.4 million of cash from operating activities during 2014, primarily from interest income received on loans and investments, net of interest expense paid on deposits and borrowings.

The Company has obligations to extend credit, but these obligations are primarily associated with existing home equity loans that have predictable borrowing patterns across the portfolio. The Company has investment security balances with carrying values that totaled $354.7 million at December 31, 2014, and that greatly exceeded the Company’s non-deposit sources of borrowing which totaled $151.4 million.

The Company’s net loan to asset ratio is 76.0% as of December 31, 2014 and deposit balances fund 83.0% of total assets as compared to 65.7% for its peers. Further, the Company’s deposit mix has a very high proportion of transaction and savings accounts that fund 53.3% of the Company’s total assets.  And, the Company uses time deposits over $250,000 to fund 2.4% of total assets compared to its peers, which fund 8.6% of total assets with such deposits.
 
INVESTMENTS
 
The Company’s investment portfolio decreased from $370 million at December 31, 2013 to $355 million at December 31, 2014.

The investment portfolio is structured to provide flexibility in managing liquidity needs and interest rate risk, while providing acceptable rates of return.


14

The majority of the Company’s investment securities continue to be mortgage-backed securities. The mortgage-backed securities in which the Company has invested are predominantly underwritten to the standards of, and guaranteed by government-sponsored agencies such as FNMA and FHLMC.

The Company's municipal bond portfolio of $42.1 million as of December 31, 2014 has an average tax equivalent yield of 5.65% with an average maturity of 7.2 years. The average dollar amount invested in each security is $0.4 million. The portfolio has 39% rated "A" or better and the remaining portfolio is unrated, as the issuances represented small issuances of revenue bonds. Additional credit support has been purchased for 21% of the portfolio, while 79% has no additional credit support. Management does underwrite 100% of the portfolio on an annual basis, using the same guidelines that are used to underwrite its commercial loans. Revenue bonds were 96% of the portfolio, while the remaining 4% were general obligation bonds. Geographically, the portfolio supports the Company's footprint, with 76% of the portfolio being from municipalities throughout West Virginia, and the remainder from communities in Ohio, Indiana and Kentucky.

TABLE FOUR
INVESTMENT PORTFOLIO

The carrying value of the Company's securities are presented in the following table (in thousands):

 
Carrying Values as of December 31,
 
2014
2013
2012
Securities available-for-sale:
 
 
 
    Obligations of states and political subdivisions
$
42,096

$
41,548

$
48,929

    U.S. Treasuries and U.S. government agencies
1,827

2,365

3,888

Mortgage-backed securities:
 
 
 
     U.S. government agencies
187,328

278,108

286,481

     Private label
1,704

2,197

3,272

Trust preferred securities
9,036

13,156

12,645

Corporate securities
7,317

9,128

15,947

     Total Debt Securities available-for-sale
249,308

346,502

371,162

Marketable equity  securities
3,213

4,673

4,186

Investment funds
1,522

1,485

1,774

      Total Securities Available-for-Sale
254,043

352,660

377,122

Securities held-to-maturity:
 
 
 
     Mortgage baked securities
86,742

—

—

    Trust preferred securities
4,044

4,117

13,454

      Total Securities Held-to-Maturity
90,786

4,117

13,454

Other investment securities:
 
 
 
   Non-marketable equity securities
9,857

13,343

11,463

       Total Other Investment Securities
9,857

13,343

11,463

 
 
 
 
Total Securities
$
354,686

$
370,120

$
402,039


During the year, the Company transferred certain securities from available-for-sale to held-to-maturity. The
non-cash transfers of securities into the held-to-maturity categories from available-for-sale were made at fair value, which was $83.4 million on the date of the transfer.

Included in non-marketable equity securities in the table above at December 31, 2014 are $1.8 million of Federal Home Loan Bank stock and $8.1 million of Federal Reserve Bank stock. At December 31, 2014, there were no securities of any non-governmental issuers whose aggregate carrying or estimated fair value exceeded 10% of shareholders’ equity.

    




15

The weighted average yield of the Company's investment portfolio is presented in the following table (dollars in thousands):
 
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
Securities available-for-sale:
 
 
 
 
 
 
 
 
    Obligations of states and political subdivisions
$
6,787

3.83
%
$
9,967

3.47
%
$
12,416

4.13
%
$
12,927

4.51
%
    U.S. Treasuries and U.S. government agencies
1,821

2.58

—

—

6

1.26

—

—

Mortgage-backed securities:
 
 
 
 
 
 
 
 
     U.S. government agencies
25

3.46

5,884

4.30

14,223

3.10

167,196

2.51

     Private label
—

—

427

4.51

—

—

1,277

2.56

Trust preferred securities
—

—

—

—

—

—

9,036

4.50

Corporate securities
—

—

2,128

6.25

2,079

5.02

3,109

6.09

     Total Debt Securities available-for-sale
8,633

3.57

18,406

4.08

28,724

3.68

193,545

2.79

Securities held-to-maturity:
 
 
 
 
 
 
 
 
  U.S. government agencies
—

—

—

—

—

—

86,742

2.94

Trust preferred securities
—

—

—

—

—

—

4,044

9.31

      Total Securities Held-to-Maturity
—

—

—

—

—

—

90,786

3.22

 
 
 
 
 
 
 
 
 
      Total  debt securities
$
8,633

3.57
%
$
18,406

4.08
%
$
28,724

3.68
%
$
284,331

2.93
%
  
Weighted-average yields on tax-exempt obligations of states and political subdivisions have been computed on a taxable-equivalent basis using the federal statutory tax rate of 35%.  Average yields on investments available-for-sale are computed based on amortized cost. Mortgage-backed securities have been allocated to their respective maturity groupings based on their contractual maturity.
 
LOANS
TABLE FIVE
LOAN PORTFOLIO

The composition of the Company’s loan portfolio as of the dates indicated follows (in thousands):
 
2014
2013
2012
2011
2010
 
 
 
 
 
 
Residential real estate
$
1,294,576

$
1,204,450

$
1,031,435

$
929,788

$
882,780

Home equity – junior liens
145,604

146,090

143,110

141,797

143,761

Commercial and industrial
132,641

148,302

108,739

130,899

134,612

Commercial real estate
1,036,738

1,057,048

821,970

732,146

661,758

Consumer
39,705

46,402

36,564

35,845

38,424

DDA overdrafts
2,802

3,905

4,551

2,628

2,876

Previously securitized loans
—

—

—

—

789

Gross loans
$
2,652,066

$
2,606,197

$
2,146,369

$
1,973,103

$
1,865,000


Loan balances increased $46 million from December 31, 2013 to December 31, 2014. Residential real estate loans increased $90 million, or 7.5%, from $1.20 billion at December 31, 2013 to $1.29 billion at December 31, 2014.   Residential real estate loans represent loans to consumers for the purchase or refinance of a residence. These loans primarily consist of single family 1, 3, 5 and 10 year adjustable rate mortgages with terms that amortize the loans over periods from 15 to 30 years secured by first liens.  The Company’s mortgage products do not include sub-prime, interest only, or option adjustable rate mortgage products.  At December 31, 2014, $23 million of the residential real estate loans were for properties under construction. The Company’s home equity loans are underwritten differently than 1-4 family residential mortgages with typically less

16

documentation but lower loan-to-value ratios.  Home equity loans consist of lines of credit, short-term fixed amortizing loans and adjustable rate loans.  

Junior lien home equity loans remained flat at $146 million during 2014.  The Company's junior lien home equity loans are underwritten differently than 1-4 family residential mortgages, with typically less documentation but lower loan-to-value ratios and include both home equity loans and lines-of-credit. This type of lending, which is secured by a junior lien on the borrower's residence, allows customers to borrow against the equity in their home. Real estate market values as of the time the loan or line is granted directly affect the amount of credit extended. Junior lien home equity loans consist of lines-of-credit, short-term fixed amortizing loans and adjustable rate loans.

The C&I portfolio consists of loans to corporate borrowers primarily in small to mid-size industrial and commercial companies. Collateral securing these loans includes equipment, machinery, inventory, receivables and vehicles. C&I loans are considered to contain a higher level of risk than other loan types, although care is taken to minimize these risks. Numerous risk factors impact this portfolio, including industry specific risks such as economy, new technology, labor rates and cyclicality, as well as customer specific factors, such as cash flow, financial structure, operating controls and asset quality. C&I loans decreased $16 million, or 10.6%, from $148 million at December 31, 2013 to $133 million at December 31, 2014.

Commercial real estate loans consist of commercial mortgages, which generally are secured by nonresidential and multi-family residential properties, including hotel/motel and apartment lending. Commercial real estate loans are to many of the same customers and carry similar industry risks as the commercial and industrial loans ("C&I"). Commercial real estate loans decreased $20 million, or 1.9%, from $1.06 billion at December 31, 2013 to $1.04 billion at December 31, 2014.  During 2014 a variety of factors have led to the decline in commercial real estate and C&I loans - a $14 million participation loan was repurchased by the lead bank; a $9 million loan from an acquisition that was classified as substandard was repaid in full; a financially weak $9 million loan was refinanced by a smaller competitor that provided the borrower a cash out option; a more competitive lending environment; and various lines of credit experienced balance reductions. However, during the second half of 2014, the Company did experience an increase in commercial real estate loan balances, which increased $25 million from June 30, 2014 to December 31, 2014. At December 31, 2014, $29 million of the commercial real estate loans were for commercial properties under construction. 

The Company categorizes commercial loans by industry according to the Standard Industry Classification System (SIC) to monitor the portfolio for possible concentrations in one or more industries. As of December 31, 2014, the Company did not have an industry classification that exceeded 10% of total loans.

Consumer loans may be secured by automobiles, boats, recreational vehicles and other personal property. The Company monitors the risk associated with these types of loans by monitoring such factors as portfolio growth, lending policies and economic conditions. Underwriting standards are continually evaluated and modified based upon these factors. Consumer loans decreased $7 million during 2014.  The majority of this decrease is attributable to the Company's decision to strategically reduce the portfolio of indirect automobile loans acquired with the Community acquisition. These loans have higher loss percentages compared to the Company’s historical consumer portfolio and accounted for approximately $6 million of the decrease in 2014.
 

17

The following table shows the scheduled maturity of loans outstanding as of December 31, 2014 (in thousands):
 
Within One Year
After One But Within Five Years
After Five Years
Total
 
 
 
 
 
Residential real estate
$
184,033

$
521,210

$
589,333

$
1,294,576

Home equity – junior liens
29,030

64,384

52,190

145,604

Commercial and industrial
65,056

63,190

4,395

132,641

Commercial real estate
290,843

513,119

232,776

1,036,738

Consumer
20,876

20,959

672

42,507

Total loans
$
589,838

$
1,182,862

$
879,366

$
2,652,066

 
 
 
 
 
 
 
 
 
 
Loans maturing after one year with interest rates that are:
 
 
 
 
Fixed until maturity
 
$
457,271

 
 
Variable or adjustable
 
1,604,957

 
 
Total
 
$
2,062,228

 
 

ALLOWANCE AND PROVISION FOR LOAN LOSSES

Management systematically monitors the loan portfolio and the appropriateness of the allowance for loan losses (“ALLL”) on a quarterly basis to provide for probable losses incurred in the portfolio. Management assesses the risk in each loan type based on historical delinquency and loss trends, the general economic environment of its local markets, individual loan performance, and other relevant factors. Individual credits in excess of $1 million are selected at least annually for detailed loan reviews, which are utilized by management to assess the risk in the portfolio and the appropriateness of the allowance. Due to the nature of commercial lending, evaluation of the appropriateness of the allowance as it relates to these loan types is often based more upon specific credit review, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for general economic conditions and other inherent risk factors. Conversely, due to the homogeneous nature of the real estate and installment portfolios, the portions of the allowance allocated to those portfolios are primarily based on prior loss history of each portfolio, adjusted for general economic conditions and other inherent risk factors. Risk factors considered by the Company in completing this analysis include: (1) unemployment and economic trends in the Company’s markets, (2) concentrations of credit, if any, among any industries, (3) trends in loan growth, loan mix, delinquencies, losses or credit impairment, (4) adherence to lending policies and others. Each risk factor is designated as low, moderate/increasing, or high based on the Company’s assessment of the risk to loss associated with each factor. Each risk factor is then weighted to consider probability of occurrence.

In evaluating the appropriateness of the allowance for loan losses, management considers both quantitative and qualitative factors. Quantitative factors include actual repayment characteristics and loan performance, cash flow analyses, and estimated fair values of underlying collateral. Qualitative factors generally include overall trends within the portfolio, composition of the portfolio, changes in pricing or underwriting, seasoning of the portfolio, and general economic conditions.

The allowance not specifically allocated to individual credits is generally determined by analyzing potential exposure and other qualitative factors that could negatively impact the overall credit risk of the loan portfolio.  Loans not individually evaluated for impairment are grouped by pools with similar risk characteristics and the related historical loss rates are adjusted to reflect current inherent risk factors, such as unemployment, overall economic conditions, concentrations of credit, loan growth, classified and impaired loan trends, staffing, adherence to lending policies, and loss trends.

Determination of the allowance for loan losses is subjective in nature and requires management to periodically reassess the validity of its assumptions. Differences between actual losses and estimated losses are assessed such that management can timely modify its evaluation model to ensure that adequate provision has been made for risk in the total loan portfolio.

As a result of the Company’s quarterly analysis of the appropriateness of the ALLL, the Company recorded a provision for loan losses of $4.1 million, $6.8 million and $6.4 million for the years ended December 31, 2014, 2013 and 2012, respectively.
 
The provision for loan losses recorded in 2014 reflects the modest growth in the loan portfolio, changes in the quality of the portfolio, and general improvement in the Company's historical loss rates used to compute the allowance not

18

specifically allocated to individual credits. Additionally, the improvement in non-performing assets also contributed to a lower provision for loan losses during 2014. Changes in the allowance for loan losses is based on the Company’s detailed systematic methodology and are directionally consistent with changes in the composition and quality of the Company’s loan portfolio.  The Company believes its methodology for determining its ALLL adequately provides for probable losses incurred in the loan portfolio and produces a provision and allowance for loan losses that is directionally consistent with changes in asset quality and loss experience. 

The Company had net charge-offs of $4.5 million for the year ended December 31, 2014 compared to $5.1 million for the year ended December 31, 2013.  Net charge-offs in 2014 consisted primarily of net charge-offs on commercial real estate of $1.8 million and residential real estate of $1.6 million for the year ended December 31, 2014.  

The Company’s ratio of non-performing assets to total loans and other real estate owned decreased from 1.20% at December 31, 2013 to 0.90% at December 31, 2014.  Excluded from this ratio are purchased credit-impaired loans which continue to perform in accordance with the estimated expectations developed as of the date of each acquisition. Such loans would be considered nonperforming loans if the loan’s performance deteriorates below the initial expectations. Total past due loans decreased from $19.5 million, or 0.75% of total loans outstanding, at December 31, 2013 to $10.7 million, or 0.40% of total loans outstanding, at December 31, 2014. Acquired past due loans represent approximately 32% of total past due loans and have declined $13.0 million, or 79%, since March 31, 2013.

The allowance allocated to the commercial real estate loan portfolio decreased $1.9 million, or 17.2%, from $10.8 million at December 31, 2013 to $8.9 million at December 31, 2014. This decrease is primarily attributable to improvements in historical loss rates in the portfolio.

The allowance related to the commercial and industrial loan portfolio increased from $1.1 million at December 31, 2013 to $1.6 million at December 31, 2014. The increase is primarily attributable to an increase in the amount of loans classified as substandard in this portfolio.

The allowance allocated to the residential real estate portfolio increased $1.2 million from $6.1 million at December 31, 2013 to $7.2 million at December 31, 2014. The increase is primarily attributable to the growth in the portfolio, as well as an increase in the historical loss rate associated with this portfolio.

The allowance allocated to the home equity decreased $0.2 million from December 31, 2013. Consumer and overdraft loan portfolios at December 31, 2014 did not significantly change from December 31, 2013.

Based on the Company’s analysis of the appropriateness of the allowance for loan losses and in consideration of the known factors utilized in computing the allowance, management believes that the allowance for loan losses as of December 31, 2014, is adequate to provide for probable losses inherent in the Company’s loan portfolio. Future provisions for loan losses will be dependent upon trends in loan balances including the composition of the loan portfolio, changes in loan quality and loss experience trends, and recoveries of previously charged-off loans, among other factors.






















19

TABLE SIX
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
    
An analysis of changes in the allowance for loan losses follows (in thousands):

 
2014
2013
2012
2011
2010
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
20,575

$
18,809

$
19,409

$
18,224

$
18,541

 
 
 
 
 
 
Charge-offs:
 
 
 
 
 
Commercial and industrial
323

1,040

226

522

73

Commercial real estate
1,925

2,187

4,604

1,989

3,304

Residential real estate
1,762

2,181

1,030

1,367

1,607

Home equity
309

295

1,355

1,089

930

Consumer
188

454

190

164

86

DDA overdrafts
1,415

1,483

1,522

1,712

3,638

Total charge-offs
5,922

7,640

8,927

6,843

9,638

 
 
 
 
 
 
Recoveries:
 
 
 
 
 
Commercial and industrial
89

84

32

23

27

Commercial real estate
113

785

289

1,981

415

Residential real estate
187

234

22

29

74

Home equity
—

—

18

7

26

Consumer
204

327

135

136

129

DDA overdrafts
850

1,128

1,456

1,252

1,557

Total recoveries
1,443

2,558

1,952

3,428

2,228

Net charge-offs
4,479

5,082

6,975

3,415

7,410

Provision for loan losses
3,771

6,251

6,375

4,600

7,093

Provision for acquired loans
283

597

—

—

—

Balance at end of period
$
20,150

$
20,575

$
18,809

$
19,409

$
18,224

 
 
 
 
 
 
As a Percent of Average Total Loans:
 
 
 
 
 
Net charge-offs
0.17
%
0.20
%
0.34
%
0.18
%
0.41
%
Provision for loan losses
0.16
%
0.27
%
0.31
%
0.24
%
0.39
%
As a Percent of Non-Performing Loans:
 
 
 
 
 
Allowance for loan losses
128.10
%
90.25
%
96.59
%
87.76
%
156.39
%

TABLE SEVEN
NON-ACCRUAL, PAST-DUE AND RESTRUCTURED LOANS

Nonperforming assets at December 31 follows (in thousands):

 
2014
2013
2012
2011
2010
Non-accrual loans
$
15,307

$
22,361

$
19,194

$
21,951

$
10,817

Accruing loans past due 90 days or more
423

436

280

166

782

Previously securitized loans past due 90 days or more
—

—

—

—

54

Total non-performing loans
$
15,730

$
22,797

$
19,474

$
22,117

$
11,653

 

20

On non-accrual and impaired loans, approximately $0.5 million, $0.6 million, and $1.0 million of interest income would have been recognized during 2014, 2013 and 2012, respectively, if such loans had been current in accordance with their original terms.  There were no commitments to provide additional funds on non-accrual, impaired, or other potential problem loans at December 31, 2014 and 2013.  

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.
 
Information pertaining to impaired loans is included in the following table (in thousands):

 
2014
2013
Impaired loans with a valuation allowance
$
1,392

$
3,416

Impaired loans with no valuation allowance
5,377

9,178

Total impaired loans
$
6,769

$
12,594

 
 
 
Allowance for loan losses allocated to impaired loans
$
252

$
880


The impaired loans with a valuation allowance were comprised of two commercial borrowing relationships that were evaluated during the year and determined that an allowance was necessary.

Regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged by the bankruptcy court and the borrower has not reaffirmed the debt.  The filing of bankruptcy is deemed to be evidence that the borrower is in financial difficulty and the discharge of the debt by the bankruptcy court is deemed to be a concession granted to the borrower.

The following table sets forth the Company’s troubled debt restructurings ("TDRs") at December 31, 2014 and 2013 (in thousands):

 
Accruing
Non-Accruing
Total
December 31, 2014
 
 
 
Commercial and industrial
$
73

—

$
73

Commercial real estate
2,263

—

2,263

Residential real estate
17,946

545

18,491

Home equity
2,673

15

2,688

Consumer
—

—

—

 
$
22,955

$
560

$
23,515

 
 
 
 
December 31, 2013
 
 
 
Commercial and industrial
$
88

—

$
88

Commercial real estate
1,783

—

1,783

Residential real estate
18,651

1,693

20,344

Home equity
2,859

14

2,873

Consumer
0

—

0

 
$
23,381

$
1,707

$
25,088









21

TABLE EIGHT
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

The allocation of the allowance for loan losses and the percent of loans in each category to total loans is shown in the table below (dollars in thousands):
 
2014
2013
2012
2011
2010
 
Amount
Percent of Loans in Each Category to Total Loans
Amount
Percent of Loans in Each Category to Total Loans
Amount
Percent of Loans in Each Category to Total Loans
Amount
Percent of Loans in Each Category to Total Loans
Amount
Percent of Loans in Each Category to Total Loans
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,582

5
%
$
1,139

6
%
$
498

5
%
$
590

7
%
$
1,864

7
%
Commercial real estate
8,921

39
%
10,775

40
%
10,440

38
%
11,666

37
%
8,488

35
%
Residential real estate
7,208

49
%
6,057

46
%
5,229

48
%
4,839

47
%
5,337

48
%
Home equity - junior liens
1,495

5
%
1,672

6
%
1,699

7
%
1,525

7
%
1,452

8
%
Consumer
85

2
%
77

2
%
81

2
%
88

2
%
95

2
%
DDA overdrafts
859

—
%
855

—
%
862

—
%
701

—
%
988

—
%
Allowance for Loan Losses
$
20,150

100
%
$
20,575

100
%
$
18,809

100
%
$
19,409

100
%
$
18,224

100
%

PREVIOUSLY SECURITIZED LOANS

As of December 31, 2014 and 2013, the carrying value of the remaining previously securitized loans was zero, while the actual contractual balances of these loans were $4.9 million and $6.2 million, respectively. During the years ended December 31, 2014, 2013 and 2012, the Company recognized $2.2 million, $2.5 million and $3.3 million, respectively, of interest income on its previously securitized loans.
  
GOODWILL
 
The Company evaluates the recoverability of goodwill and indefinite lived intangible assets annually as of November 30th, or more frequently if events or changes in circumstances warrant, such as a material adverse change in the business. Goodwill is considered to be impaired when the carrying value of a reporting unit exceeds its estimated fair value. Indefinite-lived intangible assets are considered impaired if their carrying value exceeds their estimated fair value. As described in Note One of the Notes to Consolidated Financial Statements, the Company conducts its business activities through one reportable business segment – community banking. Fair values are estimated by reviewing the Company’s stock price as it compares to book value and the Company’s reported earnings.  In addition, the impact of future earnings and activities are considered in the Company’s analysis.  The Company had $71.4 million of goodwill at both December 31, 2014 and 2013, and no impairment was required to be recognized in 2014 or 2013, as the fair value of the Company continues to exceed its book value.
 
CERTIFICATES OF DEPOSIT
 
Scheduled maturities of time certificates of deposit of $250,000 or more outstanding at December 31, 2014, are summarized in Table Nine (in thousands). The Company has time certificates of deposit of $250,000 or more totaling $83.2 million (approximately 8% of total time deposits).  













22

TABLE NINE
MATURITY DISTRIBUTION OF CERTIFICATES OF DEPOSIT OF $250,000 OR MORE
 
Amounts
Percentage
 
 
 
Three months or less
$
7,915

10
%
Over three months through six months
5,965

7
%
Over six months through twelve months
20,664

25
%
Over twelve months
48,678

58
%
Total
$
83,222

100
%

CONTRACTUAL OBLIGATIONS
 
The Company has various financial obligations that may require future cash payments according to the terms of the obligations. Demand, both noninterest- and interest-bearing, and savings deposits are, generally, payable immediately upon demand at the request of the customer. Therefore, the contractual maturity of these obligations is presented in the following table as “less than one year.” Time deposits, typically CDs, are customer deposits that are evidenced by an agreement between the Company and the customer that specify stated maturity dates and early withdrawals by the customer are subject to penalties assessed by the Company. Short-term borrowings and long-term debt represent borrowings of the Company and have stated maturity dates. The Company is not a party to any material capital or operating leases as of December 31, 2014.

TABLE TEN
CONTRACTUAL OBLIGATIONS

The composition of the Company's contractual obligations as of December 31, 2014 is presented in the following table (in thousands):
 
Contractual Maturity in
 
Less than One Year
Between One and Three Years
Between Three and Five Years
Greater than Five Years
Total
 
 
 
 
 
 
Noninterest-bearing demand deposits
$
545,465

$
—

$
—

$
—

$
545,465

Interest-bearing demand deposits(1)
640,469

—

—

—

640,469

Savings deposits(1)
661,416

—

—

—

661,416

Time deposits(1)
506,596

304,510

236,500

561

1,048,167

Short-term borrowings(1)
135,276

—

—

—

135,276

Long-term debt(1)
617

1,234

1,234

12,356

15,441

Total Contractual Obligations
$
2,489,839

$
305,744

$
237,734

$
12,917

$
3,046,234

 
(1)
Includes interest on both fixed- and variable-rate obligations. The interest associated with variable-rate obligations is based upon interest rates in effect at December 31, 2014. The contractual amounts to be paid on variable-rate obligations are affected by market interest rates that could materially affect the contractual amounts to be paid.

The Company’s liability for uncertain tax positions at December 31, 2014 was $2.4 million pursuant to ASC Topic 740.  This liability represents an estimate of tax positions that the Company has taken in its tax returns that may ultimately not be sustained upon examination by tax authorities.  As the ultimate amount and timing of any future cash settlements cannot be predicted with reasonable reliability, this estimated liability has been excluded from the contractual obligations table.
 
OFF–BALANCE SHEET ARRANGEMENTS
 
As disclosed in Note Seventeen of the Notes to Consolidated Financial Statements, the Company has also entered into agreements to extend credit or provide conditional payments pursuant to standby and commercial letters of credit. As a result of the Company’s off-balance sheet arrangements for 2014 and 2013, no material revenue, expenses, or cash flows were recognized.  In addition, the Company had no other indebtedness or retained interests nor entered into agreements to extend credit or provide conditional payments pursuant to standby and commercial letters of credit.
 

23

CAPITAL RESOURCES
 
During 2014, Shareholders’ Equity increased $3 million, or 0.8%, from $388 million at December 31, 2013 to $391 million at December 31, 2014.  This increase was primarily due to net income of $53 million and equity award vesting and exercises of $2 million, partially offset by common stock repurchases for treasury of $28 million and cash dividends declared of $25 million.

During the year ended December 31, 2014, the Company repurchased approximately 651,000 common shares at a weighted average price of $42.96. On September 24, 2014, the Company announced that the Board of Directors authorized the Company to buy back up to 1,000,000 shares of its common shares (approximately 7% of outstanding shares) in open market transactions at prices that are accretive to the earnings per share of continuing shareholders. No time limit was placed on the duration of the share repurchase program. As part of this authorization, the Company rescinded repurchases of additional shares under a repurchase program plan approved in July 2011. The Company had repurchased approximately 980,000 shares under the July 2011 Stock Repurchase Plan. At December 31, 2014, the Company could repurchase approximately 784,000 shares under the current plan.

Regulatory guidelines require the Company to maintain a minimum total capital to risk-adjusted assets ratio of 8.0%, with at least one-half of capital consisting of tangible common stockholders’ equity and a minimum Tier I leverage ratio of 4.0%. Similarly, City National is also required to maintain minimum capital levels as set forth by various regulatory agencies. Under capital adequacy guidelines, City National is required to maintain minimum total capital, Tier I capital, and leverage ratios of 8.0%, 4.0%, and 4.0%, respectively. To be classified as “well capitalized,” City National must maintain total capital, Tier I capital, and leverage ratios of 10.0%, 6.0%, and 5.0%, respectively.
 
The Company’s regulatory capital ratios for both City Holding and City National are illustrated in the following table:

 
 
 
Actual
 
 
Well
December 31,
 
Minimum
Capitalized
2014
2013
City Holding:
 
 
 
 
Total
8.0
%
10.0
%
14.2
%
13.8
%
Tier I Risk-based
4.0
%
6.0
%
13.4
%
13.0
%
Tier I Leverage
4.0
%
5.0
%
9.9
%
9.8
%
City National:
 
 
 
 
Total
8.0
%
10.0
%
12.7
%
12.2
%
Tier I Risk-based
4.0
%
6.0
%
11.9
%
11.4
%
Tier I Leverage
4.0
%
5.0
%
8.8
%
8.6
%

As of December 31, 2014, management believes that City Holding Company, and its banking subsidiary, City National, were “well capitalized.”  City Holding is subject to regulatory capital requirements administered by the Federal Reserve, while City National is subject to regulatory capital requirements administered by the OCC and the FDIC.  Regulatory agencies can initiate certain mandatory actions if either City Holding or City National fails to meet the minimum capital requirements, as shown above.  As of December 31, 2014, management believes that City Holding and City National meet all capital adequacy requirements.

Basel III Capital Rules became effective January 1, 2015. In July 2013, the Federal Reserve published final rules establishing a new comprehensive capital framework for U. S. banking organizations. The rules implement the framework known as "Basel III" for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions' regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in banking institutions' regulatory capital ratios and replace the existing risk-weighting approach. The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal agencies' rules. The Basel III Capital Rules are effective for the Company on January 1, 2015 (subject to a phase-in period for certain provisions).



Management believes that, as of December 31, 2014, City Holding Company and its banking subsidiary, City National, would meet all capital adequacy requirements under Basel III on a fully phased-in basis as if such requirements had been in effect.
 
LEGAL ISSUES
 
The Company is engaged in various legal actions that it deems to be in the ordinary course of business. As these legal actions are resolved, the Company could realize positive and/or negative impact to its financial performance in the period in which these legal actions are ultimately decided. There can be no assurance that current actions will have immaterial results, either positive or negative, or that no material actions may be presented in the future.

RECENT ACCOUNTING PROCOUNCEMENTS AND DEVELOPMENTS
 
Note One, “Recent Accounting Pronouncements,” of the Notes to Consolidated Financial Statements discusses recently issued new accounting pronouncements and their expected impact on the Company’s consolidated financial statements.
 




REPORT ON MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of City Holding Company is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report.  The consolidated financial statements of City Holding Company have been prepared in accordance with U.S. generally accepted accounting principles and, necessarily include some amounts that are based on the best estimates and judgments of management.

The management of City Holding Company is responsible for establishing and maintaining adequate internal control over financial reporting that is designed to produce reliable financial statements in conformity with U.S. generally accepted accounting principles.  The system of internal control over financial reporting is evaluated for effectiveness by management and tested for reliability through a program of internal audits with actions taken to correct potential deficiencies as they are identified.  Because of inherent limitations in any internal control system, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls.  Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation.  Further, because of changes in conditions, internal control effectiveness may vary over time.

Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2014 based upon the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013 Framework). Based on our assessment, management believes that, as of December 31, 2014, the Company's system of internal control over financial reporting is effective based on those criteria.  Ernst & Young, LLP, the Company’s independent registered public accounting firm, has issued an attestation report on the effectiveness of internal control over financial reporting. This report appears on page 27.

February 27, 2015

s/ Charles R. Hageboeck
 
/s/ David L. Bumgarner
 
Charles R. Hageboeck
 
David L. Bumgarner
 
President & Chief Executive Officer
 
Chief Financial Officer
 


26

REPORT OF ERNST & YOUNG LLP INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, ON EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING

Audit Committee of the Board of Directors and the
Shareholders of City Holding Company
 
We have audited City Holding Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). City Holding Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report on Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on City Holding Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, City Holding Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2014 of City Holding Company and our report dated February 27, 2015 expressed an unqualified opinion thereon.
 

 
 
/s/ Ernst & Young LLP
Charleston, West Virginia
 
February 27, 2015
 


27

REPORT OF ERNST & YOUNG LLP INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, ON CONSOLIDATED FINANCIAL STATEMENTS

Audit Committee of the Board of Directors and the
Shareholders of City Holding Company
 
We have audited the accompanying consolidated balance sheets of City Holding Company and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014.  These financial statements are the responsibility of City Holding 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 the standards of the Public Company Accounting Oversight Board (United States). 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of City Holding Company and subsidiaries at December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), City Holding Company's internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 27, 2015 expressed an unqualified opinion thereon.
 
 
/s/ Ernst & Young LLP
Charleston, West Virginia
 
February 27, 2015
 



28

PART I, ITEM 1 – FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
CITY HOLDING COMPANY AND SUBSIDIARIES
(in thousands)
 
December 31, 2014
December 31, 2013
Assets
 
 
Cash and due from banks
$
138,503

$
75,999

Interest-bearing deposits in depository institutions
9,725

9,877

          Cash and Cash Equivalents
148,228

85,876

 
 
 
Investment securities available for sale, at fair value
254,043

352,660

Investment securities held-to-maturity, at amortized cost (approximate fair value at December 31, 2014 and 2013 - $94,191 and $5,335, respectively)
90,786

4,117

Other securities
9,857

13,343

          Total Investment Securities
354,686

370,120

 
 
 
Gross loans
2,652,066

2,606,197

Allowance for loan losses
(20,150
)
(20,575
)
          Net Loans
2,631,916

2,585,622

 
 
 
Bank owned life insurance
95,116

92,047

Premises and equipment, net
77,988

82,548

Accrued interest receivable
6,826

6,866

Net deferred tax asset
36,766

42,165

Goodwill and other intangible assets, net
74,198

75,142

Other assets
35,909

27,852

          Total Assets
$
3,461,633

$
3,368,238

Liabilities
 
 
Deposits:
 
 
Noninterest-bearing
$
545,465

$
493,228

Interest-bearing:
 
 
  Demand deposits
639,932

601,527

  Savings deposits
660,727

612,772

  Time deposits
1,026,663

1,077,606

          Total Deposits
2,872,787

2,785,133

 
 
 
Short-term borrowings
134,931

137,798

Long-term debt
16,495

16,495

Other liabilities
46,567

41,189

          Total Liabilities
3,070,780

2,980,615

 
 
 
Shareholders’ Equity
 
 
Preferred stock, par value $25 per share: 500,000 shares authorized; none issued
—

—

Common stock, par value $2.50 per share: 50,000,000 shares authorized; 18,499,282 shares issued at December 31, 2014 and December 31, 2013, less 3,345,590 and 2,748,922, shares in treasury, respectively
46,249

46,249

 
 
 
Capital surplus
107,370

107,596

Retained earnings
362,211

333,970

Cost of common stock in treasury
(120,818
)
(95,202
)
Accumulated other comprehensive income (loss):
 
 
Unrealized gain (loss) on securities available-for-sale
1,190

(2,110
)
Underfunded pension liability
(5,349
)
(2,880
)
          Total Accumulated Other Comprehensive Loss
(4,159
)
(4,990
)
          Total Shareholders’ Equity
390,853

387,623

          Total Liabilities and Shareholders’ Equity
$
3,461,633

$
3,368,238



29

See notes to consolidated financial statements.

30

CONSOLIDATED STATEMENTS OF INCOME
CITY HOLDING COMPANY AND SUBSIDIARIES
(in thousands, except earnings per share data)
 
Year Ended December 31
 
2014
2013
2012
Interest Income
 
 
 
Interest and fees on loans
$
116,658

$
126,594

$
96,432

Interest on investment securities:
 
 
 
     Taxable
11,766

10,697

14,285

     Tax-exempt
1,142

1,226

1,442

Interest on federal funds sold
—

22

53

          Total Interest Income
129,566

138,539

112,212

 
 
 
 
Interest Expense
 
 
 
Interest on deposits
11,012

12,358

13,477

Interest on short-term borrowings
342

325

312

Interest on long-term debt
606

618

661

          Total Interest Expense
11,960

13,301

14,450

          Net Interest Income
117,606

125,238

97,762

Provision for loan losses
4,054

6,848

6,375

          Net Interest Income After Provision for Loan Losses
113,552

118,390

91,387

 
 
 
 
Non-interest Income
 
 
 
Total investment securities impairment losses
—

—

(878
)
Noncredit impairment losses recognized in other comprehensive income
—

—

302

     Net investment securities impairment losses
—

—

(576
)
Gains on sale of investment securities
1,156

764

1,530

     Net investment securities gains
1,156

764

954

 
 
 
 
Service charges
26,583

27,596

26,409

Bankcard revenue
15,063

13,521

12,406

Insurance commissions
5,978

5,832

6,071

Trust and investment management fee income
4,614

3,986

3,774

Bank owned  life insurance
3,070

3,391

2,983

Other income
2,258

2,916

2,660

          Total Non-interest Income
58,722

58,006

55,257

 
 
 
 
Non-interest Expense
 
 
 
Salaries and employee benefits
51,749

51,430

43,509

Occupancy and equipment
9,990

9,910

8,186

Depreciation
6,087

5,757

4,605

FDIC insurance expense
1,647

1,852

1,590

Advertising
3,274

2,673

2,589

Bankcard expenses
3,373

2,870

2,662

Postage, delivery, and statement mailings
2,211

2,220

2,079

Office supplies
1,595

1,728

1,669

Legal and professional fees
2,049

3,028

1,786

Telecommunications
1,876

2,212

1,614


31

Repossessed asset losses, net of expenses
579

646

1,346

Merger related costs
—

5,526

4,708

Other expenses
10,611

13,054

11,058

          Total Non-interest Expense
95,041

102,906

87,401

          Income Before Income Taxes
77,233

73,490

59,243

Income tax expense
24,271

25,275

20,298

          Net Income Available to Common Shareholders
$
52,962

$
48,215

$
38,945

 
 
 
 
Average common shares outstanding
15,403

15,564

14,714

Effect of dilutive securities:
 
 
 
     Employee stock options and warrant
85

144

82

Shares for diluted earnings per share
15,488

15,708

14,796

 
 
 
 
Basic earnings per common share
$
3.40

$
3.07

$
2.63

Diluted earnings per common share
$
3.38

$
3.04

$
2.61

Dividends declared per common share
$
1.60

$
1.48

$
1.40



See notes to consolidated financial statements.

 



32

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
CITY HOLDING COMPANY AND SUBSIDIARIES
(in thousands)


 
Year Ended December 31
 
2014
2013
2012
 
 
 
 
Net income
$
52,962

$
48,215

$
38,945

 
 
 
 
Available-for-Sale Securities
 
 
 
Unrealized (loss) gain on available-for-sale securities arising during period
6,388

(8,244
)
5,370

Reclassification adjustment for net gains
(1,156
)
(764
)
(954
)
Other comprehensive income (loss), available-for-sale securities
5,232

(9,008
)
4,416

 
 
 
 
Defined Benefit Pension Plan
 
 
 
Amortization of actuarial net gains
669

895

696

Recognition of unrealized gains (losses)
(4,584
)
2,457

(1,119
)
Change in underfunded pension liability
(3,915
)
3,352

(423
)
 
 
 
 
Other comprehensive (loss) income before income taxes
1,317

(5,656
)
3,993

Tax effect
(486
)
2,088

(1,508
)
  Other comprehensive (loss) income, net of tax
831

(3,568
)
2,485

 
 
 
 
   Comprehensive income, net of tax
53,793

44,647

41,430



 


33

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
CITY HOLDING COMPANY AND SUBSIDIARIES
(dollars in thousands)

 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
 
 
 
 
 
 
 
Balances at December 31, 2011
$
46,249

$
103,335

$
291,050

$
(125,593
)
$
(3,907
)
$
311,134

Net income
 
 
38,945

 
 
38,945

Other comprehensive income
 
 
 
 
2,485

2,485

Acquisition of Virginia Savings Bancorp, Inc.
 
276

 
7,447

 
7,723

Cash dividends declared ($1.40 per share)
 
 
(20,725
)
 
 
(20,725
)
Stock-based compensation expense, net
 
34

 
1,049

 
1,083

Exercise of 18,899 stock options
 
(121
)
 
665

 
544

Purchase of 237,535 treasury shares
 
 
 
(7,915
)
 
(7,915
)
Balances at December 31, 2012
$
46,249

$
103,524

$
309,270

$
(124,347
)
$
(1,422
)
$
333,274


 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
 
 
 
 
 
 
 
Balances at December 31, 2012
$
46,249

$
103,524

$
309,270

$
(124,347
)
$
(1,422
)
$
333,274

Net income
 
 
48,215

 
 
48,215

Other comprehensive loss
 
 
 
 
(3,568
)
(3,568
)
Acquisition of Community Financial Corporation
 
4,236

 
24,272

 
28,508

Cash dividends declared ($1.48 per share)
 
 
(23,515
)
 
 
(23,515
)
Stock-based compensation expense, net
 
(37
)
 
1,319

 
1,282

Exercise of 126,168 stock options
 
(127
)
 
3,554

 
3,427

Balances at December 31, 2013
$
46,249

$
107,596

$
333,970

$
(95,202
)
$
(4,990
)
$
387,623



34

 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
 
 
 
 
 
 
 
Balances at December 31, 2013
$
46,249

$
107,596

$
333,970

$
(95,202
)
$
(4,990
)
$
387,623

Net income
 
 
52,962

 
 
52,962

Other comprehensive income
 
 
 
 
831

831

Cash dividends declared ($1.60 per share)
 
 
(24,721
)
 
 
(24,721
)
Stock-based compensation expense, net
 
64

 
1,471

 
1,535

Exercise of 20,000 stock options
 
(290
)
 
870

 
580

Purchase of 650,799 treasury shares
 
 
 
(27,957
)
 
(27,957
)
Balances at December 31, 2014
$
46,249

$
107,370

$
362,211

$
(120,818
)
$
(4,159
)
$
390,853


See notes to consolidated financial statements.

35

CONSOLIDATED STATEMENTS OF CASH FLOWS
CITY HOLDING COMPANY AND SUBSIDIARIES
(in thousands)
 
Year Ended December 31
 
2014
2013
2012
 
 
 
 
Net income
$
52,962

$
48,215

$
38,945

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
     Amortization and accretion
(4,654
)
(11,294
)
728

     Provision for loan losses
4,054

6,848

6,375

     Depreciation of premises and equipment
6,087

5,757

4,605

     Deferred income tax expense
4,585

4,686

2,530

     Net periodic employee benefit cost
500

903

521

     Realized investment securities gains
(1,156
)
(764
)
(1,530
)
     Net investment securities impairment losses
—

—

576

     Stock-based compensation expense
1,535

1,281

1,083

     Increase in value of bank-owned life insurance
(3,069
)
(3,211
)
(2,940
)
     Originations of loans held for sale
(8,763
)
(23,280
)
(44,032
)
  Proceeds from loans held for sale
8,319

27,830

42,324

      Gain on sale of loans
(187
)
(608
)
(960
)
     Change in accrued interest receivable
40

1,220

852

     Change in other assets
(8,262
)
22,497

2,163

     Change in other liabilities
1,363

(4,187
)
2,575

          Net Cash Provided by Operating Activities
53,354

75,893

53,815

 
 
 
 
Proceeds from sales of securities available-for-sale
6,714

19,210

27,471

Proceeds from maturities and calls of securities available-for-sale
48,983

91,096

145,097

Proceeds from maturities and calls of securities held-to-maturity
6,501

10,223

10,402

Purchases of securities available-for-sale
(31,295
)
(80,778
)
(171,200
)
Purchases of securities held-to-maturity
(10,226
)
—

—

Net increase in loans
(43,714
)
(83,962
)
(102,802
)
Purchases of premises and equipment
(1,674
)
(6,622
)
(7,509
)
Acquisition of Community Financial Corporation, net of cash acquired of $8,888
—

(21,853
)
—

Acquisition of Virginia Savings Bancorp, Inc., net of cash acquired of $24,943
—

—

20,272

          Net Cash Used in Investing Activities
(24,711
)
(72,686
)
(78,269
)
 
 
 
 
Net increase in noninterest-bearing deposits
52,237

20,423

49,146

Net increase (decrease) in interest-bearing deposits
36,203

(26,450
)
16,388

Net (decrease) increase in short-term borrowings
(2,867
)
23,153

(74,404
)
Purchases of treasury stock
(27,957
)
—

(7,915
)
Proceeds from exercise of stock options
580

3,427

544

Dividends paid
(24,487
)
(22,878
)
(20,710
)
          Net Cash Provided by (Used in) Financing Activities
33,709

(2,325
)
(36,951
)
          Increase (Decrease) in Cash and Cash Equivalents
62,352

882

(61,405
)
Cash and cash equivalents at beginning of period
85,876

84,994

146,399

          Cash and Cash Equivalents at End of Period
$
148,228

$
85,876

$
84,994


36


See notes to consolidated financial statements.

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CITY HOLDING COMPANY AND SUBSIDIARIES

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 U. S. generally accepted accounting principles and require management to make estimates and develop assumptions that affect the amounts reported in the financial statements and related footnotes. 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 the consolidated financial statements.
 
The Company determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity in conformity with U. S. generally accepted accounting principles. Voting interest entities are entities in which the total equity investment at risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. The Company consolidates voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards, variable interest entities (VIEs) are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in an entity is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. The Company’s wholly owned subsidiary, City Holding Capital Trust III, is a VIE for which the Company is not the primary beneficiary. Accordingly, the accounts of this entity are not included in the Company’s consolidated financial statements.
 
       Certain amounts in the financial statements have been reclassified. Such reclassifications had no impact on shareholders’ equity or net income for any period.
 
      Description of Principal Markets and Services: The Company is a registered financial holding company under the Bank Holding Company Act headquartered in Charleston, West Virginia, and conducts its principal activities through its wholly-owned subsidiary, City National Bank of West Virginia (“City National”). City National is a retail and consumer-oriented community bank with 82 banking offices in West Virginia, Virginia, eastern Kentucky and southeastern Ohio. City National provides credit, deposit, and trust and investment management services to its customers. In addition to its branch network, City National's delivery channels include ATMs, mobile banking, debit cards, interactive voice response systems and Internet technology. The Company conducts its business activities through one reportable business segment - community banking.
 
       Cash and Due from Banks: The Company considers cash, due from banks, and interest-bearing deposits in depository institutions as cash and cash equivalents.
 
       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 held-to-maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts. Debt securities which the Company may not hold to maturity are classified as investment securities 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 comprehensive income. 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 Company utilizes a third party pricing service provider to value its investment portfolio.  Annually, the Company obtains an independent auditor’s report from its third party pricing service provider regarding its controls over valuation of investment securities.  Although an unqualified opinion regarding the design and operating effectiveness of controls was issued, the report did contain caveats and disclaimers regarding the pricing information, such as the Company should review market values for reasonableness.  On a quarterly basis, the Company selects a sample of its debt securities and reprices those securities with a third party that is independent of the primary pricing service provider to verify the reasonableness of the fair values.
 
       Also, on a quarterly basis, the Company performs a review of investment securities to determine if any unrealized losses are other than temporarily impaired.  Management considers the following, among other things, in its determination of

38

the nature of the unrealized losses, (i) the length of time and the extent to which the fair value has been less than cost; (ii) the financial condition, capital strength, and near–term (12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment; (iv) adverse conditions specifically related to the security, an industry, or a geographic area; or (v) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  The Company continues to actively monitor the market value of these investments along with the financial strength of the issuers behind these securities, as well as its entire investment portfolio.  Based on the market information available, the Company believes that (i) the declines in fair value are temporary, driven by fluctuations in the interest rate environment and not due to the credit worthiness of the issuers, (ii) the Company does not have the intent to sell any of the securities classified as available for sale, and (iii) it is more likely than not that the Company will not have to sell any such securities before recovery of cost.  The Company cannot guarantee that such securities will recover and if additional information becomes available in the future to suggest that the losses are other than temporary, the Company may need to record impairment charges in the future.

       The specific identification method is used to determine the cost basis of securities sold.
 
       Certain investment securities that do not have readily determinable fair values and for which the Company does not exercise significant influence are carried at cost and classified as other investment securities on the Consolidated Balance Sheets.  These cost-method investments are reviewed for impairment at least annually or sooner if events or changes in circumstances indicate the carrying value may not be recoverable.
 
       Loans: Loans, excluding previously securitized loans, which are discussed separately below, are reported at the principal amount outstanding, net of unearned income.  Portfolio loans include those for which management has the intent and City has the ability to hold for the foreseeable future, or until maturity or payoff.  The foreseeable future is based upon management’s judgment of current business strategies and market conditions, the type of loan, asset/liability management, and liquidity.
 
       Interest income on loans is accrued and credited to operations based upon the principal amount outstanding, using methods that generally result in level rates of return. Loan origination fees, and certain direct costs, are deferred and amortized as an adjustment to the yield over the term of the loan. The accrual of interest income generally is discontinued when a loan becomes 90 days past due as to principal or interest for all loan types.  However, any loan may be placed on non-accrual if the Company receives information that indicates that it is probable a borrower will be unable to meet the contractual terms of their respective loan agreement. Other indicators considered for placing a loan on non-accrual status include the borrower’s involvement in bankruptcies, foreclosures, repossessions, litigation and any other situation resulting in doubt as to whether full collection of contractual principal and interest is attainable. 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 for all loan classes, interest income during the period the loan is non-performing is recorded on a cash basis after recovery of principal is reasonably assured. Cash payments received on nonperforming loans are typically applied directly against the outstanding principal balance until the loan is fully repaid. 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 collectability of the total contractual principal and interest is no longer in doubt.
 
Generally, all loan types are considered past due when the contractual terms of a loan are not met and the borrower is 30 days or more past due on a payment.  Furthermore, residential and home equity junior lien loans are generally subject to charge-off when the loan becomes 120 days past due, depending on the estimated fair value of the collateral less cost to dispose, versus the outstanding loan balance. Unsecured commercial loans are generally charged off when the loan becomes 120 days past due. Secured commercial loans are generally evaluated for charge-off when the loan becomes 180 days past due. Closed-end consumer loans are generally charged off when the loan becomes 120 days past due and open-end consumer loans are generally charged off when the loan becomes 180 days past due.

Acquired Loans: In determining the estimated fair value of the acquired loans, management considered several factors, such as estimated future credit losses, estimated prepayments, remaining lives of the acquired loans, estimated value of the underlying collateral and the present value of the cash flows expected to be received.  For smaller loans not specifically reviewed, management grouped the loans into their respective homogeneous loan pool and applied a loss estimate accordingly.

    


39

Acquired loans are accounted for using one of the two following accounting standards:

(1)
ASC Topic 310-20 is used to value loans that do not have evidence of credit quality deterioration.  For these loans, the difference between the fair value of the loan and the amortized cost of the loan is amortized or accreted into income using the interest method.

(2)
ASC Topic 310-30 is used to value loans that have evidence of credit quality deterioration.  For these loans, the expected cash flows that exceed the fair value of the loan represent the accretable yield, which is recognized as interest income on a level-yield basis over the expected cash flow periods of the loans.  The non-accretable difference represents the difference between the contractually required principal and interest payments and the cash flows expected to be collected based upon management’s estimation.  Subsequent decreases in the expected cash flows will require the Company to evaluate the need for additions to the Company’s allowance for loan losses.  Subsequent increases in the expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges with a corresponding adjustment to the accretable yield, which will result in the recognition of additional interest income over the remaining lives of the loans. 

Previously Securitized Loans: Previously securitized loans represent the carrying value of loans beneficially owned by the Company as a result of exercising its early redemption option during 2003 and 2004 to fully redeem the obligations owed to investors (“notes”) in certain of the Company’s securitization transactions. The loans were recorded at the lower of fair value or their carrying values, which was the carrying value of the related retained interest asset underlying the securitization plus amounts remitted by the Company to the note holders to redeem the notes. Because the carrying value of the retained interests incorporated assumptions with regard to expected prepayment and default rates on the loans and also considered the expected timing and amount of cash flows to be received by the Company, the carrying value of the retained interests and the carrying value of the loans was less than the actual outstanding balance of the loans. Effective January 1, 2012, the carrying value of the remaining previously securitized loans was reduced to zero and any cash received on these loans is recorded as interest income in the period that it is received.
 
Allowance for Loan Losses: The allowance for loan losses is maintained at a level that represents management’s best estimate of probable losses in the loan portfolio. Management’s determination of the appropriateness of the allowance for loan losses is based upon an evaluation of individual credits in the loan portfolio, historical loan loss experience, current economic conditions, and other relevant factors. This determination is inherently subjective, as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. These evaluations are conducted at least quarterly and more frequently if deemed necessary.  The allowance for loan losses related to loans considered to be impaired is generally evaluated based on the discounted cash flows using the impaired loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Loan losses are charged against the allowance and recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of the appropriateness of the allowance after considering factors noted above, among others.
  
In evaluating the appropriateness of its allowance for loan losses, the Company stratifies the loan portfolio into six major groupings, including commercial real estate, commercial and industrial, residential real estate, home equity junior lien, and others. Historical loss experience, as adjusted, is applied to the then outstanding balance of loans in each classification to estimate probable losses inherent in each segment of the portfolio. Historical loss experience is adjusted using a systematic weighted probability of potential risk factors that could result in actual losses deviating from prior loss experience. Risk factors considered by the Company in completing this analysis include: (1) unemployment and economic trends in the Company’s markets, (2) concentrations of credit, if any, among any industries, (3) trends in loan growth, loan mix, delinquencies, losses or credit impairment, (4) adherence to lending policies and others. Each risk factor is designated as low, moderate/increasing, or high based on the Company’s assessment of the risk to loss associated with each factor. Each risk factor is then weighted to consider probability of occurrence.
 
Additionally, all commercial loans within the portfolio are subject to internal risk grading. Risk grades are generally assigned by the primary lending officer and are periodically evaluated by the Company’s internal loan review process. Based on an individual loan’s risk grade, estimated loss percentages are applied to the outstanding balance of the loan to determine the amount of probable loss.
 
Premises and Equipment: 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. Depreciation of leasehold improvements is computed using the straight-line method over the lesser of the term of the respective lease or the estimated useful life of the respective asset. Maintenance and repairs are charged to expense as incurred, while improvements that extend the useful life of premises and equipment are capitalized and depreciated over the estimated remaining life of the asset.

40

 
Other Real Estate Owned:  Other real estate owned (“OREO”) is comprised principally of commercial and residential real estate properties obtained in partial or total satisfaction of loan obligations.  OREO acquired in settlement of indebtedness is included in Other Assets at the lower of estimated fair value of the asset, less estimated selling costs or the carrying amount of the loan.  Changes to the value subsequent to transfer are recorded in non-interest expense, along with direct operating expenses.  Gains or losses not previously recognized from sales of OREO are recognized in non-interest expense on the date of the sale.  As of December 31, 2014 and 2013, the amount of OREO included in Other Assets was $8.2 million and $8.5 million, respectively.
 
Goodwill and Other Intangible Assets: Goodwill is the excess of the cost of an acquisition over the fair value of tangible and intangible assets acquired.  Goodwill is not amortized.  Intangible assets represent purchased assets that also lack physical substance, but can be separately distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability.  Intangible assets with determinable useful lives, such as core deposits, are amortized over their estimated useful lives.
 
The Company performs an annual review for impairment in the recorded value of goodwill and indefinite lived intangible assets. Goodwill is tested for impairment between the annual tests if an event occurs or circumstances change that more than likely reduce the fair value of a reporting unit below its carrying value. An indefinite-lived intangible asset is tested for impairment between the annual tests if an event occurs or circumstances change indicating that the asset might be impaired.
 
Securities Sold Under Agreements to Repurchase:  Securities sold under agreements to repurchase are accounted for as collateralized financing transactions and are recorded at the amounts at which the securities were sold plus accrued interest.  Securities sold primarily consists of U.S. government, federal agency, and municipal securities pledged as collateral under these financing arrangements and cannot be repledged or sold, unless replaced by the secured party.
 
Insurance Commissions:  Commission revenue is recognized as of the effective date of the insurance policy or the date the customer is billed, whichever is later.  The Company also receives contingent commissions from insurance companies as additional incentive for achieving specified premium volume goals and/or the loss experience of the insurance placed by the Company.  The Company maintains a reserve for commission adjustments based on estimated policy cancellations.  This reserve was not significant at December 31, 2014 or 2013.
 
Derivative Financial Instruments: The Company enters into derivative transactions principally to protect against the risk of adverse price or interest rate movements on the value of certain assets and liabilities and on future cash flows.  All derivative instruments are carried at fair value on the balance sheet. As of December 31, 2014 and 2013, the Company has derivative instruments not included in hedge relationships. These derivatives consist of interest rate swaps used for interest rate management purposes and derivatives executed with commercial banking customers to facilitate their interest rate management strategies. The change in the fair value of these derivative instruments is reflected in the statements of income. As of December 31, 2014, the Company also has a derivative instrument that is included in hedge relationships. This derivative consists of an interest rate swap used for interest rate management purposes on commercial real estate loans. The change in the fair value of these derivative instruments is reflected in the statements of income and net swap settlements are recognized in interest income.
 
Trust Assets:  Assets held in a fiduciary or agency capacity for customers are not included in the accompanying financial statements since such items are not assets of the Company.
 
Income Taxes: The consolidated provision for income taxes is based upon reported income and expense. Deferred income taxes are provided for temporary differences between financial reporting and tax bases of assets and liabilities, computed using enacted tax rates. 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.
 
The Company and its subsidiaries are subject to examinations and challenges from federal and state taxing authorities regarding positions taken in returns.  Uncertain tax positions are initially recognized in the consolidated financial statements when it is more likely than not the position will be sustained upon examination.  These positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority and assuming full knowledge of the position and all relevant facts by the taxing authority.
 
The Company invests in certain limited partnerships that operate qualified low-income housing tax credit developments.  These investments are considered variable interest entities for which the Company is not the primary beneficiary.  The tax credits are reflected in the Consolidated Statements of Income as a reduction in income tax expense.  The unamortized amount of the investments is recorded within Other Assets within the Consolidated Balance Sheets.  The Company’s

41

investments in affordable housing limited partnerships were $0.9 million and $1.3 million at December 31, 2014 and 2013, respectively.
 
Advertising Costs: Advertising costs are expensed as incurred.
 
Stock-Based Compensation: Compensation expense related to stock options and restricted stock awards issued to employees is based upon the fair value of the award at the date of grant.  The fair value of stock options is estimated utilizing a Black Scholes pricing model, while the fair value of restricted stock awards is based upon the stock price at the date of grant.  Compensation expense is recognized on a straight line basis over the vesting period for options and the respective period for stock awards.
 
Basic and Diluted Earnings per Common Share: Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding, excluding participating securities. Diluted earnings per share is computed by dividing net income by the weighted-average number of shares outstanding, excluding participating securities, increased by the number of shares of common stock which would be issued assuming the exercise of stock options and other common stock equivalents.
 
Recent Accounting Pronouncements:  In July 2013, the FASB issued ASU No. 2013-10, "Derivatives and Hedging (Topic 815) - Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes." This ASU permits the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate ("LIBOR"). ASU 2013 is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013 and did not have a material impact on the Company's financial statements.

In July 2013, the FASB issued ASU No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." This ASU provides that an unrecognized tax benefit, or a portion thereof, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. This ASU became effective for the Company beginning on January 1, 2014. The adoption of ASU No. 2013-11 did not have a material impact on the Company's financial statements.

In January 2014, the FASB issued ASU No. 2014-01, "Investments - Equity Method and Joint Ventures (Topic 323: Accounting for Investments in Qualified Affordable Housing Projects," which amended existing guidance to eliminate the effective yield election and to permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Disclosures for a change in accounting principle are required upon transition. The requirements of this ASU are effective for the Company on January 1, 2015, with early adoption permitted. The adoption of ASU No. 2014-01 is not expected to have a material impact on the Company's financial statements.

In January 2014, the FASB issued ASU No. 2014-04, "Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure," which amended existing guidance to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. These amendments clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This ASU will become effective for the Company beginning on January 1, 2015. The adoption of ASU No. 2014-04 is not expected to have a material impact on the Company's financial statements.

In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity" This ASU changes the requirements for reporting discontinued operations. A disposal of a component or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations when certain criteria are met. Additional disclosures are also required for disposals that meet the criteria

42

to be reported in discontinued operations. The Company has elected to early adopt this ASU for the year ended December 31, 2014 relating to the sale of CityInsurance Properties. The adoption of ASU 2014-08 did not have a material impact on the Company's financial statements.

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No 2014-09, "Revenue from Contracts with Customers (Topic 606)." This amendment supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this amendment specifies the accounting for some costs to obtain or fulfill a contract with a customer. This ASU will become effective for the Company on January 1, 2017. The adoption of ASU 2014-09 is not expected to have a material impact on the Company's financial statements.

In June 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No 2014-11, "Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures". This amendment align the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance sheet accounting. These amendments require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. These amendments also require expanded disclosures about the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. This ASU will become effective for the Company on January 1, 2015. The adoption of ASU 2014-11 is not expected to have a material impact on the Company's financial statements.

In June 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No 2014-12, "Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period". These amendments require that a performance target that affects vesting and could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718, Compensation - Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This ASU will become effective for the Company on January 1, 2016, with early adoption permitted. The adoption of ASU 2014-12 is not expected to have a material impact on the Company's financial statements.

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No 2014-14, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure". The amendments in this update require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a governmental guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the credit has the ability to recover the claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This ASU will become effective for the Company on January 1, 2015. The adoption of ASU 2014-14 is not expected to have a material impact on the Company's financial statements.

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties About and Entity's Ability to Continue as a Going Concern". These amendments are intended to define management's responsibility to evaluate whether there is substantial doubt about an organization's ability to continue as a going concern and to provide related footnote disclosures. These amendments provide guidance to an organization's management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations in the financial statement footnotes. This ASU will become effective for the Company on January 1, 2015. The adoption of ASU 2014-15 is not expected to have a material impact on the Company's financial statements.


43

Statements of Cash Flows: Cash paid for interest, including interest paid on long-term debt and trust preferred securities, was $12.1 million, $13.4 million, and $14.9 million in 2014, 2013, and 2012, respectively. During 2014, 2013 and 2012, the Company paid $23.0 million, $16.6 million, and $14.7 million, respectively, for income taxes.

During the year, the Company transferred certain securities from available-for-sale to held-to-maturity. The
non-cash transfers of securities into the held-to-maturity categories from available-for-sale were made at fair value on the date of the transfer. The securities had an aggregate fair value of $83.4 million on the date of transfer.

 
NOTE TWO – ACQUISITION

On January 10, 2013, the Company acquired 100% of the outstanding common and preferred stock of Community Financial Corporation and its wholly owned subsidiary, Community Bank (collectively, "Community"). As a result of this acquisition, the Company acquired eight branches along the I-81 corridor in western Virginia and two branches in Virginia Beach, Virginia. At the time of closing, Community had total assets of $460 million, loans of $410 million, deposits of $380 million and shareholders' equity of $53 million. Community shareholders received 0.1753 shares of the Company's common stock for each share of the Community Financial Corporation stock, resulting in the issuance of approximately 767,000 shares of the Company's common stock valued at $27.8 million. The common stock value was based on the closing price of $36.23 for the Company's common stock on January 9, 2013. In conjunction with this acquisition, the Company repurchased $12.7 million of Community preferred stock previously issued to the U.S. Department of Treasury ("Treasury Department"). A related warrant issued by Community to the Treasury Department has been converted into a warrant to purchase 61,565 shares of the Company's common stock, with an exercise price of $30.80 per share and an expiration period of ten years, which was subsequently reduced to six years.

The purchase price of the acquisition has been allocated as follows (in thousands):
Date of acquisition:
January 10, 2013
 
 
Consideration:
 
  Cash
$
12,738

  Common stock
27,783

  Warrant issued
725

Total consideration
$
41,246

 
 
Identifiable assets:
 
  Cash and cash equivalents
$
8,888

  Investment securities
17,659

  Loans
372,169

  Bank owned life insurance
6,935

  Premises and equipment
8,950

  Deferred tax asset, net
15,228

  Other assets
7,989

   Total identifiable assets
437,818

 
 
Identifiable liabilities:
 
  Deposits
383,070

  Other liabilities
24,484

   Total identifiable liabilities
407,554

 
 
Net identifiable assets
$
30,264

 
 
Goodwill
$
8,271

Core deposit intangible
2,711

 

44

Acquired Loans    

The following table presents information regarding the purchased credit-impaired and noncredit-impaired loans acquired in conjunction with the acquisition (in thousands):

Acquired Credit-Impaired
 
Contractually required principal and interest
$
55,983

Contractual cash flows not expected to be collected (non-accretable difference)
(19,758
)
Expected cash flows
36,225

Interest component of expected cash flows (accretable difference)
(5,469
)
Estimated fair value of purchased credit impaired loans acquired
$
30,756

 
 
Acquired NonCredit-Impaired
 
Outstanding balance
$
356,822

Less: fair value adjustment
(15,409
)
Fair value of acquired noncredit-impaired loans
$
341,413

 

Acquired Deposits 

The fair values of non-time deposits approximated their carrying value at the acquisition date.  For time deposits, the fair values were estimated based on discounted cash flows, using interest rates that are currently being offered compared to the contractual interest rates.   Based on this analysis, management recorded a premium on time deposits acquired of $1.1 million, for the Community acquisition, which is being amortized over 5 years.

Core Deposit Intangible

The Company believes that the customer relationships with the deposits acquired have an intangible value.  In connection with the Community acquisition, the Company recorded a core deposit intangible asset of $2.7 million. The core deposit intangible asset represents the value that the acquiree had with their deposit customers.  The fair value was estimated based on a discounted cash flow methodology that considered type of deposit, deposit retention and the cost of the deposit base.   The core deposit intangible is being amortized over 10 years.

Goodwill

Under GAAP, management has up to twelve months following the date of the acquisition to finalize the fair values of acquired assets and liabilities.  The measurement period ends as soon as the Company receives information it was seeking about facts and circumstances that existed as of the acquisition date or learns more information is not obtainable.  Any subsequent adjustments to the fair value of the acquired assets and liabilities, intangible assets or other purchase accounting adjustments will result in adjustments to the goodwill recorded.  The measurement period is limited to one year from the acquisition date.  The goodwill recorded in conjunction with the Community acquisition is not expected to be deductible for tax purposes.

Merger Related Costs
    
During the year ended December 31, 2013 , the Company incurred $5.5 million of merger-related costs in connection with the Community acquisition. These costs were primarily for severance ($2.5 million), professional fees ($1.4 million) and data processing costs ($1.1 million).

During the year ended December 31, 2012 , the Company incurred $4.7 million of merger-related costs primarily in connection with the Virginia Savings acquisition. These costs were primarily for severance ($0.9 million), professional fees ($1.2 million) and data processing costs ($2.4 million).







45

NOTE THREE – RESTRICTIONS ON CASH AND DUE FROM BANKS

City National is required to maintain an average reserve balance with the Federal Reserve Bank of Richmond to compensate for services provided by the Federal Reserve and to meet statutory required reserves for demand deposits. The average amount of the reserve balance for the year ended December 31, 2014 was approximately $17.7 million.

NOTE FOUR –INVESTMENTS

The aggregate carrying and approximate market values of securities follow (in thousands).  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 financial instruments.
 
 
December 31, 2014
December 31, 2013
 
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Securities available-for-sale:
 
 
 
 
 
 
 
 
U.S. Treasuries and U.S.
 
 
 
 
 
 
 
 
     government agencies
$
1,816

$
11

$
—

$
1,827

$
2,317

$
48

$
—

$
2,365

Obligations of states and
 
 
 
 
 
 
 
 
     political subdivisions
41,382

722

8

42,096

41,027

627

106

41,548

Mortgage-backed securities:
 
 
 
 
 
 
 
 
     U.S. government agencies
185,831

3,470

1,973

187,328

282,653

2,765

7,310

278,108

     Private label
1,700

8

4

1,704

2,184

16

3

2,197

Trust preferred
 
 
 
 
 
 
 
 
     securities
9,763

425

1,152

9,036

12,943

2,113

1,900

13,156

Corporate securities
7,806

204

693

7,317

9,788

183

843

9,128

     Total Debt Securities
248,298

4,840

3,830

249,308

350,912

5,752

10,162

346,502

Marketable equity  securities
2,131

1,082

—

3,213

3,334

1,339

—

4,673

Investment funds
1,525

—

3

1,522

1,525

—

40

1,485

Total Securities
 
 
 
 
 
 
 
 
   Available-for-Sale
$
251,954

$
5,922

$
3,833

$
254,043

$
355,771

$
7,091

$
10,202

$
352,660



 
December 31, 2014
December 31, 2013
 
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Securities held-to-maturity
 
 
 
 
 
 
 
 
  U.S. government agencies
$
86,742

$
2,733

$
—

$
89,475

$
—

$
—

$
—

$
—

Trust preferred securities
$
4,044

$
672

$
—

$
4,716

$
4,117

$
1,218

$
—

$
5,335

Total Securities
 
 
 
 
 
 
 
 
   Held-to-Maturity
$
90,786

$
3,405

$
—

$
94,191

$
4,117

$
1,218

$
—

$
5,335

 
 
 
 
 
 
 
 
 
Other investment securities:
 
 
 
 
 
 
 
 
   Non-marketable equity securities
$
9,857

$
—

$
—

$
9,857

$
13,343

$
—

$
—

$
13,343

Total Other Investment
 
 
 
 
 
 
 
 
   Securities
$
9,857

$
—

$
—

$
9,857

$
13,343

$
—

$
—

$
13,343


Marketable equity securities consist of investments made by the Company in equity positions of various community banks. Included within this portfolio is a 4% ownership position in First National Corporation (FXNC), a community bank holding company. Securities with limited marketability, such as stock in the Federal Reserve Bank ("FRB") or the Federal Home Loan Bank ("FHLB"), are carried at cost and are reported as non-marketable equity securities in the table above.



At December 31, 2014 and 2013, there were no securities of any non-governmental issuer whose aggregate carrying value or estimated fair value exceeded 10% of shareholders' equity.

Certain investment securities owned by the Company were in an unrealized loss position (i.e., amortized cost basis exceeded the estimated fair value of the securities) as of December 31, 2014 and 2013.  The following table shows the gross unrealized losses and fair value of the Company’s investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):
  
 
December 31, 2014
 
Less Than Twelve Months
Twelve Months or Greater
Total
 
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Securities available-for-sale:
 
 
 
 
 
 
Obligations of states and political subdivisions
$
1,559

$
3

$
125

$
5

$
1,684

$
8

Mortgage-backed securities:
 
 
 
 
 
 
     U.S. Government agencies
—

—

60,122

1,973

60,122

1,973

     Private label
1,277

4

—

—

1,277

4

Trust preferred securities
—

—

4,760

1,152

4,760

1,152

Corporate securities
—

—

4,049

693

4,049

693

Investment funds
—

—

1,496

3

$
1,496

$
3

Total
$
2,836

$
7

$
70,552

$
3,826

$
73,388

$
3,833



 
December 31, 2013
 
Less Than Twelve Months
Twelve Months or Greater
Total
 
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Securities available-for-sale:
 
 
 
 
 
 
Obligations of states and political subdivisions
$
5,600

$
87

$
243

$
19

$
5,843

$
106

Mortgage-backed securities:
 
 
 
 
 
 
     U.S. Government agencies
195,661

7,113

5,040

197

200,701

7,310

     Private label
1,491

3

—

—

1,491

3

Trust preferred securities
—

—

4,400

1,900

4,400

1,900

Corporate securities
5,881

843

—

—

5,881

843

Investment funds
$
1,460

$
40

$
—

$
—

$
1,460

$
40

Total
$
210,093

$
8,086

$
9,683

$
2,116

$
219,776

$
10,202


During the years ended December 31, 2014 and 2013, the Company recorded no credit-related net investment impairment losses. During the year ended December 31, 2012, the Company recorded $0.6 million in credit-related net investment impairment losses.  The charges deemed to be other-than-temporary were related to pooled bank trust preferred securities and were based on the Company’s quarterly reviews of its investment securities for indications of losses considered to be other-than-temporary.
Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary would be reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers, among other things (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition, capital strength, and near-term (12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment; (iv) adverse conditions specifically related to the security, an industry, or a geographic area; or (v) the intent to sell the investment security and if it’s more likely than not that the Company will not have to sell the security before recovery of its cost basis.  In addition, management

47

also employs a continuous monitoring process in regards to its marketable equity securities, specifically its portfolio of regional community bank holdings.  Although the regional community bank stocks that are owned by the Company are publicly traded, the trading activity for these stocks is minimal, with trading volumes of less than 0.1% of each respective company being traded on a daily basis.  As part of management’s review process for these securities, management reviews the financial condition of each respective regional community bank for any indications of financial weakness.

Management has the ability and intent to hold the securities classified as held-to-maturity until they mature, at which time the Company expects to receive full value for the securities.  Furthermore, as of December 31, 2014, management does not intend to sell an impaired security and it is not more than likely that it will be required to sell the security before the recovery of its amortized cost basis.  The unrealized losses on debt securities are primarily the result of interest rate changes, credit spread fluctuations on agency-issued mortgage related securities, general financial market uncertainty and unprecedented market volatility.  These conditions will not prohibit the Company from receiving its contractual principal and interest payments on its debt securities.  The fair value is expected to recover as the securities approach their maturity date or repricing date.   As of December 31, 2014, management believes the unrealized losses detailed in the table above are temporary and no additional impairment loss has been recognized in the Company’s consolidated income statement.  Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss will be recognized in net income in the period the other-than-temporary impairment is identified, while any noncredit loss will be recognized in other comprehensive income.

At December 31, 2014, the book value of the Company’s five pooled trust preferred securities totaled $2.1 million with a carrying value of $1.7 million.  All of these securities are mezzanine tranches.  Pooled trust preferred securities represent beneficial interests in securitized financial assets that the Company analyzes within the scope of ASC 320, “Investments-Debt and Equity Securities” and are evaluated quarterly for other-than-temporary-impairment (“OTTI”).  Management performs an analysis of OTTI utilizing its internal methodology as described below to estimate expected cash flows to be received in the future.  The Company reviews each of its pooled trust preferred securities to determine if an OTTI charge would be recognized in current earnings in accordance with ASC 320, “Investments-Debt and Equity Securities”.  There is a risk that continued collateral deterioration could cause the Company to recognize additional OTTI charges in earnings in the future.

Under the Volcker regulations, as originally adopted on December 10, 2013, insured depository institutions and their affiliates are prohibited from engaging in certain types of proprietary trading and it restricts their ability to sponsor or invest in private equity or hedge funds. On January 14, 2014, the Federal Deposit Insurance Corporation ("FDIC"), the Office of the Comptroller of the Currency ("OCC"), the Board of Governors of the Federal Reserve System ("Federal Reserve"), the Securities and Exchange Commission ("SEC") and the Commodity Futures Trading Commission adopted an interim final rule ("IFR") on the treatment of certain pooled trust preferred securities for the purposes of the Volcker rule. This interim final rule exempted the Company's pooled trust preferred securities from the Volcker rule.

When evaluating pooled trust preferred securities for OTTI, the Company determines a credit related portion and a noncredit related portion.  The credit related portion is recognized in earnings and represents the difference between the present value of expected future cash flows and the amortized cost basis of the security.  The noncredit related portion is recognized in other comprehensive income, and represents the difference between the book value and the fair value of the security less the amount of the credit related impairment.  The determination of whether it is probable that an adverse change in estimated cash flows has occurred is evaluated by comparing estimated cash flows to those previously projected as further described below.  The Company considers this process to be its primary evidence when determining whether credit related OTTI exists.  The results of these analyses are significantly affected by other variables such as the estimate of future cash flows, credit worthiness of the underlying issuers and determination of the likelihood of defaults of the underlying collateral. 

The Company utilizes a third party model to compute the present value of expected cash flows which considers the structure and term of each of the five respective pooled trust preferred securities and the financial condition of the underlying issuers.  Specifically, the third party model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. For issuing banks that have defaulted, management generally assumes no recovery. For issuing banks that have deferred its interest payments, management excludes the collateral balance associated with these banks and assumes no recoveries of such collateral balance in the future. The exclusion of such issuing banks in a current deferral position is based on such bank experiencing a certain level of financial difficulty that raises doubt about its ability to satisfy its contractual debt obligation, and accordingly, the Company excludes the associated collateral balance from its estimate of expected cash flows. Other assumptions used in the estimate of expected cash flows include expected future default rates and prepayments. Specifically, the model assumes annual prepayments of 1.0% with 100% at maturity and assumes 150 basis points of additional annual defaults from banks that

48

are currently not in default or deferral.  In addition, the model assumes no recoveries.  Management compares the present value of expected cash flows to those previously projected to determine if an adverse change in cash flows has occurred. If an adverse change in cash flows has occurred, management determines the credit loss to be recognized in the current period and the portion related to noncredit factors to be recognized in other comprehensive income.

The following table presents a progression of the credit loss component of OTTI on debt and equity securities recognized in earnings (in thousands).  The credit loss component represents the difference between the present value of expected future cash flows and the amortized cost basis of the security.  The credit component of OTTI recognized in earnings during a period is presented in two parts based upon whether the credit impairment in the current period is the first time the security was credit impaired (initial credit impairment) or if there is additional credit impairment on a security that was credit impaired in previous periods.
 
 
Debt Securities
Equity Securities
Total
 
 
 
 
Balance, January 1, 2013
$
21,186

$
4,813

$
25,999

Additions:
 
 
 
   Additional credit impairment
—

—

—

Deductions:
 
 
 
   Sold
—

(115
)
(115
)
Balance, December 31, 2013
21,186

4,698

25,884

Additions:
 
 
 
   Additional credit impairment
—

—

—

Deductions:
 
 
 
   Sold
—

(3,114
)
(3,114
)
Balance, December 31, 2014
$
21,186

$
1,584

$
22,770



49

The following table presents additional information about the Company’s trust preferred securities with a credit rating of below investment grade as of December 31, 2014 (dollars in thousands):
Deal Name
 
Type
Class
Original Cost
Amortized Cost
Fair Value
Difference (1)
Lowest Credit Rating
# of issuers currently performing
Actual deferrals/defaults (as a % of original dollar)
Expected deferrals/defaults (as a % of remaining of performing collateral)
 
Excess Subordination as a Percentage of Current Performing Collateral (4)
 
 
Pooled trust preferred securities:
 
 
 
 
 
 
 
 
 
 
 
Available for Sale:
 
 
 
 
 
 
 
 
 
 
P1
 
Pooled
Mezz
$
698

$
75

$
358

$
283

Caa1
6
19.5
%
20.0
%
(2)
65.7
%
P2
 
Pooled
Mezz
2,535

—

—

—

Ca
3
22.3

—

(2)
—

P3
 
Pooled
Mezz
2,962

1,419

710

(709
)
Caa3
16
23.5

7.1

(2)
—

P5
 
Pooled
Mezz
5,877

512

554

42

Ca
7
19.8

20.0

(2)
62.7

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
P6
 
Pooled
Mezz
1,351

44

717

673

Caa1
6
19.5

20.0

(2)
65.7

P7
 
Pooled
Mezz
3,367

—

—

—

Ca
3
22.3

—

(2)
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Single issuer trust preferred securities
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
S5
 
Single
 
261

235

249

14

NR
1
—

—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
S9
 
Single
 
4,000

4,000

4,000

—

NR
1
—

—

 
 

(1)
The differences noted consist of unrealized losses recorded at December 31, 2014 and noncredit other-than-temporary impairment losses recorded subsequent to April 1, 2009 that have not been reclassified as credit losses.
(2)
Performing collateral is defined as total collateral minus all collateral that has been called, is currently deferring, or currently in default. This model for this security assumes that all collateral that is currently deferring will default with a zero recovery rate. The underlying issuers can cure, thus this bond could recover at a higher percentage upon default than zero.
(3)
Performing collateral is defined as total collateral minus all collateral that has been called, is currently deferring, or currently in default.  The model for this security assumes that one of the banks that are currently deferring will cure.  If additional underlying issuers cure, this bond could recover at a higher percentage.
(4)
Excess subordination is defined as the additional defaults/deferrals necessary in the next reporting period to deplete the entire credit enhancement (excess interest and over-collateralization) beneath our tranche within each pool to the point that would cause a "break in yield." This amount assumes that all currently performing collateral continues to perform. A break in yield means that our security would not be expected to receive all the contractual cash flows (principal and interest) by maturity. The "percent of current performing collateral" is the ratio of the "excess subordination amount" to current performing collateral—a higher percent means there is more excess subordination to absorb additional defaults/deferrals, and the better our security is protected from loss.
    
    

50

The amortized cost and estimated fair value of debt securities at December 31, 2014, by contractual maturity, are shown in the following table (in thousands).  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.  Mortgage-backed securities have been allocated to their respective maturity groupings based on their contractual maturity.

 
Cost
Estimated Fair Value
Securities Available-for-Sale
 
 
Due in one year or less
$
8,602

$
8,633

Due after one year through five years
17,854

18,406

Due after five years through ten years
28,144

28,724

Due after ten years
193,698

193,545

 
$
248,298

$
249,308

 
 
 
Securities Held-to-Maturity
 
 
Due in one year or less
$
—

$
—

Due after one year through five years
—

—

Due after five years through ten years
—

—

Due after ten years
90,786

94,191

 
$
90,786

$
94,191

 
Gross gains and gross losses realized by the Company from investment security transactions are summarized in the table below (in thousands):
 
 
For the year ended December 31,
 
2014
2013
2012
 
 
 
 
Gross realized gains
$
1,256

$
764

$
1,776

Gross realized losses
(100
)
—

(246
)
Investment security gains (losses)
$
1,156

$
764

$
1,530

 
The carrying value of securities pledged to secure public deposits and for other purposes as required or permitted by law approximated $273 million and $278 million at December 31, 2014 and 2013, respectively.



51


NOTE FIVE –LOANS

The following summarizes the Company’s major classifications for loans (in thousands):

 
December 31, 2014
December 31, 2013
 
 
 
Residential real estate
$
1,294,576

$
1,204,450

Home equity – junior liens
145,604

146,090

Commercial and industrial
132,641

148,302

Commercial real estate
1,036,738

1,057,048

Consumer
39,705

46,402

DDA overdrafts
2,802

3,905

Gross loans
2,652,066

2,606,197

Allowance for loan losses
(20,150
)
(20,575
)
Net loans
$
2,631,916

$
2,585,622

 
Construction loans of $23.0 million and $17.3 million are included within residential real estate loans at December 31, 2014 and December 31, 2013, respectively.  Construction loans of $28.7 million and $24.0 million are included within commercial real estate loans at December 31, 2014 and December 31, 2013, respectively.  The Company’s commercial and residential real estate construction loans are primarily secured by real estate within the Company’s principal markets.  These loans were originated under the Company’s loan policy, which is focused on the risk characteristics of the loan portfolio, including construction loans.  Adequate consideration has been given to these loans in establishing the Company’s allowance for loan losses.
 
The following table details the loans acquired in conjunction with the Virginia Savings and Community acquisitions (in thousands):

 
Virginia Savings
Community
Total
December 31, 2014
 
 
 
Outstanding loan balance
$
38,345

$
219,923

$
258,268

 
 
 
 
Credit-impaired loans:
 
 
 
Carrying value
1,964

15,365

17,329

Contractual principal and interest
2,407

23,277

25,684

 
 
 
 
December 31, 2013
 
 
 
Outstanding loan balance
$
48,833

$
279,890

$
328,723

 
 
 
 
Credit-impaired loans:
 
 
 
Carrying value
3,182

26,330

29,512

Contractual principal and interest
3,932

38,566

42,498


    






52

Changes in the accretable yield and the carrying amount of the credit-impaired loans for the year December 31, 2014 is as follows (in thousands):

 
Virginia Savings
Community
Total
 
Accretable Yield
Carrying Amount
of Loans
Accretable Yield
Carrying Amount
of Loans
Accretable Yield
Carrying Amount
of Loans
Balance at the beginning of the period
$
698

$
3,182

$
10,389

$
26,330

$
11,087

$
29,512

Accretion
(288
)
288

(2,725
)
2,725

(3,013
)
3,013

Net reclassifications to accretable from non-accretable
385

—

4,121

—

4,506

—

Payments received, net
—

(1,506
)
—

(13,690
)
—

(15,196
)
Disposals
(248
)
—

(1,420
)
—

(1,668
)
—

Balance at the end of period
$
547

$
1,964

$
10,365

$
15,365

$
10,912

$
17,329


Increases in expected cash flow subsequent to the acquisition are recognized first as a reduction of any previous impairment, then prospectively through adjustment of the yield on the loans or pools over its remaining life, while decreases in expected cash flows are recognized as impairment through a provision for loan loss and an increase in the allowance for purchased credit-impaired loans. 
NOTE SIX –ALLOWANCE FOR LOAN LOSSES
 
Management systematically monitors the loan portfolio and the appropriateness of the allowance for loan losses on a quarterly basis to provide for probable losses inherent in the portfolio.  Management assesses the risk in each loan type based on historical trends, the general economic environment of its local markets, individual loan performance and other relevant factors.
 
Individual credits in excess of $1 million are selected at least annually for detailed loan reviews, which are utilized by management to assess the risk in the portfolio and the appropriateness of the allowance.  Due to the nature of commercial lending, evaluation of the appropriateness of the allowance as it relates to these types of loan types is often based more upon specific credit reviews, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for economic conditions and other inherent risk factors.
 
The following summarizes the activity in the allowance for loan loss, by portfolio segment (in thousands).  The following also presents the balance in the allowance for loan loss disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans, by portfolio segment (in thousands).
 
 
Commercial and industrial
Commercial real estate
Residential real estate
Home equity
Consumer
DDA overdrafts
Total
December 31, 2014
 
 
 
 
 
 
 
Allowance for loan loss
 
 
 
 
 
 
 
Beginning balance
$
1,139

$
10,775

$
6,057

$
1,672

$
77

$
855

$
20,575

   Charge-offs
323

1,925

1,762

309

188

1,415

5,922

   Recoveries
89

113

187

—

204

850

1,443

   Provision
394

(42
)
2,726

132

(8
)
569

3,771

   Provision for acquired loans with deteriorated credit quality
283

—

—

—

—

—

283

Ending balance
$
1,582

$
8,921

$
7,208

$
1,495

$
85

$
859

$
20,150

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Allowance for loan loss
 
 
 
 
 
 
 
Beginning balance
$
498

$
10,440

$
5,229

$
1,699

$
81

$
862

$
18,809

   Charge-offs
1,040

2,187

2,181

295

454

1,483

7,640

   Recoveries
84

785

234

—

327

1,128

2,558


53

   Provision
1,308

1,431

2,775

266

123

348

6,251

   Provision for acquired loans with deteriorated credit quality
$
289

$
306

$
—

$
2

$
—

$
—

597

Ending balance
$
1,139

$
10,775

$
6,057

$
1,672

$
77

$
855

$
20,575

 
 
 
 
 
 
 
 
As of December 31, 2014
 
 
 
 
 
 
 
Allowance for loan loss
 
 
 
 
 
 
 
Evaluated for impairment:
 
 
 
 
 
 
 
   Individually
$
—

$
252

$
—

$
—

$
—

$
—

$
252

   Collectively
1,540

7,898

7,208

1,429

85

859

19,019

Acquired with deteriorated credit quality
42

771

—

66

—

—

879

Total
$
1,582

$
8,921

$
7,208

$
1,495

$
85

$
859

$
20,150

 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
Evaluated for impairment:
 
 
 
 
 
 
 
   Individually
$
—

$
6,023

$
449

$
297

$
—

$
—

$
6,769

   Collectively
131,955

1,017,148

1,293,748

142,743

39,572

2,802

2,627,968

Acquired with deteriorated credit quality
686

13,567

379

2,564

133

—

17,329

Total
$
132,641

$
1,036,738

$
1,294,576

$
145,604

$
39,705

$
2,802

$
2,652,066

 
 
 
 
 
 
 
 
As of December 31, 2013
 
 
 
 
 
 
 
Allowance for loan loss
 
 
 
 
 
 
 
Evaluated for impairment:
 
 
 
 
 
 
 
   Individually
$
—

$
880

$
—

$
—

$
—

$
—

$
880

   Collectively
827

9,615

6,054

1,672

77

855

19,100

Acquired with deteriorated credit quality
312

280

3

—

—

—

595

Total
$
1,139

$
10,775

$
6,057

$
1,672

$
77

$
855

$
20,575

 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
Evaluated for impairment:
 
 
 
 
 
 
 
   Individually
$
—

$
11,837

$
459

$
298

$
—

$
—

$
12,594

   Collectively
146,318

1,020,657

1,201,894

145,025

46,292

3,905

2,564,091

Acquired with deteriorated credit quality
1,984

24,554

2,097

767

110

—

29,512

Total
$
148,302

$
1,057,048

$
1,204,450

$
146,090

$
46,402

$
3,905

$
2,606,197

  
Credit Quality Indicators
 
All non-commercial loans are evaluated based on payment history.  All commercial loans within the portfolio are subject to internal risk grading. The Company’s internal risk ratings for commercial loans are:  Exceptional, Good, Acceptable, Pass/Watch, Special Mention, Substandard and Doubtful.  Each internal risk rating is defined in the loan policy using the following criteria:  balance sheet yields, ratios and leverage, cash flow spread and coverage, prior history, capability of management, market position/industry, potential impact of changing economic, legal, regulatory or environmental conditions, purpose structure, collateral support, and guarantor support.  Risk grades are generally assigned by the primary lending officer and are periodically evaluated by the Company’s internal loan review process.  Based on an individual loan’s risk grade, estimated loss percentages are applied to the outstanding balance of the loan to determine the amount of probable loss.

The Company categorizes loans into risk categories based on relevant information regarding the customer’s debt service ability, capacity, overall collateral position along with other economic trends, and historical payment performance.  The risk grades for each credit are updated when the Company receives current financial information, the loan is reviewed by the Company’s internal loan review/credit administration departments, or the loan becomes delinquent or impaired.  The risk grades

54

are updated a minimum of annually for loans rated exceptional, good, acceptable, or pass/watch.  Loans rated special mention, substandard or doubtful are reviewed at least quarterly.  The Company uses the following definitions for its risk ratings:
Risk Rating
Description
Pass Ratings:
 
   (a) Exceptional
Loans classified as exceptional are secured with liquid collateral conforming to the internal loan policy.  Loans rated within this category pose minimal risk of loss to the bank and the risk grade within this pool of loans is generally updated on an annual basis.
   (b) Good
Loans classified as good have similar characteristics that include a strong balance sheet, satisfactory debt service coverage ratios, strong management and/or guarantors, and little exposure to economic cycles.  Loans within this category are generally reviewed on an annual basis.  Loans in this category generally have a low chance of loss to the bank.
   (c) Acceptable
Loans classified as acceptable have acceptable liquidity levels, adequate debt service coverage ratios, experienced management, and have average exposure to economic cycles.  Loans within this category generally have a low risk of loss to the bank.
   (d) Pass/watch
Loans classified as pass/watch have erratic levels of leverage and/or liquidity, cash flow is volatile and the borrower is subject to moderate economic risk.  A borrower in this category poses a low to moderate risk of loss to the bank.
Special mention
Loans classified as special mention have a potential weakness(es) that deserves management's close attention.  The potential weakness could result in deterioration of the loan repayment or the bank's credit position at some future date.  A loan rated in this category poses a moderate loss risk to the bank.
Substandard
Loans classified as substandard reflect a customer with a well defined weakness that jeopardizes the liquidation of the debt.  Loans in this category have the possibility that the bank will sustain some loss if the deficiencies are not corrected and the bank's collateral value is weakened by the financial deterioration of the borrower.
Doubtful
Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that make collection of the full contract amount highly improbable.  Loans rated in this category are most likely to cause the bank to have a loss due to a collateral shortfall or a negative capital position.


55

The following table presents the Company's commercial loans by credit quality indicators, by class (in thousands):

 
Commercial and industrial
Commercial real estate
Total
December 31, 2014
 
 
 
Pass
$
120,905

$
978,492

$
1,099,397

Special mention
761

15,103

15,864

Substandard
10,575

42,691

53,266

Doubtful
400

452

852

Total
$
132,641

$
1,036,738

$
1,169,379

 
 
 
 
December 31, 2013
 

 

 

Pass
$
141,818

$
974,368

$
1,116,186

Special mention
648

20,072

20,720

Substandard
5,416

62,139

67,555

Doubtful
420

469

889

Total
$
148,302

$
1,057,048

$
1,205,350


The following table presents the Company's non-commercial loans by payment performance, by class (in thousands):
 
Performing
Non-Performing
Total
December 31, 2014
 
 
 
Residential real estate
$
1,292,012

$
2,564

$
1,294,576

Home equity - junior lien
145,506

98

145,604

Consumer
39,692

13

39,705

DDA overdrafts
2,802

—

2,802

Total
$
1,480,012

$
2,675

$
1,482,687

 
 
 
 
December 31, 2013
 
 
 
Residential real estate
$
1,201,631

$
2,819

$
1,204,450

Home equity - junior lien
145,812

278

146,090

Consumer
46,353

49

46,402

DDA overdrafts
3,900

5

3,905

Total
$
1,397,696

$
3,151

$
1,400,847


 
Aging Analysis of Accruing and Non-Accruing Loans
 
Generally, all loan types are considered past due when the contractual terms of a loan are not met and the borrower is 30 days or more past due on a payment.  Furthermore, residential and home equity loans are generally subject to charge-off when the loan becomes 120 days past due, depending on the estimated fair value of the collateral less cost to dispose, versus the outstanding loan balance.  Unsecured commercial loans are generally charged off when the loan becomes 120 days past due.  Secured commercial loans are generally charged off when the loan becomes 120 days past due and open-end consumer loans are generally charged off when the loan becomes 180 days past due.
 
The following presents an aging analysis of the Company’s accruing and non-accruing loans, by class (in thousands). The purchased credit-impaired loan column represents the purchased credit-impaired loans that the Company acquired that are contractually past due; however, are still performing in accordance with the Company's initial expectations.

56


 
Originated Loans
 
December 31, 2014
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Purchased-Credit Impaired
Non-accrual
Total
Residential real estate
$
1,200,177

$
4,235

$
758

$
169

$
—

$
2,259

$
1,207,598

Home equity - junior lien
142,624

561

155

30

—

68

143,438

Commercial and industrial
120,950

100

—

210

—

78

121,338

Commercial real estate
877,437

479

—

—

—

7,330

885,246

Consumer
33,178

119

78

1

—

—

33,376

DDA overdrafts
2,483

317

2

—

—

—

2,802

Total
$
2,376,849

$
5,811

$
993

$
410

$
—

$
9,735

$
2,393,798

 
 
 
 
 
 
 
 
 
Acquired Loans
 
December 31, 2014
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Purchased-Credit Impaired
Non-accrual
Total
Residential real estate
$
86,129

$
714

$
—

$
—

$
—

$
135

$
86,978

Home equity - junior lien
2,164

2

—

—

—

—

2,166

Commercial and industrial
10,123

143

—

—

—

1,037

11,303

Commercial real estate
144,721

892

210

—

1,270

4,399

151,492

Consumer
6,108

172

36

13

—

—

6,329

DDA overdrafts
—

—

—

—

—

—

—

Total
$
249,245

$
1,923

$
246

$
13

$
1,270

$
5,571

$
258,268

 
 
 
 
 
 
 
 
 
Total Loans
 
December 31, 2014
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Purchased-Credit Impaired
Non-accrual
Total
Residential real estate
$
1,286,306

$
4,949

$
758

$
169

$
—

$
2,394

$
1,294,576

Home equity - junior lien
144,788

563

155

30

—

68

145,604

Commercial and industrial
131,073

243

—

210

—

1,115

132,641

Commercial real estate
1,022,158

1,371

210

—

1,270

11,729

1,036,738

Consumer
39,286

291

114

14

—

—

39,705

DDA overdrafts
2,483

317

2

—

—

—

2,802

Total
$
2,626,094

$
7,734

$
1,239

$
423

$
1,270

$
15,306

$
2,652,066

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

57

 
Originated Loans
 
December 31, 2013
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Purchased-Credit Impaired
Non-accrual
Total
Residential real estate
$
1,096,911

$
4,123

$
495

$
231

$
—

$
1,905

$
1,103,665

Home equity - junior lien
141,967

880

—

42

—

236

143,125

Commercial and industrial
128,015

—

—

—

—

79

128,094

Commercial real estate
852,090

668

—

—

—

13,097

865,855

Consumer
32,647

172

7

4

—

—

32,830

DDA overdrafts
3,511

374

15

5

—

—

3,905

Total
$
2,255,141

$
6,217

$
517

$
282

$
—

$
15,317

$
2,277,474

 
 
 
 
 
 
 
 
 
Acquired Loans
 
December 31, 2013
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Purchased-Credit Impaired
Non-accrual
Total
Residential real estate
$
99,089

$
842

$
172

$
—

$
—

$
682

$
100,785

Home equity - junior lien
2,965

—

—

—

—

—

2,965

Commercial and industrial
18,253

—

80

—

—

1,875

20,208

Commercial real estate
176,018

2,772

273

109

7,534

4,487

191,193

Consumer
12,876

622

29

45

—

—

13,572

DDA overdrafts
—

—

—

—

—

—

—

Total
$
309,201

$
4,236

$
554

$
154

$
7,534

$
7,044

$
328,723

 
 
 
 
 
 
 
 
 
Total Loans
 
December 31, 2013
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Purchased-Credit Impaired
Non-accrual
Total
Residential real estate
$
1,196,000

$
4,965

$
667

$
231

$
—

$
2,587

$
1,204,450

Home equity - junior lien
144,932

880

—

42

—

236

146,090

Commercial and industrial
146,268

—

80

—

—

1,954

148,302

Commercial real estate
1,028,108

3,440

273

109

7,534

17,584

1,057,048

Consumer
45,523

794

36

49

—

—

46,402

DDA overdrafts
3,511

374

15

5

—

—

3,905

Total
$
2,564,342

$
10,453

$
1,071

$
436

$
7,534

$
22,361

$
2,606,197


 

58


The following presents the Company’s impaired loans, by class (in thousands):
 
December 31, 2014
December 31, 2013
 
 
Unpaid
 
 
Unpaid
 
 
Recorded
Principal
Related
Recorded
Principal
Related
 
Investment
Balance
Allowance
Investment
Balance
Allowance
With no related allowance recorded:
 
 
 
 
 
 
Residential real estate
$
449

$
449

$
—

$
459

$
459

$
—

Home equity - junior liens
297

297

—

298

298

—

Commercial and industrial
—

—

—

—

—

—

Commercial real estate
4,631

4,631

—

8,421

8,361

—

Consumer
—

—

—

—

—

—

DDA overdrafts
—

—

—

—

—

—

Total
$
5,377

$
5,377

$
—

$
9,178

$
9,118

$
—

 
 
 
 
 
 
 
With an allowance recorded
 
 
 
 
 
 
Residential real estate
$
—

$
—

$
—

$
—

$
—

$
—

Home equity - junior liens
—

—

—

—

—

—

Commercial and industrial
—

—

—

—

—

—

Commercial real estate
1,392

1,392

252

3,416

3,416

880

Consumer
—

—

—

—

—

—

DDA overdrafts
—

—

—

—

—

—

Total
$
1,392

$
1,392

$
252

$
3,416

$
3,416

$
880


The following table presents information related to the average recorded investment and interest income recognized on the Company’s impaired loans, by class (in thousands):
 
For the year ended
 
December 31, 2014
December 31, 2013
 
Average
Interest
Average
Interest
 
Recorded
Income
Recorded
Income
 
Investment
Recognized
Investment
Recognized
With no related allowance recorded:
 
 
 
 
Residential real estate
$
452

$
—

$
463

$
—

Home equity - junior liens
297

—

298

—

Commercial and industrial
—

—

—

—

Commercial real estate
6,657

17

9,006

57

Consumer
—

—

—

—

DDA overdrafts
—

—

—

—

Total
$
7,406

$
17

$
9,767

$
57

 
 
 
 
 
With an allowance recorded
 
 
 
 
Residential real estate
$
—

$
—

$
—

$
—

Home equity - junior liens
—

—

—

—

Commercial and industrial
—

—

—

—

Commercial real estate
1,725

128

3,324

—

Consumer
—

—

—

—

DDA overdrafts
—

—

—

—

Total
$
1,725

$
128

$
3,324

$
—


On non-accrual and impaired loans, approximately $0.5 million, $0.6 million and $1.0 million of interest income would have been recognized during the year ended December 31, 2014, 2013 and 2012, respectively, if such loans had been current in accordance with their original terms.  There were no commitments to provide additional funds on non-accrual, impaired or other potential problem loans at December 31, 2014.


59

Loan Modifications

The Company’s policy on loan modifications typically does not allow for modifications that would be considered a concession from the Company.  However, when there is a modification, the Company evaluates each modification to determine if the modification constitutes a troubled debt restructuring (“TDR”) in accordance with ASU 2011-2, whereby a modification of a loan would be considered a TDR when both of the following conditions are met: (1) a borrower is experiencing financial difficulty and (2) the modification constitutes a concession.  When determining whether the borrower is experiencing financial difficulties, the Company reviews whether the debtor is currently in payment default on any of its debt or whether it is probable that the debtor would be in payment default in the foreseeable future without the modification.  Other indicators of financial difficulty include whether the debtor has declared or is in the process of declaring bankruptcy, the debtor’s ability to continue as a going concern, or the debtor’s projected cash flow to service its debt (including principal and interest) in accordance with the contractual terms for the foreseeable future, without a modification. 

Regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged by the bankruptcy court and the borrower has not reaffirmed the debt.  The filing of bankruptcy is deemed to be evidence that the borrower is in financial difficulty and the discharge of the debt by the bankruptcy court is deemed to be a concession granted to the borrower.

The following tables set forth the Company’s TDRs (in thousands):
 
December 31, 2014
December 31, 2013
 
Non-
 
 
Non-
 
Accruing
Accruing
Total
Accruing
Accruing
Total
Commercial and industrial
$
73

$
—

$
73

$
88

$
—

$
88

Commercial real estate
2,263

—

2,263

1,783

—

1,783

Residential real estate
17,946

545

18,491

18,651

1,693

20,344

Home equity
2,673

15

2,688

2,859

14

2,873

Consumer
—

—

—

—

—

—

 
$
22,955

$
560

$
23,515

$
23,381

$
1,707

$
25,088



 
New TDRs
New TDRs
 
For the year ended
For the year ended
 
December 31, 2014
December 31, 2013
 
Pre
Post
 
Pre
Post
 
Modification
Modification
 
Modification
Modification
 
Outstanding
Outstanding
 
Outstanding
Outstanding
Number of
Recorded
Recorded
Number of
Recorded
Recorded
Contracts
Investment
Investment
Contracts
Investment
Investment
Commercial and industrial
—

$
—

$
—

1

$
88

$
88

Commercial real estate
1

428

428

3

1,564

1,559

Residential real estate
35

2,381

2,381

36

4,041

4,041

Home equity
10

211

211

17

473

473

Consumer
—

—

—

—

—

—

 
46

$
3,020

$
3,020

57

$
6,166

$
6,161


NOTE SEVEN – PREVIOUSLY SECURITIZED LOANS

Between 1997 and 1999, the Company completed six securitization transactions involving approximately $760 million in 125% of fixed rate, junior-lien underlying mortgages.  The Company retained a financial interest in each of the securitizations until 2004.  Principal amounts owed to investors were evidenced by securities (“Notes”).  During 2003 and 2004, the Company exercised its early redemption options on each of those securitizations.  Once the Notes were redeemed, the Company became the beneficial owner of the mortgage loans and recorded the loans as assets of the Company within the loan portfolio.

As the Company redeemed the outstanding Notes, no gain or loss was recognized in the Company’s financial statements and the remaining mortgage loans were recorded in the Company’s loan portfolio as “previously securitized loans,” at the lower of carrying value or fair value.  Because the carrying value of the mortgage loans incorporated assumptions for expected prepayment and default rates, the carrying value of the loans was generally less than the actual outstanding contractual balance

60

of the loans.  As of December 31, 2014 and 2013, there was no carrying value remaining on these loans; while the actual contractual balance of these loans was $4.9 million and $6.2 million, respectively.  During the years ended December 31, 2014, 2013 and 2012, the Company recognized $2.2 million, $2.5 million and $3.3 million, respectively, of interest income from its previously securitized loans.
 
NOTE EIGHT – PREMISES AND EQUIPMENT

A summary of premises and equipment and related accumulated depreciation is summarized as follows (in thousands):

 
Estimated Useful Life
2014
2013
 
 
 
 
Land
 
$
31,217

$
31,499

Buildings and improvements
10 to 30 yrs.
85,403

85,879

Equipment
3 to 7 yrs.
37,051

39,418

 
 
153,671

156,796

Less: accumulated depreciation
 
(75,683
)
(74,248
)
 
 
$
77,988

$
82,548

 
NOTE NINE – GOODWILL AND OTHER INTANGIBLE ASSETS

The Company completed its annual assessment of the carrying value of goodwill during 2014 and concluded that its carrying value was not impaired. The following table presents a roll forward of the Company's goodwill activity (in thousands):

 
2014
2013
 
 
 
Beginning balance
$
71,401

$
62,988

Adjustments to goodwill acquired in conjunction with the acquisition of Virginia Savings
—

142

Goodwill acquired in conjunction with the acquisition of Community
—

8,271

Ending balance
$
71,401

$
71,401




The Company believes that the customer relationships with the deposits acquired have an intangible value. In connection with acquisitions, the Company recorded a core deposit intangible, which represented the value that the acquiree had with their deposit customers. The fair value was estimated based on a discounted cash flow methodology that considered the type of deposit, estimated deposit retention, the cost of the deposit base and an alternate cost of funds. The following table presents a roll forward of the Company's core deposit intangible activity (in thousands):
 
2014
2013
 
 
 
Gross carrying amount
$
8,387

$
8,387

Accumulated amortization
(5,590
)
(4,646
)
 
$
2,797

$
3,741

 
 
 
Beginning balance
$
3,741

$
2,069

Core deposit intangible acquired in conjunction with the acquisition of Community
—

2,711

Amortization expense
(944
)
(1,039
)
Ending balance
$
2,797

$
3,741


The core deposit intangible amortization expense for the year ended December 31, 2012 was $0.5 million. The core deposit intangibles are being amortized over ten years. The estimated amortization expense for core deposit intangible assets for each of the next five years is as follows (in thousands):

2015
$
652

2016
440

2017
386

2018
341

2019
303

Thereafter
675

 
$
2,797


NOTE TEN – SCHEDULED MATURITIES OF TIME DEPOSITS

Scheduled maturities of time deposits outstanding at December 31, 2014 are summarized as follows (in thousands):

2015
$
496,605

2016
185,353

2017
111,697

2018
147,564

2019
84,888

Over five years
556

 
$
1,026,663


 


Scheduled maturities of time deposits that meet or exceed the FDIC insurance limit of $250,000 or more outstanding, are summarized as follows (in thousands):
 
2014
2013
 
 
 
Within one year
$
34,544

$
44,288

Over one through two years
16,318

9,469

Over two through three years
6,014

14,273

Over three through four years
19,808

3,353

Over four through five years
6,538

14,317

Over five years
—

—

 
$
83,222

$
85,700


NOTE ELEVEN – SHORT-TERM DEBT

A summary of short-term borrowings are as follows (dollars in thousands):

 
2014
2013
2012
 
 
 
 
Balance at end of year:
 
 
 
Customer repurchase agreements
$
134,931

$
137,798

$
114,646

 
 
 
 
Avg. outstanding during the year:
 
 
 
Customer repurchase agreements
$
133,769

$
127,616

$
121,270

Federal Funds purchased
—

63

510

 
 
 
 
Max. outstanding at any month end:
 
 
 
Customer repurchase agreements
$
151,637

$
150,943

$
131,971

 
 
 
 
Weighted-average interest rate:
 
 
 
During the year:
 
 
 
Customer repurchase agreements
0.26
%
0.25
%
0.26
%
Federal Funds purchased
—

0.31
%
0.28
%
End of the year:
 
 
 
Customer repurchase agreements
0.26
%
0.25
%
0.26
%
Federal Funds purchased
—

0.31
%
0.28
%
 
Through City National, the Company has purchased 17,571 shares of Federal Home Loan Bank (“FHLB”) stock at par value as of December 31, 2014. Such purchases are required based on City National’s maximum borrowing capacity with the FHLB.  Additionally, FHLB stock entitles the Company to dividends declared by the FHLB and provides an additional source of short-term and long-term funding, in the form of collateralized advances. Financing obtained from the FHLB is based, in part, on the amount of qualifying collateral available, specifically 1-4 family residential mortgages, other residential mortgages, and commercial real estate and other non-residential mortgage loans. Collateral pledged to the FHLB included approximately $1.7 billion at both December 31, 2014 and 2013 in investment securities and one-to-four-family residential property loans.  In addition to the short-term financing discussed above and long-term financing (see Note Twelve), at December 31, 2014 and 2013, City National had an additional $1.5 billion and $1.4 billion, respectively, available from unused portions of lines of credit with the FHLB and other financial institutions.
 






63

NOTE TWELVE – LONG-TERM DEBT

The components of long-term debt are summarized below (dollars in thousands):
 
 
2014
2013
 
 
 
Junior subordinated debentures owed to City Holding Capital Trust III, due 2038, interest at a rate of 3.74% and 3.74%, respectively
$
16,495

$
16,495


The Company formed a statutory business trust, City Holding Capital Trust III (“Capital Trust III”), under the laws of Delaware. Capital Trust III was created for the exclusive purpose of (i) issuing trust-preferred capital securities (“Capital Securities”), which represent preferred undivided beneficial interests in the assets of the trust, (ii) using the proceeds from the sale of the Capital Securities to acquire junior subordinated debentures (“Debentures”) issued by the Company, and (iii) engaging in only those activities necessary or incidental thereto. The trust is considered a variable interest entity for which the Company is not the primary beneficiary. Accordingly, the accounts of the trusts are not included in the Company’s consolidated financial statements.
Distributions on the Debentures are cumulative and will be payable quarterly at an interest rate of 3.50% over the three month LIBOR rate, reset quarterly. Interest payments are due in March, June, September and December. The Debentures are redeemable prior to maturity at the option of the Company (i) in whole or at any time or in part from time-to-time, or (ii) in whole, but not in part, at any time within 90 days following the occurrence and during the continuation of certain pre-defined events.
Payments of distributions on the Capital Securities and payments on redemption of the Capital Securities are guaranteed by the Company. The Company also entered into an agreement as to expenses and liabilities with the trust pursuant to which it agreed, on a subordinated basis, to pay any cost, expenses or liabilities of the trust other than those arising under the trust preferred securities. The obligations of the Company under the junior subordinated debentures, the related indentures, the trust agreement establishing the trust, the guarantees and the agreements as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by the Company of the trust’s obligations under the trust preferred securities. The Capital Securities issued by the statutory business trusts qualify as Tier 1 capital for the Company under current Federal Reserve Board guidelines and interpretations.
NOTE THIRTEEN – DERIVATIVE INSTRUMENTS

As of December 31, 2014 and 2013, the Company has derivative financial instruments not included in hedge relationships.  These derivatives consist of interest rate swaps used for interest rate management purposes and derivatives executed with commercial banking customers to facilitate their interest rate management strategies. The Company also has an interest rate swap for the purpose of hedging changes in LIBOR related to commercial real estate loans. The fair value of this interest rate swap is less than $0.1 million with a notional value of $5.5 million at December 31, 2014 .

The following table summarizes the fair value of these derivative instruments (in thousands):

 
2014
2013
Fair Value:
 
 
   Other Assets
$
10,253

$
3,538

   Other Liabilities
10,253

3,538



The following table summarizes the change in fair value of these derivative instruments (in thousands):
 
 
Year Ended December 31,
 
2014
2013
2012
Change in Fair Value:
 
 
 
   Other income - derivative asset
$
6,811

$
(10,148
)
$
1,921

   Other income - derivative liability
(6,811
)
10,148

(1,921
)

64


Certain financial instruments, including derivatives, may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements. The Company's derivative transactions with financial institution counterparties are generally executed under International Swaps and Derivative Association ("ISDA") master agreements which include "right of setoff" provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. Nonetheless, the Company does not generally offset financial instruments for financial reporting purposes. Information about financial instruments that are eligible for offset in the consolidated balance sheet as of December 31, 2014 is presented in the following tables (in thousands):

 
 
 
 
Gross Amounts
 
 
 
 
 
 
Not Offset in the Statement
 
 
 
 
 
 
of Financial Position
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
of Gross
 
 
 
 
 
 
 
Amounts
 
 
 
 
 
 
 
Not Offset in
 
 
 
 
 
 
 
the Statement
 
 
 
 
 
 
 
of Financial
 
 
 
 
 
 
 
Position
 
 
 
 
 
Netting
 
Including
 
 
 
Gross
Net Amounts
Adjustment
 
Applicable
 
 
 
Amounts
of Assets
per
 
Netting
 
 
Gross
Offset in the
presented in
Applicable
 
Agreement
 
 
Amounts of
Statement of
the Statement
Master
Fair Value
and Fair
 
 
Recognized
Financial
of Financial
Netting
of Financial
Value of
 
Description
Assets
Position
Position
Arrangements
Collateral
Collateral
Net Amount
 
(a)
(b)
(c)=(a)-(b)
 
 
(d)
(c)-(d)
Derivative assets:
 
 
 
 
 
 
 
Interest rate swap agreements
$
10,253

$
—

$
10,253

$
—

$
10,253

$
10,253

$
—


 
 
 
 
Gross Amounts
 
 
 
 
 
 
Not Offset in the Statement
 
 
 
 
 
 
of Financial Position
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
of Gross
 
 
 
 
 
 
 
Amounts
 
 
 
 
 
 
 
Not Offset in
 
 
 
 
 
 
 
the Statement
 
 
 
 
 
 
 
of Financial
 
 
 
 
 
 
 
Position
 
 
 
 
 
Netting
 
Including
 
 
 
Gross
Net Amounts
Adjustment
 
Applicable
 
 
 
Amounts
of Liabilities
per
 
Netting
 
 
Gross
Offset in the
presented in
Applicable
 
Agreement
 
 
Amounts of
Statement of
the Statement
Master
Fair Value
and Fair
 
 
Recognized
Financial
of Financial
Netting
of Financial
Value of
 
Description
Liabilities
Position
Position
Arrangements
Collateral
Collateral
Net Amount
 
(a)
(b)
(c)=(a)-(b)
 
 
(d)
(c)-(d)
Derivative liabilities:
 
 
 
 
 
 
Interest rate swap agreements
$
10,253

$
—

$
10,253

$
—

$
13,264

$
13,264

$
—





NOTE FOURTEEN – 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 (in thousands):

 
2014
2013
Deferred tax assets:
 
 
Previously securitized loans
$
4,703

$
5,166

Allowance for loan losses
7,413

7,566

Deferred compensation payable
3,966

3,774

Underfunded pension liability
3,113

1,675

Accrued expenses
2,451

2,830

Impaired assets
1,172

1,028

Impaired securities losses
8,377

9,519

Unrealized securities losses
—

1,230

Intangible assets
4,946

8,081

Other
3,292

3,109

Total Deferred Tax Assets
39,433

43,978

Deferred tax liabilities:
 
 
Unrealized securities gains
741

—

Other
1,926

1,813

Total Deferred Tax Liabilities
2,667

1,813

Net Deferred Tax Assets
$
36,766

$
42,165


No valuation allowance for deferred tax assets was recorded at December 31, 2014 and 2013 as the Company believes it is more likely than not that all of the deferred tax assets will be realized because they were supported by recoverable taxes paid in prior years.
 
Significant components of the provision for income taxes are as follows (in thousands): 
 
2014
2013
2012
Current:
 
 
 
Federal
$
20,629

$
18,808

$
15,509

State
(943
)
1,781

2,259

Total current tax expense
19,686

20,589

17,768

 
 
 
 
Total deferred tax expense (benefit)
4,585

4,686

2,530

Income tax expense
$
24,271

$
25,275

$
20,298


     











A reconciliation of the significant differences between the federal statutory income tax rate and the Company’s effective income tax rate is as follows (in thousands):
 
2014
2013
2012
 
 
 
 
Computed federal taxes at statutory rate
$
27,031

$
25,722

$
20,735

State income taxes, net of federal tax benefit
(482
)
1,982

1,591

Tax effects of:
 
 
 
  Tax-exempt interest income
(500
)
(616
)
(712
)
  Bank-owned life insurance
(1,074
)
(1,187
)
(1,044
)
  Tax reserve adjustment
—

24

8

  Other items, net
(704
)
(650
)
(280
)
Income tax expense
$
24,271

$
25,275

$
20,298

 
The entire amount of the Company’s unrecognized tax benefits if recognized, would favorably affect the Company’s effective tax rate.   The Company anticipates that it will release $0.9 million over the next 12 months.  A reconciliation of the beginning and ending balance of unrecognized tax benefits is as follows (in thousands):

 
2014
2013
 
 
 
Beginning balance
$
4,717

$
4,376

Additions for current year tax positions
486

341

Additions for prior year tax positions
—

—

Decreases for prior year tax positions
—

—

Decreases for settlements with tax authorities
—

—

Decreases related to lapse of applicable statute of limitation
(2,805
)
—

Ending balance
$
2,398

$
4,717

 
Interest and penalties on income tax uncertainties are included in income tax expense.  During 2014, 2013 and 2012, the provision related to interest and penalties was $0.1 million, $0.1 million, and $0.2 million, respectively.  The balance of accrued interest and penalties at December 31, 2014 and 2013 was $0.4 million and $0.3 million, respectively.

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended December 31, 2011 through 2013.
 
NOTE FIFTEEN – EMPLOYEE BENEFIT PLANS

Pursuant to the terms of the City Holding Company 2003 Incentive Plan and the City Holding Company 2013 Incentive Plan (the "2003 Plan" and "2013 Plan", respectively), the Compensation Committee of the Board of Directors, or its delegate, may, from time-to-time, grant stock options, stock appreciation rights (“SARs”), or stock awards to employees, directors and individuals who provide service to the Company (collectively, "Plan Participants").  The 2003 Plan expired in April of 2013 and the 2013 Plan was approved by the shareholders in April 2013. A maximum of 750,000 shares of the Company’s common stock may be issued under the 2013 plan upon the exercise of stock options, SARs and stock awards, subject to certain limitations.  These limitations may be adjusted in the event of a change in the number of outstanding shares of common stock by reason of a stock dividend, stock split or other similar event.  Specific terms of options and SARs awarded, including vesting periods, exercise prices (stock price at date of grant) and expiration dates are determined at the date of grant and are evidenced by agreements between the Company and the awardee.  The exercise price of the option grants equals the market price of the Company’s stock on the date of grant.  All incentive stock options and SARs will be exercisable up to 10 years from the date granted and all options and SARs are exercisable for the period specified in the individual agreement.  As of December 31, 2014, under both Plans, 411,601 stock options and 216,156 stock awards are still outstanding.

Each award from the Plan is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Compensation Committee, or its delegate, determines.  The option price for each grant is equal to the fair market value of a share of the Company’s common stock on the date of the grant.  Options granted expire at such time as the Compensation Committee, or its delegate, determines at the date

67

of the grant and in no event does the exercise period exceed a maximum of ten years.  Upon a change-in-control of the Company, as defined in the Plan, all outstanding options and awards shall immediately vest.
 
Stock Options

A summary of the Company’s stock option activity and related information is presented below: 
 
2014
2013
2012
 
Options
Weighted-Average Exercise Price
Options
Weighted-Average Exercise Price
Options
Weighted-Average Exercise Price
 
 
 
 
 
 
 
Outstanding at January 1
173,601

$
35.26

289,544

$
34.38

293,817

$
33.95

     Granted
13,953

44.43

15,475

37.74

16,876

35.39

     Exercised
(20,000
)
29.19

(126,168
)
33.57

(18,899
)
28.78

     Forfeited
—

—

(5,250
)
34.56

(2,250
)
33.28

Outstanding at December 31
167,554

36.74

173,601

35.26

289,544

34.38

 
 
 
 
 
 
 
Exercisable at end of year
89,750

36.73

76,832

37.97

183,584

34.70

 
 
 
 
 
 
 
Nonvested at beginning of year
96,769

33.10

105,960

33.81

108,500

34.38

Granted during the year
13,953

44.43

15,475

37.74

16,876

35.39

Vested during the year
(32,918
)
29.25

(23,166
)
39.64

(18,166
)
38.87

Forfeited during the year
—

—

(1,500
)
30.38

(1,250
)
30.38

Nonvested at end of year
77,804

$
36.76

96,769

$
33.10

105,960

$
33.81


Additional information regarding stock options outstanding and exercisable at December 31, 2014, is provided in the following table:
  
Ranges of Exercise Prices
No. of Options Outstanding
Weighted-Average Exercise Price
Weighted-Average Remaining Contractual Life (Months)
Aggregate Intrinsic Value
(in thousands)
No. of Options Currently Exercisable
Weighted-Average Exercise Price of Options Currently Exercisable
Weighted-Average Remaining Contractual Life (Months)
Aggregate Intrinsic Value of Options Currently Exercisable 
(in thousands)
26.62 - 33.90
39,250

30.84

44
$
616

23,750

$
30.02

31
$
392

35.09 - 44.43
128,304

38.55

58
1,024

66,000

39.15

25
487

 
167,554

 
 
$
1,640

89,750

 
 
$
879


Proceeds from stock option exercises were $0.6 million in 2014, $4.2 million in 2013, and $0.5 million in 2012. Shares issued in connection with stock option exercises are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. During 2014, 2013 and 2012, all shares issued in connection with stock option exercises and restricted stock awards were issued from available treasury stock.

The total intrinsic value of stock options exercised was $0.3 million in 2014, $0.9 million in 2013 and $0.1 million in 2012, respectively.

Stock-based compensation expense related to stock options totaled $0.2 million for each of the years ended December 31, 2014, 2013 and 2012.  The total income tax benefit recognized in the accompanying consolidated statements of income related to stock-based compensation was less than $0.1 million in 2014, $0.3 million in 2013, and less than $0.1 million in 2012.  Unrecognized stock-based compensation expense related to stock options approximated $0.4 million at December 31, 2014. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 1.5 years.


68

The fair value of the options is estimated at the date of grant using a Black-Scholes option-pricing model.   The following weighted average assumptions were used to estimate the fair value of options granted:
 
2014
2013
2012
 
 
 
 
Risk-free interest rate
2.42
%
1.88
%
2.51
%
Expected dividend yield
3.60
%
3.70
%
3.90
%
Volatility factor
48.75
%
41.35
%
48.40
%
Expected life of option
8.0 years
8.0 years
5.0 years

Restricted Shares

The Company measures compensation expense with respect to restricted shares in an amount equal to the fair value of the common stock covered by each award on the date of grant. The restricted shares awarded become fully vested after various periods of continued employment from the respective dates of grant. The Company is entitled to an income tax deduction in an amount equal to the taxable income reported by the holders of the restricted shares when the restrictions are released and the shares are issued. Compensation is  charged to expense over the respective vesting periods.

Restricted shares are generally forfeited if officers and employees terminate prior to the lapsing of restrictions. The Company records forfeitures of restricted stock as treasury share repurchases and any compensation cost previously recognized is reversed in the period of forfeiture.  Recipients of restricted shares do not pay any cash consideration to the Company for the shares, have the right to vote all shares subject to such grant and receive all dividends with respect to such shares, whether or not the shares have vested.  Stock-based compensation expense related to restricted shares was approximately $1.0 million for the year ended December 31, 2014, $0.8 million for year ended December 31, 2013, and $0.6 million for the year ended December 31, 2012.  Unrecognized stock-based compensation expense related to non-vested restricted shares was $2.9 million at December 31, 2014. At December 31, 2014, this unrecognized expense is expected to be recognized over 3.4 years based on the weighted average-life of the restricted shares.
  
A summary of the Company’s restricted shares activity and related information is presented below:
 
 
2014
2013
2012
 
Restricted Awards
Average Market Price at Grant
Restricted Awards
Average Market Price at Grant
Restricted Awards
Average Market Price at Grant
 
 
 
 
 
 
 
Outstanding at January 1
142,469

 
116,711

 
108,209

 
     Granted
27,162

$
39.72

35,083

$
38.07

23,336

$
34.94

     Forfeited/Vested
(6,200
)
 
(9,325
)
 
(14,834
)
 
Outstanding at December 31
163,431

 
142,469

 
116,711

 
 
Benefit Plans
 
The Company provides retirement benefits to its employees through the City Holding Company 401(k) Plan and Trust (“the 401(k) Plan”), which is intended to be compliant with Employee Retirement Income Security Act (ERISA) section 404(c). The Company’s total expense associated with the retirement benefit plan approximated $0.8 million in 2014, $0.8 million in 2013, and $0.6 million in 2012.  The total number of shares of the Company’s common stock held by the 401(k) Plan as of December 31, 2014 and 2013 is 303,443 and 271,749, respectively.

The Company maintains two defined benefit pension plans (“the Defined Benefit Plans”), which were inherited from the Company's acquisition of the plan sponsors (Horizon Bancorp, Inc. and Community Financial Corporation). The Horizon Defined Benefit Plan was frozen in 1999 and maintains a December 31st year-end for purposes of computing its benefit obligations. The Community Defined Benefit Plan was frozen in 2012 and maintains a December 31st year-end for purposes of computing its benefit obligations.
Primarily as a result of the interest rate environment over the past several years and a revised mortality table issued in 2014, the benefit obligation exceeded the estimated fair value of plan assets as of December 31, 2014 and December 31, 2013.

69

The Company has recorded a pension liability of $6.8 million and $2.8 million as of December 31, 2014 and 2013, included within Other Liabilities within the Consolidated Balance Sheets, and a $5.3 million and $2.9 million, net of tax, underfunded pension liability in Accumulated Other Comprehensive Income within Shareholders’ Equity at December 31, 2014 and 2013, respectively. The following table summarizes activity within the Defined Benefit Plans (dollars in thousands):

 
Pension Benefits
 
2014
2013
 
 
 
Change in fair value of plan assets:
 
 
Fair value at beginning of measurement period
$
14,726

$
9,663

Acquisition
—

4,558

Actual gain (loss) on plan assets
496

1,412

Contributions
409

538

Benefits paid
(964
)
(1,445
)
Fair value at end of measurement period
14,667

14,726

 
 
 
Change in benefit obligation:
 
 
   Benefit obligation at beginning of measurement period
(17,524
)
(13,827
)
Acquisition
—

(6,297
)
Interest cost
(836
)
(776
)
Actuarial loss
(3,994
)
1,931

Benefits paid
964

1,445

Benefit obligation at end of measurement period
(21,390
)
(17,524
)
Funded status
(6,723
)
(2,798
)
 
 
 
Unrecognized net actuarial gain
8,461

4,555

Other comprehensive loss
(8,461
)
(4,555
)
Accrued Benefit Cost
$
(6,723
)
$
(2,798
)
 
 
 
Weighted-average assumptions for balance sheet liability at end of year:
 
 
Discount rate
3.93
%
4.89
%
Expected long-term rate of return
6.92
%
7.35
%
 
 
 
Weighted-average assumptions for benefit cost at beginning of year:
 
 
Discount rate
4.89
%
4.31
%
Expected long-term rate of return
7.35
%
7.46
%

The following table presents the components of the net periodic pension cost of the Defined Benefit Plans (in thousands):
 
2014
2013
2012
 
 
 
 
Components of net periodic benefit:
 
 
 
Interest cost
$
836

$
776

$
635

Expected return on plan assets
(1,032
)
(979
)
(810
)
Net amortization and deferral
696

1,106

696

Net Periodic Pension Cost
$
500

$
903

$
521


The Horizon Defined Benefit Plan is administered by the West Virginia Bankers Association (“WVBA”) and all investment policies and strategies are established by the WVBA Pension Committee. The policy established by the Pension

70

Committee is to invest assets per target allocations, as detailed in the table below. The assets are reallocated periodically to meet these target allocations. The investment policy is reviewed periodically, under the advisement of a certified investment advisor, to determine if the policy should be revised.

The overall investment return goal is to achieve a return greater than a blended mix of stated indices tailored to the same asset mix of the plan assets by 0.5%, after fees, over a rolling five years moving average basis. Allowable assets include cash equivalents, fixed income securities, equity securities, alternative investments, mutual funds, exchange-traded funds, managed separate accounts, investment partnerships and commingled funds. Prohibited investments include, but are not limited to, private placements, limited partnerships, venture capital investments, direct investment in private real estate properties and residual remics. Unless explicitly authorized by the Pension Committee, the use of leverage or speculative use of derivatives is prohibited unless as part of an alternative asset program or as means for real asset managers to hedge investment risk or replicate investment positions at a lower cost than would otherwise be created in a cash market. Managers using derivatives must have systems in place to rigorously analyze and monitor duration, liquidity and counter-party credit risk in order to minimize the risk associated with the use of derivatives.

In order to achieve a prudent level of portfolio diversification, the securities of any one company are not to exceed more than 15% of the total plan assets, and no more than 25% of total plan assets are to be invested in any one industry (other than securities of the U.S. government or agencies thereof). Additionally, no more than 25% of plan assets shall be invested in foreign securities (both equity and fixed), if any. Exchange traded index funds are allowable investments and are not subject to these restrictions.

The expected long-term rate of return for the plan’s assets is based on the expected return of each of the categories, weighted based on the median of the target allocation for each class, noted in the table below. The target, allowable, and current allocation percentages of plan assets are as follows:
 
Target Allocation 2014
Allowable- Allocation Range
Percentage of Plan Assets
At December 31
 
2014
2013
 
 
 
 
 
Equity securities
65
%
40-100%
53
%
53
%
Fixed income securities
18
%
20-40%
23
%
28
%
Cash and cash equivalents
2
%
3-10%
9
%
7
%
Alternative investments
15
%
0-15%
15
%
12
%
Total
100
%
 
100
%
100
%

 
The Community Defined Benefit Plan is administered by the Virginia Bankers Association ("VBA") and all investment polices are established by the Board of Directors of the VBA Benefits Corporation. The investment goal is to provide asset allocation models with varying degrees of investment return and risk consistent with each bank's funding objectives and participant demographics. The Board of Directors shall at least annually review the overall investment program, and each investment alternative, to ensure the current investment mix will achieve the goals of the Plan and participating banks.

The performance goal for the investments of the Plan is to exceed the investment benchmarks over the most recent three and five year periods while taking less risk than the market. Approved asset classes include equity securities, fixed income securities and cash equivalents.

Allocations to the equity and fixed income asset classes may vary within a range of + or - 5% of the noted Target, as detailed in the table below. The minimum and maximum allocations for each sub-asset class within the equity and fixed classes are equity to 50% and 150%, respectively, of its long-term strategy target allocation.









71

The expected long-term rate of return for the plan’s assets is based on the expected return of each of the categories, weighted based on the median of the target allocation for each class, noted in the table below. The target, allowable, and current allocation percentages of plan assets are as follows:

 
Target Allocation 2014
Allowable- Allocation Range
Percentage of Plan Assets
At December 31
 
2014
2013
 
 
 
 
 
Equity securities
25
%
20%-30%
25
%
26
%
Fixed income securities
75
%
70%-80%
75
%
74
%
 
100
%
 
100
%
100
%

The major categories of assets in the Company’s Defined Benefit Plans as of year-end are presented in the following table (in thousands).  Assets are segregated by the level of the valuation inputs within the fair value hierarchy established by ASC Topic 820 utilized to measure fair value (See Note Twenty).


 
Total
Level 1
Level 2
Level 3
2014
 
 
 
 
Cash and cash equivalents
$
959

$
959

$
—

$
—

Mutual funds
6,162

5,656

506

—

Investment funds
1,610

—

1,014

596

Common stocks
3,941

3,119

822

—

Mortgage-backed securities
53

—

53

—

Government and GSE bonds
1,171

—

1,171

—

Corporate Bonds
771

—

771

—

Total
$
14,667

$
9,734

$
4,337

$
596

 
 
 
 
 
2013
 
 
 
 
Cash and cash equivalents
$
714

$
714

$
—

$
—

Mutual funds
5,991

5,267

724

—

Investment funds
1,305

—

809

496

Common stocks
4,399

3,477

922

—

Mortgage-backed securities
151

—

151

—

Government and GSE bonds
1,367

—

1,367

—

Corporate Bonds
799

—

799

—

Total
$
14,726

$
9,458

$
4,772

$
496


Mutual funds include large value and fixed income funds.  Common stocks include investments in small to mid cap funds and large cap funds primarily located inside of the United States.  Common stocks also include funds invested in commercial real estate as well as international value funds.  Government and GSE bonds include U.S. Treasury notes with varying maturity dates.  Corporate bonds include taxable bonds issued by U.S. corporations.









72

The Company anticipates making contributions to the plan of $0.4 million for the year ending December 31, 2014. The following table summarizes the expected benefits to be paid in each of the next five years and in the aggregate for the five years thereafter (in thousands):
Plan Year Ending December 31,
Expected Benefits to be Paid
 
 
2015
$
1,272

2016
1,049

2017
1,147

2018
1,542

2019
1,092

2020 through 2024
5,714


In addition, the Company and its subsidiary participate in the Pentegra Defined Benefit Plan for Financial Institutions ("The Pentegra DB Plan"), a tax-qualified defined benefit pension plan. The Pentegra DB Plan's Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan. The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers. The funded status as of July 1, 2014 (the latest available valuation report) was 109.13%. It is the policy of the Company to fund the normal cost of the Pentegra DB Plan on an annual basis.  Other than for normal plan expenses, no contributions were required for the years ended December 31, 2014, 2013 and 2012.  The benefits of the Pentegra DB Plan were frozen prior to the acquisition of Classic Bancshares in 2005, and it is the intention of the Company to fund benefit amounts when assets of the plan are sufficient.

The Company has entered into employment contracts with certain of its current and former executive officers. The employment contracts provide for, among other things, the payment of termination compensation in the event an executive officer either voluntarily or involuntarily terminates his employment with the Company for other than “Just Cause.” The cost of these benefits was previously accrued for each executive and is included in Other Liabilities within the Consolidated Balance Sheets. The liability was $2.0 million at both December 31, 2014 and 2013 and is fully vested, so there was no charge to operations was incurred for the years ended December 31, 2014 and December 31, 2013.

Certain entities previously acquired by the Company had entered into individual deferred compensation and supplemental retirement agreements with certain current and former directors and officers. The Company has assumed the liabilities associated with these agreements, the cost of which is being accrued over the period of active service from the date of the respective agreement. The cost of such agreements approximated $0.2 million during 2014, 2013, and 2012, respectively. The liability for such agreements approximated $6.7 million and $7.0 million at December 31, 2014 and December 31, 2013, respectively and is included within Other Liabilities in the accompanying Consolidated Balance Sheets.
To assist in funding the above liabilities, the acquired entities had insured the lives of certain current and former directors and officers. The Company is the current owner and beneficiary of insurance policies with a cash surrender value approximating $7.8 million and $7.6 million at December 31, 2014 and 2013, respectively, which is included in Other Assets in the accompanying Consolidated Balance Sheets.
  
NOTE SIXTEEN – RELATED PARTY TRANSACTIONS

City National has granted loans to certain non-executive officers and directors of the Company and its subsidiaries, and to their associates totaling $4.5 million at December 31, 2014 and $18.6 million at December 31, 2013. 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 third-party lending arrangements.  During 2014, total principal additions were $0.1 million and total principal reductions were $14.2 million. 
NOTE SEVENTEEN – COMMITMENTS AND CONTINGENCIES

The Company is a party to certain financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  The Company has entered into agreements with its customers to extend credit or provide a conditional commitment to provide payment on drafts presented in accordance with the terms of the underlying credit documents. The Company also provides overdraft protection to certain demand deposit customers that represent an unfunded

73

commitment.  Overdraft protection commitments, which are included with other commitments below, are uncollateralized and are paid at the Company’s discretion.  Conditional commitments generally include standby and commercial letters of credit. Standby letters of credit represent an obligation of the Company to a designated third party contingent upon the failure of a customer of the Company to perform under the terms of the underlying contract between the customer and the third party. Commercial letters of credit are issued specifically to facilitate trade or commerce. Under the terms of a commercial letter of credit, drafts will be drawn when the underlying transaction is consummated, as intended, between the customer and a third party. The funded portion of these financial instruments is reflected in the Company’s balance sheet, while the unfunded portion of these commitments is not reflected in the balance sheet.  The table below presents a summary of the contractual obligations of the Company resulting from significant commitments (in thousands):
 
 
December 31, 2014
December 31, 2013
 
 
 
Commitments to extend credit:
 
 
     Home equity lines
$
175,312

$
174,417

     Commercial real estate
50,298

42,209

     Other commitments
145,283

201,065

Standby letters of credit
4,592

14,122

Commercial letters of credit
1,991

1,555


 
Loan commitments and standby and commercial letters of credit 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.

In addition, the Company is engaged in various legal actions that it deems to be in the ordinary course of business. As these legal actions are resolved, the Company could realize positive and/or negative impact to its financial performance in the period in which these legal actions are ultimately decided. There can be no assurance that current actions will have immaterial results, either positive or negative, or that no material actions may be presented in the future.
 
NOTE EIGHTEEN – PREFERRED STOCK
 
 The Company’s Board of Directors has the authority to issue preferred stock, and to 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, 2014, no such shares were outstanding, nor were any expected to be issued.
 
NOTE NINETEEN – REGULATORY REQUIREMENTS AND CAPITAL RATIOS
 
The principal source of income and cash for City Holding (the “Parent Company”) is dividends from City National. Dividends paid by City National to the Parent Company are subject to certain legal and regulatory limitations. Generally, any dividends in amounts that exceed the earnings retained by City National in the current year plus retained net profits for the preceding two years must be approved by regulatory authorities. Approval is also required if dividends declared would cause City National’s regulatory capital to fall below specified minimum levels.  At December 31, 2014, City National could pay dividends up to $12.0 million without prior regulatory permission.

During 2014, the Parent Company used cash obtained from the dividends received primarily to: (1) pay common dividends to shareholders, (2) remit interest payments on the Company’s junior subordinated debentures and (3) fund common stock repurchases for treasury. As of December 31, 2014, the Parent Company reported a cash balance of approximately $12.5 million.  Management believes that the Parent Company’s available cash balance, together with cash dividends from City National, is adequate to satisfy its funding and cash needs in 2014.

The Company, including City National, 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 City National 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 City National’s capital amounts and

74

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 City National 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, 2014, that the Company and City National met all capital adequacy requirements to which they were subject.

As of December 31, 2014, the most recent notifications from banking regulatory agencies categorized the Company and City National as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since these notifications that management believes have changed the institutions’ categories. The Company’s and City National’s actual capital amounts and ratios are presented in the following table (dollars in thousands):
 
2014
2013
Well Capitalized Ratio
Minimum Ratio
 
Amount
Ratio
Amount
Ratio
 
 
 
 
 
 
 
Total Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
Consolidated
$
353,873

14.2
%
$
346,039

13.8
%
10.0
%
8.0
%
City National
315,095

12.7
%
302,817

12.2
%
10.0
%
8.0
%
 
 
 
 
 
 
 
Tier I Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
Consolidated
$
333,163

13.4
%
$
324,859

13.0
%
6.0
%
4.0
%
City National
294,870

11.9
%
282,221

11.4
%
6.0
%
4.0
%
 
 
 
 
 
 
 
Tier I Capital (to Average Assets):
 
 
 
 
 
 
Consolidated
$
333,163

9.9
%
$
324,859

9.8
%
5.0
%
4.0
%
City National
294,870

8.8
%
282,221

8.6
%
5.0
%
4.0
%

Basel III Capital Rules become effective January 1, 2015. In July 2013, the Federal Reserve published final rules establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the framework known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach. The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. The Basel III Capital Rules are effective for the Company on January 1, 2015 (subject to a phase-in period for certain provisions). 

NOTE TWENTY –FAIR VALUE MEASUREMENTS

Fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.


75

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company bases fair value of assets and liabilities on quoted market prices, prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.  If such information is not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters.  Valuation adjustments may be made to ensure that financial instruments are recorded at fair value.  These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters.  Any such valuation adjustments are applied consistently over time.  The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values.  While management believes the company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amount presented herein.  A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.  

Financial Assets and Liabilities

The Company used the following methods and significant assumptions to estimate fair value for financial assets and liabilities measured on a recurring basis.

Securities Available for Sale.  Securities available for sale are reported at fair value utilizing Level 1, Level 2, and Level 3 inputs.  The fair value of securities available for sale is determined by utilizing a market approach by obtaining quoted prices on nationally recognized securities exchanges (other than forced or distressed transactions) that occur in sufficient volume or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.  If such measurements are unavailable, the security is classified as Level 3.  Significant judgment is required to make this determination.

The Company utilizes a third party pricing service provider to value its Level 1 and Level 2 investment securities.  Annually, the Company obtains an independent auditor’s report from its third party pricing service provider regarding its controls over investment securities.  Although no control deficiencies were noted, the report did contain caveats and disclaimers regarding the pricing information, such as the Company should review fair values for reasonableness.  On a quarterly basis, the Company selects a sample of its debt securities and reprices those securities with a third party that is independent of the primary pricing service provider to verify the reasonableness of the fair values. In addition, the Company selects a sample of securities and reviews the underlying support from the primary pricing service provider.

The Company has determined that its pooled trust preferred securities are priced using Level 3 inputs in accordance with ASC Topic 820 and guidance issued by the SEC.  The Company has determined that there are few observable transactions and market quotations available for pooled trust preferred securities and they are not reliable for purposes of determining fair value of trust preferred securities held at December 31, 2014.  Due to these circumstances, the Company has elected to utilize an income valuation approach produced by a third party pricing source.  This third party model utilizes deferral and default probabilities for the underlying issuers, estimated prepayment rates and assumes no future recoveries of any defaults or deferrals.  The Company then compares the values provided by the third party model with other external sources.  At such time as there are observable transactions or quoted prices that are associated with an orderly and active market for pooled trust preferred securities, the Company will incorporate such market values in its estimate of fair values for these securities.

Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs.  The Company utilizes a market approach by obtaining dealer quotations to value its customer interest rate swaps.  The Company’s derivatives are included within its Other Assets and Other Liabilities in the accompanying consolidated balance sheets. Derivative assets are typically secured through securities with financial counterparties or cross collateralization with a borrowing customer. Derivative liabilities are typically secured through the Company pledging securities to financial counterparties or, in the case of a borrowing customer, by the right of setoff. The Company considers such factors such as the likelihood of default by itself and its counterparties, right of setoff, and remaining maturities in determining the appropriate fair value adjustments. All derivative counterparties approved

76

by the Company's Asset and Liability Committee ("ALCO") are regularly reviewed, and appropriate business action is taken to adjust the exposure to certain counterparties, if necessary. Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of marketable collateral securing the position. This approach used to estimate impacted exposures to counterparties is also used by the Company to estimate its own credit risk in derivative liability positions. To date, no material losses have been incurred due to a counterparty's inability to pay any undercollateralized position. There was no significant change in the value of derivative assets and liabilities attributed to credit risk during the year ended December 31, 2014.

The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis.  Financial assets measured at fair value on a nonrecurring basis include impaired loans reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using Level 2 inputs based on observable market data for real estate collateral or Level 3 inputs for non-real estate collateral.  The following table presents assets and liabilities measured at fair value (in thousands):

77

 
Total
Level 1
Level 2
Level 3
Total Gains (Losses)
December 31, 2014
 
 
 
 
 
Recurring fair value measurements
 
 
 
 
 
Financial Assets
 
 
 
 
 
     U.S. Government agencies
$
1,827

$
—

$
1,827

$
—

 
Obligations of states and political subdivisions
42,096

—

42,096

—

 
     Mortgage-backed securities:


 
 
 
 
          U.S. Government agencies
187,328

—

187,328

—

 
          Private label
1,704

—

1,704

—

 
     Trust preferred securities
9,036

—

7,165

1,871

 
     Corporate securities
7,317

—

7,317

—

 
     Marketable equity securities
3,213

3,213

—

—

 
     Investment funds
1,522

1,522

—

—

 
     Derivative assets
10,253

—

10,253

—

 
 
 
 
 
 
 
Financial Liabilities
 
 
 
 
 
     Derivative liabilities
10,253

—

10,253

—

 
 
 
 
 
 
 
Nonrecurring fair value measurements
 
 
 
 
 
Financial Assets
 
 
 
 
 
     Impaired loans
$
6,517

$
—

$
—

$
6,517

$
(153
)
     Other real estate owned
8,179

—

—

8,179

(464
)
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
Recurring fair value measurements
 
 
 
 
 
Financial Assets
 
 
 
 
 
     U.S. Government agencies
$
2,365

$
—

$
2,365

$
—

 
Obligations of states and political subdivisions
41,548

—

41,548

—

 
     Mortgage-backed securities:
 
 
 
 
 
     U.S. Government agencies
278,108

—

278,108

—

 
     Private label
2,197

—

2,197

—

 
     Trust preferred securities
13,156

—

9,269

3,887

 
     Corporate securities
9,128

—

9,128

—

 
     Marketable equity securities
4,673

4,673

—

—

 
     Investment funds
1,485

1,485

—

—

 
     Derivative assets
3,538

—

3,538

—

 
 
 
 
 
 
 
Financial Liabilities
 
 
 
 
 
     Derivative liabilities
3,538

—

3,538

—

 
 
 
 
 
 
 
Nonrecurring fair value measurements
 
 
 
 
 
Financial Assets
 
 
 
 
 
     Impaired loans
$
11,714

$
—

$
—

$
11,714

$
(880
)
     Other real estate owned
8,470

—

—

8,470

(1,108
)
 

78


The table below presents a reconcilement of the Company’s financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) (in thousands): 
 
December 31,
 
2014
2013
 
 
 
Beginning balance
$
3,887

$
2,385

        Impairment losses on investment securities
—

—

        Included in other comprehensive income
(1,862
)
4,280

        Dispositions
(154
)
(2,778
)
    Transfers into Level 3
—

—

Ending Balance
$
1,871

$
3,887

  
The Company utilizes a third party model to compute the present value of expected cash flows which considers the structure and term of each of the five respective pooled trust preferred securities and the financial condition of the underlying issuers.  Specifically, the third party model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. For issuing banks that have defaulted, management generally assumes no recovery. For issuing banks that have deferred its interest payments, management excludes the collateral balance associated with these banks and assumes no recoveries of such collateral balance in the future. The exclusion of such issuing banks in a current deferral position is based on such bank experiencing a certain level of financial difficulty that raises doubt about its ability to satisfy its contractual debt obligation, and accordingly, the Company excludes the associated collateral balance from its estimate of expected cash flows. Other assumptions used in the estimate of expected cash flows include expected future default rates and prepayments. Specifically, the model assumes annual prepayments of 1.0% with 100% at maturity and assumes 150 basis points of additional annual defaults from banks that are currently not in default or deferral.  In addition, the model assumes no recoveries except for one trust preferred security which assumes that one of the banks currently deferring or in default will cure such positions.

The table below presents a reconcilement of the Company's financial assets and liabilities measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3), which solely relates to impaired loans that were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon the fair value of the underlying collateral (in thousands).  The fair value of impaired loans is estimated using one of several methods, including collateral value, liquidation value and discounted cash flows.  The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans primarily relate to discounts applied to the customers’ reported amount of collateral.  The amount of collateral discount depends upon the marketability of the underlying collateral.  During December 31, 2014 and 2013, collateral discounts ranged from 20% to 30%. During December 31, 2014 and 2013, the Company had no Level 2 financial assets and liabilities that were measured on a nonrecurring basis.
 
Year ended December 31,
2014
2013
 
 
 
Beginning balance
$
11,714

$
10,679

 
 
 
Loans classified as impaired during the period
—

3,030

Specific valuation allowance allocations
—

(750
)
 
—

2,280

 
 
 
(Additional) reduction in specific valuation allowance allocations
628

(130
)
Paydowns, payoffs, other activity
(5,825
)
(1,115
)
Ending balance
$
6,517

$
11,714





79

Non-Financial Assets and Liabilities

The Company has no non-financial assets or liabilities measured at fair value on a recurring basis.  Certain non-financial assets measured at fair value on a non-recurring basis include other real estate owned (“OREO”), which is measured at the lower of cost or fair value, and goodwill and other intangible assets, which are measured at fair value and evaluated at least annually for impairment. The table below presents OREO that was remeasured and reported at fair value based on significant unobservable inputs (Level 3) (in thousands):
 
 
2014
2013
 
 
 
Beginning Balance
$
8,470

$
8,162

OREO remeasured at initial recognition:
 
 
     Carrying value of foreclosed assets prior to remeasurement
5,746

7,012

     Charge-offs recognized in the allowance for loan losses
—

(1,565
)
         Fair value
5,746

5,447

OREO remeasured subsequent to initial recognition:
 
 
     Carrying value of foreclosed assets prior to remeasurement
1,632

2,832

     Fair value
1,168

1,724

         Write-downs included in other non-interest expense
(464
)
(1,108
)
 
 
 
Acquired
—

3,492

Disposals
(5,573
)
(7,523
)
Ending Balance
$
8,179

$
8,470

 
Based on the Company's annual assessment for impairment in the recorded value of goodwill and indefinite lived intangible assets, no impairment was recorded during the years ended December 31, 2014 and 2013.

ASC Topic 825 “Financial Instruments” as amended, 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 discount rate and estimate 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.  ASC Topic 825 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 methods and assumptions were used in estimating fair value for financial instruments:

Cash and cash equivalents: Due to their short-term nature, the carrying amounts reported in the Consolidated Balance Sheets approximate fair value.

Securities: The fair value of securities are generally based on quoted market prices or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

Other securities: It is not practicable to determine the fair value of the Company's other securities, which consist of FRB and FHLB stock, due to restrictions placed on its transferability.

Net loans:  The fair value of the loan portfolio is estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers for the same remaining maturities. Loans were first segregated by type such as commercial, real estate and consumer, and were then further segmented into fixed, adjustable and variable rate categories. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Accrued interest receivable: The carrying amount of accrued interest receivable approximates fair value.


80

Deposits: The fair values of demand deposits (e.g., interest and noninterest-bearing checking, regular savings, and other money market demand accounts) are, by definition, equal to their carrying values. The fair values of time deposits were estimated using discounted cash flow analyses. The discount rates used were based on rates currently offered for deposits with similar remaining maturities. The fair values of the time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

Short-term debt: Securities sold under agreements to repurchase represent borrowings with original maturities of less than 90 days. The carrying amount of borrowings under purchase agreements approximate their fair value.

Long-term debt: The fair value of long-term borrowings is estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements and market conditions of similar debt instruments.

Commitments and letters of credit: 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 amounts of fees currently charged on commitments and letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values have not been reflected in the following table.

The following table represents the estimates of fair value of financial instruments (in thousands). This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as noninterest-bearing demand, interest-bearing demand and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

  
 

81

 
Carrying Amount
Fair Value
Level 1
Level 2
Level 3
December 31, 2014
 
 
 
 
 
Assets:
 
 
 
 
 
Cash and cash equivalents
$
148,228

$
148,228

$
148,228

$
—

$
—

Securities available-for-sale
254,043

254,043

4,735

247,437

1,871

Securities held-to-maturity
90,786

94,191

—

94,191

—

Other securities
9,857

9,857

—

9,857

—

Net loans
2,631,916

2,638,911

—

—

2,638,911

Accrued interest receivable
6,826

6,826

6,826

—

—

Derivative assets
10,253

10,253

—

10,253

—

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
Deposits
2,872,787

2,879,126

1,846,124

1,033,002

—

Short-term debt
134,931

134,934

—

134,934

—

Long-term debt
16,495

16,464

—

16,464

—

Derivative liabilities
10,253

10,253

—

10,253

—

 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
Assets:
 
 
 
 
 
Cash and cash equivalents
$
85,876

$
85,876

$
85,876

$
—

$
—

Securities available-for-sale
352,660

352,660

6,158

342,615

3,887

Securities held-to-maturity
4,117

5,335

—

5,335

—

Other securities
13,343

13,343

—

13,343

—

Net loans
2,585,622

2,609,524

—

—

2,609,524

Accrued interest receivable
6,866

6,866

6,866

—

—

Derivative assets
3,538

3,538

—

3,538

—

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
Deposits
2,785,133

2,793,620

1,707,527

1,086,093

—

Short-term debt
137,798

137,801

—

137,801

—

Long-term debt
16,495

16,495

—

16,495

—

Derivative liabilities
3,538

3,538

—

3,538

—




82


NOTE TWENTY-ONE –CITY HOLDING COMPANY (PARENT COMPANY ONLY) FINANCIAL INFORMATION
 
Condensed Balance Sheets

The following table presents the condensed balance sheets of City Holding Company, parent company only (in thousands):
 
December 31
 
2014
2013
 
 
 
Assets
 
 
Cash
$
12,521

$
28,423

Securities available-for-sale
3,212

4,673

Investment in subsidiaries
380,348

373,886

Deferred tax asset
1,436

2,990

Fixed assets
9

10

Other assets
16,629

519

Total Assets
$
414,155

$
410,501

 
 
 
Liabilities
 
 
Junior subordinated debentures
$
16,495

$
16,495

Dividends payable
6,062

5,828

Accrued interest payable
26

25

Other liabilities
719

530

Total Liabilities
23,302

22,878

 
 
 
Shareholders’ Equity
390,853

387,623

Total Liabilities and Shareholders’ Equity
$
414,155

$
410,501

 
Junior subordinated debentures represent the Parent Company’s amounts owed to City Holding Capital Trust III.
 

83

Condensed Statements of Comprehensive Income

The following table presents the condensed statements of comprehensive income of City Holding Company, parent company only (in thousands):

 
Year Ended December 31
 
2014
2013
2012
 
 
 
 
Income
 
 
 
Dividends from subsidiaries
$
46,050

$
46,317

$
41,422

Investment securities gains
1,130

89

1,134

Other income
65

66

65

 
47,245

46,472

42,621

Expenses
 
 
 
Interest expense
605

617

661

Other expenses
849

2,352

533

 
1,454

2,969

1,194

Income Before Income Tax (Benefit) Expense and Equity in Undistributed Net Income (Excess Dividends)  of Subsidiaries
45,791

43,503

41,427

Income tax (benefit) expense
(231
)
(1,050
)
2

Income Before Equity in Undistributed Net Income (Excess Dividends)  of Subsidiaries
46,022

44,553

41,425

Equity in undistributed net income (excess dividends) of subsidiaries
6,940

3,662

(2,480
)
Net Income
$
52,962

$
48,215

$
38,945

 
 
 
 
Total Comprehensive Income
$
53,793

$
44,647

$
41,430

 
 
 

84

Condensed Statements of Cash Flows

The following table presents the condensed statements of cash flows of City Holding Company, parent company only (in thousands):

 
Year Ended December 31
 
2014
2013
2012
Operating Activities
 
 
 
Net income
$
52,962

$
48,215

$
38,945

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Realized investment securities gains
(1,130
)
(89
)
(1,134
)
Amortization and accretion
—

5

19

Stock based compensation
200

205

224

Depreciation
1

1

1

Change in other assets
(16,110
)
1,656

740

Change in other liabilities
2,146

(236
)
1,136

(Equity in undistributed net income) excess dividends of subsidiaries
(4,441
)
(3,662
)
2,480

Net Cash Provided by Operating Activities
33,628

46,095

42,411

 
 
 
 
Investing Activities
 
 
 
Purchases of available for sale securities
—

—

(403
)
Proceeds from sales of available for sale securities
2,334

137

2,473

Acquisition of Community Financial Corporation
—

(12,708
)
—

Acquisition of Virginia Savings Bank
—

—

(4,672
)
Net Cash Used in Investing Activities
2,334

(12,571
)
(2,602
)
 
 
 
 
Financing Activities
 
 
 
Dividends paid
(24,487
)
(22,878
)
(20,710
)
Purchases of treasury stock
(27,957
)
—

(7,915
)
Exercise of stock options
580

3,428

544

Net Cash Used in Financing Activities
(51,864
)
(19,450
)
(28,081
)
Increase in Cash and Cash Equivalents
(15,902
)
14,074

11,728

Cash and cash equivalents at beginning of year
28,423

14,349

2,621

Cash and Cash Equivalents at End of Year
$
12,521

$
28,423

$
14,349

 
NOTE TWENTY-TWO – SUMMARIZED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

A summary of selected quarterly financial information is presented below (in thousands, except for per share data):
 
 
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
 
 
 
 
 
2014
 
 
 
 
Interest income
$
33,018

$
31,828

$
32,438

$
32,282

Taxable equivalent adjustment
153

151

152

164

Interest income (FTE)
33,171

31,979

32,590

32,446

Interest expense
2,978

2,973

2,968

3,041

Net interest income
30,193

29,006

29,622

29,405

Provision for loan losses
1,363

435

1,872

384


85

Investment securities gains
83

818

71

184

Non-interest income
14,222

14,321

14,538

14,485

Non-interest expense
23,376

24,305

24,325

23,035

Income  before income tax expense
19,759

19,405

18,034

20,655

Income tax expense
(5,803
)
(6,497
)
(6,010
)
(5,961
)
Taxable equivalent adjustment
(153
)
(151
)
(152
)
(164
)
Net income
$
13,803

$
12,757

$
11,872

$
14,530

 
 
 
 
 
Net earnings available to common  shareholders
$
13,663

$
12,626

$
11,746

$
14,374

 
 
 
 
 
Basic earnings  per common share
$
0.87

$
0.81

$
0.76

$
0.95

Diluted earnings per common share
0.86

0.80

0.76

0.95

Average common shares outstanding:
 
 
 
 
Basic
15,631

15,556

15,363

15,096

Diluted
15,796

15,706

15,445

15,182

 
 
 
 
 
2013
 
 
 
 
Interest income
$
33,026

$
34,724

$
35,674

$
35,115

Taxable equivalent adjustment
174

167

161

158

Interest income (FTE)
33,200

34,891

35,835

35,273

Interest expense
3,455

3,427

3,304

3,115

Net interest income
29,745

31,464

32,531

32,158

Provision for loan losses
1,738

2,011

1,154

1,945

Investment securities losses
84

9

—

671

Non-interest income
14,242

14,243

14,480

14,277

Non-interest expense
29,403

23,959

24,665

24,879

Income  before income tax expense
12,930

19,746

21,192

20,282

Income tax expense
(4,769
)
(6,573
)
(7,056
)
(6,877
)
Taxable equivalent adjustment
(174
)
(167
)
(161
)
(158
)
Net income
$
7,987

$
13,006

$
13,975

$
13,247

 
 
 
 
 
Net earnings available to common  shareholders
$
7,922

$
12,890

$
13,848

$
13,127

 
 
 
 
 
Basic earnings  per common share
$
0.51

$
0.83

$
0.89

$
0.84

Diluted earnings per common share
0.51

0.82

0.88

0.83

Average common shares outstanding:
 
 
 
 
Basic
15,473

15,582

15,608

15,636

Diluted
15,627

15,752

15,790

15,799

 












86

NOTE TWENTY-THREE – EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
 
 
For the Year Ended December 31,
 
2014
2013
2012
 
 
 
 
Distributed earnings allocated to  common stock
$
23,984

$
23,100

$
20,603

Undistributed earnings allocated to common stock
28,416

24,678

18,034

Net earnings allocated to common shareholders
$
52,400

$
47,778

$
38,637

 
 
 
 
Average shares outstanding
15,403

15,564

14,714

 
 
 
 
Effect of dilutive securities:
 
 
 
     Warrant outstanding
62

60

—

     Employee stock options
23

84

82

 
 
 
 
Shares for diluted earnings per share
15,488

15,708

14,796

 
 
 
 
Basic earnings per share
$
3.40

$
3.07

$
2.63

Diluted earnings per share
$
3.38

$
3.04

$
2.61


Options to purchase approximately 124,000 shares of common stock at an exercise price between $35.09 and $40.88, per share were outstanding during 2012, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares and therefore, the effect would have been anti-dilutive. During the year ended December 31, 2014 and December 31, 2013, there were no anti-dilutive options outstanding.
 

87

NOTE TWENTY-FOUR – ACCUMULATED OTHER COMPREHENSIVE LOSS

The activity in accumulated other comprehensive loss is presented in the tables below (in thousands). All amounts are shown net of tax, which is calculated using a combined Federal and state income tax rate approximating 37%.
 
 
Accumulated Other Comprehensive Loss
 
 
Unrealized
 
 
 
Gains (Losses) on
 
 
Defined Benefit
Securities
 
 
Pension Plans
Available-for-Sale
Total
 
 
 
 
Balance at December 31, 2012
$
(4,995
)
$
3,573

$
(1,422
)
 
 
 
 
   Other comprehensive income before reclassifications
2,685

(5,201
)
(2,516
)
   Amounts reclassified from other comprehensive loss
(570
)
(482
)
(1,052
)
 
2,115

(5,683
)
(3,568
)
 
 
 
 
Balance at December 31, 2013
$
(2,880
)
$
(2,110
)
$
(4,990
)
 
 
 
 
   Other comprehensive income before reclassifications
(2,155
)
4,030

1,875

   Amounts reclassified from other comprehensive loss
(315
)
(729
)
(1,044
)
 
(2,470
)
3,301

831

 
 
 
 
Balance at December 31, 2014
$
(5,350
)
$
1,191

$
(4,159
)

 
Amount reclassified from Other Comprehensive Loss
Affected line item
 
December 31,
in the Statements
 
2014
2013
2012
of Income
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
Net securities (gains) losses reclassified into earnings
$
(1,156
)
$
(764
)
$
(954
)
Security gains (losses)
Related income tax expense
427

282

359

Income tax expense
  Net effect on accumulated other comprehensive loss
$
(729
)
$
(482
)
$
(595
)
 
 
 
 
 
 
Net periodic employee benefit cost
$
(500
)
$
(903
)
$
(521
)
Salaries and employee benefits
Related income tax (benefit)
185

333

196

Income tax expense
   Net effect on accumulated other comprehensive loss
$
(315
)
$
(570
)
$
(325
)
 

NOTE TWENTY-FIVE – SUBSEQUENT EVENTS

On January 9th, 2015 the Company sold its insurance operations, CityInsurance, to The Hilb Group effective January 1, 2015. As a result of this sale, the Company will recognize a one-time after tax gain of $5.8 million from this transaction in the first quarter of 2015. CityInsurance was an ancillary business which did not have a material impact on operations or financial results and this sale would not represent a major strategic shift by the Company as defined in Accounting Standards Update 2014-08 "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity".

88