SELECTED FINANCIAL DATA
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TABLE ONE
FIVE-YEAR FINANCIAL SUMMARY
(in thousands, except per share data)
2001 2000 1999 1998 1997
-----------------------------------------------------------------------
Summary of Operations
Total interest income $ 177,480 $ 202,912 $ 195,553 $ 196,680 $ 173,166
Total interest expense 86,415 113,756 97,133 93,337 76,012
Net interest income 91,065 89,156 98,420 103,343 97,154
Provision for loan losses 32,178 25,480 19,286 8,481 4,064
Total other income 42,852 41,033 59,535 72,423 32,613
Total other expenses 114,405 158,812 130,614 155,558 84,899
(Loss) income before income taxes (12,666) (54,103) 8,055 11,727 40,804
Income tax (benefit) expense (4,651) (15,730) 1,842 6,493 14,513
Cumulative effect of accounting
change, net of tax (17,985) - - - -
Net (loss) income (26,000) (38,373) 6,213 5,234 26,291
Per Share Data
Net (loss) income (basic) $ (1.54) $ (2.27) $ 0.37 $ 0.31 $ 1.60
Net (loss) income (diluted) (1.54) (2.27) 0.37 0.31 1.60
Cash dividends declared (1) - 0.44 0.80 0.77 0.73
Book value per share 8.67 9.68 11.77 13.08 13.13
Selected Average Balances
Total loans $ 1,758,834 $ 1,969,785 $ 1,792,625 $ 1,676,828 $ 1,427,269
Securities 370,434 370,247 390,839 377,834 409,713
Deposits 1,944,244 2,053,828 2,017,448 1,974,995 1,698,699
Long-term debt 31,854 69,508 110,592 95,926 46,129
Trust-preferred securities 87,500 87,500 87,500 32,452 -
Stockholders' equity 154,312 199,702 219,211 235,616 204,114
Total assets 2,432,349 2,777,019 2,718,732 2,566,099 2,180,460
Selected Year-End Balances
Net loans $ 1,341,620 $ 1,927,532 $ 1,859,001 $ 1,698,319 $ 1,490,411
Securities 383,552 385,462 381,112 395,722 378,330
Deposits 1,691,295 2,083,941 1,955,770 2,064,415 1,779,805
Long-term debt 29,328 34,832 116,000 102,719 75,502
Trust-preferred securities 87,500 87,500 87,500 87,500 -
Stockholders' equity 146,349 163,457 198,542 220,059 220,277
Total assets 2,116,295 2,671,500 2,792,490 2,706,004 2,286,424
Selected Ratios
Return on average assets (1.07)% (1.38)% 0.23% 0.20% 1.21%
Return on average equity (16.85) (19.22) 2.83 2.22 12.88
Average equity to average assets 6.34 7.19 8.06 9.18 9.36
Dividend payout ratio (1) N/A N/A 216.22 248.39 35.96
(1) Cash dividends and the related payout ratio are based on historical results
of the Company and do not include cash dividends of acquired companies prior
to the dates of consummation.
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1
-
TWO YEAR SUMMARY OF
COMMON STOCK PRICES AND DIVIDENDS
Cash
Dividends Market Value
Per Share* Low High
---------------------------------
2001
Fourth Quarter $ - $ 9.000 $ 13.940
Third Quarter - 9.020 13.400
Second Quarter - 7.250 14.640
First Quarter - 5.125 10.625
2000
Fourth Quarter $ 0.08 $ 4.875 $ 7.250
Third Quarter 0.08 6.000 9.875
Second Quarter 0.08 5.875 14.000
First Quarter 0.20 10.875 16.188
*As more fully discussed under the captions Liquidity and Capital Resources in
Management's Discussion and Analysis and in Note Fourteen of the Audited
Consolidated Financial Statements, the Company's ability to pay dividends to
its shareholders is dependent upon the ability of its banking subsidiaries to
pay dividends to the Parent Company.
City Holding Company's common stock trades on the NASDAQ stock market
under the symbol CHCO. This 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 December 31, 2001, there were 3,962
stockholders of record.
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 bank holding company that
provides diversified financial products and services to consumers and local
businesses. Through its network of 55 banking offices in West Virginia and
Ohio, the Company provides credit, deposit, trust, and insurance products and
services to its customers. In addition to its branch network, the Company's
delivery channels include ATMs, check cards, telemarketing, direct mail
solicitation, interactive voice response systems, and Internet technology. The
Company has approximately 8% of the deposit market in West Virginia and is the
third largest bank headquartered in West Virginia based on deposit share. In the
Company's key markets, City National Bank of West Virginia ("City National")
has first, second, or third largest market share.
The Company has historically operated three business segments: community
banking, mortgage banking, and other financial services. These business
segments were primarily identified by the products or services offered and the
channels through which the product or service is delivered. The community
banking operations have offered customers traditional banking products and
services, including deposit and loan products, and trust services. The mortgage
banking operations have included the origination, acquisition, servicing, and
sale of mortgage loans. The other financial services business segment has
consisted of nontraditional services offered to customers, such as investment
advisory, insurance, and Internet technology products. The Company has also
maintained a general corporate business segment that includes the Parent
Company and other administrative areas of the Company.
During 2001, however, the Company completed a comprehensive reorganization
plan that dramatically changed the Company's business model and refocused
attention and resources on the Company's core West Virginia community banking
franchise. As part of this reorganization, the Company completed its exit from
mortgage banking activities by transferring its $1.10 billion loan servicing
portfolio and closing remaining loan production offices in Maryland and
Georgia. Additionally, the Company sold its internet service and direct mail
divisions during 2001 and substantially completed the sale of its investment
brokerage accounts, thus, exiting its Other Financial Services business
segment. Within the community banking business segment, the Company completed
the sale of its California banking operations during the year and, as a result,
now maintains City National as its sole operating subsidiary as of December 31,
2001.
FINANCIAL SUMMARY
The Company reported a consolidated net loss for 2001 of $26.00 million,
or $1.54 per diluted common share, compared to a consolidated net loss for 2000
of $38.37 million, or $2.27 per diluted common share, and net income of $6.21
million, or $0.37 per share, in 1999. The net loss for 2001 includes the $17.99
million after tax charge against earnings to record the cumulative effect of a
change in accounting associated with the Company's retained interests in
securitized mortgage loans. Return on average assets, a measure of the
effectiveness
2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
of asset utilization, was (1.07)% in 2001, compared to (1.38)% and 0.23% in
2000 and 1999, respectively. Return on average equity, a measure of the return
on stockholders' investment was (16.85)% in 2001, compared to (19.22)% and
2.83% in 2000 and 1999, respectively.
The 2001 net loss was primarily attributable to the cumulative effect of
change in accounting principle discussed above. As discussed under the caption
Retained Interests, the Company recorded a pre-tax charge against earnings of
$29.98 million ($17.99 million after-tax) associated with its adoption of new
accounting guidance addressing the accounting for its retained interests.
Another primary factor affecting the Company's 2001 operating results was the
$32.18 million provision for loan losses recorded during the year. As more
fully discussed under the caption Allowance for Loan Losses, the Company's 2001
provision for loan losses was predicated on the identification of further
credit deterioration within the Company's loan portfolio during the year. The
Company's 2001 earnings were also negatively impacted as the Company recorded
significant non-interest expense during the year as it completed its
reorganization and divestiture plans. Expenses incurred in this area are
further discussed under the caption Non-Interest Income and Expense.
The 2000 net loss was most significantly affected by the Company's $34.83
million charge against earnings to write-off goodwill balances believed by the
Company to be impaired as of December 31, 2000. Consistent with the Company's
strategic plan adopted in 2000, it announced plans to divest its California
banking operations and recorded an impaired goodwill charge of approximately
$13.64 million. Also pursuant to its strategic plan, the Company announced in
2000 that it planned to fully exit its specialty finance loan origination
operations and recorded an impaired goodwill charge of approximately $15.18
million. Finally, the Company recorded an impaired goodwill charge of $6.01
million during 2000 associated with its internet service and direct mail
divisions. This charge resulted from the then current operating results for
these divisions, profitability projections for the divisions, and an analysis
of the undiscounted cash flows expected to be derived from these divisions over
their respective remaining goodwill amortization periods.
BALANCE SHEET ANALYSIS
2001 vs. 2000
The Company's consolidated balance sheet (see Table Two) changed
significantly during 2001, as compared to recent years. Most notably, average
total assets declined approximately $344.67 million, or 12.41%, as the Company
undertook its plan to restructure its loan portfolio, reduce its reliance on
external funding sources and higher-costing internal deposit products, and exit
its specialty finance loan origination program.
Within the community banking segment, the average loan balance declined
$210.95 million or 10.71%, from $1.97 billion in 2000 to $1.76 billion in 2001.
Because of the Company's credit quality issues in recent years in consumer,
indirect, and commercial lending, the Company embarked on a plan to reduce its
outstanding loan balances. The plan was initiated during the fourth quarter of
2000 with the Company's termination of its indirect automobile lending program
on December 31, 2000. During 2001, the Company implemented tighter credit
standards in all lending areas, centralized underwriting processes and
procedures, and focused on improving asset quality as opposed to volume growth.
Although not significantly affecting the average loan balance in 2001, the
Company's November 30, 2001 sale of its California banking operations, which
maintained a loan portfolio of between $140 and $150 million, will further
reduce the average balance of outstanding loans during 2002.
Within the mortgage banking segment, the average balance of loans held for
sale declined $69.29 million or 84.26%, from $82.23 million in 2000 to $12.94
million in 2001. As previously discussed, part of the Company's reorganization
plan was to exit its specialty finance related loan origination operations. As
a result, new loan volume in this area continued to decline during the first
half of 2001 and was eventually terminated toward the beginning of the third
quarter. The Company continued to transact loan sales during the remainder of
2001 and reclassified the remaining $5.21 million of loans previously
classified as held for sale to its permanent portfolio in December 2001.
Although the average balance of the Company's investment securities
portfolio did not change significantly in 2001, when compared to 2000, the
Company has begun to invest additional funds in its securities portfolio as a
means of offsetting some of the declines within the loan portfolio. In addition
to being a valuable tool for managing the Company's liquidity position, the
securities portfolio is also utilized to compensate for declines in interest
income resulting from the declining loan portfolio.
The average balance of total interest-bearing deposits decreased $134.83
million or 7.47%, from $1.80 billion in 2000 to $1.67 billion in 2001. This
decline was almost entirely due to the elimination of brokered deposits as a
funding source for the Company. Included in time deposits in Table Two and in
the Consolidated Balance Sheets, brokered deposits were used as a significant
funding source during 2000. This higher-costing source of funds had an average
balance of $125.89 million during 2000, compared to $23.62 million during 2001.
With significant improvement in the liquidity position of City National during
2001, the Company
3
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
did not accept any additional brokered deposits during the year and had none
outstanding as of December 31, 2001.
The improved liquidity position of City National has enabled the Company
not only to end its reliance on brokered deposits, as discussed above, but has
also permitted the Company to reduce its use of other external borrowing
facilities. Generally, external funding sources carry a higher cost of funds
than do internal funding sources such as core deposits, and part of the
Company's overall strategic plan was to become less dependent on these
higher-costing external funds. As a result, the average balance of short-term
borrowings declined $135.36 million or 43.76%, from $309.33 million during 2000
to $173.97 million in 2001. Short-term borrowings, generally comprised of
advances from the Federal Home Loan Bank and repurchase agreements, have
historically been utilized by City National to fund loan growth. With the
decline in loan balances within the permanent portfolio and the loans held for
sale classification, the Company has been able to fund the asset side of its
balance sheet with less expensive core deposits and less reliance on external
borrowings.
2000 vs. 1999
Although the average balance of total assets reflected a minimal increase
of $58.29 million or 2.14% in 2000, the average balance of the Company's loan
portfolio, loans held for sale, and securities portfolio reflected sizable
changes in 2000, as discussed below.
Within the community banking segment, the average balance of the loan
portfolio increased $177.16 million or 9.88%, from $1.79 billion in 1999 to
$1.97 billion in 2000. The majority of this loan growth was attributable to the
implementation of a new indirect automobile loan program during the second half
of 1999. This new program resulted in an additional average balance of indirect
automobile loans approximating $83.46 million in 2000. In part due to the
volume of originations during the first half of 2000, the Company began to
tighten the credit requirements for this program during the third quarter of
2000 and eventually terminated the program, effective December 31, 2000. The
July 1999 acquisition of Frontier also contributed to the increase in average
loan balances in 2000, since Frontier was included in the consolidated balances
for the full year in 2000 and only six months in 1999.
Within the mortgage banking segment, the average balance of loans held for
sale decreased significantly, from $178.71 million in 1999 to $82.23 million in
2000. This decline of $96.48 million or 53.99% is consistent with the Company's
declining participation in specialty finance loan originations. Loan volume of
the specialty finance loan product was reduced in 1999 and continued throughout
2000, as the Company continued its efforts to reduce its reliance on this loan
product. Additionally, the Company closed its California loan origination units
in June 2000.
The average balance of the securities portfolio declined $20.59 million or
5.27%, from $390.84 million in 1999 to $370.25 million in 2000. Of this
decline, $10.00 million was attributable to the mortgage banking segment and
the result of the Company's December 1999 write-off of its investment in Altiva
Financial Corporation. The remaining $10.59 million of decline in the average
balance was within the community banking segment and was due, in part, to the
tightened liquidity position of City National during the first half of 2000. As
necessary, City National utilized its securities portfolio to provide
additional liquidity sources during the first six months of 2000. However, as
City National's liquidity position improved during the second half of 2000, the
Company began to reinvest funds into the securities portfolio, such that the
balance as of December 31, 2000 reflects a small increase to $385.46 million,
compared to $381.11 million as of December 31, 1999.
The average balance of total interest-bearing deposits increased $78.53
million or 4.55% from $1.73 billion in 1999 to $1.80 billion in 2000. This
increase was primarily due to City National's increased reliance on brokered
deposits as a source of liquidity during 2000. As of December 31, 1999, the
Company reported an outstanding balance of brokered deposits of $28.04 million.
By July 2000, brokered deposits had increased to $212.31 million. Although the
outstanding brokered deposits balance declined to $134.38 million as of
December 31, 2000, City National utilized this funding source significantly
during 2000, which resulted in the overall increase in the average balance of
interest-bearing deposits. Including non-interest-bearing deposits, the
Company's average core deposits actually declined approximately $89.50 million
or 4.44%, due to the combined effect of branch sales transacted throughout 1999
and minimal deposit runoff experience during 2000.
The average balance of short-term and long-term borrowings increased
$38.19 million or 11.21%, from $340.65 million in 1999 to $378.84 million in
2000. To fund the loan growth discussed previously, the Company utilized its
borrowing facilities with the Federal Home Loan Bank resulting in the increased
average balance of external borrowings. Within the average short-term and
long-term classifications, short-term borrowings increased $79.27 million or
34.46%, while long-term debt declined $41.08 million or 37.15%. The fluctuation
between these two classifications was primarily due to the increasing interest
rate environment experienced during the second half of 1999 and throughout the
first nine months of 2000. During the period of rising interest rates, the
Company began to utilize its short-term borrowing facilities in anticipation of
future interest rate declines. Additionally, the outstanding balance of the
Parent
4
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
Company's long-term debt was reclassified to short-term borrowings in June 2000,
consistent with the revised terms and conditions of the term loan agreement. As
a result, $16.00 million was reclassified from long-term debt to short-term
borrowings as of June 30, 2000.
===============================================================================
TABLE TWO
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(in thousands)
2001 2000 1999
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------------------------------------------------------------------------------------------------
ASSETS
Loan portfolio (1) $1,758,834 $ 148,974 8.47% $1,969,785 $ 171,473 8.71% $1,792,625 $ 152,320 8.50%
Loans held for sale 12,942 1,062 8.21 82,228 9,040 10.99 178,711 16,406 9.18
Securities:
Taxable 303,746 15,518 5.11 278,584 17,389 6.24 287,333 17,675 6.15
Tax-exempt (2) 66,688 5,138 7.70 91,663 7,089 7.73 103,506 7,742 7.48
--------------------------------------------------------------------------------------------------
Total securities 370,434 20,656 5.58 370,247 24,478 6.61 390,839 25,417 6.50
Federal funds sold 39,935 1,156 2.89 3,755 217 5.78 5,093 244 4.79
Retained interests 71,459 7,430 10.40 76,958 185 0.24 82,337 3,876 4.71
--------------------------------------------------------------------------------------------------
Total interest-earning assets 2,253,604 179,278 7.96 2,502,973 205,393 8.21 2,449,605 198,263 8.09
Cash and due from banks 60,441 73,282 89,515
Premises and equipment 51,785 64,003 69,710
Other assets 111,947 164,040 129,121
Less: allowance for possible
loan losses (45,428) (27,279) (19,219)
--------------------------------------------------------------------------------------------------
Total assets $2,432,349 $2,777,019 $2,718,732
===================================================================================================
LIABILITIES
Demand deposits $ 416,281 $ 9,161 2.20% $ 408,681 $ 12,514 3.06% $ 378,645 $ 11,315 2.99%
Savings deposits 291,072 7,300 2.51 312,940 10,792 3.45 322,856 10,586 3.28
Time deposits 962,671 51,082 5.31 1,083,228 59,450 5.49 1,024,823 49,563 4.84
Short-term borrowings 173,974 8,604 4.95 309,330 18,996 6.14 230,060 11,436 4.97
Long-term debt 31,854 2,147 6.74 69,508 3,987 5.74 110,592 6,219 5.62
Trust preferred securities 87,500 8,020 9.17 87,500 8,017 9.16 87,500 8,014 9.16
Trust preferred accrued interest 1,105 101 9.14 - - - - - -
---------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 1,964,457 86,415 4.40 2,271,187 113,756 5.01 2,154,476 97,133 4.51
Demand deposits 274,220 248,979 291,124
Other liabilities 39,360 57,151 53,921
Stockholders' equity 154,312 199,702 219,211
---------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $ 2,432,349 $2,777,019 $2,718,732
===================================================================================================
Net interest income $ 92,863 $ 91,637 $ 101,130
===================================================================================================
Net yield on earning assets 4.12% 3.66% 4.13%
===================================================================================================
(1) For purposes of this table, non-accruing loans have been included in average
balances. Loan fees, which are immaterial, have been included in interest
income.
(2) Computed on a fully federal tax-equivalent basis assuming a tax rate of
approximately 35%.
===============================================================================
5
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
NET INTEREST INCOME
2001 vs. 2000
On a tax equivalent basis, net interest income increased $1.23 million,
from $91.64 million in 2000 to $92.86 million in 2001. Changes in net interest
income during 2001 can primarily be associated with three factors.
First, declining average earning asset balances, offset by declining
interest-bearing liability balances, were responsible for a decrease in net
interest income of $7.00 million (see Table Three). Average earning assets
decreased by $249.37 million or 9.96%, and average interest-bearing liabilities
decreased by $306.73 million or 13.51% during 2001. Since the yield on these
earning assets exceeds the interest paid on the liabilities, the impact of
declining balances on net interest income was negative. Future declines in
earning assets, which are anticipated, will likely have corresponding affects.
As an example, the Company's fourth quarter 2001 sale of its California banking
operations will result in a decline in the average balance of interest-earning
assets and interest-bearing liabilities in 2002, as compared to 2001.
Second, resumption of the accrual of interest on the Company's retained
interests added $7.26 million to net interest income in 2001 (see Table Three).
Had the retained interests accrued at the same rate in 2001 as in 2000,
interest income would have decreased to $172.02 million in 2001, and net
interest income would have decreased in 2001 rather than increasing by $1.23
million as reported.
Third, after adjusting for the impact of interest accrued on the retained
interests, the impact of declines in rates on both earning assets and
interest-bearing liabilities resulted in an improvement in net interest income
of $.96 million (see Table Three). This improvement can be attributed to tight
management of liability costs. The Company's improved liquidity position during
2001 allowed it to significantly reduce its reliance on short-term borrowings,
as evidenced by average short-term borrowings decreasing by 43.76%. The rates
paid on these borrowings also decreased, from 6.14% in 2000 to 4.95% in 2001.
Tight management of rates paid on savings and interest-bearing checking
accounts further contributed to the improvement in the cost of interest-bearing
liabilities.
2000 vs. 1999
On a tax equivalent basis, net interest income declined $9.49 million or
9.39%, from $101.13 million in 1999 to $91.64 million in 2000. Although
interest income increased $7.13 million in 2000, as compared to 1999, interest
expense increased $16.62 million over the same periods.
Due primarily to volume increases within the community banking segment,
interest income derived from the loan portfolio increased $19.15 million or
12.57% in 2000, as compared to 1999. However, the decline in the average
balance of loans held for sale within the mortgage banking segment resulted in
a $7.37 million reduction of interest income derived from these products. Also
within the mortgage banking segment, the Company's suspension of accruing
interest on its retained interests resulted in a $3.69 million or 95.23%
decline in interest income for 2000, as compared to 1999. The accrual of
interest income on the retained interests was suspended in mid-1999 due to the
performance of the underlying collateral loans and revised forecasts associated
with the timing of the receipt of cash flows. Interest income recognized during
2000 represented interest earned, and cash received, resulting from funds
invested during the interim period between the receipt of cash from the
borrowers and the subsequent payment of cash to noteholders.
Of the $16.62 million or 14.61% increase in interest expense in 2000, as
compared to 1999, $11.29 million was associated with interest expense on
deposit accounts. Primarily as a result of the increased reliance on brokered
deposits discussed previously, interest expense on time deposits increased
$9.89 million or 19.95%, from $49.56 million in 1999 to $59.45 million in 2000.
Interest expense associated with brokered deposits approximated $8.45 million
in 2000 and $1.15 million in 1999. Additionally, City National utilized several
higher-priced deposit products during 2000 in an effort to maintain deposit
customers and address liquidity issues, resulting in an increase in overall
funding costs to the Company.
Interest expense associated with short-term and long-term borrowings
increased $5.33 million or 30.18%, from $17.66 million in 1999 to $22.98
million in 2000. During the rising interest rate environment experienced late
in 1999 and into 2000, interest rate movements resulted in an increase in
funding costs from external borrowings of approximately $3.19 million during
2000. Additionally, increased borrowings to fund asset growth resulted in an
increase in interest expense of $2.14 million in 2000, as compared to 1999.
6
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
===============================================================================
TABLE THREE
RATE/VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
(in thousands)
2001 vs. 2000 2000 vs. 1999
Increase (Decrease) Increase (Decrease)
Due to Change In: Due to Change In:
Volume Rate Net Volume Rate Net
----------------------------------------------------------------------
Interest-Earning Assets
Loan portfolio $ (17,968) $ (4,531) $ (22,499) $ 15,349 $ 3,804 $ 19,153
Loans held for sale (6,132) (1,846) (7,978) (10,138) 2,772 (7,366)
Securities:
Taxable 1,476 (3,347) (1,871) (544) 258 (286)
Tax-exempt (1) (1,924) (27) (1,951) (909) 256 (653)
----------------------------------------------------------------------
Total securities (448) (3,374) (3,822) (1,453) 514 (939)
Federal funds sold 1,099 (160) 939 (72) 45 (27)
Retained interest in securitized loans (14) 7,259 7,245 (238) (3,453) (3,691)
----------------------------------------------------------------------
Total interest-earning assets $ (23,463) $ (2,652) $ (26,115) $ 3,448 $ 3,682 $ 7,130
======================================================================
Interest-Bearing Liabilities
Demand deposits $ 229 $ (3,582) $ (3,353) $ 914 $ 285 $ 1,199
Savings deposits (712) (2,780) (3,492) (331) 537 206
Time deposits (6,447) (1,921) (8,368) 2,938 6,949 9,887
Short-term borrowings (7,192) (3,200) (10,392) 4,491 3,069 7,560
Long-term debt (2,446) 606 (1,840) (2,354) 122 (2,232)
Trust preferred securities - 4 4 - 3 3
Trust preferred accrued interest 100 - 100 - - -
----------------------------------------------------------------------
Total interest-bearing liabilities $ (16,468) $(10,873) $(27,341) $ 5,658 $ 10,965 $ 16,623
======================================================================
Net interest income $ (6,995) $ 8,221 $ 1,226 $ (2,210) $ (7,283) $ (9,493)
======================================================================
(1) Fully federal taxable equivalent using a tax rate of approximately 35%.
The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of the change in each.
===============================================================================
NON-INTEREST INCOME AND EXPENSE
2001 vs. 2000
Excluding investment securities transactions, total non-interest income
declined $5.58 million or 12.11%, from $46.05 million in 2000 to $40.47 million
in 2001. Excluding the $8.04 million gain recognized on the sale of the
Company's California banking operations and other divisions during 2001, total
non-interest income declined $13.61 million or 29.56% in 2001 as compared to
2000.
Driving this decline was the decrease in revenues derived from mortgage
banking activities, which declined approximately $13.68 million or 77.28%, from
$17.70 million in 2001 to $4.02 million in 2001. The Company's sale of its
mortgage servicing division in December 2000 had the most significant impact to
non-interest income as loan servicing fees declined from $16.96 million in 2000
to approximately $383,000 in 2001. With the Company's exit from mortgage
banking activities, non-interest income is now primarily generated from retail
deposit relationships, trust, and insurance products. Partially offsetting the
decline in mortgage banking income, service charge fee income on retail deposit
relationships increased $7.13 million or 66.13%, from $10.78 million in 2000 to
$17.91 million in 2001. During 2001, the Company implemented policy changes that
resulted in substantially higher collection rates of service charges and
similar fees and initiated fee increases to match the Company's competitors.
During the fourth quarter of 2001, the bank had non-interest income of $13.41
million, which included no significant revenues associated with discontinued
mortgage banking activities. Non-interest income for the fourth quarter of 2001
represented 26.5% of the total of net interest income and non-interest income
(after adjusting for the gain on the sale of the California banks) as compared
to the Company's similarly sized peers, which average approximately 21.2%.
Therefore, the Company believes that it has accomplished its goal of lifting
revenues from non-interest sources to peer levels.
During 2001, the Company also recognized income on investment securities
transactions of $2.38 million. This income was primarily due to the Company's
implementation of an investment strategy designed to produce capital gains, as
opposed to interest income, in order to utilize capital loss carryforwards
available to the Company for income tax purposes.
7
-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
Non-interest expense declined $44.41 million or 27.96% in 2001, as compared
to 2000. As further described below, non-recurring expenses associated with
restructuring costs characterized both 2001 and 2000. During the fourth quarter
of 2001, the Company had non-interest expense of $22.54 million. As a percent of
non-interest income and net interest income, non-interest expense during the
fourth quarter of 2001 was 68.1% after adjusting for the gain on the sale of the
California banking subsidiaries. As a result, the Company believes that it is on
its way toward achieving peer average levels of non-interest expenses.
During 2001, the Company recorded approximately $3.42 million in
non-recurring compensation costs associated with employee terminations and
severance-related issues. Of this charge, approximately $2.14 million was
attributable to severance and outplacement benefits associated with the
Company's reorganization and staff reduction project. During the third quarter
of 2001, the Company implemented a "best practices" project to improve
operating procedures and policies throughout the Company, allowing it to staff
at levels comparable to similarly-sized institutions. This project resulted in
the elimination of approximately 300 positions through attrition and a
severance program. The elimination of these positions is expected to produce
expense savings of approximately $7.00 million annually.
As part of the Company's reorganization, it identified certain facilities
that it exited during 2001 as it consolidated operations. The Company also
identified equipment, software, and other fixed assets that no longer fit the
Company's business model. As a result, the Company recorded a charge of $3.95
million during 2001 to recognize the loss on disposal or impairment in value of
fixed assets.
The Company also recorded a $3.20 million charge to record estimated
contractual obligations to repurchase loans sold or securitized without credit
recourse upon which the Company is obligated to compensate the purchasers for
deficiencies in documentation previously warranted by the Company. This charge
includes a $1.90 million expense to reflect an estimated contractual obligation
to FNMA associated with a loan servicing portfolio previously acquired and
subsequently sold. The remaining portion of the charge includes a $1.30 million
charge to reflect an estimated obligation to repurchase previously sold or
securitized loans for documentation deficiencies found to exist in the loan
files. Over the past few years, the Company sold over $2 billion of first lien
and junior lien mortgage loans to various parties and, in doing so, made
representations and warranties as to the adequacy of the loan file
documentation.
Additionally, the Company recorded a $3.00 million charge to accrue
litigation expense to reflect developments that arose during 2001 that
increased the probability of an unfavorable outcome in litigation related to
operations the Company has either sold or closed (see Legal Issues).
The Company also recorded a $1.97 million charge to reflect the estimated
fair value of its direct mail division prior to its sale in the second quarter
of 2001.
In terms of operational areas, occupancy and equipment expense declined
$1.99 million or 17.48%, depreciation expense declined $3.51 million or 28.59%,
and telecommunications costs declined $1.08 million or 21.02% in 2001 as
compared to 2000. Each of these expense declines were the result of the
consolidation of certain operations completed during 2001, the Company's exit
from several operational facilities and branch locations, the disposal of
certain equipment and software no longer used in the Company's operations, and
the sale of subsidiaries and divisions.
With the Company's exit from its specialty finance loan origination
operations, advisory fees paid in connection with its out-of-state loan
production offices declined $1.82 million or 45.34% in 2001 as compared to 2000.
2000 vs. 1999
Excluding investment securities transactions, non-interest income declined
$23.38 million or 33.68%, from $69.43 million in 1999 to $46.05 million in
2000. Of this decline, gains recognized from the sale of branch locations in
1999 represented approximately $8.80 million, with the remaining $14.58 million
attributable to changes made within the mortgage banking segment. Excluding
investment securities transactions, non-interest income within the mortgage
banking segment declined $18.79 million or 57.79%, from $32.52 million in 1999
to $13.73 million in 2000, as discussed further below.
The Company continued to reduce its junior lien mortgage loan production
throughout 2000. The Company also terminated its loan securitization program
after its May 1999 securitization transaction, which generated a $3.88 million
pre-tax gain in 1999. Additionally, the Company entered into several
transactions during the second half of 2000 to sell remaining junior lien
mortgage loans and recorded declines in the fair value of junior lien mortgage
loans that were not sold. The combined effect of these events resulted in a
decline in revenues from loan sales of $8.20 million. Net origination fees on
junior lien mortgage loans also declined in 2000 due to the reduction of junior
lien mortgage loan production throughout 2000. Although significant volume
reductions had begun in 1999, the Company's reduced origination volume of the
junior lien mortgage loan product in 2000 resulted in a $1.96 million or 45.69%
decline in net origination fees in 2000 as compared to 1999. Also, within the
mortgage banking segment, mortgage loan servicing fees declined $5.11 million
or 23.14%, from $22.07 million in 1999 to $16.96 million in
8
- -
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
2000. This decrease was due to the decline in new loan originations, normal
runoff within the portfolio, and the November 1, 2000 transfer of the right to
service $229.74 million of loans to an independent third party.
Non-interest expense increased $28.20 million or 21.59%, from $130.61
million in 1999 to $158.81 million in 2000. As previously discussed, the
Company recorded a charge against 2000 earnings of approximately $34.83 million
that led to the increased non-interest expense in 2000. Additionally, other
expenses increased $14.32 million or 37.11%, from $38.59 million in 1999 to
$52.91 million in 2000. This increase was due, in part, to a loss on fixed
asset disposals of $4.81 million associated with discontinuance of the
specialty finance loan origination operations. Within the mortgage banking
segment, $3.87 million of this increase was attributable to advisory fees
associated with the Company's loan production offices in Virginia, Maryland,
and Georgia. The remaining increase in non-interest expense was due to various
activities in 2000 including additional professional and consulting fees
associated with the development of the Company's strategic plan, formalizing
and implementing the plan to complete an orderly exit from the Company's
California operations, compliance with City National's formal agreement with
the Office of the Comptroller of the Currency (the "OCC"), and similar 2000
events.
Partially offsetting the increases within non-interest expense,
compensation costs declined $8.57 million or 15.17%, from $56.53 million in
1999 to $47.96 million in 2000. Compensation costs for 2000 included a charge
of $2.51 million related to the termination and noncompetition agreements
signed with certain former officers of the Company. Excluding these
severance-related expenses, compensation costs declined $11.08 million or
19.60% in 2000 as compared to 1999. This decline corresponded to a 13.33%
decline in the number of full-time equivalents employed by the Company during
these periods, resulting from the downsizing and eventual closing of the
California loan origination divisions and the reorganization within the
community banking segment.
Occupancy-related expenses declined $4.34 million or 38.16%, from $11.38
million in 1999 to $7.04 million in 2000, primarily due to the reduced number
of branch locations in 2000 and the closing of the California loan origination
divisions. Advertising expense declined $8.51 million or 69.20%, from $12.30
million in 1999 to $3.79 million in 2000, as a result of the reduced volume of
nationwide, direct mail solicitation of junior lien mortgage loans in 2000 as
compared to prior years.
INCOME TAXES
Excluding the income tax implications of the cumulative effect of an
accounting change recorded during 2001, the Company recorded a $4.65 million
income tax benefit for the year ended December 31, 2001. Additionally, the
Company recorded an income tax benefit of approximately $11.99 million
associated with the cumulative effect of an accounting change associated with
the Company's retained interests in securitized mortgage loans. In total, the
Company recorded an income tax benefit of $16.64 million in 2001, which
represents an effective income tax rate of 39.03%. For the years ended December
31, 2000 and 1999, the Company recorded an income tax (benefit) expense of
$(15.73) million and $1.84 million, representing effective income tax rates of
29.07% and 22.87%, respectively. The Company's effective tax rate for 2001
differed from its statutory income tax rate slightly due to non-taxable interest
income recorded during the year, primarily attributable to interest income
earned on tax-exempt investment securities. The Company's 2000 effective tax
rate was primarily affected by the write-off of non-deductible goodwill and the
1999 effective tax rate was primarily affected by the significance of
non-taxable interest income as a percentage of pre-tax income. Note Fifteen to
the audited financial statements further illustrates the differences between
the Company's effective and statutory income tax rates.
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 increased from $44.65 million at December 31, 2000 to
$47.44 million at December 31, 2001. The components of the Company's net
deferred tax assets are disclosed in Note Sixteen. 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 the allowance for loan
losses is expected to occur as additional loan charge-offs, which have already
been provided for within the Company's financial statements, are realized. The
deferred tax asset associated with the Company's retained interests is expected
to be realized as income, derived from the retained interest, is recognized
within the Company's financial statements. The capital loss carryforward is
expected to be realized over the next few years, based on a tax-planning
initiative implemented to generate capital gains (see Investments) that will be
used to offset previously recorded capital losses. 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, 2001.
9
-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
MARKET RISK MANAGEMENT
Market risk is the risk of loss due to adverse changes in current and
future cash flows, fair values, earnings, or capital due to adverse movements
in interest rates and other factors, including foreign exchange rates and
commodity prices. Because the Company has no significant foreign exchange
activities and holds no commodities, interest rate risk represents the primary
risk factor affecting the Company's balance sheet and net interest margin.
Significant changes in interest rates by the Federal Reserve could, in turn,
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 through monthly meetings during which
product pricing issues, liquidity measures, and interest sensitivity positions
are monitored.
During 2001, ALCO implemented significant modifications to its
methodology and processes for managing the Company's interest rate risk. Most
notably, the Company fully implemented an asset/liability management and
simulation software model, which is used 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 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
interest income of more than 10% within a 12-month period, assuming a ramped
increase or decrease of 300 basis points over a 24-month period. At December
31, 2001, the Company was in compliance with its policy.
The following table summarizes the sensitivity of the Company's net
interest 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.
2001
- -------------------------------------------------------------
Estimated Increase
Immediate Estimated (Decrease) in
Basis Point Change (Decrease) in Net Economic Value of
in Interest Rates Interest Income Equity
- -------------------------------------------------------------
+500 (10.4)% (9.9)%
+300 (3.4) (14.2)
+100 (0.7) (4.9)
-100 (0.2) 8.1
2000
- -------------------------------------------------------------
Estimated Increase
Immediate Estimated Increase (Decrease) in
Basis Point Change (Decrease) in Net Economic Value of
in Interest Rates Interest Income Equity
- -------------------------------------------------------------
+300 (0.13)% (7.79)%
+200 0.13 (6.54)
+100 0.17 (5.24)
-100 (0.14) (3.51)
-200 (0.54) (3.90)
-300 (0.97) (4.86)
These results are highly dependent upon assumptions made by management,
including but not limited to, assumptions regarding the manner in which
interest-bearing demand deposit and saving deposit accounts reprice in
different interest rate scenarios, 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 results
above will be achieved in the event that interest rates increase or decrease
during 2002 and beyond.
At December 31, 2000, the federal funds rate was approximately 6%. At this
level, increases or decreases of 300 basis points were reasonable risks to
consider. And, in fact, rates decreased by over 400 basis points over a 12
month period. However, at December 31, 2001, interest rates are at historically
low levels. For example, the federal funds rate target was 1.75%. Were this
interest rate to remain in effect throughout 2002, it would be the lowest
annual rate since 1958. Therefore, the Company believes that there is
significantly more risk of rising rates than falling rates. For December 31,
2001, the Company has elected not to present the risks associated with
decreases of 200 or 300 basis points. The Company believes that it cannot
adequately predict how the financial markets would react were rates to decrease
more than an additional 100 basis points. Also, for December 31, 2001,
management has elected to present the risk of a parallel
10
- --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
increase in rates of +500 basis points. An immediate rate increase of 500 basis
points over rates in effect at December 31, 2001 is believed to be a reasonable
worst-case scenario for management consideration for 2002.
LIQUIDITY
Liquidity is evaluated at both the Company level and at City National.
City National has seen a significant improvement in liquidity during 2001.
City National manages its liquidity position to effectively and economically
satisfy the funding needs of its customers and to accommodate the scheduled
repayment of borrowings. The Company attempts to maintain a stable, yet
increasing, core deposit base as its primary funding source. The Company also
manages relationships with external funding sources, including the Federal Home
Loan Bank, to provide it with a second source of liquidity. Additionally, City
National has historically utilized the capital markets, including the
acceptance of brokered deposits, as another source of liquidity. Additionally,
the Company seeks to manage liquidity by maintaining a sufficient percentage of
its total assets as liquid assets, such as the Company's securities portfolio,
that could be sold if necessary to provide additional funding sources. As of
December 31, 2001, the Company believes that City National maintained a
sufficient liquidity position to satisfy its funding and cash needs.
Likewise, the liquidity position of the Company is significantly improved
at December 31, 2001 as compared to December 2000. At December 31, 2000, the
Company had a line of credit with City National, a short-term note and line of
credit with SunTrust Bank, as well as obligations under the City Holding
Company Capital Trust and City Holding Company Capital Trust II for issuances
of trust-preferred securities. During 2001, the Company fully paid its
obligations under a line of credit with City National. The Company also used
the proceeds of the sale of its California banking subsidiaries in November
2001 to fully repay its short-term note and line of credit with SunTrust Bank.
However, the Company continues to have significant obligations to City Holding
Company Capital Trust and City Holding Company Capital Trust II, which in turn
have obligations to holders of preferred securities issued by the Trusts.
Interest on these securities was deferred in 2001 as required by the Company's
primary regulator, the Federal Reserve Bank of Richmond. As a result, the
Company has accrued an obligation to pay cumulative deferred dividends on its
two trust-preferred issues at December 31, 2001 of $5.66 million. The Company
has the right to defer dividends on these securities for up to five years. As
discussed under the caption Capital Resources, the Company is dependent upon
dividend payments from City National to make these payments. During 2002, the
Company intends to seek permission from both the Federal Reserve Bank of
Richmond and the OCC to make dividend payments from City National to the Company
and in turn make both cumulative and current interest payments to the Capital
Trusts and subsequently to holders of the trust preferred securities. However,
there can be no assurance that the OCC will approve requests to pay dividends to
the Parent Company or that the Federal Reserve will approve requests to pay
interest on the trust preferred securities during 2002.
On a consolidated basis, the Company's cash and cash equivalents,
represented by cash, due from banks, and federal funds sold, are a product of
its operating, investing, and financing activities as set forth in the
Consolidated Statements of Cash Flows included herein. A significant portion of
the 2001 net loss was attributable to non-cash expenses, such as the $17.99
million cumulative effect of accounting change, the $32.18 million provision
for loan losses, and the $8.78 million depreciation expense. As a result,
Operating Activities actually provided cash of approximately $42.40 million
during 2001. Of this total, $18.27 million was provided from loans held for
sale transactions as the Company discontinued originating loans with the intent
to sell. Similarly, in 2000 Operating Activities provided $147.63 million of
cash despite a net loss of $38.37 million. Non-cash expenses such as $40.84
million in goodwill impairment losses and amortization, $25.48 million in
provision for loan losses, and $12.29 million in depreciation expense, while
significantly affecting the results of operations, did not affect operating
cash flows. Loans held for sale transactions generated $88.54 million of cash
and the liquidation of a portion of the Company's Bank Owned Life Insurance
generated $21.48 million of cash from Operating Activities during 2000. During
1999, net proceeds from loans held for sale transactions provided $134.86
million in cash from Operating Activities.
Within Investing Activities, declining loan balances provided $400.83
million of cash during 2001 and enabled the Company to reduce its reliance on
higher-costing funding sources, as discussed below. Partially offsetting the
increase in cash resulting from declining loan balances, the sale of the
California banking operations, which maintained a balance of $39.30 million of
federal funds sold, resulted in a decline in cash balances during 2001.
Although the Company received approximately $23.00 million of cash from the
sale of the California banking operations, the proceeds were used entirely to
repay balances outstanding on the Parent Company's short-term note and line of
credit with SunTrust Bank, who held the common stock of the California banks as
collateral for the Parent Company's borrowings. Therefore, the sale of the
California banking operations, while providing cash to repay debt obligations
of the Company, did not result in an increase in cash balances for the Company.
Net cash used in investing
11
--
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
activities during 2000 approximated $60.91 million and was directly attributable
to growth within the loan portfolio. Net cash used in investing activities in
1999 was primarily attributable to loan growth of approximately $175.06 million
and the Company's sale of seven branch locations, which largely involved the
sale of deposit relationships and represented $64.99 million of cash.
Cash used in Financing Activities approximated $316.79 million during 2001,
as interest-bearing deposits declined $234.51 million and short-term borrowings
declined $98.56 million. As previously discussed, with the improved liquidity
position of City National, the bank has been able to fund the asset side of its
balance sheet with less expensive core deposits and allow the balance of
higher-costing time deposits and short-term borrowings to decline as loan
balances have declined. Of the total decline in interest-bearing deposits,
$134.38 million is attributable to the elimination of brokered deposits as a
funding source. Net cash used in Financing Activities during 2000 approximated
$118.21 million, primarily due to reductions in both short-term and long-term
borrowings of $238.95 million. Net principal reductions in borrowings were
partially offset by an increase of $128.17 million in deposit balances during
2000, primarily from the issuances of brokered deposits. During 1999, cash
provided by Financing Activities of $135.60 million was primarily attributable
to a $191.17 million increase in short-term borrowings. The increase in
short-term borrowings was necessary to provide for the decline in deposits
attributable to the sale of seven branch locations and other declines in deposit
relationships. Short-term borrowings were also increased at December 31, 1999 to
provide for potential Y2K related deposit runoff.
INVESTMENTS
As illustrated in Table Five, the Company's investment portfolio is most
heavily concentrated in U.S. Treasury and other U.S. government agency
securities. As of December 31, 2001, 2000, and 1999, investments in these
securities represented 54%, 69%, and 62%, respectively, of the total investment
securities portfolio. The decline in the percentage of the investment portfolio
allocated to U.S. Treasury and other U.S. government agency securities during
2001 was offset by an increase in the percentage of the investment portfolio
allocated to 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
remaining investments within the portfolio include securities of state and local
subdivisions and other debt and equity securities. The Company's investment
portfolio is structured to provide flexibility in managing liquidity and
interest rate risk, while providing acceptable rates of return.
In addition to the securities described above and outlined in Table Five,
the Company invested in the Eaton Vance Institutional Short Term Treasury Fund
(the "Fund") during 2001 as part of an income tax planning strategy to generate
capital gains, as opposed to interest income, in order to utilize capital loss
carryforwards available to the Company for income tax purposes. The Fund invests
exclusively in U.S. Treasury obligations with a remaining maturity of up to five
years and repurchase agreements collateralized exclusively by U.S. Treasury
obligations. During 2001, the average balance of the Company's investment in the
Fund approximated $46.25 million, which is included in the average balance of
taxable securities in Table Two. As a result of this investment, the Company
recorded realized securities gains of approximately $1.62 million during 2001.
The capital loss carryforwards referred to above were primarily created
from investment losses recorded in 2000 and 1999. In 2000, the Company
recognized a $5.12 million loss associated with its investment in small business
investment corporations, and in 1999, the Company recognized a $10.00 million
loss associated with its investment in preferred stock of Altiva Financial
Corporation.
12
- --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
===============================================================================
TABLE FIVE
INVESTMENT PORTFOLIO
(in thousands)
Carrying Values as of
December 31
2001 2000 1999
---------------------------------
Securities available-for-sale:
U.S. Treasury and other U.S. government corporations and agencies $ 208,855 $266,139 $ 229,531
States and political subdivisions 65,900 92,817 99,143
Mortgage-backed securities 89,540 3,490 5,699
Other debt securities 6,250 5,687 5,595
---------------------------------
Total debt securities 370,545 368,133 339,968
Equity securities 13,007 17,329 41,144
---------------------------------
Total $ 383,552 $385,462 $ 381,112
=================================
At December 31, 2001, there were no securities of any non-governmental issuers
whose aggregate carrying or market value exceeded 10% of stockholders' equity.
Maturing
Within After One But After Five But After
One Year Within Five Years Within Ten Years Ten Years
Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------
U.S. Treasury and other U.S.
government corporations and
agencies $ 34,419 6.28% $ 135,604 5.75% $ 29,627 7.71% $ 9,205 7.14%
States and political subdivisions 9,975 7.80 26,476 7.58 21,259 7.53 8,190 7.45
Mortgage-backed securities 341 6.18 8,280 4.92 77,804 5.05 3,115 6.08
Other debt securities 2,119 7.85 4,131 6.35 -- -- -- --
------------------------------------------------------------------------------
Total debt securities $ 46,854 6.67% $ 174,491 6.00% $ 128,690 6.07% $ 20,510 7.10%
==============================================================================
Weighted-average yields on tax-exempt obligations of states and political
subdivisions have been computed on a fully federal tax-equivalent basis using a
tax rate of approximately 35%.
===============================================================================
===============================================================================
TABLE SIX
LOAN PORTFOLIO
(in thousands)
December 31
2001 2000 1999 1998 1997
-------------------------------------------------------------------
Commercial, financial and agricultural $ 430,748 $ 637,870 $ 589,116 $ 509,214 $ 464,678
Real estate-mortgage 729,203 959,457 949,830 842,727 676,828
Installment loans to individuals 230,304 370,832 347,168 363,988 367,095
-------------------------------------------------------------------
Total loans $ 1,390,255 $ 1,968,159 $ 1,886,114 $ 1,715,929 $ 1,508,601
-==================================================================
===============================================================================
13
--
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The total loan portfolio declined $577.90 million or 29.36%, from $1.97
billion at December 31, 2000 to $1.39 billion at December 31, 2001. Of the total
decline in outstanding loan balances, the Company's sale of its California
banking operations represented $147.40 million. The remaining decline of $430.50
million during 2001 was attributable to the Company's strategic plan to address
credit quality issues affecting the Company in recent years, primarily within
the installment, indirect, and commercial lending areas. Additionally, declines
in loan balances were also planned to improve the liquidity position of City
National and to enable City National to become less dependent on higher-costing
external funding sources and, therefore, ultimately improve the Company's net
interest margin.
Except for home equity and credit card lending, each of the major loan
classifications experienced declines in outstanding balances. Although
residential real estate loans, excluding home equity loans, experienced the
largest dollar decline, approximately $261.63 million from December 31, 2000,
the majority of this decline was attributable to the Company's sale of its
California banking operations. Commercial loans experienced the next largest
dollar decline, with a decrease in outstanding balances of approximately $207.12
million during 2001. This decline was primarily caused by a reduction in
commercial loan originations in response to the credit quality issues faced by
the Company in recent years, which were predominantly centered in the commercial
lending area. As a result, the Company has placed emphasis on improving the
credit quality of its commercial lending portfolio through tighter credit
standards, improved pricing commensurate with the credit risk inherent in
commercial lending, and centralized lending authority.
The Company has also tightened credit standards within its
consumer/installment lending function in response to recent credit quality
issues. As a result, outstanding balances of installment loans declined
approximately $93.59 million, from $218.83 million as of December 31, 2000 to
$125.24 million at December 31, 2001. Through the implementation of a credit
scoring model during 2001, the Company has been more selective in originating
new loans within the installment lending area and has, where appropriate,
redirected consumer loan activity to either a home equity product for larger
consumer-type loans or to credit cards for smaller consumer credit
relationships.
The indirect automobile lending program, a source of significant loan
growth during 2000, was terminated on December 31, 2000. As a result, the
outstanding balance of indirect loans declined $49.12 million or 36.22%, from
$135.59 million to $86.47 million at December 31, 2000 and 2001, respectively.
Balances outstanding attributable to the indirect lending program are expected
to continue to decline over the next few years.
The following table shows the maturity of loans outstanding as of December
31, 2001:
Maturing
After One
Within But Within After
One Year Five Years Five Years Total
-----------------------------------------------
(in thousands)
Residential real estate $ 232,408 $ 319,435 $ 79,260 $ 631,103
Home equity 30,913 61,874 5,313 98,100
Commercial real estate 106,324 155,553 22,882 284,759
Other commercial 90,237 48,575 7,177 145,989
Installment 72,728 52,508 -- 125,236
Indirect 31,373 55,101 -- 86,474
Credit card 18,594 -- -- 18,594
-----------------------------------------------
Total loans $ 582,577 $ 693,046 $ 114,632 $1,390,255
===============================================
Loans maturing after
one year with:
Fixed interest rates $ 381,499
Variable interest rates 426,179
----------
Total $ 807,678
==========
ALLOWANCE AND PROVISION FOR LOAN LOSSES
Management systematically monitors the loan portfolio and the adequacy 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 are selected throughout the year for detailed loan reviews, which are
utilized by management to assess the risk in the portfolio and the adequacy of
the allowance. Due to the nature of commercial lending, evaluation of the
adequacy of the allowance as it relates to these loan types is often based more
upon specific credit review, with consideration given to the potential
impairment of certain credits and historical charge-off percentages, 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 charge-off history of each portfolio, adjusted for general economic
conditions and other inherent risk factors.
In evaluating the adequacy of the allowance for loan losses, management
considers both quantitative and qualitative factors. Quantitative factors
include actual repayment characteristics and loan performance, cash flow
analyses, and estimated fair values of underlying collateral. Qualitative
factors generally include overall trends within the portfolio, composition of
the portfolio, changes in pricing or underwriting, seasoning of the portfolio,
and general economic conditions.
14
- --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The allowance not specifically allocated to individual credits is generally
determined by analyzing potential exposure and other qualitative factors that
could negatively impact the adequacy of the allowance. In accordance with SEC
Staff Accounting Bulletin No. 102, issued on July 6, 2001, the Company has taken
steps to reflect this guidance within its assessment of the Allowance for Loan
and Lease Losses. These steps include a systematic weighted method of adjusting
historical charge-off percentages that are used to allocate the allowance for
loan losses to credits not individually evaluated for impairment. These loans
are grouped by pools with similar risk characteristics and the related
historical charge-off percentages 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, loss trends, and interest rate risk.
Determination of the allowance for loan losses is subjective in nature and
requires management to periodically reassess the validity of its assumptions.
Differences between net charge-offs and estimated losses are assessed such that
management can timely modify its evaluation model to ensure that adequate
provision has been made for risk in the total loan portfolio.
The allowance for loan losses (see Table Seven) increased $8.01 million or
19.71%, from $40.63 million at December 31, 2000 to $48.64 million at December
31, 2001. This increase was primarily attributed to the commercial portfolio as
further discussed below. As a result of the increase in the allowance, the
provision for loan losses increased $6.70 million or 26.29%, from $25.48 million
for the year ended December 31, 2000 to $32.18 million for 2001. Net charge-offs
(see Table Seven) increased 85% or $10.2 million, driven by the commercial
portfolio.
The allowance allocated to the commercial portfolio (see Table Nine)
increased by $9.19 million or 39.54%, from $23.24 million at December 31, 2000
to $32.43 million at December 31, 2001. This increase was a result of growth in
classified assets and other risk factors associated with the commercial loan
portfolio. Loans graded as high risk increased by $35.13 million or 65.01%, from
$54.04 million at December 31, 2000 to $89.17 million at December 31, 2001,
resulting from management's efforts to identify further credit deterioration
during the year. Management has continued to enhance its methodology for
assessing credit risk throughout 2001 and these enhancements have identified a
significant migration of commercial loans, especially loans originated in 1999
and 2000 during unprecedented commercial loan growth, into higher risk loan
categories. The Company also noted continued increases in risk factors relating
to a slowing economy in certain markets. This resulted in an unfavorable impact
on certain commercial loan customers and their borrowings, as evidenced by the
increase in classified assets. The commercial portfolio recognized charge-offs
(see Table Seven) of $15.91 million in 2001, representing an increase of $10.83
million, or 213% as compared to 2000. Included in this charge-off figure of
$15.91 million in 2001 is approximately $3.3 million of charges related to the
sale of four commercial credits totaling approximately $18 million.
Management has taken steps to improve commercial loans past due 30 days or
greater. As a result of these efforts, commercial loans 30 days or greater past
due decreased from $17.61 million at December 31, 2000 to $11.37 million at
December 31, 2001. This represented an improvement of $6.24 million, or 35.43%.
The allowance allocated to installment loans (see Table Nine) decreased by
$5.13 million or 43.30%, from $11.84 million at December 31, 2000 to $6.71
million at December 31, 2001. The decrease was attributed to the decline in
portfolio balances during the year and improved delinquency figures. Installment
loans charged-off decreased to $7.07 million in 2001 from $7.84 million in 2000.
Additionally, installment loans past due 30 days or more improved from $15.07
million at December 31, 2000 to $7.11 million at December 31, 2001.
The allowance allocated to the real estate portfolio (see Table Nine)
increased by $3.95 million or 71.17%, from $5.5 million to $9.5 million in 2000
and 2001, respectively. Net-charge offs in the real estate portfolio increased
88% to $2.9 million for the year ended December 2001 compared to $1.5 million
for 2000. The increase in the allocated reserve was also driven by the
provisions for increased risk factors considered in management's analysis
related to the current economy, charge-off and past-due trends, and other
identified risks.
Due to the increase in nonaccrual loans (see Table Eight), the allowance
for loan losses as a percentage of non-performing and potential problem loans
deteriorated from 199.88% at December 31, 2000 to 164.54% at December 31, 2001.
The increase in nonaccrual loans was driven by management's identification
efforts. The allowance as a multiple of net charge-offs amounted to 3.40 at
December 31, 2000 and 2.20 at December 31, 2001 driven downward by increased
commercial charge-offs despite a 20% increase in the overall allowance for loan
losses balance.
In summary, based on the Company's analysis and consideration of the known
factors utilized in computing the allowance for loan losses, management believes
that the consolidated allowance for loan losses at December 31, 2001 is adequate
to provide for probable losses inherent in the Company's loan portfolio.
15
--
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
During 2002, the allowance may prove to be inadequate and the Company may
need to take additional provision expense associated with the existing loan
portfolio due to factors not currently known to management. Factors that might
require additional provision expense would include deterioration in the
financial condition of borrowers or a higher level of charge-offs as a percent
of outstanding loan balances as compared to historical trends.
Likewise, it is possible that the Company may be able to resolve its
problem loans more favorably than has been anticipated. This could result in low
levels of provision expense during 2002, and might even result in negative
provision expense. Factors that could result in lower, or negative, provision
expense include improvement in the financial condition of the Company's
borrowers, improvement in the Company's experience at recovering previously
charged-off loans, improvement in the Company's level of charge-offs as a
percent of outstanding loan balances, or success in transferring loans which the
Company presently has reserved for to other financial institutions. The Company
has hired a team of loan workout specialists to attempt to achieve improved
results with the Company's problem loans. However, there can be no assurance of
their success.
===============================================================================
TABLE SEVEN
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(in thousands)
December 31
2001 2000 1999 1998 1997
-------------------------------------------------------
Balance at beginning of year $ 40,627 $ 27,113 $ 17,610 $ 18,190 $16,888
Charge-offs:
Commercial, financial, and agricultural (15,912) (5,081) (3,925) (2,385) (906)
Real estate-mortgage (3,379) (1,703) (1,142) (1,375) (252)
Installment loans to individuals (7,071) (7,839) (7,185) (7,709) (4,594)
-------------------------------------------------------
Totals (26,362) (14,623) (12,252) (11,469) (5,752)
Recoveries:
Commercial, financial, and agricultural 2,144 890 81 297 1,219
Real estate-mortgage 513 179 301 43 149
Installment loans to individuals 1,586 1,588 1,349 1,283 1,103
-------------------------------------------------------
Totals 4,243 2,657 1,731 1,623 2,471
-------------------------------------------------------
Net charge-offs (22,119) (11,966) (10,521) (9,846) (3,281)
Provision for loan losses 32,178 25,480 19,286 8,481 4,064
Balance of (sold) acquired institution (2,051) -- 738 785 519
-------------------------------------------------------
Balance at end of year $ 48,635 $ 40,627 $ 27,113 $ 17,610 $18,190
=======================================================
As a Percent of Average Total Loans
Net charge-offs 1.26% 0.61% 0.59% 0.58% 0.23%
Provision for loan losses 1.83 1.29 1.08 0.51 0.28
As a Percent of Nonperforming and Potential Problem Loans
Allowance for loan losses 164.54% 199.88% 168.55% 118.59% 136.97%
===============================================================================
16
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
===============================================================================
TABLE EIGHT
NONACCRUAL, PAST-DUE AND RESTRUCTURED LOANS
(in thousands)
December 31
2001 2000 1999 1998 1997
-----------------------------------------------
Nonaccrual loans $ 25,957 $ 16,676 $ 9,553 $ 8,844 $ 7,801
Accruing loans past due 90 days or more 3,434 3,350 5,830 5,126 5,149
Restructured loans 167 300 703 879 331
------------------------------------------------
$ 29,558 $ 20,326 $16,086 $14,849 $13,281
================================================
During 2001 and 2000, the Company recognized approximately $1.05 million and
$1.01 million of interest income received in cash on nonaccrual and
restructured loans. Approximately $1.67 million and $1.22 million of interest
income would have been recognized during 2001 and 2000, respectively, if such
loans had been current in accordance with their original terms There were no
commitments to provide additional funds on nonaccrual, restructured, or other
potential problem loans at December 31, 2001 and 2000.
Interest on loans is accrued and credited to operations based upon the
principal amount outstanding. The accrual of interest income is generally
discontinued when a loan becomes 90 days past due as to principal or interest
unless the loan is well collateralized and in the process of collection. When
interest accruals are discontinued, interest credited to income in the current
year that is unpaid and deemed uncollectible is charged to operations. Prior
year interest accruals that are unpaid and deemed uncollectible are charged to
the allowance for loan losses, provided that such amounts were specifically
reserved.
===============================================================================
===============================================================================
TABLE NINE
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(in thousands)
December 31
2001 2000 1999 1998 1997
----------------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
----------------------------------------------------------------------------------------------------
Commercial, financial
and agricultural $ 32,428 31% $ 23,240 32% $ 14,307 31% $ 6,270 29% $ 7,284 31%
Real estate-mortgage 9,493 52 5,546 49 5,874 50 6,227 49 5,575 45
Installment loans to
individuals 6,714 17 11,841 19 6,932 19 5,113 22 5,331 24
----------------------------------------------------------------------------------------------------
$ 48,635 100% $ 40,627 100% $ 27,113 100% $ 17,610 100% $ 18,190 100%
====================================================================================================
The portion of the allowance for loan losses that is not specifically allocated
to individual credits has been apportioned among the separate loan portfolios
based on the risk of each portfolio.
===============================================================================
MORTGAGE BANKING ACTIVITIES
In December 2000, the Company sold its mortgage servicing rights associated
with $1.10 billion, or 91.67% of the Company's specialty finance loan servicing
portfolio. During 2001, the Company completed the transfer of the sold servicing
portfolio However, due, in part, to the complexity of the underlying servicing
agreements, the Company retained approximately 8.33% of its December 31, 2000
servicing portfolio. The Company continues to pursue alternatives to dispose of
the remaining loan servicing portfolio, which had a balance of approximately
$66.69 million as of December 31, 2001. There are no mortgage servicing rights
associated with
17
--
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
the loans serviced for others, and the loans are not included in the Company's
Consolidated Balance Sheets.
During the second quarter of 2001, the Company closed its two remaining
loan production offices in Maryland and Georgia, completing the Company's exit
from specialty finance loan origination activities. As a result, the Company no
longer originates a significant volume of loans with the intent to sell and,
therefore, no longer maintains a balance of loans held for sale as of December
31, 2001. Approximately $5.21 million of loans previously classified as held for
sale were transferred to the Company's permanent loan portfolio in December
2001.
RETAINED INTERESTS
Between 1997 and 1999, the Company completed six securitization
transactions involving approximately $759.76 million of fixed rate, junior lien
mortgage loans. The Company retains a financial interest in the securitizations
comprised of (1) the excess interest collected on the underlying collateral
loans over the interest paid to third-party investors and administrative fees
and (2) overcollateralization, or the excess principal balance of the underlying
collateral loans over the principal balances payable to the third-party
investors. As of December 31, 2001, $362.05 million of securitized loans remain
outstanding and principal balances payable to investors approximate $252.33
million. As a result, the Company's retained interests in securitized mortgage
loans represents the Company's financial interest in $109.72 million of
overcollateralization and the excess interest to be derived from $362.05 million
of loans still outstanding over the interest to be paid to investors on $252.33
million of principal outstanding as of December 31, 2001, plus administrative
fees. As of December 31, 2001, the weighted-average interest rate earned on the
collateral loans approximates 12.90% and the weighted- average interest rate
paid to investors approximates 6.93%. Administrative fees, comprised primarily
of loan servicing fees, trustee fees, and insurance premiums, represent an
additional 1.44%.
Neither the outstanding balance of the collateral loans nor the outstanding
principal owed to investors is included in the Company's Consolidated Balance
Sheets. The third-party investors do not have direct recourse to the Company for
amounts of principal or interest owed them. The Company provides limited
recourse by accepting the "first loss" position in the securitizations. To the
extent the underlying collateral loans default, the overcollateralization that
currently exists is used to provide additional loss protection to the investors.
However, to the extent that loan defaults exceed those projected by the Company
in estimating the fair value of its retained interests, the Company could
experience impairment in the fair value of its retained interests and recognize
an impairment loss in its Consolidated Statements of Income. Insurance premiums
paid from the excess cash flows provide insurance for the benefit of the
investors to further protect investors from a loss of principal. The Company
would not be obligated to provide additional funds or assets in the event that
the overcollateralization is extinguished by excessive defaults experienced in
the underlying collateral pools or if the insurer was unable to fulfill its
commitment to the investors.
As of December 31, 2001 and 2000, the Company reported retained interests
in its securitizations of approximately $71.27 million and $85.21 million,
respectively. The value of the retained interests is determined using cash flow
modeling techniques that incorporate key assumptions related to default,
prepayment, and discount rates. Using these assumptions, the Company forecasts
the amount and timing of future cash flows that it expects to receive based on
the then current outstanding balance of collateral loans and amounts owed to
investors. As a result of economic forecasts released during the first quarter
of 2001 and the Company's completion of the sale of its loan servicing
responsibilities for its securitized loans to an independent third party, the
Company increased its projected cumulative default rate from 13.68% as of
December 31, 2000 to 17.15% as of March 31, 2001. This change in assumption
resulted in a decline of approximately $21.22 million (pre-tax) in the estimated
fair value of the Company's retained interests. Under accounting rules in effect
as of March 31, 2001, the Company recorded a $2.18 million (pre-tax) impairment
charge in its Consolidated Statements of Income and a $19.04 million (pre-tax)
unrealized loss in its Stockholders' Equity during the first quarter of 2001.
On April 1, 2001, the Company adopted the accounting provisions of Emerging
Issues Task Force Issue 99-20 ("Issue 99-20") as required. Issue 99-20 set forth
specific accounting guidance regarding the recognition of interest income on,
and impairment of, retained interests in securitized loans. The required
adoption of Issue 99-20 resulted in the Company recording a $29.98 million
(pre-tax) or $17.99 million (net of tax) cumulative effect of accounting change
during the second quarter of 2001. In conjunction with recording this cumulative
effect of accounting change, unrealized losses on the retained interests that
were previously recorded as negative adjustments within Stockholders' Equity
were reversed and recorded through the Company's Consolidated Statements of
Income in accordance with the new accounting rules.
In addition to establishing specific guidance related to determining
whether impairment exists in the Company's retained interests, Issue 99-20 also
set forth requirements for the recognition of interest income on retained
interests in securitized loans. Issue 99-20 requires that interest income on
retained interests be recognized over the life of the retained interest using
the effective yield method. Using the effective yield approach, the Company
re-instituted the accrual of
18
- --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
interest income on its retained interests, recognizing $7.43 million (pre-tax)
of interest income through December 31, 2001.
Although the Company has recognized interest income on its retained
interests, it has not yet received any cash from this investment. The estimated
fair value of the retained interests is accrued toward the expectation of when,
and how much, cash will be received in the future. Additionally, and as further
discussed under the caption Capital Resources, regulatory agencies recently
modified the regulatory capital requirements for retained interests. Such
changes resulted in an increased capital allocation for purposes of computing
risk-based capitol ratios.
Key assumptions used in estimating the fair value of the Company's retained
interests as of December 31, 2001 and 2000 were as follows:
December 31
2001 2000
------------------
Prepayment speed (CPR) 16.00% 15%-21%
Weighted average cumulative defaults 15.59% 13.68%
Weighted average discount rate 14.00% 14.00%
===============================================================================
TABLE TEN
CERTIFICATES OF DEPOSIT
(in thousands)
Maturities of time certificates of deposit of $100,000 or more outstanding
at December 31, 2001 are summarized as follows:
Amounts Percentage
-------------------------
Three months or less $ 42,341 33%
Over three months through six months 36,491 29
Over six months through twelve months 20,853 17
Over twelve months 27,289 21
-------------------------
Total $ 126,974 100%
=========================
===============================================================================
REGULATORY MATTERS
On July 12, 2000, the Company announced that its principal bank
subsidiary, City National, had entered into a formal agreement with the OCC.
The agreement required City National to adopt a three-year comprehensive
strategic plan, improve its loan portfolio management, and develop and adhere
to a written plan for liquidity, including a formal asset and liability
management policy. City National also agreed to incorporate liquidity planning
in its financial management process, implement a satisfactory program to manage
interest rates, and ensure full compliance of its securitization program with
recent OCC regulations. Additionally, City National agreed to develop a plan to
dispose of loans held for sale that were held in excess of 90 days, develop a
three-year capital plan, strengthen internal controls and its audit committee,
and establish a program to maintain an adequate allowance for loan and lease
losses. Additionally, as a consequence of entering into this agreement, City
National became subject to certain FDIC restrictions regarding the issuance of
brokered deposits. City National also agreed to maintain its regulatory Total
Capital ratio above 10.00% and to establish a committee of its Board of
Directors to oversee compliance with the agreement.
Subsequent to the date of the agreement, City National established a
compliance oversight committee, which meets regularly to determine the status
of compliance with the agreement. City National and the Company also adopted a
three-year comprehensive strategic plan; formalized policies and procedures
related to asset and liability management, including liquidity and interest
rate risk issues; formalized policies and procedures associated with its
securitization program to ensure compliance with OCC regulations; disposed of
substantially all of its loans held for sale that had been held in excess of 90
days and transferred the unsold loans to the permanent portfolio at estimated
fair market value; and developed a three-year capital plan.
In September 2001, City National entered into a new, less comprehensive,
formal agreement with the OCC that replaced the July 12, 2000 formal agreement.
The revised agreement, which was based on the results of the April 2001
regulatory examination of City National, primarily focuses on lending policies
and procedures and on certain aspects of City National's methodology for
assessing the adequacy of its allowance for loan losses. Management continues
to devote considerable time and resources toward complying with the
requirements of the revised formal agreement.
CAPITAL RESOURCES
During 2001, Stockholders' Equity decreased $17.11 million or 10.47%, from
$163.46 million as of December 31, 2000 to $146.35 million as of December 31,
2001. This decline was due to the $26.00 million net loss reported for 2001,
partially offset by a $2.40 million, net-of-tax, unrealized gain in the
estimated fair value of the Company's investment securities portfolio and a
$6.49 million, net-of-tax,
19
--
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
reclassification adjustment for unrealized losses on the Company's retained
interests in securitized mortgage loans. As of December 31, 2000, the Company
had recorded a $6.49 million unrealized loss associated with its retained
interests that was reversed during 2001 and realized through the Company's
Consolidated Statements of Income and included in the Company's reported $26.00
million net loss for 2001.
During 2000, Stockholders' Equity decreased $35.09 million or 17.67%, from
$198.54 million at December 31, 1999 to $163.46 million at December 31, 2000.
This decline was due to the net loss of $38.37 million recorded in 2000 and the
payment of $7.43 million in dividends to the Company's common stockholders.
Offsetting the combined $45.80 million decrease resulting from these two
events, the Company recognized a $10.52 million increase in unrealized gains
within the Other Comprehensive Income (Loss) section of Stockholders' Equity.
Unrealized gains in 2000 were attributable to a $5.56 million increase in the
fair value of the securities portfolio and a $4.96 million increase in the fair
value of retained interests during the year.
Regulatory guidelines require the Company to maintain a minimum total
capital to risk-adjusted assets ratio of 8%, with at least one-half of capital
consisting of tangible common stockholders' equity and a minimum Tier I
leverage ratio of 4%. At December 31, 2001, the Company's total capital to
risk-adjusted assets ratio was 13.10% and its Tier I capital ratio was 9.38%,
compared to 11.61% and 9.05%, respectively, at December 31, 2000. The Company's
Tier I leverage ratio at December 31, 2001 and 2000 was 6.92% and 7.94%,
respectively.
Similarly, the Company's banking subsidiaries are also required to
maintain minimum capital levels as set forth by various regulatory agencies.
Under capital adequacy guidelines, the banking subsidiaries are required to
maintain minimum total capital, Tier I capital, and leverage ratios of 8.00%,
4.00%, and 4.00%, respectively. As previously discussed, City National entered
into a formal agreement with the OCC during 2000. One of the provisions of the
agreement requires City National to maintain its total capital ratio at least
equal to 10.00%. To be classified as "well capitalized," the banking
subsidiaries must maintain total capital, Tier I capital, and leverage ratios
of 10.00%, 6.00%, and 5.00%, respectively. As of December 31, 2001, City
National reported total capital, Tier I capital, and leverage ratios of 13.71%,
12.44%, and 9.76%, respectively. Although City National's regulatory capital
ratios exceed minimum ratios to be considered "well capitalized", any bank that
has entered into a formal agreement such as that discussed above is precluded
from being categorized as "well capitalized" under the regulatory framework for
prompt corrective action. As of December 31, 2000, City National reported total
capital, Tier I capital, and leverage ratios of 12.72%, 11.47%, and 10.10%,
respectively.
In November 2001, regulatory agencies issued new guidelines changing
regulatory capital standards to address the treatment of, among other things,
retained interests for purposes of computing regulatory capital and the
aforementioned regulatory capital ratios. In general, the new guidelines
require an increased allocation of regulatory capital to assets such as
retained interests in securitized mortgage loans and the new rules limit the
amount of retained interests financial institutions may include in regulatory
capital. Although the new rule becomes effective January 1, 2002, institutions
that completed transactions before December 31, 2001 impacted by the new rule
may delay application of the new standard until December 31, 2002. Had the
Company been required to comply with the new rule as of December 31, 2001, the
Company estimates that its Total Capital, Tier I Capital, and Leverage Capital
ratios would have approximated 11.43%, 7.65%, and 5.84%, respectively.
Similarly, City National estimates that its Total Capital, Tier I Capital, and
Leverage Capital ratios would have been 12.31%, 10.87%, and 9.13%,
respectively, as of December 31, 2001, which are in excess of the
aforementioned "well capitalized" ratios.
Payment of dividends is regulated by both the Federal Reserve Board, which
is the primary regulatory of the Parent Company, and by the OCC, which is City
National's primary regulatory agency. Dividends from City National are
essentially the sole source of cash for the Parent Company. The approval of the
OCC is required prior to the payment of dividends by City National in excess of
its earnings retained in the current year plus retained net profits for the
preceding two years. The Federal Reserve maintains a policy that generally
requires that dividend payments, on either common or preferred stock, be made
from net income earned in the most recent twelve-month period. As a result of
the net losses reported at both the consolidated and bank levels in 2001 and
2000, neither the Company nor City National is permitted to pay dividends
without obtaining prior regulatory approval. Therefore, the Company has
suspended the payment of dividends to its common shareholders and has deferred
the payment of interest on its trust preferred securities. In accordance with
the terms of the trust preferred securities, the Company may elect to defer
interest payments for up to five years, as long as there has been no event of
default, which includes bankruptcy, failure to pay principal payments when due,
and other events as defined in the documents governing the issuances of the
trust preferred securities. Distributions on the trust preferred securities are
cumulative and accrue interest at interest rates equivalent to the stated
interest rates for each issue.
20
- --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
LEGAL ISSUES
On December 28, 2001, the Company, its previous management team, and
members of the Boards of Directors of both the Company and City National were
named in a derivative action filed by a shareholder seeking to recover damages
on behalf of the Company. The Company, members of its previous management team,
and the Directors of both the Company and City National have retained counsel,
but the case is in the early stages and it would be premature to forecast the
outcome. However, the defendants intend to defend the action vigorously.
As previously noted under the caption Non-Interest Income and Expense, the
Company recorded a $3.00 million charge against earnings during the third
quarter of 2001 to accrue costs associated with litigation involving operations
the Company has either sold or closed. In addition, the Company is engaged in
various legal actions that it deems to be in the ordinary course of business.
The Company believes that is has adequately provided for the potential costs of
the current litigation. Nevertheless, there can be no assurance that current
actions will have immaterial results or that no material actions may be
presented in the future.
FORWARD-LOOKING STATEMENTS
All statements other than statements of historical fact included in this
Annual Report, including statements in the Letter to Shareholders and in
Management's Discussion and Analysis of Financial Condition and Result of
Operations are, or may be deemed to be, forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Exchange Act of 1934. Such information involves risks and uncertainties that
could cause the Company's actual results to differ from those projected in the
forward-looking information. Important factors that could cause actual results
to differ materially from those discussed in such forward-looking statements
include, but are not limited to, (1) the Company may incur additional loan loss
provision due to negative credit quality trends in the future that may lead to a
deterioration of asset quality, or conversely, the Company may incur less, or
even negative, loan loss provision due to positive credit quality trends in the
future and further resolution of various loan quality issues; (2) the Company
may experience increases in the default rates on its retained interests in
securitized mortgages causing it to take impairment charges to earnings; (3) the
Company could have adverse legal actions of a material nature; (4) the Company
may face competitive loss of customers associated with its efforts to increase
fee-based revenues; (5) the Company may be unable to manage its expense levels
due to the expenses associated with its loan portfolio quality, regulatory, and
legal issues; (6) current earnings from the Company's subsidiaries may not be
sufficient to fund the cash needs of the Parent Company, including the payment
of stockholders' dividends and interest payments required to be paid to City
Holding Company Capital Trust and the City Holding Company Capital Trust II; (7)
rulings affecting, among other things, the Company's and its banking
subsidiaries' regulatory capital and required loan loss allocations may change,
resulting in the need for increased capital levels; (8) changes in the interest
rate environment may have results on the Company's operations materially
different from those anticipated by the Company's market risk management
functions; (9) changes in general economic conditions and increased competition
could adversely affect the Company's operating results; and (10) changes in
other regulations and government policies affecting bank holding companies and
their subsidiaries, including changes in monetary policies, could negatively
impact the Company's operating results. Forward-looking statements made herein
reflect management's expectations as of the date such statements are made. Such
information is provided to assist stockholders and potential investors in
understanding current and anticipated financial operations of the Company and is
included pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The Company undertakes no obligation to update
any forward-looking statement to reflect events or circumstances that arise
after the date such statements are made.
21
--
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
City Holding Company
We have audited the accompanying consolidated balance sheets of City
Holding Company and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of City Holding Company and subsidiaries at December 31, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States.
As discussed in Note Seven to the Consolidated Financial Statements, in
2001 the Company changed its method of accounting for its retained interests in
securitized assets. As required, the Company adopted the accounting provisions
of Emerging Issues Task Force ("EITF") Issue 99-20 on April 1, 2001. This new
accounting guidance changed the method for determining impairment and the
recognition of interest income on retained interests in securitized assets. As
a result of adopting EITF 99-20, the Company recorded a $29.98 million pre-tax,
or $17.99 million net-of-tax, impairment loss in its Consolidated Statements of
Income for the year ended December 31, 2001.
/s/ Ernst and Young LLP
Charleston, West Virginia
January 23, 2002
22
- --
CONSOLIDATED BALANCE SHEETS
CITY HOLDING COMPANY AND SUBSIDIARIES
December 31
2001 2000
---------------------------------
(in thousands)
Assets
Cash and due from banks $ 81,827 $ 87,990
Federal funds sold 88,500 2,638
---------------------------------
Cash and Cash Equivalents 170,327 90,628
Securities available-for-sale, at fair value 383,552 385,462
Loans:
Residential real estate 631,103 892,734
Home equity 98,100 66,723
Commercial real estate 284,759 353,026
Other commercial 145,989 284,844
Installment 125,236 218,825
Indirect 86,474 135,589
Credit card 18,594 16,418
---------------------------------
Gross Loans 1,390,255 1,968,159
Allowance for loan losses (48,635) (40,627)
---------------------------------
Net Loans 1,341,620 1,927,532
Loans held for sale - 17,900
Retained interests 71,271 85,206
Premises and equipment 43,178 56,924
Accrued interest receivable 12,422 18,242
Net deferred tax assets 47,443 44,646
Other assets 46,482 44,960
---------------------------------
Total Assets $ 2,116,295 $ 2,671,500
=================================
Liabilities
Deposits:
Noninterest-bearing $ 284,649 $ 271,358
Interest-bearing:
Demand deposits 392,258 394,615
Savings deposits 272,885 301,844
Time deposits 741,503 1,116,124
---------------------------------
Total Deposits 1,691,295 2,083,941
Short-term borrowings 127,204 248,766
Long-term debt 29,328 34,832
Corporation-obligated mandatorily redeemable capital securities of subsidiary trusts
holding solely subordinated debentures of City Holding Company 87,500 87,500
Other liabilities 34,619 53,004
---------------------------------
Total Liabilities 1,969,946 2,508,043
Stockholders' 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; 16,892,913 shares
issued and outstanding at December 31, 2001 and 2000, including 4,979 shares in
treasury 42,232 42,232
Capital surplus 59,174 59,174
Retained earnings 41,152 67,152
Cost of common stock in treasury (136) (136)
Accumulated other comprehensive income (loss) 3,927 (4,965)
---------------------------------
Total Stockholders' Equity 146,349 163,457
---------------------------------
Total Liabilities and Stockholders' Equity $ 2,116,295 $ 2,671,500
=================================
See notes to consolidated financial statements.
23
--
CONSOLIDATED STATEMENTS OF INCOME
CITY HOLDING COMPANY AND SUBSIDIARIES
Year Ended December 31
2001 2000 1999
-----------------------------------------
(in thousands, except per share data)
Interest Income
Interest and fees on loans $ 150,036 $ 180,513 $ 168,726
Interest on investment securities:
Taxable 15,518 17,389 17,675
Tax-exempt 3,340 4,608 5,032
Interest on retained interests 7,430 185 3,876
Interest on federal funds sold 1,156 217 244
-----------------------------------------
Total Interest Income 177,480 202,912 195,553
Interest Expense
Interest on deposits 67,543 82,756 71,464
Interest on short-term borrowings 8,604 18,996 11,436
Interest on long-term debt 2,147 3,987 6,219
Interest on trust-preferred securities 8,121 8,017 8,014
-----------------------------------------
Total Interest Expense 86,415 113,756 97,133
-----------------------------------------
Net Interest Income 91,065 89,156 98,420
Provision for loan losses 32,178 25,480 19,286
-----------------------------------------
Net Interest Income After Provision for Loan Losses 58,887 63,676 79,134
Non-Interest Income
Investment securities gains (losses) 2,382 (5,015) (9,897)
Service charges 17,905 10,778 10,074
Mortgage loan servicing fees 383 16,962 22,068
Net origination fees on junior lien mortgages 598 2,331 4,292
Gain (loss) on sale of loans 3,039 (1,596) 6,600
Gain from sales of subsidiaries, divisions, and branches 8,036 - 8,883
Other income 10,509 17,573 17,515
-----------------------------------------
Total Non-Interest Income 42,852 41,033 59,535
Non-Interest Expense
Salaries and employee benefits 42,758 47,957 56,530
Occupancy and equipment 9,377 11,363 15,530
Depreciation 8,777 12,291 11,822
Advertising 2,465 3,788 12,297
Telecommunications 4,054 5,133 4,756
Office supplies 2,234 1,764 2,417
Postage and delivery 2,563 2,006 2,152
Loan production office advisory fees 2,198 4,021 147
Professional fees and litigation expense 9,248 4,901 4,325
Loss on disposal and impairment of fixed assets 3,951 4,805 80
Repossessed asset losses and expenses 2,557 2,541 1,541
Insurance and regulatory 2,134 1,908 1,457
Retained interest impairment 2,182 - -
Goodwill impairment - 34,832 -
Other expenses 19,907 21,502 17,560
-----------------------------------------
Total Non-Interest Expense 114,405 158,812 130,614
-----------------------------------------
(Loss) Income Before Income Taxes and Cumulative
Effect of Accounting Change (12,666) (54,103) 8,055
Income tax (benefit) expense (4,651) (15,730) 1,842
-----------------------------------------
(Loss) Income Before Cumulative Effect of (8,015) (38,373) 6,213
Accounting Change
Cumulative effect of accounting change, net of tax (17,985) - -
-----------------------------------------
Net (Loss) Income $ (26,000) $ (38,373) $ 6,213
=========================================
24
- --
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
Year Ended December 31
2001 2000 1999
-----------------------------------------
(in thousands, except per share data)
Basic (loss) earnings per common share:
Loss before cumulative effect of accounting change $ (0.47) $ (2.27) $ 0.37
Cumulative effect of accounting change (1.07) - -
-----------------------------------------
Net (Loss) Income $ (1.54) $ (2.27) $ 0.37
=========================================
Diluted (loss) earnings per common share:
Loss before cumulative effect of accounting change $ (0.47) $ (2.27) $ 0.37
Cumulative effect of accounting change (1.07) - -
-----------------------------------------
Net (Loss) Income $ (1.54) $ (2.27) $ 0.37
=========================================
Average common shares outstanding:
Basic 16,888 16,882 16,841
=========================================
Diluted 16,888 16,882 16,841
=========================================
See notes to consolidated financial statements.
25
--
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS' EQUITY
CITY HOLDING COMPANY AND SUBSIDIARIES
Common Accumulated
Stock Other Total
(Par Capital Retained Comprehensive Treasury Stockholders'
Value) Surplus Earnings Income (Loss) Stock Equity
==============================================================================
(in thousands)
Balances at December 31, 1998 $ 42,051 $ 58,365 $ 120,209 $ (292) $ (274) $ 220,059
Comprehensive loss:
Net income - - 6,213 - - 6,213
Other comprehensive loss, net of deferred
income taxes of $(10,082):
Unrealized loss on securities and
retained interests of $15,257, net of
reclassification adjustment for gains
included in net income of $62 - - - (15,195) - (15,195)
-------------
Total comprehensive loss (8,982)
Cash dividends declared ($0.80 a share) - - (13,471) - - (13,471)
Exercise of 7,686 stock options 82 184 - - 255 521
Purchase of 11,999 shares of treasury stock - - - - (398) (398)
Issuance of contingently issuable common stock 66 615 - - 132 813
------------------------------------------------------------------------------
Balances at December 31, 1999 42,199 59,164 112,951 (15,487) (285) 198,542
Comprehensive loss:
Net loss - - (38,373) - - (38,373)
Other comprehensive loss, net of deferred
income taxes of $(7,060):
Unrealized gain on securities and
retained interests of $10,513, net of
reclassification adjustment for losses
included in net income of $9 - - - 10,522 - 10,522
-------------
Total comprehensive loss (27,851)
Cash dividends declared ($0.44 a share) - - (7,426) - - (7,426)
Issuance of contingently issuable common stock 33 10 - - 149 192
------------------------------------------------------------------------------
Balances at December 31, 2000 42,232 59,174 67,152 (4,965) (136) 163,457
Comprehensive loss:
Net loss - - (26,000) - - (26,000)
Other comprehensive loss, net of deferred
income tax expense of $5,928:
Unrealized gain on securities of $2,401, net
of reclassification adjustments for losses
included in net income of $6,491 - - - 8,892 - 8,892
-------------
Total comprehensive loss (17,108)
------------------------------------------------------------------------------
Balances at December 31, 2001 $ 42,232 $ 59,174 $ 41,152 $ 3,927 $ (136) $ 146,349
==============================================================================
See notes to consolidated financial statements.
26
- --
CONSOLIDATED STATEMENTS OF CASH FLOWS
CITY HOLDING COMPANY AND SUBSIDIARIES
Year Ended December 31
2001 2000 1999
----------------------------------------
(in thousands)
Operating Activities
Net (loss) income $ (26,000) $ (38,373) $ 6,213
Cumulative effect of accounting change, net of tax 17,985 - -
-------------------------------------
(Loss) income before cumulative effect of accounting change (8,015) (38,373) 6,213
Adjustments to reconcile net income to net cash provided by
operating activities:
Net amortization and write-off of goodwill 1,014 40,837 5,674
Loss on fixed asset disposals 3,951 4,805 -
Provision for depreciation 8,777 12,291 11,822
Provision for loan losses 32,178 25,480 19,286
Deferred income tax benefit (8,463) (22,802) (9,198)
Loans originated for sale (93,875) (219,748) (343,755)
Purchases of loans held for sale - (16,065) (229,148)
Proceeds from loans sold 112,146 324,354 707,765
Realized (gains) losses on loans sold (3,039) 1,596 (6,600)
Decrease (increase) in retained interests 2,435 - (11,340)
Realized investment securities (gains) losses (2,382) 5,015 9,897
Decrease (increase) in accrued interest receivable 4,821 (93) 1,310
Decrease (increase) in other assets 5,512 25,287 (56,483)
(Decrease) increase in other liabilities (12,661) 5,045 145
----------------------------------------
Net Cash Provided by Operating Activities 42,399 147,629 105,588
Investing Activities
Proceeds from maturities and calls of securities held to maturity - - 27
Proceeds from sales of securities available-for-sale 262,241 51,606 83,185
Proceeds from maturities and calls of securities available-for-sale 171,546 32,417 24,304
Purchases of securities available-for-sale (431,113) (80,640) (105,785)
Net decrease (increase) in loans 400,832 (64,191) (175,061)
Net cash paid in sales of subsidiaries, divisions, and branches (37,869) - (56,104)
Realized gain on sales of subsidiaries, divisions, and branches (8,036) - (8,883)
Net cash acquired (paid) in acquisitions - - 7,409
Purchases of premises and equipment (3,511) (97) (7,944)
----------------------------------------
Net Cash Provided by (Used in) Investing Activities 354,090 (60,905) (238,852)
Financing Activities
Net increase (decrease) in noninterest-bearing deposits 16,280 24,803 (22,178)
Net (decrease) increase in interest-bearing deposits (234,508) 103,368 (30,323)
Net (decrease) increase in short-term borrowings (98,562) (153,953) 191,168
Proceeds from long-term debt - - 57,999
Repayment of long-term debt - (85,000) (47,719)
Purchases of treasury stock - - (398)
Exercise of stock options - - 521
Cash dividends paid - (7,426) (13,471)
----------------------------------------
Net Cash (Used in) Provided by Financing Activities (316,790) (118,208) 135,599
----------------------------------------
Increase (Decrease) in Cash and Cash Equivalents 79,699 (31,484) 2,335
Cash and cash equivalents at beginning of year 90,628 122,112 119,777
----------------------------------------
Cash and Cash Equivalents at End of Year $ 170,327 $ 90,628 $ 122,112
========================================
See notes to consolidated financial statements.
27
--
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 accounting principles generally accepted in the United
States 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.
Description of Principal Markets and Services: The Company is a bank
holding company 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 55 offices in West Virginia and Ohio. Principal activities
include providing deposit, credit, trust, and insurance related products and
services.
Cash and Due from Banks: The Company considers cash, due from banks and
federal funds sold 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 and are stated at amortized cost,
adjusted for amortization of premiums and accretion of discounts. Debt
securities for which the Company does not have the intent or ability to hold to
maturity are classified as available-for-sale along with the Company's
investment in equity securities. Securities available-for-sale are carried at
fair value, with the unrealized gains and losses, net of tax, reported in
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 specific identification method is used to determine the cost basis of
securities sold.
Loans: Interest income on loans is accrued and credited to operations based
upon the principal amount outstanding, using methods that generally result in
level rates of return. The accrual of interest income generally is discontinued
when a loan becomes 90 days past due as to principal or interest. When interest
accruals are discontinued, unpaid interest recognized in income in the current
year is reversed, and interest accrued in prior years is charged to the
allowance for loan losses. Management may elect to continue the accrual of
interest when the estimated net realizable value of collateral exceeds the
principal balance and related accrued interest, and the loan is in process of
collection.
Generally, loans are restored to accrual status when the obligation is
brought current, has performed in accordance with the contractual terms for a
reasonable period of time, and the ultimate collectibility of the total
contractual principal and interest is no longer in doubt.
Loans Held for Sale: Loans held for sale represent mortgage loans the
Company has either purchased or originated with the intent to sell in the
secondary market and are carried at the lower of aggregate cost or estimated
fair value.
Retained Interest: When the Company sold certain receivables in
securitizations of high loan-to-value loans, it retained a financial interest in
the securitizations. The financial interest or retained interest is comprised of
the estimated fair value of two components: (1) the excess cash flows between
interest collected on the underlying collateral loans minus interest paid to
third-party investors plus fees paid for servicing, insurance, and trustee
costs, and (2) overcollateralization. Gains recognized on the sale of the
receivables was based in part on the previous carrying amount of the loans sold,
allocated between the assets sold and the retained interests based on their
relative fair values at the date of the sale. Because quoted market prices are
not readily available for retained interests, the Company estimates their fair
values using cash flow modeling techniques that incorporate management's best
estimates of key assumptions--loan default rates, loan prepayment rates, and
discount rates commensurate with the risks involved.
As further discussed in Note Seven, the Company adopted the accounting
provisions of Emerging Issues Task Force Issue 99-20 on April 1, 2001. Pursuant
to Issue 99-20, the Company recognizes the excess cash flows attributable to the
retained interests over the carrying value of the retained interests as interest
income over the life of the retained interests using the effective yield method.
The Company updates the estimate of future cash flows on a quarterly basis. If
upon evaluation there is a favorable change in estimated cash flows from the
cash flows previously projected, the Company recalculates the amount of
accretable yield and
28
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
accounts for the change prospectively with the amount of accretion adjusted
over the remaining life of the retained interests. Conversely, if upon
evaluation there is an adverse change in either the amount or timing of the
estimated future cash flows, an other-than-temporary impairment loss is
recorded in the Company's Consolidated Statements of Income and the accretable
yield is negatively adjusted.
Allowance for Loan Losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses in the loan
portfolio. Management's determination of the adequacy of the allowance for loan
losses is based upon management's 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.
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. Generally,
estimated useful lives of premises and furniture, fixtures, and equipment do not
exceed 30 and 7 years, respectively.
Intangible Assets: Intangible assets, comprised of goodwill and core
deposits, are included in Other Assets in the Consolidated Balance Sheets. As of
December 31, 2001 and 2000, the carrying amount of goodwill approximated $5.53
million and $6.79 million, respectively. Core deposit intangibles approximated
$1.59 million and $1.86 million as of December 31, 2001 and 2000, respectively.
Goodwill is being amortized on a straight-line basis over 10 to 15 years and
core deposits are being amortized using accelerated methods over 10-year
estimated useful lives.
The carrying amount of goodwill is reviewed if facts and circumstances
suggest that it may be impaired. If this review indicates that goodwill will not
be recoverable, as indicated based on the estimated undiscounted cash flows of
the entity acquired over the remaining amortization period, the carrying amount
of the goodwill is reduced by the estimated shortfall of cash flows discounted
over the remaining amortization period.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 142
discontinues the practice of amortizing goodwill and indefinite lived intangible
assets and requires an annual review for impairment. Impairment would be
examined more frequently if certain indicators of impairment exist. Intangible
assets with a determinable useful life, such as core deposits, will continue to
be amortized over the estimated useful life. Statement No. 142 becomes effective
for the Company on January 1, 2002. The non-amortization provisions of Statement
No. 142 apply to goodwill and indefinite lived intangible assets acquired after
June 30, 2001. However, goodwill and intangible assets acquired before June 30,
2001 must continue to be amortized until the Company adopts Statement No. 142 in
its entirety. The Company estimates the benefit associated with the elimination
of goodwill amortization in 2002 to approximate $645,000 (pre-tax). However,
impairment testing of remaining balances of goodwill and other intangible assets
will be performed periodically and may result in charges against earnings that
cannot currently be quantified, as such testing is predicated on facts and
circumstances as of the date the impairment analysis is performed. Additionally,
Statement No. 142 requires a transitional impairment test be applied to all
goodwill and other indefinite lived intangible assets within the first half of
2002 and any resulting impairment loss be reported as a change in accounting
principle. The Company has performed preliminary transitional impairment tests
on its goodwill assets and at this time does not expect an impairment loss to be
recorded in 2002 as a result of this test.
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.
The Company files a consolidated income tax return. The respective subsidiaries
generally provide for income taxes on a separate return basis and remit amounts
determined to be currently payable to the Parent Company.
Stock-Based Compensation: As permitted, the Company has elected to follow
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its employee stock options. Because the exercise price of the
Company's employee stock options granted equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
Basic and Diluted Earnings per Common Share: Basic earnings per share is
computed by dividing net income by the weighted-average number of shares of
common stock outstanding. Diluted earnings per share is computed by dividing net
income by the weighted-average number of shares outstanding increased by the
number of shares of common stock which would be issued assuming the exercise of
stock options and other common stock equivalents. Stock options and common stock
equivalents had no effect on
29
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
average shares outstanding for purposes of computing diluted earnings per share
for 2001, 2000, or 1999.
Derivatives and Hedging Activities: Effective January 1, 2001, the Company
adopted FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended. Statement No. 133 requires that derivative
instruments be carried at fair value in the Company's Consolidated Balance
Sheets. If the derivative is considered a hedge, depending on the nature of the
hedge, changes in the fair value of derivatives are either offset against the
change in fair value of assets, liabilities, or firm commitments through
earnings or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in fair
value would be immediately recognized in earnings. The Company's adoption of
Statement No. 133 did not materially affect the Company's financial position or
results of operations.
New Accounting Pronouncements: In October 2001, the FASB issued Statement
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which
is applicable to financial statements issued for fiscal years beginning after
December 15, 2001. Statement No. 144 supersedes FASB Statement No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of, and provides a single accounting model for long-lived assets to
be disposed of. Implementation of Statement No. 144 is not expected to have a
material impact on the Company's financial position or results of operations.
Statements of Cash Flows: Cash paid for interest, including interest paid
for long-term debt and trust preferred securities, was $91.38 million, $106.72
million, and $98.71 million in 2001, 2000, and 1999, respectively. Cash paid for
income taxes was $1.34 million, $6.01 million, and $9.75 million in 2001, 2000,
and 1999, respectively.
Reclassifications: Certain amounts in the 2000 and 1999 financial
statements have been reclassified to conform to the 2001 presentation. Such
reclassifications had no impact on net income or stockholders' equity.
===============================================================================
NOTE TWO
INTANGIBLE ASSETS AND STRATEGIC
REPOSITIONING
===============================================================================
A comprehensive strategic repositioning plan, designed to focus on the
Company's core community banking franchise, was initiated during 2000. The plan
included completing an orderly exit from the Company's operations in California
and divesting unprofitable operations.
As a result of the Company's plan to exit its operations in California, the
Company recorded a $13.64 million charge against earnings to reduce the carrying
amount of its investment in its California banking operations to their estimated
fair values as of December 31, 2000. The fair value of the California banking
franchises, which is included in the community banking segment, was estimated
based on independent valuations of California franchises of similar size and
operations. At December 31, 2000, the California banking operations had a
carrying value of $16.55 million and reported net income of $1.18 million for
the year ended December 31, 2000, excluding the $13.64 million impairment
charge. Subsequently, the California banking operations were sold on November
30, 2001 to First Federal Bank of California for $23 million in cash. Proceeds
of the sale were used to fully repay an outstanding balance on a short-term note
and line of credit with SunTrust Bank. The Company recorded a pre-tax book gain
of $4.67 million on the sale.
As a consequence of the strategic repositioning plan, the Company sold its
specialty finance loan servicing operations in December 2000, effectively
completing the Company's exit from specialty finance operations. In conjunction
with the closure of these divisions, the Company recorded a $15.18 million
charge against earnings, representing the write-off of the remaining balance of
goodwill associated with these operations.
Additionally, the carrying amount of goodwill balances associated with the
Company's Internet service and direct mail divisions was reviewed for impairment
as of December 31, 2000. Based on 2000 operating results, current profitability
projections, and the Company's strategic plan, the Company determined that an
impairment analysis was necessary to ascertain the recoverability of the
goodwill balances for these divisions. Utilizing an analysis of undiscounted
cash flows over the remaining goodwill amortization period for each division,
the Company concluded that the goodwill balances were unrecoverable. As a
result, on December 31, 2000, the Company recorded a $6.01 million charge
against earnings to write off the remaining goodwill balances associated with
these divisions. Subsequently, these divisions were sold in 2001 at a book gain
of approximately $3.40 million.
===============================================================================
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
30
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
average amount of the balance for the year ended December 31, 2001 was
approximately $12.00 million.
===============================================================================
NOTE FOUR
INVESTMENTS
===============================================================================
The aggregate carrying and approximate market values of securities follow.
Fair values are based on quoted market prices, where available. If quoted
market prices are not available, fair values are based on quoted market prices
of comparable financial instruments.
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------
(in thousands)
December 31, 2001
Available-for-sale securities:
U.S. Treasury securities and
obligations of U.S. government
corporations and
agencies $ 202,422 $ 6,751 $ (318) $ 208,855
Obligations of states and
political subdivisions 64,609 1,425 (135) 65,900
Mortgage-backed securities 90,969 90 (1,519) 89,540
Other debt securities 6,089 161 - 6,250
-------------------------------------------------
Total Debt Securities 364,089 8,428 (1,972) 370,545
Equity securities 12,924 83 - 13,007
-------------------------------------------------
$ 377,013 $ 8,511 $ (1,972) $ 383,552
=================================================
December 31, 2000
Available-for-sale securities:
U.S. Treasury securities and
obligations of U.S. government
corporations and
agencies $ 264,966 $ 2,162 $ (989) $ 266,139
Obligations of states and
political subdivisions 91,586 1,491 (260) 92,817
Mortgage-backed securities 3,481 20 (11) 3,490
Other debt securities 5,663 57 (33) 5,687
-------------------------------------------------
Total Debt Securities 365,696 3,730 (1,293) 368,133
Equity securities 17,233 171 (75) 17,329
-------------------------------------------------
$ 382,929 $ 3,901 $ (1,368) $ 385,462
=================================================
The amortized cost and estimated fair value of debt securities at December
31, 2001, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because the issuers of the securities may
have the right to prepay obligations without prepayment penalties.
Estimated
Fair
Cost Value
--------------------------
(in thousands)
Available-for-Sale
Due in one year or less $ 46,013 $ 46,854
Due after one year through five years 170,442 174,491
Due after five years through ten years 127,421 128,690
Due after ten years 20,213 20,510
--------------------------
$ 364,089 $ 370,545
==========================
Gross gains of $2.67 million, $105,000, and $113,000 and gross losses of
$290,000, $5.12 million, and $10.01 million were realized on sales and calls of
securities during 2001, 2000, and 1999, respectively. Gross gains of $2.67
million in 2001 include $1.62 million of gains realized from the Company's
investmentin a mutual fund during 2001. The Company maintained an average
balance of $46.25 million invested in the mutual fund during 2001 as part of an
income tax planning strategy to generate capital gains, as opposed to interest
income, in order to utilize capital loss carryforwards available to the Company
for income tax purposes. The capital loss carryforwards were primarily generated
by the gross securities losses recognized in 2000 and 1999. Gross losses of
$5.12 million in 2000 are comprised of losses the Company recognized on its
investments in small business investment corporations. The 1999 gross loss of
$10.01 million includes the $10.00 million loss the Company recognized on its
preferred stock investment in Altiva Financial Corporation.
The book value of securities pledged to secure public deposits and for
other purposes as required or permitted by law approximated $260 million and
$332 million at December 31, 2001 and 2000, respectively. Of the $260 million
pledged as of December 31, 2001, $185 million was actually being used as
collateral for borrowings, repurchase agreements, and public deposits. The
remaining $75 million represents an excess pledged position maintained as of
December 31, 2001.
===============================================================================
NOTE FIVE
ALLOWANCE FOR LOAN LOSSES
===============================================================================
A summary of changes in the allowance for loan losses follows:
2001 2000 1999
----------------------------------
(in thousands)
Balance at January 1 $ 40,627 $ 27,113 $ 17,610
Provision for possible loan losses 32,178 25,480 19,286
Charge-offs (26,362) (14,623) (12,252)
Recoveries 4,243 2,657 1,731
Balance of (sold) acquired institutions (2,051) - 738
----------------------------------
Balance at December 31 $ 48,635 $ 40,627 $ 27,113
==================================
The recorded investment in loans that were considered impaired was $29.56
million and $20.33 million at December 31, 2001 and 2000, respectively.
Included in these amounts at December 31, 2001 and 2000 are $9.73 million and
$6.70 million, respectively, of impaired loans for which the related allowance
for loan losses is $2.86 million and $3.63 million, respectively, and $19.83
million and $13.63 million of impaired loans that, as a result of write-downs
or being well secured, do not have an allowance for loan losses. The average
recorded investments in impaired loans during the years ended December 31,
2001, 2000 and 1999, were
31
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
approximately $29.90 million, $16.44 million, and $11.32 million, respectively.
===============================================================================
NOTE SIX
LOANS HELD FOR SALE
===============================================================================
During the second quarter of 2001, the Company terminated its affiliation
with its remaining loan production offices and discontinued the majority of its
secondary market lending activities. As a result, the Company no longer
maintains a loans held-for-sale classification as of December 31, 2001. After
the fourth quarter 2001 sale of its California banking operations, which
included $2.67 million of loans classified as held-for-sale, the Company
transferred the remaining $5.21 million of loans previously classified as
held-for-sale to its permanent loan portfolio. As of December 31, 2000, the
Company reported approximately $17.90 million of loans held for sale.
The Company recorded a net gain (loss) on its loan sales of $3.04 million,
($1.60 million), and $2.72 million in 2001, 2000 and 1999, respectively,
excluding a $3.88 million securitization gain recorded in 1999. During 2000 and
1999, adverse changes in the valuation allowance for loans held for sale
approximated $4.40 million and $2.11 million, respectively and are included in
the net loss and gain, respectively.
===============================================================================
NOTE SEVEN
SECURITIZATIONS AND RETAINED
INTERESTS
===============================================================================
Between 1997 and 1999, the Company completed six securitization
transactions involving approximately $759.76 million of fixed rate, junior lien
mortgage loans. The table below summarizes information regarding delinquencies,
net credit losses, and outstanding collateral balances of securitized loans for
the dates presented:
December 31
2001 2000 1999
------------------------------------
(in thousands)
Total principal amount of loans
outstanding $ 362,051 $ 533,009 $ 651,617
Principal amount of loans 60 days
or more past due 12,544 12,263 10,544
Net credit losses during the year 23,793 21,977 12,240
The principal amount of loans outstanding is not included in the
Consolidated Balance Sheets of the Company.
As of December 31, 2001 and 2000, the Company reported retained interests
in its securitizations of approximately $71.27 million and $85.21 million,
respectively. The value of the retained interests is determined using cash flow
modeling techniques that incorporate key assumptions related to default,
prepayment, and discount rates. As a result of economic forecasts released
during the first quarter of 2001 and the Company's completion of the sale of
its loan servicing responsibilities for its securitized loans to an independent
third party, the Company increased its projected cumulative default rate from
13.68% as of December 31, 2000 to 17.15% as of March 31, 2001. This change in
assumption resulted in a decline of approximately $21.22 million (pre--tax) in
the estimated fair value of the Company's retained interests. Under accounting
rules in effect as of March 31, 2001, the Company recorded a $2.18 million
(pre-tax) impairment charge in its Consolidated Statements of Income and a
$19.04 million (pretax) unrealized loss in its Stockholders' Equity during the
first quarter of 2001.
As discussed in Note One, on April 1, 2001, the Company adopted the
accounting provisions of Emerging Issues Task Force Issue 99-20 ("Issue 99-20")
as required. Issue 99-20 set forth specific accounting guidance regarding the
recognition of interest income on, and impairment of, retained interests in
securitized loans. The required adoption of Issue 99-20 resulted in the Company
recording a $29.98 million (pre-tax), or $17.99 million (net of tax) cumulative
effect of accounting change during the second quarter of 2001. In conjunction
with recording this cumulative effect of accounting change, unrealized losses
on the retained interests that were previously recorded as negative adjustments
within Stockholders' Equity were reversed and recorded through the Company's
Consolidated Statements of Income in accordance with the new accounting rules.
In addition to establishing specific guidance related to determining
whether impairment exists in the Company's retained interests, Issue 99-20 also
set forth requirements for the recognition of interest income on retained
interests in securitized loans. Issue 99-20 requires that interest income on
retained interests be recognized over the life of the retained interest using
the effective yield method. Using the effective yield approach, the Company
re-instituted the accrual of interest income on its retained interests,
recognizing $7.43 million (pre-tax) of interest income through December 31,
2001.
Although the Company has recognized interest income on its retained
interests, it has not yet received any cash from this investment. The estimated
fair value of the retained interests is accrued toward the expectation of when,
and how much, cash will be received in the future.
32
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
Key assumptions used in estimating the fair value of the Company's retained
interests as of December 31, 2001 and 2000 were as follows:
December 31
2001 2000
----------------------
Prepayment speed (CPR) 16.00% 15%-21%
Weighted average cumulative defaults 15.59% 13.68%
Weighted average discount rate 14.00% 14.00%
At December 31, 2001, the sensitivity of the current estimated fair value
of retained interests to immediate 10% and 20% adverse changes were as follows:
Estimated fair value at December 31, 2001 $77,689
Discount rate:
Impact on fair value of 10% adverse change (5,645)
Impact on fair value of 20% adverse change (10,757)
Default curve:
Impact on fair value of 10% adverse change (4,555)
Impact on fair value of 20% adverse change (8,365)
Prepayment curve:
Impact on fair value of 10% adverse change (764)
Impact on fair value of 20% adverse change (1,600)
These sensitivity analyses are hypothetical. As these figures indicate, any
change in estimated fair value based on a 10% variation in assumptions cannot be
extrapolated because the relationship of the change in assumption to the change
in fair value is not linear. Also, in this table, the effect of a variation in a
particular assumption on the fair value of the retained interests is calculated
independent from any change in another assumption; in reality, changes in one
factor may result in changes in another, which may magnify or counteract the
sensitivities.
The estimated fair value of the retained interests increased during 2001
due to both higher than expected prepayments and lower than expected default
rates. Therefore, while the book value of the assets at December 31, 2001 was
$71.27 million, the estimated fair value was $77.69. As a result, under EITF
99-20, the Company is required to increase the rate at which it accrues income
over the life of the retained interest using the effective yield method.
===============================================================================
NOTE EIGHT
LOAN SERVICING
===============================================================================
During the fourth quarter of 2000, the Company sold its mortgage servicing
rights associated with approximately $1.10 billion of junior lien and Title I
mortgage loans. The transfer of the loan servicing portfolio to the acquirer was
completed during the first quarter of 2001. As a result of this transaction, the
Company does not have any mortgage servicing rights recorded in its Consolidated
Balance Sheets as of December 31, 2001 or 2000. Prior to the sale of its
servicing rights, the Company recorded amortization of mortgage servicing rights
of approximately $2.73 million and $2.44 million during the years ended December
31, 2000 and 1999, respectively.
With the completion of the transfer of the loan servicing portfolio in
March 2001, the Company recorded a $1.90 million charge to earnings, recorded in
Other Expense in the Consolidated Statements of Income, to reflect the estimated
contractual obligation to FannieMae associated with a specific pool of loans
included in the sale of servicing rights. The Company is obligated to reimburse
FannieMae for document deficiencies found in this particular pool of loans.
The Company continues to provide loan servicing operations for certain
pools of loans that were not included in the sale of servicing rights. The
unpaid principal balance of loans serviced for others approximated $66.69
million and $1.20 billion as of December 31, 2001 and 2000, respectively. Loans
serviced for others are not included in the accom--panying Consolidated Balance
Sheets.
===============================================================================
NOTE NINE
PREMISES AND EQUIPMENT
===============================================================================
As part of the Company's restructuring during 2001, it closed certain
branch locations and operations facilities within its community banking segment.
The carrying value of the land, buildings, and related capital improvements on
the dates these facilities were closed approximated $4.04 million. The Company
estimated the fair value, less cost to sell, of these properties at $2.35
million and recorded a $1.69 million loss in 2001 within the Non-Interest
Expense section of its Consolidated Statements of Income.
One of these properties was sold prior to December 31, 2001. The Company is
actively marketing the remaining properties and expects to sell them during
2002. As of December 31, 2001, the carrying amount of the properties not sold
approximated $2.02 million and is recorded in Other Assets in the Consolidated
Balance Sheets.
Additionally, during 2001 the Company retired capitalized software with a
carrying amount of $1.65 million and recorded this loss with the aforementioned
losses in the Non-Interest Expense section of the Consolidated Statements of
Income. The Company determined that this software, primarily related to mortgage
banking activities and certain home banking projects, did not fit the Company's
revised business model and would not be used in future operations.
33
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
A summary of premises and equipment and related accumulated depreciation is
summarized as follows:
December 31
2001 2000
------------------------
(in thousands)
Land, buildings, and improvements $ 56,616 $ 63,948
Furniture, fixtures, and equipment 47,375 57,715
------------------------
103,991 121,663
Less allowance for depreciation (60,813) (64,739)
------------------------
$ 43,178 $ 56,924
========================
===============================================================================
NOTE TEN
SCHEDULED MATURITIES OF TIME
CERTIFICATES OF DEPOSITS OF $100,000
OR MORE
===============================================================================
Scheduled maturities of time certificates of deposits of $100,000 or more
outstanding at December 31, 2001 and 2000 are summarized as follows:
2001 2000
-------------------------
(in thousands)
Within one year $ 99,685 $ 292,348
Over one through two years 21,455 31,644
Over two through three years 3,533 5,067
Over three through four years 1,577 1,839
Over four through five years 522 4,077
Over five years 202 168
-------------------------
Total $ 126,974 $ 335,143
=========================
Through its subsidiary, City National, the Company has periodically issued
brokered deposits to fund loan growth and satisfy liquidity needs. Generally,
brokered deposits are issued in increments of $100,000, have maturities of up
to five years, and pay interest equal to a comparable treasury rate, plus a
market-based spread. At December 31, 2000, $134.38 million of brokered deposits
were outstanding, and included in the table above, at an average interest rate
of 6.68% and an average remaining term of two months. Due to the significant
decline in outstanding loan balances and the resulting improved liquidity
position of City National during 2001, the Company did not issue any additional
brokered deposits during the year and has none outstanding as of December 31,
2001.
===============================================================================
NOTE ELEVEN
SHORT-TERM BORROWINGS
===============================================================================
Short-term borrowings include securities sold under agreement to
repurchase of $127.20 million and $131.73 million as of December 31, 2001 and
2000, respectively. Securities sold under agreement to repurchase were sold to
corporate and government customers as an alternative to available deposit
products. The underlying securities included in repurchase agreements remain
under the Company's control during the effective period of the agreements.
Advances obtained from the Federal Home Loan Bank ("FHLB") of $90.50 million
are also included in short-term borrowings as of December 31, 2000. A summary
of these short-term borrowings is as follows:
(in thousands)
2001:
- ----
Average amount outstanding during the year $ 173,974
Maximum amount outstanding at any month end 242,255
Weighted average interest rate:
During the year 4.95%
End of the year 2.43%
2000:
- ----
Average amount outstanding during the year $ 309,330
Maximum amount outstanding at any month end 357,293
Weighted average interest rate:
During the year 6.14%
End of the year 6.01%
1999:
- ----
Average amount outstanding during the year $ 230,060
Maximum amount outstanding at any month end 375,251
Weighted average interest rate:
During the year 4.97%
End of the year 5.18%
At December 31, 2000, short-term borrowings also include a $26.53 million
obligation of the Parent Company pursuant to a short-term note and line of
credit with SunTrust Bank. During 2001, the Parent remitted regular principal
payments of $4.20 million and paid interest at a weighted-average interest rate
of 7.70%. The remaining $22.33 million outstanding principal balance was fully
repaid from the proceeds obtained from the Parent's sale of its California
banking operations on November 30, 2001.
===============================================================================
NOTE TWELVE
LONG-TERM DEBT
===============================================================================
The Company, through its banking subsidiaries, maintains long-term
financing from the FHLB as follows:
December 31, 2001
-------------------------------
Amount Amount
Available Outstanding Interest Rate Maturity Date
- ----------------------------------------------------------------------
(in thousands)
$ 5,000 $ 5,000 5.48% February 2008
10,000 10,000 4.86 October 2008
--------------
$ 15,000
==============
The Company has purchased, through its banking subsidiaries, 81,602 shares
of FHLB stock at par value. Such purchases entitle the Company to dividends
declared by the
34
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
FHLB and provide 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 U.S. Treasury and agency
securities, mortgage-backed securities, and residential real estate loans. At
December 31, 2001, collateral pledged to the FHLB included approximately $62.86
million in investment securities and $233.49 million in residential real estate
loans.
In addition to the short-term (see Note Eleven) and longterm financing
discussed above, at December 31, 2001, the Company's banking subsidiaries had an
additional $231.44 million available from unused portions of lines of credit
with the FHLB.
As of December 31, 2001 and 2000, the Company also included $14.33 million
and $19.83 million, respectively, in its Long Term Debt representing a
fully-collateralized obligation outstanding with Freddie Mac. Collateral for
this obligation includes a pool of first lien mortgage loans that were sold to
Freddie Mac with full recourse. The outstanding balance of this financing will
decline as the principal balances of the underlying loans are repaid. Because
the loans were sold with full recourse, the outstanding principal balance of the
underlying loan pool is included in the Company's loan portfolio.
===============================================================================
NOTE THIRTEEN
TRUST PREFERRED SECURITIES
===============================================================================
The Company has formed two statutory business trusts under the laws of the
state of Delaware. The trusts are 100% owned financing subsidiaries of the
Company and exist for the exclusive purpose of (i) issuing trust preferred
capital securities ("Capital Securities"), which represent preferred undivided
beneficial interests in the assets of the trusts, (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 Debentures are the sole assets
of the trusts and the Company's payments under the Debentures are the sole
source of revenue of the trusts. The Debentures and the related income statement
effects are eliminated in the Company's consolidated financial statements.
The Company has irrevocably and unconditionally guaranteed the obligations
of the trusts, but only to the extent of funds held by the trusts. Distributions
on the Capital Securities are cumulative. The Company has the option to defer
payment of the distributions for an extended period up to five years, so long as
the Company is not in default as to the terms of the Debentures. In June 2001,
the Company was prohibited by the Federal Reserve Bank of Richmond (the "FRBR")
from making scheduled periodic dividend payments to either of its trusts.
Generally, the FRBR's policy is that bank holding companies pay dividends out of
earnings in the prior four quarters. The Company experienced losses in the
first, second, and third quarter of 2001. Therefore, the FRBR required the
Company to defer payment to the Capital Trusts through at least April 2002.
Thus, payments have only been made to shareholders of the Trust through March
15, 2001 for City Holding Company Capital Trust, and through April 15, 2001 for
City Holding Company Capital Trust II. Although cash payments have been
deferred, the Company continues to accrue and record interest expense in its
Consolidated Statements of Income. Pursuant to the terms of the Capital
Securities, interest is also accrued on the unpaid interest at interest rates
equivalent to the stated interest rates for each issue. Resumption of dividend
payments on the Capital Securities will require the approval of the Federal
Reserve Bank of Richmond. When interest payments are resumed, the Trusts will
distribute cumulative interest payments to holders of the Capital Securities at
the record date.
The Capital Securities are subject to mandatory redemption to the extent of
any early redemption of the Debentures and upon maturity of the Debentures, as
outlined below. The following table summarizes the Company's two trusts:
Liquidation Stated
Payment Value per Issuance Maturity
Trust Amount Rate Frequency Share Date Date
- -------------------------------------------------------------------------------------
City Holding $ 30,000 9.150% Semi- $ 1,000 March April
Capital Trust annually 1998 2028 (a)
City Holding 57,500 9.125 Quarterly 25 October October
Capital Trust II 1998 2028 (b)
----------
$ 87,500
==========
(a) Redeemable prior to maturity at the option of the Company (i) on or
after April, 1, 2008, in whole at any time or in part from time to
time, at declining redemption prices ranging from 104.58% to 100.00% on
April 1, 2018 and thereafter, 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.
(b) Redeemable prior to maturity at the option of the Company (i) on or
after October 31, 2003, in whole at any time or in part from time to
time, or (ii) prior to October 31, 2003, in whole, but not in part, at
any time within 90 days following the occurrence and during the
continuation of certain predefined events.
The obligations outstanding under the aforementioned trusts are classified
as "Corporation-obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures of City Holding
Company" in the liabilities section of the Consolidated Balance Sheets.
Distributions on the capital securities are recorded in the Consolidated
Statements of Income as interest
35
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
expense. The Company's interest payments on the debentures are fully
tax-deductible.
===============================================================================
NOTE FOURTEEN
RESTRICTIONS ON SUBSIDIARY DIVIDENDS
===============================================================================
During 2001, City National requested and received permission from the
Office of the Comptroller of the Currency to pay $8.87 million in dividends to
the Parent Company. The Parent Company used the cash obtained from these
dividends to remit principal and interest payments on a short-term note and line
of credit with SunTrust Bank, to remit interest payments on its trust preferred
securities through April 2001, and to provide cash for operating expenses of the
Parent Company.
The OCC is required to approve the payment of dividends by a subsidiary
bank in excess of its earnings retained in the current year plus retained net
profits for the preceding two years. Therefore, under the OCC's dividend policy,
as well as the formal agreement between the OCC and City National, the bank will
need to request and receive the OCC's permission for any dividend payments to
the Parent Company during 2002. Therefore, resumption of dividends on either the
Capital Securities or the common stock of the Company would require the approval
of both the FRBR and the OCC.
===============================================================================
NOTE FIFTEEN
INCOME TAXES
===============================================================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
December 31
2001 2000
-------------------------
(in thousands)
Deferred tax assets:
Allowance for loan losses $ 19,474 $ 16,124
Retained interests 19,076 9,552
Capital loss carryforward 4,459 5,367
Deferred compensation payable 3,331 1,658
Accrued expenses 3,514 -
Gain on sale of assets - 2,404
Goodwill amortization - 7,119
Restructuring charges - 1,631
Loans held for sale - 1,642
Unrealized losses - 3,438
Other 2,058 1,061
-------------------------
Total Deferred Tax Assets 51,912 49,996
Deferred tax liabilities:
Unrealized securities gains 2,615 -
Premises and equipment 324 1,425
Core deposit intangible 198 532
Deferred loan fees 479 1,925
Other 853 1,468
-------------------------
Total Deferred Tax Liabilities 4,469 5,350
-------------------------
Net Deferred Tax Assets $ 47,443 $ 44,646
=========================
Significant components of the provision for income taxes are as follows:
2001 2000 1999
----------------------------------
(in thousands)
Federal:
Current $ (6,798) $ 6,320 $ 10,072
Deferred (8,463) (22,802) (9,198)
----------------------------------
(15,261) (16,482) 874
State (1,380) 752 968
----------------------------------
Total $(16,641) $(15,730) $ 1,842
==================================
The $16.64 million income tax benefit recorded in 2001 includes an $11.99
million income tax benefit allocated to the cumulative effect of accounting
change associated with the Company's accounting for its retained interests in
securitized mortgage loans.
Current income tax expense attributable to investment securities
transactions approximated $953,000 in 2001, $41,000 in 2000, and $53,000 in
1999.
As of December 31, 2001, the Company has approximately $800,000 of federal
net operating loss carryforwards, obtained via a previous acquisition, that
expire in 2006.
A reconciliation of the significant differences between the federal
statutory income tax rate and the Company's effective income tax rate is as
follows:
36
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
2001 2000 1999
-------------------------------------
(in thousands)
Computed federal taxes at statutory $ (14,924) $ (18,936) $ 2,819
rate
State income taxes, net of federal tax
benefit (877) (1,590) 630
Tax effects of:
Nontaxable interest income (1,169) (1,669) (1,703)
Non-deductible goodwill 210 6,237 427
Other items, net 119 228 (331)
----------------------------------
$ (16,641) $ (15,730) $ 1,842
==================================
===============================================================================
NOTE SIXTEEN
EMPLOYEE BENEFIT PLANS
===============================================================================
The Company's 1993 Stock Incentive Plan (the "Plan"), as amended, provides
for the grant of options to key employees of the Company and persons who provide
services to the Company who have or can be expected to contribute significantly
to the profits or growth of the Company, including Directors of the Company or
its subsidiaries. The Plan, as amended, permits the grant of options for up to
1,399,300 shares of the Company's common stock, as adjusted for changes in the
capital structure of the Company since the Plan's inception. As of December 31,
2001, there are 782,792 options available for future awards. Specific terms of
options awarded, including vesting periods, exercise prices and expiration
periods are determined at the date of grant and are evidenced by agreements
between the Company and the awardees. After 2003, no additional options can be
granted under the Plan.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123 and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for the options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions: a risk-free interest rate of 3.88% and 5.90% for 2001 and 1999,
respectively; an expected dividend yield of 0.00% and 2.04% for 2001 and 1999,
respectively; a volatility factor of 0.411 and 0.293 for 2001 and 1999,
respectively; and an expected life of the option of five and four years for
2001 and 1999, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of options
is amortized to expense over the options' vesting period. Pro forma net (loss)
income for the years ended December 31, 2001, 2000, and 1999 were $(26.16)
million or $(1.55) per basic and diluted common share; $(38.39) million or
$(2.27) per basic and diluted common share; and $6.21 million or $0.37 per basic
and diluted common share, respectively.
A summary of the Company's stock option activity and related information
is presented below for the years ended December 31:
2001 2000 1999
--------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------------------------------------------------------------
Outstanding at
January 1 466,750 $ 26.72 561,967 $ 27.19 380,781 $ 32.26
Granted 295,000 6.78 - - 238,250 15.25
Exercised - - - - (30,461) 17.11
Forfeited (223,760) 28.56 (95,217) 29.51 (26,603) 31.74
---------- --------- ---------
Outstanding at
December 31 537,990 $ 15.04 466,750 $ 26.72 561,967 $ 27.19
========== ========= =========
Exercisable at end
of year 238,971 $ 22.20 288,092 $ 29.51 313,300 $ 31.74
Weighted-average
fair value of
options granted
during the year $ 2.86 $ - $ 3.06
Additional information regarding stock options outstanding and exercisable
at December 31, 2001, is provided in the following table:
Weighted Weighted
Average Average
Weighted Remaining No. of Exercise Price
Ranges of No. of Average Contractual Options of Options
Exercise Options Exercise Life Currently Currently
Prices Outstanding Price (Months) Exercisable Exercisable
- -----------------------------------------------------------------------------------
$5.75 - $8.63 220,000 $ 5.96 109 29,843 $ 6.70
$8.65 - $12.98 75,832 9.23 113 34,080 9.12
$15.25 - $22.88 144,000 15.25 36 86,500 15.25
$24.50 - $36.75 27,749 31.55 19 27,749 31.55
$40.00 - $42.75 70,409 42.75 27 60,799 42.75
----------- -----------
537,990 238,971
=========== ===========
Effective November 1, 2001, the Company modified and combined its existing
employee retirement benefit plans. The former City Holding Company Profit
Sharing and 401(k) Plan was renamed the City Holding Company 401(k) Plan and
Trust ("the 401(k) Plan"), a plan intended to be compliant with Employee
Retirement Income Security Act (ERISA) section 404(c). Any employee who has
attained age 21 is
37
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
eligible to participate beginning the first day of the month following
employment. Unless specifically chosen otherwise, every employee is
automatically enrolled in the 401(k) Plan and may make before-tax contributions
of between 1.00% to 15.00% of eligible pay up to the dollar limit imposed by
Internal Revenue Service regulations. The first 6.00% of an employee's
contribution is matched 50.00% by the Company. The employer matching
contribution is invested according to the investment elections chosen by the
employee. Employees are 100% vested in both employee and employer contributions
and the earnings they generate. As of December 31, 2001, there were twelve
investment options available under the 401(k) Plan, including City Holding
Company common stock.
The City Holding Company Employees' Stock Ownership Plan ("ESOP"), covering
all employees who have completed one year of service and have attained the age
of 21, was created January 1, 1996, and includes both Money Purchase and Stock
Bonus plan features. The Company has not contributed to the Money Purchase
account since June 2000 or to the Stock Bonus account since 1998. Effective
November 1, 2001, the Money Purchase and the Stock Bonus accounts were merged
into the City Holding Company 401(k) Plan.
The Company's total expense associated with the 401(k) Plan and the ESOP
(collectively, the benefit plans) approx-imated $263,000, $630,000, and $5.39
million in 2001, 2000, and 1999, respectively. The total number of shares of the
Company's common stock held by the benefit plans is 822,733. Other than the
benefit plans, the Company offers no postretirement benefits.
Prior to its merger with the Company, Horizon maintained a defined benefit
pension plan covering substantially all of its employees. During 1999, the
Company froze the Horizon defined benefit plan, and the accrual for the future
service of the employees covered by this defined benefit plan was transferred to
the Company's defined contribution plan. As a result of freezing the Horizon
plan, the accrual of defined benefits for future services was eliminated
resulting in the Company recognizing a $3.67 million curtailment gain,
representing the change in projected benefit obligations, less $1.00 million
charge-off of prior service costs associated with the plan. The following table
summarizes the plan's benefit obligation and asset activity:
Pension Benefits
2001 2000
---------------------
(in thousands)
Change in fair value of plan assets:
Balance at beginning of measurement $ 9,780 $ 9,614
period
Actual (loss) return on plan assets (644) 531
Benefits paid (356) (365)
---------------------
Balance at end of measurement period 8,780 9,780
Change in benefit obligation:
Balance at beginning of measurement (7,455) (7,129)
period
Interest cost (585) (578)
Actuarial loss (784) (113)
Benefits paid 356 365
---------------------
Balance at end of measurement period (8,468) (7,455)
---------------------
Funded status 312 2,325
Unrecognized net actuarial loss (gain) 1,100 (1,155)
Unrecognized net obligation (197) (225)
---------------------
Prepaid Benefit Cost $ 1,215 $ 945
=====================
Weighted-average assumptions as of December 31:
Discount rate 8.00% 8.00%
Expected return on plan assets 8.50% 8.50%
Rate of compensation increase 4.25% 5.00%
Plan assets consist principally of U.S. Government securities, corporate
stocks and bonds, and other short-term investments.
The following table presents the components of net defined benefit pension
costs:
Pension Benefits
2001 2000 1999
--------------------------------
(in thousands)
Components of net periodic
benefit cost:
Service cost $ - $ - $ 331
Interest cost 585 578 524
Expected return on plan assets (817) (805) (766)
Net amortization and deferral (41) (58) (58)
Curtailment - - (3,699)
Prior service cost recognized - - 1,008
------------------------------
Benefit Cost $ (273) $ (285) $(2,660)
==============================
The Company maintains individual deferred compensation and supplemental
retirement agreements with certain directors and officers. The cost of
such individual agreements is being accrued over the period of active
service from the date of the respective agreement. The cost of such agreements
approximated $643,000, $282,000, and $425,000 during 2001, 2000, and 1999,
respectively. The liability for such agreements approximated $3.30 million
and $2.81 million at December 31, 2001 and 2000, respectively, and is included
in other liabilities in the accompanying Consolidated Balance Sheets.
To assist in funding the above liabilities, the Company has insured the
lives of certain directors and officers. The Company is the owner and
beneficiary of the insurance policies with a cash surrender value approximating
38
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
$4.07 million and $3.64 million at December 31, 2001 and 2000 included in other
assets in the accompanying Consolidated Balance Sheets.
===============================================================================
NOTE SEVENTEEN
OTHER INCOME
===============================================================================
The following table summarizes significant items included in Other Income
for the periods indicated:
2001 2000 1999
------------------------------------
(in thousands)
Internet service fees $ 797 $ 3,443 $ 2,514
Insurance commissions 2,214 2,482 2,834
===============================================================================
NOTE EIGHTEEN
RELATED PARTY TRANSACTIONS
===============================================================================
City National has granted loans to the officers and directors of the
Company and its subsidiaries, and to their associates. The loans were made in
the ordinary course of business and on substantially the same terms, including
interest rates and collateral, as those prevailing at the same time for
comparable transactions with unrelated persons and did not involve more than
normal risk of collectibility.
The following presents the activity with respect to related party loans
during 2001 and 2000:
2001 2000
-------------------------
(in thousands)
Balance at January 1 $ 33,946 $ 42,303
Loans made 573 7,830
Principal payments received (3,214) (11,080)
Other changes (23,512) (5,107)
-------------------------
Balance at December 31 $ 7,793 $ 33,946
=========================
Amounts reported as other changes in the table above represent changes in
the composition of the Company's Board of Directors and officers during 2001
and 2000.
===============================================================================
NOTE NINETEEN
COMMITMENTS AND CONTINGENT LIABILITIES
===============================================================================
The Company recorded a $3.00 million charge against earnings during the
third quarter of 2001 to accrue costs associated with litigation involving
operations the Company has either sold or closed. In addition, the Company is
engaged in various legal actions that it deems to be in the ordinary course of
business. The Company believes that it has adequately provided for the
potential costs of current litigation. Nevertheless, current actions may have
results that are materially different than anticipated or unanticipated material
legal actions may be presented in the future.
In the normal course of business, certain financial products are offered
by the Company to accommodate the financial needs of its customers. Loan
commitments (lines of credit) represent the principal off-balance sheet
financial product offered by the Company. At December 31, 2001 and 2000,
commitments outstanding to extend credit totaled approximately $140.76 million
and $237.97 million, respectively. To a much lesser extent, the Company offers
standby letters of credit, which require payments to be made on behalf of
customers when certain specified events occur. Amounts outstanding pursuant to
such standby letters of credit were $4.92 million and $9.03 million as of
December 31, 2001 and 2000, respectively. Historically, substantially all
standby letters of credit have expired unfunded.
Loan commitments and standby 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.
===============================================================================
NOTE TWENTY
PREFERRED STOCK AND SHAREHOLDER
RIGHTS PLAN
===============================================================================
The Company's Board of Directors has the authority to issue preferred
stock, and to fix the designation, preferences, rights, dividends, and all
other attributes of such preferred stock, without any vote or action by the
shareholders. As of December 31, 2001, no such shares are outstanding, nor are
any expected to be issued, except as might occur pursuant to the Stock Rights
Plan discussed below.
The Company's Stock Rights Plan provides that each share of common stock
carries with it one right. The rights would be exercisable only if a person or
group, as defined, acquired 15% or more of the Company's common stock, or
announces a tender offer for such stock. Under conditions described in the
Stock Rights Plan, holders of rights could acquire shares of preferred stock or
additional shares of the Company's common stock--or in the event of a 50% or
more change in control, shares of common stock of the acquirer. The value of
shares acquired under the plan would equal twice the exercise price.
39
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
================================================================================
NOTE TWENTY-ONE
REGULATORY MATTERS
================================================================================
On July 12, 2000, the Company announced that its principal bank subsidiary,
City National, had entered into a formal agreement with the OCC. The agreement
required City National to adopt a three-year comprehensive strategic plan,
improve its loan portfolio management, and develop and adhere to a written plan
for liquidity, including a formal asset and liability management policy. City
National also agreed to incorporate liquidity planning in its financial
management process, implement a satisfactory program to manage interest rates,
and ensure full compliance of its securitization program with recent OCC
regulations. Additionally, City National agreed to develop a plan to dispose of
loans held for sale that were held in excess of 90 days, develop a three-year
capital plan, strengthen internal controls and its audit committee, and
establish a program to maintain an adequate allowance for loan and lease losses.
Additionally, as a consequence of entering into this agreement, City National
became subject to certain FDIC restrictions regarding the issuance of brokered
deposits. City National also agreed to maintain its regulatory Total Capital
ratio above 10.00% and to establish a committee of its Board of Directors to
oversee compliance with the agreement.
Subsequent to the date of the agreement, City National established a
compliance oversight committee, which meets regularly to determine the status of
compliance with the agreement. City National and the Company also adopted a
three-year comprehensive strategic plan; formalized policies and procedures
related to asset and liability management, including liquidity and interest rate
risk issues; formalized policies and procedures associated with its
securitization program to ensure compliance with OCC regulations; disposed of
substantially all of its loans held for sale that had been held in excess of 90
days and transferred the unsold loans to the permanent portfolio at estimated
fair market value; and developed a three-year capital plan.
In September 2001, City National entered into a new, less comprehensive,
formal agreement with the OCC that replaced the July 12, 2000 formal agreement.
The revised agreement, which was based on the results of the April 2001
regulatory examination of City National, primarily focuses on lending policies
and procedures and on certain aspects of City National's methodology for
assessing the adequacy of its allowance for loan losses. Management continues to
devote considerable time and resources toward complying with the requirements of
the revised formal agreement.
The Company, including its banking subsidiaries, is subject to various
regulatory capital requirements administered by the various banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary, action by regulators that, if undertaken,
could have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and its banking subsidiaries must meet
specific capital guidelines that involve quantitative measures of assets,
liabilities, and certain off-balance sheet items calculated under regulatory
accounting practices. The Company's and its banking subsidiaries' capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and its banking subsidiaries 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, 2001, that the Company and its banking subsidiaries met all
capital adequacy requirements to which they were subject.
As a consequence of entering into the formal agreement with the OCC, City
National cannot be categorized as "well capitalized" under the regulatory
framework for prompt corrective action. Although City National's regulatory
capital ratios exceed minimum ratios to be considered "well capitalized," any
bank that has entered into a formal agreement such as that discussed above is
precluded from being categorized as "well capitalized".
The Company's and City National's actual capital amounts and ratios are
presented in the following table.
Well
2001 2000 Capitalized Minimum
Amount Ratio Amount Ratio Ratio Ratio
=============================================================
(in thousands)
Total Capital (to Risk Weighted Assets):
Consolidated $ 214,718 13.1% $ 277,700 11.6% 10.0% 8.0%
City National 224,737 13.7 285,319 12.7 10.0 8.0
Tier I Capital (to Risk Weighted Assets):
Consolidated 153,852 9.4 216,314 9.1 6.0 4.0
City National 203,895 12.4 257,156 11.5 6.0 4.0
Tier I Capital (to Average Assets):
Consolidated 153,852 6.9 216,314 7.9 5.0 4.0
City National 203,895 9.8 257,156 10.1 5.0 4.0
In November 2001, regulatory agencies issued new guidelines changing
regulatory capital standards to address the treatment of, among other things,
retained interests for purposes of computing regulatory capital and the
aforementioned regulatory capital ratios. In general, the new guidelines require
an increased allocation of regulatory capital to assets such as retained
interests in securitized mortgage loans and the new rules limit the amount of
retained interests
40
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
financial institutions may include in regulatory capital. Although the new rule
becomes effective January 1, 2002, institutions that completed transactions
before December 31, 2001 impacted by the new rule may delay application of the
new standard until December 31, 2002. Had the Company been required to comply
with the new rule as of December 31, 2001, the Company estimates that its Total
Capital, Tier I Capital, and Leverage Capital ratios would have approximated
11.43%, 7.65%, and 5.84%, respectively. Similarly, City National estimates that
its Total Capital, Tier I Capital, and Leverage Capital ratios would have been
12.31%, 10.87%, and 9.13%, respectively, as of December 31, 2001, which are in
excess of the aforementioned "well capitalized" ratios.
================================================================================
NOTE TWENTY-TWO
FAIR VALUES OF FINANCIAL INSTRUMENTS
================================================================================
FASB Statement No. 107, Disclosures about Fair Value of Financial
Instruments, requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Statement No. 107 excludes certain
financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.
The following table represents the estimates of fair value of financial
instruments:
Fair Value of Financial Instruments
2001 2000
--------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------------------------------------------------
(in thousands)
Assets:
Cash and due from banks $ 81,827 $ 81,827 $ 87,990 $ 87,990
Securities 383,552 383,552 385,462 385,462
Net loans 1,341,620 1,352,243 1,927,532 1,914,802
Loans held for sale - - 17,900 17,900
Retained interests 71,271 77,689 85,206 85,206
Liabilities:
Deposits 1,691,295 1,700,891 2,083,941 1,961,645
Short-term borrowings 127,204 127,204 248,766 248,766
Long-term debt 29,328 29,984 34,832 34,304
Trust preferred securities 93,158 94,512 89,061 92,428
The following methods and assumptions were used in estimating fair value
amounts for financial instruments:
The fair value of the loan portfolio is estimated using discounted cash
flow analyses at interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. The carrying value of accrued
interest approximates its fair value.
The fair value of the retained interests is determined using cash flow
modeling techniques that incorporate key assumptions related to default,
prepayment, and discount rates.
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. Fair values for certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a schedule of
aggregate expected monthly maturities of time deposits.
Securities sold under agreements to repurchase represent borrowings with
original maturities of less than 90 days. The carrying amount of advances from
the FHLB and borrowings under repurchase agreements approximate their fair
values.
The fair 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.
The fair value of trust preferred securities is estimated using a
discounted cash flow calculation that applies interest rates that would be
currently offered on such securities. Both the carrying amount and estimated
fair value of trust preferred securities includes interest accrued on those
securities as of December 31, 2001 and 2000.
The fair values of commitments are estimated based on fees currently
charged to enter into similar agreements, taking into consideration the
remaining terms of the agreements and the counterparties' credit standing. The
fair value of letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties at the reporting date. The fair values
approximated the carrying values of these commitments and letters of credit as
of December 31, 2001 and 2000.
41
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
===============================================================================
NOTE TWENTY-THREE
CITY HOLDING COMPANY (PARENT
COMPANY ONLY) FINANCIAL
INFORMATION
===============================================================================
Condensed Balance Sheets
December 31
2001 2000
--------------------------------
(in thousands)
Assets
Cash $ 1,045 $ 334
Securities available for sale 347 2,366
Investment in subsidiaries 240,823 280,256
Fixed assets 329 476
Other assets 4,857 7,217
--------------------------------
Total Assets $ 247,401 $ 290,649
================================
Liabilities
Short-term borrowings $ - $ 26,534
Junior subordinated debentures 90,114 90,114
Advances from affiliates - 934
Other liabilities 10,938 9,610
--------------------------------
Total Liabilities 101,052 127,192
Stockholders' Equity 146,349 163,457
--------------------------------
Total Liabilities and Stockholders' Equity $ 247,401 $ 290,649
================================
During 2001, the Parent Company sold the majority of its investment
securities portfolio and used the proceeds to fully repay its Advances from
affiliates and to repay a portion of the outstanding balance of the Parent's
short-term term note and line of credit with SunTrust Bank. The Parent also
completed the sale of its California banking subsidiaries during 2001 and used
the proceeds obtained from the sale to fully repay the remaining outstanding
balance of the Parent's short-term borrowings with SunTrust Bank. Junior
subordinated debentures, which eliminate for purposes of the Company's
consolidated financial statements, represent the Parent Company's amounts owed
to City Holding Capital Trust II and City Holding Capital Trust (see Note
Thirteen). The balance the junior subordinated debentures is comprised of the
$87. million the Capital Trusts obtained through the issuances the trust
preferred securities and $2.61 million the Capital Trusts obtained from the
Parent Company in the form of the Parent Company's initial capitalization of the
Capital Trusts Other liabilities include approximately $5.66 million accrued
interest payable by the Parent to the Capital Trusts.
As a result of the sale of the California banking subsidiaries, the Parent
recognized a pre-tax gain approximately $4.67 million, included in Other income
in Condensed Statements of Income, below.
Condensed Statements of Income
Year Ended December 31
2001 2000 1999
-------------------------------------------
(in thousands)
Income
Dividends from bank subsidiaries $ 8,873 $ 12,500 $ 20,000
Administrative fees 2,502 3,816 1,743
Other income 4,831 - 703
--------------------------------------------
16,206 16,316 22,446
Expenses
Interest expense 9,909 10,248 9,606
Other expenses 6,195 9,345 10,322
--------------------------------------------
16,104 19,593 19,928
--------------------------------------------
Income (Loss) Before Income Tax
Benefit and (Excess Dividends) Equity
in Undistributed Net Income of
Subsidiaries 102 (3,277) 2,518
Income tax benefit (3,332) (6,083) (6,945)
--------------------------------------------
Income Before (Excess Dividends)
Equity in Undistributed Net Income
of Subsidiaries 3,434 2,806 9,463
(Excess dividends) equity in undistributed net
income of subsidiaries (29,434) (41,179) (3,250)
--------------------------------------------
Net (Loss) Income $ (26,000) $ (38,373) $ 6,213
============================================
Condensed Statements of Cash Flows
Year Ended December 31
2001 2000 1999
-------------------------------------------
(in thousands)
Operating Activities
Net (loss) income $(26,000) $(38,373) $ 6,213
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Gain on sale of subsidiaries (4,669) - -
Realized investment securities gains (111) - -
Provision for depreciation 161 287 897
Increase in other asset 422 1,265 2,356
Increase (decrease) in other liabilities 1,410 3,788 (6,513)
Excess dividends of subsidiaries (equity in
undistributed net income) 31,934 38,679 3,250
--------------------------------------------
Net Cash Provided by Operating
Activities 3,147 5,646 6,203
Investing Activities
Cash paid in acquisition - (15,134)
Proceeds from sales of securities 2,079 1,599
Purchases of investment securities - (558)
Net change in loans - - 46
Proceeds from sale of net assets to City National - 328 6,731
Purchases of premises and equipment (47) - (1,392)
--------------------------------------------
Net Cash Provided by (Used in)
Investing Activities 2,032 328 (8,708)
Financing Activities
Proceeds from long-term debt - 23,134
Decrease in short-term borrowings (3,534) - -
Principal repayments on long-term debt - (1,600) (10,000)
Decrease in advance from affiliates (934) (257)
Cash dividends paid - (7,426) (13,471)
Purchases of treasury stock - - (398)
Exercise of stock options - - 521
--------------------------------------------
Net Cash Used in Financing Activities (4,468) (9,026) (471)
--------------------------------------------
Increase (Decrease) in Cash and
Cash Equivalents 711 (3,052) (2,976)
Cash and cash equivalents at beginning of year 334 3,386 6,362
---------------------------------------------
Cash and Cash Equivalents at
End of Year $ 1,045 $ 334 $ 3,386
=============================================
42
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
CITY HOLDING COMPANY AND SUBSDIARIES
- -------------------------------------------------------------------------------
NOTE TWENTY FOUR
SEGMENT REPORTING
- -------------------------------------------------------------------------------
The Company historically operated three business segments: community
banking, mortgage banking, and other inancial services. These business segments
were primarily identified by the products or services offered and the channels
through which the product or service was offered. The community banking
operations consisted of various community banks that offered customers
traditional banking products and services through various delivery channels. The
mortgage banking operations included the origination, acquisition, servicing,
and sale of mortgage loans. The other financial services business segment
consisted of nontraditional services offered to customers, such as investment
advisory, insurance, and Internet technology products. Another defined business
segment of the Company was corporate support, which included the Parent Company
and other support needs.
During 2001, the Company completed its comprehensive strategic
repositioning that was announced in 2000 and was designed to refocus on the
Company's core community banking franchise. As a result, the Company completed
the transfer of the majority of its loan servicing portfolio to an independent
third party and disposed of its remaining specialty finance loan origination
divisions, thus, exiting its mortgage banking activities. Similarly, the Company
completed the sale of its internet service and direct mail divisions during 2001
and had substantially completed the sale of its brokerage accounts by December
31, 2001, thus, exiting its other financial services business segment. Although
the results of operations of each of these business lines for 2001, 2000, and
1999 are included in their respective business segments, as previously defined,
beginning January 1, 2002 these business segments will cease to exist.
Additionally, with the Company's overall reorganization in 2001, the
Company considers the products and services offered by its insurance division
(historically included in the Other Financial Services business segment) to be
aligned with the more traditional products and services offered by the community
banking segment. Similarly, the general corporate business segment, which
primarily includes the Parent Company, will also be consolidated into the
community banking segment. Because the Company has disposed of or terminated all
of its non-community banking operations, the corporate support historically
considered to be shared by each business segment is solely focused on the
community banking segment beginning January 1, 2002.
To more effectively evaluate and manage the operating performance of each
of the Company's business lines,.effective April 1,.1999, internal warehouse
funding was established for each divison within the mortage banking and other
financial services segment prior to April 1,1999 the community banking segment
provided necessary funding to the divisions within the mortgage banking and
other financial services segments with no associated interest cost. Beginning
April 1, 1999, any division that has obtained financing from the community
banking segment is charged a cost of funds, at market interest rates, on the
amount of funds borrowed from the community banking segment. Management has
determined
43
--
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
that the internal warehouse funding policy provides a "fully costed" assessment
of the operating performance of each division and that instituting such policy
provides a more accurate analysis of the performance of each division and
business segment. Financial information presented in the following tables has
been presented reflecting the actual internal policy in place during each
respective period.
The accounting policies for each of the business segments are the same as
those of the Company described in Note One. Selected segment information is
included in the following table:
Other
Community Mortgage Financial General
Banking Banking Services Corporate Elimination Consolidated
---------------------------------------------------------------------
2001
- ----
Net interest income (expense) $ 99,683 $ (6,774) $ (60) $ (1,784) $ -- $ 91,065
Provision for loan losses 32,178 -- -- -- -- 32,178
-----------------------------------------------------------------------
Net interest income (expense) after provision for loan losses 67,505 (6,774) (60) (1,784) 58,887
Other income 28,398 2,528 7,935 7,294 (3,303) 42,852
Other expenses 97,170 7,181 7,142 6,215 (3,303) 114,405
-----------------------------------------------------------------------
(Loss) income before income taxes and cumulative effect of
accounting change (1,267) (11,427) 733 (705) -- (12,666)
Income tax (benefit) expense (231) (4,836) 555 (139) -- (4,651)
Cumulative effect of accounting change, net of tax -- (17,985) -- -- -- (17,985)
-----------------------------------------------------------------------
Net (Loss) Income $ (1,036) $(24,576) $ 178 $ (566) $ -- $ (26,000)
=======================================================================
Average assets $2,430,768 $105,813 $ 6,518 $ 7,837 $ (118,587) $ 2,432,349
=======================================================================
2000
- ----
Net interest income (expense) $ 102,916 $(11,302) $ (289) $ (2,169) $ -- $ 89,156
Provision for loan losses 25,480 -- -- -- -- 25,480
-----------------------------------------------------------------------
Net interest income (expense) after provision for loan losses 77,436 (11,302) (289) (2,169) -- 63,676
Other income 12,421 13,729 12,921 3,629 (8,136) 34,564
Other expenses 91,369 40,668 19,536 8,906 (8,136) 152,343
-----------------------------------------------------------------------
Loss before income taxes (1,512) (38,241) (6,904) (7,446) -- (54,103)
Income tax expense (benefit) 1,643 (15,283) (285) (1,805) -- (15,730)
-----------------------------------------------------------------------
Net Loss $ (3,155) $(22,958) $ (6,619) $ (5,641) $ -- $ (38,373)
=======================================================================
Average assets $2,732,085 $176,111 $ 13,085 $ 9,583 $ (153,845) $ 2,777,019
=======================================================================
1999
- ----
Net interest income (expense) $ 105,381 $ (5,273) $ (171) $ (1,517) $ -- $ 98,420
Provision for loan losses 19,286 -- -- -- -- 19,286
-----------------------------------------------------------------------
Net interest income (expense) after provision for loan losses 86,095 (5,273) (171) (1,517) -- 79,134
Other income 29,850 22,523 12,495 64 (5,397) 59,535
Other expenses 80,387 33,528 14,792 7,304 (5,397) 130,614
-----------------------------------------------------------------------
Income (loss) before income taxes 35,558 (16,278) (2,468) (8,757) -- 8,055
Income tax expense (benefit) 12,920 (5,995) (808) (4,275) -- 1,842
-----------------------------------------------------------------------
Net Income (Loss) $ 22,638 $(10,283) $ (1,660) $ (4,482) $ -- $ 6,213
=======================================================================
Average assets $2,572,162 $306,819 $ 13,381 $ 12,697 $ (186,327) $ 2,718,732
=======================================================================
Internal warehouse funding between the community banking segment and the
mortgage banking and other financial services segments is eliminated in the
Consolidated Balance Sheets. Services provided to the banking segments by the
direct mail, insurance, and Internet service provider divisions are eliminated
in the Consolidated Statements of Income.
44
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CITY HOLDING COMPANY AND SUBSIDIARIES
===============================================================================
NOTE TWENTY-FIVE
SUMMARIZED QUARTERLY FINANCIAL
INFORMATION (UNAUDITED)
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A summary of selected quarterly financial information for 2001 and 2000 follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
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(in thousands, except common share data)
2001
- ----
Interest income $ 47,444 $ 45,953 $ 44,198 $ 39,885
Interest expense 26,836 23,383 20,496 15,700
Net interest income 20,608 22,570 23,702 24,185
Provision for possible loan losses 5,730 10,280 14,348 1,820
Investment securities gains 821 421 575 565
(Loss) income before cumulative
effect of accounting change (5,745) (2,070) (7,795) 7,595
Cumulative effect of accounting
change, net of tax - (17,985) - -
Net (loss) income (5,745) (20,055) (7,795) 7,595
Basic earnings per common share (0.34) (1.19) (0.46) 0.45
Diluted earnings per common share (0.34) (1.19) (0.46) 0.45
Average common shares outstanding:
Basic 16,878 16,888 16,888 16,888
Diluted 16,878 16,888 16,888 16,961
2000
- ----
Interest income $ 49,317 $ 52,246 $ 51,556 $ 49,793
Interest expense 26,281 28,796 29,524 29,155
Net interest income 23,036 23,450 22,032 20,638
Provision for possible loan losses 2,085 2,085 4,280 17,030
Investment securities gains (losses) - 2 - (5,017)
Net income (loss) 4,019 295 (921) (41,766)
Basic earnings per common share 0.24 0.02 (0.05) (2.47)
Diluted earnings per common share 0.24 0.02 (0.05) (2.47)
Average common shares outstanding:
Basic 16,875 16,878 16,888 16,888
Diluted 16,875 16,878 16,888 16,888
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NOTE TWENTY-SIX
EARNINGS PER SHARE
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The following table sets forth the computation of basic and diluted earnings
per share:
2001 2000 1999
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(in thousands, except per share data)
Numerator:
Net (loss) income $(26,000) $(38,373) $ 6,213
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Denominator:
Denominator for basic (loss)
earnings per share:
Average shares outstanding 16,888 16,882 16,841
Effect of dilutive securities:
Employee stock options - - -
Contingently issuable stock - - -
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Dilutive potential common
shares - - -
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Denominator for diluted (loss)
earnings per share 16,888 16,882 16,841
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Basic (loss) earnings per share $ (1.54) $(2.27) $0.37
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Diluted (loss) earnings per share $ (1.54) $(2.27) $0.37
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