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CITY HOLDING CO - Quarter Report: 2015 September (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2015
OR
[  ] TRANSITION REPORT PURSANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Transition Period From ____________To_____________.

Commission File number 0-11733
CITY HOLDING COMPANY
(Exact name of registrant as specified in its charter)
West Virginia
55-0619957
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
25 Gatewater Road
 
Charleston, West Virginia
25313
(Address of principal executive offices)
(Zip Code)
(304) 769-1100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
[X]
No
[   ]
 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes
[X]
No
[   ]
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [   ]
 
Accelerated filer [X]
 
 
 
 
 
Non-accelerated filer [   ]
 
Smaller reporting company [   ]
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
[   ]
No
[X]
 

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Table of Contents

 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common stock, $2.50 Par Value – 15,300,957 shares as of November 4, 2015.

2


FORWARD-LOOKING STATEMENTS

All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q, including statements in Management’s Discussion and Analysis of Financial Condition and Result of Operations are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such information involves risks and uncertainties that could result in the Company's actual results differing materially from those projected in the forward-looking statements. 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; (2) the Company may incur increased charge-offs in the future; (3) the Company could have adverse legal actions of a material nature; (4) the Company may face competitive loss of customers; (5) the Company may be unable to manage its expense levels; (6) the Company may have difficulty retaining key employees; (7) 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; (8) changes in general economic conditions and increased competition could adversely affect the Company’s operating results; (9) 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; (10) the Company may experience difficulties growing loan and deposit balances; (11) the current economic environment poses significant challenges for us and could adversely affect our financial condition and results of operations; (12) deterioration in the financial condition of the U.S. banking system may impact the valuations of investments the Company has made in the securities of other financial institutions resulting in either actual losses or other than temporary impairments on such investments; (13) the effects of the Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the regulations promulgated and to be promulgated thereunder, which may subject the Company and its subsidiaries to a variety of new and more stringent legal and regulatory requirements which adversely affect their respective businesses; (14) the impact of new minimum capital thresholds established as a part of the implementation of Basel III; and (15) other risk factors relating to the banking industry or the Company as detailed from time to time in the Company’s reports filed with the Securities and Exchange Commission, including those risk factors included in the disclosures under the heading “ITEM 1A Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.  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.

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Index
City Holding Company and Subsidiaries

Pages
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
 


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Part I -
Financial Information

Item 1 -
Financial Statements

Consolidated Balance Sheets
City Holding Company and Subsidiaries
(in thousands)
 
Assets
September 30, 2015
 
December 31, 2014
 
(Unaudited)
 
 
 
Cash and due from banks
$
109,627

 
$
138,503

 
Interest-bearing deposits in depository institutions
9,081

 
9,725

 
Cash and Cash Equivalents
118,708

 
148,228

 
 
 
 
 
 
Investment securities available for sale, at fair value
300,865

 
254,043

 
Investment securities held-to-maturity, at amortized cost (approximate fair value at September 30, 2015 and December 31, 2014, - $84,005 and $94,191, respectively)
81,095

 
90,786

 
Other securities
9,926

 
9,857

 
Total Investment Securities
391,886

 
354,686

 
 
 
 
 
 
Gross loans
2,696,438

 
2,652,066

 
Allowance for loan losses
(20,941
)
 
(20,150
)
 
Net Loans
2,675,497

 
2,631,916

 
 
 
 
 
 
Bank owned life insurance
97,157

 
95,116

 
Premises and equipment, net
73,419

 
77,988

 
Accrued interest receivable
7,690

 
6,826

 
Net deferred tax asset
33,342

 
36,766

 
Goodwill and other intangible assets, net
70,653

 
74,198

 
Other assets
36,266

 
35,909

 
Total Assets
$
3,504,618

 
$
3,461,633

 
Liabilities
 

 
 

 
Deposits:
 

 
 

 
Noninterest-bearing
$
542,177

 
$
545,465

 
Interest-bearing:
 

 
 

 
Demand deposits
647,792

 
639,932

 
Savings deposits
693,184

 
660,727

 
Time deposits
982,349

 
1,026,663

 
Total Deposits
2,865,502

 
2,872,787

 
 
 
 
 
 
Short-term borrowings
147,036

 
134,931

 
Long-term debt
16,495

 
16,495

 
Other liabilities
56,818

 
46,567

 
Total Liabilities
3,085,851

 
3,070,780

 
 
 
 
 
 
Shareholders’ Equity
 

 
 

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

 

 
Common stock, par value $2.50 per share: 50,000,000 shares authorized; 18,499,282 shares issued at September 30, 2015 and December 31, 2014, less 3,179,832 and 3,345,590 shares in treasury, respectively
46,249

 
46,249

 
 
 
 
 

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Capital surplus
106,108

 
107,370

Retained earnings
383,551

 
362,211

Cost of common stock in treasury
(113,581
)
 
(120,818
)
Accumulated other comprehensive income (loss):
 

 
 

Unrealized gain on securities available-for-sale
1,789

 
1,190

Underfunded pension liability
(5,349
)
 
(5,349
)
Total Accumulated Other Comprehensive Loss
(3,560
)
 
(4,159
)
Total Shareholders’ Equity
418,767

 
390,853

Total Liabilities and Shareholders’ Equity
$
3,504,618

 
$
3,461,633


See notes to consolidated financial statements.


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Consolidated Statements of Income (Unaudited)
City Holding Company and Subsidiaries
(in thousands, except earnings per share data)
Interest Income
Three months ended September 30,
 
Nine months ended September 30,
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
Interest and fees on loans
$
27,875

 
$
29,292

 
$
86,075

 
$
87,647

Interest and dividends on investment securities:
 

 
 

 
 
 
 
Taxable
2,621

 
2,864

 
7,974

 
8,797

Tax-exempt
272

 
282

 
803

 
840

Total Interest Income
30,768

 
32,438

 
94,852

 
97,284

 
 
 
 
 
 
 
 
Interest Expense
 

 
 

 
 
 
 
Interest on deposits
2,686

 
2,730

 
8,126

 
8,220

Interest on short-term borrowings
69

 
86

 
236

 
246

Interest on long-term debt
155

 
152

 
458

 
453

Total Interest Expense
2,910

 
2,968

 
8,820

 
8,919

Net Interest Income
27,858

 
29,470

 
86,032

 
88,365

Provision for loan losses
451

 
1,872

 
4,175

 
3,670

Net Interest Income After Provision for Loan Losses
27,407

 
27,598

 
81,857

 
84,695

 
 
 
 
 
 
 
 
Non-interest Income
 

 
 

 
 
 
 
Gains on sale of investment securities

 
71

 
2,130

 
972

Service charges
6,907

 
6,934

 
19,423

 
19,833

Bankcard revenue
3,895

 
3,796

 
11,971

 
11,319

Insurance commissions

 
1,396

 

 
4,740

Trust and investment management fee income
1,176

 
1,103

 
3,577

 
3,251

Bank owned  life insurance
929

 
771

 
2,476

 
2,292

Gain on sale of insurance division

 

 
11,084

 

Other income
799

 
538

 
2,471

 
1,646

Total Non-interest Income
13,706

 
14,609

 
53,132

 
44,053

 
 
 
 
 
 
 
 
Non-interest Expense
 

 
 

 
 
 
 
Salaries and employee benefits
12,179

 
13,144

 
36,551

 
39,260

Occupancy and equipment
2,575

 
2,531

 
7,694

 
7,541

Depreciation
1,522

 
1,542

 
4,549

 
4,553

FDIC insurance expense
456

 
432

 
1,351

 
1,199

Advertising
777

 
799

 
2,182

 
2,548

Bankcard expenses
785

 
877

 
2,485

 
2,607

Postage, delivery, and statement mailings
523

 
557

 
1,591

 
1,662

Office supplies
384

 
405

 
1,077

 
1,235

Legal and professional fees
620

 
476

 
1,729

 
1,497

Telecommunications
418

 
510

 
1,356

 
1,354

Repossessed asset losses, net of expenses
492

 
31

 
1,047

 
552

Merger related expenses
175

 

 
283

 

Other expenses
4,471

 
3,021

 
9,891

 
7,998

Total Non-interest Expense
25,377

 
24,325

 
71,786

 
72,006

Income Before Income Taxes
15,736

 
17,882

 
63,203

 
56,742


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Income tax expense
5,129

 
6,010

 
22,621

 
18,310

Net Income Available to Common Shareholders
$
10,607

 
$
11,872

 
$
40,582

 
$
38,432

 
 
 
 
 
 
 
 
Total comprehensive income
$
11,939

 
$
11,460

 
$
41,181

 
$
40,501

 
 
 
 
 
 
 
 
Average common shares outstanding
15,178

 
15,363

 
15,111

 
15,509

Effect of dilutive securities:
 

 
 

 
 
 
 
Employee stock awards and warrant outstanding
20

 
82

 
58

 
85

Shares for diluted earnings per share
15,198

 
15,445

 
15,169

 
15,594

 
 
 
 
 
 
 
\

Basic earnings per common share
$
0.69

 
$
0.76

 
$
2.66

 
$
2.45

Diluted earnings per common share
$
0.69

 
$
0.76

 
$
2.65

 
$
2.44

Dividends declared per common share
$
0.42

 
$
0.40

 
$
1.26

 
$
1.20


See notes to consolidated financial statements.


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Consolidated Statements of Comprehensive Income (Unaudited)
City Holding Company and Subsidiaries
(in thousands)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Net income
$
10,607

 
$
11,872

 
$
40,582

 
$
38,432

 
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale securities arising during the period
2,111

 
(582
)
 
3,079

 
4,252

Reclassification adjustment for gains

 
(71
)
 
(2,130
)
 
(972
)
   Other comprehensive income (loss) before income taxes
2,111

 
(653
)
 
949

 
3,280

Tax effect
(779
)
 
241

 
(350
)
 
(1,211
)
   Other comprehensive income (loss), net of tax
1,332

 
(412
)
 
599

 
2,069

 
 
 
 
 
 
 
 
    Comprehensive income, net of tax
$
11,939

 
$
11,460

 
$
41,181

 
$
40,501


See notes to consolidated financial statements.

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Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
City Holding Company and Subsidiaries
Nine Months Ended September 30, 2015 and 2014
(in thousands)

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

 
$
107,596

 
$
333,970

 
$
(95,202
)
 
(4,990
)
 
$
387,623

Net income

 

 
38,432

 

 

 
38,432

Other comprehensive loss

 

 

 

 
2,069

 
2,069

Cash dividends declared ($1.20 per share)

 

 
(18,681
)
 

 

 
(18,681
)
Stock-based compensation expense, net

 
(262
)
 

 
1,472

 

 
1,210

Exercise of 19,000 stock options

 
(272
)
 

 
825

 

 
553

Purchase of 456,856 treasury shares

 

 

 
(19,533
)
 

 
(19,533
)
Balance at September 30, 2014
$
46,249

 
$
107,062

 
$
353,721

 
$
(112,438
)
 
$
(2,921
)
 
$
391,673



 
Common Stock
 
Capital Surplus
 
Retained Earnings
 
Treasury Stock
 
Accumulated Other Comprehensive Income (Loss)
 
Total Shareholders’ Equity
Balance at December 31, 2014
46,249

 
$
107,370

 
$
362,211

 
(120,818
)
 
$
(4,159
)
 
$
390,853

Net income

 

 
40,582

 

 

 
40,582

Other comprehensive income

 

 

 

 
599

 
599

Cash dividends declared ($1.26 per share)

 

 
(19,242
)
 

 

 
(19,242
)
Stock-based compensation expense, net

 
(38
)
 

 
1,468

 

 
1,430

Exercise of 71,750 stock options

 
(459
)
 

 
3,108

 

 
2,649

Exercise of 61,796 warrants

 
(765
)
 

 
2,661

 

 
1,896

Balance at September 30, 2015
46,249

 
$
106,108

 
$
383,551

 
(113,581
)
 
$
(3,560
)
 
$
418,767


See notes to consolidated financial statements.


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Consolidated Statements of Cash Flows (Unaudited)
City Holding Company and Subsidiaries
(in thousands)

 
Nine months ended September 30,
2015
 
2014
Net income
$
40,582

 
$
38,432

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Accretion and amortization
(3,612
)
 
(3,889
)
Provision for loan losses
4,175

 
3,670

Depreciation of premises and equipment
4,549

 
4,553

Deferred income tax expense
3,479

 
3,921

Net periodic employee benefit cost
625

 
393

Realized investment securities gains
(2,130
)
 
(972
)
Stock-compensation expense
1,430

 
1,210

Increase in value of bank-owned life insurance
(2,476
)
 
(2,291
)
Proceeds from bank-owned life insurance
435

 

Loans originated for sale
(13,994
)
 
(4,911
)
Proceeds from the sale of loans originated for sale
14,533

 
5,075

Gain on sale of loans
(279
)
 
(131
)
Gain on sale of insurance division
(11,084
)
 

Change in accrued interest receivable
(864
)
 
(885
)
Change in other assets
1,161

 
(5,829
)
Change in other liabilities
7,805

 
(3,763
)
Net Cash Provided by Operating Activities
44,335

 
34,583

 
 
 
 
Proceeds from sales of securities available-for-sale
290

 
1,821

Proceeds from maturities and calls of securities available-for-sale
45,158

 
37,071

Proceeds from maturities and calls of securities held-to-maturity
10,640

 
4,124

Purchases of securities available-for-sale
(91,190
)
 
(17,058
)
Purchases of securities held-to-maturity

 
(10,226
)
Net (increase) in loans
(43,411
)
 
(23,454
)
Purchases of premises and equipment
(1,729
)
 
(1,085
)
Disposals of premises and equipment
133

 

Proceeds from sale of insurance division
15,250

 

Net Cash (Used In) Investing Activities
(64,859
)
 
(8,807
)
 
 
 
 
Net (decrease) increase in noninterest-bearing deposits
(3,288
)
 
5,263

Net (decrease) increase in interest-bearing deposits
(3,489
)
 
3,597

Net increase in short-term borrowings
12,105

 
8,317

Purchases of treasury stock

 
(19,533
)
Proceeds from exercise of stock options, net of tax benefit
2,649

 
553

Proceeds from exercise of warrants
1,896

 

Dividends paid
(18,869
)
 
(18,357
)
Net Cash (Used in) Financing Activities
(8,996
)
 
(20,160
)
(Decrease) Increase in Cash and Cash Equivalents
(29,520
)
 
5,616

Cash and cash equivalents at beginning of period
148,228

 
85,876

Cash and Cash Equivalents at End of Period
$
118,708

 
$
91,492


See notes to consolidated financial statements.

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Notes to Consolidated Financial Statements (Unaudited)
September 30, 2015

Note A –Background and Basis of Presentation

City Holding Company is a financial 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 operates a network of 82 branch offices primarily along the I-64 corridor from Grayson, Kentucky through Lexington, Virginia; and along the I-81 corridor through the Shenandoah Valley from Staunton, Virginia to Martinsburg, West Virginia. City National's branch network includes 57 offices in West Virginia, 14 offices in Virginia, 8 offices in Kentucky and 3 offices in Ohio. City National provides credit, deposit, and investment advisory services to a broad geographical area that includes many rural and small community markets in addition to larger cities such as Charleston (WV), Huntington (WV), Winchester (VA), Staunton (VA), Virginia Beach (VA), Ashland (KY) and Martinsburg (WV). In addition to its branch network, the bank's delivery channels include ATMs, mobile banking, on-line banking, debit cards, cash management tools and telephone banking systems.

On January 9th, 2015 the Company sold its insurance operations, CityInsurance, to The Hilb Group effective January 1, 2015. As a result of this sale, the Company recognized a one-time after tax gain of $5.8 million from this transaction in the first quarter of 2015.

On May 29, 2015, City National entered into a Branch Purchase and Assumption Agreement (the “Purchase Agreement”) with American Founders Bank, Inc. (“AFB”), a wholly-owned subsidiary of Financial Holdings, Inc., pursuant to which City National will purchase AFB’s three Lexington, Kentucky branch locations (the “Acquisition”). Under the terms of the Purchase Agreement, City National will acquire approximately $125 million in performing loans and will assume deposit liabilities of approximately $155 million. City National will pay AFB a deposit premium of 5.5% on non-time deposits, and 1.0% on premium loan balances acquired.

The accompanying consolidated financial statements, which are unaudited, include all of the accounts of the City Holding Company and its wholly-owned subsidiaries (collectively, the "Company”). All material intercompany transactions have been eliminated. The consolidated financial statements include all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations and financial condition for each of the periods presented. Such adjustments are of a normal recurring nature. The results of operations for the nine months ended September 30, 2015 are not necessarily indicative of the results of operations that can be expected for the year ending December 31, 2015. The Company’s accounting and reporting policies conform with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Such policies require management to make estimates and develop assumptions that affect the amounts reported in the consolidated financial statements and related footnotes. Actual results could differ from management’s estimates.

The consolidated balance sheet as of December 31, 2014 has been derived from audited financial statements included in the Company’s 2014 Annual Report to Shareholders.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted.  These financial statements should be read in conjunction with the financial statements and notes thereto included in the 2014 Annual Report of the Company.

Certain amounts in the financial statements have been reclassified.  Such reclassifications had no impact on shareholders’ equity or net income for any period.

Note B - Recent Accounting Pronouncements
 
In January 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2014-01, "Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects." This ASU permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). For those investments in qualified affordable housing projects not accounted for using the proportional amortization method, the investment should be accounted for as an equity method investment or a cost method investment. The ASU also requires reporting entities to disclose information that enable users of its financial statements to understand the nature of its investments in qualified affordable housing projects, and the effect of the measurement of its investments in qualified affordable housing projects and the

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related tax credits on its financial position and results of operations. This ASU became effective for the Company on January 1, 2015. The adoption of ASU 2014-01 did not have a material impact on the Company's financial statements.

In January 2014, the FASB issued ASU No. 2014-04, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure." This ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through similar legal agreement. Additionally, the amendments require interim and annual disclosures of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. This ASU became effective for the Company on January 1, 2015. The adoption of ASU 2014-04 did not have a material impact on the Company's financial statements.

In April 2014, the FASB issued ASU No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." This ASU changes the requirements for reporting discontinued operations. A disposal of a component or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations when certain criteria are met. Additional disclosures are also required for disposals that meet the criteria to be reported in discontinued operations. The Company elected to early adopt this ASU for the year ended December
31, 2014 relating to the sale of CityInsurance. The adoption of ASU 2014-08 did not have a material impact on the
Company's financial statements.

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)." The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The core principle will be achieved using a five step process. In August 2015 the FASB issued Accounting Standards Update 2015-14, "Revenue from Contracts with Customers (Topic 606)." which amends the effective date for the Company from January 1, 2017 to January 1, 2018. The adoptions of ASU 2014-09 and ASU 2015-14 are not expected to have a material impact on the Company's financial statements.

In June 2014, the FASB issued ASU No. 2014-11, "Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures." The amendments in this update require two accounting changes. First, the amendments in this update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counter-party, which will result in secured borrowing accounting for the repurchase agreement. This update also requires certain disclosures for these types of transactions. This ASU became effective for the Company on January 1, 2015. The adoption of ASU 2014-11 did not have a material impact on the Company's financial statements.

In June 2014, the FASB issued ASU No. 2014-12, "Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." The amendments in this update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Performance targets should not be reflected in estimating the grant date fair value of the award, but compensation cost should be recognized in the period for which the requisite service has already been rendered. This ASU will become effective for the Company on January 1, 2016, with early adoption permitted. The adoption of ASU 2014-12 is not expected to have a material impact on the Company's financial statements.

In August 2014, the FASB issued ASU No. 2014-14, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure." The amendments in this update require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if certain conditions are met. This ASU became effective for the Company on January 1, 2015. The adoption of ASU 2014-14 did not have a material impact on the Company's financial statements.

In February 2015, the FASB issued ASU No. 2015-02, "Consolidation (Topic 810) - Amendments to the Consolidation Analysis". ASU 2015-02 eliminates the deferral of FAS 167 and makes changes to both the variable interest model and the

13

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voting model. This ASU will become effective for the Company on January 1, 2016. The adoption of ASU 2015-02 is not expected to have a material impact on the Company's financial statements.

In April 2015, the FASB issued ASU No. 2015-03, "Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs." ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This ASU will become effective for the Company on January 1, 2016. The adoption of ASU 2015-03 is not expected to have a material impact on the Company's financial statements.

In April 2015, the FASB issued ASU No. 2015-05, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement." ASU 2015-05 provides guidance to clarify the customer’s accounting for fees paid in a cloud computing arrangement. This ASU will become effective for the Company on January 1, 2016. The adoption of ASU 2015-05 is not expected to have a material impact on the Company's financial statements.

In May 2015, the FASB issued ASU No. 2015-07, "Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)." ASU 2015-07 removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. the ASU also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. This ASU will become effective for the Company on January 1, 2016. The adoption of ASU 2015-07 is not expected to have a material impact on the Company's financial statements.

In September 2015, the FASB issued ASU No. 2015-16, "Business Combinations (Topic 85): Simplifying the Accounting for Measurement-Period Adjustments" The amendments in ASU 2015-16 require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The effect on earnings of the adjustments as a result of the change to the provisional amounts will be calculated as if the accounting had been completed at the acquisition date. The amount that would've been recorded in the previous reporting periods will be presented separately on the face of the income statement or disclosed in the notes to the financial statements. This ASU will become effective for the Company on January 1, 2016. The adoption of ASU 2015-16 is not expected to have a material impact on the Company's financial statements.






Note C –Investments

The amortized cost and estimated fair values of the Company's securities are shown in the following table (in thousands):

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Table of Contents

 
 
September 30, 2015
 
December 31, 2014
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries and U.S.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
government agencies
 
$
5

 
$

 
$

 
$
5

 
$
1,816

 
$
11

 
$

 
$
1,827

Obligations of states and
 
 
 
 
 
 
 
 

 
 

 
 

 
 

 
 

political subdivisions
 
42,254

 
466

 
18

 
42,702

 
41,382

 
722

 
8

 
42,096

Mortgage-backed securities:
 
 
 
 
 
 
 
 

 
 

 
 

 
 

 
 

U.S. government agencies
 
225,382

 
3,686

 
1,121

 
227,947

 
185,831

 
3,470

 
1,973

 
187,328

Private label
 
1,276

 
4

 
1

 
1,279

 
1,700

 
8

 
4

 
1,704

Trust preferred
 
 
 
 
 
 
 
 

 
 

 
 

 
 

 
 

securities
 
7,578

 
459

 
1,080

 
6,957

 
9,763

 
425

 
1,152

 
9,036

Corporate securities
 
17,758

 
182

 
597

 
17,343

 
7,806

 
204

 
693

 
7,317

Total Debt Securities
 
294,253

 
4,797

 
2,817

 
296,233

 
248,298

 
4,840

 
3,830

 
249,308

Marketable equity  securities
 
2,131

 
972

 

 
3,103

 
2,131

 
1,082

 

 
3,213

Investment funds
 
1,525

 
4

 

 
1,529

 
1,525

 

 
3

 
1,522

Total Securities
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Available-for-Sale
 
$
297,909

 
$
5,773

 
$
2,817

 
$
300,865

 
$
251,954

 
$
5,922

 
$
3,833

 
$
254,043

 
 
 
September 30, 2015
 
December 31, 2014
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Securities held-to-maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
US government agencies
 
$
77,095

 
$
2,910

 
$

 
$
80,005

 
$
86,742

 
$
2,733

 
$

 
$
89,475

Trust preferred securities
 
4,000

 

 

 
4,000

 
4,044

 
672

 

 
4,716

Total Securities
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Held-to-Maturity
 
$
81,095


$
2,910

 
$

 
$
84,005

 
$
90,786

 
$
3,405

 
$

 
$
94,191

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other investment securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Non-marketable equity securities
 
$
9,926

 
$

 
$

 
$
9,926

 
$
9,857

 
$

 
$

 
$
9,857

Total Other Investment
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

   Securities
 
$
9,926

 
$

 
$

 
$
9,926

 
$
9,857

 
$

 
$

 
$
9,857

 
Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost and are reported as non-marketable equity securities in the table above.

Certain investment securities owned by the Company were in an unrealized loss position (i.e., amortized cost basis exceeded the estimated fair value of the securities).  The following table shows the gross unrealized losses and fair value of the Company’s investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):

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September 30, 2015
 
Less Than Twelve Months
 
Twelve Months or Greater
 
Total
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
 
$
2,670

 
$
13

 
$
125

 
$
5

 
$
2,795

 
$
18

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 

 
 

U.S. Government agencies
 
16,782

 
102

 
35,607

 
1,019

 
52,389

 
1,121

      Private label
 
1,005

 
1

 

 

 
1,005

 
1

Trust preferred securities
 
1,015

 
16

 
4,857

 
1,064

 
5,872

 
1,080

Corporate securities
 

 

 
4,161

 
597

 
4,161

 
597

Investment funds
 

 

 

 

 

 

Total
 
$
21,472

 
$
132

 
$
44,750

 
$
2,685

 
$
66,222

 
$
2,817



 
 
December 31, 2014
 
Less Than Twelve Months
 
Twelve Months or Greater
 
Total
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
 
$
1,559

 
$
3

 
$
125

 
$
5

 
$
1,684

 
$
8

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 

 
 

U.S. Government agencies
 

 

 
60,122

 
1,973

 
60,122

 
1,973

      Private label
 
1,277

 
4

 

 

 
1,277

 
4

Trust preferred securities
 

 

 
4,760

 
1,152

 
4,760

 
1,152

Corporate securities
 

 

 
4,049

 
693

 
4,049

 
693

Investment funds
 
$

 
$

 
$
1,496

 
$
3

 
1,496

 
3

Total
 
$
2,836

 
$
7

 
$
70,552

 
$
3,826

 
$
73,388

 
$
3,833


Marketable equity securities consist of investments made by the Company in equity positions of various regional community bank holding companies, with ownership positions ranging from nominal to a 4% ownership position in First National Corporation (FXNC).
During the nine months ended September 30, 2015 and 2014, the Company had no credit-related net investment impairment losses. Also, for the year ended December 31, 2014, the Company had no credit-related net investment impairment losses.
Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary would be reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers, among other things (i) the length of time and the extent to which the fair value has been less than cost; (ii) the financial condition, capital strength, and near-term (12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment; (iv) adverse conditions specifically related to the security, an industry, or a geographic area; or (v) the intent to sell the investment security and if it’s more likely than not that the Company will not have to sell the security before recovery of its cost basis.  In addition, management also employs a continuous monitoring process in regards to its marketable equity securities, specifically its portfolio of regional community bank holding company stocks.  Although the regional community bank holding company stocks that are owned by the Company are publicly traded, the trading activity for these stocks is minimal, with trading volumes of less than 0.1% of each respective company being traded on a daily basis.  As part of management’s review process for these securities, management reviews the financial condition of each respective regional community bank for any indications of financial weakness.

Management has the ability and intent to hold the securities classified as "held-to-maturity" until they mature, at which time the Company will receive full value for the securities.  Furthermore, as of September 30, 2015, management does not intend to sell an impaired security and it is not more than likely that it will be required to sell the security before the recovery of its amortized cost basis.  The unrealized losses on debt securities are primarily the result of interest rate changes, credit spread widening on agency-issued mortgage related securities, general financial market uncertainty and market volatility.  These conditions will not prohibit the Company from receiving its contractual principal and interest payments on its debt securities.  The fair value is

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Table of Contents

expected to recover as the securities approach their maturity date or repricing date.   As of September 30, 2015, management believes the unrealized losses detailed in the table above are temporary and no impairment loss has been recognized in the Company’s consolidated income statement.  Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period where the other-than-temporary impairment is identified, while any noncredit loss will be recognized in other comprehensive income.

At September 30, 2015, the book value of the Company’s five pooled trust preferred securities totaled $1.8 million with an estimated fair value of $1.8 million.  All of these securities are mezzanine tranches.  Pooled trust preferred securities represent beneficial interests in securitized financial assets that the Company analyzes within the scope of ASC 320, “Investments-Debt and Equity Securities” and are evaluated quarterly for other-than-temporary-impairment (“OTTI”).  Management performs an analysis of OTTI utilizing its internal methodology as described below to estimate expected cash flows to be received in the future.  The Company reviews each of its pooled trust preferred securities to determine if an OTTI charge would be recognized in current earnings in accordance with ASC 320, “Investments-Debt and Equity Securities.”  There is a risk that collateral deterioration could cause the Company to recognize additional OTTI charges in earnings in the future.

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

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

The following table presents a progression of the credit loss component of OTTI on debt and equity securities recognized in earnings during the nine months ended September 30, 2015 and for the year ended December 31, 2014 (in thousands).  The credit loss component represents the difference between the present value of expected future cash flows and the amortized cost basis of the security.  The credit component of OTTI recognized in earnings during a period is presented in two parts based upon whether the credit impairment in the current period is the first time the security was credit impaired (initial credit impairment) or if there is additional credit impairment on a security that was credit impaired in previous periods.

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Table of Contents

 
Debt Securities
Equity Securities
Total
Balance at January 1, 2014
$
20,186

$
4,698

$
24,884

Additions:
 

 

 

  Initial credit impairment



  Additional credit impairment



Deductions:
 

 

 

   Called or Sold
(3,600
)
(3,114
)
(6,714
)
Balance at December 31, 2014
16,586

1,584

18,170

Additions:
 

 

 

  Initial credit impairment



  Additional credit impairment



Deductions:
 

 

 

  Called or Sold



Balance at September 30, 2015
$
16,586

$
1,584

$
18,170


The following table presents additional information about the Company’s trust preferred securities with a credit rating of below investment grade as of September 30, 2015 (dollars in thousands):
Deal Name
 
Type
 
Class
 
Original Cost
 
Amortized Cost
 
Fair Value
 
Difference (1)
 
Lowest Credit Rating
 
# of issuers currently performing
 
Actual deferrals/defaults (as a % of original dollar)
 
Expected deferrals/defaults (as a % of remaining performing collateral)
 
Excess Subordination as a Percentage of Current Performing Collateral (3)
 
 
 
Pooled trust preferred securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other-than-temporarily impaired
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for Sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
P1
 
 
Pooled
 
Mezz
 
$
632

 
$

 
$

 

 
Caa1
 
5

 
14.5
%
 
%
(2) 
 
%
P2
 
 
Pooled
 
Mezz
 
1,513

 

 

 

 
Ca
 
3

 
18.3
%
 
%
(2) 
 
%
P3

 
Pooled
 
Mezz
 
2,962

 
1,419

 
1,007

 
(412
)
 
Caa3
 
19

 
20.0
%
 
7.1
%
(2) 
 
%
P5
 
 
Pooled
 
Mezz
 
6,032

 
391

 
838

 
447

 
C
 
7

 
13.5
%
 
19.0
%
(2) 
 
33.6
%
 
 
 
Held to Maturity:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 

P6
 
 
Pooled
 
Mezz
 
1,223

 

 

 

 
Caa1
 
5

 
14.5
%
 
%
(2) 
 
%
P7
 
 
Pooled
 
Mezz
 
2,009

 

 

 

 
Ca
 
3

 
18.3
%
 
%
(2) 
 
%
 
 
 
Single issuer trust preferred securities
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 

 
 
 
Available for sale:
 
 
 
 
 
 

 
 

 
 

 
 
 
 

 
 

 
 

 
 
 

S5
 
 
Single
 
 
 
261

 
235

 
247

 
12

 
NR
 
1

 
%
 
%
 
 
 

 
 
 
Held to Maturity:
 
 
 
 
 
 

 
 

 
 

 
 
 
 

 
 

 
 

 
 
 

S9
 
 
Single
 
 
 
4,000

 
4,000

 
4,000

 

 
NR
 
1

 
%
 
%
 
 
 

 
(1)
The differences noted consist of unrealized gains (losses) recorded at September 30, 2015 and noncredit other-than-temporary impairment losses recorded subsequent to April 1, 2009 that have not been reclassified as credit losses.
(2)
Performing collateral is defined as total collateral minus all collateral that has been called, is currently deferring, or currently in default. This model for this security assumes that all collateral that is currently deferring will default with a zero recovery rate. The underlying issuers can cure, thus this bond could recover at a higher percentage upon default than zero.
(3)
Excess subordination is defined as the additional defaults/deferrals necessary in the next reporting period to deplete the entire credit enhancement (excess interest and over-collateralization) beneath our tranche within each pool to the point that would cause a "break in yield." This amount assumes that all currently performing collateral continues to perform. A break in yield means that our security would not be expected to receive all the contractual cash flows (principal and interest) by maturity. The "percent of current performing collateral" is the ratio of the "excess subordination amount" to current performing collateral—a higher percent means there is more excess subordination to absorb additional defaults/deferrals, and the better our security is protected from loss.

The amortized cost and estimated fair value of debt securities at September 30, 2015, by contractual maturity, are shown in the following table (in thousands).  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.  Mortgage-backed securities have been allocated to their respective maturity groupings based on their contractual maturity.

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Table of Contents

 
Amortized Cost
Estimated Fair Value
Securities Available-for-Sale
 
 
Due in one year or less
$
2,838

$
15,831

Due after one year through five years
14,590

14,976

Due after five years through ten years
27,168

27,464

Due after ten years
249,657

237,962

 
$
294,253

$
296,233

Securities Held-to-Maturity
 

 

Due in one year or less
$

$

Due after one year through five years


Due after five years through ten years


Due after ten years
81,095

84,005

 
$
81,095

$
84,005


Gross gains and gross losses realized by the Company from investment security transactions are summarized in the table below (in thousands). The specific identification method is used to determine the cost basis of securities sold.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
2014
 
2015
2014
 
 
 
 
 
 
Gross realized gains
$

$
71

 
$
2,130

$
972

Gross realized losses


 


Net investment security gains
$

$
71

 
$
2,130

$
972

    
The carrying value of securities pledged to secure public deposits and for other purposes as required or permitted by law approximated $274 million and $273 million at September 30, 2015 and December 31, 2014, respectively.

Statement of Cash Flows - Investing Activities - Supplemental Information

During the nine months ended September 30, 2014, the Company transferred certain securities from available-for-sale to held-to-maturity. The non-cash transfers of securities into the held-to-maturity categories from available-for-sale were made at fair value on the date of the transfer. The securities had an aggregate fair value of $83.4 million on the date of transfer. No such transfers occurred during the nine months ended September 30, 2015.
 
Note D –Loans

The following summarizes the Company’s major classifications for loans (in thousands):
 
September 30, 2015
December 31, 2014
Residential real estate
$
1,358,083

$
1,294,576

Home equity – junior liens
144,748

145,604

Commercial and industrial
124,495

140,548

Commercial real estate
1,029,103

1,028,831

Consumer
36,751

39,705

DDA overdrafts
3,258

2,802

Gross loans
2,696,438

2,652,066

Allowance for loan losses
(20,941
)
(20,150
)
Net loans
$
2,675,497

$
2,631,916


Construction loans of $14.8 million and $23.0 million are included within residential real estate loans at September 30, 2015 and December 31, 2014, respectively.  Construction loans of $12.0 million and $28.7 million are included within commercial real estate loans at September 30, 2015 and December 31, 2014, respectively.  The Company’s commercial and residential real estate construction loans are primarily secured by real estate within the Company’s principal markets.  These loans were originated

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under the Company’s loan policy, which is focused on the risk characteristics of the loan portfolio, including construction loans.  Adequate consideration has been given to these loans in establishing the Company’s allowance for loan losses.

The following table details the loans acquired in conjunction with the Virginia Savings Bancorp, Inc. ("Virginia Savings") and Community Financial Corporation ("Community") acquisitions (in thousands):
 
Virginia
 
 
 
Savings
Community
Total
September 30, 2015
 
 
 
Outstanding loan balance
$
31,143

$
190,788

$
221,931

 
 
 
 
Credit-impaired loans:
 
 
 
Carrying value
1,861

13,400

15,261

Contractual principal and interest
2,149

17,834

19,983

 
 
 
 
December 31, 2014
 
 
 
Outstanding loan balance
$
38,345

$
219,923

$
258,268

 
 
 
 
Credit-impaired loans:
 
 
 
Carrying value
1,964

15,365

17,329

Contractual principal and interest
2,407

23,277

25,684


    





    

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Table of Contents

Changes in the accretable yield of the credit-impaired loans for the nine months ended September 30, 2015 is as follows (in thousands):
 
Virginia Savings
 
Community
 
Total
 
 
Carrying
 
 
Carrying
 
 
Carrying
 
Accretable
Amount
 
Accretable
Amount
 
Accretable
Amount
 
Yield
of Loans
 
Yield
of Loans
 
Yield
of Loans
Balance at the beginning of the period
$
428

$
1,964

 
$
9,906

$
15,365

 
$
10,334

$
17,329

Accretion
(147
)
147

 
(1,915
)
1,915

 
(2,062
)
2,062

Net reclassifications to accretable yield from
 
 
 
 
 
 
 
 
   non-accretable yield


 
937


 
937


Payments received, net

(250
)
 

(1,861
)
 

(2,111
)
Disposals
(38
)

 
(1,187
)
(2,019
)
 
(1,225
)
(2,019
)
Balance at the end of period
$
243

$
1,861

 
$
7,741

$
13,400

 
$
7,984

$
15,261


Increases in expected cash flow subsequent to the acquisition are recognized first as a reduction of any previous impairment, then prospectively through adjustment of the yield on the loans or pools over its remaining life, while decreases in expected cash flows are recognized as impairment through a provision for loan loss and an increase in the allowance for purchased credit-impaired loans.

Note E – Allowance 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 reviews, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for economic conditions and other inherent risk factors.
 
The following table summarizes the activity in the allowance for loan loss, by portfolio segment, for the nine months ended September 30, 2015 and 2014 (in thousands).  The following table also presents the balance in the allowance for loan loss disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans, by portfolio segment, as of September 30, 2015 and December 31, 2014 (in thousands).
 
 
Commercial &
Commercial
Residential
 
 
DDA
 
 
Industrial
Real Estate
Real Estate
Home equity
Consumer
Overdrafts
Total
Nine months ended September 30, 2015
 
 
 
 
 
 
 
Allowance for loan loss
Beginning balance
$
1,582

$
8,921

$
7,208

$
1,495

$
85

$
859

$
20,150

Charge-offs
(1,903
)
(277
)
(758
)
(236
)
(171
)
(1,038
)
(4,383
)
Recoveries
72

49

130


154

594

999

Provision for acquired loans
521






521

Provision
2,509

(203
)
681

249

28

390

3,654

Ending balance
$
2,781

$
8,490

$
7,261

$
1,508

$
96

$
805

$
20,941

 
 
 
 
 
 
 
 
Nine months ended September 30, 2014
 

 

 

 

 

 

 

Allowance for loan loss
 

 

 

 

 

 

 

Beginning balance
$
1,139

$
10,775

$
6,057

$
1,672

$
77

$
855

$
20,575

Charge-offs
(330
)
(1,665
)
(1,348
)
(288
)
(171
)
(1,052
)
(4,854
)
Recoveries
85

94

91


172

654

1,096

Provision for acquired loans
135






135


21

Table of Contents

Provision
564

402

2,159

107

10

293

3,535

Ending balance
$
1,593

$
9,606

$
6,959

$
1,491

$
88

$
750

$
20,487

 
 
 
 
 
 
 
 
As of September 30, 2015
 

 

 

 

 

 

 

Allowance for loan loss
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$

$
274

$

$

$

$

$
274

Collectively
2,777

7,508

7,176

1,508

96

805

19,870

Acquired with deteriorated
 

 

 

 

 

 

 

credit quality
4

708

85




797

Total
$
2,781

$
8,490

$
7,261

$
1,508

$
96

$
805

$
20,941

 
 
 
 
 
 
 
 
Loans
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$
799

$
5,861

$
439

$
296

$

$

$
7,395

Collectively
123,359

1,010,611

1,357,271

142,676

36,607

3,258

2,673,782

Acquired with deteriorated
 

 

 

 

 

 

 

credit quality
337

12,631

373

1,776

144


15,261

Total
$
124,495

$
1,029,103

$
1,358,083

$
144,748

$
36,751

$
3,258

$
2,696,438

 
 
 
 
 
 
 
 
As of December 31, 2014
 

 

 

 

 

 

 

Allowance for loan loss
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$

$
252

$

$

$

$

$
252

Collectively
1,540

7,898

7,208

1,429

85

859

19,019

Acquired with deteriorated
 
 
 
 
 
 
 
  credit quality
42

771


66



879

Total
$
1,582

$
8,921

$
7,208

$
1,495

$
85

$
859

$
20,150

 
 
 
 
 
 
 
 
Loans
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$

$
6,023

$
449

$
297

$

$

$
6,769

Collectively
139,862

1,009,241

1,293,748

142,743

39,572

2,802

2,627,968

Acquired with deteriorated
 
 
 
 
 
 
 
  credit quality
686

13,567

379

2,564

133


17,329

Total
$
140,548

$
1,028,831

$
1,294,576

$
145,604

$
39,705

$
2,802

$
2,652,066



Credit Quality Indicators
 
All commercial loans within the portfolio are subject to internal risk grading.  All non-commercial loans are evaluated based on payment history.  The Company’s internal risk ratings for commercial loans are:  Pass, Special Mention, Substandard and Doubtful.  Each internal risk rating is defined in the loan policy using the following criteria:  balance sheet yields, ratios and leverage, cash flow spread and coverage, prior history, capability of management, market position/industry, potential impact of changing economic, legal, regulatory or environmental conditions, purpose, structure, collateral support, and guarantor support.  Risk grades are generally assigned by the primary lending officer and are periodically evaluated by the Company’s internal loan review process.  Based on an individual loan’s risk grade, estimated loss percentages are applied to the outstanding balance of the loan to determine the amount of probable loss.
 
The Company categorizes loans into risk categories based on relevant information regarding the customer’s debt service ability, capacity, overall collateral position along with other economic trends, and historical payment performance.  The risk grades for each credit are updated when the Company receives current financial information, the loan is reviewed by the Company’s internal loan review/credit administration departments, or the loan becomes delinquent or impaired.  The risk grades are updated a minimum of annually for loans rated exceptional, good, acceptable, or pass/watch.  Loans rated special mention, substandard or doubtful are reviewed at least quarterly.  The Company uses the following definitions for its risk ratings:

22

Table of Contents


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











23

Table of Contents



The following table presents the Company’s commercial loans by credit quality indicators, by class (in thousands):
 
Commercial and industrial
Commercial real estate
Total
September 30, 2015
 
 
 
Pass
$
111,706

$
972,067

$
1,083,773

Special mention
4,814

21,299

26,113

Substandard
7,934

35,737

43,671

Doubtful
41


41

Total
$
124,495

$
1,029,103

$
1,153,598

 
 
 
 
December 31, 2014
 

 

 

Pass
$
128,812

$
970,585

$
1,099,397

Special mention
761

15,103

15,864

Substandard
10,575

42,691

53,266

Doubtful
400

452

852

Total
$
140,548

$
1,028,831

$
1,169,379

     
The following table presents the Company's non-commercial loans by payment performance, by class (in thousands):
 
Performing
Non-Performing
Total
September 30, 2015
 
 
 
Residential real estate
$
1,354,865

$
3,218

$
1,358,083

Home equity - junior lien
144,574

174

144,748

Consumer
36,751


36,751

DDA overdrafts
3,258


3,258

Total
$
1,539,448

$
3,392

$
1,542,840

 
 
 
 
December 31, 2014
 
 
 
Residential real estate
$
1,292,012

$
2,564

$
1,294,576

Home equity - junior lien
145,506

98

145,604

Consumer
39,692

13

39,705

DDA overdrafts
2,802


2,802

Total
$
1,480,012

$
2,675

$
1,482,687


Aging Analysis of Accruing and Non-Accruing 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.  Loan origination fees, and certain direct costs, are deferred and amortized as an adjustment to the yield over the term of the loan.  The accrual of interest generally is discontinued when a loan becomes 90 days past due as to principal or interest for all loan types.  However, any loan may be placed on non-accrual if the Company receives information that indicates a borrower is unable to meet the contractual terms of their respective loan agreement.  Other indicators considered for placing a loan on non-accrual status include the borrower’s involvement in bankruptcies, foreclosures, repossessions, litigation and any other situation resulting in doubt as to whether full collection of contractual principal and interest is attainable.  When interest accruals are discontinued, unpaid interest recognized in income in the current year is reversed, and interest accrued in prior years is charged to the allowance for loan losses.  Management may elect to continue the accrual of interest when the net realizable value of collateral exceeds the principal balance and related accrued interest, and the loan is in the process of collection.

Generally for all loan classes, interest income during the period the loan is non-performing is recorded on a cash basis after recovery of principal is reasonably assured.  Cash payments received on nonperforming loans are typically applied directly against the outstanding principal balance until the loan is fully repaid.  Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
 

24

Table of Contents

Generally, all loan types are considered past due when the contractual terms of a loan are not met and the borrower is 30 days or more past due on a payment.  Furthermore, residential and home equity loans are generally subject to charge-off when the loan becomes 120 days past due, depending on the estimated fair value of the collateral less cost to dispose, versus the outstanding loan balance.  Commercial loans are generally charged off when the loan becomes 120 days past due.  Open-end consumer loans are generally charged off when the loan becomes 180 days past due.

A loan acquired and accounted for under ASC Topic 310-30 is reported as an accruing loan and a performing asset provided that the loan is performing in accordance with the initial expectations. The loan would be considered non-performing if the loan's performance deteriorates below the initial expectations.
 
The following table presents an aging analysis of the Company’s accruing and non-accruing loans, by class, as of September 30, 2015 and December 31, 2014 (in thousands):
 
 
Originated Loans
 
September 30, 2015
 
Accruing
 
 
 
 
 
Current
 
30-59 days
 
60-89 days
 
Over 90 days
 
Purchased-Credit Impaired
 
Non-accrual
 
Total
Residential real estate
$
1,274,236

 
$
4,218

 
$
386

 
$
208

 
$

 
$
2,186

 
$
1,281,234

Home equity - junior lien
142,805

 
464

 
67

 
16

 

 
159

 
143,511

Commercial and industrial
110,475

 

 
5

 

 

 
6,065

 
116,545

Commercial real estate
888,458

 
717

 
240

 
225

 

 
7,654

 
897,294

Consumer
32,577

 
85

 
3

 

 

 

 
32,665

DDA overdrafts
2,928

 
330

 

 

 

 

 
3,258

Total
$
2,451,479

 
$
5,814

 
$
701

 
$
449

 
$

 
$
16,064

 
$
2,474,507

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired Loans
 
September 30, 2015
 
Accruing
 
 
 
 
 
Current
 
30-59 days
 
60-89 days
 
Over 90 days
 
Purchased-Credit Impaired
 
Non-accrual
 
Total
Residential real estate
$
75,315

 
$
546

 
$
162

 
$

 
$

 
$
826

 
$
76,849

Home equity - junior lien
1,227

 
10

 

 

 

 

 
1,237

Commercial and industrial
7,235

 
336

 
14

 

 

 
365

 
7,950

Commercial real estate
125,218

 
701

 
245

 

 
1,493

 
4,152

 
131,809

Consumer
3,957

 
117

 
12

 

 

 

 
4,086

DDA overdrafts

 

 

 

 

 

 

Total
$
212,952

 
$
1,710

 
$
433

 
$

 
$
1,493

 
$
5,343

 
$
221,931

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Loans
 
September 30, 2015
 
Accruing
 
 
 
 
 
Current
 
30-59 days
 
60-89 days
 
Over 90 days
 
Purchased-Credit Impaired
 
Non-accrual
 
Total
Residential real estate
$
1,349,551

 
$
4,764

 
$
548

 
$
208

 
$

 
$
3,012

 
$
1,358,083

Home equity - junior lien
144,032

 
474

 
67

 
16

 

 
159

 
144,748

Commercial and industrial
117,710

 
336

 
19

 

 

 
6,430

 
124,495

Commercial real estate
1,013,676

 
1,418

 
485

 
225

 
1,493

 
11,806

 
1,029,103

Consumer
36,534

 
202

 
15

 

 

 

 
36,751

DDA overdrafts
2,928

 
330

 

 

 

 

 
3,258

Total
$
2,664,431

 
$
7,524

 
$
1,134

 
$
449

 
$
1,493

 
$
21,407

 
$
2,696,438

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

25

Table of Contents

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

 
$
4,235

 
$
758

 
$
169

 
$

 
$
2,259

 
$
1,207,598

Home equity - junior lien
142,624

 
561

 
155

 
30

 

 
68

 
143,438

Commercial and industrial
128,857

 
100

 

 
210

 

 
78

 
129,245

Commercial real estate
869,530

 
479

 

 

 

 
7,330

 
877,339

Consumer
33,178

 
119

 
78

 
1

 

 

 
33,376

DDA overdrafts
2,483

 
317

 
2

 

 

 

 
2,802

Total
$
2,376,849

 
$
5,811

 
$
993

 
$
410

 
$

 
$
9,735

 
$
2,393,798

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

 
$
714

 
$

 
$

 
$

 
$
135

 
$
86,978

Home equity - junior lien
2,164

 
2

 

 

 

 

 
2,166

Commercial and industrial
10,123

 
143

 

 

 

 
1,037

 
11,303

Commercial real estate
144,721

 
892

 
210

 

 
1,270

 
4,399

 
151,492

Consumer
6,108

 
172

 
36

 
13

 

 

 
6,329

DDA overdrafts

 

 

 

 

 

 

Total
$
249,245

 
$
1,923

 
$
246

 
$
13

 
$
1,270

 
$
5,571

 
$
258,268

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

 
$
4,949

 
$
758

 
$
169

 
$

 
$
2,394

 
$
1,294,576

Home equity - junior lien
144,788

 
563

 
155

 
30

 

 
68

 
145,604

Commercial and industrial
138,980

 
243

 

 
210

 

 
1,115

 
140,548

Commercial real estate
1,014,251

 
1,371

 
210

 

 
1,270

 
11,729

 
1,028,831

Consumer
39,286

 
291

 
114

 
14

 

 

 
39,705

DDA overdrafts
2,483

 
317

 
2

 

 

 

 
2,802

Total
$
2,626,094

 
$
7,734

 
$
1,239

 
$
423

 
$
1,270

 
$
15,306

 
$
2,652,066















26

Table of Contents


The following table presents the Company’s impaired loans, by class, as of September 30, 2015 and December 31, 2014 (in thousands). The difference between the unpaid principal balance and the recorded investment generally reflects amounts that have been previously charged-off.

 
September 30, 2015
 
December 31, 2014
 
 
Unpaid
 
 
 
Unpaid
 
 
Recorded
Principal
Related
 
Recorded
Principal
Related
 
Investment
Balance
Allowance
 
Investment
Balance
Allowance
With no related allowance recorded:
 
 
 
 
 
 
 
Residential real estate
$
439

$
439

$

 
$
449

$
449

$

Home equity - junior liens
296

296


 
297

297


Commercial and industrial
799

2,861


 



Commercial real estate
4,509

4,948


 
4,631

4,631


Consumer



 



DDA overdrafts



 



Total
$
6,043

$
8,544

$

 
$
5,377

$
5,377

$

 
 
 
 
 
 
 
 
With an allowance recorded
 
 
 
 
 
 
 
Residential real estate
$

$

$

 
$

$

$

Home equity - junior liens



 



Commercial and industrial



 



Commercial real estate
1,352

4,282

274

 
1,392

1,392

252

Consumer



 



DDA overdrafts



 



Total
$
1,352

$
4,282

$
274

 
$
1,392

$
1,392

$
252


     The following table presents information related to the average recorded investment and interest income recognized on the Company’s impaired loans, by class (in thousands):
 
For the nine months ended
 
September 30, 2015
 
September 30, 2014
 
Average
Interest
 
Average
Interest
 
Recorded
Income
 
Recorded
Income
 
Investment
Recognized
 
Investment
Recognized
With no related allowance recorded:
 
 
 
 
 
Residential real estate
$
443

$

 
$
453

$

Home equity - junior liens
296


 
297


Commercial and industrial
1,807


 


Commercial real estate
4,582

3

 
7,329

4

Consumer


 


DDA overdrafts


 


Total
$
7,128

$
3

 
$
8,079

$
4

 
 
 
 
 
 
With an allowance recorded
 
 
 
 
 
Residential real estate
$

$

 
$

$

Home equity - junior liens


 


Commercial and industrial


 


Commercial real estate
1,350


 
1,837

30

Consumer


 


DDA overdrafts


 


Total
$
1,350

$

 
$
1,837

$
30


27

Table of Contents


     Approximately $0.6 million and $0.3 million of interest income would have been recognized during the nine months ended September 30, 2015 and 2014, if such loans had been current in accordance with their original terms.  There were no commitments to provide additional funds on non-accrual, impaired or other potential problem loans at September 30, 2015.

Loan Modifications

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

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

The following tables set forth the Company’s TDRs (in thousands):

 
September 30, 2015
 
December 31, 2014
 
Non-
 
 
 
Non-
 
Accruing
Accruing
Total
 
Accruing
Accruing
Total
Commercial and industrial
$
62

$

$
62

 
$
73

$

$
73

Commercial real estate
1,921


1,921

 
2,263


2,263

Residential real estate
18,154


18,154

 
17,946

545

18,491

Home equity
2,730

16

2,746

 
2,673

15

2,688

Consumer



 



 
$
22,867

$
16

$
22,883

 
$
22,955

$
560

$
23,515

 
 
New TDRs
 
New TDRs
 
For the nine months ended
 
For the nine months ended
 
September 30, 2015
 
September 30, 2014
 
Pre
Post
 
 
Pre
Post
 
Modification
Modification
 
 
Modification
Modification
 
Outstanding
Outstanding
 
 
Outstanding
Outstanding
Number of
Recorded
Recorded
 
Number of
Recorded
Recorded
Contracts
Investment
Investment
 
Contracts
Investment
Investment
Commercial and industrial

$

$

 

$

$

Commercial real estate



 
1

432

432

Residential real estate
35

2,431

2,431

 
26

2,049

2,049

Home equity
14

368

368

 
8

203

203

Consumer



 



 
49

$
2,799

$
2,799

 
35

$
2,684

$
2,684

    

28

Table of Contents


Note F – Long-Term Debt

The components of long-term debt are summarized below (in thousands):
 
September 30, 2015
December 31, 2014
Junior subordinated debentures owed to City Holding Capital Trust III, due 2038, interest at a rate of 3.84% and 3.74%, respectively
$
16,495

$
16,495

 
The Company formed a statutory business trust, City Holding Capital Trust III (“Capital Trust III”), under the laws of Delaware.  Capital Trust III was created for the exclusive purpose of (i) issuing trust-preferred capital securities (“Capital Securities”), which represent preferred undivided beneficial interests in the assets of the trust, (ii) using the proceeds from the sale of the Capital Securities to acquire junior subordinated debentures (“Debentures”) issued by the Company, and (iii) engaging in only those activities necessary or incidental thereto.  The trust is considered a variable interest entity for which the Company is not the primary beneficiary.  Accordingly, the accounts of the trusts are not included in the Company’s consolidated financial statements.

Distributions on the Debentures are cumulative and will be payable quarterly at an interest rate of 3.50% over the three month LIBOR rate, reset quarterly.  Interest payments are due in March, June, September and December.  The Debentures are redeemable prior to maturity at the option of the Company (i) in whole at any time or in part from time-to-time, or (ii) in whole, but not in part, at any time within 90 days following the occurrence and during the continuation of certain pre-defined events.

Payments of distributions on the Capital Securities and payments on redemption of the Capital Securities are guaranteed by the Company.  The Company also entered into an agreement as to expenses and liabilities with the trust pursuant to which it agreed, on a subordinated basis, to pay any cost, expenses or liabilities of the trust other than those arising under the trust preferred securities.  The obligations of the Company under the junior subordinated debentures, the related indentures, the trust agreement establishing the trust, the guarantees and the agreements as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by the Company of the trust’s obligations under the trust preferred securities.  The Capital Securities issued by the statutory business trusts qualify as Tier 1 capital for the Company under current Federal Reserve Board guidelines.

Note G – Derivative Instruments

As of September 30, 2015 and December 31, 2014, the Company has derivative financial instruments not included in hedge relationships.  These derivatives consist of interest rate swaps used for interest rate management purposes and derivatives executed with commercial banking customers to facilitate their interest rate management strategies. For the majority of these instruments the Company acts as an intermediary for its customers. Changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company's results of operations. The Company also has an interest rate swap for the purpose of hedging changes in LIBOR related to commercial real estate loans. Hedge ineffectiveness is assessed quarterly and any ineffectiveness is recorded as non-interest expense. For the three months ended September 30, 2015 and nine month periods ended September 30, 2015 hedge ineffectiveness was less than $0.1 million.

The following table summarizes the notional and fair value of these derivative instruments (in thousands):
 
 
September 30, 2015
 
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Notional Amount
 
Fair Value

 
Notional Amount
 
Fair Value

 
 
 
 
 
 
 
 
 
 
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
 
Other Assets
$
266,284

 
$
14,099

 
$
179,958

 
$
10,253

 
Other Liabilities
274,284

 
14,250

 
179,958

 
10,253

 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges of fair value:
 
 
 
 
 
 
 
 
Other Liabilities
5,163

 
119

 
5,475

 
24


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

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Three months ended September 30,
 
Nine months ended September 30,
2015
2014
 
2015
2014
Change in Fair Value Non-Hedging interest rate derivatives:
 
 
 
 
 
Other income - derivative asset
$
6,922

$
(373
)
 
$
4,494

$
4,233

Other income - derivative liability
(7,028
)
373

 
(4,613
)
(4,233
)
 
 
 
 
 
 
Change in Fair Value Hedging Interest Rate Derivatives:
 
 
 
 
 
Hedged item - derivative asset
101


 
89


Other income - derivative liability
5


 
6



Certain financial instruments, including derivatives, may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements. The Company's derivative transactions with financial institution counterparties are generally executed under International Swaps and Derivative Association ("ISDA") master agreements which include "right of setoff" provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. Nonetheless, the Company does not generally offset financial instruments for financial reporting purposes. Information about financial instruments that are eligible for offset in the consolidated balance sheet as of September 30, 2015 is presented in the following tables (in thousands):

 
 
 
 
Gross Amounts
 
 
 
 
 
 
Not Offset in the Statement
 
 
 
 
 
 
of Financial Position
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
of Gross
 
 
 
 
 
 
 
Amounts
 
 
 
 
 
 
 
Not Offset in
 
 
 
 
 
 
 
the Statement
 
 
 
 
 
 
 
of Financial
 
 
 
 
 
 
 
Position
 
 
 
 
 
Netting
 
Including
 
 
 
Gross
Net Amounts
Adjustment
 
Applicable
 
 
 
Amounts
of Assets
per
 
Netting
 
 
Gross
Offset in the
presented in
Applicable
 
Agreement
 
 
Amounts of
Statement of
the Statement
Master
Fair Value
and Fair
 
 
Recognized
Financial
of Financial
Netting
of Financial
Value of
 
Description
Assets
Position
Position
Arrangements
Collateral
Collateral
Net Amount
 
(a)
(b)
(c)=(a)-(b)
 
 
(d)
(c)-(d) *
Non-hedging derivative assets:
 
 
 
 
 
 
Interest rate swap agreements
$
14,099

$

$
14,099

$

$
14,099

$
14,099

$



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Gross Amounts
 
 
 
 
 
 
Not Offset in the Statement
 
 
 
 
 
 
of Financial Position
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
of Gross
 
 
 
 
 
 
 
Amounts
 
 
 
 
 
 
 
Not Offset in
 
 
 
 
 
 
 
the Statement
 
 
 
 
 
 
 
of Financial
 
 
 
 
 
 
 
Position
 
 
 
 
 
Netting
 
Including
 
 
 
Gross
Net Amounts
Adjustment
 
Applicable
 
 
 
Amounts
of Liabilities
per
 
Netting
 
 
Gross
Offset in the
presented in
Applicable
 
Agreement
 
 
Amounts of
Statement of
the Statement
Master
Fair Value
and Fair
 
 
Recognized
Financial
of Financial
Netting
of Financial
Value of
 
Description
Liabilities
Position
Position
Arrangements
Collateral
Collateral
Net Amount
 
(a)
(b)
(c)=(a)-(b)
 
 
(d)
(c)-(d) *
Non-hedging derivative liabilities:
 
 
 
 
 
 
Interest rate swap agreements
$
14,250

$

$
14,250

$

$
15,697

$
15,697

$

 
 
 
 
 
 
 
 
Hedging derivative liabilities:
 
 
 
 
 
 
Interest rate swap agreements
$
119

$

$
119

 
$
131

$
131

$

 
 
 
 
 
 
 
 
*
For instances where the fair value of financial collateral meets or exceeds the amounts presented in the Statement of Financial Position, a value of zero is displayed to represent full collateralization.

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Note H – Employee Benefit Plans

Pursuant to the terms of the City Holding Company 2003 Incentive Plan and the City Holding Company 2013 Incentive Plan (the "2003 Plan” and "2013 Plan", respectively), the Compensation Committee of the Board of Directors, or its delegate, may, from time-to-time, grant stock options, stock appreciation rights (“SARs”), or stock awards to employees, directors and individuals who provide service to the Company (collectively, "Plan Participants").  The 2003 Plan expired in April of 2013 and the 2013 Plan was approved by the shareholders in April 2013. A maximum of 750,000 shares of the Company’s common stock may be issued upon the exercise of stock options, SARs and stock awards.  These limitations may be adjusted in the event of a change in the number of outstanding shares of common stock by reason of a stock dividend, stock split or other similar event.  Specific terms of options and SARs awarded, including vesting periods, exercise prices (stock price at date of grant) and expiration dates are determined at the date of grant and are evidenced by agreements between the Company and the awardee.  The exercise price of the option grants equals the market price of the Company’s stock on the date of grant.  All incentive stock options and SARs will be exercisable up to 10 years from the date granted and all options and SARs are exercisable for the period specified in the individual agreement. As of September 30, 2015, under the 2003 Plan and 2013 Plan, 438,515 stock options had been awarded and 241,596 restricted stock awards had been awarded, respectively.

Each award from the 2003 Plan and 2013 Plan is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Compensation Committee, or its delegate, determines.  The option price for each grant is equal to the fair market value of a share of the Company’s common stock on the date of the grant.  Options granted expire at such time as the Compensation Committee, or its delegate, determines at the date of the grant and in no event does the exercise period exceed a maximum of ten years.  Upon a change-in-control of the Company, as defined in the 2003 Plan and 2013 Plan, all outstanding options and awards shall immediately vest.

Certain stock options and restricted stock awards have performance-based vesting requirements. These shares will vest in three separate annual installments of approximately 33.33% per installment on the third, fourth and fifth anniversaries of the grant date, subject further to performance-based vesting requirements. The performance-based vesting requirements are as follows:

* First Installment – the mean return on average assets of the Company (excluding merger and acquisition expenses and other nonrecurring items as determined by the Board of Directors of the Company) of the three years immediately prior to the vesting date is equal to or exceeds the median return on average assets over the 20 year period immediately preceding the vesting date of all FDIC insured depository institutions.

* Second Installment – the mean return on average assets of the Company (excluding merger and acquisition expenses and other nonrecurring items as determined by the Board of Directors of the Company) of the four years immediately prior to the vesting date is equal to or exceeds the median return on average assets over the 20 year period immediately preceding the vesting date of all FDIC insured depository institutions.

* Third Installment – the mean return on average assets of the Company (excluding merger and acquisition expenses and other nonrecurring items as determined by the Board of Directors of the Company) of the five years immediately prior to the vesting date is equal to or exceeds the median return on average assets over the 20 year period immediately preceding the vesting date of all FDIC insured depository institutions.

 
Stock Options
 
A summary of the Company’s stock option activity and related information is presented below:
 
Nine months ended September 30,
 
2015
 
2014
Options
 
Weighted-Average Exercise Price
 
Options
 
Weighted-Average Exercise Price
Outstanding at January 1
167,554

 
$
36.74

 
173,601

 
$
35.26

Granted
12,961

 
46.41

 
13,953

 
44.43

Exercised
(71,750
)
 
37.01

 
(19,000
)
 
29.13

Forfeited
(4,000
)
 
31.66

 

 

Outstanding at September 30
104,765

 
$
37.95

 
168,554

 
$
36.71

 

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Additional information regarding stock options outstanding and exercisable at September 30, 2015, is provided in the following table:
Ranges of Exercise Prices
No. of Options Outstanding
Weighted-Average Exercise Price
Weighted-Average Remaining Contractual Life (Years)
Aggregate Intrinsic Value (in thousands)
No. of Options Currently Exercisable
Weighted-Average Exercise Price of Options Currently Exercisable
Weighted-Average Remaining Contractual Life (Years)
Aggregate Intrinsic Value of Options Currently Exercisable (in thousands)
25.00 - 29.99
1,250

28.15

3.5
$
26

1,250

$
28.15

3.5

$
26

30.00 - 34.99
17,750

31.63

4.1
314

17,750

31.63

4.1

314

35.00 - 39.99
51,851

36.10

6.0
684

41,000

39.13

1.3

417

40.00 - 44.99
20,953

43.24

6.5
127

7,000

40.88

2.5

59

45.00 - 50.00
12,961

46.41

9.4
37





 
104,765

 
 
$
1,188

67,000

 
 
$
816

 
Proceeds from stock option exercises were $2.7 million and $0.6 million during the nine months ended September 30, 2015 and 2014, respectively. Shares issued in connection with stock option exercises are issued from available treasury shares. If no treasury shares are available, new shares would be issued from available authorized shares. During the nine months ended September 30, 2015 and 2014 all shares issued in connection with stock option exercises and restricted stock awards were issued from available treasury stock.

The total intrinsic value of stock options exercised was $0.7 million and $0.3 million during the nine months ended September 30, 2015 and 2014, respectively.

Stock-based compensation expense was approximately $0.2 million and $0.1 million for the nine months ended September 30, 2015 and 2014, respectively.  Unrecognized stock-based compensation expense related to stock options approximated $0.5 million at September 30, 2015. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 1.4 years.

The fair value of the options is estimated at the date of grant using a Black-Scholes option-pricing model.   The following weighted average assumptions were used to estimate the fair value of options granted:

 
Nine months ended September 30,
 
2015
 
2014
Risk-free interest rate
1.95
%
 
2.42
%
Expected dividend yield
3.50
%
 
3.60
%
Volatility factor
45.40
%
 
48.75
%
Expected life of option
7.0 years

 
8.0 years


 Restricted Shares

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

Restricted shares are forfeited if officers and employees terminate prior to the lapsing of restrictions. The Company records forfeitures of restricted stock as treasury share repurchases and any compensation cost previously recognized is reversed in the period of forfeiture.  Recipients of restricted shares do not pay any cash consideration to the Company for the shares, have the right to vote all shares subject to such grant and receive all dividends with respect to such shares, whether or not the shares have vested.  Stock-based compensation expense related to restricted shares was approximately $0.9 million and $0.8 million for the nine months ended September 30, 2015 and 2014, respectively.  Unrecognized stock-based compensation expense related to non-vested restricted shares was $3.1 million at September 30, 2015. At September 30, 2015, this unrecognized expense is expected to be recognized over 3.3 years based on the weighted average-life of the restricted shares.

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A summary of the Company’s restricted shares activity and related information is presented below:
 
Nine months ended September 30,
 
2015
 
2014
Restricted Awards
 
Average Market Price at Grant
 
Restricted Awards
 
Average Market Price at Grant
Outstanding at January 1
163,431

 
 
 
142,469

 
 
Granted
25,440

 
$
46.35

 
27,162

 
$
39.72

Forfeited/Vested
(17,050
)
 
 

 
(6,200
)
 
 

Outstanding at September 30
171,821

 
 

 
163,431

 
 


Benefit Plans
 
The Company provides retirement benefits to its employees through the City Holding Company 401(k) Plan and Trust (the “401(k) Plan”), which is intended to be compliant with Employee Retirement Income Security Act (ERISA) section 404(c). The Company’s total expense associated with the retirement benefit plan approximated $0.6 million for both the nine month periods ended September 30, 2015 and 2014.

The Company maintains two frozen defined benefit pension plans the (“Defined Benefit Plans”), which were inherited from the Company's acquisition of the plan sponsors (Horizon Bancorp, Inc. and Community Financial Corporation). The Company made contributions of approximately $0.3 million to the Defined Benefit Plans during each of the nine months ended September 30, 2015 and 2014, respectively.

The following table presents the components of the net periodic pension cost of the Defined Benefit Plans (in thousands):

 
Three months ended September 30,
 
Nine months ended September 30,
2015
 
2014
 
2015
 
2014
Components of net periodic cost:
 
 
 
 
 
 
 
Interest cost
$
203

 
$
209

 
$
668

 
$
634

Expected return on plan assets
(234
)
 
(252
)
 
(757
)
 
(779
)
Net amortization and deferral
244

 
150

 
714

 
538

Net Periodic Pension Cost
$
213

 
$
107

 
$
625

 
$
393

 
Note I – Commitments and Contingencies

The Company is a party to certain financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  The Company has entered into agreements with its customers to extend credit or provide a conditional commitment to provide payment on drafts presented in accordance with the terms of the underlying credit documents. The Company also provides overdraft protection to certain demand deposit customers that represent an unfunded commitment.  Overdraft protection commitments, which are included with other commitments below, are uncollateralized and are paid at the Company’s discretion.  Conditional commitments generally include standby and commercial letters of credit. Standby letters of credit represent an obligation of the Company to a designated third party contingent upon the failure of a customer of the Company to perform under the terms of the underlying contract between the customer and the third party. Commercial letters of credit are issued specifically to facilitate trade or commerce. Under the terms of a commercial letter of credit, drafts will be drawn when the underlying transaction is consummated, as intended, between the customer and a third party. The funded portion of these financial instruments is reflected in the Company’s balance sheet, while the unfunded portion of these commitments is not reflected in the balance sheet.  The table below presents a summary of the contractual obligations of the Company resulting from significant commitments (in thousands):


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September 30, 2015
 
December 31, 2014
Commitments to extend credit:
 
 
 
Home equity lines
$
179,654

 
$
175,312

Commercial real estate
102,348

 
50,298

Other commitments
162,895

 
145,283

Standby letters of credit
4,865

 
4,592

Commercial letters of credit
2,590

 
1,991

 
Loan commitments and standby and commercial letters of credit have credit risks essentially the same as that involved in extending loans to customers and are subject to the Company’s standard credit policies. Collateral is obtained based on management’s credit assessment of the customer. Management does not anticipate any material losses as a result of these commitments.

The Company is engaged in various legal actions that it deems to be in the ordinary course of business. As these legal actions are resolved, the Company could realize positive and/or negative impact to its financial performance in the period in which these legal actions are ultimately decided. There can be no assurance that current legal actions will have an immaterial impact on financial results, either positive or negative, or that no material legal actions may be presented in the future.
 

Note J – Accumulated Other Comprehensive Loss

The activity in accumulated other comprehensive loss for the nine months ended September 30, 2015 and 2014 is presented in the tables below (in thousands). All amounts are shown net of tax, which is calculated using a combined federal and state income tax rate approximating 37%.
 
 
Accumulated Other Comprehensive Loss
 
 
 
Unrealized
 
 
 
 
 
Gains (Losses) on
 
 
 
Defined Benefit
 
Securities
 
 
 
Pension Plans
 
Available-for-Sale
 
Total
 
 
 
 
 
 
Balance at December 31, 2013
$
(2,880
)
 
$
(2,110
)
 
$
(4,990
)
 
 
 
 
 
 
   Other comprehensive income before reclassifications

 
2,683

 
2,683

   Amounts reclassified from other comprehensive loss

 
(614
)
 
(614
)
 

 
2,069

 
2,069

 
 
 
 
 
 
Balance at September 30, 2014
$
(2,880
)
 
$
(41
)
 
$
(2,921
)
 
 
 
 
 
 
Balance at December 31, 2014
$
(5,349
)
 
$
1,190

 
$
(4,159
)
 
 
 
 
 
 
   Other comprehensive income before reclassifications

 
1,943

 
1,943

   Amounts reclassified from other comprehensive loss

 
(1,344
)
 
(1,344
)
 

 
599

 
599

 
 
 
 
 
 
Balance at September 30, 2015
$
(5,349
)
 
$
1,789

 
$
(3,560
)


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Amount reclassified from Other Comprehensive Loss
 
 
Three months ended
 
Nine months ended
Affected line item
 
September 30,
 
September 30,
in the Statements
 
2015
2014
 
2015
2014
of Income
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
Net securities gains reclassified into earnings
$

$
(71
)
 
$
(2,130
)
$
(972
)
Security gains (losses)
Related income tax expense

26

 
786

358

Income tax expense
  Net effect on accumulated other comprehensive loss
$

$
(45
)
 
$
(1,344
)
$
(614
)
 

 

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Note K – Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share using the two class method (in thousands, except per share data):
 
 
Three months ended September 30,
 
Nine months ended September 30,
2015
 
2014
 
2015
 
2014
Distributed earnings allocated to common stock
$
6,362

 
$
6,073

 
$
19,086

 
$
18,220

Undistributed earnings allocated to common stock
4,125

 
5,673

 
21,040

 
19,809

Net earnings allocated to common shareholders
$
10,487

 
$
11,746

 
$
40,126

 
$
38,029

 
 
 
 
 
 
 
 
Average shares outstanding
15,178

 
15,363

 
15,111

 
15,509

Effect of dilutive securities:
 

 
 

 
 
 
 
Warrant outstanding

 
62

 
37

 
62

Employee stock awards
20

 
20

 
21

 
23

Shares for diluted earnings per share
15,198

 
15,445

 
15,169

 
15,594

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.69

 
$
0.76

 
$
2.66

 
$
2.45

Diluted earnings per share
$
0.69

 
$
0.76

 
$
2.65

 
$
2.44


During the nine months ended September 30, 2015 there were no anti-dilutive options outstanding. Options to purchase approximately 13,953 shares of common stock at an exercise price of $44.43 per share were outstanding during the third quarter of 2014 but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares and therefore, the effect would have been anti-dilutive.
 
Note L – Fair Value Measurements

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

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

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

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

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

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Table of Contents

for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Financial Assets and Liabilities

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

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

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

The Company has determined that its pooled trust preferred securities should be priced using Level 3 inputs in accordance with ASC Topic 820 and guidance issued by the SEC.  The Company has determined that there are few observable transactions and market quotations available for pooled trust preferred securities and they are not reliable for purposes of determining fair value at September 30, 2015.  Due to these circumstances, the Company has elected to utilize an income valuation approach produced by a third party pricing source.  This third party model utilizes deferral and default probabilities for the underlying issuers, estimated prepayment rates and assumes no future recoveries of any defaults or deferrals.  The Company then compares the values provided by the third party model with other external sources.  At such time as there are observable transactions or quoted prices that are associated with an orderly and active market for pooled trust preferred securities, the Company will incorporate such market values in its estimate of fair values for these securities.

Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs.  The Company utilizes a market approach by obtaining dealer quotations to value its customer interest rate swaps.  The Company’s derivatives are included within its Other Assets and Other Liabilities in the accompanying consolidated balance sheets. Derivative assets are typically secured through securities with financial counterparties or cross collateralization with a borrowing customer. Derivative liabilities are typically secured through the Company pledging securities to financial counterparties or, in the case of a borrowing customer, by the right of setoff. The Company considers factors such as the likelihood of default by itself and its counterparties, right of setoff, and remaining maturities in determining the appropriate fair value adjustments. All derivative counterparties approved by the Company's Asset and Liability Committee ("ALCO") are regularly reviewed, and appropriate business action is taken to adjust the exposure to certain counterparties, if necessary. Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of marketable collateral securing the position. This approach used to estimate impacted exposures to counterparties is also used by the Company to estimate its own credit risk in derivative liability positions. To date, no material losses have been incurred due to a counterparty's inability to pay any undercollateralized position. There was no significant change in the value of derivative assets and liabilities attributed to credit risk during the three and nine months ended September 30, 2015.

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

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Total
 
Level 1
 
Level 2
 
Level 3
 
Total Gains (Losses)
September 30, 2015
 
 
 
 
 
 
 
 
 
Recurring fair value measurements
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
U.S. Government agencies
$
5

 
$

 
$
5

 
$

 
 
Obligations of states and political subdivisions
42,702

 

 
42,702

 

 
 
Mortgage-backed securities:
 

 
 
 
 
 
 
 
 
U.S. Government agencies
227,947

 

 
227,947

 

 
 
Private label
1,279

 

 
1,279

 

 
 
Trust preferred securities
6,957

 

 
4,866

 
2,091

 
 
Corporate securities
17,343

 

 
17,343

 

 
 
Marketable equity securities
3,103

 
3,103

 

 

 
 
Investment funds
1,529

 
1,529

 

 

 
 
Derivative assets
14,099

 

 
14,099

 

 
 
Financial Liabilities
 

 
 

 
 

 
 

 
 
Derivative liabilities
14,369

 

 
14,369

 

 
 
 
 
 
 
 
 
 
 
 
 
Nonrecurring fair value measurements
 

 
 

 
 

 
 

 
 
Impaired loans
$
7,122

 
$

 
$

 
$
7,122

 
$

     Other real estate owned
6,026

 

 

 
6,026

 
(782
)
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

 
 

 
 

Recurring fair value measurements
 

 
 

 
 

 
 

 
 

Financial Assets
 

 
 

 
 

 
 

 
 

U.S. Government agencies
$
1,827

 
$

 
$
1,827

 
$

 
 

Obligations of states and political subdivisions
42,096

 

 
42,096

 

 
 

Mortgage-backed securities:
 

 
 
 
 
 
 
 
 

U.S. Government agencies
187,328

 

 
187,328

 

 
 

Private label
1,704

 

 
1,704

 

 
 

Trust preferred securities
9,036

 

 
7,165

 
1,871

 
 

Corporate securities
7,317

 

 
7,317

 

 
 

Marketable equity securities
3,213

 
3,213

 

 

 
 

Investment funds
1,522

 
1,522

 

 

 
 

Derivative assets
10,253

 

 
10,253

 

 
 

Financial Liabilities
 

 
 
 
 
 
 
 
 

Derivative liabilities
10,277

 

 
10,277

 

 
 

 
 
 
 
 
 
 
 
 
 
Nonrecurring fair value measurements
 

 
 

 
 

 
 

 
 

Impaired loans
$
6,517

 
$

 
$

 
$
6,517

 
$
(153
)
Other real estate owned
$
8,179

 
$

 
$

 
$
8,179

 
$
(464
)

The table below presents a reconcilement of the Company’s financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3), which consist solely of trust preferred securities (in thousands):

 
Nine months ended September 30,
2015
 
2014
Beginning balance
$
1,871

 
$
3,887

Impairment losses on investment securities

 

Included in other comprehensive income
220

 
(2,161
)
Dispositions

 

Transfers into Level 3

 

Ending Balance
$
2,091

 
$
1,726


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

The table below presents a reconcilement of the Company's financial assets and liabilities measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3), which solely relates to impaired loans that were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon the fair value of the underlying collateral (in thousands).  The fair value of impaired loans is estimated using one of several methods, including collateral value, liquidation value and discounted cash flows.  The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans primarily relate to discounts applied to the customers’ reported amount of collateral.  The amount of collateral discount depends upon the marketability of the underlying collateral.  During the nine months ended September 30, 2015 and 2014, collateral discounts ranged from 20% to 30%. During the nine months ended September 30, 2015 and 2014, the Company had no Level 2 financial assets and liabilities that were measured on a nonrecurring basis.

 
Nine months ended September 30,
2015
 
2014
 
 
 
 
Beginning balance
$
6,517

 
$
11,714

 
 
 
 
Loans classified as impaired during the period
799

 

Specific valuation allowance allocations

 

 
799

 

 
 
 
 
(Additional) reduction in specific valuation allowance allocations
(22
)
 
633

 
 
 
 
Paydowns, payoffs, other activity
(172
)
 
(5,730
)
 
 
 
 
Ending balance
$
7,122

 
$
6,617


Non-Financial Assets and Liabilities

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

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Nine months ended September 30,
 
2015
 
2014
 
 
 
 
Beginning balance
$
8,179

 
$
8,470

 
 
 
 
OREO remeasured at initial recognition:
 
 
 
   Carrying value of foreclosed assets prior to remeasurement
2,356

 
4,225

   Charge-offs recognized in the allowance for loan losses

 

     Fair value
2,356

 
4,225

 
 
 
 
OREO remeasured subsequent to initial recognition
 
 
 
   Carrying value of foreclosed assets prior to remeasurement
3,601

 
480

   Fair value
2,819

 
101

     Write-downs included in other non-interest expense
(782
)
 
(379
)
 
 
 
 
Disposed
(3,727
)
 
(3,155
)
 
 
 
 
Ending balance
$
6,026

 
$
9,161


ASC Topic 825 “Financial Instruments” as amended, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including discount rate and estimate of future cash flows.  In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.  ASC Topic 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used in estimating fair value for financial instruments:

Cash and cash equivalents: Due to their short-term nature, the carrying amounts reported in the consolidated balance sheets approximate fair value.

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

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

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

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

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


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Commitments and letters of credit: The fair values of commitments are estimated based on fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the counterparties’ credit standing.  The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.  The amounts of fees currently charged on commitments and letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values have not been reflected in the table below.

The following table represents the estimates of fair value of financial instruments (in thousands). This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as noninterest-bearing demand, interest-bearing demand and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.
 
Carrying Amount
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
September 30, 2015
 
 
 
 
 
 
 
 
 
Assets:
Cash and cash equivalents
$
118,708

 
$
118,708

 
$
118,708

 
$

 
$

Securities available-for-sale
300,865

 
300,865

 
4,632

 
294,142

 
2,091

Securities held-to-maturity
81,095

 
84,005

 

 
84,005

 

Other securities
9,926

 
9,926

 

 
9,926

 

Net loans
2,675,497

 
2,685,390

 

 

 
2,685,390

Accrued interest receivable
7,690

 
7,690

 
7,690

 

 

Derivative assets
14,099

 
14,099

 

 
14,099

 

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Deposits
2,865,502

 
2,873,255

 
1,883,153

 
990,102

 

Short-term debt
147,036

 
147,035

 

 
147,035

 

Long-term debt
16,495

 
16,464

 

 
16,464

 

Derivative liabilities
14,369

 
14,369

 

 
14,369

 

 
 
 
 
 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

 
 

 
 

Assets:
 

 
 

 
 

 
 

 
 

Cash and cash equivalents
148,228

 
148,228

 
148,228

 

 

Securities available-for-sale
254,043

 
254,043

 
4,735

 
247,437

 
1,871

Securities held-to-maturity
90,786

 
94,191

 

 
94,191

 

Other securities
9,857

 
9,857

 

 
9,857

 

Net loans
2,631,916

 
2,638,911

 

 

 
2,638,911

Accrued interest receivable
6,826

 
6,826

 
6,826

 

 

Derivative assets
10,253

 
10,253

 

 
10,253

 

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Deposits
2,872,787

 
2,879,126

 
1,846,124

 
1,033,002

 

Short-term debt
134,931

 
134,934

 

 
134,934

 

Long-term debt
16,495

 
16,464

 

 
16,464

 

Derivative liabilities
10,277

 
10,277

 

 
10,277

 


Item 2 -
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Critical Accounting Policies
 
The accounting policies of the Company conform with U.S. generally accepted accounting principles and require management to make estimates and develop assumptions that affect the amounts reported in the financial statements and related footnotes. These estimates and assumptions are based on information available to management as of the date of the financial statements. Actual results could differ significantly from management’s estimates. As this information changes, management’s estimates and assumptions used to prepare the Company’s financial statements and related disclosures may also change. The most

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significant accounting policies followed by the Company are presented in Note One to the audited financial statements included in the Company’s 2014 Annual Report to Shareholders. The information included in this Quarterly Report on Form 10-Q, including the Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with the financial statements and notes thereto included in the 2014 Annual Report of the Company.  Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, income taxes, other-than-temporary impairment on investment securities and purchased credit-impaired loans to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new information becomes available.

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

The Company is subject to federal and state income taxes in the jurisdictions in which it conducts business.  In computing the provision for income taxes, management must make judgments regarding interpretation of laws in those jurisdictions.  Because the application of tax laws and regulations for many types of transactions is susceptible to varying interpretations, amounts reported in the financial statements could be changed at a later date upon final determinations by taxing authorities.  On a quarterly basis, the Company estimates its annual effective tax rate for the year and uses that rate to provide for income taxes on a year-to-date basis.  The amount of unrecognized tax benefits could change over the next twelve months as a result of various factors.  However, management cannot currently estimate the range of possible change.  The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2012 through 2014 and state taxing authorities for the years ended December 31, 2011 through 2013.

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

  The Company cannot guarantee that such securities will recover and if additional information becomes available in the future to suggest that the losses are other than temporary, the Company may need to record impairment charges in future periods.  No impairment charges were recognized during the three and nine months ended September 30, 2015 as a result of this review.  The Company continues to actively monitor the market values of these investments along with the financial strength of the issuers behind these securities, as well as its entire investment portfolio.

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

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cash flows will result in a reversal of the provision for loan losses to the extent of prior charges with a corresponding adjustment to the accretable yield, which will result in the recognition of additional interest income over the remaining lives of the loans.


Financial Summary

Nine months ended September 30, 2015 vs. 2014

The Company reported consolidated net income of $40.6 million, or $2.65 per diluted common share, for the nine months ended September 30, 2015, compared to $38.4 million, or $2.44 per diluted common share, for the nine months ended September 30, 2014. Return on average assets (“ROA”) was 1.53% and return on average equity (“ROE”) was 13.1% for the nine months ended September 30, 2015 compared to 1.51% and 12.9%, respectively, for the nine months ended September 30, 2014.

The Company’s net interest income for the first nine months of 2015 decreased $2.3 million compared to the first nine months of 2014 (see Net Interest Income). The Company recorded a provision for loan losses of $4.2 million for the nine months ended September 30, 2015 compared to $3.7 million for the nine months ended September 30, 2014 (see Allowance and Provision for Loan Losses).  As further discussed under the caption Non-Interest Income and Non-Interest Expense, non-interest income increased $9.1 million.  Non-interest expenses for the nine months ended September 30, 2015 decreased $0.2 million from the nine months ended September 30, 2014.

Three months ended September 30, 2015 vs. 2014

The Company reported consolidated net income of $10.6 million, or $0.69 per diluted common share, for the three months ended September 30, 2015, compared to $11.9 million, or $0.76 per diluted common share, for the three months ended September 30, 2014. Return on average assets (“ROA”) was 1.21% and return on average equity (“ROE”) was 10.1% for the three months ended September 30, 2015 compared to 1.40% and 11.9%, respectively, for the three months ended September 30, 2014.

The Company’s net interest income for the third quarter of 2015 decreased $1.6 million compared to the third quarter of 2014 (see Net Interest Income). The Company recorded a provision for loan losses of $0.5 million for the third quarter of 2015 compared to $1.9 million for the third quarter of 2014 (see Allowance and Provision for Loan Losses).  As further discussed under the caption Non-Interest Income and Non-Interest Expense, non-interest income decreased $0.9 million from the three months ended September 30, 2014.  Non-interest expenses for the three months ended September 30, 2015 increased $1.1 million from the three months ended September 30, 2014.


Net Interest Income

Nine months ended September 30, 2015 vs. 2014
The Company’s tax equivalent net interest income decreased $2.4 million, or 2.6%, from $88.8 million for the nine months ended September 30, 2014 to $86.5 million for the nine months ended September 30, 2015. The Company’s reported net interest margin decreased from 4.02% for the nine months ended September 30, 2014 to 3.81% for the nine months ended September 30, 2015. Accretion was $5.5 million for the nine months ended September 30, 2014 and $5.1 million for the nine months ended September 30, 2015. The Company’s tax equivalent net interest income excluding accretion decreased $2.0 million, or 2.4%, from $83.3 million for the nine months ended September 30, 2014 to $81.4 million for the nine months ended September 30, 2015. Excluding the favorable impact of the accretion, the net interest margin for the nine months ended September 30, 2015 and 2014 would have been 3.58% and 3.77%, respectively. The Company continues to originate a significant portion of its commercial loans as variable rate loans based on WSJ Prime or LIBOR and has elected to keep fixed rate investment security balances at approximately 10% of total assets and allow cash balances to increase. The Company believes that these measures position its balance sheet to benefit from a rising rate environment.
Three months ended September 30, 2015 vs. 2014
The Company’s tax equivalent net interest income decreased $1.6 million, or 5.5%, from $29.6 million for the three months ended September 30, 2014 to $28.0 million for the three months ended September 30, 2015. The Company’s reported net interest margin decreased from 3.95% for the three months ended September 30, 2014 to 3.62% for the three months ended September 30, 2015. Accretion was $1.8 million for the three months ended September 30, 2014 and $1.1 million for the three months ended September 30, 2015. The Company’s tax equivalent net interest income excluding accretion decreased $0.8 million, or 3.0%, from $27.8 million for the three months ended September 30, 2014 to $26.9 million for the three months ended September 30, 2015. Excluding the favorable impact of the accretion, the net interest margin for the three months ended September 30, 2015

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and 2014 would have been 3.48% and 3.71%, respectively. The Company continues to originate a significant portion of its commercial loans based on WSJ Prime or LIBOR and has elected to keep fixed rate investment security balances at approximately 10% of total assets and allow cash balances to increase. The Company believes these measures position its balance sheet to benefit from a rising rate environment.
The following schedule presents the actual and estimated future accretion on net interest income as a result of the Company's acquisitions (in thousands). The amounts in the table below require management to make significant assumptions based on estimated future default, prepayment and discount rates. Actual performance could be significantly different from that assumed, which could result in actual results being materially different than those estimated below.
 
Virginia Savings
Community
 
 
Year Ended
Loan
Accretion
Certificates of Deposit
Loan
Accretion
Certificates of Deposit
Total
 
 
 
 
 
 
1Q 2015
123

129

2,158

40

2,450

2Q 2015
189

129

1,249

40

1,607

3Q 2015
245

129

642

40

1,056

Remainder 2015 (estimated)
88

129

1,057

40

1,314

2016 (estimated)
247

497

1,232

48

2,024

2017 (estimated)
130


889


1,019



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Table of Contents


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

Assets
Nine months ended September 30,
2015
2014
Average
Balance
Interest
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
 
 
 
 
 
 
Loan portfolio(1):
Residential real estate(2)
$
1,459,247

$
42,797

3.92
%
$
1,373,854

$
41,425

4.03
%
Commercial, financial, and agriculture(2)
1,157,677

38,759

4.48

1,158,198

41,308

4.77

   Installment loans to individuals(2),(3)
41,338

3,209

10.38

46,209

3,284

9.50

   Previously securitized loans(4)
***

1,310

***
***

1,630

***
Total loans
2,658,262

86,075

4.33

2,578,261

87,647

4.55

Securities:
 

 

 

 

 

 

Taxable
340,585

7,974

3.13

342,349

8,797

3.44

   Tax-exempt(5)
29,222

1,235

5.65

27,685

1,292

6.24

Total securities
369,807

9,209

3.33

370,034

10,089

3.65

Deposits in depository institutions
9,790



8,955



Total interest-earning assets
3,037,859

95,284

4.19

2,957,250

97,736

4.42

Cash and due from banks
202,423

 
 
127,229

 
 
Bank premises and equipment
76,273

 
 
81,038

 
 
Other assets
242,294

 
 
246,654

 
 
Less: allowance for loan losses
(20,960
)
 
 
(21,194
)
 
 
Total assets
$
3,537,889

 

 

$
3,390,977

 

 

Liabilities
 

 

 

 

 

 

   Interest-bearing demand deposits
$
643,086

$
379

0.08
%
$
612,720

$
479

0.10
%
Savings deposits
698,433

520

0.10

628,996

597

0.13

Time deposits(2)
1,005,548

7,227

0.96

1,052,625

7,144

0.91

Short-term borrowings
138,192

236

0.23

128,230

246

0.26

Long-term debt
16,495

458

3.71

16,495

453

3.67

Total interest-bearing liabilities
2,501,754

8,820

0.47

2,439,066

8,919

0.49

Noninterest-bearing demand deposits
584,046

 
 
522,341

 
 
Other liabilities
40,207

 
 
32,526

 
 
Stockholders’ equity
411,882

 
 
397,044

 
 
Total liabilities and stockholders’ equity
$
3,537,889

 

 

$
3,390,977

 

 

Net interest income
 

$
86,464

 

 

$
88,817

 

Net yield on earning assets
 

 

3.81
%
 
 
4.02
%

46

Table of Contents

(1)
For purposes of this table, non-accruing loans have been included in average balances and loan fees, which are immaterial, have been included in interest income.
(2)
Included in the above table are the following amounts for the accretion of the fair value adjustments related to the acquisitions of Virginia Savings and Community:
 
 
Nine months ended September 30, 2015
 
 
Virginia Savings
Community
Total
 
Residential real estate
$
246

$
451

$
697

 
Commercial, financial and agriculture
236

3,447

3,683

 
Installment loans to individuals
75

151

226

 
Time deposits
387

120

507

 
 
$
944

$
4,169

$
5,113

 
 
 
 
 
 
 
Nine months ended September 30, 2014
 
 
Virginia Savings
Community
Total
 
Residential real estate
$
361

$
363

$
724

 
Commercial, financial and agriculture
424

3,149

3,573

 
Installment loans to individuals
113

473

586

 
Time deposits
401

197

598

 
 
$
1,299

$
4,182

$
5,481

 
 
 
 
 
(3)
Includes the Company’s consumer and DDA overdrafts loan categories.
(4)
Effective January 1, 2012, there is no carrying value of the Company’s previously securitized loans.
(5)
Computed on a fully federal tax-equivalent basis assuming a tax rate of approximately 35%.

































47

Table of Contents

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

 
Nine months ended September 30, 2015 vs. 2014
Interest-earning assets:
Increase (Decrease)
Due to Change In:
Volume
Rate
Net
 
 
 
Loan portfolio
Residential real estate
$
2,575

$
(1,203
)
$
1,372

Commercial, financial, and agriculture
(19
)
(2,530
)
(2,549
)
Installment loans to individual
(346
)
271

(75
)
Previously securitized loans

(320
)
(320
)
Total loans
2,210

(3,782
)
(1,572
)
Securities:
 

 

 

Taxable
(45
)
(778
)
(823
)
   Tax-exempt(1)
72

(129
)
(57
)
Total securities
27

(907
)
(880
)
Total interest-earning assets
$
2,237

$
(4,689
)
$
(2,452
)
Interest-bearing liabilities:
 

 

 

   Interest-bearing demand deposits
$
24

$
(124
)
$
(100
)
Savings deposits
66

(143
)
(77
)
Time deposits
(320
)
403

83

Short-term borrowings
19

(29
)
(10
)
Long-term debt

5

5

Total interest-bearing liabilities
$
(211
)
$
112

$
(99
)
Net Interest Income
$
2,448

$
(4,801
)
$
(2,353
)
(1)
Fully federal taxable equivalent using a tax rate of approximately 35%.





48

Table of Contents

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

Assets
Three months ended September 30,
2015
2014
Average
Balance
Interest
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
 
 
 
 
 
 
Loan portfolio(1):
Residential real estate(2)
$
1,482,445

$
14,469

3.87
%
$
1,400,072

$
14,077

3.99
%
Commercial, financial, and agriculture(2)
1,156,264

12,174

4.18

1,155,269

13,733

4.72

   Installment loans to individuals(2),(3)
40,720

875

8.53

44,801

995

8.81

   Previously securitized loans(4)
***

357

***
***

487

***
Total loans
2,679,429

27,875

4.13

2,600,142

29,292

4.47

Securities:
 

 

 

 

 

 

Taxable
352,567

2,621

2.95

335,760

2,864

3.38

   Tax-exempt(5)
29,675

419

5.60

28,199

434

6.11

Total securities
382,242

3,040

3.16

363,959

3,298

3.60

Deposits in depository institutions
9,924



8,924



Total interest-earning assets
3,071,595

30,915

3.99

2,973,025

32,590

4.35

Cash and due from banks
156,575

 
 
107,550

 
 
Bank premises and equipment
74,543

 
 
79,865

 
 
Other assets
237,803

 
 
246,357

 
 
Less: allowance for loan losses
(21,425
)
 
 
(20,893
)
 
 
Total assets
$
3,519,091

 

 

$
3,385,904

 

 

Liabilities
 

 

 

 

 

 

   Interest-bearing demand deposits
$
644,375

$
122

0.08
%
$
615,830

$
138

0.09
%
Savings deposits
691,600

165

0.09

633,690

192

0.12

Time deposits(2)
989,149

2,399

0.96

1,036,370

2,400

0.92

Short-term borrowings
135,274

69

0.20

132,484

86

0.26

Long-term debt
16,495

155

3.73

16,495

152

3.66

Total interest-bearing liabilities
2,476,893

2,910

0.47

2,434,869

2,968

0.48

Noninterest-bearing demand deposits
594,821

 
 
522,083

 
 
Other liabilities
28,583

 
 
30,188

 
 
Stockholders’ equity
418,794

 
 
398,764

 
 
Total liabilities and stockholders’ equity
$
3,519,091

 

 

$
3,385,904

 

 

Net interest income
 

$
28,005

 

 

$
29,622

 

Net yield on earning assets
 

 

3.62
%
 
 
3.95
%



49

Table of Contents

(1)
For purposes of this table, non-accruing loans have been included in average balances and loan fees, which are immaterial, have been included in interest income.
(2)
Included in the above table are the following amounts for the accretion of the fair value adjustments related to the acquisitions of Virginia Savings and Community:
 
 
Three months ended September 30, 2015
 
 
Virginia Savings
Community
Total
 
Residential real estate
$
95

$
162

$
257

 
Commercial, financial and agriculture
130

446

576

 
Installment loans to individuals
20

34

54

 
Time deposits
129

40

169

 
 
$
374

$
682

$
1,056

 
 
 
 
 
 
 
Three months ended September 30, 2014
 
 
Virginia Savings
Community
Total
 
Residential real estate
$
103

$
105

$
208

 
Commercial, financial and agriculture
169

1,110

1,279

 
Installment loans to individuals
43

119

162

 
Time deposits
135

52

187

 
 
$
450

$
1,386

$
1,836

 
 
 
 
 
(3)
Includes the Company’s consumer and DDA overdrafts loan categories.
(4)
Effective January 1, 2012, there is no carrying value of the Company’s previously securitized loans.
(5)
Computed on a fully federal tax-equivalent basis assuming a tax rate of approximately 35%.



50

Table of Contents

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

 
Three months ended September 30, 2015 vs. 2014
Interest-earning assets:
Increase (Decrease)
Due to Change In:
Volume
Rate
Net
 
 
 
Loan portfolio
Residential real estate
$
828

$
(436
)
$
392

Commercial, financial, and agriculture
12

(1,571
)
(1,559
)
Installment loans to individual
(91
)
(29
)
(120
)
Previously securitized loans

(130
)
(130
)
Total loans
749

(2,166
)
(1,417
)
Securities:
 

 

 

Taxable
143

(386
)
(243
)
   Tax-exempt(1)
23

(38
)
(15
)
Total securities
166

(424
)
(258
)
Total interest-earning assets
$
915

$
(2,590
)
$
(1,675
)
Interest-bearing liabilities:
 

 

 

   Interest-bearing demand deposits
$
6

$
(22
)
$
(16
)
Savings deposits
18

(45
)
(27
)
Time deposits
(109
)
108

(1
)
Short-term borrowings
2

(19
)
(17
)
Long-term debt

3

3

Total interest-bearing liabilities
$
(83
)
$
25

$
(58
)
Net Interest Income
$
998

$
(2,615
)
$
(1,617
)

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

Table Five
Loan Portfolio
(In thousands)
 
September 30, 2015
 
December 31, 2014
 
September 30, 2014
Residential real estate
$
1,358,083

 
$
1,294,576

 
$
1,274,062

Home equity – junior liens
144,748

 
145,604

 
146,965

Commercial and industrial
124,495

 
140,548

 
139,220

Commercial real estate
1,029,103

 
1,028,831

 
1,025,835

Consumer
36,751

 
39,705

 
41,042

DDA overdrafts
3,258

 
2,802

 
3,618

Total loans
$
2,696,438

 
$
2,652,066

 
$
2,630,742


Loan balances increased $44.4 million from December 31, 2014 to September 30, 2015. Residential real estate loans increased $63.5 million, or 4.9%, from December 31, 2014 to September 30, 2015.   Residential real estate loans primarily consist of: (i) single-family 3 and 5 year adjustable rate mortgages with terms that amortize the loans over periods from 15-30 years and (ii) home equity loans secured by first liens.  The Company’s mortgage products do not include sub-prime, interest only, or option adjustable rate mortgage products.  The Company’s home equity loans are underwritten differently than 1-4 family residential mortgages with typically less documentation but lower loan-to-value ratios.  Home equity loans consist of lines of credit, short-

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term fixed amortizing loans and non-purchase adjustable rate loans.  At September 30, 2015, $14.8 million of the residential real estate loans were for properties under construction.

Junior lien home equity loans decreased $0.9 million during the first nine months of 2015.  Junior lien home equity loans consist of lines of credit, short-term fixed amortizing loans, and non-purchase adjustable rate loans with second or lower lien positions.

Commercial real estate loans increased $0.3 million from December 31, 2014 to September 30, 2015.  At September 30, 2015, $12.0 million of the commercial real estate loans were for commercial properties under construction. Commercial and industrial loans (“C&I”) decreased $16.1 million from December 31, 2014 to September 30, 2015. During the third quarter of 2015, the decrease in C&I loans outstanding is largely attributable to a more competitive lending environment, a C&I loan customer that sold its business and repaid a $7.6 million loan, and to various lines of credit that experienced balance reductions.

Consumer loans decreased $3.0 million during the first nine months of 2015.  The consumer loan portfolio primarily consists of new and used automobile loans, personal loans secured by cash and cash equivalents, unsecured revolving credit products, and other similar types of credit facilities. The Company strategically decided to reduce consumer loans due to the acquisition of an indirect portfolio of loans associated with Community. These loans have higher loss percentages compared to the Company's historical consumer portfolio. Excluding the Community loans, consumer loans decreased $0.6 million.

Allowance and Provision for Loan Losses

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

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

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

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

As a result of the Company’s quarterly analysis of the adequacy of the ALLL, the Company recorded a provision for loan losses of $4.2 million in the first nine months of 2015 and $3.7 million in the first nine months of 2014.  The provision for loan losses recorded in 2015 reflects difficulties of certain commercial borrowers of the Company during the first nine months of 2015, including difficulties encountered by a, commercial borrower of the Company engaged in the mining and energy sectors (per the North American Industry Classification System (NAICS)) and a charge-off related to a specific credit of said borrower and management’s assessment of the impact of these difficulties on the ultimate collectibility of the loans. In addition, as a result of this loss, the historical loss rates used to compute the allowance not specifically allocated to individual credits for loans in our commercial and industrial mining and energy sector increased which resulted in an increase in the provision for the first nine

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Table of Contents

months of 2015. The first nine months of 2015 also includes $0.5 million of provision expense related to purchased credit impaired loans. Changes in the amount of the provision and related allowance are based on the Company’s detailed systematic methodology and are directionally consistent with changes in the composition and quality of the Company’s loan portfolio.  The Company believes its methodology for determining its ALLL adequately provides for probable losses inherent in the loan portfolio and produces a provision and allowance for loan losses that is directionally consistent with changes in asset quality and loss experience.

The Company had net charge-offs of $3.4 million for the first nine months of 2015 and $3.8 million for the first nine months of 2014.  Net charge-offs in the first nine months of 2015 consisted primarily of net charge-offs on commercial and industrial loans of $1.8 million, residential real estate loans of $0.6 million, and overdraft deposit accounts of $0.4 million.  

The Company’s ratio of non-performing assets to total loans and other real estate owned increased from 0.90% at December 31, 2014 to 1.03% at September 30, 2015.  Excluded from this ratio are purchased credit-impaired loans in which the Company estimated cash flows and estimated a credit mark. These loans are considered performing loans provided that the loan is performing in accordance with the estimated expectations. Such loans would be considered non-performing loans if the loan's performance deteriorates below the initial expectations. This increase was primarily related to a single commercial customer engaged in the mining and energy sectors (per the NAICS) which filed for bankruptcy and for which the Company recorded a charge-off as previously discussed.

The ALLL was $20.9 million at September 30, 2015 and $20.2 million at December 31, 2014.  Below is a summary of the changes in the components of the ALLL from December 31, 2014 to September 30, 2015.

The allowance allocated to the commercial real estate loan portfolio (see Table Nine) decreased $0.4 million, or 4.83%, from $8.9 million at December 31, 2014 to $8.5 million at September 30, 2015. This is due to a decrease in loans classified as substandard as well as a decrease in historical loss rates.

The allowance related to the commercial and industrial loan portfolio increased $1.2 million from $1.6 million at December 31, 2014 to $2.8 million at September 30, 2015 (see Table Nine). This increase is due to an increase in loans classified as special mention as of September 30, 2015 and an increase in historical loss rates used for loans evaluated for impairment collectively.

The allowance allocated to the residential real estate portfolio (see Table Nine) increased modestly from $7.2 million at December 31, 2014 to $7.3 million at September 30, 2015. This was primarily due to an increase in residential real estate loans outstanding.

The allowance allocated to the home equity loan portfolio (see Table Nine) remained flat at $1.5 million at December 31, 2014 and September 30, 2015.

The allowance allocated to the consumer loan portfolio (see Table Nine) remained flat at $0.1 million at December 31, 2014 and September 30, 2015.

The allowance allocated to overdraft deposit accounts (see Table Nine) decreased modestly from $0.9 million at December 31, 2014 to $0.8 million at September 30, 2015.

Based on the Company’s analysis of the adequacy of the allowance for loan losses and in consideration of the known factors utilized in computing the allowance, management believes that the allowance for loan losses as of September 30, 2015, is adequate to provide for probable losses inherent in the Company’s loan portfolio. Future provisions for loan losses will be dependent upon trends in loan balances including the composition of the loan portfolio, changes in loan quality and loss experience trends, and recoveries of previously charged-off loans, among other factors.












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Table Six
Analysis of the Allowance for Loan Losses
(In thousands)
 
Nine months ended September 30,
 
Year ended
December 31,
2015
 
2014
 
2014
Balance at beginning of period
$
20,150

 
$
20,575

 
$
20,575

Charge-offs:
 

 
 

 
 

Commercial and industrial
(1,903
)
 
(330
)
 
(323
)
Commercial real estate
(277
)
 
(1,665
)
 
(1,925
)
Residential real estate
(758
)
 
(1,348
)
 
(1,762
)
Home equity
(236
)
 
(288
)
 
(309
)
Consumer
(171
)
 
(171
)
 
(188
)
DDA overdrafts
(1,038
)
 
(1,052
)
 
(1,415
)
Total charge-offs
(4,383
)
 
(4,854
)
 
(5,922
)
Recoveries:
 

 
 

 
 

Commercial and industrial
72

 
85

 
89

Commercial real estate
49

 
94

 
113

Residential real estate
130

 
91

 
187

Home equity

 

 

Consumer
154

 
172

 
204

DDA overdrafts
594

 
654

 
850

Total recoveries
999

 
1,096

 
1,443

Net charge-offs
(3,384
)
 
(3,758
)
 
(4,479
)
Provision for purchased credit impaired loans
521

 
135

 
3,771

Provision for loan losses
3,654

 
3,535

 
283

Balance at end of period
$
20,941

 
$
20,487

 
$
20,150

As a Percent of Average Total Loans:
 

 
 

 
 

Net charge-offs (annualized)
0.17
%
 
0.19
%
 
0.17
%
Provision for loan losses (annualized)
0.21
%
 
0.19
%
 
0.16
%
As a Percent of Non-Performing Loans:
 

 
 

 
 

Allowance for loan losses
95.81
%
 
112.61
%
 
128.10
%

Table Seven
Non-Accrual, Past-Due and Restructured Loans
(In thousands)


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Table of Contents

 
As of September 30,
 
December 31,
2015
 
2014
 
2014
Non-accrual loans
$
21,407

 
$
17,384

 
$
15,307

Accruing loans past due 90 days or more
449

 
809

 
423

Total non-performing loans
21,856

 
18,193

 
15,730

 
 
 
 
 
 
Chapter 7 troubled debt restructurings
$
20,900

 
$
20,860

 
$
21,179


Non-accrual loans increased $4.0 million from $17.4 million for the nine months ended September 30, 2014 to $21.4 million for the nine months ended September 30, 2015. This increase was primarily related to a single commercial customer engaged in the mining industry (per the NAICS) which filed for bankruptcy and for which the Company recorded a charge-off as previously discussed. The average recorded investment in impaired loans during the nine months ended September 30, 2015 and 2014 was $8.5 million and $9.9 million, respectively.  The Company recognized less than $0.1 million of interest income received in cash on non-accrual and impaired loans for both the nine months ended September 30, 2015 and September 30, 2014.  Approximately $0.6 million and $0.3 million of interest income would have been recognized during the nine months ended September 30, 2015 and September 30, 2014, respectively, if such loans had been current in accordance with their original terms.  There were no commitments to provide additional funds on non-accrual, impaired, or other potential problem loans at September 30, 2015.  

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.

The Company's troubled debt restructurings ("TDRs") related to its borrowers who had filed for Chapter 7 bankruptcy protection make up 91% of the Company's total TDRs as of September 30, 2015. The average age of these TDRs was 11.2 years; the average current balance as a percentage of the original balance was 67.6%; and the average loan-to-value ratio was 63.3% as of September 30, 2015. Of the total 498 Chapter 7 related TDRs, 35 had an estimated loss exposure based on the current balance and appraised value at September 30, 2015.

Table Eight
Impaired Loans
(In thousands)

 
As of September 30,
 
As of December 31,
2015
 
2014
 
2014
Impaired loans with a valuation allowance
$
1,352

 
$
1,397

 
$
1,392

Impaired loans with no valuation allowance
6,043

 
5,466

 
5,377

Total impaired loans
$
7,395

 
$
6,863

 
$
6,769

Allowance for loan losses allocated to impaired loans
$
274

 
$
247

 
$
252


Table Nine
Allocation of the Allowance for Loan Losses
(In thousands)


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Table of Contents

 
As of September 30,
 
As of December 31,
2015
 
2014
 
2014
Commercial and industrial
$
2,781

 
$
1,593

 
$
1,582

Commercial real estate
8,490

 
9,606

 
8,921

Residential real estate
7,261

 
6,959

 
7,208

Home equity
1,508

 
1,491

 
1,495

Consumer
96

 
88

 
85

DDA overdrafts
805

 
750

 
859

Allowance for Loan Losses
$
20,941

 
$
20,487

 
$
20,150



Non-Interest Income and Non-Interest Expense

Nine months ended September 30, 2015 vs. 2014
(In millions)
 
Nine months ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Gains on sale of investment securities
$
2.1

 
$
1.0

 
$
1.1

 
110.0
 %
Non-interest income, excluding gains on sale of investment securities
51.0

 
43.1

 
7.9

 
18.3
 %
Non-interest expense
71.8

 
72.0

 
(0.2
)
 
(0.3
)%

Non-Interest Income: During the first nine months of 2015 the Company realized investment gains of $2.1 million from the call of trust preferred securities which represented a partial recovery of impairment charges previously recognized. Effective January 1, 2015, the Company sold its insurance operations, CityInsurance, which resulted in a pre-tax gain of $11.1 million. Exclusive of this gain and the investment security gains, non-interest income declined from $43.1 million for the first nine months of 2014 to $39.9 million for the first nine months of 2015.  The primary reason for this decline was the sale of CityInsurance which had insurance commission revenues of $4.7 million in the first nine months of 2014. In addition, service charges decreased $0.4 million (2.1%), from the first nine months of 2014 to $19.4 million in the first nine months of 2015. These decreases were partially offset by increases in bankcard revenues of $0.7 million (5.8%), other income of $0.8 million (50.1%), and trust and investment management fee income of $0.3 million (10.0%).

Non-Interest Expense: Non-interest expenses decreased $0.2 million, from $72.0 million in the first nine months of 2014 to $71.8 million in the first nine months of 2015. This drop was largely due to a decline in salaries and employee benefit expense of $2.7 million, or 6.9%, to $36.6 million, that was primarily attributable to a reduction in the Company’s salary expense as a result of the sale of CityInsurance. This decrease was partially offset by an increase in other expenses of $1.9 million to $9.9 million and an increase in repossessed asset losses of $0.5 million to $1.0 million. The increase in other expenses was primarily related to a loss the Company recognized related to a partnership investment in Mountaineer Capital LP. In 2000, the Company’s former management team committed $2.8 million to an investment in Mountaineer Capital LP that to date has returned $0.6 million. The Company has taken various write-downs totaling $0.8 million related to this investment. Based upon recently obtained information from the partnership, the Company has concluded that it will not receive any significant additional value from its investment in Mountaineer Capital LP and has written down the remainder of its basis in this investment of $1.4 million. During the first nine months of 2014, the Company’s non-income based taxes decreased due to the recognition of a previously unrecognized tax position due to the close of the statute of limitations for a previous tax year and was discrete to the first quarter of 2014.

Income Tax Expense: The Company’s effective income tax rate for the nine months ended September 30, 2015 was 35.8% compared to 31.4% for the year ended December 31, 2014, and 32.3% for the nine months ended September 30, 2014.  As noted previously, the Company sold CityInsurance in the first quarter of 2015. As a result of differences between the book and tax basis of the assets that were sold, the Company’s income tax expense increased by $1.1 million. During the first nine months of 2014, the Company reduced income tax expense due to the recognition of previously unrecognized tax position resulting from the close of the statute of limitations for a previous tax year. Exclusive of the sale of CityInsurance in the first nine months of 2015 and the discrete item recognized in the first nine months of 2014, the Company’s tax rate from operations was 33.2% and 33.6%, for the year to date periods ended September 30, 2015 and September 30, 2014, respectively.


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Table of Contents

Three months ended September 30, 2015 vs. 2014
(In millions)
 
Three months ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Gains on sale of investment securities
$

 
$
0.1

 
$
(0.1
)
 
(100.0
)%
Non-interest income, excluding gains on sale of investment securities
13.7

 
14.5

 
(0.8
)
 
(5.5
)%
Non-interest expense
25.4

 
24.3

 
1.1

 
4.5
 %

Non-Interest Income: The Company did not recognize any investment gains during the third quarter of 2015. Excluding investment security gains recognized in the third quarter of 2014, non-interest income declined from $14.5 million for the three months ended September 30, 2014 to $13.7 million for the three months ended September 30, 2015. The primary reason for this decline was the sale of CityInsurance which had insurance commission revenues of $1.4 million in the three months ended September 30, 2014. This decrease was partially offset by an increase in other income of $0.3 million primarily related to mortgage banking activities and bank owned life insurance income of $0.2 million due to death benefit proceeds.

Non-Interest Expense: Non-interest expenses increased $1.1 million, from $24.3 million in the three months ended September 30, 2014 to $25.4 million in the three months ended September 30, 2015. This increase was primarily related to an increase in other expenses as the Company recognized a loss related to a partnership investment in Mountaineer Capital LP. In 2000, the Company’s former management team committed $2.8 million to an investment in Mountaineer Capital LP that to date has returned $0.6 million. The Company has taken various write-downs totaling $0.8 million related to this investment. Based upon recently obtained information from the partnership, the Company has concluded that it will not receive any significant additional value from its investment in Mountaineer Capital LP and has written down the remainder of its basis in this investment of $1.4 million. In addition, the Company realized losses of $0.5 million during the third quarter of 2015 on the sale of repossessed assets and $0.2 million in merger related expenses in connection with the Company’s forthcoming acquisition of three branches in Lexington, Kentucky from American Founders Bank, Inc., a wholly-owned subsidiary of Financial Holdings, Inc. These increases were partially offset by a decrease in salaries and employee benefits of $1.0 million, or 7.3%, to $12.2 million, which was primarily attributable to a reduction in the Company’s salary expense as a result of the sale of CityInsurance.

Income Tax Expense: The Company’s effective income tax rate for the three months ended September 30, 2015 was 32.6% compared to 31.4% for the year ended December 31, 2014, and 33.6% for the three months ended September 30, 2014.  The effective rate is based upon the Company's expected tax rate for the year ending December 31, 2015.

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 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.

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

The Company’s policy objective is to avoid negative fluctuations in net income or the economic value of equity of more than 15% within a 12-month period, assuming an immediate parallel increase or decrease of 400 basis points. The Company measures the long-term risk associated with sustained increases and decreases in rates through analysis of the impact to changes

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in rates on the economic value of equity.  Due to the current Federal Funds target rate of 25 basis points, the Company has chosen not to reflect a decrease of 25 basis points from current rates in its analysis.

The following table summarizes the sensitivity of the Company’s net income to various interest rate scenarios. The results of the sensitivity analyses presented below differ from the results used internally by ALCO in that, in the analyses below, interest rates are assumed to have an immediate and sustained parallel shock. The Company recognizes that rates are volatile, but rarely move with immediate and parallel effects. Internally, the Company considers a variety of interest rate scenarios that are deemed to be possible while considering the level of risk it is willing to assume in “worst-case” scenarios.

Immediate Basis Point Change in Interest Rates
 
Implied Federal Funds Rate Associated with Change in Interest Rates
 
Estimated Increase (Decrease) in Net Income Over 12 Months
 
Estimated Increase (Decrease) in Economic Value of Equity
September 30, 2015
 
 
 
 
 
 
+400

 
4.25
%
 
+3.9
%
 
(3.8
)%
+300

 
3.25

 
+5.8

 
+2.2

+200

 
2.25

 
+5.5

 
+5.5

+100

 
1.25

 
+2.8

 
+3.6

December 31, 2014
 
 

 
 

 
 

+400

 
4.25
%
 
+2.8
%
 
(4.1
)%
+300

 
3.25

 
+4.9

 
+1.8

+200

 
2.25

 
+5.0

 
+4.9

+100

 
1.25

 
+1.9

 
+2.9

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

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


Liquidity

The Company evaluates the adequacy of liquidity at both the City Holding Company ("Parent Company") level and at the banking subsidiary level. At the Parent Company level, the principal source of cash is dividends from its banking subsidiary, City National Bank ("City National"). Dividends paid by City National to the Parent Company are subject to certain legal and regulatory limitations. Generally, any dividends in amounts that exceed the earnings retained by City National in the current year plus retained net profits for the preceding two years must be approved by regulatory authorities. At September 30, 2015, City National could pay dividends up to $52.9 million plus net profits for the remainder of 2015, as defined by statute, up to the dividend declaration date without prior regulatory permission.

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

Over the next 12 months, the Parent Company has an obligation to remit interest payments approximating $0.6 million on the debentures held by City Holding Capital Trust III. Interest payments on the debentures can be deferred for up to five years under certain circumstances and dividends to shareholders can, if necessary, be suspended. The Parent Company anticipates continuing the payment of dividends on its common stock, which are expected to approximate $25.7 million on an annualized basis over the next 12 months based on common shareholders outstanding at September 30, 2015.  In addition to these anticipated cash needs, the Parent Company has operating expenses and other contractual obligations, which are estimated to require $1.7 million of additional cash over the next 12 months. As of September 30, 2015, the Parent Company reported a cash balance of

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$11.4 million and management believes that the Parent Company’s available cash balance, together with cash dividends from City National will be adequate to satisfy its funding and cash needs over the next twelve months.

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

City National manages its liquidity position in an effort to effectively and economically satisfy the funding needs of its customers and to accommodate the scheduled repayment of borrowings. Funds are available to City National from a number of sources, including depository relationships, sales and maturities within the investment securities portfolio, and borrowings from the FHLB and other financial institutions. As of September 30, 2015, City National’s assets are significantly funded by deposits and capital. Additionally, City National maintains borrowing facilities with the FHLB and other financial institutions that are accessed as necessary to fund operations and to provide contingency funding mechanisms. As of September 30, 2015, City National has the capacity to borrow an additional $1.6 billion from the FHLB and other financial institutions under existing borrowing facilities. City National maintains a contingency funding plan, incorporating these borrowing facilities, to address liquidity needs in the event of an institution-specific or systemic financial industry crisis. Also, although it has no current intention to do so, City National could liquidate its unpledged securities, if necessary, to provide an additional funding source.  City National also segregates certain mortgage loans, mortgage-backed securities, and other investment securities in a separate subsidiary so that it can separately monitor the asset quality of these primarily mortgage-related assets, which could be used to raise cash through securitization transactions or obtain additional equity or debt financing if necessary.

The Company manages its asset and liability mix to balance its desire to maximize net interest income against its desire to minimize risks associated with capitalization, interest rate volatility, and liquidity. With respect to liquidity, the Company has chosen a conservative posture and believes that its liquidity position is strong. The Company’s net loan to asset ratio is 76.3% as of September 30, 2015 and deposit balances fund 81.8% of total assets. The Company has obligations to extend credit, but these obligations are primarily associated with existing home equity loans that have predictable borrowing patterns across the portfolio. The Company has investment security balances with carrying values that totaled $391.9 million at September 30, 2015, and that greatly exceeded the Company’s non-deposit sources of borrowing which totaled $163.5 million.  Further, the Company’s deposit mix has a very high proportion of transaction and savings accounts that fund 53.7% of the Company’s total assets.

As illustrated in the Consolidated Statements of Cash Flows, the Company generated $44.3 million of cash from operating activities during the first nine months of 2015, primarily from interest income received on loans and investments, net of interest expense paid on deposits and borrowings.  The Company used $64.9 million of cash in investing activities during the first nine months of 2015 primarily to increase loans outstanding and for the purchase of available-for-sale securities, partially offset by the proceeds from maturities of available-for-sale securities and the sale of CityInsurance. The Company used $9.0 million of cash in financing activities during the first nine months of 2015, principally a result of cash dividends paid to the Company’s common stockholders of $18.9 million. This was partially offset by an increase of short-term borrowings of $12.1 million. In addtion, the Company received cash of $1.9 million as a result of the exercise of warrants during the first nine months of 2015.

On May 29, 2015, City National entered into a Branch Purchase and Assumption Agreement (the “Purchase Agreement”) with American Founders Bank, Inc. (“AFB”), a wholly-owned subsidiary of Financial Holdings, Inc., pursuant to which City National will purchase AFB’s three Lexington, Kentucky branch locations (the “Acquisition”). Under the terms of the Purchase Agreement, City National will acquire approximately $125 million in performing loans and will assume deposit liabilities of approximately $155 million. City National will pay AFB a deposit premium of 5.5% on non-time deposits, and 1.0% on premium loan balances acquired. The proposed acquisition is expected to be completed in the fourth quarter of 2015.



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Capital Resources

During the first nine months of 2015, Shareholders’ Equity increased $27.9 million, or 7.1%, from $390.9 million at December 31, 2014 to $418.8 million at September 30, 2015.  This increase was primarily due to net income of $40.6 million, partially offset by dividends declared of $19.2 million.

In July 2013, the Federal Reserve published the final rules that established a new comprehensive capital framework for banking organizations, commonly referred to as Basel III. These final rules substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions. The final rule became effective January 1, 2015 for smaller, non-complex banking organizations with full implementation by January 1, 2019.

Regulatory guidelines require the Company to maintain a minimum common equity tier I ("CET1") capital ratio of 4.5% and a total capital to risk-adjusted assets ratio of 8.0%, with at least one-half of capital consisting of tangible common stockholders’ equity and a minimum Tier I leverage ratio of 6.0%. Similarly, City National is also required to maintain minimum capital levels as set forth by various regulatory agencies. Under capital adequacy guidelines, City National is required to maintain minimum CET I, total capital, Tier I capital, and leverage ratios of 4.5%, 8.0%, 6.0%, and 4.0%, respectively. To be classified as “well capitalized,” City National must maintain CET I, total capital, Tier I capital, and leverage ratios of 6.5%, 10.0%, 8.0%, and 5.0%, respectively.

When fully phased in on January 1, 2019, the Basel III Capital Rules will require City Holding and City National to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets (as compared to a current minimum leverage ratio of 3.0% for banking organizations that either have the highest supervisory rating or have implemented the appropriate federal regulatory authority's risk-adjusted measure for market risk).

The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to City Holding Company or City National Bank.

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.



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The Company’s regulatory capital ratios for both City Holding and City National as illustrated in the following tables
(in thousands):

September 30, 2015
Actual
 
Minimum Required - Basel III Phase-In Schedule
 
Minimum Required - Basel III Fully Phased-In (*)
 
Required to be Considered Well Capitalized
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CET I Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
$
353,224

 
14.4
%
 
$
110,214

 
4.5
%
 
$
171,443

 
7.0
%
 
$
159,197

 
6.5
%
     City National Bank
307,528

 
12.6

 
109,507

 
4.5

 
170,344

 
7.0

 
158,177

 
6.5

Tier I Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
369,224

 
15.1

 
146,951

 
6.0

 
208,181

 
8.5

 
195,935

 
8.0

     City National Bank
331,468

 
13.6

 
146,009

 
6.0

 
206,847

 
8.5

 
194,679

 
8.0

Total Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
390,612

 
16.0

 
195,935

 
8.0

 
257,165

 
10.5

 
244,919

 
10.0

     City National Bank
352,419

 
14.5

 
194,679

 
8.0

 
255,516

 
10.5

 
243,349

 
10.0

Tier I Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
369,224

 
10.7

 
137,951

 
4.0

 
137,951

 
4.0

 
172,439

 
5.0

     City National Bank
331,468

 
9.7

 
137,336

 
4.0

 
137,336

 
4.0

 
171,669

 
5.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(*) Represents the minimum required capital levels as of January 1, 2019 when Basel III Capital Rules have been fully phased in.


December 31, 2014:
Actual
 
Minimum Required for Capital Adequacy Purposes
 
Required to be Considered Well Capitalized
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
Capital Amount
 
Ratio
 
 
 
 
 
 
 
 
 
 
 
 
Tier I Capital
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
$
333,163

 
13.4
%
 
$
99,723

 
4.0
%
 
$
149,585

 
6.0
%
     City National Bank
294,870

 
11.9

 
99,037

 
4.0

 
148,556

 
6.0

Total Capital
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
353,873

 
14.2

 
199,446

 
8.0

 
249,308

 
10.0

     City National Bank
315,095

 
12.7

 
198,074

 
8.0

 
247,593

 
10.0

Tier I Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
333,163

 
9.9

 
134,721

 
4.0

 
168,402

 
5.0

     City National Bank
294,870

 
8.8

 
133,991

 
4.0

 
167,489

 
5.0

 
 
 
 
 
 
 
 
 
 
 
 


As of September 30, 2015, management believes that City Holding Company, and its banking subsidiary, City National, were “well capitalized.”  City Holding is subject to regulatory capital requirements administered by the Federal Reserve, while City National is subject to regulatory capital requirements administered by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”).  Regulatory agencies can initiate certain mandatory actions if either City Holding or City National fails to meet the minimum capital requirements, as shown above.  As of September 30, 2015, management believes that City Holding and City National meet all capital adequacy requirements.

    

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Table of Contents

Item 3 -
Quantitative and Qualitative Disclosures About Market Risk

The information called for by this item is provided under the caption “Risk Management” under Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Item 4 -
Controls and Procedures

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic SEC filings.  There has been no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


Part II -
OTHER INFORMATION

Item 1.
Legal Proceedings

The Company is engaged in various legal actions that it deems to be in the ordinary course of business. As these legal actions are resolved, the Company could realize positive and/or negative impact to its financial performance in the period in which these legal actions are ultimately decided. There can be no assurance that current actions will have immaterial results, either positive or negative, or that no material actions may be presented in the future.

Item 1A.
Risk Factors

There have been no material changes to the factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.
Defaults Upon Senior Securities

None.



Item 4.
Mine Safety Disclosures

None.

Item 5.
Other Information

None.
Item 6.
Exhibits

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Table of Contents

 
 
(a) Exhibits
 
 
31(a)
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Charles R. Hageboeck
 
 
31(b)
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for David L. Bumgarner
 
 
32(a)
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Charles R. Hageboeck
 
 
32(b)
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for David L. Bumgarner
 
 
101.INS
XBRL Instance Document*
 
 
101.SCH
XBRL Taxonomy Extension Schema*
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase*
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase*
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase*
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase*
·

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
City Holding Company
 
 
(Registrant)
 
 
 
/s/ Charles R. Hageboeck
 
 
Charles R. Hageboeck
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
/s/ David L. Bumgarner
 
 
David L. Bumgarner
 
Senior Vice President, Chief Financial Officer and Principal Accounting Officer
 
(Principal Financial Officer)


Date: November 5, 2015


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