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Section 1: 10-K (CHCO FORM 10-K)

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

FORM 10-K

(Mark One)

[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For The Fiscal Year Ended December 31, 2017
OR
[  ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For The Transition Period From ____________To_____________.

Commission File number 0-11733
392386090_chcologoa17.jpg
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)

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class:
Name of Each Exchange on Which Registered:
Common Stock, $2.50 par value
NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act:
None 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:
Yes
[X]
No
[  ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act:
Yes
[ ]
No
[ X ]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [ ]
  
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.  (Check one): 
Large accelerated filer [X]
Accelerated filer [ ]
 
 
Non-accelerated filer [   ]
Smaller reporting company [   ]
 
 
 
Emerging growth company [ ]
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). 
Yes
[   ]
No
[X]
 
As of June 30, 2017, the last business day of the registrant’s most recently completed second quarter, the aggregate market value of the shares of common stock held by non-affiliates, based upon the closing price per share of the registrant’s common stock as reported on the Nasdaq Global Select Market, was approximately $989.4 million.  (Registrant has assumed that all of its executive officers and directors are affiliates.  Such assumption shall not be deemed to be conclusive for any other purpose.)
 
As of February 27, 2018, there were 15,508,904 shares of the Company’s common stock, $2.50 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2018 annual shareholders’ meeting to be held on April 19, 2018 are incorporated by reference into Part III, Items 10, 11, 12, 13, and 14.




FORM 10-K INDEX

PART I
 
Pages
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
Part III
 
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
Part IV
 
 
 
 
 
Item 15.
Item 16.
 
 
 
 
 





FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K contains certain forward-looking statements that are included pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such information involves risks and uncertainties that could cause the Company’s actual results to differ from those projected in the forward-looking information. Important factors that could cause actual results to differ materially from those discussed in such forward-looking statements include, but are not limited to those set forth in the Company’s Annual Report on Form 10-K under “Risk Factors” and the following: (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 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) 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 securities; (12) 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; (13) the impact of new minimum capital thresholds established as a part of the implementation of Basel III capital reforms; and (14) other risk factors relating to the banking industry.  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.




PART I
Item 1.Business
 
City Holding Company (the “Company” or "City Holding" or the "Parent Company") is a financial holding company headquartered in Charleston, West Virginia. The Company conducts its principal activities through its wholly-owned subsidiary, City National Bank of West Virginia (“City National”). City National provides banking, trust and investment management and other financial solutions through its network of 86 bank branches and 839 full-time equivalent associates located in West Virginia, Virginia, Kentucky and southeastern Ohio. The Company’s business activities are currently limited to one reportable business segment, which is community banking.

On October 16, 2017, the Company announced it will break ground in early 2018 on its new branch office located in Morgantown, West Virginia.
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Rendition of the Company's Morgantown branch expected to open in 2018.

The principal products produced and services rendered by City National include:

Commercial Banking - City National offers a full range of commercial banking services to corporations and other business customers. Loans are provided for a variety of business purposes, including financing for commercial and industrial projects, income producing commercial real estate, owner-occupied real estate and construction and land development. City National also provides deposit services for commercial customers, including treasury management, lockbox and other cash management services. City National provides merchant credit card services through an agreement with a third party vendor.

Consumer Banking - City National provides banking services to consumers, including checking, savings and money market accounts as well as certificates of deposit and individual retirement accounts. In addition, City National provides consumers with installment and real estate loans and lines of credit. City National also offers credit cards through an agreement with a third party vendor.

Mortgage Banking - City National provides mortgage banking services, including fixed and adjustable-rate mortgages, construction financing, production of conventional and government insured mortgages, secondary marketing and mortgage servicing.

Wealth Management and Trust Services - City National offers specialized services and expertise in the areas of wealth management, trust, investment and custodial services for commercial and individual customers. These services include the administration of personal trusts and estates as well as the management of investment accounts for individuals, employee benefit plans and charitable foundations. City National also provides corporate trust and institutional custody, financial and estate planning and retirement plan services.

City National’s customer base is diverse and no single depositor could have a material adverse effect on liquidity, capital, or other elements of financial performance. Although no portion of City National’s loan portfolio is concentrated within a single industry or group of related industries, it historically has held residential mortgage loans as a significant portion of its loan portfolio. At December 31, 2017, approximately 51% of the Company’s loan portfolio was categorized as residential mortgage and home equity loans. However, due to the fractured nature of residential mortgage lending, there is no concentration of credits that would be considered materially detrimental to the Company’s financial position or operating results.

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The Company’s business is not seasonal and has no significant foreign sources or applications of funds.  There are no anticipated material capital expenditures, or any expected material effects on earnings or the Company’s competitive position as a result of compliance with federal, state and local provisions enacted or adopted relating to environmental protection.
 
City National’s loan portfolio is comprised of commercial and industrial, commercial real estate, residential real estate, home equity, consumer loans and demand deposit account ("DDA") overdrafts.
 
The commercial and industrial loan portfolio consists of loans to corporate and other legal entity borrowers primarily in small to mid-size industrial and commercial companies. Commercial and industrial loans are considered to contain a higher level of risk than other loan types, although care is taken to minimize these risks. Numerous risk factors impact this portfolio including industry specific risks such as the economy, new technology, labor rates and cyclicality, as well as customer specific factors, such as cash flow, financial structure, operating controls and asset quality.  As of December 31, 2017, City National reported $208.5 million of loans classified as “Commercial and Industrial.”
 
Commercial real estate loans consist of commercial mortgages, which generally are secured by nonresidential and multi-family residential properties. Commercial real estate loans are to many of the same customers and carry similar industry risks as the commercial and industrial loans.    As of December 31, 2017, City National reported $1.28 billion of loans classified as “Commercial Real Estate.”

City National diversifies risk within the commercial and industrial and commercial real estate portfolios by closely monitoring industry concentrations (against internally designated percents of risk-based capital) and portfolios to ensure that it does not exceed established lending guidelines. Diversification is intended to limit the risk of loss from any single unexpected economic event or trend. Underwriting standards require a comprehensive credit analysis and independent evaluation of all larger balance commercial loans by the loan committee prior to approval.

City National categorizes commercial loans by industry according to the North American Industry Classification System (NAICS) to monitor the portfolio for possible concentrations in one or more industries. As of December 31, 2017, City National's loans to borrowers within the Lessors of Nonresidential Buildings categories exceeded 10% of total loans (13%). No other industry classification exceeded 10% of total loans at December 31, 2017. Management also monitors non-owner occupied commercial real estate as a percent of risk-based capital (based upon regulatory guidance). At December 31, 2017, the company had $967.5 million of commercial loans classified as non-owner occupied and was within its designated concentration threshold.

     Residential real estate loans represent loans to consumers that are secured by a first lien on residential property. Residential real estate loans provide for the purchase or refinance of a residence and first-lien home equity loans allow consumers to borrow against the equity in their home. These loans primarily consist of single family 3 and 5 year adjustable rate mortgages with terms that amortize up to 30 years. City National also offers fixed-rate residential real estate loans that are sold in the secondary market that are not included on the Company's balance sheet and City National does not retain the servicing rights to these loans.  Residential mortgage loans are generally underwritten to comply with Fannie Mae guidelines, while the home equity loans are underwritten with typically less documentation, but with lower loan-to-value ratios and shorter maturities. As of December 31, 2017, City National reported $1.47 billion of loans classified as “Residential Real Estate.”

City National's home equity loans represent loans to consumers that are secured by a second (or junior) lien on a residential property. Home equity loans allow consumers to borrow against the equity in their home without paying off an existing first lien. These loans consist of home equity lines of credit ("HELOC") and amortized home equity loans that require monthly installment payments. Home equity loans are underwritten with less documentation, similar loan-to-value ratios and similar terms than residential real estate loans. The amount of credit extended is directly related to the value of the real estate at the time the loan is made. As of December 31, 2017, City National reported $139.5 million of loans classified as “Home Equity.”

All mortgage loans, whether fixed rate or adjustable rate, are originated in accordance with acceptable industry standards and comply with regulatory requirements. Fixed rate loans are processed and underwritten in accordance with Fannie Mae and Freddie Mac guidelines, while adjustable rate loans are underwritten in accordance with City National's internal loan policy.
 
Consumer loans may be secured by automobiles, boats, recreational vehicles, certificates of deposit and other personal property or they may be unsecured. The Company monitors the risk associated with these types of loans by monitoring such factors as portfolio growth, lending policies and economic conditions. Underwriting standards are continually evaluated and modified based upon these factors. As of December 31, 2017, City National reported $29.2 million of loans classified as “Consumer.”
 

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DDA overdraft balances reflect demand deposit accounts that have been overdrawn by deposit customers and have been reclassified as loans.  As of December 31, 2017, City National reported $4.4 million of loans classified as “DDA Overdrafts.”
 
City National’s loan underwriting guidelines and standards are updated periodically and revisions are presented for approval by City Holding Company's Board of Directors. The purpose of the underwriting guidelines and standards is to grant loans on a sound and collectible basis; to invest available funds in a safe, profitable manner; to serve the legitimate credit needs of the communities in City National's primary market area; and to ensure that all loan applicants receive fair and equal treatment in the lending process. It is the intent of the underwriting guidelines and standards to: (i) minimize loan losses by carefully investigating the credit history of each applicant; (ii) verify the source of repayment and the ability of the applicant to repay; (iii) collateralize those loans in which collateral is deemed to be required; (iv) exercise care in the documentation of the application, review, approval, and origination process; and (v) administer a comprehensive loan collection program. The above underwriting guidelines are adhered to and subjected to the experience, background and personal judgment of the loan officer assigned to the loan application.
 
Market Area
 
City National operates a network of 86 bank branches primarily along the I-64 corridor from Lexington, Kentucky through Lexington, Virginia and along the I-81 corridor through the Shenandoah Valley from Lexington, Virginia to Martinsburg, West Virginia. City National's branch network includes 57 branches in West Virginia, 14 branches in Virginia, 12 branches in Kentucky and 3 branches in Ohio. City National provides credit, deposit and investment advisory products and services to a broad geographical area that includes many rural and small community markets in addition to larger cities including Charleston (WV), Huntington (WV), Martinsburg (WV), Winchester (VA), Staunton (VA), Virginia Beach (VA), Ashland (KY) and Lexington (KY).

City National also provides commercial products and services to customers that are outside of its branches' geographical footprint, such as the Columbus, Ohio, Charlotte, North Carolina and Pittsburgh, Pennsylvania markets. These loans are diversified across a broad base of industry types, such as multi-family housing, properties leased to government, nursing homes, grocery and retail stores, and other commercial and industrial loans. At December 31, 2017, the outstanding balance of commercial loans to markets outside of the geographical footprint of the bank's branches was approximately $428 million, or 29% of City National's outstanding commercial loan balances.

City National has approximately 12% of the deposit market share in the counties of West Virginia it serves. In Virginia, City National has approximately 9% of the deposit market share along the I-81 corridor which its thirteen bank branches serve. In Kentucky, City National has approximately 4% of the deposit market share in the counties where its twelve bank branches serve. In Ohio, City National has approximately 16% of the deposit market share in the county where its three bank branches serve.

According to the most recent U.S. Census Bureau estimates (2016), in the counties where City National's bank branches are located, West Virginia’s population was approximately 1.0 million and has increased 0.5% since 2010.  The population in the counties City National serves in Virginia along the I-81 corridor have increased 4.1% since 2010, which is more comparable to the national average increase of approximately 5.5%. The population in the counties that City National serves in Kentucky increased 4.0% since 2010 and in Lawrence County, Ohio, where City National's three bank branches are located, the population has decreased 2.5% since 2010.
 
Competition
 
As noted previously, the Company’s principal markets are located in West Virginia and contiguous markets in the surrounding states of Virginia, Kentucky and Ohio. The majority of the Company’s bank branches are located in the areas of Charleston (WV), Huntington (WV), Beckley (WV), Lewisburg (WV), Martinsburg (WV), Lexington (KY) and along the I-81 corridor in Virginia where there is a significant presence of other financial service providers. In its markets, the Company competes with national, regional, and local community banks for deposits, credit and trust and investment management customers. In addition to traditional banking organizations, the Company competes with credit unions, finance companies, insurance companies and other financial service providers who are able to provide specialty financial services to targeted customer groups. As further discussed below, changes in laws and regulations enacted in recent years have increased the competitive environment the Company and its subsidiaries faces to retain and attract customers.


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Regulation and Supervision
 
Overview: The Company, as a registered financial holding company, and City National, as an insured depository institution, operate in a highly regulated environment and are regularly examined by federal regulators. The following description briefly discusses certain provisions of federal and state laws and regulations to which the Company and City National are subject and the potential impact of such provisions.  These federal and state laws and regulations are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Federal Deposit Insurance Corporation’s insurance fund and are not intended to protect the Company’s security holders. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in state legislatures, and before the various bank regulatory agencies.  The likelihood and timing of any changes and the impact such changes might have on the Company are impossible to determine with any certainty.  A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations and earnings of the Company.  To the extent that the following information describes statutory or regulatory provisions, it is qualified entirely by reference to the particular statute and/or regulation.
 
As a financial holding company, the Company is regulated under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve Board. The BHCA provides generally for “umbrella” regulation of bank holding companies such as the Company by the Federal Reserve Board, and for functional regulation of banking activities by bank regulators, securities activities by securities regulators, and insurance activities by insurance regulators. The Company is also under the jurisdiction of the Securities and Exchange Commission (“SEC”) and is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. The Company is listed on the Nasdaq Global Select Market ("NASDAQ") under the trading symbol “CHCO,” and is subject to the rules of the NASDAQ for listed companies.
 
City National is organized as a national banking association under the National Bank Act. It is subject to regulation and examination by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”). The OCC's supervision and regulation of banks is primarily intended to protect the interests of depositors. The National Bank Act generally requires each national bank to maintain reserves against deposits, restricts the nature and amount of loans that may be made and the interest that may be charged, and restricts investments and other activities.
 
In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. Under the BHCA, bank holding companies that qualify and elect to be financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the OCC) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board). Activities that are financial in nature include, among other things, securities underwriting and dealing, insurance underwriting and making merchant banking investments.
 
The BHCA generally limits acquisitions by bank holding companies that are not qualified as financial holding companies to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The Federal Reserve Board has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve Board has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
 
The International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (“Patriot Act”) was adopted in response to the September 11, 2001 terrorist attacks.  The Patriot Act provides law enforcement with greater powers to investigate terrorism and prevent future terrorist acts.  Among the broad-reaching provisions contained in the Patriot Act are several designed to deter terrorists’ ability to launder money in the United States and provide law enforcement with additional powers to investigate how terrorists and terrorist organizations are financed.  The Patriot Act creates additional requirements for banks, which were already subject to similar regulations.  The Patriot Act authorizes the Secretary of Treasury to require financial institutions to take certain “special measures” when the Secretary suspects that certain transactions or accounts are related to money laundering.  These special measures may be ordered when the Secretary suspects that a jurisdiction outside of the United States, a financial institution operating outside of the United States, a class of transactions involving a jurisdiction outside of the United States or certain types of accounts are of “primary money laundering concern.”  The special measures include the following:  (a) require financial institutions to keep records and report on transactions or accounts at issue; (b) require financial institutions to obtain and retain information related to the beneficial ownership of any account opened or maintained by foreign persons; (c) require financial institutions to identify each customer who is permitted to use a payable-through or correspondent account and obtain certain information from each customer permitted to use the account; and (d) prohibit or

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impose conditions on the opening or maintaining of correspondent or payable-through accounts.  Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
 
The Company and its subsidiary bank and subsidiaries are affiliates within the meaning of the Federal Reserve Act.  The Federal Reserve Act imposes limitations on a bank with respect to extensions of credit to, investments in, and certain other transactions with, its parent bank holding company and the holding company’s other subsidiaries.  Furthermore, bank loans and extensions of credit to affiliates are also subject to various collateral requirements. Further, the authority of City National to extend credit to the Company's directors, executive officers and principal shareholders, including their immediate family members, corporations and other entities that they control, is subject to substantial restrictions and requirements of the Federal Reserve Act and Regulation O promulgated thereafter. These statutes and regulations impose specific limits on the amount of loans City National may make to directors and other insiders, and specify approval procedures that must be followed in making loans that exceed certain amounts.
 
The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. In order for a financial holding company to commence any new activity permitted by the BHCA, or to acquire any company engaged in any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering approval of a proposed transaction.  Depository institutions are typically examined for CRA compliance every three years, although the frequency is at the OCC's discretion. City National received a "satisfactory" rating on its most recent CRA examination in 2015.
 
On July 21, 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that accomplish the following:
 
Centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which has rule making authority for a wide range of consumer protection laws that apply to all banks and has broad powers to supervise and enforce consumer protection laws;
Change standards for Federal preemption of state laws related to federally chartered institutions and their subsidiaries;
Require the OCC to seek to make its capital requirements for national banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction;
Require financial holding companies, such as the Company, to be well-capitalized and well-managed. Bank holding companies and banks must also be both well-capitalized and well-managed to maintain their status as financial holding companies;
Provide for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increase the minimum reserve ratio for the deposit insurance fund from 1.15% to 1.35% and changes in the basis for determining FDIC premiums from deposits to assets;
Provide for new disclosure and other requirements relating to executive compensation and corporate governance.  These disclosures and requirements apply to all public companies, not just financial institutions;
Permanently increase the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000;
Repeal the federal prohibitions on the payment of interest on demand deposits;
Amend the Electronic Fund Transfer Act (EFTA) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer;
Enhance the requirements for certain transactions with affiliates under the Federal Reserve Act, including an expansion of the “covered transactions” definition and increase the amount of time for which collateral requirements regarding covered transactions must be maintained;
Strengthen the existing limits on a depository institution’s credit exposure to one borrower by expanding the scope of limitations to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions;
Strengthen loan restrictions to insiders by expanding the types of transactions subject to various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements, and securities lending or borrowing transactions.  Additionally, restrictions on certain asset sales to and from an insider to an institution, including

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requirements that such sales be on market terms and approved by the institution’s board of directors in certain situations are to be put in place; and
Increase the authority of the Federal Reserve to examine the Company and its non-bank subsidiaries.

On December 10, 2013 the Federal Reserve adopted the final rules implementing the Volcker Rule, which amends the BHCA to require the federal financial regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). The Volcker Rule, which became effective in July 2015, does not significantly impact the operations of the Company or City National.

In 2013, the Consumer Financial Protection Bureau (the "CFPB") issued eight final regulations governing mainly consumer mortgage lending. The first of these rules was issued on January 10, 2013, and included the ability to repay and qualified mortgage rule. This rule imposes additional requirements on banks, including rules designed to require banks to ensure borrowers' ability to repay their mortgage, and took effect January 10, 2014. The same day, the CFPB also finalized a rule on escrow accounts for higher priced mortgage loans and a rule expanding the scope of the high-cost mortgage provision in the Truth In Lending Act. On January 17, 2013, the CFPB issued its final rules implementing provisions of the Dodd-Frank Act that relate to mortgage servicing, which took effect on January 10, 2014. On January 18, 2013, the CFPB issued a final appraisal rule under the Equal Credit Opportunity Act and six federal agencies, including the CFPB, issued an interagency rule on appraisals for higher-priced mortgage loans. On November 20, 2013, the CFPB issued its final rule on integrated mortgage disclosures under the Truth In Lending Act and the Real Estate Settlement Procedures Act, for which compliance was required by October 3, 2015.

Banking regulatory agencies have increasingly used a general consumer protection statute to address unethical or otherwise bad business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the "unfair or deceptive acts or practices" ("UDAP") law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to "unfair, deceptive or abusive acts or practices", which has been delegated to the CFPB for supervision.

Uncertainty remains as to the future impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on the Company’s business, results of operations and financial condition.  Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Provisions in the legislation that require revisions to the capital requirements of the Company and City National could require the Company and City National to seek other sources of capital in the future.
 
Capital Adequacy: Federal banking regulations set forth capital adequacy guidelines, which are used by regulatory authorities to assess the adequacy of capital in examining and supervising a bank holding company and its insured depository institutions.

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 ("CET 1") capital ratio of 5.75% and a total capital to risk-adjusted assets ratio of 9.25%, with at least one-half of capital consisting of tangible common stockholders’ equity, and a minimum Tier 1 leverage ratio of 7.25%. 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 1, total capital, Tier 1 capital, and leverage ratios of 5.75%, 9.25%, 7.25%, and 4.0%, respectively. To be classified as “well capitalized,” City National must maintain CET 1, total capital, Tier 1 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 CET 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5% CET 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET 1 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

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(iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets (as compared to the previous 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 began on January 1, 2016 at the 0.625% level and will 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.

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

December 31, 2017
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 1 Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
$
430,154

 
15.1
%
 
$
163,441

 
5.750
%
 
$
198,972

 
7.0
%
 
$
184,760

 
6.5
%
     City National Bank
338,105

 
12.0
%
 
162,164

 
5.750
%
 
197,418

 
7.0
%
 
183,316

 
6.5
%
Tier 1 Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
446,154

 
15.7
%
 
206,078

 
7.250
%
 
241,609

 
8.5
%
 
227,397

 
8.0
%
     City National Bank
338,105

 
12.0
%
 
204,468

 
7.250
%
 
239,721

 
8.5
%
 
225,620

 
8.0
%
Total Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
465,292

 
16.4
%
 
262,927

 
9.250
%
 
298,458

 
10.5
%
 
284,246

 
10.0
%
     City National Bank
357,243

 
12.7
%
 
260,873

 
9.250
%
 
296,126

 
10.5
%
 
282,025

 
10.0
%
Tier 1 Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
446,154

 
11.0
%
 
161,834

 
4.000
%
 
161,834

 
4.0
%
 
202,293

 
5.0
%
     City National Bank
338,105

 
8.5
%
 
159,625

 
4.000
%
 
159,625

 
4.0
%
 
199,531

 
5.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(*) Represents the minimum required capital levels as of January 1, 2019 when Basel III Capital Rules have been fully phased in.


7


December 31, 2016
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 1 Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
$
371,677

 
13.3
%
 
$
142,845

 
5.125
%
 
$
195,105

 
7.0
%
 
$
181,169

 
6.5
%
     City National Bank
310,912

 
11.2
%
 
141,860

 
5.125
%
 
193,761

 
7.0
%
 
179,921

 
6.5
%
Tier 1 Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
387,677

 
13.9
%
 
184,653

 
6.625
%
 
236,913

 
8.5
%
 
222,977

 
8.0
%
     City National Bank
318,872

 
11.5
%
 
183,381

 
6.625
%
 
235,281

 
8.5
%
 
221,441

 
8.0
%
Total Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
408,406

 
14.7
%
 
240,397

 
8.625
%
 
292,658

 
10.5
%
 
278,722

 
10.0
%
     City National Bank
338,675

 
12.2
%
 
238,741

 
8.625
%
 
290,641

 
10.5
%
 
276,801

 
10.0
%
Tier 1 Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     City Holding Company
387,677

 
10.1
%
 
153,864

 
4.000
%
 
153,864

 
4.0
%
 
192,330

 
5.0
%
     City National Bank
318,872

 
8.3
%
 
153,088

 
4.000
%
 
153,088

 
4.0
%
 
191,359

 
5.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(*) Represents the minimum required capital levels as of January 1, 2019 when Basel III Capital Rules have been fully phased in.


Management believes that, as of December 31, 2017, City Holding and City National would meet all capital adequacy requirements under Basel III on a fully phased-in basis as if such requirements had been in effect.

Additionally, federal banking laws require regulatory authorities to take “prompt corrective action” with respect to depository institutions that do not satisfy minimum capital requirements. The extent of these powers depends upon whether the institutions in question are “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”, as such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies. As an example, a depository institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market. Additionally, a depository institution is generally prohibited from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company, may be subject to asset growth limitations and may be required to submit capital restoration plans if the depository institution is considered undercapitalized.


Dividends and Other Payments: The Company is a legal entity separate and distinct from City National. Dividends from City National are essentially the sole source of cash for the Company. The right of the Company, and shareholders of the Company, to participate in any distribution of the assets or earnings of City National through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of City National, except to the extent that claims of the Company in its capacity as a creditor may be recognized.  Moreover, there are various legal limitations applicable to the payment of dividends to the Company as well as the payment of dividends by the Company to its shareholders.
 
City National is subject to various statutory restrictions on its ability to pay dividends to the Company.  Specifically, the approval of the OCC is required prior to the payment of dividends by City National in excess of its earnings retained in the current year plus retained net profits for the preceding two years.  The payment of dividends by the Company and City National may also be limited by other factors, such as requirements to maintain adequate capital above regulatory guidelines.  The OCC has the authority to prohibit any bank under its jurisdiction from engaging in an unsafe or unsound practice in conducting its business. Depending upon the financial condition of City National, the payment of dividends could be deemed to constitute such an unsafe or unsound practice.  The Federal Reserve Board and the OCC have indicated their view that it generally would be an unsafe and unsound practice to pay dividends except out of current operating earnings.  The Federal Reserve Board has stated that, as a matter of prudent banking, a bank or bank holding company should not maintain its existing rate of cash dividends on common stock unless (1) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. Moreover, the Federal Reserve Board has indicated that bank holding companies should serve as a source of managerial and financial strength to their subsidiary banks. Accordingly, the Federal Reserve Board has stated that a bank holding company should not maintain a level of cash dividends to its shareholders that

8


places undue pressure on the capital of its bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the bank holding company’s ability to serve as a source of financial strength.
 
At December 31, 2017, City National could pay dividends up to $75.0 million without prior regulatory permission.  No dividends were paid in 2017 that required regulatory approval. During 2017, the Company used cash obtained from these dividends primarily to: (1) pay common dividends to shareholders and (2) remit interest payments on the Company’s junior subordinated debentures. Management believes that the Company’s available cash balance, together with cash dividends from City National, is adequate to satisfy its funding and cash needs in 2018.
 
Under federal law, City National may not, subject to certain limited exceptions, make loans or extensions of credit to, or invest in the securities of, or take securities of the Company as collateral for loans to any borrower. City National is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.

Governmental Policies
 
The Federal Reserve Board regulates money and credit and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future.

In view of changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve Board, it is difficult to predict the impact of possible future changes in interest rates, deposit levels, and loan demand, or their effect on the Company's business and earnings or on the financial condition of the Company's various customers.

Deposit Insurance
 
Substantially all of the deposits of City National are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. Deposit insurance assessments are based on average total assets minus average tangible equity. In October 2010, the FDIC adopted a new DIF restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. In August 2016, the FDIC announced that the DIF reserve ratio had surpassed 1.15% as of June 30, 2016. As a result, beginning in the third quarter of 2016, the range of initial assessment ranges for all institutions were adjusted downward. In March 2016, the FDIC adopted a final rule increasing the reserve ratio for the DIF to 1.35% of total insured deposits.

FDIC insurance expense totaled $1.3 million, $1.6 million and $1.8 million in 2017, 2016, and 2015, respectively. FDIC insurance expense includes deposit assessments and Financing Corporation ("FICO") assessments related to outstanding FICO bonds.
 
Under the Federal Deposit Insurance Act, as amended (“FDIA"), the FDIC may terminate deposit insurance upon finding that an institution has engaged in unsafe or unsound practices, is in unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Cybersecurity

In March 2015, federal regulators issued two statements regarding cybersecurity: (i) a statement indicating that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institutions and (ii) a statement indicating the expectation of a financial institution's management to maintain a sufficient business continuity planning process to ensure rapid recovery, resumption and maintenance of the financial institution's operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to: (a) enable recovery of data and business operations, (b) address rebuilding network capabilities, and (c) restore data if the financial institution or any of its critical service providers fall victim to this type of cyber-attack.

In October 2016, the federal banking agencies issued an advance notice of proposed rulemaking on enhanced cybersecurity risk–management and resilience standards that would apply to large and interconnected banking organizations and to services provided by third parties to these firms. These enhanced standards would apply only to banks and bank holding companies with total consolidated assets of $50 billion or more; however, it is unclear as to whether any such standards would be applied, and in what form, in the future to smaller banks and bank holding companies.

9



If the Company does not comply with this regulatory guidance, it could be subject to various regulatory sanctions, as well as financial penalties. The Company believes that it is in compliance with this guidance.
 
Future Legislation
 
Various other legislative and regulatory initiatives, including proposals to overhaul the banking regulatory system and to limit the investments that a depository institution may make with insured funds, are from time to time introduced in Congress and state legislatures, as well as regulatory agencies. Such legislation may change banking statutes and the operating environment of the Company and its subsidiaries in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance in the financial services industry generally.  The Company cannot determine the ultimate effect that such potential legislation, if enacted, would have upon its financial condition or operations.


10


Executive Officers of the Registrant

At December 31, 2017, the executive officers of the Company were as follows: 

Name
Age
Business Experience
Charles R. Hageboeck, Ph.D.
55
President and Chief Executive Officer, City Holding Company and City National Bank, Charleston, WV since February 1, 2005.  Executive Vice President and Chief Financial Officer, City Holding Company and City National Bank, Charleston, WV from June 2001 – January 2005.
Craig G. Stilwell
62
Executive Vice President of Retail Banking, City Holding Company and City National Bank, Charleston, WV since February 2005.  Executive Vice President of Marketing & Human Resources, City Holding Company and City National Bank, Charleston, WV from May 2001 – February 2005.
John A. DeRito
67
Executive Vice President of Commercial Banking, City Holding Company and City National Bank, Charleston, WV since June 2004.
David L. Bumgarner
52
Senior Vice President and Chief Financial Officer, City Holding Company and City National Bank, Charleston, WV since February 2005.
Jeffrey D. Legge
53
Senior Vice President, Chief Administration Officer and Chief Information Officer, City Holding Company and City National Bank, Charleston, WV since December 2005. 
 
Employees
 
The Company had 839 full-time equivalent employees at December 31, 2017.
 
Available Information
 
The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy any document the Company files at the SEC Public Reference Room at 100 F Street, N. E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The Company's SEC filings are also available to the public at the SEC's website at www.sec.gov.    

The Company’s Internet website address is www.bankatcity.com.  The Company makes available free of charge through its website its annual report, quarterly reports, current reports and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the Securities and Exchange Commission. The information on the Company’s website is not, and shall not be deemed to be, a part of this report or incorporated into any other filing with the Securities and Exchange Commission. Copies of the Company’s annual report will be made available, free of charge, upon written request.


11


Statistical Information
 
The information noted below is provided pursuant to Guide 3 -- Statistical Disclosure by Bank Holding Companies.

 
Description of Information
 
Page
Reference
1.
Distribution of Assets, Liabilities and Stockholders'
 
 
Equity; Interest Rates and Interest Differential
 
 
a.
Average Balance Sheets
 
b.
Analysis of Net Interest Earnings
 
c.
Rate Volume Analysis of Changes in Interest Income and Expense
 
 
 
 
2.
Investment Portfolio
 
 
a.
Book Value of Investments
 
b.
Maturity Schedule of Investments
 
c.
Securities of Issuers Exceeding 10% of Stockholders’ Equity
 
 
 
 
3.
Loan Portfolio
 
 
a.
Types of Loans
 
b.
Maturities and Sensitivity to Changes in Interest Rates
 
c.
Risk Elements
 
d.
Other Interest Bearing Assets
None
 
 
 
 
4.
Summary of Loan Loss Experience
 
 
 
5.
Deposits
 
 
 
a.
Breakdown of Deposits by Categories, Average Balance And Average Rate Paid
 
b.
Maturity Schedule of Time Certificates of Deposit and Other Time Deposits of $100,000 or More
 
 
 
 
6.
Return on Equity and Assets
 
 
 
 
7.
Short-term Borrowings


12


Item 1A.Risk Factors

An investment in the Company’s common stock is subject to risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.  You should carefully consider the risks described below, as well as the other information included or incorporated by reference in this Annual Report on Form 10-K, before making an investment in the Company’s common stock.  If any of the following risks occur, the Company’s financial condition and results of operations could be materially and adversely affected, and you could lose all or part of your investment. In this section, the term "Company" includes City National unless the circumstances dictate otherwise.

Economic Conditions in the Company's Market Areas Could Negatively Impact the Company's Business and Financial Condition

The Company’s business is concentrated in West Virginia, Virginia, Kentucky and southeastern Ohio. As a result, the Company’s results of operation, cash flows and financial condition are affected by local and regional economic conditions. A downturn in the economies within the Company’s market area, or in any one of them, could negatively impact the Company’s results of operation and financial condition. Some examples of economic deterioration include declines in economic growth, declines in consumer and business confidence, increases in inflation, increases in the cost of capital and credit, and limitations in the availability of credit. The Company’s financial performance generally, and the ability of its customers to pay interest on and repay principal of outstanding loans to City National, is highly dependent on the strength of the economic and business environment in the market areas where the Company operates and in the United States as a whole. Additionally, the value of collateral securing loans made and held by City National is impacted by the strength of the economy. Deteriorating economic conditions in the Company’s market areas could cause declines in the overall quality of the loan portfolio requiring charge-off of a greater percentage of loans and/or an increase in the allowance for loan losses, which could negatively impact the Company’s results of operations and financial condition.

While the economic and business environment in West Virginia, Virginia, Kentucky and southeastern Ohio have shown improvement since the recession of 2007 to 2009, there can be no assurance that such improvement will continue or that the economies in the Company’s market areas, or the United States as a whole, will not slip into recession. Such a lack of continued economic improvement or slippage into recession could adversely affect the Company’s results of operation and financial condition. An economic slowdown could have the following consequences:

Loan delinquencies may increase;
Problem assets and foreclosures may increase;
Demand for the products and services of City National may decline; and
Collateral (including real estate) for loans made by City National may decline in value, in turn reducing customers’ borrowing power, and making existing loans less secure.

The oil, natural gas and coal industries, and businesses ancillary thereto, play an important role in the economies of West Virginia, Virginia, Kentucky and southeastern Ohio. The volatility in oil and gas prices since 2014 has negatively impacted oil and gas and other businesses in the Company’s market areas. Additionally, the coal industry continues to be in decline as a result of increased environmental and safety regulatory burden, increased competition from alternative energy sources and a decline in demand for coal. The Company's exposure to coal industry specific loans as of December 31, 2017 is less than $10 million. Prolonged low oil and gas prices, and continued decline in the coal industry, could result in downward pressure on businesses in the Company’s market area which could negatively affect City National’s customers (both individuals and businesses). As a result the Company’s operating results and financial condition could be negatively impacted.

The Value of Real Estate Collateral May Fluctuate Significantly Resulting in an Under-Collateralized Loan Portfolio

The market value of real estate, particularly real estate held for investment, can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. If the value of the real estate serving as collateral for the Company's loan portfolio were to decline materially, a significant part of the Company's loan portfolio could become under-collateralized. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then, in the event of foreclosure, we may not be able to realize the amount of collateral that we anticipated at the time of originating the loan. This could have a material adverse effect on the Company's provision for loan losses and the Company's operating results and financial condition.



13


 The Value of the Company’s Common Stock Fluctuates
 
The market for the Company’s common stock may experience significant price and volume fluctuations in response to a number of factors including actual or anticipated quarterly variations in operating results, changes in expectations of future financial performance, changes in estimates by securities analysts, governmental regulatory action, banking industry reform measures, customer relationship developments and other factors, many of which will be beyond the Company’s control.
 
Furthermore, the stock market in general, and the market for financial institutions in particular, have experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of the Company’s common stock, regardless of actual operating performance.

The Trading Volume In The Company’s Common Stock Is Less Than That Of Other Larger Financial Services Companies

Although the Company’s common stock is listed for trading on the Nasdaq Global Select Market, the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Company’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Company has no control. Given the lower trading volume of the Company’s common stock, significant sales of the Company’s common stock, or the expectation of these sales, could cause the Company’s stock price to fall.
 
Future Sales of Shares of the Company’s Common Stock Could Negatively Affect its Market Price
 
Future sales of substantial amounts of the Company’s common stock, or the perception that such sales could occur, could adversely affect the market price of the Company’s common stock in the open market. We make no prediction as to the effect, if any, that future sales of shares, or the availability of shares for future sale, will have on the market price of the Company’s common stock.
 
Shares of the Company’s Common Stock Are Not FDIC Insured
 
Neither the FDIC nor any other governmental agency insures the shares of the Company’s common stock. Therefore, the value of your shares in the Company will be based on their market value and may decline.
 
The Company’s Ability To Pay Dividends Is Limited
 
Although the Board of Directors has declared cash dividends in the past, the current ability to pay dividends is largely dependent upon the receipt of dividends from City National. Federal laws impose restrictions on the ability of City National to pay dividends. Holders of shares of the Company’s common stock are entitled to dividends if, and when, they are declared by the Company’s Board of Directors out of funds legally available for that purpose. Additional restrictions are placed upon the Company by the policies of federal regulators, including the Federal Reserve Board’s November 14, 1985 policy statement, which provides that bank holding companies should pay dividends only out of the past year’s net income, and then only if their prospective rate of earnings retention appears consistent with their capital needs, asset quality, and overall financial condition. In general, future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including the Company’s and City National’s future earnings, capital requirements, regulatory constraints and financial condition.

The Company and City National are Extensively Regulated
 
The Company operates in a highly regulated environment and is subject to supervision and regulation by a number of governmental regulatory agencies, including the Federal Reserve Board, the OCC and the FDIC. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters including but not limited to (i) ownership and control of the Company's shares, (ii) acquisition of other companies and businesses, (iii) permissible activities to engage in, (iv) maintenance of adequate capital levels and (v) other operational aspects. The bank regulatory agencies possess broad authority to prevent or remedy unsafe or unsound practices or violations of law.

The Dodd-Frank Act instituted major changes to the bank and financial institutions regulatory regimes in light of the past performance of, and government intervention in, the financial services sector. Other changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to reduced revenues, additional

14


costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company's business, financial condition and results of operations.
 
Proposals to change the laws and regulations governing financial institutions are frequently raised in Congress and before bank regulatory authorities. Changes in applicable laws or regulations could materially affect the Company’s business, and the likelihood of any major changes in the future and their effects are impossible to determine. Moreover, it is impossible to predict the ultimate form any proposed legislation might take or how it might affect the Company.

The Company Is Subject To Lending Risk

There are inherent risks associated with the Company’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Company operates. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Company is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Company to regulatory enforcement action that could result in the assessment of significant civil money penalties against the Company.
 
The Company is Subject to Interest Rate Risk

Changes in monetary policy, including changes in interest rates, could influence not only the interest the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company’s ability to originate loans and obtain deposits, (ii) the fair value of the Company’s financial assets and liabilities, and (iii) the average duration of the Company’s mortgage-backed securities portfolio. The Company’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore earnings, could be adversely affected. Earnings also could be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although management believes it has implemented effective asset and liability management strategies, including the use of derivatives as hedging instruments, to reduce the potential effects of changes in interest rates on the Company’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Risk Management” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s management of interest rate risk.

The Company May Be Adversely Affected By The Soundness Of Other Financial Institutions

Financial services institutions are interrelated as a result of trading, clearing, counterparty, and other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Company. Any such losses could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company’s Allowance for Loan Losses May Not Be Sufficient

The Company maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense that represents management’s best estimate of probable losses in the existing portfolio of loans. The allowance, in the judgment of management, is necessary to provide for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Company to make significant estimates of current credit risks and future trends, all

15


of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the Company’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, the Company will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on the Company’s financial condition and results of operations.

Management evaluates the adequacy of the allowance for loan losses at least quarterly, which includes testing certain individual loans as well as collective pools of loans for impairment. This evaluation includes an assessment of actual loss experience within each category of the portfolio; individual commercial and commercial real estate loans that exhibit credit weakness; current economic events, including employment statistics, trends in bankruptcy filings, and other pertinent factors; industry or geographic concentrations; and regulatory guidance.  See the section captioned “Allowance and Provision for Loan Losses” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for loan losses.
 
Customers May Default On the Repayment of Loans
 
City National’s customers may default on the repayment of loans, which may negatively impact the Company’s earnings due to loss of principal and interest income. Increased operating expenses may result from management's allocation time and resources to the collection and work-out of the loan. Collection efforts may or may not be successful causing the Company to write off the loan or repossess the collateral securing the loan, which may or may not exceed the balance of the loan.

Due To Increased Competition, the Company May Not Be Able To Attract and Retain Banking Customers At Current Levels
 
The Company faces competition from the following:

local, regional and national banks;
savings and loans associations;
Internet banks;
credit unions;
finance companies;
fin-tech companies: and
brokerage firms serving the Company’s market areas.

In particular, City National’s competitors include several major national financial and banking companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions may have products and services not offered by the Company, which may cause current and potential customers to choose those institutions. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits and range and quality of services provided. If the Company is unable to attract new and retain current customers, loan and deposit growth could decrease causing the Company’s results of operations and financial condition to be negatively impacted.

Emergence of Nonbank Alternatives to the Financial System

Consumers may decide not to use banks to complete their financial transactions. Technology and other changes, including the emergence of “fin–tech companies” are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can also complete transactions, such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.


16


The Company May Be Required To Write Down Goodwill And Other Intangible Assets, Causing Its Financial Condition And Results To Be Negatively Affected
 
When the Company acquires a business, a portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The excess of the purchase price over the fair value of the net identifiable tangible and intangible assets acquired determines the amount of the purchase price that is allocated to goodwill acquired. At December 31, 2017, the Company’s goodwill and other identifiable intangible assets were approximately $79 million. Under current accounting standards, if the Company determines goodwill or intangible assets are impaired, it would be required to write down the value of these assets. The Company conducts an annual review to determine whether goodwill and other identifiable intangible assets are impaired. The Company recently completed such an impairment analysis and concluded that no impairment charge was necessary for the year ended December 31, 2017. The Company cannot provide assurance whether it will be required to take an impairment charge in the future. Any impairment charge would have a negative effect on its shareholders’ equity and financial results and may cause a decline in the Company's stock price.

Acquisition Opportunities May Present Challenges
 
Any future acquisitions may result in unforeseen difficulties, which could require significant time and attention from the Company's management that would otherwise be directed at developing its existing business. In addition, the Company could discover undisclosed liabilities resulting from any acquisitions for which it may become responsible. Further, the benefits that the Company anticipates from these acquisitions may not develop.
 
System Failure or Cybersecurity Breaches of the Company's Network Security Could Subject the Company to Increased Operating Costs, as Well as Litigation and Other Potential Losses

The computer systems and network infrastructure that the Company uses could be vulnerable to unforeseen hardware and cybersecurity issues, including “hacking” and “identity theft.” The Company's operations are dependent upon its ability to protect its computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in the Company's operations could have an adverse effect on its financial condition and results of operations. In addition, the Company's operations are dependent upon its ability to protect the computer systems and network infrastructure utilized by the Company, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through the Company's computer systems and network infrastructure, which may result in significant liability to the Company, damage its reputation and inhibit current and potential customers from its using Internet banking services.

Despite efforts to ensure the integrity of our systems, we will not be able to anticipate all security breaches of these types, nor will we be able to implement guaranteed preventive measures against such security breaches. Persistent attackers may succeed in penetrating defenses given enough resources, time and motive. The techniques used by cyber criminals change frequently, may not be recognized until launched and can originate from a wide variety of sources, including outside groups such as external service providers, organized crime affiliates, terrorist organizations or hostile foreign governments. These risks may increase in the future as we continue to increase our mobile-payment and other Internet-based product offerings and expand our internal usage of web-based products and applications.

A successful attack to our system security could cause us serious negative consequences, including significant disruption of operations, misappropriation of confidential information, or damage to our computers or systems or those of our customers and counterparties. A successful security breach could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on the Company.

The Company's Risk Management Practices May Prove to be Inadequate or Not Fully Effective

The Company's risk management framework seeks to mitigate risk and appropriately balance risk and return. The Company has established policies and procedures intended to identify, monitor and manage the types of risk which it is subject to, including credit risk, market risk, liquidity risk, operational risk and reputational risk. Although the Company has devoted significant resources to develop its risk management policies and procedures and expects to continue to do so in the future, these policies and procedures, as well as its risk management techniques, may not be fully effective. In addition, as regulations and markets in which the Company operates continue to evolve, its risk management framework may not always keep sufficient pace with those changes. If the Company's risk management framework does not effectively identify or mitigate its risks, the Company could suffer unexpected losses and could be materially adversely affected. Management of the Company's risks in some cases depends upon the use of analytical and/or forecasting models. If the models the Company uses to mitigate these

17


risks are inadequate, it may incur increased losses. In addition, there may be risks that exist, or that develop in the future, that the Company has not appropriately anticipated, identified or mitigated.


The Company’s Controls and Procedures May Fail or Be Circumvented

Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.  Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, no matter how well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.
 
Significant Legal Actions Could Result in Substantial Liabilities

From time to time, the Company is subject to claims related to its operations.  These claims and legal actions, including supervisory actions by its regulators, could involve large monetary claims and cause the Company to incur significant defense expenses.  As a result, the Company may be exposed to substantial liabilities, which could negatively affect its shareholders’ equity and financial results.
 
The Company Relies Heavily on Its Management Team, and the Unexpected Loss of Key Management May Adversely Affect Its Operations

The Company's success to date has been strongly influenced by its ability to attract and to retain senior management experienced in banking in the markets it serves. The Company's ability to retain executive officers and the current management teams will continue to be important to the successful implementation of its strategies. The Company has employment agreements with these key employees in the event of a change of control, as well as confidential information, non-solicitation and non-competition agreements related to its stock options. No other employment agreements exist with key employees. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on the Company's business and financial results.


Item 1B.Unresolved Staff Comments

None.

Item 2.Properties
 
City National owns the Company’s executive office, located at 25 Gatewater Road, Charleston, West Virginia. This facility houses the Company's executive and administrative personnel. City National owns sixty-five bank branch locations and leases twenty-one bank branch locations, pursuant to operating leases.  All of the properties are suitable and adequate for their current operations.

Item 3.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 4.Mine Safety Disclosures

None.


18


PART II

Item 5.Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Common Stock Market and Dividends
 
The Company’s common stock trades on the NASDAQ Global Select Market under the symbol "CHCO". This table sets forth the cash dividends declared per share and information regarding the closing market prices per share of the Company’s common stock for the periods indicated. The price ranges are based on transactions as reported on the NASDAQ Global Select Market. At February 27, 2018, there were 2,606 shareholders of record.
 
 
Cash Dividends Per Share
Market Value
 
Low
High
2017
 
 
 
Fourth Quarter
$
0.46

$
65.50

$
73.98

Third Quarter
0.44

59.94

71.91

Second Quarter
0.44

61.34

72.78

First Quarter
0.44

60.86

67.93

2016
 

 

 

Fourth Quarter
$
0.43

$
48.49

$
68.29

Third Quarter
0.43

44.53

50.60

Second Quarter
0.43

43.06

50.14

First Quarter
0.43

40.82

47.78

 
The Company generally pays dividends on a quarterly basis. As noted in the section captioned "Dividends and Other Payments" included in Item 1. Business, the section captioned "Liquidity" included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note Seventeen of Notes to Consolidated Financial Statements, the Company’s ability to pay dividends to its shareholders is dependent upon the ability of City National to pay dividends to the Company.

At-The-Market Common Stock Offering
 
On December 19, 2016, the Company announced that it had filed a prospectus supplement to its existing shelf registration statement on Form S-3 for the sale of its common stock having an aggregate value of up to $55 million through an "at-the-market" equity offering program. Through the year ended December 31, 2017, the Company has sold approximately 548,000 common shares at a weighted average price of $64.82, net of broker fees.  The Company has sold no shares since the first quarter of 2017. To date, the Company has received $36.4 million in gross proceeds. Under the program, the Company has the ability to receive an additional $18.6 million in gross proceeds from the sale of common shares.



19


Stock-Based Compensation Plan
 
Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2017, segregated between stock-based compensation plans approved by shareholders and stock-based compensation plans not approved by shareholders, is presented in the table below.  Additional information regarding stock-based compensation plans is presented in Note Thirteen, Employee Benefit Plans, of Notes to Consolidated Financial Statements.
 
Plan Category
Number of Shares to be Issued Upon Exercise of Outstanding Awards
(a)
Weighted-average exercise price of outstanding awards (b)
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Plans approved by shareholders
87,605

$
47.15

559,815

Plans not approved by shareholders



Total
87,605

$
47.15

559,815

 
Stock Performance
 
The following graph sets forth the cumulative total shareholder return (assuming reinvestment of dividends) to the Company’s shareholders during the five-year period ended December 31, 2017, as well as an overall stock market index (The Nasdaq Stock Market Index) and the Company’s Peer Group ("Peer Group"). The Peer Group consists of twenty-three banking institutions that (i) are over $2 billion but less than $9.5 billion in assets, (ii) have a return on average assets and a return on average equity performance ratios greater than 0%, (iii) derive at least fifteen percent of their total revenues from non-interest income, (iv) have a loan portfolio comprised of less than eighty-five percent commercial loans, (v) have more than thirty branches, and (vi) are headquartered in Delaware, Illinois, Indiana, Kentucky, Maryland, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia and New York (excluding New York City), excluding: companies in top 5 metro areas (MSAs), thrifts and thinly traded companies. The trading symbols for such financial institutions include: AROW, BUSE, CTBI, FBK, FBNC, FCBC, FCF, FISI, FMBH, FRME, GABC, PEBO, PRK, RBCAA, SASR, SRCE, STBA, SYBT, THFF, TMP, UCFC, UVSP and WSFS.  The stock performance shown on the graph below is not necessarily indicative of future price performance.

20


392386090_chart-aab099bbc19698134b7.jpg

 
2012
2013
2014
2015
2016
2017
City Holding Company
$100.00
$137.91
$143.58
$145.85
$224.10
$229.56
NASDAQ Composite
$100.00
$140.12
$160.78
$171.97
$187.22
$242.71
Peer Group
$100.00
$136.43
$145.94
$156.66
$236.53
$240.82
 
This graph shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, unless the Company specifically incorporates this report by reference. It will not be otherwise filed under such Acts.
 


21


Item 6.Selected Financial Data

Table One
Five-Year Financial Summary
(in thousands, except per share data)
 
2017
2016
2015(2)
2014
2013(1)
Summary of Operations
 
 
 
 
 
Total interest income
$
142,930

$
132,152

$
127,074

$
129,566

$
138,539

Total interest expense
16,805

13,207

11,830

11,960

13,301

Net interest income
126,125

118,945

115,244

117,606

125,238

Provision for loan losses
3,006

4,395

6,988

4,054

6,848

Total non-interest income
63,607

58,825

67,206

58,722

58,006

Total non-interest expenses
95,981

96,164

92,951

95,041

102,906

Income before income taxes
90,745

77,211

82,511

77,233

73,490

Income tax expense
36,435

25,083

28,414

24,271

25,275

Net income available to common  shareholders
54,310

52,128

54,097

52,962

48,215

 
 
 
 
 
 
Per Share Data
 
 
 
 
 
Net income basic
$
3.49

$
3.46

$
3.54

$
3.40

$
3.07

Net income diluted
3.48

3.45

3.53

3.38

3.04

Cash dividends declared
1.78

1.72

1.68

1.60

1.48

Book value per share
32.17

29.25

27.62

25.79

24.61

 
 
 
 
 
 
Selected Average Balances
 
 
 
 
 
Total loans
$
3,082,448

$
2,920,837

$
2,691,304

$
2,593,597

$
2,523,755

Securities
582,124

495,206

383,685

365,904

360,860

Interest-earning assets
3,691,714

3,426,158

3,084,722

2,968,706

2,905,783

Deposits
3,298,385

3,166,817

2,947,543

2,824,985

2,821,573

Long-term debt
16,495

16,495

16,495

16,495

16,495

Total shareholders’ equity
492,668

431,031

415,051

395,940

373,102

Total assets
4,079,674

3,835,081

3,564,730

3,404,818

3,378,351

 
 
 
 
 
 
Selected Year-End Balances
 
 
 
 
 
Net loans
$
3,108,574

$
3,026,496

$
2,843,283

$
2,631,916

$
2,585,622

Securities
628,985

539,604

471,318

354,686

370,120

Interest-earning assets
3,784,453

3,611,706

3,345,136

3,016,477

2,986,194

Deposits
3,315,634

3,231,653

3,083,975

2,872,787

2,785,133

Long-term debt
16,495

16,495

16,495

16,495

16,495

Total shareholders’ equity
502,507

442,438

419,272

390,853

387,623

Total assets
4,132,281

3,984,403

3,714,059

3,461,633

3,368,238

 
 
 
 
 
 
Performance Ratios
 
 
 
 
 
Return on average assets
1.33
%
1.36
%
1.52
%
1.56
%
1.43
%
Return on average equity
11.0

12.1

13.0

13.4

12.9

Return on average tangible common equity
13.1

14.8

15.8

16.5

16.2

Net interest margin
3.46

3.50

3.76

3.98

4.33

Efficiency ratio
51.5

54.8

53.7

53.7

55.8

Dividend payout ratio
51.0

49.7

47.5

47.1

48.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

22


 
 
 
 
 
 
 
 
Asset Quality
 
 
 
 
 
 
Net charge-offs to average loans
0.13
%
0.13
%
0.29
%
0.18
%
0.20
%
 
Provision for loan losses to average loans
0.10

0.15

0.26

0.16

0.27

 
Allowance for loan losses to nonperforming loans
178.39

140.10

110.37

127.62

90.25

 
Allowance for loan losses to total loans
0.60

0.65

0.67

0.76

0.79

 
 
 
 
 
 
 
 
Consolidated Capital Ratios
 
 
 
 
 
 
CET 1 Capital
15.1
%
13.3
%
13.7
%
*
*
 
Tier 1 Capital
15.7

13.9

14.3

13.4

13.0

 
Total Capital
16.3

14.7

15.1

14.2

13.8

 
Tier 1 Leverage
11.0

10.2

10.2

9.9

9.8

 
Average equity to average assets
12.1

11.2

11.6

11.6

11.0

 
Tangible equity to tangible assets (end of period)
10.5

9.3

9.3

9.3

9.5

 
 
 
 
 
 
 
 
Full-time equivalent employees
839

847

853

889

923

 
 
 
 
 
 
 
 
*Basel III CET 1 ratio requirements were effective beginning January 1, 2015 and were not required for prior periods.
 
 
 
 
 
 
 
 
(1) - In January 2013, the Company acquired Community Financial Corporation and its wholly owned subsidiary, Community Bank.
 
(2) - In January 2015, the Company sold its insurance operations, CityInsurance. In November 2015, the Company acquired three branches in Lexington, Kentucky from American Founder's Bank.
 


23


Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations 


CITY HOLDING COMPANY
 
City Holding Company (the “Company”), a West Virginia corporation headquartered in Charleston, West Virginia, is a registered financial holding company under the Bank Holding Company Act and conducts its principal activities through its wholly owned subsidiary, City National Bank of West Virginia ("City National"). City National is a retail and consumer-oriented community bank with 86 bank branches in West Virginia (57), Virginia (14), Kentucky (12) and Ohio (3). City National provides credit, deposit, and trust and investment management services to its customers in a broad geographical area that includes many rural and small community markets in addition to larger cities including Charleston (WV), Huntington (WV), Martinsburg (WV), Winchester (VA), Staunton (VA), Virginia Beach (VA), Ashland (KY) and Lexington (KY). In the Company's key markets, the Company's primary subsidiary, City National, generally ranks in the top three relative to deposit market share and the top two relative to branch share (Charleston/Huntington MSA, Beckley/Lewisburg counties, Staunton MSA and Winchester, VA/WV Eastern Panhandle counties). In addition to its branch network, City National's delivery channels include automated-teller-machines ("ATMs"), interactive-teller-machines ("ITMs"), mobile banking, debit cards, interactive voice response systems, and Internet technology. The Company’s business activities are currently limited to one reportable business segment, which is community banking. 

In January 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 in the first quarter of 2015.

On November 6, 2015, the Company purchased three branch locations from American Founders Bank, Inc. (“AFB”) located in Lexington, Kentucky. The Company acquired approximately $119 million in performing loans and assumed deposit liabilities of approximately $145 million. The Company paid AFB a deposit premium of 5.5% on non-time deposits and 1.0% on premium loan balances acquired.
 
CRITICAL ACCOUNTING POLICIES
 
The accounting policies of the Company conform to U.S. generally accepted accounting principles and require management to make estimates and develop assumptions that affect the amounts reported in the financial statements and related footnotes. These estimates and assumptions are based on information available to management as of the date of the financial statements. Actual results could differ significantly from management’s estimates. As this information changes, management’s estimates and assumptions used to prepare the Company’s financial statements and related disclosures may also change. The most significant accounting policies followed by the Company are presented in Note One of the Notes to Consolidated Financial Statements included herein. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified: (i) the determination of the allowance for loan losses and (ii) income taxes to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new information becomes available.

The Allowance and Provision for Loan Losses section of this Annual Report on Form 10-K provides management’s analysis of the Company’s allowance for loan losses and related provision. The allowance for loan losses is maintained at a level that represents management’s best estimate of probable losses in the loan portfolio. Management’s determination of the appropriateness of the allowance for loan losses is based upon an evaluation of individual credits in the loan portfolio, historical loan loss experience, current economic conditions, and other relevant factors. This determination is inherently subjective, as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses related to loans considered to be impaired is generally evaluated based on the discounted cash flows using the impaired loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. The allowance not specifically allocated to individual credits is generally determined by analyzing potential exposure and other qualitative factors that could negatively impact the overall credit risk of the loan portfolio. Loans not individually evaluated for impairment are grouped by pools with similar risk characteristics and the related historical loss rates are adjusted to reflect current inherent risk factors, such as unemployment, overall economic conditions, concentrations of credit, loan growth, classified and impaired loan trends, staffing, adherence to lending policies, and loss trends.

The Income Taxes section of this Annual Report on Form 10-K provides management’s analysis of the Company’s income taxes.  The Company is subject to federal and state income taxes in the jurisdictions in which it conducts business.  In computing the provision for income taxes, management must make judgments regarding interpretation of laws in those jurisdictions.  Because the application of tax laws and regulations for many types of transactions is susceptible to varying interpretations, amounts reported in the financial statements could be changed at a later date upon final determinations by taxing

24


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 Company's unrecognized tax benefits could change over the next twelve months as a result of various factors.    The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and various state taxing authorities for the years ended December 31, 2014 through 2016. 


FINANCIAL SUMMARY
 
The Company’s financial performance over the previous three years is summarized in the following table:
 
2017
2016
2015
 
 
 
 
Net income available to common shareholders (in thousands)
$
54,310

$
52,128

$
54,097

Earnings per common share, basic
$
3.49

$
3.46

$
3.54

Earnings per common share, diluted
$
3.48

$
3.45

$
3.53

ROA*
1.33
%
1.36
%
1.52
%
ROE*
11.0
%
12.1
%
13.0
%
ROATCE*
13.1
%
14.8
%
15.8
%

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

            The Company’s tax equivalent net interest income increased $7.8 million, or 6.5%, from $119.8 million in 2016 to $127.6 million in 2017 (see Net Interest Income).  The Company’s provision for loan losses decreased $1.4 million from $4.4 million in 2016 to $3.0 million in 2017 (see Allowance and Provision for Loan Losses). Non-interest income increased $4.8 million and non-interest expense decreased $0.2 million (see Non-Interest Income and Expense). As a result of a reduction in the corporate income tax rate effective January 1, 2018, the Company reassessed its deferred tax assets and liabilities, which resulted in additional deferred income taxes of $7.1 million (see Income Taxes). As a result, the Company's net income increased $2.2 million from $52.1 million in 2016 to $54.3 million in 2017 and the Company achieved a return on assets of 1.33%, a return on tangible equity of 13.1% and an efficiency ratio of 51.5%.

BALANCE SHEET ANALYSIS
 
Selected balance sheet fluctuations are summarized in the following table (in millions):
 
December 31,
 
 
 
2017
2016
$ Change
% Change
 
 
 
 
 
Investment securities
$
629.0

$
539.6

$
89.4

16.6
 %
Gross loans
3,127.4

3,046.2

81.2

2.7

Deferred tax assets, net
11,913

28,043

(16.1
)
(57.4
)
 
 
 
 
 
Total deposits
3,315.6

3,231.7

83.9

2.6

Shareholders' equity
502.5

442.4

60.1

13.6


Investment securities increased $89 million, or 16.6%, from $540 million at December 31, 2016, to $629 million at December 31, 2017. During 2017, in conjunction with its interest rate risk management strategy, the Company elected to grow investment balances and maintain cash balances to enhance net interest income.

Gross loans increased $81 million, or 2.7%, from $3.05 billion at December 31, 2016 to $3.13 billion at December 31, 2017. Commercial loans increased $70.9 million (5.0%) and residential real estate loans increased $16.8 million (1.2%) from December 31, 2016 to December 31, 2017.

Deferred tax assets decreased $16 million, or (57.4)%, from $28 million at December 31, 2016 to $12 million at December 31, 2017. This is primarily due to the remeasurement of the Company's net deferred tax assets associated with the

25


enactment of the Tax Cuts and Jobs Act ("TCJA"). This remeasurement decreased the Company's net deferred tax assets by $7.1 million. In addition, the deferred tax asset associated with other-than-temporarily impaired investment securities decreased by $3.4 million due to the sales of those securities during the year (see Income taxes).

Total deposits increased $84 million, or 2.6%, from $3.23 billion at December 31, 2016 to $3.32 billion at December 31, 2017. The increase is due to growth in interest bearing demand deposits of $73.4 million and growth in time deposits of $42.1 million. These increases were partially offset by decreases in savings deposit accounts ($25.8 million) and noninterest-bearing deposits ($5.6 million).

Shareholders' equity increased $60.1 million from December 31, 2016 to December 31, 2017 (see Capital Resources). 



26



TABLE TWO
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(In thousands)
 
 
2017
 
2016
 
2015
 
Average Balance
Interest
Yield/
Rate
 
Average Balance
Interest
Yield/
Rate
 
Average Balance
Interest
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Loan portfolio(1):
 
 
 
 
 
 
 
 
 
 
 
Residential real estate(2),(3)
$
1,598,579

$
63,649

3.98
%
 
$
1,565,079

$
60,736

3.88
%
 
$
1,474,631

$
57,692

3.91
%
Commercial, financial, and agriculture(3),(4)
1,450,144

58,243

4.02

 
1,318,094

52,812

4.01

 
1,175,707

52,177

4.44

Installment loans to individuals(3),(5)
33,725

2,514

7.45

 
37,664

2,917

7.75

 
40,966

3,442

8.40

Previously securitized loans(6)

1,346


 

1,673


 

1,796


     Total loans
3,082,448

125,752

4.08

 
2,920,837

118,138

4.04

 
2,691,304

115,107

4.28

Securities:
 
 
 
 
 
 
 
 
 
 
 
   Taxable
492,783

14,387

2.92

 
444,110

12,392

2.79

 
352,296

10,830

3.07

   Tax-exempt(7)
89,341

4,163

4.66

 
51,096

2,494

4.88

 
31,389

1,749

5.57

     Total securities
582,124

18,550

3.19

 
495,206

14,886

3.01

 
383,685

12,579

3.28

Deposits in depository institutions
27,142

85

0.31

 
10,115



 
9,733



     Total interest-earning assets
3,691,714

144,387

3.91

 
3,426,158

133,024

3.88

 
3,084,722

127,686

4.14

Cash and due from banks
85,473

 
 
 
95,295

 
 
 
180,965

 
 
Bank premises and equipment
73,540

 
 
 
76,056

 
 
 
76,136

 
 
Other assets
249,193

 
 
 
257,525

 
 
 
243,902

 
 
   Less: allowance for loan losses
(20,246
)
 
 
 
(19,953
)
 
 
 
(20,995
)
 
 
Total assets
$
4,079,674

 
 
 
$
3,835,081

 
 
 
$
3,564,730

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
705,412

643

0.09
%
 
$
685,399

615

0.09
%
 
$
644,961

505

0.08
%
Savings deposits
832,512

1,311

0.16

 
772,296

975

0.13

 
706,926

712

0.10

Time deposits(3)
1,067,181

12,872

1.21

 
1,029,172

10,462

1.02

 
1,005,232

9,669

0.96

Short-term borrowings
230,529

1,214

0.53

 
176,065

472

0.27

 
145,199

327

0.23

Long-term debt
16,495

765

4.64

 
16,495

683

4.14

 
16,495

617

3.74

     Total interest-bearing liabilities
2,852,129

16,805

0.59

 
2,679,427

13,207

0.49

 
2,518,813

11,830

0.47

Noninterest-bearing demand deposits
693,280

 
 
 
679,950

 
 
 
590,424

 
 
Other liabilities
41,597

 
 
 
44,673

 
 
 
40,442

 
 
Total shareholders’ equity
492,668

 
 
 
431,031

 
 
 
415,051

 
 
Total liabilities and shareholders’ equity
$
4,079,674

 
 
 
$
3,835,081

 
 
 
$
3,564,730

 
 
Net interest income
 
$
127,582

 
 
 
$
119,817

 
 
 
$
115,856

 
Net yield on earning assets
 
 
3.46
%
 
 
 
3.50
%
 
 
 
3.76
%
 
1.
For purposes of this table, non-accruing loans have been included in average balances and loan fees, which are immaterial, have been included in interest income.
2.Includes the Company's residential real estate and home equity loan categories.
3.
Included in the above table are the following amounts (in thousands) for the accretion of the fair value adjustments related to the Company's recent acquisitions:

 
2017
 
2016
 
2015
Residential real estate
$
530

 
$
698

 
$
893

Commercial, financial, and agriculture
1,345

 
1,505

 
4,830

Installment loans to individuals
44

 
112

 
275

Time deposits
16

 
592

 
687

     Total
$
1,935

 
$
2,907

 
$
6,685


27



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

NET INTEREST INCOME

2017 vs. 2016

The Company's net interest income increased from $118.9 million for the year ended December 31, 2016 to $126.1 million for the year ended December 31, 2017. The Company’s tax equivalent net interest income increased $7.8 million, or 6.5%, from $119.8 million in 2016 to $127.6 million in 2017. This increase was due primarily to higher average balances on commercial loans ($132.0 million) which increased interest income by $5.1 million, and residential real estate loans ($33.5 million) which increased interest income by $1.3 million as compared to the year ended December 31, 2016. Increased interest yields on residential real estate loans also increased net interest income by $1.8 million compared to the year ended December 31, 2016. In addition, higher average investment balances ($86.9 million) increased investment income by $3.2 million. These increases were partially offset by increased interest expense on interest bearing deposits ($3.0 million), primarily due to an increase in the cost of funds, and lower accretion from fair value adjustments on recent acquisitions ($1.0 million). The Company’s reported net interest margin decreased from 3.50% for the year ended December 31, 2016 to 3.46% for the year ended December 31, 2017. Excluding the favorable impact of the accretion from fair value adjustments, the net interest margin would have been 3.40% for the year ended December 31, 2017 and 3.41% for the year ended December 31, 2016.

Average interest-earning assets increased $266 million from 2016 to 2017, due to increases in commercial, financial, and agriculture loans ($132 million), investment securities ($87 million) and residential real estate loans ($34 million).   Average interest-bearing liabilities increased $173 million from 2016 due to increases in savings deposits ($60 million), short-term borrowings ($54 million), time deposits ($38 million) and interest-bearing demand deposits ($20 million).

2016 vs. 2015
 
The Company's net interest income increased from $115.2 million for the year ended December 31, 2015 to $118.9 million for the year ended December 31, 2016. The Company’s tax equivalent net interest income increased $4.0 million, or 3.4%, from $115.9 million in 2015 to $119.8 million in 2016. This increase was due primarily to an increase in average loan balances from organic growth ($127 million) and from loans associated with the acquisition of three branches in the Lexington, Kentucky market in November 2015 (approximately $102 million in loans) contributing additional net interest income of $9.0 million in 2016. In addition, higher average investment balances ($111.5 million) increased net interest income by $3.9 million. During 2016, in conjunction with its interest rate risk management strategy, the Company elected to grow investment balances and reduce cash balances to enhance net interest income. As part of this strategy, the Company purchased tax-exempt municipal securities to improve its earnings by lowering its effective income tax rate. As a result of this strategy, the Company's overnight borrowings increased during 2016 . These increases in net interest income were partially offset by lower accretion from fair value adjustments on recent acquisitions that decreased net interest income $3.8 million ($6.7 million in 2015 compared to $2.9 million in 2016) and margin compression, which lowered net interest income $3.9 million. The Company’s reported net interest margin decreased from 3.76% for the year ended December 31, 2015 to 3.50% for the year ended December 31, 2016. Excluding the favorable impact of the accretion from fair value adjustments on recent acquisitions, the net interest margin would have been 3.41% for the year ended December 31, 2016 and 3.54% for the year ended December 31, 2015. This decrease was primarily caused by loan yields (excluding accretion) compressing from 4.05% for the year ended December 31, 2015 to 3.96% for the year ended December 31, 2016 and by the yield on investment securities decreasing from 3.28% to 3.01% for the same period.

Average interest-earning assets increased $341 million from 2015 to 2016, due to increases in commercial, financial,
and agriculture loans ($142 million), investment securities ($112 million) and residential real estate loans ($90 million). Average
interest-bearing liabilities increased $161 million from 2015 due to increases in savings deposits ($65 million), interest-bearing
demand deposits ($40 million), short-term borrowings ($31 million) and time deposits ($24 million).



28


TABLE THREE
RATE/VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
(In thousands)
 
2017 vs. 2016
Increase (Decrease)
Due to Change In:
2016 vs. 2015
Increase (Decrease)
Due to Change In:
 
Volume
Rate
Net
Volume
Rate
Net
Interest-earning assets:
 
 
 
 
 
 
Loan portfolio
 
 
 
 
 
 
   Residential real estate
$
1,300

$
1,613

$
2,913

$
3,539

$
(495
)
$
3,044

   Commercial, financial, and agriculture
5,291

140

5,431

6,319

(5,684
)
635

   Installment loans to individuals
(305
)
(98
)
(403
)
(277
)
(248
)
(525
)
   Previously securitized loans

(327
)
(327
)

(123
)
(123
)
     Total loans
6,286

1,328

7,614

9,581

(6,550
)
3,031

Securities:
 
 
 
 
 
 
   Taxable
1,358

637

1,995

2,822

(1,260
)
1,562

   Tax-exempt(1)
1,867

(198
)
1,669

1,098

(353
)
745

     Total securities
3,225

439

3,664

3,920

(1,613
)
2,307

Deposits in depository institutions
$

$
85

$
85

$

$

$

Total interest-earning assets
$
9,511

$
1,852

$
11,363

$
13,501

$
(8,163
)
$
5,338

 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits
$
18

$
10

$
28

$
32

$
78

$
110

   Savings deposits
76

260

336

66

197

263

   Time deposits
386

2,024

2,410

230

563

793

   Short-term borrowings
146

596

742

70

75

145

   Long-term debt

82

82


66

66

     Total interest-bearing liabilities
$
626

$
2,972

$
3,598

$
398

$
979

$
1,377

Net Interest Income
$
8,885

$
(1,120
)
$
7,765

$
13,103

$
(9,142
)
$
3,961


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



29


Non-GAAP Financial Measures

Management of the Company uses measures in its analysis of the Company's performance other than those in accordance with generally accepted accounting principals in the United States of America ("GAAP"). These measures are useful when evaluating the underlying performance of the Company's operations. The Company's management believes that these non-GAAP measures enhance comparability of results with prior periods and demonstrate the effects of significant gains and charges in the current period. The Company's management believes that investors may use these non-GAAP financial measures to evaluate the Company's financial performance without the impact of those items that may obscure trends in the Company's performance. These disclosures should not be viewed as a substitute for financial measures determined in accordance with GAAP, nor are they comparable to non-GAAP financial measures that may be presented by other companies. The following table reconciles fully taxable equivalent net interest income and fully taxable equivalent net interest income excluding accretion with net interest income as derived from the Company's financial statements (in thousands):


TABLE FOUR
NON-GAAP FINANCIAL MEASURES
(In thousands)

 
2017
2016
2015
 
 
 
 
Net interest income ("GAAP")
$
126,125

$
118,945

$
115,244

Taxable equivalent adjustment
1,457

872

612

Net interest income, fully taxable equivalent
$
127,582

$
119,817

$
115,856

 
 
 
 
Average interest earning assets
$
3,691,714

$
3,426,158

$
3,084,722

Net interest margin
3.46
%
3.50
%
3.76
%
 
 
 
 
Net interest income ("GAAP")
$
126,125

$
118,945

$
115,244

Taxable equivalent adjustment
1,457

872

612

Accretion related to fair value adjustments
(1,935
)
(2,907
)
(6,685
)
Net interest income, fully taxable equivalent, excluding accretion
$
125,647

$
116,910

$
109,171

 
 
 
 
Net interest margin (excluding accretion)
3.40
%
3.41
%
3.54
%
 
 
 
 
Income Tax Expense ("GAAP")
$
36,435

$
25,083

$
28,414

FIN 48
331

554

592

Impact of effective tax rate decrease on deferred taxes
(7,069
)


Sale of insurance operations
$

$

$
(1,282
)
Income tax expense, excluding the impact of FIN 48, effective tax rate decrease on deferred taxes, and sale of insurance operations
$
29,697

$
25,637

$
27,724

 
 
 
 
Effective tax rate ("GAAP")
40.2
%
32.5
%
33.6
%
Effective tax rate, excluding FIN 48, effective tax rate decrease, and sale of insurance operations
32.7
%
33.2
%
34.4
%

NON-INTEREST INCOME AND NON-INTEREST EXPENSE

2017 vs. 2016

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


30


 
For the year ended December 31,
 
 
 
2017
2016
$ Change
% Change
Net investment security gains
$
4.5

$
3.5

$
1.0

27.4
 %
Non-interest income, excluding net investment securities gains
59.1

55.3

3.8

6.9

Non-interest expense
96.0

96.2

(0.2
)
(0.2
)

During the years ended December 31, 2017 and 2016, the Company realized investment gains of $4.5 million and $3.5 million, respectively, from the sale of pools of trust preferred securities, which represented a partial recovery of impairment charges previously recognized.

Exclusive of these gains, non-interest income increased $3.8 million to $59.1 million for the year ended December 31, 2017 as compared to $55.3 million for the year ended December 31, 2016. This is primarily due to increases in service charges of $1.9 million, or 7.0%, bank owned life insurance of $0.9 million, or 26.6% (primarily due to death benefit proceeds), trust revenues of $0.7 million, or 12.5%, and bankcard revenue of $0.6 million, or 3.7%.

Non-interest expenses decreased $0.2 million from $96.2 million for the year ended December 31, 2016 to $96.0 million for the year ended December 31, 2017. This is primarily due to decreases in occupancy related expenses of $0.6 million, or 5.6%, bankcard expenses of $0.5 million, or 12.0%, and FDIC insurance of $0.3 million, or 16.9%. These decreases were partially offset by increases in equipment and software related expenses of $0.5 million, or 7.2%, advertising of $0.3 million, or 11.8%, salaries and employee benefits of $0.2 million, or 0.3%, telecommunciation expenses of $0.2 million, or 9.7%, and repossessed asset losses, net of expenses, of $0.2 million or 17.4%.

2016 vs. 2015

Selected income statement fluctuations are summarized in the following table (dollars in millions):
 
For the year ended December 31,
 
 
 
2016
2015
$ Change
% Change
Net investment security gains
$
3.5

$
2.1

$
1.4

66.7
 %
Gain on sale of insurance division

11.1

(11.1
)
(100.0
)
Non-interest income, excluding net investment securities gains and gain on sale of insurance division
55.3

54.0

1.3

2.4

Non-interest expense
96.2

93.0

3.2

3.4


During the years ended December 31, 2016 and 2015, the Company realized investment gains of $3.5 million and $2.1 million, respectively, from the call or sale of trust preferred securities, which represented a partial recovery of impairment charges previously recognized.
During the year ended December 31, 2015, the Company sold its insurance operations, CityInsurance, which resulted in the recognition of a pre-tax gain of $11.1 million.
Exclusive of these gains, non-interest income increased $1.3 million to $55.3 million for the year ended December 31, 2016 as compared to $54.0 million for the year ended December 31, 2015. This is primarily due to increases in bankcard revenue of $0.6 million, or 3.9%, trust revenues of $0.4 million, or 8.8%, and service charges of $0.4 million, or 1.5%.

Non-interest expenses increased $3.2 million from the year ended December 31, 2015 to the year ended December 31, 2016. During 2015, the Company recognized $0.6 million of acquisition and integration expenses associated with the acquisition of three branches in Lexington, Kentucky. Excluding acquisition related expenses, non-interest expenses increased $3.8 million from $92.4 million for the year ended December 31, 2015 to $96.2 million for the year ended December 31, 2016. This increase was largely due to an increase in salaries and employee benefits ($2.1 million) due to salary adjustments and increased health insurance costs. In addition, non-interest expenses increased $1.7 million due to the annual operating costs of the three branches acquired in November 2015 and from an increase of $0.5 million in bankcard expenses due to increased transaction volumes.



31


INCOME TAXES
 
The Company recorded income tax expense of $36.4 million, $25.1 million and $28.4 million in 2017, 2016 and 2015, respectively. The Company’s effective tax rates for 2017, 2016 and 2015 were 40.2%, 32.5% and 34.4%, respectively. A reconciliation of the effective tax rate to the statutory rate is included in Note Twelve of the Notes to Consolidated Financial Statements. On December 22, 2017, the President signed the Tax Cut and Jobs Act ("TCJA") into law. Among other things, the TCJA reduced the corporate income tax rate from 35% to 21%, effective January 1, 2018. This change required management to remeasure its deferred tax assets and liabilities at the new income tax rate. The provisional amount recorded as a result of the remeasurement was $7.1 million. Management continues to evaluate the TCJA and refine calculations which could potentially impact the measurement of these balances. In addition, during the years ended December 31, 2017, 2016 and 2015, the Company reduced income tax expense by $0.3 million, $0.5 million and $0.6 million, respectively due to the recognition of previously unrecognized tax positions resulting from the close of the statute of limitations for previous tax years. Also, as a result of differences between the book and tax basis of the assets that were sold in conjunction with the sale of CityInsurance, the Company’s income tax expense increased by $1.1 million during the year ended December 31, 2015. Exclusive of these items, the Company’s tax rate from operations was 32.7%, 33.2% and 33.6% for the years ended December 31, 2017, 2016 and 2015, respectively.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company’s net deferred tax assets decreased from $28.0 million at December 31, 2016 to $11.9 million at December 31, 2017. The decrease is primarily driven by the income tax rate decrease as a result of the enactment of the TCJA. The components of the Company’s net deferred tax assets are disclosed in Note Twelve of the Notes to Consolidated Financial Statements. Realization of the most significant net deferred tax assets is primarily dependent on future events taking place that will reverse the current deferred tax assets. The deferred tax asset and/or liability associated with unrealized securities losses is the tax impact of the unrealized gains and/or losses on the Company’s available-for-sale security portfolio.  At December 31, 2017 and 2016, the Company had a deferred tax asset of $0.2 million and $1.3 million, respectively, associated with unrealized securities losses. The impact of the Company’s unrealized losses is noted in the Company’s Consolidated Statements of Changes in Shareholders’ Equity as an adjustment to Accumulated Other Comprehensive Income (Loss).  This deferred tax asset would be realized if the unrealized securities losses on the Company's securities were realized from either the sales or maturities of the related securities. At December 31, 2017 and 2016, the Company had a deferred tax asset of $0.4 million and $3.8 million, respectively, associated with other-than-temporarily impaired securities. The decrease of $3.4 million is primarily due to sales of other-than-temporarily impaired securities.  The deferred tax asset associated with the allowance for loan losses decreased from $7.3 million at December 31, 2016 to $4.4 million at December 31, 2017. The decrease of $2.9 million is primarily due to the income tax rate decrease associated with the TCJA. The deferred tax asset associated with the allowance for loan losses is expected to be realized as additional loan charge-offs, which have already been provided for within the Company’s financial statements, are recognized for tax purposes.  The Company believes that it is more likely than not that each of the deferred tax assets will be realized and that no valuation allowance was necessary as of December 31, 2017 or 2016.
 
LIQUIDITY

The Company evaluates the adequacy of liquidity at both the Parent Company level and at the banking subsidiary level. At the Parent Company level, the principal source of cash is dividends from its banking subsidiary, City National. Dividends paid by City National to the Parent Company are subject to certain legal and regulatory limitations. Generally, any dividends in amounts that exceed the earnings retained by City National in the current year plus retained net profits for the preceding two years must be approved by regulatory authorities. At December 31, 2017, City National could pay dividends up to $75.0 million without prior regulatory permission.

During 2017, the Parent Company used cash obtained from the dividends received primarily to: (1) pay common dividends to shareholders, (2) remit interest payments on the Company’s junior subordinated debentures and (3) fund repurchases
of the Company's common shares. Additional information concerning sources and uses of cash by the Parent Company is reflected in Note Nineteen of the Notes to Consolidated Financial Statements.

On December 19, 2016, the Company announced that it had filed a prospectus supplement to its existing shelf registration statement on Form S-3 for the sale of its common stock having an aggregate value of up to $55 million through an “at-the-market” equity offering program. Through the year ended December 31, 2017, the Company has sold approximately 548,000 common shares at a weighted average price of $64.82, net of broker fees. The Company has sold no shares since the first quarter of 2017. To date, the Company has received $36.4 million in gross proceeds. Under the program, the Company has the ability to receive an additional $18.6 million in gross proceeds from the sale of common shares.


32


Over the next 12 months, the Parent Company has an obligation to remit interest payments approximating $0.8 million on the junior subordinated debentures held by City Holding Capital Trust III. Additionally, the Parent Company anticipates continuing the payment of dividends, which are expected to approximate $28.6 million on an annualized basis for 2018 based on common shareholders of record at December 31, 2017 at a dividend rate of $1.84 for 2018.  However, interest payments on the debentures can be deferred for up to five years under certain circumstances and dividends to shareholders can, if necessary, be suspended. In addition to these anticipated cash needs, the Parent Company has operating expenses and other contractual obligations, which are estimated to require $1.4 million of additional cash over the next 12 months. As of December 31, 2017, the Parent Company reported a cash balance of $59.0 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 2018 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 Federal Home Loan Bank ("FHLB") and other financial institutions. As of December 31, 2017, City National’s assets are significantly funded by deposits and capital. City National maintains borrowing facilities with the FHLB and other financial institutions that can be accessed as necessary to fund operations and to provide contingency funding mechanisms. As of December 31, 2017, City National had 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. As illustrated in the Consolidated Statements of Cash Flows, the Company generated $77.8 million of cash from operating activities during 2017, primarily from interest income received on loans and investments, net of interest expense paid on deposits and borrowings.

The Company has obligations to extend credit, but these obligations are primarily associated with existing home equity loans that have predictable borrowing patterns across the portfolio. The Company has investment security balances with carrying values that totaled $629.0 million at December 31, 2017, and that greatly exceeded the Company’s non-deposit sources of borrowing, which totaled $268.7 million.

The Company’s net loan to asset ratio is 75.2% as of December 31, 2017 and deposit balances fund 80.2% of total assets as compared to 69.9% for its peers (Bank Holding Company Peer Group with assets ranging from $3 billion to $10 billion). Further, the Company’s deposit mix has a very high proportion of transaction and savings accounts that fund 54.0% of the Company’s total assets and the Company uses time deposits over $250,000 to fund 2.8% of total assets compared to its peers, which fund 13.1% of total assets with such deposits.
 
INVESTMENTS
 
The Company’s investment portfolio increased $89 million, or 16.5%, from $540 million at December 31, 2016, to $629 million at December 31, 2017. During 2017, in conjunction with its interest rate risk management strategy, the Company elected to grow investment balances (primarily mortgage-backed and municipal securities) and maintain cash balances to enhance net interest income. As part of this strategy, the Company increased its tax-exempt municipal securities to improve its earnings by lowering its effective income tax rate.


33


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

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

The Company's municipal bond portfolio of $96.2 million as of December 31, 2017 has an average tax equivalent yield of 4.43% with an average maturity of 12.2 years. The average dollar amount invested in each security is $0.5 million. The portfolio has 66% rated "A" or better and the remaining portfolio is unrated, as the issuances represented small issuances of revenue bonds. Additional credit support was been purchased by the issuer for 35% of the portfolio, while 65% has no additional credit support. Management does underwrite 100% of the portfolio on an annual basis, using the same guidelines that are used to underwrite its commercial loans. Revenue bonds were 71% of the portfolio, while the remaining 29% were general obligation bonds. Geographically, the portfolio supports the Company's footprint, with 70% of the portfolio being from municipalities throughout West Virginia, and the remainder from communities in Ohio, Indiana, and various other states.



34


TABLE FIVE
INVESTMENT PORTFOLIO

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

 
Carrying Values as of December 31,
 
2017
2016
2015
Securities available-for-sale:
 
 
 
    Obligations of states and political subdivisions
$
96,196

$
82,368

$
50,697

    U.S. Treasuries and U.S. government agencies
2

3

5

Mortgage-backed securities:
 
 
 
     U.S. government agencies
419,347

330,814

288,197

     Private label
652

942

1,231

Trust preferred securities
4,736

6,662

5,858

Corporate securities
22,268

23,574

18,693

     Total Debt Securities available-for-sale
543,201

444,363

364,681

Marketable equity  securities
5,699

4,231

3,273

Investment funds
1,489

1,489

1,512

      Total Securities Available-for-Sale
550,389

450,083

369,466

Securities held-to-maturity:
 
 
 
    Mortgage backed securities
60,449

71,169

84,937

    Trust preferred securities
4,000

4,000

4,000

      Total Securities Held-to-Maturity
64,449

75,169

88,937

Other investment securities:
 
 
 
   Non-marketable equity securities
14,147

14,352

12,915

       Total Other Investment Securities
14,147

14,352

12,915

 
 
 
 
Total Securities
$
628,985

$
539,604

$
471,318


Included in non-marketable equity securities in the table above at December 31, 2017 are $5.9 million of Federal Home Loan Bank stock and $8.2 million of Federal Reserve Bank stock. At December 31, 2017, there were no securities of any non-governmental issuers whose aggregate carrying or estimated fair value exceeded 10% of shareholders’ equity.

    

35


The weighted average yield of the Company's investment portfolio is presented in the following table (dollars in thousands):
 
Within
After One But
After Five But
After
 
One Year
Within Five Years
Within Ten Years
Ten Years
 
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Securities available-for-sale:
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
2,601

3.20
%
$
10,915

3.32
%
$
14,551

3.02
%
$
68,129

3.17
%
U.S. Treasuries and U.S. government agencies


2

1.97





Mortgage-backed securities:
 
 
 
 
 
 
 
 
     U.S. government agencies
374

1.18

2,588

2.19

44,347

2.32

372,038

2.61

     Private label
31

3.65





621

3.91

Trust preferred securities






4,736

3.16

Corporate securities


2,350

4.98

16,551

5.04

3,367

5.36

     Total Debt Securities available-for-sale
3,006

2.95

15,855

3.38

75,449

3.05

448,891

2.73

Securities held-to-maturity: