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Section 1: 10-Q (10-Q)

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Table of Contents

 

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

FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2018
OR
[  ] TRANSITION REPORT PURSANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Transition Period From ____________To_____________.

Commission File Number 0-11733
395659450_chcologoa02a12.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)

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
[X]
No
[   ]
 
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).
Yes
[X]
No
[   ]
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]
 
Accelerated filer [ ]
 
 
 
 
 
Non-accelerated filer [   ]
 
Smaller reporting company [   ]
 
 
 
 
 
 
 
Emerging growth company [   ]
 
 



Table of Contents

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 Exchange Act).
Yes
[   ]
No
[X]
 
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common stock, $2.50 Par Value – 15,389,278 shares as of November 5, 2018.



FORWARD-LOOKING STATEMENTS

All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q, including statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such information involves risks and uncertainties that could result in the Company's actual results differing materially from those projected in the forward-looking statements. Important factors that could cause actual results to differ materially from those discussed in such forward-looking statements include, but are not limited to, (1) the Company may incur additional loan loss provision due to negative credit quality trends in the future that may lead to a deterioration of asset quality; (2) the Company may incur increased charge-offs in the future; (3) the Company could have adverse legal actions of a material nature; (4) the Company may face competitive loss of customers; (5) the Company may be unable to manage its expense levels; (6) the Company may have difficulty retaining key employees; (7) changes in the interest rate environment may have results on the Company’s operations materially different from those anticipated by the Company’s market risk management functions; (8) changes in general economic conditions and increased competition could adversely affect the Company’s operating results; (9) changes in 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 investments; (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; (14) the businesses of City Holding Company, City National Bank of West Virginia, Poage Bankshares, Inc., Town Square Bank, Farmers Deposit Bancorp, Inc. and Farmers Deposit Bank may not integrate successfully or such integration may take longer to accomplish than expected (15) the expected cost savings and any revenue synergies from the merger of City Holding Company, City National Bank of West Virginia, Poage Bankshares, Inc., Town Square Bank, Farmers Deposit Bancorp, Inc. and Farmers Deposit Bank may not be fully realized within the expected time frames; (16) the disruption from the merger of City Holding Company, City National Bank of West Virginia, Poage Bankshares, Inc., Town Square Bank, Farmers Deposit Bancorp, Inc. and Farmers Deposit Bank may make it more difficult to maintain relationships with clients, associates, or suppliers; and (17) other risk factors relating to the banking industry or the Company as detailed from time to time in the Company’s reports filed with the Securities and Exchange Commission, including those risk factors included in the disclosures under the heading “Item 1A Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.  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.


Table of Contents

Index
City Holding Company and Subsidiaries

Pages
 
 
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
 



Table of Contents

Part I -
FINANCIAL INFORMATION

Item 1 -
Financial Statements


1

Table of Contents

Consolidated Balance Sheets
City Holding Company and Subsidiaries
(in thousands)
 
(Unaudited)
 
 
 
September 30, 2018
 
December 31, 2017
Assets
 
 
Cash and due from banks
$
49,806

 
$
54,450

Interest-bearing deposits in depository institutions
256,104

 
28,058

Cash and Cash Equivalents
305,910

 
82,508

 
 
 
 
Investment securities available for sale, at fair value
563,003

 
550,389

Investment securities held-to-maturity, at amortized cost (approximate fair value at September 30, 2018 and December 31, 2017 - $56,841 and $65,646, respectively)
57,812

 
64,449

Other securities
28,875

 
14,147

Total Investment Securities
649,690

 
628,985

 
 
 
 
Gross loans
3,146,697

 
3,127,410

Allowance for loan losses
(16,311
)
 
(18,836
)
Net Loans
3,130,386

 
3,108,574

 
 
 
 
Bank owned life insurance
105,372

 
103,440

Premises and equipment, net
72,484

 
72,682

Accrued interest receivable
11,449

 
9,223

Net deferred tax asset
15,653

 
11,913

Goodwill and other intangible assets, net
78,215

 
78,595

Other assets
51,643

 
36,361

Total Assets
$
4,420,802

 
$
4,132,281

 
 
 
 
Liabilities
 

 
 

Deposits:
 

 
 

Noninterest-bearing
$
672,042

 
$
666,639

Interest-bearing:
 

 
 

   Demand deposits
802,490

 
769,245

   Savings deposits
821,390

 
796,275

   Time deposits
1,147,709

 
1,083,475

Total Deposits
3,443,631

 
3,315,634

 
 
 
 
Short-term borrowings:
 
 
 
   Federal funds purchased
170,000

 
54,000

   Customer repurchase agreements
220,124

 
198,219

Long-term debt
16,495

 
16,495

Other liabilities
58,526

 
45,426

Total Liabilities
3,908,776

 
3,629,774

Shareholders’ Equity
 

 
 

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

 

Common stock, par value $2.50 per share: 50,000,000 shares authorized; 19,047,548 shares issued at September 30, 2018 and December 31, 2017, less 3,598,106 and 3,429,519 shares in treasury, respectively
47,619

 
47,619

Capital surplus
140,450

 
140,960

Retained earnings
484,017

 
444,481

Cost of common stock in treasury
(136,783
)
 
(124,909
)
Accumulated other comprehensive income (loss):
 

 
 

    Unrealized (loss) on securities available-for-sale
(18,244
)
 
(611
)
    Underfunded pension liability
(5,033
)
 
(5,033
)
Total Accumulated Other Comprehensive (Loss)
(23,277
)
 
(5,644
)
Total Shareholders’ Equity
512,026

 
502,507

Total Liabilities and Shareholders’ Equity
$
4,420,802

 
$
4,132,281

See notes to consolidated financial statements.

2

Table of Contents

Consolidated Statements of Income (Unaudited)
City Holding Company and Subsidiaries
(in thousands, except earnings per share data)
Interest Income
Three months ended September 30,
 
Nine months ended September 30,
2018
2017
 
2018
2017
 
 
 
 
 
Interest and fees on loans
$
36,872

$
32,004

 
$
104,082

$
93,223

Interest and dividends on investment securities:
 

 

 
 
 
Taxable
4,216

3,666

 
12,314

10,591

Tax-exempt
701

665

 
2,114

2,014

Interest on deposits in depository institutions
940

31

 
1,043

51

Total Interest Income
42,729

36,366

 
119,553

105,879

 
 
 
 
 
 
Interest Expense
 

 

 
 
 
Interest on deposits
5,497

3,796

 
14,741

10,885

Interest on short-term borrowings
1,435

349

 
2,354

693

Interest on long-term debt
239

195

 
680

565

Total Interest Expense
7,171

4,340

 
17,775

12,143

Net Interest Income
35,558

32,026

 
101,778

93,736

(Recovery of) provision for loan losses
(27
)
1,393

 
(1,910
)
2,584

Net Interest Income After (Recovery of) Provision for Loan Losses
35,585

30,633

 
103,688

91,152

 
 
 
 
 
 
Non-Interest Income
 

 

 
 
 
Net gains on sale of investment securities


 

4,276

Service charges
7,598

7,415

 
21,783

21,219

Bankcard revenue
4,677

4,291

 
13,543

12,804

Trust and investment management fee income
1,579

1,471

 
4,792

4,469

Bank owned  life insurance
813

774

 
2,356

2,972

Other income
1,086

660

 
3,382

2,303

Total Non-Interest Income
15,753

14,611

 
45,856

48,043

 
 
 
 
 
 
Non-Interest Expense
 

 

 
 
 
Salaries and employee benefits
13,576

12,580

 
40,368

38,783

Occupancy related expense
2,323

2,426

 
7,073

7,361

Equipment and software related expense
1,965

1,940

 
5,691

5,835

FDIC insurance expense
315

328

 
943

1,031

Advertising
808

689

 
2,444

2,203

Bankcard expenses
1,134

1,051

 
3,274

2,964

Postage, delivery, and statement mailings
537

517

 
1,630

1,576

Office supplies
364

377

 
1,006

1,082

Legal and professional fees
453

504

 
1,378

1,393

Telecommunications
408

494

 
1,349

1,470

Repossessed asset losses, net of expenses
156

107

 
638

589

Other expenses
3,001

3,296

 
9,098

8,799

Total Non-Interest Expense
25,040

24,309

 
74,892

73,086

Income Before Income Taxes
26,298

20,935

 
74,652

66,109

Income tax expense
5,606

7,003

 
15,369

21,463

Net Income Available to Common Shareholders
$
20,692

$
13,932

 
$
59,283

$
44,646

 
 
 
 
 
 
Total Comprehensive Income
$
16,367

$
14,240

 
$
44,307

$
47,881


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Table of Contents

 
 
 
 
 
 
Average shares outstanding, basic
15,340

15,485

 
15,360

15,391

Effect of dilutive securities
18

20

 
20

24

Average shares outstanding, diluted
15,358

15,505

 
15,380

15,415

 
 
 
 
 
 
Basic earnings per common share
$
1.34

$
0.89

 
$
3.82

$
2.87

Diluted earnings per common share
$
1.33

$
0.89

 
$
3.82

$
2.86

Dividends declared per common share
$
0.53

$
0.44

 
$
1.45

$
1.32


See notes to consolidated financial statements.


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

 
Three Months Ended
Nine Months Ended
 
September 30,
September 30,
 
2018
2017
2018
2017
 
 
 
 
 
Net income
$
20,692

$
13,932

$
59,283

$
44,646

 
 
 
 
 
Unrealized (losses) gains on available-for-sale securities arising during the period
(5,638
)
488

(19,520
)
9,404

Reclassification adjustment for gains



(4,276
)
   Other comprehensive (loss) income before income taxes
(5,638
)
488

(19,520
)
5,128

Tax effect
1,313

(180
)
4,544

(1,893
)
   Other comprehensive (loss) income, net of tax
(4,325
)
308

(14,976
)
3,235

 
 
 
 
 
    Comprehensive Income, Net of Tax
$
16,367

$
14,240

$
44,307

$
47,881


See notes to consolidated financial statements.

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Table of Contents


Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
City Holding Company and Subsidiaries
Three Months Ended September 30, 2018 and 2017
(in thousands)



 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
Balance at June 30, 2018
$
47,619

$
140,091

$
471,515

$
(136,520
)
$
(18,952
)
$
503,753

Net income


20,692



20,692

Other comprehensive income




(4,325
)
(4,325
)
Cash dividends declared ($0.53 per share)


(8,190
)


(8,190
)
Stock-based compensation expense

455




455

Exercise of 3,986 stock options

(96
)

277


181

Purchase of 7,000 treasury shares



(540
)

(540
)
Balance at September 30, 2018
$
47,619

$
140,450

$
484,017

$
(136,783
)
$
(23,277
)
$
512,026


 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
Balance at June 30, 2017
$
47,619

$
139,972

$
433,944

$
(124,943
)
$
(4,085
)
$
492,507

Net income


13,932



13,932

Other comprehensive income




308

308

Cash dividends declared ($0.44 per share)


(6,875
)


(6,875
)
Stock-based compensation expense

443




443

Restricted awards granted

(34
)

34



Balance at September 30, 2017
$
47,619

$
140,381

$
441,001

$
(124,909
)
$
(3,777
)
$
500,315


See notes to consolidated financial statements.


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Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
City Holding Company and Subsidiaries
Nine Months Ended September 30, 2018 and 2017
(in thousands)



 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
Balance at December 31, 2017
$
47,619

$
140,960

$
444,481

$
(124,909
)
$
(5,644
)
$
502,507

Net income


59,283



59,283

Other comprehensive income




(14,976
)
(14,976
)
Adoption of new accounting pronouncement (see Note B)
 
 
2,657

 
(2,657
)

Cash dividends declared ($1.45 per share)


(22,404
)


(22,404
)
Stock-based compensation expense

1,697




1,697

Restricted awards granted

(1,494
)

1,494



Exercise of 29,133 stock options

(713
)

1,862


1,149

Purchase of 221,327 treasury shares



(15,230
)

(15,230
)
Balance at September 30, 2018
$
47,619

$
140,450

$
484,017

$
(136,783
)
$
(23,277
)
$
512,026


 
Common Stock
Capital Surplus
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Shareholders’ Equity
Balance at December 31, 2016
$
46,518

$
112,873

$
417,017

$
(126,958
)
$
(7,012
)
$
442,438

Net income


44,646



44,646

Other comprehensive income




3,235

3,235

Cash dividends declared ($1.32 per share)


(20,662
)


(20,662
)
Stock-based compensation expense

1,653




1,653

Restricted awards granted

(1,351
)

1,351



Issuance of 440,604 shares of common stock
1,101

27,307




28,408

Exercise of 16,639 stock options

(101
)

698


597

Balance at September 30, 2017
$
47,619

$
140,381

$
441,001

$
(124,909
)
$
(3,777
)
$
500,315


See notes to consolidated financial statements.


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Table of Contents

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

 
Nine months ended September 30,
2018
 
2017
Net income
$
59,283

 
$
44,646

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

 
 

Accretion and amortization
1,154

 
836

(Recovery of) provision for loan losses
(1,910
)
 
2,584

Depreciation of premises and equipment
3,819

 
4,486

Deferred income tax expense
921

 
3,810

Net periodic employee benefit cost
438

 
337

Unrealized gains recognized on securities still held
(1,155
)
 

Realized investment securities gains

 
(4,276
)
Stock-compensation expense
1,697

 
1,653

Excess tax benefit from stock-compensation expense
(155
)
 
(550
)
Proceeds from life insurance
425

 
1,717

Increase in value of bank-owned life insurance
(1,932
)
 
(1,974
)
Loans originated for sale
(9,286
)
 
(13,858
)
Proceeds from the sale of loans originated for sale
9,601

 
16,315

Gain on sale of loans
(249
)
 
(437
)
Change in accrued interest receivable
(2,226
)
 
(828
)
Change in other assets
(15,709
)
 
1,562

Change in other liabilities
11,543

 
(1,505
)
Net Cash Provided by Operating Activities
56,259

 
54,518

 
 
 
 
Proceeds from sales of securities available-for-sale

 
5,576

Proceeds from maturities and calls of securities available-for-sale
53,917

 
61,367

Proceeds from maturities and calls of securities held-to-maturity
6,552

 
8,072

Purchases of securities available-for-sale
(101,227
)
 
(136,418
)
Net increase in loans
(19,057
)
 
(63,139
)
Purchases of premises and equipment
(4,236
)
 
(4,262
)
Disposals of premises and equipment
772

 
2,500

Net Cash Used in Investing Activities
(63,279
)
 
(126,304
)
 
 
 
 
Net increase in non-interest-bearing deposits
5,403

 
(2,410
)
Net increase in interest-bearing deposits
122,594

 
27,307

Net increase (decrease) in short-term borrowings
137,905

 
33,159

Proceeds from issuance of common stock

 
28,408

Purchases of treasury stock
(15,230
)
 

Proceeds from exercise of stock options
1,149

 
597

Dividends paid
(21,399
)
 
(20,249
)
Net Cash Provided by Financing Activities
230,422

 
66,812

Increase (Decrease) in Cash and Cash Equivalents
223,402

 
(4,974
)
Cash and cash equivalents at beginning of period
82,508

 
88,139

Cash and Cash Equivalents at End of Period
$
305,910

 
$
83,165


See notes to consolidated financial statements.

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Notes to Consolidated Financial Statements (Unaudited)
September 30, 2018

Note A –Background and Basis of Presentation

City Holding Company ("City Holding"), 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 87 banking offices in West Virginia (58), Virginia (14), Kentucky (12) and southeastern 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), Morgantown (WV), Winchester (VA), Staunton (VA), Virginia Beach (VA), Ashland (KY), and Lexington (KY). 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.

On July 11, 2018, the Company announced that it had concurrently executed two separate definitive agreements to acquire Poage Bankshares, Inc. (“Poage”), of Ashland, Kentucky and its principal banking subsidiary, Town Square Bank, and Farmers Deposit Bancorp, Inc. (“Farmers Deposit”), of Cynthiana, Kentucky and its principal banking subsidiary, Farmers Deposit Bank. The proposed mergers are expected to close in the fourth quarter of 2018 and the core data system conversions are also targeted to occur in the fourth quarter of 2018. City has received all regulatory approvals needed to acquire both Poage and Farmers Deposit and each merger has been approved by the shareholders of Poage and Farmers, respectively. Consummation of the respective mergers is subject to the completion of other customary closing conditions. Merger expenses are estimated at $18 million (pre-tax) for the Poage transaction and at $6 million (pre-tax) for the Farmers Deposit transaction, while core deposit intangibles are estimated at $4 million for Poage and at $1.5 million for Farmers Deposit. The Poage and Farmers Deposit transactions are not conditional upon each other.

The accompanying consolidated financial statements, which are unaudited, include all of the accounts of City Holding Company and its wholly-owned subsidiaries (collectively, the "Company"). All material intercompany transactions have been eliminated. The consolidated financial statements include all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations and financial condition for each of the periods presented. Such adjustments are of a normal recurring nature. The results of operations for the nine months ended September 30, 2018 are not necessarily indicative of the results of operations that can be expected for the year ending December 31, 2018. The Company’s accounting and reporting policies conform with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Such policies require management to make estimates and develop assumptions that affect the amounts reported in the consolidated financial statements and related footnotes. Actual results could differ from management’s estimates.

The consolidated balance sheet as of December 31, 2017 has been derived from audited financial statements included in the Company’s 2017 Annual Report to Shareholders.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted.  These financial statements should be read in conjunction with the financial statements and notes thereto included in the 2017 Annual Report of the Company.

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

Note B – Recent Accounting Pronouncements

Recently Adopted:
 
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)." This standard clarifies the principles for recognizing revenue and developed a common revenue standard. The core principle of the standard is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract or contracts with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The FASB also issued several amendments to the standard, including clarifications relating to performance obligations and licensing implementation guidance

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and reporting gross versus net revenue. The Company adopted the standard effective January 1, 2018 using the modified retrospective approach, but did not record a cumulative effect adjustment to opening retained earnings given the immaterial impact. As part of the adoption, the Company evaluated the terms of the contracts that supported each of the revenue streams that were within the scope of ASU 2014-09 and determined that the adoption did not significantly change the way the Company recognizes revenue from each stream (see Note M - Contracts with Customers).

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." This standard makes several modifications to Subtopic 825-10 including the elimination of the available-for-sale classification of equity investments, and requires equity investments with readily determinable fair values to be measured at fair value with changes in fair value recognized in net income. This ASU became effective for the Company for interim and annual periods on January 1, 2018. During the nine months ended September 30, 2018, a $1.2 million gain was recognized in other income in the consolidated statements of income as a result of the change in the fair value of equity and perpetual preferred securities due to the adoption of ASU 2016-01.  Additionally, $2.7 million, net of deferred taxes, was reclassified from other comprehensive income to retained earnings on the consolidated balance sheets to recognize the prior period unrealized gain position of these securities (see Note C - Investments and Note J - Accumulated Other Comprehensive Loss).

In January 2017, the FASB issued ASU No. 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business." This amendment clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU became effective for the Company on January 1, 2018. The adoption of ASU No. 2017-01 did not have a material impact on the Company's financial statements.

In March 2017, the FASB issued ASU No. 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." This amendment requires that an employer disaggregate the service cost component from the other components of net benefit cost and also provides explicit guidance on how to present the service cost component and the other components of net benefit cost in the income statement. This ASU became effective for the Company on January 1, 2018. The adoption of ASU No. 2017-07 did not have a material impact on the Company's financial statements.

In May 2017, the FASB issued ASU No. 2017-09, "Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting." This amendment provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASU No. 2016-09. This ASU became effective for the Company on January 1, 2018. The adoption of ASU No. 2017-09 did not have a material impact on the Company’s financial statements.

In September 2017, the FASB issued ASU No. 2017-13, "Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)." This amendment provides modifications to previously issued ASUs 2014-09 and 2016-02. The adoption of ASU No. 2017-13 did not have a material impact on the Company's financial statements.

In November 2017, the FASB issued ASU No. 2017-14, "Income Statement—Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)." This amendment supersedes various SEC paragraphs and amends an SEC paragraph pursuant to the issuance of Staff Accounting Bulletin No. 116. The adoption of ASU No. 2017-14 did not have a material impact on the Company's financial statements.

In February 2018, the FASB issued ASU No. 2018-02, "Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This amendment permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of the Tax Cuts and Jobs Act ("TCJA") to retained earnings. The guidance is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permissible. The Company elected to early adopt this amendment as of December 31, 2017 and the December 31, 2017 balance sheet reflects this adoption.

Pending Adoption:

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” This standard requires organizations to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing requirements for leases that were historically classified as operating leases under previous generally accepted accounting principals. This ASU will become effective for the Company for interim and annual periods on January 1, 2019. The Company's preliminary evaluation indicates

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that the adoption of ASU 2016-02 will have an immaterial impact on the Company's consolidated balance sheet. However, the Company continues to evaluate the extent of the potential impact the new guidance will have on the Company's consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." This standard replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The new current expected credit losses model (CECL) will apply to the allowance for loan losses, available-for-sale and held-to-maturity debt securities, purchased financial assets with credit deterioration and certain off-balance sheet credit exposures. This ASU will become effective for the Company for interim and annual periods on January 1, 2020. Management is currently evaluating the potential impact of ASU No. 2016-13 on the Company's financial statements.

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." This amendment simplifies the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. This ASU will become effective for the Company on January 1, 2020. The adoption of ASU No. 2017-04 is not expected to have a material impact on the Company's financial statements.

In March 2017, the FASB issued ASU No. 2017-08, "Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities." The amendments in this update shorten the amortization period for certain callable debt securities held at a premium and require the premium to be amortized to the earliest call date. This ASU will become effective for the Company on January 1, 2019. The adoption of ASU No. 2017-08 is not expected to have a material impact on the Company's financial statements.

In August 2017, the FASB issued ASU No. 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." This amendment expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This ASU will become effective for the Company on January 1, 2019. The adoption of ASU No. 2017-12 is not expected to have a material impact on the Company's financial statements.

In July 2018, the FASB issued ASU No. 2018-10, "Codification Improvements to Topic 842, Leases." This amendment provides improvements to specific sections of previously issued lease guidance, including a package of three practical expedients regarding the reassessment of prior period leases. This ASU will become effective for the Company on January 1, 2019. The adoption of ASU No. 2018-10 is not expected to have a material impact on the Company's financial statements.

In July 2018, the FASB issued ASU No. 2018-11, "Leases (Topic 842): Targeted Improvements." This amendment offers a practical expedient that allows the Company to recognize the prior period balance sheet impacts in the period of adoption and will not require adjustments to the prior period financial statements when adopting ASU No. 2016-02 described above. This ASU will become effective for the Company on January 1, 2019. The adoption of ASU No. 2018-11 is not expected to have a material impact on the Company's financial statements.     

In August 2018, the FASB issued ASU No. 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement." This amendment removes, modifies, and clarifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. This ASU will become effective for the Company on January 1, 2020. The adoption of ASU No. 2018-13 is not expected to have a material impact on the Company's financial statements.

In August 2018, the FASB issued ASU No. 2018-14, "Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans." This amendment removes, modifies, and clarifies certain disclosure requirements for defined benefit plans and other post-employment benefit plans. This ASU will become effective for the Company on January 1, 2021. The adoption of ASU No. 2018-14 is not expected to have a material impact on the Company's financial statements.






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Note C –Investments

The amortized cost and estimated fair values of the Company's securities are shown in the following table (in thousands):
 
September 30, 2018
December 31, 2017
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Securities available-for-sale:
 
 
 
 
 
 
 
 
U.S. Treasuries and U.S.
 
 
 
 
 
 
 
 
government agencies
$
1

$

$

$
1

$
2

$

$

$
2

Obligations of states and
 
 
 
 

 

 

 

 

political subdivisions
92,972

265

1,673

91,564

94,552

2,051

407

96,196

Mortgage-backed securities:
 
 
 
 

 

 

 

 

U.S. government agencies
469,810

222

22,286

447,746

425,559

1,093

7,305

419,347

Private label
523

6


529

649

3


652

Trust preferred securities
4,772

26


4,798

4,764

26

54

4,736

Corporate securities(1)
17,086

7

172

16,921

21,916

475

123

22,268

Total Debt Securities
585,164

526

24,131

561,559

547,442

3,648

7,889

543,201

Marketable equity  securities




2,136

3,563


5,699

Investment funds
1,526


82

1,444

1,525


36

1,489

   Total Securities
 

 

 

 

 

 

 

 

Available-for-Sale
$
586,690

$
526

$
24,213

$
563,003

$
551,103

$
7,211

$
7,925

$
550,389

Securities held-to-maturity:
 
 
 
 
 
 
 
 
Mortgage-backed securities:
 
 
 
 
 
 
 
 
U.S. government agencies
$
53,812

$

$
971

$
52,841

$
60,449

$
1,222

$
25

$
61,646

Trust preferred securities
4,000



4,000

4,000



4,000

Total Securities
 

 

 

 

 

 

 

 

Held-to-Maturity
$
57,812

$

$
971

$
56,841

$
64,449

$
1,222

$
25

$
65,646

Other investment securities:
 

 

 

 

 

 

 

 

Non-marketable equity securities
$
17,316

$

$

$
17,316

$
14,147

$

$

$
14,147

Marketable equity securities(1)
11,559



11,559





Total Other Investment
 

 

 

 

 

 

 

 

   Securities
$
28,875

$

$

$
28,875

$
14,147

$

$

$
14,147

 
 
 
 
 
 
 
 
 
(1) Effective January 1, 2018, the Company's equity and perpetual preferred securities are measured at fair value through net income.

Marketable equity securities consist of investments made by the Company in equity positions of various regional community banks. Included within this portfolio are ownership positions in the following community bank holding companies: First National Corporation (FXNC) (4%) and Eagle Financial Services, Inc. (EFSI) (1.5%). Securities with limited marketability, such as stock in the Federal Reserve Bank ("Federal Reserve") and the Federal Home Loan Bank ("FHLB"), are carried at cost and are reported as non-marketable equity securities in the table above.


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Certain investment securities owned by the Company are in an unrealized loss position (i.e., amortized cost basis exceeded the estimated fair value of the securities).  The following table shows the gross unrealized losses and fair value of the Company’s investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):
 
September 30, 2018
Less Than Twelve Months
Twelve Months or Greater
Total
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Securities available-for-sale:
 
 
 
 
 
 
Obligations of states and political subdivisions
$
45,560

$
653

$
19,197

$
1,020

$
64,757

$
1,673

Mortgage-backed securities:
 
 
 
 
 

 

U.S. Government agencies
239,964

8,325

191,172

13,961

431,136

22,286

Corporate securities
14,922

172



14,922

172

Investment funds
1,500

82



1,500

82

Total available-for-sale
$
301,946

$
9,232

$
210,369

$
14,981

$
512,315

$
24,213

 
 
 
 
 
 
 
Securities held-to-maturity:
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
       U.S. Government agencies
$
52,841

$
971

$

$

$
52,841

$
971

Total held-to-maturity
$
52,841

$
971

$

$

$
52,841

$
971



 
December 31, 2017
Less Than Twelve Months
Twelve Months or Greater
Total
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Estimated Fair Value
Unrealized Loss
Securities available-for-sale:
 
 
 
 
 
 
Obligations of states and political subdivisions
$
4,913

$
28

$
19,440

$
379

$
24,353

$
407

Mortgage-backed securities:
 
 
 
 
 

 

U.S. Government agencies
172,807

1,887

140,226

5,418

313,033

7,305

Trust preferred securities
4,475

54



4,475

54

Corporate securities
3,357

49

2,350

74

5,707

123

Investment funds
1,500

36



1,500

36

Total available-for-sale
$
187,052

$
2,054

$
162,016

$
5,871

$
349,068

$
7,925

 
 
 
 
 
 
 
Securities held-to-maturity:
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
       U.S. Government agencies
$
7,182

$
25

$

$

$
7,182

$
25

Total held-to-maturity
$
7,182

$
25

$

$

$
7,182

$
25



During the nine months ended September 30, 2018 and 2017, the Company had no investment impairment losses. At September 30, 2018, the cumulative amount of credit-related investment impairment losses that have been recognized by the Company on its equity securities that remain in the Company's investment portfolio as of that date was $1.6 million.

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary would be reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other things (i) the length of time and the extent to which the fair value has been less than cost; (ii) the financial condition, capital strength, and near-term (within 12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment; (iv) adverse conditions specifically related to the security, an industry, or a geographic area; and (v) the intent to sell the investment security and if it’s more likely than not that the Company will not have to sell the security before recovery of its cost basis. In addition, management also employs a continuous monitoring process in regards to its marketable equity securities, specifically its portfolio of regional

13

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community bank holdings. Although the regional community bank stocks that are owned by the Company are publicly traded, the trading activity for these stocks is minimal, with trading volumes of less than 0.5% of each respective company being traded on a daily basis. As part of management’s review process for these securities, management reviews the financial condition of each respective regional community bank for any indications of financial weakness.

Management has the ability and intent to hold the securities classified as held-to-maturity until they mature, at which time the Company expects to receive full value for the securities. Furthermore, as of September 30, 2018, management does not intend to sell any impaired security and it is not more than likely that it will be required to sell any impaired security before the recovery of its amortized cost basis. The unrealized losses on debt securities are primarily the result of interest rate changes, credit spread fluctuations on agency-issued mortgage-related securities, general financial market uncertainty and unprecedented market volatility. These conditions should not prohibit the Company from receiving its contractual principal and interest payments on its debt securities. The fair value is expected to recover as the securities approach their maturity date or repricing date. As of September 30, 2018, management believes the unrealized losses detailed in the table above are temporary and no additional impairment loss has been recognized in the Company’s consolidated income statement. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss will be recognized in net income in the period the other-than-temporary impairment is identified, while any noncredit loss will be recognized in other comprehensive income.

The amortized cost and estimated fair value of debt securities at September 30, 2018, by contractual maturity, are shown in the following table (in thousands).  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.  Mortgage-backed securities have been allocated to their respective maturity groupings based on their contractual maturity.
 
Amortized Cost
Estimated Fair Value
Available-for-Sale Debt Securities
 
 
Due in one year or less
$
2,685

$
2,684

Due after one year through five years
10,504

10,493

Due after five years through ten years
81,069

76,996

Due after ten years
490,906

471,386

Total
$
585,164

$
561,559

 
 
 
Held-to-Maturity Debt Securities
 

 

Due in one year or less
$

$

Due after one year through five years


Due after five years through ten years


Due after ten years
57,812

56,841

Total
$
57,812

$
56,841


The table below presents the unrealized gains (losses) that were recognized in "Other Income" in the consolidated statements of income during the three and nine months ended September 30, 2018 as a result of the change in the fair value of the Company's equity and perpetual preferred securities due to the adoption of ASU 2016-01 (in thousands). Additionally, on January 1, 2018, the Company reclassified $2.7 million, net of deferred taxes, from other comprehensive income to retained earnings on the consolidated balance sheets to recognize the prior period fair value impact of these securities. During the nine months ended September 30, 2017, the Company realized $4.3 million of investment gains. These gains represented partial recoveries of impairment charges previously recognized on pooled trust preferred securities. As a result of these sales, the Company no longer holds any pooled trust preferred securities in its investment portfolio.
 
Three months ended September 30,
Nine months ended September 30,
 
2018
2017
2018
2017
 
 
 
 
 
Equity and perpetual preferred securities:
 
 
 
 
   Unrealized gains recognized on securities still held
$
383

$

$
1,155

$

 
 
 
 
 
Gross realized gains on securities sold
$

$


4,276

Gross realized losses on securities sold




Net investment security gains
$

$

$

$
4,276


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The carrying value of securities pledged to secure public deposits and for other purposes as required or permitted by law approximated $490 million and $429 million at September 30, 2018 and December 31, 2017, respectively.

 
Note D –Loans

The following summarizes the Company’s major classifications for loans (in thousands):
 
September 30, 2018
December 31, 2017
Residential real estate
$
1,485,823

$
1,468,278

Home equity
143,540

139,499

Commercial and industrial
213,815

208,484

Commercial real estate
1,268,052

1,277,576

Consumer
31,869

29,162

DDA overdrafts
3,598

4,411

Gross loans
3,146,697

3,127,410

Allowance for loan losses
(16,311
)
(18,836
)
Net loans
$
3,130,386

$
3,108,574


Construction loans of $17.6 million and $25.3 million are included within residential real estate loans at September 30, 2018 and December 31, 2017, respectively.  Construction loans of $24.1 million and $28.9 million are included within commercial real estate loans at September 30, 2018 and December 31, 2017, respectively.  The Company’s commercial and residential real estate construction loans are primarily secured by real estate within the Company’s principal markets.  These loans were originated under the Company’s loan policy, which is focused on the risk characteristics of residential and commercial real estate lending, including specific risks related to construction lending.  Adequate consideration has been given to these loans in establishing the Company’s allowance for loan losses.

Note E – Allowance For Loan Losses
 
Management systematically monitors the loan portfolio and the adequacy of the allowance for loan losses on a quarterly basis to provide for probable losses inherent in the portfolio.  Management assesses the risk in each loan type based on historical trends, the general economic environment of its local markets, individual loan performance and other relevant factors.
 
Individual credits are selected throughout the year for detailed loan reviews, which are utilized by management to assess the risk in the portfolio and the adequacy of the allowance.  Due to the nature of commercial lending, evaluation of the adequacy of the allowance as it relates to these loan types is often based more upon specific credit reviews, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for economic conditions and other inherent risk factors.
 
The following table summarizes the activity in the allowance for loan losses, by portfolio loan classification, for the nine months ended September 30, 2018 and 2017 (in thousands).  The allocation of a portion of the allowance in one portfolio segment does not preclude its availability to absorb losses in other portfolio segments. The following table also presents the balance in the allowance for loan loss disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans, by portfolio segment, as of September 30, 2018 and December 31, 2017 (in thousands).

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Table of Contents

 
 
Commercial and
Commercial
Residential
 
 
DDA
 
 
Industrial
Real Estate
Real Estate
Home Equity
Consumer
Overdrafts
Total
Nine months ended September 30, 2018
 
 
 
 
 
 
 
Allowance for loan losses
Beginning balance
$
4,571

$
6,183

$
5,212

$
1,138

$
62

$
1,670

$
18,836

Charge-offs
(724
)
(349
)
(464
)
(219
)
(560
)
(1,976
)
(4,292
)
Recoveries
1,625

538

275


130

1,109

3,677

(Recovery of) provision
(1,583
)
(1,775
)
(557
)
385

709

911

(1,910
)
Ending balance
$
3,889

$
4,597

$
4,466

$
1,304

$
341

$
1,714

$
16,311

 
 
 
 
 
 
 
 
Nine months ended September 30, 2017
 

 

 

 

 

 

 

Allowance for loan losses
 

 

 

 

 

 

 

Beginning balance
$
4,206

$
6,573

$
6,680

$
1,417

$
82

$
772

$
19,730

Charge-offs
(150
)
(564
)
(1,295
)
(256
)
(47
)
(1,989
)
(4,301
)
Recoveries
57

92

286

45

46

1,015

1,541

(Recovery of) provision
946

205

218

68

(25
)
1,172

2,584

Ending balance
$
5,059

$
6,306

$
5,889

$
1,274

$
56

$
970

$
19,554

 
 
 
 
 
 
 
 
As of September 30, 2018
 

 

 

 

 

 

 

Allowance for loan losses
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$

$
355

$

$

$

$

$
355

Collectively
3,885

4,189

4,466

1,304

334

1,714

15,892

Acquired with deteriorated credit quality
4

53



7


64

Total
$
3,889

$
4,597

$
4,466

$
1,304

$
341

$
1,714

$
16,311

 
 
 
 
 
 
 
 
Loans
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$
656

$
9,894

$

$

$

$

$
10,550

Collectively
212,959

1,252,989

1,483,829

143,540

31,754

3,598

3,128,669

Acquired with deteriorated credit quality
200

5,169

1,994


115


7,478

Total
$
213,815

$
1,268,052

$
1,485,823

$
143,540

$
31,869

$
3,598

$
3,146,697

 
 
 
 
 
 
 
 
As of December 31, 2017
 

 

 

 

 

 

 

Allowance for loan losses
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$

$
647

$

$

$

$

$
647

Collectively
4,567

5,313

5,112

1,138

58

1,670

17,858

Acquired with deteriorated credit quality
4

223

100


4


331

Total
$
4,571

$
6,183

$
5,212

$
1,138

$
62

$
1,670

$
18,836

 
 
 
 
 
 
 
 
Loans
 

 

 

 

 

 

 

Evaluated for impairment:
 

 

 

 

 

 

 

Individually
$
849

$
8,818

$

$

$

$

$
9,667

Collectively
207,429

1,263,076

1,465,685

139,499

29,046

4,411

3,109,146

Acquired with deteriorated credit quality
206

5,682

2,593


116


8,597

Total
$
208,484

$
1,277,576

$
1,468,278

$
139,499

$
29,162

$
4,411

$
3,127,410


16

Table of Contents


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

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











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The following table presents the Company’s commercial loans by credit quality indicators, by portfolio loan classification (in thousands):
 
Commercial and Industrial
Commercial Real Estate
Total
September 30, 2018
 
 
 
Pass
$
182,275

$
1,228,716

$
1,410,991

Special mention
26,345

7,421

33,766

Substandard
5,195

31,915

37,110

Doubtful



Total
$
213,815

$
1,268,052

$
1,481,867

 
 
 
 
December 31, 2017
 

 

 

Pass
$
175,951

$
1,231,256

$
1,407,207

Special mention
25,872

8,068

33,940

Substandard
6,661

38,252

44,913

Doubtful



Total
$
208,484

$
1,277,576

$
1,486,060

     
The following table presents the Company's non-commercial loans by payment performance, by portfolio loan classification (in thousands):
 
Performing
Non-Performing
Total
September 30, 2018
 
 
 
Residential real estate
$
1,482,771

$
3,052

$
1,485,823

Home equity
143,531

9

143,540

Consumer
31,869


31,869

DDA overdrafts
3,598


3,598

Total
$
1,661,769

$
3,061

$
1,664,830

 
 
 
 
December 31, 2017
 
 
 
Residential real estate
$
1,465,445

$
2,833

$
1,468,278

Home equity
139,239

260

139,499

Consumer
29,162


29,162

DDA overdrafts
4,411


4,411

Total
$
1,638,257

$
3,093

$
1,641,350


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

Generally for all loan classes, interest income during the period the loan is non-performing is recorded on a cash basis after recovery of principal is reasonably assured.  Cash payments received on nonperforming loans are typically applied directly against the outstanding principal balance until the loan is fully repaid.  Generally, loans are restored to accrual status when the

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obligation is brought current, the borrower has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
 
Generally, all loan types are considered past due when the contractual terms of a loan are not met and the borrower is 30 days or more past due on a payment.  Furthermore, residential and home equity loans are generally subject to charge-off when the loan becomes 120 days past due, depending on the estimated fair value of the collateral less cost to dispose, versus the outstanding loan balance.  Commercial loans are generally charged off when the loan becomes 120 days past due.  Open-end consumer loans are generally charged off when the loan becomes 180 days past due.
 
The following table presents an aging analysis of the Company’s accruing and non-accrual loans, by portfolio loan classification (in thousands):
 
 
September 30, 2018
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Non-accrual
Total
Residential real estate
$
1,478,137

$
3,841

$
793

$
23

$
3,029

$
1,485,823

Home equity
143,072

407

52

9


143,540

Commercial and industrial
212,810

187



818

213,815

Commercial real estate
1,259,519

934



7,599

1,268,052

Consumer
31,829

38

1


1

31,869

DDA overdrafts
3,016

570

9

3


3,598

Total
$
3,128,383

$
5,977

$
855

$
35

$
11,447

$
3,146,697

 
 
 
 
 
 
 
 
December 31, 2017
 
Accruing
 
 
 
Current
30-59 days
60-89 days
Over 90 days
Non-accrual
Total
Residential real estate
$
1,458,746

$
5,990

$
709

$
19

$
2,814

$
1,468,278

Home equity
138,480

671

88

92

168

139,499

Commercial and industrial
206,447

549

1

142

1,345

208,484

Commercial real estate
1,269,520

1,841

245


5,970

1,277,576

Consumer
29,108

39

13

2


29,162

DDA overdrafts
3,849

541

14

7


4,411

Total
$
3,106,150

$
9,631

$
1,070

$
262

$
10,297

$
3,127,410




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The following table presents the Company’s impaired loans, by class (in thousands). The difference between the unpaid principal balance and the recorded investment generally reflects amounts that have been previously charged-off. There are no impaired residential, home equity, or consumer loans.

 
September 30, 2018
December 31, 2017
 
 
Unpaid
 
 
Unpaid
 
 
Recorded
Principal
Related
Recorded
Principal
Related
 
Investment
Balance
Allowance
Investment
Balance
Allowance
With no related allowance recorded:
 
 
 
 
 
 
Commercial and industrial
$
656

$
656

$

$
849

$
3,013

$

Commercial real estate
4,185

4,210


3,036

4,861


Total
$
4,841

$
4,866

$

$
3,885

$
7,874

$

 
 
 
 
 
 
 
With an allowance recorded: