City Holding Company

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

City Holding Company is a regional bank holding company, primarily operating in West Virginia, Kentucky, Ohio, and southeastern Indiana; its core business involves collecting deposits and using those funds to originate loans.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

City Holding Company (CHCO) is a regional bank holding company with a primary focus on serving customers in West Virginia, Kentucky, Ohio, and some parts of southeastern Indiana. Their business model centers around traditional banking activities: attracting deposits and originating loans.

  • Revenue Distribution: CHCO generates revenue primarily through its net interest income, which is the difference between the interest earned on loans and the interest paid on deposits, as well as fees and commissions on services provided. While the company has increased its focus on noninterest income streams, including treasury and trust activities, the biggest driver for revenue remains the interest rate environment.
  • Industry Trends: The banking industry is currently marked by rising interest rates (which benefit them), but also increased competition from online financial institutions and fintech companies, increasing loan competition. Deposit growth in particular is expected to slow down going forward.
  • Margins: CHCO’s net interest margin (NIM), while increasing due to rate hikes, is likely to face pressure as the cost of deposits increases. Their efficiency ratio, which has been good, is also likely to have some headwinds.
  • Competitive Landscape: The competitive environment is complex; regional banks face pressure not only from large national banks, but also from credit unions and online banking platforms which offer more aggressive rates and more accessibility.
  • What Makes CHCO Different: CHCO positions itself as a “community bank”, highlighting its focus on relationship banking, personal services, local decision-making, and long-term banking relationships. The company aims to stand out by providing more customer service and expertise and focusing less on just the lowest interest rates on its products.

Financials in Depth

Here’s an in-depth analysis of CHCO’s financials, primarily based on the 10-Q report that was released on November 3rd, 2023, and other relevant financial data:

  • Income Statement:
    • Net Interest Income (NII): The main driver for the bank, NII increased by 21.6% in the first three quarters of 2023 over the same period of 2022. They have benefited strongly from interest rates going up and higher-yielding loans. They’ve maintained a relatively good Net Interest Margin, 3.69% for the nine months ended September 30, 2023.
    • Non-Interest Income: In general, non-interest income grew, most notably trust income. However, gains from sale of loans, and securities decreased, and a recent increase in insurance expenses hurt profits.
    • Provision for Credit Losses: This item decreased greatly from $15.3 million to $4.1 million year over year, this is an indicator of the bank’s current loan health.
    • Net Income: Overall net income has gone up substantially compared to last year, increasing by almost 30%, which is the biggest takeaway.
  • Balance Sheet: * Assets: The vast majority of their assets come from loans, with the net loan balance at around $5.78 billion as of September 2023. They also hold a decent portfolio of investment securities which is worth $1.5 billion, but have seen it decline in value. * Liabilities: Deposits account for the largest portion of CHCO’s liabilities ($6.5 billion), along with borrowings, and other liabilities. Non-interest bearing deposits, which are most attractive, are slowly trending down from 25.9 to 24.1 percent. * Capital Structure: The company has maintained a strong capital base. Their Tier 1 leverage ratio is at 10.3%, and both their capital ratio and Tier 1 ratios are above the requirements of regulators. * Financials Comments: CHCO’s financial profile is strong at the moment, with great revenue growth, declining allowances for loan losses, high capital ratio, and with no major asset quality issues. However, the company continues to face pressure on deposits and has seen its noninterest income being hurt by the financial markets.

Recent Concerns and Controversies

  • Acquisition: The company completed the acquisition of Citizens Commerce Bank Inc on March 10, 2023. This is a large acquisition for them that they are still in the process of integrating. The acquisition has brought some issues to the forefront as they are now competing in more competitive and more mature markets such as Lexington and Louisville. They are trying to convert the customers of the acquired bank, and while the early returns are positive, it remains to be seen whether they will be able to retain and continue to grow that side of the business.
  • Interest Rate Risk: With most banks, the largest risk is interest rate fluctuation, and this is also true with CHCO. A sudden or quick drop in interest rates could lead to lower earnings, but they have been working to lessen their interest rate risk. While they will benefit in this high-interest environment, future economic changes will hurt their interest margin.

Moat Analysis (2 / 5)

City Holding Company possesses a narrow moat, stemming primarily from its established reputation as a “community bank” within its operational area. This provides some customer loyalty. They have been consistently serving their customer base for over 100 years, and that provides for a certain level of stickiness, but it is not a large moat. Here’s the analysis:

  • Intangible Assets: CHCO has a solid local brand, but lacks any national brand recognition. While the company is well-regarded in its communities, it does not have the strong pricing power that an established brand gives a company.
  • Switching Costs: While some customers may find it cumbersome to change banks, particularly if they have had long-standing relationships, the switching costs for most customers are quite low; this makes the moat very shallow.
  • Network Effect: The network effect isn’t very impactful for the bank. While deposits can increase to a level that provides value, most regional players offer comparable products.
  • Cost Advantages: While CHCO tries to reduce costs to stay competitive, its main cost structure is dictated by the cost of deposits, and there are no major differences in it. Moreover, it can’t compete with bigger banks and their vast reach of cheap deposits. CHCO’s low branch density compared with its rivals means it has to attract more remote deposits which may not be as sticky as retail deposits.

Risks to the Moat and Business Resilience

Here are a list of risks for the company:

  • Increased competition: Regional banks are facing increasing pressure from larger banks, fintechs, and credit unions, all of which are increasing their reach, technology, and financial capacity.
  • Macroeconomic factors: Rising interest rates benefit the bank now, but if they come down, the bank could face a big hit to their revenues. Likewise, if the loan defaults increase, their profits would also decline significantly.
  • Technological disruption: While CHCO has started adopting new technology, they still face an increasing threat of disruption from fintechs that are offering more innovative and more convenient ways to bank.
  • Loss of core customers: CHCO relies on the local community for much of its business. If the community changes (either demographics or financial conditions) they can suffer losses.
  • Integration Risk: integrating the acquired bank in 2023 can prove to be a hassle. It is possible that they won’t be able to leverage the business unit as much as they expect, or may face more problems, especially in regards to integration with the local community.

However, the company has proven their resilience through previous economic downturns, and they remain well-capitalized. Their focus on relationship banking, conservative lending standards, and focus on their local communities can help them weather tough times.

Understandability (2/5)

City Holding Company has an understandability score of 2 out of 5. Here is the justification:

  • Basic Business Model is Easy To Grasp: The core business model of collecting deposits and issuing loans is relatively straightforward. Most people are familiar with what a bank does.
  • Financials are a bit complex: Their financials involve complex terminology and accounting standards, and this makes it hard to analyze the bank. You need to carefully scrutinize items like allowances for credit losses, deferred taxes, etc, which have their own nuances. A detailed breakdown of financial statements is also included in this report, if you need more help.
  • Nuances of Financial Institutions: Banks have their own unique metrics and regulations, and there are many special considerations that must be taken into consideration. Understanding how different loans perform, the company’s net interest margin, how interest rates affect it, and the underlying risk they take are all a little complex. It requires knowledge of accounting, financial principles, and banking.
  • Regulatory Environment: The banking sector is heavily regulated, and it is important to understand the implications of the regulations and policies, both at state and federal level.
  • Local Market Knowledge Understanding the nuances of a local market also matters, since that will influence growth rates and risk profiles.

Balance Sheet Health (4/5)

City Holding Company’s balance sheet health is rated as 4 out of 5. Here is the justification:

  • Strong capital ratios: CHCO’s Tier 1 capital ratios are above regulatory requirements, implying a sufficient cushion to weather downturns and unexpected losses.
  • Good liquidity position: The bank holds a good amount of cash and liquid assets that are easily convertible to cash if they are needed.
  • Good loan quality: Nonperforming assets and allowances for credit losses are at healthy levels, indicating that their loan portfolio is under control.
  • Moderate Debt: While CHCO does use debt in operations, their debt to assets is quite low, implying that they aren’t reliant on debt.
  • Potential Pressures: There are a few areas of concern. Their investments in securities have declined in value. Their noninterest income is not very predictable. And they are in a somewhat competitive environment, which could potentially hurt their deposit growth.
  • Overall: Overall, CHCO’s balance sheet is quite strong, but may face some challenges in the future if the financial environment changes drastically. They have enough flexibility and capital cushion to weather most shocks.

That said, CHCO’s ability to grow and compete in new markets depends on integrating Citizens well, and maintaining their local base.