2023-11-07 16:52:51 ET
Summary
- City Holding Company is a solid performer, but trades at a premium compared to its peers.
- There are concerns about the segmentation and short-term weakness of CHCO's loan portfolio.
- Buying CHCO today is likely buying near the peak of interest rates, which also may have implications for its net interest margin growth.
City Holding Company ( CHCO ) is a 'Hold' despite being a solid performer. The company appears to be fairly valued but also trades at a premium in comparison to banks in the peer universe.
There are some peripheral concerns with the segmentation and short-term weakness of its loan portfolio and perhaps management's overconfidence in today's macro environment.
I would be happy to hold CHCO in my portfolio. Still, initiating a position today is likely buying near the peak of interest rates in the short term, which has implications and uncertainties for its net interest margin growth moving forward.
Company Overview
City Holding Company, headquartered in Charleston, West Virginia, is a financial holding company primarily engaged in community banking. Founded in 1957, the company has focused on providing a range of consumer, mortgage, and business banking services, including deposit and loan products. CHCO operates through its subsidiary, City National Bank , to offer localized banking services.
According to CHCO's most recent quarterly report , it operates 99 banking offices across four states, with its most substantial presence in West Virginia.
The breakdown of its branch locations is as follows:
- West Virginia: 58 banking offices.
- Kentucky: 24 banking offices.
- Virginia : 13 banking offices.
- Ohio : 4 banking offices.
As a regional community bank, its main competitive advantage comes from the local relationships it has with its customers. This loyalty is amplified by its long operating history. Other notable advantages include its low-cost core deposits by its crucial retail and commercial clients, as well as its conservative underwriting culture, which could become essential in our " high for longer " interest rate backdrop.
Peer Analysis
CHCO identifies its main competitors as larger national banks, like Wells Fargo & Company ( WFC ) , regional and community service banks in its geographical service areas, and fintech companies.
As per the company's website, it identifies its peer group of competitors as being the following:
Company name | Ticker |
1st Source Corporation | SRCE |
Arrow Financial Corporation | AROW |
Community Trust Bancorp Inc | CTBI |
FB Financial Corporation | FBK |
Financial Institutions, Inc. | FISI |
First Bancorp | FBNC |
First Busey Corporation | BUSE |
First Commonwealth Financial Corporation | FCF |
First Community Bankshares, Inc. | FCBC |
First Financial Corporation | THFF |
First Mid Bancshares, Inc. | FMBH |
German American Bancorp, Inc. | GABC |
Peoples Bancorp Inc. | PEBO |
S&T Bancorp, Inc. | STBA |
Sandy Spring Bancorp, Inc. | SASR |
Stock Yards Bancorp, Inc. | SYBT |
Compared with its peers, CHCO carved out a notable niche for itself, securing a market share of nearly 5% in 2022. With revenues reaching $246,078,000, it stood out among its peers, capturing 4.98% of the total market.
CHCO's revenue is approximately 15.24% below the average revenue and market share of the companies listed.
Company name | Ticker | Year | Revenue | |
1st Source Corporation | SRCE | 2022 | $ 354,731,000.00 | |
Arrow Financial Corporation | AROW | 2022 | $ 149,241,000.00 | |
Community Trust Bancorp Inc | CTBI | 2022 | $ 227,018,000.00 | |
FB Financial Corporation | FBK | 2022 | $ 526,902,000.00 | |
| FISI | 2022 | $ 212,350,000.00 | |
First Bancorp | FBNC | 2022 | $ 392,839,000.00 | |
First Busey Corporation | BUSE | 2022 | $ 450,241,000.00 | |
First Commonwealth Financial Corporation | FCF | 2022 | $ 410,929,000.00 | |
First Community Bankshares, Inc. | FCBC | 2022 | $ 140,581,000.00 | |
First Financial Corporation | THFF | 2022 | $ 211,758,000.00 | |
First Mid Bancshares, Inc. | FMBH | 2022 | $ 254,659,000.00 | |
| GABC | 2022 | $ 259,717,000.00 | |
Peoples Bancorp Inc. | PEBO | 2022 | $ 320,928,000.00 | |
| STBA | 2022 | $ 374,042,000.00 | |
| SASR | 2022 | $ 497,507,000.00 | |
| SYBT | 2022 | $ 311,901,000.00 | |
City Holding Company | CHCO | 2022 | $ 246,078,000.00 |
However, regarding market share growth, things look better for the company. CHCO's five-year revenue growth per share stands at 35.84% or 5.19 percentage points above the median of its peers.
Similarly, CHCO's five-year operating cash flow growth per share is 13.24%, which is above the average when considering the negative values and the range of growth rates among its peers. Its growth is moderate but stable.
CHCO's 5-year dividend per share growth per share is also moderate. There are much better options, notably 1st Source Corporation ( SRCE ), which I analyzed earlier this month . SRCE is coming up to 36 years of consecutive dividend growth.
I find that dividend growth per share is one of the best financial ratios for gauging the attractiveness of a dividend stock.
In terms of its performance ratios, CHCO stands out. CHCO outperforms its peers with a superior Return on Average Assets (ROAA) of 1.95%, reflecting higher profitability from its assets and an Efficiency Ratio of 46.36%, demonstrating its operations are more cost-effective relative to its revenue than the median and average.
This peer analysis shows that CHCO demonstrates solid financial health with a market share of nearly 5% and superior performance ratios. This means it has efficient operations and a profitability that surpasses the normalized performance of its peers.
Financial Results
CHCO reported mainly positive results for the last quarter. However, there are still some doubts in my mind about the health of its loan portfolio, which has started to show some weakness.
CHCO reported a quarterly net income of $29.9 million, or $1.98 per diluted share. Net interest income increased slightly to $55.5 million. Loan growth of 2.2% and higher loan yields helped offset the impact of higher deposit costs.
Non-interest income decreased slightly to $17.4 million, primarily due to realized securities losses of $0.7 million. Non-interest expenses increased 11.2% to $35 million, driven by higher salaries, bank card expenses, and other expenses. The company remains well capitalized with a tangible equity ratio of 7.6%.
This quarterly performance aligns with its broader trends over the last three years, taken from its 10K.
Notably, total loans increased from $3.64 billion at the end of 2020 to $3.65 billion at the end of 2022, a slight 0.5% increase. Residential real estate and commercial & industrial loans grew, while commercial real estate loans decreased.
Some forms of deposits also grew substantially over the same period.
- Total deposits increased from $4.34 billion at the end of 2020 to $4.87 billion at the end of 2022, a 12% increase.
- Noninterest-bearing deposits increased from $1.04 billion to $1.35 billion (30% increase).
- Time deposits decreased from $1.33 billion to $0.89 billion (33% decrease).
The change in deposits, I believe, can be chalked up to the (relatively) low-interest rate environment in 2020 and 2021. Another way of phrasing this is that investors chose liquidity over yield. As the rates rose in late 2022, some deposits have likely shifted back into noninterest-bearing accounts in expectation of locking in higher interest rates or yields later.
Below is CHCO's loan portfolio segmentation. The portfolio is heavily invested in real estate, split almost evenly between commercial and residential properties, with a significant portion in non-residential, non-owner occupied spaces. Diversification across property types mitigates some risk, while minimal allocations to consumer loans, home equity, and DDA overdrafts suggest a conservative stance on higher-risk segments.
Segment Name | Value (In Millions) |
Commercial and Industrial | $ 424.60 |
1-4 Family Residential | $ 135.20 |
Hotels | $ 321.20 |
Multi-family Residential | $ 192.30 |
Non-Residential Non-Owner Occupied | $ 713.30 |
Non-Residential Owner Occupied | $ 222.50 |
Total Commercial real estate | $ 1,584.60 |
Total Residential real estate | $ 1,768.30 |
Home equity | $ 159.60 |
Consumer | $ 65.50 |
DDA overdrafts | $ 4.50 |
But while Residential Real Estate carries lower risk due to being secured loans, the high concentration in Commercial and Industrial Commercial Real Estate loans exposes CHCO to heightened risk in the event of a downturn in commercial lending markets. The company may face higher credit losses if business loans and commercial properties decline in credit quality.
Residential loans are secured by residential property and are otherwise at lower risk due to underwriting and collateral. Commercial real estate, however, is inherently riskier due to borrowers being in more cyclical industries than others.
This means that CHCO's risk profile is worse than some of its peers and notably worse than 1st Source Corporation, which only has around 1% of its loans in the high-risk category. CHCO's loan portfolio is also less diversified across different sectors and industries.
Portfolio Risks Ahead
Some cracks have started to show in its loan book. There was an increase in classified/downgraded commercial loans, which indicates pockets of credit weakness emerging.
Its provision for credit losses ticked up to $200,000 in Q3 compared to no provision in the year-ago quarter. This reflects some emerging credit weaknesses, as there was $1.3 million worth of provisions related to downgrading two commercial loans in the first nine months of 2023.
Something I also found to be a bit perplexing is that its allowances for loan losses were 0.58% at the time of writing. This number seems too low for several reasons:
- The company's risk profile (half of all its loans are held by borrowers in cyclical industries, especially the Hotel segment, has already shown weakness).
- Low for the peer average, which ranges between 0.8% to 1%.
- And low for today's high inflation, high interest rate, and uncertain economic environment.
Whether you agree or disagree that it's too low, I think we can meet in the middle and say that management seems confident it won't exceed this percentage given the above factors.
Overall, the credit trends are stable, but bears will be closely monitoring its deterioration, especially if economic conditions get worse. If its allowances for loan losses are too low, it may sting the company later.
Valuation
CHCO's net interest margin has increased, resulting in a higher TBV. However, it remains to be seen if it can continue to raise its NIM when and after interest rates peak. For this reason, I don't believe now is the appropriate time to enter a position in CHCO, given that it appears to be fairly valued.
Furthermore, except for some outliers, CHCO trades at a premium to its tangible book value compared with its peers. On average, it trades at twice its TBV compared with the other companies it selected to be part of its peer universe.
If I aim to get the best yield on cost possible, I wouldn't want to invest in these companies until interest rates revert to their long-term averages. I believe investors who buy these companies now are more or less buying near their peak in terms of NIM, which we are unlikely to see again, especially if economic cracks start to widen.
Risks
Investing in City Holding Company carries inherent risks, particularly due to its loan portfolio's exposure to cyclical industries such as hospitality, which could be adversely affected in economic downturns. The company's conservative allowance for loan losses might not cover potential defaults in a high-risk environment, posing a threat to profitability.
Additionally, while the company currently enjoys a strong market share and performance ratios, any significant economic shifts could challenge its operational efficiency and market position.
There's also the real risk of capital depreciation when interest rates inevitably decline, but the rising prices of long-term bonds it holds on its balance sheet could also offset this.
Conclusion
Investors should weigh the company's solid financials against an evolving interest rate environment and market dynamics when considering the long-term value of holding CHCO stock.
The company's performance is likely to remain strong, but there are some apparent risks with its loan portfolio, which bears will be keeping a close eye on.
I reiterate my 'Hold' rating for CHCO for the above reason
For further details see:
City Holding Company: Portfolio Weaknesses In An Uncertain Environment