Bank with Loan Shortage Buying One with a Surplus

Striking balance is the underlying theme of City Holding's deal to buy Community Financial (CFFC).

City Holding (CHCO), a $2.9 billion-asset banking company, has thrived at accumulating low-cost deposits. Community Financial, a $504 million asset thrift company, has struggled to bring in core deposits to offset a sizable loan portfolio.

The all-stock deal announced late Thursday brings greater equilibrium to the combined company's balance sheet.

Community Financial elected to sell because the Staunton, Va., company no longer felt it had enough liquidity to support its loans, Skip Hageboeck, City Holding's president and chief executive, said during a conference call Friday to discuss the deal.

The seller's loan-to-deposit ratio stood at 119% at March 31, or roughly $1.20 in loans for every dollar of deposits. City Holding's ratio was 86% at June 30.

"I know our regulators wouldn't want us to have a 120% loan-to-deposit ratio, and I wouldn't want to have it either," Hageboeck said during the call.

City Holding, of Cross Lanes, W. Va., has no problem collecting deposits in the small towns and rural areas of West Virginia that comprise its core territory. The combined company's ratio will be about 90%, Hageboeck said.

Transaction accounts make up about 40% of City Holding's deposits; they contribute to just 24% of the deposits at Community Financial. (Jumbo time deposits make up 21% of the seller's deposits.)

The all-stock acquisition will also bring balance in terms of capital. City Holding will repay the $12.6 million that Community Financial still owes from its participation in the Treasury Department's Troubled Asset Relief Program. The overall deal value, including stock to Community Financial shareholders, should be about $26 million.

The consideration runs counter to a recent wave of all-cash deals. City Holding's management decided an acquisition was a better use of capital than repurchasing common stock, Hageboeck said. "You can reasonably expect us to be less active on the buyback front," he added.

Community Financial has been on City Holding's radar for some time, Hageboeck said. The companies know each other well. City Holding has owned a minority stake in Community Financial for several years.

"We thought, sooner or later, we would love to be a partner with them," Hageboeck said in an interview after the conference call.

City Holding owns roughly 4% of Community Financial's common stock — a stake that is not large enough to be reported in the thrift company's regulatory filings. City Holding has minority stakes in several community banks, including the $1.4 billion-asset First United in Oakland, Md.

Community Financial "seems to make strategic sense" for City Holding, said Kevin Fitzsimmons, an analyst at Sandler O'Neill. "City has the currency to be able to do deals and they feel strongly they can come in and take out a certain amount of costs and take out the drag of credit-related costs."

City Holding said it expects to reduce costs at Community Financial by 30%, according to materials filed with the Securities and Exchange Commission. The company also expects to record $5.5 million in merger-related expenses from the deal, which should close in the first quarter of next year.

Fitzsimmons said he would like to see more deals like this materialize. "This is what should be happening in the banking space," he said. "Smaller players struggling with credit quality and the need to raise capital should be looking to partner with larger players."

City Holding is on a roll after taking a six-year hiatus from bank acquisitions. Late last year the company agreed to pay $13.4 million for Virginia Savings Bancorp in Front Royal, which marked its entry into Virginia. City Holding completed that acquisition during the second quarter.

Community Financial is based in Virginia's Shenandoah Valley, but it also has two branches in the booming Hampton Roads area along the coast. City Holding had stuck to its roots in the mountains and had never expressed an interest in moving far out of market.

Still, Community Financial's branches in Virginia Beach offer the prospect of loan growth, Hageboeck said in the interview.

"Hampton Roads would not have initially been on our radar screen," he said. "It goes back to our need to generate loans more than deposits. We're not always able to utilize all our deposit dollars."