Though flush with capital after it survived a near-death experience three years ago, City Holding Co. has been in no rush to build assets.
Ill-advised acquisitions under previous management had helped push the Charleston, W.Va., company to the brink of failure in 1999 and 2000, so the new team focused on shrinking the balance sheet and making quality loans.
The conservative approach worked. City has been profitable for three years now, and for the last two it has ranked among the industry's best performers. Its stock price has increased by nearly 600% since early 2001.
But now the $2.5 billion-asset parent of City National Bank is entering a new phase. Its chief executive, Charles R. "Skip" Hageboeck, says it will be hard-pressed to sustain the strong returns without bulking up some. Indeed, the company's second-quarter results, released Wednesday, show some slippage. For example, while still impressive, its return on assets dipped to 2.09% from 2.39% a year earlier.
City recently opened three branches in Wal-Mart stores and unveiled plans for at least two more. More significantly, it bought a small Kentucky bank in April - its first bank acquisition since 1998 - and Mr. Hageboeck says he is on the lookout for similar deals.
In an interview last month, Mr. Hageboeck said City could still deliver decent returns without getting much bigger. West Virginia may not be a fast-growing state, but its stable economy - driven by the coal, chemical, and timber industries and by tourism - provides ample opportunity to gather deposits and make loans, he said.
"Within our footprint, population has been growing at a rate of about 1% a year," he said. "But as long as we are able to continue to grow market share, City will do well."
City's investors have come to expect top-notch performance, however, and Mr. Hageboeck said that his challenge - as it is for other top-performing community banks - is figuring out how best to achieve growth while maintaining profitability at high levels.
"City has no intention of growing its balance sheet using excessive leverage or poorly conceived acquisitions solely to be larger," he said. "I have peers that have done that and I am not impressed."
Mr. Hageboeck, City's former chief financial officer, was the handpicked successor of the turnaround specialist Gerald R. Francis.
Mr. Francis and Mr. Hageboeck had worked together for close to a decade, first at Peoples Bank and Trust Co. in Indianapolis and at City since early 2001. By the time Mr. Francis resigned as CEO in January to lead another turnaround in Indianapolis, Mr. Hageboeck, 42, was essentially running the bank. He officially took over as CEO on Feb. 1.
"Skip had the broadest knowledge of anyone on our team," said Mr. Francis, now CEO at the $1.3 billion-asset Hasten Bancshares. "Plus he's one of the brightest guys I've ever worked with."
Mr. Francis remains City's chairman - there is no conflict, because the banks are not competitors - but his departure still made some investors nervous. Within two months after his resignation City's stock had fallen more than 10%.
"Jerry had a bit of a cult following, so there may have been some concern from people who didn't know who Skip was," said James Record, an analyst at Moors & Cabot in Boston. "Plus, I think that when Jerry left, a lot of people who had thought the bank would sell, sold their stock."
Indeed, that City remains independent is a surprise to some observers.
Over the years Mr. Francis had earned a reputation for fixing up troubled or underperforming banks and then selling them for top dollar. Though he says he never heads into a turnaround situation with the intention of selling, Mr. Francis told American Banker in 2002 that consolidation makes sense because "there is too much capital chasing too little business."
Mr. Hageboeck would not say if City was ever officially on the block, but Mr. Record said it probably "tested the waters" and was never offered what its board thought was a fair price.
"When you are performing at their level, you don't need to sell," Mr. Record said.
Before Mr. Francis and his team were brought in, City was losing tens of millions of dollars a quarter and operating under enforcement orders from both the Office of the Comptroller of the Currency and the Federal Reserve.
Its problems stemmed largely from losses in subprime lending, a business it got into in the late 1990s. Previous management was also distracted by acquisitions of two underperforming banks in California, as well as nonbanking businesses, including an Internet service provider and a printing company.
The turnaround team's strategy was simple: Get rid of the problem loans, unload the California banks and the ancillary businesses, and focus on the bank's strength - its branch network in its home state.
"It took a group of people who weren't from West Virginia to recognize that the true value of the franchise is in West Virginia," Mr. Hageboeck said.
Within a year City was making money, and in every quarter since mid-2003 its return on assets has been above 2%. By comparison, the average quarterly ROA at commercial banks with $1 billion to $10 billion of assets was 1.45% in that period, according to Federal Deposit Insurance Corp. statistics. City's average quarterly return on equity was 22.2%, versus 13.58% for its peers.
City's second-quarter net income fell 7.5%, to $12.3 million. But it noted that the year-earlier results included a $3.2 million one-time gain from the settlement of a lawsuit. Its return on equity for the three months was 19.76%. Year-to-date earnings of $24 million were off 1.13% compared with the first six months of 2004. Its return on equity for the first six months was 20.3%.
City did not take a provision for loan losses - and hasn't for three years. But as its loans increase, its allowance for loan losses as a percentage of loans will decline.
Mr. Hageboeck said that at some point this year City would have to begin expensing provisions again, and the company projects that a 25-basis-point expense would lower earnings by about $2 million after taxes.
Also, high-loan-to-value loans that date to the previous management continue to run off City's books. That could mean a 5% earnings reduction, Mr. Hageboeck said.
On the plus side, analysts note that City has strong asset quality and low funding costs. Its best asset, they say, is its branch network, which is concentrated in the state's four most vibrant markets: Charleston, Huntington, the northeastern panhandle, and the southeastern coalmining region, where it has a 30% market share.
City does not lend directly to the coal industry but has many customers whose livelihoods are tied to it. Albert Savastano, an analyst at Janney Montgomery Scott LLC in New York, said coal will probably remain central to the state's economy, which bodes well for City.
"As long as oil is $60 a barrel, coal is always going to be attractive," he said.
Mr. Record said he would like to see City boost its loan-to-deposit ratio - 78%, well below its peers. But "there's something to be said for a conservatively run company that doesn't have any exposure to the commercial real estate bubble," he said.
City is largely a retail bank - 90% of its loans are secured by residential and commercial real estate. That might be a concern in markets where real estate values have doubled in the last five years, but as Mr. Hageboeck points out, "West Virginia is not that market."
So where does City go from here?
Mr. Francis said the biggest task facing well-run community banks is to keep growth from eating into earnings.
He said that "improving its distribution system" - shutting down underperforming branches and opening new ones in better locations - will be important for City.
City believes it has an opportunity to drive loan and deposit growth with a reenergized branch network. Mr. Hageboeck says it plans to close one branch in downtown Charleston and open a larger one in a more visible site. And it wants better branch positioning in the panhandle, the state's fastest-growing region, he said.
"We have not focused on growth opportunities in the panhandle market very well, and expect to make several announcements regarding new locations within that region in the very near future," Mr. Hageboeck said.
Since September, City has opened branches in Wal-Mart stores in Charleston, Huntington, and Beckley, and it will open one each in Ashland, Ky., in August and in Ripley, W.Va., next year.
"This is a new strategy for City designed to not only provide a convenient point of access for existing customers, but also to establish new relationships with Wal-Mart customers that currently bank with someone else," he said.
As for acquisitions, Mr. Hageboeck says he is "interested but not committed" and is concentrating on banks that have assets of $100 million to $500 million and that, like City, have a solid retail presence in markets that are not overly competitive.
Buying the $340 million-asset Classic Bancshares in Ashland gave City its first branches in Kentucky - eight in all - and two more in Ohio. It also vaulted City from No. 3 to No. 1 in market share in the Huntington, W.Va./Ashland metropolitan statistical area, according to FDIC data.
"We successfully integrated Classic in the second quarter, and are very happy with the results. We'll be looking at other deals like that one," Mr. Hageboeck said. "It shouldn't be so big that we'd choke on it. It shouldn't be so small that it would be meaningless."
Investors appear to like what they have been hearing from the new CEO. Since bottoming out at $27.80 in mid-April, City’s stock is up 39% and is now trading close to its 52-week high of $38.67. In fact, Mr. Record has downgraded it to “hold”; he said it has become too pricey.
Mr. Hageboeck began his banking career in 1989 managing interest rate risk for Indiana National Bank in Indianapolis. Later, after Indiana National merged with National Bank of Detroit, he became the Indiana affiliate's treasurer, focusing on asset-liability management. Not wanting to move to Chicago after NBD merged with First Chicago, he joined the $700 million-asset Peoples in 1995 and stayed there until it was sold to Fifth Third Bancorp in 1999.
Mr. Hageboeck acknowledges that having been CFO of several publicly traded banks, he is stronger in some areas, such as profitability management, balance sheet management, interest rate risk, and corporate governance, than in others, such as commercial lending.
And, Mr. Francis is just a phone call away. "I know he's there if I need him," Mr. Hageboeck said.
