Republic Bancorp, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; comparative results are for the periods ended June 30, 2017 unless otherwise noted. Republic is a Kentucky-based financial holding company with banking, warehouse lending, mortgage banking, tax refund, and consumer credit operations. Amounts below are in U.S. dollars; financial statement amounts are rounded to millions.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $51.1m | $43.1m | $118.7m | $99.6m |
| Net interest margin | 4.19% | 3.87% | 4.85% | 4.44% |
| Noninterest income | $14.3m | $12.9m | $41.8m | $37.9m |
| Provision for loan losses | $4.9m | $5.1m | $22.2m | $17.4m |
| Noninterest expense | $40.6m | $35.7m | $83.7m | $74.7m |
| Income before taxes | $19.8m | $15.3m | $54.7m | $45.3m |
| Net income | $15.7m | $10.1m | $43.1m | $30.1m |
| Diluted EPS, Class A / Class B | $0.74 / $0.68 | $0.48 / $0.44 | $2.06 / $1.88 | $1.45 / $1.32 |
Management reported Q2 net income growth of 56% and six-month growth of 43%. The federal corporate tax-rate reduction from 35% to 21% lowered the effective tax rate to 20.94% in Q2 and 21.18% for the first half, versus 34.04% and 33.64%, respectively, in 2017. Management estimated the lower rate benefited diluted EPS by about $0.10 in Q2 and $0.29 for the first half. Revenue and profit growth therefore reflect both operating improvement and lower taxes.
Net interest income benefited from loan growth and margin expansion. Interest expense also rose: Q2 interest expense was $7.3m versus $4.7m, and first-half expense was $13.4m versus $9.1m. Noninterest expense increased 14% in Q2 and 12% for the first half, notably from salaries and benefits, technology, and occupancy costs. No company-wide operating margin or efficiency ratio is clearly stated in the filing text.
Balance sheet, cash flow, and liquidity
- At June 30, total assets were $5.27bn, up from $5.09bn at December 31, 2017. Gross loans were $4.20bn, up 5%; deposits were $3.47bn, up 1%; and stockholders’ equity was $664m, up from $632m.
- Cash and cash equivalents were $387m, versus $299m at year-end. For the first six months, operating cash flow was $63.0m, investing cash outflow $99.9m, and financing cash inflow $124.5m; cash increased $87.6m.
- Borrowings included $860m of FHLB advances (up from $737.5m), $175.3m of repurchase agreements and other short-term borrowings (down from $204.0m), and a $41.2m subordinated note. FHLB advances included $500m overnight at 1.92%.
- Available FHLB borrowing capacity was $209m; unsecured lines of credit totaled $125m. The bank also reported $221m of unencumbered securities. Its loan-to-deposit ratio, excluding brokered deposits, was 122%, compared with 120% at year-end.
- Regulatory capital ratios remained above well-capitalized thresholds. At June 30, the Bank’s total risk-based capital ratio was 13.88%, common equity tier 1 ratio 12.88%, and Tier 1 leverage ratio 11.54%. The Company reported 16.15%, 14.28%, and 13.59%, respectively.
Material changes and credit quality
- Growth was led by traditional banking and warehouse loans. Commercial real estate loans rose to $1.24bn from $1.21bn at year-end; commercial and industrial loans rose to $369m from $342m; warehouse lines rose to $634m from $526m.
- Nonperforming loans increased to $18.4m from $15.1m; nonperforming loans to total loans rose to 0.44% from 0.38%. Delinquent loans improved to 0.31% from 0.35%. The allowance was $45.0m, or 1.07% of loans, compared with $42.8m, or 1.07%, at year-end.
- First-half net charge-offs increased to $19.9m from $12.4m, mainly reflecting tax refund advances and Republic Credit Solutions (RCS). TRS recorded $12.5m in first-half provision, versus $7.6m; Easy Advance originations increased to $430m from $329m, and the reported loss rate was 2.88% of originations.
- RCS, which serves many subprime or near-prime borrowers, recorded $8.0m of first-half provision, versus $7.8m. Its allowance was 16.13% of RCS loans. RCS delinquency improved to 5.23% from 8.43% at year-end.
- Quarterly segment net income rose across the reported segments. Traditional Banking earned $9.0m, Warehouse $2.4m, Mortgage Banking $0.2m, TRS $2.0m, and RCS $2.1m. Mortgage Banking income declined as competitive pricing reduced gains on loan originations.
Outlook, risks, contingencies, and unusual items
- Outlook: No formal earnings or financial guidance is provided. Management said further Federal Funds rate increases were considered probable in the second half of 2018 and generally favorable to near-term net interest income, while warning that higher deposit costs, deposit attrition, or a flatter yield curve could pressure margins. Its interest-rate model projected net interest income increases of 3.4% to 5.7% under +100 to +400 basis-point shocks and a 3.7% decline under a -100 basis-point shock; these are model scenarios, not guidance.
- Consumer product changes: The Bank and its partner stopped marketing the RCS subprime credit card to new clients and began winding down the product. It also suspended new installment-loan originations and sales pending review of state-law changes. About $2.2m of those loans was moved to held-for-investment and a $427,000 fair-value charge was recorded.
- Concentration and funding: The 20 largest non-sweep deposit relationships represented about $589m, or 17% of deposits; two corporate clients withdrew roughly $100m for seasonal needs before quarter-end, redepositing it in July. Management noted replacement funding could cost more. The bank had $912m in deposits across 141 large relationships exceeding $2m each.
- Seasonality and credit risk: TRS business is concentrated in the first half; it typically incurs preparation costs and operates at a loss in the second half. Easy Advance losses depend partly on tax refund funding patterns, which could differ from prior years. Warehouse balances are seasonal and volatile. RCS carries comparatively higher credit risk.
- Other items: A $1.0m nonrefundable capital commitment fee was recognized in Q1 for completing infrastructure and funding obligations for a collaborative credit product. The 2018 lease-accounting standard is expected to add approximately $28m to assets and liabilities from 2019, with minimal impact expected on performance and regulatory capital metrics. Management expected CECL adoption in 2020 to increase the allowance, but had not quantified the effect.
- Contingencies: The company reported ordinary-course legal proceedings and stated that management knew of no pending or threatened matter expected to cause a material adverse change. Total off-balance-sheet commitments were $1.50bn, including unused warehouse lines, home-equity lines, other loan commitments, and letters of credit.
Important facts for investors to verify
- How much of earnings growth persists after separating the tax-rate benefit from net interest margin, loan growth, and seasonal TRS results.
- Whether deposit costs and funding needs continue to rise, particularly given higher FHLB usage, the 122% loan-to-deposit ratio, and large-depositor concentration.
- Trends in charge-offs, nonperforming loans, and the allowance, especially in tax refund advances and RCS consumer credit.
- The eventual outcome of the suspended installment-loan program and the wind-down of the subprime credit card product, including any further valuation or credit-loss effects.
- Whether mortgage pricing pressure, higher operating costs, and second-half TRS seasonality affect full-year profitability; the filing provides no formal full-year guidance.