Business context and reporting period
Republic Bancorp, Inc. is a Kentucky-based financial holding company with banking, mortgage, tax-refund and consumer-credit businesses. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. Unless otherwise noted, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $53.0 | $48.3 | $171.8 | $147.9 |
| Noninterest income | $11.5 | $10.4 | $53.3 | $48.2 |
| Net revenue (net interest income plus noninterest income) | $64.5 | $58.7 | $225.1 | $196.1 |
| Provision for loan and lease losses | $4.1 | $4.2 | $26.3 | $21.6 |
| Noninterest expense | $41.2 | $38.0 | $124.9 | $112.7 |
| Income before taxes | $19.2 | $16.4 | $73.9 | $61.8 |
| Net income | $17.4 | $10.7 | $60.5 | $40.8 |
| Diluted EPS, Class A | $0.83 | $0.51 | $2.90 | $1.96 |
- Net interest margin was 4.32% in Q3 2018 versus 4.17% a year earlier, and 4.67% for the first nine months versus 4.34%. Management attributed net interest income growth to loan growth and margin expansion.
- At September 30, 2018, total assets were $5.22 billion, gross loans $4.14 billion, deposits $3.57 billion, and stockholders’ equity $676.8 million. Since year-end 2017, loans increased $122 million, deposits $134 million, and equity $44 million.
- Cash and cash equivalents were $365.5 million, up from $299.4 million at year-end. Nine-month operating cash flow was $85.7 million; investing activities used $76.0 million and financing activities provided $56.5 million.
- Borrowings included $715 million of FHLB advances, $163.8 million of repurchase agreements and other short-term borrowings, and a $41.2 million subordinated note. FHLB advances were down $22.5 million from year-end; the subordinated note’s stated maturity is 2035.
- Liquidity sources included $347 million of available FHLB capacity, $125 million of unsecured credit lines, and $252 million of unencumbered securities. The loan-to-deposit ratio excluding brokered deposits was 117%, versus 120% at year-end. Management said the Bank was compliant with Board liquidity policies at quarter-end but expected liquidity to remain near internal minimums.
- The allowance for loan and lease losses was $43.8 million, or 1.06% of gross loans. Nine-month net charge-offs were $25.2 million, compared with $14.4 million in 2017. Nonperforming loans were $17.3 million, or 0.42% of loans, versus $15.1 million and 0.38% at year-end; delinquent loans were 0.43% versus 0.35%.
Material changes versus comparable periods
- Q3 net income rose 63% year over year and nine-month net income rose 48%. Pre-tax income increased 17% in Q3 and 20% year to date, so lower taxes contributed materially to the larger net-income increases.
- Q3 net interest income increased 10%; nine-month net interest income increased 16%. Traditional Banking loan growth and improved yields contributed, while reported Warehouse Lending net interest income was reduced by a new funds-transfer-pricing methodology, which shifted $272,000 of Q3 and $986,000 year-to-date income to Traditional Banking.
- Noninterest expense rose 8% in Q3 and 11% year to date. Higher salaries, employee benefits, technology and data-processing costs were notable contributors.
- Tax Refund Solutions originated $430 million of Easy Advances in the first nine months, up from $329 million. Its provision increased to $11.5 million from $6.8 million, reflecting higher volume and a higher estimated loss rate.
- Republic Credit Solutions’ nine-month net interest income grew 38%, primarily from line-of-credit fees, while RCS loan-loss provision remained elevated at $12.5 million. RCS loans sold increased to $577 million from $453 million.
Outlook, management commentary, risks and unusual items
- Taxes: The Tax Cuts and Jobs Act’s lower federal rate was estimated to add $1.9 million to Q3 net income and $8.2 million to nine-month net income. The Company also recorded $2.8 million of additional Q3 federal tax benefits from a cost-segregation study, a tax-accounting-method change and R&D credits; about $2.6 million was considered nonrecurring. These items materially affect comparisons with 2017.
- Rates and margins: Management viewed further short-term rate increases as potentially favorable in the near term. It cautioned that higher deposit costs or loss of deposits could weaken results, and that a flatter yield curve could pressure net interest income and margin. Its rate model projected net interest income changes over the following 12 months of -3.6% for a 100-basis-point decline and +2.0% to +2.8% for increases of 100 to 300 basis points; the +400-basis-point scenario was +2.5%. These are model estimates, not guidance.
- Consumer-credit programs: The Bank planned to increase the maximum Easy Advance for the 2019 tax season, which management expected to increase loan volume and could also heighten losses. EA losses depend on tax-refund funding patterns, which may differ from prior years. RCS serves many subprime or near-prime borrowers and carries higher credit risk than Traditional Banking.
- Program changes and valuation: The Bank suspended new installment-loan originations in Q2 amid changes in applicable state law. It discontinued marketing its subprime credit-card product to new customers and reached an agreement in concept to sell the existing portfolio. In Q3 it marked the portfolio down from a $3.5 million book value for its retained interest to an estimated net realizable value of $1.5 million. Completion and final proceeds of the proposed sale remain to be verified.
- Other items and risks: A $1.0 million nonrefundable capital commitment fee was recorded in Q1 for completing infrastructure and initial funding for a third-party collaborative credit product. Management cited interest-rate and yield-curve movements, deposit competition, credit losses, economic conditions, regulatory and tax changes, cyber risks, and reliance on third-party providers among risks. It gave no numerical earnings guidance. The filing reported no pending or threatened legal proceeding known to management that could materially adversely affect the Company.
Important facts for investors to verify
- How much of earnings growth is repeatable after excluding the $2.8 million one-time tax benefits and the ongoing benefit of the lower federal tax rate.
- Whether credit costs continue to rise, particularly in Easy Advances and RCS; monitor charge-offs, allowance coverage, delinquencies and nonperforming loans.
- Whether deposit growth and pricing can support loan growth without increased reliance on higher-cost funding, and whether liquidity stays within internal limits.
- Progress and final terms of the RCS credit-card portfolio sale, and the future status and economics of the suspended installment-loan program.
- Actual performance against the proposed higher Easy Advance limits for the 2019 tax season, including originations and loss rates.
- Whether reported margin gains persist as funding costs rise and the yield curve changes; review the assumptions and limitations of the Bank’s interest-rate sensitivity model.