Republic Bancorp, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Republic Bancorp is a bank holding company with Traditional Banking, Mortgage Banking, and Tax Refund Solutions (TRS) segments. Amounts below are in U.S. dollars; financial figures are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $27.2 | $26.5 | $138.0 | $131.4 |
| Provision for loan losses | $(0.1) credit | $(1.8) credit | $17.5 | $18.0 |
| Non-interest income | $10.5 | $7.8 | $113.2 | $80.0 |
| Non-interest expense | $26.4 | $25.1 | $97.8 | $100.9 |
| Net income | $7.9 | $7.3 | $87.9 | $60.3 |
| Diluted EPS, Class A | $0.38 | $0.35 | $4.19 | $2.89 |
- Third-quarter net interest margin was 3.60%, versus 3.49% a year earlier. The nine-month consolidated margin was reported as 5.60%, versus 5.08%; seasonal TRS activity materially affects this measure. Traditional Banking margin was 3.48% for the first nine months, down from 3.62%.
- Nine-month operating cash flow was $134.0 million, compared with $99.3 million. Investing cash use was $236.1 million and financing cash use was $608.8 million. Cash and cash equivalents fell $710.8 million to $75.6 million.
- At September 30, total assets were $3.10 billion, loans net of allowance were $2.20 billion, deposits were $1.80 billion, and stockholders’ equity was $453.1 million. Compared with December 31, 2010, assets declined $527.6 million, deposits declined $500.3 million, and equity increased $81.7 million.
- Interest-bearing deposits were $1.42 billion; FHLB advances were $524.7 million, short-term borrowings and repurchase agreements were $227.5 million, and subordinated notes were $41.2 million. The filing reports a 132% loan-to-deposit ratio excluding brokered deposits.
- Liquidity sources included $333 million of additional FHLB borrowing capacity and $216 million of unsecured lines at other financial institutions. Management described liquidity as sufficient for routine needs, while noting the risk of losing large deposit relationships or access to funding.
- Regulatory capital remained above well-capitalized requirements. Republic Bancorp, Inc. reported total risk-based capital of 25.16% and Tier 1 leverage capital of 15.14%; Republic Bank and Trust Co. reported 23.41% and 13.14%, respectively.
Changes, drivers, and management outlook
- Q3 net income rose 8%. Traditional Banking net income increased to $8.8 million from $5.5 million, supported by higher net interest income, lower loan-loss provision, securities gains, and a $2.9 million pre-tax gain on the Bowling Green branch sale. TRS recorded a $1.5 million loss, compared with $1.0 million income a year earlier; Mortgage Banking income also declined.
- Nine-month net income rose 46%, with TRS contributing $68.9 million, about 78% of company net income. TRS non-interest income increased principally because ERC/ERD fees rose; RAL pricing also increased after the IRS discontinued its Debt Indicator. RAL dollar volume fell from $3.0 billion in the 2010 tax season to $1.0 billion in 2011, following a 66% strategic reduction.
- Deposit balances contracted largely as seasonal brokered CDs used to fund the 2011 tax season matured. Separately, Dodd-Frank changes allowing interest on demand accounts led corporate money-market balances to shift into transactional NOW accounts. The Bowling Green branch sale transferred approximately $33 million of deposits and $13 million of loans and generated the $2.9 million pre-tax gain.
- To support margins, the Bank shifted excess cash into longer-duration securities and loans, purchased about $37 million of commercial real estate loans at a 13% discount, retained some residential loans previously sold, and launched warehouse lending. Management said these steps improved recent net interest income, but expects continued downward repricing of loans and investments to pressure future net interest income and margins. Its rate model showed projected net interest income excluding loan fees declining 3.14% under a 100-basis-point rate increase and 6.47% under a 300-basis-point increase.
- Management expected first-quarter 2012 RAL volume not to differ materially from first-quarter 2011 and anticipated funding on terms similar to those obtained in late 2010. The filing provides no full-year earnings or EPS guidance.
- Mortgage Banking income weakened as loan originations for sale fell to $93 million for the first nine months from $197 million a year earlier. Lower long-term rates also increased expected prepayments and prompted a $203,000 mortgage-servicing-rights impairment charge.
Risks, contingencies, and unusual items
- FDIC proceedings and RAL exposure: The FDIC’s amended notice alleges, among other matters, unsafe or unsound practices and violations related to the RAL business and third-party oversight. The FDIC assessed a $2 million civil money penalty; management disputes the allegations but considers payment of all or a material portion probable and accrued the liability. The administrative hearing was scheduled for February 6, 2012. A separate company lawsuit against the FDIC remained pending on a motion to dismiss. An adverse outcome could restrict or end RAL offerings and harm ERC/ERD business; TRS is highly material to earnings.
- Other litigation: A putative class action filed in Kentucky alleges improper overdraft-fee practices. Management could not estimate any possible loss or range of loss and intends to defend the case.
- Credit and securities: Non-performing loans improved to $23.8 million, or 1.07% of loans, from $28.3 million, or 1.30%, at year-end. However, impaired loans increased to $55.7 million from $45.1 million, and troubled debt restructurings increased to $48.5 million from $32.2 million; 94% of TDRs were performing under modified terms. The allowance was $23.9 million, or 1.08% of loans. Four illiquid private-label mortgage-related securities had a $5.8 million carrying value and speculative-to-default ratings; management cited possible additional impairment up to that carrying value.
- Concentrations and operating risks: Jackson Hewitt and Liberty generated approximately 40% and 20%, respectively, of nine-month TRS revenue. Jackson Hewitt had filed for Chapter 11 bankruptcy. The filing also identifies RAL funding and collection risk, regulatory restrictions, overdraft-fee changes, deposit concentration, interest-rate risk, real-estate collateral values, and potential changes to government-sponsored mortgage programs as material risks.
- The Bank’s revised checking-account fees generated approximately $459,000 during the quarter, primarily over two months. Management cautioned that customer acceptance and account retention will determine the long-term effect; a negative response could reduce deposit balances and fee income.
Important facts for investors to verify
- Developments and outcomes in the FDIC administrative case, the $2 million penalty, and the separate FDIC lawsuit; whether RALs and related ERC/ERD products can continue.
- Actual RAL collections, charge-offs, and loss rates, including the $14.8 million of 2011-originated RALs reported as uncollected at September 30.
- TRS partner stability and concentration, particularly Jackson Hewitt’s ability to perform and the effect on future tax-season volumes.
- Deposit retention, large-depositor concentration, brokered-deposit dependence, and available borrowing capacity as seasonal tax funding needs approach.
- Loan quality trends, TDR performance, allowance adequacy, and valuation of the illiquid private-label securities and mortgage servicing rights.
- Whether margin-support initiatives offset ongoing asset repricing, and whether customers accept the new checking-account fee structure.