Republic Bancorp, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Republic Bancorp is a Louisville-based financial holding company with five reportable segments: Traditional Banking, Warehouse Lending, Mortgage Banking, Tax Refund Solutions (TRS), and Republic Credit Solutions (RCS). Results were affected by the COVID-19 pandemic and related economic conditions. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $52.3 | $55.5 | $177.2 | $181.7 |
| Provision for expected credit losses | $1.5 | $3.2 | $30.8 | $24.8 |
| Noninterest income | $20.6 | $12.8 | $69.9 | $55.4 |
| Noninterest expense | $45.5 | $42.4 | $137.3 | $131.3 |
| Net income | $20.4 | $18.4 | $62.9 | $65.9 |
| Diluted EPS, Class A | $0.98 | $0.88 | $3.02 | $3.15 |
| Net interest margin | 3.59% | 4.07% | 4.21% | 4.60% |
Total net revenue, defined as net interest income plus noninterest income, was $72.8 million in Q3 versus $68.3 million a year earlier, and $247.1 million for the first nine months versus $237.1 million. Q3 net income rose 11%, while nine-month net income fell 5%. Mortgage banking income increased sharply with refinance activity; lower credit-loss provision in Q3 also supported earnings. For the nine-month period, higher credit-loss provision more than offset revenue growth.
Financial position, cash flow, and liquidity
- At September 30, total assets were $6.24 billion, versus $5.62 billion at year-end 2019. Loans were $4.99 billion, up 13%; deposits were $4.99 billion, up 32%; and stockholders’ equity was $810.4 million, versus $764.2 million.
- The allowance for credit losses on loans was $59.9 million, or 1.20% of loans, compared with $43.4 million at year-end 2019. Nonperforming loans were $21.1 million, or 0.42% of loans, versus 0.53% at year-end; delinquent loans were 0.34% versus 0.47%.
- Nine-month operating cash flow was $62.0 million; investing cash flow was negative $633.3 million and financing cash flow was positive $527.9 million. Cash and cash equivalents decreased $43.3 million to $342.0 million.
- Period-end borrowings included $132.5 million of Federal Home Loan Bank advances, $126.2 million of short-term borrowings and repurchase agreements, and a $41.2 million subordinated note. FHLB advances were down from $750.0 million at year-end. No PPPLF borrowing was outstanding at September 30.
- Liquidity resources included $692 million of available FHLB borrowing capacity, $125 million of unsecured lines, and $375 million of unencumbered debt securities. The loan-to-deposit ratio excluding brokered deposits was 107%, down from 126%. The Bank said it remained within Board-approved liquidity policies at quarter-end, but was not always within policy parameters during the quarter.
- The Bank was categorized as well-capitalized. At September 30, the Company’s total risk-based capital ratio was 17.98% and Common Equity Tier 1 ratio was 16.12%; the Bank’s respective ratios were 15.91% and 14.86%.
Material changes and management commentary
- Q3 net interest income declined 6% and net interest margin fell 48 basis points year over year, reflecting lower asset yields and limited room for liability costs to reprice downward. Management expects margins to likely continue declining in the near term as earning-asset yields reprice lower.
- Mortgage banking income was $10.8 million in Q3 versus $3.1 million; secondary-market mortgage originations were $204 million versus $124 million. Management said favorable pricing lifted gain rates, but expects pricing to become more competitive and historically typical as refinance activity slows.
- Traditional Banking’s Q3 net income fell 73% year over year, with margin pressure, COVID-related provision, and lower deposit-service and interchange income. Warehouse Lending net income rose 99%, benefiting from refinance-driven activity and lower funding costs. RCS net income declined 7%; marketing for its higher-yielding credit products had been reduced in response to the pandemic, with line-of-credit marketing gradually increasing in Q3.
- PPP loans totaled $515 million net of deferred fees at quarter-end and are SBA-guaranteed; forgiveness depends on qualifying program requirements. The Bank had originated approximately $528 million of PPP loans and expected most borrowers to seek forgiveness at the earliest permitted time.
- Deposits increased substantially, including noninterest-bearing balances management attributed partly to a pandemic-related “flight to safety.” Management cautioned that the duration of these balances was uncertain. The May 2020 assumption of approximately $250 million in prepaid-card balances also contributed to deposit growth.
- COVID-19 accommodations had been granted on approximately $754 million, or 20%, of Traditional Banking loans earlier in 2020. About $21 million of previously accommodated balances required additional accommodation. Management said the ultimate effects on delinquencies and credit performance remain uncertain.
- The Company adopted CECL on January 1, 2020. Adoption increased the loan allowance by $6.7 million and reduced opening retained earnings by $4.3 million. A new CRE vacancy forecast factor added $2 million to the allowance in Q3.
Outlook, risks, and unusual items
The filing provides no numerical earnings or revenue guidance. Management warns that the pandemic’s duration and financial effects remain uncertain. Credit losses could rise as accommodations expire; the allowance depends on forecasts, including unemployment and CRE vacancy assumptions, and may be volatile. Management believes loan losses may lag historical relationships to unemployment because of borrower and government relief. COVID-19 could also affect asset values, mortgage servicing rights, liquidity, and operations.
Other notable risks include interest-rate and deposit repricing sensitivity; a dynamic model showed lower projected net interest income under all modeled rising-rate scenarios at September 30. The Company also disclosed dependence on third-party providers, cybersecurity exposure, potential stress among warehouse clients, and risks to subprime or near-prime RCS borrowers. TRS’s Easy Advance charge-offs were higher year to date than in 2019, which management linked partly to IRS processing delays; subsequent recoveries provided Q3 provision credits. No pending or threatened legal proceeding was identified as likely to cause a material adverse change. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Track COVID-19 accommodation expirations, repeat deferrals, and migration into delinquency, nonaccrual, or classified status.
- Assess the adequacy and sensitivity of CECL reserves, particularly the unemployment, CRE vacancy, and industry-risk assumptions.
- Verify whether elevated mortgage volumes and gain margins persist, and monitor mortgage servicing rights valuation and impairment.
- Monitor deposit retention, large-depositor concentration, brokered funding costs, and the Bank’s liquidity-policy headroom.
- Review PPP forgiveness timing and fee recognition, as well as IRS-related Easy Advance recovery experience and resulting TRS provision credits.
- Compare reported capital and liquidity measures with regulatory requirements and assess the effect of any deterioration in credit quality or funding conditions.