Business context and reporting period
Republic Bancorp, Inc. is a Kentucky-based bank holding company operating Traditional Banking, Mortgage Banking and Republic Processing Group (RPG). This Form 10-K covers the fiscal year ended December 31, 2012; amounts are in U.S. dollars unless stated otherwise. During the year, the company acquired failed Tennessee Commerce Bank and First Commercial Bank through FDIC-assisted transactions, entering the Nashville and Minneapolis markets.
Financial results and condition
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Net income | $119.3 million | $94.1 million |
| Diluted EPS, Class A | $5.69 | $4.49 |
| Net interest income | $160.7 million | $164.9 million |
| Provision for loan losses | $15.0 million | $18.0 million |
| Non-interest income | $165.1 million | $119.6 million |
| Non-interest expense | $126.7 million | $122.3 million |
| Net interest margin, total company | 4.82% | 5.09% |
| Return on average assets / equity | 3.35% / 22.51% | 2.76% / 21.42% |
- Net income rose 27%, although net interest income fell 3% and total-company net interest margin contracted 27 basis points. Non-interest income rose 38%, driven primarily by acquisition gains.
- FY 2012 included $55.4 million in pre-tax bargain purchase gains, $45.3 million of RAL fees in interest income and $78.3 million in refund-transfer fees. These items make reported earnings unusually dependent on acquisitions and tax-refund products.
- At year-end, total assets were $3.394 billion, gross loans $2.650 billion, deposits $1.983 billion, and stockholders’ equity $536.7 million. Cash and cash equivalents were $137.7 million.
- Loans grew 16% to $2.650 billion; deposits grew 14%. The loan-to-deposit ratio excluding brokered deposits was 143%. Available additional FHLB borrowing capacity was $472 million; the filing also reports $196 million in bank unsecured credit lines and a separate $20 million parent-company line.
- Year-end borrowings included $542.6 million of FHLB advances, $250.9 million of repurchase agreements and other short-term borrowings, and a $41.2 million subordinated note. FHLB advances declined $392 million year over year.
- Operating cash flow was $89.9 million, investing cash flow was positive $991.6 million (including FDIC-assisted transaction proceeds), and financing cash flow was negative $1.307 billion. Cash decreased $225.3 million during the year.
- Capital remained strong: total risk-based capital was 25.28% at the holding company; RB&T’s total risk-based and Tier 1 risk-based ratios were 20.37% and 18.36%. Regulators classified the banks as well-capitalized.
- Credit metrics were mixed: non-performing loans declined to $21.7 million, or 0.82% of loans, from $23.3 million and 1.02%. However, non-performing assets rose to $47.9 million from $34.3 million, largely reflecting higher other real estate owned (OREO), which increased to $26.2 million. Troubled debt restructurings were $93.0 million, up from $67.0 million.
- Fourth-quarter net income was $6.6 million versus $6.2 million in fourth-quarter 2011, according to the unaudited quarterly data.
Material changes versus the prior comparable period
- Two FDIC-assisted acquisitions generated $55.4 million of bargain purchase gains: $27.6 million from TCB and $27.8 million from FCB. By year-end, about $905 million of TCB deposits and $126 million of FCB deposits had exited following repricing; $112 million of acquired deposits remained.
- Traditional Banking net interest income increased $9.5 million, supported by loan growth, including HEAL loans and warehouse lending; its margin rose to 3.64% from 3.55%. RPG net interest income declined $13.7 million, principally from lower RAL activity.
- Mortgage Banking income increased to $8.4 million from $3.9 million as mortgage loan sales rose to $247 million from $149 million, with refinancing representing 81% of 2012 sales. MSR impairment charges were $142,000.
- Allowance for loan losses edged down to $23.7 million from $24.1 million, while net charge-offs declined to $15.4 million from $17.0 million. Traditional Banking net charge-offs increased to $8.5 million from $5.4 million.
- OREO increased substantially, from $11.0 million to $26.2 million; approximately $14 million of year-end OREO related to the acquired banks.
- The company declared $1.749 per Class A share and $1.590 per Class B share in 2012, including a one-time special dividend of $1.10 and $1.00 per share, respectively.
Outlook, commentary, risks and contingencies
- Management expects a substantial decline in 2013 net income and overall results versus 2012. Bargain purchase gains are not expected to recur at 2012 levels, RAL revenue ended after April 30, 2012, and RT revenue is expected to fall substantially.
- Liberty Tax Service and Jackson Hewitt terminated material TRS agreements in 2012. Together, these relationships generated about 59% of TRS gross revenue in 2012. Management expects the terminations and resulting competition and pricing pressure to materially hurt 2013 and later results. RPG net income was estimated at $3–$5 million for first-quarter 2013; RPG typically operates at a loss after the first quarter.
- RB&T disputes the terminations and is pursuing arbitration. The Jackson Hewitt matter, including a counterclaim, was scheduled for arbitration in June 2013; the filing does not quantify potential damages or establish a certain resolution date. Liberty-related arbitration was also contemplated.
- FCB acquisition fair values remained subject to review through September 2013. Management warned that further recast adjustments to the bargain purchase gain could be significant and adversely affect earnings.
- Interest-rate and funding risks include continued downward repricing of loans and securities, possible net interest margin pressure, and sensitivity to deposit outflows. Management noted that rising rates could also adversely affect asset values and margins given its balance-sheet positioning.
- Other notable exposures include acquired-bank credit quality and OREO valuation, potential additional losses on the remaining private-label mortgage-backed security, warehouse lending and mortgage-market dependence, regulatory oversight of TRS and overdraft programs, and consumer-protection compliance.
- A putative class action alleges improper overdraft-fee practices. The case was stayed pending related appellate and Supreme Court standing issues; management could not estimate a possible loss or range of loss.
- The independent auditor gave an unqualified opinion on the consolidated financial statements and internal control over financial reporting; management also concluded controls were effective at December 31, 2012.
Investor verification priorities
- Assess sustainable earnings excluding the $55.4 million acquisition gains, RAL income, and other tax-season revenue; verify actual 2013 results against management’s stated outlook.
- Track replacement TRS contracts, arbitration outcomes, RT volumes and pricing, and whether FDIC oversight permits continued operations.
- Review FCB fair-value revisions, acquired-loan performance, acquired-bank non-performing assets, and OREO sales and write-downs.
- Monitor net interest margin, loan and deposit growth, funding costs, liquidity availability, and reliance on FHLB advances, brokered deposits and large deposit relationships.
- Test whether allowance levels and credit trends remain adequate, particularly for TDRs, commercial real estate, construction loans and warehouse lines.
- Check the overdraft class action, potential securities impairment, dividend capacity and the sustainability of the special-dividend-level payout.