Republic Bancorp, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2011; balance-sheet comparisons are with December 31, 2010. Republic Bancorp is a bank holding company operating Traditional Banking, Mortgage Banking and Tax Refund Solutions (TRS). TRS activity is highly seasonal and is concentrated in the first quarter.
Financial performance and condition
Amounts below are in millions, except per-share data and ratios.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $26.8 | $28.1 | $110.8 | $104.9 |
| Provision for loan losses | $(0.4) credit | $3.0 | $17.6 | $19.8 |
| Non-interest income | $15.4 | $12.3 | $102.7 | $72.2 |
| Non-interest expense | $28.5 | $24.6 | $71.3 | $75.8 |
| Net income | $8.7 | $8.4 | $80.1 | $53.0 |
| Diluted Class A EPS | $0.41 | $0.40 | $3.82 | $2.54 |
| Net interest margin | 3.50% | 3.73% | 6.48% | 5.73% |
- Q2 net income rose 3%; six-month net income rose 51%. Six-month earnings benefited substantially from TRS: the segment reported $70.3 million net income, approximately 88% of company net income. The six-month NIM includes seasonal TRS activity; Traditional Banking NIM was 3.42% versus 3.70%.
- Q2 NII declined 4%, while non-interest income increased 25%, including a $1.9 million pre-tax gain on securities sales. Q2 non-interest expense included a $2.0 million FDIC civil money penalty accrual. For the half year, higher ERC/ERD fees drove non-interest income growth.
- At June 30, assets were $3.105 billion, net loans $2.197 billion, deposits $1.791 billion, and shareholders’ equity $445.7 million. Assets fell from $3.623 billion at year-end, largely reflecting the runoff of seasonal brokered deposits and a substantial reduction in cash. Cash and equivalents were $130.3 million, down from $786.4 million.
- Funding obligations included $519.8 million of FHLB advances, $218.2 million of repurchase agreements and other short-term borrowings, and a $41.2 million subordinated note. Deposits fell $512 million from year-end; the decline was primarily seasonal brokered CDs used to fund RALs. The bank reported $277 million of additional FHLB borrowing capacity and $216 million of unsecured credit lines. Management reported the bank was well-capitalized; Republic Bancorp’s total risk-based capital ratio was 25.13% and its Tier I leverage ratio 14.63%.
- Six-month cash flow: $139.2 million provided by operating activities, $166.5 million used in investing, and $628.7 million used in financing, for a $656.1 million net decrease in cash.
Material changes versus comparable periods
- TRS six-month net income increased 54% to $70.3 million. Electronic refund check/deposit fees rose to $87.6 million from $58.2 million as processed volume increased. RAL originations fell sharply: dollar volume declined about 66% year over year, from $3.0 billion to $1.0 billion, following tighter underwriting and a $1,500 maximum loan after the IRS stopped providing its Debt Indicator.
- Traditional Banking Q2 net income increased $3.9 million year over year, supported by a much lower loan-loss provision. Its NIM nevertheless declined 15 basis points year over year in Q2; management cited downward repricing of earning assets.
- Mortgage Banking income weakened as secondary-market originations fell: $26 million in Q2 2011 versus $65 million in Q2 2010, and $53 million for the half year versus $114 million.
- Asset quality was mixed. Non-performing loans were $28.5 million, or 1.28% of loans, compared with 1.30% at year-end. Impaired loans increased to $57.5 million from $45.1 million; TDRs were $35.4 million, of which $15.6 million were on non-accrual. Construction-loan delinquency was elevated at 12.03%.
Outlook, risks, contingencies and unusual items
- Outlook: No specific earnings guidance was provided. Management expects continued downward repricing to pressure NII and margins, and planned additional securities purchases in Q3 to address margin compression. Its interest-rate simulation projected NII declines of 2.45% to 4.84% for parallel rate increases of 100 to 300 basis points. The model excludes loan fees and is subject to material assumptions and limitations.
- Regulatory and TRS exposure: The FDIC’s amended enforcement notice alleges issues involving RAL underwriting, third-party oversight and consumer-protection compliance, among others, and proposes a $2 million penalty. Republic accrued the full amount, which management considered probable, while contesting the charges. The administrative hearing was scheduled for February 6, 2012; a separate suit challenging the FDIC process was pending. A restriction or termination of RALs, or disruption to ERC/ERD operations, could materially affect results. The filing also notes that JH, a major tax-services partner, filed for Chapter 11; JH and Liberty together accounted for about 60% of first-half TRS revenue.
- Other legal matter: A putative class action over overdraft fees was filed July 19, 2011. The company said it could not estimate a possible loss or range.
- Liquidity and funding: Management cited a 134% loan-to-deposit ratio excluding brokered deposits and dependence on large depositor relationships, brokered deposits and borrowing lines. Loss of significant funding sources or higher replacement funding costs could pressure liquidity and earnings. TRS also has concentrated seasonal funding needs.
- Other unusual items and plans: The Bowling Green branch sale, expected to close in Q3 2011 subject to approvals, covers about $35 million of deposits and $15 million of loans; management expected a pre-tax gain of $2.5–$3.5 million. A $5 million charitable foundation contribution was made in each first half of 2011 and 2010. New overdraft guidance and checking-account fee changes were expected to affect future fee income; management could not quantify the impact.
- Investment risk: Four illiquid private-label mortgage-related securities had a $5.8 million carrying value. Management said further deterioration could result in impairment charges up to that amount.
Most important facts for investors to verify
- Track the FDIC proceeding, the $2 million accrued penalty, the court challenge and whether the company may continue RAL and ERC/ERD operations.
- Assess whether TRS can sustain revenue and earnings given RAL volume reduction, the loss of the IRS Debt Indicator, and reliance on JH and Liberty.
- Monitor deposit stability, large depositor concentration, seasonal funding requirements, borrowing availability and the high loan-to-deposit ratio.
- Review loan quality trends, especially rising impaired loans and TDR non-accruals and construction-loan delinquencies, alongside allowance adequacy and subsequent charge-offs.
- Evaluate margin sensitivity, the impact of planned securities reinvestment and whether the expected Bowling Green sale gain is realized.
- Reconcile a filing inconsistency: the income statement and segment data report first-half 2010 net income of $53.025 million, while the EPS reconciliation lists $55.025 million.