UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
ý Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
OR
o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 0-24649
REPUBLIC BANCORP, INC.
(Exact name of registrant as specified in its charter)
Kentucky
61-0862051
(State of other jurisdiction of incorporationor organization)
(I.R.S. Employer Identification No.)
(Address of principal executive offices) (Zip Code)
(502) 584-3600
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
ý Yes oNo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Indicate the number of shares outstanding of the issuer’s class of common stock as of the latest practicable date.
16,099,053 shares of Class A Common Stock, no par value and 2,049,835 shares of Class B Common Stock, no par value were issued and outstanding at October 31, 2004.
FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1.
Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II - OTHER INFORMATION
Legal Proceedings
Unregistered Sales of Equity Securities and Use of Proceeds
Item 5.
Other Information
Item 6.
Exhibits
EX-31.1
Section 302 Certification of Principal Executive Officer
EX-31.2
Section 302 Certification of Principal Financial Officer
EX-32.1
Section 1350 Certification of Principal Executive Officer
EX-32.2
Section 1350 Certification of Principal Financial Officer
Signatures
2
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (in thousands)
September 302004
December 312003
(unaudited)
ASSETS:
Cash and cash equivalents
$
103,058
60,876
Securities available for sale
350,560
295,520
Securities to be held to maturity (fair value of $89,913 in 2004 and $114,736 in 2003)
90,173
115,411
Mortgage loans held for sale
11,753
13,732
Loans, less allowance for loan losses of $13,535 (2004) and $13,959 (2003)
1,719,195
1,567,993
Federal Home Loan Bank stock
20,106
19,148
Premises and equipment, net
34,566
34,329
Other assets and accrued interest receivable
23,325
20,762
TOTAL ASSETS
2,352,736
2,127,771
LIABILITIES:
Deposits:
Non interest-bearing
265,492
193,321
Interest-bearing
1,135,172
1,103,791
Total deposits
1,400,664
1,297,112
Securities sold under agreements to repurchase and other short-term borrowings
317,784
220,040
Federal Home Loan Bank borrowings
420,309
420,178
Other liabilities and accrued interest payable
22,588
21,062
Total liabilities
2,161,345
1,958,392
STOCKHOLDERS’ EQUITY:
Preferred stock, no par value
—
Class A and Class B Common Stock, no par value
4,380
4,157
Additional paid in capital
57,899
40,260
Retained earnings
130,881
126,251
Unearned shares in Employee Stock Ownership Plan
(1,995
)
(2,289
Accumulated other comprehensive income
226
1,000
Total stockholders’ equity
191,391
169,379
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
(in thousands, except per share data)
Three Months EndedSeptember 30
Nine Months EndedSeptember 30
2004
2003
INTEREST INCOME:
Loans, including fees
27,660
25,904
89,169
81,122
Securities:
Taxable
3,205
2,455
8,608
7,836
Non taxable
1
Federal Home Loan Bank stock and other
296
219
961
746
Total interest income
31,161
28,579
98,738
89,707
INTEREST EXPENSE:
Deposits
5,262
4,768
15,210
14,673
1,113
439
2,471
1,407
4,196
3,879
12,503
10,772
Total interest expense
10,571
9,086
30,184
26,852
NET INTEREST INCOME
20,590
19,493
68,554
62,855
Provision for loan losses
(127
223
1,475
6,418
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
20,717
19,270
67,079
56,437
NON INTEREST INCOME:
Service charges on deposit accounts
3,578
2,519
9,902
7,263
Electronic refund check fees
61
70
5,253
3,932
Title insurance commissions
329
865
1,087
2,204
Mortgage banking income
757
1,567
2,299
10,718
Debit card interchange fee income
663
470
1,774
1,374
Other
210
480
870
1,203
Total non interest income
5,598
5,971
21,185
26,694
NON INTEREST EXPENSES:
Salaries and employee benefits
8,411
7,926
26,277
24,407
Occupancy and equipment, net
3,444
3,160
10,466
8,962
Communication and transportation
741
608
2,094
2,038
Marketing and development
534
676
1,722
2,249
Bankshares tax
485
502
1,604
1,478
Supplies
222
293
871
1,025
Data processing
405
425
1,181
1,247
1,459
1,742
4,609
5,219
Total non interest expenses
15,701
15,332
48,824
46,625
INCOME BEFORE INCOME TAX EXPENSE
10,614
9,909
39,440
36,506
INCOME TAX EXPENSE
3,632
3,560
13,552
12,939
NET INCOME
6,982
6,349
25,888
23,567
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Change in unrealized gain (loss) on securities
(2,600
(774
(1,226
Less: Reclassification of realized amount
Net unrealized gain (loss) recognized in comprehensive income
COMPREHENSIVE INCOME
8,163
3,749
25,114
22,341
BASIC EARNINGS PER SHARE:
Class A Common Share
0.39
0.36
1.45
1.33
Class B Common Share
0.38
0.35
1.43
1.31
DILUTED EARNINGS PER SHARE:
1.39
1.30
0.37
0.34
1.38
1.28
4
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
Unearned
Shares in
Accumulated
Common Stock
Additional
Employee Stock
Total
Class A
Class B
Paid In
Retained
Ownership
Comprehensive
Stockholders’
Shares
Amount
Capital
Earnings
Plan
Income (Loss)
Equity
BALANCE, January 1, 2004
15,809
2,055
Stock options exercised, net of shares redeemed
102
23
1,343
(620
Repurchase of Class A and Class B Common Stock
(16
(3
(52
(246
(301
Conversion of Class B Common Stock to Class A Common Stock
(4
Shares committed to be released under the Employee Stock Ownership Plan
24
171
294
465
Dividend declared Common Stock:
Class A ($0.2169 per share)
(3,427
Class B ($0.1971 per share)
(405
Stock dividend
203
16,357
(16,560
Note receivable on common stock, net of cash payments
(180
Net change in accumulated other comprehensive income (loss)
Net income
BALANCE, September 30, 2004
15,923
2,051
5
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (in thousands)
OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, net
7,097
4,426
Federal Home Loan Bank stock dividends
(605
(562
Net gain on sale of mortgage loans held for sale
(2,271
(12,062
Origination of mortgage loans held for sale
(189,074
(750,060
Proceeds from sale of mortgage loans held for sale
193,324
805,351
Employee Stock Ownership Plan expense
295
Changes in assets and liabilities:
(2,352
(4,107
1,092
2,263
Net cash provided by operating activities
35,039
75,529
INVESTING ACTIVITIES:
Purchases of securities available for sale
(2,871,540
(268,398
Purchases of securities to be held to maturity
(31,514
(137,720
Purchases of Federal Home Loan Bank stock
(353
(68
Proceeds from calls, maturities and paydowns of securities available for sale
2,815,718
285,067
Proceeds from calls, maturities and paydowns of securities held to maturity
56,701
99,638
Net increase in loans
(153,792
(235,249
Purchases of premises and equipment, net
(6,348
(12,805
Net cash used in investing activities
(191,128
(269,535
FINANCING ACTIVITIES:
Net change in deposits
103,552
180,255
Net change in securities sold under agreements to repurchase and other short-term borrowings
97,744
(48,666
Payments on Federal Home Loan Bank borrowings
(151,239
(73,028
Proceeds from Federal Home Loan Bank borrowings
151,370
176,697
Repurchase of Common Stock
(339
Proceeds from Common Stock options exercised
649
Cash dividends paid
(3,601
(2,940
Net cash provided by financing activities
198,271
232,628
NET INCREASE IN CASH AND CASH EQUIVALENTS
42,182
38,622
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
39,853
CASH AND CASH EQUIVALENTS, END OF PERIOD
78,475
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest
30,644
32,699
Income taxes
12,143
12,020
SUPPLEMENTAL NONCASH DISCLOSURES:
Transfers from loans to real estate acquired in settlement of loans
935
750
Client transfers from securities sold under agreements to repurchase into deposits
35,829
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – SEPTEMBER 30, 2004 AND 2003 (UNAUDITED) AND DECEMBER 31, 2003
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation – The consolidated financial statements include the accounts of Republic Bancorp, Inc. (the “Holding Company”) and its wholly-owned subsidiaries: Republic Bank & Trust Company and Republic Bank & Trust Company of Indiana (together referred to as the “Bank”), Republic Funding Company and Republic Invest Co. Republic Invest Co. includes its wholly-owned subsidiary, Republic Capital LLC. All companies are collectively referred to as “Republic” or the “Company”. The consolidated financial statements also include the wholly-owned subsidiaries of Republic Bank & Trust Company: Republic Financial Services, LLC and Republic Insurance Agency, LLC. All significant intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States of America generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto-included in Republic’s annual report on Form 10-K for the year ended December 31, 2003.
Stock Option Plans – Employee compensation expense under stock option plans is reported using the intrinsic value method. No stock based compensation cost is reflected in net income, as all options granted had an exercise price equal to the market price of the underlying common stock at the date of grant.
The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock Based Compensation”:
7
Three months endedSeptember 30
Nine months endedSeptember 30
(dollars in thousands, except per share data)
Net income, as reported
Deduct:
Stock based compensation expense determined under the fair value based method, net of tax
133
173
397
555
Pro forma net income
6,849
6,176
25,491
23,012
Earnings per share as reported:
Pro forma earnings per share:
1.41
Diluted earnings per share as reported:
Pro forma diluted earnings per share:
1.37
1.27
0.33
1.35
1.25
There were 512,500 options granted during the three and nine months ended September 30, 2004. There were 86,636 options granted during the nine month period ended September 30, 2003 with 10,500 of these options granted during the three months ended September 30, 2003.
Recently Adopted Accounting Standards – See discussion in Note 1 to the consolidated financial statements in Republic’s annual report on Form 10-K for the year ended December 31, 2003 for a discussion of recent accounting pronouncements.
Reclassifications – Certain amounts presented in prior periods have been reclassified to conform to the current period presentation. All prior period share and per share data has been restated to reflect the five percent (5%) stock dividend that was declared in the first quarter of 2004.
8
2. SECURITIES
Securities Available For Sale:
Gross
Amortized
Unrealized
September 30, 2004 (in thousands)
Cost
Gains
Losses
Fair Value
U.S. Treasury securities and U.S. Government agencies
177,811
126
(727
177,210
Mortgage backed securities, including CMOs
172,401
1,037
(88
173,350
Total securities available for sale
350,212
1,163
(815
December 31, 2003 (in thousands)
154,533
328
(43
154,818
139,472
1,274
(44
140,702
294,005
1,602
(87
Securities To Be Held To Maturity:
20,594
39
(11
20,622
69,579
105
(393
69,291
Total securities to be held to maturity
144
(404
89,913
9,707
18
9,725
105,704
82
(775
105,011
100
114,736
Securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes, as required or permitted by law are as follows:
(in thousands)
September 30, 2004
December 31, 2003
Amortized cost
385,013
272,801
Fair value
384,959
273,561
9
3. LOANS
Residential real estate
827,500
762,000
Commercial real estate
478,844
442,083
Real estate construction
63,535
70,897
Commercial
37,193
34,553
Consumer
63,626
58,034
Home equity
262,667
215,088
Total loans
1,733,365
1,582,655
Less:
Unearned interest income and unamortized loan fees
635
703
Allowance for loan losses
13,535
13,959
Loans, net
The following table illustrates real estate loans pledged to collateralize advances and letters of credit from the Federal Home Loan Bank (“FHLB”):
First lien, 1-4 family residential
745,000
703,000
Multi-family, commercial real estate
52,000
36,000
Home equity lines of credit
168,000
142,000
Activity in the allowance for loan losses is summarized as follows:
Three months ended September 30
Nine months ended September 30
Balance, beginning of period
13,530
12,668
10,148
Charge offs
(414
(564
(4,384
(5,037
Recoveries
546
1,353
2,485
2,151
Balance, end of period
13,680
Information regarding Republic’s impaired loans is as follows:
Loans with no allocated allowance for loan losses
Loans with allocated allowance for loan losses
5,359
Amount of the allowance for loan losses allocated
1,094
1,484
Non-performing loans were as follows:
Loans past due 90 days still on accrual
486
473
Non-accrual loans
8,046
12,466
10
4. DEPOSITS
Demand (NOW and SuperNOW)
290,211
271,022
Money market accounts
178,850
124,145
Internet money market accounts
56,815
96,034
Savings
41,004
35,735
Money market certificates of deposit
71,192
70,208
Individual retirement accounts
45,573
42,073
Certificates of deposit, $100,000 and over
195,409
196,026
Other certificates of deposit
209,996
203,893
Brokered deposits
46,122
64,655
Total interest-bearing deposits
Total non interest-bearing deposits
5. FHLB BORROWINGS
FHLB convertible fixed interest rate advances with a weighted average interest rate of 5.17%(1)
115,000
FHLB fixed interest rate advances with a weighted average interest rate of 3.54% due through 2034
305,309
305,178
(1) Represents convertible advances with the FHLB. These advances have original fixed rate periods ranging from one to five years with original maturities ranging from three to ten years if not converted earlier by the FHLB. The Company has $90 million in these advances that are currently eligible to be converted on their quarterly repricing date. Based on market conditions at this time, management does not believe these advances are likely to be converted in the short term.
FHLB advances are collateralized by a blanket pledge of eligible real estate loans. At September 30, 2004, Republic had available collateral to borrow an additional $149 million from the FHLB. Republic also has unsecured lines of credit totaling $135 million available through several financial institutions.
Aggregate future principal payments on borrowed funds, based on contractual maturity dates as of September 30, 2004 are as follows:
Year
19,000
2005
82,570
2006
100,000
2007
60,000
2008 and thereafter
158,739
11
6. EARNINGS PER SHARE
Class A and B shares participate equally in undistributed earnings. The difference in earnings per share between the two classes of common stock results solely from the 10% per share dividend premium paid on Class A Common Stock over that paid on Class B Common Stock.
A Reconciliation of the combined Class A and B Common Stock numerators and denominators of the earnings per share and diluted earnings per share computations is presented below:
Net Income, basic and diluted
Average shares outstanding
17,956
17,803
17,921
17,765
Effect of dilutive securities
693
587
671
Average shares outstanding including dilutive securities
18,649
18,390
18,592
18,170
Basic earnings per share:
Diluted earnings per share:
There were no antidilutive stock options during the three and nine months ended September 30, 2004 and 2003.
7. SEGMENT INFORMATION
The reportable segments are determined by the type of products and services offered, primarily distinguished between banking operations, mortgage banking operations, tax refund services and deferred deposit transactions. Loans, investments and deposits provide the majority of revenue from banking operations; servicing fees and loan sales provide the majority of revenue from mortgage banking operations; Refund Anticipation Loan (“RAL”) fees and Electronic Refund Check (“ERC”) fees provide the majority of the revenue from tax refund services; and fees for providing deferred deposit transactions represent the primary revenue source for the deferred deposit segment. All four reportable segments are domestic.
The accounting policies used for Republic’s reportable segments are the same as those described in the summary of significant accounting policies. Income taxes are allocated based on income before income tax expense. Transactions among reportable segments are made at fair value.
Information reported internally for performance assessment follows:
12
Three Months Ended September 30, 2004
Banking
Tax RefundServices
MortgageBanking
DeferredDeposits
ConsolidatedTotals
Net interest income
16,848
514
3,228
(92
(205
170
Other revenue
5,586
(7
(799
4,780
Income tax expense
2,704
(202
67
1,063
Segment profit
5,355
(371
129
1,869
Segment assets
2,296,663
2,582
11,766
41,725
Three Months Ended September 30, 2003
16,897
274
2,322
205
5,784
(66
(1,384
4,334
2,895
(182
90
5,163
(325
161
1,350
1,944,281
2,356
22,495
40,610
2,009,742
Nine Months Ended September 30, 2004
49,793
8,523
1,629
8,609
(923
1,707
691
15,907
(22
(2,252
13,633
7,051
3,259
310
2,932
14,161
6,225
592
4,910
Nine Months Ended September 30, 2003
50,113
6,742
1,270
4,730
4,241
1,850
327
15,705
(46
(3,615
12,044
6,479
2,191
2,707
1,562
12,125
3,991
4,931
2,520
13
ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Management’s Discussion and Analysis of Financial Condition and Results of Operations of Republic Bancorp, Inc. (“Republic” or the “Company”) analyzes the major elements of Republic’s consolidated balance sheets and consolidated statements of income. Republic, a bank holding company headquartered in Louisville, Kentucky, is the Holding Company of Republic Bank & Trust Company, Republic Bank & Trust Company of Indiana (together referred to as the “Bank”), Republic Funding Company and Republic Invest Co. Republic Invest Co. includes its wholly-owned subsidiary Republic Capital LLC. The consolidated financial statements also include the wholly-owned subsidiaries of Republic Bank & Trust Company: Republic Financial Services, LLC and Republic Insurance Agency, LLC. This section should be read in conjunction with the consolidated Financial Statements and accompanying Notes and other detailed information.
This discussion includes various forward-looking statements with respect to credit quality including, but not limited to, delinquency trends and the adequacy of the allowance for loan losses, corporate objectives, the Company’s interest rate sensitivity model and other financial and business matters. Broadly speaking, forward-looking statements include:
• projections of the Company’s revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items;
• descriptions of plans or objectives of the Company’s management for future operations, products or services;
• forecasts of Republic’s future economic performance; and
• descriptions of assumptions underlying or relating to any of the foregoing.
The Company may make forward-looking statements discussing management’s expectations about:
• future credit losses and non-performing assets;
• the future value of mortgage servicing rights;
• the impact of new accounting standards;
• future short-term and long-term interest rate levels and their impact on Republic’s net interest margin, net income, liquidity and capital; and
• future capital expenditures.
Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would,” or similar expressions. Do not unduly rely on forward-looking statements. Forward-looking statements detail management’s expectations about the future and are not guarantees. Forward-looking statements speak only as of the date they are made and management may not update them to reflect changes that occur after the date the statements are made.
Net income for the third quarter of 2004 was $7.0 million, representing an increase of $633,000 or 10% compared to the same period in 2003. Diluted earnings per Class A Common Share increased 9% for the quarter to $0.38. Republic’s rise in earnings for the quarter was attributed to increases in net interest income, service charges on deposit accounts and deferred deposit transaction fees. Republic’s net income for the quarter was also positively impacted by a negative provision for loan losses of $127,000.
Net income for the first nine months of 2004 was $25.9 million, an increase of $2.3 million or 10% compared to the same period in 2003. Diluted earnings per Class A Common Share increased 7% for the first nine months of 2004 to $1.39. Republic’s rise in earnings for the first nine months of 2004 was attributable to increases in net interest income, service charges on deposit accounts, deferred deposit transaction fees and a lower provision for loan losses.
14
Increased earnings at Republic Bank Tax Refund Solutions, a division of Republic Bank & Trust Company, which generates substantially all of its revenue during the first quarter of each year, also significantly impacted net income for the first nine months of 2004. The improvements in revenue for both the third quarter and first nine months of 2004 offset a decline in mortgage banking income of $810,000 for the quarter and $8.4 million for the first nine months of 2004.
FACTORS THAT MAY AFFECT FUTURE RESULTS
There are factors, many beyond our control, which may significantly change the results or expectations of the Company. Some of these factors are described below; however, many are described in the sections that follow. There are also other items which are included in the Annual Report on Form 10-K for the year ended December 31, 2003. Any factor described in this document, or in the Company’s 2003 Annual Report on Form 10-K, could, by itself, or with other factors, adversely affect our business, results of operations or financial condition. There are also additional factors not described in this document or in the 2003 Annual Report on Form 10-K which could cause our expectations to differ or could produce significantly different results.
Company Factors
The Holding Company relies on dividends from its subsidiaries for substantially all of its revenue. Republic Bancorp, Inc. is a separate legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its largest subsidiary, Republic Bank & Trust Company. Various federal and state laws and regulations limit the amount of dividends that may be paid to the Holding Company.
The Company’s accounting policies and estimates are critical components of the Company’s presentment of its financial statements. Our management must exercise judgment in selecting and adopting various accounting policies and in applying estimates. Actual outcomes can and may be materially different than amounts previously estimated. Management has identified two accounting policies as being critical to the presentation of the Company’s financial statements. These policies are further described in our 2003 Annual Report on Form 10-K in the section titled “Critical Accounting Policies” and relate to the allowance for loan losses and the valuation of mortgage servicing rights. Because of the inherent uncertainty of estimates, we cannot provide any assurance that the Company will not significantly increase its allowance for loan losses if actual losses are more than the amount reserved or recognize a significant provision for impairment of its mortgage servicing rights.
The Company has lines of business and products not typically associated with traditional banking. In addition to traditional banking products, i.e. customer loans and deposits, the Company provides Refund Anticipation Loans (“RALs”) and Electronic Refund Checks (“ERCs”), mortgage banking products, “Overdraft Honor” deposit accounts and deferred deposit transactions. Management believes diverse product offerings mitigate the Company’s exposure to significant downturns in any one segment of the banking industry; however, non-traditional banking products also expose the Company’s earnings to different additional risks and uncertainties. The following details specific risk factors related to Republic’s lines of business:
• RALs represent a significant business risk, and if the Company terminated the business it would materially impact earnings of the Company. Republic offers bank products to facilitate the electronic filing of tax returns by individuals across the country. The Company is one of only a few financial institutions in the United States of America that provides this service to taxpayers. Under this program, the taxpayer may receive a RAL or an ERC. In return, the Company charges a fee for the service. There is credit risk associated with a RAL because the money is disbursed to the client before the Company receives the client’s refund from the Internal Revenue Service (“IRS”). There is minimal credit risk with an ERC because the Company does not disburse the funds to the client until the Company has received the refund from the IRS. Various consumer groups have, from time to time, questioned the fairness of the Republic Bank Tax Refund Solutions program and have accused this industry of charging excessive rates of interest via the fee and engaging in predatory lending practices. A competing RAL financial institution is currently defending two lawsuits in the state of California relating to the cross-collection provision contained in its RAL contracts with customers. While the Company is a party to these two suits, it has not been named as a Defendant by the Plaintiffs regarding its cross-collection activities with customers. However, the issue of
15
cross-collection provisions in RAL contracts could result in litigation exposure for all RAL financial institutions, including the Company, as consumer groups have shown a willingness to oppose the RAL cross-collection provisions through litigation. Pressure from these groups, regulatory changes, or material litigation could result in the Company exiting this business at any time. Exiting this line of business, either voluntarily or involuntarily, would significantly reduce Company earnings.
• Mortgage banking activities can be significantly impacted by interest rates. Changes in interest rates can impact gain on sale of loans, loan origination fees and loan servicing fees, which account for a significant portion of mortgage banking income. A decline in interest rates generally results in higher demand for mortgage products, while an increase in rates generally results in a slow down in demand. If demand increases, mortgage banking income will be positively impacted by more gains on sale, however, the valuation of mortgage servicing rights will decrease and may result in a significant impairment. In addition to the previously mentioned risks, a decline in demand for mortgage banking products could also adversely impact other programs/products such as home equity lending, title insurance commissions and service charges on deposit accounts.
• The Company’s “Overdraft Honor” program represents a significant business risk, and if the Company terminated the program it would materially impact earnings of the Company. Republic’s “Overdraft Honor” program permits selected clients to overdraft their accounts up to $500 for the Company’s customary fee. Customers’ checking accounts that have been current for a certain period of time are allowed the privilege to enter into the program. This service is not considered an extension of credit, but rather is considered a fee for paying checks when sufficient funds are not otherwise available to the customer. This fee, if computed as a percentage of the amount overdrawn, results in an extremely high rate of interest when annualized and thus is considered excessive by some consumer groups. There can be no assurance, however, that the Company’s regulators or others will not impose limitations on this program or that the Company’s ability to offer the product will not be negatively impacted by regulatory authorities. The Company’s elimination of this program, either voluntarily or involuntarily, would significantly reduce Company earnings.
• Deferred deposit transactions represent a significant business risk and if the Company terminated the business it would materially impact earnings of the Company. Deferred deposits are transactions whereby customers receive cash advances in exchange for a check for the advanced amount plus a fixed fee (commonly referred to as a “payday loan” or “payday lending”). Various consumer groups have, from time to time, questioned the fairness of deferred deposit transactions and have accused this industry of charging excessive rates of interest via the fixed fee and engaging in predatory lending practices. Various federal and state regulatory agencies have also questioned whether this business should be permitted by member banks. There can be no assurance that the Federal Deposit Insurance Corporation (“FDIC”) or others will not impose additional limitations on or prohibit banks from engaging altogether in deferred deposit transactions. There also can be no assurances that private litigation might require the Company to exit from the program in one or more jurisdictions, or that the Company’s ability to continue to engage in the business profitably, or at all, will not be negatively impacted by the requirements of applicable laws, regulations or guidelines. The Company exiting this business, either voluntarily or involuntarily, would significantly reduce Company earnings.
Republic’s stock price can be extremely volatile. The Company’s stock price can fluctuate widely in response to a variety of factors. Factors include actual or anticipated variations in the Company’s quarterly operating results, recommendations by securities analysts, new technologies, operating and stock price performance of other companies, news reports and changes in government regulations, among other factors. The Company’s stock also generally has a low average daily trading volume, which limits a person’s ability to quickly accumulate or quickly divest themselves of large blocks of Republic’s stock. In addition, a low average daily trading volume can lead to significant price swings even when a relatively small number of shares are being traded.
Industry Factors
General business and economic conditions can significantly impact the Company’s earnings. General business and economic conditions in the United States of America and abroad can impact the Company. Conditions
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include short-term and long-term interest rates, inflation, monetary supply and fluctuations in both debt and equity markets and the federal and state economies in which we operate. Economic factors such as a customer’s loss of employment can limit the ability of borrowers to repay principal and interest on their outstanding loans.
The Company’s earnings are significantly impacted by the fiscal and monetary policies of federal and state governments. The Board of Governors of the Federal Reserve Bank System regulates the supply of money and credit in the United States of America. Its policies determine, in large part, our cost of funds for lending and investing and the return we earn on those loans and investments, all of which impact our net interest margin. Its policies can materially affect the value of our financial instruments and earnings and can also affect our borrowers and their ability to repay their outstanding loans.
Republic’s industry is highly competitive. The Company operates in a highly competitive industry that could become even more competitive as a result of legislation, regulatory and technological changes, new market entries and acquisition activity. Many of our competitors have fewer regulatory constraints and some have lower cost structures. Federal legislation could also provide for changes in the banking laws that could impact the financial condition or results of operations of the Company or its subsidiaries.
Republic is heavily regulated by federal and state agencies. The Holding Company and its subsidiary banks are heavily regulated at both federal and state levels. This regulatory oversight is primarily intended to protect depositors, the federal deposit insurance funds and the banking system as a whole, not the shareholders of the Company. Changes in policies, regulations and statutes could significantly impact the earnings or products of Republic. Also, failure to comply with laws, regulations or policies could result in significant penalties or sanctions by regulatory agencies.
The Company relies on the accuracy and completeness of information provided by vendors, customers and other counterparties. In deciding whether to extend credit or enter into transactions with other parties, the Company relies on information furnished by or on behalf of customers or entities related to that customer. Our financial condition and earnings could be negatively impacted to the extent the Company relies on information that is false, misleading or inaccurate.
Deferred deposits are transactions whereby customers receive cash advances in exchange for a check for the advanced amount plus a fixed fee (commonly referred to as a “payday loan” or “payday lending”). Republic agrees to delay presentment of the check for payment until the advance due date, typically 14 to 30 days from the cash advance date. On or before the advance due date, the customer can redeem their check in cash for the amount of the advance plus the fee. If the customer does not reclaim the check in cash by the advance due date, the check is deposited. These transactions are recorded as loans on the Company’s financial statements and the corresponding fees are recorded as a component of interest income on loans.
Total outstandings were $31.8 million at September 30, 2004 compared to $27.6 million at December 31, 2003. FDIC guidance issued in July 2003 requires that banks limit deferred deposit transaction outstandings to the lesser of 25% of Tier I capital or the amount that actual capital levels exceed the “well-capitalized” classification for Tier I and total capital. Based on the Company’s capital levels at the end of the third quarter, deferred deposit transaction outstandings were below the Company’s regulatory limit of $39 million.
The Marketer/Servicers with which the Company does business have at times experienced legal and/or regulatory obstacles in some states in which they do business. In these states, laws have been enacted or amended to prohibit or limit their ability to conduct business without a financial institution partner. In addition, the Comptroller of the Currency has effectively prohibited national banks from conducting this business. This has provided opportunities for certain state-chartered commercial banks to enter the business and increase earnings with acceptable capital outlays. Certain legal and administrative risks are directly attributable to Republic’s deferred deposit transaction program.
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The legal and regulatory climate for this product also continues to change. The FDIC’s guidance characterizes deferred deposit transactions as presenting substantial credit risks for lenders, because among other things, the loans are unsecured and the borrower generally has limited financial resources, as well as increased transaction, legal and reputation risks when a third party arrangement is used. This guidance proposes, among other items, that banks hold significantly more capital than would be required for other sub-prime type loans, suggesting required capital of as much as 100% of deferred deposit transactions outstanding. The guidance also requires that the allowance for loan and lease losses be adequate and take into account that many such transactions remain outstanding beyond their initial term due to renewals and rollovers, deferred deposit transactions be classified “substandard,” and transactions outstanding for more than 60 days generally be classified as “loss.” The guidance also prescribes limits on the ability of a borrower to renew or rollover a deferred deposit transaction and the number of transactions that can be entered into within a given period of time. The guidance requires examiners to assess the bank’s risk management program for third party marketing and servicing relationships, including the bank’s due diligence process for selecting third party marketing and servicing providers and its monitoring of the third party’s activities and performance. Banks are also advised to evaluate the third party’s compliance with consumer protection laws and applicable regulations.
The Company believes that it has adequately considered and addressed the risks associated with its deferred deposit transaction business, including the risks discussed in the FDIC guidelines and that the Company’s size, technological resources and experience in the successful management of other non-traditional banking product lines, among other factors, will enable the Company to adequately manage its deferred deposit transaction business. There can be no assurance, however, that state and federal regulators, court rulings or others will not impose additional limitations on or prohibit banks from engaging altogether in deferred deposit transactions. There is an identifiable potential that the business might lead to material litigation, public or private, and that the Company’s ability to continue to engage in the business profitably, or at all, will be impacted by requirements of applicable laws, regulations, guidelines or court decisions.
The Attorney General of North Carolina recently issued an investigative demand to one of the Company’s Marketer/Servicers in the state of North Carolina. The Attorney General seeks to make a determination as to whether or not the Company’s Marketer/Servicer complies with North Carolina statues. The Company’s Marketer/Servicer has been asked to document how it conducts its business in the state of North Carolina and has been asked to disclose its contractual relationship with the Company and produce other documents relating to the deferred deposit transaction business. The North Carolina Commissioner of Banks has joined this inquiry. This action does not currently affect operations in the state of North Carolina and all agreements between customers and Republic remain valid and enforceable.
RESULTS OF OPERATIONS
Net Interest Income
The principal source of Republic’s revenue is net interest income. Net interest income represents the difference between interest income on interest-earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, such as interest-bearing deposits and borrowings. Net interest income is impacted by both changes in the amount and composition of interest-earning assets and interest-bearing liabilities as well as market interest rates.
Despite contraction of the net interest spread and margin during the third quarter of 2004, the Company was able to increase its net interest income primarily through growth in the securities and loan portfolios, including an increase in deferred deposit transactions outstanding. In general, the contraction of the Company’s net interest spread and margin generally occurred as long-term market interest rates trended lower while short term interest rates increased, due to Federal Reserve Bank interest rate actions. As a result, downward repricing continued to occur in both the securities and loan portfolios as maturities and prepayments were replaced by lower yielding assets. Overall, Republic’s yield on earning assets declined 52 basis points compared to the third quarter of 2003.
Republic’s increase in interest expense during the third quarter of 2004 resulted primarily from growth in interest bearing liabilities while the Company experienced a slight decrease of four basis points in its overall cost of funds due to a market driven shift in product mix. Generally, Republic experienced more growth in its lower-cost deposit
product types such as transaction accounts, money markets and repurchase agreements than it experienced in its higher cost certificates of deposit and Federal Home Loan Bank borrowings. As a result, the lower cost product types became a larger percentage of the total interest bearing liabilities thus driving down the overall cost of funds. While this change in product mix benefited current earnings through a lower cost of funds, future results could be impacted in a rising interest rate environment due to the immediate repricing potential of the lower-cost product types compared to the time deposits with fixed interest rates. (See sections titled “Deposits” and “Securities Sold Under Agreements to Repurchase and Other Short-term Borrowings” on pages 27-28 for additional discussion on changes in balance sheet accounts. See section titled “ASSET/LIABILITY MANAGEMENT AND MARKET RISK” on page 31 for additional discussion on the impact of changes in interest rates on future net interest income.)
Similar to the third quarter of 2004, the Company grew net interest income for the nine months ended September 30, 2004 while experiencing contraction in the net interest spread and margin. As with the third quarter, the Company was able to increase its net interest income for the first nine months of 2004 primarily through growth in the securities and loan portfolios, including an increase in deferred deposit transactions outstanding. In addition, the Company also had a significant increase in RAL volume during the first quarter of 2004 compared to the same period in 2003. The contraction of the Company’s net interest spread and margin generally occurred as long-term market interest rates trended lower while short term interest rates increased, primarily due to Federal Reserve Bank interest rate actions. As a result, downward repricing continued to occur in both the securities and loan portfolios as maturities and prepayments were replaced by lower yielding instruments. Overall, Republic’s yield on earning assets declined 59 basis points compared to the first nine months of 2003.
As with the third quarter, Republic’s increase in interest expense during the first nine months of 2004 resulted primarily from growth in interest bearing liabilities while the Company experienced a decrease of 20 basis points in its overall cost of funds due to a shift in product mix. Generally, Republic experienced more growth in its lower-cost deposit product types such as transaction accounts, money markets and repurchase agreements than it experienced in its higher cost certificates of deposit and Federal Home Loan Bank borrowings. As a result, the lower cost product types became a larger percentage of the total interest bearing liabilities thus driving down the overall cost of funds. While this change in product mix benefited current earnings through a lower cost of funds, future results could be impacted in a rising interest rate environment due to the immediate repricing potential of the lower-cost product types compared to the time deposits. (See sections titled “Deposits” and “Securities Sold Under Agreements to Repurchase and Other Short-term Borrowings” on pages 27-28 for additional discussion on changes in balance sheet accounts. See section titled “ASSET/LIABILITY MANAGEMENT AND MARKET RISK” on page 31 for additional discussion on the impact of changes in interest rates on future net interest income.)
Table 1 and Table 2 provide detailed information as to average balances, interest income/expense and rates by major balance sheet category for the three and nine month periods ended September 30, 2004 and 2003. Table 2 provides an analysis of the changes in net interest income attributable to changes in rates and changes in volume of interest-earning assets and interest-bearing liabilities.
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Table 1 – Average Balance Sheets and Interest Rates for the Three Months Ended September 30, 2004 and 2003
September 30, 2003
(dollars in thousands)
AverageBalance
AverageRate
ASSETS
Earning assets:
Investment securities(1)
450,172
3,419
3.04
%
315,546
2,646
3.35
Federal funds sold and other
21,097
1.56
13,818
29
0.84
Total loans and fees(2)
1,718,513
6.44
1,512,817
6.85
Total earning assets
2,189,782
5.69
1,842,181
6.21
Less: Allowance for loan losses
13,533
13,077
Non-earning assets:
74,521
59,799
35,277
31,005
Other assets (2)
17,499
23,590
Total assets
2,303,546
1,943,498
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Transaction accounts
333,256
651
0.78
274,316
533
303,911
784
1.03
283,903
541
0.76
44,463
390
3.51
39,291
360
3.66
Certificates of deposits and other time deposits
371,319
3,076
3.31
355,843
3,101
3.49
46,362
361
3.11
36,017
233
2.59
Repurchase agreements and other short-term borrowings
325,114
187,486
0.94
420,995
3.99
385,942
4.02
Total interest-bearing liabilities
1,845,420
2.29
1,562,798
2.33
Non interest-bearing liabilities and stockholders’ equity:
Non interest-bearing deposits
245,736
182,945
Other liabilities
23,754
27,280
Stockholders’ equity
188,636
170,475
Total liabilities and stockholders’ equity
Net interest spread
3.40
3.88
Net interest margin
3.76
4.23
(1) For the purpose of this calculation, the fair market value adjustment on investment securities resulting from SFAS 115 is included as a component of other assets.
(2) The amount of fee income included in interest on loans was $3.8 million and $3.3 million for the quarters ended September 30, 2004 and 2003.
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Table 2 – Average Balance Sheets and Interest Rates for the Nine Months Ended September 30, 2004 and 2003
421,150
9,212
2.92
311,089
8,394
3.60
44,818
357
1.06
23,061
191
1.10
1,691,424
7.03
1,453,222
7.44
2,157,392
6.10
1,787,372
6.69
14,120
11,806
76,187
45,562
35,755
27,727
19,321
23,075
2,274,535
1,871,930
323,332
1,845
259,136
1,684
0.87
303,572
2,184
0.96
243,135
1,503
0.82
43,244
1,131
38,730
1,088
3.75
367,133
8,919
3.24
360,394
9,599
3.55
51,234
2.94
50,748
799
2.10
299,360
182,020
423,371
3.94
345,084
4.16
1,811,246
2.22
1,479,247
2.42
257,272
198,098
25,651
29,424
180,366
165,161
4.27
4.24
4.69
(2) The amount of fee income included in interest on loans was $19.2 million and $13.9 million for the nine months ended September 30, 2004 and 2003.
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The following table illustrates the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities affected Republic’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume) and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Table 3 – Volume/Rate Variance Analysis
Three months ended September 30, 2004compared to theThree months ended September 30, 2003
Nine months ended September 30, 2004compared to theNine months ended September 30, 2003
Increase/(Decrease)due to
Total NetChange
Volume
Rate
Interest income:
Investment securities
773
1,042
(269
818
2,603
(1,785
53
33
166
Total loans and fees
1,756
3,376
(1,620
8,047
12,745
(4,698
Net change in interest income
4,438
(1,856
9,031
15,521
(6,490
Interest expense:
118
115
383
(222
243
40
681
410
271
30
46
43
122
(79
Certificates of deposit and other time deposits
(25
132
(157
(680
177
(857
128
75
332
324
674
414
260
1,064
963
101
317
349
(32
1,731
2,337
(606
Net change in interest expense
1,485
1,171
314
3,332
4,400
(1,068
Increase in net interest income
1,097
3,267
(2,170
5,699
11,121
(5,422
22
Non interest Income
Non interest income declined 6% for the third quarter ended September 30, 2004 compared to the same period in 2003. The decrease was driven by the decline in mortgage banking income and title insurance commissions, which closely correlates with mortgage origination volume. These declines were partially offset by increases in both service charges on deposit accounts and debit card interchange income.
Non interest income declined 21% for the first nine months of 2004 compared to the same period in 2003. As with the third quarter of 2004, the decrease was related to the decline in mortgage banking income and title insurance commissions. The year to date decline was partially offset by increases in service charges on deposit accounts, debit card interchange income and ERC fees.
Service charges on deposit accounts increased 42% during the third quarter compared to the same period in 2003. The increase was due primarily to growth in the Company’s checking account base supported by the Company’s “Overdraft Honor” program, which permits selected clients to overdraft their accounts up to $500 for the Company’s customary fee. Total overdraft fees increased $521,000 or 24% while the total number of accounts eligible for the “Overdraft Honor” program increased to 48,000 from 41,000 at September 30, 2003.
Service charges on deposit accounts increased 36% during the first nine months of 2004 compared to the same period in 2003. Total overdraft fees increased $1.4 million or 23% for the first nine months of the year. The increase in service charges on deposit accounts for the year was for the same reasons described in the preceding paragraph.
ERC fees increased $1.3 million during the first nine months of 2004 compared to the same period in the prior year. The increase was due primarily to a substantial increase in overall ERC volume attributed to successful program marketing efforts in the second half of 2003. The majority of these fees are received during the first quarter of the calendar year.
Mortgage banking income includes net gain on sale of loans, loan servicing income and amortization of Mortgage Servicing Rights (“MSRs”). Mortgage banking income decreased $810,000 during the quarter ended September 30, 2004 compared to the same period in 2003. The decrease was primarily due to a $1.3 million decline in net gain on sale of loans. The reduction in gain on sale of loans resulted from a substantial decline in mortgage origination volume of 15 and 30 year fixed rate residential real estate loans from the strong levels attained by the Company in the third quarter of 2003. The higher volume of originations during the prior year resulted from aggressive marketing of the Company’s “$999” closing cost loan product and sustained consumer demand for fixed rate, first mortgage residential real estate loan products due to historically low market interest rates during that period. This demand began to decline substantially during the third quarter of 2003, reaching and sustaining lower levels during the first nine months of 2004.
Mortgage banking income decreased $8.4 million during the first nine months of 2004 compared to the same period in 2003. The decrease resulted from a $9.8 million decline in net gain on sale of loans resulting from the lower volume of loans sold into the secondary market compared to the record volume attained during the first nine months of 2003.
Title insurance commissions decreased $536,000 and $1.1 million during the third quarter of 2004 and first nine months of 2004 compared to the same periods in 2003 due primarily to the decline in mortgage origination volume.
Non interest Expenses
Non interest expenses increased $369,000 or 2% during the quarter ended September 30, 2004 compared to the same period in 2003. The Company continued its extensive focus on controlling non interest expenses during the third quarter of 2004.
Salaries and employee benefits increased $485,000 for the third quarter of 2004 compared to the same period in 2003. Included within the salaries and employee benefits category is the Company’s deferral for direct expenses on origination of loans. Republic’s deferral decreased $597,000 for the third quarter of 2004 compared to the third
quarter of 2003 due to a reduction in the volume of new mortgage loans originated. The Company’s number of full-time equivalent employees (“FTE’s”) decreased to 587 at September 30, 2004 from 638 at September 30, 2003. For the first nine months of 2004, total salaries and employee benefits increased $1.9 million. The deferral for the first nine months of 2004 decreased $1.4 million compared to the first nine months of 2003 due to a reduction of new loan originations.
Occupancy and equipment increased for both the three and nine month periods due primarily to costs associated with the new banking centers opened during the latter half of 2003 and first half of 2004.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
Securities available for sale primarily consists of U.S. Treasury and U.S. Government Agency obligations, including agency mortgage backed securities (“MBSs”) and collateralized mortgage obligations (“CMOs”). The MBSs consist of 15-year fixed, 7-year balloons, 5-year balloons, as well as other adjustable rate mortgage securities, underwritten and guaranteed by Ginnie Mae (“GNMA”), Freddie Mac (“FHLMC”) and Fannie Mae (“FNMA”). CMOs held in the investment portfolio are substantially all floating rate securities that adjust monthly. Securities available for sale increased from $296 million at December 31, 2003 to $351 million at September 30, 2004. Securities to be held to maturity consist primarily of floating rate CMOs and decreased from $115 million at December 31, 2003 to $90 million at September 30, 2004. In addition to economic and market conditions, the overall management strategy of the investment portfolio is determined by, among other factors, loan demand, deposit mix, liquidity and collateral needs, the Company’s interest rate risk position and the overall structure of the balance sheet. During the first nine months of 2004, Republic purchased $2.9 billion in securities and had maturities of $2.8 billion. Approximately $2.7 billion of the securities purchased were agency discount notes, which the Company utilized primarily for collateral purposes. The yield on these discount notes was 1.05% with an average term of 6 days.
Net loans, primarily consisting of secured real estate loans, increased by $151 million to $1.7 billion at September 30, 2004. This growth was primarily attributable to a $66 million increase in residential real estate loans, a $48 million increase in home equity loans and a $37 million increase in commercial real estate loans during the first nine months of 2004.
Republic experienced steady growth in its residential real estate adjustable rate mortgage loan portfolios. The $66 million increase in this category resulted primarily from the promotion of these products through reduced closing costs to the client. Republic offered closing costs as low as $499 on many of its adjustable rate products during the first nine months of 2004. With reduced closing costs and lower interest rates, these loans compared favorably to longer-term, fixed rate secondary market products. Management anticipates continuing to offer residential real estate products with promotional closing costs during the fourth quarter of 2004, which could heavily impact origination volume.
Home equity loans, substantially all with loan to values of 100% or less, increased from $215 million at December 31, 2003 to $263 million at September 30, 2004. The rise in home equity loans was primarily the result of the Company’s promotional product, which has a zero percent interest rate for the first three months of the loan. Management anticipates continuing to offer promotional rate home equity loans during the fourth quarter of 2004, but will reassess the program if there is an increase in short-term interest rates by the Federal Reserve Bank. At September 30, 2004, Republic clients had $220 million of home equity line balances available for funding.
Allowance and Provision for Loan Losses
The total allowance for loan losses decreased $424,000 from December 31, 2003 to $13.5 million at September 30, 2004. Management believes, based on information presently available, that it has adequately provided for loan losses at September 30, 2004.
Republic recorded a negative provision for loan losses of $127,000 during the third quarter of 2004 due primarily to low levels of charge-off activity, lower delinquency trends in the portfolio and further improvement in overall asset quality. The Company’s year to date provision for loan losses decreased from $6.4 million for the first nine months of 2003 to $1.5 million for the same period in 2004. Included in the provision for loan losses was $1.7 million for RALs during the first nine months of 2004 compared to $1.9 million for the first nine months of 2003. The overall decrease in the provision for the first nine months of 2004, exclusive of RALs, was primarily due to continued low levels of charge-offs, lower delinquency trends in the portfolio and an improvement in overall asset quality.
Table 4 - Summary of Loan Loss Experience
Allowance for loan losses at beginning of period
Charge offs:
Real estate:
Residential
(71
(131
(192
(563
(18
(1,223
Construction
(135
(8
(50
(233
(336
(662
(108
(36
(115
(39
Tax refund loans
(2
(3,403
(2,300
Recoveries:
228
114
281
1,009
1,068
35
34
63
78
98
277
263
48
26
207
1,696
450
Net loan (charge offs) / recoveries
789
(1,899
(2,886
Allowance for loan losses at end of period
Total deposits increased $104 million from December 31, 2003 to September 30, 2004 to $1.4 billion. Interest-bearing deposits increased $32 million while non interest-bearing deposits increased $72 million from December 31, 2003 to September 30, 2004.
The increase in non interest-bearing accounts relates primarily to growth in escrow, retail and commercial transaction accounts across the Company’s retail banking center network. Interest bearing accounts experienced changes across several different product lines. Increases were recorded in demand accounts, money market accounts and certificates of deposit. These increases were partially offset by a decline in internet money market accounts and brokered deposits.
Demand accounts increased $19 million primarily from promotion of the Company’s “High Interest Checking” product. Through much of 2004, this product offered a premium rate of interest with balances growing as high as $293 million. When the Federal Reserve Bank began raising short-term interest rates late in the second quarter,
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however, management began moderating the rate on this account closer to market levels. As a result, the balances in this account type began to decline in the third quarter. Management anticipates a strategy that includes continued moderation of the rate paid on this account type during the fourth quarter unless additional funds are needed to meet loan demand or for liquidity purposes.
Money market accounts, excluding internet money market accounts, increased $55 million for the first nine months of 2004. The increase in money market accounts was primarily the result of growth in the Company’s Premier First account. Premier First accounts are Commercial Cash Management’s primary product offering for medium to large business relationships. A dedicated force of six full-time sales associates promotes this product for the Company.
Internet money market accounts declined $39 million and brokered deposits declined $19 million for the first nine months of 2004. Both Internet money market accounts and brokered deposits were utilized in the first quarter of 2004 as a funding mechanism for RALs. The Internet money market accounts were accumulated beginning in the third quarter of 2003. Pricing on the product was moderated in February 2004, when funding was no longer needed to fund RALs. Since the pricing was moderated in February 2004, these accounts have decreased $43 million. The Company acquired its brokered deposits beginning in the fourth quarter of 2003. Because the funding needs for RALs are short-term in nature, a substantial portion of these brokered deposits had maturities of 3 months.
Total certificates of deposit increased $6 million during the first nine months of 2004. The Company began offering more competitive pricing on its traditional CD products as their rates became more favorable compared to Federal Home Loan Bank borrowings.
Securities Sold Under Agreements to Repurchase and Other Short-term Borrowings
Securities sold under agreements to repurchase and other short-term borrowings increased $98 million during the first nine months of 2004. The majority of this increase was related to two large cash management accounts with average balances of approximately $90 million that the Company opened during 2004.
ASSET QUALITY
Loans, including impaired loans under SFAS 114, excluding consumer loans, are placed on non-accrual status when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in the process of collection. When loans are placed on non-accrual status, all unpaid accrued interest is reversed. These loans remain on non-accrual status until the borrower demonstrates the ability to remain current or the loan is deemed uncollectible and is charged off.
Loans on non-accrual status(1)
Loans past due 90 days or more
Total non-performing loans
8,532
Other real estate owned
Total non-performing assets
8,755
Percentage of non-performing loans to total loans
0.49
Percentage of non-performing assets to total assets
0.61
(1) Loans on non-accrual status include impaired loans.
Total non-performing loans decreased to 0.49% at September 30, 2004, down from 0.82% at December 31, 2003, while the total balance of non-performing loans decreased by $4.4 million for the same period. The decrease in the non-performing loans category was primarily related to three large commercial real estate relationships totaling $3 million that paid off or paid down during 2004.
Republic defines impaired loans to be those commercial real estate loans that management has classified as doubtful (collection of total amount due is improbable) or loss (all or a portion of the loan has been written off or a specific allowance for loss has been provided) or otherwise meet the definition of impaired. Republic’s policy is to charge off all or that portion of its investment in an impaired loan upon a determination that it is probable the full amount will not be collected. Impaired loans, which are a component of loans on non-accrual status, decreased from $6.2 million at December 31, 2003 to $5.4 million at September 30, 2004. The impaired balance remained attributable to three commercial real estate lending relationships.
Republic maintains sufficient liquidity to fund loan demand and routine deposit withdrawal activity. Liquidity is managed by maintaining sufficient liquid assets in the form of investment securities. Funding and cash flows can also be realized by the sale of securities available for sale, principal paydowns on loans and MBSs and proceeds realized from loans held for sale. Republic’s banking centers and its Internet site, republicbank.com, also provide access to retail deposit markets. These retail deposits, if offered at attractive rates, have historically been a source of additional funding when needed. The Company utilized brokered deposits during 2003 and the first nine months of 2004 as an additional funding source for RALs and in part to fund loan growth.
Traditionally, the Company has also utilized borrowings from the FHLB to supplement its funding requirements. On September 30, 2004, the Company had capacity with the FHLB to borrow an additional $149 million. Republic also utilizes unsecured line of credit facilities through various financial institutions in order to meet liquidity needs. The purpose of these lines of credit is to provide short term working capital to the Holding Company and its subsidiaries, if necessary. At September 30, 2004 the Company had $135 million available through various third party sources. In the short term, management anticipates the cost of borrowing under the line of credit will be lower than the cost of accessing the capital markets to issue additional common stock.
Liquidity at the Holding Company level should also be considered separately from the consolidated liquidity since there are restrictions on the ability of the banking affiliates to distribute funds to the Holding Company. The Holding Company is defined as the Company on an unconsolidated basis. The Holding Company’s primary sources of funds are dividends and distributions from its subsidiaries, proceeds from the issuance of its common stock, and access to the capital markets.
CAPITAL
Total stockholders’ equity increased from $169 million at December 31, 2003 to $191 million at September 30, 2004. The increase in stockholders’ equity was primarily attributable to net income earned during the first nine months of 2004 and exercises of Company stock options.
Prior to 2000, Republic’s board of directors approved a Class A Common Stock repurchase program of 525,000 shares. In March 2003, the Company’s board of directors authorized management to purchase an additional 262,500 shares bringing the total shares authorized for purchase to 787,500. The repurchase program will remain effective until the number of shares authorized is repurchased or until Republic’s board of directors terminate the program. Republic repurchased 16,700 shares during the first nine months of 2004 and 10,900 during the third quarter of 2004. Through September 30, 2004, Republic has purchased 537,288 shares with a weighted-average cost of $10.14 and a total cost of $5.4 million. All amounts above have been adjusted to reflect the five percent (5%) stock dividend that was declared in the first quarter of 2004.
Regulatory Capital Requirements – The Holding Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Republic’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Holding Company and each of the Banks must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to
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qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Holding Company and each Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). As of September 30, 2004, the Holding Company, Republic Bank & Trust Company and Republic Bank & Trust Company of Indiana met all capital adequacy requirements.
The most recent notification from the FDIC categorized each Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, each Bank must maintain minimum Total Risk Based, Tier I Risk Based and Tier I Leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the banks’ capital ratings.
In March 2004, the Company received final regulatory approval to execute an intragroup trust preferred transaction, which will provide Republic Bank & Trust Company access to additional capital markets, if needed, in the future. On a consolidated basis, this transaction has had no impact to the capital levels and ratios of the total Company. The subordinated debentures held by Republic Bank & Trust Company as a result of this transaction, however, are treated as Tier 2 capital based on requirements administered by the federal banking agencies. If Republic Bank & Trust Company’s Tier I capital ratios do not meet the minimum requirement to be well capitalized, the Company can immediately modify the transaction in order to maintain its well capitalized status.
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Minimum
Requirement
To Be Well
For Capital
Capitalized Under
Adequacy
Prompt Corrective
Actual Purposes
Action Provisions
As of September 30, 2004 (dollars in thousands)
Ratio
Total Risk Based Capital (to Risk Weighted Assets)
Republic Bancorp, Inc.
204,190
13.22
123,567
8.00
154,459
10.00
Republic Bank & Trust Co.
191,876
12.72
120,685
150,856
Republic Bank & Trust Co. of Indiana
6,085
16.89
2,883
3,603
Tier I Capital (to Risk Weighted Assets)
190,655
12.34
61,784
4.00
92,676
6.00
155,309
10.30
60,342
90,513
5,667
15.73
1,441
2,162
Tier I Leverage Capital (to Average Assets)
8.28
92,142
115,177
5.00
6.84
90,873
113,591
11.64
1,947
2,433
Dividend Limitations – Kentucky banking laws limit the amount of dividends that may be paid to the Holding Company by Republic Bank & Trust Company without prior approval of the Kentucky Department of Financial Institutions. Under these laws, the amount of dividends that may be paid in any calendar year is limited to current year’s net income, combined with the retained net income of the preceding two years, less any dividends declared during those periods. At September 30, 2004, Republic Bank & Trust Company had $33 million of retained earnings, subject to capital requirements, that could be utilized for payment of dividends if authorized by its board of directors without prior regulatory approval.
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Asset/liability management control is designed to ensure safety and soundness, maintain liquidity and regulatory capital standards and achieve acceptable net interest income. Interest rate risk is the exposure to adverse changes in net interest income as a result of market fluctuations in interest rates. Management, on an ongoing basis, monitors interest rate and liquidity risk in order to implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be Republic’s most significant market risk in a fluctuating rate environment.
Republic utilizes an earnings simulation model to analyze net interest income sensitivity. Potential changes in market interest rates and their subsequent effects on net interest income are then evaluated. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis point increments. These projections are computed based on various assumptions, which are used to determine the 100 and 200 basis point increments as well as the base case (which is a 12 month projected amount) scenario. Assumptions based on growth expectations and on the historical behavior of Republic’s deposit and loan rates and their related balances in relation to changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and the application and timing of various management strategies.
The interest sensitivity profile of Republic at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and liabilities as well as their relative pricing schedules. It is also influenced by market interest rates, deposit growth, loan growth and other factors.
The following table illustrates Republic’s estimated annualized earnings sensitivity profile based on the asset/liability model for as of September 30, 2004 and December 31, 2003:
Table 7 – Interest Rate Sensitivity
Decrease in Rates
Increase in Rates
September 30, 2004(dollars in thousands)
200Basis Points
100Basis Points
Base
Projected interest income:
Short-term investments
224
235
565
895
1,288
Investments
12,687
14,104
16,515
18,595
20,677
Loans, excluding fees
94,450
98,621
104,244
109,885
115,401
107,361
112,960
121,324
129,375
137,366
Projected interest expense:
18,526
20,115
24,716
30,919
37,213
Securities sold under agreements to repurchase
3,046
3,501
6,770
10,560
14,346
16,130
16,281
16,373
16,421
16,933
37,702
39,897
47,859
57,900
68,492
69,659
73,063
73,465
71,475
68,874
Change from base
(3,806
(402
(1,990
(4,591
% Change from base
(5.18
)%
(0.55
(2.71
(6.25
December 31, 2003(dollars in thousands)
103
92
941
1,303
6,420
7,129
10,487
12,920
15,224
86,782
90,649
94,814
100,166
105,724
93,305
97,848
105,393
114,027
122,251
17,541
18,867
22,555
29,284
35,970
1,018
1,368
2,503
5,057
7,607
16,673
16,714
16,795
16,749
17,214
35,232
36,949
41,853
51,090
60,791
58,073
60,899
63,540
62,937
61,460
(5,467
(2,641
(603
(2,080
(8.60
(4.16
(0.95
(3.27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item is included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was conducted under the supervision and with the participation of Republic’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)14(c) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by Republic in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
There were no significant changes in Republic’s internal control over financial reporting that occurred during the fiscal quarter covered by this report that have materially affected or are reasonably likely to materially affect Republic’s internal control over financial reporting.
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PART II – OTHER INFORMATION
On July 27, 2004, certain Deferred Deposit customers (the “Plaintiffs”) filed suit in North Carolina requesting certification as a Class Action, seeking to enjoin one of the Company’s Marketer/Servicers from continuing to market and service deferred deposit transactions in the state of North Carolina. Other Marketer/Servicers, with whom the Company has no contractual agreement with, were also named as Defendants in separate lawsuits. The state court suit alleges that the Company’s Marketer/Servicer is not authorized to engage in payday lending operations, that it is operating in violation of several consumer protection statutes and other state law violations. The Plaintiffs seek a Declaratory Judgment that the Company’s Marketer/Servicer is unlawfully operating in North Carolina, and the Plaintiffs are seeking an injunction barring further alleged violations and an unspecified award of money damages. The Complaint specifies that the Plaintiffs do not assert claims against any bank. The Company believes that the allegations as to its Marketer/Servicer are without merit and intends to vigorously support its Marketer/Servicer in its defense of the litigation. In this regard, the Company filed a Petition for Declaratory Judgment, Order Directing Arbitration, and Injunctive Relief on September 24, 2004 in the United States District Court, Eastern District of North Carolina, Southern Division. The petition seeks to require the Plaintiffs in the North Carolina state court action to submit to arbitration and, also seeks an injunction enjoining the Plaintiffs from seeking to adjudicate any dispute in any non-arbitral forum except a small claims tribunal with jurisdiction. If the Plaintiffs were to prevail in their state court action against the Company’s North Carolina Marketer/Servicer, the Company would not be able to continue its deferred deposit business in the State of North Carolina.
A competing RAL financial institution is currently defending two lawsuits in the state of California relating to the cross-collection provision contained in its RAL contracts with customers. Both lawsuits purport to be class actions and the Plaintiffs are seeking restitution under the California Unfair Competition Act. Both lawsuits pose a serious challenge to the competing financial institution’s practice of cross-collection of delinquent RAL loans. These suits, if successful, could likely be expanded to include other financial institutions, including the Company. Additionally, the Company and other RAL financial institutions have been brought into the two California state court actions as a cross-defendant as the competing RAL financial institution is asserting that the Company may be subject to a claim of indemnity under the Company’s cross-collection agreement with the Defendant. The indemnity claim is expressly limited to the RAL products that were cross-collected for the benefit of the Company. The Company intends to vigorously defend against this claim. The outcome of the litigation against the competing RAL lender and that Lender’s subsequent claim for indemnity against the Company are not currently discernable.
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Details of Republic’s common stock repurchases during the third quarter of 2004 are included in the following table:
(In thousands, except per share data)
2004 period
Total number ofsharespurchased
Average pricepaid per share
Total sharespurchasedas part of publiclyannounced plan orprograms
Maximumnumber of sharesthat may yet bepurchasedunder the plan orprograms
July 1 – July 31
10,900
18.23
250,212
August 1 – August 30
Sept 1 – Sept 30
During the first nine months of 2004, Republic issued 1,437 shares of Class A Common Stock upon conversion of shares of Class B Common Stock by shareholders of Republic in accordance with the share-for-share conversion provision option of the Class B Common Stock. The exemption from registration of the newly issued Class A Common Stock relied upon was Section (3)(a)(9) of the Securities Act of 1933.
There were no equity securities of the registrant sold without registration during the quarter covered by this report.
There were no material changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors since the disclosure provided in Republic’s Proxy Statement filed March 2, 2004.
The following exhibits are filed or furnished as a part of this report:
Exhibit Number
Description of Exhibit
10.1
1995 Stock Option Plan (as amended to date)
10.2
Form of Stock Option Agreement for Directors and Executive Officers
31.1
Certification of Principal Executive Officer, pursuant to Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Principal Financial Officer, pursuant to Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* This certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, nor shall it be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
(Registrant)
Principal Executive Officer:
Date:
November 8, 2004
/s/ Steven E. Trager
Steven E. Trager
President & Chief Executive Officer
Principal Financial Officer:
/s/ Kevin Sipes
Kevin Sipes
Executive Vice President, Chief FinancialOfficer & Chief Accounting Officer