Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The consolidated financial statements include the accounts of Republic Bancorp, Inc. (the “Parent Company”) and its wholly-owned subsidiaries, Republic Bank & Trust Company and Republic Insurance Services, Inc. As used in this filing, the terms “Republic,” the “Company,” “we,” “our,” and “us” refer to Republic Bancorp, Inc., and, where the context requires, Republic Bancorp, Inc. and its subsidiaries. The term the “Bank” refers to the Company’s subsidiary bank: Republic Bank & Trust Company. The term the “Captive” refers to the Company’s insurance subsidiary: Republic Insurance Services, Inc. All significant intercompany balances and transactions are eliminated in consolidation.
Republic is a financial holding company headquartered in Louisville, Kentucky. The Bank is a Kentucky-based, state-chartered non-member financial institution that provides both traditional and non-traditional banking products through five reportable segments using a multitude of delivery channels. While the Bank operates primarily in its market footprint, its non-brick-and-mortar delivery channels allow it to reach clients across the U.S. The Captive is a Nevada-based, wholly-owned insurance subsidiary of the Company. The Captive provides property and casualty insurance coverage to the Company and the Bank as well, as a group of third-party insurance captives for which insurance may not be available or economically feasible.
Republic Bancorp Capital Trust is a Delaware statutory business trust that is a wholly-owned unconsolidated finance subsidiary of Republic Bancorp, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations of Republic should be read in conjunction with Part II Item 8 “Financial Statements and Supplementary Data.”
Forward-looking statements discuss matters that are not historical facts. As forward-looking statements discuss future events or conditions, the statements often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would,” “potential,” or similar expressions. Do not rely on forward-looking statements. Forward-looking statements detail management’s expectations regarding the future and are not guarantees. Forward-looking statements are assumptions based on information known to management only as of the date the statements are made and management undertakes no obligation to update forward-looking statements, except as required by applicable law.
Broadly speaking, forward-looking statements include:
● the potential impact of the COVID-19 pandemic on Company operations;
● forecasts of future economic performance; and
● descriptions of assumptions underlying or relating to any of the foregoing.
Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties, including, but not limited to the following:
● natural disasters impacting the Company’s operations;
● changes in political and economic conditions;
● equity and fixed income market fluctuations;
● client bankruptcies and loan defaults;
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● inflation;
● recession;
● future acquisitions;
● integrations of acquired businesses;
● changes in technology;
● changes in fiscal, monetary, regulatory and tax policies;
● changes in accounting standards;
● monetary fluctuations;
● changes to the Company’s overall internal control environment;
● success in gaining regulatory approvals when required;
● the Company’s ability to qualify for future R&D federal tax credits;
Accounting Standards Updates
For disclosure regarding the impact to the Company’s financial statements of ASUs, see Footnote 1 “Summary of Significant Accounting Policies” of Part II Item 8 “Financial Statements and Supplementary Data.”
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Republic’s consolidated financial statements and accompanying footnotes have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reported periods.
Management continually evaluates the Company’s accounting policies and estimates that it uses to prepare the consolidated financial statements. In general, management’s estimates and assumptions are based on historical experience, accounting and regulatory guidance, and information obtained from independent third-party professionals. Actual results may differ from those estimates made by management.
Critical accounting policies are those that management believes are the most important to the portrayal of the Company’s financial condition and operating results and require management to make estimates that are difficult, subjective and complex. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of the financial statements. These factors include, among other things, whether the estimates have a significant impact on the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including independent third parties or available pricing, sensitivity of the estimates to changes in economic conditions and whether alternative methods of accounting may be utilized under GAAP. Management has discussed each critical accounting policy and the methodology for the identification and determination of critical accounting policies with the Company’s Audit Committee.
Republic believes its critical accounting policies and estimates relate to the following:
ACLL and Provision — At December 31, 2020, the Bank maintained an ACLL for expected credit losses inherent in the Bank’s loan portfolio, which includes overdrawn deposit accounts. Management evaluates the adequacy of the ACLL monthly, and presents and discusses the ACLL with the Audit Committee and the Board of Directors quarterly.
Effective January 1, 2020, the Company adopted ASC 326 Financial Instruments – Credit Losses, which replaced the pre-January 1, 2020 “probable-incurred” method for calculating the Company’s ACL with the CECL method. CECL is applicable to financial assets measured at amortized cost, including loan and lease receivables and held-to-maturity debt securities. CECL also applies to certain off-balance sheet credit exposures.
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When measuring an ACL, CECL primarily differs from the probable-incurred method by: a) incorporating a lower “expected” threshold for loss recognition versus a higher “probable” threshold; b) requiring life-of-loan considerations; and c) requiring reasonable and supportable forecasts. The Company’s CECL method is a “static-pool” method that analyzes historical closed pools of loans over their expected lives to attain a loss rate, which is then adjusted for current conditions and reasonable, supportable forecasts prior to being applied to the current balance of the analyzed pools. Due to its reasonably strong correlation to the Company's historical net loan losses, the Company has chosen to use the U.S. national unemployment rate as its primary forecasting tool. For its CRE loan pool, the Company also uses one-year forecasts of vacancy rates for CRE in the Company’s market footprint.
Management’s evaluation of the appropriateness of the ACLL is often the most critical accounting estimate for a financial institution, as the ACLL requires significant reliance on the use of estimates and significant judgment as to the reliance on historical loss rates, consideration of quantitative and qualitative economic factors, and the reliance on a reasonable and supportable forecast.
Adjustments to the historical loss rate for current conditions include differences in underwriting standards, portfolio mix, delinquency level, or term, as well as for changes in environmental conditions, such as changes in property values or other relevant factors. One-year forecast adjustments to the historical loss rate are based on the U.S. national unemployment rate and vacancy rates for CRE in the Company’s market footprint. Subsequent to the one-year forecasts, loss rates are assumed to immediately revert back to long-term historical averages.
Prospectively, the impact of utilizing the CECL approach to calculate the ACLL will be significantly influenced by the composition, characteristics and quality of the Company’s loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the ACLL, and therefore, greater volatility to the Company’s reported earnings.
See additional detail regarding the Company’s adoption of ASC 326 and the CECL method under Footnote 1 “Summary of Significant Accounting Policies” and Footnote 4 “Loans and Allowance for Credit Losses” of Part II Item 8 “Financial Statements and Supplementary Data.”
Management’s Evaluation of the ACLL
Management evaluates the ACLL for its Core Banking operations separately from its non-traditional RPG operations. Core Banking operations consist of the Company’s Traditional Banking, Warehouse, and Mortgage Banking segments. RPG operations consist of the Company’s TRS and RCS segments.
In prior periods under the probable-incurred standard, management conducted two annual calculations to evaluate the reasonableness of its Core Bank ACLL:
Management considered these historic absorption and exhaustion formulas less meaningful at December 31, 2020 because of its January 1, 2020 CECL adoption and because Core Bank loan losses were substantially restrained during 2020 by pandemic-related financial relief provided to borrowers.
See additional detail regarding pandemic-related financial relief provided to the Bank’s loan clients under Footnote 4 “Loans and Allowance for Credit Losses” of Part II Item 8 “Financial Statements and Supplementary Data.”
Management evaluated the reasonableness of its Core Bank ACLL as of December 31, 2020 by evaluating modified absorption and exhaustion rates that account for CECL life-of-loan considerations and the economic hardship and uncertainty brought about by the COVID-19 pandemic. The modified absorption rate considered total Core Bank net loan losses from 2008 to 2013 as a percent of the end-of-year Core Bank ACLL. The modified exhaustion rate considered how many years of gross Core Bank loan charge-offs the end-of-year Core Bank ACLL could withstand based on average annual net Core Bank loan losses from 2008 to 2013. The years
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2008 to 2013 represent a six-year period during which the U.S. unemployment rate rose above 8% and the Core Bank incurred a historically high period of loan losses. Management believes Core Bank losses from 2008 to 2013 are more representative of current economic conditions than more recent years just prior to the onset of the COVID-19 pandemic. At December 31, 2020, four years represented the weighted average term of the Core Bank loan portfolio, with this term adjusted to approximately six years after exclusion of the Bank’s PPP portfolio, which is short-term and government guaranteed, and the Bank’s Warehouse portfolio, which is also generally short-term. The Core Bank’s modified absorption rate was 84% and its modified exhaustion rate was 6.1 years at December 31, 2020. Management considers these rates reasonable under current economic conditions. The table below reflects the Core Bank’s modified and standard exhaustion and absorption rates for each of the last three years:
Core Bank:
Based on management’s evaluation, a Core Bank ACLL of $52 million, or 1.11% of total Core Bank loans, was an adequate estimate of expected losses within the loan portfolio as of December 31, 2020 and resulted in Core Banking Provision for its loans of $16.7 million during 2020. This compares to an ACLL of $30 million as of December 31, 2019 and a loan Provision of $3.1 million for 2019 under the probable incurred accounting standard. If the mix and amount of future charge-off percentages differ significantly from those assumptions used by management in making its determination, an adjustment to the Core Bank ACLL and the resulting effect on the income statement could be material.
The RPG ACLL at December 31, 2020 primarily relates to loans originated and held for investment through the RCS segment. RCS generally originates small-dollar, consumer credit products. In some instances, the Bank originates these products, sells 90% of the balances within three days of loan origination, and retains a 10% interest. RCS loans typically earn a higher yield but also have higher credit risk compared to loans originated through Core Banking operations, with a significant portion of RCS clients considered subprime or near-prime borrowers.
At December 31, 2020, management evaluated the ACLL on its only active RCS product that has incurred meaningful losses since inception, its line-of-credit product. Due to the general short-term nature of this product, management utilized its traditional absorption and exhaustion calculations using 2020 charge-offs and net losses with the beginning-of-the-year ACLL. The absorption and exhaustion rates were 43% and 2.1 years, respectively, and considered reasonable.
RPG maintained an ACLL for loan products offered through its RCS segment at December 31, 2020, including its line-of-credit product and its healthcare-receivables products. At December 31, 2020, the ACLL to total loans estimated for each RCS product ranged from as low as 0.25% for its healthcare-receivables portfolio to as high as 48.96% for its line-of-credit portfolio. A lower reserve percentage was provided for RCS’s healthcare receivables at December 31, 2020, as such receivables have recourse back to the Company’s third-party service providers in the transactions. Based on management’s calculation, an ACLL of $9.0 million, or 6.7%, of total RPG loans was an adequate estimate of expected losses within the RPG portfolio as of December 31, 2020.
RPG’s TRS segment offered its EA tax-credit product during the first two months of 2020, 2019, and 2018. An ACLL for losses on EAs is estimated during the limited, short-term period the product is offered. EAs are generally repaid within 35 days of origination. Provisions for EA losses are estimated when advances are made, with all estimated provisions made in the first quarter of each year. No ACLL for EAs existed as of December 31, 2020 and 2019, as all EAs originated during the first two months of each year had either been paid off or charged-off by June 30th of each year.
Related to the overall credit losses on EAs, the Bank’s ability to control losses is highly dependent upon its ability to predict the taxpayer’s likelihood to receive the tax refund as claimed on the taxpayer’s tax return. Each year, the Bank’s EA approval model is based primarily on the prior-year’s tax refund funding patterns. Because much of the loan volume occurs each year before that year’s
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tax refund funding patterns can be analyzed and subsequent underwriting changes made, credit losses during a current year could be higher than management’s predictions if tax refund funding patterns change materially between years.
In response to changes in the legal, regulatory and competitive environment, management annually reviews and revises the EA’s product parameters. Further changes in EA product parameters do not ensure positive results and could have an overall material negative impact on the performance of the EA and therefore on the Company’s financial condition and results of operations.
See additional discussion regarding the EA product under the sections titled:
● Part I Item 1A “Risk Factors”
RPG recorded a net charge of $14.4 million, $22.7 million, and $27.8 million to the Provision during 2020, 2019, and 2018, with the Provision for each year primarily due to net losses on EAs and growth in short-term, consumer loans originated through the RCS segment. If the number of future charge-offs on EAs and RCS loans differ significantly from assumptions used by management in making its determination, an adjustment to the RPG ACLL and the resulting effect on the income statement could be material.
2019 Branch Divestiture
In July 2019, the Bank entered into a definitive agreement to sell its four banking centers located in the Kentucky cities of Owensboro, Elizabethtown, and Frankfort to Limestone Bank (“Limestone”), a subsidiary of Limestone Bancorp, Inc. The agreement provided that Limestone acquire loans, with balances of approximately $128 million as of November 15, 2019 (the “Closing Date”), and assume deposits with balances of approximately $132 million as of the Closing Date, associated with the four banking centers.
In addition to the sale of loans and assumption of deposits, Limestone also acquired substantially all of the fixed assets of these locations, which had a book value of $1.3 million as of the Closing Date. Based on the Closing Date deposits, the all-in blended premium for the transaction was 6.1% of the total deposits transferred. The final calculated premium was based on the trailing 10-day average amount of the deposits as of the Closing Date, as well as the branch location for the deposits.
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OVERVIEW
Total Company net income was $83.2 million and Diluted EPS was $3.99 for 2020, compared to net income of $91.7 million and Diluted EPS of $4.39 for 2019. Unusual or infrequently occurring items impacting Fiscal 2020 and/or Fiscal 2019 included the following:
Table 1 below presents Republic’s financial performance for the years ended December 31, 2020, 2019, and 2018:
Table 1 — Summary
Percent Increase/(Decrease)
Diluted EPS of Class A Common Stock 3.99 4.39 3.74 (9) 17
Additional discussion follows in this section of the filing under “Results of Operations.”
General highlights by reportable segment for the year ended December 31, 2020 consisted of the following:
Traditional Banking segment
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Warehouse Lending segment
● Warehouse net income increased $7.1 million, or 77%, during 2020.
● Average line usage was 66% during 2020 and 59% during 2019.
Mortgage Banking segment
Tax Refund Solutions segment
● TRS net income decreased $520,000, or 4%, during 2020.
● TRS net interest income increased $1.3 million, or 6%, during 2020.
● Net RT revenue decreased $861,000, or 4%, during 2020.
Republic Credit Solutions segment
● RCS net income increased $1.4 million, or 9%, during 2020.
● RCS net interest income decreased $7.3 million, or 24%, during 2020.
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● Noninterest income remained at $4.9 million from 2019 to 2020.
● Noninterest expense increased $1.1 million, or 44%, during 2020.
RESULTS OF OPERATIONS
This section provides a comparative discussion of Republic’s Results of Operations for the two-year period ended December 31, 2020, unless otherwise specified. Refer to Results of Operations on pages 55-68 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”) for a discussion of the 2019 versus 2018 results.
Net Interest Income
Banking operations are significantly dependent upon net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities and the interest expense on interest-bearing liabilities used to fund those assets, such as interest-bearing deposits, securities sold under agreements to repurchase, and FHLB advances. 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.
A large amount of the Company’s financial instruments track closely with or are primarily indexed to either the FFTR, Prime, or LIBOR. These market rates trended higher from December 2015 through December 2019 but moved lower again during 2020 as the FOMC reduced the FFTR by 75 basis points during the year. The FOMC has provided on-going guidance that additional changes to the FFTR will be data dependent, depending upon market conditions.
Additional increases in short-term interest rates and overall market rates are generally believed by management to be favorable to the Bank’s net interest income and net interest margin in the near term, while additional decreases in short-term interest rates and overall market rates are generally believed by management to be unfavorable to the Bank’s net interest income and net interest margin in the near term. Increases in short-term interest rates, however, could have a negative impact on net interest income and net interest margin if the Bank is unable to maintain its deposit balances and the cost of those deposits at the levels assumed in its interest-rate-risk model. In addition, a further flattening or inversion of the yield curve, causing the spread between long-term interest rates and short-term interest rates to decrease, could negatively impact the Company’s net interest income and net interest margin. Unknown variables, which may impact the Company’s net interest income and net interest margin in the future, include, but are not limited to, the actual steepness of the yield curve, future demand for the Bank’s financial products and the Bank’s overall future liquidity needs.
Total Company net interest income decreased $3.8 million, or 2%, during 2020 compared to the same period in 2019. Total Company net interest margin decreased to 4.10% during 2020 compared to 4.46% in 2019.
The most significant components affecting the total Company’s net interest income and net interest margin by reportable segment follow:
Traditional Banking segment
The Traditional Banking segment’s net interest income decreased $8.7 million, or 5%, during 2020 compared to 2019. The Traditional Banking net interest margin decreased to 3.42% for 2020 compared to 3.76% for 2019.
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The following factors primarily impacted the Traditional Bank’s net interest income and net interest margin during 2020:
For additional information on the potential future effect of changes in short-term interest rates on Republic’s net interest income, see the table titled “Bank Interest Rate Sensitivity at December 31, 2020 and 2019” under “Financial Condition.”
Warehouse Lending segment
Net interest income increased $10.2 million, or 64%, for 2020 compared to 2019. Average outstanding Warehouse balances grew from $654 million during 2019 to $813 million during 2020, as falling mortgage rates during 2020 drove a surge in consumer refinance volume for Warehouse clients. Overall, committed Warehouse lines-of-credit grew from $1.1 billion to $1.2 billion and usage rates on those lines were 59% and 66%, respectively, during the same periods.In addition, the Warehouse net interest margin increased to 3.19% for 2020 compared to 2.42% for 2019, as many of the Bank’s Warehouse client reached contractual interest rate floors on their lines-of-credit during the second quarter of 2020 preventing further declines in the segment’s loan yields, while the segment’s cost of funds continued to decline.
Warehouse Lending net interest income is greatly influenced by the overall mortgage market and the competitive environment. The Mortgage Bankers Association’s economic forecast released in January 2021 projected mortgage originations to decrease 24% across the United States from 2020 to 2021. If this economic forecast turns out to be substantially accurate, management believes that usage rates among the Bank’s Warehouse Lending clients may also decrease. This predicted decrease in mortgage volume would likely increase the competitive environment and may negatively impact the Bank’s ability to maintain its existing Warehouse Lending clients and to attract new mortgage companies to its warehouse platform, thus making it difficult to increase net interest income overall within the Warehouse Lending segment.
Tax Refund Solutions segment
TRS’s net interest income increased $1.3 million for 2020 compared to 2019. TRS’s EA product earned $19.7 million in interest income during 2020, a $557,000 increase resulting primarily from modifications to the product’s pricing tiers. EA pricing includes a direct fee to the taxpayer, with the annual percentage rate to the taxpayer for his or her portion of the total fee being less than 36% for all offering tiers.
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See additional discussion regarding the EA product under the sections titled:
● Part I Item 1A “Risk Factors”
Republic Credit Solutions segment
RCS’s net interest income decreased $7.3 million, or 24%, from 2019 to 2020. The decrease was driven primarily by a decline in fee income from RCS’s line-of-credit product. Loan fees on RCS’s line-of-credit product recorded as interest income decreased to $18.5 million during 2020 compared to $25.6 million during 2019 and accounted for 78% and 79% of all RCS interest income on loans during the periods. The decrease in loan fees was the direct result of a decline in outstanding line-of-credit balances, as the Company reduced marketing for the product in response to the COVID-19 pandemic.
Future long-term growth in interest income from RCS’s line-of-credit product is restricted by a current on-balance-sheet Board-approved risk limit of $40 million for the Company. As of December 31, 2020, the total outstanding on-balance-sheet amount, including loans held for sale, related to this product was $19 million.
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Table 2 — Total Company Average Balance Sheets and Interest Rates
Years Ended December 31,
Average Average Average Average Average Average
ASSETS
Interest-earning assets:
Noninterest-earning assets:
Net interest spread 3.87 % 4.07 % 4.32 %
Net interest margin 4.10 % 4.46 % 4.62 %
(5) Interest income includes loan fees of $8.6 million for 2020.
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Table 3 illustrates the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities impacted 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) 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 — Total Company Volume/Rate Variance Analysis
Year Ended December 31, 2020 Year Ended December 31, 2019
Compared to Compared to
Year Ended December 31, 2019 Year Ended December 31, 2018
(in thousands) Change Volume Rate Change Volume Rate
Interest income:
Interest expense:
Federal Reserve PPP Liquidity Facility 153 153 — — — —
*Volume for Easy Advances is based on total loans originated during the period presented.
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Provision
Effective January 1, 2020, the Company adopted ASC 326 Financial Instruments – Credit Losses, which replaces the pre-January 1, 2020 “probable-incurred” method for calculating the Company’s ACL with the CECL method. CECL is applicable to financial assets measured at amortized cost, including loan and lease receivables and held-to-maturity debt securities. CECL also applies to certain off-balance sheet credit exposures.
See additional detail regarding the Company’s adoption of ASC 326 and the CECL method under Footnote 1 “Summary of Significant Accounting Policies” of Part II Item 8 “Financial Statements and Supplementary Data.”
The Company recorded a Provision of $31.3 million during 2020, compared to $25.8 million in 2019. The most significant components comprising the Company’s Provision by reportable segment follow:
Traditional Banking segment
The Traditional Banking Provision during 2020 was $16.3 million compared to $2.4 million in 2019. An analysis of the Provision for 2020 compared to 2019 follows:
o the pandemic’s impact on national unemployment;
Offsetting the increase in the Provision due to the impact of the COVID-19 pandemic was a reduction in the Provision of approximately $4.4 million driven by a $274 million decrease in Traditional Bank non-PPP period-end balances during 2020.
The Provision in 2019 included the impact of a $900,000 credit upon the final settlement of the Company’s branch divestiture.
As a percentage of total loans, the Traditional Banking ACLL was 1.34% from December 31, 2020 compared to 0.78% at December 31, 2019. The Company believes, based on information presently available, that it has adequately provided for Traditional Bank loan losses at December 31, 2020.
See the sections titled “Allowance for Credit Losses” and “Asset Quality” in this section of the filing under “Financial Condition” for additional discussion regarding the Provision and the Bank’s delinquent, nonperforming, impaired, and TDR loans.
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See additional detail regarding the impact of COVID-19 under:
● Part I Item 1A “Risk Factors”
● Part II Item 8 “Financial Statements and Supplementary Data”
o Footnote 2 “Investment Securities”
o Footnote 4 “Loans and Allowance for Credit Losses”
o Footnote 13 “Off Balance Sheet Risks, Commitments, and Contingent Liabilities”
Warehouse Lending segment
The Warehouse Provision was a net charge of $613,000 for 2020 compared to a net charge of $622,000 for 2019. Provision expense for both 2020 and 2019 reflects the changes in general reserves for fluctuations in outstanding balances during the periods. Outstanding Warehouse balances increased $246 million during 2020 and $249 million during 2019.
As a percentage of total Warehouse outstanding balances, the Warehouse ACLL was 0.25% at December 31, 2020 and 2019. The Company believes, based on information presently available, that it has adequately provided for Warehouse loan losses at December 31, 2020.
Tax Refund Solutions segment
TRS recorded a net charge to the Provision of $13.2 million during 2020 compared to a net charge of $11.2 million in 2019.
The higher net charges to the Provision during 2020 resulted from EA repayment rates from the U.S. Treasury that significantly lagged those during the same period in 2019. Management believes the significant decline in repayment rates from the U.S. Treasury during 2020, particularly during the second quarter, was directly related to the impact of the COVID-19 pandemic.
TRS originated $388 million of EAs during 2020 compared to $389 million in 2019. The Company’s net loss on EAs to total EA originations for 2020 increased 62 basis points from 2019 to 3.36%. Each 0.10% in estimated loan loss reserves for EAs during 2020 equates to approximately $388,000 in Provision expense, while each 0.10% during 2019 equated to approximately $389,000.
As of December 31, 2020 and 2019, all unpaid EAs originated during each year had been charged-off.
See additional detail regarding the EA product under Footnote 4 “Loans and Allowance for Credit Losses” of Part II Item 8 “Financial Statements and Supplemental Data.”
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Republic Credit Solutions segment
RCS recorded a Provision of $1.2 million during 2020, a decrease of $10.2 million compared to same period in 2019. The decrease in the Provision was driven by a reduction in both net charge-offs and outstanding balances for RCS’s line-of-credit product, as the Company reduced marketing for RCS’s line-of-credit product in response to the COVID-19 pandemic. RCS began incrementally increasing its marketing for its line-of-credit product during the third quarter of 2020.
While RCS loans generally return higher yields, they also present a greater credit risk than Traditional Banking loan products. As a percentage of total RCS loans, the RCS ACLL was 7.94% and 12.45% at December 31, 2020 and 2019. The Company believes, based on information presently available, that it has adequately provided for RCS loan losses at December 31, 2020.
The following table presents RCS Provision by product:
Table 4 — RCS Provision by Product
Percent Increase/(Decrease)
Product:
Credit card — — 2,728 — (100)
Hospital receivables 41 55 53 (25) 4
Noninterest Income
Table 5 — Analysis of Noninterest Income
Percent Increase/(Decrease)
Net gains (losses) on other real estate owned (40) 540 729 (107) (26)
Net gain on branch divestiture — 7,829 — (100) NM
NM - Not meaningful
Total Company noninterest income increased $12.0 million, or 16%, for 2020 compared to 2019. The following were the most significant components comprising the total Company’s noninterest income by reportable segment:
Traditional Banking segment
Traditional Banking noninterest income decreased $11.1 million, or 29%, for 2020 compared to 2019. The most significant categories affecting the change in noninterest income for 2019 follow:
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Mortgage Banking segment
Within the Mortgage Banking segment, mortgage banking income increased $22.3 million, or 235%, during 2020 compared to 2019. Falling mortgage rates during 2020 drove strong growth in the Company’s consumer refinance activity, particularly within the Company’s relatively new Consumer Direct channel. Overall, the Company originated $783 million of secondary market mortgage loans during 2020 compared to $356 million for 2019.
In addition to the strong mortgage banking origination volume during 2020, the Company’s profit margin, measured as cash gains recognized as a percent of total loans sold, increased by approximately 150 basis points from 2.3% in 2019 to 3.8% in 2020. The stronger profit margin resulted from favorable market conditions on pricing during 2020. If, and when, consumer refinance volume begins to slow down in the future, management believes market conditions for pricing will become more competitive and return to a range of 2.0%-3.0%, which is more in-line with historical profit margins.
Mortgage banking income is greatly influenced by the overall mortgage market and the competitive environment. The Mortgage Bankers Association’s economic forecast released in January 2021 projected mortgage originations to decrease 24% across the United States from 2020 to 2021. If this economic forecast turns out to be substantially accurate, management believes that its mortgage banking income may also decrease. This predicted decrease in mortgage volume would likely increase the competitive environment and may negatively impact the Bank’s ability to maintain its existing origination volume and its existing profit margin on its loans sold.
Tax Refund Solutions segment
Within the TRS segment, noninterest income increased $918,000, or 4%, during 2020 compared to 2019. This increase reflected a $1.6 million increase in prepaid card program fees as a result of the Company’s May 1, 2020 acquisition of approximately $250 million in prepaid card balances offset by a $861,000 decrease in net RT fees. RTs processed decreased 8% from 2019 to 2020.
Republic Credit Solutions segment
Within the RCS segment, noninterest income remained at $4.9 million, with a $627,000 increase in program fees offset by a $659,000 decrease in other income resulting from a one-time gain recorded on discontinuation of RCS’s credit card product during 2019. RCS program fees increased primarily from $1.7 million in fees from RCS’s new installment loan product launched in December 2019 partially offset by a $1.3 million reduction in fees for RCS’s line-of-credit product. The Company reduced marketing for RCS’s installment loan and line-of-credit products during the first quarter of 2020 in response to the COVID-19 pandemic. RCS began incrementally increasing its marketing for its line-of-credit product during the third quarter of 2020.
The following table presents RCS program fees by product:
Table 6 — RCS Program Fees by Product
Percent Increase/(Decrease)
Product:
Credit card — — 1,703 — (100)
*The Company has elected the fair value option for this product, with mark-to-market adjustments recorded as a component of program fees.
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Noninterest Expense
Table 7 — Analysis of Noninterest Expense
Percent Increase/(Decrease)
FHLB advances early termination penalties 2,108 — — NM NM
Total Company noninterest expense increased $13.3 million, or 8%, during 2020 compared to 2019. The most significant components comprising the change in noninterest expense by reportable segment follow:
Traditional Banking segment
For 2020 compared to 2019, Traditional Banking noninterest expense increased $5.4 million, or 4%. The following were the most significant categories affecting the change in noninterest expense:
●Salaries and employee benefits expense increased $2.5 million, or 3%, driven primarily by annual merit increases.
Republic Credit Solutions segment
RCS noninterest expense increased $1.1 million, or 44%, during 2020 compared to 2019. The fluctuation resulted from a $700,000 contingent legal reserve reversed during the fourth quarter of 2019 due to a positive settlement of the matter.
Income Tax Expense
The Company’s effective tax rate was approximately 19% in 2020 and 2019.
See additional detail regarding the Company’s Income Tax Expense under Footnote 19 “Income Taxes” of Part II Item 8 “Financial Statements and Supplemental Data.”
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FINANCIAL CONDITION
Cash and Cash Equivalents
Cash and cash equivalents include cash, deposits with other financial institutions with original maturities less than 90 days and federal funds sold. Republic had $486 million in cash and cash equivalents at December 31, 2020 compared to $385 million at December 31, 2019. During 2019 and 2020, the Bank maintained a relatively high cash balance on its balance sheet for liquidity purposes.
For cash held at the FRB, the Bank earns a yield on amounts more than required reserves. This yield decreased from 1.55% at January 1, 2020 to 0.10% at December 31, 2020. For cash held within the Bank’s banking center and ATM networks, the Bank does not earn interest.
The Company’s Captive maintains cash reserves to cover insurable claims. Captive cash reserves totaled approximately $3 million and $3 million at December 31, 2020 and 2019.
Investment Securities
Table 8 — Investment Securities Portfolio
Available-for-sale debt securities (fair value):
U.S. Treasury securities and U.S. Government agencies — — — — 506
Mortgage backed securities - residential 99 104 132 151 158
Obligations of state and political subdivisions 356 462 463 464 —
AFS debt securities primarily consists of U.S. Treasury securities and U.S. Government agency obligations, including agency MBS and agency CMOs. The agency MBSs primarily consist of hybrid mortgage investment securities, as well as other adjustable rate mortgage investment securities, underwritten and guaranteed by the GNMA, the FHLMC and the FNMA. Agency CMOs held in the investment portfolio are substantially all floating rate securities that adjust monthly. The Bank uses a portion of the investment securities portfolio as collateral to Bank clients for SSUARs. The remaining eligible securities that are not pledged to secure client SSUARs may be pledged to the FHLB as collateral for the Bank’s borrowing line.
During 2020, the Bank purchased $299 million in investment debt securities, allocated among $54 million in MBSs and $245 million in U.S. government agencies. The mortgage-backed securities that were purchased had an expected weighted-average yield of approximately 2.02% and a weighted average expected life at purchase of 4.0 years. The U.S. Government agencies purchased had an expected weighted average yield of approximately 0.68% and a weighted average life of 3.5 years.
From 2013 to 2019, the Bank purchased various floating-rate corporate bonds. These bonds were rated “investment grade” by accredited rating agencies as of their respective purchase dates. The total fair value of the Bank’s corporate bonds represented 10%
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and 10% of the Bank’s investment portfolio as of December 31, 2020 and 2019. During 2019, one of these bonds was downgraded to BBB+ (S&P/Fitch), driving a significant decrease in the bond’s market value. As of December 31, 2020, this bond had generally recovered its lost value and reflected an unrealized gain of $43,000.
Strategies for the investment securities portfolio are influenced by economic and market conditions, loan demand, deposit mix, and liquidity needs. For the past several years, the Bank has continued to utilize a general strategy within the investment portfolio of purchasing securities with shorter-term durations. The Bank has used this general strategy for liquidity purposes and as an interest rate risk management tool in what has been a long period of historically low interest rates. Management believes the Bank will likely continue with this general strategy into the foreseeable future as market interest rates are expected to continue to rise in 2021.
Table 9 — Mortgage Backed Securities
Table 10 — Available-for-Sale Debt Securities
Weighted
Weighted Average
Amortized Fair Average Maturity in
December 31, 2020 (dollars in thousands) Cost Value Yield Years
U.S. Treasury securities and U.S. Government agencies:
Corporate bonds:
Table 11 — Held-to-Maturity Debt Securities
Weighted
Weighted Average
Carrying Fair Average Maturity in
December 31, 2020 (dollars in thousands) Value Value Yield Years
Corporate bonds:
Obligations of state and political subdivisions:
Total obligations of state and political subdivisions 356 364 1.81 1.62
Total mortgage backed securities - residential 99 104 3.76 14.06
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Loan Portfolio
Table 12 — Loan Portfolio Composition
Traditional Banking:
Residential real estate:
Paycheck Protection Program 392,319 — — — —
Consumer:
Republic Processing Group*:
Tax Refund Solutions:
Easy Advances — — — — —
* Identifies loans to borrowers located primarily outside of the Bank’s market footprint.
** Total loans are presented inclusive of premiums, discounts and net loan origination fees and costs.
Gross loans increased by $380 million, or 9%, during 2020 to $4.8 billion at December 31, 2020. The most significant components comprising the change in loans by reportable segment follow:
Traditional Banking segment
Traditional Banking loans increased $120 million, or 3%, during 2020. The following primarily drove the change in loan balances during 2020:
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Regarding the Company’s PPP loans, these loans have a stated maturity of two years, an annualized fixed coupon rate of 1.0% to the client, are 100% guaranteed by the SBA, and 100% forgivable to the client if certain program metrics are met. The Bank earns an origination fee of 1%, 3%, or 5% based on the size of the loan.
Republic carried approximately $9 million in unaccreted PPP loan fees as of December 31, 2020, which it expects to accrete into income over the remaining life of the loans. While no guarantee can be made as to the overall life of these loans, management believes the loans are likely to remain on the Company’s balance sheet less than one year, as it expects the substantial majority of its clients to request forgiveness for their loans from the SBA as soon as possible, presuming these clients achieve the required program metrics.
The Economic Aid Act was enacted in December 2020 in further response to the COVID-19 pandemic. Among other things, the Economic Aid Act provides relief to borrowers to access additional credit through the SBA's PPP program. The Bank began actively participating in the new program during the first quarter of 2021 and had funded approximately $100 million in additional PPP loans through February 19, 2021.
Warehouse Lending segment
Outstanding Warehouse loans increased $245 million from December 31, 2019 to December 31, 2020. Due to the volatility and seasonality of the mortgage market, it is difficult to project future outstanding balances of Warehouse lines of credit. As was the case in 2020, the growth of the Bank’s Warehouse Lending business greatly depends on the overall mortgage market and typically follows industry trends. Since its entrance into this business in 2011, the Bank has experienced volatility in the Warehouse portfolio consistent with overall demand for mortgage products. Weighted average quarterly usage rates on the Bank’s Warehouse lines have ranged from a low of 31% during the fourth quarter of 2013 to a high of 71% during the fourth quarter of 2019. On an annual basis, weighted average usage rates on the Bank’s Warehouse lines have ranged from a low of 40% during 2013 to a high of 66% during 2020.
Republic Credit Solutions segment
Outstanding RCS loans increased $5 million from December 31, 2019 to December 31, 2020 primarily reflecting a $16 million increase in hospital receivables partially offset by a $10 million decrease in outstanding balances for RCS’s line-of-credit product. As previously mentioned, the decrease in balances for RCS’s line-of-credit product was the direct result of a reduction in marketing for the product in response to the COVID-19 pandemic. RCS began incrementally increasing its marketing for its line-of-credit product during the third quarter of 2020.
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See additional detail regarding the impact of COVID-19 under:
● Part I Item 1A “Risk Factors”
● Part II Item 8 “Financial Statements and Supplementary Data”
o Footnote 2 “Investment Securities”
o Footnote 4 “Loans and Allowance for Credit Losses”
o Footnote 13 “Off Balance Sheet Risks, Commitments, and Contingent Liabilities”
The table below illustrates the Bank’s fixed and variable rate loan maturities:
Table 13 — Selected Loan Distribution
Over One
One Year Through Over
December 31, 2020 (in thousands) Total Or Less Five Years Five Years
Fixed rate loan maturities:
Warehouse lines of credit — — — —
Variable rate loan maturities:
Paycheck Protection Program — — — —
Lease financing receivables — — — —
Aircraft — — — —
Total: