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.
In 2005, Republic Bancorp Capital Trust, an unconsolidated trust subsidiary of Republic, was formed and issued $40 million in TPS. On September 30, 2021, as permitted under the terms of RBCT’s governing documents, Republic redeemed these securities at the par amount of approximately $40 million, without penalty. Although the TPS were treated as part of Republic’s Tier I Capital while outstanding, Republic’s capital ratios remained well above “well capitalized” levels following this redemption.
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;
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● the discontinuation of LIBOR;
● equity and fixed income market fluctuations;
● client bankruptcies and loan defaults;
● 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.”
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Selected Financial Data
The following table sets forth Republic Bancorp Inc.’s selected financial data from 2019 through 2021. This information should be read in conjunction with Part II Item 8 “Financial Statements and Supplementary Data.” Certain amounts presented in prior periods have been reclassified to conform to the current period presentation.
As of and for the Years Ended December 31,
Balance Sheet Data:
Average Balance Sheet Data:
Income Statement Data - Total Company:
Income Statement Data - Core Bank (1):
Provision for expected credit loss expense (319) 16,870 3,066
(continued)
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Selected Financial Data (continued)
As of and for the Years Ended December 31,
Per Share Data:
Period-end shares outstanding:
Basic earnings per share:
Class A Common Stock $ 4.25 $ 4.00 $ 4.41
Diluted earnings per share:
Class A Common Stock $ 4.24 $ 3.99 $ 4.39
Cash dividends declared per share:
Performance Ratios:
Return on average assets 1.38 % 1.38 % 1.64 %
Efficiency ratio (3) 59 58 57
Yield on average interest-earning assets 3.85 4.45 5.30
Cost of average interest-bearing liabilities 0.18 0.58 1.23
Cost of average deposits (4) 0.10 0.33 0.75
Net interest margin - Total Company 3.75 4.10 4.46
Net interest margin - Core Bank 3.20 3.39 3.61
Capital Ratios - Total Company:
Average stockholders’ equity to average total assets 13.41 % 13.35 % 13.16 %
Dividend payout ratio 29 29 24
Other Information:
Period-end FTEs - Core Bank 958 997 997
Number of banking centers 42 42 41
(continued)
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Selected Financial Data (continued)
As of and for the Years Ended December 31,
Credit Quality Data and Ratios:
Credit Quality Asset Balances:
Nonperforming Assets - Total Company:
Loans past due 90-days-or-more and still on accrual 48 47 157
Nonperforming Assets - Core Bank (1):
Loans past due 90-days-or-more and still on accrual 1 5 —
Delinquent loans:
Credit Quality Ratios - Total Company:
Nonaccrual loans to total loans 0.46 0.49 0.53
ACLL to nonaccrual loans 315 259 186
Nonperforming loans to total loans 0.46 0.49 0.53
Nonperforming assets to total loans (including OREO) 0.50 0.54 0.53
Nonperforming assets to total assets 0.37 0.42 0.42
ACLL to nonperforming loans 314 259 185
Delinquent loans to total loans (7) 0.30 0.41 0.47
Net loan charge-offs to average loans 0.25 0.42 0.61
Credit Quality Ratios - Core Bank:
ACLL to total loans 1.18 % 1.11 % 0.70 %
Nonaccrual loans to total loans 0.47 0.50 0.54
ACLL to nonaccrual loans 251 221 129
Nonperforming loans to total loans 0.47 0.50 0.54
Nonperforming assets to total assets 0.40 0.45 0.43
ACLL to nonperforming loans 251 221 129
Delinquent loans to total loans 0.17 0.21 0.30
Net charge-offs to average loans 0.01 0.03 0.11
See Footnote 25 “Segment Information” under Part II Item 8 “Financial Statements and Supplemental Data” for additional information regarding the segments that constitute the Company’s Core Banking operations.
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Selected Financial Data (continued)
Less: Core deposit intangible — 189 469
Less: Core deposit intangible — 189 469
Book value per share - GAAP (a/e) $ 41.75 $ 39.40 $ 36.49
Tangible book value per share - Non-GAAP (c/e) 40.48 38.27 35.41
Less: Net gain on branch divestiture — — 7,829
Less: Net gain (loss) on securities (69) 49 78
Efficiency Ratio - Non-GAAP (b/a) 59 % 58 % 57 %
(5) FTEs – Full-time-equivalent employees.
(6) RPG operations consist of the TRS and RCS segments.
Critical Accounting 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
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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 — As of December 31, 2021, 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.
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 employed a one-year forecast of CRE vacancy rates through March 31, 2021 but discontinued use of this forecast during the second quarter of 2021 in favor of a one-year forecast of general CRE values. This change in forecast method had no material impact on the Company’s ACLL.
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 or term, delinquency level, 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 CRE values. Subsequent to the one-year forecasts, loss rates are assumed to immediately revert back to long-term historical averages.
The impact of utilizing the CECL approach to calculate the ACLL is 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 4 “Loans and Allowance for Credit Losses” of Part II Item 8 “Financial Statements and Supplementary Data.”
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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.
Prior to January 1, 2020, 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 as of December 31, 2021 and 2020 because of its January 1, 2020 CECL adoption and because Core Bank loan losses were substantially restrained during 2021 and 2020 by pandemic-related financial relief provided to borrowers.
Management evaluated the reasonableness of its Core Bank ACLL as of December 31, 2021 and 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 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 relative to an average year of loan losses for the Core Bank. 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.
As of December 31, 2021, the weighted average term of the Core Bank loan portfolio was approximately five years, with this term adjusted to approximately six years after exclusion of the Bank’s short-term/government-guaranteed PPP portfolio and the Bank’s short-term Warehouse portfolio. The Core Bank’s modified absorption rate was 85% and its modified exhaustion rate was approximately 6.0 years as of December 31, 2021. 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 1.18% of total Core Bank loans, was an adequate estimate of expected losses within the loan portfolio as of December 31, 2021 and resulted in Core Banking Provision for its loans of a net credit of $319,000 during 2021. This compares to an ACLL of $52 million as of December 31, 2020 and a loan Provision of $16.9 million for 2020. 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.
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The RPG ACLL as of December 31, 2021 primarily related 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%-95% of the balances within three days of loan origination, and retains a 5%-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.
As of December 31, 2021, management only evaluated the ACLL on its active RCS products that had incurred meaningful losses since their inception, which were its line-of-credit products. Due to the general short-term nature of these products, management utilized its traditional absorption and exhaustion calculations using 2021 net charge-offs with the beginning-of-the-year ACLL. The absorption and exhaustion rates were 32% and 2.8 years, respectively, both of which were considered reasonable.
RPG maintained an ACLL for all the loan products held at amortized cost and offered through its RCS segment as of December 31, 2021, including its line-of-credit products and its healthcare-receivables products. As of December 31, 2021, the ACLL to total loans estimated for each RCS product ranged from as low as 0.25% for its healthcare-receivables portfolios to as high as 48.96% for its line-of-credit portfolios. A lower reserve percentage was provided for RCS’s healthcare receivables as of December 31, 2021, 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 $13.0 million, or 9.1%, of total RPG loans was an adequate estimate of expected losses within the RPG portfolio as of December 31, 2021.
RPG’s TRS segment offered its EA tax-credit product during the first two months of 2021, 2020, and 2019. An ACLL for losses on EAs is estimated during the limited, short-term period the product is offered. EAs were repaid, on average, within 32 days of origination during 2021. Provisions for EA losses are estimated when advances are made during the first quarter of each year and adjusted to actual net charge-offs as of June 30th of each year. No ACLL for EAs existed as of December 31, 2021 and 2020, 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 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 $15.1 million, $14.4 million, and $22.7 million to the Provision during 2021, 2020, and 2019, 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.
Cancelled TRS Sale Transaction
See Footnote 1 “Summary of Significant Accounting Policies” of Part II Item 8 “Financial Statements and Supplementary Data” for discussion regarding the cancelled sale of the TRS business and associated litigation.
In connection with the litigation the Bank filed in Delaware Chancery court, the Bank concluded that the Sale Transaction would not be consummated, and on January 7, 2022, the Bank served Green Dot with a formal notice of termination of the Purchase Agreement pursuant to Section 7.1(c) of the Purchase Agreement. In response to the formal notice of termination, Green Dot paid the Termination Fee of $5 million to the Bank during the first quarter of 2022 pursuant to Section 7.2(b) of the Purchase Agreement. As
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provided by Section 7.2(a) of the Purchase Agreement, the Bank maintains that the Bank’s notice of termination of the Purchase Agreement and corresponding payment of the Termination Fee does not release Green Dot from any liability, in addition to the Termination Fee, related to the Sale Transaction occurring before the Bank’s notice of termination. The Bank believes that Green Dot’s actions have adversely affected the TRS operations, and the Bank is currently determining the extent of its damages. The Bank will continue to seek the additional monetary damages and equitable relief arising from Green Dot’s actions in the litigation before the Court.
OVERVIEW
Total Company net income was $86.8 million and Diluted EPS was $4.24 for 2021, compared to net income of $83.2 million and Diluted EPS of $3.99 for 2020. Table 1 below presents Republic’s financial performance for the years ended December 31, 2021, 2020, and 2019:
Table 1 — Summary
Percent Increase/(Decrease)
Diluted EPS of Class A Common Stock 4.24 3.99 4.39 6 (9)
Additional discussion follows in this section of the filing under “Results of Operations.”
General highlights by reportable segment for the year ended December 31, 2021 consisted of the following:
Traditional Banking segment
● Traditional Banking net income increased $15.7 million or 78%.
● Noninterest income increased $4.1 million, or 15% during 2021.
● Noninterest expense decreased $3.7 million, or 2% during 2021.
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Warehouse Lending segment
● Average line usage was 53% during 2021 and 66% during 2020.
Mortgage Banking segment
Tax Refund Solutions segment
● TRS net interest income decreased $7.1 million, or 31%, from 2020 to 2021.
● Net RT revenue decreased $49,000, or less than 1%, from 2020 to 2021.
Republic Credit Solutions segment
● RCS net income decreased $2.3 million, or 13%, from 2020 to 2021.
● RCS net interest income decreased $1.4 million, or 6%, from 2020 to 2021.
● The RCS Provision was $8.4 million for 2021 compared to $1.2 million for 2020.
● Noninterest expense increased $283,000, or 8%, during 2021.
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RESULTS OF OPERATIONS
This section provides a comparative discussion of Republic’s Results of Operations for the two-year period ended December 31, 2021, unless otherwise specified. Refer to Results of Operations on pages 52-61 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”) for a discussion of the 2020 versus 2019 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 lower with the onset of the COVID-19 pandemic during 2020, as the FOMC reduced the FFTR to approximately 25 basis points during 2020. With the rise of inflation during the latter half of 2021, the FOMC has signaled a more aggressive and hawkish approach to its monetary policies over the next few years. Included in its expected actions is raising the FFTR multiple times, ending its quantitative easing program of buying certain types of bonds in the open market, and implementing a quantitative tightening program by reducing the size of its balance sheet and selling certain types of bonds in the market.
The FOMC’s signaling of these actions caused long-term market interest rates for bonds and loans to begin to rise rapidly during the last quarter of 2021 and the first few weeks of 2022. Further monetary tightening by the Federal Reserve in the future will likely cause both short-term and long-term market interest rates to increase during 2022 and beyond. Increases in market interest rates are expected to impact the various business segments of the Company differently and will be discussed in further detail in the sections below.
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 as of December 31, 2021 and 2020” under “Financial Condition.”
Total Company net interest income decreased $11.7 million, or 5%, during 2021 compared to the same period in 2020. Total Company net interest margin decreased to 3.75% during 2021 compared to 4.10% in 2020.
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 $2.1 million, or 1%, during 2021 compared to 2020. The Traditional Banking net interest margin decreased to 3.18% for 2021 compared to 3.42% for 2020.
The following factors primarily impacted the Traditional Bank’s net interest income and net interest margin during 2021:
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As of December 31, 2021, net PPP loans of $56 million remained on the Traditional Bank’s balance sheet, including $15 million in loan balances originated during 2020, $42 million in loan balances originated during 2021, and $1 million of unaccreted PPP fees reported as a credit offset to these originated balances. Unaccreted PPP fees will generally be recognized into income over the estimated remaining life of the PPP portfolio, with fee recognition accelerated if loans are forgiven or repaid earlier than estimated.
The Company earns fees and a coupon interest rate of 1.0% on its PPP portfolio. Due to the short-term nature of the PPP, management believes Traditional Bank net interest income, excluding PPP fees and coupon interest, is a more appropriate measure to analyze the challenges within the Traditional Bank’s net interest income and net interest margin. The following table reconciles Traditional Bank net interest income and net interest margin to Traditional Bank net interest income and net interest margin, excluding PPP fees and interest, a non-GAAP measure.
Table 2 — Traditional Bank Net Interest Income and Net Interest Margin Excluding PPP (Non-GAAP)
Net Interest Income Interest-Earning Assets Net Interest Margin
As previously disclosed, both short-term and long-term market interest rates are expected to increase during 2022 and beyond as a result of expected monetary tightening by the FOMC. Additional increases in short-term interest rates and overall market rates are generally believed by management to be favorable to the Traditional 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 Traditional Bank’s net interest income and net interest margin in the near term.
Increases in market interest rates, however, could have a negative impact on net interest income and net interest margin if the Traditional 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 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 Traditional Bank’s net interest income and net interest margin. Variables which may impact the Traditional Bank’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 Traditional Bank’s financial products and the Traditional Bank’s overall future liquidity needs.
Warehouse Lending segment
Net interest income decreased $739,000, or 3%, for 2021 compared to 2020. Average outstanding Warehouse balances decreased from $813 million during 2020 to $748 million during 2021, as falling mortgage rates during 2020 drove a surge in consumer refinance volume for Warehouse clients. Overall, committed Warehouse lines-of-credit grew from $1.2 billion in 2020 to $1.4 billion in 2021, while usage rates on those lines were 66% and 53%, respectively, during the same periods.In addition, the Warehouse net interest margin increased to 3.37% for 2021 compared to 3.19% for 2020, as many of the Bank’s Warehouse clients reached contractual interest rate floors on their lines-of-credit during the second quarter of 2021, preventing further declines in the segment’s loan yields, while the segment’s cost of funds continued to decline.
Market interest rates for treasury bonds and mortgages began to rise rapidly, however, during the last quarter of 2021 and the first few weeks of 2022. With the rise in mortgage rates, mortgage refinance activity began to slow dramatically late in the fourth quarter of 2021, and as a result, Warehouse usage began to decline, as well. This decline in usage, combined with competitive pricing pressures, caused the Warehouse net interest income and net interest margin to decline meaningfully during the fourth quarter of 2021. Additional monetary tightening by the FOMC in 2022 will likely further decrease mortgage demand and Warehouse line usage and increase competitive pressures to the Warehouse segment. These factors are expected to cause a further decline in net interest income
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and the net interest margin for the Warehouse segment during 2022. The exact amount of the decline in net interest income and net interest margin is unable to be predicted at this time.
Tax Refund Solutions segment
TRS’s net interest income decreased $7.1 million from 2020 to 2021. TRS’s EA product earned $13.2 million in interest income during 2021, a $6.4 million decrease from 2020 resulting primarily from a $138 million decrease in EA originations from period to period. Management believes that economic impact (stimulus) payments, pandemic health risks, and a two-week delay in the start to the 2021 tax season, all, in varying degrees, negatively impacted demand for its EA product during 2021.
See additional discussion regarding the EA product under the sections titled:
● Part I Item 1A “Risk Factors”
Overall product demand for the TRS segment is not assumed to be interest rate sensitive and therefore management does not believe a rising interest rate environment will impact demand for its Easy Advances. A rising interest rate environment, however, likely will impact the Company’s internal FTP benefit and FTP cost allocated to each of its business segments, which could impact the overall profitability of a business segment. The impact of rising interest rates to TRS could be positive or negative depending on the exact change in the internal FTP benefit and FTP cost assigned, as well as, the overall volume and mix of loans and deposits for the segment.
Republic Credit Solutions segment
RCS’s net interest income decreased $1.4 million, or 6%, from 2020 to 2021. The decrease was driven primarily by a decline in fee income from RCS’s LOC I product. Loan fees on this product, recorded as interest income on loans, decreased to $16.2 million during 2021 compared to $18.5 million during the same period in 2020 and accounted for 75% and 78% of all RCS interest income on loans during the periods. The decrease in loan fees was the direct result of a decline in balances for RCS’s LOC I product following a reduction of marketing for this product during the second and third quarters of 2020. While the marketing for this product was reinstated during the fourth quarter of 2020, management believes the ongoing impact of government stimulus payments continued to reduce demand for this product during the first six months of 2021. Demand for the product began returning closer to historical norms during the latter half of 2021.
Future loan fee income from RCS’s LOC I product will likely continue to be negatively impacted by the on-going COVID-19 pandemic and any related stimulus programs implemented by the federal government.
Overall product demand for the RCS segment is not assumed to be interest rate sensitive and therefore management does not believe a rising interest rate environment will impact demand for its various consumer loan products. A rising interest rate environment, however, likely will impact the Company’s internal FTP cost allocated to this segment. As a result, the impact of rising interest rates to RCS during 2022 will be negative to the segment’s financial results, although the exact amount of the negative impact will depend on the internal FTP cost assigned, as well as, the overall volume and mix of loans it generates.
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Table 3 — 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 3.67 % 3.87 % 4.07 %
Net interest margin 3.75 % 4.10 % 4.46 %
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Table 4 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 4 — Total Company Volume/Rate Variance Analysis
Year Ended December 31, 2021 Year Ended December 31, 2020
Compared to Compared to
Year Ended December 31, 2020 Year Ended December 31, 2019
(in thousands) Change Volume Rate Change Volume Rate
Interest income:
Interest expense:
Federal Reserve PPP Liquidity Facility (153) (153) — 153 153 —
*Since interest income for Easy Advances is composed entirely of loan fees and EAs are only offered during the first two months of each year, volume and rate measurements for this product are based on total EAs originated instead of average EA balances during the period. EA originations totaled $250 million, $388 million, and $389 million for the years ended December 31, 2021, 2020, and 2019. The unannualized EA yield as a function of total EA originations was 5.28%, 5.07%, and 4.91% for the years ended December 31, 2021, 2020, and 2019.
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Provision
The Company recorded a Provision of $14.8 million during 2021 compared to $31.3 million in 2020. The most significant components comprising the Company’s Provision by reportable segment follow:
Traditional Banking segment
The Traditional Banking Provision during 2021 was a net credit of $38,000 compared to a net charge of $16.3 million for 2020. An analysis of the Provision for 2021 compared to the same period in 2020 follows:
As a percentage of total Traditional Bank loans, the Traditional Bank ACLL was 1.41% as of December 31, 2021 compared to 1.34% as of December 31, 2020. Traditional Bank ACLL to total non-PPP Traditional Bank loans, a non-GAAP measure, was 1.43% as of December 31, 2021 compared to 1.50% as of December 31, 2020. The Company believes, based on information presently available, that it has adequately provided for Traditional Bank loan losses as of December 31, 2021.
Due to the near risk-free nature of the Bank’s PPP portfolio, management believes Traditional Bank ACLL to total non-PPP Traditional Bank loans is a more appropriate measure to analyze the Traditional Bank’s ACLL adequacy. The following table reconciles Traditional Bank ACLL to total Traditional Bank loans to Traditional Bank ACLL to total non-PPP Traditional Bank loans, a non-GAAP measure.
Table 5 — Traditional Bank ACLL to Non-PPP Traditional Bank Loans (Non-GAAP)
Years Ended December 31,
Allowance Allowance
Less: Paycheck Protection Program 56,014 — 392,319 —
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.
Warehouse Lending segment
The Warehouse Provision was a net credit of $281,000 for 2021 compared to a net charge of $613,000 for 2020. Provision expense for both 2021 and 2020 reflected the changes in general reserves for fluctuations in outstanding balances during the periods. Outstanding Warehouse balances decreased $112 million during 2021 and increased $246 million during 2020.
As a percentage of total Warehouse outstanding balances, the Warehouse ACLL was 0.25% as of December 31, 2021 and 2020. The Company believes, based on information presently available, that it has adequately provided for Warehouse loan losses as of December 31, 2021.
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Tax Refund Solutions segment
TRS recorded a net charge to the Provision of $6.7 million during 2021 compared to a net charge of $13.2 million in 2020.
TRS’s Provision for EA loan losses was $6.7 million, or 2.69% of its $250 million in EAs originated during 2021, compared to a Provision of $13.0 million, or 3.36% of its $388 million in EAs originated during 2020. The lower Provision during 2021 resulted from a $138 million decrease in EAs originated and better repayment rates on EA loans from the U.S. Treasury over those attained during 2020. Management believes that economic impact (stimulus) payments, pandemic health risks, and a two-week delay in the start to the 2021 tax season, all, in varying degrees, negatively impacted demand for its EA product during 2021. Management also believes the better repayment rates in 2021 as compared to 2020 were a result of the negative impact of the COVID-19 pandemic to the 2020 payments’ process. As of December 31, 2021 and 2020, 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.”
Republic Credit Solutions segment
RCS recorded a Provision of $8.4 million during 2021, an increase of $7.2 million compared to 2020. The increase in the Provision was driven by an increase in outstanding balances for RCS’s lines of credit during 2021 compared to a decrease in similar balances during 2020. The Company reduced marketing for its LOC I product during the second and third quarters of 2020 and reinstated such marketing during the fourth quarter of 2020. While management believes the ongoing impact of government stimulus payments continued to reduce demand for this product during the first six months of 2021, demand for the product began returning closer to historical norms during the latter half of 2021.
The Company began offering its LOC II product during the first quarter of 2021.
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 13.91% and 7.94% as of December 31, 2021 and 2020. The Company believes, based on information presently available, that it has adequately provided for RCS loan losses as of December 31, 2021.
The following table presents RCS Provision by product:
Table 6 — RCS Provision by Product
Percent Increase/(Decrease)
Product:
Hospital receivables (65) 41 55 (259) (25)
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Noninterest Income
Table 7 — Analysis of Noninterest Income
Percent Increase/(Decrease)
Net gain on branch divestiture — — 7,829 NM (100)
NM - Not meaningful
Total Company noninterest income decreased $194,000 for 2021 compared to 2020. The following were the most significant components comprising the total Company’s noninterest income by reportable segment:
Traditional Banking segment
Traditional Banking noninterest income increased $4.1 million, or 15%, for 2021 compared to 2020. Service Charges on Deposit Accounts increased $935,000 from 2020 to 2021, while Interchange Fee Income increased $1.8 million comparing the same years. Service Charges on Deposit Accounts were below normal levels during 2020, as a pandemic-driven rise in the consumer savings rate drove a reduction in the Bank’s overdraft-related fees. Both Interchange Fee Income and Service Charges on Deposits began to trend upward during the first quarter of 2021, following the removal of pandemic-related restrictions.
The Bank earns a substantial majority of its fee income related to its overdraft service program from the per item fee it assesses its customers for each insufficient-funds check or electronic debit presented for payment. The total per item fees, net of refunds, included in service charges on deposits for 2021 and 2020 were $5.6 million and $5.5 million. The total daily overdraft charges, net of refunds, included in interest income in 2021 and 2020 were $1.1 million and $809,000. The Bank suspended its daily overdraft charges during the first eight months of 2020 to help mitigate the economic hardship of the COVID-19 pandemic on its clients. The Bank reinstituted the charging of its daily overdraft fee on September 1, 2020.
Mortgage Banking segment
Within the Mortgage Banking segment, mortgage banking income for 2021 decreased $11.9 million, or 37%, compared to 2020.For 2021, the Core Bank sold $718 million in secondary market loans and achieved an average gain-as-a-percent-of-loans-sold during the year of 3.22%, with comparable originations of $788 million and comparable gains of 3.64% during 2020. Favorable market conditions drove historically high gain percentages for the Core Bank and the mortgage industry, in general, during the last nine months of 2020 and into January 2021. These favorable conditions began to normalize during February 2021 causing the Core Bank’s gain-as-a-percent-of-loans-sold to trend toward more normal historical levels at or near 2.50%.
With the rise of inflation during the latter half of 2021, the FOMC has signaled a more aggressive and hawkish approach to its monetary policies over the next few years. Included in its expected actions is raising the FFTR multiple times, ending its quantitative easing program of buying certain types of bonds in the open market, and implementing a quantitative tightening program by reducing the size of its balance sheet and selling certain types of bonds in the market. The FOMC’s signaling of these actions caused market interest rates for treasury bonds and mortgages to begin to rise rapidly during the last quarter of 2021 and the first few weeks of 2022. With the rise in mortgage rates, mortgage refinance activity began to slow dramatically late in the fourth quarter of 2021, and as a result, mortgage origination volume began to decline significantly. Further monetary tightening by the FOMC in 2022 will likely further decrease mortgage demand. In addition, a decrease in mortgage demand across the mortgage industry could also cause competitive pricing pressure on the Bank to lower its mortgage pricing in order to maintain higher volumes, causing its cash-gains-as-
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a-percentage-of-loans-sold to decline. The Bank will likely experience decreased Mortgage Banking revenue during 2022 due to expected rising market interest rates and strong industry competition and pricing pressures.
Tax Refund Solutions segment
Within the TRS segment, noninterest income increased $1.0 million, or 4%, during 2021 compared to 2020. This increase primarily reflected a $978,000 increase in prepaid card program fees. Prepaid card program fees benefited from government stimulus payments during 2021 and a full year’s benefit of the Company’s May 1, 2020 assumption of approximately $250 million in prepaid card balances.
Republic Credit Solutions segment
Within the RCS segment, noninterest income increased $6.4 million, with program fees representing the entirety of RCS’s noninterest income. Pandemic-driven restrictions negatively impacted RCS program fees during 2020, with those program fees beginning to normalize during 2021 following the removal of the pandemic-driven restrictions.
The following table presents RCS program fees by product:
Table 8 — RCS Program Fees by Product
Percent Increase/(Decrease)
Product:
*The Company has elected the fair value option for this product, with mark-to-market adjustments recorded as a component of program fees.
Noninterest Expense
Table 9 — Analysis of Noninterest Expense
Percent Increase/(Decrease)
State and local bank franchise tax expense 1,329 5,369 5,293 (75) 1
FHLB advances early termination penalties — 2,108 — NM NM
Total Company noninterest expense decreased $3.2 million, or 2%, during 2021 compared to 2020. The most significant components comprising the change in noninterest expense by reportable segment follow:
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Traditional Banking segment
For 2021, compared to 2020, Traditional Banking noninterest expense decreased $3.7 million, or 2%. The following were the most significant categories affecting the change in noninterest expense:
Tax Refund Solutions segment
TRS noninterest expense decreased $1.2 million, or 7%, during 2021 compared to 2020. The decline resulted primarily from a $1.5 million decrease in allocated bank franchise tax expense.
See additional detail regarding the Bank’s lawsuit against Green Dot under Footnote 1 “Summary of Significant Accounting Policies” of Part II Item 8 “Financial Statements and Supplemental Data.”
Income Tax Expense
The Company’s effective tax rate was approximately 21% in 2021 and 19% in 2020.
The following items provided $2.4 million in federal income tax benefits during 2021 and drove the Total Company’s federal effective tax rate for that period lower than the federal corporate tax rate of 21%. However, the overall Total Company’s combined federal and state effective tax rate was 21.34%, which was higher than previous years due to the Kentucky corporate income tax filing requirement beginning in 2021.
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The following items provided $3.1 million in federal income tax benefits during 2020 and drove the Total Company’s effective tax rate for that period lower than the federal corporate tax rate of 21%:
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.”