Item 1. Business.
Republic Bancorp, Inc. (“Republic” or the “Company”) is a financial holding company headquartered in Louisville, Kentucky. Republic is the parent company of Republic Bank & Trust Company (“RB&T” or the “Bank”) and Republic Insurance Services, Inc. (the “Captive”). The Bank is a Kentucky-based, state chartered non-member financial institution that provides both traditional and non-traditional banking products through four distinct operating 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 United States. The Captive is a Nevada-based, wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and the Bank as well as 10 other 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 100%-owned unconsolidated finance subsidiary of Republic Bancorp, Inc.
As of December 31, 2016, Republic had 44 full-service banking centers with locations as follows:
Kentucky - 32
Metropolitan Louisville - 19
Central Kentucky - 8
Elizabethtown - 1
Frankfort - 1
Georgetown - 1
Lexington - 4
Shelbyville - 1
Western Kentucky - 2
Owensboro - 2
Northern Kentucky - 3
Covington - 1
Florence - 1
Independence - 1
Southern Indiana - 3
Floyds Knobs - 1
Jeffersonville - 1
New Albany - 1
Metropolitan Tampa, Florida - 6
Metropolitan Cincinnati, Ohio - 1
Metropolitan Nashville, Tennessee - 2
Republic’s headquarters are located in Louisville, which is the largest city in Kentucky based on population.
The principal business of Republic is directing, planning and coordinating the business activities of the Bank. The financial condition and results of operations of Republic are primarily dependent upon the results of operations of the Bank. At December 31, 2016, Republic had total assets of $4.8 billion, total deposits of $3.2 billion and total stockholders’ equity of $604 million. Based on total assets as of December 31, 2016, Republic ranked as the largest Kentucky-based financial holding company. The executive offices of Republic are located at 601 West Market Street, Louisville, Kentucky 40202, telephone number (502) 584-3600. The Company’s website address is www.republicbank.com.
Website Access to Reports
The Company makes its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, available free of charge through its website, www.republicbank.com, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. The information provided on the Company’s website is not part of this report, and is therefore not incorporated by reference, unless that information is otherwise specifically referenced elsewhere in this report.
General Business Overview
As of December 31, 2016, the Company was divided into four distinct operating segments: Traditional Banking, Warehouse Lending (“Warehouse”), Mortgage Banking and Republic Processing Group (“RPG”). Management considers the first three segments to collectively constitute “Core Bank” or “Core Banking” activities. Correspondent Lending operations and the Company’s national branchless banking platform, MemoryBank®, are considered part of the Traditional Banking segment. The RPG segment includes the following divisions: Tax Refund Solutions (“TRS”), Republic Payment Solutions (“RPS”) and Republic Credit Solutions (“RCS”). TRS generates the majority of RPG’s income, with the relatively smaller divisions of RPG, RPS and RCS, considered immaterial for separate and independent segment reporting. All divisions of the RPG segment operate through the Bank.
Net income, total assets and net interest margin by business segment for the years ended December 31, 2016, 2015 and 2014 are presented below:
Segment assets are reported as of the respective period ends while income and margin data are reported for the respective periods. 		
NM - Not Meaningful
For expanded segment financial data see Footnote 24 “Segment Information” of Part II Item 8 “Financial Statements and Supplementary Data.”
(I) Traditional Banking segment
Acquisition of Cornerstone Bancorp, Inc.
On May 17, 2016, the Company completed its acquisition of Cornerstone Bancorp, Inc. (“Cornerstone”), and its wholly-owned bank subsidiary Cornerstone Community Bank (“CCB”), for approximately $32 million in cash. The primary reason for the acquisition of Cornerstone was to expand the Company’s footprint in the Tampa, Florida metropolitan statistical area.
For additional information concerning the Company’s acquisition of Cornerstone Bancorp, Inc., see Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
MemoryBank
In October 2016, the Bank opened the “digital doors” of MemoryBank, a national branchless banking platform. MemoryBank is a separately branded division of the Bank, which from a marketing perspective, focuses on technologically savvy customers that prefer to carry larger balances in highly-liquid bank accounts.
Additional MemoryBank features include the following:
·
Higher Returns: MemoryBank’s initial product, the EarnMore account, offers a 1.0% Annual Percentage Yield plus an additional 0.50% bonus on all deposits for the first year to qualifying customers, with no minimum balance to begin earning.
·
FDIC Insurance: As a division of RB&T, MemoryBank provides its account holders the peace of mind that comes with their accounts being Federal Deposit Insurance Corporation (“FDIC”) insured up to the applicable limit.
·
Universal Access: MemoryBank clients have access to over 75,000 surcharge-free automated teller machines (“ATMs”) in the United States. In addition, MemoryBank customers also have access to over 10,000 international surcharge-free ATMs.
·
Password-free login: Eyeprint and fingerprint identification offer secure smart device login without the hassle of a password.
·
Mobile deposits: MemoryBank customers can take a picture of a check with a mobile device to direct deposit into their MemoryBank account.
With the launch of MemoryBank in October 2016, the Traditional Banking segment began marketing the EarnMore deposit account to customers outside of its traditional market footprint under its MemoryBank brand. As of December 31, 2016 and through the date of this filing, generally all Traditional Banking products and services, except for the EarnMore deposit account, were offered through the Company’s traditional RB&T brand.
Lending Activities
The Bank’s principal lending activities consists of the following:
Retail Mortgage Lending - Through its retail banking centers, its Correspondent Lending channel and its Internet Banking channel, the Bank originates single family, residential real estate loans. In addition, the Bank originates home equity amortizing loans (“HEALs”) and home equity lines of credit (“HELOCs”) through its retail banking centers. Such loans are generally collateralized by owner occupied property. During 2016, the Bank continued to market its HELOCs utilizing a promotional rate product. Under the terms of the promotional product during 2016, clients received a fixed interest rate for the first 12 months with no upfront closing costs. When the promotional rate expires after 12 months, rates are adjusted to an index based on the New York Prime Rate (“Prime”).
For those loans originated through the Bank’s retail banking centers, the collateral is predominately located in the Bank’s market footprint, while loans originated through the Correspondent Lending channel and Internet Banking are generally secured by owner occupied collateral located outside of the Bank’s market footprint.
The Bank offers single family, first lien residential real estate, adjustable rate mortgages (“ARM”s) with interest rate adjustments tied to various market indices with specified minimum and maximum adjustments. The Bank generally charges a higher interest rate for its ARMs if the property is not owner occupied. The interest rates on the majority of ARMs are adjusted after their fixed rate periods on an annual basis, with most having annual and lifetime limitations on upward rate adjustments to the loan. These loans typically feature amortization periods of up to 30 years and have fixed interest rate periods generally ranging from five to ten years, with demand dependent upon market conditions. In general, ARMs containing longer fixed rate periods have historically been more attractive to the Bank’s clients in a relatively low rate environment, while ARMs with shorter fixed rate periods have historically been more attractive to the Bank’s clients in a relatively high rate environment. While there is no requirement for clients to refinance their loans at the end of the fixed rate period, clients have historically done so the majority of the time, as most clients are interest rate risk-averse on their first mortgage loans.
Depending on the term and amount of the ARM, loans collateralized by single family, owner-occupied first lien residential real estate may be originated with a loan-to-value (“LTV”) up to 90% and a combined LTV up to 100%. The Bank also offers a 100% LTV product for home purchase transactions within its primary markets. The Bank does not require the borrower to obtain private mortgage insurance for ARM loans. Except for the HEAL product under $150,000, the Bank requires mortgagee’s title insurance on single family, first lien residential real estate loans to protect the Bank against defects in its liens on the properties that collateralize the loans. The Bank normally requires title, fire, and extended casualty insurance to be obtained by the borrower and, when required by applicable regulations, flood insurance. The Bank maintains an errors and omissions insurance policy to protect the Bank against loss in the event a borrower fails to maintain proper fire and other hazard insurance policies.
Single family, first lien residential ARMs originated prior to January 10, 2014 generally contain an early termination penalty (“ETP”). Effective January 10, 2014, with the implementation of the Ability to Repay (“ATR”) Rule, the Bank eliminated ETPs for subsequently originated ARMs.
Single family, first lien residential real estate loans with fixed rate periods of 15, 20 and 30 years are primarily sold into the secondary market. Mortgage Servicing Rights (“MSRs”) attached to the sold portfolio are either sold along with the loan or retained. All loans sold into the secondary market, along with their corresponding MSRs, are included as a component of the Company’s Mortgage Banking segment, as discussed elsewhere in this filing. The Bank, as it has in the past, may retain such longer-term fixed rate loans from time to time in the future to help combat market compression. Any such loans retained on balance sheet would be reported as a component of the Traditional Banking segment.
The Bank does, on occasion, purchase single family, first lien residential real estate loans in low-to-moderate income areas in order to meet its obligations under the Community Reinvestment Act (“CRA”). The Bank generally applies secondary market underwriting criteria to the review of these purchased loan portfolios and generally reserves the right to reject particular loans from a loan package being purchased that do not meet its underwriting criteria. In connection with loan purchases, the Bank receives various representations and warranties from the sellers regarding the quality and characteristics of the loans.
Commercial Lending - The Bank conducts commercial lending activities primarily through its Commercial and Corporate Banking (the “CCB Department”) and its Business Banking department.
The CCB Department is composed of the following divisions: Corporate Banking; Commercial Finance; Municipal Lending; and Republic Realty. All credit approvals and processing for the CCB Department are prepared and underwritten through the Bank’s existing Credit Administration Department (“CAD”). Clients are generally located within the Bank’s market footprint, including adjacent areas that are within approximately two-hour drive of a specific market.
The Corporate Banking division focuses on locally-based companies, typically with revenues of $15 million to $150 million. Credit opportunities are generally driven by the following: companies expanding their businesses; companies acquiring new businesses; generational transfers from existing owners to children, existing management, or employees (Employee Stock Ownership Plans); and refinancing of existing debt at other banks. Corporate Banking’s primary product focus is Commercial & Industrial (“C&I”) lending, and to a lesser degree, Commercial Real Estate (“CRE”) opportunities. The targeted C&I credit size for client relationships is $2.5 million to $25 million, with limited exceptions for corporate borrowers of the highest credit quality. On an exception basis, for large locally-based or publicly-traded institutions, the Bank may consider participations in larger credit facilities.
C&I loans typically include those secured by General Business Assets (“GBA”), which consist of equipment, accounts receivable, inventory, and other business assets owned by the borrower/guarantor. Credit facilities include annually renewable lines of credit and term loans with maturities typically from three to seven years, and may also involve quarterly financial covenant requirements. These reporting requirements are monitored by the Bank’s CAD. Underwriting C&I loans is based on the borrower’s financial capacity to repay these loans from its Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), with capital strength, collateral and management experience also important underwriting considerations.
The Commercial Finance division targets financing for equipment, typically ranging from $100,000 to $500,000 per unit financed with five to seven year terms. Credit exposures to individual relationships are expected to be $500,000 to $5 million. Both leasing and lending are used to accommodate financing needs, with EBITDA, company financial history, and collateral values/useful life primary underwriting considerations.
The Municipal Lending division responds to financing requests from cities and counties, largely in the state of Kentucky and in southern Indiana. The Bank issues general obligation and/or appropriation leases/loans to cities and counties. General obligation leases/loans range between $100,000 to $5 million, with credits above $5 million requiring approval from the Bank’s Executive Loan Committee. Appropriation leases generally do not exceed $1 million individually.
The Republic Realty division, initiated by the Bank in 2015, focuses on stabilized CRE loans with low leverage and strong cash flows. Generally all borrowers are single-asset entities and loan sizes typically range from $3 million to $25 million. Primary underwriting considerations are property cash flow (current and historical), quality of leases, financial capacity of sponsors, and collateral value of property financed. The majority of interest rates offered are based on the 30-day London Interbank Offered Rate (“LIBOR”). Fixed rate terms of up to 10 years are facilitated to borrowers by utilizing interest rate swaps. In some cases, limited or non-recourse (of owners) loans will be issued, with such cases based upon the capital position, cash flows, and stabilization of the borrowing entity.
The Bank’s CRE and multi-family loans are typically secured by improved property such as office buildings, medical facilities, retail centers, warehouses, apartment buildings, condominiums, schools, religious institutions and other types of commercial use property.
The Business Banking department focusses on locally based small-to-medium sized businesses in the Bank’s market footprint with revenues of $1 million to $20 million. The needs of Business Banking clients range from expansion or acquisition, equipment financing, owner-occupied real estate financing, and operating lines of credit. Business Banking utilizes all appropriate programs of the Small Business Administration (“SBA”) to reduce credit risk exposure. Additionally, Business Banking includes making loans to real estate investors for various types of investment properties, including rental homes and apartments, shopping centers, and office buildings. Business Banking also makes loans to various not-for-profit agencies located within the Bank’s market footprint. The targeted credit size for a relationship in this segment is between $500,000 and $5 million.
Construction and Land Development Lending - The Bank originates business loans for the construction of both single family residential properties and commercial properties (apartment complexes, shopping centers, office buildings). On a much smaller scale, the Bank may originate loans for the acquisition and development of residential or commercial land into buildable lots.
Single family residential construction loans are made in the Bank’s market area to established homebuilders with solid financial records. The majority of these loans are made for “contract” homes, which the builder has already pre-sold to a homebuyer. The duration of these loans is generally less than 12 months and repaid at the end of the construction period from the sale of the constructed property. Some loans are made on “speculative” homes, which the builder does not have pre-sold to a homebuyer, but expects to execute a contract to sell during the construction period. These speculative homes are considered necessary to have in inventory for homebuilders, as not all homebuyers want to wait during the construction period to purchase and move into a newly-built home. Generally, the Bank will require a larger amount of equity from the builder when financing a speculative home compared to a contract home due to the increased risk of failing to sell the underlying property in a reasonable period of time.
Commercial construction loans are made in the Bank’s market to established commercial builders with solid financial records. Typically these loans are made for investment properties and have tenants pre-committed for some or all of the space. Some projects may begin as speculative, with the builder contracting to lease or sell the property during the construction period. Generally, commercial construction loans are made for the duration of the construction period and slightly beyond and will either convert to permanent financing with the Bank or with another lender at or before maturity.
Construction-to-permanent loans are another type of construction-related financing offered by the Bank. These loans are made to borrowers who are going to build a property and retain it for ownership after construction completion. The construction phase is handled just like all other construction loans, and the permanent phase offers similar terms to a permanent CRE loan, while allowing the borrower a one-time closing process at loan origination. These loans are offered on both owner occupied and nonowner occupied CRE properties.
Internet Lending - The Bank accepts online loan applications for its RB&T brand through its website at www.republicbank.com. Historically, the majority of loans originated through the internet have been within the Bank’s traditional markets of Kentucky and Indiana. Other states where loans are marketed include California, Colorado, Florida, Georgia, Illinois, Michigan, Minnesota, North Carolina, Ohio, Tennessee and Virginia, as well as the District of Columbia.
Correspondent Lending - Primarily from its Warehouse clients, the Core Bank acquires for investment single family, first lien mortgage loans that meet the Core Bank’s specifications through its Correspondent Lending channel. Substantially all loans purchased through the Correspondent Lending channel are purchased at a premium.
Consumer Lending - Traditional consumer loans made by the Bank include home improvement and home equity loans, other secured and unsecured personal loans, and credit cards. With the exception of home equity loans, which are actively marketed in conjunction with single family, first lien residential real estate loans, other traditional consumer loan products, while available, are not and have not been actively promoted in the Bank’s markets.
The Bank has, from time to time, acquired unsecured consumer installment loans for investment from a third-party originator. Such consumer loans were purchased at par and were selected by the Bank based on certain underwriting characteristics.
Indirect Lending - In the fourth quarter of 2015, the Bank began to grow its presence in the consumer automobile loan market. The program involves establishing relationships with automobile dealers in the Bank’s market footprint and obtaining consumer automobile loans in a low-cost delivery method. As a result of its success in Indirect Auto Lending, the Bank entered Dealer Floor Plan lending during the fourth quarter of 2016.
See additional discussion regarding Lending Activities under the sections titled:
·
Part I Item 1A
Item 1A. Risk Factors.
FACTORS THAT MAY AFFECT FUTURE RESULTS
An investment in Republic Bancorp, Inc.’s (“Republic” or the “Company”) common stock is subject to risks inherent in its business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this filing. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially and adversely affect its business, financial condition and results of operations in the future. The value or market price of the Company’s common stock could decline due to any of these identified or other risks, and an investor could lose all or part of their investment.
There are factors, many beyond the Company’s control, which may significantly change the results or expectations of the Company. Some of these factors are described below, however many are described in the other sections of this Annual Report on Form 10-K.
ACCOUNTING POLICIES/ESTIMATES, ACCOUNTING STANDARDS AND INTERNAL CONTROL
The Company’s accounting policies and estimates are critical components of the Company’s presentation of its financial statements. Management must exercise judgment in selecting and adopting various accounting policies and in applying estimates. Actual outcomes may be materially different from amounts previously estimated. Management has identified several accounting policies and estimates as being critical to the presentation of the Company’s financial statements. These policies are described in Part II Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the section titled “Critical Accounting Policies and Estimates.” The Company’s management must exercise judgment in selecting and applying many accounting policies and methods in order to comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report the Company’s financial condition and results. In some cases, management may select an accounting policy that might be reasonable under the circumstances, yet might result in the Company’s reporting different results than would have been reported under a different alternative. Materially different amounts could be reported under different conditions or using different assumptions or estimates.
The Bank may experience goodwill impairment, which could reduce its earnings. The Bank performed its annual goodwill impairment test during the fourth quarter of 2016 as of September 30, 2016. The evaluation of the fair value of goodwill requires management judgment. If management’s judgment was incorrect and goodwill impairment was later deemed to exist, the Bank would be required to write down its goodwill resulting in a charge to earnings, which would adversely affect its results of operations, perhaps materially.
Changes in accounting standards could materially impact the Company’s financial statements. The Financial Accounting Standards Board (“FASB”) may change the financial accounting and reporting standards that govern the preparation of the Company’s financial statements. These changes can be difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In addition, those who interpret the accounting standards, such as the Securities and Exchange Commission (“SEC”), the banking regulators and the Company’s independent registered public accounting firm may amend or reverse their previous interpretations or conclusions regarding how various standards should be applied. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the Company recasting, or possibly restating, prior period financial statements. See additional discussion regarding accounting standard updates in Part II Item 8 “Financial Statements and Supplemental Data” under the section titled “Adoption of Issued but Not Yet Effective Accounting Pronouncements.”
If the Company does not maintain strong internal controls and procedures, it may impact profitability. Management reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures on a routine basis. This system is designed to provide reasonable, not absolute, assurances that the internal controls comply with appropriate regulatory guidance. Any undetected circumvention of these controls could have a material adverse impact on the Company’s financial condition and results of operations.
If the Bank’s other real estate owned (“OREO”) portfolio is not properly valued or sufficiently reserved to cover actual losses, or if the Bank is required to increase its valuation reserves, the Bank’s earnings could be reduced. Management typically obtains updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property is taken in as OREO and at certain other times during the asset’s holding period. The Bank’s net book value of the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A writedown is recorded for any excess in the asset’s net book value over its fair value. If the Bank’s valuation process is incorrect, or if property values decline, the fair value of the Bank’s OREO may not be sufficient to recover its carrying value in such assets, resulting in the need for additional writedowns. Significant additional writedowns to OREO could have a material adverse effect on the Bank’s financial condition and results of operations.
TRADITIONAL BANK LENDING AND THE ALLOWANCE FOR LOAN AND LEASE LOSSES (“ALLOWANCE”)
The Allowance could be insufficient to cover the Bank’s actual loan losses. The Bank makes various assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of its loans. In determining the amount of the Allowance, among other things, the Bank reviews its loss and delinquency experience, economic conditions, etc. If its assumptions are incorrect, the Allowance may not be sufficient to cover losses inherent in its loan portfolio, resulting in additions to its Allowance. In addition, regulatory agencies periodically review the Allowance and may require the Bank to increase its provision for loan and lease losses or recognize further loan charge-offs. A material increase in the Allowance or loan charge-offs would have a material adverse effect on the Bank’s financial condition and results of operations.
Deterioration in the quality of the Traditional Banking loan portfolio may result in additional charge-offs, which would adversely impact the Bank’s operating results. Despite the various measures implemented by the Bank to address the economic environment, there may be further deterioration in the Bank’s loan portfolio. When borrowers default on their loan obligations, it may result in lost principal and interest income and increased operating expenses associated with the increased allocation of management time and resources associated with the collection efforts. In certain situations where collection efforts are unsuccessful or acceptable “work-out” arrangements cannot be reached or performed, the Bank may charge-off loans, either in part or in whole. Additional charge-offs will adversely affect the Bank’s operating results and financial condition.
The Bank’s financial condition and earnings could be negatively impacted to the extent the Bank relies on borrower information that is false, misleading or inaccurate. The Bank relies on the accuracy and completeness of information provided by vendors, clients and other parties in deciding whether to extend credit, or enter into transactions with other parties. Additional charge-offs will adversely affect the Bank’s operating results and financial condition.
The Bank’s use of appraisals as part of the decision process to make a loan on or secured by real property does not ensure the value of the real property collateral. As part of the decision process to make a loan secured by real property, the Bank generally requires an independent third-party appraisal of the real property. An appraisal, however, is only an estimate of the value of the property at the time the appraisal is made. An error in fact or judgment could adversely affect the reliability of the appraisal. In addition, events occurring after the initial appraisal may cause the value of the real estate to decrease. As a result of any of these factors, the value of collateral securing a loan may be less than supposed, and if a default occurs, the Bank may not recover the outstanding balance of the loan. Additional charge-offs will adversely affect the Bank’s operating results and financial condition.
The Bank is exposed to risk of environmental liabilities with respect to properties to which it takes title. In the course of its business, the Bank may own or foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. The Bank may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if the Bank is the owner or former owner of a contaminated site, the Bank may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect the Bank.
Prepayment of loans may negatively impact the Bank’s business. The Bank’s clients may prepay the principal amount of their outstanding loans at any time. The speeds at which such prepayments occur, as well as the size of such prepayments, are within the Bank clients’ discretion. If clients prepay the principal amount of their loans, and the Bank is unable to lend those funds to other clients or invest the funds at the same or higher interest rates, the Bank’s interest income will be reduced. A significant reduction in interest income would have a negative impact on the Bank’s results of operations and financial condition.
The Bank is highly dependent upon programs administered by the Federal Home Loan Mortgage Corporation (“Freddie Mac” or the “FHLMC”) and the Federal National Mortgage Association (“FNMA” or “Fannie Mae”). Changes in existing U.S. government-sponsored mortgage programs or servicing eligibility standards could materially and adversely affect its business, financial position, results of operations and cash flows. The Bank’s ability to generate revenues through mortgage loan sales to institutional investors depends to a significant degree on programs administered by Freddie Mac and Fannie Mae. These entities play powerful roles in the residential mortgage industry, and the Bank has significant business relationships with them. The Bank’s status as an approved seller/servicer for both is subject to compliance with their selling and servicing guides.
Any discontinuation of, or significant reduction or material change in, the operation of Freddie Mac or Fannie Mae or any significant adverse change in the level of activity in the secondary mortgage market or the underwriting criteria of Freddie Mac or Fannie Mae would likely prevent the Bank from originating and selling most, if not all, of its mortgage loan originations.
Loans originated through the Bank’s Correspondent Lending channel subject the Bank to additional negative earnings sensitivity as the result of prepayments and additional credit risks that the Bank does not have through its historical origination channels. Loans acquired through the Bank’s Correspondent Lending channel are typically purchased at a premium and also represent out-of-market loans originated by a non-Republic representative. Loans purchased at a premium inherently subject the Bank’s earnings to additional sensitivity related to prepayments, as increases in prepayment speeds will negatively affect the overall yield to maturity on such loans, potentially even causing the net loan yield to be negative for the period of time the loan is owned by the Bank.
Loans originated out of the Bank’s market footprint by non-Republic representatives will inherently carry additional credit risk from potential fraud due to the increased level of third-party involvement on such loans. In addition, the Bank will also experience an increase in complexity for customer service and the collection process, given the number of different state laws the Bank could be subject to from loans purchased throughout the U.S. As of December 31, 2016, the Bank’s Correspondent Lending channel maintained loans with collateral in 26 different states, with the largest concentration of 75% from the state of California.
Failure to appropriately manage the additional risks related to this lending channel could lead to reduced profitability and/or operating losses through this origination channel.
Loans originated through the Bank’s Internet Lending channel will subject the Bank to credit and regulatory risks that the Bank does not have through its historical origination channels. The dollar volume of loans originated through the Bank’s Internet Lending channel is expected to be increasingly out-of-market. Loans originated out of the Bank’s market footprint inherently carry additional credit risk, as the Bank will experience an increase in the complexity of the customer authentication requirements for such loans. Failure to appropriately identify the end-borrower for such loans could lead to fraud losses. Failure to appropriately manage these additional risks could lead to reduced profitability and/or operating losses through this origination channel. In addition, failure to appropriately identify the end-borrower could result in regulatory sanctions resulting from failure to comply with various customer identification regulations.
BANK OWNED LIFE INSURANCE
The Bank holds a significant amount of bank owned life insurance which creates credit risk relative to the insurers and liquidity risk relative to the product. At December 31, 2016, the Bank held bank-owned life insurance (“BOLI”) on certain employees. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to the Bank if needed for liquidity purposes. The Bank continually monitors the financial strength of the various insurance companies that carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return the Bank’s cash surrender value. If the Bank needs to liquidate these policies for liquidity purposes, it would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.
DEPOSITS AND RELATED ITEMS
Clients could pursue alternatives to bank deposits, causing the Bank to lose a relatively inexpensive source of funding. Checking and savings account balances and other forms of client deposits could decrease if clients perceive alternative investments, such as the stock market, as providing superior expected returns. If clients move money out of bank deposits in favor of alternative investments, the Bank could lose a relatively inexpensive source of funds, increasing its funding costs and negatively impacting its overall results of operations.
The loss of large deposit relationships could increase the Bank’s funding costs. The Bank has several large deposit relationships that do not require collateral; therefore, cash from these accounts can generally be utilized to fund the loan portfolio. If any of these balances are moved from the Bank, the Bank would likely utilize overnight borrowing lines on a short-term basis to replace the balances. The overall cost of gathering brokered deposits and/or FHLB advances, however, could be substantially higher than the Traditional Bank deposits they replace, increasing the Bank’s funding costs and reducing the Bank’s overall results of operations.
The Bank’s “Overdraft Honor” program represents a significant business risk, and if the Bank terminated the program, it would materially impact the earnings of the Bank. There can be no assurance that Congress, the Bank’s regulators, or others, will not impose additional limitations on this program or prohibit the Bank from offering the program. The Bank’s “Overdraft Honor” program permits eligible clients to overdraft their checking accounts up to a predetermined dollar amount for the Bank’s customary overdraft fee(s). Limitations or adverse modifications to this program, either voluntary or involuntary, would significantly reduce net income.
REPUBLIC PROCESSING GROUP (“RPG”)
The Company’s lines of business and products not typically associated with traditional banking expose earnings to additional risks and uncertainties. The RPG segment is comprised of three distinct divisions: Tax Refund Solutions (“TRS”), Republic Payment Solutions (“RPS”) and Republic Credit Solutions (“RCS”).
RPG’s products represent a significant business risk and management believes the Bank could be subject to additional regulatory and public pressure to exit these product lines, which may have a material adverse effect on the Bank’s operations.
Various governmental, regulatory and consumer groups have, from time to time, questioned the fairness of the products offered by RPG. Actions of these groups and others could result in regulatory, governmental, or legislative action or litigation against the Bank, which could have a material adverse effect on the Bank’s operations. If the Bank can no longer offer its RPG products, it will have a material adverse effect on its profits.
The TRS division represents a significant operational risk, and if the Bank were unable to properly service this business, it could materially impact earnings. In order to process its business, the Bank must implement and test new systems, as well as train new employees. The Bank relies heavily on communications and information systems to operate the TRS division. Any failure, sustained interruption or breach in security of these systems could result in failures or disruptions in client relationship management and other systems. Significant operational problems could also cause a material portion of the Bank’s tax-preparer base to switch to a competitor to process their bank product transactions, significantly reducing the Bank’s projected revenue without a corresponding decrease in expenses.
The Bank’s Easy Advance (“EA”) and Refund Transfer (“RT”) products represent a significant third-party management risk, and if RB&T’s third-party program managers fail to comply with all the statutory and regulatory requirements for these products or if RB&T fails to provide proper monitoring of its third-party program managers offering these products, it could have a material negative impact on earnings. RPG and its third-party partners operate in a highly regulated environment and deliver products and services that are subject to strict legal and regulatory requirements. Failure by RB&T’s third-party program managers or failure of RB&T to provide proper monitoring of is third party program managers with laws and regulations could result in fines and penalties that materially and adversely affect RB&T’s earnings. Such penalties could also include the discontinuance of any and all third party program manager products and services.
The Bank’s EA and RT products represent a significant compliance and regulatory risk, and if RB&T fails to comply with all statutory and regulatory requirements, it could have a material negative impact on earnings. Federal and state laws and regulations govern numerous matters relating to the offering of consumer loan products, such as the EA, and consumer deposit products such as the RT. Failure to comply with disclosure requirements or with laws relating to the permissibility of interest rates and fees charged could have a material negative impact on earnings. In addition, failure to comply with applicable laws and regulations could also expose RB&T to civil money penalties and litigation risk, including shareholder actions.
EAs represent a significant credit risk, and if RB&T is unable to collect a significant portion of its EAs, it would materially, negatively impact earnings. There is credit risk associated with an EA because the funds are disbursed to the customer prior to RB&T receiving the customer’s refund as claimed on the return. Because there is no recourse to the customer if the EA is not paid off by the customer’s tax refund, RB&T must collect all of its payments related to EAs through the refund process. Losses will generally occur on EAs when RB&T does not receive payment due to a number of reasons, such as Internal Revenue Service (“IRS”) revenue protection strategies, including audits of returns, errors in the tax return, tax return fraud and tax debts not previously disclosed to RB&T during its underwriting process. While RB&T’s underwriting during the EA approval process takes these factors into consideration based on prior years’ payment patterns, if the IRS significantly alters its revenue protection strategies or if refund payment patterns for a given tax season meaningfully change, or RB&T is incorrect in its underwriting assumptions, RB&T could experience higher loan loss provisions above those projected. The provision for loan losses is a significant component of the RPG segment’s overall earnings.
Management offered the EA product during the first quarter 2017 tax season with different minimum and maximum amounts than its first quarter 2016 offering. This change, along with additional due diligence measures implemented by the federal and state governments, which will delay the timing of individual tax refund payments or possibly deny those individual payments outright, could present an increased credit risk to the Company. TRS first offered its EA tax credit product during the first quarter of 2016, with repayment of the EA to the Bank deducted from the taxpayer’s tax refund proceeds. For the first quarter 2016 tax season through December 31, 2016, the Company recorded $5.2 million in interest income from EAs and experienced net EA charge-offs of $3.0 million. In contrast to the singular $750 EA amount offered during 2016, management lowered the minimum EA to amounts below $750 and increased the maximum EA to amounts greater than $750 during the first quarter 2017 tax season.
Additionally, to protect against fraudulent tax returns, the federal government and many state governments have enacted laws and procedures that provide for additional due diligence by the applicable governmental authority prior to issuing an income tax refund. This additional due diligence is expected to drive a longer period of time between the filing of a tax return and the receipt of the corresponding refund. The federal government, specifically as a result of the PATH Act, has announced that taxpayers filing tax returns with certain characteristics will not receive their corresponding refunds before February 15, 2017. These funding delays will negatively impact the Company’s ability to make mid-season modifications to its EA underwriting model based on then-current year tax refund funding patterns, because the substantial majority of all EAs will have been issued prior to February 15, 2017. In addition, these enhanced due diligence measures implemented by the federal and state governments could prevent the taxpayer’s refund from being issued altogether. These governmental changes by themselves, or in combination with management’s changes to the EA
offering amounts, could have a material negative impact on the performance of the EA product and therefore on the Company’s financial condition and results of operations if the loss rate on the EA product increases materially.
Consumer loans originated through the RCS division of RPG represent a higher credit risk than Core Bank loans. RCS originates both a short-term line-of-credit product and a credit card product. The Bank sells 90% of the balances maintained through these two products within two days of loan origination and retains a 10% interest. Both of these products are unsecured and made to borrowers with below prime credit scores, therefore representing an elevated credit risk. The ratio of net charge-offs to total average loans during the years ended December 31, 2016 and 2015 for these two products were higher than Traditional Bank net charge-offs to average Traditional Bank unsecured consumer loans for the same periods and more in line with loss rates on overdrawn deposit accounts. A material increase in the RCS loan charge-offs would have a material adverse effect on the Bank’s financial condition and results of operations.
WAREHOUSE LENDING (“WAREHOUSE”)
The Warehouse Lending business is subject to numerous risks that may result in losses. Risks associated with warehouse loans include, without limitation, (i) credit risks relating to the mortgage bankers that borrow from the Bank, (ii) the risk of intentional misrepresentation or fraud by any of such mortgage bankers and their third party service providers, (iii) changes in the market value of mortgage loans originated by the mortgage banker during the time in warehouse, the sale of which is the expected source of repayment of the borrowings under a warehouse line of credit, or (iv) unsalable or impaired mortgage loans so originated, which could lead to decreased collateral value and the failure of a purchaser of the mortgage loan to purchase the loan from the mortgage banker. Failure to mitigate these risks could have a material adverse impact on the Bank’s financial statements and results of operations.
Outstanding Warehouse lines of credit can fluctuate significantly and negatively impact the Bank’s liquidity and earnings. The Bank has a lending concentration in outstanding Warehouse lines of credit. Because outstanding Warehouse balances are contingent upon residential mortgage lending activity, changes in the residential real estate market nationwide can lead to wide fluctuations of balances in this product. Additionally, Warehouse Lending period-end balances are generally higher than the average balance during the period due to increased mortgage activity that occurs at the end of a month. A sudden increase in loans may materially impact the Company’s liquidity position, while a sudden decrease in loans may materially impact the Company’s results of operations.
Outstanding Warehouse lines of credit and their corresponding earnings could decline due to several factors, such as intense industry competition, overall mortgage demand and the interest rate environment. The Bank may experience decreased earnings on its Warehouse lines of credit due primarily to strong industry competition, overall mortgage demand and the interest rate environment. Such decreased earnings may materially impact the Company’s results of operations.
The Company may lose Warehouse clients due to mergers and acquisitions in the industry. The Bank’s Warehouse clients are primarily mortgage companies across the United States. Mergers and acquisitions affecting such clients may lead to an end to the client relationship with the Bank. The loss of a significant amount of clients may materially impact the Company’s results of operations.
ASSET/LIABILITY MANAGEMENT AND LIQUIDITY
Fluctuations in interest rates could reduce profitability. The Bank’s asset/liability management strategy may not be able to prevent changes in interest rates from having a material adverse effect on results of operations and financial condition. The Bank’s primary source of income is from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. The Bank expects to periodically experience “gaps” in the interest rate sensitivities of its assets and liabilities, meaning that either interest-bearing liabilities will be more sensitive to changes in market interest rates than interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to the Bank’s position, earnings may be negatively affected.
A continued low interest rate environment may reduce profitability. An on-going low interest rate environment will cause the Bank’s interest-earning assets to continue to reprice into lower yielding assets without the ability for the Bank to offset the decline in interest income through a reduction in its cost of funds. Continued contraction in the Bank’s net interest margin may cause net interest income to decrease if growth in interest-earning assets cannot fully compensate for such contraction in net interest margin. The overall impact of such contraction in net interest margin will depend on the period of time that the current interest rate environment remains and the Bank’s interest-earning asset growth and asset mix over such time period.
A flattening interest rate yield curve may reduce profitability. Changes in the slope of the “yield curve,” or the spread between short-term and long-term interest rates, could reduce the Bank’s net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because the Bank’s liabilities tend to be shorter in duration than its assets, when the yield curve flattens, as is the case in the current interest rate environment, or even inverts, the Bank’s net interest margin could decrease as its cost of funds increases relative to the yield it can earn on its assets.
Mortgage Banking activities could be adversely impacted by increasing or stagnant long-term interest rates. The Company is unable to predict changes in market interest rates. Changes in interest rates can impact the gain on sale of loans, loan origination fees and loan servicing fees, which account for a significant portion of Mortgage Banking income. A decline in market interest rates generally results in higher demand for mortgage products, while an increase in rates generally results in reduced demand. Generally, if demand increases, Mortgage Banking income will be positively impacted by more gains on sale; however, the valuation of existing mortgage servicing rights will decrease and may result in a significant impairment. A decline in demand for Mortgage Banking products resulting from rising interest rates could also adversely impact other programs/products such as home equity lending, title insurance commissions and service charges on deposit accounts.
The Bank may be compelled to offer market-leading interest rates to maintain sufficient funding and liquidity levels. The Bank has traditionally relied on client deposits, brokered deposits and advances from the FHLB to fund operations. Such traditional sources may be unavailable, limited or insufficient in the future. If the Bank were to lose a significant funding source, such as a few major depositors, or if any of its lines of credit were canceled or curtailed, such as its borrowing line at the FHLB, or if the Bank cannot obtain brokered deposits, the Bank may be compelled to offer market leading deposit interest rates to meet its funding and liquidity needs. Obtaining funds at market-leading interest rates may have an adverse impact on the Company’s net interest income and overall results of operations.
COMPANY COMMON STOCK
The Company’s common stock generally has a low average daily trading volume, which limits a stockholder’s ability to quickly accumulate or quickly sell large numbers of shares of Republic’s stock without causing wide price fluctuations. Republic’s stock price can fluctuate widely in response to a variety of factors, as detailed in the next risk factor. A low average daily stock trading volume can lead to significant price swings even when a relatively small number of shares are being traded.
The market price for the Company’s common stock may be volatile. The market price of the Company’s common stock could fluctuate substantially in the future in response to a number of factors, including those discussed below. The market price of the Company’s common stock has in the past fluctuated significantly and is likely to continue to fluctuate significantly. Some of the factors that may cause the price of the Company’s common stock to fluctuate include:
·
Variations in the Company’s and its competitors’ operating results;
·
Actual or anticipated quarterly or annual fluctuations in operating results, cash flows and financial condition;
·
Changes in earnings estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to the Bank or other financial institutions;
·
Announcements by the Company or its competitors of mergers, acquisitions and strategic partnerships;
·
Additions or departure of key personnel;
·
The announced exiting of or significant reductions in material lines of business within the Company;
·
Changes or proposed changes in banking laws or regulations or enforcement of these laws and regulations;
·
Events affecting other companies that the market deems comparable to the Company;
·
Developments relating to regulatory examinations;
·
Speculation in the press or investment community generally or relating to the Company’s reputation or the financial services industry;
·
Future issuances or re-sales of equity or equity-related securities, or the perception that they may occur;
·
General conditions in the financial markets and real estate markets in particular, developments related to market conditions for the financial services industry;
·
Domestic and international economic factors unrelated to the Company’s performance;
·
Developments related to litigation or threatened litigation;
·
The presence or absence of short selling of the Company’s common stock; and,
·
Future sales of the Company’s common stock or debt securities.
In addition, the stock market, in general, has historically experienced extreme price and volume fluctuations. This is due, in part, to investors’ shifting perceptions of the effect of changes and potential changes in the economy on various industry sectors. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their performance or prospects. These broad market fluctuations may adversely affect the market price of the Company’s common stock, notwithstanding its actual or anticipated operating results, cash flows and financial condition. The Company expects that the market price of its common stock will continue to fluctuate due to many factors, including prevailing interest rates, other economic conditions, operating performance and investor perceptions of the outlook for the Company specifically and the banking industry in general. There can be no assurance about the level of the market price of the Company’s common stock in the future or that you will be able to resell your shares at times or at prices you find attractive.
The Company’s insiders hold voting rights that give them significant control over matters requiring stockholder approval. The Company’s Chairman/CEO and President hold substantial voting authority over the Company’s Class A Common Stock and Class B Common Stock. Each share of Class A Common Stock is entitled to one vote and each share of Class B Common Stock is entitled to ten votes. This group generally votes together on matters presented to stockholders for approval. These actions may include, for example, the election of directors, the adoption of amendments to corporate documents, the approval of mergers and acquisitions, sales of assets and the continuation of the Company as a registered company with obligations to file periodic reports and other filings with the SEC. Consequently, other stockholders’ ability to influence Company actions through their vote may be limited and the non-insider stockholders may not have sufficient voting power to approve a change in control even if a significant premium is being offered for their shares. Majority stockholders may not vote their shares in accordance with minority stockholder interests.
An investment in the Company’s Common Stock is not an insured deposit. The Company’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in the Company’s common stock is inherently risky for the reasons described in this section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire the Company’s common stock, you could lose some or all of your investment.
GOVERNMENT REGULATION / ECONOMIC FACTORS
The Company is significantly impacted by the regulatory, fiscal and monetary policies of federal and state governments that could negatively impact the Company’s liquidity position and earnings. These policies can materially affect the value of the Company’s financial instruments and can also adversely affect the Company’s clients and their ability to repay their outstanding loans. In addition, failure to comply with laws, regulations or policies, or adverse examination findings, could result in significant penalties, negatively impact operations, or result in other sanctions against the Company. The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the U.S. Its policies determine, in large part, the Company’s cost of funds for lending and investing and the return the Company earns on these loans and investments, all of which impact net interest margin.
The Company and the Bank are heavily regulated at both the federal and state levels and are subject to various routine and non-routine examinations by federal and state regulators. This regulatory oversight is primarily intended to protect depositors, the Deposit Insurance Fund and the banking system as a whole, not the stockholders of the Company. Changes in policies, regulations and statutes, or the interpretation thereof, could significantly impact the product offerings of Republic causing the Company to terminate or modify its product offerings in a manner that could materially adversely affect the earnings of the Company.
Federal and state laws and regulations govern numerous matters including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms of extensions of credit and investments, permissible non-banking activities, the level of reserves against deposits and restrictions on dividend payments. Various federal and state regulatory agencies possess cease and desist powers, and other authority to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulations. The Federal Reserve (“FRB”) possesses similar powers with respect to bank holding companies. These, and other restrictions, can limit in varying degrees, the manner in which Republic conducts its business.
Government responses to economic conditions may adversely affect the Company’s operations, financial condition and earnings. Enacted financial reform legislation has changed and will continue to change the bank regulatory framework. Ongoing uncertainty and adverse developments in the financial services industry and the domestic and international credit markets, and the effect of new legislation and regulatory actions in response to these conditions, may adversely affect Company operations by restricting business activities, including the Company’s ability to originate or sell loans, modify loan terms, or foreclose on property securing loans. These measures are likely to increase the Company’s costs of doing business and may have a significant adverse effect on the Company’s lending activities, financial performance and operating flexibility. In addition, these risks could affect the performance and value of the Company’s loan and investment securities portfolios, which also would negatively affect financial performance.
The Company may be subject to examinations by taxing authorities that could adversely affect results of operations. In the normal course of business, the Company may be subject to examinations from federal and state taxing authorities regarding the amount of taxes due in connection with investments it has made and the businesses in which the Company is engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. The challenges made by taxing authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in the Company’s favor, they could have an adverse effect on the Company’s financial condition and results of operations.
The Company may be adversely affected by the soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Company. Any such losses could have a material adverse effect on the Company’s financial condition and results of operations.
A decrease to the corporate federal income tax rate may impair the Company’s deferred tax assets (“DTAs”). At December 31, 2016, the Company’s DTAs were approximately $27 million. While a decline in the corporate tax rate may lower the Company’s tax provision expense, it may also significantly impair the value of the Company’s DTAs in the year the rate decrease is enacted. Such impairment could have a material adverse effect on the Company’s earnings in the year the rate decrease is enacted.
MANAGEMENT, INFORMATION SYSTEMS, ACQUISITIONS, ETC.
The Company is dependent upon the services of its management team and qualified personnel. The Company is dependent upon the ability and experience of a number of its key management personnel who have substantial experience with Company operations, the financial services industry and the markets in which the Company offers services. It is possible that the loss of the services of one or more of its senior executives or key managers would have an adverse effect on operations; moreover, the Company depends on its account executives and loan officers to attract bank clients by developing relationships with commercial and consumer clients, mortgage companies, real estate agents, brokers and others. The Company believes that these relationships lead to repeat and referral business. The market for skilled account executives and loan officers is highly competitive and historically has experienced a high rate of turnover. In addition, if a manager leaves the Company, other members of the manager’s team may follow. Competition for qualified account executives and loan officers may lead to increased hiring and retention costs. The Company’s success also depends on its ability to continue to attract, manage and retain other qualified personnel as the Company grows.
The Company’s operations could be impacted if its third-party service providers experience difficulty. The Company depends on a number of relationships with third-party service providers, including core systems processing and web hosting. These providers are well-established vendors that provide these services to a significant number of financial institutions. If these third-party service providers experience difficulty or terminate their services and the Company is unable to replace them with other providers, its operations could be interrupted, which would adversely impact its business.
The Company’s operations, including third-party and client interactions, are increasingly done via electronic means, and this has increased the risks related to cyber security. The Company is exposed to the risk of cyber-attacks in the normal course of business. In general, cyber incidents can result from deliberate attacks or unintentional events. Management has observed an increased level of attention in the industry focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. Cyber-attacks may also be carried out in a manner that does not require gaining unauthorized access, such as by causing denial-of-service attacks on websites. Cyber-attacks may be carried out by third parties or insiders using techniques that range from highly sophisticated efforts to electronically circumvent network security or overwhelm websites to more traditional intelligence gathering and social engineering aimed at obtaining information necessary to gain access. While the Company has not incurred any material losses related to cyber-attacks, the Bank may incur substantial costs and suffer other negative consequences if the Bank or one of the Bank’s third party service providers fall victim to successful cyber-attacks. Such negative consequences could include: remediation costs for stolen assets or information; system repairs; consumer protection costs; increased cyber security protection costs that may include organizational changes; deploying additional personnel and protection technologies, training employees, and engaging third-party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract clients following an attack; litigation and payment of damages; and reputational damage adversely affecting client or investor confidence.
The Company’s information systems may experience an interruption that could adversely impact the Company’s business, financial condition and results of operations. The Company relies heavily on communications and information systems to conduct its business. Any failure or interruption of these systems could result in failures or disruptions in client relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the impact of the failure or interruption of information systems, there can be no assurance that any such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed. The occurrences of any failures or interruptions of the Company’s information systems could damage the Company’s reputation, result in a loss of client business, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.
New lines of business or new products and services may subject the Company to additional risks. From time to time, the Company may develop and grow new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Company’s business, results of operations and financial condition. All service offerings, including current offerings and those that may be provided in the future, may become more risky due to changes in economic, competitive and market conditions beyond the Company’s control.
Negative public opinion could damage the Company’s reputation and adversely affect earnings. Reputational risk is the risk to Company operations from negative public opinion. Negative public opinion can result from the actual or perceived manner in which the Company conducts its business activities, including sales practices, practices used in origination and servicing operations, the management of actual or potential conflicts of interest and ethical issues, and the Company’s protection of confidential client information. Negative public opinion can adversely affect the Company’s ability to keep and attract clients and can expose the Company to litigation.
The Company’s ability to successfully complete acquisitions will affect its ability to grow its franchise and compete effectively in its market footprint. The Company has announced plans to pursue a policy of growth through acquisitions in the near future to supplement internal growth. The Company’s efforts to acquire other financial institutions and financial service companies or branches may not be successful. Numerous potential acquirers exist for many acquisition candidates, creating intense competition, which affects the purchase price for which the institution can be acquired. In many cases, the Company’s competitors have significantly greater resources than the Company has, and greater flexibility to structure the consideration for the transaction. The Company may also not be the successful bidder in acquisition opportunities that it pursues due to the willingness or ability of other potential acquirers to propose a higher purchase price or more attractive terms and conditions than the Company is willing or able to propose. The Company intends to continue to pursue acquisition opportunities in its market footprint. The risks presented by the acquisition of other financial institutions could adversely affect the Bank’s financial condition and results of operations.
Successful Company acquisitions present many risks that could adversely affect the Company’s financial condition and results of operations. An institution that the Company acquires may have unknown asset quality issues or unknown or contingent liabilities that the Company did not discover or fully recognize in the due diligence process, thereby resulting in unanticipated losses. The acquisition of other institutions also typically requires the integration of different corporate cultures, loan and deposit products, pricing strategies, data processing systems and other technologies, accounting, internal audit and financial reporting systems, operating systems and internal controls, marketing programs and personnel of the acquired institution, in order to make the transaction economically advantageous. The integration process is complicated and time consuming and could divert the Company’s attention from other business concerns and may be disruptive to its clients and the clients of the acquired institution. The Company’s failure to successfully integrate an acquired institution could result in the loss of key clients and employees, and prevent the Company from achieving expected synergies and cost savings. Acquisitions also result in professional fees and may result in creating goodwill that could become impaired, thereby requiring the Company to recognize further charges. The Company may finance acquisitions with borrowed funds, thereby increasing the Company’s leverage and reducing liquidity, or with potentially dilutive issuances of equity securities.
REPUBLIC INSURANCE SERVICES, INC.
Transactions between the Company and its insurance subsidiary, Republic Insurance Services, Inc. (the “Captive”), may be subject to certain IRS responsibilities and penalties. The Company’s Captive is a Nevada-based, wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and the Bank as well as 10 other third-party insurance captives for which insurance may not be available or economically feasible. The Treasury Department of the United States and the IRS by way of Notice 2016-66 have stated that transactions believed similar in nature to transactions between the Company and the Captive may be deemed “transactions of interest” because such transactions may have potential for tax avoidance or evasion. If the IRS ultimately concludes such transactions do create tax avoidance or evasion issues, the Company could be subject to the payment of penalties and interest.
Item 1B.
Item 1B. Unresolved Staff Comments.
None
Item 2.
Item 2. Properties.
The Company’s executive offices, principal support and operational functions are located at 601 West Market Street in Louisville, Kentucky. As of December 31, 2016, Republic had 32 banking centers located in Kentucky, six banking centers located in Florida, three banking centers in Indiana, two in Tennessee and one banking center in Ohio. During the first quarter of 2017, Republic opened a banking center in Lexington, Kentucky and a loan production office in Brentwood, Tennessee.
The location of Republic’s facilities, their respective approximate square footage and their form of occupancy are as follows:
(1)
Locations are leased from partnerships in which Steven E. Trager, Chairman and Chief Executive Officer and A. Scott Trager, President, are partners. See additional discussion included under Part III Item 13 “Certain Relationships and Related Transactions, and Director Independence.” For additional discussion regarding Republic’s lease obligations, see Part II Item 8 “Financial Statements and Supplementary Data” Footnote 21 “Transactions with Related Parties and Their Affiliates.”
(2)
The banking centers at these locations are owned by Republic; however, the banking center is located on land that is leased through long-term agreements with third parties.
(3)
Office lease commenced during the first quarter of 2017.
Item 3.
Item 3. Legal Proceedings.
In the ordinary course of operations, Republic Bancorp, Inc. (“Republic”) and Republic Bank & Trust Company (the “Bank”) are defendants in various legal proceedings. There is no proceeding pending or threatened litigation, to the knowledge of management, in which an adverse decision could result in a material adverse change in the business or consolidated financial position of Republic or the Bank.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market and Dividend Information
Republic Bancorp, Inc.’s (“Republic” or the “Company”) Class A Common Stock is traded on The NASDAQ Global Select Market® (“NASDAQ”) under the symbol “RBCAA.” The following table sets forth the high and low market value of the Class A Common Stock and the respective dividends declared during 2016 and 2015.
(1)
- Sales price based on closing market price.
At February 10, 2017, the Company’s Class A Common Stock was held by 565 shareholders of record and the Class B Common Stock was held by 111 shareholders of record. There is no established public trading market for the Company’s Class B Common Stock. The Company intends to continue its historical practice of paying quarterly cash dividends; however, there is no assurance by the Board of Directors that such dividends will continue to be paid in the future. The payment of dividends in the future is dependent upon future income, financial position, capital requirements, the discretion and judgment of the Board of Directors and numerous other considerations.
For additional discussion regarding regulatory restrictions on dividends, see Part II Item 8 “Financial Statements and Supplementary Data” Footnote 14 “Stockholders’ Equity and Regulatory Capital Matters.”
Republic has made available to its employees participating in its 401(k) Plan the opportunity, at the employee’s sole discretion, to invest funds held in their accounts under the plan in shares of Class A Common Stock of Republic. Shares are purchased by the
independent trustee administering the plan from time to time in the open market in the form of broker’s transactions. As of December 31, 2016, the trustee held 237,432 shares of Class A Common Stock and 2,648 shares of Class B Common Stock on behalf of the plan.
Details of Republic’s Class A Common Stock purchases during the fourth quarter of 2016 are included in the following table:
During 2016, the Company repurchased 43,536 shares and there were no shares exchanged for stock option exercises. During 2011, the Company’s Board of Directors amended its existing share repurchase program by approving the repurchase of 300,000 additional shares from time to time, as market conditions are deemed attractive to the Company. The repurchase program will remain effective until the total number of shares authorized is repurchased or until Republic’s Board of Directors terminates the program. As of December 31, 2016, the Company had 250,325 shares which could be repurchased under its current share repurchase programs.
During 2016, there were approximately 239 shares of Class A Common Stock issued upon conversion of shares of Class B Common Stock by stockholders of Republic in accordance with the share-for-share conversion provision option of the Class B Common Stock. The exemption from registration of the newly issued Class A Common Stock relied upon was Section (3)(a)(9) of the Securities Act of 1933.
There were no equity securities of the registrant sold without registration during the quarter covered by this report.
STOCK PERFORMANCE GRAPH
The following stock performance graph does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates the performance graph by reference therein.
The following stock performance graph sets forth the cumulative total shareholder return (assuming reinvestment of dividends) on Republic’s Class A Common Stock as compared to the NASDAQ Bank Stocks Index and the Standard & Poor’s (“S&P”) 500 Index. The graph covers the period beginning December 31, 2011 and ending December 31, 2016. The calculation of cumulative total return assumes an initial investment of $100 in Republic’s Class A Common Stock, the NASDAQ Bank Index and the S&P 500 Index on December 31, 2011. The stock price performance shown on the graph below is not necessarily indicative of future stock price performance.
			 		
Item 6.
Item 6. Selected Financial Data. (continued)
Item 6. Selected Financial Data. (continued)
(1)
“Core Bank” or “Core Banking” operations consist of the Traditional Banking, Warehouse Lending and Mortgage Banking segments.
See Footnote 24 “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.
(2)
The following table provides a reconciliation of total stockholders’ equity in accordance with U.S. generally accepted accounting principles (“GAAP”) to tangible stockholders’ equity in accordance with applicable regulatory requirements, a non-GAAP measure. The Company provides the tangible book value ratio, a non-GAAP measure, in addition to those defined by banking regulators, because of its widespread use by investors as a means to evaluate capital adequacy.
Item 6. Selected Financial Data. (continued)
(3)
The efficiency ratio, a non-GAAP measure, equals total noninterest expense divided by the sum of net interest income and noninterest income. The ratio excludes net gain (loss) on sales, calls and impairment of investment securities, if applicable.
(4)
The cost of deposits ratio equals total interest expense on deposits divided by total average interest-bearing deposits plus total average noninterest-bearing deposits.
(5)
FTEs - Full-time-equivalent employees.
(6)
The delinquent loans to total loans ratio equals loans 30-days-or-more past due loans divided by total loans. Depending on loan class, loan delinquency is determined by the number of days or the number of payments past due.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s Discussion and Analysis of Financial Condition and Results of Operations of Republic Bancorp, Inc. (“Republic” or the “Company”) analyzes the major elements of Republic’s consolidated balance sheets and statements of income. Republic, a financial holding company headquartered in Louisville, Kentucky, is the parent company of Republic Bank & Trust Company (“RB&T” or the “Bank”) and Republic Insurance Services, Inc. (the “Captive”). The Bank is a Kentucky-based, state chartered non-member financial institution that provides traditional banking products to clients primarily in its market footprint through its network of banking centers and to clients outside of its market footprint primarily through its Digital and Correspondent Lending delivery channels.
The Captive is a Nevada-based, wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and the Bank as well as 10 other third-party insurance captives for which insurance may not be available or economically feasible.
Republic Bancorp Capital Trust (“RBCT”) is a Delaware statutory business trust that is a 100%-owned unconsolidated finance subsidiary of Republic.
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.”
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; and the term the “Bank” refers to the Company’s subsidiary bank, RB&T.
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 may not update them to reflect changes that occur subsequent to the date the statements are made.
Broadly speaking, forward-looking statements include:
·
projections of revenue, income, expenses, losses, earnings per share, capital expenditures, dividends, capital structure or other financial items;
·
descriptions of plans or objectives for future operations, products or services;
·
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:
·
changes in political and economic conditions;
·
the magnitude and frequency of changes to the Federal Funds Target Rate (“FFTR”) implemented by the Federal Open Market Committee (“FOMC”) of the Federal Reserve Bank (“FRB”);
·
long-term and short-term interest rate fluctuations as well as the overall steepness of the yield curve;
·
competitive product and pricing pressures in each of the Company’s business segments;
·
equity and fixed income market fluctuations;
·
client bankruptcies and loan defaults;
·
inflation;
·
recession;
·
future acquisitions;
·
integrations of acquired businesses;
·
changes in technology;
·
changes in applicable laws and regulations or the interpretation and enforcement thereof;
·
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;
·
information security breaches or cyber security attacks involving either the Company or one of the Company’s third-party service providers;
·
as well as other risks and uncertainties reported from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”), including Part 1 Item 1A “Risk Factors.”
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Republic’s consolidated financial statements and accompanying footnotes have been prepared in accordance with U.S. generally accepted accounting principles (“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:
·
Allowance for Loan and Lease Losses (“Allowance”) and Provisions for Loan and Lease losses (“Provision”)
·
Accounting for Business Acquisitions
·
Goodwill and Other Intangible Assets
·
Mortgage Servicing Rights (“MSRs”)
·
Income Tax Accounting
·
Investment Securities
·
Other Real Estate Owned (“OREO”)
·
Correspondent Loan Premiums
Allowance for Loan and Leases Losses and Provision for Loan and Lease Losses - The Bank maintains an allowance for probable incurred credit losses inherent in the Bank’s loan portfolio, which includes overdrawn deposit accounts. Management evaluates the adequacy of the Allowance on a monthly basis and presents and discusses the analysis with the Audit Committee and the Board of Directors on a quarterly basis.
The Allowance consists of both specific and general components. The specific component relates to loans that are individually classified as impaired. The general component relates to pooled loans collectively evaluated on historical loss experience adjusted for qualitative factors.
Specific Component - Loans Individually Classified as Impaired
The Bank defines impaired loans as follows:
·
All loans internally rated as “Substandard,” “Doubtful” or “Loss”;
·
All loans on nonaccrual status;
·
All Troubled Debt Restructurings (“TDRs”);
·
All loans internally rated in a purchased credit impaired (“PCI”) category with cash flows that have deteriorated from management’s initial acquisition day estimate; and
·
Any other situation where the full collection of the total amount due for a loan is improbable or otherwise meets the definition of impaired.
Generally, loans are designated as “Classified” or “Special Mention” to ensure more frequent monitoring. These loans are reviewed to ensure proper accrual status and management strategy. If it is determined that there is serious doubt as to performance in accordance with original or modified contractual terms, then the loan is generally downgraded and may be charged down to its estimated value and placed on nonaccrual status.
Under GAAP, the Bank uses the following methods to measure specific loan impairment, including:
·
Cash Flow Method - The recorded investment in the loan is measured against the present value of expected future cash flows discounted at the loan’s effective interest rate. The Bank employs this method for a significant portion of its TDRs. Impairment amounts under this method are reflected in the Bank’s Allowance as specific reserves on the respective impaired loan. These specific reserves are adjusted quarterly based upon reevaluation of the expected future cash flows and changes in the recorded investment.
·
Collateral Method - The recorded investment in the loan is measured against the fair value of the collateral less applicable selling costs. The Bank employs the fair value of collateral method for its impaired loans when repayment is based solely on the sale or operations of the underlying collateral. Collateral fair value is typically based on the most recent real estate valuation on file. Measured impairment under this method is generally charged off unless the loan is a smaller-balance, homogeneous loan. The Bank’s selling costs for its collateral-dependent loans typically range from 10-13% of the fair value of the underlying collateral, depending on the asset class. Selling costs are not applicable for collateral-dependent loans whose repayment is based solely on the operations of the underlying collateral.
In addition to obtaining appraisals at the time of origination, the Bank typically updates appraisals and/or broker price opinions (“BPOs”) for loans with potential impairment. Updated valuations for commercial-related credits exhibiting an increased risk of loss are typically obtained within one year of the previous valuation. Collateral values for delinquent residential mortgage loans and home equity loans are generally updated prior to a loan becoming 90 days delinquent, but no more than 180 days past due. When measuring impairment, to the extent updated collateral values cannot be obtained due to the lack of recent comparable sales or for other reasons, the Bank discounts such stale valuations primarily based on age of valuation and market conditions of the underlying collateral.
General Component - Pooled Loans Collectively Evaluated
The general component of the Allowance covers loans collectively evaluated for impairment by loan class and is based on historical loss experience, with potential adjustments for current relevant qualitative factors. Historical loss experience is determined by loan performance and class and is based on the actual loss history experienced by the Bank. Large groups of smaller-balance, homogeneous loans are typically included in the general component but may be individually evaluated if classified as a TDRs, on nonaccrual, or a case where the full collection of the total amount due for a such loan is improbable or otherwise meets the definition of impaired.
In determining the historical loss rates for each respective loan class, management evaluates the following historical loss rate scenarios:
·
Rolling four quarter average
·
Rolling eight quarter average
·
Rolling twelve quarter average
·
Rolling sixteen quarter average
·
Rolling twenty quarter average
·
Rolling twenty-four quarter average
·
Rolling twenty-eight quarter average
·
Rolling thirty-two quarter average
·
Current year to date historical loss factor average
In order to take account of periods of economic growth and economic downturn, management generally uses the highest of the evaluated averages above for each loan class when determining its historical loss factors.
Loan classes are also evaluated utilizing subjective factors in addition to the historical loss calculations to determine a loss allocation for each class. Management assigns risk multiples to certain classes to account for qualitative factors such as:
·
Changes in nature, volume and seasoning of the portfolio;
·
Changes in experience, ability and depth of lending management and other relevant staff;
·
Changes in the quality of the Bank’s credit review system;
·
Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;
·
Changes in the volume and severity of past due, nonperforming and classified loans;
·
Changes in the value of underlying collateral for collateral-dependent loans;
·
Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of portfolios, including the condition of various market segments;
·
The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
·
The effect of other external factors, such as competition and legal and regulatory requirements on the level of estimated credit losses in the Bank’s existing portfolio.
As this analysis, or any similar analysis, is an imprecise measure of loss, the Allowance is subject to ongoing adjustments. Therefore, management will often take into account other significant factors that may be necessary or prudent in order to reflect probable incurred losses in the total loan portfolio.
Management’s Evaluation of the Allowance
Management evaluates the Allowance for its more traditional Core Banking operations differently than its non-traditional Republic Processing Group (“RPG”) segment.
For Core Banking operations, management performs two calculations at year-end in order to confirm the reasonableness of its Allowance. In the first calculation, management compares the beginning Allowance to the net charge-offs for the most recent calendar year. The ratio of net charge-offs to the beginning-of-year Allowance indicates how adequately the beginning-of-year Allowance accommodated subsequent charge-offs. Higher ratios suggest the beginning-of-year Allowance may not have been large enough to absorb impending charge-offs, while inordinately low ratios might indicate the accumulation of excessive allowances. The Core Bank’s net charge-off ratio to the beginning-of-year Allowance was 7% at both December 31, 2016 and 2015. The Core Bank’s five-year annual average for this ratio was 15% as of December 31, 2016. Management believes the Core Bank’s net charge-off ratio to beginning Allowance was within a reasonable range at December 31, 2016 and 2015.
For the second calculation, management assesses the Core Bank’s Allowance exhaustion rate. Exhaustion rates indicate the time (expressed in years) taken to use the beginning-of-year Allowance in the form of actual charge-offs. Management believes an exhaustion rate that indicates a reasonable Allowance is in a range of four to eight years. The Core Bank’s Allowance exhaustion rates at December 31, 2016 and 2015 were 7.6 years and 5.6 years compared to the five-year annual average of 4.7 years as of December 31, 2016. Management believes the Core Bank’s Allowance exhaustion rates were within a reasonable range at December 31, 2016 and 2015.
Based on management’s calculation, a Core Bank Allowance of $28 million, or 0.74% of total loans and leases, was an adequate estimate of probable incurred losses within the loan portfolio as of December 31, 2016 compared to $26 million, or 0.78%, at December 31, 2015. This estimate resulted in Core Banking Provision of $3.9 million during 2016 compared to $3.1 million in 2015. 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 Allowance and the resulting effect on the income statement could be material.
The RPG Allowance at December 31, 2016 and 2015 primarily related to loans originated and held for investment through the Republic Credit Solutions (“RCS”) division. RCS generally originates small-dollar, short-term credit products. In some instances, the Bank originates these products, sells 90% of the balances within two days of loan origination, and retains a 10% interest.
One short-term line-of-credit product represented the substantial majority of the RCS held-for-investment loan portfolio at December 31, 2016. For this product, management conducts an analysis of historical losses and delinquencies by month of loan origination when determining the Allowance. For RCS’s other products, the Allowance is estimated using a method similar to Core Bank loans, as described above. Due to their non-traditional, small-dollar and short-term nature, RCS loans generally experience higher loss rates than Core Bank consumer products. Based on management’s calculation, an Allowance of $4.9 million, or 13%, of total RPG loans was an adequate estimate of probable incurred losses within the RPG portfolio as of December 31, 2016 compared to an Allowance of $1.7 million, or 24%, at December 31, 2015.
RPG’s Tax Refund Solutions (“TRS”) division first offered its Easy Advance (“EA”) tax-credit product during the first two months of 2016 and again during the first quarter of 2017. An Allowance for losses on EAs is estimated during the limited, short-term period the product is offered, which was through February 29, 2016 for the first quarter 2016 tax season. During 2016, EAs were generally repaid within three weeks of origination. Provisions for loan losses on EAs were estimated when advances were made, with all provisions made in the first quarter of 2016. No Allowance for EAs existed as of December 31, 2016, as all EAs had been paid off or had been charged-off within 81 days of origination. The majority of EA charge-offs were recorded during the second quarter of 2016.
Related to the overall credit losses on EAs, the Bank’s ability to control those 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 on the prior-year’s tax refund funding patterns with on-going changes made in-season, if possible, to adjust for any new current-year tax refund funding patterns recognized by the Bank. 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.
See additional discussion regarding the EA product under the sections titled:
·
Part I Item 1A “Risk Factors”
·
Part II Item 8 “Financial Statements and Supplementary Data,” Footnote 5 “Loans and Allowance for Loan and Lease Losses”
RPG recorded a net charge of $10.5 million and $2.3 million to the Provision during 2016 and 2015, with the 2016 Provision primarily due to net losses on EAs and growth in short-term, consumer loans originated through the RCS division. If the amount 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 Allowance and the resulting effect on the income statement could be material.
Accounting for Business Acquisitions - The Bank accounts for its business acquisitions in accordance with the acquisition method as outlined in Account Standards Codification (“ASC”) Topic 805, Business Combinations. The acquisition method requires: a) identification of the entity that obtains control of the acquiree; b) determination of the acquisition date; c) recognition and measurement of the identifiable assets acquired and liabilities assumed, and any noncontrolling interest in the acquiree; and d) recognition and measurement of goodwill or bargain purchase gain.
Identifiable assets acquired, liabilities assumed, and any noncontrolling interest in acquirees are generally recognized at their acquisition date (“day-one”) fair values based on the requirements of ASC Topic 820, Fair Value Measurements and Disclosures. The measurement period for day-one fair values begins on the acquisition date and ends the earlier of: (a) the day management believes it has all the information necessary to determine day-one fair values; or (b) one year following the acquisition date. In many cases, the determination of day-one fair values requires management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly complex and subjective in nature and subject to recast adjustments, which are retrospective adjustments to reflect new information existing at the acquisition date affecting day-one fair values. More specifically, these recast adjustments for loans and other real estate owned may be made, as market value data, such as valuations, are received by the Bank. Increases or decreases to day-one fair values are reflected with a corresponding increase or decrease to bargain purchase gain or goodwill.
Acquisition related costs are expensed as incurred unless those costs are related to issuing debt or equity securities used to finance the acquisition.
Loans purchased in a business acquisition are accounted for using one of the following accounting standards:
·
ASC Topic 310-20, Non Refundable Fees and Other Costs, is used to value loans that have not demonstrated post origination credit quality deterioration and the acquirer expects to collect all contractually required payments from the borrower. For these loans, the difference between the loan’s day-one fair value and amortized cost would be amortized or accreted into income using the interest method.
·
ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, is used to value PCI loans. For these loans, it is probable the acquirer will be unable to collect all contractually required payments from the borrower. Under ASC Topic 310-30, the expected cash flows that exceed the initial investment in the loan, or fair value, represent the “accretable yield,” which is recognized as interest income on a level-yield basis over the expected cash flow periods of the loans. Additionally, the difference between contractual cash flows and expected cash flows of PCI loans is referred to as the “non-accretable discount.”
Purchased loans accounted for under ASC Topic 310-20 are accounted for as any other Bank-originated loan, potentially becoming nonaccrual or impaired, as well as being risk rated under the Bank’s standard practices and procedures. In addition, these loans are considered in the determination of the Allowance once day-one fair values are final.
Management utilized the following criteria in determining which loans were classified as PCI loans for its May 17, 2016 Cornerstone acquisition:
·
Loans for which the Bank assigned a non-accretable discount
·
Loans classified as nonaccrual when acquired
·
Loans past due 90+ days when acquired
See additional detail regarding the Company’s acquisition of Cornerstone Bancorp, Inc. under Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
In determining the day-one fair values of PCI loans, management considers a number of factors including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. The Bank typically accounts for PCI loans individually, as opposed to aggregating the loans into pools based on common risk characteristics such as loan type.
Management separately monitors the PCI portfolio and on a quarterly basis reviews the loans contained within this portfolio against the factors and assumptions used in determining the day-one fair values. In addition to its quarterly evaluation, a loan is typically reviewed when it is modified or extended, or when material information becomes available to the Bank that provides additional insight regarding the loan’s performance, estimated life, the status of the borrower, or the quality or value of the underlying collateral.
To the extent that a PCI loan’s performance does not reflect an increased risk of loss of contractual principal beyond the non-accretable yield established as part of its initial day-one evaluation, such loan would be classified in the Purchased Credit Impaired - Group 1 (“PCI-1”) category, whose credit risk is considered by management equivalent to a non-PCI Special Mention loan within the Bank’s credit rating matrix. PCI-1 loans are considered impaired if, based on current information and events, it is probable that the future estimated cash flows of the loan have deteriorated from management’s initial acquisition day estimate. Provisions are made for impaired PCI-1 loans to further discount the loan and allow its yield to conform to at least management’s initial expectations. Any improvement in the expected performance of a PCI-1 loan would result in a reversal of the Provision to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.
If during the Bank’s periodic evaluations of its PCI loan portfolio, management deems a PCI-1 loan to have an increased risk of loss of contractual principal beyond the non-accretable discount established as part of its initial day-one evaluation, such loan would be classified PCI-Substandard (“PCI-Sub”) within the Bank’s credit risk matrix. Management deems the risk of default and overall credit risk of a PCI-Sub loan to be greater than a PCI-1 loan and more analogous to a non-PCI Substandard loan. PCI-Sub loans are considered to be impaired. Any improvement in the expected performance of a PCI-Sub loan would result in a reversal of the Provision to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.
PCI loans are placed on nonaccrual if management cannot reasonably estimate future cash flows on such loans.
If a troubled debt restructuring is performed on a PCI loan, the loan is considered impaired under the applicable TDR accounting standards and transferred out of the PCI population. The loan may require an additional Provision if its restructured cash flows are less than management’s initial day-one expectations. PCI loans for which the Bank simply chooses to extend the maturity date are generally not considered TDRs and remain in the PCI population.
Goodwill and Other Intangible Assets - Goodwill resulting from business acquisitions prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business acquisitions after January 1, 2009 represents the future economic benefits arising from other assets acquired that are individually identified and separately recognized. Goodwill and intangible assets acquired in a business acquisition and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually.
The Company has selected September 30th as the date to perform its annual goodwill impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Bank’s balance sheet.
All goodwill is attributable to the Company’s Traditional Banking segment and is not expected to be deductible for tax purposes. Based on its assessment, the Company believes its goodwill of $16 million and $10 million at December 31, 2016 and 2015 was not
impaired and is properly recorded in the consolidated financial. Related to the Company’s May 17, 2016 acquisition of Cornerstone Bancorp, Inc., the Company recorded $6 million of goodwill.
Other intangible assets consist of core deposit intangible (“CDI”) assets arising from business acquisitions. CDI assets are initially measured at fair value and then amortized on an accelerated method over their estimated useful lives.
Related to the Company’s May 17, 2016 acquisition of Cornerstone Bancorp, Inc., the Company maintained $1 million of CDI assets as of December 31, 2016, with no similar intangible assets recorded as of December 31, 2015. The Cornerstone related CDI is scheduled to amortize through 2022.
See additional detail regarding the Company’s acquisition of Cornerstone Bancorp, Inc. under Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
Mortgage Servicing Rights - Mortgage loans held for sale are generally sold with the MSRs retained. When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value, with the income statement effect recorded as a component of net servicing income within Mortgage Banking income. Fair value is based on market prices for comparable mortgage servicing contracts, when available or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method, which requires servicing rights to be amortized into Mortgage Banking income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Amortization of MSRs are initially set at seven years and subsequently adjusted on a quarterly basis based on the weighted average remaining life of the underlying loans.
MSRs are evaluated for impairment quarterly based upon the fair value of the MSRs as compared to carrying amount. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate, loan type, loan terms and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Bank later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the valuation allowance is recorded as an increase to income. Changes in valuation allowances are reported within Mortgage Banking income on the income statement. The fair value of the MSR portfolio is subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates.
A primary factor influencing the fair value is the estimated life of the underlying loans serviced. The estimated life of the loans serviced is significantly influenced by market interest rates. During a period of declining interest rates, the fair value of the MSRs is expected to decline due to increased anticipated prepayment speeds within the portfolio. Alternatively, during a period of rising interest rates, the fair value of MSRs is expected to increase, as prepayment speeds on the underlying loans would be anticipated to decline. Based on the estimated fair value at December 31, 2016 and 2015, management determined there was no impairment within the MSR portfolio.
The Bank’s carrying value of its MSR portfolio was $5 million and $5 million at December 31, 2016 and 2015.
Income Tax Accounting - Income tax liabilities or assets are established for the amount of taxes payable or refundable for the current year. Deferred tax liabilities and assets are also established for the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and deductions that can be carried forward (used) in future years. The valuation of current and deferred tax liabilities and assets is considered critical, as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax liabilities and assets involves the use of estimates, assumptions, interpretations and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. The Company believes its tax assets and liabilities are adequate and are properly recorded in the consolidated financial statements at December 31, 2016 and 2015.
Investment Securities - Unrealized losses for all investment securities are reviewed to determine whether the losses are “other-than-temporary.” Investment securities are evaluated for other-than-temporary impairment (“OTTI”) on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in value below amortized
cost is other-than-temporary. In conducting this assessment, the Bank evaluates a number of factors including, but not limited to the following:
·
The length of time and the extent to which fair value has been less than the amortized cost basis;
·
The Bank’s intent to hold until maturity or sell the debt security prior to maturity;
·
An analysis of whether it is more-likely-than-not that the Bank will be required to sell the debt security before its anticipated recovery;
·
Adverse conditions specifically related to the security, an industry, or a geographic area;
·
The historical and implied volatility of the fair value of the security;
·
The payment structure of the security and the likelihood of the issuer being able to make payments;
·
Failure of the issuer to make scheduled interest or principal payments;
·
Any rating changes by a rating agency; and
·
Recoveries or additional decline in fair value subsequent to the balance sheet date.
The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for the anticipated credit losses.
The Bank held one security at December 31, 2016 and 2015 with a total carrying value of $5 million and $5 million for which it recorded OTTI charges in previous years.
Other Real Estate Owned - Assets acquired through loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. The Bank’s selling costs for OREO typically range from 10-13% of each property’s fair value, depending on property class. Fair value is commonly based on recent real estate appraisals or BPO. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Operating costs after acquisition are expensed.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Once the appraisal is received, a member of the Bank’s Credit Administration Department (“CAD”) typically reviews the assumptions and approaches utilized in the appraisal, as well as the fair value in comparison with independent data sources, such as recent market data or industry-wide statistics. On at least an annual basis, the Bank performs a back test of collateral appraisals by comparing actual selling prices on recent collateral sales to the most recent appraisal of such collateral. Back tests are performed for each collateral class and may lead to additional adjustments to the value of unliquidated collateral of similar class.
The Bank’s total OREO recorded was $1 million and $1 million at December 31, 2016 and 2015.
Correspondent Loan Premiums - The Bank began acquiring single family, first lien mortgage loans for investment through its Correspondent Lending channel in May 2014. Correspondent Lending generally involves the Bank acquiring, primarily from its Warehouse Lending (“Warehouse”) clients, closed loans that meet the Bank’s specifications. Substantially all loans purchased through the Correspondent Lending channel are purchased at a premium.
Premiums on loans held for investment acquired though the Correspondent Lending channel are amortized into interest income on the level-yield method over the expected life of the loan. During a period of declining interest rates, the expected life of Correspondent Loans would generally be expected to decline due to anticipated prepayments within the portfolio. Alternatively, during a period of rising interest rates, the expected life of Correspondent Loans would generally be expected to increase as prepayments on the underlying loans would be anticipated to decline. Shorter estimated lives will increase premium amortization expense and decrease interest income, with longer lives having the reverse effect.
Unamortized premiums totaled $2 million and $4 million at December 31, 2016 and 2015. The weighted average estimated remaining life of the Correspondent Loan portfolio was 4.4 and 4.9 years at December 31, 2016 and 2015. In the third quarter of 2016, the Bank sold $71 million of mortgage loans previously originated through its Correspondent Lending channel in order to enhance its overall liquidity position and recorded a $1.1 million gain on this sale.
OVERVIEW
Net income for 2016 was $45.9 million, representing an increase of $10.7 million, or 31%, compared to 2015. Diluted earnings per Class A Common Share increased 31% to $2.22 for 2016 compared to $1.70 for 2015. As discussed further below, growth in net income during 2016 was spread across all four of the Company’s operating segments.
Table 1 - Summary
Additional discussion follows in this section of the filing under “Results of Operations.”
General highlights by business segment for the year ended December 31, 2016 consisted of the following:
Traditional Banking segment
·
Net income increased $1.0 million, or 4%, for 2016 compared to 2015. A key driver of this increase was the successful execution of organic loan growth initiatives over the previous two years. Additionally, the Traditional Bank’s net income was meaningfully impacted by accretive benefits from the Company’s May 17, 2016 Cornerstone Bancorp (“Cornerstone”) acquisition.
See additional detail regarding the Company’s acquisition of Cornerstone Bancorp, Inc. under Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
·
Net interest income increased $13.4 million, or 12%, for 2016 to $121.7 million. The Traditional Banking segment net interest margin increased six basis points for the year ended December 31, 2016 to 3.26%.
·
The Traditional Banking Provision was $3.4 million for 2016 compared to $2.9 million for 2015.
·
Total noninterest income increased $2.3 million, or 10%, for 2016 compared to 2015.
·
Total noninterest expense increased $14.6 million, or 16%, during 2016 compared 2015.
·
Gross Traditional Bank loans increased by $254 million, or 9%, from December 31, 2015 to December 31, 2016. A significant portion of the increase in Traditional Bank loans was attributable to the Cornerstone acquisition.
·
Traditional Bank deposits grew by $647 million, or 27%, from December 31, 2015 to December 31, 2016. A significant portion of the increase in Traditional Bank deposits was attributable to the Cornerstone acquisition.
·
Total nonperforming loans to total loans for the Traditional Banking segment was 0.50% at December 31, 2016 compared to 0.75% at December 31, 2015.
·
Delinquent loans to total loans for the Traditional Banking segment was 0.21% at December 31, 2016 compared to 0.39% at December 31, 2015.
Warehouse Lending segment
·
Net income increased $2.1 million, or 36%, for 2016 compared to 2015. Key drivers of this increase were increases in the number of Warehouse clients and the continuing strong usage of committed Warehouse lines.
·
Net interest income increased $4.3 million, or 35%, for 2016 compared to 2015. The Warehouse segment net interest margin increased one basis point from 2015 to 3.59% for 2016.
·
The Warehouse Provision was $497,000 for 2016 compared to $168,000 for 2015.
·
Total committed Warehouse lines increased from $670 million at December 31, 2015 to $1.0 billion at December 31, 2016.
·
Average line usage was 57% during 2016 compared to 55% during 2015.
·
There were no nonperforming loans or delinquent loans associated with the Warehouse segment at December 31, 2016 and 2015.
Mortgage Banking segment
·
Within the Mortgage Banking segment, mortgage banking income increased $2.5 million, or 56%, during 2016 compared to 2015, with $1.1 million of the increase attributable to a bulk loan sale of $71 million representing a portion of the Company’s correspondent loan portfolio during the third quarter of 2016.
·
Overall, excluding the aforementioned bulk loan sale, Republic’s proceeds from the sale of secondary market loans totaled $215 million during 2016 compared to $167 million during the same period in 2015.
Republic Processing Group segment
·
Net income increased $5.7 million, or 108%, for 2016 compared to 2015, driven by the Tax Refund Division’s (“TRS”) newly introduced EA product and growth in the Republic Credit solutions (“RCS”) division’s short-term loan programs.
·
Net interest income increased $14.4 million for 2016 compared to 2015, with the above-mentioned newly introduced EA product and growth in short-term credit products driving the increase.
·
RPG recorded a net charge to the Provision of $10.5 million during 2016, compared to a net charge of $2.3 million for 2015, with the above mentioned newly introduced EA product and growth in short-term credit products also driving the increased Provision.
·
Noninterest income was $24.2 million for 2016 compared to $19.6 million for 2015.
·
Net Refund Transfers (“RT”) revenue increased $1.9 million, or 11%, during 2016 compared to 2015.
·
Noninterest expenses were $13.9 million for 2016 compared to $12.1 million for 2015.
·
Total nonperforming loans to total loans for the RPG segment was 0.21% at December 31, 2016 compared to 0.00% at December 31, 2015.
·
Delinquent loans to total loans for the RPG segment was 5.49% at December 31, 2016 compared to 3.41% at December 31, 2015.
General highlights by business segment for the year ended December 31, 2015 consisted of the following:
Traditional Banking segment
·
Net income increased $2.6 million, or 12%, for 2015 compared to 2014.
·
Net interest income increased $3.5 million, or 3%, for 2015 to $108.3 million. The Traditional Banking segment net interest margin decreased 17 basis points for the year ended December 31, 2015 to 3.15%.
·
The Traditional Banking Provision was $2.9 million for 2015 compared to $3.0 million for 2014.
·
Total noninterest income increased $2.3 million, or 11%, for 2015 compared to 2014.
·
Total noninterest expense increased $3.0 million, or 3%, during 2015 compared 2014.
·
Gross Traditional Bank loans increased by $216 million, or 8%, from December 31, 2014 to December 31, 2015.
·
Traditional Bank deposits grew by $395 million, or 19%, from December 31, 2014 to December 31, 2015.
·
Total nonperforming loans to total loans for the Traditional Banking segment was 0.75% at December 31, 2015 compared to 0.87% at December 31, 2014.
·
Delinquent loans to total loans for the Traditional Banking segment was 0.39% at December 31, 2015 compared to 0.58% at December 31, 2014.
Warehouse Lending segment
·
Net income increased $2.6 million, or 75%, for 2015 compared to 2014.
·
Net interest income increased $4.8 million, or 64%, for 2015 compared to 2014. The Warehouse segment net interest margin decreased 19 basis points from 2014 to 3.58% for 2015.
·
The Warehouse Provision was $168,000 for 2015 compared to $350,000 for 2014.
·
Total committed lines increased from $528 million at December 31, 2014 to $670 million at December 31, 2015.
·
Average line usage was 55% during 2015 compared to 47% during 2014.
·
There were no nonperforming loans or delinquent loans associated with the Warehouse segment at December 31, 2015 and 2014.
Mortgage Banking segment
·
Within the Mortgage Banking segment, mortgage banking income increased $1.5 million, or 54%, during 2015 compared to 2014.
·
Overall, Republic’s proceeds from the sale of secondary market loans totaled $167 million during 2015 compared to $82 million during 2014. Volume during 2015 benefited from favorably low, long-term mortgage rates during the period.
Republic Processing Group segment
·
Net income increased $854,000, or 19%, for 2015 compared to 2014.
·
RPG recorded a net charge to the Provision of $2.3 million during 2015, compared to a net credit of $533,000 for 2014.
·
Noninterest income was $19.6 million for 2015 compared to $17.9 million for 2014.
·
Net RT revenue increased $1.3 million, or 8%, during 2015 compared to 2014.
·
Noninterest expenses were $12.1 million for 2015 compared to $11.7 million for 2014.
RESULTS OF OPERATIONS
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 Federal Home Loan Bank (“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.
Discussion of 2016 vs. 2015
Total Company net interest income increased $32.1 million, or 26%, during 2016 compared to the same period in 2015. The primary drivers of the increase in total Company net interest income were growth in the Core Bank’s average loans, loan volume associated with the EA product at TRS and growth in the RCS small-dollar consumer loan programs. The total Company net interest margin increased to 3.65% during 2016 compared to 3.27% for the same period in 2015, with higher margins on TRS’s EA product and RCS’s small-dollar consumer loan programs being significant drivers of the overall increase in the Company’s net interest margin.
The most significant components affecting the total Company’s net interest income and net interest margin by business segment were as follow:
Traditional Banking segment
Net interest income within the Traditional Banking segment increased $13.4 million, or 12%, during 2016 compared to 2015. The Traditional Banking net interest margin was 3.26% for 2016, an increase of six basis points from 2015.
The increases in the Traditional Bank’s net interest income and net interest margin during 2016 were primarily attributable to the following:
·
Average Traditional Bank loans outstanding, excluding loans from the Company’s May 17, 2016 Cornerstone acquisition and 2012 FDIC-assisted transactions, were $2.9 billion with a weighted average yield of 4.09% during 2016 compared to $2.8 billion with a weighted average yield of 4.06% during 2015. The overall effect of this change in volume was an increase of $6.7 million in interest income. This increase in average loans for 2016 over 2015 was driven primarily by growth in the Bank’s commercial real estate (“CRE”), commercial and industrial (“C&I”) and home equity line of credit (“HELOC”) portfolios.
·
Net interest income related to the Company’s May 17, 2016 Cornerstone acquisition contributed $4.9 million to the Traditional Bank’s overall net interest income during 2016. Loan accretion income related to the Cornerstone acquisition was approximately $240,000 for 2016. See additional detail regarding the Company’s acquisition of Cornerstone Bancorp, Inc. under Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
·
Net interest income related to loans from the Company’s 2012 FDIC-assisted transactions was lower during 2016 compared to 2015 primarily due to a lower rate of favorable payoffs and paydowns on the portfolio. When loans from these transactions are paid off, all unearned discount on such loans is immediately accreted into income. Accretion income during 2016 from this portfolio was $1.1 million compared to $2.4 million in 2015. Overall, the average balance of the portfolio was $20 million with a yield of 13.30% during 2016 compared to $32 million with a yield of 13.60% in 2015. The overall effect of these changes in rate and volume was a decrease of $1.7 million in interest income.
·
The weighted average cost of FHLB advances during 2016 compared to 2015 declined to 1.87% from 1.99%. The average outstanding FHLB advances decreased $16 million during the same period, with the Traditional Bank continuing to employ a higher mix of lower cost overnight borrowings during 2016. The net effect of these changes in rate and volume was an increase in net interest income of $1.0 million.
·
The Company’s subordinated note related to RBCT paid a fixed interest rate of 6.015% through September 30, 2015 and adjusted to LIBOR plus 1.42% thereafter. During 2016, the note’s coupon rate was based on the LIBOR index and approximately 4.00% lower than the note’s coupon rate during the first nine months of 2015. The overall lower rate during 2016 equated to $1.2 million less in interest expense compared to 2015. This subordinated note matures on December 31, 2035 and is currently redeemable at the Company’s option on a quarterly basis. The Company elected not to redeem its subordinated note on January 1, 2017.
The FFTR increased for only the second time in 10 years during December 2016. Additionally, the FOMC of the FRB has provided further guidance that additional FFTR increases are likely during 2017. While an increase in short-term interest rates is generally believed by management to be favorable to the Bank’s net interest income and net interest margin in the near-term, such increases in short-term interest rates could have a negative impact to net interest income and net interest margin if the Bank is unable to maintain its overall funding costs at those levels assumed in its interest rate risk model or the yield curve flattens causing the spread between long-term interest rates and short-term interest rates to decrease. Unknown variables, which may impact the 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 Bank’s financial products and the Bank’s overall future liquidity needs.
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, 2016” under “Financial Condition.”
Warehouse Lending segment
Net interest income within the Warehouse Lending segment increased $4.3 million, or 35%, in 2016 compared to 2015. The increase in net interest income was partially attributable to higher average outstanding balances and partially to higher weighted average loan yield for the current period as compared to 2015. Total Warehouse line commitments increased to $1.0 billion at December 31, 2016 from $670 million at December 31, 2015, with the Company continuing to grow its Warehouse client base over the previous 12 months. Furthermore, average line usage on Warehouse commitments increased to 57% during 2016 compared to 55% during 2015. Usage rates during both years benefitted from continued low, long-term mortgage rates. The yield for Warehouse lines of credit during 2016 increased 15 basis points from the same period in 2015, as the Warehouse yield was positively impacted by an increase in short-term interest rates.
Overall, average outstanding Warehouse lines of credit during 2016 increased $119 million, or 35%, compared to 2015. Average outstanding warehouse lines were $460 million during 2016 with a weighted average yield of 3.99%, compared to average outstanding lines of $341 million with a weighted average yield of 3.84% during 2015.
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 February 2017 projected mortgage originations to decline 17% across the United States from 2016 to 2017, which leads management to believe that usage rates among the Bank’s Warehouse Lending clients may also decrease. This predicted decline in mortgage volume, along with a very competitive landscape, 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.
Republic Processing Group segment
Net interest income within the RPG segment increased $14.4 million during 2016 compared to 2015. The increase in RPG’s net interest income was primarily attributed to the following factors:
·
The TRS division’s newly introduced EA product earned $5.2 million in interest income during 2016, with the substantial majority of this income earned during the first quarter of 2016.
See additional discussion regarding the EA product under the sections titled:
o
Part I Item 1A “Risk Factors”
o
Part II Item 8 “Financial Statements and Supplementary Data,” Footnote 5 “Loans and Allowance for Loan and Lease Losses”
·
The TRS division had a short-term commercial loan relationship with one of the Company’s third-party program managers in the tax business. TRS earned $1.1 million in loan fees from this relationship during 2016 compared to $700,000 in 2015.
·
Short-term, consumer credit products through the RCS division of RPG earned $11.0 million in net interest income during 2016 compared to $2.3 million for the same period in 2015. The increase was driven by the previously discussed growth in one of its RCS loan programs, which expanded in June 2015 beyond its pilot phase.
Discussion of 2015 vs. 2014
Total Company net interest income increased $11.2 million, or 10%, during 2015 compared to 2014. The primary driver of the increase in total Company net interest income was growth in the Company’s average loans during 2015, which increased $436 million, or 16%, over this time period. The benefit from loan growth was partially offset by a continuing general decline in the Company’s interest-earning asset yields. The total Company net interest margin decreased to 3.27% for 2015 from 3.33% during 2014.
The most significant components affecting the total Company’s net interest income and net interest margin by business segment were as follow:
Traditional Banking segment
Net interest income within the Traditional Banking segment increased $3.5 million, or 3%, for 2015 compared to 2014. The Traditional Banking net interest margin decreased 12 basis points from 2014 to 3.20%. The increase in the Traditional Bank’s net interest income and decrease in net interest margin during 2015 was primarily attributable to the following:
·
Traditional Bank loans, excluding loans acquired through the Company’s 2012 FDIC-assisted transactions, experienced yield compression of 23 basis points during 2015. Average loans outstanding, excluding loans from the 2012 FDIC-assisted transactions, were $2.8 billion with a weighted average yield of 4.06% during 2015 compared to $2.5 billion with a weighted average yield of 4.29% during 2014. The overall effect of these changes in rate and volume was an increase of $7.2 million in interest income.
·
Net interest income related to loans from the Company’s 2012 FDIC-assisted transactions was lower during 2015 due to payoffs on the portfolio over the previous 12 months together with diminishing benefits from discount accretion. Overall, the average balance of the portfolio was $32 million with a yield of 13.60% for 2015 compared to $57 million with a yield of 15.79% for 2014. The overall effect of these changes in rate and volume was a decrease of $4.7 million in interest income. Interest income on this portfolio was $4.3 million for 2015, with $2.4 million, or 55%, of such income attributable to
discount accretion compared to $9.0 million during 2014, with $5.2 million, or 58%, of such income attributable to discount accretion.
·
The weighted average cost of FHLB advances during 2015 compared to 2014 declined to 1.99% from 2.24%. The average outstanding advances increased $15 million during the same period, with the Traditional Bank employing a higher mix of lower cost overnight borrowings during 2015. The net effect of these changes in rate and volume was an increase in net interest income of $1.1 million.
·
The weighted average cost of time deposits during 2015 compared to 2014 increased to 0.96% from 0.65%, while average time deposits increased $26 million during the same period. These changes in rate and volume drove a $788,000 increase in interest expense and were primarily driven by the Bank’s promotion of its five-year certificate of deposit product. This promotion first began in September of 2014, and through December 31, 2015, had raised $67 million in certificates of deposit at a weighted average cost of 1.90%.
·
The subordinated note related to RBCT paid a fixed interest rate of 6.015% through September 30, 2015 and adjusted to LIBOR + 1.42% thereafter. Based on this repricing, the note’s coupon rate repriced from 6.015% through September 30, 2015 to 1.75% on October 1, 2015. The overall savings during 2015 from the change in rate when compared to 2014 totaled $459,000.
Warehouse Lending segment
Net interest income within the Warehouse Lending segment increased $4.8 million, or 64%, for 2015 compared to 2014, despite a decline in net interest margin of 19 basis points. The increase in net interest income was primarily attributable to higher average outstanding balances for 2015 as compared to 2014.
Total Warehouse line commitments increased to $670 million at December 31, 2015 from $528 million at December 31, 2014. Average line usage rates of such commitments increased to 55% during 2015 compared to 47% during 2014. Usage rates for 2015 benefitted from continued low, long-term mortgage rates during the period, while the overall yield declined due to competitive pricing pressures within the industry.
Driven by the increase in outstanding commitments and usage rates, average outstanding Warehouse lines of credit during 2015 increased $144 million, or 73%, compared to 2014. Average outstanding warehouse lines were $341 million during 2015 with a weighted average yield of 3.84%, compared to average outstanding lines of $197 million with a weighted average yield of 4.00% for 2014.
Republic Processing Group segment
Net interest income within the RPG segment increased $2.9 million for 2015 compared to 2014. The increase in net interest income was primarily attributable to year-over-year growth in higher yielding short-term, consumer credit products originated through RPG’s RCS division. In addition, net interest income at RPG also increased due to loan fees earned on two new, large short-term commercial loans to one of the Company’s third party program managers in the tax business. Average RPG loans outstanding were $8 million during 2015 compared to $5 million during 2014.
Table 2 - Total Company Average Balance Sheets and Interest Rates
(1)
For purpose of this calculation, the market value adjustment on investment securities resulting from ASC Topic 320, Investments - Debt and Equity Securities, is included as a component of other assets.
(2)
The amount of loan fee income included in total interest income was $24.2 million, $10.3 million and $9.4 million for 2016, 2015 and 2014.
(3)
Average balances for loans include the principal balance of nonaccrual loans and loans held for sale and are inclusive of all premiums, discounts, fees and costs.
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
Provision for Loan and Lease Losses
Discussion of 2016 vs. 2015
The Company recorded a Provision of $14.5 million during 2016, compared to $5.4 million in 2015. The significant components comprising the Company’s Provision by business segment were as follows:
Traditional Banking segment
The Traditional Banking Provision during 2016 was $3.4 million, compared to $2.9 million in 2015. An analysis of the Provision for 2016 compared to 2015 follows:
·
Related to the Bank’s pass-rated and non-rated credits, the Bank recorded net charges of $3.1 million and $2.0 million to the Provision for 2016 and 2015. Loan growth primarily drove the net charges to the Provision in both periods.
·
Related to the Bank’s loans rated Substandard and Special Mention, the Bank recorded net charges of $756,000 and $680,000 to the Provision during 2016 and 2015. Charges of $472,000 related to one CRE relationship and $234,000 related to one C&I relationship drove the 2016 Provision. The net charge during 2015 was the result of an increase in the assumed lives for a large portion of the Bank’s retail TDRs based on an updated analysis of the payment histories of these loans.
·
Related to PCI loans, the Bank recorded a net credit of $410,000 to the Provision during 2016 compared to a net charge of $173,000 during 2015. Charges generally reflect projected shortfalls in cash flows below initial day-one estimates for PCI loans, while credits are primarily attributable to generally positive dispositions.
As a percentage of total loans, the Traditional Banking Allowance decreased to 0.83% at December 31, 2016 compared to 0.85% at December 31, 2015. The Company believes, based on information presently available, that it has adequately provided for loan losses at December 31, 2016.
See the sections titled “Allowance for Loan and Lease Losses and Provision for Loan and Lease 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 $497,000 for 2016, a $329,000 increase from 2015. Provision expense for both 2016 and 2015 reflects general reserves for growth in outstanding balances. Outstanding Warehouse balances grew $199 million during 2016 compared to growth of $67 million during 2015.
As a percentage of total Warehouse outstanding balances, the Warehouse Allowance was 0.25% at December 31, 2016 and 2015. The Company believes, based on information presently available, that it has adequately provided for Warehouse loan losses at December 31, 2016.
Republic Processing Group segment
RPG recorded a net charge to the Provision of $10.5 million during 2016, an increase of $8.2 million compared to 2015. The increase in Provision was primarily attributable to the introduction of the EA product during 2016 and general loss reserves for growth in loans originated through the RCS division.
The TRS division of RPG recorded a Provision of $3.0 million during 2016 on its new EA product. Of the $123 million in EAs originated during 2016, all were either collected or charged off at December 31, 2016.
The Bank recorded net charges of $7.8 million and $2.6 million to the Provision during 2016 and 2015 associated with short-term consumer loans originated through the RCS division of RPG.
While RPG loans generally return higher yields, these loans also present a greater credit risk than Traditional Banking loan products. As a percentage of total RPG loans, the RPG Allowance was 12.82% at December 31, 2016 compared to 23.65% at December 31, 2015.
See additional detail regarding the EA product under Footnote 5 “Loans and Allowance for Loan and Lease Losses” of Part II Item 8 “Financial Statements and Supplemental Data.”
Discussion of 2015 vs. 2014
The Company recorded total Provision of $5.4 million for 2015 compared to $2.9 million during 2014. The significant components comprising the Company’s Provision by business segment were as follows:
Traditional Banking segment
The Traditional Banking Provision during 2015 was $2.9 million compared to $3.0 million recorded during 2014. An analysis of the Provision for 2015 compared to 2014 follows:
·
Related to the Bank’s pass rated and non-rated credits, the Bank recorded net charges of $2.0 million and $2.5 million to the Provision during 2015 and 2014, primarily driven by loan growth.
·
Related to the Bank’s loans rated Substandard or Special Mention, the Bank recorded net charges of $680,000 and $1.2 million to the Provision during 2015 and 2014. The net charge recorded during 2015 was primarily the result of an increase in the assumed lives for a large portion of the Bank’s retail TDRs based on an updated analysis of payment histories of these loans. The longer assumed lives on such loans increased the impairment for these loans measured under the cash flow method. By comparison, the net charge to the Provision during 2014 was partially due to loss allocations on collateral-dependent impaired loans and partially due to an updated migration analysis on the Bank’s small dollar, retail nonaccrual loans.
·
The Bank recorded a net charge of $173,000 to the Provision in 2015 compared to a net credit to the Provision of $726,000 for 2014 for PCI loans. The charges generally reflect deterioration in the projected future cash flows for the PCI loans from the Bank’s initial acquisition day estimates of those cash flows, while the credits generally reflect improvements in their projected cash flows.
As a percentage of total loans, the Traditional Banking Allowance decreased to 0.85% at December 31, 2015 compared to 0.87% at December 31, 2014.
Warehouse Lending segment
The Warehouse Provision was $168,000 for 2015, a decrease of $182,000 from $350,000 recorded during 2014. The higher Provision during 2014 was due to higher year-over-year growth compared to 2015, with the Provision attributable to growth during 2014 partially offset by a five basis point reduction in the qualitative factor applied to the portfolio during 2014. The qualitative factor was lowered during 2014 because the portfolio had achieved over three years of vintage with no losses incurred.
As a percentage of total Warehouse outstanding balances, the Warehouse Allowance was 0.25% at December 31, 2015 and 2014.
Republic Processing Group segment
RPG recorded recoveries of $278,000 and $582,000 during 2015 and 2014 to the Provision for the collection of prior period RAL charge-offs. Additionally, RPG recorded charges of $2.6 million and $49,000 to the Provision during 2015 and 2014 due to growth in short-term consumer loans originated by the RCS division. The increase in Provision for RPG during 2015 was primarily driven by the growth in one of RCS’ loan programs, as the Company moved beyond the pilot phase for this particular program.
Noninterest Income
Table 4 - Analysis of Noninterest Income
Discussion of 2016 vs. 2015
Noninterest income increased $9.5 million, or 20%, for 2016 compared to 2015. The most significant components comprising the total Company’s change in noninterest income by business segment were as follows:
Traditional Banking segment
Traditional Banking noninterest income increased $2.3 million, or 10%, for 2016 compared to 2015. The most significant categories affecting the change in noninterest income for 2016 were as follows:
·
Interchange fees increased $1.4 million, or 19%, primarily due to a 7% increase in checking accounts, which helped to drive an 11% increase in the Company’s active debit cards.
·
Net gains (losses) on OREO improved $545,000, as the Bank’s OREO required $270,000 in mark-to-market writedowns during 2016 compared to approximately $1.3 million in such charges during the same period in 2015. Partially offsetting the difference related to mark-to-market writedowns was a decrease of $443,000 in net realized gains on the final disposition of OREO from 2016 to 2015.
Service charges on deposit accounts increased from $13.0 million during 2015 to $13.2 million during 2016. 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 2016 and 2015 were $7.8 million and $7.5 million. The total daily overdraft charges, net of refunds, included in interest income were $1.7 million and $1.6 million for 2016 and 2015.
Mortgage Banking segment
Within the Mortgage Banking segment, mortgage banking income increased $2.5 million, or 56%, during 2016 compared to the same period in 2015, with $1.1 million of the increase attributable to a bulk loan sale of $71 million representing a portion of the Company’s correspondent loan portfolio during the third quarter of 2016.
Overall, excluding the aforementioned bulk loan sale, Republic’s proceeds from the sale of secondary market loans totaled $215 million during 2016 compared to $167 million during 2015. Republic’s net gains as a percentage of loans sold increased from 2.43% during 2015 to 2.55% during 2016. Volume during both 2016 and 2015 benefited from continued low, long-term mortgage interest rates.
Republic Processing Group segment
The TRS division of RPG accounts for the majority of RPG’s annualized revenues. TRS derives substantially all of its revenues during the first half of the year and historically operates at a net loss during the second half of the year, as the Company prepares for the next tax season.
Within the RPG segment, noninterest income increased $4.6 million, or 24%, during 2016 compared to 2015. The increase was partially due to a $1.9 million, or 11%, increase in net RT revenue from 2015, primarily driven by an increase in RT volume.
Additionally, RPG program fees increased $1.8 million to $3.0 million for 2016 compared to $1.2 million in 2015. The increase in RPG program fees resulted from the previously reported increase in volume from one of the RCS’ small-dollar consumer loan programs. As part of this program, the Company retains a 10% ownership in the loans originated and sells a 90% participation interest in these loans. During the 2016, the Company sold approximately $331 million of loans from this program compared to $138 million during 2015. Furthermore, the RCS division benefited from the recognition of $1.2 million of income related to a first-year volume guarantee for its installment credit product.
Discussion of 2015 vs. 2014
Noninterest income increased $5.5 million, or 13%, for 2015 compared to 2014. The most significant components comprising the total Company’s change in noninterest income by business segment were as follows:
Traditional Banking segment
Traditional Banking noninterest income increased $2.3 million, or 11%, for 2015 compared to 2014. The most significant categories affecting the change in noninterest income for 2015 were as follows:
Service charges on deposit accounts decreased from $13.8 million for 2014 to $13.0 million for 2015. 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 during 2015 and 2014 were $7.5 million and $7.7 million. The total daily overdraft charges, net of refunds, included in interest income for 2015 and 2014 was $1.6 million in both periods.
Interchange income increased from $6.2 million during 2014 to $7.5 million during 2015. The increase in interchange income was primarily driven by increases in both credit and debit card sales volume of 31% and 4%, respectively. Such sales growth was further complemented by a greater mix of commercial credit and signature debit transactions, which generally generate higher margins than consumer and PIN related transactions.
Net losses on OREO fluctuated from a net loss of $2.2 million during 2014 to a net loss of $301,000 for 2015. The net losses during 2015 and 2014 were primarily driven by mark-to-market writedowns of OREO properties.
Mortgage Banking segment
Within the Mortgage Banking segment, mortgage banking income increased $1.5 million, or 54%, during 2015 compared to 2014. Overall, Republic’s proceeds from the sale of secondary market loans totaled $167 million during 2015 compared to $82 million during 2014. Volume during 2015 benefited from continued low, long-term interest rates.
Republic Processing Group segment
RPG’s noninterest income increased $1.6 million, or 9%, to $19.6 million during 2015. The higher profitability was primarily driven by a 39% increase in RT volume over 2014. This higher RT volume was driven by growth in retail store-front product demand resulting from an increase in the number of tax preparation offices served through existing contracts and new contracts between the Company and third party tax preparation companies.
The higher RT volume more than offset the impact of a lower profit margin the Company earned on its RT product during the year due to less favorable pricing the Company is receiving on some of its newer contracts. Driving the overall decline in profit margin for the RT product from its new contracts was stiff competition in the marketplace. In addition, also driving a decline in RT profit margin was a shift in program management responsibilities, along with the corresponding revenue of those responsibilities, away from Republic over to some of its third party partners in the business.
Noninterest Expenses
Table 5 - Analysis of Noninterest Expenses
Discussion of 2016 vs. 2015
Total Company noninterest expenses increased $16.8 million, or 15%, during 2016 compared to 2015. The most significant components comprising the change in noninterest expense by business segment were as follows:
Traditional Banking segment
For 2016 compared to 2015, Traditional Banking noninterest expenses increased $14.6 million, or 16%. The following factors drove the increase:
·
Salaries and benefits expense increased $9.6 million, or 20%, primarily due to an increase of 141 full-time-equivalent (“FTEs”) employees from December 31, 2015 to December 31, 2016. A total of 36 of these additions were directly attributable to the Company’s Cornerstone acquisition. The remaining increase of 105 FTEs was driven by additional staffing needed to implement the Company’s strategic initiatives.
·
Data processing expenses increased $1.6 million, or 42%, with $628,000 of the increase attributable to the Company’s Cornerstone acquisition. The remainder of the increase was spread across multiple loan and deposit platforms and was due to growth in the Company’s overall customer base and their associated activity.
·
Occupancy expense increased $1.2 million, or 6%, with $532,000 of the increase attributable to the Company’s Cornerstone acquisition. The remaining increase of $639,000 primarily reflects recent renovations to the Traditional Bank’s premises over the previous 12 months, which drove an 8% increase in depreciation expense.
·
Interchange-related expense increased $694,000, or 22%, consistent with the increases in debit card and credit card transaction volume over the previous 12 months.
·
Marketing expenses increased $474,000, or 16%, partially driven by new sponsorship agreements with two professional sports teams in the Company’s market footprint and partially by increased promotions of both RB&T and MemoryBank branded products.
·
Legal and professional fees decreased $537,000, or 19%, during 2016 compared to 2015 primarily due to higher legal expenses incurred during the prior year related to the Company’s Cornerstone acquisition.
·
The Company incurred an $846,000 prepayment penalty on payoff of $50 million in higher-costing FHLB advances during the third quarter of 2016, with no similar penalty in 2015.
Warehouse Lending segment
For 2016 compared to 2015, Warehouse noninterest expenses increased $616,000, or 24%. The increase was primarily related to an increase in salaries and employee benefits expense, driven by additional staffing over the previous 12 months along with annual merit increases.
Republic Processing Group segment
For 2016 compared to 2015, RPG noninterest expenses increased $1.8 million, or 15%, primarily due to a $2.0 million, or 29% increase in salaries and employee benefits expense, driven by additional staffing to support RPG’s lending initiatives.
Discussion of 2015 vs. 2014
Total Company noninterest expenses increased $5.2 million, or 5%, during 2015 compared to 2014. The most significant components comprising the change in noninterest expense by business segment were as follows:
Traditional Banking segment
For 2015 compared to 2014, Traditional Banking noninterest expenses increased $3.0 million, or 3%.
Salaries and benefits increased $1.8 million, or 4%, for 2015 compared to 2014. The higher expense for the year was primarily the result of an increase in the Traditional Bank’s FTEs from 657 at December 31, 2014 to 711 at December 31, 2015. The increased staffing was in order to meet loan demand and execute the Company’s overall long-term growth objectives.
Occupancy expense decreased $802,000, or 4%, during 2015 due primarily to the Company’s closure of five banking centers over the past two years and a reduction in overhead costs associated with the Company’s new telecommunications system that was implemented during the fourth quarter of 2014.
Data processing expenses increased $753,000, or 25%, during 2015 partially due to $233,000 in costs associated with the Company’s then-pending acquisition of Cornerstone Bancorp, Inc. and partially due to additional technology employed by the Traditional Bank concentrated in the loan and deposit operational areas.
Interchange-related expenses increased $360,000, or 13%, during 2015 driven by increased credit and debit card sales volume during 2015.
Legal expense increased $434,000, or 41%, during 2015, primarily due to costs associated with the Company’s acquisition efforts, including the Company’s then-pending acquisition of Cornerstone Bancorp, Inc.
Warehouse Lending segment
For 2015 compared to 2014, Warehouse noninterest expenses increased $669,000, or 36%. The increase was primarily related to an increase in salaries and employee benefits expense, driven primarily by additional staffing over the previous 12 months.
Republic Processing Group segment
For 2015 compared to 2014, RPG noninterest expenses increased $473,000, or 4%.
Salaries and employee benefits increased $499,000, or 8%, primarily due to increased contract labor costs, driven by the 39% increase in RT’s processed during 2015 compared to 2014.
Occupancy expenses decreased $627,000, or 37%, for 2015 compared to 2014, primarily due to the Company’s new telecommunications system that was implemented during the fourth quarter of 2014.
Legal fees increased $209,000, primarily related to increased usage of outside legal counsel for contract review and program design of new prepaid card and small dollar credit programs.
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 $289 million in cash and cash equivalents at December 31, 2016 compared to $210 million at December 31, 2015. The Company maintained a higher level of cash and cash equivalents at December 31, 2016, primarily to support its overall liquidity position.
For cash held at the FRB, the Bank earned a yield of 0.50% for most of 2016 on amounts in excess of required reserves. In mid-December 2016, this rate increased to 0.75% in connection with the FOMC’s action to increase the FFTR. For all other 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 $2 million and $2 million at December 31, 2016 and 2015.
Investment Securities
Table 6 - Investment Securities Portfolio
Securities available for sale primarily consists of U.S. Treasury securities and U.S. Government agency obligations, including agency mortgage backed securities (“MBSs”) and agency collateralized mortgage obligations (“CMOs”). The agency MBSs primarily consist of hybrid mortgage investment securities, as well as other adjustable rate mortgage investment securities, underwritten and guaranteed by Ginnie Mae (“GNMA”), Freddie Mac (“FHLMC”) and the Federal National Mortgage Association (“FNMA” or “Fannie Mae”). 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 securities sold under agreements to repurchase (“repurchase agreements”). The remaining eligible securities that are not pledged to secure client repurchase agreements may be pledged to the FHLB as collateral for the Bank’s borrowing line. Strategies for the investment securities portfolio are influenced by economic and market conditions, loan demand, deposit mix and liquidity needs.
Table 7 - Mortgage Backed Investment Securities
Table 8 - Securities Available for Sale
NM - Not meaningful, as the security does not have a finite maturity.
Table 9 - Securities Held to Maturity
NM - Not meaningful.
Loan Portfolio
Table 10 - Loan Portfolio Composition
* 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 $484 million, or 15%, during 2016 to $3.8 billion at December 31, 2016, primarily driven by $199 million in growth in outstanding Warehouse lines of credit and $190 million in loans from the Company’s Cornerstone acquisition.
See additional detail regarding the Company’s acquisition of Cornerstone Bancorp, Inc. under Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
Warehouse Lines of Credit
As of December 31, 2016, the Bank had $585 million outstanding on total committed Warehouse credit lines of $1.0 billion. As of December 31, 2015, the Bank had $387 million outstanding on total committed Warehouse credit lines of $670 million. The $343 million increase in committed lines generally reflects growth in the number of Warehouse clients combined with a 27% increase in the average line amount. The $199 million increase in outstanding balances reflects the impact of the growth in committed lines combined with a favorable mortgage rate environment, which helped sustain higher usage rates on outstanding Warehouse lines as of December 31, 2016.
Due to the volatility and seasonality of the mortgage market, it is difficult to project future outstanding balances of Warehouse lines of credit. 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 segment during 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 64% during the second quarter of 2015. 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 57% during 2016.
Correspondent Loans
During the third quarter of 2016, the Bank sold $71 million of mortgage loans previously originated through its Correspondent Lending channel in order to enhance its overall liquidity position and recorded a $1.1 million gain on this sale.
The table below illustrates the Bank’s fixed and variable rate loan maturities:
Table 11 - Selected Loan Distribution
Allowance for Loan and Lease Losses (“Allowance”)
The Bank maintains an Allowance for probable incurred credit losses inherent in the Bank’s loan portfolio, which includes overdrawn deposit accounts. Management evaluates the adequacy of the Allowance on a monthly basis and presents and discusses the analysis with the Audit Committee and the Board of Directors on a quarterly basis.
The Bank’s Allowance increased $5 million, or 20%, during 2016 to $33 million at December 31, 2016, primarily driven by reserves for growth in RCS small-dollar credit products and general growth in Core Bank portfolios.
As a percent of total loans, the total Bank’s Allowance increased to 0.86% at December 31, 2016 compared to 0.83% at December 31, 2015. The increase in ratio of Allowance to total loans was primarily driven by reserves for growth in RCS small-dollar consumer products. An analysis of the Allowance by business segment follows:
Traditional Banking segment
The Allowance at the Traditional Banking segment, increased to $27 million at December 31, 2016 from $25 million at December 31, 2015. The Allowance to total Traditional Bank loans decreased to 0.83% at December 31, 2016 from 0.85% at December 31, 2015 primarily because the $190 million of loan growth as a result of the Company’s Cornerstone acquisition required minimal loss reserves at December 31, 2016, as such loans were acquired and recorded at fair value, which gives consideration to estimated future losses within the portfolio.
Warehouse Lending segment
The Allowance on loans originated through the Company’s Warehouse segment remained at approximately $1 million, as the Allowance to total Warehouse loans remained at 0.25% from December 31, 2015 to December 31, 2016.
Republic Processing Group segment
The Allowance on loans originated through the Company’s RPG segment increased to $5 million at December 31, 2016 from $2 million at December 31, 2015, as RPG grew its loan portfolio $25 million during 2016. The Allowance to total RPG loans decreased to 12.82% at December 31, 2016 from 23.65% at December 31, 2015, as RPG diversified its product mix during 2016, reserving as low as 0.25% for its newly obtained $12 million healthcare receivables portfolio and as high as 24.10% for its $19 million line-of-credit portfolio during 2016. Lower reserve percentages are provided for RCS’s healthcare receivables, as such receivables are generally repurchased by the Bank’s healthcare partner if they become 90-days-or-more delinquent.
For additional discussion regarding Republic’s methodology for determining the adequacy of the Allowance, see the section titled “Critical Accounting Policies and Estimates” in this section of the filing.
See additional detail regarding Republic Credit Solution’s loan products under Item 1 “Business.”
Table 12 - Summary of Loan and Lease Loss Experience
NA - not applicable 		
The following table sets forth management’s allocation of the Allowance by loan class. The Allowance allocation is based on management’s assessment of economic conditions, historical loss experience, loan volume, past due and nonaccrual loans and various other qualitative factors. Since these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance or future Allowance allocation.
Table 13 - Management’s Allocation of the Allowance for Loan and Lease Losses
NA - Not Applicable
*Values of less than 50 basis points are rounded down to zero.
Management believes, based on information presently available, that it has adequately provided for loan and lease losses at December 31, 2016 and 2015.
For additional discussion regarding Republic’s methodology for determining the adequacy of the Allowance, see the section titled “Critical Accounting Policies and Estimates” in this section of the filing.
Asset Quality
Classified and Special Mention Loans
The Bank applies credit quality indicators, or “ratings,” to individual loans based on internal Bank policies. Such internal policies are informed by regulatory standards. Loans rated “Loss,” “Doubtful,” “Substandard” and PCI-Substandard (“PCI-Sub”) are considered “Classified.” Loans rated “Special Mention” or PCI Group 1 (“PCI-1”) are considered Special Mention. The Bank’s Classified and Special Mention loans decreased $9 million during 2016, primarily due to the payoffs and paydowns of Substandard and PCI loans during the period.
See Footnote 5 “Loans and Allowance for Loan and Lease Losses” of Part II Item 8 “Financial Statements and Supplementary Data” for additional discussion regarding Classified and Special mention loans.
Table 14 - Classified and Special Mention Loans
Nonperforming Loans
Nonperforming loans include loans on nonaccrual status and loans past due 90-days-or-more and still accruing. Impaired loans that are not placed on nonaccrual status are not included as nonperforming loans. The nonperforming loan category included TDRs totaling approximately $10 million and $12 million at December 31, 2016 and 2015. Generally, all nonperforming loans are considered impaired.
Nonperforming loans to total loans decreased to 0.42% at December 31, 2016 from 0.66% at December 31, 2015, as the total balance of nonperforming loans decreased by $6 million, or 27%, while total loans increased $484 million, or 15%, during 2016.
Table 15 - Nonperforming Loans and Nonperforming Assets Summary
*Loans on nonaccrual status include impaired loans. See Footnote 5 “Loans and Allowance for Loan and Lease Losses” of Part II Item 8 “Financial Statements and Supplementary Data” for additional discussion regarding impaired loans.
** Loans past due 90-days-or-more and still accruing consist of PCI loans or smaller-balance consumer loans.
Approximately $13 million, or 80%, of the Bank’s total nonperforming loans at December 31, 2016 were concentrated in the real estate mortgage category (residential real estate and HELOCs), with the underlying collateral predominantly located in the Bank’s primary market footprint of Kentucky. The Bank’s nonperforming real estate mortgage concentration was $16 million, or 73%, as of December 31, 2015.
Approximately $3 million, or 17%, of the Bank’s total nonperforming loans were concentrated in the CRE and construction and land development portfolios as of December 31, 2016, compared to the $6 million, or 26%, at December 31, 2015. While CRE is the primarily collateral for such loans, the Bank also obtains in many cases, at the time of origination, personal guarantees from the principal borrowers and secured liens on the guarantors’ primary residences.
Table 16 - Nonperforming Loan Composition
NA - Not Applicable
Table 17 - Stratification of Nonperforming Loans
Approximately $8 million in nonperforming loans at December 31, 2015, were removed from the nonperforming loan classification during 2016. Approximately $329,000, or 4%, of these loans were removed from the nonperforming category because they were charged-off. Approximately $3 million, or 37%, in loan balances were transferred to OREO with the remaining $5 million, or 59%, refinanced at other financial institutions.
Interest income that would have been recorded if nonaccrual loans were on a current basis in accordance with their original terms was $888,000, $1.1 million and $898,000 in 2016, 2015 and 2014.
Based on the Bank’s review as of December 31, 2016, management believes that its reserves are adequate to absorb probable losses on all nonperforming credits.
Table 18 - Rollforward of Nonperforming Loan Activity
Table 19 - Detail of Loans Removed from Nonperforming Status
Delinquent Loans
Delinquent loans to total loans decreased to 0.24% at December 31, 2016, from 0.35% at December 31, 2015, as the total balance of delinquent loans decreased by $3 million, or 24%. With the exception of PCI loans and smaller-balance consumer loans, all loans past due 90-days-or-more as of December 31, 2016 and 2015 were on nonaccrual status.
As detailed in the following table, delinquent loans within the residential real estate and home equity categories decreased $3 million, or 33%, during 2016, while Construction, CRE and C&I delinquencies decreased $2 million, or 74%, for the same period.
Table 20 - Delinquent Loan Composition*
*Represents total loans 30-days-or-more past due. Delinquent status may be determined by either the number of days past due or number of payments past due.
NA - Not applicable.
Approximately $10 million in delinquent loans at December 31, 2015, were removed from delinquent status during 2016. Approximately $150,000, or 1%, of these loans were removed from the delinquent category because they were charged-off. Approximately $3 million, or 27%, in loan balances were transferred to OREO with $4 million, or 38%, refinanced at other financial institutions. The remaining $3 million, or 33%, in delinquent loans were paid current in 2016.
Table 21 - Rollforward of Delinquent Loan Activity
*Includes relatively-small consumer portfolios, e.g., credit cards.
Table 22 - Detail of Loans Removed From Delinquent Status
Impaired Loans and Troubled Debt Restructurings
The Bank’s policy is to charge-off all or that portion of its recorded investment in a collateral-dependent impaired credit upon a determination that it is probable the full amount of contractual principal and interest will not be collected. Impaired loans totaled $53 million at December 31, 2016 compared to $66 million at December 31, 2015.
A TDR is the situation where, due to a borrower’s financial difficulties, the Bank grants a concession to the borrower that the Bank would not otherwise have considered. The majority of the Bank’s TDRs involve a restructuring of loan terms such as a temporary reduction in the payment amount to require only interest and escrow (if required), reducing the loan’s interest rate and/or extending the maturity date of the debt. Nonaccrual loans modified as TDRs remain on nonaccrual status and continue to be reported as nonperforming loans. Accruing loans modified as TDRs are evaluated for nonaccrual status based on a current review of the borrower’s financial condition, and ability and willingness to service the modified debt. As of December 31, 2016, the Bank had $42 million in TDRs, of which $10 million were also on nonaccrual status. As of December 31, 2015, the Bank had $50 million in TDRs, of which $12 million were also on nonaccrual status.
Table 23 - Impaired Loan Composition
See Footnote 5 “Loans and Allowance for Loan and Lease Losses” of Part II Item 8 “Financial Statements and Supplementary Data” for additional discussion regarding impaired loans and TDRs.
Other Real Estate Owned
Table 24 - Stratification of Other Real Estate Owned
Table 25 - Rollforward of Other Real Estate Owned Activity
*Inclusive of non-cash proceeds where the Bank financed the sale of the property.
The fair value of OREO represents the estimated value that management expects to receive when the property is sold, net of related costs to sell. These estimates are based on the most recently available real estate appraisals, with certain adjustments made based on the type of property, age of appraisal, current status of the property and other relevant factors to estimate the current value of the property.
Bank Owned Life Insurance (“BOLI”)
BOLI offers tax advantaged noninterest income to help the Bank offset employee benefits expenses. The Company carried $62 million and $53 million of BOLI on its consolidated balance sheet at December 31, 2016 and 2015. The Company acquired $7 million of BOLI during 2016 in association with its May 17, 2016 Cornerstone acquisition.
Table 26 - Rollforward of Bank Owned Life Insurance
Deposits
Table 27 - Deposit Composition
*Represents a time deposit.
Total Company deposits increased $673 million, or 27%, from December 31, 2015 to $3.2 billion at December 31, 2016. Total Company interest-bearing deposits increased $336 million, or 18%, while total Company noninterest bearing deposits increased $337 million, or 53%.
The Company assumed $205 million in deposits through its May 17, 2016 Cornerstone acquisition, including approximately $152 million in interest-bearing deposits and $53 million in noninterest-bearing deposits. Outside of the Company’s Cornerstone acquisition and a $160 million increase in brokered money market deposits, increases in balances for several large corporate clients drove the Company’s overall increase in deposits during 2016.
Despite an increase in short-term interest rates in mid-December 2016, the Bank did not increase interest rates, in general, on its deposit product offerings in an effort to combat on-going compression within the Bank’s net interest margin. Due to on-going competitive pressures, however, management is uncertain if, and to what extent, it will be able to maintain this strategy in the future if short-term interest rates continue to rise. If the Bank begins to experience an increased outflow of deposits due to its pricing structure, it may be forced to increase rates on most, if not all, of its transactional deposit accounts in order to maintain adequate liquidity for anticipated asset growth and the normal operations of the Bank. Such an increase in the Bank’s deposit rates would likely have a negative impact on the Bank’s net interest income and net interest margin.
Table 28 - Average Deposits
Table 29 - Maturities of Time Deposits Greater than $100,000 at December 31, 2016
Securities Sold Under Agreements to Repurchase and Other Short-term Borrowings
Securities Sold under Agreements to Repurchase (“SSUARs”) are collateralized by securities and are treated as financings; accordingly, the securities involved with the agreements are recorded as assets and are held by a safekeeping agent and the obligations to repurchase the securities are reflected as liabilities. All securities underlying the agreements are under the Bank’s control.
SSUARs decreased approximately $222 million, or 56%, during 2016, with two large corporate clients accounting for $174 million, or 78%, of the decrease. The first client transferred approximately $120 million in funds to a competing financial institution as a result of proposed changes by the Bank to the client’s account structure. The second client reflected a decrease of $54 million during the period due to normal seasonal cash flow needs. The substantial majority of SSUARs are indexed to immediately repricing indices such as the FFTR.
Table 30 - Securities Sold Under Agreements to Repurchase
Federal Home Loan Bank Advances
FHLB advances increased $103 million, or 15%, from December 31, 2015 to $803 million at December 31, 2016. The Bank obtained a $100 million 90-day advance in December 2016 at a fixed rate of 0.74%. In addition, the Bank renewed its $10 million variable rate advance tied to 3-month LIBOR in December 2016. Term advances totaling $142 million were repaid during 2016. Of the repaid advances, $92 million of advances at a rate of 1.67% were paid off at maturity, while $50 million at a rate of 4.39% were terminated early during the third quarter of 2016 with a prepayment penalty of $846,000. The Bank expects to recover the amount of this penalty through a reduction in interest expense over what would have been the remaining original term of these advances.
The Bank held $285 million in overnight advances at a rate of 0.64% as of December 31, 2016, compared to $150 million in overnight advances at a rate of 0.35% held at December 31, 2015. The Company’s usage of overnight FHLB advances increased during 2016 primarily due to significant growth in outstanding warehouse lines credit. Management anticipates its usage of FHLB overnight advances will continue to correlate with fluctuations in outstanding warehouse lines in 2017.
Table 31 - Federal Home Loan Bank Advances
Interest Rate Swaps
Interest Rate Swaps Used as Cash Flow Hedges
The Bank entered into two interest rate swap agreements during 2013 as part of its interest rate risk management strategy. The Bank designated the swaps as cash flow hedges intended to reduce the variability in cash flows attributable to either FHLB advances tied to the 3-month the LIBOR or the overall changes in cash flows on certain money market deposit accounts tied to 1-month LIBOR. The counterparty for both swaps met the Bank’s credit standards and the Bank believes that the credit risk inherent in the swap contracts is not significant.
Non-hedge Interest Rate Swaps
During the second quarter of 2015, the Bank began entering into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments, the Bank enters into offsetting positions in order to minimize the Bank’s interest rate risk. These swaps are derivatives, but are not designated as hedging instruments, and therefore changes in fair value are reported in current year earnings.
See Footnote 8 “Interest Rate Swaps” of Part II Item 8 “Financial Statements and Supplementary Data” for further information regarding the Bank’s interest rate swaps.
Liquidity
The Bank had a loan to deposit ratio (excluding brokered deposits) of 138% and 148% at December 31, 2016 and 2015. At December 31, 2016 and 2015, the Company had cash and cash equivalents on-hand of $289 million and $210 million. In addition, the Bank had available collateral to borrow an additional $378 million and $567 million from the FHLB at December 31, 2016 and 2015. In addition to its borrowing line with the FHLB, the Bank also had unsecured lines of credit totaling $150 million and $170 million available through various other financial institutions as of December 31, 2016 and 2015.
The Bank maintains sufficient liquidity to fund routine loan demand and routine deposit withdrawal activity. Liquidity is managed by maintaining sufficient liquid assets in the form of investment securities. Funding and cash flows can also be realized by the sale of securities available for sale, principal paydowns on loans and MBSs and proceeds realized from loans held for sale. The Bank’s liquidity is impacted by its ability to sell certain investment securities, which is limited due to the level of investment securities that are needed to secure public deposits, securities sold under agreements to repurchase, FHLB borrowings, and for other purposes, as required by law. At December 31, 2016 and 2015, these pledged investment securities had a fair value of $232 million and $490 million. Republic’s banking centers and its website, www.republicbank.com, provide access to retail deposit markets. These retail deposit products, if offered at attractive rates, have historically been a source of additional funding when needed. If the Bank were to lose a significant funding source, such as a few major depositors, or if any of its lines of credit were canceled, or if the Bank cannot obtain brokered deposits, the Bank would be compelled to offer market leading deposit interest rates to meet its funding and liquidity needs.
At December 31, 2016, the Bank had approximately $623 million in deposits from 69 large non-sweep deposit relationships where the individual relationship individually exceeded $2 million. The 20 largest non-sweep deposit relationships represented approximately $435 million, or 14%, of the Company’s total deposit balances at December 31, 2016. These accounts do not require collateral; therefore, cash from these accounts can generally be utilized to fund the loan portfolio. If any of these balances were moved from the Bank, the Bank would likely utilize overnight borrowing lines in the short-term to replace the balances. On a longer-term basis, the Bank would likely utilize brokered deposits to replace withdrawn balances. Based on past experience utilizing brokered deposits, the Bank believes it can quickly obtain brokered deposits if needed. The overall cost of gathering brokered deposits, however, could be substantially higher than the Traditional Bank deposits they replace, potentially decreasing the Bank’s earnings.
Due to its on-going success of growing loans and its overall use of non-core funding sources, the Bank has regularly approached, and in some cases, has fallen outside of its internal policy limits for liquidity management, as set forth by the Bank’s Board of Directors. Management also believes that in the near-term, as loan growth is expected to continue to outpace deposit growth, the Bank could continue to approach and sometimes fall outside of its internal liquidity policy limits. On a long-term basis, management is focusing its efforts on various deposit gathering strategies, including raising significant deposits through its MemoryBank brand, in order to improve the Bank’s overall liquidity position. As of December 31, 2016, the Bank was in compliance with all Board-approved liquidity policies.
Capital
Table 32 - Capital
Information pertaining to the Company’s capital balances and ratios follows:
*See Footnote 2 of Part II, Item 6 “Selected Financial Data” for additional detail.
NA - Not applicable.
Total stockholders’ equity increased from $577 million at December 31, 2015 to $604 million at December 31, 2016. The increase in stockholders’ equity was primarily attributable to net income earned during 2016 reduced by cash dividends declared and common stock repurchases.
See Part II, Item 5. “Unregistered Sales of Equity Securities and Use of Proceeds” for additional detail regarding stock repurchases and stock buyback programs.
Common Stock - The Class A Common shares are entitled to cash dividends equal to 110% of the cash dividend paid per share on Class B Common Stock. Class A Common shares have one vote per share and Class B Common shares have ten votes per share. Class B Common shares may be converted, at the option of the holder, to Class A Common shares on a share for share basis. The Class A Common shares are not convertible into any other class of Republic’s capital stock.
Dividend Restrictions - The Parent Company’s principal source of funds for dividend payments are dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid to the Parent Company by the Bank without prior approval of the respective states’ banking regulators. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years. At December 31, 2016, the Bank could, without prior approval, declare dividends of approximately $60 million.
Regulatory Capital Requirements - The Parent Company and the Bank are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Republic’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Parent Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Effective January 1, 2015 the Company and the Bank became subject to the capital regulations in accordance with Basel III. These regulations established higher minimum risk-based capital ratio requirements, a new common equity Tier 1 Risk-Based Capital ratio and a new capital conservation buffer. The regulations included revisions to the definition of capital and changes in the risk weighting of certain assets. For prompt corrective action, the new regulations establish definitions of “well capitalized” as a 6.5% Common Equity Tier 1 Risk-Based Capital ratio, an 8.0% Tier 1 Risk-Based Capital ratio, a 10.0% Total Risk-Based Capital ratio and a 5.0% Tier 1 Leverage ratio.
Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, the Company and Bank must hold a capital conservation buffer composed of Common Equity Tier 1 Risk-Based Capital above their minimum risk-based capital requirements. The capital conservation buffer phases in over time based on the following schedule: a capital conservation buffer of .625% effective January 1, 2016; 1.25% effective January 1, 2017; 1.875% effective January 1, 2018; and a fully phased in capital conservation buffer of 2.5% on January 1, 2019.
Banking regulators have categorized the Bank as well capitalized. To be categorized as well capitalized, the Bank must maintain minimum Total Risk-Based Capital, Common Equity Tier I Risk-Based Capital, Tier I Risk-Based Capital and Tier I Leverage capital ratios. Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the individual risk profiles of financial institutions. Republic continues to exceed the regulatory requirements for Total Risk-Based Capital, Common Equity Tier I Risk-Based Capital, Tier I risk based capital and Tier I Leverage capital. Republic and the Bank intend to maintain a capital position that meets or exceeds the “well-capitalized” requirements as defined by the FRB, and FDIC. Formal measurements of the capital ratios for Republic and the Bank are performed by the Company at each quarter end.
In 2005, Republic Bancorp Capital Trust (“RBCT”), an unconsolidated trust subsidiary of Republic, was formed and issued $40 million in Trust Preferred Securities (“TPS”). The sole asset of RBCT represents the proceeds of the offering loaned to Republic in exchange for a subordinated note with similar terms to the TPS. The RBCT TPS are treated as part of Republic’s Tier I Capital.
The subordinated note and related interest expense are included in Republic’s consolidated financial statements. The subordinated note paid a fixed interest rate of 6.015% through September 30, 2015 and adjusted to 3-month LIBOR plus 1.42% on a quarterly basis thereafter. The subordinated note matures on December 31, 2035 and is redeemable at the Company’s option on a quarterly basis. The
Company chose not to redeem the subordinated note on January 1, 2017, and is currently carrying the note at a cost of LIBOR plus 1.42%.
As a result of its acquisition of Cornerstone Bancorp, Inc. on May 17, 2016, Republic became the 100% successor owner of Cornerstone Capital Trust 1 (“CCT1”), an unconsolidated finance subsidiary. In 2006, CCT1 issued $4 million of adjustable-rate TPS due December 15, 2036. As permitted under the terms of CCT1’s governing documents, the Company redeemed these securities at the par amount of approximately $4 million, without penalty, on September 15, 2016.
Off Balance Sheet Items
Summarized credit-related financial instruments, including both commitments to extend credit and letters of credit follows:
Table 33 - Off Balance Sheet Items
*Commitments are made through the Bank’s Correspondent Lending channel.
A portion of the unused commitments above are expected to expire or may not be fully used, therefore the total amount of commitments above does not necessarily indicate future cash requirements.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. Commitments outstanding under standby letters of credit totaled $16 million and $13 million at December 31, 2016 and 2015. In addition to credit risk, the Bank also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Bank does not deem this risk to be material.
Commitments to extend credit generally consist of unfunded lines of credit. These commitments generally have variable rates of interest.
Aggregate Contractual Obligations
In addition to owned banking facilities, the Bank has entered into long-term leasing arrangements to support the ongoing activities of the Company. The Bank also has required future payments for long-term and short-term debt as well as the maturity of time deposits. The required payments under such commitments follow:
Table 34 - Aggregate Contractual Obligations
*Includes accrued interest.
**Primarily includes dividends declared on common stock, the Bank’s Supplemental Executive Retirement Plan (“SERP”), and the Bank’s significant long-term vendor contracts.
See Footnote 9 “Deposits” of Part II Item 8 “Financial Statements and Supplementary Data” for further information regarding the Bank’s time deposits.
FHLB advances represent the amounts that are due to the FHLB.
See Footnote 11 “Federal Home Loan Bank Advances” of Part II Item 8 “Financial Statements and Supplementary Data” for further information regarding the Bank’s FHLB advances.
See Footnote 12 “Subordinated Note” of Part II Item 8 “Financial Statements and Supplementary Data” for further information regarding the Bank’s subordinated note.
Securities sold under agreements to repurchase generally have indeterminate maturity periods and are predominantly included in the less than one-year category above.
See Footnote 18 “Benefit Plans” of Part II Item 8 “Financial Statements and Supplementary Data” for further information regarding the Bank’s SERP commitments.
Lease commitments represent the total minimum lease payments under non-cancelable operating leases.
See Footnote 21 “Transactions with Related Parties and their Affiliates” of Part II Item 8 “Financial Statements and Supplementary Data” for further information regarding the Bank’s lease commitments.
Asset/Liability Management and Market Risk
Asset/liability management is designed to ensure safety and soundness, maintain liquidity, meet regulatory capital standards and achieve acceptable net interest income based on the Bank’s risk tolerance. Interest rate risk is the exposure to adverse changes in net interest income as a result of market fluctuations in interest rates. The Bank, on an ongoing basis, monitors interest rate and liquidity risk in order to implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be a significant risk to the Bank’s overall earnings and balance sheet.
The interest sensitivity profile of the Bank at any point in time will be impacted by a number of factors. These factors include the mix of interest sensitive assets and liabilities, as well as their relative pricing schedules. It is also influenced by changes in market interest rates, deposit and loan balances and other factors.
The Bank utilizes earnings simulation models as tools to measure interest rate sensitivity, including both a static and dynamic earnings simulation model. A static simulation model is based on current exposures and assumes a constant balance sheet. In contrast, a dynamic simulation model relies on detailed assumptions regarding changes in existing business lines, new business, and changes in management and customer behavior. While the Bank runs the static simulation model as one measure of interest rate risk, historically, the Bank has utilized a dynamic earnings simulation model as its primary interest rate risk tool to measure the potential changes in market interest rates and their subsequent effects on net interest income for a one year time period. This dynamic model projects a “Base” case net interest income over the next 12 months and the effect to net interest income of instantaneous movements in interest rates between various basis point increments equally across all points on the yield curve. Many assumptions based on growth expectations and on the historical behavior of the Bank’s deposit and loan rates and their related balances in relation to changes in interest rates are incorporated into this dynamic model. These assumptions are inherently uncertain and, as a result, the dynamic model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to the actual timing, magnitude and frequency of interest rate changes, the actual timing and magnitude of changes in loan and deposit balances, as well as the actual changes in market conditions and the application and timing of various management strategies as compared to those projected in the various simulated models. Additionally, actual results could differ materially from the model if interest rates do not move equally across all points on the yield curve.
As of December 31, 2016 and 2015, a dynamic simulation model was run for increases in interest rates from “Up 100” basis points to “Up 400” basis points. A simulation for declining interest rates as of December 31, 2016 and 2015 was not considered meaningful and is not presented by the Bank because decreases in the Fed Funds Target Rate were considered unlikely as of December 31, 2016. The Federal Open Market Committee raised the FFTR for the second time in 10 years during December 2016 from between 0.25% and 0.50% to 0.50% and 0.75%, with further guidance suggesting that additional increases to the FFTR were more likely than not during 2017.
The Bank’s dynamic simulation model as of December 31, 2016 projected improvement in the Bank’s net interest income relative to the Base case in the Up 100 to Up 400 basis points scenarios. With the exception of the Up 100 scenario, the improvement in each of these scenarios was greater than the projected improvement reflected in the same scenarios as of December 31, 2015. The less favorable projection in the Up 100 scenario compared to the prior year’s simulation forecast was driven by the Bank’s use of more conservative beta assumptions on its non-maturity deposit portfolio at December 31, 2016. While the Up 200 to Up 400 scenarios were also impacted by the use of more conservative beta assumptions on the non-maturity deposit portfolio, this factor was outweighed by growth in shorter-term loans during 2016, in particular the Bank’s warehouse lines of credit, which reprice monthly. Also benefitting the December 31, 2016 scenarios when compared to the December 31, 2015 scenarios was growth in the Bank’s deposit base during the 2016.
The following tables illustrate the Bank’s projected percent change from its Base net interest income as of December 31, 2016 and 2015 based on instantaneous movements in interest rates from Up 100 to Up 400 basis points equally across all points on the yield curve. The Bank’s dynamic earnings simulation model excludes all loan fees.
Table 35 - Bank Interest Rate Sensitivity at December 31, 2016
Table 36 - Bank Interest Rate Sensitivity at December 31, 2015
The Board of Directors of the Bank has established separate and distinct policy limits for acceptable percent changes in the Bank’s net interest income based on modeled changes in market interest rates. Historically, if model projections of the percent change in net interest income fall outside Board approved limits at a given point in time or are projected to fall outside such limits based on certain trends, the Bank has taken certain actions intended either to bring model projections back within Board approved limits or explain how future anticipated events will correct the current situation. These actions have included, but are not limited to, restructuring of interest earning assets and interest bearing liabilities, seeking additional fixed rate term FHLB advances, executing interest rate swaps and modifying the pricing or terms of loans, leases and deposits. These actions have historically had a negative impact on current earnings.
Along with the Bank’s dynamic earnings simulation model, the Board of Directors of the Bank has established separate and distinct policy limits for acceptable changes in the Bank’s Economic Value of Equity (“EVE”) based on certain projected changes in market interest rates. EVE represents the difference between the net present value of the Bank’s interest-earning assets and interest-bearing liabilities at a point in time.
The Bank’s EVE calculation as of December 31, 2016 reflected a decline from the Base case in the Up 100 to Up 400 basis points scenarios. The projected decline was less than the projected decline at December 31, 2015 for the same scenarios. Similar to the drivers of improvement in the Bank’s dynamic earnings simulation scenarios mentioned above, the smaller decline from the Base case in EVE compared to the prior year’s scenarios was primarily driven by growth in the Bank’s shorter-term loans and deposit base during 2016.
The following tables illustrate the Bank’s EVE sensitivity as of December 31, 2016 and 2015:
Table 37 - Bank Economic Value of Equity Sensitivity for 2016
Table 38 - Bank Economic Value of Equity Sensitivity for 2015
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
See the section titled “Asset/Liability Management and Market Risk” included under Part II Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 8.
Item 8. Financial Statements and Supplementary Data.
The following are included in this section:
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Management of Republic Bancorp, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the Company’s annual consolidated financial statements. All information has been prepared in accordance with U.S. generally accepted accounting principles and, as such, includes certain amounts that are based on Management’s best estimates and judgments.
Management is responsible for establishing and maintaining adequate internal control over financial reporting presented in conformity with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Two of the objectives of internal control are to provide reasonable assurance to Management and the Board of Directors that transactions are properly authorized and recorded in the Company’s financial records, and that the preparation of the Company’s financial statements and other financial reporting is done in accordance with U.S. generally accepted accounting principles. There are inherent limitations in the effectiveness of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to reliability of financial statements. Furthermore, internal control can vary with changes in circumstances.
Management has made its own assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016, in relation to the criteria described in the report, Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based on its assessment, Management believes that as of December 31, 2016, the Company’s internal control was effective in achieving the objectives stated above. Crowe Horwath LLP has provided its report on the audited 2016 and 2015 consolidated financial statements and on the effectiveness of the Company’s internal control in their report dated March 9, 2017.
Steven E. Trager
Chairman and Chief Executive Officer
Kevin Sipes
Chief Financial Officer and Chief Accounting Officer
March 9, 2017
			 		
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
of Republic Bancorp, Inc.
Louisville, Kentucky
We have audited the accompanying consolidated balance sheets of Republic Bancorp, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited Republic Bancorp, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Republic Bancorp, Inc.’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (U.S.). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Republic Bancorp, Inc. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Republic Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Louisville, Kentucky
March 9, 2017
			 		
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, (in thousands, except share data)
See accompanying footnotes to consolidated financial statements.
			 		
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, (in thousands, except per share data)
See accompanying footnotes to consolidated financial statements.
			 		
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, (in thousands)
See accompanying footnotes to consolidated financial statements.
			 		
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2016, 2015 and 2014
(continued)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)
(continued)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)
See accompanying footnotes to consolidated financial statements.
			 		
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, (in thousands)
See accompanying footnotes to consolidated financial statements.
FOOTNOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation - The consolidated financial statements include the accounts of Republic Bancorp, Inc. (the “Parent Company”) and its wholly-owned subsidiaries, Republic Bank & Trust Company (“RB&T” or the “Bank”) and Republic Insurance Services, Inc. (the “Captive”). The Bank is a Kentucky-based, state chartered non-member financial institution that provides both traditional and non-traditional banking products through four distinct operating 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 United States. 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 10 other third-party insurance captives for which insurance may not be available or economically feasible. Republic Bancorp Capital Trust (“RBCT”) is a Delaware statutory business trust that is a wholly-owned unconsolidated finance subsidiary of Republic Bancorp, Inc. All companies are collectively referred to as (“Republic” or the “Company”). All significant intercompany balances and transactions are eliminated in consolidation.
As a result of its acquisition of Cornerstone Bancorp, Inc. on May 17, 2016, Republic Bancorp, Inc. became the 100% successor owner of Cornerstone Capital Trust 1 (“CCT1”), an unconsolidated finance subsidiary. As permitted under the terms of CCT1’s governing documents, the Company redeemed these securities at the par amount of approximately $4 million, without penalty, on September 15, 2016.
As of December 31, 2016, the Company was divided into four distinct operating segments: Traditional Banking, Warehouse Lending (“Warehouse”), Mortgage Banking and Republic Processing Group (“RPG”). Management considers the first three segments to collectively constitute “Core Bank” or “Core Banking” activities. Correspondent Lending operations and the Company’s national branchless banking platform, MemoryBank, are considered part of the Traditional Banking segment. The RPG segment includes the following divisions: Tax Refund Solutions (“TRS”), Republic Payment Solutions (“RPS”) and Republic Credit Solutions (“RCS”). TRS generates the majority of RPG’s income, with the relatively smaller divisions of RPG, RPS and RCS, considered immaterial for separate and independent segment reporting. All divisions of the RPG segment operate through the Bank.
Core Bank (includes Traditional Banking, Warehouse Lending and Mortgage Banking segments)
The Traditional Banking segment provides traditional banking products primarily to customers in the Company’s market footprint. As of December 31, 2016, Republic had 44 full-service banking centers with locations as follows:
·
Kentucky - 32
·
Metropolitan Louisville - 19
·
Central Kentucky - 8
·
Elizabethtown - 1
·
Frankfort - 1
·
Georgetown - 1
·
Lexington - 4
·
Shelbyville - 1
·
Western Kentucky - 2
·
Owensboro - 2
·
Northern Kentucky - 3
·
Covington - 1
·
Florence - 1
·
Independence - 1
·
Southern Indiana - 3
·
Floyds Knobs - 1
·
Jeffersonville - 1
·
New Albany - 1
·
Metropolitan Tampa, Florida - 6
·
Metropolitan Cincinnati, Ohio - 1
·
Metropolitan Nashville, Tennessee - 2
Republic’s headquarters are located in Louisville, which is the largest city in Kentucky based on population.
Core Banking results of operations are primarily dependent upon net interest income, which represents the difference between the interest income and fees on interest-earning assets and the interest expense on interest-bearing liabilities. Principal interest-earning Core Banking assets represent investment securities and commercial and consumer loans primarily secured by real estate and/or personal property. Interest-bearing liabilities primarily consist of interest-bearing deposit accounts, securities sold under agreements to repurchase, as well as short-term and long-term borrowing sources. Federal Home Loan Bank (“FHLB”) advances have traditionally been a significant borrowing source for the Bank.
Other sources of Core Banking income include service charges on deposit accounts, debit and credit card interchange fee income, title insurance commissions, fees charged to clients for trust services, increases in the cash surrender value of Bank Owned Life Insurance (“BOLI”) and revenue generated from Mortgage Banking activities. Mortgage Banking activities represent both the origination and sale of loans in the secondary market and the servicing of loans for others, primarily the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “FHLMC”).
Core Banking operating expenses consist primarily of salaries and employee benefits, occupancy and equipment expenses, communication and transportation costs, data processing, interchange related expenses, marketing and development expenses, Federal Deposit Insurance Corporation (“FDIC”) insurance expense, franchise tax expense and various other general and administrative costs. Core Banking results of operations are significantly impacted by general economic and competitive conditions, particularly changes in market interest rates, government laws and policies and actions of regulatory agencies.
The Core Bank provides short-term, revolving credit facilities to mortgage bankers across the United States through mortgage warehouse lines of credit. These credit facilities are primarily secured by single family, first lien residential real estate loans. The credit facility enables the mortgage banking clients to close single family, first lien residential real estate loans in their own name and temporarily fund their inventory of these closed loans until the loans are sold to investors approved by the Bank or purchased by the Bank through its Correspondent Lending channel. Individual loans are expected to remain on the warehouse line for an average of 15 to 30 days. Reverse mortgage loans typically remain on the line longer than conventional mortgage loans. Interest income and loan fees are accrued for each individual loan during the time the loan remains on the warehouse line and collected when the loan is sold. The Core Bank receives the sale proceeds of each loan directly from the investor and applies the funds to pay off the warehouse advance and related accrued interest and fees. The remaining proceeds are credited to the mortgage-banking client.
Primarily from its Warehouse clients, the Core Bank acquires single family, first lien mortgage loans that meet the Core Bank’s specifications through its Correspondent Lending channel. Substantially all loans purchased through the Correspondent Lending channel are purchased at a premium. Loans acquired through the Correspondent Lending channel generally reflect borrowers outside of the Bank’s historical market footprint, with 75% of loans acquired through this origination channel as of December 31, 2016, secured by collateral in the state of California.
Republic Processing Group
Tax Refund Solutions division - Through its TRS division, the Bank is one of a limited number of financial institutions that facilitates the receipt and payment of federal and state tax refund products and offers a credit product through third-party tax preparers located throughout the United States, as well as tax-preparation software providers (collectively, the “Tax Providers”). Substantially all of the business generated by the TRS division occurs in the first half of the year. The TRS division traditionally operates at a loss during the second half of the year, during which time the division incurs costs preparing for the upcoming year’s first quarter tax season.
Refund Transfers (“RTs”) are fee-based products whereby a tax refund is issued to the taxpayer after the Bank has received the refund from the federal or state government. There is no credit risk or borrowing cost associated with these products because they are only delivered to the taxpayer upon receipt of the tax refund directly from the governmental paying authority. Fees earned on RTs, net of rebates, are reported as noninterest income under the line item “Net refund transfer fees.”
TRS first offered its Easy Advance (“EA”) tax credit product during the first two months of 2016 with the following features:
·
An advance amount of $750 per taxpayer customer;
·
No EA fee charged to the taxpayer customer;
·
All fees for the product were paid by the tax preparer or tax software company (collectively, the “Tax Providers”) with a restriction prohibiting the Tax Providers from passing along the fees to the taxpayer customer;
·
No requirement that the taxpayer customer pay for another bank product, such as an RT;
·
Multiple funds disbursement methods, including direct deposit, prepaid card, check or Walmart Direct2Cash® product, based on the taxpayer customer’s election;
·
Repayment of the EA to the Bank was deducted from the taxpayer customer’s tax refund proceeds; and
·
If an insufficient refund to repay the EA occurred:
o
there was no recourse to the taxpayer customer,
o
no negative credit reporting on the taxpayer customer, and
o
no collection efforts against the taxpayer customer.
Fees paid by the Tax Providers to the Company for the EA product are reported as interest income on loans under the line item “Loans, including fees.”
Republic Credit Solutions division - Through its RCS division, the Bank offers short-term consumer credit products. In general, the credit products are unsecured, small dollar consumer loans with maturities of 30-days-or-more, and are dependent on various factors including the consumer’s ability to repay.
The Company reports RCS loans originated for investment under “Loans,” while loans originated for sale are reported under “Consumer loans held for sale.” The Company reports interest income and loan origination fees earned on RCS loans under Loans, including fees, while any gains or losses on sale reported as noninterest income under “Program fees.”
Republic Payment Solutions division - Through its RPS division, the Bank is an issuing bank offering general-purpose reloadable prepaid cards through third party program managers.
The Company reports fees related to RPS programs under Program fees. Additionally, the Company’s portion of interchange revenue generated by prepaid card transactions is reported as noninterest income under Interchange fee income.
Use of Estimates - Financial statements prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) require management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. These estimates and assumptions impact the amounts reported in the financial statements and the disclosures provided. Actual amounts could differ from these estimates.
Concentration of Credit Risk - With the exception of loans originated through its Correspondent Lending channel, most of the Company’s Traditional Banking business activity is with clients located in Kentucky, Indiana, Florida, and Tennessee. The Company’s Traditional Banking exposure to credit risk is significantly affected by changes in the economy in these specific areas.
Loans originated through the Traditional Bank’s Correspondent Lending channel are primarily secured by single family, first lien residences located outside the Company’s market footprint, with 75% of such loans secured by collateral located in the state of California as of December 31, 2016. Furthermore, warehouse lines of credit are secured by single family, first lien residential real estate loans originated by the Bank’s mortgage clients across the United States. As of December 31, 2016, 25% of collateral securing warehouse lines were located in California.
Earnings Concentration - For 2016, 2015 and 2014, approximately 20%, 13% and 12% of total Company net revenues (net interest income plus noninterest income) were derived from the RPG segment.
For 2016, 2015 and 2014, approximately 8%, 7% and 5% of total Company net revenues (net interest income plus noninterest income) were derived from the Company’s Warehouse segment.
Cash Flows - Cash and cash equivalents include cash, deposits with other financial institutions with original maturities less than 90 days and federal funds sold. Net cash flows are reported for client loan and deposit transactions, interest-bearing deposits in other financial institutions, repurchase agreements and income taxes.
Interest-Bearing Deposits in Other Financial Institutions - Interest-bearing deposits in other financial institutions mature within one year and are carried at cost.
Trust Assets - Property held for clients in fiduciary or agency capacities, other than trust cash on deposit at the Bank, is not included in the consolidated financial statements since such items are not assets of the Bank.
Securities - Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity.
Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized and accreted on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more-likely-than-not that it would be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. OTTI related to credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
In order to determine OTTI for purchased beneficial interests that, on the purchase date, were not highly rated, the Bank compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.
Accounting for Business Acquisitions - The Bank maintains an acquisition strategy to selectively grow its franchise as a complement to its internal growth strategies.
The Bank accounts for acquisitions in accordance with the acquisition method as outlined in Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. The acquisition method requires: a) identification of the entity that obtains control of the acquiree; b) determination of the acquisition date; c) recognition and measurement of the identifiable assets acquired and liabilities assumed, and any noncontrolling interest in the acquiree; and d) recognition and measurement of goodwill or bargain purchase gain.
Identifiable assets acquired, liabilities assumed, and any noncontrolling interest in acquirees are generally recognized at their acquisition date (“day-one”) fair values based on the requirements of ASC Topic 820, Fair Value Measurements and Disclosures. The measurement period for day-one fair values begins on the acquisition date and ends the earlier of: (a) the day management believes it has all the information necessary to determine day-one fair values; or (b) one year following the acquisition date. In many cases, the determination of day-one fair values requires management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly complex and subjective in nature and subject to recast adjustments, which are retrospective adjustments to reflect new information existing at the acquisition date affecting day-one fair values. More specifically, these recast adjustments for loans and other real estate owned may be made, as market value data, such as valuations, are received by the Bank. Increases or decreases to day-one fair values are reflected with a corresponding increase or decrease to bargain purchase gain or goodwill.
Acquisition related costs are expensed as incurred unless those costs are related to issuing debt or equity securities used to finance the acquisition.
Mortgage Banking Activities - Mortgage loans originated and intended for sale in the secondary market are carried at fair value, as determined by outstanding commitments from investors. Net gains on mortgage loans held for sale are recorded as a component of Mortgage Banking income and represent the difference between the selling price and the carrying value of the loans sold. Substantially all of the gains or losses on the sale of loans are reported in earnings when the interest rates on loans are locked.
Commitments to fund mortgage loans (“interest rate lock commitments”) to be sold into the secondary market and non-exchange traded mandatory forward sales contracts (“forward contracts”) for the future delivery of these mortgage loans are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the Bank enters into the derivative. Generally, the Bank enters into forward contracts for the future delivery of mortgage loans when interest rate lock commitments are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in the fair values of these mortgage derivatives are included in net gains on sales of loans, which is a component of Mortgage Banking income on the income statement.
Mortgage loans held for sale are generally sold with the mortgage servicing rights (“MSRs”) retained. When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded as a component of net servicing income within Mortgage Banking income. Fair value is based on market prices for comparable mortgage servicing contracts, when available or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method, which requires servicing rights to be amortized into Mortgage Banking income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Amortization of MSRs are initially set at seven years and subsequently adjusted on a quarterly basis based on the weighted average remaining life of the underlying loans.
MSRs are evaluated for impairment quarterly based upon the fair value of the MSRs as compared to carrying amount. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate, loan type, loan terms and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Bank later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the valuation allowance is recorded as an increase to income. Changes in valuation allowances are reported within Mortgage Banking income on the income statement. The fair value of the MSR portfolios is subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates.
A primary factor influencing the fair value is the estimated life of the underlying serviced loans. The estimated life of the serviced loans is significantly influenced by market interest rates. During a period of declining interest rates, the fair value of the MSRs generally will decline due to higher expected prepayments within the portfolio. Alternatively, during a period of rising interest rates the fair value of MSRs generally will increase, as prepayments on the underlying loans would be expected to decline. Based on the estimated fair value at December 31, 2016 and 2015, management determined there was no impairment within the MSR portfolio.
Loan servicing income is reported on the income statement as a component of Mortgage Banking income. Loan servicing income is recorded as loan payments are collected and includes servicing fees from investors and certain charges collected from borrowers. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned. Loan servicing income totaled $2.0 million, $1.9 million and $1.8 million for the years ended December 31, 2016, 2015 and 2014. Late fees and ancillary fees related to loan servicing are considered nominal.
Loans - The Bank’s financing receivables consist primarily of loans and a nominal amount of lease financing receivables (together referred to as “loans”). Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, inclusive of purchase premiums or discounts, deferred loan fees and costs and the Allowance. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method. Premiums on loans held for investment acquired though the Correspondent Lending channel are amortized into interest income on the level-yield method over the expected life of the loan.
Lease financing receivables, all of which are direct financing leases, are reported at their principal balance outstanding net of any unearned income, deferred fees and costs and applicable Allowance. Leasing income is recognized on a basis that achieves a constant periodic rate of return on the outstanding lease financing balances over the lease terms.
Interest income on mortgage and commercial loans is typically discontinued at the time the loan is 80 days delinquent unless the loan is well secured and in process of collection. Past due status is based on the contractual terms of the loan, which may define past due status by the number of days or the number of payments past due. In most cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 80 days still on accrual include both smaller balance, homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
Interest accrued but not received for all classes of loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, typically a minimum of six months of performance. Consumer and credit card loans, are not placed on nonaccrual status, but are reviewed periodically and charged off when the loan is deemed uncollectible, generally no more than 120 days.
Loans purchased in a business acquisition are accounted for using one of the following accounting standards:
·
ASC Topic 310-20, Non Refundable Fees and Other Costs, is used to value loans that have not demonstrated post origination credit quality deterioration and the acquirer expects to collect all contractually required payments from the borrower. For these loans, the difference between the loan’s day-one fair value and amortized cost would be amortized or accreted into income using the interest method.
·
ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, is used to value purchased credit impaired (“PCI”) loans. For these loans, it is probable the acquirer will be unable to collect all contractually required payments from the borrower. Under ASC Topic 310-30, the expected cash flows that exceed the initial investment in the loan, or fair value, represent the “accretable yield,” which is recognized as interest income on a level-yield basis over the expected cash flow periods of the loans. Additionally, the difference between contractual cash flows and expected cash flows of PCI loans is referred to as the “non-accretable discount.”
Purchased loans accounted for under ASC Topic 310-20 are accounted for as any other Bank-originated loan, potentially becoming nonaccrual or impaired, as well as being risk rated under the Bank’s standard practices and procedures. In addition, these loans are considered in the determination of the Allowance once day-one fair values are final.
Management utilized the following criteria in determining which loans were classified as PCI loans for its May 17, 2016 Cornerstone acquisition:
·
Loans for which the Bank assigned a non-accretable discount
·
Loans classified as nonaccrual when acquired
·
Loans past due 90+ days when acquired
See additional detail regarding the Company’s acquisition of Cornerstone Bancorp, Inc. under Footnote 2 “Acquisition of Cornerstone Bancorp, Inc.” of Part II Item 8 “Financial Statements and Supplementary Data.”
In determining the day-one fair values of PCI loans, management considers a number of factors including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. The Bank typically accounts for PCI loans individually, as opposed to aggregating the loans into pools based on common risk characteristics such as loan type.
Management separately monitors the PCI portfolio and on a quarterly basis reviews the loans contained within this portfolio against the factors and assumptions used in determining the day-one fair values. In addition to its quarterly evaluation, a loan is typically reviewed when it is modified or extended, or when material information becomes available to the Bank that provides additional insight regarding the loan’s performance, estimated life, the status of the borrower, or the quality or value of the underlying collateral.
To the extent that a PCI loan’s performance does not reflect an increased risk of loss of contractual principal beyond the non-accretable yield established as part of its initial day-one evaluation, such loan would be classified in the Purchased Credit Impaired - Group 1 (“PCI-1”) category, whose credit risk is considered by management equivalent to a non-PCI Special Mention loan within the Bank’s credit rating matrix. PCI-1 loans are considered impaired if, based on current information and events, it is probable that the future estimated cash flows of the loan have deteriorated from management’s initial acquisition day estimate. Provisions for loan losses are made for impaired PCI-1 loans to further discount the loan and allow its yield to conform to at least management’s initial expectations. Any improvement in the expected performance of a PCI-1 loan would result in a reversal of the Provision to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.
If during the Bank’s periodic evaluations of its PCI loan portfolio, management deems a PCI-1 loan to have an increased risk of loss of contractual principal beyond the non-accretable discount established as part of its initial day-one evaluation, such loan would be classified PCI-Substandard (“PCI-Sub”) within the Bank’s credit risk matrix. Management deems the risk of default and overall credit risk of a PCI-Sub loan to be greater than a PCI-1 loan and more analogous to a non-PCI Substandard loan. PCI-Sub loans are considered to be impaired. Any improvement in the expected performance of a PCI-Sub loan would result in a reversal of the Provision to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.
PCI loans are placed on nonaccrual if management cannot reasonably estimate future cash flows on such loans.
If a troubled debt restructuring (“TDR”) is performed on a PCI loan, the loan is considered impaired under the applicable TDR accounting standards and transferred out of the PCI population. The loan may require an additional Provision if its restructured cash flows are less than management’s initial day-one expectations. PCI loans for which the Bank simply chooses to extend the maturity date are generally not considered TDRs and remain in the PCI population.
Allowance for Loan and Lease Losses (“Allowance”) - The Bank maintains an allowance for probable incurred credit losses inherent in the Bank’s loan portfolio, which includes overdrawn deposit accounts. Loan losses are charged against the Allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the Allowance. Management estimates the Allowance required using historical loan loss experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors. Allocations of the Allowance may be made for specific classes, but the entire Allowance is available for any loan that, in management’s judgment, should be charged off.
Management evaluates the adequacy of the Allowance on a monthly basis and presents and discusses the analysis with the Audit Committee and the Board of Directors on a quarterly basis.
The Allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component is based on historical loss experience adjusted for qualitative factors.
Specific Component -Loans Individually Classified as Impaired
The Bank defines impaired loans as follows:
·
All loans internally rated as “Substandard,” “Doubtful” or “Loss”;
·
All loans on nonaccrual status;
·
All TDRs;
·
All loans internally rated in a PCI category with cash flows that have deteriorated from management’s initial acquisition day estimate; and
·
Any other situation where the full collection of the total amount due for a loan is improbable or otherwise meets the definition of impaired.
Generally, loans are designated as “Classified” or “Special Mention” to ensure more frequent monitoring. These loans are reviewed to ensure proper earning status and management strategy. If it is determined that there is serious doubt as to performance in accordance with original or modified contractual terms, then the loan is generally downgraded and often placed on nonaccrual status.
Under GAAP, the Bank uses the following methods to measure specific loan impairment, including:
·
Cash Flow Method - The recorded investment in the loan is measured against the present value of expected future cash flows discounted at the loan’s effective interest rate. The Bank employs this method for a significant portion of its TDRs. Impairment amounts under this method are reflected in the Bank’s Allowance as specific reserves on the respective impaired loan. These specific reserves are adjusted quarterly based upon reevaluation of the expected future cash flows and changes in the recorded investment.
·
Collateral Method - The recorded investment in the loan is measured against the fair value of the collateral less applicable selling costs. The Bank employs the fair value of collateral method for its impaired loans when repayment is based solely on the sale or operations of the underlying collateral. Collateral fair value is typically based on the most recent real estate valuation on file. Measured impairment under this method is generally charged off unless the loan is a smaller-balance, homogeneous mortgage loan. The Bank’s selling costs for its collateral-dependent loans typically range from 10-13% of the fair value of the underlying collateral, depending on the asset class. Selling costs are not applicable for collateral-dependent loans whose repayment is based solely on the operations of the underlying collateral.
In addition to obtaining appraisals at the time of origination, the Bank typically updates appraisals and/or broker price opinions (“BPOs”) for loans with potential impairment. Updated valuations for commercial-related credits exhibiting an increased risk of loss are typically obtained within one year of the previous valuation. Collateral values for past due residential mortgage loans and home equity loans are generally updated prior to a loan becoming 90 days delinquent, but no more than 180 days past due. When measuring impairment, to the extent updated collateral values cannot be obtained due to the lack of recent comparable sales or for other reasons, the Bank discounts such stale valuations primarily based on age and market conditions of the underlying collateral.
General Component - Pooled Loans Collectively Evaluated
The general component of the Allowance covers loans collectively evaluated for impairment by loan class and is based on historical loss experience, with potential adjustments for current relevant qualitative factors. Historical loss experience is determined by loan performance and class and is based on the actual loss history experienced by the Bank. Large groups of smaller-balance, homogeneous loans, such as consumer and residential real estate loans, are typically included in the general component but may be individually evaluated if classified as a TDRs, on nonaccrual, or a case where the full collection of the total amount due for a such loan is improbable or otherwise meets the definition of impaired.
In determining the historical loss rates for each respective loan class, management evaluates the following historical loss rate scenarios:
·
Rolling four quarter average
·
Rolling eight quarter average
·
Rolling twelve quarter average
·
Rolling sixteen quarter average
·
Rolling twenty quarter average
·
Rolling twenty-four quarter average
·
Rolling twenty-eight quarter average
·
Rolling thirty-two quarter average
·
Current year to date historical loss factor average
In order to take account of periods of economic growth and economic downturn, management generally uses the highest of the evaluated averages above for each loan class when determining its historical loss factors.
Loan classes are also evaluated utilizing subjective factors in addition to the historical loss calculations to determine a loss allocation for each class. Management assigns risk multiples to certain classes to account for qualitative factors such as:
·
Changes in nature, volume and seasoning of the portfolio;
·
Changes in experience, ability and depth of lending management and other relevant staff;
·
Changes in the quality of the Bank’s credit review system;
·
Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;
·
Changes in the volume and severity of past due, nonperforming and classified loans;
·
Changes in the value of underlying collateral for collateral-dependent loans;
·
Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of portfolios, including the condition of various market segments;
·
The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
·
The effect of other external factors, such as competition and legal and regulatory requirements on the level of estimated credit losses in the Bank’s existing portfolio.
As this analysis, or any similar analysis, is an imprecise measure of loss, the Allowance is subject to ongoing adjustments. Therefore, management will often take into account other significant factors that may be necessary or prudent in order to reflect probable incurred losses in the total loan portfolio.
A “portfolio segment” is defined as the level at which an entity develops and documents a systematic methodology to determine its Allowance. A “class” of loans represents further disaggregation of a portfolio segment based on risk characteristics and the entity’s method for monitoring and assessing credit risk. In developing its Allowance methodology, the Company has identified the following Traditional Banking portfolio segments:
Portfolio Segment 1 - Loans where the Allowance methodology is determined based on a loan review and grading system (primarily commercial related loans and retail TDRs).
For this portfolio, the Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, public information, and current economic trends. The Bank also considers the fair value of the underlying collateral and the strength and willingness of the guarantor(s). The Bank analyzes loans individually, and based on this analysis, establishes a credit risk rating consistent with its credit risk matrix.
Portfolio Segment 2 - Loans where the Allowance methodology is driven by delinquency and nonaccrual data (primarily small dollar, retail mortgage or consumer related).
For this portfolio, the Bank analyzes risk classes based on delinquency and/or nonaccrual status.
Allowance for Loans Originated Through the Republic Processing Group Segment
The RPG Allowance at December 31, 2016 and 2015 primarily related to loans originated and held for investment through the RCS division. RCS generally originates small-dollar, short-term credit products. In some instances, the Bank originates these products, sells 90% of the balances within two days of loan origination, and retains a 10% interest.
One short-term, line-of-credit product represented the substantial majority of the RCS held-for-investment loan portfolio at December 31, 2016. For this product, management conducts an analysis of historical losses and delinquencies by month of loan origination when determining the Allowance. For RCS’s other products, the Allowance is estimated using a method similar to Core Bank loans, as described above. Due to their non-traditional, small-dollar and short-term nature, RCS loans generally experience higher loss rates than Core Bank consumer products.
RPG’s TRS division first offered its EA tax-credit product during the first two months of 2016 and again during the first quarter of 2017. An Allowance for losses on EAs is estimated during the limited, short-term period the product is offered, which was through February 29, 2016 for the first quarter 2016 tax season. During 2016, EAs were generally repaid within three weeks of origination. Provisions for loan losses on EAs were estimated when advances were made, with all provisions made in the first quarter of 2016. No Allowance for EAs existed as of December 31, 2016, as all EAs had been paid off or had been charged-off within 81 days of origination. The majority of EA charge-offs were recorded during the second quarter of 2016.
See Footnote 5 “Loans and Allowance for Loan and Lease Losses” in this section of the filing for additional discussion regarding the Company’s Allowance.
Transfers of Financial Assets - Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Other Real Estate Owned (“OREO”) - Assets acquired through loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. The Bank’s selling costs for OREO typically range from 10-13% of each property’s fair value, depending on property class. Fair value is commonly based on recent real estate appraisals or broker price opinions. Operating costs after acquisition are expensed.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Once the appraisal is received, a member of the Bank’s Credit Administration Department (“CAD”) reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value in comparison with independent data sources, such as recent market data or industry-wide statistics. On at least an annual basis, the Bank performs a back test of collateral appraisals by comparing actual selling prices on recent collateral sales to the most recent appraisal of such collateral. Back tests are performed for each collateral class, e.g. residential real estate or commercial real estate, and may lead to additional adjustments to the value of unliquidated collateral of similar class.
Premises and Equipment, Net - Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed over the estimated useful lives of the related assets on the straight-line method. Estimated lives typically range from 25 to 39 years for buildings and improvements, three to ten years for furniture, fixtures and equipment and three to five years for leasehold improvements.
Federal Home Loan Bank Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security and annually evaluated for impairment. Because this stock is viewed as a long-term investment, impairment is based on ultimate recovery of par value. Both cash and stock dividends are recorded as interest income.
Bank Owned Life Insurance - The Bank maintains BOLI policies on certain employees. BOLI is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. The Bank recognizes tax-free income from the periodic increases in cash surrender value of these policies and from death benefits in noninterest income. Credit ratings for the Bank’s BOLI carriers are reviewed at least annually.
Goodwill and Other Intangible Assets - Goodwill resulting from business acquisitions prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business acquisitions after January 1, 2009 represents the future economic benefits arising from other assets acquired that are individually identified and separately recognized. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually.
The Company has selected September 30th as the date to perform its annual goodwill impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Bank’s balance sheet.
All goodwill is attributable to the Company’s Traditional Banking segment and is not expected to be deductible for tax purposes. Based on its assessment, the Company believes its goodwill of $16 million and $10 million at December 31, 2016 and 2015 was not impaired and is properly recorded in the consolidated financial.
Other intangible assets consist of core deposit intangible (“CDI”) assets arising from business acquisitions. CDI assets are initially measured at fair value and then amortized on an accelerated method over their estimated useful lives.
Related to the Company’s May 17, 2016 acquisition of Cornerstone Bancorp, Inc., the Company maintained $1 million of CDI assets as of December 31, 2016, with no similar intangible assets recorded as of December 31, 2015. The Cornerstone related CDI is scheduled to amortize through 2022.
Off Balance Sheet Financial Instruments - Financial instruments include off balance sheet credit instruments, such as commitments to fund loans and standby letters of credit. The face amount for these items represents the exposure to loss, before considering client collateral or ability to repay. Such financial instruments are recorded upon funding. Instruments such as standby letters of credit are considered financial guarantees and are recorded at fair value.
Derivatives -Derivatives are reported at fair value in other assets or other liabilities. The Company’s derivatives include interest rate swap agreements. For asset/liability management purposes, the Bank uses interest rate swap agreements to hedge the exposure or to modify the interest rate characteristic of certain immediately repricing liabilities.
The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a derivative designated as a cash flow hedge, the effective portion of the derivative’s unrealized gain or loss
is recorded as a component of other comprehensive income (loss). For derivatives not designated as hedges, the gain or loss is recognized in current period earnings.
Net cash settlements on interest rate swaps are recorded in interest expense and cash flows related to the swaps are classified in the cash flow statement the same as the interest expense and cash flows from the liabilities being hedged. The Bank formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet. The Bank also formally assesses, both at the hedge’s inception and on an ongoing basis, whether a swap is highly effective in offsetting changes in cash flows of the hedged items. The Bank discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in cash flows of the hedged item, the derivative is settled or terminates, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
The Bank enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Bank enters into offsetting positions with dealer counterparties in order to minimize the Bank’s interest rate risk. These swaps are derivatives, but are not designated as hedging instruments, and therefore changes in fair value are reported in current year earnings.
Interest rate swap contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty or client owes the Bank, and results in credit risk to the Bank. When the fair value of a derivative instrument contract is negative, the Bank owes the client or counterparty and therefore, has no credit risk.
Stock Based Compensation - For stock options and restricted stock awards issued to employees, compensation cost is recognized based on the fair value of these awards at the date of grant. The Company utilizes a Black-Scholes model to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation expense is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Income Taxes - Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized
A tax position is recognized as a benefit only if it is “more-likely-than-not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more-likely-than-not” test, no tax benefit is recorded.
Retirement Plans - 401(k) plan expense is recorded as a component of salaries and employee benefits and represents the amount of Company matching contributions.
Earnings Per Common Share - Basic earnings per share is based on net income (in the case of Class B Common Stock, less the dividend preference on Class A Common Stock), divided by the weighted average number of shares outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential Class A common shares issuable under stock options. Earnings and dividends per share are restated for all stock dividends through the date of issuance of the financial statements.
Comprehensive Income - Comprehensive income consists of net income and other comprehensive income (“OCI”). OCI includes, net of tax, unrealized gains and losses on securities available for sale and unrealized gains and losses on cash flow hedges, which are also recognized as a separate component of equity.
Loss Contingencies - Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any outstanding matters that would have a material effect on the financial statements.
Restrictions on Cash and Cash Equivalents - Republic is required by the Federal Reserve Bank (“FRB”) to maintain average reserve balances. Cash and due from banks on the consolidated balance sheet included no required reserve balances at December 31, 2016 and 2015.
The Company’s Captive maintains cash reserves to cover insurable claims. Reserves totaled $2 million and $2 million as of December 31, 2016 and 2015.
Equity - Stock dividends in excess of 20% are reported by transferring the par value of the stock issued from retained earnings to common stock. Stock dividends for 20% or less are reported by transferring the fair value, as of the ex-dividend date, of the stock issued from retained earnings to common stock and additional paid in capital. Fractional share amounts are paid in cash with a reduction in retained earnings.
Dividend Restrictions - Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to Republic or by Republic to shareholders.
Fair Value of Financial Instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Footnote 15 “Fair Value” in this section of the filing. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Segment Information - Segments represent parts of the Company evaluated by management with separate financial information. Republic’s internal information is primarily reported and evaluated in four lines of business - Traditional Banking, Warehouse, Mortgage Banking and RPG.
Reclassifications - Certain amounts presented in prior periods have been reclassified to conform to the current period presentation. These reclassifications had no impact on previously reported prior periods’ net income or shareholders’ equity.
Adoption of Issued but Not Yet Effective Accounting Pronouncements:
The following Account Standard Updates (“ASUs”) were issued prior to December 31, 2016 and are considered relevant to the Company’s financial statements:
2.ACQUISITION OF CORNERSTONE BANCORP, INC.
OVERVIEW
On May 17, 2016, the Company completed its acquisition of Cornerstone Bancorp, Inc. (“Cornerstone”), and its wholly-owned bank subsidiary Cornerstone Community Bank (“CCB”), for approximately $32 million in cash. The primary reason for the acquisition of Cornerstone was to expand the Company’s footprint in the Tampa, Florida metropolitan statistical area.
ACQUISITION SUMMARY
The following table provides a summary of the assets acquired and liabilities assumed as recorded by Cornerstone, the previously reported preliminary fair value adjustments necessary to adjust those acquired assets and assumed liabilities to fair value, final recast adjustments to those previously reported preliminary fair values, and the final fair values of those assets and liabilities as recorded by the Company. Effective October 1, 2016, management believes it has finalized the fair values of the acquired assets and assumed liabilities within the 12 months following the date of acquisition, as allowed by GAAP.
Explanation of preliminary fair value adjustments:
a.
Reflects the fair value adjustment based on the Company’s evaluation of the acquired loan portfolio and to eliminate the acquiree’s recorded allowance for loan losses.
b.
Reflects the fair value adjustment based on the Company’s evaluation of the premises and equipment acquired.
c.
Reflects the fair value adjustment for the core deposit intangible asset recorded as a result of the acquisition.
d.
Reflects the differences in the carrying values of acquired assets and assumed liabilities for financial reporting purposes and their basis for federal income tax purposes.
e.
Reflects the fair value adjustment based on the Company’s evaluation of the assumed time deposits.
f.
Reflects the amount needed to adjust other liabilities to estimated fair value and to record certain liabilities directly attributable to the acquisition of Cornerstone.
Goodwill of approximately $6 million, which is the excess of the merger consideration over the fair value of net assets acquired, was recorded in the Cornerstone acquisition and is the result of expected operational synergies and other factors. This goodwill is all attributable to the Company’s Traditional Banking segment and is not expected to be deductible for tax purposes.
With regard to the Company’s Cornerstone acquisition, pro forma financial information as if the acquisition had occurred at the beginning of 2015 is not considered material and is not included in this filing.
CORNERSTONE CONTRIBUTION FOR THE REPORTING PERIOD
The Company’s consolidated statements of income include the impact of the Company’s Cornerstone acquisition for the year ended December 31, 2016. The results of operations of the assets acquired and liabilities assumed in the Company’s Cornerstone acquisition, inclusive of any pre-acquisition related costs, are summarized in the following table:
Explanation of acquisition-related items:
a.
Accretion of loan discounts.
b.
Amortization of deposit premiums.
c.
Severance payouts and signing bonuses for former Cornerstone employees.
d.
Notices to former Cornerstone stakeholders of change in ownership and merger-related travel.
e.
Primarily core system conversion-related costs.
f.
Costs to update forms and supplies to RB&T brand.
g.
Includes legal, audit, tax and other acquisition related consulting costs.
h.
Includes amortization of core deposit intangible asset.
3.INVESTMENT SECURITIES
Securities Available for Sale
The gross amortized cost and fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
Securities Held to Maturity
The carrying value, gross unrecognized gains and losses, and fair value of securities held to maturity were as follows:
At December 31, 2016 and 2015, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.
Sales of Securities Available for Sale
During 2016, 2015 and 2014, there were no sales of securities available for sale.
During 2015, the Bank recognized a gross gain of $88,000 on the call of one security available for sale. The tax provision related to the Bank’s realized gain totaled $31,000 for the year ended December 31, 2015.
Investment Securities by Contractual Maturity
The amortized cost and fair value of the investment securities portfolio by contractual maturity at December 31, 2016 follows. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are detailed separately.
Freddie Mac Preferred Stock
During 2008, the U.S. Treasury, the Federal Reserve Board, and the Federal Housing Finance Agency (“FHFA”) announced that the FHFA was placing Freddie Mac under conservatorship and giving management control to the FHFA. The Bank contemporaneously determined that its 40,000 shares of Freddie Mac preferred stock were fully impaired and recorded an OTTI charge of $2.1 million in 2008. The OTTI charge brought the carrying value of the stock to $0. During 2014, based on active trading volume of Freddie Mac preferred stock, the Company determined it appropriate to record an unrealized gain to OCI related to its Freddie Mac preferred stock holdings. Based on the stock’s market closing price as of December 31, 2016, the Company’s unrealized gain for its Freddie Mac preferred stock totaled $483,000.
Corporate Bonds
During 2013 and 2016, the Bank purchased floating rate corporate bonds. The 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 8% of the Bank’s investment portfolio as of December 31, 2016 and 2015.
Mortgage Backed Securities and Collateralized Mortgage Obligations
At December 31, 2016, with the exception of the $4.8 million private label mortgage backed security, all other mortgage backed securities and collateralized mortgage obligations (“CMOs”) held by the Bank were issued by U.S. government-sponsored entities and agencies, primarily Freddie Mac and the Federal National Mortgage Association (“Fannie Mae” or “FNMA”). At December 31, 2016 and December 31, 2015, there were gross unrealized losses of $1.5 million and $1.1 million related to available for sale mortgage backed securities and CMOs. Because these unrealized losses are attributable to changes in interest rates and illiquidity, and not credit quality, and because the Bank does not have the intent to sell these securities, and it is likely that it will not be required to sell the securities before their anticipated recovery, management does not consider these securities to have OTTI.
Trust Preferred Security
During the fourth quarter of 2015, the Parent Company purchased a $3 million floating rate trust preferred security at a price of 68% of par. The coupon on this security is based on the 3-month LIBOR + 159 basis points, giving the Parent Company an expected yield to maturity of 4.27% when considering the discount. The Company performed an initial analysis prior to acquisition and performs ongoing analysis of the credit risk of the underlying borrower in relation to this security.
Market Loss Analysis
Securities with unrealized losses at December 31, 2016 and 2015, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
At December 31, 2016, the Bank’s portfolio consisted of 179 securities, 45 of which were in an unrealized loss position.
At December 31, 2015, the Bank’s portfolio consisted of 162 securities, 34 of which were in an unrealized loss position.
Other-Than-Temporary Impairment
Unrealized losses for all investment securities are reviewed to determine whether the losses are “other-than-temporary.” Investment securities are evaluated for OTTI on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in value below amortized cost is other-than-temporary. In conducting this assessment, the Bank evaluates a number of factors including, but not limited to the following:
·
The length of time and the extent to which fair value has been less than the amortized cost basis;
·
The Bank’s intent to hold until maturity or sell the debt security prior to maturity;
·
An analysis of whether it is more-likely-than-not that the Bank will be required to sell the debt security before its anticipated recovery;
·
Adverse conditions specifically related to the security, an industry, or a geographic area;
·
The historical and implied volatility of the fair value of the security;
·
The payment structure of the security and the likelihood of the issuer being able to make payments;
·
Failure of the issuer to make scheduled interest or principal payments;
·
Any rating changes by a rating agency; and
·
Recoveries or additional decline in fair value subsequent to the balance sheet date.
The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for the anticipated credit losses.
The Bank owns one private label mortgage backed security with a total carrying value of $4.8 million at December 31, 2016. This security, with an average remaining life currently estimated at four years, is mostly backed by “Alternative A” first lien mortgage loans, but also has an insurance “wrap” or guarantee as an added layer of protection to the security holder. This asset is illiquid, and as such, the Bank determined it to be a Level 3 security in accordance with ASC Topic 820, Fair Value Measurements and Disclosures. Based on this determination, the Bank utilized an income valuation model (“present value model”) approach, in determining the fair value of the security. This approach is beneficial for positions that are not traded in active markets or are subject to transfer restrictions, and/or where valuations are adjusted to reflect illiquidity and/or non-transferability. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support for this investment.
See additional discussion regarding the Bank’s private label mortgage backed security in this section of the filing under Footnote 15 “Fair Value.”
The following table presents a rollforward of the Bank’s private label mortgage backed security credit losses recognized in earnings:
Further deterioration in economic conditions could cause the Bank to record an additional impairment charge related to credit losses of up to $3.7 million, which is the current gross amortized cost of the Bank’s remaining private label mortgage backed security.
Pledged Investment Securities
Investment securities pledged to secure public deposits, securities sold under agreements to repurchase and securities held for other purposes, as required or permitted by law are as follows:
4.LOANS HELD FOR SALE
In the ordinary course of business, the Bank originates for sale mortgage loans and short-term, consumer loans. Mortgage loans originated for sale are primarily originated and sold into the secondary market through the Bank’s Mortgage Banking operations, while short-term, consumer loans originated for sale are originated and sold through the RCS division of the Company’s RPG segment.
Mortgage Loans Held for Sale, at Fair Value
See additional detail regarding mortgage loans originated for sale, at fair value under Footnote 16 “Mortgage Banking Activities” of this section of the filing.
Consumer Loans Held for Sale, at Fair Value
During the first quarter of 2016, RCS initiated a short-term installment loan program, in which the Company sells 100% of the receivables approximately 21 days after origination. The Company carries these loans at fair value, with the loans marked to market on a monthly basis, with changes in their fair value reported as a component of “Program fees.”
Activity for consumer loans held for sale and carried at fair value was as follows:
Consumer Loans Held for Sale, at Lower of Cost or Fair Value
RCS originates, primarily for sale, both a short-term, line-of-credit product and a credit card product. The Bank sells 90% of the balances maintained through these two products within two days of loan origination and retains a 10% interest. The Company carries such loans at the lower of cost or fair value. The short-term, line-of-credit product represented the substantial majority of RCS activity during the years ended December 31, 2016 and 2015, as RCS moved beyond the pilot phase for this product in June 2015. In December 2015, RCS began piloting its credit card product. Any gains or losses on sale of such products are reported as a component of “Program fees.”
Activity for consumer loans held for sale and carried at the lower of cost or market value was as follows:
5.LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
The composition of the loan portfolio at period end follows:
*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. See table directly below for expanded detail.
The following table reconciles the contractually receivable and carrying amounts of loans at December 31, 2016 and 2015:
(1)
Relates to lease financing receivables.
(2)
Predominately relate to loans acquired through the Bank’s Correspondent Lending channel.
(3)Includes both accretable and non-accretable discounts and predominately relates to loans acquired in the Bank’s 2016 Cornerstone acquisition and 2012 FDIC-assisted transactions.
Loan Purchases not Associated with a Business Acquisition
The Core Bank acquires for investment single family, first lien mortgage loans that meet the Core Bank’s specifications through its Correspondent Lending channel. In addition, the Bank has acquired in the past unsecured consumer installment loans for investment from a third-party originator. Such consumer loans were purchased at par and were selected by the Bank based on certain underwriting specifications.
The table below reflects the purchase activity of single family, first lien mortgage loans and unsecured consumer loans, by class, during 2016, 2015 and 2014.
*Represents origination amount, inclusive of applicable purchase premiums.
Loans Acquired in Cornerstone Acquisition
The following table summarizes loans acquired in the Company’s May 17, 2016 Cornerstone acquisition, finalized as of October 1, 2016:
Purchased-Credit-Impaired (“PCI”) Loans
The Bank acquired PCI loans on May 17, 2016 in its Cornerstone acquisition and during the year ended December 31, 2012 in two FDIC-assisted transactions. PCI loans are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.
Management utilized the following criteria in determining which loans were classified as PCI loans for its May 17, 2016 Cornerstone acquisition:
·
Loans for which the Bank assigned a non-accretable discount
·
Loans classified as nonaccrual when acquired
·
Loans past due 90+ days when acquired
The following table reconciles the contractually required and carrying amounts of all PCI loans at December 31, 2016 and 2015:
The following table presents a rollforward of the accretable amount on all PCI loans for years ended December 31, 2016, 2015 and 2014:
Credit Quality Indicators
Bank procedures for assessing and maintaining credit gradings differs slightly depending on whether a new or renewed loan is being underwritten, or whether an existing loan is being re-evaluated for potential credit quality concerns. The latter usually occurs upon receipt of updated financial information, or other pertinent data, that would potentially cause a change in the loan grade. Specific Bank procedures follow:
·
For new and renewed commercial and industrial (“C&I”), commercial real estate (“CRE”) and construction and land development loans, the Bank’s CAD assigns the credit quality grade to the loan.
·
Commercial loan officers are responsible for monitoring their respective loan portfolios and reporting any adverse material changes to the senior management. When circumstances warrant a review and possible change in the credit quality grade, loan officers are required to notify the Bank’s CAD.
·
A senior officer meets monthly with commercial loan officers to discuss the status of past due loans and possible classified loans. These meetings are designed to give loan officers an opportunity to identify existing loans that should be downgraded.
·
Monthly, members of senior management along with managers of Commercial Lending, CAD, Accounting, Special Assets and Retail Collections attend a Special Asset Committee (“SAC”) meeting. The SAC reviews all C&I and CRE, classified, and impaired loans and discusses the relative trends and current status of these assets. In addition, the SAC reviews all classified and impaired retail residential real estate loans and all classified and impaired home equity loans. SAC also reviews the actions taken by management regarding credit quality grades, foreclosure mitigation, loan extensions, troubled debt restructurings and collateral repossessions. Based on the information reviewed in this meeting, the SAC approves all specific loan loss allocations to be recognized by the Bank within the Allowance analysis.
·
All new and renewed warehouse lines of credit are approved by the Executive Loan Committee. The CAD assigns the initial credit quality grade to warehouse facilities. Monthly, members of senior management review warehouse lending activity including data associated with the underlying collateral to the Warehouse facilities, i.e., the mortgage loans associated with the balances drawn. Key performance indicators monitored include average days outstanding for each draw, average Fair Isaac Corporation (“FICO”) credit report score for the underlying collateral, average loan-to-value (“LTV”) for the underlying collateral and other factors deemed relevant.
On at least an annual basis, the Bank’s internal loan review department analyzes all aggregate lending relationships with outstanding balances greater than $1 million that are internally classified as “Special Mention,” “Substandard,” “Doubtful” or “Loss.” In addition, on an annual basis, the Bank analyzes a sample of “Pass” rated loans.
The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, public information, and current economic trends. The Bank also considers the fair value of the underlying collateral and the strength and willingness of the guarantor(s). The Bank analyzes loans individually, and based on this analysis, establishes a credit risk rating. The Bank uses the following definitions for risk ratings:
Risk Grade 1 - Excellent (Pass): Loans fully secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans fully secured by publicly traded marketable securities where there is no impediment to liquidation; or loans to any publicly held company with a current long-term debt rating of A or better.
Risk Grade 2 - Good (Pass): Loans to businesses that have strong financial statements containing an unqualified opinion from a Certified Public Accounting firm and at least three consecutive years of profits; loans supported by unaudited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans that are guaranteed or otherwise backed by the full faith and credit of the U.S. government or an agency thereof, such as the Small Business Administration; or loans to publicly held companies with current long-term debt ratings of Baa or better.
Risk Grade 3 - Satisfactory (Pass): Loans supported by financial statements (audited or unaudited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.
Risk Grade 4 - Satisfactory/Monitored (Pass): Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than Satisfactory loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision.
Risk Grade 5 - Special Mention: Loans that possess some credit deficiency or potential weakness that deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) credit weaknesses are considered potential and are not defined impairments to the primary source of repayment.
Purchased Credit Impaired Loans - Group 1 (“PCI-1”): To the extent that a PCI loan’s performance does not reflect an increased risk of loss of contractual principal beyond the non-accretable yield established as part of its initial day-one evaluation, such loan would be classified in the Purchased Credit Impaired - Group 1 (“PCI-1”) category, whose credit risk is considered by management equivalent to a non-PCI “Special Mention” loan within the Bank’s credit rating matrix. PCI-1 loans are considered impaired if, based on current information and events, it is probable that the future estimated cash flows of the loan have deteriorated from management’s initial acquisition day estimate. Provisions are made for impaired PCI-1 loans to further discount the loan and allow its yield to conform to at least management’s initial expectations. Any improvement in the expected performance of a PCI-1 loan would result in a reversal of the Provision to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.
Purchased Credit Impaired Loans - Substandard (“PCI-Sub”): If during the Bank’s periodic evaluations of its PCI loan portfolio, management deems a PCI-1 loan to have an increased risk of loss of contractual principal beyond the non-accretable yield established as part of its initial day-one evaluation, such loan would be classified PCI-Substandard (“PCI-Sub”) within the Bank’s credit risk matrix. Management deems the risk of default and overall credit risk of a PCI-Sub loan to be greater than a PCI-1 loan and more analogous to a non-PCI “Substandard” loan within the Bank’s credit rating matrix. PCI-Sub loans are considered to be impaired. Any improvement in the expected performance of a PCI-Sub loan would result in a reversal of the Provision to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.
Risk Grade 6 - Substandard: One or more of the following characteristics may be exhibited in loans classified as Substandard:
·
Loans that possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.
·
Loans are inadequately protected by the current net worth and paying capacity of the obligor.
·
The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.
·
Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.
·
Unusual courses of action are needed to maintain a high probability of repayment.
·
The borrower is not generating enough cash flow to repay loan principal, however, it continues to make interest payments.
·
The Bank is forced into a subordinated or unsecured position due to flaws in documentation.
·
The Bank is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.
·
There is significant deterioration in market conditions to which the borrower is highly vulnerable.
Risk Grade 7 - Doubtful: One or more of the following characteristics may be present in loans classified as Doubtful:
·
Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.
·
The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.
·
The possibility of loss is high but because of certain important pending factors, which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.
Risk Grade 8 - Loss: Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified “Loss” when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.
For all real estate and consumer loans, including small-dollar RGP loans, that do not meet the scope above, the Bank uses a grading system based on delinquency and nonaccrual status. Loans that are 90 days or more past due or on nonaccrual are graded Substandard. Occasionally, a real estate loan below scope may be graded as “Special Mention” or “Substandard” if the loan is cross-collateralized with a classified C&I or CRE loan.
Purchased loans accounted for under ASC Topic 310-20 are accounted for as any other Bank-originated loan, potentially becoming nonaccrual or impaired, as well as being risk rated under the Bank’s standard practices and procedures. In addition, these loans are considered in the determination of the Allowance once day-one fair values are final.
Management separately monitors PCI loans, and on at least a quarterly basis, reviews them against the factors and assumptions used in determining day-one fair values. In addition to its quarterly evaluation, a PCI loan is typically reviewed when it is modified or extended, or when information becomes available to the Bank that provides additional insight regarding the loan’s performance, the status of the borrower, or the quality or value of the underlying collateral.
If a troubled debt restructuring is performed on a PCI loan, the loan is considered impaired under the applicable TDR accounting standards and transferred out of the PCI population. The loan may require an additional Provision if its restructured cash flows are less than management’s initial day-one expectations. PCI loans for which the Bank simply chooses to extend the maturity date are generally not considered TDRs and remain in the PCI population.
The following tables include loans by risk category based on the Bank’s internal analysis performed:
*At December 31, 2016 and 2015, Special Mention loans included $2 million and $180,000 and Substandard loans included $928,000 and $1 million, which were removed from PCI accounting in accordance with ASC 310-30-35-13 due to a post-acquisition troubled debt restructuring.
**The above tables excludes all non-classified residential real estate, home equity and consumer loans at the respective period ends.
Subprime Lending
Both the Traditional Banking segment and the RPG segment of the Company have certain classes of loans that are considered to be “subprime” strictly due to the credit score of the borrower at the time of origination.
Traditional Bank loans considered subprime totaled approximately $50 million and $51 million at December 31, 2016 and 2015. Approximately $13 million and $14 million of the outstanding Traditional Bank subprime loan portfolio at December 31, 2016 and 2015 were originated for Community Reinvestment Act (“CRA”) purposes. Management does not consider these loans to possess significantly higher credit risk due to other underwriting qualifications.
The RCS division of the RPG segment originates both a short-term line-of-credit product and a credit card product. The Bank sells 90% of the balances maintained through these two products within two days of loan origination and retains a 10% interest. Both of these products are unsecured and made to borrowers with subprime or near prime credit scores. The aggregate outstanding balance held-for-investment for these two portfolios totaled $20 million and $7 million at December 31, 2016 and 2015.
Allowance for Loan and Lease Losses
Activity in the Allowance follows:
The following tables present the activity in the Allowance by portfolio class for the years ended December 31, 2016, 2015 and 2014:
Nonperforming Loans and Nonperforming Assets
Detail of nonperforming loans and nonperforming assets and select credit quality ratios follows:
*Loans on nonaccrual status include impaired loans.
**Loans past due 90-days-or-more and still accruing consist of PCI loans or smaller balance consumer loans.
The following table presents the recorded investment in nonaccrual loans and loans past due 90-days-or-more and still on accrual by class of loans:
* Loans past due 90-days-or-more and still accruing consist of PCI loans or smaller balance consumer loans.
Nonaccrual loans and loans past due 90-days-or-more and still on accrual include both smaller balance, primarily retail, homogeneous loans that are individually evaluated for impairment and classified impaired loans. Nonaccrual loans are typically returned to accrual status when all the principal and interest amounts contractually due are brought current and held current for six consecutive months and future contractual payments are reasonably assured. TDRs on nonaccrual status are reviewed for return to accrual status on an individual basis, with additional consideration given to performance under the modified terms.
The Bank considers the performance of the loan portfolio and its impact on the Allowance. For residential and consumer loan classes, the Bank also evaluates credit quality based on the aging status of the loan and by payment activity. The following tables present the recorded investment in residential and consumer loans based on payment activity as of December 31, 2016 and 2015:
Delinquent Loans
The following tables present the aging of the recorded investment in loans by class of loans:
*All loans past due 90 days-or-more, excluding PCI loans, were on nonaccrual status.
**Delinquent status may be determined by either the number of days past due or number of payments past due.
***Represents total loans 30-days-or-more past due divided by total loans.
*All loans past due 90 days-or-more, excluding PCI loans, were on nonaccrual status.
**Delinquent status may be determined by either the number of days past due or number of payments past due.
***Represents total loans 30-days-or-more past due divided by total loans.
Impaired Loans
Information regarding the Bank’s impaired loans follows:
Approximately $4 million and $7 million of impaired loans at December 31, 2016 and 2015 were PCI loans. Approximately $3 million and $1 million of impaired loans at December 31, 2016 and 2015 were formerly PCI loans which became classified as “impaired” through a post-acquisition troubled debt restructuring.
The following tables present the balance in the Allowance and the recorded investment in loans by portfolio class based on impairment method as of December 31, 2016 and 2015:
The following tables present loans individually evaluated for impairment by class of loans as of December 31, 2016, 2015 and 2014. The difference between the “Unpaid Principal Balance” and “Recorded Investment” columns represents life-to-date partial write downs/charge-offs taken on individual impaired credits.
Troubled Debt Restructurings
A TDR is a situation where, due to a borrower’s financial difficulties, the Bank grants a concession to the borrower that the Bank would not otherwise have considered. In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of their debt in the foreseeable future without the modification. This evaluation is performed in accordance with the Bank’s internal underwriting policy.
All TDRs are considered “Impaired,” including PCI loans subsequently restructured. The majority of the Bank’s commercial related and construction TDRs involve a restructuring of financing terms such as a reduction in the payment amount to require only interest and escrow (if required) and/or extending the maturity date of the debt. The substantial majority of the Bank’s residential real estate TDR concessions involve reducing the client’s loan payment through a rate reduction for a set period based on the borrower’s ability to service the modified loan payment. Retail loans may also be classified as TDRs due to legal modifications, such as bankruptcies.
Nonaccrual loans modified as TDRs typically remain on nonaccrual status and continue to be reported as nonperforming loans for a minimum of six months. Accruing loans modified as TDRs are evaluated for nonaccrual status based on a current evaluation of the borrower’s financial condition and ability and willingness to service the modified debt. At December 31, 2016 and 2015, $10 million and $12 million of TDRs were on nonaccrual status.
Detail of TDRs differentiated by loan type and accrual status follows:
The Bank considers a TDR to be performing to its modified terms if the loan is in accrual status and not past due 30 days-or-more as of the reporting date. A summary of the categories of TDR loan modifications outstanding and respective performance under modified terms at December 31, 2016 and 2015 follows:
As of December 31, 2016 and 2015, 72% and 74% of the Bank’s TDRs were performing according to their modified terms. The Bank had provided $4 million and $5 million of specific reserve allocations to clients whose loan terms have been modified in TDRs as of December 31, 2016 and 2015. The Bank had no commitments to lend any additional material amounts to its existing TDR relationships at December 31, 2016 and 2015.
A summary of the categories of TDR loan modifications and respective performance as of December 31, 2016, 2015 and 2014 that were modified during the years ended December 31, 2016, 2015 and 2014 follows:
The tables above are inclusive of loans that were TDRs at the end of previous years and were re-modified, e.g., a maturity date extension during the current year.
The table above is inclusive of loans that were TDRs at the end of previous years and were re-modified, e.g., a maturity date extension during the current year.
As of December 31, 2016, 2015 and 2014, 62%, 65% and 68% of the Bank’s TDRs that occurred during the years ended December 31, 2016, 2015 and 2014 were performing according to their modified terms. The Bank provided approximately $377,000, $300,000 and $1 million in specific reserve allocations to clients whose loan terms were modified in TDRs during 2016, 2015 and 2014.
There was no significant change between the pre and post modification loan balances at December 31, 2016, 2015 and 2014.
The following tables present loans by class modified as troubled debt restructurings within the previous 12 months of December 31, 2016, 2015 and 2014 and for which there was a payment default during 2016, 2015 and 2014:
Foreclosures
The following table presents the carrying amount of foreclosed properties held at December 31, 2016 and 2015 as a result of the Bank obtaining physical possession of such properties:
The following table presents the recorded investment in consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction as of December 31, 2016 and 2015:
Easy Advances
The Company’s RPG segment offered its new EA product through the TRS division during the first quarter of 2016. TRS originated $123 million in EAs during the first quarter of 2016. The provision for loss on EAs equated to 2.47% of total EA originations for the year ended December 31, 2016. The Company based its 2016 provision for loss on EAs on prior year tax refund funding patterns with adjustments based on current year tax refund funding patterns. At December 31, 2016, all EAs originated had been either charged-off or collected.
Information regarding EAs follows:
6.PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and equipment follows:
The Company held three former banking centers for sale as of December 31, 2016. The Company closed its Hudson, Florida banking center in January 2015 and has held the property for sale since closing. In addition, the Company obtained two Florida-based, former banking centers in its May 17, 2016 Cornerstone acquisition. The Company carried all three former banking centers for sale at a value of $2 million, inclusive of accumulated depreciation, at December 31, 2016.
In July 2015, the Company sold its banking center in Elizabethtown, Kentucky and recognized a $28,000 gain on the transaction. The premises of the banking center were carried at approximately $1 million, which equated to the total cost of the premises less accumulated depreciation.
Depreciation expense related to premises and equipment follows:
7.GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS
A progression of the balance for goodwill follows:
The goodwill balance relates entirely to the Company’s Traditional Banking operations. The Bank did not record any goodwill associated with its 2012 FDIC-assisted acquisitions.
Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. At December 31, 2016 and 2015, the Company’s Core Banking reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more-likely-than-not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was not more-likely-than-not that the carrying value of the reporting unit exceeded its fair value. Therefore, the Company did not complete the two-step impairment test as of December 31, 2016, 2015 and 2014.
The Company recorded a $1 million core deposit intangible (“CDI”) asset in association with its May 17, 2016 Cornerstone acquisition. For the years ending December 31, 2016, 2015 and 2014, aggregate CDI amortization expense follows:
8.INTEREST RATE SWAPS
Interest rate swap derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a cash flow hedging relationship. For a derivative designated as a cash flow hedge, the effective portion of the derivative’s unrealized gain or loss is recorded as a component of other comprehensive income (“OCI”). For derivatives not designated as hedges, the gain or loss is recognized in current period earnings.
Interest Rate Swaps Used as Cash Flow Hedges
The Bank entered into two interest rate swap agreements (“swaps”) during 2013 as part of its interest rate risk management strategy. The Bank designated the swaps as cash flow hedges intended to reduce the variability in cash flows attributable to either FHLB advances tied to the 3-month LIBOR or the overall changes in cash flows on certain money market deposit accounts tied to 1-month LIBOR. The counterparty for both swaps met the Bank’s credit standards and the Bank believes that the credit risk inherent in the swap contracts is not significant.
The swaps were determined to be fully effective during all periods presented; therefore, no amount of ineffectiveness was included in net income. The aggregate fair value of the swaps is recorded in other liabilities with changes in fair value recorded in OCI. The amount included in AOCI would be reclassified to current earnings should the hedge no longer be considered effective. The Bank expects the hedges to remain fully effective during the remaining term of the swaps.
The following table reflects information about swaps designated as cash flow hedges as of December 31, 2016 and 2015:
The following table reflects the total interest expense recorded on these swap transactions in the consolidated statements of income during the years ended December 31, 2016, 2015 and 2014:
The following table presents the net gains (losses) recorded in accumulated OCI and the consolidated statements of income relating to the swaps for the years ended December 31, 2016, 2015 and 2014:
The estimated net amount of the existing losses that are reported in accumulated OCI at December 31, 2016 that is expected to be reclassified into earnings within the next 12 months is $240,000.
Non-hedge Interest Rate Swaps
The Bank enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Bank enters into offsetting positions in order to minimize the Bank’s interest rate risk. These swaps are derivatives, but are not designated as hedging instruments, and therefore changes in fair value are reported in current year earnings.
Interest rate swap contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counter party or client owes the Bank, and results in credit risk to the Bank. When the fair value of a derivative instrument contract is negative, the Bank owes the client or counterparty, and therefore, has no credit risk.
A summary of the Bank’s interest rate swaps related to clients as of December 31, 2016 and 2015 is included in the following table:
The Bank is required to pledge securities as collateral when the Bank is in a net loss position for all swaps with dealer counterparties when such net loss positions exceed $250,000. The fair value of cash or investment securities pledged as collateral by the Bank to cover such net loss positions totaled $1.8 million and $1.5 million at December 31, 2016 and 2015.
9.DEPOSITS
Ending deposit balances at December 31, 2016 and 2015 were as follows:
*Represents a time deposit.
The following table summarizes deposits acquired in the Company’s May 17, 2016 Cornerstone acquisition, finalized as of October 1, 2016:
*Represents a time deposit.
Time deposits at or above the FDIC insured limit of $250,000 are presented in the table below:
At December 31, 2016, the scheduled maturities and weighted average rate of all time deposits, including brokered certificates of deposit, were as follows:
10.SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase consist of short-term excess funds from correspondent banks, repurchase agreements and overnight liabilities to deposit clients arising from the Bank’s treasury management program. While comparable to deposits in their transactional nature, these overnight liabilities to clients are in the form of repurchase agreements. Repurchase agreements collateralized by securities are treated as financings; accordingly, the securities involved with the agreements are recorded as assets and are held by a safekeeping agent and the obligations to repurchase the securities are reflected as liabilities. Should the fair value of currently pledged securities fall below the associated repurchase agreements, the Bank would be required to pledge additional securities. To mitigate the risk of under collateralization, the Bank typically pledges at least two percent more in securities than the associated repurchase agreements. All such securities are under the Bank’s control.
At December 31, 2016 and 2015, all securities sold under agreements to repurchase had overnight maturities. Additional information regarding securities sold under agreements to repurchase follows:
Additional information regarding securities sold under agreements to repurchase for the years ended December 31, 2016, 2015 and 2014 follows:
11.FEDERAL HOME LOAN BANK ADVANCES
At December 31, 2016 and 2015, FHLB advances were as follows:
*On a quarterly basis, the FHLB has the right to require payoff of these advances by the Bank at no penalty.
Each FHLB advance is payable at its maturity date, with a prepayment penalty for fixed rate advances that are paid off earlier than maturity. The Company incurred an $846,000 prepayment penalty on the payoff of $50 million in FHLB advances during 2016, with no similar penalty incurred in 2015 and 2014.
FHLB advances are collateralized by a blanket pledge of eligible real estate loans. At December 31, 2016 and 2015, Republic had available borrowing capacity of $378 million and $567 million, respectively, from the FHLB. In addition to its borrowing capacity with the FHLB, Republic also had unsecured lines of credit totaling $150 million and $170 million available through various other financial institutions as of December 31, 2016 and 2015.
Aggregate future principal payments on FHLB advances based on contractual maturity and the weighted average cost of such advances are detailed below:
NA - Not applicable
Due to their nature, the Bank considers average balance information more meaningful than period end balances for its overnight borrowings from the FHLB. Information regarding short-term overnight FHLB advances follows:
The following table illustrates real estate loans pledged to collateralize advances and letters of credit with the FHLB:
12.SUBORDINATED NOTE
In 2005, Republic Bancorp Capital Trust (“RBCT”), an unconsolidated trust subsidiary of Republic, was formed and issued $40 million in Trust Preferred Securities (“TPS”). The sole asset of RBCT represents the proceeds of the offering loaned to Republic in exchange for a subordinated note with similar terms to the TPS. The TPS are treated as part of Republic’s Tier I Capital.
The subordinated note and related interest expense are included in Republic’s consolidated financial statements. The subordinated note paid a fixed interest rate of 6.015% through September 30, 2015 and adjusted to LIBOR + 1.42% thereafter. The subordinated note matures on December 31, 2035 and is now redeemable at the Company’s option on a quarterly basis. The Company chose not to redeem the subordinated note on January 1, 2017, and carried the note at a cost of LIBOR + 1.42% at December 31, 2016.
As a result of its acquisition of Cornerstone Bancorp, Inc. on May 17, 2016, Republic became the 100% successor owner of Cornerstone Capital Trust 1 (“CCT1”), an unconsolidated finance subsidiary. In 2006, CCT1 issued $4 million of adjustable-rate TPS due December 15, 2036. As permitted under the terms of CCT1’s governing documents, Republic redeemed these securities at the par amount of approximately $4 million, without penalty, on September 15, 2016.
13.OFF BALANCE SHEET RISKS, COMMITMENTS AND CONTINGENT LIABILITIES
The Company, in the normal course of business, is party to financial instruments with off balance sheet risk. These financial instruments primarily include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.
The Company also extends binding commitments to clients and prospective clients. Such commitments assure a borrower of financing for a specified period of time at a specified rate. Additionally, the Company makes binding purchase commitments to third party loan correspondent originators. These commitments assure that the Company will purchase a loan from such correspondent originators at a specific price for a specific period of time. The risk to the Company under such loan commitments is limited by the terms of the contracts. For example, the Company may not be obligated to advance funds if the client’s financial condition deteriorates or if the client fails to meet specific covenants.
An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. These commitments generally have variable rates of interest.
The following table presents the Company’s commitments, exclusive of Mortgage Banking loan commitments for each year ended:
*Commitments are made through the Company’s Correspondent Lending channel.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material.
14.STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL MATTERS
Common Stock - The Company’s Class A Common shares are entitled to cash dividends equal to 110% of the cash dividend paid per share on Class B Common Stock. Class A Common shares have one vote per share and Class B Common shares have ten votes per share. Class B Common shares may be converted, at the option of the holder, to Class A Common shares on a share for share basis. The Class A Common shares are not convertible into any other class of Republic’s capital stock.
Dividend Restrictions - The Parent Company’s principal source of funds for dividend payments are dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid to the Parent Company by the Bank without prior approval of the respective states’ banking regulators. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years. At December 31, 2016, the Bank could, without prior approval, declare dividends of approximately $60 million.
Regulatory Capital Requirements - The Parent Company and the Bank are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Republic’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Parent Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2016 and 2015, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
Effective January 1, 2015 the Company and the Bank became subject to the capital regulations in accordance with Basel III. These regulations established higher minimum risk-based capital ratio requirements, a new common equity Tier 1 Risk-Based Capital ratio and a new capital conservation buffer. The regulations included revisions to the definition of capital and changes in the risk weighting of certain assets. For prompt corrective action, the new regulations establish definitions of “well capitalized” as a 6.5% Common Equity Tier 1 Risk-Based Capital ratio, an 8.0% Tier 1 Risk-Based Capital ratio, a 10.0% Total Risk-Based Capital ratio and a 5.0% Tier 1 Leverage ratio.
Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, the Company and Bank must hold a capital conservation buffer composed of Common Equity Tier 1 Risk-Based Capital above their minimum Risk-Based Capital requirements. The capital conservation buffer phases in over time based on the following schedule: a capital conservation buffer of .625% effective January 1, 2016; 1.25% effective January 1, 2017; 1.875% effective January 1, 2018; and a fully phased in capital conservation buffer of 2.5% on January 1, 2019.
15.FAIR VALUE
Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Bank used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Securities available for sale: Quoted market prices in an active market are available for the Bank’s Community Reinvestment Act (“CRA”) mutual fund investment and fall within Level 1 of the fair value hierarchy.
Except for the Bank’s CRA mutual fund investment, its private label mortgage backed security and its TRUP investment, the fair value of securities available for sale is typically determined by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
The Bank’s private label mortgage backed security remains illiquid, and as such, the Bank classifies this security as a Level 3 security in accordance with ASC Topic 820, Fair Value Measurements and Disclosures. Based on this determination, the Bank utilized an income valuation model (present value model) approach in determining the fair value of this security.
See in this section of the filing under Footnote 3 “Investment Securities” for additional discussion regarding the Bank’s private label mortgage backed security.
The Company acquired its TRUP investment in November 2015 and considered the most recent bid price for the same instrument to approximate market value at December 31, 2016. The Company’s TRUP investment is considered highly illiquid and also valued using Level 3 inputs, as the most recent bid price for this instrument is not always considered generally observable.
Mortgage loans held for sale, at fair value: The fair value of mortgage loans held for sale is determined using quoted secondary market prices. Mortgage loans held for sale are classified as Level 2 in the fair value hierarchy.
Consumer loans held for sale, at fair value: During 2016, RCS initiated a short-term installment loan program and elected to carry all loans originated through this program at fair value. Such loans are generally sold within 21 days of origination, with their fair value based on contractual terms, Level 3 inputs.
Mortgage Banking derivatives: Mortgage Banking derivatives used in the ordinary course of business primarily consist of mandatory forward sales contracts (“forward contracts”) and interest rate lock loan commitments. The fair value of the Bank’s derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants. The pricing is derived from market observable inputs that can generally be verified and do not typically involve significant judgment by the Bank. Forward contracts and rate-lock loan commitments are classified as Level 2 in the fair value hierarchy.
Interest rate swap agreements: Interest rate swaps are recorded at fair value on a recurring basis. The Company values its interest rate swaps using a third-party valuation service and classifies such valuations as Level 2. Valuations of these interest rate swaps are also received from the relevant counterparty and validated against the Company’s calculations. The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.
Impaired loans: Collateral-dependent impaired loans generally reflect partial charge-downs to their respective fair value, which is commonly based on recent real estate appraisals or broker price opinions (“BPOs”). These appraisals or BPOs may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the process by the independent experts to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Collateral-dependent loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Other real estate owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals or BPOs. These appraisals or BPOs may utilize a single approach or a combination of approaches, including comparable sales and the income approach. Adjustments are routinely made in the process by the independent experts to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value.
Appraisals for collateral-dependent impaired loans, impaired premises and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank. Once the appraisal is received, a member of the Bank’s Credit Administration Department reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value in comparison with independent data sources, such as recent market data or industry-wide statistics. On at least an annual basis, the Bank performs a back test of collateral appraisals by comparing actual selling prices on recent collateral sales to the most recent appraisal of such collateral. Back tests are performed for each collateral class, e.g., residential real estate or commercial real estate, and may lead to additional adjustments to the value of unliquidated collateral of similar class.
Mortgage servicing rights: On a quarterly basis, MSRs are evaluated for impairment based upon the fair value of the MSRs as compared to carrying amount. If the carrying amount of an individual grouping exceeds fair value, impairment is recorded and the respective individual tranche is carried at fair value. If the carrying amount of an individual grouping does not exceed fair value, impairment is reversed if previously recognized and the carrying value of the individual tranche is based on the amortization method. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and that can generally be validated against available market data (Level 2). There were no MSR tranches carried at fair value at December 31, 2016 and 2015.
Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Bank has elected the fair value option, are summarized below:
All transfers between levels are generally recognized at the end of each quarter. There were no transfers into or out of Level 1, 2 or 3 assets during the years ended December 31, 2016 and 2015.
The following table presents a reconciliation of the Bank’s Private Label Mortgage Backed Security measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended December 31, 2016, 2015 and 2014:
Private Label Mortgage Backed Security
The fair value of the Bank’s single private label mortgage backed security is supported by analysis prepared by an independent third party. The third party’s approach to determining fair value involved several steps: 1) detailed collateral analysis of the underlying mortgages, including consideration of geographic location, original loan-to-value and the weighted average FICO score of the borrowers; 2) collateral performance projections for each pool of mortgages underlying the security (probability of default, severity of default, and prepayment probabilities) and 3) discounted cash flow modeling.
The significant unobservable inputs in the fair value measurement of the Bank’s single private label mortgage backed security are prepayment rates, probability of default and loss severity in the event of default. Significant fluctuations in any of those inputs in isolation would result in a significantly different fair value measurement.
The following tables present quantitative information about recurring Level 3 fair value measurements at December 31, 2016 and 2015:
Trust Preferred Security
The Company invested in its TRUP in November 2015. The following table presents a reconciliation of the Company’s TRUP measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ending December 31, 2016 and 2015:
The fair value of the Company’s TRUP investment is based on the most recent bid price for this instrument, as provided by a third-party broker.
Mortgage Loans Held for Sale
The Bank has elected the fair value option for mortgage loans held for sale. These loans are intended for sale and the Bank believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with Bank policy for such instruments. None of these loans were past due 90-days-or-more nor on nonaccrual as of December 31, 2016 and 2015.
As of December 31, 2016 and 2015, the aggregate fair value, contractual balance (including accrued interest), and unrealized gain was as follows:
The total amount of gains and losses from changes in fair value of mortgage loans held for sale included in earnings for 2016, 2015 and 2014 are presented in the following table:
Consumer Loans Held for Sale
During the first quarter of 2016, RCS initiated a short-term installment loan program and elected to carry all loans originated through this program at fair value. Such loans are generally sold within 21 days of origination, with their fair value based on contractual terms. Interest income is recorded based on the contractual terms of the loan and in accordance with Bank policy for such instruments. None of these loans were past due 90-days-or-more or on nonaccrual as of December 31, 2016.
A reconciliation of the Company’s consumer loans held for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2016 is included in Footnote 4 of this section of the filing.
The significant unobservable inputs in the fair value measurement of the Bank’s short-term installment loans are the net contractual premiums and level of loans sold at a discount price. Significant fluctuations in any of those inputs in isolation would result in a significantly lower/higher fair value measurement.
The following table presents quantitative information about recurring Level 3 fair value measurement inputs for short-term installment loans as of December 31, 2016:
As of December 31, 2016, the aggregate fair value, contractual balance, and unrealized gain on consumer loans held for sale, at fair value, was as follows:
Assets measured at fair value on a non-recurring basis are summarized below:
* The difference between the carrying value and the fair value of impaired loans measured at fair value is reconciled in a subsequent table of this Footnote.
The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2016 and 2015:
Impaired Loans
Collateral-dependent impaired loans are generally measured for impairment using the fair value for reasonable disposition of the underlying collateral. The Bank’s practice is to obtain new or updated appraisals or BPOs on the loans subject to the initial impairment review and then to evaluate the need for an update to this value on an as necessary or possibly annual basis thereafter (depending on the market conditions impacting the value of the collateral). The Bank may discount the valuation amount as necessary for selling costs and past due real estate taxes. If a new or updated appraisal or BPO is not available at the time of a loan’s impairment review, the Bank may apply a discount to the existing value of an old valuation to reflect the property’s current estimated value if it is believed to have deteriorated in either: (i) the physical or economic aspects of the subject property or (ii) material changes in market conditions. The impairment review generally results in a partial charge-off of the loan if fair value less selling costs are below the loan’s carrying value. Impaired loans that are collateral-dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.
Impaired collateral-dependent loans are as follows:
Other Real Estate Owned
Other real estate owned, which is carried at the lower of cost or fair value, is periodically assessed for impairment based on fair value at the reporting date. Fair value is determined from external appraisals or BPOs using judgments and estimates of external professionals. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3.
Details of other real estate owned carrying value and write downs follow:
The carrying amounts and estimated fair values of financial instruments, at December 31, 2016 and 2015 are as follows:
NA - Not applicable 		
NA - Not applicable 		 Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the Bank’s estimates.
The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company.
In addition to those previously disclosed, the following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents - The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
Consumer loans held for sale, at lower of cost or fair value - Consumer loans held for sale at the lower of cost or fair value constitute short-term consumer loans generally sold within two business days of origination. The carrying amounts of these loans, due to their short-term nature, approximate fair value and result in a Level 2 classification.
Loans, net of Allowance - The fair value of loans is calculated using discounted cash flows by loan type resulting in a Level 3 classification. The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio without considering widening credit spreads due to market illiquidity. The estimated maturity is based on the Bank’s historical experience with repayments adjusted to estimate the effect of current market conditions. The Allowance is considered a reasonable discount for credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
Federal Home Loan Bank stock - It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
Accrued interest receivable/payable - The carrying amounts of accrued interest, due to their short-term nature, approximate fair value and result in a Level 2 classification.
Deposits - Fair values for time deposits have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities and are classified as Level 2. The carrying amounts of all other deposits, due to their short-term nature, approximate their fair values and are also classified as Level 2.
Securities sold under agreements to repurchase and other short-term borrowings - The carrying amount for securities sold under agreements to repurchase and other short-term borrowings generally maturing within ninety days approximates its fair value resulting in a Level 2 classification.
Federal Home Loan Bank advances - The fair value of the FHLB advances is obtained from the FHLB and is calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms resulting in a Level 2 classification.
Subordinated note - The fair value for the subordinated note is calculated using discounted cash flows based upon current market spreads to London Interbank Borrowing Rate (“LIBOR”) for debt of similar remaining maturities and collateral terms resulting in a Level 2 classification.
The fair value estimates presented herein are based on pertinent information available to management as of the respective period ends. Although management is not aware of any factors that would dramatically affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, estimates of fair value may differ significantly from the amounts presented.
16.MORTGAGE BANKING ACTIVITIES
Mortgage Banking activities primarily include residential mortgage originations and servicing.
Activity for mortgage loans held for sale was as follows:
Mortgage loans serviced for others are not reported as assets. The Bank serviced loans for others, primarily FHLMC, totaling $971 million and $883 million at December 31, 2016 and 2015. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and processing foreclosures. Custodial escrow account balances maintained in connection with serviced loans were approximately $7 million and $6 million at December 31, 2016 and 2015.
The following table presents the components of Mortgage Banking income:
Activity for capitalized mortgage servicing rights was as follows:
There was no balance or activity in the valuation allowance for capitalized mortgage servicing rights for the years ended December 31, 2016, 2015 and 2014.
Other information relating to mortgage servicing rights follows:
* Rates are applied to individual tranches with similar characteristics.
Estimated future amortization expense of the MSR portfolio (net of any applicable impairment charge) follows; however, actual amortization expense will be impacted by loan payoffs and changes in estimated lives that occur during each respective year:
Mortgage Banking derivatives used in the ordinary course of business primarily consist of mandatory forward sales contracts and interest rate lock loan commitments. Mandatory forward contracts represent future commitments to deliver loans at a specified price and date and are used to manage interest rate risk on loan commitments and mortgage loans held for sale. Interest rate lock loan commitments represent commitments to fund loans at a specific rate. These derivatives involve underlying items, such as interest rates, and are designed to transfer risk. Substantially all of these instruments expire within 90 days from the date of issuance. Notional amounts are amounts on which calculations and payments are based, but which do not represent credit exposure, as credit exposure is limited to the amounts required to be received or paid.
Mandatory forward contracts also contain an element of risk in that the counterparties may be unable to meet the terms of such agreements. In the event the counterparties fail to deliver commitments or are unable to fulfill their obligations, the Bank could potentially incur significant additional costs by replacing the positions at then current market rates. The Bank manages its risk of exposure by limiting counterparties to those banks and institutions deemed appropriate by management and the Board of Directors. The Bank does not expect any counterparty to default on their obligations and therefore, the Bank does not expect to incur any cost related to counterparty default.
The Bank is exposed to interest rate risk on loans held for sale and rate lock loan commitments. As market interest rates fluctuate, the fair value of mortgage loans held for sale and rate lock commitments will decline or increase. To offset this interest rate risk the Bank enters into derivatives, such as mandatory forward contracts to sell loans. The fair value of these mandatory forward contracts will fluctuate as market interest rates fluctuate, and the change in the value of these instruments is expected to largely, though not entirely, offset the change in fair value of loans held for sale and rate lock commitments. The objective of this activity is to minimize the exposure to losses on rate loan lock commitments and loans held for sale due to market interest rate fluctuations. The net effect of derivatives on earnings will depend on risk management activities and a variety of other factors, including: market interest rate volatility; the amount of rate lock commitments that close; the ability to fill the forward contracts before expiration; and the time period required to close and sell loans.
The following table includes the notional amounts and fair values of mortgage loans held for sale and mortgage banking derivatives as of the period ends presented:
17.STOCK PLANS AND STOCK BASED COMPENSATION
In January 2015, the Company’s Board of Directors adopted the Republic Bancorp, Inc. 2015 Stock Incentive Plan (the “2015 Plan”), which became effective April 23, 2015 when the Company’s shareholders approved the 2015 Plan. The 2015 Plan replaced the Company’s 2005 Stock Incentive Plan, which expired on March 15, 2015.
The number of authorized shares under the 2015 Plan is fixed at 3,000,000, with such number subject to adjustment in the event of certain events, such as stock dividends, stock splits, or the like. There is a minimum three-year vesting period for awards granted to employees under the 2015 Plan that vest based solely on the completion of a specified period of service, with options generally exercisable five to six years after the issue date. Stock options generally must be exercised within one year from the date the options become exercisable and have an exercise price that is at least equal to the fair market value of the Company’s stock on their grant date.
All shares issued under the above-mentioned plans were from authorized and reserved unissued shares. The Company has a sufficient number of authorized and reserved unissued shares to satisfy all anticipated option exercises. There are no Class B stock options outstanding or available for exercise under the Company’s plans.
Stock Options
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes based stock option valuation model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. Expected volatilities are based on historical volatility of Republic’s stock and other factors. Expected dividends are based on dividend trends and the market price of Republic’s stock price at grant. Republic uses historical data to estimate option exercises and employee terminations within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve at the time of grant.
All share-based payments to employees, including grants of employee stock options, are recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values.
The fair value of stock options granted was determined using the following weighted average assumptions as of grant date:
The following table summarizes stock option activity from January 1, 2015 through December 31, 2016:
Information related to the stock options during each year follows:
Loan balances of non-executive officer employees that were originated solely to fund stock option exercises were as follows:
Restricted Stock Awards
Restricted stock awards generally vest five to six years after issue, with accelerated vesting due to “change in control” or “death or disability of a participant” as defined and outlined in the 2015 Plan.
The following table summarizes restricted stock activity from January 1, 2015 through December 31, 2016:
The fair value of the restricted stock awards is based on the closing stock price on the date of grant with the associated expense amortized to compensation expense over the vesting period, generally five to six years.
Performance Stock Units
The Company first granted performance stock units (“PSUs”) under the 2015 Plan in January 2016. Shares of stock underlying the PSUs may be earned over a four-year performance period commencing on January 1, 2017 and ending on December 31, 2020 as follows:
·
If the Company achieves a Return on Average Assets (“ROAA”), as defined in the award agreement, of 1.25% for a calendar year in the performance period, then between March 1st and March 15th of the following year, provided that the recipient is still employed in good standing on the payment date, the Company will issue shares of fully-vested stock to the participant equal to 50% of the number of the PSUs initially granted to the participant; and
·
If the ROAA of 1.25% is met again at the end of another calendar year during the remaining term of the performance period, the Company will similarly issue fully vested stock in an amount equal to the remaining 50% of the initial PSUs granted to the participant.
The following table summarizes PSU activity from January 1, 2016 through December 31, 2016:
Expense Related to Stock Incentive Plans
The Company recorded expense related to stock incentive plans for the years ended December 31, 2016, 2015 and 2014 as follows:
Unrecognized expenses related to unvested awards (net of estimated forfeitures) under stock incentive plans are estimated as follows:
Director Deferred Compensation
In November 2004, the Company’s Board of Directors approved a Non-Qualified Deferred Compensation Plan (the “Plan”). The Plan governs the deferral of board and committee fees of non-employee members of the Board of Directors. Members of the Board of Directors may defer up to 100% of their board and committee fees for a specified period ranging from two to five years. The value of the deferred director compensation account is deemed “invested” in Company stock and is immediately vested. On a quarterly basis, the Company reserves shares of Republic’s stock within the Company’s stock option plan for ultimate distribution to Directors at the end of the deferral period.
The following table presents information on director deferred compensation shares reserved for the periods shown:
Director deferred compensation has been expensed as follows:
18.BENEFIT PLANS
401 (k) Plan
Republic maintains a 401(k) plan for eligible employees. All employees become eligible for the plan as soon as administratively feasible following their date of hire. Participants in the plan have the option to contribute from 1% to 75% of their annual eligible compensation, up to the maximum allowed by the Internal Revenue Service (“IRS”). The Company matches 100% of participant contributions up to 1% and an additional 75% for participant contributions between 2% and 5% of each participant’s annual eligible compensation. Participants are fully vested after two years of employment.
Republic also contributes bonus contributions in addition to the aforementioned matching contributions if the Company achieves certain operating goals. Normal and bonus contributions for each of the periods ended were as follows:
Supplemental Executive Retirement Plan
In association with its May 17, 2016 Cornerstone acquisition, the Company inherited a Supplemental Executive Retirement Plan (“SERP”). The SERP requires the Company to pay monthly benefits following retirement of the SERP’s four participants. The Company accrues the present value of such benefits on a monthly basis. The SERP liability was approximately $2 million at December 31, 2016. Expense under the SERP was $81,000 for the year ended December 31, 2016.
19.INCOME TAXES
Allocation of federal income tax between current and deferred portion is as follows:
Effective tax rates differ from federal statutory rate of 35% applied to income before income taxes due to the following:
Year-end deferred tax assets and liabilities were due to the following:
*The Company has federal and state net operating loss carryforwards (acquired in the Cornerstone acquisition) of $10.2 million (federal) and $7.2 million (state). These carryforwards begin to expire in 2030 for both federal and state purposes. The use of these federal and state carryforwards are each limited under IRC Section 382 to $722,000 annually for federal and $709,000 annually for state. The Company also has a Kentucky net operating loss of $26.6 million, which began to expire in 2013. The Company maintains a valuation allowance, as it does not anticipate generating taxable income in Kentucky to utilize these carryforwards prior to expiration. Finally, the Company has AMT credit carryforwards (acquired in the Cornerstone acquisition) of $84,000 with no expiration date.
Unrecognized Tax Benefits
The Company has not filed tax returns in certain jurisdictions where it has conducted limited lending activity but had no offices; therefore, the Company is open to examination for all years in which the lending activity has occurred. The Company adopted the provisions of ASC 740-10, Accounting for Uncertainty in Income Taxes, on January 1, 2007 and recognized a liability for the amount of tax which would be due to those jurisdictions should it be determined that income tax filings were required. It is the Company’s policy to recognize interest and penalties as a component of income tax expense related to its unrecognized tax benefits.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Of the 2016 total, $972,000 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. The Company plans on recognizing a tax benefit of $357,000 during the first quarter of 2017 as the statute of limitations related to one jurisdiction has closed.
Amounts related to interest and penalties recorded in the income statements for the years ended December 31, 2016, 2015 and 2014 and accrued on the balance sheets as of December 31, 2016, 2015 and 2014 are presented below:
The Company files income tax returns in the U.S. federal jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by taxing authorities for all years prior to and including 2012.
The Company completed an IRS examination of its 2013 corporate income tax return during 2016 and was notified that the examination resulted in no significant adjustments to the Company’s tax liability.
20.EARNINGS PER SHARE
Class A and Class B shares participate equally in undistributed earnings. The difference in earnings per share between the two classes of common stock results solely from the 10% per share cash dividend premium paid on Class A Common Stock over that paid on Class B Common Stock. See Footnote 14, “Stockholders’ Equity and Regulatory Capital Matters” of this section of the filing.
A reconciliation of the combined Class A and Class B Common Stock numerators and denominators of the earnings per share and diluted earnings per share computations is presented below:
Stock options excluded from the detailed earnings per share calculation because their impact was antidilutive are as follows:
21.TRANSACTIONS WITH RELATED PARTIES AND THEIR AFFILIATES
Republic leases office facilities under operating leases from limited liability companies in which Republic’s Chairman/Chief Executive Officer and President are partners. Rent expense under these leases was as follows:
Total minimum lease commitments under non-cancelable operating leases are as follows:
A director of Republic Bancorp, Inc. is the President and Chief Executive Officer of a company that leases space to the Company. Fees paid by the Company totaled $15,000, $15,000 and $16,000 for years ended December 31, 2016, 2015 and 2014.
A director of Republic Bancorp, Inc. is designated as a staff attorney with a local law firm. While this director has an arrangement where a percentage of revenues paid to the law firm by certain clients is remitted to him, fees paid to the law firm by the Company are not included in this arrangement. Fees paid by the Company to this law firm totaled $183,000, $183,000 and $160,000 in 2016, 2015 and 2014.
A director of the Bank is an executive of two consulting firms and a local chamber of commerce. Fees paid by the Company to these entities totaled $122,000, $101,000 and $66,000 in 2016, 2015 and 2014.
A director of the Bank is a partner of an accounting firm that received fees from the Company of $1,000, $2,000 and $9,000 in 2016, 2015 and 2014.
Loans made to executive officers and directors of Republic and their related interests during 2016 were as follows:
Deposits from executive officers, directors, and their affiliates totaled $81 million and $82 million at December 31, 2016 and 2015.
By an agreement dated December 14, 1989, as amended August 8, 1994, the Company entered into a split-dollar insurance agreement with a trust established by the Company’s deceased former Chairman, Bernard M. Trager. Pursuant to the agreement, from 1989 through 2002 the Company paid $690,000 in total annual premiums on the insurance policies held in the trust. The policies are joint-life policies payable upon the death of Mrs. Jean Trager, as the survivor of her husband Bernard M. Trager. The cash surrender value of the policies was approximately $2.1 million and $2.1 million as of December 31, 2016 and 2015.
Pursuant to the terms of the trust, the beneficiaries of the trust will each receive the proceeds of the policies after the repayment of the $690,000 of indebtedness to the Company. The aggregate amount of such unreimbursed premiums constitutes indebtedness from the trust to the Company and is secured by a collateral assignment of the policies. As of December 31, 2016 and 2015, the net death benefit under the policies was approximately $3.5 million. Upon the termination of the agreement, whether by the death of Mrs. Trager or earlier cancellation, the Company is entitled to be repaid by the trust the amount of indebtedness outstanding at that time.
22.OTHER COMPREHENSIVE INCOME
OCI components and related tax effects were as follows:
Significant amounts reclassified out of each component of accumulated OCI for the years ended December 31, 2016, 2015 and 2014:
The following is a summary of the accumulated OCI balances, net of tax:
23.PARENT COMPANY CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
STATEMENTS OF CASH FLOWS
24.SEGMENT INFORMATION
Reportable segments are determined by the type of products and services offered and the level of information provided to the chief operating decision maker, who uses such information to review performance of various components of the business (such as banking centers and business units), which are then aggregated if operating performance, products/services, and clients are similar.
As of December 31, 2016, the Company was divided into four distinct business operating segments: Traditional Banking, Warehouse, Mortgage Banking and RPG. Management considers the first three segments to collectively constitute “Core Bank” or “Core Banking” activities. Correspondent Lending operations and the Company’s national branchless banking platform, MemoryBank, are considered part of Traditional Banking operations. The RPG segment includes the following divisions: TRS, RPS and RCS. TRS generates the majority of RPG’s income, with the relatively smaller divisions of RPG, RPS and RCS, considered immaterial for separate and independent segment reporting. All divisions of the RPG segment operate through the Bank.
The nature of segment operations and the primary drivers of net revenues by reportable segment are provided below:
The accounting policies used for Republic’s reportable segments are the same as those described in the summary of significant accounting policies. Segment performance is evaluated using operating income. Goodwill is allocated to the Traditional Banking segment. Income taxes are generally allocated based on income before income tax expense unless specific segment allocations can be reasonably made. Transactions among reportable segments are made at carrying value.
Segment information for the years ended December 31, 2016, 2015 and 2014 is as follows:
Segment assets are reported as of the respective period ends while income and margin data are reported for the respective periods.
NM ---Not Meaningful
25.SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
Presented below is a summary of the consolidated quarterly financial data for the years ended December 31, 2016, 2015 and 2014.
(1)
The first quarters of 2016 and 2015 were significantly impacted by the TRS division of RPG.
(2)
Provision expense:
The relatively higher levels of provision expense during the first and fourth quarters of 2016 were driven primarily by provision expense at the RPG segment. Provision expense at RPG was $4.7 million during the first quarter of 2016 and was primarily driven by the TRS division’s EA product. Provision expense at RPG was $3.3 million during the fourth quarter of 2016 and was primarily driven by short-term consumer loans originated through the RCS division of RPG.
(3)
Noninterest income:
During the third quarter of 2016, the Company recorded a $1.1 million gain on the bulk-loan sale of approximately $71 million of its correspondent loan portfolio.
(4)
Noninterest expenses:
During the fourth quarters of 2016 and 2015, the Company reversed $1.7 million and $2.3 million of incentive compensation accruals based on revised payout estimates.
During the third quarter of 2015, the Company reversed $450,000 of incentive compensation accruals based on revised payout estimates.
During the third quarter of 2016, The Company incurred an $846,000 prepayment penalty on payoff of $50 million in FHLB advances.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None
Item 9A.
Item 9A. Controls and Procedures.
As of the end of the period covered by this report, an evaluation was carried out by Republic Bancorp, Inc.’s management, with the participation of the Company’s Chairman/Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fourth quarter of the Company’s fiscal year ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting and the Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting and on the Financial Statements, thereon are set forth under Part II Item 8 “Financial Statements and Supplementary Data.”
Item 9B.
Item 9B. Other Information.
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item appears under the headings “PROPOSAL ONE: ELECTION OF DIRECTORS,” “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” and “THE BOARD OF DIRECTORS AND ITS COMMITTEES” of the Proxy Statement of Republic Bancorp, Inc. (“Republic” or the “Company”) for the 2016 Annual Meeting of Shareholders (“Proxy Statement”) to be held April 20, 2017, all of which is incorporated herein by reference.
Set forth below is certain information with respect to the Company’s executive officers:
Executive officers of the Company are elected by the Board of Directors and serve at the pleasure of the Board of Directors. Steven E. Trager and A. Scott Trager are cousins.
Steven E. Trager began serving as Chairman and CEO of Republic in 2012 and has served as Chairman and CEO of Republic Bank & Trust Company (the “Bank”) since 1998. From 1994 to 1997 he served as Vice Chairman of the Company. From 1994 to 1998 he served as Secretary, and from 1998 to 2012 he served as President and CEO of Republic.
A. Scott Trager has served as President of Republic since 2012 and as President of the Company since 1984. From 1994 to 2012, he served as Vice Chairman of Republic.
Kevin Sipes joined the Company in 1995 and has served as Executive Vice President and Treasurer of Republic and the Company since 2002 and CFO of Republic and the Company since 2000. He began serving as Chief Accounting Officer of the Company in 2000.
William R. Nelson has served as President of Republic Processing Group since 2007. He previously served as Director of Relationship Management of HSBC, Taxpayer Financial Services, in 2004 and was promoted to Group Director - Independent Program in 2006 through 2007. He previously served as Director of Sales, Marketing and Customer Service with RPG from 1999 through 2004.
Anthony T. Powell joined the Company in 1999 as VP. In 2001, he was promoted to SVP and Senior Commercial Lending Officer. In 2005, he was promoted to SVP and Managing Director of Business Banking. In 2015, he assumed responsibility for the Retail Banking division of the Company and was named SVP and Chief Credit and Retail Officer. In January 2017, he was named EVP and Chief Lending Officer.
Steven E. DeWeese joined the Company in 1990 and has held various positions within the Company since then. In 2000, he was promoted to SVP. In 2003, he was promoted to Managing Director of Business Development. In 2006, he was promoted to Managing Director of Retail Banking, and in January, 2010 he was promoted to Executive Vice President of the Company. In 2015, he was named the Company’s Managing Director of Private and Business Banking.
Robert J. Arnold joined the Company in 2006 as SVP and Chief Operating Officer of Commercial Banking. In 2015 he was named the Company’s Managing Director of Commercial and Corporate Banking.
John Rippy joined the Company in 2005 as SVP and Risk Management Officer. In 2009, he was named SVP and Chief Legal and Compliance Officer. In 2013, he was named SVP and Chief Risk Management Officer.
Juan Montano joined the Company in 2009 as SVP and Managing Director of Finance. In 2015, he was named SVP and Managing Director of Mortgage Lending.
Item 11.
Item 11. Executive Compensation.
The information required by this Item appears under the sub-heading “Director Compensation” and under the headings “CERTAIN INFORMATION AS TO MANAGEMENT” and “COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION” of the Proxy Statement all of which is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Equity Compensation Plan Information
The following table sets forth information regarding Republic’s Common Stock that may be issued upon exercise of options, warrants and rights under all equity compensation plans as of December 31, 2016. There were no equity compensation plans not approved by security holders at December 31, 2016.
Column (1) above represents options issued for Class A Common Stock only. Options for Class B Common Stock have been authorized but are not issued.
Additional information required by this Item appears under the heading “SHARE OWNERSHIP” of the Proxy Statement, which is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information required by this Item is under the headings “COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION” and “CERTAIN OTHER RELATIONSHIPS AND RELATED TRANSACTIONS” of the Proxy Statement, all of which is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
Information required by this Item appears under the heading “INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” of the Proxy Statement which is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements:
The following are included under Item 8 “Financial Statements and Supplementary Data:”
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated balance sheets - December 31, 2016 and 2015
Consolidated statements of income and comprehensive income - years ended December 31, 2016, 2015 and 2014
Consolidated statements of stockholders’ equity - years ended December 31, 2016, 2015 and 2014
Consolidated statements of cash flows - years ended December 31, 2016, 2015 and 2014
Notes to consolidated financial statements
(a)(2) Financial Statements Schedules:
Financial statement schedules are omitted because the information is not applicable.
(a)(3) Exhibits:
The Exhibit Index of this report is incorporated herein by reference. The management contracts and compensatory plans or arrangements required to be filed as exhibits to this Form 10-K pursuant to Item 15(b) are noted in the Exhibit Index.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.
/s/ Steven E. Trager
Chairman, Chief Executive Officer
March 10, 2017
Steven E. Trager
and Director
/s/ A. Scott Trager
President and Director
March 10, 2017
A. Scott Trager
/s/ Kevin Sipes
Chief Financial Officer and
March 10, 2017
Kevin Sipes
Chief Accounting Officer
/s/ Craig A. Greenberg
Director
March 10, 2017
Craig Greenberg
/s/ Michael T. Rust
Director
March 10, 2017
Michael T. Rust
/s/ Mark A. Vogt
Director
March 10, 2017
Mark A. Vogt
/s/ R. Wayne Stratton
Director
March 10, 2017
R. Wayne Stratton
/s/ Susan Stout Tamme
Director
March 10, 2017
Susan Stout Tamme
INDEX TO EXHIBITS
No.
Description
3(i)
Articles of Incorporation of Registrant, as amended (Incorporated by reference to Exhibit 3(i) to the Registrant’s Form 8-K filed October 13, 2016 (Commission File Number: 0-24649))
3(ii)
Amended Bylaws (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended September 30, 2006 (Commission File Number: 0-24649))
4.1
Provisions of Articles of Incorporation of Registrant defining rights of security holders (see Articles of Incorporation, as amended, of Registrant incorporated as Exhibit 3(i) herein)
4.2
Agreement Pursuant to Item 601 (b)(4)(iii) of Regulation S-K (Incorporated by reference to Exhibit 4.2 of the Registrant’s Form 10-K for the year ended December 31, 1997 (Commission File Number: 33-77324))
10.01*
Officer Compensation Continuation Agreement with Steven E. Trager, dated January 12, 1995 (Incorporated by reference to Exhibit 10.1 to Registrant’s Form 10-K for the year ended December 31, 1995 (Commission File Number: 33-77324))
10.02*
Officer Compensation Continuation Agreement, as amended and restated, with Steven E. Trager effective January 1, 2006 (Incorporated by reference to Exhibit 10.34 of Registrant’s Form 10-K for the year ended December 31, 2005 (Commission File Number: 0-24649))
10.03*
Officer Compensation Continuation Agreement, as amended, with Steven E. Trager effective February 15, 2006 (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed February 21, 2006 (Commission File Number: 0-24649))
10.04*
Officer Compensation Continuation Agreement, as amended and restated, with Steven E. Trager effective April 30, 2008 (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended March 31, 2008 (Commission File Number: 0-24649))
10.05*
Officer Compensation Continuation Agreement with A. Scott Trager, dated January 12, 1995 (Incorporated by reference to Exhibit 10.5 to Registrant’s Form 10-K for the year ended December 31, 1995 (Commission File Number: 33-77324))
10.06*
Officer Compensation Continuation Agreement, as amended and restated, with A. Scott Trager effective January 1, 2006 (Incorporated by reference to Exhibit 10.35 of Registrant’s Form 10-K for the year ended December 31, 2005 (Commission File Number: 0-24649))
10.07*
Officer Compensation Continuation Agreement, as amended, with A. Scott Trager effective February 15, 2006 (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed February 21, 2006 (Commission File Number: 0-24649))
10.08*
Officer Compensation Continuation Agreement, as amended and restated, with A. Scott Trager effective April 30, 2008 (Incorporated by reference to Exhibit 10.3 of Registrant’s Form 10-Q for the quarter ended March 31, 2008 (Commission File Number: 0-24649))
10.09*
Officer Compensation Agreement with A. Scott Trager, effective March 21, 2012 (Incorporated by reference to Exhibit 10.3 of Registrant’s Form 10-Q for the quarter ended March 31, 2012 (Commission File Number: 0-24649))
10.10*
Officer Compensation Continuation Agreement with Kevin Sipes, dated June 15, 2001 (Incorporated by reference to Exhibit 10.23 of Registrant’s Form 10-Q for the quarter ended June 30, 2001 (Commission File Number: 0-24649))
No.
Description
10.11*
Officer Compensation Continuation Agreement, as amended and restated, with Kevin Sipes effective January 1, 2006 (Incorporated by reference to Exhibit 10.38 of Registrant’s Form 10-K for the year ended December 31, 2005 (Commission File Number: 0-24649))
10.12*
Officer Compensation Continuation Agreement, as amended, with Kevin Sipes effective February 15, 2006 (Incorporated by reference to Exhibit 10.5 of Registrant’s Form 8-K filed February 21, 2006 (Commission File Number: 0-24649))
10.13*
Officer Compensation Continuation Agreement, as amended and restated, with Kevin Sipes effective April 30, 2008 (Incorporated by reference to Exhibit 10.4 of Registrant’s Form 10-Q for the quarter ended March 31, 2008 (Commission File Number: 0-24649))
10.14*
Officer Compensation Agreement with Kevin Sipes, effective March 21, 2012 (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended March 31, 2012 (Commission File Number: 0-24649))
10.15*
Officer Compensation Agreement with Kevin Sipes, effective March 21, 2012 (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended March 31, 2012 (Commission File Number: 0-24649))
10.16*
Officer Compensation Agreement with Kevin Sipes, effective November 7, 2012 (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended September 30, 2012 (Commission File Number: 0-24649))
10.17*
Officer Compensation Agreement with Kevin Sipes, effective November 7, 2012 (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended September 30, 2012 (Commission File Number: 0-24649))
10.18*
Death Benefit Agreement with Bernard M. Trager dated September 10, 1996 (Incorporated by reference to Exhibit 10.9 to Registrant’s Form 10-K for the year ended December 31, 1996 (Commission File Number: 33-77324))
10.19
Split Dollar Insurance Policy with Citizens Fidelity Bank and Trust Company as the Trustee of the Bernard Trager Irrevocable Trust, dated December 14, 1989, as amended August 8, 1994 (Incorporated by reference to Exhibit 10.70 to Registrant’s Form 10-K for the year ended December 31, 2012 (Commission File Number: 33-77324))
10.20
Right of First Offer Agreement by and among Republic Bancorp, Inc., Teebank Family Limited Partnership, Bernard M. Trager and Jean S. Trager. (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed September 19, 2007 (Commission File Number: 0-24649))
10.21
Lease between Republic Bank & Trust Company and Jaytee Properties, dated August 1, 1982, relating to 2801 Bardstown Road, Louisville (Incorporated by reference to Exhibit 10.11 of Registrant’s Form 10-Q for the quarter ended March 31, 1998 (Commission File Number: 0-24649))
10.22
Lease between Republic Bank & Trust Company and Jaytee Properties, dated August 1, 2008, relating to 2801 Bardstown Road, Louisville (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed June 9, 2008 (Commission File Number: 0-24649))
10.23
Lease between Republic Bank & Trust Company and Teeco Properties, dated April 1, 1995, relating to property at 601 West Market Street (Incorporated by reference to exhibit 10.10 of Registrant’s Form 10-Q for the quarter ended March 31, 1998 (Commission File Number: 0-24649))
10.24
Lease between Republic Bank & Trust Company and Teeco Properties, dated October 1, 1996, relating to property at 601 West Market Street (Incorporated by reference to exhibit 10.10 of Registrant’s Form S-1 (Commission File Number: 333-56583))
No.
Description
10.25
Lease extension between Republic Bank & Trust Company and Teeco Properties, dated September 25, 2001, relating to property at 601 West Market Street (Incorporated by reference to exhibit 10.25 of Registrant’s Form 10-Q for the quarter ended September 30, 2001 (Commission File Number: 0-24649))
10.26
Lease between Republic Bank & Trust Company and Teeco Properties, dated May 1, 2002, relating to property at 601 West Market Street (Incorporated by reference to exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended March 31, 2002 (Commission File Number: 0-24649))
10.27
Lease between Republic Bank & Trust Company and Teeco Properties, dated October 1, 2005, relating to property at 601 West Market Street, Louisville, KY (Floor 4), amending and modifying previously filed exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended March 31, 2002 (Incorporated by reference to exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended September 30, 2005 (Commission File Number: 0-24649))
10.28
Lease between Republic Bank & Trust Company and Teeco Properties, as of October 1, 2006, relating to property at 601 West Market Street, Louisville, KY. (Incorporated by reference to exhibit 10.1 of Registrant’s Form 8-K filed September 25, 2006 (Commission File Number: 0-24649))
10.29
Lease between Republic Bank & Trust Company and Teeco Properties, as of July 8, 2008, as amended, relating to property at 601 West Market Street (Floors 1,2,3,5 and 6), Louisville, KY. (Incorporated by reference to exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended June 30, 2008 (Commission File Number: 0-24649))
10.30
Lease between Republic Bank & Trust Company and Teeco Properties, as of July 8, 2008, as amended, relating to property at 601 West Market Street (Floor 4), Louisville, KY. (Incorporated by reference to exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended June 30, 2008 (Commission File Number: 0-24649))
10.31
Assignment of Lease relating to property at 601 West Market Street (Floors 1,2,3,5 and 6), Louisville, KY. (Commission File Number: 0-24649))
10.32
Assignment of Lease relating to property at 601 West Market Street (Floor 4), Louisville, KY. (Commission File Number: 0-24649))
10.33
Lease between Republic Bank & Trust Company and Jaytee Properties, dated February 3, 1993, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.12 of Registrant’s Form 10-Q for the quarter ended March 31, 1998 (Commission File Number: 0-24649))
10.34
Lease between Republic Bank & Trust Company and Jaytee Properties, dated February 1, 1999, as amended, relating to 661 South Hurstbourne Parkway (Incorporated by reference to Exhibit 10.17 of Registrant’s Form 10-Q for the quarter ended June 30, 1999 (Commission File Number: 0-24649))
10.35
Lease between Republic Bank & Trust Company and Jaytee Properties, dated February 1, 2000, as amended, relating to 661 South Hurstbourne Parkway (Incorporated by reference to Exhibit 10.21 of Registrant’s Form 10-K for the year ended December 31, 1999 (Commission File Number: 0-24649))
10.36
Lease between Republic Bank & Trust Company and Jaytee Properties, dated July 1, 2003, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended June 30, 2003 (Commission File Number: 0-24649))
10.37
Lease between Republic Bank & Trust Company and Jaytee Properties, dated August 2, 1993, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.16 of Registrant’s Form 10-K for the year ended December 31, 2003 (Commission File Number: 0-24649))
No.
Description
10.38
Lease between Republic Bank & Trust Company and Jaytee Properties, dated September 1, 1995, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.18 of Registrant’s Form 10-K for the year ended December 31, 2003 (Commission File Number: 0-24649))
10.39
Lease between Republic Bank & Trust Company and Jaytee Properties, dated February 16, 1996, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.19 of Registrant’s Form 10-K for the year ended December 31, 2003 (Commission File Number: 0-24649))
10.40
Lease between Republic Bank & Trust Company and Jaytee Properties, dated January 21, 1998, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.20 of Registrant’s Form 10-K for the year ended December 31, 2003 (Commission File Number: 0-24649))
10.41
Lease between Republic Bank & Trust Company and Jaytee Properties, dated September 11, 1998, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.21 of Registrant’s Form 10-K for the year ended December 31, 2003 (Commission File Number: 0-24649))
10.42
Lease between Republic Bank & Trust Company and Jaytee Properties, dated February 1, 2004, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended March 31, 2004 (Commission File Number: 0-24649))
10.43
Lease between Republic Bank & Trust Company and Jaytee Properties, dated September 1, 2005, as amended, relating to 661 South Hurstbourne Parkway, Louisville, KY, amending and modifying previously filed exhibit 10.12 of Registrant’s Form 10-Q for the quarter ended March 31, 1998 (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended September 30, 2005 (Commission File Number: 0-24649))
10.44
Lease between Republic Bank & Trust Company and Jaytee Properties, dated July 1, 2008, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed June 9, 2008 (Commission File Number: 0-24649))
10.45
Lease between Republic Bank & Trust Company and Jaytee Properties, dated August 14, 2015, as amended, relating to 661 South Hurstbourne Parkway, Louisville (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10K for the quarter ended September 30, 2015 (Commission File Number: 0-24649))
10.46
Lease between Republic Bank & Trust Company and Jaytee Properties, dated November 17, 1997, as amended, relating to 9600 Brownsboro Road (Incorporated by reference to Exhibit 10.18 of Registrant’s Form 10-Q for the quarter ended March 31, 1998 (Commission File Number: 0-24649))
10.47
Lease between Republic Bank & Trust Company and Jaytee Properties, dated August 1, 1999, as amended, relating to 9600 Brownsboro Road (Incorporated by reference to Exhibit 10.18 of Registrant’s Form 10-Q for the quarter ended June 30, 1999 (Commission File Number: 0-24649))
10.48
Lease between Republic Bank & Trust Company and Jaytee Properties, dated October 30, 1999, as amended, relating to 9600 Brownsboro Road (Incorporated by reference to Exhibit 10.20 of Registrant’s Form 10-K for the year ended December 31, 1999 (Commission File Number: 0-24649))
10.49
Lease between Republic Bank & Trust Company and Jaytee Properties, dated May 1, 2003, as amended, relating to 9600 Brownsboro Road (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended June 30, 2003 (Commission File Number: 0-24649))
10.50
Lease between Republic Bank & Trust Company and Jaytee Properties, dated November 1, 2005, as amended, relating to 9600 Brownsboro Road (Incorporated by reference to Exhibit 10.33 of Registrant’s Form 10-K for the year ended December 31, 2005 (Commission File Number: 0-24649))
No.
Description
10.51
Assignment and Assumption of Lease by Republic Bank & Trust Company with the consent of Jaytee Properties, dated May 1, 2006, relating to 9600 Brownsboro Road, Louisville, KY. (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended June 30, 2006 (Commission File Number: 0-24649))
10.52
Lease between Republic Bank & Trust Company and Jaytee Properties, dated January 17, 2008, as amended, relating to 9600 Brownsboro Road, Louisville, KY (Incorporated by reference to Exhibit 10.40 of Registrant’s Form 10-K for the year ended December 31, 2007 (Commission File Number: 0-24649))
10.53
Lease between Republic Bank & Trust Company and Jaytee Properties, dated January 15, 2014, as amended, relating to 9600 Brownsboro Road (Incorporated by reference to Exhibit 10.47 of Registrant’s Form 10-K for the year ended December 31, 2013 (Commission File Number: 0-24649))
10.54
Ground lease between Republic Bank & Trust Company and Jaytee Properties, relating to 9600 Brownsboro Road, dated January 17, 2008, as amended, relating to 9600 Brownsboro Road, Louisville, KY (Incorporated by reference to Exhibit 10.41 of Registrant’s Form 10-K for the year ended December 31, 2007 (Commission File Number: 0-24649))
10.55
Lease between Republic Bank & Trust Company and Jaytee Properties II SPE, LLC, dated June 27, 2008, relating to 200 South Seventh Street, Louisville, KY. (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed July 1, 2008 (Commission File Number: 0-24649))
10.56
Lease between Republic Bank & Trust Company and Jaytee Properties II SPE, LLC, dated January 31, 2011, relating to 200 South Seventh Street, Louisville, KY (Incorporated by reference to Exhibit 10.66 of the Registrant’s Form 10-K for the year ended December 31, 2010 (Commission File Number: 0-24649))
10.57
Lease between Republic Bank & Trust Company and Jaytee Properties II SPE, LLC, dated May 1, 2013, relating to 200 South Seventh Street, Louisville, KY (Incorporated by reference to Exhibit 10.1 of the Registrant’s Form 10-Q for the quarter ended June 30, 2013 (Commission File Number: 0-24649))
10.58
Lease between Republic Bank & Trust Company and Jaytee Properties II SPE, LLC, dated January 15, 2014, as amended, relating to 200 South Seventh Street, Louisville, KY (Incorporated by reference to Exhibit 10.54 of Registrant’s Form 10-K for the year ended December 31, 2013 (Commission File Number: 0-24649))
10.59
Lease between Republic Bank & Trust Company and Jaytee Properties II SPE, LLC, dated March 18, 2015, as amended, relating to 200 South Seventh Street, Louisville, KY. (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended March 31, 2015 (Commission File Number: 0-24649))
10.60
Lease between Republic Bank & Trust Company and Jaytee Properties II SPE, LLC, dated September 30, 2015, as amended, relating to 200 South Seventh Street, Louisville, KY. (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended September 30, 2015 (Commission File Number: 0-24649))
10.61*
Form of Stock Option Agreement for Directors and Executive Officers (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended September 30, 2004 (Commission File Number: 0-24649))
10.62*
2005 Stock Incentive Plan (Incorporated by reference to Form 8-K filed March 18, 2005 (Commission File Number: 0-24649))
10.63*
2005 Stock Incentive Plan Amendment Number 1 (Incorporated by reference to Exhibit 10.61 of Registrant’s Form 10-K for the year ended December 31, 2008 (Commission File Number: 0-24649))
10.64*
2005 Stock Incentive Plan Amendment, as amended November 14, 2012 (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed November 19, 2012 (Commission File Number: 0-24649))
No.
Description
10.65*
2015 Stock Incentive Plan (Incorporated by reference to Annex A of Registrant’s 2015 Proxy Statement (Commission File Number: 0-24649))
10.66*
Option Award Agreement for 2015 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended June 30, 2015 (Commission File Number: 0-24649))
10.67*
Restricted Stock Award Agreement for 2015 Stock Incentive Plan (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended June 30, 2015 (Commission File Number: 0-24649))
10.68*
Performance Stock Unit Award Agreement for 2015 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed January 27, 2016 (Commission File Number: 0-24649))
10.69*
Restricted Stock Award Agreement, as amended November 14, 2012 (Incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed November 19, 2012 (Commission File Number: 0-24649))
10.70*
Republic Bancorp, Inc. 401(k)/Profit Sharing Plan and Trust (Incorporated by reference to Form S-8 filed December 28, 2005 (Commission File Number: 0-24649))
10.71*
Republic Bancorp, Inc. 401(k) Retirement Plan, as Amended and Restated, effective April 1, 2011 (Incorporated by reference to Form 11-K for the year ended December 31, 2011 (Commission File Number: 0-24649))
10.72*
Republic Bancorp, Inc. 401(k) Retirement Plan, as Amended and Restated, effective January 1, 2015 (Incorporated by reference to Exhibit 23.2 of Form 11-K for the year ended December 31, 2014 (Commission File Number: 0-24649))
10.73*
Republic Bancorp, Inc. and subsidiaries Non-Employee Director and Key Employee Deferred Compensation and the Republic Bank & Trust Company Non-Employee Director and Key Employee Deferred Compensation Plan (as adopted November 18, 2004) (Incorporated by reference to Form S-8 filed November 30, 2004 (Commission File Number: 333-120857))
10.74*
Republic Bancorp, Inc. and Subsidiaries Non-Employee Director and Key Employee Deferred Compensation Plan Post-Effective Amendment No. 1 (Incorporated by reference to Form S-8 filed April 13, 2005 (Commission File Number: 333-120857))
10.75*
Republic Bancorp, Inc. and subsidiaries Non-Employee Director and Key Employee Deferred Compensation, as amended and restated as of March 16, 2005 (Incorporated by reference to Form 8-K filed March 18, 2005 (Commission File Number: 333-120857))
10.76*
Republic Bancorp, Inc. and subsidiaries Non-Employee Director and Key Employee Deferred Compensation as amended and restated as of March 19, 2008 (Incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended March 31, 2008 (Commission File Number: 0-24649))
10.77
Junior Subordinated Indenture, Amended and Restated Trust Agreement, and Guarantee Agreement (Incorporated by reference to Exhibit 4.1 of Registrant’s Form 8-K filed August 19, 2005 (Commission File Number: 0-24649))
10.78*
Cash Bonus Plan for Acquisitions, effective November 7, 2012 (Incorporated by reference to Exhibit 10.3 of Registrant’s Form 10-Q for the quarter ended September 30, 2012 (Commission File Number: 0-24649))
10.79
Purchase and Assumption Agreement - Whole Bank; All Deposits, among the Federal Deposit Insurance Corporation, receiver of Tennessee Commerce Bank, Franklin, Tennessee, the Federal Deposit Insurance Corporation and Republic Bank & Trust Company, dated as of January 27, 2012 (Incorporated by reference to Exhibit 2.1 of Registrant’s Form 8-K filed February 1, 2012 (Commission File Number: 0-24649))
No.
Description
Subsidiaries of Republic Bancorp, Inc.
Consent of Independent Registered Public Accounting Firm
31.1
Certification of Principal Executive Officer, pursuant to the Sarbanes-Oxley Act of 2002
31.2
Certification of Principal Financial Officer, pursuant to the Sarbanes-Oxley Act of 2002
32**
Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003
Interactive data files: (i) Consolidated Balance Sheets at December 31, 2016 and 2015, (ii) Consolidated Statements of Income and Comprehensive Income for the years ended December 31, 2016, 2015 and 2014, (iii) Consolidated Statement of Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014 and (v) Notes to Consolidated Financial Statements.
*Denotes management contracts and compensatory plans or arrangements required to be filed as exhibits to this Form 10-K pursuant to Item 15(b).
**This certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, nor shall it be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.