| REPUBLIC BANCORP INC /KY/ Item 1A Risk Factors |
| FACTORS THAT MAY AFFECT FUTURE RESULTS There are factors, many beyond our control, which may significantly change the results or expectations of the Company |
| Some of these factors are described below in the sections titled “Company Factors” and “Industry Factors;” however, many are described in the other sections of this Form 10-K document |
| Company Factors The Company’s accounting policies and estimates are critical components of the Company’s presentation of its financial statements |
| Our management must exercise judgment in selecting and adopting various accounting policies and in applying estimates |
| Actual outcomes may be materially different than amounts previously estimated |
| Management has identified two accounting policies as being critical to the presentation of the Company’s financial statements |
| “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the section titled “Critical Accounting Policies and Estimates” and relate to the allowance for loan losses and the valuation of mortgage servicing rights |
| Due to the inherent uncertainty of estimates, we cannot provide any assurance that the Company will not significantly increase its allowance for loan losses if actual losses are more than the amount reserved or recognize a significant provision for impairment of its mortgage servicing rights |
| The Company’s lines of business and products not typically associated with traditional banking expose the Company’s earnings to additional risks and uncertainties |
| In addition to traditional banking and mortgage banking products, the Company provides RALs, ERCs/ERDs, payday loans and “Overdraft Honor” deposit accounts |
| The following details specific risk factors related to these lines of business: • RALs represent a significant business risk, and if the Company terminated the business it would materially impact the earnings of the Company |
| TRS offers bank products to facilitate the payment of tax refunds for customers that electronically file their tax returns |
| The Company is one of only a few financial institutions in the US that provides this service to taxpayers |
| Under this program, the taxpayer may receive a RAL or an ERC/ERD In return, the Company charges a fee for the service |
| There is credit risk associated with a RAL because the money is disbursed to the client prior to the Company receiving the client’s refund from the Internal Revenue Service (“IRS”) |
| There is minimal credit risk with an ERC/ERD because the Company does not disburse the funds to the client until the Company has received the refund from the state or IRS Various consumer groups have, from time to time, questioned the fairness of the TRS program and have accused this industry of charging excessive rates of interest, via the fee, and engaging in predatory lending practices |
| Consumer groups have also claimed that customers are not adequately advised that a RAL is a loan product and that alternative, less expensive means of obtaining the tax refund proceeds may be available |
| Pressure from these groups, regulatory or legislative changes or material litigation could result in the Company exiting this business or selected markets of this business at any time |
| The Company’s liquidity risk is increased during the first quarter of each year due to the RAL program |
| The Company has committed to the electronic filers and tax preparers that it will make RALs available to their customers under the terms of its contracts with them |
| This requires the Company to estimate liquidity needs for the RAL program well in advance of the tax season |
| If management materially overestimates the need for liquidity during the tax season, a significant expense could be incurred with no offsetting revenue stream |
| If management materially underestimates the need for liquidity during the tax season, the Bank could experience a significant shortfall of capital needed to fund RALs and could potentially be required to stop originating new RALs |
| Exiting this line of business, either voluntarily or involuntarily, would significantly reduce the Company’s earnings |
| See additional discussion about this product under the sections titled Item 1 |
| “Business,” Item 7 |
| “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Footnote 20 “Segment Information” of Item 8 |
| ” 14 ______________________________________________________________________ • Our mortgage banking activities would be significantly adversely impacted by rising long-term 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 interest rates generally results in higher demand for mortgage products, while an increase in rates generally results in reduced demand |
| 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 |
| In addition to the previously mentioned risks, a decline in demand for mortgage banking products could also adversely impact other programs/products such as home equity lending, title insurance commissions and service charges on deposit accounts |
| See additional discussion about this product under the sections titled Item 1 |
| “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Footnote 20 “Segment Information” of Item 8 |
| ” • Payday loans offered through third party Marketer/Servicers represent a material component of the Company historical earnings |
| Payday loans originated through a marketer/servicer arrangement are transactions whereby customers pay a fixed fee to receive a cash advance in exchange for a check |
| Various federal and state agencies have questioned whether this business should be permitted by member banks |
| Subsequent to December 31, 2005, the FDIC specifically cited inherent risks associated with payday lending activities and asked Republic to consider terminating this line of business |
| In July 2005, the Company’s two Marketing/Servicing contracts with Advance America were terminated |
| The termination of the Advance America contracts had a material adverse impact on the earnings of the Company during the second half of 2005 |
| In addition and as a result of the FDIC letter described above, Republic reached an agreement with ACE subsequent to December 31, 2005 to terminate their marketing/servicing agreement with the Company for Texas during the first quarter of 2006 and for Pennsylvania and Arkansas during the second quarter of 2006 |
| The termination of all of these contracts will have a material adverse impact on the Company’s 2006 earnings when comparing them to the Company’s 2005, 2004 and 2003 earnings |
| See additional discussion about this product under the sections titled Item 1 |
| “Business,” Item 7 |
| “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Footnote 20 “Segment Information” and Footnote 22 “Subsequent Event” of Item 8”Financial Statements and Supplementary Data |
| ” • The Company’s “Overdraft Honor” program represents a significant business risk, and if the Company terminated the program it would materially impact the earnings of the Company |
| There can be no assurance that the Company’s regulators, or others, will not impose additional limitations on this program or prohibit the Company from offering the program |
| Republic’s “Overdraft Honor” program permits selected clients to overdraft their checking accounts up to a predetermined dollar amount up to dlra750, for the Company’s customary fee |
| Clients’ checking accounts that have been current for a certain period of time are allowed to enter the program |
| Under regulatory guidelines, this service is not considered an extension of credit, but rather is considered a fee for paying checks when sufficient funds are not otherwise available |
| This fee, if computed as a percentage of the amount overdrawn, results in a high rate of interest when annualized and thus is considered excessive by some consumer groups |
| Additional limitations or elimination, or adverse modifications to this program, either voluntarily or involuntarily, could significantly reduce Company earnings |
| The Company’s stock generally has a low average daily trading volume, which limits a shareholder’s ability to quickly accumulate or quickly sell large numbers of shares of Republic’s stock without causing negative price fluctuations |
| Also, Republic’s stock price can fluctuate widely in response to a variety of factors, such as actual or anticipated variations in the Company’s operating results, recommendations by securities analysts, operating and stock price performance of other companies, news reports, results of litigation, regulatory actions or changes in government regulations, among other factors |
| In addition, a low average daily trading volume can lead to significant price swings even when a relatively small number of shares are being traded |
| 15 ______________________________________________________________________ Industry Factors Fluctuations in interest rates may negatively impact our banking business |
| Republic’s core source of income from operations consists of net interest income, which is equal to the difference between interest income received on interest-earning assets (usually loans and investment securities) and the interest expenses incurred in connection with interest-bearing liabilities (usually deposits and borrowings) |
| These rates are highly sensitive to many factors beyond our control, including general economic conditions, both domestic and foreign, and the monetary and fiscal policies of various governmental and regulatory authorities |
| Republic’s net interest income can be affected significantly by changes in market interest rates |
| Changes in interest rates may reduce Republic’s net interest income as the difference between interest income and interest expense decreases |
| As a result, Republic has adopted asset and liability management policies to minimize potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments and funding sources |
| However, even with these policies in place, a change in interest rates could negatively impact the Company’s results of operations or financial position |
| An increase in interest rates could also have a negative impact on Republic’s results of operations by reducing the ability of our clients to repay their outstanding loans, which could not only result in increased loan defaults, foreclosures and charge offs, but may also likely necessitate further increases to Republic’s allowance for loan losses |
| The Company is significantly impacted by the regulatory, fiscal and monetary policies of federal and state governments which could negatively impact the Company’s liquidity position |
| These policies can materially affect the value of the Company’s financial instruments and earnings and can also adversely affect the Company’s borrowers and their ability to repay their outstanding loans |
| Also, 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 to the Company |
| The Board of Governors of the Federal Reserve Bank regulates the supply of money and credit in the US Its policies determine, in large part, our cost of funds for lending and investing and the return we earn on these loans and investments, all of which impact our net interest margin |
| The Company and the Bank are heavily regulated at both federal and state levels |
| This regulatory oversight is primarily intended to protect depositors, the federal deposit insurance funds and the banking system as a whole, not the shareholders of the Company |
| Changes in policies, regulations and statutes could significantly impact the earnings or products of Republic |
| 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 Bank 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 |
| Republic is subject to regulatory capital adequacy guidelines, and if we fail to meet these guidelines our financial condition may be adversely affected |
| Under regulatory capital adequacy guidelines, and other regulatory requirements, Republic and the Bank must meet guidelines that include quantitative measures of assets, liabilities and certain off balance sheet items, subject to qualitative judgments by regulators about components, risk weightings and other factors |
| If Republic fails to meet these minimum capital guidelines and other regulatory requirements, Republic’s financial condition will be materially and adversely affected |
| Republic’s failure to maintain the status of “well capitalized” under our regulatory framework, or “well managed” under regulatory exam procedures, or regulatory violations, could compromise our status as a FHC and related eligibility for a streamlined review process for acquisition proposals and limit financial product diversification |
| Our financial condition and earnings could be negatively impacted to the extent the Company relies on information that is false, misleading or inaccurate |
| The Company relies on the accuracy and completeness of information provided by vendors, clients and other counterparties |
| In deciding whether to extend credit or enter into transactions with other parties, the Company relies on information furnished by, or on behalf of, clients or entities related to that client |
| 16 ______________________________________________________________________ Defaults in the repayment of loans may negatively impact our business |
| When borrowers default on obligations of one or more of their loans, it may result in lost principal and interest income and increased operating expenses, as a result of the increased allocation of management time and resources to the collection and work out of the loans |
| In certain situations where collection efforts are unsuccessful or acceptable “work out” arrangements cannot be reached, the Company may have to charge off the loan in part or in whole |
| Prepayment of loans may negatively impact Republic’s business |
| Generally, our clients may prepay the principal amount of their outstanding loans at any time |
| The speed at which such prepayments occur, as well as the size of such prepayments, are within our clients’ discretion |
| If clients prepay the principal amount of their loans, and we are unable to lend those funds to other clients or invest the funds at the same or higher interest rates, Republic’s interest income will be reduced |
| A significant reduction in interest income would have a negative impact on Republic’s results of operations and financial condition |