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Refund Anticipation Loan Crackdown: Be Wary of Republic Bancorp

February 14, 2011 | About:
Republic Bancorp (RBCAA) dropped 7% on Friday after receiving notice from the FDIC saying its funding of refund anticipation loans was unsafe. Republic is one of the few banks that continues to issue refund anticipation loans, doing so through Jackson Hewitt (JTX). This drop puts their P/B down to 1, which is a 10 year low for them. Setting their share price aside, Republic has been one of the best performing banks through the financial crisis and they have continued to stay profitable, but this notice is a major threat to their outsized profits over the last few years.

Republic operates 43 banking centers in Kentucky, Indiana, Ohio, and Florida. The majority of their business is residential mortgage loans, and about 30% is commercial loans. Looking at their financials, Republic had a record year in 2010. They increased their dividend for the 11th straight year and are now yielding 3.2%. EPS was $3.10 and their ROE is approaching 18%. Additionally, their non-performing and delinquent loans have decreased significantly YoY. They’re seeing deposit growth and should benefit from the steepening yield curve in 2011.

Here’s where the problem comes in. Republic’s refund anticipation loan program generated $44 million in net income in 2010. The FDIC decision threatens to erase all of that in coming years. The bank is challenging the decision, but a hearing won’t be held until late April. CEO Steve Trager said that if Republic loses in that hearing, they’ll have the ability to appeal to the U.S. Court of Appeals. Regulators are frowning upon the use of refund anticipation loans because they potentially carry high interest rates and are seen as preying on the poor and uninformed. Republic charges about $60 per loan. In 2010, these loans equaled $3 billion, and made about $51 million in fees. Trager has said that regardless of the FDIC order, 2011 will most likely only see half the volume of previous years.

How do we price this in? The bank’s net income was $65 million in 2010, and I’m going to immediately knock off about $22 million in net earnings for 2011. For 2012 and beyond, it appears unlikely that Republic will be able to offer the loans. If 2011 earnings stay steady and you price in the refund anticipation loan reduction, you’re left with 2011 EPS of about $2. Going forward to 2012, EPS would drop to less than $1. This isn’t a totally fair comparison because the rest of their business is improving as well, but this exercise certainly explains the low P/B level and stock price drop. There may be more room to fall.

Republic has been an impressive performer through the years. They should continue to remain profitable even if these refund anticipation loans go away, but it will remove a large portion of their net income. Their dividend yield is still impressive, and it remains to be seen what affect this potential loss of business will have on their dividend, although if I was a dividend investor in Republic, I would be very nervous. I think there are too many other opportunities out there to take on the risk in Republic.

Disclosure: No positions

About the author:

Steven Kiel
Steven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at steven.kiel@arquitos.com or through the firm's website at www.arquitos.com.

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