At first glance the bank looks cheap. It trades at 4.5 times earnings and 5.1 times forward earnings. It trades at 90% of book value and has a dividend yield of 3.1%. It even trades cheaply by historical standards as shown below.
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So why is it so cheap? Loans don’t look to be a big problem. Bank loan charge-offs, gross and net, have been falling. Gross charge-offs were $2.4 million in 2010 and dropped to $1.5 million in 2011. Net loan charge-offs (charge-offs after any recoveries) fell from $2.2 million to $.9 million. Non-performing loans have been falling, from 1.84% of total loans a year ago to 1.81% in the most recent quarter.
The low price certainly isn’t in issue of capitalization; the company is well capitalized by any measure. As of the latest quarter Republic Bancorp had a Total Risk Based Capital of 25.13%, Tier I Capital of 23.89%, and Tier I Leverage Capital of 14.63%.
Like many banks, Republic is experiencing a declining net interest margins (“NIM”). NIM fell from 3.96% in 2008 to 3.79% in 2009 to 3.57% in 2010 but perked back up to 3.65% in the last quarter. This could be one reason that the stock would be cheap, but net income from banking operations has remained relatively steady so it’s unlikely to be the main reason.
The main reason Republic is so cheap is that it actually doesn’t get most of its income from traditional banking operations. Most of Republic’s income comes from its Tax Refund Solutions (“TRS”) business, and most of that business is made up of underwriting Refund Anticipation Loans (“RALS”) for Liberty Tax Services and Jackson Hewitt.
|Net Income ($000)||2010||2009||2008|
|Traditional & Mortgage Banking||$ 20,513.00||$ 22,152.00||$ 20,394.00|
|Tax Refund Solutions||$ 44,240.00||$ 19,979.00||$ 13,258.00|
|Total||$ 64,753.00||$ 42,131.00||$ 33,652.00|
In fact, the RAL business has gone from being an ancillary business to being Republic’s main source of income. Ordinarily a bank providing a different type of banking service (RAL underwriting) wouldn’t be reason for alarm except that the government is on a mission to do away with Refund Anticipation Loans and is essentially pursuing policies through various regulators that amount to a de facto ban while the IRS is simultaneously changing its refund policies to make RALs less appealing to consumers.
Regulatory Action to De Facto Ban RALs
Banks are regulated by the Federal Deposit Insurance Corp (FDIC), the Office of the Comptroller of the Currency (OCC), and/or the Office of Thrift Supervision (OTS) depending on the banks charter type. In 2009 there were four major banks that provided RAL funding: Santa Barbara Trust, Chase, HSBC, and Republic. In 2009 the OCC forced Santa Barbara Trust to leave the RAL funding business. Chase, seeing the writing on the wall, left voluntarily. Then in the fall of 2010 the OCC barred HSBC from funding RALs. This left Republic as the only RAL player standing, but not for long. On Feb. 10, 2011 the FDIC issued a Notice of Charges for an Order to Cease and Desist and Notice of Hearing regarding Republic’s RAL program. The notice alleged that the practice of originating RALs without the DI was unsafe and unsound and that Republic should cease underwriting RALs. Republic is currently disputing the notice. Republic also filed a complaint against the FDIC in U.S. District Court. While the legal action may or may not succeed the writing is on the wall. RALs are on their way out one way or another, it is just a matter of time.
IRS Action to Reduce Attractiveness of RALs
Meanwhile the IRS has been waging its own war against RALs. On Aug. 5, 2010 the IRS announced it would no longer provide tax preparers and their associated financial institutions with the Debt Indicator (DI) which told preparers whether or not the taxpayer will have a portion of their refund withheld because of unpaid debts. Without this indicator, underwriting RALs become more difficult and more risky (and provided the bank regulators a good excuse to ban banks from underwriting RALs). In addition to removing the DI, the IRS began to speed up the time it took to issue refunds to make short term loans like RALs less appealing to consumers.
With the inevitable disappearance of RAL income, Republic doesn’t look as undervalued as it did at first. Investors would be wise to compile pro forma balance sheets and income statements as if Republic did not have its RAL program before deciding on the suitability of Republic as an investment.
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