Republic Bancorp Inc.
Annual Report 2003

Plain-text annual report

R E P U B L I C B A N C O R P 2 0 0 3 A N N U A L R E P O R T Republic Bancorp, Inc. 601 West Market Street Louisville, KY 40202 (502) 584-3600 or outside Louisville (888) 584-3600 www.republicbank.com Republic Bancorp, Inc. ("Republic" or "the Company") is a bank holding company headquartered in Louisville, Kentucky. The Company derives substantially all of its revenue and income from the operation of its wholly owned subsidiaries, Republic Bank & Trust Company – a Kentucky chartered bank and trust company and Republic Bank & Trust Company of Indiana – an Indiana chartered bank and trust company (collectively "Bank"). Republic’s Class A Common Stock trades on the NASDAQ Stock Market ® under the symbol "RBCAA". Currently, Republic has 33 full-service banking centers, 19 of which are located in the metropolitan Louisville area, including the Company’s principal office. There are five banking centers located in Lexington, Kentucky, two in Frankfort, Kentucky and one each in the Kentucky communities of Bowling Green, Elizabethtown, Georgetown, Owensboro and Shelbyville. Republic Bank & Trust Company of Indiana has two full-service banking centers located in Clarksville and New Albany, Indiana, with one under construction in Jeffersonville. At the close of 2003, Republic had assets of $2.1 billion, making the corporation the second-largest independent bank holding company in Kentucky. Locations Louisville, KY Lexington KY Frankfort, KY Bowling Green, KY Elizabethtown, KY Georgetown, KY Owensboro, KY Shelbyville, KY Clarksville, IN New Albany, IN Jeffersonville, IN Indicates principal office 19 5 2 1 1 1 1 1 1 1 1 FINANCIAL HIGHLIGHTS (dollars in thousands, except per share data) 2003 2002 2001 As of and for the Years Ended December 31, Income Statement Data: Interest income Interest expense Net interest income Provision for loan losses Non interest income Non interest expenses Income before income tax expense Net income $ 119,060 $ 36,795 82,265 6,574 30,933 62,859 43,765 28,203 106,101 41,761 64,340 3,338 24,522 53,839 31,685 20,489 Balance Sheet Data: Total assets Total securities Total loans, net Allowance for loan losses Total deposits Repurchase agreements and other short-term borrowings Federal Home Loan Bank borrowings Total stockholders' equity $ 2,127,771 410,931 1,567,993 13,959 1,297,112 220,040 420,178 169,379 Per Share Data: Basic Class A Common Stock earnings per share Basic Class B Common Stock earnings per share Diluted Class A Common Stock earnings per share Diluted Class B Common Stock earnings per share Market value Book value Cash dividends declared per Class A Common Stock Cash dividends declared per Class B Common Stock Performance ratios: Return on average assets (ROA) Return on average equity (ROE) Net interest margin $ 1.67 1.62 1.64 1.59 19.54 9.96 0.506 0.460 % 1.47 16.88 4.50 $1,752,706 288,459 1,299,915 10,148 1,040,190 224,929 319,299 150,796 $ 1.2 3 1.21 1.2 0 1 .19 11 .27 8.96 0.209 0.190 % 1.25 14.44 4.07 $ 117,396 57,917 59,479 3,493 19,741 50,340 25,387 16,808 $1,590,831 293,945 1,176,094 8,607 866,358 282,023 296,950 125,115 $ 1.04 1.03 1.01 0 .99 13.49 7.77 0.176 0.160 % 1.10 13.85 4.04 TABLE OF CONTENTS 2 Letter to Shareholders 44 Consolidated Financial Statements 21 Selected Consolidated Financial Data 49 Notes to Consolidated Financial Statements 22 Management’s Discussion and Analysis 66 Corporate Information 43 Report of Independent Auditors On the cover: Jonathan Payne - Sr. V. P. – Louisville Region, Cathy Slider - Sr. V.P. – Cash Management, Steve DeWeese - Sr. V.P. – Business Development, Kathy Potts - Sr. V.P. – Louisville Region, Jenifer Duncan - Sr. V.P. – Lexington Region, Andy Powell - Sr. V.P. – Commercial Lending 1 Valued Shareholders, checking account and automatic approval on a home equity line of credit at no additional cost. As a result of this success, Louisville’s Business First magazine recognized Republic as the number one local mortgage Proud, Humble, Focused, Passionate, and Enthusiastic. These five words best sum up my feelings coming originator for the second consecutive year. out of 2003 and looking ahead to 2004 and beyond. Deposit fee income also contributed meaningfully to non interest income growing 28% from $8.3 million in Proud because the past year was one of record earnings and significant growth in our banking centers. 2002 to $10.7 million in 2003. The rise in deposit fee income resulted from growth in Republic’s transaction Humble because we continue to invest our time and resources into the communities in which we live and accounts, as we opened nearly 17,000 new accounts during 2003. Certainly our ability to offer competitive work. Focused on positioning the Company as the Bank of choice in all of our markets. Passionate about products combined with impecable service through an expanded banking center network continues to servicing our clients at a level unmatched anywhere in the industry. Enthusiastic for the future because of attract great numbers of clients. the strong client relationships we have formed providing us an opportunity to grow for many years to come. Non interest expenses increased during 2003 primarily resulting from our In 2003, we made a significant commitment to “Building for our Future”. As a locally owned company, we investment in six new locations. Although new banking centers typically remain nimble, able to respond and differentiate ourselves from the competition. We believe our results do not become profitable for twelve to eighteen months, they enhance speak for themselves. During 2003 we posted net income of $28.2 million representing a 38% increase or access to potential new clients and allow us to be closer to our current $7.7 million over 2002. Diluted earnings per Class A Common Stock increased 37% over 2002 to $1.64. clients – letting us further expand these vital banking relationships. We provided one of the highest returns in the Company’s history for our shareholders as reflected by a These new banking centers represent a tremendous investment for our 1.47% return on average assets (ROA) and a 16.88% return on average equity (ROE) for the year. In future, but one that we believe is essential for the long-term success of addition to these solid earnings results, the Company surpassed $2 billion in total assets, a significant the Company. milestone in our history. Another key ingredient to our success is maintaining our high standards The financial achievements of 2003 resulted from success across many different traditional and non- of asset quality. Republic’s percentage of delinquent loans to total loans traditional lines of business. Net interest income increased 28% during the year primarily as a result of and percentage of non-performing loans to total loans remained below 1% at 0.82% at December 31, growth in our residential real estate loan portfolio combined with growth in our deferred deposit and 2003, both indicators of strong asset quality. We are extremely proud of our documented track record for Refund Anticipation Loan programs. strong asset quality and sound underwriting practices at Republic. Success on the lending side of the balance sheet was complemented by achievements in our Cash We look ahead to 2004 with much enthusiasm and tremendous focus. Our goals remain lofty for 2004 Management function, which continued to attract low cost deposits during 2003 primarily through the despite a projected downturn in secondary market lending and its contributions to the Company’s bottom "Premier First" product. Our ‘Cash Management’ relationships include many types of businesses such as line. Our traditional banking strategies in 2004 will be simple and time-tested. In commercial banking, the professional groups and educational institutions, as well as many major hospitals. Investment in technology focus will be to grow the balance sheet through the commercial lending and commercial cash management and recruiting of additional associates in this line of business are important factors that will continue to pay areas without sacrificing the credit quality we hold so dear. For our retail banking, the focus will be to make dividends for the Company. We believe that we are uniquely positioned, as the largest Kentucky-owned our newest banking centers profitable ahead of our already aggressive goals. Matching our success from financial institution based in our local area, to provide service to any size organization in our communities. 2003 will be a difficult task, but a challenge our 600-plus associates are ready to face. Non interest income was once again strong for the Company increasing 26% to $30.9 million for the year. We also remain excited about the prospects for our Refunds Now® and deferred deposit programs in 2004. When speaking of non interest income we must start with the tremendous effort of our lending staff who We believe our size and technology provide us the capability to succeed in these businesses. Our senior originated approximately $800 million in secondary market residential real estate loans. Their efforts management team remains diligent in its oversight of these two nontraditional lines of business and contributed not only $11.1 million in mortgage banking income, but forged long-term relationships with optimistic about their potential contribution in the future. thousands of new clients through the Company’s partnership package, which includes an "Absolutely Free" 2 3 We maintain our belief that investment in the community is paramount to our success. During 2003 we continued as the proud sponsor of the Kentucky Derby Festival Pegasus Parade and various local high school basketball tournaments, including being title sponsor of the boys and girls division of the Louisville Invitational Tournament. We also were contributors of both time and resources to Habitat for Humanity, Hospice, American Heart Association, MS Society, Juvenile Diabetes Foundation, March of Dimes and Senior Housing Crime Prevention, just to name a few. We are proud of our participation in these worthy causes and will continue our commitment in the future of dedicating our time and resources to the communities where we live and work. It is my belief that success comes to those who are focused on doing the job at hand with determination and conviction – the reward is in pushing the limits on what we expect of ourselves, and not with the expectations of what that success will bring. At Republic, we maintain unwavering adherence to improving the bottom-line and a commitment to creating an environment where our associates can realize their potential and excel in serving our clients. Our management team and all of our associates continue to work tirelessly to position the Company for future success. So, while we are all extremely proud of what we accomplished in 2003, our associates realize there is much work to be done in order to achieve even greater success in 2004 and beyond. Steven E. Trager President and Chief Executive Officer RETURN ON AVERAGE EQUITY (%) DILUTED CLASS A COMMON STOCK EARNINGS PER SHARE ($) 1.80 1.60 1.40 1.20 1.00 0.80 0.60 NET INCOME ($) In thousands 30,000 28,000 26,000 24,000 22,000 20,000 18,000 16,000 14,000 12,000 10,000 8,000 2001 2002 2003 2001 2002 2003 2001 2002 2003 17 16 15 14 13 12 11 10 4 R E P U B L I C ’ S C O R P O R A T E F A C I L I T I E S Republic Bank Corporate Center 601 West Market Street, Louisville Cash Management Compliance Executive Offices Finance/Accounting Information Technology Internal Audit Legal Marketing Purchasing & Facilities Management Republic Financial Services Treasury Trust Republic Bank Place 661 S. Hurstbourne Parkway, Louisville Commercial Lending Loan Administration Mortgage Republic Bank Building 9600 Brownsboro Road, Louisville Bank Administration Human Resources 5 Banking Center Executives (3rd Row) Tucker Ballinger – Shelbyville, Steve DeWeese – Hurstbourne, Billy Blair – Harrodsburg Rd., Todd Lancaster – Charlestown Rd., Scott Osborn – Andover, Barb Cutter – Baptist East, David Jett – New Cut Rd., Andy Mayer – Poplar Level Rd., Chip Hancock – Corporate Center, Jacob Call – Hikes Point (2nd Row) Rodney Williams – Frankfort, Mary Matheny – Outer Loop, Jeffrey Zinger – Perimeter Dr., Janet Pierce – Bowling Green, Eric Higdon – Springhurst, Kari Thom – Clarksville, Cindy Burton – Tates Creek, Jill Napier - Fern Creek, Rob Nicolas – Dixie Hwy. (1st Row) David Krebs – St. Matthews, B.J. Webb – Chevy Chase, Keri Jones – Brownsboro Rd., Pearlie Walker – West Broadway, Missy Fultz – Prospect, Steve Coleman – Fern Valley Rd., Larry Stewart – Jeffersontown, Lisa George – Bardstown Rd., Shirley Cecil – Owensboro C O M M U N I T Y I N V O L V E M E N T REPUBLIC “...investment in the community is paramount to our success.” - Steve Trager President and CEO Republic Bank Community Clean-Up St. Matthews banking center Republic Bank Girls' Louisville Invitational Tournament Republic Bank Team at American Heart Walk Republic Bank sponsorship Green Mile program Republic Bank – Brightside Community Wide CleanUp Republic Bank sponsors Kentucky Derby Festival's Pegasus Parade BANCORP Hikes Point Banking Center 3902 Taylorsville Road Louisville, Kentucky Opened March 2003 Left Page: Joe Sutter - V.P./Treasury, Ed McDougal - Sr. V.P./Chief Operating Officer – Secondary Market Lending Right Page: (Back Row) Sandra Lamison - V.P. – Commercial Credit, Janice Kingsolver - V.P. – Loan Processing, Kent Rohrer - V.P. – Commercial Loan Operations, Donna Blincoe - V.P. – Loan Operations (Front Row) Ann Taber - V.P. – Loan Servicing, Duane Wilson -V.P. – Collections, Shannon Reid - Sr. V.P. – Loan Administration 6 7 Jewish Hospital Banking Center 224 East Muhammad Ali Boulevard Louisville, Kentucky Opened May 2003 Left Page: Barb Cutter - V.P., Larry Kozlove - Sr. V.P., John Mason - Sr. V.P. Right Page: (Back Row) Jeff Norton - Sr. V.P. – Commercial Banking, Commercial Lending: Tom Fangman - V.P., John Mauldin - Sr. V.P., Craig Dunn - Sr. V.P. (Front Row) Andy Powell - Sr.V.P., Darryl Witten - Sr. V.P., Bob McQueary - V.P. 8 9 Jeffersontown Banking Center 3811 Ruckriegel Parkway Louisville, Kentucky Opened May 2003 Left Page: Sharon Terrell - Training Development Officer, Margaret Wendler - V.P. – Retail Sales & Training, Laura Dixon - Loan Training Specialist Right Page: Ron Jolly - A.V.P. – Bardstown Road, Greg Siegrist - V.P. – Business Development, Amy Lim - V.P. – Commercial Lending, Drew Perkins - Banking Officer - Blankenbaker 10 11 New Cut Road Banking Center 5125 New Cut Road Louisville, Kentucky Opened September 2003 Left Page: Rebecca Hamilton - V.P. – Telebanking, Patty Walls - A.V.P. – Overdraft Honor, Vikki Kisling - Internet Banking Manager Right Page: Cash Management: (Back Row) Cathy Slider - Sr.V.P., Jason Morrison - Cash Management Officer, Logan Hillyard - A.V.P., Casey Carwile - V.P., Sharon McGee - V.P., Meredith Brown - V.P. (Front Row) Tom Odle - V.P., Kevin Wynne - Cash Management Officer - Tuition First, Ellen Wilson - Cash Management Officer 12 13 Poplar Level Road Banking Center 1420 Poplar Level Road Louisville, Kentucky Opened October 2003 Left Page: Kathy Potts - Sr. V.P. – Louisville, Claudio Monzon - Sr.V.P. – Elizabethtown, Bowling Green, Owensboro, Georgetown, Frankfort, Shelbyville, Jenifer Duncan - Sr. V.P. – Lexington, Jonathan Payne - Sr. V.P. - Louisville Right Page: (Back Row) Kay Rothman - V.P. – Bank Administration, Jeanette Brown - V.P. – Bank Administration, Jeff Nelson - Sr.V.P. – Retail Bank Administration, Denise Brown - V.P. – Bank Administration (Front Row) Sandy Richardson - V.P. – Bank Administration, Barbara Trager - V.P. – Bank Administration 14 15 Tates Creek Road Banking Center 3608 Walden Drive Lexington, Kentucky Opened November 2003 Left Page: (Back Row) Alan Lodge - Sr. V.P. – COO – Refunds Now, Bryan Hendrick - V.P. – Deferred Deposits, Kenny Fox - V.P. – Currency Connection (Front Row) Mike Keene – President – Republic Financial Services Right Page: (Back Row) Mike Ringswald - Sr. V.P. – General Counsel, Mike Beckwith - V.P. – Controller, Ann Bauer - V.P. – Internal Audit, Jack Horn - V.P. – Accounting, Garry Throckmorton - Sr. V.P. – Compliance, Paula Langford - V.P. –Trust, (Front Row) Rod Gillespie - Sr. V.P. – Facilities, Security, Purchasing, Dorothy Pitt - Sr. V.P. – Human Resources, Greg Williams - Sr.V.P. – Treasury - Chief Investment Officer 16 17 Georgetown Banking Center 430 Connector Road Georgetown, Kentucky Opened January 2004 Left Page: Carolle Jones Clay - V.P. – Community Relations, Michael Sadofsky - Sr. V.P. – Marketing Right Page: (Back Row) Mike Rice - V.P. - Tech Support, Mike Mather - V.P. – Systems Programming, Keith Koebel - A.V.P. – PC Support, Dennis Lanham - V.P. – PC Support, Kevin McKay - V. P. – Computer Operations (Front Row) Brenda Haley - V.P. – Central Operations, Tom Clausen - Sr. V.P. – Information Technology, Shellie Pearcy - Systems Security Administrator 18 19 (Back Row) David Vest - Executive V.P. – CLO, Bill Petter - Vice Chairman, Scott Trager - Vice Chairman (Front Row) Kevin Sipes - Executive V.P. – CFO, Steve Trager - President and Chief Executive Officer, Bernard Trager - Chairman 2 0 0 3 F I N A N C I A L R E V I E W 20 The following table sets forth Republic's selected consolidated historical financial information from 1999 through 2003. This information should be read in conjunction with the Consolidated Financial Statements and the related Notes. Factors affecting the comparability of certain indicated periods are discussed in "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." As of and for the Years Ended December 31, 2001 2000 2002 (dollars in thousands, except per share data) Income Statement Data: Interest income Interest expense Net interest income Provision for loan losses Non interest income Non interest expenses Income before income tax expense Net income Balance Sheet Data: Total assets Total securities Total loans, net Allowance for loan losses Total deposits Repurchase agreements and other short-term borrowings Federal Home Loan Bank borrowings Total stockholders' equity $ 2003 119,060 36,795 82,265 6,574 30,933 62,859 43,765 28,203 $ 2,127,771 410,931 1,567,993 13,959 1,297,112 220,040 420,178 169,379 $ Per Share Data: Basic Class A Common Stock earnings per share Basic Class B Common Stock earnings per share Diluted Class A Common Stock earnings per share Diluted Class B Common Stock earnings per share Market value Book value Cash dividends declared per Class A Common Stock Cash dividends declared per Class B Common Stock Performance Ratios: Return on average assets (ROA) Return on average equity (ROE) Net interest margin Efficiency ratio Asset Quality Ratios: Non-performing assets to total loans Net loan charge offs to average loans Allowance for loan losses to total loans Allowance for loan losses to non-performing loans Capital Ratios: Average stockholders' equity to average total assets Tier 1 leverage Tier 1 risk based capital Total risk based capital Dividend payout ratio Other Key Data: End of period full time equivalent employees Number of bank offices 1.67 1.62 1.64 1.59 19.54 9.96 0.506 0.460 1.47% 16.88 4.50 56 0.82% 0.19 0.88 108 8.69% 8.08 11.99 12.99 30 645 31 $ 106,101 41,761 64,340 3,338 24,522 53,839 31,685 20,489 $ 1,752,706 288,459 1,299,915 10,148 1,040,190 224,929 319,299 150,796 $ 117,396 57,917 59,479 3,493 19,741 50,340 25,387 16,808 $ 1,590,831 293,945 1,176,094 8,607 866,358 282,023 296,950 125,115 $ 1.23 1.21 1.20 1.19 11.27 8.96 0.209 0.190 1.25% 14.44 4.07 61 0.78% 0.15 0.77 103 8.65% 9.02 12.77 13.64 17 570 25 $ 1.04 1.03 1.01 0.99 13.49 7.77 0.176 0.160 1.10% 13.85 4.04 64 0.48% 0.23 0.73 154 7.96% 8.36 12.44 13.26 17 532 22 $ 1999 97,157 49,552 47,605 1,806 10,084 37,383 18,500 12,252 $ 118,660 66,851 51,809 1,382 8,859 40,029 19,257 12,921 $ 1,508,072 275,568 1,136,531 7,862 863,761 $ 1,368,983 214,558 1,031,512 7,862 800,909 263,001 246,050 116,942 215,718 231,383 103,770 $ 0.78 0.77 0.76 0.75 6.19 7.04 0.151 0.138 0.89% 11.77 3.71 66 0.40% 0.12 0.69 193 7.58% 8.13 12.01 12.78 19 $ 0.73 0.72 0.71 0.69 8.56 6.22 0.118 0.108 0.98% 11.90 3.96 65 0.38% 0.19 0.76 213 8.27% 8.61 13.36 14.28 16 462 22 467 21 I S E L E C T E D C O N S O L D A T E D F N A N C A L D A T A I I 21 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 balance sheets and statements of income. Republic, a bank holding company headquartered in Louisville, Kentucky, is the parent of Republic Bank & Trust Company, Republic Bank & Trust Company of Indiana (collectively “Bank”) and Republic Funding Company. This section should be read in conjunction with the Company's Consolidated Financial Statements and accompanying Notes and other detailed information. This discussion includes various forward-looking statements with respect to credit quality Including but not limited to delinquency trends and the adequacy of the allowance for loan losses, corporate objectives, the Company’s interest rate sensitivity model and other financial and business matters. Broadly speaking, forward-looking statements include: • projections of the Company’s revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items; • descriptions of plans or objectives of the Company’s management for future operations, products or services; • forecasts of Republic’s future economic performance; and • descriptions of assumptions underlying or relating to any of the foregoing. The Company may make forward-looking statements discussing management’s expectations about: • future credit losses and non-performing assets; • the future value of mortgage servicing rights; • the impact of new accounting standards; • future short-term and long-term interest rate levels and their impact on Republic’s net interest margin, net income, liquidity and capital; and • future capital expenditures. Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would,” or similar expressions. Do not unduly rely on forward-looking statements. They detail management’s expectations about the future and are not guarantees. Forward- looking statements speak only as of the date they are made, and management may not update them to reflect changes that occur after the date the statements are made. There are several factors, many beyond management’s control, that could cause results to differ significantly from management’s expectations. These factors include, among other things, industry factors and company factors. COMPANY OVERVIEW As of December 31, 2003, Republic had a total of 29 banking centers in Kentucky communities and two in southern Indiana. Republic’s two primary market areas are located in North Central and Central Kentucky. The North Central Kentucky market includes the Louisville metropolitan area. Louisville, the largest city in Kentucky, is the location of Republic’s headquarters and the location of 18 banking centers at December 31, 2003. Republic's Central Kentucky market includes 11 banking centers in the following Kentucky cities: Bowling Green (1); Elizabethtown (1); Frankfort (2); Lexington, the second largest city in Kentucky (5); Owensboro (1); and Shelbyville (1) at December 31, 2003. Republic Bank & Trust Company of Indiana has offices located in New Albany and Clarksville, Indiana. Republic has also announced plans to open one additional banking center in its Louisville market and one in both the southern Indiana and Georgetown, Kentucky markets during early 2004. Republic has developed a community banking network, with most of its banking centers located either in separate communities or portions of urban areas that represent distinct communities. Each of Republic's banking centers is managed by one or more officers with the authority to make loan decisions within Company policies and guidelines. Republic continues to seek and evaluate additional expansion opportunities, either through the establishment of de novo banking centers and/or through acquisitions of existing institutions in the financial services industry and ancillary non banking businesses. The Company intends to continue to consider various strategic acquisitions of banks, banking assets or financial services entities related to banking in those geographical areas that management believes would complement and increase Republic's existing business lines, or expansion in new market areas or product lines that management determines would be in the best interest of the Company and its shareholders. Republic's operating revenues are derived primarily from interest earned from its loan and investment securities portfolios and fee income from loan, deposit and other banking products. The Company has historically extended credit and provided general banking services through its banking center network to individuals, professionals and businesses. Over the past several years, the Company has begun to seek new lines of business to diversify its asset mix and further enhance its profitability. While each new line of business reflects the Company's efforts to enrich its asset mix, each of these lines of I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 22 business is an outgrowth of the basic community banking concepts in which the Company has traditionally engaged. The Company principally markets its products and services through the following delivery channels: Mortgage Lending - The Company utilizes its banking centers to offer a complete line of single family residential mortgage products. The Company generally retains mortgage loans with variable rates or adjustable rates or with up to 10-year fixed rate terms. Prior to 2003, the Company typically sold its longer term fixed rate loans into the secondary market, however, over the past 15 months Republic retained some 15 and 20 year fixed rate loans as part of a specific program. Once closed, the secondary market loans are sold without recourse to institutional investors. Generally, fixed rate loans in process or held for sale are covered by forward commitments to these investors, thus limiting Republic's interest rate risk. During 2002, Republic began a practice of selling the majority of its fixed rate loans with the servicing retained by the Company. When administering loans with the servicing retained, the responsibility of collecting principal and interest payments, escrowing for taxes and insurance and remitting payments to the secondary market investors remains with Republic. A fee is received by Republic for performing these standard servicing functions. Commercial Lending - Commercial loans are primarily real estate secured and are generated at banking centers in the Company's market areas. The Company makes commercial loans to a variety of industries, and intends to expand this business through focused calling programs, seeking to broaden relationships by providing commercial clients with loan, deposit and cash management services. Preferred Client Services - Republic has established long standing relationships with the medical communities in its primary markets. Special loan and deposit products have been tailored to meet the needs of physicians and their practices. Consumer Lending – Traditional consumer loans made by the Company include automobile loans, home improvement and home equity loans, operating lines of credit and personal loans (both secured and unsecured). With the exception of home equity loans, which are actively marketed in conjunction with 1-4 family first lien mortgage loans, traditional consumer loan products are not aggressively promoted in Republic’s markets. Specialized Lending - Republic has pursued specialized lending opportunities to complement its traditional lending programs. One specialized product line includes Refund Anticipation Loans (“RALs”) from Refunds Now®, a program special- izing in tax refund anticipation services. Additionally, the Company also originates deferred deposit transactions, which are In a deferred deposit transaction, customers can receive cash advances in also commonly referred to as “payday loans”. exchange for a check for the advanced amount plus a fixed fee. See below sections titled “Refunds Now” and “Deferred Deposit Transactions” for additional information. Internet Banking - Republic continues to expand its market penetration and service delivery by offering clients Internet banking services through republicbank.com. Approximately 38% of the Bank's existing checking account clients utilize Republic's Internet banking services as of December 31, 2003. Republicbank.com is also available to clients outside of Kentucky and has over $134 million in deposits from 48 states and the District of Columbia as of December 31, 2003. Other Banking Services - The Bank also provides investment management and trust services and engages in life, long term care and title insurance sales, item processing and other related financial institution lines of business. At December 31, 2003, Republic had approximately $1 billion in trust assets under custody. 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; however, many are described in the sections that follow. There are also other items, which are included in the Annual Report on Form 10-K for the year ended December 31, 2003. Any factor described in this report or in the Company’s 2003 Annual Report on Form 10-K could, by itself or with other factors, adversely affect our business, results of operations or financial condition. There are also other factors not described in this report or in the 2003 Annual Report on Form 10-K which could cause our expectations to differ or could produce significantly different results. Industry Factors General business and economic conditions can significantly impact the Company’s earnings. General business and economic conditions in the United States of America and abroad can impact the company. Conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity markets and the federal and state economies in which we operate. Economic factors such as a customer’s loss of employment can limit the ability of the customer to repay principal and interest on their outstanding loan. The Company’s earnings are significantly impacted by the fiscal and monetary polices of federal and state governments. The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States of America. Its polices determine, in large part, our cost of funds for lending and investing and the return we I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 23 I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I earn on those loans and investments, all of which impact our net interest margin. of our financial instruments and earnings and can also affect our borrowers and their ability to repay their loans. Its policies can materially affect the value Republic’s industry is highly competitive. The Company operates in a highly competitive industry that could become even more competitive as a result of legislation, regulatory and technological changes and continued consolidation. Many of our competitors have fewer regulatory constraints and some have lower cost structures. Federal legislation could also provide for changes in the banking laws that could impact the financial condition or results of operations of the Company or its subsidiaries. Republic is heavily regulated by federal and state agencies. The holding company and its subsidiary banks are heavily regulated at the federal and state levels. The regulation is intended to protect the depositors, 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 that Republic may deliver. Also, failure to comply with laws, regulations or policies could result in significant penalties or sanctions by regulatory agencies. The Company relies on the accuracy and completeness of information provided by vendors, customers and other counterparties. on information furnished by or on behalf of customers or related entities to that customer. Our financial condition and earnings could be negatively impacted to the extent the Company relies on information that is misleading or inaccurate. In deciding whether to extend credit or enter into transactions with other parties, the Company relies Company Factors The holding company relies on dividends from its subsidiaries for most of its revenues. Republic Bancorp, Inc. It receives substantially all of its revenue from dividends from its largest is a separate legal entity from its subsidiaries. subsidiary, Republic Bank & Trust Company. Various federal and state laws and regulations limit the amount of dividends that may be paid to the holding company. The Company’s accounting policies and estimates are key to how we present our financial statements. Republic’s accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying various accounting policies and making estimates. Actual outcomes can 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. These polices are described below in the section titled “Critical Accounting Policies” and relate to the allowance for loan losses and the valuation of mortgage servicing rights. Because of 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 current amount reserved or recognize a significant provision for impairment of its mortgage servicing rights. The Company has lines of business or products other than banking. In addition to traditional banking, i.e customer loans and deposits, the Company provides RALs and Electronic Refund Check (“ERCs”), mortgage banking, ‘Overdraft Honor’ and deferred deposit transactions. Management believes this diversity helps mitigate the Company’s exposure to significant downturns in any one segment of the banking industry; however, it also means that the Company’s earnings could be sub- ject to different risks and uncertainties. The following details specific risk factors related to Republic’s lines of business: • Mortgage banking activities can be significantly impacted by interest rates. Changes in interest rates can impact gain on sale of loans, loan origination fees and loan servicing fees, which account for a significant portion of mortgage-related revenues. A decline in interest rates generally results in higher demand for mortgage products while an increase in rates generally results in a slow down in demand. revenue will be positively impacted by more gains on sale, however, the valuation of mortgage servicing rights will decrease and may result in a significant impairment. demand for mortgage banking products could also adversely impact other programs/products in the bank such as, home equity lending, title insurance commissions and service charges on deposit accounts. See below sections for additional discussion of mortgage banking activities. In addition to the previously mentioned risks, a decline in If demand increases, mortgage banking • Deferred deposit transactions represent a significant business risk and if the Company terminated the business it would materially impact earnings of the Company. Deferred deposits are transactions whereby customers receive cash advances in exchange for a check for the advanced amount plus a fixed fee (commonly referred to as a “payday loan”). Various consumers groups have, from time to time, questioned the fairness of deferred deposit transactions and have accused this industry of charging excessive rates of interest via the fee and engaging in predatory lending practices. Both federal and state regulatory agencies have also questioned whether this business should be permitted by member Banks. There can be no assurance that the FDIC or others will not impose additional limitations on or prohibit banks from engaging altogether in deferred deposit transactions. There also can be no assurances that private litigation might not result from the program, or that the Bank’s ability to continue to engage in the business profitably or at all will not be negatively impacted by the requirements of 24 applicable laws, regulations or guidelines. The Company exiting this business, either voluntary or involuntary, would significantly reduce earnings. See additional discussion about this product in a separate section titled “Deferred Deposit Transactions” below. • RALs represent a significant business risk and if the Company terminated the business it would materially impact earnings of the Company. Republic offers Bank products to facilitate the electronic filing of tax returns by individuals across the country. The Company is one of only a few financial institutions in the United States of America that provides this service to potential taxpayers. Under this program, the taxpayer may receive a RAL or In return the Company charges a fee for service. There is credit risk associated with a RAL because the an ERC. money is dispersed to the client before the Bank receives the client’s refund from the Internal Revenue Service (“IRS”). There is minimal credit risk with an ERC because the Bank does not disperse the funds to the client until the Company has received the refund from the IRS. Various consumers groups have, from time to time, questioned the fairness of the Refunds Now program and have accused this industry of charging excessive rates of interest via the fee and engaging in predatory lending practices. Pressure from these consumer groups could result in the Company exiting this business at any time. Pressure from these consumer groups to the Company’s regulators could also cause Republic to exit this line of business at any time. Exiting this line of business, either voluntarily or involuntarily, would significantly reduce earnings. See additional discussion about this product in section titled “Refunds Now” below. • The Company’s ‘Overdraft Honor’ program represents a significant business risk and if the Company terminated the program it would materially impact earnings of the Company. Republic’s “Overdraft Honor” program permits selected clients to overdraft their accounts up to $500 for the Bank’s customary fee. Customers’ checking accounts that have been current for a certain period of time are allowed the privilege to enter into the program. This service is not considered extending credit and is considered providing the customer of the Bank with a service of paying checks for a fee when sufficient funds are not available. This fee, if computed as a percentage of the amount overdrawn, can sometimes result in an extremely high rate of interest and thus be considered excessive by some consumer groups. There can be no assurance, however, that the FDIC or others will not impose limitations on this program or that the Bank’s ability to engage in the product will not be negatively impacted by federal or other regulatory authorities. The Company, altering or eliminating this program, either voluntarily or involuntarily, would significantly reduce earnings. Republic’s stock price can be extremely volatile. The Company’s stock price can fluctuate widely in response to a variety of factors. Factors include, actual or anticipated variations in the Company’s quarterly operating results, recommendations by securities analysts, new technologies, operating and stock price performance of other companies, news reports and changes in government regulations, just to name a few. The Company also has a low average daily trading volume, which limits a person’s ability to quickly accumulate or quickly divest himself/herself of Republic’s stock. daily trading volume can lead to large price swings based on a relatively few number of shares being traded. In addition, a low average HIGHLIGHTS Net income for 2003 was $28.2 million, representing an increase of $7.7 million over 2002. Diluted earnings per Class A Common Stock increased 37% for the year to $1.64. Republic’s rise in earnings was primarily due to increased net interest income including deferred deposit transaction, gain on sale of mortgage loans, service charges on deposit accounts and increased earnings at Refunds Now (as described below). Following is a brief description of a few Company highlights during 2003: 1) Republic’s total assets surpassed $2 billion during the year ending 2003 with $2.1 billion in total assets. As of December 31, 2003, Republic was the second largest independently-owned, Kentucky-based bank holding company. 2) Net interest income grew 28% during the year as the Company continued to benefit from a decline in short-term market interest rates combined with growth in the loan portfolio, particularly in residential real estate loans, deferred deposit transactions and RALs. The Company continued a program in 2003 of retaining fixed rate resi- dential real estate loans and funding the loans with long-term Federal Home Loan Bank (“FHLB”) advances and brokered CDs with laddered maturities while achieving an approximate spread of 2.00%. 3) Republic reported another strong year in its mortgage banking operations as favorable long-term market interest rates, coupled with the Company’s promotion of its “$999” maximum closing cost product, led to strong gains on the sale of 1-4 family, fixed rate residential real estate loans into the secondary market. Altogether, the Company sold over $850 million in secondary market loans during 2003. I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 25 4) Refunds Now reported record earnings during 2003 due to a substantial increase in transaction volume related to new sales and a shift in product mix to more RAL products. Overall, the number of tax preparers serviced by Refunds Now during 2003 increased 79% over 2002 to 5,600 tax offices. 5) Republic opened six new banking centers during 2003 with three additional locations under construction that are scheduled to open early in 2004. 6) Service charges on deposit accounts increased significantly during the year as the Company’s checking accounts grew by nearly 10,000 accounts. A large number of these new accounts were added in conjunction with the Company’s promotion of its “$999” maximum closing cost, fixed rate mortgage product, which requires a primary checking account to receive the favorable fixed closing cost. Service charges on deposit accounts also benefited from accounts opened at Republic’s six new banking centers during 2003 and from the growth in the number of accounts eligible for the Company’s “Overdraft Honor” program. 7) Loans increased $272 million or 21% as Republic retained approximately $180 million in fixed rate residential real estate loans, which the Company traditionally sold into the secondary market. Republic also achieved a $56 million increase in home equity loans outstanding as the Company added over 5,000 new home equity lines of credit during 2003. These new lines of credit primarily originated from cross-selling opportunities created in conjunction with the Company’s “$999” mortgage product. 8) The Company grew its deferred deposit transactions outstanding to $28 million at December 31, 2003. Republic reported net income during 2002 of $20.5 million compared to $16.8 million for 2001, an increase of 22%. Diluted earnings per Class A Common Stock shares increased 19% to $1.20 for the year ended December 31, 2002. On a percentage basis, the increase in diluted earnings per Class A Common Stock increased less than net income primarily due to the conversion of Republic’s guaranteed preferred beneficial interests in the Company’s subordinated debentures. The rise in earnings for 2002 was primarily attributable to increased net interest income, increased income associated with Refunds Now, gains on the sale of loans into the secondary market and service charges on deposits. Republic’s book value increased from $7.77 at December 31, 2001 to $8.96 per share at December 31, 2002. The following table summarizes selected financial information regarding Republic’s financial performance: Table 1 – Summary Years Ended December 31, (dollars in thousands) Net income Diluted earnings per Class A Common Stock Return on average assets (ROA) Return on average equity (ROE) CRITICAL ACCOUNTING POLICIES AND ESTIMATES 2003 $ 28,203 1.64 1.47% 16.88 2002 $ 20,489 1.20 1.25% 14.44 2001 $ 16,808 1.01 1.10% 13.85 Republic’s consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America. 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 it uses to prepare the consolidated financial statements. In general, management’s estimates are based on historical experience, on information from regulators and third party professionals and on various assumptions that are believed to be reasonable. Actual results could 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 results, and require management to make estimates that are difficult, subjective or 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 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 third parties or available pricing, sensitivity of the estimates to changes in economic conditions and whether alternative methods of accounting may be utilized under accounting principles generally accepted in the United States of America. Management has discussed the identification and determination of critical accounting policies with the Company’s Audit Committee. Republic believes its critical accounting policies and estimates include the valuation of the allowance for loan losses and mortgage servicing rights. I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 26 Allowance for Loan Losses – Republic maintains an allowance for probable credit losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses on a quarterly basis and regularly presents and discusses the analysis with the Audit Committee and the board of directors. Management estimates the allowance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower capacity, estimated collateral values, economic conditions, regulatory requirements and guidance and other factors. While management estimates the allowance for loan losses, in part, based on historical losses within each loan category, estimates for losses within the commercial real estate portfolio are more dependent upon credit analysis and recent payment performance. Allocations of the allowance may be made for specific loans or loan categories, but the entire allowance is available for any loan that may be charged off. Loan losses are charged against the allowance at the point when management deems a loan uncollectible. Management makes allocations within the allowance for specifically classified loans regardless of loan amount, collateral or loan type. Loans that are past due 90 days or more and that are not specifically classified are uniformly assigned a risk-weighted percentage ranging from 15% to 100% of the loan balance based upon loan type. Management evaluates the remaining loan portfolio by utilizing the historical loss rate for each respective loan type. Both an average five-year loss rate and a loss rate based on heavier weighting of the previous two years’ loss experience are utilized in the analysis. Specialized loan categories are evaluated by utilizing subjective factors in addition to a historical loss calculation to determine a loss allocation for each of those types. Because this analysis or any similar analysis is an imprecise measure of loss, the allowance is subject to ongoing adjustments. Therefore, management will also take into account other significant factors as may be necessary or prudent in order to reflect probable incurred losses in the total loan portfolio. Based on management’s calculation, an allowance of $14 million or 0.88% of total loans was an adequate estimate of losses within the loan portfolio as of December 31, 2003. This estimate resulted in a provision for loan losses on the income statement of $6.6 million during 2003. If the mix and amount of future charge off percentages differ significantly from those assumptions used by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement could be materially affected. Mortgage Servicing Rights – Mortgage servicing rights (“MSRs”) represent an estimate of the present value of future cash servicing income, net of estimated costs that Republic expects to receive on loans sold with servicing retained by the Company. MSRs are capitalized as separate assets when loans are sold and servicing is retained. This transaction is posted to net gain on sale of loans, a component of mortgage banking income. The carrying value of MSRs is amortized in proportion to, and over the period of, net servicing income. The amortization is recorded as a reduction to mortgage banking income. The total MSR asset, net of amortization, recorded at December 31, 2003 is $5 million. The carrying value of the MSRs asset is periodically reviewed for impairment based on the fair value of the MSRs, using groupings of the underlying loans by interest rates and by geography and prepayment characteristics. Any impairment of a grouping would need to be reported as a valuation allowance. 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 should decline due to expected prepayments within the portfolio. Alternatively, during a period of rising interest rates the fair value of MSRs should increase as prepayments on the underlying loans would be expected to decline. Management utilizes an independent third party on a quarterly basis to assist with the fair value estimate of the MSRs. Based on the estimated fair value at December 31, 2003 and 2002, management determined no impairment of these assets existed. On an ongoing basis, management considers all relevant factors, in addition to pricing considerations from other servicers, to estimate the fair value of the MSRs to be recorded when the loans are initially sold with servicing retained by the Company. DEFERRED DEPOSIT TRANSACTIONS Deferred deposits are transactions whereby customers typically receive cash advances in exchange for a check for the advanced amount plus a fixed fee (commonly referred to as a “payday loan” or “payday lending”). Republic agrees to delay presentment of the check for payment until the advance due date, typically 14 to 31 days from the cash advance date. On or before the advance due date, the customer can redeem his or her check in cash for the amount of the advance plus the If the customer does not reclaim the check in cash by the advance due date, the check is deposited. Based on fee. accounting principles generally accepted in the United States of America, these transactions are recorded as loans on the Company’s financial statements and the corresponding fees are recorded as a component of interest income on loans. The Company has been conducting a deferred deposit transaction business, in conjunction with third party marketer/servicers since August 2001. party marketer/servicers in order to increase its deferred deposit transaction business. During 2003, the Company further expanded its relationship with one of its marketer/servicers that contributed to a substantial increase in deferred deposit transactions. Total outstandings were $28 million at December 31, 2003 compared to $3 million at December 31, 2002. Management anticipates deferred deposit transactions outstanding will decrease by the end of the first quarter of 2004 due In the fourth quarter of 2002, the Company entered into contracts with two third I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 27 to seasonality, but does not believe the decrease will exceed 25% of deferred deposit outstandings at December 31, 2003. FDIC guidance issued in July 2003 requires that banks limit deferred deposit transaction outstandings to the lesser of 25% of Tier I capital or the amount that actual capital levels exceed the “well-capitalized” classification for Tier I and total capital. Based on the Bank’s capital levels at year end, deferred deposit transaction outstandings were well below the Bank’s regulatory limit of $40 million. The marketer/servicers with which the Company does business have at times experienced legal and or regulatory obstacles in some states in which they do business. their ability to conduct business without a financial institution partner. effectively prohibited national banks from conducting this business. This has provided opportunities for certain state- chartered commercial banks to enter the business and increase earnings with acceptable capital outlays. In addition, the Comptroller of the Currency has In these states, laws have been enacted or amended to prohibit or limit The legal and regulatory climate for this product also continues to change. The FDIC’s final guidance issued in July 2003 characterizes deferred deposit transactions as presenting substantial credit risks for lenders, because among other things, the loans are unsecured and the borrower generally has limited financial resources as well as increased transaction, legal and reputation risks when a third party arrangement is used. This guidance proposes, among other items, that banks hold significantly more capital than would be required for other sub-prime type loans, suggesting required capital of as much as 100% of deferred deposit transactions outstanding. The guidance also requires that the allowance for loan and lease losses be adequate and take into account that many such transactions remain outstanding beyond their initial term due to renewals and rollovers, that deferred deposit transactions be classified “substandard,” and that transactions outstanding for more than 60 days generally be classified as “loss.” The guidance also prescribes limits on the ability of a borrower to renew or rollover a deferred deposit transaction and on the number of transactions that can be entered into with an individual customer within a given period of time. The guidance requires examiners to assess the bank’s risk management program for third party marketing and servicing relationships, including the bank’s due diligence process for selecting third party marketing and servicing providers and its monitoring of the third party’s activities and performance. Banks are also advised to carefully evaluate compliance with consumer protection laws and applicable regulations. The Company believes that it has adequately considered and addressed the risks associated with its deferred deposit transaction business, including the risks discussed in the FDIC guidelines and that the Company’s size, technological resources and experience in the successful management of non-traditional product lines, among other factors, will enable the Company to effectively manage and control its participation in the deferred deposit transaction business. There can be no assurance, however, that the FDIC or others will not impose additional limitations on or prohibit banks from engaging altogether in deferred deposit transactions, that private litigation might not result from the program, or that the Bank’s ability to continue to engage in the business profitably or at all will not be negatively impacted by the requirements of applicable laws, regulations or guidelines. REFUNDS NOW ® Refunds Now is a tax refund processing service for taxpayers receiving both federal and state tax refunds through tax preparers located nationwide. RALs are made to taxpayers filing income tax returns electronically. The RALs are repaid by the taxpayer when the taxpayer’s refunds are electronically received by the Bank from governmental taxing authorities. Refunds Now also provides ERCs and electronic refund deposits (“ERDs”) to taxpayers. After receiving refunds electronically from governmental taxing authorities, a check or a direct payment to the taxpayer’s account is issued for the amount of the refund, less fees. For 2003, Refunds Now generated $6.7 million in RAL fees, compared to $3.3 million for the same period in 2002. Refunds Now also received $4.0 million in ERC fees during 2003, compared to $3.2 million during 2002. The total volume of tax return refunds processed during the 2002 tax season was $1.1 billion (approximately $250 million in RALs and $850 Internal analysis of government tax million in ERCs), a 48% increase over the volume processed for the 2001 tax season. refund payments to recipients not approved for a RAL during the 2002 tax season resulted in an increase in the number of RAL applications approved during the 2003 tax season. This resulted in a shift in product mix toward the RAL product. In addition, the total number of tax preparers served by Refunds Now during 2003 increased 79% over 2002. Overall, RAL volume increased 81% during 2003 compared to 2002 while ERC volume rose 102% for the same period. RESULTS OF OPERATIONS Net Interest Income The principal source of Republic's revenue is net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, such as interest-bearing deposits and borrowings. 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. I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 28 For 2003, net interest income was $82.3 million, up $17.9 million over 2002. The Company was able to increase its net interest income primarily through increased loan volume and a reduction in the Company’s cost of funds. Fees from deferred deposit transactions, which increased $7.4 million over the $156,000 recognized during 2002 and fees from RALs, which increased $3.4 million over the $3.3 million recognized during 2002, were major components of the overall increase for 2003. The Company also experienced an increase in net interest income as a result of growth in the loan portfolio, resulting primarily from the retention of nearly $240 million in fixed-rate residential real estate loans since October 2002. Overall, the Company’s net interest spread and net interest margin were higher in 2003 compared to 2002. The increase in spread and margin resulted from a sharp decrease in cost of funds without a corresponding decrease in yield on interest-earning assets. Republic was able to minimize the decrease in its yield on interest-earning assets primarily through increased fees from deferred deposit transactions and RALs. While the Company believes that these fees will continue for the foreseeable future, as stated above, there is regulatory risk and other risk inherent in these sources of income which could limit their future availability. During 2003, the Company also began to experience compression of its net interest spread and margin. This resulted primarily from the $240 million in residential real estate loans that were retained and funded by fixed rate FHLB borrowings and brokered deposits achieving a spread of approximately 2.00%. Net interest spread and margin also experienced compression during the fourth quarter of 2003, as Republic invested excess cash on a short-term basis in order to mitigate the potential impact of future interest rate increases on net interest income. Management anticipates that the Company’s net interest margin and net interest spread will increase significantly during the first quarter of 2004 compared to the fourth quarter of 2003 due to seasonal RAL activity at Refunds Now. Because RAL volume occurs primarily in the first quarter, the net interest spread and net interest margin for the remainder of 2004 will decline subsequent to the first quarter and could likely be lower than the corresponding periods in 2003. Republic’s cost of funds decreased 74 basis points for 2003 compared to 2002. This decrease was primarily the result Interest of lower borrowing costs from the FHLB and lower interest expense associated with certificates of deposit (“CDs”). expense on FHLB borrowings decreased for the year due to the maturity or early payoff of approximately $115 million of advances with a weighted average cost of 6.29% subsequent to the second quarter of 2002. decreased significantly due to the availability of lower cost funding sources that allowed the Company to generally lower pricing on its CD product offerings. As a result of strategic CD pricing, the Company’s overall average CD balances declined during 2003. Interest expense on CDs I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I For 2002, net interest income was $64.3 million, up $4.8 million over the $59.5 million attained during 2001. Factors that effected net interest income in 2002 were different than those that affected it in 2003. Republic was primarily able to increase its net interest income through balance sheet growth, particularly growth in mortgage backed securities (“MBSs”) and loans. While the loan portfolio decreased slightly during the first six months of 2002, the Company experienced strong growth in the loan portfolio during the last six months of 2002, principally in residential real estate loans, commercial real estate loans and home equity lines of credit. Cash received during 2002 from the sale of loans into the secondary market as well as sales, calls and prepayments on investment securities was reinvested by the Company into MBSs. The increases in the balances of loans and MBSs were the significant factors in the Company’s overall increase in net interest income during 2002 compared to 2001. Although, net interest income was higher during 2002 compared to 2001, continued downward repricing of the Bank’s adjustable rate mortgage portfolio and the prepayment of higher yielding portfolio loans limited the Company’s ability to increase net interest income through changes in rate. To help mitigate this, management elected to retain $60 million in fixed rate, 15-year residential real estate loans in October 2002. The Company funded these loans through FHLB borrowings with terms of two to six years. Achieving a spread of approximately 2.25% on this $60 million positively affected the Company’s net interest income but negatively impacted the Company’s net interest spread and net interest margin. The Company also sold approximately $56 million in MBSs and collateralized mortgage obligations (“CMOs”) during 2002 in anticipation of rapid prepayments due to declining long-term market interest rates. These securities had a bond equivalent yield of 5.55% at the time of sale. As an additional response to declining long-term market interest rates and in order to reduce future borrowing costs, Republic prepaid a $25 million advance during 2002 from the FHLB with a coupon of 6.40%. 29 I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I Table 2 provides detailed information as to average balances, interest income/expense and rates by major balance sheet category for 2001 through 2003. Table 3 provides an analysis of the changes in net interest income attributable to changes in rates and changes in volume of interest-earning assets and interest-bearing liabilities. Table 2 – Average Balance Sheets and Interest Rates for Years Ended December 31, (dollars in thousands) ASSETS Earning assets: Investment securities Federal funds sold and other Total loans and fees(1) Total earning assets Average Balance 2003 Interest Average Rate Average Balance 2002 Interest Average Rate Average Balance 2001 Interest Average Rate $ 316,642 26,792 1,485,024 $ 11,136 279 107,645 3.52% $ 1.04 7.25 307,852 53,560 1,220,046 $ 13,060 887 92,154 4.24% $ 253,127 34,254 1.66 1,185,945 7.55 $ 13,926 1,146 102,324 5.50% 3.35 8.63 1,828,458 119,060 6.51 1,581,458 106,101 6.71 1,473,326 117,396 7.97 Less: Allowance for loan losses 12,305 Non-earning assets: Cash and cash equivalents Premises and equipment, net Other assets 54,422 29,290 22,928 9,125 30,181 21,298 15,985 8,061 27,756 19,462 12,497 Total assets $ 1,922,793 $ 1,639,797 $ 1,524,980 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Transaction accounts Money market accounts Individual retirement accounts Certificates of deposits and other time deposits Brokered deposits Repurchase agreements and other short-term borrowings Federal Home Loan Bank borrowings $ 266,316 253,942 39,454 $ 2,263 2,193 1,464 0.85% $ 0.86 3.71 168,414 $ 1,639 2,992 222,373 1,665 36,713 0.97% $ 100,055 225,830 1.35 33,612 4.54 $ 1,101 7,737 1,972 1.10% 3.43 5.87 364,560 52,094 189,984 363,656 12,812 1,212 1,897 14,954 3.51 2.33 1.00 4.11 383,450 891 225,671 291,756 16,485 38 3,246 15,696 4.30 4.26 1.44 5.38 379,057 - 21,896 - 251,068 282,879 8,529 16,682 5.78 - 3.40 5.90 Total interest-bearing liabilities 1,530,006 36,795 2.40 1,329,268 41,761 3.14 1,272,501 57,917 4.55 Non interest-bearing liabilities and stockholders’ equity: Non interest-bearing deposits Other liabilities Stockholders' equity 196,442 29,248 167,097 150,481 18,140 141,908 116,409 14,748 121,322 Total liabilities and stockholders' equity Net interest income Net interest spread Net interest margin $ 1,922,793 $ 1,639,797 $ 1,524,980 $ 82,265 $ 64,340 $ 59,479 4.11% 4.50% 3.57% 4.07% 3.42% 4.04% (1) The amount of fee income included in interest on loans was $17,280, $5,512 and $5,593 for the years ended December 31, 2003, 2002 and 2001. 30 Table 3 illustrates the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities affected 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) the 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 – Volume/Rate Variance Analysis Year Ended December 31, 2003 compared to Year Ended December 31, 2002 Increase/(Decrease) Year Ended December 31, 2002 compared to Year Ended December 31, 2001 Increase/(Decrease) (in thousands) Interest income: Investment securities Federal funds sold and other Total loans and fees Total Net Change $ (1,924) (608) 15,491 Due To Volume Rate $ 364 (349) 19,334 $ (2,288) (259) (3,843) Total Net Change $ (866) (259) (10,170) $ 2,676 474 2,874 Due To Volume Rate Total increase (decrease) in interest income 12,959 19,349 (6,390) (11,295) 6,024 Interest expense: Transaction accounts Money market accounts Individual retirement accounts Certificates of deposit and other time deposits Brokered deposits Repurchase agreements and other short-term borrowings Federal Home Loan Bank borrowings Total increase (decrease) in interest expense 624 (799) (201) (3,673) 1,174 (1,349) (742) (4,966) 854 382 118 (781) 1,199 (460) 3,402 4,714 (230) (1,181) (319) (2,892) (25) (889) (4,144) (9,680) 538 (4,745) (307) (5,411) 38 (5,283) (986) (16,156) 678 (117) 170 251 38 (789) 511 742 $ (3,542) (733) (13,044) (17,319) (140) (4,628) (477) (5,662) - (4,494) (1,497) (16,898) I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I Increase (decrease) in net interest income $ 17,925 $ 14,635 $ 3,290 $ 4,861 $ 5,282 $ (421) Non Interest Income Table 4 - Analysis of Non Interest Income Year Ended December 31, (dollars in thousands) Service charges on deposit accounts Electronic refund check fees Title insurance commissions Mortgage banking income Net gain on sale of securities Debit card interchange fee income Other Total *Not meaningful 2003 $ 10,672 3,981 2,532 11,104 - 1,825 819 2002 $ 8,314 3,198 2,129 6,894 1,559 1,441 987 $ 30,933 $ 24,522 2001 $ 6,267 2,087 1,515 6,438 1,864 1,020 550 $ 19,741 Percent Increase/(Decrease) 2002/2001 2003/2002 28% 24 19 61 NM* 27 (17) 26% 33% 53 41 7 (16) 41 79 24% Service charges on deposit accounts increased 28% during 2003 compared to 2002. The increase was due primarily to growth in the Company’s checking account base supported by the Bank’s “Overdraft Honor” program, which permits selected clients to over- draft their accounts up to $500 for the Bank’s customary fee. Total overdraft fees increased from $6.5 million in 2002 to $8.3 million in 2003 while the total number of accounts eligible for the “Overdraft Honor” program increased to 43,000 at December 31, 2003 from 32,000 at December 31, 2002. Additionally, the Company’s total number of checking accounts, exclusive of commercial accounts, increased from 45,000 at December 31, 2002 to 54,000 at December 31, 2003. The increase in the number of retail checking accounts was primarily attributable to the continued success of the Company’s “$999” maximum closing cost, secondary market loan product, which requires a primary checking account in order for the customer to receive the discounted closing fees. A decrease in volume of the “$999” program could negatively impact the number of new Company checking accounts. Conversely, Republic’s checking account base is expected to be positively impacted by accounts opened at the Company’s newest banking centers, direct mail solicitations and other marketing initiatives. Republic opened six new banking centers in 2003 and plans to open three new banking centers in early 2004. 31 I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I Electronic refund check (ERC) fees, the majority of which are received during the first quarter of the year, increased $783,000 in 2003. This increase was due primarily to the increase in overall ERC volume compared to the prior year resulting from successful marketing efforts and an increase in the number of tax preparers. The Company also experienced significant growth in ERC fees during 2002 compared to 2001 due primarily to the same reasons. Title insurance commissions increased $403,000 for the year ended December 31, 2003, compared to the same period in 2002. Title insurance commissions are earned when title insurance policies are sold to clients in conjunction with newly originated real estate secured loans. Since a substantial portion of these commissions are earned on policies relating to single family 1-4 family, secondary market real estate loans, the income closely correlates to secondary market loan origination volume, which was $863 million during 2003 compared to $791 million during 2002. Management anticipates that title insurance commissions will decline in the first quarter of 2004 due to an expected reduction in secondary market loan volume. Title insurance commissions increased $614,000 for 2002 over 2001. The large volume of refinance activity in 1-4 family, secondary market real estate loans during this period contributed to the increase for the year ended December 31, 2002. Mortgage banking income includes net gain on sale of loans, loan servicing income and amortization of MSRs. Mortgage banking income increased $4.2 million during 2003 due primarily to a $5.7 million increase in net gain on sale of loans resulting from the higher volume of loans sold into the secondary market. This higher volume of loans sold in 2003 resulted from aggressive marketing of the Company’s “$999” loan product and sustained consumer demand for fixed rate, first mortgage residential loan products due to historically low market interest rates through the first six months of the year. This demand began to decline substantially during the third quarter of 2003 reaching more traditional lower levels during the fourth quarter of 2003. As a percentage of loans sold, net gains increased to 1.47% in 2003 compared to 0.92% in 2002. The increase in gains as a percentage of loans sold primarily occurred in the first six months of 2003. During the first six months of 2003, interest rates declined sharply, reaching historic lows in mid-June. The Company was able to increase the gain on sale margins during this declining interest rate environment by selling directly to end investors achieving higher premiums. In 2004, the Company does not expect gains as a percentage of loans sold to reach the level attained in 2003 due to higher coverage ratios as well as more competitive pricing to help maintain market share. Overall, the Bank originated nearly $800 million in mortgage loans held for sale during 2003 compared to $791 million during 2002. The increase in net gain on sale of loans during 2003 was partially offset by a $2 million increase in amortization expense of MSRs. This increase primarily resulted from two factors. First, management elected to sell a higher percentage of loans with servicing retained in 2003 resulting in a larger MSR asset to be amortized compared to 2002. Secondly, a declining interest rate environment during the first six months of 2003 shortened the estimated life of the expected future servicing income due to projected prepayments on the underlying loans. Mortgage banking income increased 7% during 2002 as declining market interest rates prompted an increase in consumer refinance activity of 1-4 family, fixed rate residential loans. Revenue from mortgage banking activities, principally gains on sale of loans, increased as a result of higher secondary market sales volume. As a percentage of loans sold, net gains on sale decreased to 0.92% in 2002 compared to 1.20% in 2001. The decrease in gains as a percentage of loans sold was primarily attributable to management’s decision to offer more competitive pricing on its fixed rate, residential real estate products in order to gain market share. Overall, the Bank originated $791 million in mortgage loans held for sale during 2002 compared to $548 million during 2001. Net gain on sale of securities available for sale was $1.6 million for 2002 compared to $1.9 million during 2001. Management elected to sell $56 million of the Company’s MBSs during 2002 to mitigate the risk of the projected prepayment of these securities. Non Interest Expenses Table 5 – Analysis of Non Interest Expenses Year Ended December 31, (dollars in thousands) Salaries and employee benefits Occupancy and equipment, net Communication and transportation Marketing and development Bankshares tax Supplies Federal Home Loan Bank prepayment penalties Outsourced technology services Other 2003 $ 32,144 12,416 2,729 3,037 1,980 1,481 - 1,722 7,350 2002 $ 28,039 9,984 2,329 2,934 1,727 1,139 1,381 1,575 4,731 Total $ 62,859 $ 53,839 2001 $ 25,943 9,073 2,319 2,839 1,513 1,170 1,049 1,134 5,300 $ 50,340 Percent Increase/(Decrease) 2002/2001 2003/2002 15% 24 17 4 15 30 NM 9 55 17% 8% 10 - 3 14 (3) 32 39 (11) 7% 32 The increases in salaries and benefits as well as occupancy and equipment were primarily attributable to banking center expansion. Republic opened two banking centers during the third quarter of 2002 and six banking centers during 2003. The Company also hired additional support staff to service the new banking center expansion activities. Total full time equivalent employees (FTE’s) increased to 645 at December 31, 2003 from 570 at December 31, 2002. Salary and employee benefits also increased for 2002 compared to 2001. The increase was primarily attributable to annual merit increases and associated incentive compensation accruals, additional seasonal staff at Refunds Now and a modest increase in staff to support secondary market origination volume. Total FTE’s increased to 570 at December 31, 2002 from 532 at December 31, 2001. The Company recognized prepayment penalties of $1.4 million and $1.0 million on the early termination of advances from the FHLB during 2002 and 2001. The Company elected to incur these penalties in order to refinance a portion of its advances from the FHLB into lower cost borrowings with extended maturities, taking advantage of the favorable interest rate environment at the time. Other expenses increased $2.6 million during 2003. The increase was primarily related to credit underwriting costs and correspondent banking expenses associated with the Company’s deferred deposit program. FINANCIAL CONDITION Loan Portfolio Net loans, primarily consisting of secured real estate loans, increased by $268 million to $1.6 billion at December 31, 2003. Commercial real estate loans, which comprise 28% of the total loan portfolio at December 31, 2003, are concentrated primarily within the Bank’s existing markets. These loans are principally secured by multi-family investment properties, 1-4 family developments, medical facilities, small business owner occupied offices, retail properties and hotels. These loans typically have interest rates that are initially fixed for one to seven years with the remainder of the loan term subject to repricing based on various market indices. during a declining interest rate environment, the Company requires an early termination penalty on substantially all commercial real estate loans for a portion of the fixed-term period. Overall, commercial real estate loans increased $29 million from December 31, 2002. During 2003, Republic maintained its underwriting standards, which typically includes personal guarantees on most commercial real estate loans. Pricing requirements, as well as the Company’s underwriting requirements, led to competitive pressure during 2003. As a result, the commercial real estate portfolio experienced modest growth compared to prior years. In order to reduce the negative effect of refinance activity within the portfolio Similar to commercial real estate loans, residential real estate loans that are not sold into the secondary market typically have fixed interest rate periods of one to seven years with the remainder of the loan term subject to repricing based on various market indices. These loans also typically carry early termination penalties during a portion of their fixed rate periods in order to lessen the overall negative effect to the Company of refinancing in a declining interest rate environment. Despite early termination penalties on many of its portfolio residential real estate loans, the Company experienced a high level of refinance activity into fixed rate secondary market products during 2003. However, residential real estate loans increased by $162 million during 2003 due to management’s election to retain three separate pools of secondary market eligible loans totaling $180 million. The total amount retained over the most recent fifteen-month period totaled approximately $240 million. To fund these loans and mitigate the interest rate risk on this portion of the residential real estate loan portfolio, the Company borrowed $125 million in FHLB advances with maturities ranging from one to five years and $46 million in brokered CDs with maturities ranging from one to five years. Management anticipates earning an approximate spread of 2.00% on these transactions, which will positively affect the Company’s net interest income in 2004 but will negatively impact the Company’s net interest spread and net interest margin. The consumer loan portfolio principally consists of various short-term, unsecured loans to individual clients. Also included in this category are deferred deposit transactions, which are considered loans under accounting principles generally accepted in the United States of America. The Company had approximately $28 million in deferred deposit transactions outstanding at December 31, 2003 compared to $3 million at December 31, 2002. Home equity loans, substantially all approved at no more than 100% of loan to value, increased from $159 million at December 31, 2002 to $215 million at December 31, 2003. The rise in outstandings was primarily the result of increased cross-sale opportunities in conjunction with the origination of fixed rate, secondary market loan products as part of the Company’s “partnership package.” As part of the package, the Company’s fixed rate, secondary market loan clients are usually approved for a home equity line of credit. The Company increased the number of home equity lines of credit during 2003 by 35%. At December 31, 2003, Republic clients had $207 million of home equity line balances available for funding. I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 33 I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I In addition to changes in the traditional loan portfolio, loans serviced for others by Republic increased from $283 million at December 31, 2002, to $732 million at December 31, 2003. Loans serviced for others consists of loans Republic has sold into the secondary market while retaining the servicing of the loans. Prior to 2003, Republic sold a substantial portion of its loans into the secondary market including the corresponding servicing of the loan. Beginning in 2003, Republic began selling a large portion of its loans directly to third party governmental agencies, which do not purchase the servicing component of the loan. Management elected to utilize this strategy due to more favorable pricing received from the governmental agencies, as well as faster funding to the Company for the loans sold. Management will continue to evaluate the feasibility of selling or retaining the servicing component to third parties. Table 6 – Loans by Type As of December 31, (in thousands) Real estate: Residential Commercial Construction Commercial Consumer Home Equity Total Loans 2003 2002 2001 2000 1999 $ 762,000 442,083 70,897 34,553 58,034 215,088 $ 597,797 413,115 68,020 33,341 39,347 159,261 $ 571,959 360,056 70,870 30,627 26,905 125,360 $ 633,328 256,834 77,437 30,008 32,662 115,467 $ 636,012 163,064 63,928 31,411 42,408 103,833 $ 1,582,655 $ 1,310,881 $ 1,185,777 $ 1,145,736 $ 1,040,656 Mortgage loans held for sale is primarily comprised of fixed rate, 1-4 family residential loans the Company intends to sell into the secondary market. Although management elected to retain three separate pools of secondary market eligible loans in 2003, it has traditionally been the Company’s strategy to sell the majority of its fixed rate 1-4 family residential loans into the secondary market in order to reduce its exposure to market interest rate risk. At December 31, 2003, mortgage loans held for sale was down significantly from $66 million at year end 2002 to $14 million at year end 2003 due to slow- down in refinancing activity resulting from rising interest rates during the second half of 2003. As a result of Republic’s mortgage banking operations, certain loan commitments are accounted for as derivatives. In addition, Republic enters into agreements to sell loans for amounts and terms offsetting the interest rate risk of loans held for sale and loan commitments expected to close. These agreements to sell loans are also accounted for as derivatives. Sales contract derivatives are entered into for amounts and terms offsetting the interest rate risk of loan commitment derivatives. Both derivatives are carried at fair value with their changes in fair value included in earnings, which substantially offset each other. Substantially all of the gain on sales generated from mortgage banking activities continues to be recorded when closed loans are delivered into the sales contracts. Table 7 illustrates Republic's fixed rate maturities and repricing frequency for the loan portfolio: Table 7 – Selected Loan Distribution As of December 31, 2003 (in thousands) Total Fixed rate maturities: Real estate: Residential Commercial Construction Commercial Consumer Home equity Total fixed Variable rate repricing: Real estate: Residential Commercial Construction Commercial Consumer Home equity Total variable 34 $ 277,680 30,739 1,062 13,452 47,249 1,915 $ 372,097 $ 484,320 411,344 69,835 21,101 10,785 213,173 $ 1,210,558 One Year Or Less $ 14,668 5,711 961 7,144 35,633 451 $ 64,568 $ 218,745 153,282 69,619 21,101 8,742 213,173 $ 684,662 Over One Through Five Years Over Five Years $ 59,920 9,045 85 5,976 4,472 514 $ 80,012 $ 248,520 246,164 216 - 2,043 - $ 496,943 $ 203,092 15,983 16 332 7,144 950 $ 227,517 $ 17,055 11,898 - - - - $ 28,953 Allowance and Provision for Loan Losses The Company’s provision for loan losses increased from $3.3 million for 2002 to $6.6 million for 2003. Included in the provision for loan losses were $1.9 million and $47,000 for RALs during 2003 and 2002. The increase in provision associated with RALs during 2003 was primarily the result of the significant increase in RAL losses, which was mostly due to increased volume. The increase in the provision, exclusive of Refunds Now, during 2003 was primarily due to an increase in certain classified commercial real estate loans and deferred deposit transactions. For the twelve months ended December 31, 2002, the Included in the provision for provision for loan losses was $3.3 million compared to $3.5 million during the year of 2001. loan losses was $47,000 and $1.1 million for RALs during 2002 and 2001. The substantial decrease in losses associated with RALs during 2002 was primarily the result of a significant reduction of errors in information received from government entities, which is used to underwrite RALs. The Company also received better than expected collection of prior year losses. This is largely due to the unusually high charge offs experienced during 2001 that in turn led to increased recovery opportunities during the 2002 tax season. The total allowance for loan losses increased $3.8 million from December 31, 2002 to $14 million at December 31, 2003. The increase in the allowance for loan losses was due to growth in commercial real estate lending, an overall change in the product mix within the loan portfolios and the increase in non-performing loans. Management believes, based on information presently available, that it has adequately provided for loan losses at December 31, 2003. Management continues to closely monitor the commercial real estate loan portfolio in detail, recognizing that commercial real estate loans generally carry a greater risk of loss than residential real estate loans. (For discussion of Republic’s methodology for determining the adequacy of the allowance for loan losses, see section on Critical Accounting Policies and Estimates.) Table 8 – Summary of Loan Loss Experience Year Ended December 31, (dollars in thousands) Allowance for loan losses at beginning of year 2003 $ 10,148 2002 $ 8,607 2001 $ 7,862 2000 $ 7,862 1999 $ 7,862 Charge offs: Real estate: Residential Commercial Construction Commercial Consumer Home equity Tax refund loans Total Recoveries: Real estate: Residential Commercial Construction Commercial Consumer Home equity Tax refund loans Total Net loan charge offs Provision for loan losses (670) (1,223) (135) (50) (155) (994) (2,300) (5,527) 448 1,074 300 100 26 366 450 2,764 (2,763) 6,574 (706) (420) (255) (444) (705) (164) (1,482) (4,176) 88 159 12 271 412 2 1,435 2,379 (1,797) 3,338 (798) (703) (8) (114) (818) (182) (1,550) (4,173) 40 313 - 24 502 65 481 1,425 (2,748) 3,493 Allowance for loan losses at end of year $ 13,959 $ 10,148 $ 8,607 (241) (571) (115) (51) (734) (78) (500) (2,290) 34 5 - 15 616 9 229 908 (404) (77) (61) (97) (1,508) (51) (200) (2,398) 15 - - 8 557 - 12 592 (1,382) 1,382 $ 7,862 (1,806) 1,806 $ 7,862 Ratios: Allowance for loan losses to total loans Net loan charge offs to average loans outstanding for the period Allowance for loan losses to non-performing loans 0.88% 0.77% 0.73% 0.69% 0.76% 0.19 108 0.15 103 0.23 154 0.12 193 0.19 213 I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 35 Table 9 depicts management's allocation of the allowance for loan losses by loan type. The allowance allocation is based on management's assessment of economic conditions, past loss experience, loan volume, past due history and other factors. Since these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance. Table 9 – Management's Allocation of the Allowance for Loan Losses 2003 2002 2001 Percent of Loans to Total Loans 48% 28 4 2 4 14 Percent of Loans To Total Loans 46% 31 5 3 3 12 Allowance $ 892 5,761 759 458 647 90 Percent of Loans To Total Loans 48% 30 6 3 2 11 Allowance $ 1,283 6,986 764 322 700 93 Allowance $ 1,502 8,935 805 325 2,263 129 $ 13,959 100% $ 10,148 100% $ 8,607 100% As of December 31, (dollars in thousands) Real estate: Residential Commercial Construction Commercial Consumer Home Equity Total Asset Quality Loans, including impaired loans under SFAS 114, excluding consumer loans, are placed on non-accrual status when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in the process of collection. When loans are placed on non-accrual status, all unpaid accrued interest is reversed. These loans remain on non-accrual status until the borrower demonstrates the ability to remain current or the loan is deemed uncollectible and is charged off. Consumer loans are not placed on non-accrual status, but are reviewed periodically and charged off when they reach 120 days past due or are deemed uncollectible. The Bank’s level of loans delinquent more than 30 days, which excludes non-accrual loans paid current, decreased to 0.82% at December 31, 2003 from 1.02% at December 31, 2002. The change is primarily attributable to a small number of commercial real estate loans past due at December 31, 2002, that were brought current as of December 31, 2003. Republic experienced an increase in total non-performing loans from $9.9 million at December 31, 2002 to $12.9 million at December 31, 2003. This increase was concentrated in non-accrual loans. The increase in non-accrual loans is primarily attributable to a single $5 million commercial real estate development loan. This loan was placed on non-accrual sta- tus due to inadequate projected cash-flows and real estate collateral to support full repayment. Management believes it has allocated an appropriate reserve within the allowance for loan losses on this particular commercial real estate loan. Table 10 – Non-performing Assets As of December 31, (dollars in thousands) 2003 2002 2001 2000 1999 Loans on non-accrual status(1) Loans past due 90 days or more Total non-performing loans Other real estate owned Total non-performing assets $ 12,466 473 12,939 - $ 7,967 1,915 9,882 320 $ 5,056 521 5,577 149 $ 3,100 984 4,084 478 $ 2,721 968 3,689 218 $ 12,939 $ 10,202 $ 5,726 $ 4,562 $ 3,907 Percentage of non-performing loans to total loans Percentage of non-performing assets to total loans 0.82% 0.82 0.75% 0.78 0.47% 0.48 0.36% 0.40 0.35% 0.38 (1) Loans on non-accrual status include impaired loans. See note 4 to the Consolidated Financial Statements for additional discussion on impaired loans. Republic defines impaired loans to be those commercial loans that management has classified as doubtful (collection of total amount due is improbable) or loss (all or a portion of the loan has been written off or a specific allowance for loss has been provided) or that otherwise met the definition of impaired. Republic's policy is to charge off all or that portion of its investment in an impaired loan upon a determination that it is probable the full amount will not be collected. Impaired loans, which are a component of loans on non-accrual status, increased from $1.2 million at December 31, 2002 to $6.2 million at December 31, 2003. For discussion of the increase, see the preceding paragraph on non-performing loans which describes the large increase in non-accrual loans being the same cause of the increase in impaired loans. I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 36 Investment Securities Table 11 – Investment Securities Portfolio December 31, (in thousands) 2003 2002 2001 2000 1999 Securities Available for Sale: U.S. Treasury and Government agency securities $ 154,818 140,702 Mortgage backed securities, including CMOs - Corporate bonds - Other securities $ 51,123 151,924 - - $ 32,023 179,576 - - $ 87,309 65,556 18,810 125 $ 97,029 66,340 18,258 - Total Securities Available for Sale 295,520 203,047 211,599 171,800 181,627 Securities to be Held to Maturity: U.S. Treasury and Government agency securities States and political subdivisions Mortgage backed securities, including CMOs Total Securities to be Held to Maturity 9,707 - 105,704 115,411 8,175 100 77,137 85,412 50,995 200 31,151 82,346 40,375 275 63,118 103,768 25,353 3,775 3,803 32,931 Total $ 410,931 $ 288,459 $ 293,945 $ 275,568 $ 214,558 The investment portfolio primarily consists of U.S. Treasury and U.S. Government agency securities including MBSs and CMOs. The MBSs consist of 15-year fixed, 7-year balloons, 5-year balloons, 7/1 and 5/1 Adjustable Rate Mortgages (ARMs), as well as other adjustable rate mortgage securities underwritten and guaranteed by Ginnie Mae (GNMA), Freddie Mac (FHLMC) and Fannie Mae (FNMA). CMOs held in the investment portfolio are substantially all floating rate securities that adjust monthly. In addition to economic and market conditions, the overall management strategy of the investment portfolio is determined by, among other factors, loan demand, deposit mix, liquidity and collateral needs, the Company’s interest rate risk position and the overall structure of the balance sheet. As of December 31, 2003, investment securities with a fair value of $274 million and amortized cost of $273 million were utilized to secure deposits and securities sold under agreements to repurchase. Securities available for sale primarily consist of U.S. Government Agency obligations, which include agency MBSs and CMOs. The agency MBSs consist of 15-year fixed and 7-year and 5-year balloons, as well as other adjustable rate mortgage securities. The Company’s mortgage related floating rate securities include both agency and corporate securities. Securities available for sale increased from $203 million at December 31, 2002 to $296 million at December 31, 2003. The increase in the available for sale portfolio is primarily due to the investment of cash being collected in preparation for the 2004 tax season at Refunds Now. Table 12 – Securities Available for Sale As of December 31, 2003 (dollars in thousands) U.S. Treasury and U.S. Government agency securities: Within one year Over one through five years Total U.S. Treasury and U.S Government agency securities Total mortgage backed securities, including CMOs Amortized Cost $ 136,013 18,520 154,533 139,472 Approximate Fair Value $ 136,199 18,619 154,818 140,702 Total available for sale investment securities $ 294,005 $ 295,520 Table 13 – Securities to be Held to Maturity As of December 31, 2003 (dollars in thousands) U.S. Treasury and U.S. Government agency securities: Over one through five years Total U.S. Treasury and Government agency securities Total mortgage backed securities, including CMOs Total securities to be held to maturity Amortized Cost $ 9,707 9,707 105,704 $ 115,411 Approximate Fair Value $ 9,725 9,725 105,011 $ 114,736 Average Maturity in Years 0.08 2.98 0.43 4.02 2.13 Average Maturity in Years 2.67 2.67 15.69 14.59 Weighted Average Yield 1.20% 3.43 1.46 4.06 2.70% Weighted Average Yield 3.20% 3.20 2.63 2.68% I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 37 Deposits Total deposits were $1.3 billion at December 31, 2003 compared to $1.0 billion at December 31, 2002. Interest-bearing deposits increased $239 million while non interest-bearing deposits increased $18 million from December 31, 2002 to December 31, 2003. Interest-bearing demand deposit accounts increased $82 million during 2003. This increase was primarily due to the promotion of the Company’s “High Interest Checking” product, which offers above market interest rates. The Bank’s interest- bearing money market accounts, excluding Internet money markets and money market certificates of deposit, increased $75 million during 2003. A substantial portion of the increase in this product was from funds transferred from securities sold under agreements to repurchase into the Company’s “Premier First” product. The “Premier First” account, which is designed for business clients and provides competitive market rates, is the lead product offered by the Bank’s cash management department. The Bank’s Internet money market accounts increased $48 million during 2003 to $96 million. The Company actively pursued these deposits in anticipation of funding needs at Refunds Now during the 2004 tax season. Brokered deposits increased $62 million during 2003. Management utilized these deposits to fund, in part, the fixed rate residential real estate loans retained during the third quarter of 2003. The Company also increased these deposits by approximately $14 million during December 2003 to fund anticipated RALs during the first quarter of 2004. The Company may utilize additional brokered deposits in the first quarter of 2004 depending upon the funding needs at Refunds Now. Table 14 – Deposits December 31, (in thousands) 2003 2002 2001 2000 1999 Demand (NOW and SuperNOW) Money market accounts Internet money market accounts Savings Money market certificates of deposit Individual retirement accounts Certificates of deposit, $100,000 and over Other certificates of deposit Brokered deposits Total interest-bearing deposits Total non interest-bearing deposits $ 174,872 220,178 96,150 35,735 70,208 42,073 196,026 204,984 63,565 1,103,791 193,321 $ 222,316 90,637 47,824 23,993 80,190 37,530 111,204 249,798 1,238 864,730 175,460 $ 46,532 94,077 44,838 16,293 155,601 34,299 87,154 258,012 - 736,806 129,552 $ 15,156 122,116 69,239 12,584 76,818 32,933 106,313 321,185 100 756,444 107,317 $ 52,199 122,177 29,695 12,158 43,152 29,380 91,848 319,558 16,486 716,653 84,256 Total $ 1,297,112 $ 1,040,190 $ 866,358 $ 863,761 $ 800,909 Securities Sold Under Agreements to Repurchase and Other Short-term Borrowings Securities sold under agreements to repurchase and other short-term borrowings decreased $5 million during 2003. This category decreased approximately $36 million during the year due to a switch in product type by several clients into the Company’s higher yielding “Premier First” money market product. This decrease was partially offset by an increase of short- term funds deposited by a small number of large cash management relationships. FHLB Borrowings FHLB advances increased $101 million during the year to $420 million at December 31, 2003. The increase in advances was primarily utilized to fund the growth in residential real estate loans. Approximately $305 million of the Company’s advances are fixed with the majority having original maturities ranging from one through seven years. Of these fixed rate advances, $24 million is scheduled to mature in 2004 with a weighted average coupon rate of 2.78%. The remaining $115 million in the Company’s borrowings consists of convertible advances with original fixed rate periods ranging from one to five years and original maturities ranging from three to ten years. At the end of their respective fixed If the FHLB elects to rate periods, the FHLB has the right to convert the borrowings to floating rate advances tied to LIBOR. convert the debt to a floating rate instrument, Republic also has the right to pay off the advances without penalty. The Company has $55 million in these advances with a weighted-average coupon of 5.45% that are currently eligible to be converted on their quarterly repricing date. Based on market conditions at this time, management does not believe these advances are likely to be converted in the near term. I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 38 Liquidity Republic maintains sufficient liquidity to fund 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. Republic’s banking centers and its Internet site, republicbank.com, also provide access to retail deposit markets. These retail deposits, if offered at attractive rates, have historically been a source of additional funding when needed. The Company utilized brokered deposits during 2003 as a funding source for RALs at Refunds Now and to fund residential real estate loan growth. The Company may increase its utilization of brokered deposits during the first quarter of 2004 as an additional funding source for RALs. Traditionally, the Bank has also utilized borrowings from the FHLB to supplement its funding requirements. On December 31, 2003, the Company had total borrowing capacity with the FHLB to borrow an additional $112 million. While Republic utilizes numerous funding sources in order to meet liquidity requirements, the Company also has $110 million in approved unsecured line of credit facilities available at December 31, 2003 through various third party sources. Capital Total stockholders’ equity increased from $151 million at December 31, 2002 to $169 million at December 31, 2003. The increase in stockholders’ equity was primarily attributable to net income earned during 2003. There was a decline in accumulated other comprehensive income as a result of a decrease in the value of the available for sale securities portfolio. In addition, stockholders’ equity increased as a result of stock options exercised by Republic’s employees and directors. Prior to 2000, Republic Bancorp’s board of directors approved a Class A Common Stock repurchase program of 500,000 shares. Through December 31, 2003, Republic purchased approximately 496,000 shares with a weighted-average cost of $10.38 and a total cost of $5.1 million. purchase an additional 250,000 shares bringing the total shares available for purchase to 254,000. The Company does not plan to aggressively pursue the purchase of these shares in the near term. In March of 2003, the Company’s board of directors authorized management to During the fourth quarter of 2003, the Company declared a special cash dividend of $0.253 per share on Class A Common Stock and $0.23 per share on Class B Common Stock, payable December 17, 2003 to shareholders of record as of December 2, 2003. The total special dividend payment was $4.3 million. The Board of Directors approved the special dividend to provide shareholders with a return for the success of 2003 at a level that would still maintain the Company and Bank capital within the well-capitalized categories. The Board of Directors has not approved any additional special dividends. 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 Tier I leverage, Tier I risk-based and total risk based capital. Republic and the Bank intend to maintain a capital position that meets or exceeds the "well-capitalized" requirements as defined by the Federal Reserve and FDIC. Republic’s average capital to average assets ratio was 8.69% at December 31, 2003 compared to 8.65% at December 31, 2002. Republic elected and successfully maintains financial holding company status. Off Balance Sheet Arrangements Table 15 – Off Balance Sheet Arrangements December 31, 2003 (in thousands) Standby letters of credit FHLB letters of credit Commitments to extend credit Less than 1 year $ 3,458 60,000 319,800 Greater than 1 year to 3 years $ 33,374 13,137 18,572 Maturity by Period Greater than 3 years to 5 years $ 930 14,724 1,185 Greater than 5 years $ 726 - 5,363 Total $ 38,488 87,861 344,920 Standby letters of credit represent commitments by the Company to repay a third party beneficiary when a customer fails to repay a loan or debt instrument. 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 stand by letters of credit because funding for these obligations could be required immediately. I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I 39 The Company obtained letters of credit from the FHLB to be used as collateral on public funds deposits and as credit enhancements for client bond offerings. Approximately $28 million of these letters of credit at December 31, 2003 were used as credit enhancements for client bond offerings. The remaining $60 million was used to collateralize a public funds deposit, which the Company classifies as a short-term borrowing. Aggregate Contractual Obligations Table 16 – Aggregate Contractual Obligations December 31, 2003 (in thousands) Deposits FHLB borrowings Lease commitments Less than 1 year $ 975,407 24,000 2,912 Greater than 1 year to 3 years $ 86,919 177,570 5,376 Maturity by Period Greater than 3 years to 5 years $ 175,654 117,500 3,184 Greater than 5 years $ 59,132 101,108 9,881 Total $ 1,297,112 420,178 21,353 Total $ 1,002,319 $ 269,865 $ 296,338 $ 170,121 $ 1,738,643 Deposits represent non interest bearing, money market, savings, NOW, certificates of deposits, brokered, and all other deposits held by the Company. Amounts that have an indeterminate maturity period are included in the less than one-year category above. FHLB borrowings represent the amounts that are due to the FHLB of Cincinnati. These amounts have fixed maturity dates. Some of these borrowings, although fixed, are subject to conversion provisions at the option of the FHLB or the Company can prepay these advances without a penalty. Management does not believe these advances will be converted in the near term. Lease commitments represent the total minimum lease payments under noncancelable operating leases. Asset/Liability Management and Market Risk Asset/liability management control is designed to ensure safety and soundness, maintain liquidity and regulatory capital standards, and achieve acceptable net interest income. interest income as a result of market fluctuations in interest rates. Management, 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 Republic’s most significant market risk. Interest rate risk is the exposure to adverse changes in the net Republic utilizes an earnings simulation model to analyze net interest income sensitivity. Potential changes in market interest rates and their subsequent effects on net interest income are then evaluated. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis point increments. Assumptions based on growth expectations and on the historical behavior of Republic’s deposit and loan rates and their related balances in relation to changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the 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 timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and the application and timing of various management strategies. Republic’s interest sensitivity profile reflected a change from December 31, 2002 to December 31, 2003. Given a sus- tained 100 basis point downward shock to the yield curve used in the simulation model, Republic’s base net interest income would decrease by an estimated 4.16% at December 31, 2003 compared to a decrease of 1.09% at December 31, 2002. Given a 100 basis point increase in the yield curve, Republic’s base net interest income would decrease by an estimated 0.95% at December 31, 2003 compared to a decrease of 2.48% at December 31, 2002. The interest sensitivity profile of Republic at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and liabilities as well as their relative pricing schedules. market interest rates, deposit growth, loan growth and other factors. The Company’s interest rate risk position at December 31, 2003 would be more negatively impacted in a decreasing interest rate environment than its interest rate risk position at December 31, 2002 due primarily to short-term investing strategies of excess cash which management began utilizing during the latter part of 2003. The Company’s interest rate risk position from rising interest rates improved during this same time period due to the same short-term investing strategies of excess cash and a lower assumption of prepayments within the loan and investment portfolios as of December 31, 2003. It is also influenced by I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 40 I M A N A G E M E N T ' S D S C U S S O N A N D A N A L Y S S O F I I I I I I F N A N C A L C O N D T O N A N D R E S U L T S O F O P E R A T O N S I Tables 17 and 18 illustrate Republic's estimated annualized earnings sensitivity profile based on the asset/liability model as of year end 2003 and 2002: Table 17 – Interest Rate Sensitivity for 2003 Decrease in Rates Increase in Rates 200 Basis Points 100 Basis Points Base 100 Basis Points 200 Basis Points Table 18 – Interest Rate Sensitivity for 2002 (dollars in thousands) Projected interest income: Short-term investments Investments Loans, excluding fees Total interest income Projected interest expense: Deposits Securities sold under agreements to repurchase Federal Home Loan Bank borrowings Total interest expense Net interest income Change from base % Change from base (dollars in thousands) Projected interest income: Short-term investments Investments Loans, excluding fees Total interest income Projected interest expense: Deposits Securities sold under agreements to repurchase Federal Home Loan Bank borrowings Total interest expense Net interest income Change from base % Change from base Market and Dividend Information $ 103 6,420 86,782 93,305 17,541 1,018 16,673 35,232 $ 58,073 $ (5,467) $ 70 7,129 90,649 97,848 18,867 1,368 16,714 36,949 $ 60,899 $ (2,641) (8.60)% (4.16)% Decrease in Rates 200 Basis Points 100 Basis Points $ 66 8,520 81,382 89,968 16,289 793 13,877 30,959 $ 59,009 $ (2,554) $ 67 9,304 84,232 93,608 17,675 1,161 13,877 32,713 $ 60,890 $ (673) $ 92 10,487 94,814 105,393 22,555 2,503 16,795 41,853 $ 63,540 $ Base 266 11,173 86,552 97,991 19,681 2,870 13,877 36,428 $ 941 12,920 100,166 114,027 29,284 5,057 16,749 51,090 $ 1,303 15,224 105,724 122,251 35,970 7,607 17,214 60,791 $ 62,937 $ (603) $ 61,460 $ (2,080) (0.95)% (3.27)% Increase in Rates 100 Basis Points 200 Basis Points $ 549 12,890 90,437 103,876 24,476 5,485 13,877 43,838 $ 665 14,588 94,513 109,766 29,199 8,077 14,060 51,336 $ 58,430 $ (3,133) $ 61,563 $ 60,038 $ (1,525) (4.15)% (1.09)% (2.48)% (5.09)% Republic’s Class A Common Stock is traded on the Nasdaq National Market System (NASDAQ) under the symbol “RBCAA.” The following table sets forth the high and low closing prices of the Class A Common Stock and the dividends declared on the Class A Common Stock and Class B Common Stock during the past two years. Quarter Ended March 31 June 30 September 30 December 31 Quarter Ended March 31 June 30 September 30 December 31 Market Value Market Value High $ 12.10 15.17 19.28 20.53 High $ 13.72 12.65 13.18 12.25 2003 Low $ 10.80 11.58 14.29 18.37 2002 Low $ 10.55 10.56 10.44 10.28 Dividend Dividend Class A $ 0.055 0.066 0.066 0.319 Class A $ 0.044 0.055 0.055 0.055 Class B $ 0.050 0.060 0.060 0.290 Class B $ 0.040 0.050 0.050 0.050 41 There is no established public trading market for the Class B Common Stock. At February 6, 2004, the Class A Common Stock was held by 820 shareholders of record and the Class B Common Stock was held by 182 shareholders of record. The Company intends to continue its historical practice of paying quarterly cash dividends although 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 on future income, financial position, capital requirements, the discretion and judgment of the Board of Directors and other considerations. Further, the Board of Directors has not approved any additional special dividends, such as the amount declared and paid during the fourth quarter of 2003. In addition, the payment of dividends is subject to the regulatory restrictions described in Note 13 to the Company’s consolidated financial statements. NEW ACCOUNTING PRONOUNCEMENTS See discussion in Note 1 to the consolidated financial statements for a discussion of recent accounting pronouncements. I I F O S S Y L A N A D N A N O S S U C S D S ' T N E M E G A N A M I I S N O T A R E P O F O S T L U S E R D N A N O T D N O C L A C N A N I F I I I 42 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders of Republic Bancorp, Inc. We have audited the accompanying consolidated balance sheets of Republic Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income and comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of Republic’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Republic Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ending December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Crowe Chizek and Company LLC Louisville, Kentucky January 9, 2004 43 DECEMBER 31, (in thousands, except share data) 2003 2002 ASSETS: Cash and cash equivalents Securities available for sale Securities to be held to maturity (fair value $114,736 in 2003 and $85,483 in 2002) Mortgage loans held for sale Loans, less allowance for loan losses of $13,959 and $10,148 (2003 and 2002) Federal Home Loan Bank stock Premises and equipment, net Other assets and accrued interest receivable TOTAL ASSETS LIABILITIES: Deposits: Non interest-bearing Interest-bearing Total deposits Securities sold under agreements to repurchase and other short-term borrowings Federal Home Loan Bank borrowings Other liabilities and accrued interest payable Total liabilities STOCKHOLDERS’ EQUITY: Preferred stock, no par value, 100,000 shares authorized Series A 8.5% noncumulative convertible Class A Common Stock, no par value, 30,000,000 shares authorized, 15,056,134 shares (2003) and 14,852,153 shares (2002) issued and outstanding; Class B Common Stock, no par value, 5,000,000 shares authorized, 1,957,108 shares (2003) and 1,979,414 shares (2002) issued and outstanding Additional paid in capital Retained earnings Unearned shares in Employee Stock Ownership Plan Accumulated other comprehensive income Total stockholders’ equity $ 60,876 295,520 $ 39,853 203,047 115,411 13,732 1,567,993 19,148 34,329 20,762 85,412 65,695 1,299,915 18,324 23,152 17,308 $ 2,127,771 $ 1,752,706 $ 193,321 1,103,791 1,297,112 220,040 420,178 21,062 1,958,392 $ 175,460 864,730 1,040,190 224,929 319,299 17,492 1,601,910 - - 4,157 40,260 126,251 (2,289) 1,000 169,379 4,120 39,174 107,567 (2,663) 2,598 150,796 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 2,127,771 $ 1,752,706 See accompanying notes to consolidated financial statements. S T E E H S E C N A L A B D E T A D L O S N O C I 44 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 75,691 YEARS ENDED DECEMBER 31, (in thousands, except per share data) 2003 2002 2001 $ 107,645 $ 92,154 $ 102,324 INTEREST INCOME: Loans, including fees Securities: Taxable Non taxable Federal Home Loan Bank stock and other Total interest income INTEREST EXPENSE: Deposits Securities sold under agreements to repurchase and other short-term borrowings Federal Home Loan Bank borrowings Total interest expense NET INTEREST INCOME PROVISION FOR LOAN LOSSES NON INTEREST INCOME: Service charges on deposit accounts Electronic refund check fees Title insurance commissions Mortgage banking income Net gain on sale of securities Debit card interchange fee income Other Total non interest income NON INTEREST EXPENSES: Salaries and employee benefits Occupancy and equipment, net Communication and transportation Marketing and development Bankshares tax Supplies Federal Home Loan Bank prepayment penalties Outsourced technology services Other Total non interest expenses INCOME BEFORE INCOME TAX EXPENSE INCOME TAX EXPENSE NET INCOME 10,377 3 1,035 119,060 19,944 1,897 14,954 36,795 82,265 6,574 10,672 3,981 2,532 11,104 - 1,825 819 30,933 32,144 12,416 2,729 3,037 1,980 1,481 - 1,722 7,350 62,859 43,765 15,562 12,219 8 1,720 106,101 22,819 3,246 15,696 41,761 64,340 3,338 61,002 8,314 3,198 2,129 6,894 1,559 1,441 987 24,522 28,039 9,984 2,329 2,934 1,727 1,139 1,381 1,575 4,731 53,839 31,685 11,196 12,775 11 2,286 117,396 32,706 8,529 16,682 57,917 59,479 3,493 55,986 6,267 2,087 1,515 6,438 1,864 1,020 550 19,741 25,943 9,073 2,319 2,839 1,513 1,170 1,049 1,134 5,300 50,340 25,387 8,579 $ 28,203 $ 20,489 $ 16,808 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: Change in unrealized gain on securities Less: Reclassification of realized amount Net unrealized gain recognized in comprehensive income COMPREHENSIVE INCOME BASIC EARNINGS PER SHARE: Class A Common Stock Class B Common Stock DILUTED EARNINGS PER SHARE: Class A Common Stock Class B Common Stock See accompanying notes to consolidated financial statements. $ (1,598) - (1,598) $ 26,605 $ 1.67 1.62 1.64 1.59 $ 3,334 1,013 2,321 $ 22,810 $ 1.23 1.21 1.20 1.19 $ 1,948 1,219 729 $ 17,537 $ 1.04 1.03 1.01 0.99 I C O N S O L D A T E D S T A T E M E N T S O F I N C O M E A N D C O M P R E H E N S V E I I N C O M E 45 YEARS ENDED DECEMBER 31, 2003, 2002 and 2001 (in thousands, except per share data) BALANCE, January 1, 2001 Stock options exercised, net of shares redeemed Repurchase of Class A Common Stock Conversion of Class B Common Stock to Class A Common Stock Conversion of Capital Trust Preferred to Class A Common Stock Shares committed to be released under the Employee Stock Ownership Plan Dividends declared Common Stock: Class A ($ 0.176 per share) Class B ($ 0.160 per share) Net changes in accumulated other comprehensive income (loss) Net income BALANCE, December 31, 2001 Stock options exercised, net of shares redeemed Repurchase of Class A Common Stock Conversion of Class B Common Stock to Class A Common Stock Conversion of Capital Trust Preferred to Class A Common Stock Shares committed to be released under the Employee Stock Ownership Plan Dividends declared Common Stock: Class A ($ 0.209 per share) Class B ($ 0.190 per share) Net changes in accumulated other comprehensive income (loss) Net income Common Stock Class B Shares 2,105 22 (48) 2,079 3 (103) Amount $ 4,079 44 (182) 12 $ 3,953 49 (3) 121 Class A Shares 14,512 155 (763) 48 50 25 14,027 203 (15) 103 508 26 BALANCE, December 31, 2002 14,852 1,979 $ 4,120 179 (20) 17 28 43 (6) (5) (17) Stock options exercised, net of shares redeemed Repurchase of Class A and Class B Common Stock Conversion of Class B Common Stock to Class A Common Stock Shares committed to be released under the Employee Stock Ownership Plan Dividends declared Common Stock: Class A ($ 0.506 per share) Class B ($ 0.460 per share) Notes receivable on common stock, net of cash payments Net changes in accumulated other comprehensive income (loss) Net income BALANCE, December 31, 2003 15,056 1,957 $ 4,157 See accompanying notes to consolidated financial statements. I Y T U Q E ’ S R E D L O H K C O T S F O S T N E M E T A T S D E T A D I L O S N O C 46 Additional Paid In Capital $ 33,294 808 (1,521) 488 (52) $ 33,017 1,258 (29) 4,956 (28) $ 39,174 1,620 (57) 73 (550) Retained Earnings $ 83,345 (385) (6,113) (2,449) (333) 16,808 $ 90,873 (203) (131) (3,081) (380) 20,489 $ 107,567 (678) (316) (7,622) (903) 28,203 Unearned Shares in Employee Stock Ownership Plan $ (3,324) 319 Accumulated Other Comprehensive Income (Loss) $ (452) 729 Total Stockholders’ Equity $ 116,942 467 (7,816) 500 267 (2,449) (333) 729 16,808 $ (3,005) $ 277 $ 125,115 342 2,321 1,104 (163) 5,077 314 (3,081) (380) 2,321 20,489 $ (2,663) $ 2,598 $ 150,796 374 (1,598) 985 (379) - 447 (7,622) (903) (550) (1,598) 28,203 $ 40,260 $ 126,251 $ (2,289) $ 1,000 $ 169,379 47 YEARS ENDED DECEMBER 31, (in thousands) 2003 2002 2001 OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization, net Federal Home Loan Bank stock dividends Provision for loan losses Net gain on sale of mortgage loans held for sale Net gain on sale of securities available for sale Origination of mortgage loans held for sale Proceeds from sale of mortgage loans held for sale Employee Stock Ownership Plan expense Changes in assets and liabilities: Other assets and accrued interest receivable Other liabilities and accrued interest payable Net cash provided by (used in) operating activities INVESTING ACTIVITIES: Purchases of securities available for sale Purchases of securities to be held to maturity Purchases of Federal Home Loan Bank stock Proceeds from calls and maturities of securities to be held to maturity Proceeds from calls, maturities and paydowns of securities available for sale Proceeds from sales of securities available for sale Net increase in loans Purchases of premises and equipment, net Net cash used in investing activities FINANCING ACTIVITIES: Net increase in deposits Net increase (decrease) in securities sold under agreements to repurchase and other short-term borrowings Payments on Federal Home Loan Bank borrowings Proceeds from Federal Home Loan Bank borrowings Repurchase of Common Stock Redemption of the Company’s guaranteed preferred beneficial interests in Republic’s subordinated debentures Proceeds from Common Stock options exercised Cash dividends paid Net cash provided by financing activities NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR $ 28,203 $ 20,489 $ 16,808 6,050 (756) 6,574 (12,718) - (798,657) 863,338 447 (1,881) 3,350 93,950 (508,371) (145,305) (68) 115,214 412,935 - (275,952) (16,593) (418,140) 221,093 30,940 (75,818) 176,697 (379) - 985 (8,305) 345,213 21,023 39,853 4,262 (949) 3,338 (6,998) (1,559) (790,657) 767,452 314 (4,967) 2,729 (6,546) (333,751) (101,590) - 98,474 288,937 58,227 (127,929) (7,560) (125,192) 134,348 (17,610) (70,258) 92,607 (163) (775) 1,104 (3,231) 136,022 4,284 35,569 3,736 (1,204) 3,493 (6,191) (1,864) (547,735) 523,663 267 2,267 2,622 (4,138) (248,731) (80,845) - 139 191,715 122,516 (43,680) (3,955) (62,841) 2,597 19,022 (99,837) 150,737 (7,816) - 467 (2,837) 62,333 (4,646) 40,215 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 60,876 $ 39,853 $ 35,569 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest Income taxes SUPPLEMENTAL NONCASH DISCLOSURES: Transfers of securities to be held to maturity to securities available for sale Conversion of the Company’s guaranteed preferred beneficial interests in Republic’s subordinated debentures to Class A Common Stock Client transfers from securities sold under agreements to repurchase into deposits See accompanying notes to consolidated financial statements. $ $ 36,170 16,412 - - 35,829 $ $ 38,036 11,600 $ 59,076 8,701 - $ 102,153 5,077 39,484 - - S W O L F H S A C F O S T N E M E T A T S D E T A D L O S N O C I 48 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Nature of Operations – The consolidated financial statements include the accounts of Republic Bancorp, Inc. (Parent Company) and its wholly owned subsidiaries: Republic Bank & Trust Company and Republic Bank & Trust Company of Indiana (together referred to as “Bank”), and Republic Funding Company (collectively “Republic” or “the Company”). The consolidated financial statements also include the wholly owned subsidiaries of Republic Bank & Trust Company: Republic Financial Services, LLC (d/b/a Refunds Now®) and Republic Insurance Agency, LLC. All significant intercompany balances and transactions have been eliminated. Republic operates 31 banking centers, primarily in the retail banking industry and conducts its operations predominately in metropolitan Louisville, central Kentucky, southern Indiana and through an Internet banking software application. Republic’s consolidated results of operations are dependent upon net interest income, which is the difference between the interest income and fees on interest earning assets and the interest expense on interest-bearing liabilities. Principal interest-earning assets are securities and real estate mortgage, commercial and consumer loans. Interest-bearing liabilities consist of interest-bearing deposit accounts and short-term and long-term borrowings. Other sources of income include fees charged to customers for a variety of banking services such as transaction deposit accounts and trust services. Republic also generates revenue from its mortgage banking activities, which include the origination and sale of loans in the secondary market and servicing loans for others, and through providing deferred deposit transactions (payday loans), Refund Anticipation Loan (“RAL”) fees and Electronic Refund Check (“ERC”) fees. Republic’s operating expenses consist primarily of salaries and employee benefits, occupancy and equipment expenses, marketing and development, communication and transportation costs and other general and administrative expenses. Republic’s results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory agencies. Use of Estimates – Financial statements prepared in conformity with accounting principles generally accepted in the United States of America 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. Estimates that are particularly subject to change include the allowance for loan losses, mortgage servicing rights (“MSRs”) and the fair value of financial instruments. Actual results could differ from these estimates. Cash Flows – Cash and cash equivalents include cash, deposits with other financial institutions under 90 days and federal funds sold. Net cash flows are reported for lending, deposit and other borrowing transactions. Securities – Securities to be held to maturity are those which Republic has the positive intent and ability to hold to maturity and are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Securities available for sale, carried at fair value, consist of securities not classified as trading securities nor as held to maturity securities. Unrealized holding gains and losses, net of tax, on securities available for sale are reported as a separate component of stockholders’ equity until realized. Gains and losses on the sale of available for sale securities are determined using the specific identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. In conjunction with Republic’s adoption of new guidance regarding accounting for derivative instruments and hedging activities, on January 1, 2001, Republic transferred substantially all of its securities classified as held to maturity at that date to available for sale. Declines in the fair value of individual securities below their cost that are other than temporary result in write downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. Federal Home Loan Bank (“FHLB”) stock is carried at cost. Mortgage Banking Activities – Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. To deliver closed loans to the secondary market and to control its interest rate risk prior to sale, Republic enters non-exchange traded mandatory forward sales contracts, which are considered derivatives. The aggregate market value of mortgage loans held for sale considers the price of the sales contracts. Loan commitments related to the origination of mortgage loans held for sale are considered derivatives. Republic’s commitments are for fixed rate mortgage loans, generally lasting 60 to 90 days and are at market rates when initiated. Republic had commitments to originate $35 million and $161 million in loans as of December 31, 2003 and 2002 that it intends to sell or were sold after the loans are or were closed. Because sales contract derivatives are entered into for amounts and terms offsetting the interest rate risk of loan commitment derivatives and both are carried at their fair value with changes included in earnings and substantially offset, the impact is not material. Substantially all of the gain on sale generated from mortgage banking activities continues to be recorded when closed loans are delivered into the sales contracts. N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 49 MSRs represent an estimate of the present value of future cash servicing income, net of estimated costs, the Company expects to receive on loans sold with servicing retained. MSRs are capitalized as separate assets when loans are sold and servicing is retained. Prior to 2003, Republic’s loans sold in the secondary market had been primarily sold with servicing released which did not result in an MSR. Beginning in 2003, Republic primarily sold loans into the secondary market with servicing retained and a corresponding MSR. This transaction is posted to net gain on sale of loans, a component of mortgage banking income. The carrying value of MSRs is amortized in proportion to, and over the period of, net servicing income and this amortization is recorded as a reduction to mortgage banking income. The total MSR asset, net of amortization, recorded at December 31, 2003 and 2002 is $5 million and $3 million. The carrying value of the MSRs asset is periodically reviewed for impairment based on the fair value of the MSR, using groupings of the underlying loans by interest rates and by geography and prepayment characteristics. Any impairment of a grouping would need to be reported as a valuation allowance. 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 should decline due to expected prepayments within the portfolio. Alternatively, during a period of rising interest rates the fair value of MSRs should increase as prepayments on the underlying loans would be expected to decline. Management utilizes an independent third party on a quarterly basis to assist with the fair value estimate of the MSRs. Based on the estimated fair value at December 31, 2003 and 2002, management determined no impairment of these assets existed. On an ongoing basis, management considers all relevant factors, in addition to pricing considerations from other servicers, to estimate the fair value of the MSRs to be recorded when the loans are initially sold with servicing retained. Loan servicing income is recorded as principal payments are collected and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. Costs of loan servicing, which are included in mortgage banking income, are charged to expense as incurred. Loans – Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance adjusted for any charge offs, the allowance for loan losses and any deferred fees or costs on originated loans. Interest on loans is computed on the principal balance outstanding. Loan origination fees and certain direct loan origination costs relating to successful loan origination efforts are deferred and recognized over the lives of the related loans as an adjustment to yield. Generally, the accrual of interest on loans, including impaired loans, is discontinued when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for 90 days or more, Interest received on non-accrual loans generally is unless such loans are well secured and in the process of collection. either applied against principal or reported as interest income, according to management’s judgment as to the ultimate collectibility of principal. When loans are placed on non-accrual status, all unpaid accrued interest is reversed. Such loans remain on non-accrual status until the borrower demonstrates the ability to remain current or the loan is deemed uncollectible and is charged off. Consumer loans generally are not placed on non-accrual status but are reviewed periodically and charged off when deemed uncollectible. Republic recognizes interest income on an impaired loan when earned, unless the loan is on non-accrual status, in which case interest income is recognized when received. Allowance for Loan Losses – The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge offs net of recoveries. Management estimates the necessary allowance balance using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions, regulatory guidance and various other factors. Allocations of the allowance may be made for specific loans or loan categories, but the entire allowance is available for any loan that may be charged off. Loan losses are charged against the allowance when management deems a loan uncollectible. A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated collectively for smaller balance loans of similar nature such as residential mortgage and consumer loans, and on an individual loan basis for commercial and commercial real estate loans. is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. If a loan is impaired, a portion of the allowance is allocated so that the loan Premises and Equipment – Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed over the estimated useful lives of the related assets on the straight-line method. Estimated lives are 25 to 39 years for buildings and improvements, 3 to 5 years for furniture, fixtures and equipment and 3 to 9 years for leasehold improvements. Long-Lived Assets – Long-lived assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at discounted amounts. S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 50 Securities Sold under Agreements to Repurchase and Other Short-term Borrowings – Substantially all repurchase agreement liabilities represent amounts advanced by customers. Securities are pledged to cover most of these liabilities as they are not covered by federal deposit insurance. Certain of these liabilities are secured by private insurance purchased by Republic or FHLB letters of credit rather than by a pledge of securities. Other short-term borrowings primarily include federal funds purchased. Stock Option Plans – Employee compensation expense under stock option plans is reported using the intrinsic value method. No stock based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock Based Compensation”: (dollars in thousands, except per share data) Net income as reported Deduct: Stock based compensation expense determined under fair value based method, net of tax Pro forma net income Basic earnings per share as reported: Class A Common Stock Class B Common Stock Pro forma basic earnings per share: Class A Common Stock Class B Common Stock Diluted earnings per share as reported: Class A Common Stock Class B Common Stock Pro forma diluted earnings per share: Class A Common Stock Class B Common Stock 2003 $ 28,203 722 $ 27,481 $ 1.67 1.62 1.63 1.58 1.64 1.59 1.59 1.55 2002 $ 20,489 645 $ 19,844 $ 1.23 1.21 1.19 1.18 1.20 1.19 1.17 1.15 2001 $ 16,808 153 $ 16,655 $ 1.04 1.03 1.00 0.99 1.01 0.99 0.96 0.95 The weighted average assumptions for options granted during the year and the resulting estimated weighted average fair values per share used in computing pro forma disclosures are as follows: Assumptions: Risk free interest rate Expected dividend yield Expected life of options (in years) Expected volatility Estimated fair value per share 2003 3.17% 2.05 6.00 24% 2002 4.83% 1.97 5.95 32% 2001 4.99% 2.37 6.00 34% $ 2.91 $ 3.41 $ 2.46 Income Taxes – Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Employee Stock Ownership Plan (“ESOP”) – The cost of shares held by the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. The difference between market price and the cost of shares committed to be released is recorded as an adjustment to paid in capital. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest. 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 customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit, that are considered financial guarantees in accordance with FASB Interpretation No. 45 are recorded at fair value. Derivatives – Republic only uses derivative instruments as described in “Mortgage Banking Activities.” 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 such matters that will have a material effect on the financial statements. N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 51 Earnings Per Share – 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. ESOP shares are considered outstanding unless unearned. Earnings per share assuming dilution shows the effect of additional common shares issuable under stock options and guaranteed preferred beneficial interests in Republic's subordi- nated debentures. Comprehensive Income – Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity, net of tax. Segment Information – Segments are parts of a company evaluated by management with separate financial information. Republic’s internal information is primarily reported and evaluated in four lines of business – banking, mortgage banking, Refunds Now and deferred deposits. Reclassifications – Certain amounts presented in prior periods have been reclassified to conform with the current year presentation. New Accounting Pronouncements – In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 expands disclosures to be made by a guarantor to recognize in its financial statements about its obligations under certain guarantees and requires the guarantor to recognize a liability for the fair value of an obligation assumed under a guarantee. The adoption of FIN 45 did not have a material effect on the Company’s consolidated financial statements. In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of ARB No. 51, Consolidated Financial Statements, for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. FIN 46 requires variable interest entities to be con- solidated by the primary beneficiary which represents the enterprise that will absorb the majority of the variable interest entities expected losses if they occur, receive a majority of the variable interest entities’ residual return if they occur, or both. Qualifying special purpose entities are exempt from the consolidation requirement of FIN 46. Although Republic leases office facilities from Republic’s Chairman and from partnerships in which Republic’s Chairman and Chief Executive Officer are partners under operating leases, the Company concluded this did not meet the criteria of FIN 46. The adoption of FIN 46 did not have a material effect on the Company’s consolidated financial statements. In April 2003, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” The Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, when a derivative contains a financing component, and amends the definition of to conform it to language used in FIN 45 and other pronounce- ments. The adoption of SFAS No. 149 did not have a material effect on the Company’s consolidated financial statements. In May 2003, the FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. within its scope as a liability (or an asset in some circumstances). The adoption of SFAS No. 150 did not have a material effect on the Company’s consolidated financial statements. It requires that an issuer classify a financial instrument that is 2. RESTRICTIONS ON CASH AND DUE FROMS Republic is required by the Federal Reserve Bank to maintain average reserve balances. Cash and due from banks in the consolidated balance sheet includes $424,000 and $3 million of reserve balances at December 31, 2003 and 2002. The Company does not earn interest on these cash balances. S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 52 3. SECURITIES Securities available for sale: December 31, 2003 (in thousands) U.S. Treasury securities and U.S. Government agencies Mortgage backed securities, including CMOs Total securities available for sale December 31, 2002 (in thousands) U.S. Treasury securities and U.S. Government agencies Mortgage backed securities, including CMOs Total securities available for sale Securities to be held to maturity: December 31, 2003 (in thousands) U.S. Treasury securities and U.S. Government agencies Mortgage backed securities, including CMOs Total securities to be held to maturity December 31, 2002 (in thousands) U.S. Treasury securities and U.S. Government agencies Obligations of state and political subdivisions Mortgage backed securities, including CMOs Total securities to be held to maturity Amortized Cost $ 154,533 139,472 $ 294,005 Amortized Cost $ 50,175 148,936 $ 199,111 Gross Unrealized Gains $ 328 1,274 $ 1,602 Gross Unrealized Gains $ 948 2,990 $ 3,938 Gross Unrealized Losses Fair Value $ (43) $ 154,818 (44) 140,702 $ (87) $ 295,520 Gross Unrealized Losses $ $ - (2) (2) Fair Value $ 51,123 151,924 $ 203,047 Amortized Cost Gross Unrecognized Gains Gross Unrecognized Losses Fair Value $ 9,707 $ 105,704 $ 115,411 18 82 $ 100 $ - $ 9,725 (775) $ (775) 105,011 $ 114,736 Amortized Cost Gross Unrecognized Gains Gross Unrecognized Losses $ 8,175 $ 20 $ Fair Value $ 8,195 102 - - (66) 77,186 100 77,137 $ 85,412 2 115 $ 137 $ (66) $ 85,483 Securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes, as required or per- mitted by law are as follows: December 31, (in thousands) Amortized cost Fair value December 31, (in thousands) Sale of securities available for sale: Proceeds on sales Proceeds on calls Gross gains 2003 $ 272,801 273,561 2003 $ - 33,740 - 2002 $ 253,266 257,053 2002 $ 58,227 26,500 1,559 2001 $ 122,516 63,000 1,864 N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 53 The amortized cost and fair value of securities, by contractual maturity are as follows: December 31, 2003 (in thousands) Due in one year or less Due after one year through five years Mortgage backed securities, including CMOs Total Securities available for sale Securities to be held to maturity Amortized Cost $ 136,013 18,520 139,472 $ 294,005 Fair Value $ 136,199 18,619 140,702 $ 295,520 Amortized Cost $ - 9,707 105,704 $ 115,411 Fair Value $ - 9,725 105,011 $ 114,736 Securities with unrealized losses not recognized in income are as follows: December 31, 2003 (in thousands) U.S. Treasury securities and U.S. Government agencies Mortgage backed securities, including CMOs Less than 12 months 12 months or more Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ 124,952 $ (29) $ 6,440 $ (14) $ 131,392 $ (43) $ - $ - $ 122,465 $ (819) $ 122,465 $ (819) All unrealized losses are reviewed to determine whether the losses are other than temporary. Factors considered include whether the securities are backed by the U.S. Government or its agencies and concerns surrounding the recovery of full principal. While it’s likely that management will hold the securities to maturity, even though some are classified as available for sale, management believes the unrealized losses are market driven and no ultimate loss will occur. 4. LOANS December 31, (in thousands) Residential real estate Commercial real estate Real estate construction Commercial Consumer Home equity Total loans Less: Unearned interest income and unamortized loan fees Allowance for loan losses Loans, net $ 2003 762,000 442,083 70,897 34,553 58,034 215,088 $ 2002 597,797 413,115 68,020 33,341 39,347 159,261 1,582,655 1,310,881 703 13,959 818 10,148 $ 1,567,993 $ 1,299,915 Republic utilizes eligible real estate loans to collateralize advances and letters of credit from the FHLB. At December 31, 2003 and 2002, Republic had $703 million and $541 million in first lien, 1-4 family residential real estate loans pledged to secure advances and letters of credit from the FHLB. The Company also had $67 million and $38 million, in multi family, commercial real estate loans pledged at December 31, 2003 and 2002 and $142 million in home equity lines of credit pledged at December 31, 2003. Activity in the allowance for loan losses is summarized as follows: December 31, (in thousands) Balance, beginning of year Provision for loan losses charged to income Charge offs Recoveries Balance, end of year 2003 $ 10,148 6,574 (5,527) 2,764 $ 13,959 2002 $ 8,607 3,338 (4,176) 2,379 $ 10,148 2001 $ 7,862 3,493 (4,173) 1,425 $ 8,607 S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 54 Information about Republic’s impaired loans is as follows: As of and for the Year Ended December 31, (in thousands) Year end loans with no allocated allowance for loan losses Year end loans with allocated allowance for loan losses Total Amount of the allowance for loan losses allocated Average of impaired loans during the year Interest income recognized during impairment Cash basis interest income recognized Non-performing loans were as follows: Loans past due 90 days still on accrual Nonaccrual loans 2003 $ - 6,176 $ 6,176 $ 1,484 3,604 - - 473 12,466 2002 $ - 1,152 $ 1,152 $ 288 1,369 - - 1,915 7,967 2001 $ - 104 $ 104 $ 26 707 - - 521 5,056 Non-performing loans include impaired loans and smaller balance homogeneous loans as defined in Note 1. Loans made to executive officers and directors of Republic and their related interests in the ordinary course of business, subject to substantially the same credit policies as other loans and current in their terms, are as follows: December 31, 2003 (in thousands) 5. MORTGAGE BANKING ACTIVITIES Balance, Beginning of Period $ 19,545 Change in Related Party Status New Loans Repayments Balance, End of Period $ (900) $ 8,737 $ (9,807) $ 17,575 Mortgage banking activities primarily include residential and commercial mortgage originations and servicing. The following table presents the components of mortgage banking non interest income: December 31, (in thousands) Net gain on sale of mortgage loans held for sale Net loan servicing (expense) income Mortgage banking income 2003 $ 12,718 (1,614) $ 11,104 2002 $ 6,998 (104) $ 6,894 2001 $ 6,191 247 $ 6,438 Republic serviced loans for others (primarily FHLMC) totaling $732 million and $283 million at December 31, 2003 and 2002. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and processing foreclosures. Loan servicing (expense) income reflected in the above includes amortization of servicing rights (see below) and loan servicing income of $1,293,000, $642,000 and $534,000 for the years ended 2003, 2002 and 2001. Custodial escrow account balances maintained in connection with serviced loans were $3 million and $981,000 at year end December 31, 2003 and 2002. Activity for capitalized mortgage servicing rights is as follows: December 31, (in thousands) Balance January 1 Additions Amortized to expense Balance December 31 Valuation allowance 2003 $ 2,882 4,848 (2,907) $ 4,823 $ - The fair value of mortgage servicing rights was $6.7 million at December 31, 2003. 2002 $ 1,885 1,743 (746) $ 2,882 $ - $ 2001 624 1,548 (287) $ 1,885 $ - N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 55 6. PREMISES AND EQUIPMENT December 31, (in thousands) Land Office buildings and improvements Furniture, fixtures and equipment Leasehold improvements Construction in progress Total premises and equipment Less accumulated depreciation and amortization Premises and equipment, net 2003 $ 2,836 18,959 33,404 3,176 1,913 60,288 25,959 $ 34,329 2002 $ 1,822 13,261 24,440 2,500 801 42,824 19,672 $ 23,152 Depreciation expense related to premises and equipment was $5.4 million in 2003, $4.0 million in 2002 and $3.9 million in 2001. 7. DEPOSITS Time deposits of $100,000 or more were $196 million and $111 million at year end 2003 and 2002. The scheduled maturities of all time deposits are as follows: December 31, 2003 (dollars in thousands) 2004 2005 2006 2007 2008 Thereafter Total Amount $ 184,943 86,919 98,589 77,065 34,925 24,207 $ 506,648 Weighted Average Rate 2.13% 2.93 3.26 3.99 2.42 0.88 2.73% 8. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE These liabilities consist of short-term excess funds from correspondent banks, repurchase agreements and overnight liabilities to deposit customers arising from Republic’s cash management program. While effectively deposit equivalents, the overnight liabilities to customers are in the form of repurchase agreements or liabilities secured by FHLB letters of credit or private insurance policies purchased by Republic. 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. All securities underlying the agreements were under Republic’s control. Information concerning securities sold under agreements to repurchase and liabilities secured by insurance policies at year end 2003 and 2002 are as follows: December 31, (dollars in thousands) Average outstanding balance during the year Average interest rate during the year Maximum month end balance during the year Weighted average rate at year end 9. FHLB BORROWINGS December 31, (in thousands) 2003 $ 189,984 1.00% 227,760 0.98% 2002 $ 225,671 1.44% 294,915 1.31% 2003 2002 FHLB convertible fixed interest rate advances from 4.40% to 6.35%, with a weighted average interest rate of 5.17%(1) $ 115,000 $ 115,000 FHLB fixed interest rate advances from 1.44% to 5.94%, with a weighted average interest rate of 3.52% at December 31, 2003, due through 2032 305,178 $ 420,178 204,299 $ 319,299 (1) Represents convertible advances with the FHLB. These advances have original fixed rate periods ranging from one to five years and original maturities ranging from three to ten years. At the end of their respective fixed rate periods, the FHLB has the right to convert the borrowings to floating rate advances tied to LIBOR or the Company can prepay the borrowings at no penalty. The Company has $55 million in these advances that are currently eligible to be converted on their quarterly repricing date. Based on market conditions at this time, management does not believe these advances are likely to be converted in the near term. S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 56 FHLB advances are collateralized by a blanket pledge of eligible real estate loans. At December 31, 2003, Republic had available collateral to borrow an additional $112 million from the FHLB. Republic also has unsecured lines of credit totaling $110 million available through various financial institutions. N O T E S Aggregate future principal payments on borrowed funds, based on contractual maturity dates as of December 31, 2003 are as follows: Year 2004 2005 2006 2007 2008 and thereafter Total (in thousands) $ 24,000 82,570 95,000 60,000 158,608 $ 420,178 During 2003, the Company did not prepay any FHLB Advances. In 2002, the Company prepaid $25 million on 6.40% FHLB advances due November 2002. The transaction resulted in a penalty of $1.4 million or $891,000 net of tax ($0.05 per share). 10. GUARANTEED PREFERRED BENEFICIAL INTERESTS In February 1997, Republic Capital Trust, a trust subsidiary of Republic Bancorp, Inc., completed the private placement of 64,520 shares of cumulative trust preferred securities (Trust Preferred Securities) with a liquidation preference of $100 per security. Each security can be converted into ten shares of Class A Common Stock at the option of the holder. The sole asset of Republic Capital Trust represents the proceeds of the offering loaned to Republic Bancorp, Inc. in exchange for subordinated debentures which have terms that are similar to the Trust Preferred Securities. The subordinated debentures and the related interest expense, payable quarterly at the annual rate of 8.5%, are included in the consolidated financial statements. As permitted under the agreement, management redeemed these securities on April 1, 2002. Approximately $800,000 of these securities was redeemed for cash while the remaining $5.1 million were converted into 507,700 shares of the Company’s Class A Common Stock. INCOME TAXES 11. Income tax expense is summarized as follows: Year Ended December 31, (in thousands) Current Deferred expense (benefit) Total 2003 $ 13,942 1,620 $ 15,562 2002 $ 11,536 (340) $ 11,196 The provision for income taxes differs from the amount computed at the statutory rate as follows: Year Ended December 31, (in thousands) 2003 2002 Federal statutory rate Increase (decrease) resulting from: State taxes, net of federal benefit Low income housing tax credit Other, net Effective rate 35.0% 0.2 (0.5) 0.9 35.6% 35.0% - - 0.3 35.3% The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows: 2001 $ 8,687 (108) $ 8,579 2001 35.0% - - (1.2) 33.8% December 31, (in thousands) Deferred tax assets: Depreciation Allowance for loan losses Accrued expenses Total deferred tax assets Deferred tax liabilities: Depreciation FHLB dividends Loan fees Mortgage servicing rights Unrealized securities gains Other Total deferred tax liabilities Net deferred tax liability $ 2003 - 4,044 1,329 5,373 1,345 2,740 360 1,696 515 475 (7,131) $ (1,758) 2002 $ 532 2,715 1,098 4,345 - 2,469 294 1,011 1,338 194 5,306 $ (961) I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 57 12. EARNINGS PER SHARE A reconciliation of the combined Class A and B Common Stock numerators and denominators of the earnings per share and diluted earnings per share computations is presented below. Class A and 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 dividend premium paid on Class A Common Stock over that paid on Class B Common Stock as discussed in Note 13. The aggregate dividend premium paid on Class A Common Stock for 2003, 2002 and 2001 was $691,000, $279,000 and $224,000. Basic: Years Ended December 31, (in thousands, except per share data) Net income available to common shareholders Weighted average shares outstanding Basic Earnings per Share: Class A Common Stock Class B Common Stock 2003 $ 28,203 16,939 $ 1.67 1.62 2002 $ 20,489 16,636 $ 1.23 1.21 2001 $ 16,808 16,126 $ 1.04 1.03 Diluted: Net income Interest expense, net of tax benefit, on assumed conversion of guaranteed preferred beneficial interests in Republic’s subordinated debentures Net income available to common shareholders, assuming conversion Weighted average shares outstanding Dilutive effects of assumed conversion and exercise: Convertible guaranteed preferred beneficial interest in Republic’s subordinated debentures Stock options Weighted average shares and dilutive potential shares outstanding Diluted Earnings Per Share: Class A Common Stock Class B Common Stock $ 28,203 $ 20,489 $ 16,808 - $ 28,203 16,939 - 369 17,308 $ 1.64 1.59 79 $ 20,568 16,636 146 334 17,116 $ 1.20 1.19 332 $ 17,140 16,126 610 356 17,092 $ 1.01 0.99 Stock options for 20,000 and 191,000 shares of Class A Common Stock were excluded from the 2003 and 2002 earnings per share assuming dilution because their impact was antidilutive. 13. STOCKHOLDERS’ EQUITY Common Stock – The Class A Common shares are entitled to cash dividends equal to 110% of the cash dividend paid per share on the 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 Stock may be converted, at the option of the holder, to Class A Common Stock on a share-for-share basis. The Class A Common Stock is not convertible into any other class of Republic’s capital stock. Dividend Limitations – Kentucky banking laws limit the amount of dividends that may be paid to the Parent Company by Republic Bank & Trust Company without prior approval of the Kentucky Department of Financial Institutions. Under these laws, the amount of dividends that may be paid in any calendar year is limited to current year's net income, combined with the retained net income of the preceding two years, less any dividends declared during those periods. At December 31, 2003, Republic Bank & Trust Company had $37.4 million of retained earnings that could be utilized for payment of dividends if authorized by its board of directors without prior regulatory approval subject to capital requirements. Indiana banking laws prohibit the payment of dividends to the Parent Company by Republic Bank & Trust Company of Indiana until May 2004 without prior approval of the Indiana Department of Financial Institutions. These laws also require a minimum Tier I Capital ratio of 8% to be maintained for a period of three years. Regulatory Capital Requirements – The Parent Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. 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 each bank must meet specific capital guidelines that involve quantitative measures of the bank’s assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. The S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 58 capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Parent Company and each bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regula- tions) to risk weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2003, the Parent Company, Republic Bank & Trust Company and Republic Bank & Trust Company of Indiana meet all capital adequacy requirements to which they are subject to. The most recent notification from the FDIC categorized each bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, each bank must maintain minimum Total Risk Based, Tier I Risk Based and Tier I Leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the banks’ capital ratings. Minimum Requirement For Capital Adequacy Purposes Minimum Requirement To Be Well Capitalized Under Prompt Corrective Action Provisions Actual (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio As of December 31, 2003 Total Risk Based Capital (to Risk Weighted Assets) Republic Bancorp, Inc. Republic Bank & Trust Co. Republic Bank & Trust Co. of Indiana $ 181,856 171,210 5,897 12.99% $ 112,011 109,074 12.49 2,307 20.45 8% 8 8 $ 140,013 137,130 2,884 10% 10 10 Tier I Capital (to Risk Weighted Assets) Republic Bancorp, Inc. Republic Bank & Trust Co. Republic Bank & Trust Co. of Indiana Tier I Leverage Capital (to Average Assets) Republic Bancorp, Inc. Republic Bank & Trust Co. Republic Bank & Trust Co. of Indiana As of December 31, 2002 Total Risk Based Capital (to Risk Weighted Assets) 167,897 157,593 5,555 167,897 157,593 5,555 11.99 11.49 19.26 8.08 7.68 15.55 56,005 54,852 1,153 83,080 82,106 1,428 4 4 4 4 4 4 84,008 82,278 1,730 103,850 102,632 1,786 6 6 6 5 5 5 Republic Bancorp, Inc. Republic Bank & Trust Co. Republic Bank & Trust Co. of Indiana $ 158,044 148,318 5,512 13.64% $ 92,679 90,814 13.07 2,049 21.52 8% 8 8 $ 115,849 113,518 2,562 10% 10 10 Tier I Capital (to Risk Weighted Assets) Republic Bancorp, Inc. Republic Bank & Trust Co. Republic Bank & Trust Co. of Indiana Tier I Leverage Capital (to Average Assets) Republic Bancorp, Inc. Republic Bank & Trust Co. Republic Bank & Trust Co. of Indiana 147,896 138,456 5,226 147,896 138,456 5,226 12.77 12.20 20.40 9.02 8.53 23.15 46,340 45,407 1,025 65,591 64,945 903 4 4 4 4 4 4 69,509 68,111 1,537 81,990 81,181 1,129 6 6 6 5 5 5 N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 59 S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 60 14. STOCK OPTION PLAN Under the stock option plan, certain key employees and directors are granted options to purchase shares of Republic’s Common Stock at fair value at the date of the grant. Options granted become fully exercisable at the end of two to six years of continued employment and must be exercised within one year. A summary of Republic’s stock option activity and related information for the years ended December 31 follows: 2003 2002 Options Class A Shares 1,539,000 92,500 (235,250) (64,750) Weighted Average Exercise Price $ 9.62 13.25 7.55 10.01 1,331,500 10.22 Outstanding beginning of year Granted Exercised Forfeited Outstanding year end Exercisable (vested) end of year 94,750 10.60 Options Class B Shares Weighted Average Exercise Price Options Class A Shares Weighted Average Exercise Price Options Class B Shares Weighted Average Exercise Price - - - - - - $ - - - - - - 982,750 873,000 (222,000) (94,750) 1,539,000 149,500 $ 7.76 10.64 5.99 8.19 9.62 5.98 4,000 - (4,000) - - - $ 5.53 - 5.53 - - - 2001 Options Class A Shares Weighted Average Exercise Price Options Class B Shares Weighted Average Exercise Price Outstanding beginning of year Granted Exercise Forfeited Outstanding year end Exercisable (vested) 1,045,500 194,750 (207,000) (50,500) 982,750 end of year 134,500 $ 7.20 7.57 4.72 7.95 7.76 5.90 30,000 - (26,000) - 4,000 4,000 $ 4.18 - 3.97 - 5.53 5.53 Options outstanding at year end 2003 were as follows: Remaining Contractual Number Weighted Average Life Weighted Average Price $ 6.35 10.40 12.35 16.02 10.22 Exercisable Number 32,500 - 62,250 - 94,750 Weighted Average Price $ 6.00 - 13.00 - 10.60 2.83 4.64 2.60 5.71 3.97 Outstanding Class A Options Range of Exercise Prices $5.88 - $7.00 $8.13 - $10.60 $10.98 - $13.00 $13.07 - $18.37 227,500 814,250 257,250 32,500 Total Outstanding 1,331,500 15. EMPLOYEE BENEFIT PLANS Republic maintains a 401(k) plan for full time employees who have been employed for 1,000 hours in a plan year and have reached the age of 21. Participants in the plan have the option to contribute from 1% to 25% of their annual compen- sation. Republic matches 50% of participant contributions up to 5% of each participant’s annual compensation. Republic’s contribution may increase if the Bank achieves certain operating ratios. Republic’s matching contributions were $762,000, $637,000 and $506,000 for the years ended December 31, 2003, 2002 and 2001. On January 29, 1999, Republic formed an Employee Stock Ownership Plan (ESOP) for the benefit of its employees. The ESOP borrowed $3.9 million from the Parent Company and directly and indirectly purchased 300,000 shares of Class A Common Stock from Republic’s largest beneficial owner at a market value price of $12.91 per share. The purchase price, determined by an independent pricing committee, was the average closing price for the thirty trading days immediately prior to the transaction. Shares in the ESOP are allocated to eligible employees based on principal payments over the term of the loan, which is ten years. Participants become fully vested in allocated shares after five years of credited service and may receive their distributions in the form of cash or stock. At year end 2003, approximately 177,000 unallocated shares had a fair value of $3.5 million. N O T E S Year Ended December 31, (in thousands) Unearned shares allocated to participants in the plan Compensation expense 2003 28,485 $ 446,000 2002 26,499 $ 314,000 2001 24,649 $ 267,000 The Company maintains a death benefit for the Chairman of the Company equal to three times the average compensa- tion paid for the two years proceeding death. Upon a change in control, defined as a sale or assignment of more than 55% of the outstanding stock of the Company, the benefit is canceled. 16. LEASES AND TRANSACTIONS WITH AFFILIATES Republic leases office facilities under operating leases from Republic’s Chairman and from partnerships in which Republic’s Chairman and Chief Executive Officer are partners. Rent expense for the years ended December 31, 2003, 2002 and 2001 under these leases was $1,892,000, $1,549,000 and $1,475,000. Total rent expense on all operating leases was $2,698,000, $2,302,000 and $2,092,000 for the years ended December 31, 2003, 2002 and 2001. The total minimum lease commitments under noncancelable operating leases are as follows: I T O C O N S O L D A T E D F N A N C A L I I December 31, 2003 (in thousands) 2004 2005 2006 2007 Thereafter Total Affiliate $ 1,837 1,817 1,553 845 817 $ 6,869 Other $ 1,075 1,066 940 885 10,518 $ 14,484 Total $ 2,912 2,883 2,493 1,730 11,335 $ 21,353 S T A T E M E N T S A director of Republic Bank & Trust Company is a partner in a law firm. Fees paid by Republic to this firm totaled $73,000, $91,000 and $74,000 for the years ended December 31, 2003, 2002 and 2001. 17. OFF BALANCE SHEET RISKS, COMMITMENTS AND CONTINGENT LIABILITIES Republic is a party to financial instruments with off balance sheet risk in the normal course of business in order to meet the financing needs of its customers. 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 Republic pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with Republic’s credit policies. Collateral from the customer may be required based on management’s credit evaluation of the customer and may include business assets of commercial customers, as well as personal property and real estate of individual customers or guarantors. Republic also extends binding commitments to customers and prospective customers. Such commitments assure the borrower of financing for a specified period of time at a specified rate. The risk to Republic under such loan commitments is limited by the terms of the contracts. For example, Republic may not be obligated to advance funds if the customer’s financial condition deteriorates or if the customer fails to meet specific covenants. An approved, but unfunded, loan commit- ment represents a potential credit risk once the funds are advanced to the customer. This is also a liquidity risk since the customer may demand immediate cash that would require funding, and interest rate risk as market interest rates may rise In addition, since a portion of above the rate committed. Republic’s liquidity position is managed to meet its need for funds. these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. As of December 31, 2003, exclusive of mortgage banking loan commitments discussed in Note 1, Republic had outstanding loan commitments totaling $345 million which includes unfunded home equity lines of credit totaling $207 million. These commitments generally have variable rates. Standby letters of credit are conditional commitments issued by Republic to guarantee the performance of a customer 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 $38 million at December 31, 2003. At December 31, 2003, Republic had $88 million in letters of credit from the FHLB issued on behalf of the Bank’s clients. Approximately $28 million of these letters of credit were used as credit enhancements for client bond offerings. The remaining $60 million was used to collateralize a public funds deposit, which the Company classifies in short-term borrowings. These letters of credit reduce Republic’s available borrowing line at the FHLB by $88 million. Republic uses a blanket pledge of eligible real estate loans to secure the letters of credit. 61 S T N E M E T A T S 18. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of financial instruments has been determined by Republic using available market information and appropriate valuation methodologies. However, judgment of management is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts Republic could realize in a market exchange. The use of different market assumptions and/or estimation method- ologies may have a material effect on the estimated fair value amounts. (in thousands) Assets: Cash and cash equivalents Securities available for sale Securities to be held to maturity Mortgage loans held for sale Loans, net Federal Home Loan Bank stock Accrued interest receivable Liabilities: Deposits: Non interest-bearing accounts Transaction accounts Certificate of deposit and individual retirement accounts Securities sold under agreements to repurchase and other short-term borrowings Federal Home Loan Bank borrowings Accrued interest payable December 31, 2003 December 31, 2002 Carrying Amount Fair Value Carrying Amount Fair Value $ 60,876 295,520 115,411 13,732 1,567,993 19,148 6,710 $ 60,876 295,520 114,853 13,877 1,600,608 19,148 6,710 $ 39,853 203,047 85,412 65,695 1,299,915 18,324 6,998 $ 39,853 203,047 85,483 66,176 1,345,477 18,324 6,998 $ 193,321 597,143 $ 193,321 597,143 $ 175,460 464,961 $ 175,460 464,959 506,648 513,691 399,769 410,235 220,040 420,178 3,441 220,114 426,437 3,441 224,929 319,299 2,816 224,957 348,226 2,816 Cash and Cash Equivalents – The carrying amount is a reasonable estimate of fair value. Securities Available for Sale, Securities to be Held to Maturity and Federal Home Loan Bank Stock – Fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. For FHLB stock, the carrying amount is an estimate of fair value. Mortgage Loans Held for Sale – Estimated fair value is based on the corresponding sales contract. Loans – The fair value is estimated by discounting the future cash flows using the interest rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. Deposits – The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the interest rates offered for deposits of similar remaining maturities. Securities Sold Under Agreements to Repurchase and Other Short-term Borrowings – The carrying amount is management’s estimate of fair value. Federal Home Loan Bank Borrowings – The fair value is estimated based on the estimated present value of future cash outflows using the rates at which similar loans with the same remaining maturities could be obtained. Accrued Interest Receivable/Payable –The carrying amount is a reasonable estimate of fair value. Commitments to Extend Credit – The fair value of commitments to extend credit is based upon the difference between the interest rate at which Republic is committed to make the loans and the rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for the estimated volume of loan commitments expected to close. The fair value of such commitments is not material. Commitments to Sell Loans – The fair value of commitments to sell loans is based upon the difference between the interest rates at which Republic is committed to sell the loans and the quoted secondary market price for similar loans. The fair value of such commitments is not material. Financial Guarantees – Estimated fair value is based on current fees or costs that would be charged to enter or terminate such arrangements and is not material. I I L A C N A N F D E T A D L O S N O C O T I S E T O N 62 The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2003 and 2002. Although management is not aware of any factors that would significantly 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. 19. PARENT COMPANY CONDENSED FINANCIAL INFORMATION BALANCE SHEETS December 31, (in thousands) Assets: Cash and cash equivalents Due from subsidiaries Investment in subsidiaries Other assets Total assets Liabilities and stockholders’ equity: Other liabilities Stockholders’ equity Total liabilities and stockholders’ equity STATEMENTS OF INCOME Years Ended December 31, (in thousands) Income and expenses: Dividends from subsidiary Interest income Interest expense Other expenses Income before income taxes Income tax benefit Income before equity in undistributed net income of subsidiaries Equity in undistributed net income of subsidiaries Net income STATEMENTS OF CASH FLOWS Years Ended December 31, (in thousands) Operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Undistributed net income of subsidiaries Change in due from subsidiary Change in other assets Change in other liabilities Net cash provided by operating activities Investing activities: Dividends on unallocated ESOP shares Dissolution of Republic Capital Trust Common stock Purchase of common stock of subsidiary bank Purchase of premises Net cash provided by (used in) investing activities Financing activities: Dividends paid Proceeds from stock options exercised Redemption of the Company’s guaranteed preferred beneficial interest in Republic’s subordinated debentures Repurchase of Class A Common Stock Net cash used in financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year 2003 2002 $ 3,960 2,579 164,638 425 $ 171,602 $ 2,223 169,379 $ 171,602 2003 $ 9,100 187 - (480) 8,807 284 9,091 19,112 $ 28,203 $ 2,538 3,667 146,575 14 $ 152,794 $ 1,998 150,796 $ 152,794 $ 2002 3,406 211 (129) (589) 2,899 272 3,171 17,318 $ 20,489 2001 $ 15,699 253 (548) (401) 15,003 297 15,300 1,508 $ 16,808 2003 2002 2001 $ 28,203 $ 20,489 $ 16,808 (19,112) 1,088 (11) (545) 9,623 (102) - - (400) (502) (8,305) 985 - (379) (7,699) 1,422 2,538 (17,318) 885 4 53 4,113 (47) 300 - - 253 (3,231) 1,104 (1,075) (163) (3,365) 1,001 1,537 (1,508) (440) 105 21 14,986 (43) - (5,000) - (5,043) (2,837) 467 - (7,816) (10,186) (243) 1,780 Cash and cash equivalents, end of year $ 3,960 $ 2,538 $ 1,537 N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 63 20. SEGMENT INFORMATION The reportable segments are determined by the type of products and services offered, primarily distinguished between banking, mortgage banking operations, deferred deposits and tax refund services. Loans, investments, and deposits provide the substantial amount of revenue from the banking operation; servicing fees and loan sales provide the substantial amount of revenue from mortgage banking; fees for providing deferred deposits represent the primary revenue source for the deferred deposit segment; and refund anticipation loan fees and electronic refund check fees provide the substantial amount of revenue from tax refund services. All four operations are domestic. The accounting policies used for Republic’s segments are the same as those described in the summary of significant accounting policies. Income taxes are allocated and indirect expenses are allocated on revenue. Transactions among segments are made at fair value. Information reported internally for performance assessment follows. (in thousands) Net interest income Provision for loan losses Electronic refund check fees Mortgage banking income Other revenue Income tax expense Segment profit Segment assets (in thousands) Net interest income Provision for loan losses Electronic refund check fees Mortgage banking income Other revenue Income tax expense/(benefit) Segment profit/(loss) Segment assets (in thousands) Net interest income Provision for loan losses Electronic refund check fees Mortgage banking income Other revenue Income tax expense Segment profit Segment assets $ $ Banking 66,864 4,245 - - 19,461 8,718 15,801 2,063,371 Banking 59,596 2,395 - - 18,453 9,189 16,746 1,682,508 Banking $ 55,264 2,424 - - 13,784 7,052 13,822 1,549,346 Tax Refund Services $ 6,742 1,850 3,981 - 35 1,930 3,499 1,829 2003 Mortgage Banking Deferred Deposits Consolidated Totals $ 1,353 - - 11,104 (3,648) 2,795 5,066 13,757 $ 7,306 479 - - - 2,119 3,837 48,814 $ 82,265 6,574 3,981 11,104 15,848 15,562 28,203 2,127,771 2002 Tax Refund Services Mortgage Banking Deferred Deposits Consolidated Totals $ 3,563 47 3,198 - 71 1,419 2,636 1,167 Tax Refund Services $ 3,278 1,069 2,087 - 36 425 831 507 $ $ $ 1,025 - - 6,894 (4,094) 877 1,630 65,816 2001 Mortgage Banking $ 937 - - 6,438 (2,604) 1,102 2,155 40,978 156 900 - - - (289) (523) 3,215 $ 64,340 3,342 3,198 6,894 14,430 11,196 20,489 1,752,706 Deferred Deposits Consolidated Totals - - - - - - - - $ 59,479 3,493 2,087 6,438 11,216 8,579 16,808 1,590,831 S T N E M E T A T S I I L A C N A N F D E T A D L O S N O C O T I S E T O N 64 21. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED) Presented below is a summary of the consolidated quarterly financial data for the years ended December 31, 2003 and 2002. (in thousands, except per share data) 2003: Interest income Net interest income Provision for loan losses Income before income tax expense Net income Basic earnings per share: Class A Common Stock Class B Common Stock Diluted earnings per share: Class A Common Stock Class B Common Stock (in thousands, except per share data) 2002: Interest income Net interest income Provision for loan losses Income before income tax expense Net income Basic earnings per share: Class A Common Stock Class B Common Stock Diluted earnings per share: Class A Common Stock Class B Common Stock Fourth Quarter $ 29,353 19,410 156 7,260 4,637 0.28 0.25 0.27 0.24 Fourth Quarter $ 25,498 15,533 1,849 6,351 4,092 0.24 0.24 0.24 0.23 Third Quarter $ 28,579 19,493 223 9,909 6,349 0.38 0.37 0.36 0.36 Third Quarter $ 25,647 15,232 265 7,354 4,731 0.28 0.28 0.28 0.27 Second Quarter $ 28,399 19,585 1,854 11,259 7,267 0.43 0.42 0.42 0.41 Second Quarter $ 25,627 14,965 (1,473) 7,769 5,007 0.30 0.29 0.29 0.29 First Quarter $ 32,730 23,778 4,341 15,338 9,951 0.59 0.59 0.58 0.58 First Quarter $ 29,329 18,610 2,697 10,211 6,659 0.41 0.41 0.40 0.39 N O T E S I T O C O N S O L D A T E D F N A N C A L I I S T A T E M E N T S 65 I N O T A M R O F N I I E T A R O P R O C ANNUAL MEETING The Annual Meeting of Shareholders of Republic Bancorp, Inc. will be held at 10:00 a.m. (EDT), Thursday, April 15, 2004 at 3202 Shelbyville Road, Shelbyville, KY. FINANCIAL INFORMATION Shareholders may obtain a free copy of the 2003 Form 10-K including financial statements and schedules required to be filed with the Securities and Exchange Commission by contacting: Kevin Sipes, Executive Vice President and Chief Financial Officer, at the executive office address listed below or by calling 502-560-8628; or Mike Ringswald, Senior Vice President and General Counsel, 502-561-7128. STOCK LISTING Republic Bancorp, Inc. Class A Common Stock is listed under the symbol “RBCAA” on the NASDAQ Stock Market® TRANSFER AGENT Inquiries relating to shareholder records, stock transfers, changes of ownership, changes of address and dividend payment should be sent directly to our transfer agent at the following address: Computershare Investor Services, PO Box 169, Chicago, Illinois 60690-1689 INDEPENDENT PUBLIC ACCOUNTANTS The independent public accountants of Republic Bancorp, Inc. are Crowe Chizek and Company LLC, Louisville, KY. EXECUTIVE OFFICES Republic Bancorp, Inc. 601 West Market Street Louisville, Kentucky 40202-2700 502-584-3600 or outside Louisville 888-584-3600 WEB SITE www.republicbank.com info@republicbank.com BANKING CENTERS AND CHIEF OPERATING OFFICERS Republic Bank & Trust Company Bowling Green Elizabethtown Frankfort East West Georgetown Lexington Louisville Owensboro Shelbyville Andover Chevy Chase Harrodsburg Road Perimeter Tates Creek Road Baptist Hospital East Bardstown Road Blankenbaker Pkwy. Brownsboro Road Corporate Center Dixie Highway Fern Creek Fern Valley Road Hikes Point Hurstbourne Pkwy Jeffersontown Jewish Hospital New Cut Road Outer Loop Poplar Level Road Prospect St. Matthews Springhurst West Broadway Janet Pierce Claudio Monzon Rodney Williams Susan Smith Scott Osborn B. J. Webb Billy Blair Jeffrey Zinger Cindy Burton Barb Cutter Lisa George 1700 Scottsville Road, Bowling Green, KY 42104 1690 Ring Road, Elizabethtown, KY 42701 1001 Versailles Road, Frankfort, KY 40601 100 Highway 676, Frankfort, KY 40601 430 Connector Road, Georgetown, KY 40324 3098 Helmsdale Place, Lexington, KY 40509 641 East Euclid Avenue, Lexington, KY 40502 2401 Harrodsburg Road, Lexington, KY 40504 651 Perimeter Drive, Lexington, KY 40517 3608 Walden Drive, Lexington, KY 40517 3950 Kresge Way, Suite 108, Louisville, KY 40207 2801 Bardstown Road, Louisville, KY 40205 11330 Main Street, Middletown, KY 40243 4921 Brownsboro Road, Louisville, KY 40222 601 West Market Street, Louisville, KY 40202 5250 Dixie Highway, Louisville, KY 40216 10100 Brookridge Village Blvd., Louisville, KY 40291 Jill Napier 3605 Fern Valley Road, Louisville, KY 40219 3902 Taylorsville Road, Louisville, KY 40220 661 South Hurstbourne Pkwy, Louisville, KY 40222 3811 Ruckriegel Parkway, Louisville, KY 40299 224 East Muhammad Ali Blvd., Louisville, KY 40202 5125 New Cut Road, Louisville, KY 40214 4655 Outer Loop, Louisville, KY 40219 1420 Poplar Level Road, Louisville, KY 40217 9101 US Hwy 42, Prospect, KY 40059 3726 Lexington Road, KY 40207 9600 Brownsboro Road, KY 40241 2028 West Broadway, Louisville, KY 40203 3500 Frederica Street, Owensboro, KY 42301 1614 Midland Trail, Louisville. KY 40065 David Jett Mary Matheny Andy Mayer Missy Fultz David Krebs Eric Higdon Pearlie Walker Shirley Cecil Tucker Ballinger Steve Coleman Jacob Call Steve DeWeese Larry Stewart Keri Jones Chip Hancock Rob Nicolas Republic Bank & Trust Company of Indiana Clarksville New Albany Jeffersonville* * Scheduled to open in 2004 610 Eastern Boulevard, Clarksville, IN 47129 3001 Charlestown Crossing, New Albany, IN 47150 3141 Highway 62, Jeffersonville, IN 47130 Kari Thom Todd Lancaster 66 270-782-9111 270-769-6356 502-695-9000 502-875-4300 502-570-8868 859-264-0990 859-255-6267 859-224-1183 859-266-1165 859-273-3933 502-897-3800 502-459-2200 502-254-7555 502-339-9700 502-584-3600 502-448-7000 502-231-5522 502-964-8848 502-451-2006 502-425-2300 502-266-5466 502-588-3115 502-363-4644 502-969-8999 502-636-2661 502-228-2755 502-893-2533 502-339-2200 502-772-7500 270-684-3333 502-633-6660 812-288-1111 812-949-2600 812-282-1200 Republic Bancorp, Inc. Directors Charles E. “Andy” Anderson President, Anderson Insurance & Financial Services J. Michael Brown Member, Stites & Harbison PLLC Bill Petter Vice Chairman, Republic Bancorp, Inc. Sandra Metts Snowden President, Metts Company Realtors – Sandy Metts & Associates R. Wayne Stratton, CPA Member, Jones, Nale & Mattingly PLC Samuel G. Swope* Chairman, Sam Swope Auto Group, LLC Sue Stout Tamme President and Chief Executive Officer, Baptist Hospital East Bernard M. Trager Chairman, Republic Bancorp, Inc. A. Scott Trager Vice Chairman, Republic Bancorp, Inc. Steven E. Trager President and Chief Executive Officer, Republic Bancorp, Inc. *Director Emeritus Republic Bank & Trust Company Directors Henry M. “Sonny” Altman, Jr. Owner, Altman Consulting LLC J. Michael Brown Member, Stites & Harbison PLLC Stan Curtis Senior Vice President, Hilliard Lyons Laura Douglas* Director of External Communications, LG&E Energy Corp. Lawrence C. “Lonnie” Falk Mayor, City of Prospect George E. Fischer Retired - Chairman, SerVend International, Inc. D. Harry Jones President, Jones Plastic & Engineering Corp. Thomas M. Jurich Vice President for Athletics, University of Louisville Bill Petter Executive Vice President and Chief Operating Officer, Republic Bank & Trust Company Michael T. Rust, FACHE President and Chief Executive Officer, Kentucky Hospital Association Bernard M. Trager Chairman - Executive Committee, Republic Bank & Trust Company A. Scott Trager President, Republic Bank & Trust Company Steven E. Trager Chairman and Chief Executive Officer, Republic Bank & Trust Company Beverly A. Wheatley President, Wheatley Roofing Company, Inc. * Term started January 2004 Republic Bank & Trust Company of Indiana Directors Bill Petter Executive Vice President and Chief Operating Officer, Republic Bank & Trust Company of Indiana Bernard M. Trager Director, Republic Bank & Trust Company of Indiana A. Scott Trager President, Republic Bank & Trust Company of Indiana Steven E. Trager Chairman and Chief Executive Officer, Republic Bank & Trust Company of Indiana Kevin Sipes Executive Vice President and Chief Financial Officer, Republic Bank & Trust Company of Indiana Republic Bank & Trust Company Advisory Directors Eastern Kentucky Region (Frankfort and Lexington) Tom Burich Gordon Duke Bill Johnson Jas Sekhon Dr. Emery Wilson Western Kentucky Region (Bowling Green, Elizabethtown and Owensboro) Jeffrey Blankley Mark Harris Gary Larimore Dr. William Moss Terry Patterson Dr. Dattatraya Prajapati Jody Richards Kevin Shurn G. Ted Smith Jack Wells Shelbyville Todd Davis Dr. Christin Honaker R. Lee Shannon CPA* Brad Montell* * Term started in 2004 Republic Bancorp, Inc. Executive Officers Bernard M. Trager Chairman Steven E. Trager President and Chief Executive Officer A. Scott Trager Vice Chairman Bill Petter Vice Chairman Kevin Sipes Executive Vice President and Chief Financial Officer David Vest Executive Vice President and Chief Lending Officer Republic Bank & Trust Company Senior Management Steven E. Trager Chairman and Chief Executive Officer A. Scott Trager President Bill Petter Executive Vice President and Chief Operating Officer Kevin Sipes Executive Vice President and Chief Financial Officer David Vest Executive Vice President and Chief Lending Officer Bank Administration Jeff Nelson, Senior Vice President Cash Management Cathy Slider, Senior Vice President Compliance Garry Throckmorton, Senior Vice President Controller Mike Beckwith, Vice President Commercial Banking Jeff Norton, Senior Vice President Commercial Lending Darryl Witten, Senior Vice President Human Resources Dorothy Pitt, Senior Vice President Information Technology Tom Clausen, Senior Vice President Internal Audit Ann Bauer, Vice President Legal Mike Ringswald, Senior Vice President and General Counsel Loan Administration Shannon Reid, Senior Vice President Marketing Michael Sadofsky, Senior Vice President Preferred Client Services Larry Kozlove, Senior Vice President John Mason, Senior Vice President Purchasing & Facilities Management Rod Gillespie, Senior Vice President Republic Financial Services Mike Keene, President Regional Managing Directors Jenifer Duncan, Senior Vice President – Lexington Claudio Monzon, Senior Vice President – Western Kentucky Jonathan Payne, Senior Vice President - Louisville Kathy Potts, Senior Vice President - Louisville Secondary Market Lending Ed McDougal, Senior Vice President and Chief Operating Officer Treasury Greg Williams, Senior Vice President and Chief Investment Officer Trust Paula Langford, Vice President I D R E C T O R S A N D O F F C E R S I 67 

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