Jackson Hewitt solves its RAL Partner Problem

Jackson Hewitt will be able to get the money it needs to make refund anticipation loans during the upcoming tax season.  JTX, which has received some funding for its RALs from a small savings and loan in Kentucky, renewed its agreement with the likely intent of scaling up its relationship.  Republic Bank (Kentucky) has helped to fund a portion of JTX’s RALs since 2007.  Now it will grow, as JTX is no longer working with Pacific Capital Bancorp.  Both institutions made this announcement (see JTX 8-k) (see RBCAA 8-k) through 8-K filings on December 30th. The arrangement preserves Jackson Hewitt’s ability to offer refund anticipation loans during the 2010 tax season.  JTX had been under some pressure, after its main RAL partner was forced to shut down their RAL funding business.

The Office of the Comptroller of the Currency (the “OCC”) told Pacific Capital Bancorp to cease its tax refund solutions business last week.  Pacific Capital had been, and continues to be, under severe regulatory capital constraints.  Some of their regulatory ratios were far below minimums established by the FDIC. Pacific Capital has not been able to make dividend payments on their $187 million TARP investment. They have extensive exposure to California’s commercial real estate markets. In short, Pacific Capital was a wounded bank. Handing out RAL money, where fraud has been high and losses are steep, made no sense from a safety and soundness perspective.

Republic is an old hand at the refund anticipation loan business.  Republic is a small bank and would seem to be unable to provide the liquidity to disburse hundreds of thousands of refund anticipation loans in just a few weeks. To help with that endeavor, Republic relies on brokered deposits. During the 2008 tax season, Republic paid 5.09 percent interest to access more than $640 million in deposits.  Upon making the loans, Republic securitizes the debt. Republic securitized $1.1 billion in RALs in 2008. Republic could not securitize its RALs in 2009, owing to the unique market constraints.  That didn’t stop the business. Republic just too on more debt – tapping brokered deposits for more than $1.2 billion in short-term funds during the fourth quarter of 2008 and the first quarter of 2009.

Republic is much like Pacific Capital to the extent that it relies on the RAL product for much of its income.  Income from refund check fees and refund anticipation loan securitizations exceeded $30 million for the year ending Dec. 2008 – about two-thirds of all non-interest income for the entire thrift.

Solution: Shop for A New Regulator

The new arrangement reflects what is wrong with having so many regulatory agencies.  Republic Bank is not regulated by the OCC, but instead by the FDIC.

Part of what is so maddening about this development is that Republic is already under an FDIC cease and desist order for its tax refund solutions business.  The FDIC concluded that Republic “had engaged in unsafe or unsound banking practices and had violated laws or regulations.” This includes a few specific observations:

• policies and practices in the area of consumer compliance that are detrimental to the Bank.
• inadequate supervision
• determined that Republic filed incorrect disclosures on its Home Mortgage Disclosure Act reports for 2006 and 2007.
• ineffective compliance management system…of the Bank’s third party relationships
• violating federal consumer protection laws
• failing to establish an effective process to monitor compliance with federal consumer protection laws
• failing to provide adequate training to third parties.

These are concrete problems. The most significant elements are the ones that speak to how Republic works to make sure that its tax prep partners are not violating federal laws. The tax prep partners are acting as loan processors. That means that they have to pay attention to things like the Truth-in-Lending Act and the Equal Credit Opportunity Act.  The FDIC order put the onus of responsibility upon Republic to make sure that tax prep partners follow the law.  The HMDA violation came with a $22,000 penalty.

Nina Olson, taxpayer representative to the IRS, has been vocal about problems with tax prep partners. All types of people get involved in tax prep. Granted, most people go to an accountant, or at least a tax prep chain that seeks to work in the spirit of accountancy. That doesn’t hold true for everyone, though. Moreover, the linkage of tax prep to large tax refunds seems to attract trouble. Olson likes to talk about some of these outliers. There are massage parlors that provide tax services, for example.

The cease and desist order, filed in February 2009, appears to make little difference to the OTS.  It must be elicited some anger down at the FDIC.

Working the Same Hen House

Jackson Hewitt and Republic Bancorp should work well together. Republic’s record for acting outside of the law, as described by the FDIC, is matched by the work at Jackson Hewitt.  In 2007, JTX entered into a $5 million agreement with the California Attorney General for deceptive marketing practices with its refund anticipation lending. The opportunity to take a percentage off tax refunds has proved all too attractive at other JTX franchises. My favorite example comes from the IRS. They found that a Jackson Hewitt franchise allowed a customer to claim a fuel tax credit for using 25,000 gallons of fuel for his work as a barber. That kind of tax credit prompts a large refund. Is it worth point out that a RAL that gives the prep firm a fee based on refund size?

If the FDIC doesn’t act, then it is unlikely that shareholders will have any ability to put pressure on Republic Bank.  Republic is about as insular a bank as you can imagine. It is largely owned by the Trager family. Their shares are closely held. Moreover, the bank’s corporate structure gives all of the voting power to holder’s of the bank’s Class B shares.  Each Class B share gets more votes, by a large multiple, than holders of common stock. The Trager family has a strangehold on the preferred. Indeed, the Class B shares rarely trade on the open markets.  It would be mathematically impossible for a proxy vote to pass against the interests of the Trager family.

Not So Fast

There is a ray of hope. Republic has also announced that they will meet with the FDIC to review their new plans. Hopefully, that process will allow for some input from the public.  Advocates and tax payers are likely to want to say something about consumer protection and systemic fraud.

Care to say something? You can let the FDIC know how you feel through their website or by sending them an email.