No Debt Indicator – Perhaps no Jackson Hewitt?

Wells Fargo has the power of life and death over Jackson Hewitt. In the next few months, we’ll get the first sense of how much patience Wells has for its patient.

Wells has extended a large revolving line of credit to Jackson Hewitt. The terms are about as strict as can be.  For Jackson Hewitt, those terms are a problem, because regulatory events in recent weeks have created the grounds for Wells Fargo to declare that JTX is in “event of default” on their loan.

Last May, Jackson Hewitt and Wells re-negotiated their agreement. Jackson Hewitt reduced its line. Subsequently, the line of credit is $105 million. The debt is expensive: Wells is charging them LIBOR plus 11 percent.

The new amendment includes all kinds of requirements for Jackson Hewitt. If their leverage ratios get too high, for instance, Wells can change the terms of the loan. There’s also a clause that gives Wells the right to pull back their loan if Jackson Hewitt gets an unfavorable analysis by their auditors. It can be an event of default if Wal-Mart‘s agreement to put Jackson Hewitt offices inside their stores is severed.

RALs are a fundamental aspect of the JTX business model. The agreement focuses on that “regulatory risk.” See Exhibit 10.1, Section 9.1:

There is another paragraph to this section, which is also worth reading. It leads to the statement that the Administative Agent (Wells) can use a disruption to RAL funding as a means to determine that JTX is in default. A disruption includes any event where 100 percent of their 2011 RAL need is not met.

The IRS has decided that it will no longer provide the debt indicator. This does not end refund anticipation loans. It does nothing to make them illegal. Nonetheless, it makes them much more risky for the banks that extend those loans. In this environment, where most lenders are extremely weary of risk, this spells trouble.

This doesn’t say that the refund loan program has to dry up. It simply says that if the refund program is not operating in a way that the Administrative Agent or the lenders deem “acceptable,” then the agreement is over.

These are some strict terms of credit. It speaks to the challenges that Jackson Hewitt must face in seeking buyers for their debt. The terms limit many options for JTX. For instance, Wells has to consent if Jackson Hewitt is going to:

• make any acquisitions, and issue any shares in order to make an acquisition
• spend more than specified limits
• have more than $5 million in cash

If Wells feels that there is some doubt about the ongoing capacity of Jackson Hewitt to secure 100 percent of its RAL needs, then it can ask for a “proposal letter,” on Sept. 15th, 2010.  The terms allow Wells to decide if the new proposal letter is satisfactory. If it is not, in Wells’ opinion, satisfactory, then it constitutes an event of default.  The expectations become more concrete in the coming months. Jackson Hewitt has to produce a commitment letter by November 19th, 2010 that guarantees that they will have the RAL funding secured for the next year.

Buy your puts now.

(note: this is not advice to make an investment, because I am not authorized to make that kind of advice, and you shouldn’t take my opinion as the basis for any kind of investment decision.)