Republic Bank (RBCAA) is an example of a bank that works hard to make its customers work hard.

Some observers naively examine the low rates of loan defaults on Republic’s home mortgage loan operations and assume that it a conservative small-town community bank. Hoover’s, a web site operated by Dunn & Bradstreet, makes this comment:

“…perhaps you bank at Republic Bancorp. It’s the largest Kentucky-based bank holding company, and parent to Republic Bank & Trust, which has about 40 branches in central Kentucky and southern Indiana. In 2006 the company entered Florida, where it has four branches, via its purchase of Tampa’s GulfStream Bank, since renamed Republic Bank. The banks offer checking and savings accounts, investment management, and trust services. Their lending activities mainly consist of residential mortgages (about half of the company’s loan portfolio) and commercial real estate loans (almost 30%).”

A closer look shows that Republic’s community banking is driven by fee income on overdrafts. Outside of its (more…)

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 (more…)

Republic Bank (RBCAA) of Louisville reported its earnings today.  First quarter earnings jumped by 16 percent, to $1.24 per share.  Given that its stock is currently trading between $21 and $22 per share, that’s indicative of a stock that could be undervalued.

A closer look at the results shows that most of its income came from one source.  The firm’s tax refund solutions business provided $20.9 million of the banks $25.8 million in profits.  Outside of that, results were mixed.  Mortgage banking surged, but it still made less than $3 million.  Banking outside of mortgages actually declined by 74 percent, to just over $2 million.

The tax refund business provides short-term liquidity to tax preparers that provide their clients with refund anticipation loans.  Most of the individual loans last from between 9 and 15 days.  For the filers, the costs might consist of between $40 and $120.  Republic doesn’t see all of that money, but they are able to generate a steady stream of dollars.  Its actually somewhat recession resistant, as in times like these, more people qualify for the Earned Income Tax Credit.  Moreover, more qualifiers are able to qualify for larger refunds, too.

Notice how Republic Bank gives incentives to tax preparers to provide RALs.

One of the downsides of this business, from the perspective of shareholders, is that it can’t be captured again until the first quarter of next year.  Thus, the $1.24 in earnings is likely to shrink by a significant margin for the remaining quarters.

Perhaps a larger problem is the possibility of some kind of government intervention that puts a wrench in this line of business.  One possible change would be for the IRS to slow down the response time on the debt indicator.  Right now, preparers using RALs are able to get refunds back to clients in one day.  Otherwise, e-filing is likely to require at least a week and perhaps longer.  If the debt indicator turnaround time was lengthened, the marginal value to consumers would shrink.

The debt indicator solution could be achieved without legislative change.  It could merely be enacted through administrative preference.  That makes Republic vulnerable.  It would put a stake in the heart of their earnings.

That fix might not occur, but the earnings remain tied to the TRS.  Moreover, the regulatory wolves are at the door.  In February, the FDIC issued a cease-and-desist order against Republic for its management of the RAL program.

The FDIC had issued a cease and desist order for Republic Bank and its RAL business.  Wait – it’s not a clean sweep, however.  The cease and desist does not mean that it can not make RALs but that it applies to the practices and policies that lead to the violations.  Yet to correct their deficiencies will be hard and expensive.

For consumers, this is a very important development.  Refund Anticipation Loans (RALs) are utilized by many tax filers, the majority of whom are low income. RALs drain the impact of our nation’s leading anti-poverty program, the Earned Income Tax Credit.  By providing so many RALs, Republic’s business plan intercepts public funds that have been designated for a stated object of federal policy. RALs are a unintended recipient of these funds.  It has raised of some some legislators, including Charles Schumer (D-NY) and Daniel Akaka (D-HA). A bill seeking regulatory constraints upon RALs has been co-sponsored by Akaka, along with Max Baucus (D-MT), Mark Pryor (D-AR), and Charles Grassley (R-IA).

This is a copy of the actual order. (pdf)

The FDIC has created a costly and high standard of compliance, which may lay the groundwork for a total cease and desist if they can’t meet the standard.   Highlights include:

1)  Training all of their RAL originators on all relevant compliance issues. And not just the agency, but everyone in the agency that talks with a customer.   This is in effect establishing a minimum training program for tax preparers who use RALs.  The FDIC is doing what the IRS should have in requiring standards.  This will be a huge challenge.  Sure, a national company like Jackson Hewitt can demonstrate a standard training program implemented for its employees and franchises is possible.  How will they certify a training program on TILA, ECOA, Reg B, etc for all of the mom-and-pop RAL providers?  Go online, read and take a test maybe?

2)  Auditing at least 10 percent of its RAL providers.  Auditing includes every type of review  – testing, site visits, statistical analysis for compliance with all consumer laws.  If the outside review finds problems, then they have to be corrected.  Holy cow, an audit system for tax preparers paid for by Republic Bank.  Thank you Republic.

3)  Auditing Republic Bank RAL operations. So in addition to auditing the RAL providers, Republic pays for an external auditor to audit the bank – twice a year.  The FDIC has to approve the audit standards and performance.  Sounds like the FDIC just had Republic pay for its own oversight so the FDIC won’t have to.

4)  The board of directors has to sign off on committee meeting minutes, audits, reviews, plan development. The FDIC talks about management as if it is not to be trusted.   If someone disagrees it has to be noted.  The board of directors has a level of a high level of involvement.  Something is going on, because the board of directors is in large part – Management!  Of the ten board members, two are employees and three are Tragers.  That leaves five directors who are independent, according to the definition of the SEC.  T Insiders control 51.87 percent of shares, according to Thomson. There are two classes of voting shares as well, with preferred shares given a voting power that is much greater than common.  This is one more step that insulates RBCAA from external influence.

Is the FDIC trying to highlight the conflict of interest of Steve Trager serving as both CEO and Chairman? The FDIC is asking the board to oversee management.  Will that work? It is hard to know for certain. Still, the FDIC is asking Republic’s board to oversee a reorientation of its business, and that will be difficult as management dominates the board.

There is no end date on the order.  This order is good for as long as the FDIC feels like it.

The FDIC has issued a cease and desist letter against Republic Bank of Kentucky (RBCAA).  The issues concerns the funding of refund anticipation loans (RALs) by RBCAA.  The FDIC is asserting that Republic does not have adequate safeguards in place to thwart fraud among the tax preparers that submit their refund applications to RBCAA.

RBCAA also got its Community Reinvestment Act Evaluation today.  The company did well on services and investments, earning a high satisfactory rating.  However, on the lending test, RBCAA got a “needs to improve.  A “needs to improve” is a very bad score.  In recent years, less than 3 percent of all ratings have been as low as this.

RBCAA would be stung if they were unable to continue with their RAL lending.  Although the bank has regular branches in Louisville, they draw a substantial portion of their business from their tax refund services (TRS) segment.  In 2007, TRS consisted of 11 percent of net income.  Its steady income, too, so going forward it might be a hard thing to give up.

Losses on what would appear to be a relatively risk-less business, given that the Federal government provides underwriting to cue Republic if a filer has an outstanding tax lien, were actually 1.14 percent of TRS revenue in 2007.

The RALs are troubled by the lack of a healthy securitization market, more broadly.  It is not yet evident (more…)