The FDIC is shutting down refund anticipation loans and refund anticipation checks.

I just spoke to a source at River City Bank in their tax group. I asked him if could confirm that the FDIC told River City that they had to stop making refund anticipation loans.

“Yes,” he said, “it is true.”

Why?

“As far as we know, they are acting against the third party relationships.  They are concerned with tax preparers, as opposed to bank personnel.”

He was clear that the timing was not specific, and that RALs could very possibly remain available through next tax season.

“It is unofficial”, he said. “We’re hoping that they will let us go one more year, but after that, that is how it is looking at this point.”

I pressed him to say if this would be the case for other banks.  Would it be the case for Republic?

“Yes,” he said, “unofficially, that is the case.”

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The FDIC has had concern in the past about the ability of bank partners to monitor their tax preparer partners. That was the basis for their cease-and-desist order against Republic Bank, issued last year. Republic is one of the tax prep partners for Jackson Hewitt. It makes sense that the underlying justification for this new directive would spring from the same anxiety over the lack of oversight.  It is hard to make sure that scores of tax franchisees are following the law. It has been hard for the FDIC to even get the bank partners to agree to take responsibility for their staffing and training.

As an advocate, I have to say that this is very exciting.  This means that the day that we’ve been working towards for at least four years is now here.

RALs are not done.  JP Morgan Chase and HSBC will not be touched by this decision. Moreover, the source at River City emphasized that this might not be something that shuts down their participation for at least one year.

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I spoke to a source at Republic’s tax products group.  He could not confirm that Republic had received this letter.  In fact, he was somewhat upbeat.  He said that with the OCC’s release of a guidance last month, it seemed plausible that there would be a long-term future for refund loans products.

“Now that we have an official statement on how do this and be in compliance,” he said, “its much better.”

“I think it is good,” he added. “It would not be fair for the government to say that Chase and HSBC can do this, but Republic and other state-regulated banks cannot.”

He added that the FDIC had said that they would be speaking with Republic, but that action had been delayed.

It has been quite a year for regulatory attention on this market.  First, the IRS established new training standards for tax preparers.  Then, the OCC issued guidelines for refund anticipation loans. Now, it seems that the FDIC is stepping in to close the door on bank participation in RALs.

The FDIC did the same thing a few years back with payday lending. They did not make payday lending illegal, but they refused to allow their banks to fund it.  That alone impacted the payday market. Given the liquidity demands of funding RALs, a lack of bank participation would cripple the RAL market. It seems possible that without scale, that preparers would not even be able to have enough access to RALs to make them a standard offering in their stores. That situation would be predicated on Chase and HSBC exiting as well (and no new banks entering!), though.

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.