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Refund Anticipation Loans

Get a RAL, Get Taken

Adam R.'s picture

Posted May 6, 2009

Often, people pass off the seeming lack of logic concerning the use of refund anticipation loans as evidence that the poor make poor decisions, or that they fail to understand the time value of money.

When described by academics, there's even a name for people who exhibit this kind of decision-making: they are individuals with a "high discount rate."  What this means is that the poor, in this example, value money in the present greatly.  They would take a dollar today over a much higher amount in the future.

The price of a RAL, where an APR can be over 200 percent, infers a very high discount rate.  We are talking about people who might take $1500 tomorrow (you have to wait one day to get your refund with a RAL), rather than waiting to get $1700 in about ten days.

I think the mechanics of a RAL tell us that this academic description of how the poor are making decisions is a little bit off the mark.

Borrowers who get RALs avoid paying for their tax preparation services out of pocket. It might cost them $150 otherwise to get taxes done at one of the mainstream franchise tax prep services. That can be a lot of money to a person trying to support a household on a minimum wage salary.

Here's how the conversation might go:

Tax prep guy: Your return is ready.  You are going to get $1,700 back.  Do you want to pay me now, or in two weeks?  If you pay me later, I'll just take it out of your refund.  It's really easy.

RAL candidate: Uh, that sounds pretty simple to me.  I'll pay you later.

Let's assume that the RAL candidate is operating with a good understanding of how much a RAL is going to cost.  That is a big assumption, considering how clear it is that many people do not have a strong financial education. In that somewhat optimistic scenario, the RAL applicant might realize that it's a very costly convenience to get the RAL.  That person might have explored options for credit to be had elsewhere.

That is the rub.  Because in the most optimistic scenario, what this tells us is that there is little recourse to find credit elsewhere for these poor consumers.  It reflects very poorly on our credit providers.  The only loan product that could be more expensive might be a payday loan.  Even credit cards would be far better - suggesting that for many of these consumers, credit cards are out of reach.

Looking at the RAL decision from a less rosy viewpoint will lead you to an even darker conclusion.  Then, the RAL is going to someone who does not understand the full implications of their choice.  That points to a lack of transparency. It's a situation that borders on coercion.

What is revealed is a situation that is aptly characterized as extortionate.

Let's play this out in the context of another product, almost as ubiquitous as cash and definitely something that you would have a "high discount rate" for in the event that you were caught without any of it.

Imagine if you ran out of gas.  The gas in this case represents cash.

You walk to the gas station.

The attendant notices that you are on foot.  He says, "gee, I just raised the price on my gas.  Today, my gas is $20 a gallon.  Sorry.  I think I will have gas in two weeks for $1.99.  Do you still want some fuel?"

Oh, yeah, that would be irritating.

But then the guy behind the counter goes on.  "Gee," he says, "I'd be happy to pump your gas for you right now."

Republic's Quarter Might be a Short-Term Trend that belies problems

Adam R.'s picture

Posted April 23, 2009

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.

Magic Throws Peeps a Brick

Adam R.'s picture

Posted March 17, 2009

Magic Johnson, pitchman for Jackson Hewitt, has his own tax agenda. It is one that probably wouldn't square with his public persona as a person trying to bring capital into underserved communities.

Johnson is part of a small group lobbying on behalf of hedge funds for a special tax exemption.  Johnson is part of the Access to Capital Coalition. (wsj:subscription) That has a ring to it.  Most often, groups using that phrase are speaking on behalf of low-income and minority borrowers.  Not so with Johnson.  This coalition wants to make sure that there aren't any taxes on carried interest. Currently, these groups pay a tax rate of 15 percent on their carried interest - below the effective corporate tax rate of most banks or other corporations.

Johnson's is a partner in the Canyon Johnson Urban Fund.

His partnership with Jackson Hewitt helps to take capital out of low-income neighborhoods.  JH provides tax prep with high cost refund anticipation loans.  Most of the consumers of these loans are low-income filers getting the Earned Income Tax Credit.  The RAL speeds up their return, and it also means that filers do not have to pay income tax preparation fees out-of-pocket.  Jackson Hewitt is providing some help for Magic's Foundation.  Check out how well Charity Navigator says his foundation runs.  Not that half of the money it collects goes to administrative fees!

Carried interest in the main means of income for general partners of hedge funds and private equity

FDIC issues Cease and Desist to Republic (RBCAA)

Adam R.'s picture

Posted February 27, 2009

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

Bank open to using TARP money for Refund Anticipation Loans

Adam R.'s picture

Posted January 9, 2009

Pacific Capital Bancorp (PCBC) indicates that its $181 million TARP allocation will give it more liquidity, and provide alternatives for the bank to keep funding to its refund anticipation loan (RAL) business.

Check out this transcription of PCBC's last earnings call, on Nov. 21st, with investors:

Julianna Balicka -- Keefe, Bruyette & Woods

I have two quick questions on RAL and I'll step back. The $4.5 to $5 billion funding that you could potentially do on balance if all other methods fail, does that include your TARP capital or does your TARP capital funding change the game that you can now do more on balance sheet?

Stephen Masterson, CFO, PCBC

The TARP program obviously helps us in a lot of regards. We want to use that TARP money for the purposes that it was intended and that is to continue lending in our marketplace, to continue the economic viability in our marketplace to strengthen our banking infrastructure. We didn't take the TARP money to increase our RAL program or to build our RAL program, but it certainly helps our capital ratios.

RALs are short-term advances made to people filing their tax returns.  Instead of waiting for their refund, a RAL allows a local tax preparer to give the consumer their money by the next day.  If a consumer uses electronic filing, wait times for refunds average about 11 days.

PCBC does not provide tax preparation.  Instead, they act as the funder to the independent tax preparers.  Those tax prep

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