Tax-time loans, already an embattled product, now face even more regulatory scrutiny — and not just from the traditional banking agencies.
The Internal Revenue Service, as part of its plan to regulate tax preparers on the federal level, said it will examine refund-anticipation loans and other tax-time financial products, just as banking regulators crack down on some of the few financial institutions that still fund such loans.
Regulators have summoned Republic Bancorp Inc. in Louisville to a February meeting "to review the future viability" of its tax loan program beyond the upcoming tax season, the company said. The Office of the Comptroller of the Currency has already blocked Republic's rival Pacific Capital Bancorp Inc. from continuing to make these loans.
"Washington seems to be trying to curb the amount of refund-anticipation loans being lent out to taxpayers by all means and from all sides, through squeezing the financial institutions and squeezing the tax preparers," said Vishnu Lekraj, an analyst who follows tax-preparation firms for Morningstar Inc. "This is going to affect in a huge way the profitability of certain financial institutions."
Last week the IRS proposed that it regulate what the agency estimates to be about one million tax-preparation firms, which are not currently supervised at the federal level.
The proposals — which would take effect sometime after the coming tax season — contain no immediate conclusions on refund-anticipation loans. But in a December report that informed the proposals, the IRS said it would convene a working group to study the products. Among other things, the group would consider eliminating a program that helps firms vet applicants for the loans, and "explore additional opportunities to improve the efficiency of refund delivery." The IRS did not respond to requests for more information.
Refund-anticipation loans and checks are targeted to lower-income, and often unbanked, consumers, as a way for them to pay for tax-preparation services without any out-of-pocket expense — and to get their refunds faster.
Tax preparers (and the banks that fund such loans) charge high up-front fees for the loans, which have long drawn consumer advocates' ire. Negative publicity is one of several factors that have led to a decline in demand for the loans; another is improvements in tax-refund delivery technology.
"A lot of people already believe that the RAL is going to eventually work its way out of existence in the next five to seven years," said Jennifer Tescher, the director of the Center for Financial Services Innovation, a nonprofit affiliate of Chicago's ShoreBank Corp. But "the fact that the IRS is paying attention to this issue may hasten the demise of the RAL as we currently know it."
The more immediate threat appears to be coming from banking regulators. Last month, after Pacific Capital said it would sell its tax division under pressure from the OCC, Republic acknowledged that it, too, had attracted renewed interest from its regulator, the Federal Deposit Insurance Corp.
In February the $3 billion-asset company's Republic Bank and Trust "expects to meet with the" FDIC, "at their request, to review the future viability of the Bank's Refund Anticipation Loan program beyond the upcoming tax season," Republic said in a Dec. 31 filing.
"I really don't have expectations," Steven Trager, Republic's CEO, said last week. But "I don't anticipate" that the FDIC will follow in the OCC's footsteps and bar Republic from making tax loans. "I don't think that's analogous. That other financial institution, they had some serious issues."
The FDIC offered no comment by press time.
The OCC's action gave Republic an opportunity to pick up business from Pacific's partners, Jackson Hewitt Tax Service Inc. and from JTH Tax Inc., which does business as Liberty Tax. Last month Republic agreed to fund 90% of the loans at Liberty (which last year relied on Pacific for 90% of its funding) and a bigger share of Jackson Hewitt's loans.
But despite appearances, Republic's tax business is retrenching.
"Overall our business will experience modest to little growth this year. We'll service the same number of stores," Trager said. Republic moved some contracts from independent tax preparers to franchisees of Liberty and Jackson Hewitt, rather than increase the number of loans it would make.
Republic also cut the fees on its refund-anticipation loans almost in half, to about $68 on an average loan of $3,000, for the upcoming tax season. And it has discontinued its "immediate" refund-anticipation loan, which gave the bank less time to vet applicants.
John Hewitt, who founded Jackson Hewitt and now runs Liberty, said he was unconcerned about the heightened regulatory interest in his company's new partner, Republic. And he has backup plans — last year Liberty tried to buy Generations Bank in Overland Park, Kan., before hitting snags with banking regulators and eventually withdrawing the bid.
There's still "a lot of opportunity" for Liberty to buy a distressed bank, Hewitt said. Still, "I prefer not to own a bank. I don't want to be in the banking business. I just want a strong banking partner."
A spokeswoman for Jackson Hewitt said, "We look forward to that opportunity to share our thoughts and answer any questions" for the IRS study. H&R Block Inc. did not return calls. HSBC Holdings PLC, which offers refund-anticipation products through H&R Block, would not discuss the business. Neither would JPMorgan Chase & Co., which offers the products through about 13,000 independent providers.
Chi Chi Wu, a staff attorney for the National Consumer Law Center in Boston and a longtime critic of refund-anticipation loans, said she and her colleagues "were hoping for maybe a little bit more than a working group" from the IRS.
But Lekraj was more certain that the IRS's decision to look at RALs presages regulation.
"Convening a working group in Washington generally means that they're going to do something," he said. "There's going to be some RAL regulation coming down the pike here, probably for the upcoming tax seasons past 2010."
He pointed to the private-equity firm interested in buying Pacific Capital's tax division as an example of how refund loans could be funded in the future. (Pacific Capital would not identify the firm.) "What you may see in the future are shadow banking operations providing funding, … folks with cash that don't care about the bad headline risk," Lekraj said.
But Wu questioned whether RALs could exist outside the banking system. Whoever buys Pacific Capital's tax-loan business, "they need a bank, to take advantage of preemption," she said. "And believe you me, whatever bank buys this business, we will immediately contact the regulators and let them know our objections."
