Steve Trager has> been a regular guest on Fox Business Network shows exploring the credit crisis. He dispenses Main Street insights from Louisville, where his Republic Bancorp (RBCAA)
Yet Wall Street seems to like Trager's bank fine. Before the financial system's fracture, Republic had one of the year's best-performing bank stocks. The shares more than doubled to 35 through August, before sliding back to a recent 24.
But the rise of Trager's bank has been fueled by a kind of lending that many regulators and consumer activists consider predatory. As Republic's profits from more traditional banking services shrank in recent years, it plowed into tax-refund anticipation loans - ultra-high-interest loans typically made to the working poor and lasting just a week and a half on average, until repaid from the borrower's tax refund. In concert with tax preparers like Jackson Hewitt (JTX)
"The bulk of this lending is to the working poor," says Jean Ann Fox of the Consumer Federation of America, a Washington-based consumer-advocacy group. "They have pressing needs and it's hard for them to wait for their refund." The tax-return industry and its lead bankers have built their growth strategies around these "refund anticipation loans," or RALs. More than a third of Jackson Hewitt's revenue comes from arranging these loans, and the company says the quick-cash offers are crucial in attracting its customers. At Trager's Republic Bancorp, a small regional outfit with $3 billion in assets, half of all profits in this year's first nine months came from the tax-refund business.
Regulators aren't happy with the RAL business. Concerned that the loans exploit the poor and abet tax fraud, the Internal Revenue Service has proposed severe restrictions. Last year, the military curtailed RAL offers to enlisted personnel. RAL demand naturally will dwindle as more returns go through a new IRS computer system that delivers refunds in under a week, free of charge. The subprime crisis and Barack Obama's election make the regulatory future all the more doubtful for any lending perceived as predatory. And without the tax-loan vig, we calculate that Republic's expected $1.92 in 2008 earnings per share would drop by a third: On the remaining $1.15 in per-share earnings, an industry-average multiple of 10 times would send Republic's shares below the mid-teens.
Behind Trager's friendly TV appearances (Fox is part of News Corp., Barron's parent) and his bank's local boosterism is a history of aggressively seeking to profit from hard-up borrowers. In the face of disapproving regulators, Republic doggedly promoted "payday loans" - small dollar loans against the borrower's next paycheck, at annualized interest rates up to 390%. When the Federal Deposit Insurance Corp. clamped down on Republic's storefront cash-advance partners, Trager tried to continue the payday lending over the Internet. The FDIC stopped that tactic after four months.
Republic's profits dropped after the agency halted the payday lending in early 2006. While trying to make up the difference with tax-refund loans, Republic is now attempting to get out from under the FDIC's supervision. In August, it applied to be regulated by the Office of Thrift Supervision - the federal regulator for savings and loans.
CEO Trager says that his plan to convert to a thrift isn't an attempt to dodge regulation. As for the bank's tax-refund business, Trager says he's serving the needs of 1.5 million customers. "My goal is to satisfy the million-and-a-half people that want this product," says Trager. "I can't let a handful of people that think we charge too much dictate whether I offer it."
Even as Republic tries to become a national powerhouse in non-traditional banking services, it maintains its small-bank demeanor. Trager answers his own phone. His father started assembling local banks outside Louisville some 30 years ago. Other Kentucky banks sold out to national holding companies, but the Tragers kept control of Republic with a class of supervoting B shares. Calling itself "Locally Owned - And Proud of It!" the bank has generously supported civic activities like the Kentucky Derby. Republic now has 45 branches in its home state, Indiana, Ohio and Florida.
Republic is well-capitalized, with shareholder equity exceeding 9% of its $3 billion in tangible assets. Trager's proud that he avoided the subprime pursuits that resulted in regional rival National City's rescue by PNC Financial (PNC)
But what sent Republic shares soaring this year was its leap in refund-anticipation lending. Republic charged into a gap left by HSBC, which has pulled back from some of the refund lending pursued by its 2003 acquisition, Household International. Republic took HSBC's place as a refund anticipation lender for the Jackson Hewitt chain, alongside Pacific Capital's Santa Barbara Bank & Trust. Jackson Hewitt is a rich catch, as the second-largest tax-prep chain after H&R Block. Republic has also picked up independent tax preparers that are no longer served by HSBC or by JPMorgan (JPM),
Refund-anticipation lending seems like a great business, offering fat profits and low risk. Borrowers apply to the bank for a refund-anticipation loan as they have their returns filed electronically by a tax preparer (who gets a $6 to $12 fee from the bank). The government does the lender's underwriting work by automatically flagging applicants with unpaid taxes or child support. If approved, the borrower gets cash in a day or two. The IRS then sends the refund to the bank, which applies it to the loan, tax-prep fees and loan-interest fees that for Republic range from $34 to $125 on loan amounts of $500 to $8,000. If the refund doesn't arrive, the borrower must repay the lender immediately.
Republic is a high-priced lender among large RAL banks, charging nearly double the rates charged by HSBC or JPMorgan. The annual percentage rate it discloses with its average loan amount of $3,300 is 110%. But Trager says the legally required presentation of an APR is inapt, since Republic's $110 fee is just 3.3% of the loan amount and remains at that dollar amount regardless of how long the RAL goes unpaid. On average, however, its refund-anticipation loans get paid in 11 days. So even though Republic made $1.8 billion in RALs in this year's first quarter, scarcely any exposure showed on its March balance sheet.
Another reason the tax business is so sweet is that most borrowers get government income-support payments. The refund-anticipation loan industry indirectly gets its fees leavened by the government's largest antipoverty program - the Earned Income Tax Credit, whose 22 million working-poor beneficiaries supply 63% of RAL borrowers. The $43 billion program adds an average of $2,000 to each beneficiary's refund. Hundreds of millions of dollars from the program wind up in the coffers of businesses that merely give taxpayers cash a few days sooner than they'd otherwise get it free.
No industry charges fees to deliver food stamps, Social Security or veterans payments, notes Peter Skillern of the Community Reinvestment Association of North Carolina, a fair-lending watchdog group. "There are five banks that are taking a big bite out of the EITC benefit to low-income families," says Skillern, "and Republic is one of the largest and highest-priced."
Republic and other RAL lenders say they're doing low-income borrowers a favor. "The demand for this product is there," says Republic's Trager. "I facilitate it." RAL loans are a better deal, says the bank, than the late fees that cash-strapped clients might otherwise incur on their credit cards. Republic and its peers portray RAL critics as a self-appointed handful whose paternalistic views would keep poor people from their cash.
But RAL critics appear at every level of government from state and local consumer- affairs offices up through the U.S. Treasury. New rules proposed in January by the IRS would throw a monkey wrench in RAL machinery by preventing tax preparers from showing customers' tax returns to banks that make loans. There's no deadline for the IRS to adopt or drop the proposal. Objections were filed by Republic, the tax- prep industry and thousands of RAL borrowers who signed form letters. Comments in support of the IRS proposal were filed by consumer groups, legal-aid lawyers and the attorneys general of 34 states.
The Bottom Line
Republic has no subprime loan problem and has growing earnings. Yet its shares could fall below the midteens if the government decides to curb tax-refund loans.
"The time has come," said the attorneys general memo, "to put an end to a decades-long saga of misleading and deceiving taxpayers and undermining the public fisc." A complaint filed this year by the New York State Division of Human Rights accuses Jackson Hewitt of targeting minorities and poor people for the loans. The tax-prep chain denies that charge and with its banker Pacific Capital Bancorp (which wasn't itself a defendant in the state's complaint) asked a federal judge to stop the New York action, saying that without their RAL business they'll suffer "incalculable" revenue loss.
Refund loans have figured in many tax-fraud cases, including a prominent civil suit filed by the Justice Department last year against five big Jackson Hewitt franchises that the government accused of processing $70 million in phony claims. The defendants had operated 125 Jackson Hewitt shops. In an October 2007 settlement, without admitting wrongdoing, the defendants consented to a ban from the tax prep business. An investigation by Jackson Hewitt concluded that the franchiser did no wrong.
Trager says he can't predict what the IRS will do about RALs. He says he won't fight regulators if they curb the tax-refund business. "Every year, there is a question with regard to the future of this product," Republic's boss says. "If the tax business is there, and there's a demand for the product, we'll offer it. If it's not there and there's no demand for the product, we won't offer it."