Complex M&A Faces Reg Hurdles: Lesson from Republic/H&R Block

Republic Bancorp (RBCAA) and regulators apparently just can't see eye to eye on the tax business.

The Louisville, Ky., company's deal to buy H&R Block's (HRB) banking operations fell through, apparently because federal regulators objected to this latest effort to combine banking and tax-refund processing.

Approval has become increasingly difficult for simple bank M&A transactions, and the hurdle for specialized deals has gotten even taller.

"Any acquirer of an out-of-the box business today should plan a little more time to make sure regulators fully understand that it has the ability to operate the new line of business," says Frank Bonaventure, Jr., a principal at Ober Kaler in Baltimore and a former senior counsel at the Office of the Comptroller of the Currency. "If Republic goes out and buys a plain-vanilla bank, the issues are fewer."

The news is a blow to Republic, which has been looking for ways to preserve its tax business after it agreed to end its refund-anticipation loan business in late 2011 after a protracted and costly battle with the Federal Deposit Insurance Corp., which opposed the product.

Republic on Tuesday announced that it withdrew its application with the OCC to switch from a state charter to a national one. H&R Block terminated its agreement to sell Republic its banking operations because the charter conversion was one of the requirements of the agreement.

Last month Republic warned that it probably would not close the deal this year as planned because of the slow pace of talks with OCC.

An OCC spokesman declined to comment Wednesday, saying the agency does not discuss matters involving specific institutions.

Steve Trager, the chief executive of Republic, said his company is disappointed, but he declined to go into specifics about his company's regulatory dealings or its role in dissolving the deal. Trager said the company is still committed to the tax business, which it has been in for nearly two decades.

Additionally, he remains on the hunt for acquisitions of financial institutions.

"The potential to work with H&R Block was exciting. It would have been good for us," Trager says. "We had 22 letters of support. … We have an impeccable history of being a good provider in the tax business. We served about a million taxpayer customers last year and we are committed to it — very committed to it."

Trager said the letters of support were written by various civic leaders including the mayor of Louisville and other business leaders.

H&R Block, which has been looking for a way to shed the responsibilities of owning a bank, will begin looking for a new buyer, William Cobb, the company's president and CEO, said on a conference call Wednesday. H&R Block does not believe "this outcome is attributable to concerns by regulators regarding our bank, or its products or services," Cobb added.

The deck may have been stacked against the deal, observers say. Deals that involve specialized businesses that focus on consumers can also face additional scrutiny.

"Now you have the [Consumer Financial Protection Bureau] looking over everyone's shoulder, so that could make the deal more challenging from a consumer-protection standpoint," says Kevin Petrasic, a partner in the corporate department at Paul Hastings in Washington. "If the regulator is looking at an application that could raise the risk profile in terms of consumer protection," that can have an effect on the process.

Republic's trying to switch charters and buy a bank focused on the tax business may have raised regulators' ire. The FDIC issued Republic Bank a consent order involving the tax business in 2011 but withdrew it when Republic agreed to stop making refund-anticipation loans. Since then, regulators have allowed Republic to buy two failed banks, but observers say it may not have been forgive and forget.

"They could still have a shadow of their scarlet letter hanging over them," says Lawrence Kaplan, also a partner at Paul Hastings.

Trager says he is still looking to acquire other banks and his company is well-suited to do so. It had a 17.01% leverage ratio at the end of the second quarter. Trager said a robust capital position gives him options. Dealing with regulators comes with being a bank, he says.

"We are in a regulated industry," Trager says. "You can expect regulatory scrutiny in any kind of transaction. Our industry benefits from appropriate regulation."

The end of the refund-anticipation loans was compounded by Liberty Tax Services and Jackson Hewitt severing their processing relationships with Republic. Trager is legally challenging those terminations, but in the meantime the tax business continues to process refund payments for independent tax preparers.

Though Republic's tax business is much smaller than it once was, Trager says he is committed to it because of the company's tenure. As he sees it, they are the best in the business. Companies like Liberty and Jackson might be working with other banks for now, but other banks typically don't last in the business, he says, because it is capital intensive as the balance sheet swells in the first quarter each year to handle the volume.

"This business can change dramatically, and we continued to be well positioned, perhaps better than any other bank, to offer this product," Trager says.